ASIAN INFLUENCE: CHINA’S ENVIRONMENTAL MESS: IMPLICATIONS FOR CANADIAN BUSINESS

China’s land, air and water are so heavily contaminated that will take years and billions of dollars to clean them up. But while the situation may seem ripe for Canadian business, managers and operators must heed the reliable adage of caveat emptor. Before any Canadian business walks in and tries to vie for contracts, its executives and managers should read this article and follow at least some of its suggestions for doing business in China.

In China, a legacy of half a century of heavy central planning together with massive population pressures, rapid economic growth, chronic poverty; outdated industrial machinery and a lax environmental protection regime have contributed to serious environmental stress. The United Nations Development Programme (UNDP) reported that the costs of environmental degradation, including soil erosion and water shortages, costs China some four percent to seven percent, or $14 billion to $27 billion, of GDP annually (All amounts are in U.S. dollars unless otherwise stated.) Another estimate puts the annual cost of China’s environmental degradation at between 10 to 15 percent of GDP.

Despite China’s rhetorical commitment to sustainable development, officials are unlikely to sacrifice economic growth in the interest of the environment. In fact, continued rapid economic growth and demographic pressures will only exacerbate land, water and air pollution problems in China.

CLEAN-WATER SHORTAGE

The most immediate environmental threat to China is the degradation of its freshwater supply. Increasingly, the quality and availability of drinking water in China’s cities, especially in the north and northwest, appear to be at risk. According to Chinese government officials, some 85 percent of the country’s cities lack safe drinking water. In fact, it was recently reported that 300 cities are short of water, 108 are experiencing serious water problems, and a further 60 are having critical water shortages. By one estimate, water shortages cost China $14 billion in lost industrial production each year. Much of its coastal waters and many major rivers, such as the Yangtze, Yellow and Huai, are badly polluted. Both surface and ground waters in many areas are also contaminated.

The key source of pollution in urban areas is industrial wastewater, which includes nitrates, sulphates, arsenic and cyanide. The U.S. Department of Commerce estimated that around 738 million tonnes of industrial solid waste is produced yearly in China; Liaoning, Hebei, Shandong, Sichuan and Shanxi account for more than 40 percent of the total. About one-third of industrial wastewater is treated, and, even after treatment, some of the water fails to meet effluent discharge standards. The share of municipal sewage that is treated is even lower.

The situation for Chinese rural dwellers is equally distressing; roughly 1 in 7 residents have access to safe drinking water. Heavy fertilizer use contributes to poor water quality through the leaching of nitrates into ground water and runoff into streams. Pesticide and fertilizer contamination has also adversely affected the quality and safety of the country’s food supply. One report suggests that more than 200,000 Chinese people have been poisoned by eating contaminated vegetables over the last decade.

China’s township and village enterprises (TVEs) further compound rural industrial pollution problems. These enterprises are typically small, widely scattered, and employ outdated technology. Waste from TVEs is rarely treated. The further contamination of China’s surface and ground-water bodies suggests that outbreaks of water-borne diseases such as cholera, typhoid and hepatitis, will become a larger and growing problem. One estimate suggests that 10 percent of China’s population either suffers from hepatitis or carries the hepatitis virus. Ignored, China’s water problems will further burden the nation’s already overstretched health-care delivery system and contribute to escalating healthcare costs. It could also seriously affect China’s appeal as one of the world’s major international tourist destinations, and thus undermine the country’s capacity to generate foreign exchange.

Water consumption in China continues to be heavily subsidized, with both residential and industrial consumers paying only a fraction of water production and distribution costs. In 1999, residential and industrial water tariffs in Beijing reportedly reached, respectively, some 0.15 cents and 0.18 cents a cubic metre. Meanwhile, rural water tariff rates averaged approximately 0.02 cents a cubic metre. Artificially low water rates will continue to exacerbate China’s chronic water shortages and water pollution problems.

Before the outbreak of the Asian crisis in mid-1997, the World Bank calculated that China’s water and sanitation investment requirements could reach $102 billion during the 1995-2004 period. The protracted Asian economic and financial crises and rising budget and funding pressures have caused infrastructure investments to be scaled back, postponed or cancelled. Borrowing from foreign sources has also become more expensive. Despite financial pressures, rising rural and urban household and industrial water demand will pressure China’s already strained water resources in the years ahead. In the long term, phasing out China’s decades-old water subsidization system should encourage domestic and foreign investment in upgrading and expanding the country’s water production and distribution systems.

BURNING FOSSIL FUELS

Poor air quality in China is largely related to coal consumption, the country’s most abundant fossil fuel. Coal accounts for roughly three-quarters of the total current energy consumption and production. For example, Beijing’s coal consumption is almost 20 million tonnes annually. China’s enormous recoverable and estimated coal reserves, coupled with its aging onshore oil- and gas-producing areas, including Daqing, Shengli, Liaohe and Sichuan, suggest that this percentage will not change markedly It can be expected that the recent hike in world oil prices will likely stimulate exploration and development in high-cost, high-risk onshore and offshore areas, including Western China and the disputed Spratly and Paracel Islands. Energy conservation and efficiency efforts will also be bolstered to offset ballooning import bills and conserve foreign exchange.

About 80 percent of the coal consumed in China is unwashed before combustion, and consequently has higher emissions levels. This is unlikely to change soon, given the country’s tight financial situation and scarce water resources. It is also estimated that over 16 million tonnes, or some 90 percent of the yearly sulphur dioxide emissions, come from burning coal. By one estimate, acid rain causes some $3 billion worth of damage to agriculture, industry and forests annually. The environmental impact of burning unwashed low-quality coal, including carbon dioxide emissions and acid deposition, has local, regional and global spillovers. Heightened international tensions, especially with such nearby neighbours as Japan, South Korea and Russia, might follow.

China’s industrial sector accounts for over one-half of the total coal use, with thermal electricity generation the next largest consumer of coal (26 percent), followed by the commerce sector and households (22 percent). Failure to decontrol energy prices fully will discourage improvements in energy efficiency and conservation efforts, particularly in China’s iron and steel, cement, fertilizer and pulp and paper industries. The government also aims to increase coal (metallurgical and thermal) exports to boost much-needed foreign exchange earnings. This could displace third-country coal sales, such as those from Canada, to Japan and South Korea.

China has little scope for fuel diversification. Substitution of cheap and abundant coal with less polluting fuels is not an economically viable option on a large scale. Greater use of natural gas could reduce environmental degradation; however, natural gas represents only two percent of commercial consumption, and proven reserves are low. Hydroelectric and nuclear power generation have potential, but their development requires huge capital outlays and long construction periods.

HIGHER GRAIN CONSUMPTION

The Organization for Economic Co-operation and Development (OECD) noted that Chinese officials have ambitious plans to increase grain production. But to increase cereal yields, Chinese farmers will need to make greater use of chemical fertilizers and pesticides. China’s need to expand grain production will heighten competition for water and land resources in coming years. It will also contribute to worsening further the pesticide and fertilizer contamination of domestic food supplies.

A growing population, rising per capita incomes, changing diets, ongoing import liberalization, an expanded livestock sector, continued farmland losses and pollution imply that China will become more heavily dependent on imported grain. Several studies have concluded that China’s grain imports will continue to grow over the foreseeable future. The OECD estimated that China’s medium- to long-term import grain requirements may range from between 20 million to 40 million tonnes annually (five percent to eight percent of domestic production). More grain imports, however, mean higher future grain import bills.

ECONOMIC AND SOCIAL PROGRESS

Chinese officials will need to continue to target high economic growth rates to reduce poverty, improve living conditions and maintain political and social stability. If, as expected, a rapid pace is sustained, continued fossil-fuel consumption will be necessary. This will produce large-scale emissions of carbon dioxide and other greenhouse gas emissions, contributing to global climate change. The U.S. Department of Energy estimated, for example, that China’s carbon emissions might reach almost 1,840 million tonnes by 2015, compared to 625 million tonnes in 1990.

China‘s pollution levy system is designed to provide an incentive for enterprises to reduce pollution. Under the system, violators pay a fine for failing to meet emissions standards. Should violations persist, enterprises may face additional fines. But, in practice, fees and fines are low and do not provide enough incentive for guilty enterprises to change their polluting habits. Consequently, neither pollution fees and fines nor administrative regulations are likely to carry sufficient force, or be systematically applied to, encourage the reduction of environmental degradation.

Equally important, most Chinese remain unaware of the nature and extent of their country’s environmental degradation. Although urban dwellers are acutely conscious of increased pollution, the majority grudgingly accept this as the necessary cost of rapid economic development and social advancement. Changing Chinese attitudes mean that policymakers will need to consider citizens’ demands for a higher quality of life. Meeting these demands, however, will be a long-term endeavour.

As incomes rise, consumers will demand and purchase a wide range of goods, including refrigerators, air conditioners, fans, televisions, washing machines and automobiles. This situation will contribute to increased emissions of carbon dioxide and chlorofluorocarbons (CFCs). Incidentally, China has committed to phase out the use of CFCs by 2010. Construction of new power-generation stations and transportation infrastructures will also be necessary to meet increased electric power consumption and a greater number of vehicles. This, combined with an ambitious domestic housing-development program, will contribute to the destruction of valuable farmland and affect future land and water use. China’s growing love affair with the automobile also means mounting vehicular pollution and higher health-care costs. For example, there were 83,000 victims of traffic accidents in 1999, and their associated costs were approximately $412 million.

INEFFICIENT STATE ENTERPRISES

The widespread use of old, energy-consuming industrial and electrical equipment has increased average energy consumption and waste in plants well above international standards. The willingness and capacity of Chinese industry to install new, cleaner, energy-efficient capital stock is constrained by mounting interenterprise debts, the ongoing corporate welfare burden, excess industrial capacity and chronic operating losses. In the absence of massive industrial upgrading and restructuring, there will be little significant reduction in greenhouse gas emissions and effluent discharges over the next decade.

Of China’s estimated 300,000 state-owned enterprises, approximately three-quarters are unprofitable. According to the International Monetary Fund, the profits of Chinese state-owned enterprises dropped to some one percent of GDP from about six percent. If left unaddressed, China’s money-losing enterprises will remain a major strain on public coffers and the country’s ailing banking sector. By one estimate, some 90 percent of Chinese banks’ credit is channelled to state-owned enterprises. China’s accession to the World Trade Organization suggests that deeper economic and industrial reforms will be required. Still, growing concerns over political and social stability, and rising unemployment, will influence the pace and extent of state-enterprise reforms.

If current state budget allocations and bank lending practices persist, fewer resources will be freed up for other uses, including environmental protection and conservation efforts. A devaluation of the Chinese currency – the yuan – will also exacerbate the country’s environmental woes, as the purchase of newer and cleaner foreign technologies and expertise becomes more and more costly

In the longer term, the installation of modern capital equipment, together with the introduction of market-oriented corporate governance and the establishment of a national social safety net, is likely to improve enterprise performance. This may eventually contribute to future enterprise reductions of greenhouse gas emissions and effluent discharges. Stricter enforcement of environmental regulations and standards will also support this trend.

POPULATION PRESSURES

China’s large and growing population, more than 1.2 billion, will remain a major contributor to environmental degradation. Projections suggest that the population could reach more than 1.6 billion by 2050. If this is correct, there will be enormous pressure on food, land, water, housing, healthcare infrastructure and energy resources. Land and water resources may not be adequate to accommodate these additional people, leading to potentially destabilizing legal and illegal out-migration.

China is also expected to become more urbanized. Based on projections, the number of city dwellers could swell to about 840 million people (55 percent of the projected population) by 2025. In China, roughly 108 million tonnes of municipal solid waste is generated annually. Urbanization also decreases arable land in China by roughly 0.53 million hectares annually

Should such rapid urban population growth occur, garbage and waste, especially in Beijing, Shanghai, Sheyang and Tianjin, will most likely accumulate. It will also likely overwhelm those cities’ respective infrastructures and social-service delivery systems, further decreasing quality of life and health. Railway and road-traffic congestion, power shortages, and water and sanitation problems are likely to mount. As economic and social priorities increase, China’s commitment to environmental protection will likely wane.

MASS MIGRATION

The recent mass migration of Chinese rural workers to urban centres is largely in response to rapid and sustained economic development and improved job opportunities in the country’s coastal regions. It is reckoned that there could be as many as two million migrants in Beijing today. The lack of new agricultural lands and falling demand for agricultural workers will continue to encourage millions of rural labourers to seek out better living conditions in Chinas high-income, high-growth coastal areas. With a floating population of rural migrant workers that could number some 200 million, it is extremely unlikely that this surplus labour will be fully absorbed into China’s more industrialized areas.

Overcrowding and pollution will worsen in migrant-receiving areas. Newcomers living in extremely poor conditions are likely to become more vulnerable to highly communicable diseases, including tuberculosis and cholera. This could easily overwhelm China’s health-care infrastructure. Also, the mass movement of people within China is likely to pose a serious challenge to the ability of the police and civil authorities to maintain law and order in the major migrant-receiving centres. Public administration and governance in China will become extremely difficult.

With respect to illegal migration, Southeast Asia, Japan, Australia, Russia and Western countries with sizeable ethnic Chinese communities, such as the United States and Canada, could increasingly become the main destination for Chinese illegal migrants. This is especially true if economic and social conditions deteriorate further.

TOUGHER ENVIRONMENTAL ENFORCEMENT

Since 1979, China has enacted a large number of laws and regulations dealing with environmental protection. The United Nations Environment Programme recently noted that there are about 2,900 environmental protection bureaus in China, over 2,000 environmental monitoring stations, and some 1,850 monitoring and compliance enforcement stations. The UNEP also reported that there are around 100,000 people employed in environmental protection. Since 1996, according to Chinese government officials, some 65,000 polluting enterprises have been closed.

Nevertheless, under the current system, the government is, in many situations, both the principal polluter and the environmental manager/regulator. As a result, it is often difficult for regulators to carry out objective reviews or assessments of the actions of state entities, or to take opposing positions. It has also been reported that Chinese environmental officials accord a higher priority to large-scale polluters, which are often large state-run enterprises and major employers. Lack of qualified staff and financial resources and widespread corruption hinder action against smaller enterprises, which generally use older, less environmentally-sound technologies and often lack pollution-control equipment.

China’s new land administration law and the creation of the more powerful Ministry of State Land and Natural Resources suggest a tougher enforcement and regulation of the granting, leasing and allocation of land-use rights for state-owned land. Stricter enforcement of land-related environmental obligations and responsibilities will lead to higher future land costs, contributing to lower corporate earnings and profits. Foreign investors should acquaint themselves fully with China’s land and environmental laws to avoid being held responsible or liable for cleaning up sites that previous users contaminated.

As foreign-debt burdens rise, foreign-debt payments will absorb a greater share of government revenues and export earnings. China will need to attract more and more foreign investments to generate export receipts to service international obligations. Lower Chinese environmental standards and regulations, as well as weaker enforcement efforts, may play a role in firms’ investment decisions, potentially making China a polluters’ haven.

Even though China is party to many international agreements on the environment, there should be no illusion about the capacity of developed nations to influence events in China. Environmental policy in China – as in so many other spheres – will continue to be determined by domestic, not international, considerations. Moreover, the waning of tight central control means that officials will find it tougher to implement and enforce international accords, including environmental agreements and protocols.

CLEANUP COSTS

Cleaning up China’s environment will be very costly. For the 1995-2000 period, officials have allocated roughly $18 billion, or under one percent of GDP, to clean up its polluted environment. Nonetheless, even China’s State Environmental Protection Agency reckoned that environmental cleanup expenditures should have been closer to $54 billion. In China’s 10th Five-Year Plan (2001-2005), government spending on environmental projects might reach 1.5 percent of GDP. The funding constraints imposed by declining budgets, increased global interest rates, competing demands for scarce capital, skilled labour shortages, rampant corruption and the sheer magnitude of environmental degradation suggest that progress on cleaning up China’s environment is likely to be very slow, expensive and uneven.

Delays in cleaning up China’s environment will only increase future cleanup costs beyond present projections. Little, if any noticeable improvement in environmental and pollution-related health problems can be anticipated over the next decade. China will need to attract massive foreign capital and know-how to support future environmental cleanup efforts. This will mean numerous commercial possibilities for foreign investors, lenders and suppliers of antipollution equipment and cleaner industrial technology, especially through joint ventures, direct investment, technology transfers and licensing agreements.

IMPLICATIONS FOR CANADIAN BUSINESS

Environmental opportunities in China have declined noticeably since the Asian financial meltdown erupted in mid-1997. Slower economic and export performance, a debt-burdened banking system, rising foreign debt-servicing costs and the downsizing or postponement of domestic and foreign-funded projects suggest that demand for all types of environmental products and services might remain flat or modest over the next two to five years. As the environmental market in China rebounds in the longer term, Canadian companies will find vast opportunities. A stronger regulatory environment and higher world oil prices will also stimulate sales of energy-efficient technologies and services.

The best prospects for increased Canadian export sales are for pollution control equipment, environmentally sound waste disposal systems and water treatment plants, and for environmental consulting and monitoring services. Likewise, China’s expanding grain needs should translate into increased export sales for Canada’s agri-food sector, particularly wheat, barley, fertilizers, farm machinery and improved livestock breeds. China’s ambitious residential-housing plans, which call for the construction of between 480 and 550 million square metres of residential housing annually over the next two decades, may also produce strong demand for all types of Canadian building products and services. Membership in the WTO, oil and gas industry restructuring and consolidation, as well as increased onshore and offshore energy exploration and development, also offer Canadian companies commercial opportunities. Continued lending by international financial institutions (IFIs), such as the World Bank and the Asian Development Bank, provide commercial opportunities for expanded Canadian involvement in IFI-funded environmental prevention and cleanup projects.

Canadian sellers of environmental products, however, will face stiff competition from American, Japanese, German and French rivals. Competition from Chinese environmental protection-equipment manufacturers will become a long-term challenge.

Chinese officials are likely to progressively demand more favourable pricing, financing and loan repayment packages in return for winning environmental sales contracts. China will also increase demands for financial support, including low-cost loans and credits, and for the non-commercial transfers of environmentally sound technologies. That could produce razor-thin profit margins. The use of non-debt-creating modalities, such as offsets and barter, can also be expected to rise as China intensifies efforts to slow foreign debt accumulation, conserve foreign exchange, and offset rising import bills.

China’s underdeveloped legal and regulatory regimes, and frequent environmental policy reversals, will remain major sources of uncertainty for foreign exporters, investors and lenders. Less-than-diligent Canadian investors might have to foot the bill for cleaning up sites contaminated by previous users. The resolution of business disputes or settlement of outstanding payments will continue to be slow and costly. To minimize repayment difficulties, Canadian exporters and lenders should request third-party guarantees, implement earnings-based managerial incentive and bonus systems, bolster risk assessment capabilities or avoid cash-strapped Chinese customers altogether.

In Canada, newcomers from China will be economically motivated rather than “environmental refugees.” In the longer term, a China undergoing deteriorating economic conditions, social unrest and political instability would encourage potentially destabilizing emigration.

About the Author

Nicolino Strizzi is a Research Analyst with the Research Division of the Canadian Tourism Commission, Industry Canada.

About the Author

Robert T. Stranks is a Policy Manager with the Economics Issue Branch of Environmental Canada.

About the Author

Robert T. Stranks is a Policy Manager with the Economics Issue Branch of Environmental Canada.

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