By Valerie Karplus, Assistant Professor of Global Economics and Management, MIT Sloan School of Management

Among the host of issues confronting participants in the 21st Conference of the Parties to the United Nations Framework Convention on Climate Change was how to balance the desperate need to reduce greenhouse gas emissions without slowing development – especially in developing nations.

One way to do this is to introduce economically-efficient climate policies, such as a price on CO2. On his September visit to the United States, President Xi announced that China would do exactly that, by developing a national emissions trading system (ETS) by 2017. The new system has great potential to deliver emissions reductions at a lower cost compared to existing command-and-control approaches, especially if authorities allow it to do most of the heavy lifting.

Putting a price on CO2, however low it is at first, will gradually shift the economy away from CO2-intensive activity by taking reductions starting with where the cost is least. Emission trading systems have been shown to be highly effective when they are allowed to work. But a major sticking point has been how the costs of such a system would be distributed.

China, which is responsible for about 28 percent of worldwide CO2 emissions, has embarked on an ambitious pathway for establishing a national carbon market in the next five to 10 years. However, in the United States (which produces about 16 percent of global CO2 emissions) the issue has become highly politicized, as seen by the failure of the 2009 Markey/Waxman Bill that would have established emissions trading. While the U.S. pledge at the Paris climate talks was quite ambitious (to reduce CO2 emissions by 26-28% by 2025, relative to 2005), discussions of how a CO2 price could help by lowering the cost of reaching this goal have all but stalled.

In China, the debate is more technocratic: Which ministry should lead? Which provinces should have higher emission standards? China doesn’t avoid politics; it just takes a different form.

This month, we publish a paper, “Equity and Emission Trading in China” in the journal Climatic Change that outlines a sophisticated menu aimed at Chinese policymakers showing how the burden of reducing carbon emissions could be shared or divided across the country’s provinces under a market-based carbon pricing system. The paper is based on a regional model of China’s energy and economic system developed by Tsinghua-MIT China Energy and Climate Project (CECP) in the MIT Joint Program on the Science and Policy of Global Change. The Tsinghua-MIT CECP is also supported through the MIT Energy Initiative.

In this work, we first use the model to analyze how alternative provincial-level permit allocation schemes under a possible Chinese emissions trading scheme could incorporate specific equity principles, for instance, by holding polluters responsible or ensuring equality or progressivity of regional impacts. Our analysis demonstrates how different equity criteria can be embedded in initial allocation of emissions permits, and what the implications of choosing different criteria at the national level mean for the distribution of impacts.

Researchers on the team then surveyed individuals involved in policy analysis at the central level about which criteria were most important to them when allocating the cost of climate policy. About 54 percent respondents said a fair distribution of the emissions reduction burden (or equity) and reducing emissions at least cost (or efficiency) were equally important. And a majority of respondents were concerned that economic burden of greenhouse gas reduction being equitably distributed among China’s provinces.

China’s eastern provinces and coastal areas are generally more energy efficient, with more advanced development and higher per capita earning. Many survey respondents, which included national ETS analysts and decision makers, expressed support for schemes that ask the east to shoulder a disproportionate share of the cost. The country’s interior or western may produce more emissions, but are generally less developed and have lower wages. Thus, if you allocate more emission permits to the west, this reduces the burden on the west, relative to the eastern region.

Overall, we found a relative preference for allocation schemes that put less emissions-reduction burdens on the western provinces, a medium burden on the central provinces, and a high burden on the eastern provinces.

But here’s the bottom line: China is quickly moving to set up the basic architecture of an emission trading system, and policymakers are eager to identify strategies that would be both political acceptable as well as economically efficient. In many respects, China’s leaders see CO2 pricing as an opportunity to shift their growth in a cleaner direction, while generating incentives to move early to develop the clean technologies at home that will become ever more important globally in reducing humanity’s CO2 footprint.

China’s experiment with emissions trading should give the United States pause to consider whether and how CO2 pricing might be a prudent solution, if not a generator of competitive advantage in a carbon-constrained world. This discussion could start by recognizing that as a nation we want to meet our CO2 reduction goals at least cost. To do this, we will need a CO2 price as a starting point. Then, we can discuss how to distribute the costs.

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