Market Failure in Beijin's Economy

Diagram showing a negative externality of consumption (e.g.: pollution):

        Beijing’s goal is to cut the country’s energy consumption by 20% per dollar of output by 2010 in just five years time. By raising the price of electricity, Beijing hopes the disincentive will slowdown the growth of large energy consuming industries such as the metallurgy industry, and force the inefficient factories out of business. Hence energy consumption will decrease and the externalities of pollution internalized.

Diagram showing the internalization of a negative externality of consumption through a price increase (e.g.: a tax):

        Albeit, Beijing’s solution is flawed in many ways. The inefficiency of the Chinese approach to estimate the capabilities of its industries is enhanced through this policy as it forces the most inefficient, not necessarily the major polluting ones, out of business. Hence, the pollution is little reduced. Moreover, the policy refrains small to medium-size factories from purchasing newer, more efficient machines that meet the new requirements as their revenues decrease with a price-increase. Hence, only the smaller companies are put out of business, raising unemployment, social unrest, instead of decreasing consumption.

        Likewise, the government has limited the amount of new coal-burning plants to decrease coal production and gain further lost welfare (see diagram above). However, the western provinces rely entirely on the local heavy industry (the most energy-consuming type of industry) as they lack most natural resources, with the exception of coal. Again, the limiting of such industries in these provinces is causing massive unemployment and tension between the local and Beijing governments; thus overall, the lost welfare of society is not fully regained by Beijing’s policy (see diagram above).

        Furthermore, the raise in the price of electricity as a way to internalize the negative externality of pollution is, in fact creating itself new market failures, for example: black markets. Local officials in the eastern provinces fear of the impact of a price-increase on their gross domestic product. Hence they allow the biggest of companies to undercut even the officially established energy prices. They then remove them from the national electric grid and supply them separately by a local company. Thus the government believes its price increase is effectively reducing consumption when, in truth, is rising.

        Another market failure created by Beijing’s policy is the immobility of factors of production. Whereas east China enjoys the booming of the economy, the west is drowning in unemployment due to the new policy. In theory, the unemployed people of the west should “move” to the east. However most will lack the skills necessary for the new jobs (for they are trained for the heavy industry) and may not be prepared to move from their area. Hence, structural unemployment emerges due to occupational and geographical immobility.

        In conclusion, considering that China’s energy consumption has quadrupled since 1980 and that demand for coal is predicted to double in just twenty years time, Beijing’s goal to reduce energy consumption by 20% per dollar of output seems rather inconceivable. The new policy brings out China’s difficulty to impose a drastic change on such a large country and enhances the country’s weakness in assessing its regions’ industries and their capabilities. Hence, the policy which should in theory solve the market failure created in reality only generates further market failures and fails to solve the issue of pollution.

 

Sources:

“Far From Beijing’s Reach, Officials Bend Energy Rules” New York Times (November 24th, 2007)

 

“Choking on Growth” New York Times (December 17th 2008)

 

“China’s Growth is Not Fully Dependent On Exports” The Economist (January 5th 2008)

“Why China Could Blame its CO2 on the West” New York Times (December 17th 2007)

        

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