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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© 2022 International Monetary Fund 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 Zhunussova 1 IMF Working Papers describe research in progress by the authors and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the authors 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 growthgrowth 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 the 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 WChenimf.org 1 The authors would like to thank S im on B lack and Ian P arry for signifi cant contri butions to this paper. Th e p ap er h as also ben efited sig n ificantly fro m co mmen ts by Helg e Berg er an d semin ar p articip an ts at th e 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 ETS Design Details _____________________________________________________________________________ 31 3 Brief Description of the IMF-ENV CGE Model__________________________________________________________ 32 4. Distributional Analysis Outcomes by Scenario_________________________________________________________ 35 5. Other Sectoral Policies__________________________________________________________________________________ 38 FIGURES 1. Globa l E ner gy-Rela ted CO2 E mis s io ns Pa thwa ys _______________________________________________________ 5 2. Hi storical GHG Emi ssi ons ________________________________________________________________________________ 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 Emi ssi on P ath s by P olicy Scenari o _______________________________________________________________ 19 4 11. Abatement Costs by Policy Scenario and Time Range _______________________________________________ 20 12. Carbon Price by Policy Scenario ______________________________________________________________________ 21 13.Rebalancing vs. Non-Reba la ncing CO2 E miss io ns Pr o jections_______________________________________ 22 14 Changes in Sectoral ___________________________________________________________________________________ 23 15. Changes in Sectoral Composition_____________________________________________________________________ 23 16. Mean Effect on Consumption Deciles, before Revenue-Recycling by Policy in 2030 _______________ 24 17. Mean Effect on Consumption Deciles, after Revenue-Recycling by Policy in 2030 _________________ 24 18. Mean Consumption Effect on Consumption Deciles, after Revenue-Recycling using Cash Transfers, by Policy in 2020 __________________________________________________________________________________________ 25 TABLES 1. Effective Carbon Tax Rates in China, 2020 _____________________________________________________________ 14 5 A. Introduction Climate mitigation in China is critical to ensuring the durability of its long-term development path. China is especially vulnerable to rising extreme weather events and its warming rate is outpacing the global average. 2 Higher temperatures have a direct effect on productivity and are strongly linked to more f requent and extreme weather events that pose risks to economic growth, health, livelihoods, f ood security, water supply, and human security, which are likely to affect the vulnerable the most see Appendix 1. Moreover, local air pollution from fossil fuel combustion caused an estimated 1.2 million premature deaths in China in 2019, with coal, petroleum products, and gas accounting for 78, 20, and 2 percent of these deaths respectively. 3 Figure 1. Global Energy-Related CO2 Emissions Pathways Figure 2. Historical GHG Emissions Source WRI 2021, IPCC 2018, and IMF staff estimates. No tes baselin e an d NDC p ro jectio ns fro m th e Carbo n Pricin g Assessmen t To o l 175 countries, 95 o f g lo bal emissio ns. Source WRI 2021, IMF staff calculations. Note GHG exclude land-use ch an g e an d fo restry LUCF an d bun ker fuels emissio n s. Climate mitigation in China also has enormous global importance given the size of China’s economy and its role as a major emitter. At the global level, CO2 emissions need to be reduced by 30-60 percent below “business-as-usual” BAU levels in 2030 4 to get on track with containing warming to 1.5-2 o Ceven if fully implemented, current mitigation pledges would only cut global emissions by 1/3 of what is needed for 1.5 o C and 2/3 of what is needed for 2 o C Figure 1. 5 Greenhouse gas emissions GHGs in China grew 275 percent between 1990 and 2018 Figure 2 and are projected to 2 A ccording to the latest China M eteorologic al A dm inis tration Blue Pap er 2021, Ch in a is p articularly suscep tible to n atural d isasters such as h eavy p recip itatio n an d extreme h eat. Its an n ual averag e surface temp erature h as in creased by 0.26 d eg rees Celsius every 10 years fro m 1951 to 2020, much h ig h er th an th e g lo bal averag e in crease o f 0.15 d eg rees Celsius in the same period. 3 P arry and others 2021a. 4 That is a scenario with no new or tighteni ng of existing, m itigation pol ic ies. 5 See also Black an d o th ers 2021. -10 0 10 20 30 40 50 billion tons CO2 per year China EU27 India US Rest of the World China BAU 2C pathway 1.5C pathway 2020 NDCs Global BAU Source WRI 2021, IPCC 2018, and IMF staff estimates. Notes baseline and NDC projections from the Carbon Pricing Assessment Tool 170 countries, 95 of global emissions. 0 2 4 6 8 10 12 14 billlions tons of CO2e Energy Industrial processes Agriculture Waste 6 increase by 39 percent from 2018 to reach 18.7 billion tons in 2030 under the BAU scenario. 6 Under that same scenario, China would account for a third of global energy-related CO2 emissions in 2030, about the same as the global emissions reduction required for a 1.5 o C pathway. In per capita terms, China will be among the top five emitters in the G20. Actions to mitigate emissions in China theref ore make a huge difference at the global level and confer large benefits on all countries. Additionally, action in China will likely catalyze mitigation action among other countries. Thus, China’s achievement of its carbon neutrality goal before 2060and the path it takes towards achieving that goalwill be critical to any successful global strategy to deliver the needed reductions in global emissions. For China, attaining carbon neutrality before 2060 will require the full use of existing and new climate policy tools while forging ahead on the reform path toward high-quality growthgrowth that is balanced, inclusive, and green. As most of China’s CO2 emissions are generated from power and industrial activities, owing to its high investment-intensive growth, any successful climate reform agenda will also require a significant transformation of the economy over the next 40 years. Continuing further on the path of unbalanced growth would not only drive up the already excessive investment share of GDP and accelerate the decline in returns to capital see China’s 2021 Article IV Staf f Report, but also, due to the high carbon-intensity of investment, make it much more difficult to reach China’s climate goals. Conversely, economic rebalancing towards more consumption offers more sustainable and equitable growth benefitting more households and helps the quest for carbon neutrality by reducing the tradeoffs between growth and climate goals. The announcement of China’s climate ambitions has set off a flurry of academic and policy work on potential ways for China to decarbonize by mid-century. Many studies have taken a sectoral approach in assessing the optimal emissions reduction consistent with a net zero goal. Very few studies to date, however, have integrated emissions reduction strategies with economic policies. In particular, the link between economic rebalancing and emissions reduction for China has so far been explored by only a few studies in a systematic way e.g., IEA, 2017, Feng, Howes and Adams, 2014, He and Kujis, 2007. This paper takes a comprehensive and forward-looking quantitative approach and aims to evaluate the impacts of macroeconomic policies, including rebalancing, combined with climate policies on China’s CO2 emissions. A global dynamic computable general equilibrium CGE modelthe IMF-ENV model 7 calibrated to China’s economic parameters provides a particularly well-suited framework to analyze the macroeconomic impacts of climate policies. It links economic activity to environmental outcomes and provides scenario analysis and quantitative policy assessments that are internally consistent. To help quantify the economic and CO2 emission impacts, the paper sets out to evaluate potential policy avenues reflective of China’s climate goals and their resulting paths and cost of adjustments, using the IMF-ENV model. Specifically, there are four types of policy scenarios under consideration, the f irst one being a scenario that incorporates the announced policy actions so far, while the 6 Despite accounting for a significant decline in the energy intensi ty of GDP . Other studies project em issions growth for China of around 15-30 percent over this period e.g., CAT 2020, Den Elzen an d o th ers 2019, Li an d Qin 2019, To n g an d o th ers 2018. 7 Th e IMF-ENV mo d el h as been only recently o peration al at th e IMF, but so me asp ects are still un d er d evelopment including the drafting of a documentation. Meanwhile, readers interested in the model can consult the docum entations of the twin m odels IM F-ENV is built o n th e “ENVISAGE” mo d el van d er Men sbrug g h e 2019 and the “OECD ENV-Lin kag es Mo d el” Ch âteau, Dellin k, an d Lan zi 2014. 7 subsequent scenarios reflect additional policies. All the policy scenarios are compared against a BAU baseline scenario Base action This scenario assumes that all countries implement carbon pricing consistent with reaching their 2030 NDC targets along with a move towards a world of net zero GHG emission NZE in 2050. In this scenario, Chinese GHG emissions would “peak” around 2028consistent with China’s NDC goals of peaking before 2030and then start to decline drastically to reach net zero emissions by 2060. Technically, the model’s timeframe ends in 2050, but the amount of CO2 in 2050 is calibrated such that a continuation of the same policies for the next decade would yield a net zero result. In this “conservative” scenario, the Chinese power system is still characterized by some market imperfection while maintaining the current f eatures of the broader Chinese economy e.g., high investment in infrastructure, heavy industry predominance and investment-oriented growth. Earlier CO2 emission peak in 2023 Intensifying decarbonization efforts sooner than currently envisaged is likely to save costs and reduce unforeseen risks of delays. More intensive decarbonization efforts in the near term will allow for a smoother pace of adjustment that carries lower GDP costs as the climate benefits and positive technological spillovers from supporting green technologies will materialize earlier. An earlier peak would also reduce the risks of delay at the expense of future generations, especially if technology does not develop as expected, or China’s overall growth path changes unexpectedly to the downside. Power market reforms Reforms to the power
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