The Economics of China's Pollution Problem

On January 12, a Saturday earlier this year, residents of Beijing woke up to air so thick with pollution that pedestrians could barely see a few feet in front of them. Hourly readings of the city's Air Quality Index (AQI) being reported by the United States Embassy ran off the scale, which ends at 500, peaking at 755. The levels of particulates smaller than 2.5 micrometers -- fine air particulates that pose the biggest health risk, which are considered safe at readings of around 25 parts per million -- reached almost 900. 

Following the pollution of the past winter, the pressure to clean up China's air has never been so acute. "The government has been left with no choice but to respond and take action," says Wei Huang, an air pollution specialist at Greenpeace in Beijing. The economics of environmental cleanup, however, are unclear. According to experts, a lasting policy would demand a shift in the types of industry that drive the country's economy and involves a potential slowdown in GDP growth. And, while the recipe for cleaner air could cause some industries to suffer, others are expecting a potential windfall with the rollout of new environmental measures.

The difficulty in putting a number on the economic costs and benefits of tackling China's air pollution comes from both sides of the issue -- the economic losses due to pollution and the cost of cleaning it up. "It's hard to pull out an exact number on the economic loss due to air pollution in China," notes Wei. "[The country] just started to publically publish [pollution] data in 2013 for all the major cities." 

In a study released last year, Greenpeace pegged the cost of pollution in Beijing at around US$328 million, based on levels measured in 2010. In Shanghai, the cost was even higher, at US$420 million. This estimate, however, is based only on the number of premature deaths due to air pollution. Other costs -- such as those related to chronic illness, lost productivity and environmental degradation -- were so difficult to measure with existing data that Greenpeace left them out of its metric entirely. In a Massachusetts Institute of Technology study released the same year, researchers looked at labor and healthcare costs in 2005 and concluded that China had lost US$112 billion due to air pollution.

Although China has made efforts to calculate the cost of pollution in the past, with a "Green GDP" effort spearheaded by the country's Ministry of Environmental Protection, those numbers were never released. Without them, it is difficult to measure the economic gains and losses of a cleanup. At the moment, China spends US$91 billion a year on environmental protection, or about 1.3% of its GDP. Experts estimate a further investment is needed to really clean things up -- anywhere from 2% to 4% of GDP, or up to US$500 billion each year. 

The Target Industries

Although pollution sources vary regionally, the 2012 Greenpeace report places a majority of the blame for China's air pollution on coal and automobile exhaust fumes. Any plan for a clean-up must take into account energy production and China's expanding population of automobile owners. In a report released by Deutsche Bank in March, experts encouraged an aggressive approach to tackling pollution in the next five years. China needs "big bang measures," wrote Jun Ma, Deutsche Bank's chief economist, in the report. "The public is now demanding immediate and material government actions to improve air quality." 

Among the suggestions listed in the report was a reduction in average coal consumption growth by half from the years 2013 to 2017, lowering expectations from 4% annual growth to 2%. According to the report, this measure could be complimented with an increase in the annual growth rate of clean energy sources and a deployment of clean coal technologies that could help reduce emissions from coal-fired power plants by up to 70%. 

In addition, the Deutsche Bank report suggests lowering expectations for future growth in the sales of passenger vehicles and regulations that increase fuel efficiency. At the same time, the report suggests increasing investment in public transportation options such as rail and subway lines. 

The report predicts that this can all be done while maintaining an economic growth rate of 6.8% annually -- a slight reduction from China's current projections of a 7.5% growth rate for 2013. While this seems simple enough, it is predicated on China cutting its energy intensity per unit of economic output in half -- a move that would enable economic growth to continue while increases in energy use slow. But that would require a shift from energy-intensive manufacturing toward an increase in the high-tech and service industries. This process could lead to significant economic costs. 

For example, China's steel industry is currently responsible for producing around 46% of the world's steel. Smelting steel is an energy-intensive, highly polluting business. Slimming down the industry would likely lead to factory closures and layoffs. Some experts hope that these costs would be offset by an increase in more environmentally-friendly jobs, such as healthcare or tourism, but the adjustment could still be painful. 

Tackling China's Cars

China's ongoing efforts to increase the fuel efficiency of new cars are an example of the challenges regulators face in tackling the economic issues inherent in pollution cleanup. At first glance, increasing fuel efficiency is a much easier issue to tackle than overall energy consumption. In fact, many of these programs are paired with economic stimulus, offering money to consumers to trade in their older vehicles for new ones that meet higher fuel-efficiency standards. 

This is already being done by municipalities and cities throughout China, says David Vance Wagner, a senior researcher at the International Council on Clean Transportation (ICCT). "China has moved aggressively on implementing new standards for vehicles,"Wagner notes. "Today, a vehicle that is five or 10 years old can emit as much as 40 times more pollution than a new vehicle. [Increasing the number of newer vehicles on the road is] a very efficient way to clean up the air." 

The exchange--money for old cars--is typically called a "scrappage program" and has been carried out on a national and local level. Nationally, China offered $3,000 for old vehicles from 2009 to 2010 -- not enough, according to Wagner, to really incentivize people. Earlier this year, Hong Kong announced that it was dedicating around US$1.3 billion to removing 88,000 older vehicles from city streets, offering subsidies worth about 30% of the value of a new vehicle. Beijing has its own scrappage program aimed at getting rid of half a million older vehicles by the end of 2015. Doing scrappage at a local level, however, is not ideal. "A lot of those vehicles just get transferred to other parts of China,"Wagner points out. "To be really effective you have to have a national program." 

The challenge to implementing a national program, however, is fuel. Vehicles manufactured to meet more stringent emissions standards require a higher quality of fuel than is typically available at the Chinese pump. Low-quality fuel can ruin certain parts of the engine. Refining high-quality fuel, however, costs money. "Someone," says Wagner, "has to bear that cost." 

In China, the price of fuel is set by the National Development and Reform Commission (NDRC), while the cost of refining is borne by large state-owned enterprises like PetroChina and Sinopec. The Ministry of Environmental Protection (MEP) has jurisdiction only over vehicle standards. And, without the ability to pass the cost of refining higher-quality fuel to customers, the state-owned enterprises have no incentive to improve their fuel. The MEP has spent the last decade trying to negotiate higher fuel quality with the oil companies, the NDRC and China's Ministry of Commerce. 

In the United States, Wagner notes, fuel standards can be set by the Environmental Protection Agency. Fuel companies can then choose to change their gasoline prices and defer that cost to customers at the pump. 

But in China, it took the notable January 12 pollution event, which attracted the attention of China's top leaders, to finally reach an agreement on setting standards. "In January 2013, this stalemate was finally ended by an unprecedented high pollution episode occurring in hundreds of major cities throughout the nation," according to an ICCT report on the matter. By the end of February, China's government released a time table, mandating that new fuel quality standards for diesel and gasoline be issued by the end of this year, in order to be implemented by the end of 2014 for the first phase of improvements, and 2017 for a second phase. 

"Now we are waiting for the standards to come out," says Wagner. 

The ICCT estimates these fuel improvements will end up increasing the cost of fuel by .10 RMB per liter of gasoline. "They haven't said how they're going to pay for it,"Wagner notes. One possible option is requiring that the NDRC change the price of fuel at the pump, allowing refineries to transfer the cost. "More likely, we'll see a tax adjustment," says Wagner. In this scenario PetroChina and Sinopec would be taxed at a lower rate for higher-quality fuel. 

"The other big component of this is the actual vehicle standards,"Wagner notes. "They have a few key steps to take and then the fuel quality is going to be there. Then, they can move forward with vehicle standards." This, he adds, would pave the way for a larger scrappage program. "If you're going to scrap a few million vehicles, you wan to make sure they're replaced with the cleanest vehicles possible." 

Alternative Energies

The resolution to China's fuel quality problems demonstrates the nation's preference for environmental measures that can be combined with economic stimulus or alleviated through tax breaks. There is no other industry so likely to benefit from this strategy as alternative energy. 

In fact, the pollution of the last few months has already given a boost to China's lagging solar panel manufacturers. By the end of January, China had already announced plans to increase its 2015 targets for solar installation by 67%. In 2012, China's solar companies were suffering from an oversupply of panels and the price of bonds issued by the companies had plummeted. Panel prices were down by 25%. With the increase in pollution, however, more investors are convinced that China's government will continue to keep these companies prosperous. Bond prices have already started to respond. 

China's commitments to increasing clean energy overall have shifted from a 36-gigawatt increase of installed capacity in 2012 to a 52-gigawatt uptick planned for this year. 

While the mandated increases in solar capacity are good for domestic industry, growth in other areas is poised to benefit Western companies. "U.S. companies and European companies are quite happy about China moving on standards," says Wagner. "It will be a tougher push for Chinese domestic companies." 

In a report released by the Pew Charitable Trusts earlier this month, U.S. suppliers of renewable energy and power management products had a US$1.63 billion trade surplus with China in the year 2011, out of a total US$8.5 billion in clean energy goods and services that were exchanged. 

In addition, China's increasing investment in alternative energy sources is occurring at the same time other nations are drawing back on similar initiatives. While China excels in manufacturing wind turbine blades and solar panels, Western companies lead in the high tech and specialty equipment required to run those energy sources and connect them successfully to an energy grid.

While China's increasing commitment to cleanup will boost certain clean energy and environmentally-friendly industries, some experts worry that these measures alone will not be enough to improve air quality. "We hope that there will also be stricter regulations, from approving new coal-fired power plants to information disclosure from factories and punishment to those factories that violate the emission controls,"Wei notes. "It will be very difficult for China to clean up its air."


Published : 2013.04.10



 
















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