Friday, 22 December 2017

The unintended consequences of China's coal ban

Internationally, pollution is a problem, but is more of a problem in some countries than others. When it comes to dealing with the problem of pollution, policy-makers have two options: (1) a command-and-control policy, where pollution is heavily restricted (and backed by enforcement mechanisms such as fines for firms that fail to comply); or (2) a market-based solution, such as an environmental (Pigovian) tax or tradeable pollution permits (see my earlier post discussing these two options).

It is well-known that China has a severe pollution problem, and it is also well-known that when China has a problem the solution is often heavy-handed. In this case, that means a command-and-control policy that restricts pollution, in this case implemented by local officials who banned the use of coal (I might add, this is a policy favoured by some in New Zealand as well, and in place in some areas and under some conditions already). The main problem with command-and-control policies is that they are very inflexible to market conditions. However, they can also come with other unintended consequences.

So, it came as little surprise to me when South China Morning Post reported this week:
Clearly [Chinese president Xi Jinping] is highly sensitive to the anger of ordinary people at China’s sky-high levels of pollution. And clearly his message struck home with party officials. After local government officials either restricted or simply banned coal use across much of Northern China, the residents of Beijing enjoyed unseasonably blue skies and fresh air through November.
But the centrally dictated clean-up came at a heavy price. Coal is not only the main source of fuel for power stations and industry, accounting for about two-thirds of China’s electricity generation, it is also burnt to heat millions of households through Northern China.
So when officials imposed their ban on coal use in line with Xi’s concern for the environment, they triggered a price surge and supply squeeze in substitute clean energy, notably natural gas. And millions of poorer households and many towns and villages unconnected to the gas supply grid were left out in the cold.
Over the past couple of months, natural gas prices have jumped by 70 per cent, hurting energy-intensive businesses, many of which were already operating on razor thin margins. Some have been forced to shut down. That’s bad enough, but even more embarrassing as far as government officials are concerned, are the tales of personal hardship that have spread across the internet and through the media, complete with stories about schoolchildren suffering frostbite because of the lack of heating in their classrooms.
The sad thing is that none of this should have been particularly surprising. When you ban the use of coal, how are households where coal is the only heating option supposed to respond? In terms of industry and electricity generation, coal and natural gas are substitutes. When you ban the use of coal, the demand for natural gas will rise, and so will its price.

You can't just legislate away the trade-offs in decisions like these. A market-based solution, such as a tax on coal, would reduce (but not eliminate) coal use, but would also create incentives for firms and households to switch to cleaner-burning fuels. However, those changes take time. If the government wants to push through change more quickly by imposing a ban, then there are clear human costs that will have to be borne. There is no overnight fix for China's pollution problems that avoids these costs, and it appears that the government has backtracked:
Now the government is using the same mechanisms of central control to reverse its policy. That should help to solve its immediate troubles. But in the longer run the underlying problem will remain in place. As long as Beijing continues to govern by diktat, attempting to manage the supply side of the economy in order to hit arbitrary and often impractical targets, it will continue to encounter similar difficulties.
Indeed. The longer term problem is best solved by creating the right incentives.

[HT: New Zealand Herald]

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