Carbon emission reduction is one of the most discussed policy goals in the world. But which methods actually work? This study tests two of the most prominent approaches — carbon emissions trading systems (ETS) and sustainable energy strategies — using panel data across 30 provinces in China from 2009 to 2019.
The results are clear on one front and nuanced on the other. Substituting fossil fuels with clean energy consistently reduces emissions. Carbon trading, meanwhile, only works under specific conditions.
Two approaches, very different results
The study tests both methods simultaneously, controlling for population, GDP, and total energy consumption. The sustainable energy strategy — measured by the fossil fuel substitution effect (SUB), which captures the share of electricity generated from hydro, nuclear, wind, and solar — is significantly and consistently associated with lower CO2 emissions across all model specifications.
The carbon emissions trading system tells a more complicated story. The researchers separate ETS into two variables: a national-level signal (was carbon trading active anywhere in China?) and a regional-level variable (did this province have its own ETS pilot?). The regional ETS pilot reduces emissions locally. But the national-level signal alone has limited impact — it only shows statistical significance when the regional variable is excluded.
Firms prefer to trade carbon credits within their own province. Without a local ETS pilot, the national-level policy acts as a signal of future rewards — but not a direct incentive strong enough to change behaviour. The implication: rolling out more regional pilots would be more effective than relying on a top-down announcement alone.
The fossil fuel substitution effect across China
The geographical variation is striking. By 2019, provinces like Yunnan had reached a SUB of over 90%, essentially free from fossil fuel dependence for electricity. Meanwhile, heavily urbanised provinces like Shanghai and Tianjin started from near zero in 2009 and only gradually increased their clean energy share — often catalysed by the introduction of local ETS pilots.
The data shows an interesting synergy: in provinces where ETS pilots were introduced, the adoption of sustainable energy also accelerated. Tianjin's SUB jumped from 0% in 2012 to 3.6% in 2013, the year carbon trading was introduced. Neighbouring Hebei's SUB rose from 0.33% to over 15% during the decade, partly driven by spillover from Beijing and Tianjin's ETS activity.
Economic structure matters
Provinces with productive, diversified economies can reduce emissions while maintaining growth. But provinces whose economies depend heavily on energy-intensive industries face a harder trade-off — financial incentives from ETS may not be enough to offset the economic cost of reducing energy use.
This is exactly where the sustainable energy strategy becomes critical. By substituting fossil fuels rather than simply reducing energy consumption, provinces can cut emissions without sacrificing economic output.
Who should pay attention
| Audience | What this means for you |
|---|---|
| Policymakers | National ETS announcements need regional implementation to be effective — expand local pilots rather than relying on top-down signals |
| ESG investors | When assessing carbon exposure in Chinese assets, check whether the province has an active ETS pilot and what its clean energy substitution rate looks like |
| Climate-risk analysts | The fossil fuel substitution effect (SUB) is a useful metric for comparing provincial decarbonisation progress beyond headline emissions figures |
| International observers | China's provincial variation offers a natural experiment: the lessons on local vs national carbon trading apply to any country designing an ETS |
The bigger picture
This research shows that the two most prominent carbon reduction strategies work through different mechanisms and at different scales. Clean energy substitution is a reliable, province-level lever that works across the board. Carbon trading is effective but conditional — it needs local infrastructure, local markets, and local enforcement to deliver results.
For countries designing their own carbon reduction frameworks, the lesson is practical: don't rely on a single instrument. Build local trading ecosystems alongside national policy, and prioritise the transition to sustainable energy sources — especially in regions where fossil fuels still dominate economic production.
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Sherry Xu's books cover the practical intersection of sustainability, investment, and the built environment.