Kyushu University Global COE Program
Journal of Novel Carbon Resource Sciences, Vol. 1, pp. 24-28, Mar. 2010

Incentive Mechanisms for the Development of a
Low-carbon Society in Asia
Shiro Hori*1 and Toshiyuki Fujita*2
Art, Science and Technology Center for Cooperative Research, Kyushu University*2
Faculty of Economics, Kyushu University*1(Received December 11, 2009; accepted January 27, 2010)
Energy consumption in Asian countries has been increasing rapidly, and, in parallel, the emission of carbon dioxide
has been rising. This rapid increase of energy consumption is triggered by the economic development and expanding
business activities in these countries. Lack of energy-saving mechanisms is another factor contributing to the risingenergy consumption level.
In this paper, we provide an overview of the energy consumption patterns in Asian countries, particularly in China,
and examine the impediments not to operate incentives and mechanisms to reduce energy consumption in residentialbuilding and industry. We also demonstrate the alternative framework to promote incentives and the economic theory
based on social optimum to create a low-carbon society.

Energy consumption in Asian countries has been
increasing rapidly, and, in parallel, the emission of carbon
dioxide has been rising. This rapid increase of energy
consumption is a reflection of the economic development
and expanding business activities in these countries.
Lack of energy-saving mechanisms is another factor
contributing to the rising energy consumption level.
In this context, the development of a low-carbon
society in Asian countries is a challenging issue. In thispaper, we provide an overview of the energy situation in
Asian countries, examine the incentives and mechanisms
for reducing energy consumption in major sectors, anddemonstrate the framework and economic theory forcreating effective incentives for a low-carbon society.

2. Overview of the Energy Situation in Asia

According to the International Energy Agency (IEA;
2009a), energy consumption in member countries
increased by 19% from 1990 to 2006. The transport andservice sectors dominated this growth with 52% and22%, respectively. However, the growth in non-member
countries was 62%, with the service sector accounting
for only 5%, as compared to 39% for the manufacturingsector and 34% for households. This means that as thestage of development advances, the relative shares ofenergy consumption shift from the manufacturing andhousehold sectors to the service sector.
100%
90%
80%
70%
60%
50%

other

40%

residential

30%

transport

20%

Figure 2 shows that the energy intensity in non-OECD
countries is high, compared to OECD countries, pointing
to the high energy-saving potential in developing
countries.
The energy intensity in Russia, China, and Mongolia isvery high, which suggests that space heating is responsible
for high levels of energy intensity in cold regions.
Figure 3 shows the residential energy consumption inseveral provinces of China. Consumption patterns in the
Northern provinces show very high residential energy
use for heating indoors—more than 40%, for example,
in the Liaoning province. However, the heating share is
90,00080,00070,00060,00050,00040,00030,00020,00010,0000

Fig. 2

Source: EIA (2009).
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

industry

10%0%Fig. 1 Energy consumption by sector (2007 data).
Source: IEA (2009a).

Energy intensity in 2006.

other energy
electricy
heatother coking products
natural gas
petroleum products
other gas
Beijing
Tianjin
Hebei
Shanxi
Inner Mongolia
Liaoning
Jilin
Heilongjiang
Shanghai
Jiangsu
Zhejiang
Anhui
FujianJiangxi
Shandong

1. Introduction

Fig. 3coke oven gas
coke
coal

Sources of energy for the household sector in thenorthern Chinese provinces (2007 data).
Source: National Bureau of Statistics (2008).

Journal of Novel Carbon Resource Sciences, Vol.1, Mar. 2010

far lower in the Southern provinces. This indicates that
district heating is a major factor leading to increased
energy consumption in the northern areas.
Energy consumption and intensity patterns differ
according to the stage of development and climaticconditions of a location. Therefore, incentives andpolicy measures to encourage energy saving should beconsidered in association with these factors.

3. Incentives and Policy Measures

The importance of energy saving, particularly in theindustry and household sectors, has been indicated in theprevious section. To encourage energy saving in these
sectors, many policy measures have been considered.
These policy measures are based on three approaches:command and control, a market-based approach, and a
voluntary approach. Let us review the policy measures inthe three sectors. (*1)

1) Residential buildings

Command and control: Mandatory building energy
code.
Market-based approach: Providing subsidy, taxincentive for replacements with more energy-efficient
appliances and incentives for energy-efficient buildings;
metering district heating to provide consumers incentives
to monitor energy savings.

2) Industry

Command and control: Emission standard, target
for improving energy efficiency, and reduction in
consumption.
Market-based approach: Subsidy to support energysaving equipment installation, emission trading, emission
tax, tax-incentive, eco-labeling, rating, and providing
incentives for energy-efficient equipment.
Voluntary approach: Voluntary agreement and action.

3) HouseholdMarket-based approach: Supporting replacements withmore energy-efficient products and solar generators (PV),providing incentives such as eco-labels and subsidies,creating public awareness about more eco-friendly
lifestyles.
Table 1 shows incentives and policy measures appliedin Asian countries. To date, Asian countries haveintroduced command and control policy measures tobuild low-carbon societies in some cases; however, theyoften use market-based approaches. In the industry sector,
rating and voluntary approaches have been widely used.
In residential buildings, space heating, especially in thenorthern area, is an important target, and metering is
considered one of the effective measures.

4. Some Major Issues

In this section, we examine some important energy
consumption issues.
First, the key to lower consumption in the residentialbuilding sector is to encourage residents to save energy

Table 1

Incentive tools in sectors
incentive

case in Asia

visibility, metering

16sites in China

Japan

residential building
metering, smart
metering, space heatingPVheat gain (shutters, shade)material
heating &hot water (HP)eﬃcient lighting
cookingeﬃcient appliance(air-con, etc)
building energy code
alternate refrigeranthousehold
RBM, residential biogas modeleﬃcient stove(chacoal, coal, briquette, wood)eﬀcient lighting
biogas cooking
biomass power station
public awarness
industry
voluntary agreement
unilateral agreement
negotiated agreement
top runnerbulletin systemcomand &control
emission standard
eco label （＊）

subsidy
eco label, CASBEE○○

subsidysaving costsaving cost
tax-incentive,
subsidy, eco-label○○
the Philippines,
Thailand, China
China

○

subsidy

China

○

ditto

China

tax-incentive,
subsidy, eco-label
subsidy

China, Thailand○○○

subsidy,
information service
ditto
ditto

China

○
○

China

information service

corporate rating （＊）
eco ﬁnanceﬁnancial support
dittoemission tradetax
note: (*) be used for environmental indicator

China,Thailand,
Indonesia, Korea
Indonesia, China,
Phillipines
China○

Source: References 3), 4), 8), 9), 10), 11).

by showing them the benefits of doing so. However,
governments in Asia often provide energy as a welfare
program; therefore, energy supply and demand are notdetermined by the market.
Second, in Asian countries, the regulatory framework
to enforce energy conservation in industry is not strong
enough, because currently, institutional structures do notexist. Therefore, other mechanisms such as incentivedriven tools are needed. Let us consider those mechanisms
which would be effective in promoting energy efficiency
in business activities.

4.1 Residential building

Of the total energy use in China, consumption inresidential buildings accounts for 23%. Space heating
consumes a significant amount of energy in the northernpart of China, where consumption is two to three times
as much as in other places with similar latitude (Zhao etal., 2009). In China, space heating is important in 70%of the land, and heating demand is high, especially in thenorthern area.
One of the reasons for the rise in energy consumption isthe district heating system widely used in northern China.
Energy consumption for district heating is significantly
high, while the incentive for energy saving is low becauseof the current charge system, which is based on floor
space, and not consumption volume.
A pay-as-you-go system is regarded as an effective
tool to provide incentives for energy saving. Recently,

Incentive Mechanisms for the Development of a Low-carbon Society in Asia

government introduced the meter system on a trial
basis; by the eleventh five-year plan, the system will be
introduced in a 150-km2 area (Zhao et al., 2009).
The district heating system is a typical case of the lackof incentives for energy saving. The system is regarded
as a social welfare program as well as an energy supply
tool that does not allow market mechanisms to operate. In
general, if consumption is linked to costs, the demand andsupply are balanced. On the other hand, public goods, orgoods supplied by public agencies, are often oversupplied,because the price paid by the consumer does not reflect
the actual cost. Over-consumption in district heating canbe explained by the lack of linkages between consumer
perception and the real cost. The low perceived cost not
only discourages energy saving but also leads to lowawareness about environmental damage. This would not
be the case if the cost burden were correctly passed on to
the consumer on the basis of actual consumption.
In a number of similar cases, energy saving can beachieved through incentives to consumers—for example,
in the installation of solar panels in residential houses. The
solar panel is an effective tool to reduce CO2 emission by
substituting for fossil fuel. Further, the incentive to thehousehold for the energy saved is visible in the form of
reduced payments for power consumed.
In this case, the energy consumed would be a private
good, not a public good, and the demand and supply
would be determined accordingly. This is an effective
way to create energy-saving incentives.

4.2 Industry

In developing countries, companies cannot affordenergy-saving investment, and the regulatory framework
is not well developed. In this situation, companies do
not focus on energy saving. The important issue is, howcompanies can be convinced as to the economic merits ofpromoting energy saving. We will review several policy
measures adopted to provide incentives and consider
the relatively more effective techniques to establish an
incentive mechanism.
According to classical economic theory, all policy
measures such as subsidy, tax, and emission trading resultin the same welfare quotient. However, companies receive
different welfare benefits and incentives according to thevarious policy measures.
We will evaluate following policy measures in theserespects: (a) command and control, (b) emission tax,(c) voluntary agreement, (d) voluntary action, (e) tax
incentive, (f) subsidy, and (g) rating. In general, as one
moves down the list, the resistance of companies to themeasures applied becomes progressively lower. The ideal
point can be realized with command and control measures
if the government has perfect information. Otherwise,
taxes and subsidies are other effective market-based
methods that can be used.
Companies tend to respond to voluntary agreements
and action and rating systems, considering the social
environment and their reputation in society. These
are more effective than unreasonable actions of thegovernment. These market-based approaches have been
introduced not only in OECD countries but in Asiandeveloping countries as well. According to the OECD, theincentives for voluntary action are the benefits derived by
the company on considering the alternative of regulation,
improvement in production, and the value added effect.
In Japan, the EU, and the US, voluntary agreements havealready been introduced as one of the tools in the global
environment policy.
Rating is also an effective measure that companies inthese countries respond to because of their public image.
In Asian countries such as China, Indonesia, Japan, andKorea, eco-labeling has been introduced. Indonesia
and the Philippines have established a rating system.
In the Shandon province of China, a rating system forcompanies based on energy saving has been introduced.
These are indicative policy measures that can be adopted
as alternates to the command and control system. These
measures, including rating, which are based on sharing
information with the public, are sometimes categorized
as a third approach in addition to regulation and marketbased methods.

5. Economic theory

5.1 Energy savings of households

Let us assume that n households with the same lifestyleand type of housing live in a certain area. Let Ei denote
energy consumption of household i (= 1,…, n) for district
heating. The household gets the comfort of centralized
heating but suffers the effects of environmental damage,which depends on total energy consumption, E ≡ ∑ ni = 1 Ei.
The comfort and the damage can be evaluated in monetary
terms, and are denoted by a benefit function B(Ei) and adamage function D(E). The local government supplies
energy E for a cost C(E). We make reasonable assumptions
regarding the properties of these functions, that is, B' > 0,
B" < 0, D' > 0, D" > 0, C' > 0, and C" > 0. The government
collects taxes equally from each household, and supplies
energy using the tax revenues.
The welfare (payoff) of a household i is(1)
πi = B(Ei) - D(E) - C(E) / n. 		
Household i chooses Ei, satisfying the first-order condition(2)dπi / dEi = B'(Ei) - D'(E) - C'(E) / n
to maximize πi. Social welfare is expressed as
SW = Σin= 1 πi = Σin= 1 B(Ei) - nD(E) - C(E) , (3)and the first-order condition to be satisfied by Ei tomaximize (3) is(4)
dSW / dEi = B'(Ei) - nD'(E) - C'(E) = 0.
If we denote Ei that solves (2) and (4) by E*i and Ȇi,
respectively, E*i > Ȇi holds, as we can see from Figure 4.
This shows that energy would be over-consumed relative
to the social optimum.
Under these conditions, how would consumptionchange when energy is priced according to pay-as-you-go
systems at p per unit? In this case, the payoff to householdi becomes(5)πi = B(Ei) - D(E) - pEi. 			
From (5) we see that the household chooses Ei which
satisfies(6)dπi / dEi = B'(Ei) - D'(E) - p		
Social welfare is unchanged and is expressed by (3).
(Note that the net revenue of the government is pE-C(E).)

Journal of Novel Carbon Resource Sciences, Vol.1, Mar. 2010

D( E ) − D( E )N’T・nD’+C’

Q’

C’

Bi’
D’+p

・P

D’+C’/n

C
S
・

O

Eˆ i
Fig. 4*i

E

Ei

Decision making on energy consumption.

Conducting a comparative static analysis on the pricep, we can easily see that Ei decreases with an increasein p (see Figure 4). Moreover, if the price p is equal to(n-1)D'(nȆi)+C'(nȆi), Ei satisfying (6) also satisfies (4),and the social optimum is attainable.
From these discussions, we have shown that sincehouseholds do not care about environmental damage toother households, there is no incentive under the fixedcharge system for them to reduce their energy consumption
on district heating. It is also clear that if district heating
is priced according to the meter system, every household
would save energy, and the social optimum would beachieved.
Energy-saving activity by a household is regarded as
the provision of public goods since it results in a better
environment for all other households. However, under the
fixed charge system, even if one household saves energy,
the merit perceived is too limited to give the household
an incentive to save energy. The meter system, which
provides monetary benefits to households, should be
introduced for increased energy saving. Here, the priceworks as a signal of the value of an improved environment.

5.2 Policy measures to enhance incentives to firms
and their energy savings

Section 4 describes a variety of policy measures
introduced by different governments. Here, we discuss
the effects of these measures.
Consider a firm that uses energy in the production
process, emitting a pollutant, and a consumer affected by
the pollutant. The firm gets a profit of π(E), using energy
E, and causes a damage of D(E). We assume π' > 0,π" < 0, D(0) = 0, D' > 0, and D" > 0. This is a case of
external diseconomy, since only the consumer is affectedby the damage.
If no policy measure is taken, the firm is considered
to have a right to pollute because the environment isgenerally regarded as a free good, so it chooses the energy
input Ē that satisfies π'(Ē) = 0. On the other hand, thesocially optimal energy input is E*, which maximizes
π(E)-D(E); that is, it satisfies π'(E*)-D'(E*) = 0. Therefore,O

Fig. 5Q
π (E* )

π (E)

N
l
π (E)

Policy measures and payoff allocation.

Ē is not a socially optimal level, and it is necessary thatthe government implement suitable policies.
In Figure 5, the horizontal axis represents the payoff
to the firm (profit), and the vertical axis represents thepayoff to the consumer, which is equal to the reduction ofdamage due to the decrease of energy input from Ē. The
downward-sloping curve QQ’ is called a Pareto frontier;it shows the combination of payoffs corresponding tovarious values of E.
Direct regulation is a policy that simply imposes E* on
the firm, which occurs at point P in Figure 5, at whichsocial welfare is maximized. In case this regulation isdetermined by bargaining between the government andthe firm, the government subsidizes the firm according
to its entitlement. If the firm has a right to emit thepollutant freely, the start point of the bargaining is Q. If
the government imposes energy input E* on the firm andat the same time pays a subsidy funded by tax revenue,
the feasible region is line l, which passes through P and
has a slope of -1. If the government considers that thefirm should be guaranteed a profit corresponding to point
Q, the subsidy is π(Ē)-π(E*) and a point C is realized. The
Nash bargaining solution with a disagreement point Q isrepresented by a point N, so the firm gets more subsidies.
On the other hand, suppose that no right to pollute isgiven to the firm. If the firm must compensate consumers
for all the damage it causes, payoff allocation C’ isrealized. The disagreement point and the Nash bargaining
solution are Q’ and N’, respectively. In this case, theamount of subsidy is negative, and the firm must pay apart of its profit. Thus, the realized outcome depends on
the rights given to the firm.
If a unit tax is levied for energy use, energy input
decreases as the tax rate increases, and coincides with
E* when the tax rate is equal to π'(E*) or D'(E*). The tax
that leads to social optimum is called the Pigovian tax.
If the revenue from the Pigovian tax is given back to theconsumer, the payoff allocation is shown by a point T,
which is located on line l in the upper left region of C’.
The positional relation between T and C’ follows from theconvexity of D and the fact that D(0) = 0.

Incentive Mechanisms for the Development of a Low-carbon Society in Asia

When a subsidy is paid, the energy input is the sameas in the case of a tax. However, the payoff allocation
corresponding to the Pigovian subsidy is shown by apoint S located on line l in the lower right region of C.
The positional relation between S and C follows fromthe concavity of π. These analyses reveal why firms
oppose tax policies but welcome subsidy policies.
Voluntary actions by firms have been frequently
observed in the recent past. The cost of energy saving
is generally the private information of the firm, and
it is unknown to the government. Consequently,
governmental regulation tends to be inefficient, withfirms being required to purchase unnecessarily expensive
equipment. Moreover, monitoring compliance isconsidered to be costly. If such regulation is anticipated,firms try to avoid it by offering voluntary action plansof energy reduction in advance. If the monitoring costis high and the inefficiency of regulation is negligible,
payoff allocation shown by a point like D1, in Figure 6, isexpected as a result of direct regulation, and D1 becomesa disagreement point. Firms offer voluntary actionplans to reduce energy input to Ȇ1, and consequently
payoff allocation V1 is realized. On the contrary, if theinefficiency of regulation is high and the monitoring costis negligible, a point like D2 becomes the disagreement
point. Firms offer voluntary action plans to reduceenergy input to Ȇ2, and payoff allocation V2 is realized.
Positional relations among V1, V2, and other points in
Figure 6 depend on the position of the disagreement
point.
With respect to rating, the demand for the goods
produced by highly rated firms increases, and the pricegoes up. As a result, the profit of the firm increases, and
the Pareto frontier shifts to the right, similar to Q’Q” in
Figure 6, and the payoff allocation is shown by R.
As seen in the preceding discussions, the policy
measures available, in the order of the burden on thefirm, are negotiation with no rights allowed (Pigoviantax), direct regulations, negotiation with rights allowed
to the firm (voluntary action, Pigovian subsidy, andrating).
D( E ) − D( E )

Q’
V2
D2
・

・P

・R

・ V1
・D
1

O

Q
π ( Eˆ 2 )π ( E * ) π ( Eˆ1 ) π ( E )

Q’’

π (E)

Fig. 6 Voluntary actions and rating.

6. Conclusion

This paper shows the critical importance of incentive
mechanisms to encourage energy saving. Energy
conservation is not emphasized in economic development,
especially in developing countries, and introducing
obligatory regulation is not easy. To build low-carbon
societies, governments need to implement effective
incentive mechanisms for both people and firms.
In this paper, we examine the features of energy
consumption in Asian countries, and focus on some
important issues such as district heating systems andenergy-saving incentives for industry. The district heating
system in China is a typical case of the lack of energysaving incentives. Cost incentive mechanisms such as
meter systems are more effective than the present setup,
in which energy is regarded as a public good. Several
incentive mechanisms that encourage firms to save energy
exist—such as subsidies, voluntary action, and rating
systems. These are explained as effective alternatives forgovernmental regulation—if the government does nothave full information.
Incentives should be designed after careful examinationof the situation, as well as a theoretical analysis toestablish the universality of the procedures.

(*1) Note: The policies for households may in fact overlap
with the residential sector. However, many articles focus on
the household and residential sectors separately. Accordingly,
we list the policies for the two sectors separately.

Acknowledgment: We would like to thank ourcolleagues and an anonymous reviewer for theircomments and suggestions, and Miyuki Shimizu forher assistance. This work was supported by the Global
Environment Research Fund [H-096] under the auspicesof the Ministry of Environment, Japan.
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1)