Using the Supply and Demand Model to Understand China's Recent Electricity and Coal Shortage

 The New York Times has published an excellent piece about an emerging coal shortage in China.  Let’s use the supply and demand framework to study this issue.  Aggregate demand for coal in China is rising because it is winter and much of the nation’s winter heating is supplied by burning coal.  The manufacturing sector is making a comeback and this sector uses plenty of electricity.  At the same time that aggregate demand is rising, aggregate supply has declined because the national Chinese government is in the midst of a feud with Australia. Australia is a leading exporter of coal to China.  A second reason is that China’s domestic mines have faced major safety challenges as miners have died and the new regulations these mines face has reduced domestic supply.  I will return to this point below.

On an Econ 101 exam, students are asked the following question.  If aggregate demand for a good is rising and if aggregate supply is declining, what happens to the equilibrium price?  

The diligent student is supposed to draw the curves and show that the price of the good in question will rise.  Dear Reader, note that this prediction is for a free market economy. In “Communist” China, I doubt that this has taken place.  When prices do not change to reflect market fundamentals, a shortage emerges because the price sticks at the original “communist price”.  At that “low price”,  demand exceeds supply and the New York Times reporters see a shortage.  For some details, read this.

The solution to this “shortage” issue is to allow prices to float to reflect scarcity.  Price ceilings create a type of moral hazard effect as major consumers of electricity do not need to invest in energy efficiency because they know that their Communist Leaders will protect them against price spikes. Why incur a fixed cost to achieve energy efficiency if energy prices can never soar?   

Let me propose two new academic research projects here;

1.   I would like to see a study of the diffusion of electricity smart meters across China. How many firms and residential homes have  a smart meter measuring consumption so that these entities could be exposed to dynamic pricing?   I predict that the state run SOEs are less likely to have this equipment in place.  The elasticity of demand with respect to price would be more elastic if more of these entities had smart meters.   

The Chinese Communist Party has introduce free market features to many parts of their economy.  Has the electricity sector been exposed to dynamic pricing?  “Shortages” will vanish when price signals are informative.

2. Returning to the coal mining point above related to the safety at mines.  First, read this very interesting QJE paper.  

In 2004, Dora and I published a paper using U. S data documenting that the Value of a Statistical Life rises faster over time than a nation’s per-capita growth rate.  As China grows richer, the society is willing to pay more to reduce the death risk in risky jobs such as coal mining.  We need new research studying the dynamics of the VSL in the developing world using revealed preference methods. Intuitively, what would I need to pay you for you to work for a week in a Chinese coal mine?  Now repeat this exercise but ask Jeff Bezos the same question. What would I need to pay him for a week for him to work in that same mine? The two answers would differ!   That’s the income elasticity of avoiding risk!!

3.   A good economist could also write a big think paper on how China’s energy efficiency efforts have been slowed down by its government’s continuing rules that maintain energy price ceilings.  If every coal and electricity consumer anticipated that they face potential price spikes due to the law of supply and demand, how much more energy efficiency would they invest in?  So, I’m returning to the “moral hazard” point I made above.  The expectation of price spikes encourages investments in efficiency. In the case of gasoline, the fear of high gas prices nudges people to buy a Prius or a EV.  The same logic holds for an overall economy.