China has embarked on an ambitious pathway for establishing a national carbon market in the next five to ten years. In this study, we analyze the distributional aspects of a Chinese emissions-trading scheme from ethical, economic, and stated-preference perspectives. We focus on the role of emissions permit allocation and first show how specific equity principles can be incorporated into the design of potential allocation schemes. We then assess the economic and distributional impacts of those allocation schemes using a computable general equilibrium model with regional detail for the Chinese economy. Finally, we conduct a survey among Chinese climate-policy experts on the basis of the simulated model impacts. The survey participants indicate a relative preference for allocation schemes that put less emissions-reduction burden on the western provinces, a medium burden on the central provinces, and a high burden on the eastern provinces. Most participants show strong support for allocating emissions permits based on consumption-based emissions responsibilities.

Three questions with Valerie J. Karplus

What are the challenges associated with CO2 emissions reduction in China's Twelfth Five-Year Plan?

The Twelfth Five-Year Plan aims to reduce national carbon intensity by 17% by assigning reduction targets to each of China’s provinces. Provincial targets are difficult to assign because policymakers are trying to take into account both the country’s uneven distribution of production and consumption activities and the diverse levels of economic development. By implementing provincial targets without an emissions trading system (ETS), reductions are not necessarily taken at the lowest cost and some cost-effective opportunities are overlooked. Allowing trading of emissions permits across provinces encourages reductions where they are cheapest, regardless of how permits are initially allocated. Moving from the current provincial target system to an ETS would reduce the total cost of undertaking reductions.

How can equity principles be used to develop an ETS in China?

We investigated the impacts of using ten different equity criteria to guide the initial allocation of emissions permits to provinces in an ETS. We considered criteria that hold individuals or entities responsible for emissions based on certain attributes (e.g., emissions, population), as well as criteria that explicitly target changes in welfare across different groups. In the second category, we consider allocations that would equally burden all provinces, or scale the burden in proportion to economic metrics, such as GDP. The results are used to generate a menu of options for policymakers that can inform ETS design, based on a clear understanding of the outcomes and tradeoffs associated with alternative allocation approaches.

What do you find?

We show that, depending on how permits are allocated, widely different outcomes result. For example, if allocations are based on GDP, the western and central provinces are burdened most, while the eastern provinces are burdened least. Meanwhile, basing allocation on polluter pays (PPP), consumer pays (CPP), or ability–to–pay (ABT) principles results in benefits for the western provinces, while placing greater burden on the central provinces and even more on the eastern provinces. Under several of the allocation scenarios we consider, provinces are allowed to increase their territorial emissions. We find very different welfare outcomes if allocations are adjusted to prevent any province from increasing its emissions (and instead the excess permits are allocated to other provinces in proportion to emissions shares). In general, this adjustment has the effect of reducing welfare loss in the eastern provinces while shrinking the welfare gains in the western and central provinces.