Through the lens of government revenues and expenditures, China is the most decentralized country in the world[1]. With 31 provinces, 334 prefecture units, 2,851 county-level administrative units, and more than 41,000 township level units[2], these subnational governments have significant autonomy in governing the world’s largest population. In fact, local government accounts for almost 70-80% of all government spending in China, double that of other OECD countries[3].While China might appear to have a top-down, hierarchical command-and-control government, fragmentation of authority is actually at the heart of China’s political system[4].
It has not always been this way. Decades of political reform that began in the 1970s have led to waves of centralization and de-centralization of government control. Understanding this dynamic is crucial to make sense of China’s future – in particular, its ability to carry out the economic reforms it promised to make when it joined the World Trade Organization (WTO) in 2001. China’s economy is the lynchpin on which social stability hinges, and Xi Jinping plans to drive future growth not through the free-market reforms which made it into the economic juggernaut it is today, but through re-imposing central control on key parts of the economy.
The fragmentation of China’s contemporary political and economic system began in 1978, when Deng Xiaoping inaugurated a period of “reform and opening up”. Agriculture was de-collectivized, large state-owned enterprises (SOEs) were privatized, and government interference in economic forces like employment and inflation were relaxed[5]. The result was double-digit growth and the lifting of roughly 800 million people out of poverty[6]. As China pushed to join the WTO, the central government began to slash tariffs, strengthen intellectual property rights, and welcome in foreign companies. However, regional governments, who retained substantial control over their local economies, did not always share Beijing’s enthusiasm for this paradigm shift.
China’s decision to join the WTO and the ensuing threat of foreign competition produced a range of regional reactions, some in lockstep in Beijing while others resisted, fearing that competition would slow their efforts to maintain ambitious growth. For example, the prefecture of Yanbian in northeast China began to consolidate its cement industry in 2003. Rather than allowing market forces decide which firms should stay in business, the local government handpicked the winners and took away business licenses and machinery from firms they felt were inefficient[7]. This type of regional subversion against the market liberalization that China had promised the world reflected a wider divergence between the interests of Beijing and its ability to influence the sprawling network of subnational entities to follow their lead.
This regional subversion, however, was also responsible for China’s infrastructure boom. In 1994, the central government centralized tax collection and effectively starved regional governments of their revenue. In order to meet their growth targets, local governments turned to a new source of revenue – land. They began leasing millions of acres of land to real estate developers which was turned into highways, subways, high-rise apartments, and associated urban infrastructure[8]. The result was a doubling of the length of China’s highways between 2007 to 2017 – enough to go around the world three times – as well as ha ving 8 of the world’s 12 longest metro-rail systems.
The global economic crisis of 2008 turned the tide in Beijing’s interest to fulfill the hopes of its accession to the WTO. To China’s leaders, the crisis exposed America’s model of free-market capitalism to be fundamentally weak[9]. The solution, they argued, was a re-centralization of economic power and an anti-corruption drive to rid the nation of crony capitalism. Since Xi Jinping came to power, SOEs have become significantly stronger and larger, taking on leading roles in China’s Belt and Road Initiative to build infrastructure around the world and ultimately export their form of state capitalism[10]. This has corresponded with a retreat of the private sector through a crackdown on financial technology firms like Alibaba and Tencent as well as a recalibration of center-local revenue sharing to reduce debt accumulation[11].
Xi’s anti-corruption drive, the longest and widest in the CCP’s history, can also be understood through the lens of reigning in the autonomy of subnational governments. One of the primary mechanisms of central influence through the fragmented system is by the CCP and the state appointing a nested hierarchy of cadre leaders. These are bureaucrats placed at all levels and are supposed to be trained in the party’s ideology and carry out the will of the central government[12]. So far, Xi’s campaign has ensnared 1.5 million officials, both high level and low level, who will ultimately be replaced with those who will more closely hew the line of the central government, and Xi himself[13].
Under Xi’s reign, China is returning to an era that it is most familiar with – command and control. To deliver economic reforms and continued growth, China will grapple with its structure of fragmented authoritarianism through centralized crackdowns in an attempt to execute a uniform agenda and vision. Will it work? History has shown that decentralization has led to China’s most explosive growth, but perhaps Xi will continue to defy all odds.
[4] Kenneth Lieberthal and Michael Oksenberg, “Policy Making in China: Leaders, Structures, and Processes. Princeton University Press”, pg. 137, Princeton University Press, 1988.
[12] Maria Edin, “State Capacity and Local Agent Control in China: CCP Cadre Management from a Township Perspective,” The China Quarterly, March 2003, No. 173 (Mar., 2003), pp. 35-52.
Time is running out to prevent a 2°C rise in global temperature. The world has 29 years to make annual carbon emissions 40 – 70 percent lower than they are today[1]; otherwise, 190 million people will be exposed to extreme droughts, and more than 70 percent of Earth’s coastlines will be flooded[2]. While there are several avenues to reduce emissions, carbon pricing is a uniquely powerful mitigation solution. One analysis found that on its own, carbon pricing could deliver almost a third of the emission reductions necessary to avoid a rise of 2°C – more than any other mitigation option available.[3]
Carbon pricing is an economic tool that discourages pollution by imposing monetary costs on CO2 emissions. When faced with a price tag on carbon, industries will pursue emission reduction opportunities that are cheaper rather than paying the price. The price of carbon can be set through two vehicles: a carbon tax or a carbon cap.
A carbon tax directly prices carbon through a fixed, per-unit charge for each ton of CO2 emitted. While the level of emissions may fluctuate, the tax is set according to a projected amount of emissions at that price.[4]
A carbon cap indirectly prices carbon through a quantity-based approach. It sets a quota of carbon allowances, or permits, for emitters which represents their emission target. A carbon cap is often called “cap-and-trade” or an “emissions trading system” because the cap limits the number of allowances that businesses can have, but there is a market which enables the emitters to buy and sell their permits, effectively setting a price for emitting CO2.
The primary advantages of carbon pricing are that its effects radiate across all sectors of the economy, it’s technology neutral, it provides a transparent price/quantity, and it generates revenue that can be used by governments to support an equitable clean energy transition.
Here, we argue that carbon taxes are preferable to cap-and-trade schemes due to offering price certainty, a simpler implementation and administrative cost, and a comparatively lower chance of corruption and rent-seeking behavior.
What are the Economic Assumptions Behind Carbon Pricing?
At its core, carbon pricing seeks to address the market failure of pollution control. In a market economy, firms have no incentive to restrict the negative externalities from greenhouse gas emissions like sulfur dioxide and particulate matter or dumping toxic waste.
The burning of coal is responsible for 800,000 premature deaths in the U.S. every year [5] while the byproducts of fracking have known links to asthma, childhood leukemia, cardiac problems, and birth defects in surrounding communities[6]. Yet companies rarely pay for these harmful impacts unless through successful litigation or penalties imposed by government authorities like the EPA. Carbon pricing attempts to impose a cost on these firms for their polluting activities by determining a socially efficient level of pollution.
The socially efficient level of pollution is determined through a cost-benefit analysis that balances the marginal social benefits (MSB) from pollution control with the marginal social costs (MSC). While striving for zero pollution would be ideal in the context of combatting climate change, the costs of achieving this would be astronomical and may not even be possible. At the same time, cleaning up the last few units of pollution would likely not provide that much additional marginal benefit.
As indicated in Figure 14-3[7], where the MSB and MSC curves intersect at Point E is considered the socially efficient level of pollution because the emissions rate maximizes the net social value of production.[8] The marginal private benefit (MPB) curve represents the benefits to the firm of cleaning up its pollution. As is evident from the graph, the firm does not achieve that much benefit compared to what the community receives and if left to its own devices would abate emissions at point I, far below Point E. Thus, to abate emissions at a socially efficient level an external intervention is needed.
Carbon pricing analyzes this market dynamic and attempts to compel firms to abate emissions at a socially efficient level. At Point E, the carbon tax would be set at the price on the Y axis, while cap-and-trade would set the emission cap based on the quantity on the X axis. Both schemes rely on foundational ceteris paribus, or all-else-unchanged, economic assumptions about the MSC and MSB of abatement. If these assumptions change, then the economic rationale for these policies also changes.
The first assumption is that the marginal social benefits curve is downward sloping. This implies that the first few units of abatement provide a lot of social benefit, but this benefit decreases over time as more emissions are cut. The logic is that as more emissions are cut the end products those emissions are created for – be it electricity, consumer goods, or transportation – get further reduced which diminishes your quality of life. But what if the MSB curve was upward sloping? In this case as more emissions are reduced, then the positive environmental externalities of cleaner air and water and preserved forests improve your quality of life more than carbon-intensive goods becoming more expensive. In that scenario, the tax price would be a lot higher, and the emissions cap a lot lower since the marginal social benefits are increasing the more pollution is reduced and everyone is better off if emissions can be abated more aggressively.
The second assumption is that the marginal social costs curve is upward sloping. This implies that the more emissions are abated, the more expensive it gets for the firm and society to do so. While some emission reductions could be easier and cheap to achieve early on, after the low hanging fruit are addressed then more expensive technology and product substitutes are needed to achieve additional reductions.
A carbon cap uses a quantity based approach by allocating a fixed amount of carbon allowances tied to an emissions target. A carbon cap is often called “cap-and-trade” or an “emissions trading system” because while the cap limits the number of pollution allowances that businesses can have, there is a market where emitters can buy and sell their allowances, effectively setting a price for emitting CO2.
However, this relationship is likely not linear. As firms begin reducing emissions, there will be improvements in energy efficiency and technology along the way which will decrease the cost of abatement over time. As a result, the marginal social cost curve can be thought of as an initially upward sloping curved line that then begins to flatten and move downward. Consequently, the price of a carbon tax would likely be lower and the emission cap higher. This is because as the abatement cost decreases, then the socially efficient pollution point is further down the marginal social benefits curve so a higher amount of emissions can be curtailed (cap) at a lower price (tax).
The third assumption is that the carbon price or emission quantity at the socially efficient pollution level is sufficient to avoid the impacts of climate change. There is no guarantee that the point where the MSC and MSB curves intersect is the exact quantity which prevents a rise of 2°C. Indeed, there is still considerable uncertainty as to the exact amount of emission reductions that are needed to avoid this fate. If a tax or a cap is placed at the socially efficient pollution level and the planet continues to warm beyond the target 2°C benchmark, then carbon pricing schemes can no longer be set at socially efficient pollution levels and instead need to be set at a higher amount, economically inefficient level in the hopes of achieving the reductions necessary.
Which Carbon Pricing Scheme is Preferable?
There are several advantages and disadvantages when choosing between a carbon tax or cap-and-trade system, but in theory both will create incentives for cost effective emission reductions in the short run and cost reducing innovation in the long run.[9]
Based on years of real-world results, a carbon tax is preferable to cap-and-trade for three reasons[10]: more effective revenue collection, lower risk of corruption, and carbon price stability.
First, carbon taxes can capture revenues more easily than cap-and-trade with lower administrative cost. Cap-and-trade systems are more complicated to implement due to the need to determine the pricing of permit allocations as well as developing trading infrastructure so firms who reduce more emissions than required can sell their additional reductions to firms that are behind. This complexity is compounded by the need for some degree of free permits needed to be given to energy-intensive industries where fossil fuel substitutes don’t exist, like in the creation of cement or steel. Carbon taxes are a comparatively easier and more straightforward way to collect revenue since they are evenly applied across all industries and at a flat rate based on the quantity of emissions released.
The ease of revenue collection under a carbon tax connects to our first assumption – what if the marginal social benefits curve is actually upward sloping, not downward? In that scenario every unit of emissions reductions gets converted into revenue that the government can use to accelerate mitigation and adaptation efforts. This improves your quality of life more than the negative effect of certain products being more difficult or expensive to consume, especially if you’re living in a coastal community affected by sea-level rise, or in the American West that’s been ravaged by wildfires. Thus, choosing a carbon tax which can more effectively collect revenue is preferrable to increase the marginal social benefits of abatement.
Second, carbon taxes provide less opportunity for corruption which can occur through rent-seeking behavior with cap-and-trade permits. Cap-and-trade systems create a new valuable asset in the form of pollution permits. It also creates a scarcity where one previously did not exist. As a result, scarce permits can be exploited by politicians and corrupt administrators who can sell off permits to certain favored industries and pocket the fees. A carbon tax provides less opportunity for corruption because it doesn’t create artificial scarcities, monopolies, or rents.[11] The tax cannot be sold to other entities and there are no new rent-seeking opportunities.
This benefit of carbon taxes connects to our second assumption – that the marginal social costs of abatement is assumed to increase over time but may actually be decreasing. Carbon taxes help drive a decrease in social costs because the fees are not being diverted by corrupt economic agents like could potentially happen in a cap-and-trade system. Rather these funds can be re-invested to bring down the cost of expensive technology that’s needed to achieve additional reductions after easy decarbonization steps are taken.
Third, a carbon tax offers price certainty as opposed to quantity certainty which limits volatility in the market price for carbon. Under a cap-and-trade system only the quantity of emissions is fixed, thus allowing the price to fluctuate as economic agents shoulder their own individual costs in order to meet that emission limit. For example, in 2006 the carbon prices the European cap-and-trade system ranged from $44.47 to $143.06 per ton of CO2.[12] While cap-and-trade provides greater emission reduction certainty and is more environmentally effective, the price uncertainty of this approach may make the gains short lived. Uncertainty in the price of carbon will slow investments in clean energy, disrupt energy markets, and may become extremely unpopular with the public if the price fluctuates frequently causing instability in the price of everyday consumer goods.
This drawback of cap-and-trade connects to our third assumption – even if we have quantity certainty about the emissions we’ll reduce, how do we know that’s sufficient? If the assumption changes that the quantity of emissions at the socially efficient pollution point is not enough to mitigate against climate change, then carbon taxes provide a preferrable alternative since they drive market behavior through prices not quantity and can achieve progressively higher emission reductions through higher prices.
The Way Forward
Ultimately, carbon pricing is a crucial tool for reducing CO2 emissions as the environment continues to deteriorate. Currently, four-fifths of global emissions are unpriced, and the global average emissions price is only $3 per ton[13] – far too low to induce substantial emission cuts. As policymakers continue to explore avenues to decarbonize their economies, pricing carbon at the socially efficient pollution level presents a market-driven opportunity to act on this existential crisis.
Introducing carbon taxes as part of international climate negotiations at COP26 is one viable path forward to increase their uptake. For example, negotiations are continuing on how much money developed countries will donate to developing countries to help with adaptation and mitigation costs. These transfer payments could be conditioned on developing countries instituting carbon taxes with more aid going to countries with higher carbon taxes. This approach would incentivize more ambitious carbon pricing globally and increase trust in the system that climate aid is tangibly going towards higher amounts of abatement.
Chetan Hebbale is currently a graduate student at the Johns Hopkins School of Advanced International Studies (SAIS) in Washington, D.C. focused on international economics, climate change, and sustainability.
Prior to this, he spent over 4 years at Deloitte Consulting working on technology and strategy projects at the CDC and U.S. Treasury Department.
He is a native of Atlanta, GA and attended the University of Georgia.
There are billions of financial transactions happening right now between consumers, businesses, and governments around the world. The vast majority of these transactions are denominated in U.S. dollars. As the world’s reserve currency, the dollar serves as the unit of account for most global trade and foreign exchange transactions. Simply put, there is no currency more important to the functioning of the world economy than the dollar.
As a result, the U.S. has spent the last 75 years in the driver’s seat of the global financial system incurring a range of economic and geopolitical advantages. U.S. consumers have enjoyed low interest rates and cheap imports for decades, spawning one of the world’s highest standards of living. In turn, the U.S. government has been able to sustain large trade deficits without inflation and successfully advance its national security interests through economic sanctions which prevent nations from accessing the dollar for cross-border transactions. For years, adversaries have sought to bypass the Western financial system with little success.
However, the reign of dollar supremacy is not guaranteed. China is now preparing to take the most ambitious step yet to internationalize an alternative currency to the dollar. In April, China’s central bank became the first to pilot a national digital currency for the renminbi, known as the e-RMB. The renminbi represents the most viable currency to dethrone the dollar due to the size of China’s economy and its integral role in the global supply chain. If successful in its vision to create an alternative to the dollar, China could shift the paradigm of the global economy into a new era – one with a duopoly of reserve currencies that would have a significant impact on international competition.
In this new era, imagine that the U.S. comes to learn that North Korea is trying to acquire uranium from Iran for its nuclear weapons program. The U.S. would issue new sanctions, but North Korea and Iran would have shifted much of their global trade into using the new Chinese digital currency thus allowing them to circumvent the dollar payments system. Now the sanctions are ineffective at damaging North Korea or Iran’s economy in order to change their calculus, and the U.S. no longer has the visibility to track and shut down illicit financial flows going to purchase nuclear materials.
The U.S. is currently unprepared for a scenario like this. As COVID-19 accelerates the digitalization of the world economy, the U.S. cannot afford to fall behind China in the sphere of digital currency. China’s brand of techno-authoritarianism, if successfully applied to money, would pose a fundamental threat to the rules-based world order that the dollar underpins. The U.S. must act now by developing a “digital dollar” – a new national, central bank digital currency issued by the Federal Reserve.
Rather than letting other nations dictate the terms of a digital world economy, the U.S. would lead the way by modernizing the dollar’s underlying technological infrastructure. Advancements that enable the programmability of money could unleash innovative new functions like customized privacy and data ownership (e.g. preventing the selling of payment data), consumer wallets for the unbanked (e.g. direct government assistance payments), or frictionless peer-to-peer cross-border payments and currency conversions (e.g. remittances).
Amidst the global economic turmoil caused by the pandemic, the dollar’s role as an anchor of economic stability is more important than ever. A digital dollar presents an opportunity to future-proof the dollar’s role as the world’s reserve currency by spurring new innovations and operational efficiencies while also reinforcing U.S. values of transparency, rule of law, and privacy in a world soon to be dominated by competing digital currencies.
Chetan Hebbale is currently a graduate student at the Johns Hopkins School of Advanced International Studies (SAIS) in Washington, D.C. focused on international economics, climate change, and sustainability.
Prior to this, he spent over 4 years at Deloitte Consulting working on technology and strategy projects at the CDC and U.S. Treasury Department.
He is a native of Atlanta, GA and attended the University of Georgia.
Over the last few years, Congress as well as U.S. businesses have raised concerns over the risks to U.S. technological leadership, national defense, and economic security due to growing foreign direct investment (FDI), primarily by Chinese firms, in U.S. high-tech companies.
The Committee on Foreign Investment in the United States (CFIUS) is an interagency committee authorized to review certain transactions involving foreign investment in the United States in order to determine the effect of such transactions on the national security of the United States.
CFIUS is chaired by the Secretary of the Treasury and includes representatives from 16 U.S. departments and agencies, including the Defense, State and Commerce departments, as well as the Department of Homeland Security.
Just recently, Congress passed the Foreign Investment Risk Review Modernization Act of 2018 (FIRRMA) to reform and modernize the CFIUS review process. It represents the first update to the CFIUS statute in more than a decade and implements a number of major institutional and operational changes to CFIUS so the U.S. can better keep pace with changes in the national security environment that have increased the risks created by some forms of foreign investment.
Changes to CFIUS
Institutional Changes
FIRRMA allows the chairperson to centralize certain CFIUS functions in the Treasury Department
Two new Senate-confirmed positions in the department were created that are responsible for overseeing CFIUS operations, and there must be a dedicated CFIUS staff, including an assistant secretary or equivalent position, at all other member agencies.
The bill requires CFIUS to establish procedures for members to recuse themselves in the case of a conflict of interest and to publish dissenting opinions if CFIUS cannot reach consensus
The bill significantly increases the reporting requirements for CFIUS, including addressing both finance and intelligence Congressional committees
No later than 180 days after the bill’s enactment (February 9th, 2019), the CFIUS chair must submit a report to Congress and provide in-person testimony that describes the timeline and process for implementing the bill, as well as any additional staff and resources required
Biennial reports, through 2026, on Chinese investment in the U.S., including how it comports with the objectives of the Made in China 2025 plan, how it compares to U.S. investment in China, and any data collection difficulties
A report, within a year, assessing national security threats related to foreign direct investment in the U.S. by foreign-state-owned or -controlled entities in manufacturing assets required for rail systems, and how CFIUS can respond to any such threats
A briefing to the congressional finance committees on CFIUS investigations in the past five years that would have allowed foreign persons to influence domestic and foreign democratic institutions and processes and any actions taken as a result of those investigations.
Operational Changes
FIRRMA identifies several factors that Congress wants CFIUS to take into account when considering the national security risks posed by foreign investments. These include:
Whether a transaction involves a country of special concern that has a strategic goal of acquiring technologies that would affect U.S. technological leadership in that area
The national security effects of cumulative market share control by foreign persons
Whether a foreign person involved in a transaction has a history of complying with U.S. law
How the control of U.S. industries and commercial activity affects the capability and capacity of the United States to meet the requirements of national security, including the reduction in employment of United States persons whose skills are critical to national security and the continued U.S. production of items necessary for national security
The extent to which a transaction is likely to expose sensitive data of U.S. citizens to exploitation by foreign persons and governments
Whether a transaction exacerbates cybersecurity vulnerabilities or allows a foreign government to gain new capabilities to engage in malicious cyber activities against the U.S., including activities designed to affect the outcome of any federal election.
One of FIRRMA’s most substantial changes is to the scope of “covered transaction,” which defines much of CFIUS’s jurisdiction. The bill expands covered transactions to include:
The purchase or lease by foreign persons of certain U.S. real estate near a U.S. port, military facility, or other “sensitive” government property;
All non-passive foreign investments in any company that deal with “critical technology,” “critical infrastructure,” or “sensitive personal data of United States citizens that may be exploited in a manner that threatens national security.” Covered investments are those that provide corporate control, any position on the board of directors, a role in sensitive decision-making, or access to “material non-public technical information,” with detailed exemptions for investment funds;
Changes in existing ownership rights that could result in foreign ownership or control of a U.S. business
Any other transactions structured to evade CFIUS review.
The also bill amends the CFIUS process in several ways, including extending the timeline (e.g. initial review is extended from 30 calendar days to 45 calendar days), adding a new “declarations process” for companies to notify CFIUS of transactions and offer a path to expedited approval, and expanding CFIUS’s authority to mandate reviews or take unilateral action
Considerations for User Fee Implementation
The bill establishes a CFIUS fund which may receive both appropriated funds and fees for a variety of CFIUS-related functions. Between FY19 and FY23, $20,000,000 will be appropriated to this fund.
Any fees are to be deposited into a fund exclusively for CFIUS use, although the chair may transfer money to CFIUS member agencies if necessary for them to perform CFIUS duties.
The total amount of fees collected from administering Sec. 1723 cannot exceed the cost of administering said section, the committee will periodically reconsider and readjust to ensure that the fee does not exceed the cost of administering the section
The fee amount charged must be less than the lesser of either a) 1% percent of the value of the transaction, or b) $300,000 (adjusted for inflation)
The fee will take into account the burden on small businesses, the expenses of the Committee in conducting activities mandated in this section, the impact of foreign investment, and other matters deemed appropriate by the committee
The bill also authorizes CFIUS to study the implementation of a “prioritization fee” which no later than 270 days after the passage of the act (May 10th 2019), the Chairperson to the committee will complete a study on the on the feasibility and merits of establishing a fee or fee-scale, and will submit a report on the findings of said study to Congress
Chetan Hebbale is currently a graduate student at the Johns Hopkins School of Advanced International Studies (SAIS) in Washington, D.C. focused on international economics, climate change, and sustainability.
Prior to this, he spent over 4 years at Deloitte Consulting working on technology and strategy projects at the CDC and U.S. Treasury Department.
He is a native of Atlanta, GA and attended the University of Georgia.
Chetan Hebbale 