Modeling the Linkage between Vertical Contracts and Strategic Environmental Policy: Energy Price Marketization Level and Strategic Choice for China

The lower price of energy leads to higher coal consumption in China. The idea of an “environment-for-trade policy” could be used to achieve an international competitive advantage, which, in turn, has important implications. To address the issue, we develop properties to examine the link between the low price of energy and strategic environmental policy in China and investigate the choice of policy instruments in a strategic environmental policy model with vertical contracts. In addition, to contribute to the literature on strategic environmental policy, this paper also develops properties to investigate different choices of instruments for the environmental policy and includes the degree of energy marketization for the wholesale price in the study. To do so, we assume that the wholesale price of the polluting input increases with the market price. By using this assumption, this paper analyzes the effects of two instruments of the environmental policy on social welfare and concludes that there is no reason to expect both downstream and upstream firms to establish a high wholesale price. Due to the low level of marketization, when the government selects an emission tax as the policy instrument, the optimal tax rates should be higher than the marginal damage of emissions. However, the optimal resource tax is uncertain when its effect on environmental damage is taken into account. In other words, the resource tax is ineffective as a policy instrument. Our results can be used to draw some practical policies for countries to use their energy effectively. To promote energy sustainability, governments should liberate resource prices and reform the system to get efficient environmental policies.