Will High Carbon Prices Reduce Fossil Fuel Use in China? Evidence from Price Elasticity Estimates using Firm Data

China is transitioning from command-and-control energy-saving and carbon abatement policies to a carbon trading mechanism, aiming to reduce CO2 emissions more cost-effectively, replacing implicit carbon pricing with explicit carbon pricing. This shift raises a critical question: will high carbon prices reduce fossil fuel consumption in China? If so, carbon trading could serve as a pivotal tool for limiting emissions while addressing policy conflicts with Europe under the Carbon Border Adjustment Mechanism (CBAM) to some extent. Our study explores how Chinese manufacturing firms might respond to higher carbon prices by examining how they respond to energy prices. We do this by estimating long- and short-run energy price elasticities using firm-level data from 2007–2016. We leverage provincial energy price variations for long-run elasticity estimates through pooled cross-sectional analysis and examine short-run elasticity using an unbalanced panel model. The results indicate that manufacturing firms are responsive to energy price changes in the long run but largely unresponsive in the short term, likely due to the short-term effects of technology lock-in. These findings suggest that transitioning to carbon trading is an effective strategy for reducing CO2 emissions and mitigating China’s CBAM liabilities on energy-intensive exports, though ensuring policy continuity remains a significant challenge.