Overview

Rapid economic development combined with lax enforcement of regulations has saddled China with severely polluted air and water. This pollution impacts both the health of the population and GDP growth prospects. Studies estimate premature deaths from air pollution at 1 to 2 million per year, and the World Bank puts the overall cost of China’s water crisis at 2.3% of GDP. Policymakers are aware of these threats: more than 10% of the Third Plenum reform plan focused on the ecological crisis and the responsibility of the state to reverse it. Aided by structural transition away from pollution heavy industries, initial reform efforts are making some difference. Yet much more is required to put a sustainable future within reach, let alone clean up China’s air and water enough to approach international standards.

To gauge environmental progress, we track measures of air and water pollution. Lower levels indicate improved conditions. We seasonally adjust these indicators to account for annual weather patterns and energy consumption changes. Improvements may reflect factors other than environmental reform implementation, such as macroeconomic growth slowdown or industry consolidation. That said, short of a growth collapse, China’s environmental goals demand extraordinary policy reforms. To supplement our analysis, we also look at wind curtailment in clean energy generation, sales of new energy vehicles, and non-fossil-fuel electricity generation.

Quarterly Assessment and Outlook

Improving environmental realities is a major political mandate for the Chinese government, born of popular disquiet with rampant pollution and recurrent environmental crises. By spoiling China’s natural resources, current environmental degradation levels also undermine future growth potential. The 2013 Third Plenum Decisions, therefore, focused on improving environmental regulations and management systems to strengthen enforcement and advance a longer-standing goal of reducing coal’s share in the nation’s energy mix. That included using tax reform to raise prices for “products that consume too much energy.”

Our environmental indicators are direct: to track progress on environmental improvement, we track air and water quality. Our indicators show that both improved this quarter beyond our assessments for the previous quarter. The environment remains one of the two (out of ten) clusters we track where data suggest Beijing is making compelling reform progress. Our water pollution index reverted back to a positive trend from a poorly performing 3Q2017. Air pollution indicators showed the best regional improvements since 1Q2016. Factory closures and mandated fuel-switching efforts made for bluer winter skies in Beijing and surrounding areas. At the same time, other indicators show that the root causes of air pollution, including heavy industry, gasoline vehicle sales, and coal electricity production, all were up year-on-year (yoy) for 2017. This suggests that total particulate emissions likely increased but shifted to less populous regions and less pollution-intense seasons – a net plus for human health, but with caveats.

Our outlook is for production and pollution restrictions to remain in place for the spring and summer, sustaining this improvement in air quality. For water, new environmental regulations set for 2018 may improve conditions further; however, it is likely that high industrial production levels and weather events will complicate the story. The Chinese government announced at the National People’s Congress (NPC) that it would recast the Ministry of Environmental Protection as the Ministry of Ecological Environment and give it new responsibilities previously under the purview of the land, water, and agricultural ministries. Given that reform goals focus on improved management and regulatory systems, this is a sign of continued reform progress as well as political willingness on Beijing’s part to address the environmental crisis.

378,000 new energy vehicles were sold in China in 4Q2017 – nearly double the 200,000 sold in the United States in all of 2017.

This Quarter’s Numbers

Air quality in China’s major cities showed substantial improvement during our review period for this Dashboard edition. In 4Q2017, the average airborne particulate pollution (PM2.5) concentration index improved dramatically: quarter-on-quarter (qoq) the index improved by 23.5%, a sizeable jump from the average of 2% qoq advancements we’ve seen previously. Looking at actual PM2.5 concentrations across the five major cities we monitor, the average declined to 39.7 micrograms per cubic meter from 51.8. This is the second-largest drop on record in our data and, given that lower-hanging policy efforts were implemented long ago (e.g., moving coal power plants out of urban centers), it is impressive.

The regional distribution of air pollution realities shows the importance of local-level environmental policy implementation. Beijing, Shenyang, and Shanghai saw drastic improvements in air quality, with concentrations of PM2.5 declining by 49.1%, 39.9%, and 31.2%, respectively. Chengdu and Guangzhou, meanwhile, saw concentrations increase by 0.9% and 10.1%, respectively. Improvements in Beijing demonstrate the power of policies such as switching heating fuels from coal to natural gas. Given the makeup of their local economies, the deterioration in Chengdu and Guangzhou more likely reflects vehicle sales and light industry production, key drivers of air pollution in non-northern cities.

Water pollution also improved by 9.1% from the previous quarter according to our primary indicator. The end of a bad flooding season and more complete data reported in 4Q2017 are both likely at work. Regionally, most river basins improved – the Hai, Huai, Pearl, Songhua, Yangtze, and Zhejiang-Fujian River Basins all saw 8% to 19% improvements in our index, which captures a broad set of pollution indicators from chemical oxygen demand to total phosphorus content. The Yellow River Basin was the exception, declining in quality by 12%.

Our supplemental indicators tell a largely positive story about the environmental trajectory as well. While all forms of electricity generation grew in 2017 (see Overall Electricity Generation), non-fossil generation grew slightly faster than fossil generation. In turn, adjusted for seasonality, in 4Q2017 our non-fossil generation index (see Non-Fossil Generation) hit the highest levels since its inception in 2009 as more nuclear, wind, solar, and hydropower came online. Compared to 4Q2016, the amount of wind energy wasted due to poor grid management declined to 12% from 32% despite overall production of wind energy increasing by an astounding 60% (see Wind Energy Curtailment). New energy vehicle (NEV) sales also increased to record levels, accounting for 4.3% of total sales. In fact, 378,000 new energy vehicles were sold in China in 4Q2017 – nearly double the 200,000 sold in the United States in all of 2017 (see Sales of New Energy Vehicles).

Policy Analysis

At the NPC this March, China announced that the Ministry of Environmental Protection (MEP) will now be the Ministry for Ecological Environment and have responsibility for China’s climate policies, in addition to MEP’s traditional pollution mitigation duties. The new agency will also take over environmental responsibilities previously under the purview of the land, water, and agricultural ministries. This suggests that environmental protection efforts will be better coordinated and reinforces an ongoing political prioritization of those efforts. Also during the NPC, the government announced that it would extend for three years a consumer-focused electric vehicle tax rebate of 10% that was set to expire at the end of 2017. This ensures that one of the most important incentives for NEV sales remains in place and raises expectations for robust growth in China’s NEV market.

Policy was the key driver of the significant improvements in air quality in 4Q2017. Actions were wide ranging, from shutting down iron and steel plants to mandating fuel switching. Roughly 4 million households shifted away from coal to either electric or gas heating. Coupled with quarter-on-quarter (qoq) steel and cement production declines due to forced production cuts, policy had a real impact on air pollution in the Beijing area in particular. Looking ahead, factory closures and coal-burning limitations appear to be continuing with significant ramifications for coal and heavy industry. The government plans for an additional 11 million households to shift away from coal by 2021, suggesting that these improvements would be sustained.

There were some hiccups in implementing policy in the fourth quarter, however. Natural gas supply shortfalls left households, businesses, and even schools out in the literal cold, sparking public outcry. Supplies had to be reshuffled from as far away as Sichuan to reroute gas to households in the east. Environmental regulators were forced to allow some burning of coal in regions where it was intended to be prohibited. It is likely that local governments will be able to adapt and prepare moving forward, as the amount of natural gas needed to heat homes and small businesses is not large compared to other more industrial demands.

Even with significant improvements in 4Q2017, China’s air remains unhealthy, and many of the fundamental harder-to-control drivers of pollution including coal power and auto emissions grew. Our indicators show fundamental improvement but also the need for sustained policy efforts to lock these improvements in for future generations.

On that note, in late December the National Development and Reform Commission launched a national carbon market, starting with simulated trading focused on the power sector. Although the announcement was light on details, it set things rolling to create what will become the world’s largest carbon market. The likely timeframe for full implementation is 2020. A national carbon-trading system should improve China’s environment by reducing greenhouse gas emissions, as the program would potentially set a cap on the volume of emissions. Firms are incentivized to keep greenhouse gas emissions under this limit, with rights to trade the difference among themselves. The degree of improvement will depend on how the system is implemented, accurate measurement of emissions, and sufficient enforcement.

For water pollution policies, the government continued to implement the “river chief” program in which a local government official is assigned direct responsibility for water quality in every natural water source. The program is part of a set of updated 2018 laws focused on more stringent water pollution regulation and penalties. The river chief system is part of the revised Water Pollution Prevention and Control Law, which took effect in January. In addition, an updated Environmental Protection Tax Law, approved by the Standing Committee of the NPC in December and effective in January, will give local tax bureaus responsibility to collect environmental pollution fees, with the intention of breaking some of the incentives local enforcers have to overlook violations.

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