Zhou Xiaochuan: New Growth Tasks for the Financial Sector
Retooling China’s economy through product replacement, new technology and emission cuts must include the financial sector.
Zhou Xiaochuan, governor, The People’s Bank of China 30 April 2009
(Caijing Magazine) Expanding domestic demand is one of the most important aspects of China’s response to the international financial crisis. A main reason for this emphasis is softened external demand; export growth has been negative since November of last year. Today’s reliance on external demand simply cannot be wished away, so we must focus on generating more internal demand.
China has already introduced a number of policy measures to do just that, such as a 4 trillion yuan stimulus package and encouraging home appliance purchases in the countryside. To that end, efforts to support economic restructuring as well as upgrading and replacing products and technologies were highlighted at China’s Central Economic Work Conferences in December.
Creating Demand
Product upgrades and replacement can create tremendous demand, serving as a source of new economic growth. It is often said that “what’s new cannot come if the old does not go.” New products, new technologies and new processes can make important contributions toward increasing internal demand. Of course, it would be a waste to throw away old products simply to replace them with new ones. But if we enjoy more modern, more efficient, more environmentally friendly and more user-friendly products, we are conserving in the end. This satisfies both the requirements of scientific development and those related to creating domestic demand.
I believe the financial sector needs to pay particular attention to using the financial system to find ways to support technological transformation while updating and replacing products, technologies and processes. We must shift from traditional finance to modern finance. When I say we must modernize finance, I’m not referring to complicated financial derivatives products that few understand. Actually some derivatives products are quite useful. But others have caused a lot of trouble. What we need to understand about the modernization of finance is that the financial services industry must serve the development of society and the entire economy. And it should be people-oriented.
Therefore, I would like to take this opportunity to say that, aside from the usual function of finance, we need to be more concerned about the use of financial services for scientific and technological innovation, cycles of upgrading and replacement, as well as the role of risk management across the board. If executed well, this will spark new economic development and tremendous demand.
Let me give a couple of examples to show how upgrading and replacement can lead to significantly higher demand. Televisions, for example, used to be black and white, and then they were colour. Now they are high-definition, flat panels with liquid crystal or plasma displays. The broadband and multiple application capabilities of 1080p displays are certain to stir further demand.
In the past, refrigerators and air conditioners used Freon, which hurt the ozone layer. Now we are switching to non-chlorofluorocarbon devices, and mandatory replacement policies will rapidly generate demand for upgrades. In the 1980s, the personal computer arrived with an Intel 8088 microprocessor. Now we use dual-core processors. In terms of operating systems, we began with Microsoft DOS in the 1980s and now use Windows Vista, while awaiting an upgrade to Windows 7. Computer monitors likewise have moved from CRT displays to LCDs.
Another example is the mobile phone. In the 1980s, most people were using beepers and few had access to mobile phones, which at the time were the size of bricks. Subsequently, we moved to second-generation phones, and now third-generation (3G) phones.
Electronic products have short upgrade cycles but comprise only a small portion of GDP. Automobiles make up a much higher proportion. In addition to new features, many car buyers are increasingly concerned about emissions ratings, which are moving from Euro III standards to Euro IV and beyond. Current interest is shifting to the next generation of cars, whether hydrogen powered, electric powered or hybrid. This leads to a whole series of changes involving the entire auto industry. The auto parts industry and the entire fuel supply chain will undergo change, creating great demand and a new source for growth.
Another sector worth noting is housing. Emerging soon will be many, new energy-saving houses, both through construction of new buildings and modifications of others. In cold European countries, we already see many of these housing modifications, which are beneficial for environmental friendliness as well as in their ability to generate domestic demand.
Emissions Challenges
Automobiles and housing are good examples, but I feel there is an area with a greater need for upgrading and replacements: the energy sector. Setting a new course for energy resources mainly concerns issues surrounding greenhouse gasses and whether we can jump to a new stage of energy use while reducing emissions of carbon dioxide (CO2).
The Chinese government has attached great importance to the emissions reduction issue. The 11th Five Year Plan places special emphasis on reducing emissions. But when the plan was written, we neglected to include requirements for reducing CO2 emissions. So far, we have referred mainly to reducing sulfur dioxide emissions and chemical oxygen demand. Each year, the government attaches great importance to completing emissions reduction targets in these areas.
Questions surrounding CO2 emissions have been so difficult because there has been no clear direction. Is there a specific, scientific or technological method for resolving CO2 emissions problems? Would emphasizing CO2 emission reductions put pressure on China’s economic development or slow the pace of living standard improvements?
And there is another point. Until recently, we didn’t know how harmful CO2 emissions were. Different groups of scientists made different claims. Now, we are learning more about this topic every day. I’m not an expert in this area and cannot make conclusions. However, it seems more attention is being paid to this issue, and we cannot afford to ignore it.
There are some noteworthy CO2 emissions-reducing technologies, such as wind and solar power, which fall under the category of renewable energy. However, in terms of annual megawatt hours, these technologies can currently satisfy only a small part of electricity demand. The main need, then, is still to resolve emissions problems linked to traditional power generation methods such as coal power and, to a lesser extent, oil and natural gas.
There are many options for power companies, but the choices are complicated. One choice is nuclear power, which is a difficult issue in itself. In the China-U.S. Strategic Economic Dialogue, nuclear power is an important topic of discussion. We have indicated our support for this. But, realistically, how much can nuclear energy contribute to the energy mix? This is worth debating. Another technology we should be paying attention to is carbon capture and storage (CCS), and I believe the financial sector has a role to play in this.
Burning fossil fuels produces CO2, but what if we capture CO2 and store it? I’d like to briefly mention that CCS technology requires power to capture and store CO2, and some fuel and electricity may be used in the capture and sequestration process. How much extra fuel? Existing data points to a 21 to 91 percent increase in consumption, meaning the energy produced would be more expensive.
This touches a problem over how to deal with more expensive energy. By relying on nearby reserves, a typical coal-fired power plant could resolve this problem with a 25 percent increase in coal consumption. A natural gas-fired power plant would use less -- around 15 percent. Energy consumption might be greater during start-up periods due to extra costs for technology and, in the initial usage period, consumption might be greater. The cheapest carbon storage technology is that which finds places suitable for storing carbon, such as depleted oil and gas fields or similar geological structures. If a geological formation happens to be close to a power plant, and storage technology allows storing CO2 for a long period, how much could emissions be reduced? CCS technology can reduce 90 percent of CO2 emissions, depending on the process.
CCS technology is not in the distant future, as some may imagine. Successful tests have already been carried out in Norway, Canada, Texas and Mississippi in the United States, the Netherlands, Australia and other places. There are a number of carbon capture technologies. Post-combustion technology captures carbon after fuel is burned, typically from flue gas. Pre-combustion technology removes the carbon before fuel is burned. And there are other methods. Forcing flue gas into oil fields that are still being exploited can increase the volume of accessible oil. Other technologies utilize gas fields, salt mines and basalt structures to store carbon. Some are exploring ocean storage and mineral carbonation storage technologies. Mineral carbonation refers to fixing carbon dioxide in the form of inorganic carbonates such as calcium carbonate and magnesium carbonate.
You might wonder: Will geological sequestration eventually lead to leakage? Current technologies show a 99 percent probability that geological sequestration can ensure non-leakage for more than 1,000 years. Therefore, this is an example of a large-scale upgrade and replacement process.
Emissions reduction is an important step in the quest for technological upgrades and replacement. Potential demand can be measured in hundreds of billions or even trillions of dollars. Moreover, emissions reduction seems unavoidable; investment will have to be undertaken sooner or later. The question is, when?
If we embrace some of these sorts of upgrade and replacement projects, domestic demand could be markedly improved.
Financial Markets and Carbon
Now, I’d like to discuss how the issue of emissions reduction involves financial services. Who is actually going to pay for power that is 25 to 50 percent more expensive? Those who work in economics know consumers seldom care how electricity is generated. And if cheap electricity is available, no one is going to buy the expensive stuff. Yet someone has to pay the cost of more expensive electricity.
There are two options. The first is a universal cost rise, which would mean that all people using electricity, at some point in the future, would have to pay an additional 25 to 50 percent. I’m afraid this would have too great an impact on the economy. Another option is the incremental cost method, through which anyone who wants to increase energy consumption would have to pay a relatively higher price. This is a bit like household water and electricity quotas. Prices are low within certain limits, but get more expensive whenever the line is crossed.
Thus, we return to economic questions over pricing and allocation; that is, the issue of carbon caps. A number of financial markets are attempting cap and trade programs. If this were done on an international level, a number of problems would arise, such as the issue of fairness between developing and developed countries. Because countries that developed earlier have previously produced significant emissions that made them well-off today, and later developing countries have a smaller historical responsibility but still have an urgent need to develop global carbon quotas, questions of fairness arise that are not easily resolved.
Setting aside questions over allocating international carbon caps, should China control carbon emissions on its own in the future? If we want to control overall quantity, a domestic cap could be imposed. The first step should be an incremental cap. By that, I mean one would acknowledge historical emissions, but a higher price would have to be paid by one who wants to use more electricity in the future. Not long ago, The People’s Bank of China joined other government agencies in sponsoring a seminar on carbon caps and carbon tax issues.
Carbon cap and trade connects to the role played by financial markets. We say financial markets can set prices for carbon quotas; they can discover prices and, therefore, decide the most efficient allocations of incremental caps on carbon emissions. Moreover, allocating incremental caps can further transform sources of investment capital and overcome time limit allocation problems. In fact, financial markets can seek out capital sources for reducing emissions.
Nuclear and CSS technologies require massive investment and would require numerous technological adjustments. These new investments would have to be calculated according to future returns, a large portion of which would come from future users – a fact related to pricing allocations for carbon credits. Thus, from carbon caps to emissions reduction investments, financial markets can play an important role as an intermediary.
This relates to the current issue of a lag between investments and applications of new technologies. New investments require a long period before showing returns. Financial markets allow for bridges to be built between investment supply and demand by introducing intermediaries. In this way, financial markets link supply and demand over time.
Finally, finance can help us manage market risk. Any project involving future emissions reductions or future technologies involves significant risks; some will succeed while others fail. Such risk management is precisely what we seek through our capital markets.
The financial services industry should do everything possible to support the development of advanced technology and independent innovation to build an innovative nation. If we succeed, we can create new demand through upgrading and replacements, supporting new economic growth. At the same time, the financial sector will be encouraged to provide better services.
Within the financial sector there should be a variety of talent, although not necessarily specialized. We need enthusiasm for developing the real economy and society, for environmental protection and high-tech advancement. In this new era, the financial sector will increasingly walk the road of capital operations and depend less on traditional, indirect financing.
Of course, we must also master moderation and quality. The current economic crisis has shown that many went overboard with financial innovation. Moving too quickly can cause problems. In terms of general trends, we will have to rely more on financial market operations, including pricing, market trading, risk management and other skills.
The author serves as governor of The People’s Bank of China. His opinion was originally presented as the closing speech at Caijing’s Annual Meeting 2009: Forecasts and Strategies, and was amended by the author for publication.
1 comment:
Zhou Xiaochuan: New Growth Tasks for the Financial Sector
Retooling China’s economy through product replacement, new technology and emission cuts must include the financial sector.
Zhou Xiaochuan, governor, The People’s Bank of China
30 April 2009
(Caijing Magazine) Expanding domestic demand is one of the most important aspects of China’s response to the international financial crisis. A main reason for this emphasis is softened external demand; export growth has been negative since November of last year. Today’s reliance on external demand simply cannot be wished away, so we must focus on generating more internal demand.
China has already introduced a number of policy measures to do just that, such as a 4 trillion yuan stimulus package and encouraging home appliance purchases in the countryside. To that end, efforts to support economic restructuring as well as upgrading and replacing products and technologies were highlighted at China’s Central Economic Work Conferences in December.
Creating Demand
Product upgrades and replacement can create tremendous demand, serving as a source of new economic growth. It is often said that “what’s new cannot come if the old does not go.” New products, new technologies and new processes can make important contributions toward increasing internal demand. Of course, it would be a waste to throw away old products simply to replace them with new ones. But if we enjoy more modern, more efficient, more environmentally friendly and more user-friendly products, we are conserving in the end. This satisfies both the requirements of scientific development and those related to creating domestic demand.
I believe the financial sector needs to pay particular attention to using the financial system to find ways to support technological transformation while updating and replacing products, technologies and processes. We must shift from traditional finance to modern finance. When I say we must modernize finance, I’m not referring to complicated financial derivatives products that few understand. Actually some derivatives products are quite useful. But others have caused a lot of trouble. What we need to understand about the modernization of finance is that the financial services industry must serve the development of society and the entire economy. And it should be people-oriented.
Therefore, I would like to take this opportunity to say that, aside from the usual function of finance, we need to be more concerned about the use of financial services for scientific and technological innovation, cycles of upgrading and replacement, as well as the role of risk management across the board. If executed well, this will spark new economic development and tremendous demand.
Let me give a couple of examples to show how upgrading and replacement can lead to significantly higher demand. Televisions, for example, used to be black and white, and then they were colour. Now they are high-definition, flat panels with liquid crystal or plasma displays. The broadband and multiple application capabilities of 1080p displays are certain to stir further demand.
In the past, refrigerators and air conditioners used Freon, which hurt the ozone layer. Now we are switching to non-chlorofluorocarbon devices, and mandatory replacement policies will rapidly generate demand for upgrades. In the 1980s, the personal computer arrived with an Intel 8088 microprocessor. Now we use dual-core processors. In terms of operating systems, we began with Microsoft DOS in the 1980s and now use Windows Vista, while awaiting an upgrade to Windows 7. Computer monitors likewise have moved from CRT displays to LCDs.
Another example is the mobile phone. In the 1980s, most people were using beepers and few had access to mobile phones, which at the time were the size of bricks. Subsequently, we moved to second-generation phones, and now third-generation (3G) phones.
Electronic products have short upgrade cycles but comprise only a small portion of GDP. Automobiles make up a much higher proportion. In addition to new features, many car buyers are increasingly concerned about emissions ratings, which are moving from Euro III standards to Euro IV and beyond. Current interest is shifting to the next generation of cars, whether hydrogen powered, electric powered or hybrid. This leads to a whole series of changes involving the entire auto industry. The auto parts industry and the entire fuel supply chain will undergo change, creating great demand and a new source for growth.
Another sector worth noting is housing. Emerging soon will be many, new energy-saving houses, both through construction of new buildings and modifications of others. In cold European countries, we already see many of these housing modifications, which are beneficial for environmental friendliness as well as in their ability to generate domestic demand.
Emissions Challenges
Automobiles and housing are good examples, but I feel there is an area with a greater need for upgrading and replacements: the energy sector. Setting a new course for energy resources mainly concerns issues surrounding greenhouse gasses and whether we can jump to a new stage of energy use while reducing emissions of carbon dioxide (CO2).
The Chinese government has attached great importance to the emissions reduction issue. The 11th Five Year Plan places special emphasis on reducing emissions. But when the plan was written, we neglected to include requirements for reducing CO2 emissions. So far, we have referred mainly to reducing sulfur dioxide emissions and chemical oxygen demand. Each year, the government attaches great importance to completing emissions reduction targets in these areas.
Questions surrounding CO2 emissions have been so difficult because there has been no clear direction. Is there a specific, scientific or technological method for resolving CO2 emissions problems? Would emphasizing CO2 emission reductions put pressure on China’s economic development or slow the pace of living standard improvements?
And there is another point. Until recently, we didn’t know how harmful CO2 emissions were. Different groups of scientists made different claims. Now, we are learning more about this topic every day. I’m not an expert in this area and cannot make conclusions. However, it seems more attention is being paid to this issue, and we cannot afford to ignore it.
There are some noteworthy CO2 emissions-reducing technologies, such as wind and solar power, which fall under the category of renewable energy. However, in terms of annual megawatt hours, these technologies can currently satisfy only a small part of electricity demand. The main need, then, is still to resolve emissions problems linked to traditional power generation methods such as coal power and, to a lesser extent, oil and natural gas.
There are many options for power companies, but the choices are complicated. One choice is nuclear power, which is a difficult issue in itself. In the China-U.S. Strategic Economic Dialogue, nuclear power is an important topic of discussion. We have indicated our support for this. But, realistically, how much can nuclear energy contribute to the energy mix? This is worth debating. Another technology we should be paying attention to is carbon capture and storage (CCS), and I believe the financial sector has a role to play in this.
Burning fossil fuels produces CO2, but what if we capture CO2 and store it? I’d like to briefly mention that CCS technology requires power to capture and store CO2, and some fuel and electricity may be used in the capture and sequestration process. How much extra fuel? Existing data points to a 21 to 91 percent increase in consumption, meaning the energy produced would be more expensive.
This touches a problem over how to deal with more expensive energy. By relying on nearby reserves, a typical coal-fired power plant could resolve this problem with a 25 percent increase in coal consumption. A natural gas-fired power plant would use less -- around 15 percent. Energy consumption might be greater during start-up periods due to extra costs for technology and, in the initial usage period, consumption might be greater. The cheapest carbon storage technology is that which finds places suitable for storing carbon, such as depleted oil and gas fields or similar geological structures. If a geological formation happens to be close to a power plant, and storage technology allows storing CO2 for a long period, how much could emissions be reduced? CCS technology can reduce 90 percent of CO2 emissions, depending on the process.
CCS technology is not in the distant future, as some may imagine. Successful tests have already been carried out in Norway, Canada, Texas and Mississippi in the United States, the Netherlands, Australia and other places. There are a number of carbon capture technologies. Post-combustion technology captures carbon after fuel is burned, typically from flue gas. Pre-combustion technology removes the carbon before fuel is burned. And there are other methods. Forcing flue gas into oil fields that are still being exploited can increase the volume of accessible oil. Other technologies utilize gas fields, salt mines and basalt structures to store carbon. Some are exploring ocean storage and mineral carbonation storage technologies. Mineral carbonation refers to fixing carbon dioxide in the form of inorganic carbonates such as calcium carbonate and magnesium carbonate.
You might wonder: Will geological sequestration eventually lead to leakage? Current technologies show a 99 percent probability that geological sequestration can ensure non-leakage for more than 1,000 years. Therefore, this is an example of a large-scale upgrade and replacement process.
Emissions reduction is an important step in the quest for technological upgrades and replacement. Potential demand can be measured in hundreds of billions or even trillions of dollars. Moreover, emissions reduction seems unavoidable; investment will have to be undertaken sooner or later. The question is, when?
If we embrace some of these sorts of upgrade and replacement projects, domestic demand could be markedly improved.
Financial Markets and Carbon
Now, I’d like to discuss how the issue of emissions reduction involves financial services. Who is actually going to pay for power that is 25 to 50 percent more expensive? Those who work in economics know consumers seldom care how electricity is generated. And if cheap electricity is available, no one is going to buy the expensive stuff. Yet someone has to pay the cost of more expensive electricity.
There are two options. The first is a universal cost rise, which would mean that all people using electricity, at some point in the future, would have to pay an additional 25 to 50 percent. I’m afraid this would have too great an impact on the economy. Another option is the incremental cost method, through which anyone who wants to increase energy consumption would have to pay a relatively higher price. This is a bit like household water and electricity quotas. Prices are low within certain limits, but get more expensive whenever the line is crossed.
Thus, we return to economic questions over pricing and allocation; that is, the issue of carbon caps. A number of financial markets are attempting cap and trade programs. If this were done on an international level, a number of problems would arise, such as the issue of fairness between developing and developed countries. Because countries that developed earlier have previously produced significant emissions that made them well-off today, and later developing countries have a smaller historical responsibility but still have an urgent need to develop global carbon quotas, questions of fairness arise that are not easily resolved.
Setting aside questions over allocating international carbon caps, should China control carbon emissions on its own in the future? If we want to control overall quantity, a domestic cap could be imposed. The first step should be an incremental cap. By that, I mean one would acknowledge historical emissions, but a higher price would have to be paid by one who wants to use more electricity in the future. Not long ago, The People’s Bank of China joined other government agencies in sponsoring a seminar on carbon caps and carbon tax issues.
Carbon cap and trade connects to the role played by financial markets. We say financial markets can set prices for carbon quotas; they can discover prices and, therefore, decide the most efficient allocations of incremental caps on carbon emissions. Moreover, allocating incremental caps can further transform sources of investment capital and overcome time limit allocation problems. In fact, financial markets can seek out capital sources for reducing emissions.
Nuclear and CSS technologies require massive investment and would require numerous technological adjustments. These new investments would have to be calculated according to future returns, a large portion of which would come from future users – a fact related to pricing allocations for carbon credits. Thus, from carbon caps to emissions reduction investments, financial markets can play an important role as an intermediary.
This relates to the current issue of a lag between investments and applications of new technologies. New investments require a long period before showing returns. Financial markets allow for bridges to be built between investment supply and demand by introducing intermediaries. In this way, financial markets link supply and demand over time.
Finally, finance can help us manage market risk. Any project involving future emissions reductions or future technologies involves significant risks; some will succeed while others fail. Such risk management is precisely what we seek through our capital markets.
The financial services industry should do everything possible to support the development of advanced technology and independent innovation to build an innovative nation. If we succeed, we can create new demand through upgrading and replacements, supporting new economic growth. At the same time, the financial sector will be encouraged to provide better services.
Within the financial sector there should be a variety of talent, although not necessarily specialized. We need enthusiasm for developing the real economy and society, for environmental protection and high-tech advancement. In this new era, the financial sector will increasingly walk the road of capital operations and depend less on traditional, indirect financing.
Of course, we must also master moderation and quality. The current economic crisis has shown that many went overboard with financial innovation. Moving too quickly can cause problems. In terms of general trends, we will have to rely more on financial market operations, including pricing, market trading, risk management and other skills.
The author serves as governor of The People’s Bank of China. His opinion was originally presented as the closing speech at Caijing’s Annual Meeting 2009: Forecasts and Strategies, and was amended by the author for publication.
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