Energy savings potential in China's industrial sector: From the perspectives of factor price distortion and allocative inefficiency

- We measure energy savings potential resulted from allocative inefficiency in China's industrial sector.
- Allocative inefficiency is explained based on the theoretical and empirical models.
- Factor prices of capital, labor and energy are distorted because of government regulations.
- Energy pricing reform is conducive to improving energy allocative efficiency.

China's industrial energy consumption accounted for 70.82% of national and 14.12% of world energy usage in 2011. In the context of energy scarcity and environmental pollution, the industrial sector in China faces unsustainable growth problems. By adopting the stochastic frontier analysis (SFA) framework, this paper analyzes the factor allocative efficiency of China's industrial sector, and estimates the energy savings potential from the perspective of allocative inefficiency. This paper focuses on three issues. The first is examining the factor allocative inefficiency of China's industrial sector. The second is measuring factor price distortion by the shadow price model. The third is estimating the energy savings potential in China's industrial sector during 2001-2009. Major conclusions are thus drawn. First, factor prices of capital, labor and energy are distorted in China due to government regulations. Moreover, energy price is relatively low compared to capital price, while is relatively high compared to labor price. Second, the industry-wide energy savings potential resulted from energy allocative inefficiency was about 9.71% during 2001-2009. The downward trend of energy savings potential implies the increasing energy allocative efficiency in China's industrial sector. Third, a transparent and reasonable pricing mechanism is conducive to improving energy allocative efficiency.