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2008-01-21 | All chapters

Sustaining Ideas
Joerg Wuttke, China Daily, 21st January 2008, page 4

At the end of WWII, Friedrich Hayek, an Austrian economist who is often seen in the West as the grandfather of neoclassical economics, had an insight on prices: they are not just about cost plus profit. They are concentrated forms of information about supply, demand, quality and timing. In a modern economy, information is dispersed among millions of individual consumers and producers.

Hayek showed that only market pricing could efficiently coordinate economic activity among these diverse actors. Let's look at the issue of price and sustainable energy development in China's economy, first from the energy demand side, and then from the energy supply side - in particular the supply of clean fuels.

China's incredible economic achievements since reform and opening up are built in part on a recognition of markets and market pricing as powerful tools for organizing the economy. China's rapid growth has been made more sustainable thus far: China's energy intensity, or the amount of energy needed to produce one unit of GDP, has declined by about two-thirds since reforms began. The government's wise leadership has been critical to this success.

Broad-based reforms, including market-price reforms, helped China achieve this victory for sustainable development. Although energy prices themselves were not reformed until the mid-1990s, the indirect effect of constant, steady reforms of retail prices in the economy drove Chinese firms to become much more efficient energy users, especially in their use of coal.

But today, China faces a new challenge: energy demand is now growing faster than GDP, and energy efficiency gains have slowed. This is a sign that in recent years, energy consumers have not been receiving the proper signals about the true cost of energy use.

Although coal prices in China have been partially marketized, most other energy prices, including refined products, electric power and natural gas, are not yet market based. Continuing market price reforms for producer goods, including energy, could be part of the solution to the challenge of ensuring that growth is matched by gains in energy efficiency.

On the supply side, a key question for Asia's sustainable energy future is whether suppliers will get the appropriate signal to supply clean energy resources to Chinese markets. This includes international suppliers who may want to export energy to China.

To use one example, natural gas is potentially one part of a sustainable energy mix. Natural gas is a very attractive fuel: fewer emissions of greenhouse gases, sulfur dioxide and particulates than coal, competitive pricing vs oil, and high efficiency. China has already recognized the attractiveness of natural gas. However, China's domestic natural gas resources will not be sufficient to meet the anticipated demand for these clean fuels. Imports will be required. Fortunately, global natural gas resources are abundant, and imports will be available from both pipelines and via liquefied natural gas (LNG) shipments.

But international suppliers exist in a market price environment, and are driven by economic incentives. They also must make choices. Currently, there is a significant difference between global energy markets, and Chinese domestic end-user markets. Global and regional markets are characterized by market-based prices, while China's domestic markets are characterized by government-guided prices. It is in this environment that China finds itself competing for global energy supplies, including supplies of clean fuels like natural gas and LNG.

There are important historical reasons for these differences. The key issue is how to go forward, and how to link these markets in a way that will ensure that China has access to the energy it needs to fuel continued growth in the most efficient and sustainable way. Putting domestic energy prices on a market basis will be an important next step on the road to a sustainable energy future in China. And of course China's choices will deeply affect the prospects for continued sustainable development in Asia.

China has many choices on the road to a sustainable energy future. These will be choices about which fuels to use, which technologies to develop, and which suppliers to select to participate in China's growth. Market price signals will be a beneficial tool in making these choices, and China's continuing growth and rising incomes make the choice to move to market prices possible.

The difficulty is that today we have mixed signals. Chinese companies are now facing an important disadvantage. They are stuck between two systems as they seek to import energy supplies. They may need policy assistance and further price reforms to compete for supplies and to satisfy demand. This is true not only for oil supplies, but also for clean fuels such as natural gas. International suppliers want to supply clean energy to China, but the question is how can they do this and still survive in the international marketplace? How to integrate the domestic system of natural gas and electric power prices with the global and regional supply systems for natural gas and LNG?

Hayek can be part of the answer - more market-determined energy prices can be part of a sustainable energy future for China. Pricing reform does not have to be a sudden overnight move, but it should be a constant and continuous one. It can be done in a steady, constant way.

To be clear: market based pricing will attract energy supply, and therefore, we should not consider market prices simply as a cost, but also as a tool that China can deploy to ensure its energy security by giving suppliers the proper signals, and attracting clean energy to China.

Market based pricing is one path towards a harmonious, well-off society. Ultimately, market-based pricing has benefits for all.

Click here to view the article on China Daily's website.