The Myth of US-China Carbon Cooperation

Climate change was high on the agenda at the recently concluded fifth annual US-China Strategic and Economic Dialogue. A special session on the topic, held on the first day of the two-day summit, focused on low-carbon growth and green energy.

While there were no major breakthroughs, the two sides made non-binding commitments to reduce carbon emissions from coal-fired power plants, factories, and heavy-duty vehicles. They also pledged to increase carbon capture, utilization, and storage; increase energy efficiency in buildings, industry, and transport; improve greenhouse-gas data collection and management; and promote smart grids.

The emphasis on the environment at this event was not surprising given that "going green" is now a hot topic in both China and the US. Unlike some of the other issues facing the two countries—cyber-espionage and Chinese maritime claims, for example—"saving the planet" is relatively un-contentious.

There is, however, no reason to expect any reduction in China's enormous carbon footprint. Beijing has never been able to regulate emissions effectively and its green-energy priorities often do little more than encourage Potemkin environmentalism on the part of lower-level officials. Cooperation with the US will do nothing to make Chinese environmental policy more effective.

While China is often described as "centrally planned," regulating pollution is generally left to local governments. They routinely fail in this task, allowing plants to operate without required air-pollution control devices or dump untreated effluents into China's streams, rivers, and lakes. Because local officials' performance evaluations put more weight on GDP growth within their jurisdictions than on any other single factor, promoting industry and investment invariably takes precedence over protecting the environment.

Central-government industrial policies requiring smaller, less energy-efficient plants to close have proved unenforceable. Local governments continue to promote highly polluting small-scale steel mills, cement kilns, and nonferrous-metals smelters, many of which use production methods that are decades out of date. Beijing's periodic crackdowns on such producers have little long-term effect. Once the danger has passed, many of them restart their operations and similar new entrants may come on line as well.

The role of the state in China's economic system is thus exactly the opposite of what would be required for efficient outcomes. The state intervenes in cases where the market outcome would be optimal—through subsidizing otherwise loss-making state-owned enterprises, for example—but does not intervene to address market failures. Indeed, allowing polluters to skip required environmental approvals has long been a common form of Chinese local-government subsidy.

Attempts to promote green energy have also been ineffective. Consider wind power, which got a big boost from a 2006 directive requiring the large state-owned power producers to raise non-hydroelectric alternative energy sources to 8% of total installed capacity by 2020. This objective created an incentive to build in the windiest locations, regardless of their proximity to the grid. As a result, by the end of 2010, 26% of China's wind-power capacity was not online.

Local governments were quick to jump on the bandwagon, setting up turbine manufacturers to take advantage of a central-government subsidy for wind-power equipment suppliers. Most of these new factories were quite small—the top 13 producers, out of a total of more than 100, now account for 98% of production. Excess capacity is reportedly as high as 50%.

Beijing's green-energy initiatives suffer from the same level of inefficiency as the rest of the state sector. While lower-level officials responsible for carrying them out have strong incentives to hit whatever target they are assigned, they have much weaker incentives to focus on economic rationality.

The just-announced goal of increasing energy efficiency in buildings, for example, could easily result in local governments installing solar panels on every large rooftop they can find, regardless of the available sunlight. Connecting the panels to the buildings' electrical and water systems might be a low priority as well. Simply paneling a sufficient number of square meters might be all that was necessary to claim that a locality had "gone green."

US-China cooperation is not going to reduce China's carbon footprint because real progress will be impossible in the absence of Chinese political reform. Without radical changes at the state-enterprise and local-government levels, Beijing will have no better luck with CO2 than it has had with sulfur dioxide or toxic metals. And even if new green technologies are developed, there will be no way to ensure that they are deployed effectively. Ultimately, China is going to have to solve its environmental problems on its own.

(Dr. Mark A. DeWeaver manages the emerging markets fund Quantrarian Asia Hedge and is the author of Animal Spirits with Chinese Characteristics: Booms and Busts in the World's Emerging Economic Giant)