Background

The Environmental Economics Working Group has been part of CCICED since its inception. At the outset, the Group recognized that its research and policy recommendations should be designed to reflect the massive structural changes currently taking place in China's economy, which are in general characterized by a shift from an administered system to one that is becoming increasingly reliant upon market forces. One of the key tests of the success of this process is its environmental impact, that is, whether market liberalization is likely to result in sustainable development.

Some aspects of the market liberalization process are clearly beneficial for the environment. Although rapid changes are taking place, resource prices in China (as in other countries) still do not fully reflect their economic, social and environmental costs. In effect, use of key natural resources such as land, energy and water, and in particular use of the natural environment for disposing of waste material tends to be heavily subsidized. Such a policy results in wasteful and economically inefficient as well as environmentally unsound production and consumption patterns. The market system, in bringing about closer relationships between prices and the real economic costs of supply can in general be expected to be environmentally beneficial in that it encourages efficient (non-wasteful) resource use.

However, as the Working Group has emphasized many times in its presentations to the Council, it is apparent, judging from the experience of more mature market economies, that a free market system cannot be relied upon to ensure that resource use is at once economically efficient and environmentally sound. Thus it can be expected that market failure in the form of environmental externalities, e.g. the costs of industrial water pollution suffered by downstream users, will be a growing problem. In China, industrial enterprises, hitherto having significant social goals - and often soft budget constraints - are now encouraged to maximize profits, and abandonment of environmental objectives, and re-assignment of environmental staff, is already occurring. This trend might be compounded by scale effects. For example, even if the average quality of industrial effluents improves, the very success of the market in generating increased economic activity may result in an increase in total pollution loads.

Attainment of environmental objectives therefore typically requires government intervention. So do a number of income distributional and other social objectives which may not result automatically from an unfettered market system. Growing income disparities between occupational groups and geographic regions are already a major issue in China. This is especially evident in this transitional period, in which unevenness in the pace of development requires that many policy reforms - including some related to environmental management - must be introduced gradually. This is illustrated by the inability of the older and less efficient industrial enterprises to pay for the large clean up program that is required. A long-term strategy must therefore be developed to address these interrelated social and environmental issues. Meanwhile it is necessary to identify measures that can be taken in the fairly short term, most of which in practice should build upon existing policies or instruments.

With this background, the Working Group's program began by developing the general theoretical principles that should govern the pricing of key natural resources, recognizing that optimal pricing from a social and environmental point of view is unlikely to emerge automatically from a freely functioning market system. These general principles were then adapted to research and policy recommendations in the fields of industrial pollution control; biodiversity; and green taxation in general.

Regulatory or economic instruments for environmental management should in principle be based upon the economic costs of environmental degradation, and this topic has been addressed, as has the issue of incidence – i.e. who gains and who loses from environmental degradation and its remedial measures. Special attention has been paid to the impact of environmental policy on the poorest members of society. Highlights of these activities are presented below, with relatively greater detail given to recent and on-going studies than previous work.

Natural Resource Pricing

This work developed the general principles that should govern the pricing of key natural resources, with case studies conducted for water supply, coal, timber, fisheries, and rice production. The studies showed that when economic, rather than purely financial costs are used, and adjustments made for environmental damage and depletion, the real cost to society of use of these resources is greatly in excess of the price that would be expected to result from free market forces.

The studies recognize however that it will rarely be desirable form either an economic efficiency or equity standpoint, to insist upon immediate increases in prices to reflect true social costs of production and consumption of these commodities. Rather, price increases should be increased gradually, roughly in line with overall trends in market liberalization in the Chinese economy.

Two major publications stemmed from this work, namely:

Li Yining and J. Warford (eds), Natural Resource Pricing in China: Water Supply, Coal and Timber (1998), and

D. Norse, Li Ji, Jin Leshan and Zhang Zheng, Environmental Costs of Rice Production in China: Hunan and Hubei (2001).

Industrial Pollution

This study examined the state of industrial pollution and policy instruments in China and made a series of recommendations. Most of them revolved around the existing pollution levy system, where the structure, level, and coverage of charges all required considerable adjustment for this to be an effective instrument. Reforms are currently underway. In addition the study proposed a wide range of enabling policies, without which the pollution levy or other incentive or regulatory measures will be ineffective. These included greater use of economic incentives in complementary activities, such as energy use, funding proposals, and improved use of economic analysis in environmental policy formulation.

This study was published as:

H. Sunman, M. Munasinghe and Zhang Shiqiu, Economics, Environment, and Industry in China (1999).

Biodiversity

This study developed an economic framework for the managed development of ecotourism for the effective conservation of biodiversity. Empirical work was based on the Wolong Panda Reserve, Sichuan Province, but the analytical approach employed and policy recommendations are of generic relevance for biodiversity protection in China.

The study itself employed the "contingent valuation" method for evaluating the willingness to pay, or economic benefits, of providing various levels of ecotourism service. It was estimated that the value of ecotourism in the Reserve (if properly managed) lies between $29 million and $42 million. This could be achieved while remaining within the carrying capacities of the Reserve, and financed by user fees.

In addition, there is evidence that the average tourist in China is willing to contribute toward panda conservation in China even if they do not actually travel to Sichuan to see the species. The study proposes that a surcharge based on the estimated willingness to pay for panda conservation could raise $57 million annually. Therefore in total about $100 million annually could be raised, in contrast to the $250,000 currently spent on management of the Reserve.

Details of the methodology and results of this study were published in:

T. Swanson, Wang Qiwen, A. Kontoleon, Qiao Xuejun, and Yang Tao, The Economics of Panda Reserve Management, 2001.

Valuing Environmental Damage

The first part of this study reviewed and assessed existing literature and data on the subject from both Chinese and foreign sources. It concluded that while there has been a growing literature of steadily improving quality, there was little in terms of comprehensive national estimates of environmental damage that were based on theoretically correct methodology. Moreover, the existing estimates varied from 3.5% to 19% of GDP giving little guidance to policy makers as to the magnitude of economic losses to China and hence the justifiable level of environmental expenditure to control the damage.

The second part of the study, which is on-going, explores the possibility of obtaining more comprehensive and reliable estimates of environmental damage in China through a method known as benefit transfer. This method involves the use of adjusted dose response functions and values from comparable sites elsewhere in combination with Chinese exposure figures to obtain damage estimates, which are theoretically valid. The study now concentrates just on air and water pollution, and makes no attempt to address the costs of soil erosion, deforestation, etc.

Results of the study indicate an annual cost to China from air and water pollution of

US$ 146 billion or 14.6% of Chinese GDP in the late 1990's. It is notable that 85% of the total environmental damage cost from pollution is accounted for by morbidity and mortality; damages to productivity and materials are relatively modest. Air pollution accounts for over 90% of the estimated damages. These results therefore suggest that policy makers in China should focus their efforts on controlling or mitigating the health effects of air pollution, especially acute and chronic respiratory illness affecting both children and adults.

Particulates (PM-10) constitute the single most damaging pollutant to health, accounting for over 80% of health damages from all recorded pollutants and over two-thirds of pollution impacts from all sources. China can make dramatic improvements in its environment and the welfare of its people, by continuing and redoubling its efforts to control particulate pollution, not only PM-10 but also PM-5 and smaller particles which, while less perceptible, could be equally if not more damaging to health. The lack of data on fine particulates needs to be addressed urgently.

The most dramatic impact of water pollution is the effect on the mental and physical development of children of contaminated drinking water and food by untreated industrial and municipal wastewater. Investment in clean drinking water and sanitation and industrial wastewater treatment should be a high priority since water pollution affects mostly the poor who are least able to protect themselves. Similarly, damages to crops and materials while relatively modest by comparison to health damages are important to rural areas and lower socioeconomic groups that can ill afford them. However, it is encouraging that environmental damages, while still very large in China by any measure, show no upward trend despite rapid industrialization.

The first part of this work was published as:

T. Panayotou and Zhang Zheng, The Cost of Environmental Damage in China: Assessment and Valuation Framework (2000)

A second and final publication, incorporating the results of the air and water pollution

damage estimates, is scheduled for December 2001.

Poverty and Environment

Linkages between environment and poverty are complex. In some circumstances poverty is a cause of environmental degradation; in others, rapid industrialization and income-generating activity is a major cause. Market and policy failures exacerbate the problems suffered by the poor, who tend to suffer most in physical terms from environmental degradation, although even here it is not invariably the case. At all events, it is clear that a sound environmental policy should be developed in light of the incidence of the costs and benefits of the damage and of the remedial measures, in order that an efficient and equitable solution can be reached.

In practice, however, this is not usually done, not only because of a genuine difficulty in assessing costs and benefits of environmental actions, or their incidence, but also because there may be opposition to the search for such solutions by parties benefiting from the status quo, i.e. from the "externalities" that they may cause. It is considered that identification of the impact of certain categories of environmental degradation by income group, and the distributional incidence of the costs of alternative environmental policy measures among socio-economic groups is essential. Highlighting this issue is a necessary (although clearly not a sufficient) step in identifying policies that are at once both efficient and equitable.

The environment-poverty study, which is still on-going, started with an assessment of studies and statistical material available in China and elsewhere, using sources such as environmental assessments, natural resource and pollution surveys, and project reports, and combining them with income distribution, household, and other socio-economic data.

This initial assessment was followed by a review of existing environmental taxes and proposed green tax initiatives and reforms in China and identify the types of green taxes that concern the target groups, especially the poor in Western China. The implementation of many such green taxes and their local adaptation are known to vary among regions and provinces, and their incidence is not well known. The study therefore analyses empirical evidence to determine distributive and poverty impacts of green taxes at the household level. Such information is sought from poor rural households in Western China by means of a household income and expenditure survey in a poor part of Guizhou Province. A sample of 300 rural households from 3 counties in Guizhou Province is used. Special attention is paid to environmental taxes or user charges for coal, water supply, and transportation.

Preliminary results suggest that there is considerable scope for environmental taxation in these three areas without undue costs to the poorest members of society. This is largely because the most basic necessities for this group of people are met outside of the market economy, or income effects are otherwise insignificant. However, where services are only available from commercial or public authorities, adjustment to user charge structures will be required to protect the poor. This can be done quite easily with regard to some services, such water supply, where "lifeline rates" or other measures can be employed.

The findings of this study add an important dimension to both the valuation and the green taxation studies with respect to the policy recommendations stemming from their respective analyses. The results are important not only for those responsible for environmental policy in China, but also for those concerned with poverty alleviation and equitable income distribution.

Field work for this study is now almost complete, and publication of the results is scheduled for approximately February 2002.

Green Taxation

Preliminary work on this topic included a review of the general principles that should govern the use of environmental taxes and other economic incentives designed to improve environmental management, the relationship between green taxes and overall fiscal policy; international experience with environmental taxes. It then briefly reviewed existing environmental taxes in China, and made a number of policy recommendations, including a specific proposal to introduce a nine yuan per ton carbon tax (in 1999) and to double this tax over a three to five year period. It also proposed a nation-wide sulfur dioxide tax about four times as high as the current experimental tax rate of 200 yuan per ton, such increase to be introduced gradually over the following three years.

However, it was necessary to refine estimates of the overall implications for the Chinese economy if further concrete recommendations were to be made. In particular, the linkages between alternative environmental taxes and the overall economy needed to be assessed. This is the subject of the second phase of this topic, which is still underway. Following a review of green taxation models, and selecting a prototype for China, current work includes various simulations using the calibrated Computable General Equilibrium (CGE) Model for China, to predict the effects on environment and economy of different environmental taxes: energy taxes, other product taxes, carbon taxes, SO2 taxes, and other pollution taxes. These models will incorporate the results of the environmental damage study with regard to the economic costs of air and water pollution.

The first phase of this topic was published as:

T. Panayotou and Wu Yajun, Green Taxation: International Experience and Relevance to China (1999)

The final report awaits completion of the CGE studies, which are due in December 2001. Following that, a publication will be prepared on the prospects for a comprehensive pollution tax program in China. This publication will also incorporate the key findings and recommendations of the damage valuation and environment-poverty alleviation studies, since an appropriate taxation policy will certainly require some assessment of the damage caused by environmentally degrading behavior as well as the incidence of costs and benefits of ameliorative measures.

Next Steps

The Working Group has been unable to complete its ambitious program in time for the final meeting of the CCICED, but should in substance be almost complete by the end of 2001. However it has funding to allow it to continue its activities until mid-2002. During this period it will finalize its reports and publications, one of which, in addition to those referred to above, will include an overview of all its work over the last ten years. This will be comprised of summaries of work already published or otherwise completed, plus ongoing work.

It is proposed to hold a seminar in Beijing in late March 2002, with attendance restricted to a relatively small number of high level officials plus the WG members. The agenda for discussion will be the overview referred to in the previous paragraph, and will be available in both English and Chinese. The report will be finalized for publication in both languages after the workshop, so that feedback from government officials can be accommodated.

Comprehensive policy recommendations stemming from the Environmental Economics Working Group's activities will therefore not be available until mid-2002. However, it is hoped that its final report may be an input into the deliberations of the first meeting of the Third Phase of the CCICED.

The Group would like to emphasize that all its work is very preliminary. Data requirements and the labor-intensity of the empirical and analytical work required to further integrate environmental policy into overall economic policy are immense. However it is hoped that our efforts have at least demonstrated the importance of the topics we have addressed, and confirm the need to develop capacity within the governmental structure to advance more rapidly in this area.