Energy Policy 45 (2012) 350–358

Contents lists available at SciVerse ScienceDirect

Energy Policy

0301-42

doi:10.1

n Corr

E-m

wangm

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Development policy for non-grid-connected wind power in China: Ananalysis based on institutional change

Yong Fang a,n, Jing Li b, Mingming Wang a,n

a School of Economics and Management, Beijing University of Chemical Technology, Beijing 100029, Chinab Corporate Technology, Siemens Ltd., Beijing 100102, China

a r t i c l e i n f o

Article history:

Received 15 February 2011

Accepted 17 February 2012Available online 18 March 2012

Keywords:

Non-grid-connected wind power

Energy policy

New institutional economics

15/$ - see front matter & 2012 Elsevier Ltd. A

016/j.enpol.2012.02.043

esponding authors. Tel.: þ86 10 6444 5123.

ail addresses: fangyongtm@gmail.com (Y. Fan

m@mail.buct.edu.cn (M. Wang).

a b s t r a c t

Government policy continues to play a crucial role in the development of wind power industry in China.

The 2005 ‘‘Renewable Energy Law’’ and related policies have driven the rapid increase in wind power

installed capacity in China over the past half-decade, with capacity doubling annually since 2005.

However, a large number of wind farms generate electricity well below their installed capacity,

resulting in considerable wastage of resources. Non-grid-connected wind power theory proposes that

large-scale wind power output does not necessarily have to be fed into the grid, but can be used directly

in industrial production. Thus, the use of the theory can promote the sustainable development of the

wind power industry by obviating the need for power grid. In this paper we analyze the influence of

government policy on wind power industry from the perspective of institutional change, by employing

the basic theories of new institutional economics. A development model for non-grid-connected wind

power is proposed in order to implement institutional change in accordance with the specific

characteristics of wind power industry in China. This model requires the government to play an active

role in institutional development by increasing economic efficiency in order to promote the sustainable

development of wind power.

& 2012 Elsevier Ltd. All rights reserved.

1. Introduction

Wind power is an important form of green energy. Against thebackdrop of current energy shortages, it represents a promisingfuture direction in energy generation, and is therefore is strate-gically important to national and socio-economic development(Lema and Ruby, 2006). Therefore, wind power development isinextricably related to national policy. The demands for energyconservation and alternative energy sources have prompted theChinese government to focus increasing attention on the devel-opment of wind power. Since 2005, the Chinese government haspublished a large number of wind power development policiesinvolving legislation, development planning and other measuresto support the wind power industry. These include favorable poolpurchase pricing of wind power, tax exemption or reduction, andfinancial subsidies, which have stimulated the rapid developmentof the wind power industry. Data from the Chinese Wind EnergyAssociation (CWEA) show that the wind power installed capacityin China increased from 760.2 MW at the end of 2004to 41,827.3 MW at the end of 2010 (CWEA, 2011). The average

ll rights reserved.

g),

annual growth in this period exceeded 100%, and the total windpower installed capacity in China has now surpassed the UnitedStates and ranks first in the world (NDRC, 2011). China hasbecome a leading investor in wind power, and the wind powerdevelopment policy of the Chinese government is thereforeattracting close attention.

China’s wind power development has obvious differences fromthat of other countries:

(1)

Wind power policy directly affects the wind power industry.In the development of China’s economy, government policyemphasizes both planning and the market, and China has acentralized government that can make policy decisions veryquickly compared with the US and Europe. The economic andindustrial development program of the Chinese governmenthas a stronger influence than is the case for governments inthe United States and Europe. China’s total power installedcapacity is currently in excess of 9 million MW. When theChinese government formulates successive Five-Year Plans,they assign quotas for the proportions of generation andinstallation capacity due to wind power in the whole powergrid. Currently, wind power contributes a small proportion ofthe whole power grid, but only minor changes will bring hugeinvestment opportunities which directly affect the entirewind power industry.

Fig. 1. Distribution of wind power resources in China.

Source: Distribution of Effective Wind Power Density in China (CWERA, 2010).

Y. Fang et al. / Energy Policy 45 (2012) 350–358 351

(2)

There are abundant but unevenly distributed wind powerresources in China, giving rise to problems in electricitytransmission. China has a vast land area, and has rich windresources in the northeast, northwest and eastern coastalregions. However, economic development in the country isalso extremely uneven. The eastern coastal region is the mostdeveloped economic region, while the vast area of the west isunderdeveloped. Therefore most areas that have rich windresources are underdeveloped, meaning they consume com-paratively little electricity (Fig. 1) (Yu et al., 2011). This givesrise to the problem of how to transmit a large quantity ofelectricity to the distant load centers. In contrast, economicdevelopment is more balanced in the US and Europe, so theproblem of electricity transmission is less serious than is thecase for China.

(3)

In China there is a centralized network structure, with aunified power grid, and most power grids being controlled bythe State Grid Corporation of China (SGCC). SGCC is a hugestate-owned enterprise, which to a certain extent reflects theaims of the government. SGCC has suggested that thereremains a need for a unified and strong smart grid in China(SGCC, 2010). Wind power cannot supply electricity directlyto end users via a local grid near to the load, but must be fedinto the national transmission grid. This is different from theconcept of a distributed grid common in Western countries(Nair and Zhang, 2009), where the emphasis is on the balanceof supply and demand of local electric power. In this case,wind power either can supply local users or be transmittedvia the electric distribution network. Therefore unlike inChina, utilization of wind power in Western counties doesnot depend totally on the national grid.

(4)

Electricity markets in China are not complete. Since the1990s, many countries have implemented market reform inthe electric power industry. The traditional power industrywas deregulated giving separate and competitive markets.The electricity industry involves separate power generation,transmission, distribution, and consumption markets. As theleaders of market reform, the US and Europe have constructedcomplete and competitive electricity markets, and electricitycan be freely traded in the markets (Rahimi and Sheffrin,2003; Toke, 2011). However, China is now still in the earlystages of developing an electricity market. Only the northeastand eastern China have opened power generation to themarket, and about 10–20% of electric power is currentlytraded in electricity markets (SERC, 2004). Wind power farms

have no right to sell their power directly to end users or to bidin electricity markets. Wind power farms that have beenapproved by the government can only sell all the power theygenerate to the state power grid companies such as SGCC.

(5)

State-owned enterprises are the mainstay of the investmentin wind power investment in China. All wind power invest-ment requires the approval of the government and the entrythreshold is very high for private companies. Thereforealthough there are many other sources of finance for windpower investment—including private capital and foreigninvestment—state-owned enterprises remain in a dominantposition. At present, the five biggest state-owned powergeneration groups and some local government investmentcompanies account for most of the investment in wind power(Li et al., 2011). The chief executives of state-owned enter-prises are appointed or removed by government and theirperformance is also evaluated by government. Since enter-prise strategies and national policies are closely related,investment in wind power must be a clear policy goal.

Wind power access to the grid is traditionally the only routefor large-scale wind farm applications (Gu, 2010), and thecharacteristics of wind power development in China have tendedto strengthen the importance of the grid. The irregular outputfrom wind power installations has a considerable effect on thetraditional grid, directly influencing its safe operation. Giventhese safety concerns, current estimates indicate that wind poweraccounts for no more than 10% of the total transmission capacityof the power grid (Gu, 2006a). Given the total installed capacity,this indicates that a large number of wind turbines are idlebecause they cannot access the grid: The Ministry of Industryand Information Technology reported that the wind powerinstalled capacity of China reached 25,805 MW in 2009, but only62.51% is connected to the grid, giving an effective installedcapacity of only 16,130 MW. The soaring increase in installedwind power capacity has led to a large number of wind farms thatcannot generate energy in accordance with their installed capa-city, and this has become a major impediment to the sustainabledevelopment of wind power (Yu and Qu, 2010; Lee, 2010).

Non-grid-connected wind power theory proposes that theoutput of large-scale wind power can be supplied directly tospecific industrial production units, and that can increase theproportion of wind power in total electricity consumption insome regional areas from less than 5% to 100% (Gu, 2006b). Thetheory challenges the traditional assumption that the output oflarge-scale wind power installations must be fed into the maingrid, and attracted considerable attention as soon as it wasproposed. The Non-Grid-Connected Wind Power Symposiumwas held in 2007 to explore technical issues in the advancementof non-grid-connected wind power and was sponsored by GE,Vestas, and Suzlon, among other companies. The World Non-Grid-Connected Wind Power and Energy Conference, jointly organizedby the World Wind Energy Association, IEEE, the Power & EnergySociety (PES), and other organizations has been held annuallysince 2009, and enjoys an excellent worldwide reputation. TheChinese Ministry of Science and Technology sponsored researchon non-grid-connected wind power through the National BasicResearch Program (973 Program) in 2007 and the results arecurrently being implemented in Jiangsu Province (Zhao et al.,2009). Therefore, non-grid-connected wind power serves as afeasible development path for the wind power industry in China.

However, given China’s unique background, implementingnon-grid-connected wind power is strongly influenced by policyfactors. When wind power development in China faces a specificchallenge, the government publishes an appropriate policy tosolve it, and the state-owned enterprises follow this lead since

Y. Fang et al. / Energy Policy 45 (2012) 350–358352

their strategies must be consistent with government policy.However, this means that they often do not take sufficientaccount of technology and market implications, and this givesrise to more problems. Meanwhile electricity markets are notcomplete in China, these problems will be deteriorated furtherdue to non free trade among enterprises, and enterprises seekhelp from the government again, and in response the governmentformulates updated or new policies. This results in a cyclicalprocess of wind power development, in which the key variable isnational policy. Given the influence of national policy on windpower development, many papers have focused on the analysis ofChinese policies on wind power (Liao et al., 2010; Cherni andKentish, 2007; Brennand, 2001; Chang et al. 2003; Liu and Kokko,2010). However, these authors were unable to formulate anoverall policy framework since they did not utilize an effectivetheory to analysis the in-depth reason for policies and therelationships between policies.

New institutional economics (NIE) has been shown to be asuccessful and effective tool to analyze a policy (Williamson,2002). It can successfully explain the key role of institutions ineconomic development (North and Thomas, 1973), and hasbecome a focus of current economics research. Given that non-grid-connected wind power is a new field, national policy orinstitutional factors will play a significant role in its futuregrowth. This paper employs the basic theories of NIE, analyzesthe evolution and development paths of non-grid-connected windpower, and proposes a development model and policy strategiesfor non-grid-connected wind power.

Accordingly, Section 2 of this paper summarizes the historicaldevelopment of Chinese wind power and the present situation,and analyzes the institutional changes affecting the developmentof non-grid-connected wind power in China. Section 3 analyzesthe institutional changes affecting non-grid-connected windpower from the viewpoint of transaction costs, and explains theintrinsic features of these institutional changes. The analysisshows that the existing institutional change cannot solve thecurrent problems of Chinese wind power. Then we propose ahybrid development mode of institutional change in Section 4,and analyze the role and function of each sector. Section 5 furtheranalyses the potential policies and measures needed to promoteinstitutional change according to the hybrid development mode,and Section 6 gives the conclusions.

Fig. 2. Annual change in the installed capacity of wind power in China.

Source: The Chinese Wind Energy Association (CWEA, 2011).

2. Characteristics of institutional change in non-grid-connected wind power

While adopting the method of cost-benefit analysis, NIE usestransaction cost theory to analyze institutional changes in termsof supply and demand. Institutional change is categorized intomandatory and induced institutional change; these classificationsare based on the essence of institutional change and its causes(Williamson, 2002). The former refers to the process of institu-tional change imposed by laws and regulations when governmentpursues the maximization of monopoly rents and total socialoutput, thereby generating institutional supply. The latter per-tains to the process of spontaneous change when an individual or agroup of people pursues potential profit opportunities, generatinginstitutional demand.

In the process of the development of wind power in China, thegovernment employed economic development planning and energydevelopment planning, and imposed mandatory requirements forwind power equipment and wind power farm construction, speci-fications for wind power access to the grid, and the price of windpower access to the grid. Thus the development of wind power hasbeen strongly influenced by mandatory institutional change.

Although the institutional environment is dominated by thegovernment, other parties including investment companies,operators of wind power, electric power users, power gridcorporations, and local governments will seek to make full useof wind power resources and profit from them. These inducedinstitutional changes have also played a role in the developmentof wind power.

Based on these two kinds of institutional change, we cananalyze the institutional change characteristics of non-grid-con-nected wind power.

2.1. Mandatory institutional change

Mandatory institutional change is supply-dominated institu-tional change. Government is the principal driver of institutionalchange and adopts top-down changes. The origins of mandatoryinstitutional change are very complicated. They may be based onideology rather than logic, and can be enforced through coercion.This means that institutional change can be imposed rapidly,while reducing transaction costs because an administrativemonopoly force sets artificial entry barriers and reduces externaluncertainty.

The key characteristic of mandatory institutional change isthat it can be accomplished quickly in a very short period drivenby the government. Wind power installed capacity in Chinamaintained a slow growth rate before 2004. However, rapidgrowth in wind power installed capacity ensued after 2005(Fig. 2). One of the core reasons for this was the approval of the‘‘Renewable Energy Law’’ in 2005, which has had a greaterinfluence than any other legislation governing renewable energy.Since this is an example of mandatory institutional change, wecan put forth our first hypothesis concerning the development ofwind power in China.

Hypothesis 1. Wind power development is characterized bysupply-dominated institutional change.

This hypothesis can be tested by examining the developmentof wind power in the specific context of some important laws andregulations issued by the Chinese government.

Before 2004, the government paid little attention to the windpower industry. The government neither provided sufficientscientific research funds (there were no major scientific researchprojects in this area), nor powerful policy support. By the end of2004, there were 43 wind farms in the country, with 1292 windpower turbines and 760.2 MW of installed capacity. This ranked10th in the world and, in Asia, was behind Japan and India.

Under the influence of growing energy demand and thepressure for energy saving and emission reduction, the govern-ment began to pay more attention to renewable energy. On 28February 2005, the ‘‘Renewable Energy Law of the People’sRepublic of China’’ was approved. Its essence is reflected in the‘‘Related Provisions about Renewable Energy Generation’’ (NDRC,2006a) and the ‘‘Pilot Management Scheme of Price and

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Cost-Sharing of Renewable Energy,’’ (NDRC, 2006b) implementedby the National Development and Reform Commission (NDRC).These provided strong policy support for wind power generationand manufacturing, and included incentives such as those forpricing and taxes. In particular, under the policy for competitivepricing, government regulations explicitly prescribe that windpower should be enabled to access to a nearby regional powergrid network and be allowed for the purchase of all the electricity.In 2006, newly installed wind power capacity reached 1340 MW,accounting for 8.9% of the world total, amounting to an increaseof 165.83% compared with 2005 (Fig. 2). To date, the wind powergeneration in China has continued to grow at a rapid pace and, asnoted above it is now the largest producer in the world.

During this period, national policy played an extremelyimportant role in stimulating the inflow of investment. Currently,there are multiple channels of investment in the wind powerfield, including private capital and foreign capital, but the mainbody of investment still comes from state-owned enterprises.In 2010, China’s newly installed wind power capacity reached1892 MW and five state-owned power generation groups (ChinaElectric Group, Huaneng Group, Datang Group, Huadian Group,and the CLP Group) accounted for 56% of the total. Of the totalinstalled wind power of 41,827.3 MW in China, these five state-owned power generation groups accounted for 56.3% (Li et al.,2011). In addition, the majority of other companies investing inwind power, including China Nuclear Power Group and GuohuaPower, are state-owned enterprises. Thus state-owned enter-prises, which tend to be more focused on the government’stargets and subsidies than the operating efficiency of wind powerfarms, account for most of the investment in wind power. Sincestate-owned enterprises closely follow the government’s gui-dance and regulations, government policy has a direct impacton the development of the wind power industry. Therefore, therapid development of the wind power industry in a short period isclearly characterized by mandatory institutional change.

2.2. Induced institutional change

Induced institutional change refers to spontaneous institu-tional changes when individual and groups respond to potentialprofit opportunities. In contrast to mandatory institutionalchange, the principal drivers of induced institutional change aregrassroots movements, local government, or individuals. It involvesa progressive bottom-up reform mode.

As discussed above, government regulations mandate thatwind power access to the grid is currently the only applicationmode available to large-scale wind farms. However, the irregularnature of wind power severely affects the stability of the tradi-tional power grid, restricting wind power access to the grid. Thisbrings two challenges in the sustainable development of windpower.

(1)

The efficiency of wind power farms is poor, and many windfarms cannot generate electricity in accordance with theirinstalled capacity. As discussed above, the Ministry of Industryand Information reported that over one-third of the installedcapacity of wind farms was idle and that electricity could not betransmitted to the grid because of system restrictions.

(2)

Fig. 3. Two profit modes of wind power.

The rapid development of wind power may be restricted inthe future. Achieving a wind power contribution of more than�10% to the power grid is difficult if there is no gas power orhydropower available to deliver dispatchable power ondemand for peak regulation of the grid. This is a globalproblem that poses considerable challenges to the sustainabledevelopment of wind power. In the other words, if Chinafollows the traditional mode of large-scale development of

wind power, it must also build a large number of dispatchablepower sources to ensure the stability of the power grid.However, the high cost and the geographical environment inChina will restrict construction of these dispatchable powersources, so that the traditional grid pattern seriously limitsthe development of wind power. At present some countries,such as Germany, have adopted distributed wind power farmsto alleviate this contradiction. In 2009, the wind powerinstalled capacity in Germany reached 25,700 MW, but mostof this wind power comes from small and medium capacitydistributed wind farms, with the biggest one being only60 MW (CWEA, 2010). Thus Germany has avoided the enor-mous challenges posed by the Chinese model of large scalewind farm development, and the development of wind powerhas proceeded more rapidly.

Non-grid-connected wind power theory proposes that large-scale wind farms can supply electric power directly to energy-intensive industries, including chlor-alkali processing, seawaterdesalination, and electrolytic aluminum manufacturing plants(Fang et al., 2009; Fang and Huang, 2008; Gu, 2008). It providesa new model for the development of wind power. Since the windpower is not fed into the grid, the problems of grid instabilityassociated with conventional wind power do not arise. It therebyoffers a creative solution to the problems encountered in thelarge-scale and sustainable development of wind power.

Generators of wind power, power users, power grid compa-nies, and local governments will all benefit if wind farms can beoperated effectively in this new mode. In Jiangsu Province, localgovernments and generators have established a non-connected-grid wind power operation, driven by the potential profits to bemade (Zhao et al., 2009). In addition, the Ministry of Science andTechnology has increasingly supported enterprises and universi-ties exploring the theory and application of non-connected-gridwind power through its major scientific projects (MOST, 2007).Hence, we can put forth the second hypothesis for the develop-ment of wind power in China.

Hypothesis 2. Demand-induced institutional change is becomingincreasingly important in the development of wind power.

The characteristics and influence of this induced institutionalchange can be investigated by comparing the profit modes fortraditional and non-grid-connected forms of wind power, asshown in Fig. 3.

The electricity generated by a large-scale wind farm in thetraditional mode can only be transmitted to a power grid, whichthen supplies electricity to end-users in accordance with networkconditions. Thus, the profitability of wind power depends totallyon the power grid, making this approach a unilateral incentivemode. National policy encourages wind farms to generate elec-tricity, but the power grid enterprise is not necessarily capable ofproviding these high-risk electrical power from wind. Meanwhile,end-users are only supplied with power by the power grid andsome energy-intensive industries are forced to accept higherelectricity prices because they are not entitled to benefit from

Y. Fang et al. / Energy Policy 45 (2012) 350–358354

government policies on discounted electricity applying to lessenergy-intensive industries.

The non-grid-connected wind power mode enables thedemand and supply sides to directly negotiate power output.Under this mode, wind farms can provide electricity at a lowerprice, as the cost of wind power decreases markedly becausethere is no need to invest in grid connection. This mode enableswind farms to generate electricity in accordance with installedcapacity, while end-users can lower their operating costs becauseof the comparatively lower electricity price. Both suppliers andconsumers can benefit from this mode; thus, non-grid-connectedwind power is a shared incentive mode. The potential profitopportunities will motivate both wind farms and energy-intensiveenterprises to promote the development of non-grid-connectedwind power. This scenario illustrates the demand-induced charac-teristic of institutional change.

3. Analysis of impending institutional change for non-grid-connected wind power

Institutional change for non-connected-grid wind powerinvolves aspects of both mandatory institutional change andinduced institutional change. Therefore in considering the originand effects of institutional change in the development of windpower in China both need to be considered.

In NIE, the value of economic institutions is believed to changeunder the influence of costs associated with long-term economicgrowth. Institutional change normally occurs when individuals orgroups are willing to bear the cost of change, and the expected netprofit exceeds the expected cost. The transaction cost shouldtherefore be the focus in any analysis of institutional change.

3.1. Transaction cost analysis under mandatory institutional change

Government is a central participant in the process of manda-tory institutional change, which offers two major advantages interms of transaction cost.

(1)

Economies of scale. As the principal driver of mandatoryinstitutional change, government is a monopolist that has legallicense to use coercive power. It can expand its influence andscope; thus, mandatory institutional change benefits from largeeconomies of scale.

(2)

High efficiency of institutional implementation. Governmentscan compel institutions to eliminate institutional imbalanceas long as expected returns surpass expected costs. Thecoercive power of the government can promote institutionalchange at the fastest pace in the shortest possible time; thus,mandatory institutional change has a high efficiency in termsof institutional implementation.

The advantages of mandatory institutional change are relevantto Hypothesis 1 for non-grid-connected wind power. Historically,the oil imports have accounted for about 50% of consumption, andelectricity is in short supply in China. Satisfying the demand forutility energy is a bottleneck in the efforts to sustain its rapiddevelopment. The wind power industry is a catalyst for growth inthe industrial sector—particularly the machinery, electronics,electrical equipment, and other related industries—thereby pro-moting economic development. The policies issued by the gov-ernment can therefore eliminate institutional imbalance andbring about economies of scale. In 2004, the market share ofdomestic wind turbines was 18%, and construction cost was about9000 yuan/kW; thus, the cost of operating wind farms wasconsiderably higher than the on-grid tariff. By 2009, the market

share of domestic wind turbines had increased to over 60%, whilstconstruction cost had decreased to about 5000 yuan/kW, gener-ating profits for wind farms (CWEA, 2011).

The rapid development of wind power since 2005 has bene-fited from favorable national policies. The ensuing developmentexceeded expectations, driving a rapid increase in wind powerscale. However, a mismatch between supply and grid admissioncapacity occurred. This was also unexpected at the beginning ofpolicy implementation. This problem may have resulted from theinherent weaknesses and disadvantages of mandatory institu-tional change:

(1)

The duality of interest and mutual conflict in the goals ofinstitutional change. Through institutional innovation, gov-ernment aims to achieve dual goals—economic and political.Once the economic goal conflicts with the political, thegovernment is likely to prioritize the latter, which generallyleads to increasing inefficiency in institutions. Influenced bythese dual goals, even if it is aware that the grid canaccommodate more wind power at lower risk, the govern-ment cannot lessen or eliminate inefficiency because it isunwilling to shoulder the high social costs that can stem fromunexpected grid faults.

(2)

The limited rationality and incomplete knowledge of theprincipal driver. Mandatory institutional change requiresgovernment to have complete knowledge of institutionaldesign. However, uncertainties always exist in the course ofinstitutional implementation. From the approval of the‘‘Renewable Energy Law’’ in 2005 to the ‘‘11th Five-year Planof Renewable Energy’’ announced in 2008, the governmentconsistently expected wind power to reach an installedcapacity 10,000 MW by 2010 (NDRC, 2008). However, revi-sions to the policies during the past few years resulted in amuch larger actual installed capacity of 25,805 MW by 2009.This poses difficulties for large wind farms in generatingelectricity in accordance with their installed capacity.

Although the disadvantages of mandatory institutional changepartly explain the current predicament of wind power develop-ment, the external environment also affects wind power access tothe grid. The distribution of the wind power resources in China ismainly concentrated in the west, whereas the bulk of energyconsumption is concentrated in the east. Thus, electricity must betransmitted from the west to the east via the power grid.However, the power grids are not sufficiently well linked witheach other to enable efficient transmission of generated windpower. These key factors present challenges in wind power accessto the grid (Chen et al., 2010).

3.2. Transaction cost analysis under induced institutional change

Induced institutional change results from opportunities forprofit. It has certain advantages over mandatory institutionalchange in terms of higher economic efficiency:

(1)

Priority given to economic efficiency. Induced institutionalchange results from opportunities for profit, which cannot berealized under existing institutional arrangements. The prin-cipal driver of induced institutional change can be an indivi-dual, a group of people, or an organization. They becomeaware of potential profit that cannot be obtained underexisting institutional arrangements; thus, they are willing tochange the current situation. However, institutional changewill only occur when the potential profits exceed the costs ofinnovation. Therefore, induced institutional change followsthe principle of prioritizing economic efficiency.

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(2)

High efficiency of institutional operation. Induced institu-tional change is spontaneous. It is based on intrinsic optimi-zation and evolution mechanisms, and incorporates anextensive correction system that lowers the decision-makingerror rate. Incentive mechanisms for the pursuit of profit canbe permanent, which serves as a continuous driving force forreform. Therefore, an institution formed by induced institu-tional change has higher operating efficiency.

The advantages of induced institutional change are explainedin Hypothesis 2 for non-grid-connected wind power. In thisscenario, a large number of wind farms cannot access to the grid,and construction of the necessary grid is a long-term prospect.This encourages stakeholders to seek alternative systems outsidethe grid. Non-grid-connected wind power is an example ofspontaneous institutional change in response to this challengeand can serve as a new path for wind power development. In thismodel, the wind farm cooperates with specific industrial usersbased on considerations of economic efficiency. This is clearlydifferent from the institutional change being promoted by thegovernment. An increasing number of wind farms and users arebeginning to focus their attention on this development model,and have begun shifting in this direction (Zhao et al., 2009).

Despite this, however, the advantages of induced institutionalchange remain restricted by many factors:

(1)

Restrictions in relation to transaction costs. Induced institu-tional change is a process of gradual promotion. The principaldrivers of institutional change need to search for tradingpartners, negotiate (one-on-one or in multiple modes), andwork with various groups to maintain the transaction. There-fore, induced institutional change has higher organization andtransaction costs, and takes longer to implement.

(2)

Solving externality and ‘‘free riders’’ through institutionchange is difficult to achieve. The groups who first carry outinstitutional innovation can reach agreement through internalnegotiation, communication, and persuasion to eliminate thefactors that hinder institutional innovation. However, theincompleteness of the agreement itself can lead to problemssuch as ‘‘free riders’’ who may hinder the promotion ofinstitutional change.

The shortcomings of induced institutional change explain thecurrent status of non-grid-connected wind power in China. Thehigh transaction costs and lack of institutional framework providea considerable challenge to wind farms and users in initiatinginstitutional change. Although both the government and powercompanies have been turning their attention to non-grid-con-nected wind power, this sector has not developed as hoped.Government and industry stakeholders have therefore now begunto focus their efforts on the promotion of non-grid-connectedwind power and the resolution of the problems presented bywind power access to the grid.

4. Path of institutional change for non-grid-connected windpower

Non-grid-connected wind power theory provides a new pathfor the sustainable development of wind power. Induced institu-tional change is clearly the right course but this entails a longerimplementation period. The development of wind power in anon-grid-connected system is restricted by the policies on tradi-tional wind power. Therefore, the further development of non-grid-connected wind power is confronted with problems ofinstitutional change promotion and path choice.

4.1. Transformation from supply-dominated type to demand-

induced type

Generally, the process of institutional change can be dividedinto five stages, according to NIE (Lance and North, 1971).

�

First, a group that first promotes institutional change or plays akey part in this process is established. � Second, the schemes for institutional change are proposed. � Third, the schemes are evaluated and chosen in accordance

with the principles of institutional change.

� Fourth, a second group that promotes institutional change is

established.

� Fifth, institutional change is accomplished through the joint

efforts of both action groups.

From the perspective of the wind power development process,non-grid-connected wind power is currently undergoing institu-tional change. Attracted by potential profits, wind farms andenergy-intensive enterprises have become the first groups toinitiate institutional change, since they both have the incentiveto promote the development of non-grid-connected wind power.This is the first stage of institutional change. Non-grid-connectedwind power theory and breakthroughs in combining the opera-tions of some energy-intensive industries and wind power com-panies serve as the bases for the preliminary plans forinstitutional change initiated by the first action group. Comparedwith the traditional wind power mode, non-grid-connected windpower incurs lower operating costs and a lower electricity pricefor end user, thereby becoming a feasible path choice. These arethe second and third stages of institutional change.

Non-grid-connected wind power in China is currently in thethird stage of institutional change. The industry has attractedconsiderable attention because of the potential profits and, thus,its development clearly falls under induced institutional change.The process demonstrates the transformation from government-led mandatory institutional change to enterprise-led inducedinstitutional change, which is more efficient economically forthe sustainable development of wind power.

4.2. Role of promotion in mandatory institutional change

The promotion of non-grid-connected wind power develop-ment requires a second action group (which occurs in the fourthstage of institutional change). The profit potential of non-grid-connected wind power shows that institutional change in thecontext of non-grid-connected systems is not only beneficial tolarge wind farms and energy-intensive enterprises, but also to thestate grid (by reducing the risks associated with connecting largewind farms to the grid). However the state grid cannot directlyprofit from non-grid-connected wind power; thus, convincing itto become the second action group of institutional change is adifficult process.

In the process of wind power development, the governmentplays a part by implementing incentive policies. Those policiesadvance the development of wind power, while the cost isshouldered by society. As noted above, with the increasing scaleof development, wind power construction cost decreased from9000 yuan/kW in 2004 to 5000 yuan/kW in 2009. In addition, themarket share of domestic wind power equipment now exceeds60%. Since government promotion of the wind power industry hasbeen so successful, the abolition of stimulation policies is inevi-table. Nevertheless, the operation of many wind farms dependson these preferential policies, and they may experience losses ifthe government withdraws completely. The government is there-fore obligated to regulate wind power policies and provide

Y. Fang et al. / Energy Policy 45 (2012) 350–358356

incentives to enterprises so that they can independently developwind power capacity. As a result, the government is likely tobecome the second action group in the development of non-grid-connected wind power.

As the second action group, the government can bring theadvantages of mandatory institutional change to bear on theexisting induced institutional change. The provisions for windpower in the ‘‘Renewable Energy Law’’ and other supportingpolicies are essentially based on the traditional mode of windpower (with access to a grid), and no supporting policies for non-grid-connected wind power are currently in place. In the next 10years, China is planning to build seven wind power developmentareas of 10 GW capacity or higher in Gansu, Xinjiang, Hebei, Jilin,Inner Mongolia, and Jiangsu (Fig. 4). Such large-scale wind powerdevelopment will further aggravate the problems posed by accessto the grid, particularly in the northwest and northeast wherethere are more abundant wind power resources but less welldeveloped power grids. Furthermore, since non-grid-connectedwind power is based on induced institutional changes that cannotadapt to the rapid development of wind power, the governmentshould, therefore, have the responsibility to promote the devel-opment of non-grid-connected wind power through appropriatepolicies (Su et al., 2010).

4.3. Hybrid development mode of institutional change

The fifth stage of institutional change involves concertedaction by both the first and second action groups. That is,mandatory institutional change and induced institutional changeboth play their parts. This development model is shown in Fig. 5.The wind power farms and end-users are the first action groups,and the government is the second action group.

‘‘Electricity Law’’ of China prescribes that a wind farm is notpermitted to directly sell electricity to end-user so that policies ontrade between wind farms and energy-intensive enterprises

Fig. 4. Planned 10 GW wind power development areas in China.

Source: Development and Planning of Wind Power in China (Zhang et al., 2010a).

Fig. 5. Development mode of non-grid-connected wind power.

requires reform. Direct trade between generators and end-usersis currently undergoing trial runs in the electricity markets ofChina (SERC, 2010). Thus, grid companies (or the State ElectricityRegulatory Commission, SERC) may also join the second actiongroup and issue rules for electricity trading for non-grid-con-nected wind power. Since grid companies can only be involved inthe formulation of such rules for electricity trading, they cannotdirectly profit from non-grid-connected wind power. They arethus an invisible member of the second action group.

Lowering transaction costs is a key consideration in the hybridmode. The first action group aims for economic efficiency, but itsorganizational and time costs are relatively high. The government,as the second action group, can exploit the advantages ofmandatory institutional change to improve the efficiency ofinstitutional implementation. Therefore, the government shouldplay a role in economic efficiency and institutional constitution,including bridging the gaps in institutional arrangements, byissuing reasonable and legal interpretations and supporting thenew institutional arrangements (Zhang et al., 2010b).

5. Policy implications

Concerted effort from the first and second action groups isrequired to promote institutional change under the developmentmodel of non-grid-connected wind power. Owing to the limita-tions imposed by policies, wind farms and industrial end-users(the first action group) are confronted with high transaction costs.Consequently, this necessitates that the second action group (thegovernment and power grid companies) improve economic effi-ciency and reduce transaction costs in areas such as institutionaldevelopment, market environment, and power grid construction.

5.1. Preferential policies of the government

Government policy is a key factor in driving the rapid growthof the wind power industry. Policies range from competitivepricing to tax incentives and support for companies in the fieldof wind power generation and manufacturing. However, thecurrent policy is based solely on the traditional utilization ofgrid-connected wind power.

Non-grid-connected wind power has not benefited from ear-lier policies. Therefore, it is necessary to amend the currentpreferential policies for wind power and issue equally competi-tive policies for non-grid-connected wind power to provideincentives for the growth of non-grid-connected wind power.Price subsidies and tax incentives are the most feasible measures.These preferential policies should inspire the first action group toinvest in non-grid-connected wind power and promote institu-tional change.

5.2. Electricity market development

The electricity markets in China are unique because only thegeneration side is open (a real electricity market should includenot only generation, but also transmission, distribution, andconsumption markets in general) among the four sectors involved(Jaccard and Mao, 2001). The current operational markets are theEast China and Northeast electricity markets. Bilateral and multi-lateral trade is prohibited in these markets (SERC, 2004), that is,all generators must sell their electricity to power grid companies.Therefore, appropriate electricity trading arrangements formu-lated by SGCC or the State Electricity Regulatory Commission(SERC) are needed to enable non-grid-connected wind power toparticipate in the electricity market.

Y. Fang et al. / Energy Policy 45 (2012) 350–358 357

The SERC has recently recommended that electric powercompanies be allowed to sell power directly to large powercustomers (SERC, 2010). It also hopes to facilitate trading arrange-ments supportive of bilateral trade, and lay the policy foundationneeded by non-grid-connected wind power to directly supplyelectricity to their end-users. Wind farms should be providedwith more self-operation rights, which will serve as incentives inthe development of non-grid-connected wind power systems.Electricity trading arrangements should permit them to selectvarious development models on the basis of environmental andmarket needs. If these measures are successful, grid connectionwill no longer be the only way for wind farms to operate andprosper.

5.3. Market building in the wind power industry

National policies provide only the basic principles of electricitypricing, and wind farms can obtain different subsidies or pricesbecause of their different local environments and stages ofregional economic development. Some wind farms incur year-round losses because of low subsidies. Therefore, regional govern-ments have to implement other measures to compensate windfarms for the losses that they incur. Competition in the windpower industry is covert—a characteristic that is harmful toits development, as this encourages unfair competition andcorruption.

With the improvements in technical competency in the windpower industry, manufacturing and operating costs are graduallydeclining while economies of scale are being strengthened. Thepreferential policies of the government will be gradually phasedout as wind power costs continue to decrease. The primaryobligation of the government is to regulate the industrial envir-onment and cultivate an atmosphere of fair, transparent, andefficient competition in the wind power industry. In other words,it should foster a suitable market environment for the windpower industry.

5.4. Smart grid construction

The distribution of energy resources and economic develop-ment in China are uneven, in that the west is rich in energyresources while the regions with advanced levels of economicdevelopment are mainly concentrated in the east (Wu and Fang,2009). Therefore, the electricity generated in the west must betransmitted to the east. However, the speed of grid constructionhas failed to satisfy the demand for electric power driven byeconomic development. Thus, SGCC has proposed a developmentprogram involving an investment of four trillion RMB to updateand build a new smart grid (SGCC, 2010).

A smart grid is important in order to address the issue of windpower access to the grid. However, it will incur substantial costs ifthe aim is merely focused on addressing the strong fluctuations inwind power. A more coordinated development is thereforenecessary in the wind power industry. Part of the grid connectionproblem may be solved by the smart grid but industrial policiesshould complement this infrastructural approach. Incentives fornon-grid-connected wind power will help achieve on-site balancebetween power supply and demand, and the pressure on the gridcan be reduced. Therefore, non-grid-connected wind powershould be integrated with the construction of the smart grid.

6. Conclusions

Non-grid-connected wind power is an institutional innovationand a beneficial supplement to traditional wind power. Within

the framework of new institutional economics, the developmentof non-grid-connected wind power is currently in the third stageof institutional change. Collaboration between the principaldrivers is necessary for the successful accomplishment of institu-tional change.

Institutional change theory indicates that the development ofnon-grid-connected wind power is recommended. Under the pro-posed model, the government can capitalize on the advantages ofmandatory institutional change, and lower transaction and timecosts through its important roles in influencing economic efficiencyand institutional development. This will eventually ensure thesustainable development of wind power industry in China.

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