In addition to addressing the shortcomings of the target-based implementation system, China has also experimented with small-scale market-based pilot projects to supplement existing command and control tools. Recent experiments with market-based instruments include rolling out a three-tiered electricity pricing system, promoting energy service companies (ESCO) (see _Box 10_ ) and introducing numerous payment for eco-system services to improve water, air, forest, and soil management (Kostka and Shin, 2013; Liang and Mol, 2013; Shin, 2013). In addition, numerous pilot projects at subnational levels aim to achieve lower carbon emissions:

- _13 low-carbon pilot projects -_ In 2010, five provinces and eight cities were selected to develop low-carbon development plans and accelerate the establishment of low-carbon industrial, construction and transportation systems (Kostka and Mol, 2013). In 2012, another 29 cities were chosen to join the low-carbon pilot projects (Xie, 2013).

- _7 pilot emissions trading schemes -_ New carbon emissions trial trading schemes are currently being set up in seven major cities and provinces. These include the cities of Beijing, Shanghai, Tianjin, and Chongqing, the provinces of Guangdong and Hubei and the Shenzhen Special Administrative Region. Shanghai and Shenzhen plan to start local trading schemes by mid 2013. Shanghai’s trading scheme will start with 200 local companies (Shanghai Daily, 2013). In Shenzhen, the scheme will start with 635 companies, which together accounted for 38% of Shenzhen’s total greenhouse gas emissions in 2010 (Greenbiz, 2013). The other five cities and provinces have announced that they will initiate their trial trading programs in fall 2013. It is expected that these pilots will pave the way for a national carbon-trading scheme to be introduced by 2015.

Yet, these efforts and pilot programs need to be interpreted with a cautious optimism. In years past, the majority of market-based pilot projects have not scaled up from regional to nationwide programs due to the lack of market preconditions and excessive state intervention in emission trading formats, allocation methods, and pricing approaches (Lo, 2013; Shin, 2013). For example, previous pilots to establish local SO2 permit trading schemes did not scale up. SO2 emission trading schemes failed mainly because of the dominant role played by local governments that led to unfair allocation of permits and interference in the monitoring of emissions (World Bank China 2030). Without a unified supervision system overseen by an independent regulatory body, local governments can decide unilaterally on emissions quotas for companies in their jurisdiction. Excessive intervention by local governments may also feed rent-seeking such that local companies offer payments to bureaucrats for an increase in their allowable emission levels. In addition, local governments are not incentivized to set high quotas in order to protect local economic growth (Global Times, 2013).

# **Box 10: Policies to support the ESCO industry**

Over the last few years, the NDRC and the Ministry of Finance (MoF) as well as local governments introduced financial and tax incentives to support the ESCO industry. For example, in 2008, Shanghai set up a special fund to promote ESCO projects. The NDRC and MoF offered 240 RMB for 1 tonne of standard coal equivalent as a financial incentive for using ESCOs services and exempted ESCOs from business tax for revenue generated from Energy Performance Contracting (EPC) projects. The NDRC and MoF also issued a list of 984 officially approved ESCOs.

Despite these numerous initiatives, ESCOs remain marginal players in delivering energy efficiency goals in China. The current list of 984 approved ESCOs lacks transparent and stringent selection criteria and provides neither information about ESCOs technical and financial capabilities nor data on the companies’ previous success in implementing energy efficiency projects. A sophisticated accreditation system would be beneficial to ensure confidence in the published list of approved ESCOs. Such ESCO accreditation system has been successfully adopted in India and has helped to build trust and confidence in India’s emerging ESCO industry. Moreover, China’s commercial banks need to train their loan officers in developing and using internal energy efficiency saving measures and standards. An introduction of standardized measurements and verification protocols to verify energy 35 savings at the national level would also be helpful.

_Source: Kostka and Shin (2013)_