Strengthening US-China Cooperation in Clean Energy Investment
Daniel Poneman
Prepared for the Paulson Institute Conference on Energy Investment
Beijing, China
March 17, 2015
The Paulson Institute’s Taiya Smith and Damien Ma contributed to the content of this paper.
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n November 2014, Presidents Barack Obama and Xi Jinping stood side by side in the
Great Hall of the People in Beijing and announced a groundbreaking agreement to work
together toward the adoption of an ambitious international accord to combat climate
change at the United Nations Climate Conference in Paris in 2015. The two presidents also
committed to undertake concrete actions to promote clean energy, with President Obama
targeting CO2 reductions of 26 to 28 percent by 2025, and President Xi committing China
for the first time to cap its CO2 emissions by 2030, pledging to reach that peak sooner if
possible. The Chinese president further committed to obtain 20 percent of China’s power
from clean sources by 2030.
These announcements were significant in several dimensions. Given that the United States
and China represent the world’s two largest economies, consumers of energy, and emitters
of greenhouse gases, success in achieving significant reductions in greenhouse gas
emissions will depend critically upon the leadership, commitment, and cooperation of
these two nations. Indeed, unless the United States and China forge an effective partnership
on energy and climate change, global efforts writ large will be doomed to fail.
But how are these ambitious goals to be attained?
One thing is clear: continuing on our current path of energy use will not produce the results
our leaders seek. According to the International Energy Agency, the ability to avoid
breaching the 2-degree Centigrade limit—and the associated risk of catastrophic climate
change—is slipping out of reach. To mitigate that risk, the world must nearly double its
annual investment in renewables, nuclear energy, carbon capture and sequestration, and
efficiency, to more than $1.5 trillion per year, according to the 2014 World Energy Outlook.
Otherwise, the world’s entire quota for CO2 emissions for this century will be consumed in
the next 25 years.
The question in the United States and China is the same—how to encourage and unleash
that kind of investment in clean technologies? The circumstances in the United States and
China are unique in many ways, but the two countries can learn a great deal from each
other. And there may be ways to expand upon current US-China cooperation.
US-China Energy R&D Cooperation
For years, the United States and China have recognized the importance of working jointly
on research aimed at addressing some of the toughest energy and climate challenges, with
potentially the highest pay-off. In December 2007, through the Strategic Economic
Dialogue, then-US Treasury Secretary Henry Paulson and then-Chinese Vice Premier Wu Yi
established the first platform for US-China collaboration, called the Ten-Year Framework
on Energy and the Environment. In November 2009, President Obama and then-President
Hu Jintao announced the launch of the US-China Clean Energy Research Center (CERC), to
which both countries committed to contribute $75 million each in public and private funds
over five years.
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Under CERC, three research consortia were established—on advanced coal technology,
clean vehicles, and building efficiency—which then developed joint work programs. CERC
now serves as a proven model for enhanced cooperation on technology research and
development. Its three technical tracks together account for about 90 projects, support
1,086 researchers, and have 112 partners.
Though modest in scale, the $150 million dedicated to CERC’s effort is important in
acknowledging both the opportunity and the responsibility implicit in cooperation between
the United States and China. CERC may also provide a vehicle to establish useful rules of the
road for bilateral cooperation in energy research and development.
One critical challenge that will need to be addressed for this model to work is assuring
sufficient protection for intellectual property, so that intellectual property (IP) developers
are willing to invest and participate. In order to address IP concerns related to CERC’s R&D
activities head-on, each research consortium has agreed upon and signed a contract that
details the IP rules for participation.
Called a Technology Management Plan, the contract sets up a framework that is unique in
collaborative research in the clean energy space. The Plan was specifically designed to
clarify the joint ownership of IP resulting from joint research activities, and invented jointly
by signatories to the CERC protocol from both the United States and China. The Technology
Management Plan serves as a “template” and provides guidance to the CERC, establishing a
more flexible international IP regime than previous science and technology agreements.
While CERC participants must negotiate the details of any particular relationship, the
Technology Management Plan sets guidelines with respect to such contentious issues as
background IP and licensing terms. Thus, even though the Plan does not add any new IP
protections that the law does not otherwise provide, it plays an important role in
establishing a clear framework surrounding the ownership and protection of IP rights.
Challenges of Bringing Technology to Market
Both the United States and China face two major hurdles in getting new technologies to
market: early-stage development of new ideas and scaling up of technologies to
commercial scale.
The first hurdle involves creating bridges between the formulation of a new technological
approach, establishment of proof of concept, and development of the technology and its
demonstration as a viable technological solution. There are a number of reasons that
governments should not attempt to choose “winners.” For one, at early stages of
development, it is too soon to determine which technology paths will prove most
productive. What’s more, governments are notoriously unsuccessful at picking technology
winners and losers. The United States has found it a better approach to promote a wide
variety of possible technology solutions—all chosen through a transparent process of peer
review—through a wide variety of mechanisms.
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The First Hurdle: Early-stage experience in the United States
In the United States, federal and local governments, foundations, universities, NGOs,
venture capital companies and related types of organizations all play important roles in
funding early-stage technology development. Traditionally, the centerpiece of the US
Department of Energy’s contribution to that effort has consisted of grant funding for
advanced technologies years before they had any prospect to be deployed commercially, as
in the case of hydrogen fuel cells, ocean energy, and shale gas.
To illustrate the power of these kinds of investments, the Department of Energy’s
investment of $137 million from 1978 to 1992 in advanced gas drilling techniques, at a
time when the oil and gas industry had little interest in investing in that field, laid the
groundwork for the bow wave of shale gas and tight oil development that has transformed
the American energy picture. Shale gas production grew from 1 percent of US natural gas
supplies in 2001 to 40 percent in 2013, leading the United States to become the top natural
gas producer in the world. And the application of those technologies for US tight oil
formations has led the daily average US crude oil production to increase from 5 million
barrels in 2009 to over 9 million barrels today.
At this early stage, it is impossible to know which ideas will be successful. A portfolio
approach, which diversifies investments across a wide array of technologies and
approaches, allows inventors to maximize opportunities for success.
In that spirit, since 2009 the United States government has established three additional
mechanisms to help the Department of Energy drive energy innovation. Projects are
selected through a transparent, competitive, peer-reviewed process.
1) Energy Frontier Research Centers are five-year research efforts—with annual
funding of $2 to $5 million—tackling basic research challenges through
collaboration among universities, national laboratories, nonprofit organizations,
and for-profit firms.
2) Energy Innovation Hubs—similar to the approach taken at Bell Labs—tackle
complex, multidisciplinary challenges that require science, engineering, and
industrial efforts to solve major energy challenges, as in the areas of critical
materials, battery storage, and nuclear reactor simulation.
3) The Advanced Research Projects Agency for Energy—ARPA-E—awards grants to
entrepreneurs with potentially transformational energy technologies with
commercial potential. Since 2009, ARPA-E has funded 362 potentially
transformational energy technology projects. ARPA-E awardees have made
significant achievements, such as developing a 1-megawatt silicon carbide
transistor the size of a fingernail, engineering microbes that use hydrogen and
carbon dioxide to make liquid transportation fuel, and pioneering a nearisothermal compressed air energy storage system. Technical achievements like
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these have spurred millions of dollars in follow-on private-sector funding to a
number of ARPA-E projects.
In addition to these three mechanisms, the American Energy Innovation Council was
formed in 2010 by a group of six corporate leaders who came together to share their
experience of broad-based success in innovation, with a focus on meeting the clean energy
challenge. The Council has been urging U.S. policy-makers to increase federal
appropriations for energy research and development across all low-carbon energy sources;
support increasing authorizations for Department of Energy energy innovation programs,
such as through reauthorization of America COMPETES legislation, which encourages
investment in innovation; and support large-scale demonstration projects and limited
downstream innovation investments, such as through a Clean Energy Deployment Agency
or other investment authority, and/or through appropriately targeted tax provisions.
Important steps are under way to overcome the first hurdle. What about the second?
The Second Hurdle: Scaling to commercial production
The second major hurdle in energy investments lies between the demonstration of the
commercial practicality of a new technology and its deployment at commercial scale.
Projects at this stage become too expensive to be supported by venture capital or private
equity, but have not yet been sufficiently de-risked to attract publicly-issued debt or equity.
The most efficient way to allocate benefits and burdens in a manner likely to produce
sufficient investment flows to bend the greenhouse gas emissions curve would be a carbon
tax. As Paulson Institute Chairman Henry Paulson pointed out in a recent article in the New
York Times: ‘A tax on carbon emissions will unleash a wave of innovation to develop
technologies, lower the costs of clean energy and create jobs as we and other nations
develop new energy products and infrastructure.’ But a carbon tax is politically challenging
in the United States. While there has been a regional initiative in the Northeastern United
States and Eastern Canada to reduce greenhouse gas emissions through a cap-and-trade
system for carbon emissions, to date the United States has no price on carbon at the federal
level to help stimulate clean energy investments.
The Power of Loan Guarantees
Loan guarantees have proven to be another useful tool in promoting the scaling up of clean
technology in the United States. Traditionally, the size of investments required to deploy
energy systems at commercial scale (whether manufacturing or power generation
facilities), combined with the view that the proper role of federal government should be
confined to early-stage investment in research and development, has meant that the US
Department of Energy did not support investments needed to scale up technologies to the
commercial stage.
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But by the 2000s, two developments had changed the policy environment in Washington
sufficiently to support the use of loan guarantees to drive investment in the deployment of
energy technologies at commercial scale.
The first development was growing concern in the United States about climate change,
which led to language in the Energy Policy Act of 2005 (EPAct 2005) that authorized the US
Department of Energy to issue loan guarantees for projects that "avoid, reduce or sequester
air pollutants or anthropogenic emissions of greenhouse gases; and employ new or
significantly improved technologies as compared to commercial technologies in service in
the United States at the time the guarantee is issued." Thus the Congress established (and
the President signed into law) a mandate for loan guarantees based not exclusively on
standard creditworthiness underwriting guidelines, but also on reduction of air pollution
and employment of new technologies. (Those non-credit-based criteria both imply
Congressional approval of a higher default risk for the sake of public policy objectives.)
The second development was the financial crisis of 2008, which led to severe contraction of
commercial debt markets, a deep recession, and the consequent loss of 700,000 jobs per
month by the beginning of 2009. Congress responded by passing the American
Reinvestment and Recovery Act, which made additional loan authority available to support
energy projects, with an emphasis on those that were “shovel ready” and could employ
significant numbers of workers.
Loan guarantees can therefore be used to stimulate clean energy investment. The issuance
of a government-backed guarantee can reduce the risk to lenders on major capital projects,
making additional debt available at interest rates that lower the overall cost of the project.
Lowering borrowing costs is a critical element to enhancing the economic viability of
capital-intensive projects, such as wind and solar plants, where fuel costs are zero. Loan
guarantees also mitigate the risks associated with first-mover projects—such as the Vogtle
nuclear power station in the United States, the first new US commercial nuclear power
station to be built in three decades.
Public-Private Partnerships
Loan guarantees encourage the creation of public-private partnerships, coaxing private
capital from the sidelines. While funds must be budgeted as an effective loan-loss reserve
for these loan guarantees, if the projects are completed without default, those funds in fact
never leave government coffers. So, in the absence of loan defaults, funds appropriated for
government loan guarantees can become an evergreen source of additional underwriting of
carbon-free projects.
Under the loan guarantee program in the United States, the government committed more
than $34 billion to a series of projects that have been largely successful. The loans resulted
in the first-ever deployment of grid-scale solar photovoltaic (PV) and concentrated solar
power stations, as well as construction of biomass refineries and one of the largest wind
farms in the world. The financial performance of the program speaks for itself. Of the
nearly $22 billion disbursed under the program, nearly $3.5 billion of principal has been
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repaid, while American taxpayers have collected $850 million in interest. While the loan
guarantee program drew criticism from some quarters, most notably at the time of the
bankruptcy of the solar manufacturer, Solyndra, the losses in the program to date
represent only 2.28 percent of the outstanding capital. Given the legislative purposes of the
program—to drive clean energy, new technology, and jobs—these results are impressive
and suggest a strong return on taxpayer investment.
The case of grid-scale solar photovoltaic power plants highlights the program’s success. In
2009, there were no such plants in the United States; all solar PV was deployed on rooftops
or in support of particular load centers. The loan guarantee program supported the
construction of the first five grid-scale solar PV plants. The private sector supported—and
financed—the construction of the next ten.
Leveraging Chinese Government Funds
While the American loan guarantee program does not directly translate into the Chinese
context, there are ways to utilize finance similarly to reduce the risks resulting from scaling
technologies for commercial production. Further, given the scale of the investments needed
to fulfill China’s commitment to achieve 20 percent clean power generation by 2030,
programs that leverage Chinese government funds in similar fashion to the loan guarantee
program and hopefully break the ice on a new generation of grid-scale wind and solar
plants can establish a track record of successful projects that will increase the confidence in
the financial market to support the next wave of projects.
While public-private partnerships will continue to be important in both the United States
and China—particularly in those areas with the greatest technological, engineering and
commercial hurdles to widespread commercial deployment, such as carbon capture and
sequestration—the role of the private sector will continue to grow as government
investments recede. This should evolve naturally, as public sector support for first movers
creates a growing asset class of projects that have been built and are operating, generating
cash flow, and providing power to consumers.
So far, clean energy counts for one third of installed capacity in China, generating electricity
to 200 million homes and producing returns on the order of 6 to 9 percent. This clean
energy is backed by long-term power purchasing agreements, with zero project-completion
and commodity risks (for wind and solar), modest regulatory risks, and predictable
operations and maintenance expenses.
Such low-risk, long-term power purchasing contract-backed projects raise the possibility
that a collection of similar assets could be bundled and securitized, allowing the creation of
a new asset class represented by financial instruments in which modestly-priced shares
can be issued. These instruments could significantly lower the barriers to entry for clean
energy investment and expand the available pool of capital beyond private equity to the
public capital markets.
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In that case, instead of illiquid, large, project-based investments in a single project,
investors interested in clean energy could gain much easier, more efficient, and more
flexible ownership opportunities in contract-backed projects. Given the long-term power
purchasing agreements that back up many of these energy projects, as well as their
relatively modest rate of return on equity, this new asset class may appeal in particular to
those with long-dated liabilities—including pension funds and insurance companies—that
could be matched to these long-dated assets.
These kinds of investment vehicles that distribute cash flows from owned assets to
investors are known as “yieldcos.” Spun off from alternative energy parent companies,
yieldcos own renewable energy assets and operations, collecting revenue via long-term
power purchasing agreements. Such investments can be attractive to shareholders because
they can expect low-risk returns that are over a significant period of time and, rather than
taxation taking place twice (once at the corporate level and again at the shareholder level),
the yieldco is able to pass its untaxed earnings directly through to investors. Since 2013,
approximately a dozen yieldcos have begun trading on exchanges in the United States.
China and the Price of Carbon
At the policy level, Beijing is taking several actions to help spur clean energy development
and carbon reduction. First, China is implementing a set of energy-related taxes, such as the
resource and environmental tax, which are meant to give provinces additional revenue to
invest in clean energy and carbon reduction. Even an actual carbon tax may not be out of
the question for China over the next several years, especially if the current carbon trading
pilots become role models that are replicated across other Chinese regional markets.
China currently has seven pilot emissions trading schemes (ETS), though it is not entirely
clear how many industries and companies are actually participating in these schemes.
Because of specific local conditions and different sectors covered under the various
schemes, the price of carbon has differed significantly across these pilots. Nonetheless, the
National Development and Reform Commission (NDRC), the Chinese agency leading the
emissions trading scheme effort, appears confident enough to propose the rollout of a
national emissions trading scheme in 2016, which is expected to be larger than the
European Union trading program. It is possible that Beijing intends to announce such a
rollout as it heads into the United Nations Paris climate negotiations at the end of 2015.
Second, Beijing is actively encouraging companies and existing private funds to use the
country’s $4 trillion in foreign exchange reserves to make better investments and yield
higher returns. This suggests that more new funds or other spin-offs could be created as
the foreign exchange reserves are further leveraged to create funds that could specifically
target clean energy sectors and technology acquisition. In similar fashion, the Ministry of
Finance’s 2015 budget explicitly states that it intends to create “a national seed fund for
investment in business start-ups in emerging industries [of which clean energy is a part],
offering financial support primarily to innovative enterprises in emerging industries which
are still in the embryonic stage, thus generating impetus for new businesses, innovation,
and the upgrading of industry by pooling government, nongovernment, and private funds.”
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These dynamics all suggest a ripe environment for increasing and strengthening US-China
collaboration in clean energy investment and financing. While China has already helped
fund the Clean Energy Research Center, which can be expanded, there is room for
numerous alternative vehicles and new entities to enter this realm.
China’s Advantage: The ability to scale up technologies
Technology and robust investments can help China maintain economic growth while
bending the carbon emissions growth curve to meet China’s 2030 “peak carbon” goal. China
has several comparative advantages in this regard. First, it has significant capital to invest.
Second, the cycle of adopting existing technology is very fast in China and quickly extends
across the vast Chinese market size. Third, Chinese leaders are willing to deploy nascent
technologies in the home market to determine effectiveness.
Renewable energy is a good example of China’s ability to scale up technology. In just a few
years, China became one of the biggest markets for solar and wind energy. Unfortunately,
that speed of deployment led to some inefficient investment. For example, generous feedin-tariffs and subsidies for solar in Europe, as well as demand in the United States, meant
that Chinese solar panel makers had a ready foreign market to absorb their products. When
European governments cut back on solar subsidies and the United States government
decided to impose tariffs on Chinese solar exports, however, the Chinese solar industry was
severely jolted.
Traditionally, Beijing and the state-owned enterprises have financed early-stage
technology solutions through various technology programs, such as the “973” program on
science and technology basic research launched in the late 1990s, and at the corporate
level. Much of China’s industrial policy has aimed at producing technologically innovative
players through the so-called “indigenous innovation.” The results have been mixed.
Impressive wind and solar deployment have occurred. On the other hand, progress in
developing significant production of Chinese shale gas has been slower than hoped, as the
availability of perhaps 1,000 trillion cubic feet of reserves below ground does not address
all of the “above ground” issues that affect production, including land ownership rights,
pipeline infrastructure, available water, and other factors.
The question is how to encourage China’s vibrant private sector and its growing venture
capital and private equity funds sector to make investments in emerging clean
technologies. China’s investors are already constantly scouring the globe, particularly in the
OECD countries, for promising new technologies.
In this instance, a joint US-China fund (or perhaps public-private funds) could be created to
target investments in existing technologies that are struggling to get to the commercial
production stage. These technologies would need to be carefully assessed and determined
to be commercially viable and serve China’s objectives on energy and carbon, and strong
intellectual property protections would need to be built into the arrangements. For
American technology inventors and the companies where they work, the “China market
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entry bump”—meaning a positive impact on the company’s prospects and potentially even
its valuation—could certainly garner attention and other sources of capital that otherwise
would not have found their way to the company.
Next steps, for both the United States and China
The United States and China face a unique confluence of challenges and opportunities.
Presidents Obama and Xi have agreed on the scale of the energy and climate challenge
facing the planet, and on the opportunity—and responsibility—to work together to meet
that challenge. Success will require many players to play many parts, in both the public and
private sectors, deploying both equity and debt.
While the scale of the task is daunting, success is possible if our leaders’ determination
leads to concrete, significant, near-term action. We have briefly identified a number of
mechanisms that can mobilize the significant capital resources that will need to be invested
in the coming decades to meet this challenge.
As noted above, the simplest, most efficient tool to drive that investment would be a carbon
tax, followed by various versions of the same idea – be it in the form of a gasoline tax, a
wires charge (the fee charged for the right to send or receive power over another party's
energy distribution system), clean energy standards for both fixed plants and vehicles, or
state-based renewable portfolio standards.
Significant investment from both public and private sources of capital will be required.
Fortunately, available resources exist. Current estimates peg US un-invested capital at
more than $10 trillion. China holds $3.9 trillion in currency reserves and its sovereign
wealth fund, the China Investment Corporation, has more than $575 billion under
management. While nearly all these reserves are already invested, managers looking for
new investments may find the combination of clean energy innovation and the Chinese
market appealing. Tapping into these sources of capital could provide sufficient resources
available to help bend the curve from our current dangerous course to a lower carbon
future, with reduced risk for catastrophic climate change. The question is whether we –
individually and collectively—will have the wisdom and the will to take the necessary
actions.
Setting regulatory guideposts, financial incentives for investment
The role of the public side of the partnership will be to set the regulatory guideposts
needed to clean our air and water, to deploy (where available) sovereign wealth or other
tax-derived funds to invest in clean technology or to provide credit enhancements and
other tools to coax additional publicly-raised capital into clean energy investments, to
purchase clean energy (whether procuring vehicles, building efficiency upgrades, or
renewable energy credits), and to invest, certainly at the early stage and in appropriate
circumstances at the point of scaling up to commercial production.
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In the United States, the funds to be used for direct investment could come from a
combination of private capital in partnership with public sources drawn from general
revenues, a carbon or gasoline tax, and from a wires charge. At the federal level, while
annual budget requests have exceeded $2 billion for energy efficiency and renewableenergy programs, the final appropriations between 2011 and 2015 have ranged from $1.8
to $1.9 billion. Over that period, U.S. investments through energy-tax expenditures reached
roughly $20 billion.
But U.S. private-sector energy research and development investment is dangerously low,
and venture investment is flat. Energy R&D investment from the private sector dropped
from $5 billion before the financial crisis to $3-3.5 billion, while venture capital has stayed
at around $1 billion.
Governments can also design tax provisions to support clean energy investments. For
example, a simple mechanism like a carbon tax would efficiently direct capital into clean
investments. Other favorable tax treatments that have been used to encourage clean energy
investment have included investment and production tax credits or cash grants in lieu of
tax credits. Real estate investment trusts and master limited partnerships—which have
promoted the construction of such assets as hotels and pipelines, respectively—have
created large pools of capital available to borrowers at much lower rates than demanded
by private equity (e.g., 10-12 percent).
Conclusion
Extending preferential tax treatments to carbon-free energy solutions could create de facto
public-private pools of equity to protect our climate. At the same time, strong public policy
reasons favor a wholesale reform of the United States tax code, including the elimination of
tax breaks and preferences, with a view to achieving a simpler, more efficient, and more
equitable tax regime for all Americans. We would need to rethink tax policies regarding
clean energy investment in the context of whatever new regime emerges from such
reforms.
Even in such a world, a strong argument could be made in favor of including taxes that
simply recognize economic realities by placing a price upon activities that impose actual
costs upon society—for example in the form of medical treatments to those who suffer
adverse health effects from air pollution—which must either be paid through taxes or by
other mechanisms. In any event, as long as the existing United States tax code continues to
favor certain kinds of investments through tax preferences, our interest in protecting the
climate would argue for favoring clean energy investments with tax benefits as generous as
those conferred, say, upon building hotels and pipelines.
In addition, investment vehicles such as yieldcos can increasingly be used to create larger
pools of investment capital for renewable energy assets at reasonable interest rates.
And government can de-risk clean energy lending through loan guarantees, which lower
the cost of borrowing while reducing the risk of default.
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Given the scale of the combined energy demand and combined greenhouse gas emissions in
the United States and China, tapping into the trillions of dollars of available capital in both
countries could put both countries on the road to meeting the ambitious target the two
presidents set forth last November in Beijing. The next step will be for thought leaders,
investors, officials and others to develop these concepts into concrete actions. Our
discussions in Beijing on March 17 are to start that process.
Daniel Poneman is a distinguished fellow at the Paulson Institute. He served as the United
States Deputy Secretary of Energy from 2009 to 2014. The Paulson Institute’s Taiya Smith and
Damien Ma also contributed to this report. The Paulson Institute is an independent,
nonpartisan center established in 2011 by Henry M. Paulson, Jr., the 74th United States
Secretary of the Treasury and former chairman and CEO of Goldman Sachs. The Institute
promotes sustainable economic growth and environmental protection in the United States
and China. The Institute is committed to the principle that today’s most pressing economic
and environmental challenges can be solved only if leading countries work together in
complementary ways.
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