Tuesday, February 18, 2014

The Chinese Government Will Fail To Curb Urban Smog with Price-Based Mechanisms

Nature has the story, here. Until China proves me wrong, I will continue to predict that market-based instruments for pollution control will fail to function effectively (let alone efficiently) in heavily polluting sectors of China's economy, which are still dominated by state-owned enterprises. Those enterprises suffer from soft-budget constraints, which leave them insensitive to price signals because their existence depends not on surviving in competitive markets but on meeting planned (output-based) production targets; any financial penalties they pay for pollution would go almost unnoticed.

Meanwhile, local regulators in China suffer from an endemic regulatory conflict of interest, as their career prospects turn on meeting development targets, rather than environmental goals. Until that changes - implicating the entire socialist structure of heavy industrial production in China - the only form of environmental protection that can be expected to succeed are technology-based requirements and plant shut-downs.

But never mind all that, China's economists and policy makers have learned from those in the West that market-based mechanisms of pollution control are always and everywhere superior to cumbersome and inefficient forms of direct regulation. No need to worry about the fact that market-based approaches depend on well-functioning markets, which don't yet exist in many of the most heavily polluting sectors of China's economy.

China's environmental situation today is not much different from that of Poland and other East European countries in the 1980s, where a similar combination of soft-budget constraints and regulatory conflicts of interest doomed price-based mechanisms for pollution control. It was not until those countries privatized polluting industries - something China has not yet done for major sectors like electricity production - that pollution levels began to drop, following the fall of communism.

In 1998, I published a book about Poland's experience with environmental protection before, during, and after communism (see here). I'm not surprised that Chinese economists and policy makers have not read my little-known work. I'm more surprised that they haven't taken on board some of fundamental lessons of Janos Kornai's studies of socialist economic systems. China's current pollution problems merely underscore the fact that Kornai deserves a Nobel Prize.

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