Emission Trading Scheme in Shanghai, some way to livability?

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Abstract

Major air pollution of CO, SO2, NO2, O3, PM2.5 and PM10 over the past decades in Shanghai has resulted in an unhealthy air quality state, affecting public health and economic development. Recent research into the extent of these effects has raised public concerns and accounts for the need of emission regulations to sustain a transition towards a healthy and liveable environment. A system that has proven to be able to accomplish this transition is an absolute cap-and-trade Emission Trading Scheme (ETS). By implementing this market-based system in Shanghai, the maximum amount of pollution can be regulated and subsequently air quality could be improved. However, to allow for the implementation of an ETS in Shanghai, the presence of certain fundamental principles is essential. The aim of the report is to identify and discuss these for the Shanghai case, by combining expert knowledge from an economic, political and modelling perspective. From this, the concept of general equilibrium models was used to develop four possible future scenarios. To allow for successful implementation it was found that a capitalistic supporting political system is needed. Secondly, strict regulation is essential to support for a successful efficient ETS. Moreover, a bottom-up political system is needed to allow for the implementation of a local ETS. Since Shanghai is currently a “state-led” pseudo communistic top–down regulated market system, to accomplish a healthy and liveable environment, a transition towards a capitalistic bottom-up system is needed before an ETS can be successfully implemented.

University of Amsterdam

Lisa Bakker, 10287841, Human Geography Julian van Velzen, 6353363, Modeling Lennard Visser, 10263330, Economics

Emission Trading Scheme in Shanghai,

some way to livability?

Final 23-05-2014 Interdisciplinary Project, 2014 Future Planet Studies

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Introduction

Problem identification

Shanghai, situated at the Yangtze River delta in China (figure 1), has due to its favourable port location become an important distribution and trading centre within Asia. This has resulted in the transition of Shanghai into a main global financial centre over the past decades. The large industrial activity that this entailed has led to major air polluting emissions nowadays. As a consequence a constant unhealthy air quality state, reaching toxic levels more and more often, is found in Shanghai. According to recent conducted research, the current unhealthy state of the air quality is significantly harming the environment and liveability of the city; as a consequence costs of associated health effects were estimated at 3.8% of GDP last year. Current described effects in conjunction with the prediction of increasing emissions in the near future have raised concerns and public pressure on political regulations regarding the air quality in Shanghai (The World Bank, 2007; Ottery, 2013).

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Since pollution affects the sustainability potential of the city and therewith, as described by Lehman (2010), the fundamentals required for economic development, the importance of improving air quality becomes even greater for Shanghai’s future. To counter emissions, adequate policy measures should be implemented that limits pollution and subsequent significantly improves air quality. Furthermore, such a policy should reduce air pollution to a state in which a stable, healthy and liveable environment is created. A system that could trigger and accomplish such a transition must account for the price associated with pollution and set a limit to the maximum amount of pollution allowed. Although there are plenty of policy measures that could be considered, an absolute cap-and-trade Emission Trading Scheme (hereafter ETS) appears to be the most suitable policy since it manages both of the requirements. For example, a tax system only takes into account the price associated with pollution, whereas setting a pollution limit only masters the second requirement (The World Bank, 2007; Kuik & Mulder, 2010; Kuik, 2014).

Emission Trading Scheme

An ETS is a market-based approach that allows companies to trade or sell the granted emission permits. These permits are issued by the regulator, in this case the municipality of Shanghai, which will set a limit on the total emission allowed over a certain time period. According to Kuik (2014) disposes an ETS over the ability to be a reliable and adequate policy to enhance a reduction in emissions, if accurate implementation is provided. The first introduced trading scheme was part of the United States Acid Rain Program (ARP) in 1990 and from the US ARP the European Union Emission Trading Scheme (EU ETS) evolved. Although these ETSs focus on the reduction of respectively SO2 and CO2 emissions, during developing a new ETS much can be learned from the extensive data available regarding the implementation of these two programs. Scientific research such as the survey of Wang (2004) composes a theoretical framework which can be used in implementation of an ETS in general. Wang indicated factors that affect the performance of environmental policy instruments in an economic framework. Moreover, among others Wang describes that initial allocation auction, banking mechanism and abandonment of related former environmental standards are key factors that contribute to a successful implementation (Kan & Chen, 2004; Zhang, 2010; Tiezzi, 2014).

In the past decades China has already shown great interest in introducing a similar program to counter air pollution. According to Tao (2009) success of the implemented pilot ETSs was

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constrained by problems in three areas of governing capacities, namely: in state, policy and administrative capacities. These problems appear to be a deeper reflection of a market transition over the past three decades. Although China's market is in transition towards a free market, in reality it is a "state-led" pseudo market. Tao also indicates multiple distinctive features from Chinese ETSs from western programs that might raise issues; these include a top-down nature within the political system and limited trading due to a small number of qualified potential buyers and sellers. Tao further notes that the pilot ETSs were based on instructive prices, instead of a market based price as is the concept of a cap-and-trade system. According to Zhang (2010) there also exist a lack of data regarding environmental capacity and value determination, the allocation of emission, establishment of operation of market system and legislation and enforcement of an ETS (Tao, 2009; Kuik & Mulder, 2010; Zhang, 2010; Tiezzi, 2014).

Advantages and disadvantages of an ETS

A great advantage of an ETS in comparison with other similar existing policy measures regarding air pollution is the ability to determine the maximum amount of emission that is granted. However, a disadvantage of an ETS is that the regulator is not able to determine or influence the market price related to the issued permits directly. This could lead to market prices that are too high or low, and therefore unrepresentative for the actual costs associated with generating air pollution. As a result, the economic system within the ETS zone, in this case Shanghai, could unintended be affected with the risk of deteriorating the current economic system and future development (Kuik & Mulder, 2010; Kuik, 2014).

Furthermore, the limit on the total amount of allowances according to the ETS creates scarcity. This is needed to establish trade and thereby support the companies to take measures to reduce their reduction, for example, more efficient mechanisms and technology or using “green” energy sources. However, if it would be cheaper for big polluters to introduce new technologies instead of buying allowances and continue with their old technologies, companies would choose for the first and cheapest option. This would be an important step towards a more “sustainable city”.

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Research question and objectives

As can be concluded from the previous section, an ETS could significantly reduce air pollution, and contribute in accomplishing a healthy and liveable environment. However, it is essential that implementation of the ETS is conducted carefully. The focus of this report lays on indicating the success factors and fundamental principles of the implementation of an ETS in Shanghai and their importance in achieving the contemplated goal. Consequently, the research question is: ‘How should an Emission Trading Scheme be implemented in Shanghai to help support a decrease in pollution (of CO, SO2, NO2, O3 and particulate matter PM2.5 and PM10) and therewith contribute to a transition towards a healthier and liveable environment?’

Since the main polluters deteriorating the local and regional air quality are CO, SO2, NO2, O3 and particulate matter PM2.5 and PM10 (hereafter referred to as pollutants), the research will focus on reducing these pollutants. Moreover particulate matter consist of tiny coarse or fine, solid or liquid particles in the form of smoke or toxic compounds and is expected to be the air pollutant that most commonly affects people’s health (The World Bank, 2007; AQI, 2014).

Due to the complex nature of the research question, an interdisciplinary research approach is essential to enable identification of deeper insights into the ability of the implementation of an ETS in Shanghai. These will be gathered and offered by combining the three disciplines, politics, economics and modelling, whereby no single discipline is able to address the problem comprehensively. Subsequently, by creating common ground and building bridges between issues at the interface of the sub-disciplines the research will be able to overcome constraints regarding the implementation of an ETS.

Structure

This paper consists of five parts. In the following section important insights from the sub-disciplines will be explained in the theoretical framework. This section will be followed by the methodology, wherein the used methods in and the concept of the research, using different scenarios, is described. The fourth section clearly sums up all important obtained results wherein relevant qualitative and quantitative data is interpret. Thereafter the conclusion and recommendations to the Shanghai municipality concerning the implementation of an ETS in Shanghai will be provided. The paper will be ended with a discussion and bibliography.

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Theoretical Framework

This chapter provides the theoretical background of the research problem, concerning relevant theories and key concepts. By integrating these main theories and key concepts from the perspective of the three disciplines, deeper insights into the complex character of the research problem will be gathered (in chapter 3 ‘Methods’). However, according to Repko (2012) successful integration can only be obtained if these underlying theories and concepts are fully understood. Therefore, relevant theories regarding to the importance of creating a liveable environment, the onset of the unhealthy air quality, the concept of an ETS and theories and key concepts concerning the ability to implement an ETS in general will be introduced and described in this section.

Economics

Firstly, economic theories and concepts are used to describe the importance of creating sustainability in a mega city, to identify driving factors of the existence of the problem and to explain the principle of an ETS.

The importance of sustainability

The importance of sustainability has been brought to attention by Burton (1997) and Jenks & Burgess (2000), and by Lehman (2005) in the form of the concept of ‘Green Urbanism’. These authors among others describe similar theories concerning their vision for developing urban renewal and environmental sustainability within cities, based on fundamental principles. One of these principles by Lehman, describes the need for a ‘triple-zero’ frameworks, based on zero fossil fuel energy use, zero waste and zero emissions. Therefore, to create a sustainable city air quality must be improved by reducing pollution. Moreover, Lehman (2010) states that ‘achieving more sustainable growth for Asian metropolitan cities’ specifically is a necessity and addresses the importance of liveability and a healthy community to support a sustainable city. The aim of applying the introduced concepts is to create a high density overlapping mixed use energy efficient megacity, whereas living and working environments are combined and there is ‘low-to-no-carbon emissions. For the Shanghai case this means that to create a sustainable city and subsequently allow for sustainable economic and population growth a liveable and healthy community must be created. Wherefore, to support a transition towards a liveable and healthy community and

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eventually a sustainable Shanghai, air quality should significantly improve in Shanghai (Burton, 2000; Lehmann, 2006; Wang & Hao, 2012; IISD, 2014).

Onset of the problem

The past development towards an unhealthy air quality state in Shanghai could best be explained by the theory of Hardin (1968), named ‘Tragedy of the Commons’. This theory describes the urge of companies to behave in their own interest when no property rights are declared, leading to externalities on the common goods or common resources. Underlying reasoning contains that if there is a lack of defined property rights, for-profit companies that are acting independently and rationally will behave in their self-interest. In practise on the individual company level, economic costs associated with preventing for externalities are higher than the in economic terms expressed consequences. As a result, these companies tend to do not care about the negative external effects on the common goods (for example the environment) caused by their production process. This theory will even hold when this is in contradiction with the public long-term best interest. In the case of Shanghai, due to the lack of declared property rights regarding clean air or air pollution, responsible companies are not fully confronted with the long term public costs related to their pollution. Subsequently, this behaviour results in major air pollution at the moment in the form of externalities (Hardin, 1968; The World Bank, 2007; AQI, 2014).

Therefore, to be able to counter the major pollution present companies must be confronted with the associated costs of the pollution generated. This could be achieved by forcing companies to take into account the costs related to the externalities within the production process, based on the concept of internalizing (Varian, 2010).

Concept of an ETS

One way to accomplish internalisation of the externalities is by implementing an ETS, since the price of the externality will be addressed and become on behalf of the responsible offenders. Such an ETS is based on the concept of a cap-and-trade system, whereby the inefficient market outcomes will be corrected for, as the societal costs of externalities will become internalized. In figure 2 this principle is visualised and operates as follows: the government or city council sets a limit (cap) on the maximum amount of pollution allowed, by issuing a limited number of permits. Next, companies are allowed to trade these emissions whereby market efficiency is created, since companies with the lowest abatement costs will

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decrease their pollution. The effectiveness of an ETS depends on the strictness and fines set. Strict regulation will prevent exceeding the set cap (Pigou, 1932; Varian, 2010).

In Shanghai an ETS could be able to address a price on air pollution and therefore associated costs will be taken into account within the production costs of the enterprises. However the effectiveness of an ETS in Shanghai depends on the amount of permits that are issued by the city council and the strictness of the regulation policies that are implemented. As these determine the amount of pollution that is allowed to be generated and if companies will meet or exceed the set cap. Therefor strict policy must be adopted to allow for successful implementation (Wang & Chang, 2010).

Politics

To be able to implement an ETS successful the political system should support the ETS. Therefore from a political perspective important theories and concepts are identified to obtain

Figure 2, shows the principle of a cap-and-trade system. The government agency determines a

‘cap’ or limit on the amount of pollution allowed, by issuing a number of permits. Furthermore, companies will be fined when exceeding these caps. To allow companies to expanse their production they are able to trade the allowances with each other. The system will result in a reduction of pollution when costs of decreasing pollution are lower than the price of the allowances.

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the ability to implement the ETS successfully in Shanghai and subsequently set a transition towards sustainability. Hereby general theories are compared to the current system found in Shanghai.

Resilience thinking

A first theory that is essential to obtain a healthy and liveable city is resilience thinking. Walker and Salt (2006) defined resilience thinking as “the ability of a system to absorb disturbance and still retain its basic function and structure”. Hereby the resilience is determined by the ability of city dwellers to respond on disturbances of the ecosystem as a result of changes of the environment, like increasing emissions. The reaction of the population could be explained in evolutionary terms, whereby different characteristics or factors are altered as a reaction on the observed changes to ensure their survival (Pisano, 2012). “The need for persistence” is a key concept to achieve the goal of building sustainable cities (Pisano, 2012). According to Pisano (2012), “humanity has a need for persistence”. To reach security and sustainability, the population uses ecosystem services whereby all disciplines (economics, politics, social sciences, ecological science, etcetera) are involved in the process towards wealth (Pisona, 2012). In Shanghai the concept of resilience thinking and persistence is not present within both the government and the community. However, to support a successful implementation of an ETS the government of Shanghai should adopt the concept of ‘resilience’ thinking within the community. Due to the current governmental system that is found in China, as will be described below, Shanghai has a limited ability to implement local policies (Tao, 2009; Shin, 2012).

Governmental system

The efficiency of an ETS is among others determined by the type of governmental approach present, varying between top-down and bottom-up, whereby the concept of a bottom-up approach is essential for successful implementation. When the local government plays an important role in making policies (in other words, when a bottom-up approach would be present) the distance between city dwellers and local industries is reduced. Wherefrom the community will benefit since policy measures can be customized to the local situation and only local actors play a role. Since there are many actors with economic interests, implementing environmental law is not always easy. This concept will be further elaborated on in the “Results” section (Tao, 2009; Wang & Chang, 2010; Shin, 2012).

At the moment, the government of Shanghai is currently regulated by a top-down policy, since in China national interests are more important than local. This influences the ability of

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the municipalities to implement their initiatives to counter current air pollution. However, implementation of local environmental laws is not ruled out, in 2000 the municipality of Shanghai came up with a three-year Environmental Action Plan to improve the air quality. The first step towards a sustainable and liveable city had been made by the government whereby resilience thinking played an important role during the development of the policy (Shin, 2012).

Another important topic from a political perspective concerns the current national ideals of China. Under Deng Xiaoping (leader of the People’s Republic of China from 1978 to 1992) the ideals of China shifted to a form of “market socialism” whereby he successfully opened up China to the outside world and China experienced industrialization. The current constitution was born in 1982, where the first step towards freedom and the right to own private property was set. In practice, the constitution did not completely exist. This was visible in the national and local legal system, whereby it was not allowed to implement new law. As a result of the increasing rate of computer usage in China, ethics became a more openly discussed topic. This resulted in an increase in the demand for privacy and ownership over the past years. In contrast to the capitalistic bottom-up approach needed to support an ETS in general, the government of China is currently regulated in the form of a “state-led” market system. The presence of the current system could deteriorate the effect of the implementation of an ETS. To support for a successful implementation of an ETS, a transition towards a bottom-up capitalistic market regulation system in China is expected to be essential. However the question remains if this transition is possible, this will further be elaborated on in the results section (Han 2000; Shin, 2012).

Modelling

General equilibrium model

Lastly, the key concept of closed models from the modelling discipline is used to describe the current situation and determine the effect of an ETS on the air quality. A model that is frequently used is to map the outcome of new policy implementations is the computable general equilibrium (CGE) model. The CGE is a model that describes a simplified representation of a certain market. The fundamental basis of the CGE models is the theory of equilibrium formed by Leon Walras in 1874 (Cardenete, 2012). For an economic system to reach equilibrium it has to be closed, meaning that the flow of commodities stays within the system. Different actors are represented in the state of equilibrium. The fundamental

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assumption is that both products and value circulate through the system, and are therefore conserved. This means that no value or product can be created, or destroyed out of nothing. Research of Changhong (2001) suggests that case of Shanghai can be described by a CGE model, treating it as a closed system. A frequently used example of a CGE model is the MARKAL model by Changhong (2001). Problems might arise since China is led by a top-down structured national government, therefore a closed system of Shanghai might not be representative for the laws and policies that are present in the current system. However, the research problem concerns air pollution which is a local effect and could therefore be described by a local or regional closed system. Therefore if air quality and related policies are regulated on the local level, a closed system could be realistic for Shanghai (Tao, 2009; Shin, 2012).

A closed model that appears to be sufficient to describe the system, problem and the intended solution is MARKEL. MARKAL is a numerical model provided by the International energy agency for analysis of different energy systems. The system allows the input of parameters such as energy costs, building performance, and plant costs. It is then used to solve the general equilibrium and provide optimal emission abatement options.

In conclusion, in this section insights in the fundamental parameters of implementing an ETS in Shanghai are provided. From a political perspective; the importance of resilience thinking and a bottom-up approach is identified. From an economic perspective; concepts such as ‘internalization’, ‘cap-and-trade’ and ‘green urbanism’ are relevant to enable stable economic growth. From modelling perspective; the necessity of a closed regulated system is identified.

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Methodology

The research started with the identification of the important single disciplines that define the complex situation of emission trading in Shanghai. From the available literature it was observed that economics and politics are the fundamental disciplines regarding implementation of an ETS to reduce air pollution in Shanghai. Furthermore, it was obtained that by modelling important insights regarding an efficient and successful implementation could be exhibited. Subsequently, to arrive at deeper insights into the problem, a monodisciplinary research was conducted by experts in these disciplines; Bakker (politics), Velzen-van (modelling) and Visser (economics). In the individual monodisciplinary ventures, a literature study was conducted to obtain general concepts and theories that are applicable in the subject of emission trading in Shanghai. Furthermore, a depth interview with Kuik senior environmental economist at the Institute for Environmental Studies (IVM) from the economic perspective was conducted. Kuik which among others did research on the EU ETS, contributed to exposing fundamental and critical insights in implementing an ETS. During the monodisciplinary research, focus was centred on the fundamental principles and assumptions that lay the foundation for mono-disciplinary theories.

Common ground

The common ground between single monodisciplinary theories was found by the integrative techniques of Repko (2008). Repko mentions five techniques that include the integrative technique of extension, transformation, redefinition, (re)organization. The first technique, extension, can be summarized as a magnification of the existing theory, whereby new content is added. The integrative technique of transformation describes a transition from a discrete to a continuous range of concept. The integrative technique of redefinition includes the transition of a narrow definition, to a broad concept of the theory.

In the search for common ground these techniques were used to connect overlapping and conflicting theories. All connections are summarized in figure 3. In the field of economics, the most important theories regarding emission trading in Shanghai are the theory of cap-and-trade, Internalization, and a general market system theory. These theories are interrelated with both political and modelling concepts and theories.

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Firstly common ground concerning the cap-and-trade system and the state regime in China was found by redefinition. As China has a state-led market this is in conflict with the trade system, which originally describes a free market based system. By redefining a cap-and-trade system to a broader concept, whereas it allows for interventions of China’s municipality, a new multi-disciplinary theory of cap-and-trade is formed.

The technique of redefinition can also be used to integrate the market system into the concept of a closed model system of the general equilibrium theory. In order to describe a market economically, one must know all actors involved for it to be representative. So when a market system is redefined to a broader concept of a closed system that obeys economic rules, it can successfully describe both the market system theory from an economic perspective and the closed system theory from a modelling perspective.

From a modelling perspective, the most important concepts include the conservation of value, and a closed system theory. Conservation of value implies no value leaves an observed system, and so all externalities are internalized. The same idea is applicable to the theory of

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externalisation. Therefore, by the technique of extension, conservation of value can be integrated with the theory of internalization by creating a new theory that describes both monodisciplinary theories by the same principles. From a political perspective, state regime and resilience are the most important theories. If the political theory of resilience is redefined to a broader sense, it is also applicable in the field of modelling, since models describe turbulences from certain equilibrium.

Finally, when all theories and concepts are reorganized, the concept of modelling scenarios functions as an overlapping container that involves aspects from the political, economic and modelling perspective.

Scenario development

With help of the integrative techniques theories from the disciplinary perspectives were compared. This led to the identification of the most important parameters that control all disciplines and therefore influence the ability to implement an ETS in Shanghai. These parameters formed the basis of the common ground.

After extensive literature studies of mono disciplinary research we identified the main parameters to be the following.

1: The degree in which the Chinese government initiates a shift from a communistic system, in which the market is top down driven, to a capitalistic system, where the economy is driven by a rational free market. This is an important parameter, since it influences the nature of the economy in Shanghai, the political state (which also matters for the manner a trading scheme is enforced) and the manner in which an ETS successfully can be described by any kind of model. The outcome of this parameter remains uncertain. Although the Chinese government has reported a five-year plan, in which ambitions in order to open up its market are noted, the precise interpretation of this plan remains uncertain, on both national and regional level.

2: The ambition of the Shanghai legislation to decrease emissions, ie at what level quota is set concerning emission rights. This parameter is determined by the political state, which is responsible for any kind of legislation and law enforcements that are shaped. Subsequently, the parameter obviously influences the nature of the economy in Shanghai, since it determines

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the economic incentive for polluters to reduce pollution. It also determines the nature of any kind of model that describes the emission trading. CGE models that were described in the previous section numerically solve for possible scenarios, and therefore depend on the value of this parameter.

Within the research we develop four different scenarios on the basis of two axes (figure 4). In all four scenarios same principles of an ETS in the form of the described absolute cap-and-trade system are introduced, including a same effective amount of permits. On the x axis in figure 1, we set the degree of a shift to a market based system. On the far left side, politic remains in the current communistic top-down nature

and the market is governmental driven. The far right represents a total shift to a free market, and rational system with a capitalistic bottom-up nature. On the y axis the degree of regulation is set, since in the EU ETS problems arose concerning the degree of regulations. At the below quadrants, there is soft regulation whereby soft governmental action is taken regarding sanctions, like fines, for exceeding the allowed amount of emission by companies. This divides the future emission trading into following four scenarios:

A: a capitalistic system whereby strict regulation is managed. In this scenario due to political alterations a transition towards a free market is predicted. As a consequence of the implemented regulations regarding an ETS and the strict regulations executed a significant decrease in emissions is expected.

B: a capitalistic system whereas soft regulation is carried out. In this scenario there may be economic changes to shift the Shanghai production economy to be more efficiently. However, due to the implementation of soft regulations the extent to what pollution will be reduced is notwithstanding the ability to determine maximal pollution is uncertain.

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C: represents a communistic system in which soft regulations are applied. The political system will be top-down regulated from the national governance, therefore the ETS market will be regulated. In light of creating a successful ETS in Shanghai, this scenario is the least likely to occur since an ETS is understood to be dependent on a free market economy whereby strict regulations are essential in order to efficiently and significantly reduce emissions. Since the law will not be effectively enforced, there is no economic incentive to efficiently reduce emission pollution.

D: a communistic system where strict regulations are set. In this scenarios the lack of a sufficient fundamental political basis is expected to result in a poorly governance of an ETS.

In the results section these scenarios and their consequences will be further elaborated and interpret, also the effect of leading parameters and success factors on the state of an ETS in Shanghai will be discussed. Scenario building is a valuable method in describing an ETS in Shanghai since it takes multiple uncertain parameters into account.

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Results

This section shows an overview of the most important results. First, we will describe why an ETS would be an effective mechanism to reduce emissions. Second, we will sum up the conditional aspects for implementation an ETS. Third, we will analyse constraints that appeared at the implementation of the EU ETS to overcome the same problems. Fourth, we will describe four future scenarios of Shanghai based on political and economic parameters to analyse which combination of parameters would fit best into an Emission Trading system.

Conditions for an ETS

Top-down or bottom-up approach?

Research shows that the role of the government is fundamental and essential in implementing an ETS, as interventions of the government could influence the development of the market. Therefore they must draw a clear boundary between the market behaviour and government intervention (Betsill, 2010). As a consequence it is important to implement good legislation and focus on the right approach, which includes a bottom-up and a more capitalistic system (Shin, 2012). The current political basis focuses on a top down approach, whereby this approach shows major institutional weaknesses. This top down perspective assumes that policy goals can be specified by policy makers and that implementation is possible by setting up certain mechanisms and methods. In other words, it shows the policymaker’s view. Also, it shows a strong demand for generalizing policy advice. On the other side, a bottom-up approach pays attention at not only formal but also informal relationship regarding the policy systems. This includes all the parties involved in creating and implementing policies. According to this approach, the focus is more on individual, small parties and the local community in comparison with a top-down perspective. A bottom-up approach allows the local community and the local stakeholders to express their perspectives and interests and thereby participate in the process towards implementing new law. These actors could help define the development of a policy for the city in line with their own interests; this is a fundamental element regarding implementation of an ETS.

Nevertheless, there is a conflict between the two approaches; both perspectives disagree with the different viewpoints which make it impossible to combine the best of both objectives. In

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the current political system, the leading municipality decides whether the initiatives from the municipalities of Shanghai regarding new law to improve the air quality, can be implemented (Shin, 2012). The municipality is in the end responsible for implementing the legislation of Shanghai; the centralized national government has strong influence on the political agenda of Shanghai, and enables the municipalities of the city to come up with new initiatives and implement policies (Shin, 2012). This implies that the current political system of China is based on a top down approach.

Cap-and-trade and capitalism

In order for a cab-and-trade system, as described in the theoretical framework, to function properly the political and economic system should support the operation of an ETS. This paragraph describes the importance and conditions regarding implementation of a cap-and-trade system from an economic and political perspective.

From an economic perspective, since an ETS is based on free market operation, a free economic market system is essential to implement a successful ETS. Nowadays, China and subsequently the city of Shanghai find themselves in an already three decades lasting transition towards free market system as described in the 5 year plan, however this transition is not completed yet and therefore Shanghai does not dispose over a free market. Instead, its market is currently described as a “state-led” pseudo market, such that the economic market is, to some extent, regulated by the municipality. Kuik (2014) among others state that the presence of a free market is essential in the operation of an ETS, wherefore the ETS is in conflict with the current found system (Kuik & Hofkes, 2010).

In order to overcome this fundamental issue and support an ETS, the mentioned transition towards free market system should be achieved first. This is easier said than done since the political system in China and subsequently Shanghai is top-down regulated in a more communistic than capitalistic fashion. Therefore, a political supporting system is an essential fundament for an ETS to operate successfully. As mentioned before, the political system must shift towards a capitalistic bottom-up functioning system. Concerning creating a sufficient basis of a political system, as mentioned in the introduction, Tao (2009) indicates limitations arising in three main areas of governing capacities: state, policy and administrative capacities. States, since policies in China are nationally controlled. Policy, as there is at the moment a lack of pollution regulations present in China. Furthermore, administrative capacities should

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be expanded on, to be able to support in all needed aspects concerning an ETS. To overcome these limitations, the top-down nature of the state should be altered such that Shanghai is able to create own policy, subsequently new policy measures regarding pollution must be implemented and also administrative capacity should be expanded (Tao, 2009).

Constraints EU ETS

To overcome this problem, before developing new policy measures concerning implementation of an ETS in Shanghai, the concept and the implemented system should be considered carefully. A first step is made by analysing constraints that appeared at the implementation of the EU ETS. The main issue of the limited positive effect of the EU ETS follows from the amount of emission permits issued. In the EU the amount of permits is too high resulting in a lack of the emergence of scarcity, and therefore a too low price. The abundance of permits is the result of the three following causes. Firstly, the EU has distributed too many permits out of fear of intercontinental competition. Secondly, since the economic crisis was not foreseen, the decrease in production and energy consumption was unidentified such that the less permits were needed. Finally, as multinationals are allowed to purchase emission rights outside the EU, for example from China, more emission rights are available than those distributed by the EU. Another limitation that came to light from the EU ETS is the lack of strict introduced regulations regarding maintenance tools, like fines, to ensure that companies do not exceed the allowed emissions (Kuik & Oosterhuis, 2009; Kuik & Hofkes, 2010; Kuik, 2014).

From this it can be concluded that prior to the implementation of an ETS in Shanghai, the accurate amount of permits needed must be determined to create a successful ETS. Whereby, the expected economic development, costs associated with reducing pollution and the level of current emissions should be taken into account.

Comparison to existing models

The use of computable models can be in particular valuable for generating quantitative data. Due to the complex situation of emission systems, these models tend to involve numerous actors and variables. This paper, therefore, makes uses of existing research, that has utilizes MARKAL simulations of Shanghai energy systems, or comparable situations. The MARKAL

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model, that has been described in previous section, is particular useful in this situation, because it has the entire energy market dynamics embedded in it.

For this paper, the MARKAL simulations of Changhong (2006), Kan (2004) and Gielen (2001) were investigated. Since all simulations cover the energy market of Shanghai, the results can be used as quantified data for the research of this paper. However, all three researches are based on different implementation of the MARKAL model; all constructed scenarios are based on more or less the same starting point. Both the simulations of Changhong, Kan and Gielen describe a 'business as usual' (BAU) case in which energy consumption will follows the same pathway as the recent past. Changhong notes that in this case energy usage in 2035 will reach more than 3000 Peta-joule (PJ) for Shanghai. The energy usage will be mostly provided by coal driven power stations, which pollutes hazardous emission of SO2 and PM10. In the simulations of Kan, the BAU scenario considers only economic growth and no energy and environmental policies are implemented. Kan notes that, compared to various energy scenarios, the BAU case would cause an extra 1189 to 10,462 PM10 related deaths in 2020.

Besides the BAU scenario the investigated simulations all provide some scenarios in which new energy policy is adapted. The simulations of Changhong describe two scenarios in which a coal cap is considered. In the first case, a coal cap of 50 million tons is considered. Changhong notes that this can be considered as a robust forecast that may be relatively easy to achieve in the future. In the other scenario a coal cap of 45 million tons is considered. This scenario is less likely to be achieved due to the relatively high price of coal alternatives. Gielen describes three different scenarios in which energy policy is adapted. The energy policy case, in which also a coal cap of 50 million tons is involved, show a decline of 15% of CO2 emissions compared to BAU case in 2020. Other scenarios that include SO2 and Nox emission constraints and CO2 reduction incentives besides a 50 million tons coal cap result to a decline of up to 24% of CO2 emissions.

The scenarios C and D, which were obtained in the previous section of this report, are well comparable to the BAU case used in the MARKAL models. Scenario C and D are defined by a low degree of regulation of an implemented ETS. Although an ETS is implemented, emissions are not reduced significantly and the ETS legislation has low impact. The results of BAU scenarios are therefore comparable, resulting in a significant increase of emissions, and

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associated air pollution deaths. The scenarios A and D share a lot of similarities to the energy scenarios of the MARKAL model simulations. Although an ETS regulates the emission permits directly, instead of capping coal usage, both scenarios describe economic / political methods in order to control emissions in Shanghai. The results of the energy scenarios that were obtained by simulation are roughly applicable to scenarios A and D since they thoroughly describe ambitious energy policy in Shanghai. It can therefore be estimated that emissions will decline between 15% and 24%, comparable to the C and D scenarios in 2020.

Four Scenarios

Four scenarios have been described in the previous chapter whereby two parameters have been taken into account. These parameters include the degree of regulation and the degree of the Chinese government regarding a communistic or a capitalist system. The gathered insights have been combined into the formation of four scenarios. The aim of the scenarios is to determine which combination of the parameters would allow Shanghai to implement an ETS most successfully. The four scenarios show the conditions regarding implementation of an ETS in Shanghai.

A Strict regulation and capitalism

The free market and the forces of supply and demand, will support trade of emissions. From an economic perspective, a free economic market system is essential to implement an ETS in Shanghai. A cap-and-trade system, as described in this section, is necessary to support trade of emissions. However, a maximum is set on the total amount of greenhouse gases that could be emitted by all companies as a result of strict regulation. To improve emission trade, good and subsequent strict regulation is needed; strong law and a strong administrative system is essential to create the trading scheme. The capitalistic bottom-up functioning system will create a right political basis to support the operation of an ETS by allowing for a free economic market in Shanghai. As a consequence, local governance will benefit from the interests and demands of the local industries and city dwellers and this influences the ability of the local government to implement their law, ideals and initiatives to improve the environment. Also, strict regulations concerning exceeding allowed pollution, will force companies to reduce pollution to meet the set emission targets. According to this scenario, implementation of an efficient and successful ETS would be possible.

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B Soft regulation and capitalism

In this scenario there will be a free market whereby the system is free of intervention by the government. This is the exact opposite of the regulated market in which the government intervenes in the forces of supply and demand through creating laws. Less regulation of the government, results in more trade of the emissions, because of the possibility to grant property rights regarding to the emissions. In the capitalist economy, division of property rights is managed by companies themselves through the forces of supply and demand. Also, soft regulation creates new opportunities for the local government to create and implement new law to stimulate the introduction of an ETS. However, China has to guarantee a transparent legal and administrative framework in order to support participation of the polluters. In this scenario, an ETS could be implemented very easily.

C Soft regulation and communism

According to this scenario, the market is top-down regulated, whereby the national government controls and regulates the local government (municipalities) of Shanghai. This communistic viewpoint is similar to scenario D but involves less regulation. However, similar to scenario B, soft regulation creates new opportunities for the municipalities of Shanghai to introduce new legislation in order to support implementation of an ETS. In order to reduce the emissions, new legislation is introduced based on the economy of Shanghai. Property is owned by the state and production levels are managed by the national State instead of via supply and demand; this implies that emission trading is not possible in a communist based system as a result of the regulated and controlled market instead of a free market. Implementation of an ETS based on this scenario, will be very hard.

D Strict regulation and communism

Strict regulation and limits on pollution will force the big polluters to reduce their emissions. The set emission target avoids excessive pollution. As mentioned in the first scenario, a strong administrative basis and strong law supports operation of the market. However, the communistic approach according to this scenario is similar to scenario C. Common ownership, whereby private ownership is limited, is one of the most important concepts regarding to communism. This means that the division of the property rights regarding to the emissions, is not possible and that does not fit with the ideology of the Trading Scheme. In other words, a communist system whereby the state owns and directly manages all productive assets and thereby limits private ownership of productive assets, is not able to adopt a trading scheme similar to the EU ETS, because the “cap-and-trade” approach (emission trading) does not fit in a strictly “top-down” regulated system.

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Conclusion

To accomplish a healthy and liveable environment and to improve the health of the city dwellers of Shanghai, the government on local, as well as national scale should come up with solutions to reduce emissions and significantly improve air quality. An effective and successful solution for this environmental problem could be the introduction of an ETS. This report focuses on the question whether implementation of an ETS in Shanghai is possible and what alteration are essential regarding the economic market and political basis to improve the success factor of an ETS. It furthermore focuses on the capacity of representing the state of an ETS by means of models, based on economic and political parameters.

In other words; How should an Emission Trading Scheme be implemented in Shanghai to help support a decrease in pollution (of CO, SO2, NO2, O3 and particulate matter PM2.5 and PM10) and therewith contribute to a transition towards a healthier and liveable environment?’ The complexity of the research question requires an interdisciplinary approach whereby three disciplines have been combined; politics, economics and modelling. The aim of this research was to determine which changes have to be made within each discipline to implement an ETS.

From a political perspective, two essential principles should be adopted; the government of China has to make her policies from a capitalistic perspective, to provide a well-functioning political basis to adopt and implement emission regulations. Secondly, the government should adopt resilience thinking to provide a healthy and livable community within a major economic industrial region. Furthermore, an economic perspective shows that the concept of a “cap-and-trade” system, the internalization of pollution, and “green urbanism”, to provide for a livable economic environment, are essential concepts to enable future sustainable economic growth. At last, computable models, specifically computable general equilibrium models, have shown to be able to provide valuable insights. It does, however, require a closed system that is based on rational decisions.

The gathered insights have been combined into the formation of four scenarios. For this two determining parameters have been identified. Those include at first the degree in which the Chinese government initiates a shift from a communistic system to a capitalistic system, and secondly the ambition of the shanghai legislation to decrease emissions, i.e. at what extend

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quota are set and regulation are applied concerning emission rights and consequences of pollution exceeding by companies.

The four resulting scenarios are: A) Strict regulation and capitalism, B) Soft regulation and capitalism, C) Soft regulation and communism, D) Strict regulation and communism. Scenario A provides the conditions necessary for an ETS to be successful. A capitalistic system will substantiate the economic requirement for an ETS. Legislation and political willingness ensure a strict regulation. Furthermore, best predictions and precautionary for the implementation of an ETS can be made within this scenario by the means of modeling because the system in Shanghai is based on understood and rational decisions. The Chinese government has shown to be ambitious towards this scenario, there is however, a long road ahead. To allow for a healthy and liveable city, a first step is to alter the political basis from a top-down national regulated system into a local bottom-up functioning system, to among others allow Shanghai to implement nationally independent pollution policies regarding CO2, SO2, NO3, O3 and particulate matter PM2.5 and PM10. Secondly, the political system must shift from a communistic towards a more capitalistic system, such that the concept of an ETS, based on free market principles is supported for by policy measures. Moreover, clear and strict policy should be implemented in Shanghai. If China and thereby Shanghai, is able to switch towards a more capitalistic bottom-up system, implementation of an effective ETS will be possible and the municipality of Shanghai is expected to be able to improve the air quality and provide for a healthy livable environment, subsequently by adopting these measurements Shanghai will set a first step towards a sustainable city.

In sum, we have discovered that implementation of an ETS in Shanghai could be possible under the following conditions. First, the political system of China has to adopt a capitalistic approach instead of a communistic approach. Second, the government of Shanghai should implement strict regulation. Third, China has to switch from a top-down approach towards a bottom-up system. Fourth, China and thereby Shanghai should implement a “cap-and-trade” system whereby she supports the operation of an ETS by allowing for a free economic market in Shanghai.

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Discussion

In the previous section it is concluded that in order to implement an ETS successfully, certain alterations in political fundamental parameters, like a shift towards a bottom-up approach and a transition towards a capitalistic economic market, are needed. However, taken into consideration the major impact on politics that accompany these transitions, which will if possible at all be fairly time consuming, the ability to implement an ETS on short notice is affected. Since policy regulations are currently necessary to improve air quality, there might be a lack of time to provide for the described economic and political parameters to support an ETS. Therefore, to achieve a healthy and liveable environment, alternative methods or strategies should be elaborated and valuated that can be implemented at the moment to replace a potential ETS in Shanghai or act as a temporary system, to reduce air polluting emissions on short notice. In this section two discussion points are described: at first alternative methods to reduce emissions, and secondly criteria for success regarding an ETS.

Alternative methods

The alternative methods mostly include introduction of new legislation and policy action, such as tax based approaches and limits, to reduce and control the emissions of big polluters whereby the municipality of Shanghai could play an important role on waste management and energy consumption (Betsill, 2010). Political leadership on the environmental issues is basically the most important factor to create opportunities for linking emissions and the local agenda: therefore, a bottom-up approach would be necessary (Betsill, 2010). Since China regulates the country from a top-down approach, implementation of local legislation would be difficult.

From previous literature studies an ETS is expected to be the most efficient method in achieving the objectives of setting a limit to the allowed pollution and taking into account the price related to the emissions, to accomplish a transition towards a healthy and livable environment (Kuik & Mulder, 2004). Therefore, there has only been paid attention to fundamental aspects and outcome of an ETS in Shanghai. However, there are several different methods for achieving these objectives, from tax based approaches until pollution limits, which are not described in this research (Betsill, 2010). Although from literature ETS appears to be the most suitable method, observing the specific characteristics associated with the Shanghai case other methods based on policy action might be more efficient and easier to implement (Betsill, 2010). Therefore, for this

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case these methods should be discussed and compared to the described ETS to obtain the most efficient and reliable method to reduce air pollution.

Criteria for success

What could be a reason for China to fail implementing an ETS? At first institutional weaknesses; china is still missing the legal and strong administrative basis to be able to implement the scheme (Shin, 2012). China first needs strong law and a strong administration system to adopt the ETS. And secondly, the national government does not support the local municipalities and government fully (Shin, 2012). If China does not want to fail implementing the Scheme, the country needs to improve the relationship between the local and national governments by switching from a top down approach towards a bottom-up system (Shin, 2012). If this relationship will improve and the national government is able to decentralize her powers, the local government will be able to transform the local legislation and implement an ETS.

To implement an ETS successfully, some basic measures are necessary. The first basis measure to establish a successful trading scheme is having it formally adopted as a directive. The trading rules should not be taken for granted but should be based on legislation.

Secondly, the companies as well the policy makers should keep their goal in mind; namely, the mission to decrease the air pollution. Therefore, achievement of the agreed emission reduction is a key metric of success. An emission trading scheme could be considered successful when reduction of emission on the long term, is a result of the emission trading. Also, when companies will participate and be involved as long as the emission trading exists, the ETS will be considered as successful.

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