Can China go green?

Pollution is invariably one of the first impressions visitors form of China. From bicycles to cars in 25 years, urban China rarely sees much in the way of blue sky anymore. Rapid and large-scale industrialization only compounds the problem. The Chinese government knows full well it must take prompt and forceful actions to avoid an environmental crisis. There are encouraging signs it is now rising to the occasion. Can China pull it off while, at the same time, staying the course of its remarkable economic development strategy?

What is the scale of China's pollution problem?

On a per capita basis, China's pollution problem hardly jumps off the page. Its ratio of carbon emissions per person is less than half the global average and less than one-tenth that of the world's biggest polluter the United States. China's enormous population, of course, distorts those comparisons. On an absolute basis, it's a different story altogether. China's total carbon emissions are more than double those of Japan and Russia, fractionally behind the European Union, and a little more than half those of the US. The essence of the Chinese environmental degradation problem is both its scale and growth. Over the 19922002 period, CO2 emissions in China have expanded at a 3.7% average annual rate more than two and a half times the global average of 1.4%. At that rate, according to a recent report issued by the International Energy Agency, China will surpass the United States as the global leader in carbon emissions by 2009.

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In terms of sulphur dioxide, China's current rate of discharge is already double its so-called environmental capacity responsible for an acid rain that now covers about one-third of China's total land mass. According to SO2-based measures of air pollution, seven of the ten most polluted cities in the world are in China. With respect to the emissions of organic water pollutants, China leads the world by more than three times the number two polluter the United States. Moreover, fully 90% of China's urban rivers are polluted, and 90% of its grassland has been degraded. (Data cited above are from Al Gore's Inconvenient Truth [2006], Nicholas Stern's The Economics of Climate Change [2007], and a recent paper prepared by the Development Research Center of China's State Council, "China: Accelerating Structural Adjustment and Growth Pattern Change" [2007]).

China's environmental moment of truth is now at hand.

Why economic rebalancing could solve environmental problems

The problem is twofold, in my view: It is not just an issue of moving from dirty to clean technologies that drive production, distribution, and transportation platforms, but it is also a matter of shifting the macro structure of the Chinese economy from a pollution-intensive to an environmentally-friendly mix. This latter point is a key and often overlooked aspect of China's environmental challenge. It is also a crucial element of the rebalancing challenge that shapes China's macro debate.

The issue, in a nutshell, is that the Chinese economy is heavily skewed toward exports and fixed investment two sectors that now collectively make up over 80% of China's GDP. This concentration represents the most lopsided mix of a major economy in modern history. It is not sustainable from a macro point of view in that it threatens to produce the twin possibilities of a deflationary overhang of excess capacity and a protectionist backlash to an open-ended export boom. And it is not sustainable from an environmental point of view because the industrial-production-driven export and investment booms have a natural bias toward excessive carbon emissions.

This latter conclusion is key but, unfortunately, difficult to quantify in light of the paucity of data on the carbon intensity of the various sectors of the Chinese economy. Bear with me as I take you through a brief, but important, digression that uses the United Kingdom production model to illustrate what China is up against. The Stern Review contains a detailed breakdown of the carbon intensity of 123 production sectors in the UK economy. Not surprisingly, services are at the low end of the UK spectrum in terms of carbon emissions averaging around 0.3 on the carbon intensity scale; for manufacturing industries, the range is wide motor vehicles (0.5) and sporting goods/toys (0.8) are at the low end while the paper (2.4) and steel (2.7) industries are at the high end. A comparable dispersion is evident in the energy share of total UK business costs with non-transportation services at the low end of the spectrum and manufacturing industries at the high end.

OK, China is not exactly England. But I strongly suspect and this is my key analytical leap of faith that the relative dispersion of the carbon- and energy-intensity of the major sectors of the Chinese economy is comparable to that of the UK. In other words, just as manufacturing is more carbon-intensive than services in the UK, the same ranking is likely in China. Under that presumption, consider the following: The latest data put China's industrial sector at around 52% of its GDP well in excess of the 32% share of the average developed economy and considerably higher than the 37% average of the low- and middle-income countries of the developing world. That means the manufacturing-intensive Chinese economy is most likely highly skewed toward a pollution- and energy-intensive model of economic activity.

In the case of China, there is an important twist it is the heaviest consumer of coal of all the major economies in the world today. According to China's Development Research Center, coal-driven power accounted for fully 79% of total electricity generated in 2003 eight percentage points higher than in 1990 and essentially double the 40% share of coal-powered electricity for the world as a whole. The adverse environmental implications of coal power are well known; according to the Stern Review, the CO2 emissions of coal per unit of energy generation are twice as much as those associated with the combustion of natural gas and about 50% more than those generated by oil-burning technologies. Inasmuch as UK coal consumption fuelling 34% of the country's total energy generation is less than half the share in China, there is actually good reason to believe that the pollution implications for the Chinese economy per unit of GDP would be a good deal worse than those implied by the British results cited above.

The India comparison is also an interesting one in putting Chinese environmental issues in perspective. India's per capita carbon emissions are only about half those in China and its total emissions are about one-third those of the Chinese. But the 4.3% average annual growth rate of Indian CO2 emissions over the 1992-2002 period is more than 15% faster than the rapid growth evident in China over the same period suggesting that if India stays its current course, its environmental threats will quickly get out of hand. Even so, the structure of Indian GDP a much smaller industrial portion (28%) than China (52%) and a much larger services share (53%) than China (34%) is biased toward a less pollution- and energy-intensive growth trajectory. That's not to let India off the hook on environmental issues but only to stress that China is very much in a league of its own.

Is China taking steps towards solving its pollution problems?

China has a rare and important opportunity to kill two birds with one stone. A successful rebalancing of the Chinese economy moving away from excess reliance on investment and exports and embracing more of a pro-consumption growth model would be a huge plus in dealing with two key issues: On the one hand, it would enable China to avoid the capacity excesses and protectionist risks that might arise from a continued irrational expansion of a severely unbalanced real economy. But it would also have the advantage of tilting the mix of Chinese output away from a pollution- and energy-intensive growth trajectory.

The latest statements from official Beijing are quite encouraging in addressing this conjoined problem. Premier Wen Jiabao's 5 March "Work Report" to the National People's Congress strongly endorsed a strategy of macro rebalancing, energy conservation, and environmental remediation. Just as China has had the will and determination to deliver on the reform front over the past 28 years, I am hopeful that it will rise to the occasion and deliver on the rebalancing front. In the end, there is no other choice. And time is growing short.

By Stephen Roach, global economist at Morgan Stanley, as first published on Morgan Stanley's Global Economic Forum