Impacts of Local and Regional Carbon Market in Hong Kong and China’s Greater Bay Area: A Dynamic CGE Analysis

Abstract

<p><strong>Background</strong></p><p>In this study, we estimate the economic impacts of Hong Kong’s official carbon-mitigation targets, in connection with Hong Kong’s independent carbon market and the market’s potential integration with the nearby Shenzhen and Guangdong emissions trading schemes (ETSs). Hong Kong has recently set an ambitious goal of carbon neutrality to be attained by 2050, but sole dependence on conventional command-and-control type regulatory measures would be extremely costly. However, Hong Kong’s tiny local carbon market and oligopolized power-sector structure leave little room for market-based instruments, such as an ETS.</p><p><br></p><p><strong>Research Questions</strong></p><p>In this context, Hong Kong has an incentive to test a regional level carbon market integration with nearby Shenzhen and Guangdong ETSs to bring a market-based mechanism to the city. In particular, we examine the following two research questions.</p><ul><li>What impacts will Hong Kong’s proposed carbon-neutrality targets bring to the local economy if it operates an independent carbon market?</li><li>How can an integrated regional carbon market affect the policy compliance costs required for carbon neutrality in Hong Kong and China’s Greater Bay Area?</li></ul><p><br></p><p><strong>Theory/Concepts</strong></p><p>Our hypothesis is built on the microeconomic theory that quantity control with market-based carbon-pricing mechanisms (e.g., ETS) is superior to command-and-control regulations (e.g., technology-specific requirements at a firm level) or price control (e.g., carbon tax), since the former is subject to lower information/administrative costs and is less market-distortionary. We also hypothesize that an integrated regional carbon market is more efficient than a bundle of local markets, given the theorem of optimization under relaxed resource constraints.</p><p><br></p><p><strong>Method</strong></p><p>We take a computable general equilibrium (CGE) approach. Our recursive-dynamic, multi-region CGE model, titled the <em>Greater Bay Area Economic Model</em> (GBAEM), consists of 8 regions, including Hong Kong, Shenzhen, and the Rest of Guangdong (excluding Shenzhen), and 16 production sectors, including 8 electricity generation technologies. We run this model with one reference case scenario and three counterfactual policy scenarios assuming three different forms of regional carbon market integration.</p><p><br></p><p><strong>Findings</strong></p><p>Our results show that Hong Kong’s proposed carbon-neutrality targets would incur large policy-compliance costs comparable to ≤69% of baseline gross domestic product in each of the modelled years 2021 to 2060 when Hong Kong operates its own independent carbon market. By comparison, an integrated carbon markets with Shenzhen and Guangdong ETSs enables Hong Kong to achieve the same reduction goal at ≤49% and ≤75% lower costs, respectively, compared to an independent market. Such integrated regional carbon markets are also mutually beneficial to Shenzhen and Guangdong, allowing them to save compliance costs required to meet their own carbon-neutrality targets by ≤35% and ≤50%, respectively. In sum, an integrated carbon market in China’s Greater Bay Area would improve overall efficiency at the regional level and benefit all major stakeholder economies. In relative terms, however, Hong Kong will enjoy greater benefits from the regional carbon-market integration than Shenzhen and Guangdong. This suggests that Hong Kong needs to play a more active role in cross-border collaboration on climate mitigation and emissions trading.</p>