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2022

JULY

A Comprehensive

Package of

Macroeconomic

Policy Measures for

Implementing

China’s Climate

Mitigation Strategy

Jean Chateau, Wenjie Chen, Florence Jaumotte, and Karlygash

Zhunussova

WP/22/142

IMF Working Paper

Asia and Pacific Department

A Comprehensive Package of Macroeconomic Policy Measures for Implementing China’s

Climate Mitigation Strategy

Authorized for distribution by Helge Berger

Jean Chȃteau, Wenjie Chen, Florence Jaumotte, and Karlygash Zhunussova1

IMF Working Papers describe research in progress by the author(s) and are published to elicit comments

and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do

not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Abstract

This paper presents ways for China to achieve its climate goals while also attain high-quality

growth—growth that is balanced, inclusive, and green. Using a dynamic computable general

equilibrium model that is calibrated to China, multiple scenarios are considered that incorporate a

sequence of layered policies: (i) f rontloading mitigation with an earlier emissions peak, (ii) power

market ref orms, and (iii) economic rebalancing. The results highlight that these policies can

significantly contribute to the success of the climate strategy overall, including by lowering the

shadow price of carbon as well as t he associated mitigation costs. Distribution analysis offers

proposals to lessen the impact on vulnerable households.

JEL Classification Numbers: O53,Q54, O14, D58

Keywords: Chinese economy; climate policy; carbon neutrality; rebalancing;

Computable General Equilibrium model

Corresponding Author’s E-Mail

Address: WChen@imf .org

1 The authors would like to thank Simon Black and Ian Parry for significant contributions to this paper. The paper

has also benefited significantly from comments by Helge Berger and seminar participants at the IMF.

Contents

ABSTRACT _________________________________________________________________________________________________ 2

A. Introduction______________________________________________________________________________________________ 5

B. China’s Investment-Intensive Growth Model and Resulting Carbon Emissions _______________________ 9

C. Overview of China’s Climate Targets___________________________________________________________________ 10

D. Other Climate Mitigation Initiatives ___________________________________________________________________ 12

E. Policy Simulations for China’s Road to Net Zero ______________________________________________________ 15

I. BASELINE (BAU) SCENARIO _________________________________________________________________________ 16

II. BASE ACTION SCENARIO ___________________________________________________________________________16

III. EARLY EMISSIONS PEAK SCENARIO _____________________________________________________________17

IV. POWER MARKET REFORMS SCENARIO__________________________________________________________17

V. ECONOMIC REBALANCING SCENARIO ___________________________________________________________17

VI. SIMULATION RESULTS _____________________________________________________________________________18

VII. SECTORAL IMPACTS _______________________________________________________________________________ 22

VIII. DISTRIBUTIONAL ANALYSIS_____________________________________________________________________24

IX. POLICY IMPLICATIONS _____________________________________________________________________________ 25

A. Concluding Remarks____________________________________________________________________________________ 27

APPENDICES

1. Impacts of Existing and Projected Climate Change____________________________________________________ 30

2. China’s E TS: Design Deta ils _____________________________________________________________________________ 31

3: Brief Description of the IMF-ENV CGE Model__________________________________________________________ 32

4. Dis tr ibutio na l Ana lysis Outcomes b y Scenario_________________________________________________________ 35

5. Other Sectoral Policies__________________________________________________________________________________ 38

FIGURES

1. Glob al E ner gy-Rela ted CO2 E mis sions Pa thwa ys _______________________________________________________ 5

2. Historical GHG Emissions ________________________________________________________________________________ 5

3. Carbon Intensity of GDP, Selected Countries ___________________________________________________________ 9

4. GHG Emissions by Sector and Fuel Type, 2018 _________________________________________________________ 9

5. China’s Newly Added and Retired Coal-Fir ed Capacity by Year, GWh ________________________________ 10

6. Illustrative Efficiency Frontier ___________________________________________________________________________ 10

7. ETS Trading Prices and Volumes _______________________________________________________________________ 12

8. Selected (National and EU Level) Carbon Pricing Schemes in 2021___________________________________ 13

9. Aggregate Demand and Current Account _____________________________________________________________ 17

10. CO2 Emission Paths by Policy Scenario _______________________________________________________________ 19

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2022JULYAComprehensivePackageofMacroeconomicPolicyMeasuresforImplementingChina’sClimateMitigationStrategyJeanChateau,WenjieChen,FlorenceJaumotte,andKarlygashZhunussovaWP/22/142©2022InternationalMonetaryFundIMFWorkingPaperAsiaandPacificDepartmentAComprehensivePackageofMacroeconomicPolicyMeasuresforImplementingChina’sClimateMitigationStrategyAuthorizedfordistributionbyHelgeBergerJeanChȃteau,WenjieChen,FlorenceJaumotte,andKarlygashZhunussova1IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement.AbstractThispaperpresentswaysforChinatoachieveitsclimategoalswhilealsoattainhigh-qualitygrowth—growththatisbalanced,inclusive,andgreen.UsingadynamiccomputablegeneralequilibriummodelthatiscalibratedtoChina,multiplescenariosareconsideredthatincorporateasequenceoflayeredpolicies:(i)frontloadingmitigationwithanearlieremissionspeak,(ii)powermarketreforms,and(iii)economicrebalancing.Theresultshighlightthatthesepoliciescansignificantlycontributetothesuccessoftheclimatestrategyoverall,includingbyloweringtheshadowpriceofcarbonaswellastheassociatedmitigationcosts.Distributionanalysisoffersproposalstolessentheimpactonvulnerablehouseholds.JELClassificationNumbers:O53,Q54,O14,D58Keywords:Chineseeconomy;climatepolicy;carbonneutrality;rebalancing;ComputableGeneralEquilibriummodelCorrespondingAuthor’sE-MailAddress:WChen@imf.org1TheauthorswouldliketothankSimonBlackandIanParryforsignificantcontributionstothispaper.ThepaperhasalsobenefitedsignificantlyfromcommentsbyHelgeBergerandseminarparticipantsattheIMF.ContentsABSTRACT_________________________________________________________________________________________________2A.Introduction______________________________________________________________________________________________5B.China’sInvestment-IntensiveGrowthModelandResultingCarbonEmissions_______________________9C.OverviewofChina’sClimateTargets___________________________________________________________________10D.OtherClimateMitigationInitiatives___________________________________________________________________12E.PolicySimulationsforChina’sRoadtoNetZero______________________________________________________15I.BASELINE(BAU)SCENARIO_________________________________________________________________________16II.BASEACTIONSCENARIO___________________________________________________________________________16III.EARLYEMISSIONSPEAKSCENARIO_____________________________________________________________17IV.POWERMARKETREFORMSSCENARIO__________________________________________________________17V.ECONOMICREBALANCINGSCENARIO___________________________________________________________17VI.SIMULATIONRESULTS_____________________________________________________________________________18VII.SECTORALIMPACTS_______________________________________________________________________________22VIII.DISTRIBUTIONALANALYSIS_____________________________________________________________________24IX.POLICYIMPLICATIONS_____________________________________________________________________________25A.ConcludingRemarks____________________________________________________________________________________27APPENDICES1.ImpactsofExistingandProjectedClimateChange____________________________________________________302.China’sETS:DesignDetails_____________________________________________________________________________313:BriefDescriptionoftheIMF-ENVCGEModel__________________________________________________________324.DistributionalAnalysisOutcomesbyScenario_________________________________________________________355.OtherSectoralPolicies__________________________________________________________________________________38FIGURES1.GlobalEnergy-RelatedCO2EmissionsPathways_______________________________________________________52.HistoricalGHGEmissions________________________________________________________________________________53.CarbonIntensityofGDP,SelectedCountries___________________________________________________________94.GHGEmissionsbySectorandFuelType,2018_________________________________________________________95.China’sNewlyAddedandRetiredCoal-FiredCapacitybyYear,GWh________________________________106.IllustrativeEfficiencyFrontier___________________________________________________________________________107.ETSTradingPricesandVolumes_______________________________________________________________________128.Selected(NationalandEULevel)CarbonPricingSchemesin2021___________________________________139.AggregateDemandandCurrentAccount_____________________________________________________________1710.CO2EmissionPathsbyPolicyScenario_______________________________________________________________19411.AbatementCostsbyPolicyScenarioandTimeRange_______________________________________________2012.CarbonPricebyPolicyScenario______________________________________________________________________2113.Rebalancingvs.Non-Rebalancing:CO2EmissionsProjections_______________________________________2214:ChangesinSectoral___________________________________________________________________________________2315.ChangesinSectoralComposition_____________________________________________________________________2316.MeanEffectonConsumptionDeciles,beforeRevenue-RecyclingbyPolicyin2030_______________2417.MeanEffectonConsumptionDeciles,afterRevenue-RecyclingbyPolicyin2030_________________2418.MeanConsumptionEffectonConsumptionDeciles,afterRevenue-RecyclingusingCashTransfers,byPolicyin2020__________________________________________________________________________________________25TABLES1.EffectiveCarbonTaxRatesinChina,2020_____________________________________________________________145A.IntroductionClimatemitigationinChinaiscriticaltoensuringthedurabilityofitslong-termdevelopmentpath.Chinaisespeciallyvulnerabletorisingextremeweathereventsanditswarmingrateisoutpacingtheglobalaverage.2Highertemperatureshaveadirecteffectonproductivityandarestronglylinkedtomorefrequentandextremeweathereventsthatposeriskstoeconomicgrowth,health,livelihoods,foodsecurity,watersupply,andhumansecurity,whicharelikelytoaffectthevulnerablethemost(seeAppendix1).Moreover,localairpollutionfromfossilfuelcombustioncausedanestimated1.2millionprematuredeathsinChinain2019,withcoal,petroleumproducts,andgasaccountingfor78,20,and2percentofthesedeathsrespectively.3Figure1.GlobalEnergy-RelatedCO2EmissionsPathwaysFigure2.HistoricalGHGEmissionsSource:WRI(2021),IPCC(2018),andIMFstaffestimates.Notes:baselineandNDCprojectionsfromtheCarbonPricingAssessmentTool(175countries,>95%ofglobalemissions).Source:WRI(2021),IMFstaffcalculations.Note:GHGexcludeland-usechangeandforestry(LUCF)andbunkerfuelsemissions.ClimatemitigationinChinaalsohasenormousglobalimportancegiventhesizeofChina’seconomyanditsroleasamajoremitter.Atthegloballevel,CO2emissionsneedtobereducedby30-60percentbelow“business-as-usual”(BAU)levelsin20304togetontrackwithcontainingwarmingto1.5-2oC—eveniffullyimplemented,currentmitigationpledgeswouldonlycutglobalemissionsby1/3ofwhatisneededfor1.5oCand2/3ofwhatisneededfor2oC(Figure1).5Greenhousegasemissions(GHGs)inChinagrew275percentbetween1990and2018(Figure2)andareprojectedto2AccordingtothelatestChinaMeteorologicalAdministrationBluePaper(2021),Chinaisparticularlysusceptibletonaturaldisasterssuchasheavyprecipitationandextremeheat.Itsannualaveragesurfacetemperaturehasincreasedby0.26degreesCelsiusevery10yearsfrom1951to2020,muchhigherthantheglobalaverageincreaseof0.15degreesCelsiusinthesameperiod.3Parryandothers(2021a).4Thatisascenariowithnonewortighteningofexisting,mitigationpolicies.5SeealsoBlackandothers(2021).-1001020304050billiontonsCO2peryearChinaEU27IndiaUSRestoftheWorldChinaBAU2Cpathway1.5Cpathway2020NDCsGlobalBAUSource:WRI(2021),IPCC(2018),andIMFstaffestimates.Notes:baselineandNDCprojectionsfromtheCarbonPricingAssessmentTool(170countries,>95%ofglobalemissions).02468101214billlionstonsofCO2eEnergyIndustrialprocessesAgricultureWaste6increaseby39percentfrom2018toreach18.7billiontonsin2030undertheBAUscenario.6Underthatsamescenario,Chinawouldaccountforathirdofglobalenergy-relatedCO2emissionsin2030,aboutthesameastheglobalemissionsreductionrequiredfora1.5oCpathway.Inpercapitaterms,ChinawillbeamongthetopfiveemittersintheG20.ActionstomitigateemissionsinChinathereforemakeahugedifferenceatthegloballevelandconferlargebenefitsonallcountries.Additionally,actioninChinawilllikelycatalyzemitigationactionamongothercountries.Thus,China’sachievementofitscarbonneutralitygoalbefore2060—andthepathittakestowardsachievingthatgoal—willbecriticaltoanysuccessfulglobalstrategytodelivertheneededreductionsinglobalemissions.ForChina,attainingcarbonneutralitybefore2060willrequirethefulluseofexistingandnewclimatepolicytoolswhileforgingaheadonthereformpathtowardhigh-qualitygrowth—growththatisbalanced,inclusive,andgreen.AsmostofChina’sCO2emissionsaregeneratedfrompowerandindustrialactivities,owingtoitshighinvestment-intensivegrowth,anysuccessfulclimatereformagendawillalsorequireasignificanttransformationoftheeconomyoverthenext40years.ContinuingfurtheronthepathofunbalancedgrowthwouldnotonlydriveupthealreadyexcessiveinvestmentshareofGDPandacceleratethedeclineinreturnstocapital(seeChina’s2021ArticleIVStaffReport),butalso,duetothehighcarbon-intensityofinvestment,makeitmuchmoredifficulttoreachChina’sclimategoals.Conversely,economicrebalancingtowardsmoreconsumptionoffersmoresustainableandequitablegrowthbenefittingmorehouseholdsandhelpsthequestforcarbonneutralitybyreducingthetradeoffsbetweengrowthandclimategoals.TheannouncementofChina’sclimateambitionshassetoffaflurryofacademicandpolicyworkonpotentialwaysforChinatodecarbonizebymid-century.Manystudieshavetakenasectoralapproachinassessingtheoptimalemissionsreductionconsistentwithanetzerogoal.Veryfewstudiestodate,however,haveintegratedemissionsreductionstrategieswitheconomicpolicies.Inparticular,thelinkbetweeneconomicrebalancingandemissionsreductionforChinahassofarbeenexploredbyonlyafewstudiesinasystematicway(e.g.,IEA,2017,Feng,HowesandAdams,2014,HeandKujis,2007).Thispapertakesacomprehensiveandforward-lookingquantitativeapproachandaimstoevaluatetheimpactsofmacroeconomicpolicies,includingrebalancing,combinedwithclimatepoliciesonChina’sCO2emissions.Aglobaldynamiccomputablegeneralequilibrium(CGE)model—theIMF-ENVmodel7—calibratedtoChina’seconomicparametersprovidesaparticularlywell-suitedframeworktoanalyzethemacroeconomicimpactsofclimatepolicies.Itlinkseconomicactivitytoenvironmentaloutcomesandprovidesscenarioanalysisandquantitativepolicyassessmentsthatareinternallyconsistent.TohelpquantifytheeconomicandCO2emissionimpacts,thepapersetsouttoevaluatepotentialpolicyavenuesreflectiveofChina’sclimategoalsandtheirresultingpathsandcostofadjustments,usingtheIMF-ENVmodel.Specifically,therearefourtypesofpolicyscenariosunderconsideration,thefirstonebeingascenariothatincorporatestheannouncedpolicyactionssofar,whilethe6DespiteaccountingforasignificantdeclineintheenergyintensityofGDP.OtherstudiesprojectemissionsgrowthforChinaofaround15-30percentoverthisperiod(e.g.,CAT2020,DenElzenandothers2019,LiandQin2019,Tongandothers2018).7TheIMF-ENVmodelhasbeenonlyrecentlyoperationalattheIMF,butsomeaspectsarestillunderdevelopmentincludingthedraftingofadocumentation.Meanwhile,readersinterestedinthemodelcanconsultthedocumentationsofthetwinmodelsIMF-ENVisbuilton:the“ENVISAGE”model(vanderMensbrugghe2019)andthe“OECDENV-LinkagesModel”(Château,Dellink,andLanzi2014).7subsequentscenariosreflectadditionalpolicies.AllthepolicyscenariosarecomparedagainstaBAUbaselinescenario:•Baseaction:Thisscenarioassumesthatallcountriesimplementcarbonpricingconsistentwithreachingtheir2030NDCtargetsalongwithamovetowardsaworldofnetzeroGHGemission(NZE)in2050.Inthisscenario,ChineseGHGemissionswould“peak”around2028—consistentwithChina’sNDCgoalsofpeakingbefore2030—andthenstarttodeclinedrasticallytoreachnetzeroemissionsby2060.Technically,themodel’stimeframeendsin2050,buttheamountofCO2in2050iscalibratedsuchthatacontinuationofthesamepoliciesforthenextdecadewouldyieldanetzeroresult.Inthis“conservative”scenario,theChinesepowersystemisstillcharacterizedbysomemarketimperfectionwhilemaintainingthecurrentfeaturesofthebroaderChineseeconomy(e.g.,highinvestmentininfrastructure,heavyindustrypredominanceandinvestment-orientedgrowth).•EarlierCO2emissionpeak(in2023):Intensifyingdecarbonizationeffortssoonerthancurrentlyenvisagedislikelytosavecostsandreduceunforeseenrisksofdelays.MoreintensivedecarbonizationeffortsintheneartermwillallowforasmootherpaceofadjustmentthatcarrieslowerGDPcostsastheclimatebenefitsandpositivetechnologicalspilloversfromsupportinggreentechnologieswillmaterializeearlier.Anearlierpeakwouldalsoreducetherisksofdelayattheexpenseoffuturegenerations,especiallyiftechnologydoesnotdevelopasexpected,orChina’soverallgrowthpathchangesunexpectedlytothedownside.•Powermarketreforms:Reformstothepowersectorwouldallowthecostofmitigationpoliciestobepassedforwardtoelectricityusersbyenablinggeneratorstoadjustquantitiesandelectricitypricesinlinewithdemandandsupply—includingbetweenrenewablepowergeneratorsandfirmsthroughdirectelectricitytrading—aswellasinresponsetothecarbonpricesignalofthenationalEmissionTradingScheme(ETS).•Economicrebalancing:Rebalancingfromtraditional,construction-heavyinvestmenttomoreconsumption-ledgrowthwouldtranslateintoashiftfromheavyindustryandconstructiontowardslesscarbon-intensivesectorslikeservices(includingeducationandhealth)andhighvalue-addedgoods.Thisstructuralchangewillreducetheenergyandcarbonemissionintensitiesofoutputand,therefore,reduceoverallCO2emissionswhilecontributingtoamorebalancedgrowthpathbyloweringtheinvestmentasashareofGDP.8DecreasingtheenergyintensityofChina’sGDPthroughrebalancingwouldalsolessenitsenergydemandandeasethepressureforenergysecurity—inparticular,thedependenceoncoal,thelargestsourceofenergygeneration.ThebottomthreescenarioshavethesignificantadvantageofallowingChinatoenhanceitsclimateambitionandactionwhileaddressingsustainablegrowthobjectives.Themodelsimulationsincorporateasequenceoflayeredpoliciesbasedonthescenariosdiscussedaboveandprovideprojectionsforthepathofacarbonprice—orashadowpriceofcarbonif,inpractice,thepathwouldbemetthroughamixofpricingandnon-pricingmeasures—compatiblewithChina’senvisagedtransitiontocarbonneutrality.Thecomparisonoftheseprojectedcarbonpricepaths,alongwiththeexpectedGDPcostsassociatedwiththetransitionacrossthesepolicyscenarios,revealtheextentofChina’sclimateambitions.Itmustbenoted,however,thatmodelprojectionsofcostsandpricesareinherently,andincreasingly,uncertainoverthemediumtolongerterm—forexample,thefutureviabilityandcostsof“future”technologies(e.g.,hydrogen,carboncaptureandstorage,anddirectair8SeeManoandZhang(2018)andZhang(2016)foradetailedanalysisofChina’sinvestment-heavygrowthmodelandtheneedforeconomicrebalancingfromagrowthperspective.8capture)areespeciallyspeculative.GDPcostsarealsosensitivetotheuseofpotentialcarbonpricingrevenues.9Theresultsofthemodelsimulationsareinsightful,however,astheyallowforcomparingtheimpactsofpolicymixesontheentireeconomyinequilibrium.Theresultshighlightagradualdecreaseintheassociatedshadowpriceofcarbonreflectiveofeachscenario’spolicy,indicatingreductionsininefficiencies.Atthesametime,theaverageannualGDPcostinthepolicyscenariorelativetotheBAUcasealsodeclinesaspoliciesprogressfromthe2030peakscenariotoamoreoptimalscenariowithearlypeakinemissions,reformsinthepowersector,andeconomicrebalancing.Thepaperalsoanalyzesthedistributionalimplicationsofthepolicymeasuresbasedontheassociatedshadowpriceofcarbon.Theincidenceanalysisuseshouseholdsurveysandinput-outputtablestohighlightthechannelsofhowacarbontaxwouldaffecthouseholds.First,calculationsbasedoninput-outputtablesshowhowhigherenergypricesinducedbyacarbontaxwouldleadtohigherconsumerpricesinenergyandnon-energyrelatedgoods.Second,combiningthesehigherconsumerpriceswithhouseholdsurveys,theanalysisquantifiesthenegativeimpactonwelfarebasedonthehouseholdexpenditurebundles.Lastly,theanalysisprovidespoliciesthatcouldbeimplementedtocompensatehouseholds,reduceinequality,andbuildsupportforadoption.Themainresultsofthepaperare:•Bydeployingacombinationofclimatepoliciescenteredaroundrebalancing,Chinacannotonlygreatlyreducethecostofdecarbonization,butthiswouldalsohelpitachievehigh-qualitygrowth.Specifically,simulationresultsbasedonadynamiccomputablegeneralequilibriummodelshowthatthedeviationsinaverageannualGDPcostrelativetoabusiness-as-usualbaselinecanbealmostcutinhalfbasedontheadoptionofasequenceofpoliciesincludingfrontloadingmitigation,makingthebestpossibleuseofavailablecarbonpricingmechanismwhileenhancingpowermarketreforms,andeconomicrebalancing.•Economicrebalancing(i.e.structuralchange)towardsaconsumption-ledgrowthmodelitselfwillsignificantlyreducecarbonemissions.Astrongreformefforttoshiftawayfromheavy-industry,suchasconstructionandmetalproduction,andtowardslesscarbon-intensiveservicesectorswillreducetheenergyandcarbonintensityofoutputand,therefore,reduceoverallCO2emissions.Rebalancingalonecanhelpreducecarbonemissionsbyabout15percentoverthenextthreedecades.•Theresultsfromtheincidenceanalysisshowthatregardlessofthepolicyscenario,poorerhouseholdstendtobemoredisproportionatelyaffectedbycarbonpricingpoliciescomparedtowealthierhouseholds.However,anillustrativeexampleofusing85percentoftherevenuescollectedfromthecarbontaxonlabortaxreductionsand15percentoftherevenuesoncashtransferstargetingthebottom25percentofhouseholdsshowsthatthenegativeimpactwouldbeoffset,andcarbonpricingcombinedwiththerevenuerecyclingcansupportreducingpovertyandregionalinequalities.ThenextsectionpresentsanoverviewofthesourcesofChina’scarbonemissions.SectionChighlightsthemainclimatetargetsthathavebeenannouncedtodate,followedbySectionDthatprovidesanoverviewofkeyclimatepoliciesthathavebeenimplementedsofar.ThesubsequentSectionEpresentspolicyrecommendationsfora‘roadtonetzero’relyingontheprojectionsfromthe9GDPcostsaredifferentfromemissionsabatementoreconomicefficiencycosts.Thelatterprimarilyreflecttheannualizedcostsofusingcleaner,butcostlier,technologieswhiletheformeralsoincludeGDPeffectsarisingfromreallocations,adjustments,andaggregatechangesinemployment.9modelsimulationsbasedonalternativepolicyscenarios.SectionFprovidestheresultsofadistributiveanalysisbasedonthepolicyscenariosimulations,andsectionGconcludeswithadiscussionoftheelementsinthecomprehensivepolicypackageandprovidessomeguidanceontheimplementationofthesepolicies.B.China’sInvestment-IntensiveGrowthModelandResultingCarbonEmissionsChina’srapidriseinCO2emissionsisaconsequenceofChina’sinvestment-ledgrowthmodelthatformanyyearshasreliedpredominantlyonproductionfromheavyindustries.Thelatter’shighenergyintensity,coupledwithdependenceoncarbon-intensivecoalinpowergenerationandindustry,hasresultedinChinabecoming,byfar,theworld’ssinglelargestCO2emitter.AndalthoughChina’scarbonintensityofGDPhasdeclinedrapidlysince1990,itremainshigh(seeFigure3)relativetomostotheremergingmarkets(EMs).Thissuggeststhatasuccessfulclimatestrategywillhavetosignificantlycurbenergydemandand,inparticular,thehighcarboncontentofenergysupply.Abreakdownofemissionsrevealsthatenergy-relatedCO2emissionsaccountedfor76percentofChina’s12.5billiontonsofGHGemissionsin2018(seeFigure4).Bysector,powergeneration/districtheatingaccountedfor42percentofChina’sGHGs.Byfuel,combustionofcoal,oilproducts,andnaturalgasaccountedfor80,13,and7percentofenergyrelatedCO2,respectively.Figure4.GHGEmissionsbySectorandFuelType,2018Source:WRI(2021);IMFstaffcalculations.Note:GHGsexcludeemissionsfromLULUCFandinternationaltransportation.Themainreasonforthehighshareofenergy-relatedCO2emissionsisChina’sheavyrelianceoncoalforitspowergeneration,representingalmost70percentofpowergeneration,incomparisontoonly3percentforgas,whereas(carbon-free)hydro,nuclear,wind,andsolaraccountedfor17,4,5,Agriculture,6%Industrialprocesses,9%Waste,2%Power/districtheatng,42%Transport,7%Buildings,4%Fugitive,6%Industry,22%Other,2%Energy-related,83%Coal,CO274%Naturalgas,CO27%Oil,CO212%OtherGHGs8%Energy-relatedemissions:10and2percent,respectively.10Thelionshareofenergyconsumptionwenttoindustry,accountingfor76percentofelectricityconsumptionin2018,whilehouseholdsconsumed14percent,transportation2percent,andotherenergyusemadeup9percentofusage.Asaresult,China’sconsumptionandproductionofcoalisthebiggestintheworld.Infact,in2019,China’sconsumptionofcoalexceededtheamountconsumedbytherestoftheworldcombined(Sandalow,2020).Substantialconstructionofnewcoal-firedpowerplantcapacitycontinuedthroughout2020(Figure5),withabout7.5GWofnetnewcapacityaddedinthefirsthalfof2021(thoughthisislessthanonepercentofitsexistingcoalgenerationcapacity).Thisheavyrelianceonhigh-energyintensityproduction,coupledwiththedependencyoncoalforfuel,posesachallengetoChina’slong-termclimateambitionsandhasrecentlycontributedtofrictionsbetweenChina’sclimategoalsanditspowersystem(seenextsection).Goingforward,anyplanstodecarbonizeChinawillhavetofactorinacarefulphasingoutofitshighcoalconsumptionandinevitablyforcearethinkofChina’shigh-energyintensivegrowthmodel.C.OverviewofChina’sClimateTargetsPresidentXiJinping’sannouncementofChina’scommitmenttonet-zeroCO2emissionsby2060onSeptember22,2020infrontoftheUnitedNationsGeneralAssemblymarkedasignificantturningpointinChina’sclimateambitions.11WhileChinahadannouncedagoalofCO2emissionpeakingbefore2030earlier,thecarbonneutralityambitionwasunexpectedandimportant.12Comparedtoothermajorpollutingcountries,thetimebetweenemissionspeakandnetzero,however,ismorecompressedforChina(Figure6).Asofdate,moreconcretedetailsonhowexactlyChinaintendstofulfillitscarbonneutralitygoalhaveyettoberevealed.TheChinesegovernmenthas10IEA(2021a).11Netzeroimpliesthatsomesectorscanstillemitpositiveamountsofemissionsiftheyareoffsetbynegativeemissionselsewhere(e.g.,throughforestcarbonstorageordirectaircapture).Inaddition,thetargetislimitedtoCO2emissionsandexcludes,forexample,methanereleasesfromagricultureandwaste.12China’sPledgetoBeCarbonNeutralby2060:WhatItMeans-TheNewYorkTimes(nytimes.com)11sofarpublishedahigh-leveloverarchingworkingguidanceonhowtoachievecarbonneutrality,withmoresector-specificdirectivestofollow.Together,theymakeuptheso-called“1+N”policyframework,with“1”referringtotheoverarchingplanspanningministriesandsectors,and“N”indicatingthenumberofplanscoveringsectoral-specificpolicies.Asofnow,theseplansonlycontainChina’smainclimateobjectives,asstatedinthemostrecentFive-Year-Plans—acomprehensivepolicyblueprintreleasedbyChinaeveryfiveyearstoguideitsoveralleconomicandsocialdevelopmentoverthemedium-term—specifically,forthe14thFive-YearPlan(FYP)period(2021-2025)andthe15thFYPperiod(2026-2030).Relyingonmedium-termpolicyframeworksisanestablishedwayforChinatoimplementitspolicyobjectives.Thisapproachalsoappliestoitsclimategoals,whichhavebeenfeaturedinthemediumplanssincethe12thFive-YearPlan(2011-2015)intheformofbindingreductiontargetsforenergyintensity,totalenergyconsumption,andcarbonintensity.Thelatest14thFYPcontainskeyinterimclimatetargets.Specifically,the14thFYPplanstipulatesthefollowingbindingtargets:•13.5percentreductionforenergyintensitybetween2021-2025,•18percentreductionofCO2intensityofGDPbetween2021-2025,and•Animprovementoftheforestcoverageratefrom23.4%in2020to24.1percentin2025.Sofar,ChinahasadheredtoitsbindingFYPclimatetargetsineachofthetwopreceding5-yearperiods,butthepandemichasbroughtcomplications.13TheunbalancednatureofChina’srecoveryfromthepandemicrecessionhasledtoasignificantjumpinenergyconsumptionin2021.Heavyindustrieslikesteel,non-ferrousmetals,chemicals,andbuildingmaterialslikecementandglasshaveledthechargetosatisfyincreasedmanufacturedexportdemandandtheboomindomesticconstructionandinfrastructureinvestment.Astherecoveryinconsumptionandservicescontinuestolag,theshareofthesecondaryindustry—withitsmuchhigherenergyintensityinGDP—hasincreasedinboth2020and2021.Thisposeddifficultyinfulfillingannualclimatetargetsattheprovincialleveland,togetherwithotherfactors,contributedtotemporarypowercrunchesacrossseveralprovincesinthesecondhalfof2021.14TheannouncedclimatetargetsalsoindicateaslowandincrementalstartinthereductionofCO2emissionsintheneartermandleavetheheavyliftinguntilafter2030.Hypothetically,assumingthatGDPgrowthevolvesroughlyinlinewiththeIMFWEOprojections,evenifcarbonintensityfallsbythetargetedamount,thereisariskthatCO2emissionlevelscouldstillincreaseandforceamuchmoreintensivedecarbonizationeffortafter2030.Forexample,allowingcoalcapacitytoincreaseintheneartermcouldrequiresharpcapacityreductiondowntheroad.Theabsenceofabsolutecapsoncoaluse—newcoalplantsmightbeforcedtoretireearlygiventheiraveragelifespanofaround50years—andcarbonemissionsleavesroomforemissionstoincreaseoverthenextseveralyears,implyingsharperpolicyshiftslateron—andiftheavailabilityandcostsofcleantechnologyalternativeslikesolardonotevolveasexpected,orfuturegrowthpathschangeunexpectedlyonthedownside,Chinawillhavemadeiteventougherforfuturegenerationstocurbemissions.13Thesenationaltargetsaregenerallytranslatedintoprovincialandannualtargets.Forinstance,thetargetofcumulativereductioninenergyintensityforthe14thFYPtranslatestoabout3percentperyearandwasfurtherdisaggregatedintobindingannualprovincialtargets.Similarly,thetargetforaverageannualgrowthintotalenergyconsumptionwassetat2percent.14AttheheightofthepowershortageinOctober,factoriesin20provincesexperiencedeitherslowdowninorsuspensionofproduction,whilethebulkoftheChinesepopulationthatlivedandworkedinthoseregionsalsosufferedfromelectricityblackouts.12D.OtherClimateMitigationInitiativesInadditiontothemedium-termclimatetargetsdiscussedabove,Chinahasahostofexistinginitiativestofosterlow-carbondevelopment.Thissectionhighlightsseveralofthemthatwilllikelyplayanimportantroleinachievingtheauthorities’climateagendabutwillalsorequiresubstantialreformsandimprovementstofosterlow-carbondevelopment.CarbonPricingAcentralcomponentofChina’seffortstoimplementitsmitigationobjectivesistherecentlylaunchednationalemissionstradingscheme(ETS).Initsfirstcyclein2021,thesystemisapplieddownstreamatthepointoffuelcombustionto2,225entitiesinthepoweranddistrictheatingsector,withannualemissionsexceedingathresholdlevel.15Currently,theETScoversabout40percentofChina’sCO2emissions—reportedly,thegovernmentintendstoextendcoveragetocementandaluminumnext,followedbyironandsteel,nonferrousmetals,petroleumrefining,chemicals,pulpandpaper,andaviation(whichwouldextendcoverageuptoabout70-80percent).ThenationalETSwillprogressivelyreplacesixregionalpilotETSsthathavebeenoperatingsince2015.SincetheopeningoftheallowancetradingmarketinJuly2021,priceshavebeenhoveringataround$6-8perton(seeFigure7).UnlikeotherETSs(e.g.,intheEU,California,andKorea)thecapinChina’sETSisnotsetexogenously;insteaditvariesendogenouslywithproductionlevelsandotherfactors.ThecapisbuiltupfromallowanceallocationsthatarelinkedtorecentproductionlevelsandbenchmarkemissionratesperMWh,where(toeaseburdensoncoalintensiveregions)benchmarksaremuchhigherforcoalplantsthannaturalgas.Theemissionscapisalsoadjustedex-postbasedonactualproductionlevelsandhigherfutureproduction,increasingfutureemissionscaps.Declinesincapacityutilizationcanalsoincreasefutureemissionscaps,asextraallowancesareawardedtoplantsoperatingwithlowloadfactors.Coalplantsareonlyrequiredtocoveremissionsupto20percentabovebenchmarkallocationswithallowances—beyondthis,theiremissionscanexpandwithoutanyneedtoacquireallowancesfortheextraemissions.Inshort,thereiscurrentlynoguaranteethataggregateemissionscoveredbytheETSwillstabilize,letalonedeclineovertime.SeeAnnex2forfurtherdetailsontheETS.Initscurrentsetting,emissionsreductionsunderChina’sETSareunlikelytobecosteffective.16TheChineseETSimplicitlysubsidizeselectricityoutputusinganintensity-basedbenchmarkratherthancaps,whichlimitstheuseofoutput-reductionasachannelforreducingemissions.Italsogives1526,000tonsofCO2,whichisroughlyequivalenttotheannualemissionsofasmall5MWcoal-firedpowerplant.16SeeGoulderandothers(2021)forfurtherdiscussionoftheseinefficiencies.13powerplantswithespeciallylowemissions-outputratiosincentivestoexpandoutputrelativetobaselinelevels.Theuseofdifferingbenchmarksalsocompromisescost-effectivenessbydistortingrelativeproductionlevelsandbyloweringthecost-reducingpotentialofallowancetrading.Forexample,sinceallowanceallocationsadjustbasedonactualoutput,onlyunitswithemissionsintensityabovethebenchmarkwillhaveincentivestoreduceCO2emissionsbycurtailingoutput.Figure8.Selected(NationalandEULevel)CarbonPricingSchemesin2021Sources:AnupdateofFigure1inParryandothers(2021c),Figure1.InstitutionalfeaturesofthepowersectorinChinamayfurtherunderminemitigationresponsesandcosteffectiveness.InChina,powerdispatchandpricingarecommonlydeterminedbyadministrativemechanisms,aspowergeneratorsreceivemulti-yearcontractstosupplycertainamountsofenergyatspecifiedprices.Chinagenerallylacksmarketsfortradingpower,makingitdifficultforprovinceswithalotofcoalfiredplantstopurchaserenewablegenerationfromotherprovinces.Theseobstaclesarefurtherexacerbatedbyalackofreliabletransmissionlines.And,asmostcoal-firedpowerplantsarestateownedenterprises(SOEs),theburdenofcarbonpricingmaybelargelyreflectedinlossesforlocalgovernmentsratherthanhigherelectricitypricesforindustryandhouseholds.Nonetheless,thesectorhasbeenundergoingcontinualreformsince1985,whenthestatemonopolyended,andArgentinaColombiaDenmarkEstoniaFinlandFranceChileIcelandIrelandJapanLatviaLiechtensteinNorwayPolandPortugalSingaporeSloveniaSouthAfricaSpainSwedenUkraineMexico(carbontax)EUNewZealandKazakhstanUKKoreaGermanyChinaEUETS2030(forecast)Mexico(pilotETS)CanadaSwitzerlandCanada2030(legislation)-200204060801001201401601800102030405060708090Carbonprice($US/tCO2e)Coverageofnationwidegreenhousegases(%)CarbontaxETSCarbontaxandETS=0.1%ofGDPBubblesizeshowsvalueofpricinginitiative:ColorshowsshareofglobalGHGs:<0.05%0.05%to1%>1%14currentlyaboutathirdofelectricityoutputissoldatmarketprices.17SpotmarkettradingwasintroducedduringtheFive-YearPlanfor2016-2020forafewselectprovinces,andtherehasbeenmoremarkettradingactivityinlongertermcontracts,thoughcompetitionremainslackingingeneral.Furtherreformsmightbeinitiatedintheupcoming5-yearplanoftheNationalEnergyAgency.MostothernationalcarbonpricingschemeshavegreatercoverageandhigheremissionspricesthaninChina,thoughinpartbecauseotherschemeswereestablishedearlier(andhavesincebeenstrengthened).Ofthe30nationalpricingschemesandtheEUscheme(illustratedinFigure8),22havegreatercoveragethanChina’sschemeand19havehighercarbonprices.Indeed,globalmomentumforcarbonpricingisincreasing.AsidefromthelaunchofChina’sscheme,amajorpricingschemewasrecentlyimplementedinGermany,pricesintheEUETShaverisenaboveUS$90perton,andCanadahasannounceditsminimumcarbonpricewillrisetoUS$135pertonby2030.FueltaxesChinahastaxesinplaceonmostfossilfuelproducts(seeTable1)—mostnotablyforcoal—whichwouldbestraightforward(fromanadministrativeperspective)torampuptoreinforcemitigationincentives.MostoftheCO2reductionsunderaneconomy-wideCO2pricewouldcomefromreductionsincoaluse(seebelow),withafarmoremoderatecontributionfromreduceduseofoilproductsandnaturalgas;taxingcoalaloneisthereforearelativelyeffectivewaytocutnationwideemissions.Chinahasanexcisetaxoncoalwhichiseffectivelyonconsumption.Thetaxisleviedatthemine-mouthcoalplants,butitalsocoversimportedcoalandisrebatedforexportedcoal.Forpowerandindustrialcoalconsumption,however—togetheraccountingfor77percentofeconomy-wideCO2emissions—theexciseisequivalenttoonlyamodestchargeof$3-4pertonofCO2.Indeed,localairpollutiondamagesfromcoalarearound25timesthecurrenttax.18Chinahasahighertaxonpowerandindustrialuseofnaturalgas—equivalentto$70pertonofCO2—buttheyonlyaccountfor5percentofeconomy-wideCO2emissions.Gasolineanddieseltaxesarehigherstill—$168and$65pertonofCO2,respectively—thoughagain,roadfuelsarearelativelymodestshare,8percent,ofnationwideCO2emissions,and(asinothercountries)thesetaxesfallwellshortofthefullrangeofenvironmentalcostsofvehicleuse.1917Ho,Wang,andYu(2017).18Parryandothers(2021a),Figure1.19Includinglocalpollution,trafficcongestion,accidents,androaddamage.SeeParryandothers(2021a).Table1.EffectiveCarbonTaxRatesinChina,2020Sector/fueltypecoalnaturalgasotherfossilfuelscoalnaturalgasotherfossilfuelsgasolinedieselotherproductscoalnaturalgasShareinCO2emissions,%4710304344121Effectivecarbontaxequivalent,$pertontCO23706470351686527-3-24Source:IMFstaffcalculationsNote:Taxratesincludefuelexcisesandsubsidies.VATisexcludedasitappliestoallconsumergoodsPowerIndustryTransportResidential15E.PolicySimulationsforChina’sRoadtoNetZeroWhatstrategywillleadtoNet-Zeroemissions?Ideally,arobustcarbonpricereflectingChina’sclimategoalswouldbetheapproachofchoicetoreinincarbonemissionsbecauseitprovidestherightincentivesforallmarketparticipantstoseekandimplementthemostcost-effectivewaysofreflectingthesegoals.Forpoliticalandotherreasons,however,itisnotafeasiblestrategyforChinaatthispoint.Abest-availablestrategy,combiningexistingandneweconomicpolicieswithinnovativeclimatepolicyinstruments,couldprovidethenecessaryeconomicincentivestoreduceemissions.GivenChina’sinvestment-ledgrowthmodel,withheavyrelianceonenergy-intensivesectorsandpoweredbycoal,macroeconomicpoliciesandmarket-basedreformswillhavetoplayanimportantroleinreducingtheenergyintensityofgrowthwhileincentivizingthetransitionoutofcoal.Thissectionexplorestheeffectsofacombinationofpoliciesthatincludeanearlieremissionspeak,economicrebalancingtowardsamoreconsumption-basedgrowthmodel,andtheuseofexistingcarbonpricingtoolsunderimprovedmarketconditions.ThispaperusestheIMF-ENVmodeltoconductsimulationsonavarietyofscenarios,eachassociatedwithaspecificpolicy.IMF-ENVisarecursivedynamicneo-classical,global,generalequilibriummodel,builtprimarilyonadatabaseofnationaleconomiesandbilateraltradeflows.20Itiswellsuitedfortheanalysisofclimatemitigationpoliciesoveralong-timehorizonbecausethedetailedrepresentationofeconomicsectorsallowscapturingthestructuralchangesoftheeconomyresultingfromimplementationofthepolicies.Moreover,themodelalsoincludesafullsetofbilateralinternationaltradeflows,allowingassessingtradeandcompetitivenessimpactsof(coordinatedoruncoordinated)globalclimateactions.Themodelalsoincludesvintagecapitalstocks,implyingbothtime-to-buildadjustmentcostforinvestmentandlimitedsubstitutionpossibilitiesbetweeninputsintheshortrunrelativetothelongrun.Thechoiceofmodelcomeswithcertaintradeoffs.Intheverylongrun,themodelmayoverestimatethecostofdecarbonizationsinceitdoesnotconsiderradicaltechnologyinnovationsthatcouldmaterializeatthislongerhorizon—suchashydrogen,carboncapture,andstoragetechnology,amongothers.Moreover,currently,themodeldoesnotaccountforlongrunbenefitsofmoderatingglobaltemperaturechanges.Atthesametime,intheshortrun,thecostofthetransitiondynamicscouldbeunderestimatedsincemostcommoditymarkets(electricityexcluded)aswellasthelabormarketareassumedtobealmostperfectlycompetitive;inthecaseoflabormarket,itimpliesthatworkerscanmovefromanyjobtoanotherwithoutanycost.Moreover,themodelhasrepresentativeagentsmakingitdifficulttoassessthedistributiveimpactsofthescenarios(seesectionVI).Lastly,whilethemodelcanshowtheimpactofpoliciesonairpollutants,thecorrespondingco-benefitsofreducingairpollutantsarenotdirectlyincorporatedinthemodel.Tocomplementthemacroeconomicanalysis,inalatersection,theCPATmodelisusedforthedistributionalandincidenceanalysisontheimpactsonhouseholds.TheworldeconomyintheIMF-ENVmodelisdisaggregatedinto10separateregions,includingChina,India,Japan,andtheUnitedStatesand55economicsectors.ThemainsectorscontributingtoGHGsemissionsaremodeledseparately,includingfivefossilfuelgoods(coalmining,crudeoil,refinedoil,gasextraction,andgasdistribution),eightpowergenerationsectors(coal,oilandgas-poweredelectricity,hydropower,wind,solar,nuclear,andotherpower),andfiveenergy-intensive20SeeAppendix3formoredetailsonthemodel.Acompletedescriptionofthemodel,itscalibrationandbaselineprojectionwillbereleasedsooninaforthcomingWP.16andtradeexposed(EITE)industries(ironandsteel,non-metallicminerals,chemicals,pulpandpaper,andnon-ferrousmetals).21AfterfeedingthedifferentpoliciesintotheIMF-ENVmodel,itcapturestheshadowpriceofcarboncompatiblewithChina’senvisagedtransitiontocarbonneutralityandmapsthedifferentsourcesofGHGemissionsdirectlyintotheassociatedeconomicactivities.Themodelthenshowsacomparisonofeconomiccostsacrossscenarios,measuredbydeviationsinrealGDP.Italsoprojectsstructuralchangesinthesectoralcompositionoftheeconomyandchangesininternationaltradepatterns.Thispapercomparesfourmainpolicyscenariosagainstabusiness-as-usual(BAU)baseline.Inparticular,apartfromthefirstpolicyscenario,allsubsequentpolicyscenariosarenested,witheachonebuildingonthepoliciesofthepreviousscenario.Themainindicatorsunderevaluationacrossallpolicyscenariosaretheprojectedpathofcarbonprice,therealGDPcosts,andpathofCO2emissions.Whiletheresultsarepresentedupto2050forexpositorypurpose,projectionsafter2035-2040arehighlyspeculativesincedisruptivetechnologicalinnovations(e.g.,hydrogen,carboncaptureandstorage,directaircapture,advancednuclear,amongothers)couldmaterializeatlongerhorizonsbutarenotexplicitlyincorporatedinthecurrentsimulations.Therefore,resultsafter2035-2040areindicativeandshouldbeinterpretedmoreinqualitativethanprecisequantitativeterms.I.BASELINE(BAU)SCENARIOMacroeconomicprojectionsfortheBAUscenarioarebasedontheApril2021WEOupto2025andlonger-termgrowthprojectionsassumethatcountryincomelevels(e.g.,GDPinPPPpercapita)convergetowardsthoseofmostdevelopedeconomies.Otherassumptionsarechosentoprojectchangesinsectoralproductionanddemandpatterns(includingthoseimpliedbyacceleratedpopulationageinginChina)inlinewithknownstylizedfacts.IncomeelasticitiesforenergyandothergoodsensurethatincreasesinGDPpercapitareducebudgetsharesfornecessarygoodslikeelectricityandfood.Overtime,incomeelasticitiesareassumedtoconvergetowardsthoseforadvancedcountriesasincomepercapitarises.Similarassumptionsaremadeforconditionalconvergencetowardstheproductioncost-structureandsectoralproductivityofmoreadvancedcountries.ThisBAUscenarioactsasthebase“layer”forthesubsequentpolicyscenarios.II.BASEACTIONSCENARIOThefirstpolicyscenarioisconstructedassumingallcountriesimplementcarbonpricingandpublicinvestmentsinthepowersectorandtransmission/distributionofelectricityconsistentwithreachingtheir2030NDCgoals,alongwithamovetowardsaworldofnetzeroemission(NZE)in2050.Inthisscenario,Chineseemissionswould“peak”around2028—consistentwithChina’sNDCgoalsofpeakingbefore2030—andthenstarttodeclinedrasticallytoreachzeroemissionsin2050.22Inthisconservativepolicyscenario,thebroaderChineseeconomyisprojectedasinvestment-focused,reflectingChina’srelativelyhighinvestmentininfrastructure,largeshareofheavyindustry,andgenerallyinvestment-orientedandexport-orientedgrowthpattern.Inaddition,theIMF-ENVmodelincludessomeoftheexistingimperfectmarketfunctioninginChina’spowersectorowedtostate-ownershipandregulationsthroughanad-hocmarkuponelectricitysellingprice,calibratedbasedon21SeeAppendix3formoredetailedcalibrationofthemodel.22Asdiscussedearlier,whileChina’sclimategoalenvisageszeroemissionsonlyby2060,itisalsoassumedthattheremainingCO2willbeeliminatedthroughthedecadebetween2050-2060,includinga20percentreductionthroughcarboncapturestorageutilization(CCUS).Theverylargeuncertaintyespeciallyaroundtechnologytowardstheendofthesimulationhorizonmaketheearlierendpointchosenherelessofanissue.17informationprovidedbyIEA(2019),wheretheextra“pureprofit”isretainedbythegovernmentbudget.Byincorporatinganapproximationofthepricerigiditiesinthepowersectorintothemodel,theprojectedshadowpricealsocapturesimportantreal-wordlimitationsinmarket-basedapproachestoreducingcarbonemissionsinChina.III.EARLYEMISSIONSPEAKSCENARIOThe“EarlyPeak”policyscenarioassumesCO2emissionspeakin2023whileallotherassumptionsremainthesame,includingthepowermarketrigidities.Carbonpricingisthemaininstrumentthatdrivestheemissions’pathwayinthispolicyscenario.WhilethisscenarioassumesthesamecumulativeamountofCO2asthebaseactionscenario,moreintensivedecarbonizationeffortsintheneartermallowsforasmootherpaceofadjustment.ThisimplieslowerGDPcostsfromreapingearlierbenefitsofpositivetechnologicalspilloversfromsupportinggreentechnologies.IV.POWERMARKETREFORMSSCENARIOInadditiontotheearlypeakinemissions,thisscenarioalsoassumesmarket-basedpowersectorpricing.Marketreformstothepowersectorcanmakecarbonpricingmoreefficientbyallowingabetterpass-throughofpricesontofinalconsumers.Byreducingtherigiditiesinthepowersectorandlettingelectricitypricesadjustmorefreely,thesimulationresultsareexpectedtoyieldalowershadowpricethatisneededtoaccomplishasimilarnetzerocarbonpath.23Moregenerally,aregulatoryframeworktoeffectivelymobilizepowersystemflexibilitywouldensurethatcarbonpricingwouldbepassedthroughontofinalconsumers,thusreducingthedemandforenergyaswellasincentivizingashiftawayfromfossilfuelstowardsrenewableenergysources.Inpractice,powermarketreformsmightincludeestablishingspotmarkets,allowingshort-termenergytradingbetweenprovinces,andupgradingtransmissionconnectivitytobringmorerenewableenergyonline.V.ECONOMICREBALANCINGSCENARIOThelastpolicyscenarioaddseconomicrebalancingtotheexistingpolicymixofearlydecarbonizationandpowermarketreforms.TheshareofinvestmentinChina’sGDPremainshigh,pointingtocontinueddomestic23IncorporatingtheexactrigiditiesoftheChinesepowermarketintotheIMF-ENVmodelisbeyondthepaper’sscope.Technically,itisassumedinboththepowermarketreformsandtheeconomicrebalancingscenariosthatthesameclimatepoliciesasinthe“EarlyPeak”scenarioareimplementedbutunderadifferenteconomicenvironmentwheretheelectricitymarketisnotcharacterizedbymarketpowerinelectricitysupply.18imbalances.24Whiletheshareofprivateconsumptionhasbeenrisingduringthelastdecade,itremainssignificantlybelowitsend-1990slevel(Figure9)andthatofpeereconomies.AkeydriverofthedomesticimbalancesisChina’sunusuallyhighhouseholdsavingrates,partlyreflectingprecautionarysavingsneedsrelatedtogapsinthecoverageandlimitsintheadequacyofthesocialprotectionsystem.Continuedvery-highinvestment,includinginconstruction,willlikelymeanfallingproductivityandlowerefficiency,drivingupalready-highdebtandfurtherelevatingfinancialrisks.25Rebalancingwillalsosupporthigh-qualitygrowthwhilereducingcarbonemissions.Ashiftawayfromheavy-industrysuchasconstructionandmetalproductionandtowardslesscarbon-intensiveservicesectorswillreducetheenergyandcarbonemissionintensityofoutputand,therefore,reduceoverallCO2emissions.Rebalancingtowardsamoreconsumptionandservices-basedeconomyhasbeenaconsistentpriorityinthelastseveralFYPs.Inthemodel,therebalancingscenarioassumesasignificantdecreaseintheinvestmentshareofGDP—byabout15percentagepointsoverthenextthreedecades—tolevelsmoresimilartothoseinadvancedeconomiesintheregion,whiletheshareofconsumptioninGDPincreasesoverthisperiod(2020-2050).26Thechanneltoachievetheeconomicrebalancingisprimarilythroughthedecreaseofhouseholdsavings.ButotherchannelsoftheChineseeconomy’stransformationareassumed,followingchapter15ofthe“2017WorldEnergyOutlook”report(IEA,2017),suchasahighercontributionofservicesbothintheproductionprocess(servicificationofindustries)andintotalvalueadded(drivenbyincreasingneedsineducationandhealth).27VI.SIMULATIONRESULTSThissectionpresentsthesimulationresultswitheachofthefourpolicyscenariosdescribedinturn.BaseActionScenario.TherelativelylatepeakinCO2emissionsinthisscenario(in2028)highlightsthebackloadednatureofChina’sdecarbonizationpathcomparedtocountriesthathavemuchlongertimehorizonsbetweentheiremissionspeakandnetzerogoals.Figure10illustratestheCO2emissionpathsassociatedwiththerespectivescenarios.Foreaseofcomparison,thecumulativecarbonemissionsforthebaseactionandearlypeakscenariosaresettosimilarlevels.24SeemoredetailsaboutthereasonsbehindChina’shighsavingsrateinZhangandothers(2018),“China’sHighSavingsRate:Drivers,Prospects,andPolicies.”25SeeIMFChinaSelectedIssuesPaper2021,“AdequateSocialProtectionforAll.”26ThestartingpointisinlinewithChina’shighinvestmentsharecomparedtoothercountrieswithsimilargrowthrates(seeZhangandothers,2018).Moreover,Chinaisalsowidelyexpectedtobecomeahigh-incomecountryduringthisperiodbetween2020-2050,whichwouldalsohelpincreasetheconsumptionshareofGDP.27ThemacroeconomicanalysisonChina’seconomicrebalancingprovidedinthe2017IEAWorldEnergyOutlookhasbeenperformedwiththeOECDENV-LinkageswhichisaverysimilartotheIMF-ENVmodelandthereforesimilarassumptionshavebeenadoptedhere.19Basedonthesimulationresultsforthisscenario,therelativelydelayedpathofdecarbonizationcomeswithhigherabatementcost.AsillustratedinFigure11,whiletheaverageannualdeviationinrealGDPassociatedwiththisbaseactionscenarioisalmost5percentagepointsacrossthewholetimeperiod(2022-2050),ittendstobeespeciallylargeinthelastdecade—around11percentagepointsbetween2041-2050.Thelargercostreflectstheshiftinthedecarbonizationeffortstolateryears,andthus,theneedtocompresstheeffortsintoashortertimeframe,makingithardertodefraytheadjustmentcostovertime.Inturn,thecostsinyear2030islowerinthebaseactionscenariocomparedtothatintheearlypeakscenario,reflectingtheinactionsintheformerscenariothatbearahigherpriceinlaterdecades.Whiletheassociatedcarbonpriceinthebaseactionscenariostartsatalowerlevel,itrisesatasteeperrateafter2028comparedtothecarbonpricetrajectoryreflectingtheearlierpeakscenarioandcontinuesitssteepincreasethroughoutthelaterdecades(Figure11).NotethattheaverageannualdeviationinrealGDPtendstoincreaseinlaterdecadesregardlessofthepolicyscenario.Whilethesecostsmightbelowerintherealworldasthemodelislimitedbytechnologiesthatareavailabletodaywhilenotincorporatingtechnologiesthatareintroducedinlaterperiodspotentiallycontributingtocostreductions,itshouldalsobenotedthattheintroductionofnewtechnologiesinlaterperiodstaketimetodevelop,andgainsarenotcertaintoberealizedintime,especiallyinthecasewherenoseriousmitigationpoliciesareputinplaceearlyon,e.g.,inthebaseactionscenariooflateemissionspeak.20Figure11.AbatementCostsbyPolicyScenarioandTimeRange(AverageAnnualDeviationinRealGDPfromBAUinPercentagePoints)Sources:IMF-ENVmodel;IMFWorldEconomicOutlook;andIMFstaffcalculations.Notes:NumbersbasedonsimulationsusingadynamiccomputablegeneralequilibriummodelandareaveragerealGDPdeviationsbetweentherespectivescenariovs.business-as-usual.Earlypeakassumesapeakemissionin2023.Scenarioswithoutpowermarketreformsassumepricerigidities,andrebalancingassumesshiftfrominvestmentsharetoconsumptionshareofGDP.-6-5-4-3-2-10BaseactionEarlypeakEarlypeak+powermarketreformEarlypeak+powermarketreform+rebalancing2022-2050-12-10-8-6-4-20BaseactionEarlypeakEarlypeak+powermarketreformEarlypeak+powermarketreform+rebalancing20302031-20402041-205021EarlyEmissionsPeakscenario.Keepingthecumulativeemissionsover2022-2050andotherpoliciesunchanged,delayingthepeakresultsinamoreintensivedecarbonizationeffortlater—asexhibitedbythesteeperslopeoftheemissionsprojectionintotheouteryears(Figure12).Anearlieremissionspeakalsoresultsinlowerabatementcostaswellasalowershadowpriceofcarbon—thatis,thenecessarycarbonpricecommensuratewithNZEby2050—comparedtoalaterpeak.Whileitisslightlymorecostlyintheimmediateyears,theextraeffortindecarbonizationintheearlieryearsismorethancompensatedbythelargerreductioninabatementcostinthelaterdecades(Figure11bottompanel).TheearlieremissionspeakscenariohasanaverageannualdeviationfromtheBAUbaselineofabout3.4percentagepointsofGDPacrosstheentiretimeperiod,whichis1.4percentagepointslowerthaninthebaseactionscenario.Thedifferenceismostlydrivenbythemuchlowerabatementcostoftheearlyemissionspeakscenarioduringthelastdecadeofthereductioneffortofalmost4percentagepointsofGDP.Incontrast,thedifferenceincostfor2030isonlyaround0.2percentagepoints.PowerMarketReforms.Ontopoftheearlyemissionspeak,theadditionofpowermarketreformsthatensureamarket-basedsettingofpricingandquantitiesyieldsfurtherefficiencygainsandcostreductionstothedecarbonizationprocess.TheimplementationofthenationalETSinthepowersectorwithanadditionalimprovementofpricesignalstofinalconsumersraisesincentivesforconsumerstoloweroverallenergydemandandfossilfuel-basedenergysources.Italsoleadstoincreasinginvestmentsintorenewables.Fortheentireperiodof2022-2050,theaverageannualdeviationinrealGDPfromtheBAUbaselinedecreasesbyalmost1percentagepointfromtheearlypeakscenarioandalittleover2percentagespointscomparedtothebaseactionscenario.Again,itisthelatestdecadethatcontributestothemajorcostreductions.Similarly,thecarbonpriceassociatedwiththeadditionofpowermarketreformislowerthanthoseinthebaseactionandintheearlypeakemissionscenarios,respectively.EconomicRebalancing.Finally,addingeconomicrebalancing—asignificantshiftfrominvestmenttoconsumptionasshareofGDP—tothepreviouspoliciesofearlypeakandpowermarketreformsfurtherlowersabatementcostandtheassociatedcarbonpriceconsistentwithNZEin2050(Figure11andFigure12).Comparedtothebaseactionscenario,theaveragedeviationinrealGDPfromtheBAUbaselineovertheentiretimeperiodismorethanhalvedwhencombiningearlypeak,powermarketreforms,andeconomyrebalancing,representingareductionofover3percentagepoints.Hereaswell,thelargestreductionoccursinthelastdecade,withthecombinedpolicymixscenarioabletoreducetheGDPcostsofmorethan7percentagepointscomparedtothatinthebaseactionscenariofor2041-2050.Thechangeisalsopronouncedwhencomparingtherespectivecarbonpricingassociatedwiththedifferentpolicyscenarios.The2040carbonprice,reflectiveofthebaseactionscenariowithapeakin2028,isalmostthreetimesashighasthecarbonpricereflectiveofthecombinationofearlypeak,powermarketreformandrebalancingscenario.22AseparatesimulationhelpstoillustratetheimportanceofeconomicrebalancinginChina’squestforclimatemitigation.Therebalancingscenarioassumesareductionof15percentagepointsintheinvestmentshareofGDPandanincreaseofsimilarmagnitudeintheconsumptionshareofGDP,whilethecurrentaccountisassumedtosteadilytrendtowardszero.Tohelpidentifytheimpactofrebalancing,thepathofGDPgrowthiskeptconstantacrosstherebalancingandnon-rebalancingscenarios.TheresultsshowthatrebalancingalonecansignificantlycontributetoareductioninCO2emissions,translatingintoa15percentreductionafterthreedecadesunderthegivenassumptions(Figure13).ThefallinglobalCO2emissionswouldbearound4.5percentcomparedtothenon-rebalancingscenario.VII.SECTORALIMPACTSWhiletheprevioussectionevaluatedthecarbonpriceandrealGDPcostsofthepolicyscenariosattheaggregatelevel,thepoliciesalsoprompttransitionsandshiftsintheeconomy,withdifferentiatedeffectsacrosssectors.Thissectionwillhighlightthesectoralimpactsofthefullpolicyscenariothatincorporatesallproposedpoliciesandrebalancing.TheaggregateadjustmentcostforthefullpolicyscenariorelativetotheBAUintermsofGDPdeviationisaround2.3percentin2040(Figure11,lowerpanel),buteconomicsectorsareaffectedverydifferently.Figure14belowshowshowthefullpolicyscenarioaffectsrealvalueaddedatthesectorallevel.Whilemostsectorsgrowrelativeto2019,emission-intensivesectorsgrowlessquicklythaninthebaseline,andlow-carbonsectorsbenefitfromthechangedincentives.Comparedtothebaseline,valueaddedinfossilfuelextractionandtransformationsectorsdeclinebymorethan40percent.Energy-intensivesectorslikeEITEindustries(i.e.,chemicals,ironandsteelandnon-metallicminerals,pulpandpaper)andconstructionarethemostaffectedbybothcarbonpolicyandtheeconomicrebalancing.Theelectricitysectorbenefitsfromthepolicies,asitaddsrenewableenergyandimprovementstotheelectricitygrid.Forservicessectors,thepictureislessclear.Publiclyprovidedservices(includingeducationandhealth)expandrelativetothebaselineastheyarenotveryenergyintensiveandbenefitfromtherebalancingoftheeconomy,buttransportationservicesthatrelyonfossilfuelsaremorenegativelyimpacteddespitetheincreaseofelectrification.23Figure14:ChangesinSectoralCompositionofRealValuedAdded(atfactorcost)in2040(PercentChangesoftheFullPolicyScenariowithRespecttoBaseline)Source:IMF-ENVModelFigure15.ChangesinSectoralCompositionofEmploymentin2040(DifferenceinMillionsintheFullPolicyScenariowithRespecttoBaseline)Source:IMF-ENVModelThepowersectorisparticularlyaffected(bottompanelofFigure14).Non-fossilfuelpowergenerationexpandstoreplacealmostentirelyfossilfuelpowergenerationin2040.Thesesectoralreallocationscancreatedifficulttransitionsforfirmsandworkersthatwillrequirecarefulpolicyplanning.Followingthesechangesinvalueadded,asignificantreallocationofemploymentacrosssectorsisshowninFigure15.Constructionand,toalesserextent,fossilfuelsectorswilllosesubstantialfractionsofemploymentrelativetotoday.EmploymentintotalEITEindustriesin2040isalsoprojectedtobelowerthantoday,whileglobalemploymentwasalreadyprojectedtofallinsomeofthesesectorsunderthebaselinescenarioduetoChina’slargestructuralanddemographicchanges.Incontrast,employmentinthenon-fossilfuelpowersectorincreasesbylargeamountsfollowingthepatternofoutputchangesinFigure14.Theservicesectorsalsoincreaseemployment,asthesesectorsarelaborintensiveandbenefitfromtherebalancingoftheeconomy.-50%-40%-30%-20%-10%0%10%20%30%40%ConstructionOtherminingWaste&WaterGasdistributionPaperChemicalpdt.IronandSteelNon-metallicmineralsNon-ferrousmetalsElectricaleqpt.ElectronicsFabricatedmetalpdt.Woodpdt.MotorvehiclesOthertransporteqpt.Othermachinery&eqpt.Othermanufacturingpdt.Businesssvcs.Transportsvcs.Collectivesvcs.PrimaryactivitiesFossilExtractionNat.Gasmanuf.&distrib.PetroleumrefiningElectricityT&DTOTAL-100%0%100%200%300%400%CoalpoweredelectricityOilpoweredelectricityGasPoweredelectricitySolarpowerWindpowerOtherpowerNuclearpowerHydropowerTOTALPOWER-20-15-10-5051015ConstructionOtherminingWaste&WaterGasdistributionPaperChemicalpdt.IronandSteelNon-metallicmineralsNon-ferrousmetalsElectricaleqpt.ElectronicsFabricatedmetalpdt.Woodpdt.MotorvehiclesOthertransporteqpt.Othermachinery&eqpt.Othermanufacturingpdt.Businesssvcs.Transportsvcs.Collectivesvcs.PrimaryactivitiesFossilExtractionNat.Gasmanuf.&distrib.PetroleumrefiningElectricityT&DTOTAL-0,50,00,51,01,52,02,53,03,54,0CoalpoweredelectricityOilpoweredelectricityGasPoweredelectricitySolarpowerWindpowerOtherpowerNuclearpowerTOTALPOWER24VIII.DISTRIBUTIONALANALYSISAsindicatedintheprevioussection,thesectoralshiftsinproductionandemploymentimplysignificantdistributionalimpactsonhouseholdincomes,creatingimportantchallenges,especiallyforthepoorandmostvulnerablehouseholds.Thissectionevaluateshouseholdincidenceimpactsanddiscussesmeasuresthatcouldcounteractthenegativeimpactofcarbonpricingonthosemostaffected.AstheIMF-ENVmodelreliesonrepresentativeagents,itcannotcapturedistributiveimpacts,thus,themaintoolofanalysisinthissectionreliesontheCarbonPricingAssessmentTool(CPAT).28Theanalysisisbasedonatwo-stepapproachtoassessthedistributionalimpactsofthereforms:firstly,usinginput-outputtablestocalculatetheeffectofcarbonpricingondifferentcategoriesofconsumergoods;secondly,mappingpriceincreasestodataonbudgetsharesfordifferentgoodsbyhouseholdincomegroupusinghouseholdexpendituresurveysthatareembeddedinCPAT.Figure16.MeanEffectonConsumptionDeciles,beforeRevenue-RecyclingbyPolicyin2030(%ChangeinHouseholdConsumptionRelativetoPre-Policy)EarlyPeak+PowerMarketReforms+RebalancingFigure17.MeanEffectonConsumptionDeciles,afterRevenue-RecyclingbyPolicyin2030(%ChangeinHouseholdConsumptionRelativetoPre-Policy)EarlyPeak+PowerMarketReforms+RebalancingSource:IMFStaffcalculations.Note:thepanelshowsrelativetoconsumptionimpactofthecarbonpricingscenariosonconsumptiondecilesbeforerevenuerecyclingthroughincreasesinpricesofenergyandnon-energygoods.Theresults(Figure16)fromtheincidenceanalysisonthefullpolicyscenarioshowpoorerhouseholdstendtobedisproportionatelyaffectedbycarbonpricingpoliciescomparedtowealthier28CPATwasdevelopedbyIMFandWorldBankstaffandevolvedfromanearlierIMFtoolused,forexample,inIMF(2019aandb).Fordescriptionsofthemodelanditsparameterization,seeIMF(2019b)AppendixIII,andParryandothers(2021b),andforfurtherunderlyingrationaleseeHeineandBlack(2019).25households(thisalsoholdstrueacrossotherpolicyscenarios),consistentwithlong-establishedresultsthattheimpactonhouseholdsfromcarbonpricingtendstoberegressive.29Whiletheimpactsfromhigherelectricitypricesarelarge(0.14-0.55percentofconsumptionover2020-2030),especiallyforlowerincomehouseholds,theyarerelativelysmallcomparedtoindirecteffects,withthelatterbeingdrivenbyincreasesinthepriceofgeneralconsumptiongoodsduetohigherenergycostsinindustries.Notethatindirecteffectsaredistributionally-neutral.Tothedegreethatthefullpolicyscenariobuildsontheuseofacarbontaxorsimilarapproachescreatingnewfiscalrevenue,revenuerecycling(Figure17)wouldoffsetthenegativeimpactofcarbonpricingonhouseholds,whiletargetedrecyclingcouldevenmakethereformspro-poor.Forexample,if85percentofcarbontaxrevenueswereusedongenerallabortaxreductionand15percentontargetedcashtransfersforthebottom25percentofhouseholds,allreformswouldbecomeprogressiveandpro-poor.Lowerincomehouseholdswouldbebetteroffonnetbyaround2to7percentofpre-policyconsumption.Lastly,revenuerecyclingcanalsobedesignedtoenhanceregionalequity,sincetheruralpoorhouseholdstargetedbycashtransferswouldbenefitmorethanurbanhouseholds.Inadifferentsetup,forexample,cashtransfersmightaddfrom10to13percentoftotalconsumptiontothepoorestruralhouseholds,bringingneteffectofthereformsto7-10percentofconsumption(Figure18).Theimpactonthepooresturbanhouseholdsislower:theneteffectwouldbearound3to5percentoftotalpre-policyconsumption.30IX.POLICYIMPLICATIONSModelsimulationssuggestthatcombining(i)anearlieremissionspeakin2023,(ii)powermarketreforms,and(iii)economicrebalancingwillnotonlyincreaseefficiencygainsbutalsoreducethecostsofclimatemitigation.Implementingthesegoalswillrequireapackageofexistingandnewpoliciestoprovidethenecessaryeconomicincentivestoreduceemissions.Inparticular,thepackageshouldincludepoliciesforimprovingandexpandingthenationalETS,complementarypowermarketreforms,andmacroeconomicpoliciestoenhanceeconomicrebalancingtowardsamoreconsumption-basedgrowthmodel.31Whileapurecarbontaxliketheoneinthemodelsimulationsmightnotbefeasible,anext-bestsolutionistoimprovethenationalETS.Thisincludesextendingtoothersectorsbeyondpower,29SeeAppendix4fortheoutcomeofthedistributionalanalysisontheotherscenarios.30Theanalysisincludesonlytheimpactofcashtransfers(15%ofcarbonrevenues)targetingbottom25percentofhouseholdsandassuming90%coverageand10%leakage.Theanalysisdoesnotincludethelabortaxreduction.31Seethe2021ChinaArticleIVStaffReportforadetailedroadmapofavailablepolicies.26consolidatingmultiplebenchmarksintoanabsolutecaponemissionsthatiscommensuratewithanearlierpeakoralternatively,throughtheimplementationofapricefloorthatrisesatasteadystatealignedwithChina’smitigationobjectives,andauctioningoffallocationpermitswithrevenuesrecycledviatransferstocompensatevulnerablehouseholdsandinvestingreendevelopment.32MarketreformsinthepowersectorcanfurtherenhancetheeffectivenessoftheETSbyallowinggeneratorstoadjustquantityandelectricitypricesmorefreelytodemandandsupply.33Policiestoadvanceeconomicrebalancingneedtoaddressthehighsavingsratesaswellasthehighinvestmentrates.Greaterfiscalsupportfocusedonstrengtheningsocialprotectionwouldreducehouseholds’precautionarysavingsandfacilitatethetransitiontoconsumption-drivenandinclusivegrowth.Insteadoftraditionalandbrowninfrastructureinvestment,shiftingthecompositionoffiscalsupporttowardsvulnerablehouseholdscouldmakecountercyclicalfiscalstimulusmoreeffective.Similarly,agradualandorderlytransitionofChina’srealestatesector—abigsourceofenergy-intensiveproductionandcarbonoutput—towardsanewsustainablegrowthpathwouldalsosupporteconomicrebalancing.Moregenerally,economicrebalancingcanoffermoresustainableandequitablegrowthbenefittingmorehouseholdsandhelpsthequestforcarbonneutrality.Givenuncertaintiesoverthefutureprogressofinstitutionalreformstomakecarbonpricingmoreeffective,anadditionalchannelistocombinetheETSwithaprogressiveincreaseinthecoaltax—thisistechnicallystraightforwardandiseffectiveatreducingCO2andlocalairemissionsbut(likecarbonpricing)mayhavechallengingdistributionalimpactsduetoitseffectonenergyprices.Carbonpricingcouldalsobereinforcedbyother,lessefficientbutlikelymoreacceptable,sectoralmitigationinstruments.ThedetaileddiscussioninAppendix5focusesmostlyonrevenue-neutralfeebatesacrossmanysectors,whichprovideaslidingscaleoffeesonproductsoractivitieswithaboveaverageemissionratesandaslidingscaleofrebatesforproductsoractivitieswithbelowaverageemissionrates.Thesereinforcingmeasuresarelessefficientthancarbonpricingastheyavoidsignificantincreasesinenergypricesandthereforedonotpromotethefullrangeofmitigationresponses(e.g.,theydonotencouragepeopletodriveless)thatcouldbepromotedbycarbonpricing.Thedistributionalanalysisshowsthatwithoutanyrevenueredistribution,theeffectsofcarbonpricingtendtobemildlyregressive.However,aredistributionofrevenuesfromauctioningallowancesandanycomplementaryrevenue-raisinginstrumentslikethecoaltaxcanmakethereformbothprogressiveandpro-pooroverall.Assistingthemostvulnerablehouseholds,workers,andprovincescanhelpensureajusttransitiontowardsagreeneconomy.Lastly,thedecarbonizationeffortstowardsnetzerowillalsorequirelargefinancingneeds,includingthedevelopmentanddeploymentofrenewables,updateoftheelectricalpowergridsystem,andadvancementofcarbonabatementtechnologies.TheChineseauthoritieshaveindeedsignaledtheneedtoleveragegreenfinance,makingupasignificantshareofthetotalfinancingneeds,whichtheyexpecttomobilizethroughprivatesectorsources.Whileitisbeyondthescopeofthispaper,measurestostrengthengreenfinanceincludeimprovingdatacollectionanddisclosurerequirementsandaligninggreenbondissuancepracticetointernationalstandardsaswellasstrongerprudential32SeeKarplus(2021)foranexcellentoverviewoftheChineseETSandpotentialimprovements.33SeedetailedplanforthetransformationofChina’senergysectorinIEA(2021),“AnenergysectorroadmaptocarbonneutralityinChina.”27policiesforclimaterisktosupportfinancialstabilityandreinforcegreen-friendlycreditallocation.34Lastly,havingsolidclimatepoliciesthatbolsterthecredibilityoftheclimategoalsshouldalsohelpChinaattractgreenfinance.A.ConcludingRemarksChinawillneedacomprehensivestrategytotransitiontowardscarbonneutralitywhileensuringhigh-qualityeconomicgrowth.Thispaperprovidesaframeworktoassessapackageofmitigationpoliciesconsistingofearlyemissionspeak,powermarketreforms,andeconomicrebalancing.Thedistributionalanalysisalsoillustratestheincidencecostsofclimatemitigationandpotentialwaysofredistributiontoalleviatethecosttothemostvulnerablehouseholds.EconomicrebalancingemergesasthekeychannelforChinatoattainhigh-qualityeconomicgrowthaswellasachievingitsclimategoals.Transitioningtoagreenereconomythroughrebalancingwillalsoreducetradeoffsbetweenclimategoalsandsustainablegrowth.Asashifttowardsmoreconsumption-ledgrowthwillreduceenergyandcarbonemissionintensityofoutput,itwilllessenthecountry’senergydemandandthus,easethepressureforenergysecurity.Finally,whilethispaperfocusedonmacroeconomicpoliciestoachieveChina’sclimatework,futureworkcouldusefullydelveintomoredetailedanalysesonspecificaspectsofChina’stransitiontonetzeroemissions.Forinstance,thecoalsectorplaysanoutsizedroleasthemainsupplierofenergyinChina.Abetterunderstandingofhowtotransitionoutofcoalwhileminimizingdisruptionstoenergysecurityisofcriticalimportance.Otherpotentialfocalareasincludedetailedanalysisofthepowersectorandbestwaystoimplementmarketreformsthatwouldenableenergytradingandsharingacrossprovinces.34Seethe2021ChinaArticleIVStaffReportformoredetailsongreenfinancepolicies.28ReferencesAguiar,Angel,MaksymChepeliev,ErwinL.Corong,RobertMcDougall,DominiquevanderMensbrugghe“TheGTAPDataBase:Version10”,JournalofGlobalEconomicAnalysis,Vol4,No1.2019.ArreguiNicolasandIanParry,2020.“ReconsideringClimateMitigationPolicyintheUK.”WorkingpaperNo.20-268,InternationalMonetaryFund,WashingtonDC.Black,Simon,RuoChen,AikoMineshima,VictorMylonas,IanParry,andDinarPrihardini,2021.“ScalingupClimateMitigationPolicyinGermany.“Workingpaper,InternationalMonetaryFund,WashingtonDC,forthcoming.CAT,2020.CountryAssessmentsSeptember2020.PreparedforClimateActionTrackerbyClimateAnalyticsandNewClimateInstitute.Availableathttp://climateactiontracker.org.CAT,2021.China:CurrentPolicyProjections.ClimateActionTracker.Availableat:https://climateactiontracker.org/countries/china/current-policy-projections.Chȃteau,Jean,RobDellinkandElisaLanzi,2014,“AnoverviewoftheENV-Linkagesmodel–version3”,OECDEnvironmentWorkingPapers,No.43,OECDPublishing.DenElzen,Michel,TakeshiKuramochi,NiklasHöhne,JasminCantzler,KendallEsmeijer,HannaFekete,TarynFransenandothers,2019."AretheG20economiesmakingenoughprogresstomeettheirNDCtargets?."Energypolicy126:238-250.Feng,Shenghao,StephenHowes,andPhilipAdams,2014.“EconomicrebalancingandcarbondioxideemissionsinChina.”WorkingPaperGTAPTradeAnalysisProject.Goulder,LawrenceH.,XianlingLong,JieyiLu,andRichardD.Morgenstern,2021.“China’sUnconventionalNationwideCO2EmissionsTradingSystem:Cost-EffectivenessandDistributionalImpacts.”Discussionpaper,DepartmentofEconomics,StanfordUniversity.HeJianwuandLouisKujis,2007.“RebalancingChina'seconomy-modelingapolicypackage.”WorldBankChinaResearchPaper,No.7.Heine,DirkandSimonBlack,2019.“BenefitsBeyondClimate:EnvironmentalTaxReforminDevelopingCountries.”InM.Pigato(ed.),FiscalPoliciesforDevelopmentandClimateAction,WorldBank,WashingtonDC,pp.1–56.Ho,MunS.,ZhongminWang,andZichaoYu,2017.China’sPowerGenerationDispatch.ResourcesfortheFuture,Washington,DC.IEA,2021a.ExtendedWorldEnergyBalances.InternationalEnergyAgency,Paris.IEA,2020.GlobalEVOutlook2020-EnteringtheDecadeofElectricDrive?InternationalEnergyAgency,Paris.IEA,2019.ChinaPowerSystemTransformation.InternationalEnergyAgency,Paris.A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iodsTheETScameintoeffecton1February2021andonJuly16,2021tradingcommenced.Currentlytherearenodefinedtradingperiods--currentregulationsapplyonlytothe2019and2020complianceperiod(otherETSshavedistinctphaseswithtradingwithinaphase).2,225powersectorenitites,includingcombinedheatandpower,aswellascaptivepowerplantsofothersectors.Inclusionthresholds:EntitieswithannualCO2emissionsatleast26,000tonsinanyyearfrom2013-2019.OnlyCO2isincluded.Coveragewilllaterincludepetrochemicals,chemicals,buildingmaterials,steel,nonferrousmetals,paper,anddomesticaviation,thoughthereiscurrentlynotimelineforthisexpansion.Thecapiscalculatedusingabottom-upapproachasthesumofthetotalallowanceallocationstothecoveredentities.The2021capisexpectedtobe30percentofnationwideGHGs,orover4,000billiontonsofCO2.Allowancescanbepurchasedandcancelledvoluntarily.AllowanceAllocationThereare4benchmarksforfreeallowanceallocationexpressedintonsCO2perMWh:0.877forconventionalcoalplantsproducinglessthan300MW;0.979forconventionalcoalplantsproducingmorethan300MW;1.146forunconventionalcoalplants;and0.392fornaturalgasplants.Allowanceallocationsequal70percentofentities'2018outputmultipliedbytherespectivebenchmarkfactor.Allocationwillbeadjustedtoactual2019and2020ouputlater.Aloadcorrectionfactorcanallocateadditionalallowancesforentitiesrunningatlessthan85percentofcapacity.AuctionsAllocationisdonethroughfreeallocationthoughlegislationprovidesforthepossibilityofauctioninginthefuture.CarbonPriceTheETSlaunchedwithanopeningallowancepriceof$7.41onJuly16th2021andclosedwithatradingpriceof$7.89,higherthantheaveragepriceofpreviousregionalpilots.BankingandBorrowingTheETSisexpectedtoallowforbankingbutnotforborrowing,thoughruleshavenotyetbeenestablished.MarketStabilityProvisionsAdjustmentmechanisms,riskprevention,andcontrolmechanismsarebeingdevelopedtoconstrainirregularpricefluctuationsandavoidmarketmanipulations.OffsetsEntitiescanoffsetupto5percentoftheiremissionsusingtheChinaCertifiedEmissionsReduction(CCER)projects.MonitoringandEnforcementEntitiesmustsubmitthepreviousyear’semissionreportsbytheendofMarch.Reportingfailuresaresubjecttofinesbetween$1,449and$4,347andcompliancefailuresfinesof$2,898-$4,347.Gas-firedplantsdonotfacecomplianceobligations.Otherplantsareobligatedtosurrenderallowancescoveringupto20percentofverifiedemissionsabovethefreeallocationreceived.Gapsbetweenthecomplianceobligationandforegoneallowanceswillbedeductedfromthefollowingyear.InstitutionsInvolvedChineseMinistryofEcologyandEnvironment(MEE)surpervisestheETS;ProvinciallevelMEEsubsidiariesorganizetheverificationofemissionreportsandsystemimplementation;ShanghaiEnvironmentandEnergyExchange(SEEE)operatesthetradingplatform;municipal-levelauthoritieshavesomelocalmanagementduties.Sources:ICAP(2021a,b),WBG(2021).EmissionsCapCoverage32APPENDIX3:BRIEFDESCRIPTIONOFTHEIMF-ENVCGEMODELThemodelisarecursivedynamicneo-classical,global,generalequilibriummodel,builtprimarilyonadatabaseofnationaleconomiesandsetofbilateraltradeflows.ThecentralinputofthemodelisthedataoftheGTAPV10database.35Thedatabasecontainscountry-specificinput-outputtablesfor141countriesand65commoditiesandrealmacroflows.Thedatabasealsorepresentsworldtradeflowscomprehensivelyforagivenstartingyear.Thecurrentlyusedversion10isbasedondatafrom2014.Themodeldescribeshoweconomicactivitiesandagentsareinter-linkedacrossseveraleconomicsectorsandcountriesorregions.Themodelisbasedontheactivitiesofthekeyactors:firms,households,andmarkets.Firmspurchaseinputsandprimaryfactorstoproducegoodsandservices.Householdsreceivethefactorincomeandinturndemandthegoodsandservicesproducedbyfirms.Marketsdetermineequilibriumpricesforfactors,goods,andservices.Frictionsonfactororproductmarketsarelimited,exceptasdescribedbelow.Onlyrealeconomicflowsareconsideredinthemodel;inaddition,heterogeneityoffirmsandhouseholdsarenotconsidered.Themodelissolvedasasequenceofcomparativestaticequilibria.Thefactorsofproductionareexogenousforeachtimestepandlinkedbetweentimeperiodswithaccumulationexpressions,similartothedynamicofaSolowgrowthmodel.Outputproductionisimplementedasaseriesofnestedconstant-elasticity-of-substitution(CES)functionstocapturethedifferentsubstitutabilityacrossallinputs.Internationaltradeismodeledusingtheso-called“Armington”specificationthatpositsthatdemandforgoodsaredifferentiatedbyregionoforigin.Thisspecificationusesafullsetofbilateralflowsandpricesbytradedcommodity.Incontrasttointermediateinputs,primaryfactorsofproductionarenotmobileacrosscountries.Whilethecapitalmarketischaracterizedbyrealrigidities,thelabormarketisnot.Onemajorcharacteristicofthemodelistofeaturevintagecapitalstocksinsuchawaythatafirm’sproductionstructureandafirm’sbehavioraredifferentintheshortandlongrun.Ineachyear,newinvestmentisflexibleandcanbeallocatedacrossactivitiesuntilthereturntothe“new”capitalisequalizedacrosssectors;the“old”(existing)capitalstock,onthecontrary,ismostlyfixedandcannotbereallocatedacrosssectorswithoutcosts.Asaconsequence,shortrunelasticitiesofsubstitutionacrossinputsinproductionprocesses(orsubstitutionpossibilities)aremuchlowerthaninthelongrunandmakeadjustmentsofcapitalmorerealistic.Incontrast,labor(andland)marketfrictionsarelimited:ineachyear,labor(land)canshiftacrosssectorswithnoadjustmentcostuntilwages(landprices)equalize;andthelabor(land)supplyrespondswithsomeelasticitytochangesinnet-of-taxeswagerate(landprice).Themodelalsolinkseconomicactivitytoenvironmentaloutcomes.Emissionsofgreenhousesgasesandotherairpollutantsemissionsarelinkedtoeconomicactivitieseitherwithfixedcoefficients,likeforemissionsfromfuelcombustion,orwithemissionintensitieswhichdecrease(nonlinearly)withcarbonprices—MarginalAbatementCost(MAC)curves.Thislattercaseappliestoemissionsassociatedtonon-energyinputuses(e.g.,N2Oemissionsresultingfromfertilizeruses)ortooutputprocesses(likeCH4emissionsfromwastemanagementorCO2emissionsfromcementmanufacturing).Intheverylongrun,themodelmayoverestimatethecostofdecarbonization,sinceit35https://www.gtap.agecon.purdue.edu/33doesnottakeintoaccountradicaltechnologyinnovationsthatcouldmaterializeatthislongerhorizon(hydrogen,secondgenerationofnuclearandbiofueltechnologies,carboncaptureandstoragetechnology).Whilesomeofthesenewtechnologiesareatanexperimentalstage,itisdifficulttoincludetheminthemodelatthemomentduetolackofinformationaboutthefuturecostsofthesetechnologiesiftheyweredeployedatindustrialscale.Themodelcanbeusedforscenarioanalysisandquantitativepolicyassessments.Forscenarioanalysis,themodelprojectsupto2050aninternallyconsistentsetoftrendsofalleconomic,sectoral,trade-related,andenvironmentalvariables.Environmentalvariablesaregreenhousesgasesandairpollutants.Inthiscontext,themodelcanbeusedtoanalyzeeconomicimpactsofvariousdriversofstructuralchangesliketechnologicalprogress,increasesinlivingstandards,changesinpreferencesandinproductionmodes.Forscenarioanalysis,asetofexternalprojectionsaregenerallyrequired.Aseconduseforthemodelisquantitativeeconomicandenvironmentalpolicyassessmentforthecomingdecades,includingscenariosofatransitiontoalowcarboneconomy.InthiscasethemodelassessesthecostsandbenefitsofdifferentsetsofpolicyinstrumentsforreachinggiventargetslikeGHGsemissionreduction.Themodeldistinguishesbetween55sectors.Sincethefocusoftheanalysisisonclimatemitigationpolicies,themainsectorscontributingtoGHGsemissionsaremodeledseparately.Thisincludesfourfossilfuelsgoods(coalmining,crudeoil,refinedoil,gasextraction,anddistribution),eightpowergenerationsectors(Coal,oilandgas-poweredelectricity,Hydropower,Wind,Solar,Nuclear,andotherpower)andfiveEnergy-IntensiveandTradeExposed(EITE)industries(ironandsteel,non-metallicminerals,chemicals,pulpandpaper,andnon-ferrousmetals).Forthispaper,fivecountriesaremodeledindividually—China,USA,Australia,JapanandIndia—andtheremainingcountriesaregroupedintofiveaggregateregions(includedEU)basedonregionalproximity.Listofsectorspdr-aPaddyRicewht-aWheatandmeslingro-aOtherGrainsv_f-aVegetablesandfruitsosd-aOilSeedsc_b-aSugarcaneandsugarbeetpfb-aPlantFibresocr-aOtherCropscow-aLivestock:CattleandRawMilknco-aLivestock:otheranimalsfrs-aForestryfsh-aFisheriescoa-aCoalextractionoil-aCrudeOilextractionp_c-aPetroleumandcoalproductsgas-aNaturalgas:extraction34gdt-aNaturalgas:manufacture&distributionomn-aMineralsn.e.s.etd-aElectricitytransmissionanddistributionclp-aCoalpoweredelectricityolp-aOilpoweredelectricitygsp-aGasPoweredelectricitynuc-aNuclearpowerhyd-aHydropowerwnd-aWindpowersol-aSolarpowerxel-aOtherpowerwts-aWatersupply;sewerage;wastemanagementandremediationactivitiesosc-aOtherFinancialservices(includingDwellings,insurance,realestate)trd-aTrade(includingaccommodation,warehousing)obs-aOtherBusinessServicesnec.andcommunicationedu-aEducationhht-aHumanhealthandsocialworkosg-aOthercollectiveservicescns-aConstructionatp-aAirTransportwtp-aWaterTransportotp-aTransportn.e.s.:Landtransportandtransportviapipelinesppp-aPaper&PaperProductscrp-aChemicalproductsbph-aBasicpharmaceuticalsrpp-aRubberandplasticproductsfdp-aFoodProductstxt-aTextilesnmm-aNon-metallicmineralsi_s-aIronandSteelnfm-aNon-ferrousmetalsfmp-aFabricatedmetalproductsele-aElectronicslum-aWoodproductsotn-aOthertransportequipmentomf-aOthermanufacturing(includesrecycling)ome-aMachineryandequipmentn.e.s.eeq-aElectricalequipmentmvh-aMotorvehicles35APPENDIX4.DISTRIBUTIONALANALYSISOUTCOMESBYSCENARIOFigureA1.MeanConsumptionEffectonConsumptionDeciles,beforeRevenue-RecyclingbyPolicyin2030(%ChangeinHouseholdConsumptionRelativetoPre-Policy)RebalancingPowermarketreformEarlypeakBaseactionSource:IMFStaffcalculations.Note:thepanelshowsrelativetoconsumptionimpactofthecarbonpricingscenariosonconsumptiondecilesbeforerevenuerecyclingthroughincreasesinpricesofenergyandnon-energygoods.36FigureA2.MeanConsumptionEffectonConsumptionDeciles,afterRevenue-RecyclingbyPolicyin2030(%ChangeinHouseholdConsumptionRelativetoPre-Policy)RebalancingPowerMarketReformEarlyPeakBaseActionSource:IMFStaffcalculations.Note:thepanelshowsrelativetoconsumptionimpactofthecarbonpricingscenariosonconsumptiondecilesassuming15percentofrevenueswouldbeusedforacashtargetedtransfer(assumedtargetingbottom25householdswitha90percentcoverageand10percentleakagerate)and85percentforreducinglabortaxation.37FigureA3.MeanConsumptionEffectonConsumptionDeciles,afterRevenue-RecyclingusingCashTransfers,byPolicyin2030(%ChangeinHouseholdConsumptionRelativetoPre-Policy)RebalancingPowerMarketReformEarlyPeakBaseActionSource:IMFStaffcalculations.Note:thepanelshowsrelativetoconsumptionimpactofthecarbonpricingscenariosonconsumptiondecilesbyurbanandruralpopulaiton,assuming15percentofrevenueswouldbeusedforacashtargetedtransfer(assumedtargetingbottom25householdswitha90percentcoverageand10percentleakagerate).38Appendix5.OtherSectoralPoliciesTransportation1.ElectricandotherlowcarbonvehiclesareapriorityinChina.Itisdifficulttopromotethesevehiclesthroughcarbonpricingorhigherroadfueltaxesaloneduetotherelativelymodestimpactofthesepoliciesonretailfuelpricesandpublicresistancetohigherroadfuelprices—Chinahasthereforefocusedonotherapproaches.Chinametitsgoalofonemillionnewelectricvehicles(NEVs)soldby2018(twoyearsaheadofschedule)andisrequiringmanufacturerstoprogressivelyincreasetheshareofNEVsinnewvehiclesalesto25percentby2025and40percentby2030,meanwhilepreviousconsumersubsidiesforthepurchaseofNEVsarephasingoutgiventheirhighfiscalcosts.36Chinaisalsointroducingfueleconomystandardsforlight-andheavy-dutycommercialvehiclesstartingin2021(averagedacrossmanufacturers’salesfleets)—thelightvehiclestandardfor2025is4litersper100km,or90gramsCO2perkm.37Thesalesshareandfueleconomyrequirementsarenotcompatibleinstrumentshowever,inthatsensethatwithhigherNEVsalessharesmanufacturersmayoffsetthefuelsavingsbyincreasingtheirsalessharesforlowfueleconomyvehiclesandstillmeetagivenaveragefueleconomyrequirement—thisisonereasontoconsideraddingafeebatetotheexistingpolicymix.382.Integratinga(revenue-neutral)feebateintothevehiclepurchasetaxsystem(currently10percent)wouldenhanceincentivesforNEVsandotherlowemissionvehicles,whileavoidingafiscalcosttothegovernment.Underafeebate,eachnewvehiclewouldbesubjecttoanadditionalfeegivenby:CO2price×[CO2/km─CO2/kmofthenew(industry-wide)vehiclefleet]×[averagelifetimevehiclekm]Emissionratedatabymodeltypecanbeinferredfromdatacurrentlyusedtoadministerthefueleconomystandards.Thefeebate:•Promotesthefullrangeofbehavioralresponsesforreducingemissionrates,asthereisalwaysacontinuousreward(lowertaxesorhighersubsidies)fromswitchingfromanyvehiclewithahigheremissionratetoonewithaloweremissionrate;39•Iscosteffective,astherewardisalwaysproportionaltothereductionintheemissionrate;and•Maintains(approximate)revenueneutrality—bydefinition,feesoffsetrebatesastheaverageemissionrateinthefeebateformulaisupdatedovertime.36ThetargetsareambitiousgiventheNEVsalessharewas5percentin2019.China’srecenteconomicstimuluspackageincludesfundingforNEVchargingstations,high-speedrail,andelectricpublictransportsystems.SeeCAT(2021).37Forcomparison,thecurrentEUstandardis95gramsCO2perkmthoughitissettorampupsharplyby2030.SeeIEA(2020).38SeeKrupnickandothers(2010),Ch5.39Vehiclemanufacturesarethereforerewardedforgoingbeyondprevailingfueleconomystandards(andpenalizedfornotmeetingthem)—inthisway,thefeebateisfullycompatiblewith,andreinforces,theexistingstandards.393.Forillustration,afeebatewithapriceof$500pertonofCO2wouldprovideasubsidyof$5,000forNEVsandapplyataxof$5,000toavehiclewith200gramsCO2/km(seeFigureA4).ManyEuropeancountriesimposehighertaxesonemissionsintensivevehicles(thoughtheshareofthesevehiclesinsalesfleetsisdecliningrapidly).SubsidiesforNEVswoulddeclineovertimeastheaveragefleetemissionratedeclines,whichisappropriateasthecostdifferentialbetweenthesevehiclesandtheirgasoline/dieselcounterpartsfallsovertime(e.g.,withimprovementsinelectricvehiclebatterytechnology).FigureA4.CO2-BasedComponentsofVehicleTaxes,SelectedCountriesSources:ACEA(2018);IMFstaffcalculations.Notes:Feebateassumesafleetaverageemissionrateof100gramsCO2/km.CirculationtaxesforGermanyareexpressedonalifetimebasis.PowerGeneration4.Ideallyacomplementaryinstrumentforthepowersector—thatavoidsasignificantincreaseinelectricityprices—wouldcost-effectivelyexploitallbehavioralresponsesforreducingtheemissionsintensityofgeneration.Theseresponsesinclude:(i)shiftingfromcoaltogas;(ii)shiftingfromcoalandgastorenewables;(iii)shiftingfromcoalandgastonuclearandfossilfuelplantswithcarboncaptureandstorage(thesetworesponseshoweverareexcludedfromIMFstaffmodelling);and(iv)efficiencyimprovementswhichlowertheuseofcoalandgasrequiredtogenerateakWhofelectricity(e.g.,byreducingheatlossduringfuelcombustion).-10-505101520050100150200250vehicletax($1,000)NorwayPortugalFranceUK$500feebategramsCO2/kmNetherlandsGermany405.Allthesebehavioralresponsescanbepromotedundercarbonpricing.Combinedtheyaccountforabout88percentoftheCO2reductionsbelowBAUlevelsinthepowersectorundera$50carbonpriceinChinain2030withmarketreforms—theother12percentcomesfromreductionsinelectricitydemand.Emissionsreductionsarecosteffectivelyallocatedacrossalltheseresponses(withmarketreforms)asthecarbonpriceprovidesthesamerewardforreducinganextratonofCO2acrosseachresponse.FigureA5.ProjectedElectricityGenerationSources($50CarbonPrice)Source:IMFstaffcalculations.Thus,thecost-effectivegenerationmixin2030is48percentcoal,15percenthydro,3percentnuclear,9percentsolarand12percentwind(seeFigureA5).Regulationsorfiscalincentivestopromoterenewablepowergeneration(likefeed-in-tariffsrecentlyphasedoutforsolarPVandonshorewind)promoteamuchnarrowerrangeofbehavioralresponsescomparedwithcarbonpricing—theyonlypromoteresponse(ii)aboveandtheydonotreduceelectricitydemand.6.Likecarbonpricing,afeebatecouldalsocost-effectivelyreducestheemissionsintensityofgeneration.UnderafeebateSOEswouldbesubjecttoafeedependingontheaverageemissionsacrosstheirgenerationplantsgivenby:CO2price×[CO2/kWh─pivotpointCO2/kWh]×electricitygenerationInprinciple,thisschemeprovidesSOEswithincentivestoexploitanybehavioralresponsethatlowerstheiraverageemissionrates—thisreducesfeesimplicitinplantswithemissionratesabovethepivotpointrateandincreasesrebatesimplicitforplantswithemissionratesbelowthepivotpoint.Aswithcarbonpricing,theefficientallocationofresponsesispromoted(withmarketreforms),asanyresponsethatcutsCO2byanextratonleadstothesamebenefit.Feebatescanbe(approximately)revenueneutralifthepivotpointreflectstherecent(economy-wide)averageemissionrate.Andanexogenoustrajectoryoffuturepivotpointemissionratescanbesetbasedonexpecteddeclinesinfutureemissionrates,topreserveapproximaterevenueneutralityforthesector.CapacityrequirementsforimplementingafeebateareminimalgiventhatgenerationemissionsarealreadymonitoredunderChina’sETS.0%10%20%30%40%50%60%70%80%90%100%CoalOilGasNuclearBiomassOtherREHydroSolarWind417.Forillustration,afeebatewithprice$50pertonneCO2wouldapplyfeesequivalentto6.6and0.2centsperkWhforcoalandnaturalgasgeneration,whileprovidingasubsidyof4.8centsperkWhforrenewables(FigureA6).Feesforcoalwouldincrease,andsubsidiesforrenewablesdecline,asthepivotpointemissionrateisupdatedovertime.Industry8.Energy-intensivetrade-exposed(EITE)industriessuchassteel,chemicals,metals,cement,glass,andpapergeneratemostindustrialGHGsFigureA6.IllustrativeFeebateforPowerSectorSource:IMFstaffcalculationsbasedon2018data.inChina,40butpresentlytherearenomajorpoliciestode-carbonizethesesectors.AstheETSisextendedtocoverindustry,measureswillbeneededtoaddresstheinternationalcompetitvenessimpactsofcarbonpricng—seeAnnexIV.Herethediscussionisaboutthepotentialuseoffeebatestocomplementcarbonpricingandreinforceincentivesforreducingemissionratesperunitofoutputintheseindustries(butwithoutareductioninoutputlevels).Underfeebates,firmswithinanindustrywouldbesubjecttoafeegivenby:[CO2price]×[CO2/output─industry-wideaverageCO2/output]×[firmoutput]9.Thefeebate,whichwouldapplytoemissionsfromfuelcombustionandprocessemissions(e.g.,releasedduringconversionofclinkertocement),avoidsafirst-orderallowancepurchaserequirementontheaverageproducerastheypaynochargeontheirremainingemissions.Thishelpstoalleviateconcernsaboutcompetitivenesscomparedwithapricingschemethatchargesforremainingemissions.Again,theschemecouldbuildoffexistingproceduresformonitoringindustrialfirmemissionsthatarebeingestablishedundertheETS.Buildings10.Coal,oil,andgascombustioninhomesaccountsforonly4percentofChina’sGHGemissions,butcountingindirectemissionsfromresidentialelectricityconsumptionwouldincreasethisshareto12percent—reducingenergyuseinbuildingsisthereforeapotentiallyimportantcomponentofChina’smitigationstrategy.Improvingtheenergyefficiencyofbuildingsthroughbetterinsulationandcleanerandmoreefficientheatingequipment,includingelectricheating,isonechannelforreducingenergyuse.Otherenergyreductionchannelsincludeenergy-efficientlightingandappliances,digitalizationto“smart”homes(suchasoptimalautomaticadjustmentofheatingtemperatures),andrenewableenergy-basedwaterheatingsystems.40UNFCCC(2021).-6-4-202460.00.20.40.60.81.01.2Electricitytax/subsidy,cents/kWh$50feebateCO2/1,000kWhNaturalgasCoal(conventional)Renewable4211.Variousfeebateschemescouldcomplementexistingeffortstopromoteenergyefficientbuildings.41Forexample,salesofrefrigerators,airconditioners,andotherenergy-consumingproductscouldincurafeegivenby:CO2price×CO2perunitofenergy×[energyconsumptionperunit─industry-wideenergyconsumptionperunit]×numberofunitsForrefrigerators,forexample,theenergyconsumptionratewouldbekWhpercubicfootcooled(andthenumberofunitswouldbecubicfeet).Asimilarschemeapplyingtaxestofossilfuel-basedheatingsystems(forexistingbuildings),andasubsidyforelectricheatpumps,couldhelpacceleratethetransitiontozero-carbonheatingsystemsforpre-existingbuildings.Feebatescouldalsobelinkedtotheenergyperformanceofnewbuildingstoencourageenergysavinginvestments.42FugitiveEmissionsfromCoalExtraction12.95percentoffugitiveemissionsinChinaarefromcoalmining,wherethemainemissionssourceisventingofmethane.43Potentialabatementmeasuresincluderecoveryofmethaneforpipelineinjectionoron-sitepowergeneration,flaring(toconvertmethaneintolesspotentCO2),andcatalyticorthermaloxidationofventilation.4413.Pricingschemesforfugitiveemissionscouldpromotethefullrangeofresponsesforreducingemissionratesandcouldbeappliedusingdefaultemissionrateswithrebatingforentitiesdemonstratingloweremissionrates.Emissionsmonitoringtechnologies45generallyprovideonlydiscretemeasurementsatalimitednumberofsites,thoughtechnologiesareimproving.Fuelsuppliersmightbetaxedbasedonadefaultleakageratewithrebatestofirmsdemonstratinglowerleakageratesthanthedefaultratethroughmitigationandinstallingtheirowncontinuousemissionmonitoringsystems.FugitiveemissionsarereleasedwithinChineseborders,andthereforeshouldbepricedregardlessofwhethercoalissolddomesticallyoronworldmarkets.Pricingapproachesaremoreflexibleandcost-effectivethanmandatesrequiringallproducerstousethesamemitigationtechniqueregardlessofwhichtechniqueisleastcostlyforthem.Forillustration,apriceof$50pertonontheCO2equivalent41Theseincludeenergyefficiencyregulationsfornewbuildingsandrequirementsforretrofittingexistingbuildings.42Arreguiandothers(2020)discussavarietyofothercomplementarymeasuresforthebuildingsector.43UNFCCC(2021).44USEPA(2019).45Includingsatellites,aircraft,drones,andremotesensingfromvehicles.43fromfugitiveemissionswouldapplychargesequivalent(priortomitigation)ofapproximately$7pertonofcoal.46Forestry14.Forestryandlandusepoliciesshouldpromote,nationwide,themainchannelsforincreasingcarbonstorage.Theseinclude:(i)reducingdeforestation;(ii)afforestation;and(iii)enhancingforestmanagement(e.g.,plantinglargertrees,fertilizing,treethinning,increasingrotationlengths).Totheextentforestcoverageisexpandedthiscan,moreover,generateotherenvironmentalco-benefitsbeyondcarbonstoragesuchasreducedrisksofwaterloss,floods,soilerosion,andriversiltation.China’sforestrypoliciesfocusonrecoveringnativeforests,protectingecologicallysensitivezones,andbanningtradeinillegallogs,thoughthereareconcernsthesepatchworkeffortsmightcauseleakageandexacerbateforestclearanceinotherregionsofChina,47whichunderscorestheneedforanationwideapproach.15.Anationalfeebateprogramcouldcost-effectivelypromoteallresponsesforincreasingcarbonstoragewithoutafiscalcosttothegovernment.Thepolicywouldapplyafee,mostimportantlyforlandparcelsattheagricultural/forestryboundary,givenby:[CO2rentalprice]×[carbonstorageontheparceloflandinabaselineperiod─storedcarboninthecurrentperiod]Thisschemewouldrewardallthreechannelsforenhancingcarbonstorage,eitherthroughreducedfeesorincreasedsubsidies(unlikeanafforestationsubsidywhichjustrewardsonechannel).Periodsherecouldbedefinedasaveragesovermultipleyearsgiventhatcarbonstoragemightbelumpyduringyearswhenharvestingoccurs.Feebatescanbedesigned—throughappropriatescalingofthebaselineovertime48—toberevenue-neutralinexpectedterms(again,unlikeanafforestationsubsidy).FeebateshavenotpreviouslybeenusedintheforestrysectorbuttheybearpartialresemblancetoenvironmentalservicespaymentsprogramsthatwerefirstintroducedinCostaRica.49Forestcarboninventoriesindifferentcountriesarebeingdevelopedthroughacombinationofsatellitemonitoring,aerialphotography,andon-the-groundtreesampling.5016.Feebatesshouldinvolverentalpayments(ratherthanlargeupfrontpaymentsfortreeplanting),giventhatchangesincarbonstoragemaynotbepermanent(e.g.,duetofires).Rentalpaymentsshouldequaltheproductofthecarbonpricetimestheinterestrateand46IMFstaff.47CAC(2021).48SeeParry(2020)fordetails.49See,forexample,www.fonafifo.go.cr/en.CostaRica’sschemeinvolvespaymentstodevelopandmaintainforests(butdoesnotapplyfeesforreductionsinforestcoverage).50Seeforexamplewww.forestcarbonpartnership.org.44thenumberofyearsinaperiod.51Thecarbonpricewouldneedtoriseovertimetoprovideongoing(ratherthanoneoff)increasesincarbonstorage.Partialexemptionsfromfeesmaybewarrantedfortimberharvestedforwoodproductsbecausethecarbonemissions(releasedattheendoftheproductlife)willbedelayed,perhapsbyseveraldecadesormore.51SedjoandMarland(2003).

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