Jim Jubak

Jubak's Journal2/9/2007 12:00 AM ET

How long can China pollute for free?

One of the nation's big industrial advantages over other countries is growth that's virtually unchecked by environmental laws. Here's how and when the waking giant may be forced to change.

By Jim Jubak

These are boom times for Shanxi province in northern China. The province produced 25% of the country's coal in 2005 at a time when coal prices were soaring. Shanxi's economy grew by 12.5% in 2005, well ahead of even the astonishing 10% growth for China's economy as a whole.

Or maybe not.

The province is home to Linfen, Yangquan and Datong, the three most polluted cities in China. Life expectancy in Linfen is 10 years below the Chinese national average. Unchecked coal mining -- the province closed 4,800 illegal mines in 2005 -- and the drilling of illegal wells for water have created a chronic water shortage and a steady loss of farmland as it subsides into underground mine shafts and drained aquifers.

If you subtract the costs of air and water pollution from Shanxi's growth rate, local officials have told Deutsche Bank, the province's real economic growth rate is close to zero.

Net growth? Almost nil

Understandably, those officials have chosen to remain anonymous, but official numbers on the national economy confirm the drift of their figures. The central government's most recent report put the cost of pollution at $64 billion in 2004. Subtract that from the country's gross domestic product, and growth in 2004 was closer to 7%.

That's still a growth rate that most countries in the world would love to have, but it's far short of the 10% annual growth that China reports in its headlines -- and frighteningly similar to the 7% rate of growth that most economists calculate as the minimum necessary to create enough jobs for the country's growing population.

It's easy to find economists outside China who are even more pessimistic. The World Bank puts the costs of China's pollution at 8% of GDP. Some economists peg it as high as 10% of GDP. According to this accounting, China isn't growing at all.

Getting it on the books

On one level, of course, this is all academic. No country -- certainly not the United States -- uses accounting like this to calculate its gross domestic product or the growth rate of its economy, although China's Environmental Protection Administration is trying to implement some kind of green accounting.

Polluting the air or water, releasing toxic amounts of mercury, using so much water that a river runs dry -- these are all what economists call externalities. The costs of these externalities aren't paid by the producers of the pollution but are passed along to third parties -- the general public, in most cases -- in the form of increased illness or higher death rates, and they remain external to the country's GDP accounts.

However, today's externality has a way of becoming tomorrow's on-the-books cost. Just ask any U.S., European or Japanese company about what it costs them to clean up their wastewater, scrub their emissions and safely dispose of their toxic waste today. Those were once externalities -- companies used to simply dump their waste into the air, water and ground. Now disposal is part of the cost of doing business.

Closing the 'externality gap'

That will happen in China, too, someday. Today, however, Chinese companies have a sizable cost advantage over their rivals in the developed world because many of the environmental costs of doing business in the United States, Europe and Japan are still externalities in China. Polluting the air, water and ground at no cost to the company's bottom line makes it easy to undercut the prices charged by companies that don't have a right to pollute for free.

Closing the "externality gap" between China and the developed world would eliminate one source of China's cost advantage and slow the country's economic growth rate. If we want to know how sustainable China's current growth rate of 10% per annum is, we need to look at how quickly current environmental externalities will get on the corporate books.

Death by pollution

There are two factors that determine the speed of that process. First, how long will it take until China's environment is at a breaking point that will force an end to polluting for free? Second, how quickly will the global economy force the Chinese economy to change its ways?

The environmental figures out of China, even the official ones, are appalling. More than 400,000 of China's 1.3 billion people die from air-pollution-related illness each year, according to the Chinese Academy on Environmental Planning. About 300 million Chinese don't have access to clean drinking water, and 400 of the country's 668 largest cities are short of water. Acid rain falls over 30% of the country. Of the 20 most polluted cities on earth, according to the World Bank, 16 are in China.

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The situation is getting worse fast. By 2020, 550,000 Chinese a year are likely to die from air-pollution-related illness. Human health costs from air pollution, according to the Chinese Academy for Environmental Planning, now at 2% to 3% of China's GDP, will reach 13% of GDP by 2020, if current trends continue.

Power sector runs amok

But I'm pretty sure that as bad as things are, they aren't bad enough to force much change yet. Oh, the central government in Beijing is convinced of the need to clean up the country's environmental act, but as always in China, what the center wants isn't necessarily what the center gets. As the saying goes, "The mountains are high, and the emperor is far away."

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