Chinese President Xi Jinping has made a landmark commitment on climate change during his state visit to the United States. A Chinese cap-and-trade carbon pricing program is scheduled to begin in 2017 will be the world’s largest carbon market.

In a US-China joint climate statement issued yesterday, China pledged to lower carbon dioxide emissions per unit of gross domestic product (GDP) by 60-65% from the 2005 level by 2030, and introduce a national emission trading system covering key industry sectors such as iron and steel, power generation, chemicals, building materials, paper, and non-ferrous metals.

China is the world’s largest emitter of greenhouse gases, producing 25.9% of the world’s total carbon dioxide emissions in 2012.

Carbon pricing creates incentives for cutting greenhouse gases. According to the World Bank, 39 national and 23 subnational jurisdictions are putting a price on carbon through emission trading schemes (ETSs) and carbon taxes. These schemes and taxes cover 12% of the annual global greenhouse gas emissions: 8% from ETSs and 4% from carbon taxes.

China’s pilot schemes

China’s decision to run a domestic ETS was made in a closed-door meeting as early as 2010. Since 2013, pilot ETSs have come into operation in seven major cities and provinces: Beijing, Shanghai, Chongqing, Tianjin, Shenzhen, Hubei and Guangdong. Carbon prices vary across these pilot sites, ranging from US$1.9 per tonne in Shanghai to US$7.3 per tonne in Beijing (as of September 14-18, 2015).

The Chinese carbon markets have developed faster than expected. The pilot ETSs were approved in 2011, and China took only two years to get them up and running. Now, another two years later, President Xi has confirmed a crucial move towards a national scheme.

Meanwhile, the pilot schemes continue to tighten their regulations. For example, Guangdong Province plans to include more sectors, such as transport and construction, in its pilot ETS, which is the largest one in China. Chongqing City has reduced its cap at a greater rate than anticipated, lowering the number of freely allocated carbon allowances by 7%. There are plans for linking up ETSs across regions and creating new schemes in other provinces and cities, such as Hangzhou City and Anhui Province.

The blossoming of Chinese carbon markets stands in contrast to Australia’s stepping back from the transitory carbon tax, which would have become an ETS this year if it hadn’t been repealed by the Abbott government. While President Xi declared the climate change commitment on US soil, US President Obama himself failed in 2010 to get the Senate’s support for a similar cap-and-trade program. As a so-called “socialist market economy”, China seems to be more proactive than the neoliberal states such as the United States and Australia.

Hurdles to overcome

But there are still a lot of uncertainties about China’s scheme. The initial plan for a national ETS was scheduled in 2015, later deferred to 2016, and finally now confirmed for 2017.

Officials know all too well that any time sooner is unrealistic. Market regulation and infrastructure are far from complete. Companies are not active in the domestic carbon market. Local government officials and enterprises have limited capacity and expertise to manage trading activities.

Financial institutions are interested but concerned about the small scale of the market and the low trading volume. This is an issue because even small cities and counties have set up their carbon exchanges to reap benefits from carbon trading (and have closed down prematurely). Building a national cap-and-trade system will be a steep learning curve for China.

The falling coal consumption in China has made room for capping emissions. China used to be highly sceptical of emissions trading because it requires an absolute emissions cap to function properly, which would pose limits on the use of coal for power generation.

At the same time, car ownership in China is increasing, meaning that petrol use is likely to increase too. The Beijing government could keep cars off the roads by forcing car owners to drive only on alternate days (depending on their licence plate number), as it did during the APEC Summit held in Beijing in 2014 and the Tiananmen parade in 2015. Some heavy industries were forced to shut down their plants temporarily to meet emissions targets.

It may turn out that 2017 is too soon for China to develop a national ETS without an outdated “command-and-control” approach. A better way forward may be to develop an interim carbon tax scheme before moving to an ETS, as Australia previously attempted to do.

Experts have indicated that carbon taxes are a better option than ETSs. In 2011, UK climate economist Nicholas Stern, the principal author of the influential Stern Review, along with a group of prominent economists and senior academics from Chinese official think tanks, said:

…a carbon tax is probably the more robust instrument than a cap-and-trade system for cutting carbon emissions at this stage of China’s development, and it is also the favoured option of China’s policy-makers.

China needs a lot more time to build up a fully functioning carbon market, but it doesn’t have time to get it wrong. Covering more than a quarter of the world’s greenhouse gas emissions, the Chinese carbon market will be a game-changer, but it will also be too big to fail.

Alex Lo is an Assistant Professor at the University of Hong Kong. This article was originally published in The Conversation on 26 September 2015. It is republished with permission.