The Chinese Environment: Positive Trends toward Environmental Protection

Introduction

shutterstock_112030406Environmental degradation in China has increased significantly in the last 30 years. In 2000, China’s Environmental Protection Agency found that two thirds of China’s 300 largest cities had air quality which exceeded WHO standards for acceptable levels of total suspended particulates. Additionally, China’s water is also both in short supply and highly polluted.  Stresses to China’s environment will grow in the future. By 2030, it is estimated that approximately 300 million new vehicles will fill China’s roads; an additional 350 million people will move into China’s cities; and an expanding number middle class will demand better food and more consumer goods. By 2030, even with China’s rapidly developing alternative fuels capacity, it is estimated that China will need to burn almost 200 million tons more coal than in 2005 to provide sufficient heating and electricity for its new urban citizens. Indeed, overall coal-based power generation capacity is projected to triple from its 2005 rate by 2030. In 2007, the World Bank assessed that China’s combined health and non-health cost of outdoor air and water pollution to be conservatively $100 billion annually, or 5.8% of the country’s GDP, and that up to 500,000 people in China die each year from air and water pollution.

Yet, despite the magnitude of China’s environmental crisis, positive trends are emerging which will begin to slow the damage being inflicted on China’s and the world’s environment. Perhaps most importantly, Beijing is increasingly recognizing that China is placing unsustainable stress on it ecology. For the first time, China’s 12th Five Year Plan prominently features both the importance of improving energy efficiency, and of mitigating climate change. As a result, in the next five years, Beijing will invest heavily in green technologies, alternative fuels, and energy efficiency. Beijing sees these investments as one way for China to take the lead in green industries; indeed, by 2015, for example, China is projected to have the world’s largest installed capacity of alternative fuels.

This trend toward greater environmental protection is also being driven by a growing emphasis on green lending within China’s banking sector, and by China’s need to comply to international environmental standards such as the ISO 14001 in order to compete in international markets. Domestic and international NGOs are also gradually raising environmental awareness in a whole range of areas. Multinational corporations, too, are playing their part, progressively insisting that their Chinese factories meet local environmental regulations, and introducing into China environmentally friendly technologies and practices.

China’s 12th Five Year Plan –Featuring Climate Change Prominently

shutterstock_87381041For the first time, China’s 12th Five Year Plan highlights climate change and energy efficiency prominently. The plan sets a GDP growth target of 7%, which would be a significant slowdown from the average 11.2% rate of growth reached between 2006 and 2010. The 12th Five Year Plan and subsequent commitments also adopt as domestic, binding law the voluntary climate pledges China made at Copenhagen in 2009. Specifically, by 2015, China plans to reduce its carbon intensity by between 40% and 45% from 2005 levels, to increase its forest cover by 12.5 million hectares and its forest stock volume by 600 million m³. As of 2015, these same goals remain unchanged, and China has pushed them another five years into the future. The country now hopes to realize these reductions by 2020. Measuring China’s progress towards these goals remains inaccurate because the nation has not released many reliable and updated figures on carbon intensity to the public. The figures remain ambitious: by 2020 China aims for an energy distribution of 350 GW in hydropower, 200 GW in wind power, and 100 GW in solar power.

The five year plan sets several separate targets for 2015, including: a 16% reduction in energy intensity; a 17% reduction in CO2 emissions per unit of GDP;  an 8% reduction in demand for both chemical oxygen and sulfur dioxide; a 10% reduction in both ammonia nitrogen and nitrogen oxides. The plan also highlights the need to improve sewage and sludge treatment, and to better the rates of desulfurization and de-nitrification. It also seeks to protect the living environment with policies to reduce rural pollution from agriculture, to expand nature reserve development and biodiversity conservation, and to extend waste management infrastructure. Beijing is also planning to upgrade subway and light rail in cities that already have urban transit systems, as well as to construct new systems in at least nine other cities. It will also build 35,000 miles of high speed railway with the ultimate goal of connecting every Chinese city of 500,000 or more people. China may also soon unveil plans to create 10 million electric car charging spots by 2020.

Looking at the layout of the 12th Five Year Plan, decisions 52 through 54 of the 12th FYP are especially promising. The 52nd decision puts forward a commitment to establishing national parks and outlines a more flexible plan for local governments. Municipal officials in environmentally damaged areas who were once expected to meet certain GDP targets will no longer be held accountable to those numbers. Instead, their decisions and implemented policies will be closely monitored to assure that they are not furthering the environmental damage in their respective regions. The 54th decision works together with the 52nd, laying out the groundwork for a system where all environmentally-related developments must be licensed. With the added scrutiny and pressure to meet economic goals removed, it will be much more difficult for government officials to find legitimate reasons supporting preferential treatment for companies damaging local rivers and farms. Decision 53 acts as a capstone to this policy outline, reflecting China’s recognition that the current environmental situation has resulted from years of damaging habits and forming a national plan to rehabilitate damaged farmland.

China’s 12th Five Year Plan –Emphasis on Renewable Energy

The 12th Five Year Plan also seeks to have renewable energy account for 11.4% of China’s power consumption by 2015. China plans to increase wind power by 70 gigawatts. With regard to nuclear power, China projects installing 40 additional gigawatts of safe capacity by 2015, though after the disaster at Fukushima in Japan, China has also vowed to review and strengthen the safety of all its nuclear power as part of its expansion strategy. China anticipates increasing its hydropower to approximately 380,000 MW by 2020 and expects to have solar capacity of between 10 GW to 30 GW by 2020. Indeed, seven of the planet’s top 10 solar panel makers are now Chinese. At the end of 2014, the China Electricity Council reported that renewable energy sources had increased their share by 19%, while fossil fuel usage declined 0.7%. Energy capacities also increased significantly: China’s non-fossil fuel energy capacity rose by 55.8 GW to 444GW, with solar, hydro, and wind power rising by 10.6 GW, 22 GW, and 23.2 GW respectively. These changes surpass those outlined in China’s 12th Five Year Plan, and put it on track to meet 2020 targets. Should it meet them, China will have the most installed wind, nuclear, and hydro-power in the world, and will have one of the largest solar capacities.

As a whole, China’s renewable energy sector has expanded dramatically over the last few years. From 2009 to 2013, the total production of renewable energy sources expanded nearly 13.3% annually, and is expected to remain fairly high at 11.8% per year in the five years ending 2018. National investment in green energy has also increased quite healthily, with USD $87.5 billion invested in total during 2014, up 36% from 2013 and comprising just over 32% of global investment in the sector. All of these positive changes have catapulted China into the number one spot in many renewable- and green energy-related production indices, and have made the nation the world leader in renewable power development. In the 2015 report from the Renewable Energy Policy Network for the 21st Century, known as REN21, China took the top spot in 11 of 26 categories: greatest investment in 2014 in renewable power and fuels, hydropower capacity, solar photovoltaic and water heating capacity, wind power capacity, and greatest generation by volume of renewable power (both including and excluding hydropower), total hydropower capacity, total wind power capacity, total solar water heating capacity, and total geothermal heat capacity. Wind power continues to rise in China, with Asia as the dominant market for the past seven years. As of 2014, the total capacity of wind power in Asia has surpassed that of Europe, in large part because of China’s extensive investment in the field. Indeed, the whole renewables industry has momentum that will carry China forward into future years and determine goals established in further Five Year Plans.

China’s 12th Five Year Plan –Pushes More Effective Pollution Data Collection

Of key importance to its environmental efforts is China’s intention to implement comprehensive data collection and monitoring systems, soon allowing it to follow a more data-driven approach to environmental policy. Yet, it is not clear how much of that data will ultimately be made available to either the public or the wider world. China’s political vulnerability because of environmental pollution is still a serious concern within a Chinese leadership that fears environmentally triggered “mass incidents” (a euphemism for protests or social unrest) and the resulting social instability. There is also concern that foreigners will use environmental data to interfere in China’s internal affairs.

For example, recent air quality monitoring by the US embassies in Beijing, and most recently Shanghai, has led to controversy as US reading  contradict Chinese official data. Increasing numbers of Chinese citizens, along with many in the expat community in China, are turning to US environmental data.  In 2011, for instance, Beijing health authorities insisted that air quality was perfectly safe 80% of the time while US statistics rated the air quality is good for about  4% of the time. The discrepancy in readings results from the fact that the US Embassy monitors small air particles known as  PM 2.5 which Beijing authorities have neglected to include in their data. Chinese authorities have work to quell increasing controversy by agreeing to measure the PM 2.5 particles as of 2015. They have also called into question the accuracy of the US readings. According to Wikileaks, in 2009, Chinese officials went as far as to request that the US Embassy stop tweeting its air pollution data because it said the conflicting data was “confusing” and could cause “social consequences”.  As of May 2012, the US Consulate in Shanghai has also begun issuing pollution statistics. The US Consulate alerted Shanghai officials in advance that it would be publishing pollution data. In its tweets, the US Consulate emphasizes that the pollution results are derived from monitoring equipment solely based at the US Consulate, and do not necessarily reflect the air pollution quality of the entire city. Again, US data conflicted with the official Shanghai statistics, with the US consulate finding the air quality as unhealthy, where the Chinese data finds the air quality good.  By June 2012, the Shanghai Environmental Protection Bureau will also release air quality data including PM 2.5 particulates.

Like the divergent air quality statistics, reports on provincial emissions often differ significantly from on-site data. Some suggest that this may be the result of China’s national carbon emission reduction targets, because businesses find it easier to meet their carbon goals if they overestimate them at the outset. To remedy this inconsistency, the Chinese Academy of Sciences has begun a year-long study to identify the largest carbon emission culprits and their numerical contribution to China’s carbon outlay.

Studies on the pollutants affecting China’s soil quality also remain scarce. Some of the more recent statistics indicate a large, but largely ignored problem. Pollution in 16% of all Chinese soil exceeded standards, and 19.4% of all arable land contained heavy metals, also above acceptable limits. Enough productive land has been affected that China may be risking a loss of food security and self-sufficiency should the decline in land quality continue. The 12th Five Year Plan does push for improved data collection, but China still has areas in the environmental sector that need improved data collection before resources are destroyed beyond repair.

China’s 12th Five Year Plan –Looking to the Market to Help Protect China’s Environment

In addition to new pollution targets and better data gathering, China 12th Five Year Plan articulates market-driven solutions to reduce pollution domestically, including: offering financial incentives to enterprises engaged in sewage treatment, sludge treatment, desulfurization, de-nitrification and waste disposal; strengthening the pollution charging system so that high-pollution production faces higher costs; encouraging lending to green projects; and increasing the portion of green products on government procurement lists.  Beijing is also considering evaluating party member performance on pollution mitigation as well as GDP growth targets. The plan also proposes an environment tax in order to deter pollution, promote clean technology and create funding for environmental clean-up. It is likely that the tax will be first introduced in China’s wealthier provinces, and then rolled out nationally. Cap-and-trade carbon pilots on the national scale are also being deliberated, as is an expansion of the 11th Five Year Plan “1000 Enterprises Program” to “10,000 Enterprises Program.” Regional carbon trading programs have already officially begun pilot testing in several provinces, with the ultimate goal of creating a unified carbon cap-and-trade system sometime around 2017. Going estimates place the size of this potential market at around RMB 100 billion by 2020.

In 2005, it was determined that the energy consumption of the top 1000 Energy Consuming Enterprises accounted for 33% of national and 47% of the dead industrial energy usage in 2004. Under the program, 2010 energy consumption targets were determined for each enterprise. High energy consumption enterprises include those competing in the iron and steel, petroleum and petrochemicals, chemicals, electric power generation, non-ferrous metals, coal mining, construction materials, textiles, and pulp and paper industries. While detailed information on program results is difficult to attain due to confidentiality, a 2010 study by Lynn Price, Xuejun Wang and Jiang Yun indicated that the Top 1000 Enterprises Plan was tracking positively to reach its goal of saving 100 metric tons carbon equivalent (Mtce) in 2010, could even surpass the figure by as much as 48 Mtce. When calculated in terms of reduced CO2 emissions, the effect of the Top-1000 program is enormous. Meeting the 2010 100 Mtce savings target will result in energy-related CO2 emissions reductions of 300 MtCO2, an amount equivalent to the 2005 annual emissions of Poland.

Indeed, improving energy efficiency is key to China’s new, “scientific outlook” on development. The scientific outlook most immediately focuses on technological solutions, notably through improved efficiency as the principle short term way to conserve resources. The program also promotes the idea of a “circular economy” where China actively reduces, reuses and recycles. It is by efficiency gains, the pursuit of the circular economy, the employment of alternative energies, and the embracing of new green technologies that Beijing believes that it can significantly grow GDP while ensuring sound ecological conditions.

Large Projected Investments in Green technologies

If all the measures proposed in the 12th five-year plan are implemented, China will be creating a huge market for clean technologies, with the potential to exceed $1 trillion. Beijing will be investing heavily in the sector. During the 12th five-year planning period, Beijing’s green sectors investments are expected to reach $468 billion, up from $211 billion over the previous plan. The bulk of the investment is slated for waste recycling and reutilization, green technologies such as alternative fuel vehicles, and renewable energy. This investment will drive projected annual growth in China’s environmental protection industries to an average of between 15% and 20% through 2020. World Watch Institute, a research institute devoted to the analysis of global environmental concerns, expects that China will create as many as 4.5 million new green jobs during that period.

With these and other investments, in the future, China hopes to lead the world in green technology, leapfrogging the developed world’s carbon-based economies. The transition costs to a less carbon-dependent economy will be less for China than for advanced economies, because it is not locked into a high-carbon model to the same degree. Also, green technology levels in the developed and developing worlds are on par, so that China also does not have to play catch-up to be competitive in the sector. Indeed, many in the international environmental movement have expressed hope that China may ultimately lead in climate change initiatives, particularly given its large and growing investments in the sector.

Other Factors Working to Reduce Environmental Degradation in China – Green Lending

In February 2012 the China Banking Regulatory Commission (CBRC), China’s top banking regulator, issued the Green Credit Guidelines to help facilitate China’s transition to a more environmentally friendly development model. The guidelines apply to domestic policy banks, commercial banks, rural cooperation banks and rural credit cooperatives, as well as village banks, loan companies, rural funding cooperatives and non-banking financial institutions. . The guidelines encourage lenders to reduce loans to industries with high levels of energy consumption and high levels of pollution, and to strengthen financial support for green industries and projects. Specifically, the guidelines require the financial institutions’ Board of Directors or Council to take charge of establishing a “green credit development strategy”, as well as to approve green credit loans, issue regular green credit reports, and supervise the institution’s green credit performance.  Senior management will be responsible for reporting annually to the Board of Directors and regulators about the progress of green credit practices. Additionally, banks will also be required to maintain a list of high-polluting clients, and urge these clients to take pollution mitigating measures. In the future, banks will also be expected to do more thorough environmental due diligence before lending, and restrict credit to highly polluting clients.

Even if credit has been granted, disbursement of the loan proceeds can be suspended or terminated if the client begins to engage in environmentally damaging practices. Post-lending, banks are required to report to regulators any behaviors by its borrowers which are resulting in environmental damage. For overseas projects, financial institutions must ensure their financing is for projects complying with local environmental regulation. Banks are also required to conduct internal audits of their green credit practices regularly; every two years, a comprehensive evaluation of its green credit practices are to be submitted to the CBRC. The CBRC is to conduct off-site and on-site inspections to ensure that financial institutions comply with its Green Credit Guidelines.

These regulations are designed to further develop what was already a growing trend in green lending in China. By end of 2011, China’s six largest banks – China Development Bank, Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China, China Construction Bank, and Bank of Communications – had a total of $301.75 billion in green credit lending. In particular, in 2011, China Development Bank lent $104 billion to support environmental protection, energy saving and emissions reduction projects, accounting for 12.7% of the bank’s total outstanding loans. Even before the 2012 guidelines, green lending in China was growing because of rising demand by customers, and because government support for green projects has meant that many green loans have lower non-performance ratios. Ultimately, the future success of the guidelines will be dependent on the banking industry’s ability to collect accurate environmental data on its customers. Certainly, the government’s 12th Five-Year Plan indicates a greater commitment to environmental data gathering. Again, it still remains to be seen whether Beijing will then allow this information to be more widely circulated.

Other Factors Working to Reduce Environmental Degradation in China – Meeting ISO Standards

shutterstock_104036633China’s participation in standardization laws are also helping to drive pro-environmental business practices. ISO, an international organization headquartered in Geneva, issues two kinds of specification standards to which China strives to comply: those which facilitate commerce by normalizing product standards and those which standardize procedures. The IS0 14001 incorporates environmental policy into its framework by creating a standardization of management practices and implementation of environmental procedures. Since 2006, China has led the world in ISO 14001 certificate registrations. China’s ISO compliance efforts are driven by the fact that many of the markets into which China exports now request ISO 14001 observance.

Other Factors Working to Reduce Environmental Degradation in China – NGOs

Domestic and international NGOs are also becoming increasingly important to China’s environmental activism. The Academy for Green Culture, now called Friends of Nature, was the first environmental NGO formally registered in China in 1994. Since then, several hundred international and domestic NGOs engage in nature conservation, species protection, environmental education, policy advocacy, data collection, legal advocacy, environmental information exchange, wasteland reclamation and organic farming. Indeed, leaders of three Chinese NGOs were appointed as environmental advisers to the Beijing 2008 Olympic Bid Committee and were instrumental in helping China win its bid. These NGOs work both at a community and a national level. Examples of NGOs active in China include Green River, Global Village of Beijing, Institute of Environment and Development, the World Wildlife Fund, Green Earth Volunteers, Green-Web, the Natural Resources Defense Council, Greener Beijing, and the Center for Legal Assistance to Pollution Victims.

Despite their growing presence, NGOs face real challenges when working in China. NGOs often lack any real influence, particularly when faced with entrenched business interests. Domestic NGOs are often challenged by fund raising difficulties. On many occasions, new NGOs have been refused registration, thus denying them the benefits of NGO status. The government also closely scrutinizes the work of these NGOs in order to prevent environmentalism from evolving into a push for broader political reform. In general, domestic NGOs are reticent to criticize the central government publicly, and work hard instead to engage in cooperative relationships with local officials.

Other Factors Working to Reduce Environmental Degradation in China – Multinationals Making a Difference

Multinationals are also beginning to positively impact environmental protectionism in China. Given that China is often their factory, and given the growing environmental activism within China at the governmental, NGO, academic and social levels, multinational corporations are increasingly under pressure to ensure that their production, and the production of their suppliers, in is in compliance with local environmental standards. For example, in August 2011, Apple received bad press for ignoring its suppliers’ outstanding public pollution violations which had been brought to its attention by a consortium of five Chinese environmental NGOs. Within a month, Apple was working with its suppliers and the NGOs to improve environmental performance.

Multinationals are also increasing taking initiative in helping their Chinese suppliers use energy, water and materials more efficiently, and reduce emissions where possible. Shell China, for instance, one of the largest multinational companies operating in China, has been introducing better environmental practices and technologies. In 2009, in the Changbei Gas Field, where it works jointly with PetroChina, Shell increased gas production by 11% while decreasing energy intensity, resulting in annual savings of around 2500 tons of standard coal – enough to provide sufficient power to support 10,000 urban Chinese families for three and a half years.  The project also reduced the volume of its wastewater by 70%. These environmental practices are good business as they improve profitability. Yet, they are also introducing methods and technologies that are then absorbed more broadly. Multinational investors also drive environmental practice in China. Worried about environmental liability, they encourage multinationals to implement stricter environmental practices.

Trends

shutterstock_110013224Despite the many factors which will continue to perpetuate environmental degradation in China over the coming decades, and the magnitude of China’s environmental challenge, China’s environmental trends are not all grim. Indeed, many developments indicate that China will make increasing progress in the field of environmental protection.

One of the most important of these developments is the growing emphasis Beijing is placing on environmental protection. Indeed, not only is Beijing beginning to articulate a well thought out and increasingly detailed plan as to how China can begin to protect and restore its bio-capacity, but it is also backing that plan with an unprecedented level of short-term investment. This investment will soon allow China to take leading positions in many environmental sectors. For instance, by 2015, China will have more installed alternative fuel capacity than any other country.

This investment will create huge opportunities in China’s green technologies market. Investing heavily in green technologies may enable China to gain an advantage over developed countries with a heavy reliance on their carbon-intensive economies. For instance, China now has the largest solar water heater market in the world. Approximately 95% of patents for core solar water heating parts are owned by Chinese companies. These patents allow heaters to function even under grey skies and at temperatures well below freezing. It is estimated that at least 30 million Chinese households now heat their water with solar panels.

Indeed, leading the development and implementation of green technology is one of the ways China is creating the competitive edge it needs to remain an economic powerhouse in the future, especially as its rapidly aging and shrinking workforce means that it will not be able to indefinitely compete just on the basis of cheap, plentiful labor. As the impact of global warming is increasingly felt, and as growing fossil fuel demand continues to put upward pressure on fuel prices, demand for green technologies will rise. China will position itself to profit from these opportunities by first introducing green technologies at home before aggressively seeking to export them to foreign markets.

China will begin to lead the way in green architecture and urban development as 70% of its population settles into cities by 2030. It will increasingly introduce technologies which will avoid high electricity consumption in buildings. Specifically, we will see China install more energy-efficient lighting, appliances, heating, ventilation and air-conditioning systems, and better insulation in walls, windows and roofs. Similarly, it will also prioritize retrofitting its existing building stock with energy-saving features.

shutterstock_104036633China will also invest in the development of alternatives to internal combustion engine (ICE) transportation. This can already be seen in its growing commitment to the construction of rail and mass transit systems. China can also be expected to increasingly reduce emissions and increase fuel efficiency in the ICE cars that do reach its streets. It will also continue to invest heavily in alternatives to ICE cars. Specifically, China plans to push the full range of advanced battery technology for electric vehicles. Indeed, by exploiting its current pool of low-cost labor, along with its fast-growing domestic car market, its proven success in rechargeable battery technology, and its substantial investments in R&D, China has the potential to emerge as a global leader in electric vehicle technology in the coming decades. Indeed, its plans to create 10 million electric car charging parking spots by 2020 suggests that it the pursuit of affordable, high-performance electric vehicles will continue to be a priority. Currently, China has 16,000 AC charging spots in operation.

Despite China’s growing commitment to alternative fuels, its use of coal will still rise significantly in the future. Increasingly, China will work to offset its carbon emissions by investing in technology that sequesters carbon emissions for next-generation coal plants. Indeed, China wants its clean energy sectors and it clean energy technology to become 15% of its economy by 2020.

Also of note is China’s growing nuclear program, which has exhibited consistently high rates of growth over the last 15 years. Consumption in the sector is expected to increase by 15.4% for the next five years ending 2020, while renewable energy is projected to grow around 7.5%—though this is likely due to the high level of development that China has already achieved in its fairly mature renewable energy sector (which accounts for 9% of energy production in the nation, compared to the 1% share occupied by nuclear energy).

Furthermore, China currently produces a lot of industrial municipal waste that it does not recycle or properly manage. China will increasingly rectify this by employing technologies that will allow it to convert its waste into useful material. For instance, there’ll be a growing trend toward coal-bed methane recovery and recovery of blast furnace slag resulting from steel production. It will also seek to burn more of its municipal waste to generate electricity, instead of sending it all directly to landfill.

Green lending, ISO compliance, the influence of domestic and international NGOs and multinationals will also continue to drive positive environmental behavior in China. It can be expected that China will also be inviting more foreign investment in the green technologies sectors.

All that said, many of China’s dominant economic and political incentives have not changed. 129 million Chinese citizens still live on less than $1.25 a day, and 400 million earn $2 a day. China’s population will continue to grow through at least 2030, and inequality in China has increased significantly both within the population, between rural and urban residents, and between different regions within the country. Those Chinese moving into the middle classes will demand a better diet and consumer goods. China’s government will thus remain under enormous pressure to improve the standard of living of its people and to reduce inequality nationally.  Proponents of low carbon future for China thus face significant opposition by others who suggest that China should focus on unrestrained development until more of its population has reached a modest but dignified standard of living.  China’s 11th Five Year Plan also advocated a slower, more balanced GDP growth, yet China’s GDP growth exceeded 11% during the period. Local governments, in particular, have many incentives to keep to business as usual.

Still, within the international climate community, there is some hope that China may come to take a leadership role in climate change mitigation. They note that China has not stepped back from its 2009 voluntary Copenhagen commitments; instead it has translated them into binding domestic law. They also note China’s opportunity to leapfrog the carbon-based infrastructure installed in developed countries, partly because of its history of radical experimentation, but also because of the greater ability of its authoritarian government to dictate far-reaching environmental policy. China’s obvious desire to profit from the rapidly growing green technology sectors is, therefore, potentially good news for everyone.

Ultimately, Chinese leaders have an opportunity to follow a path of development that diverges from a Euro-American capitalist model that is no longer accepted as indefinitely sustainable; in the long run, the world does not have the bio-capacity to support billions of new people consuming like Americans and Europeans. The Chinese leaders seem to increasingly acknowledge this. In 2008, for instance, Ambassador Yu Qingtai noted that while he could not accept that as a Chinese, he was only entitled to one quarter of what western developed nations have enjoyed, he also recognized that it would be a nightmare for China if its 1.3 billion people had the same per capita emissions as the Americans. That representatives of the Chinese government are beginning to articulate that high Chinese per capita emissions would be a nightmare for the Chinese themselves is also grounds for optimism about the possibility of improved global environmental protection. The outlook continues to be positive. In November 2014, China announced plans to halt emissions increases by 2030. With these national efforts China will certainly see large changes, and perhaps the birth of entirely new markets, in the coming years.

How China is Tackling its Water Challenge

Introduction

TheChinaFile

China faces a severe water shortage. Its current water per capita is one quarter of the world average. This per capita water availability will decrease in the coming decades as China’s population peaks at between 1.4 and 1.5 billion people by 2030. China’s water usage per capita may be low by international standards, but it is expected to grow by between 40 and 50% by 2030. Factors such as higher living standards, increasing urbanization and further industrialization are driving water demand.

The water that China does have is often badly polluted. An estimated 70% of China’s rivers and lakes are currently contaminated and 300 million people drink water tainted with inorganic pollutants such as arsenic, excessive fluoride, untreated factory wastewater, agricultural chemicals, leaching landfill waste, and human sewage. China’s water is also inefficiently consumed, compounding its water challenges. 45% of water destined for agricultural use is lost before it even reaches crops. Only 40% of its industrially used water is recycled, compared with 75% to 85% in developed countries and water lost from urban plumbing leaks accounts for 18% of total urban water withdrawals.

Moreover, China’s water is unequally distributed throughout the country. The Yangtze River basin and areas to the south receive 80% of China’s naturally available water resources to support only 54% of its population, 35% of its arable land, and 55% of its GDP, while the north gets just 20% of China’s water. Deforestation, overgrazing and unsustainable agriculture have destroyed local ecology in many parts of China, affecting China’s overall rainfall, and exacerbating China’s age-old challenges of drought and flooding. To meet its growing water demands, especially in the north, China is depleting its underground aquifers, lakes and river systems at untenable rates. As water becomes scarcer, competition for water is increasing between agriculture and industry as well as among China’s growing cities and different regions of the country. This trend will only continue in the coming years; by 2009, surveys revealed that 58.3% of river water, 49.7% of lakes, 79.5% of reservoirs and 38.7% of wells were of quality necessary to be deemed adequate water sources. China remains particularly opaque and is reticent about releasing regular and up-to-date water statistics.

China has tried to solve its flooding, drought, and water scarcity problems through hydro-engineering projects such as the Three Gorges Dam and the South-North Water Diversion Project. Yet hydro-engineering alone will be unable to create sufficient water supplies to meet China’s future demand. China will need to improve the management of its water resources and the legislation governing its use. Perhaps most importantly, Beijing will need to increase the price of water to better reflect its scarcity value, allowing for the economic restructuring that this higher cost will cause. Repairing China’s ecology will also be essential. A healthy ecology will not only aid the prevention of desertification, with all the water loss that such environmental damage causes, but it will also help to maintain upstream eco-systems, which are essential for the long-term supply of good water sources. China will also need to upgrade the efficiency of its water delivery systems to agriculture and to its cities, and to improve the efficiency utilization rates in industry. Environmental protection will be essential in ensuring the water that China does have is potable. China must clarify its environmental protection laws, improve enforcement and increase fines. Without implementation of such measures, water scarcity risks limiting China’s future economic growth. Water scarcity could also challenge China’s political and social stability. Increasing illness caused by polluted water is driving up healthcare costs and generating more internal dissent. In 2005, the Chinese government acknowledged that 50,000 environmentally related “mass incidents” (a euphemism for protests) occurred, many of which were sparked by water degradation.

Interestingly, the Chinese Committee of Political and Legislative Affairs also acknowledged about the same amount of “mass incidents” (about 50,000) in 2013 as they did nearly a decade ago. The reality, however, is that environmental mass incidents have been steadily increasing: from 1996 to 2011, environmental protests increased at an average rate of 29% per year, spiking up nearly 120% in 2011 alone. The scale of the protests is also increasing, with around half of all “mass incidents” involving 10,000 or more people.

The South-North Water Diversion Project

TheChinaFile

Historically, China has sought to solve its water scarcity problems through reliance on large infrastructure projects. Indeed, many of China’s top leaders are trained engineers, including Hu Jintao, who is a trained hydraulic engineer. Mao Zedong is reputed to have said in 1952, “the south has a lot of water, the north little. If possible, it is okay to lend a little water”, apparently acting as the spur for building what is now called the the South-North Water Diversion Project. When completed in 2050, the $62 billion mega-aqueduct is projected to divert 44.8 billion m³ of water yearly from the Yangtze to the north. The project will follow three routes. The eastern route will transfer 14.8 billion cubic meters of water yearly from the lower Yangtze, via the ancient 1800 km Hangzhou to Beijing canal, to Jiangsu, Anhui, Shandong and Hebei provinces as well as to the city of Tianjin. It is now projected to be completed in 2013 or 2014. The central route, begun in December 2003, will divert 13 billion m³ of water from the Danjiangkou reservoir on the Han River (a Yangtze tributary) to Beijing, Tianjin and other cities. It is scheduled to be completed in 2014. The western route would transfer water from the upper reaches of the Yangtze tributaries across the Qinghai-Tibet Plateau through the earthquake prone Kunlun Mountains via a network of tunnels into northwest China. Given its technical difficulty, the western route has not yet been given official approval and it is possible that it will be quietly shelved. It is expected that as many as 400,000 people might be displaced by the projects overall, though this would be fewer if the western route were scrapped.

Overall, the South-North Water Diversion Project faces many logistical challenges, the most important of which is ensuring that the water that does reach the north is sufficiently pollution-free to be usable. The eastern route, for instance, crosses 53 heavily polluted river sections. Clean-up efforts and water treatment facilities on this route alone will account for about 40% of the total aqueduct cost. If effectively implemented, it will be one of the most comprehensive water clean-up operations ever seen. 379 pollution control projects including wastewater treatment plants and wastewater recycling facilities are slated to be constructed, and major sources of industrial pollution such as paper mills are being shut down. Nevertheless, the clean-up process continues to be challenging.

Water Desalinization

China is also investing heavily in water desalinization in order to increase its water supplies. Research into water desalinization began in 1958 and more than 20 seawater desalination projects have been constructed which currently desalinate 600,000 m³ of water a day. China aims to produce as much as 3 million m³ of desalinated water daily by 2020, mainly for use in the north of the country. Desalination, however, is expensive and energy-intensive, and also requires water for its production. For these reasons, it cannot be considered to be a serious solution to China’s water shortages.

In 2012, the Chinese government outlined their policy goals for the next three years, ending at the conclusion of 2015. The government hopes to reach 2.2 to 2.6 million cubic meters or water per day, a far cry from the 660,000 cubic meters currently produced per day in China, but still possible given that plans exist to bring another 1.4 million cubic meters of water production online in large-scale desalination plants.

As of 2014, China had expanded its efforts in water desalinization with a total of 75 desalination plants, with nine more under construction. Though this technology may not be the most efficient at providing coastal cities with drinking water, these plants supply water that is used in coastal factories, sewage, and other wastewater management solutions, thereby allowing more drinking water from lakes, rivers, and reservoirs to be directed towards individual use. In the last decade alone, 60 desalination plants were built to run on seawater reverse-osmosis technology, producing 348,000 cubic meters of water per day, and an additional 11 plants were designed to utilize low temperature multi-effect distillation and produce a further 222,300 cubic meters per day.

Water Management

Ultimately, China will need to tackle its water scarcity issues not just by generating more supply, but by more efficiently managing and using its existing water resources. China’s water resource management system is highly fragmented. Multiple institutions have responsibility for China’s water resources, including data and information collection, hydro-infrastructure construction, environmental protection, and agricultural, urban and industrial development. There are frequent overlaps between these departments which raise administrative costs and exacerbate water’s “Tragedy of the Commons” problem. In other words, while China recognizes nationally the need for clean, well-managed water, it is in the interest of each user locally to consume water in whatever way will maximize their own short-term economic gain. This frequently gives China’s water management agencies conflicting priorities. Regional governments, for instance, often sacrifice water quality to protect local industries and jobs; they tend to focus on the water within their administrative areas, while failing to look at China’s water needs as a whole. Those considering water use in agriculture are often focused on accessing the water necessary to maintain agricultural yields. Those looking at the environmental protection of river basins try to limit the water drained from the river eco-systems. A failure to address the problem in a joined-up way persists.

This individualistic approach to the water supply in China, combined with local government corruption, has led to large-scale industrial dumping into lakes, rivers, and other aquifers. Often these waste products are, or are in large part, made up of heavy metals like cadmium or chromium that have been linked to increased risk of cancer. A recent scandal in 2011 involved the Lüliang Chemical Industry Company, which was found to be storing 288,400 tons of untreated chromium byproducts only a few feet from the Nanpan River, whose waters flow west and eventually join with those of the Pearl River. The company had been disposing of waste in this manner since 1989, and had gone as far as hiring divers to secretly dump metal into mountain reservoirs in order to reduce metal treatment and detoxification costs. Chromium levels in the river were 2,000 times China’s legally permissible standards. Effective progress in water management remains relatively slow due to ongoing and pervasive corruption that still sways local officials.

Water Legislation and Enforcement

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Not only are water governing authorities fragmented, but laws governing the management of China’s water resources are still being developed. Historically, China’s water laws have been ambiguous and lacking in effective enforcement mechanisms. They have had a bias toward decentralization, with local government agencies often having a determinative voice in water issues within their region. This has resulted in widely varying levels of water-law enforcement, corruption and confusing standards for industries. Indeed, some water legislation reformers have been advocating greater centralized regulation. They point to the success of centralized management in helping to restore at least some perennial flow in the Yellow River delta. In the late 1990s, its downstream flow disappeared annually for over 200 days, because upstream provinces were drawing on the river too heavily. Beijing began limiting water allocations to each of the provinces, so downstream provinces had sufficient water. Today, the entire length of the Yellow River is monitored in real-time by data collection from dozens of monitoring stations along the length of the river. The system is designed to check and manage pollution, drought and flood control, while enforcing fair distribution of scarce water resources among the nine provinces that share the waterway. Engineers can regulate the river’s flow by opening or closing a network of automated sluice gates and monitoring devices. This system is currently undergoing an upgrade which will make it the most advanced water rationing system in the world by the time of completion which is expected to be around 2015.

Indeed, recent water legislation stresses a greater move toward a unified management of water resources. This legislation emphasizes the importance of a balance between water resources, the still-growing population, economic development and the environment. It also focuses on improved efficiency in water use and it strives to set a foundation for greater transparency, equity and efficiency in the access of and payment for water by all levels of the economic spectrum. It advocates that allocation, distribution and regulation of water resources should be increasingly made through water-drawing permit systems where users are allocated and charged for water according to sector quotas, taking into account annual water-availability conditions and the sustainability of river basins, lakes and groundwater. The legislation also attempts to make clear distinctions as to who is responsible for the quality of water in each of China’s regions and to ensure that each of those responsible works to minimize pollution and improve overall water quality. To achieve improved water quality, recent legislation also specifies the need for setting up data and information systems at all levels, and to make data gathered available to stakeholders. Indeed, in 2007, Beijing’s Institute of Public and Environmental Affairs launched its online water database, allowing public access to water quality and pollution data, including corporate regulatory breaches. Yet, this move toward better information access has been tempered by Beijing’s conflicting and simultaneous instinct to prevent the independent gathering of information on China’s water, especially regarding its trans-boundary rivers, ostensibly to safeguard China’s national security.

The 2008 Law of the People’s Republic of China on Prevention and Control of Water Pollution ties the performance evaluation of public officials, at least in part, to their meeting of water and environmental targets. It also increased monetary sanctions against enterprises discharging wastewater illegally and specified the amount of chemical oxygen depletion caused by agricultural run-off allowed in waterways. In a significant legal development, it also allowed, for the first time, class action suits to be brought against polluters.

Several decisions made at the Third Plenum also show a greater commitment in dealing with corruption in local and village governments. Officials in environmentally damaged areas will no longer be expected to meet the same GDP targets as those in other provinces, and local government actions will be monitored in an attempt to reduce the prevalence of companies bribing towns to look the other way as they pollute rivers and water sources that ultimately make their way into China’s largest rivers.

Water Pricing, Water Rights and Efficiency

Ultimately, the most important step in solving China’s water scarcity will be raising the price of water. Water is highly subsidized by the central government, often making it effectively almost free for users, creating no incentive to save water. In 2009, the average price of water per cubic meter was $3.01 in Germany, $2.37 in the UK, $1.02 in South Africa and Canada, $0.74 in the US and $0.31 in China. Of 19 major economies, only India had cheaper water tariffs. Five years later, the price of water per cubic meter rose to $3.18 in Germany, $2.41 in the UK, $2.05 in Canada, $1.46 in the US, and $0.38 in China. Prices do not seem to be ending their upward trend anytime soon.

Higher water prices are likely to generate a significant restructuring in China’s economy. Higher water prices will encourage farmers to plant crops that are less water-intensive and will encourage more efficient irrigation. Indeed, growing urban and industrial water demands may eventually lead to the elimination of winter wheat in northern China as the higher cost of water forces the shift to higher-valued uses that produce more jobs and income per water unit. Currently, 1000 tons of water produce 1 ton of wheat worth $200, whereas industry yields $14,000 of economic output for the same amount of water. Reducing China’s grain production would reflect a significant shift in the decades-old policy of 95% self-reliant grain production, and would have a real impact on global grain markets. It would also spur urbanization as farmers migrate to cities in search of new employment.

Higher water prices would also encourage factories to recycle more of their water. In the special case of the North China Plain, it is likely to check the overexpansion of some high water consuming industries. Currently the region produces 20% of China’s steel, 10% of its power, and 14% of its paper, all industries which use water heavily and cause severe pollution. This would also make the cost of water treatment more feasible as it would become more economical to process and recycle water than to dump it untreated into the rivers. Higher water costs would also make living in water-scarce cities more expensive, potentially discouraging immigration into these areas. It would foster improved efficiency of its water delivery systems to agriculture and to cities.

Such a move may also check pressure on Beijing to tap new coal supplies, particularly the enormous coal reserves in the dry north. Without further water transfer schemes, such as the controversial – and possibly unachievable – western route of the South-North Water Diversion Project, there will not be enough water to mine the northern coal reserves and still develop the modern cities and manufacturing centers that China envisages for the region. The fresh water needed for mining, processing, and consuming coal accounts for the largest share of China’s industrial water use, over a fifth of all the water consumed nationally.

Higher water prices will also help control the scale of the South-North Diversion Scheme, serving to minimize the impact on the Yangtze River. Having the cost of the scheme added into the price of water for end-users will encourage them to use the water more sparingly. Ma Jun has estimated that the cost of cleaning up the northern Huai River system and of running its industry sustainably was greater than the total annual value in production that the industry within the Huai River system generated. Economic progress has brought more people to the river valleys, so that the area now supports 1.5 times the national average. After 1949, mainly for flood control, 5100 large and small-scale reservoirs were constructed along the upper reaches of the Huai waterway and more than 10 major flood control retention reservoirs were built. Without the huge hydro-engineering in the Huai River Basin, the area would not have been able to sustain so many people. Rapid development, however, made previous hydro-engineering projects inadequate. Beijing responded by building new hydro-projects to expand water supplies further. In what has become a vicious cycle, Beijing now faces the need to divert water from the southern Yangtze to support the people and the economy in the area. Ultimately, China’s desire for development is infinite, but its water resources are finite. Unless water pricing reflects its true scarcity value sooner rather than later, China’s lack of water will put the brakes on its rapid economic development.

Enforceable water rights will also be important to reducing China’s overall water wastage. Currently, even with the recent legislation, it is still not clear who holds many water rights and what benefits these rights provide. Ideally, China needs to establish a nationwide water rights program, leaving enough clean water so its eco-systems and aquifers are sustainable. Permits should be issued to each water user, with pricing at a level which encourages increased water productivity. Creating a market to sell or lease these water rights will advance water productivity further. Those who do more to protect the river and other water basins should have greater rights. This includes those provinces and regions near the waters’ sources. The provinces could then profit by selling rights, instead of wasting water on parched land and inefficient industrial projects. Appropriate incentives for water saving technologies and behaviors also need to be developed. For instance, a tariff system could be implemented in which people pay higher bills when they consume more than a set quota.

Authorities have been slow to raise water prices because of their fears about how the higher costs will affect China’s poor. Recent research has shown, however, that lower income Chinese often get little benefit from subsidies as, ultimately, low water costs mean that they frequently receive water that is highly polluted. Nevertheless, the government remains concerned with inflation, always a hot issue in China, and this adds to the pressure to maintain low water prices despite the arguments in favor of raising them; it is unlikely that the poorest in society would welcome a price increase even if it were in their own long-term benefit in terms of improving the quality of their water supply.

Pollution

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Despite China’s efforts over the last three decades, water pollution has spread from the coastal to inland areas and from the surface to underground water resources. Essential to controlling China’s water pollution is the strengthening of law enforcement to improve compliance by industries and other polluters. Overall compliance with China’s environmental laws remains low. Yet, strengthening environmental protection is a multi-faceted process which not only requires raising water prices and establishing clearer water rights, but also necessitates the continued development of water protection legislation, the further advancement of China’s judicial system, greater financing and staffing of China’s Ministry of Environmental Protection (MEP), and making public a more rigorous collection and analysis of water data. Economic incentives such as pollution levies and fines have to be rigorously enforced. Overall, pollution fines should be increased. Lawsuits should be initiated against polluters and those most hurt by damaged public goods such as river basin ecosystems should have greater rights to demand compensation. State subsidies could be given to small towns and villages to help them to construct adequate water treatment facilities. Those waste-water treatment facilities that are constructed need to be continually monitored to ensure they remain operational and in compliance. China’s Tenth Five-Year Plan (2001–2005) mandated, for instance, the construction of thousands of new waste water treatment plants, yet a 2006 survey by SEPA (the State Environmental Protection Agency, the forerunner of the MEP) revealed that half of the new plants actually built were either not operating or were operating improperly. Corruption will also need to be tackled. Lax environmental codes are often rarely enforced and easily avoided by bribing officials. Tackling corruption will likely be done most effectively by linking compensation and performance figures to environmental protection as well as economic achievement. This would make it in the personal interests of officials to perform in the environmental arena, mitigating the “Tragedy of the Commons” conundrum, though this would also represent a significant shift in government behavior.

Future Trends

China’s water challenges are becoming too big for Beijing to ignore. China’s Twelfth Five Year Plan (2011-2015) projects record levels of water use, rising to 620 billion m³ by 2015, up from 599 billion m³ in 2010. Its traditional response to growing water demand – building large hydro-engineering projects in order to increase supply – will no longer be sufficient to meet the water demands of China’s agriculture, industry and cities in the coming decades. As a result, China will begin to implement new policies in order to better manage its water resources and to reach its 2015 goals of cutting water consumption per unit of value added industrial output by 30%, reducing arsenic, lead, cadmium, chromium and mercury levels by 15% from 2007 discharges, reducing ammonia nitrate fertilizer runoff by 10% and its corresponding chemical oxygen depletion by 8%. The plan also targets the construction of water conservation structures, improved irrigation, and commits to investing in the clean-up of rivers and lakes through the construction of wastewater treatment and recycling pipes.

At the heart of these new policies will be the gradual raising of the price of water throughout China. This trend is already in evidence in many cities across the country. Shanghai, for instance, increased residential water prices 25% in 2009, and another 22% in 2010. Beijing raised the price of commercially used water by 50% in 2010 and expects to raise its water charges to residential users by 24% in stages by 2013. China’s water users have not accepted the rises without discontent and some government officials fear that higher water prices could lead to social unrest, particularly as China is concurrently struggling with inflation. This unrest is due both to poor public education about the extent of China’s water challenges and to public skepticism that higher costs will translate into more effective water management.

Fixing the quality of China’s water will also be a growing priority for Beijing in the future. China needs to improve its water pollution record both by government investment and by encouraging private investment in the water treatment and management sectors. In 2011, for instance, China allocated $606 billion to clean up water and water infrastructure over the next decade. Larger, wealthier cities had already started investing in the water treatment sector, but without government support, smaller cities and rural areas have lacked the means and incentives to make much-needed investments.

Beijing is also explicitly encouraging foreign participation in China’s water markets. Foreign firms invested about $1.7 billion in China’s water sector between 2004 and 2009, with over $500 million being spent in 2009 alone. The investments were in waste-water treatment, municipal and industrial water supply sectors, and in direct investments in China’s water companies. This involvement will continue to expand in the near future.

China will also begin to move more aggressively against significant water polluters. In 2007, maximum fines to individuals or companies who discharge highly toxic pollutants into drinking water resources were raised fivefold to 500,000 RMB (approximately $80,000). Fines for companies who dump industrial residue urban waste into drinking water resources or who store solid waste or other pollutants below the water lines along rivers and reservoirs increased 20-fold to 200,000 RMB (around $32,000). While these are significant increases the fines remain relatively low and there is room for an expansion in this area. Increasingly, enterprises will also be responsible for bearing all costs to contain water pollution accidents and may face fines as high as 30% of the direct economic loss, according to the severity of the incident. Historically, pollution levies have been so low that it has been cheaper to pay penalties rather than to treat discharge. There is a growing realization that this cannot continue.

Litigation against water polluters will also increase, with rulings to progressively penalize those fouling China’s water systems. In 2009, for instance, an Asian Development Bank study determined the number of environmental lawsuits filed in China has increased an average of 25% annually since 1988. Since 2009, the Supreme People’s Court has been encouraging China’s maritime courts to adjudicate water pollution cases brought on behalf of a public interests. Additionally, three specialized environmental courts have been established in the provinces of Guizhou, Jiangsu and Yunnan.

China’s water challenges are daunting and urgent. The array of measures that are needed to more effectively manage its resources is huge. Still, China’s leadership is well aware of the importance of water to continued economic growth and to the health and well-being of its people. Poor water management has toppled many a Chinese government throughout the millennia, a risk to which the CCP is not immune. While progress toward solving China’s water challenges is likely to be uneven, overall it is expected that China’s water management will improve on most fronts over the next five to ten years.

Economics

Sino-US Trade: Mutual Benefit, Mutual Problems

Introduction

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The US has run a trade deficit with China since 1973. The deficit increased from $10 billion in 1990 to $266 billion in 2008. It dropped to $227 billion in 2009, and then grew to $295 billion in 2011 but dropped again in 2012 to $262 billion. The Sino-US trade deficit consistently accounts for more than 40% of the US’ overall deficit in its global trade.

Some in the US argue that this large deficit with China is caused by the competitive advantages China gains from practices such as keeping its currency artificially depreciated, having lax environmental and health and safety legislation, poorly protecting intellectual property rights, not comprehensively implementing WTO obligations, and widely employing industrial policies and discriminatory government procurement practices which work to subsidize and protect domestic Chinese firms at the expense of their foreign competitors. Critics argue that these practices have in turn caused the US to unfairly lose manufacturing and other jobs to China.

Others have argued that Chinese economic policies, which have enabled China’s GDP to grow 9% annually over the last two decades, have provided many advantages to the United States. For instance, China’s rapid economic growth has generated significant demand for US exports. For the last 10 years, China has been the US’ fastest growing export market. In the future, this market is expected to further expand as China’s domestic demand develops, as the living standards of its citizens improve, and as a sizable Chinese middle class emerges.

US consumers have also benefited from cheap Chinese imports, both because they increase US consumer purchasing power, and because they act to keep inflation low. US firms have profited from China’s competitive workforce, either by using China as a low-cost assembler of its manufacturing components or as a source of inexpensive components to be assembled in the United States. As importantly, by purchasing US treasury securities – nearly $1.2 trillion as of September 2012 – China helps keep US interest rates low, which in turn spurs domestic US economic activity.

Since the financial crisis of 2008, trade relations between the US and China have come under greater scrutiny by government and business leaders from both countries. Some members of the US Congress have recently ratcheted up their complaints about what they consider to be China’s distorted trade policies, given the US’s persistently slow US GDP growth and high unemployment. This trade friction is likely to intensify as the current sovereign debt crisis faced by Western countries places a new spotlight on US debt levels.

US Exports to China

The US exported $90 billion of merchandise to China in 2012, down from $104 billion in 2011 but still more than 30% higher than 2009 levels. US exports to China account for around 7% of total US exports, up from to 2.1% in 2000. The largest exports to China included oilseeds and grains, waste and scrap, semiconductors and electronic components, aircraft and parts, and resins and synthetic rubber and fibers. It is expected that US exports to China should continue to grow rapidly in the future. This export growth will be driven by factors such as the continuing modernization of Chinese infrastructure, by increasing domestic demand from its growing numbers of middle-class and affluent consumers, by the growth of its transportation industries, particularly its rising need for airplanes, trucks and cars, and by its increased imports of food products.

China’s Exports to the US

Yet, despite the success the US has made in increasing exports to China over the last decade, Chinese exports to the US still dwarf US sales to China. In 2012 China’s exports to the US were worth $351 billion, which was down from $399 billion from the previous year. The top 2010 Chinese exports to the US were apparel, manufactured goods such as toys and games, computers and communications equipment and parts, and audio and video equipment. The mix of Chinese exports to the US is shifting. Throughout the 1980s and 1990s, the majority of US imports from China were low-value, labor-intensive products such as textiles and toys. Increasingly, however, more of US imports from China are comprised of advanced technology products, reflecting China’s growing international competitiveness in the assembly and manufacture of high-technology.

Skewed Accounting of International Trade

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One of the principal drivers of the US trade deficit with China is the worldwide increase in global production sharing, from which China has benefited enormously. Many products that used to be entirely made in such places as Japan, Taiwan and Hong Kong, are now being made or assembled in China as those countries have shifted all or parts of their production to China in order to take advantage of its low-cost labor. For instance, the US International Trade Commission estimated that in 2002, 99% of computer exports to the US from China were sold by foreign firms manufacturing in China. Taiwan, a world leader in information technology manufacturing, now produces over 90% of its information hardware equipment in China. Similarly, many US technology companies outsource their manufacturing to Taiwan, which in turn outsources this production to its facilities in China. Yet, these exports, even if they are commissioned by US firms, are credited against China when calculating the US trade deficit as China is the place from which the products were shipped to the US. To illustrate this, it is worth considering that while US imports of computer equipment from China rose 620.5% between 2000 and 2010, the total value of US imports of computers worldwide rose only 41.9%.

Similarly, China now has more than 40% of all international processing or assembling trade. The iPod, for example, is assembled in China by the Taiwanese firm Foxconn, from parts produced globally. A 2005 study by the University of California estimated that it costs approximately $144 to make each iPod unit, yet only about $4 of the total cost is generated by the Chinese workers who assemble it. Yet, when China ships the iPod to the US, it increases the Sino-US trade deficit by the full $144 cost of the unit, not by the $4 of value that China earned assembling the different components. In similar fashion, the iPhone trade has increased the US-Sino 2009 deficit by $1.9 billion. Yet, if the trade were measured through value added in China, the US trade deficit would have decreased by $48 million. Likewise, each unit of the iPad 2 increases the deficit by approximately $250. On the day of its release, the iPad 2 was estimated to have contributed $130 million to the Sino-US trade shortfall.

As shown with the Apple example, international trade data struggles to accurately account for component processing. In its trade numbers, China is credited with the full value of the finished exported goods, regardless of the origin of the component parts. For example, if Japan supplies the original components to China and then China does nothing but assembles the components and then ships the finished product to the US, Japan’s US trade balance is unaffected, but the US’s trade deficit with China increases by the full cost of the finished good. This distorts trade data, giving a skewed impression of the total value of the goods originating from China. As China’s trade has increasingly shifted away from the production of textiles and other primary products to the manufacture and assembly of technology goods, this skewing has increased.

The services trade is also equally difficult to quantify. Most trade data does not take account of the value added to a product by services, such as IT, financial, or management consultancy services. As the largest supplier of these services worldwide, the US generates income by effectively employing its advantage of human capital. The incomplete accounting of these services in world trade data means that the overall US deficit appears larger than it is in actuality.

An Undervalued RMB?

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Another important driver of the trade imbalance between the US and China is Beijing’s pegging of the RMB to the dollar at what is deemed by many to be a substantially discounted rate. While many agree that the RMB is undervalued, few concur on the actual level of distortion with estimates ranging from 15% to as much as 50%. The depreciated currency increases the competitiveness of Chinese exports, leading many US companies to import from China over domestic or other international suppliers. China’s currency has not always been undervalued. In the early 1980s, for instance, it was greatly overvalued, with 1.5 RMB per USD, a rate set to allow China more easily import the goods it needed to develop its economy. There have been numerous revaluations of the RMB-dollar exchange rate since the 1980s. Between 1994 and 2005, the rate remained stable at around 8.3 RMB per USD. Though generally resistant to international pressure, particularly regarding key domestic interests, the CCP has since allowed the RMB to appreciate, albeit very gradually. The most significant appreciation occurred between 2005 and 2008 when the rate shifted from 8.27 RMB to 6.81 RMB per USD, an appreciation in value of the Chinese currency of almost 18%. However, it remained at or around that rate for another two years, before a further gradual appreciation was allowed to begin in 2010. By June 2012, it was valued at 6.36 RMB to the USD. China is able to maintain this low rate of exchange through vast purchases of US treasuries, which helps keep the dollar strong; as of November 2011, China held approximately $1.3 trillion dollars in reserves, equating to around 40% of its enormous foreign reserves.

This implicit subsidy to Chinese exporters has meant that US manufacturers have struggled to compete against Chinese products, causing US manufacturing industries to suffer and US unemployment to increase. Some estimates have put the number of additional US unemployed because of China’s devalued exchange rate at 2.4 million between the years of 2001 and 2008. Yet, what is often forgotten in debates on US unemployment figures is that the average US citizen has benefited from cheaper consumer products and, consequently, a greater disposable income. Recent estimates suggest that the average American household is $625 per year better off as a result of low-cost Chinese trade.

Beijing insists that its foreign exchange policy is vital to domestic economic security; the stability of its society and its monopoly on power is very much dependent on its ability to provide economic prosperity to its people. Additionally, an appreciation in the RMB also means that its US dollar holdings will buy less in its own currency. For example, an appreciation of the RMB by 41% would result in a value of $672 billion effectively being wiped off China’s US securities’ holdings in terms of what those holdings would be able to purchase if converted into its domestic currency.

Implications of China’s Large US Dollar Holdings

Some US analysts contend that China’s holdings of US debt give it a potentially powerful tool which it can use as leverage against the United States. Yet, China’s economic reliance on the US economy as an export market and its substantial holdings of US securities means that any effort to sell large volumes of dollars would likely hurt China as much as it would damage the US. A large sell-off of dollars would cause the currency to sharply depreciate against global currencies, diminishing the value of China’s remaining dollar holdings. Additionally, as long as China continues to pursue a depreciated currency policy, it has no choice but to purchase US dollars, thus making the likelihood of a large Chinese sell-off of the currency highly unlikely.

China has its own concerns about its large US dollar holdings. It fears that high levels of US debt, and the potential implementation of expansionary monetary policies by the US government could spark inflation in the United States which would result in a sharp depreciation of the dollar. To offset this risk, China has argued for the creation of an alternative reserve currency, such as through the International Monetary Fund’s special drawing rights system. Yet, most expect that the creation of an alternative reserve currency is not likely not to occur in the near future. In the absence of such a solution, China has sought to diversify its foreign currency reserves, notably through purchases of Japanese yen and Euros.

China and the World Trade Organization

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China became a WTO member in December 2001. US policymakers supported China’s accession as they believed WTO membership would spur deeper market reforms, encourage the rule of law, diminish the government’s role within the Chinese economy, further assimilate China into the world economy, and enable the United States to use the WTO dispute resolution mechanism to resolve trade disputes between the two countries. In the first years after China’s accession to the WTO, it made great strides in opening its economy to both trade and FDI. Its ratio of imports to GDP – a common measure of how open an economy is – has now surpassed 30%, which is twice the level of the United States and three times that of Japan.

Yet, by 2008, government and business officials had begun to note that Chinese efforts to liberalize its markets appeared to have slowed. With the tougher global economic environment many argue that China relies more on state intervention in markets to gain China a competitive advantage. This has caused some friction between the two within the WTO. As of January 2013, the United States has brought 16 trade complaints against China whereas China has brought 8 cases against the US. Of these 24 disputes, 5 were raised in 2012 making it the most fractious year to date.

A key area of WTO complaints by the US has been the violation of intellectual property rights within China, and the US has brought two cases against China over this issue. The US International Trade Commission estimated that US firms with significant intellectual property interests lost $48.2 billion in sales, royalties and license fees in 2009 because of international property rights violations in China. The International Intellectual Property Alliance estimated that business software piracy in China alone cost US forms $3.4 billion in lost trade in 2009. However, these figures have been questioned by some economists who point out that the calculations are based on an assumption that genuine products would be purchased if all counterfeit goods were eliminated. Given that the price in China for a counterfeit DVD is usually around $1.50, compared with in excess of $12 for an authorized version, it is highly unlikely that an elimination of counterfeit products would have no impact on the overall sales figures of these products. It may not be possible to give a wholly accurate figure for the losses that the widespread IPR-infringements cause. US critics feel that, even when IPR enforcement is in place, fines and punishments for IPR infringements are often not sufficiently punitive to deter Chinese companies from piracy. Some estimates suggest that between 15% and 20% of all products made in China are counterfeit, equal to about 8% of China’s total annual domestic product. Under pressure from the US, in late 2010, China launched a six month campaign against IPR abuse and counterfeit goods.

Future Trends

Although it is understandable that Beijing is somewhat protectionist in its exchange rate policy, a revaluation of the RMB is essential if current imbalances are to be eased. China cannot continue to purchase US securities indefinitely – indeed it has already shown that would prefer to diversify away from its overwhelming reliance on the dollar – and the US cannot continue to get deeper and deeper into debt to foreign creditors. To resolve the situation, China needs to stimulate domestic consumption and allow its exchange rate to appreciate. A key to increasing Chinese domestic consumption will be shoring up its healthcare and pension systems that were largely dismantled when the Chinese privatized large sections of its state-owned industries. A stronger currency will decrease the international competitiveness of Chinese products, but will reduce pressure on the US, China’s largest trading partner. This will lead to greater global economic stability, which is ultimately in China’s interests. Thus while China’s manipulation of the RMB is expected to continue, in the long-run, a slow appreciation of the RMB would be expected as a more balanced trade environment is in the interests of both China and the US. In fact, between September 2010 and December 2012, China allowed the RMB to appreciate 7.4% against the dollar. Though China needs to take action on this issue, 2012 Presidential Candidate Mitt Romney’s vow to declare China a “currency manipulator” on his first day in office had he win the election, is not the sort of tactic that should be employed. Such a move would have made it politically more difficult for the Chinese to act in the way that the US would like them to do.

At the same time, in order to reduce its trade deficit, the US needs to stimulate domestic manufacturing and become more internationally competitive. Investment in infrastructure, education and the creation of a national industrial policy with taxes and other incentives to spur the development of strategic industries would enhance the ability of the US to continue to design and produce products that would be in demand internationally. The challenge for the US is that the increasingly divergent views of its two main political parties has made it progressively more difficult for it to take the necessary legislative steps to invest in economic competitiveness.

While both the US and China have benefited substantially through closer economic ties, the trade imbalance has increasingly become a political concern. To date, no concrete plan has been formulated to bring the deficit back into balance. However, some steps have been taken to increase economic cooperation between the two nations. The annual US-China Strategic and Economic Dialogue (S&ED), established in April 2009, is intended as a forum to discuss “long-term strategic challenges”. However, in the 2011 session there was no consensus as to the future of the trade imbalance between the two countries and it received mixed reviews from American business leaders and government officials.

The issue of the amount of US sovereign debt held by China is of huge political significance. On a positive note, China’s extension of credit has helped decrease US inflation and, hence, to maintain domestic economic stability. Yet US indebtedness to China is seen by many American thinkers to be a real risk; China and the US only formally resumed diplomatic relations in 1979, having been at ideological loggerheads since the founding of the PRC in 1949. Even today, the US and China disagree on many international issues. There are numerous domestic political ramifications of your largest creditor also being traditionally perceived as an ideological competitor. The amount of US debt held by China means that it would be incredibly difficult to offload all at once, and would trigger a huge devaluation in its remaining holdings. Such a situation is unlikely and would be particularly unwise, but shows the extent of the economic power China holds over the US. Yet China is increasingly using that economic power it holds over the US as leverage over contentious political issues, such as Taiwan and its human rights record. This trend should be expected to continue.

The reality is that the fates of the economies of China and the US are closely entwined, each reliant on the health of the other. China has been recording a substantial trade surplus with the US over the past 20 years and there has been a considerable decline in the US manufacturing sector. We have seen, however, that China’s trade surplus with the US is more a product of the system of trade-data collection than of a mercantilist strategy to undermine US manufacturers. The imbalance is, of course, a concern for both countries, but it is in neither country’s interests for the other’s economy to fail. The deficit must be addressed through mutual cooperation and dialogue in order for both countries to prosper and will, in turn, lead to a more balanced and secure global economy.