Breakingviews: Ethical economy - The smog of development

Wed Aug 29, 2012 8:39am EDT

A general view shows Beijing skyline on a hazy day July 26, 2012. Smoke from factories and heating plants, winds blowing in from the Gobi Desert and fumes from millions of vehicles can combine to blanket the city in this pungent shroud for days. REUTERS/Jason Lee

A general view shows Beijing skyline on a hazy day July 26, 2012. Smoke from factories and heating plants, winds blowing in from the Gobi Desert and fumes from millions of vehicles can combine to blanket the city in this pungent shroud for days.

Credit: Reuters/Jason Lee

(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

The pollution in the great new cities of China is hard to miss. There is often a visible miasma of dirt and dust. It is not just the air; water and earth have also been badly despoiled. The Chinese authorities, which were competent enough to provide more or less adequate sewage, electricity and urban housing, have let the environment deteriorate badly. Although central government officials routinely include pollution on the list of urgent problems, relatively little has been done. Rules are made, but commonly flouted.

What has gone wrong? The leaders of the Chinese Communist Party carefully studied the fall of the Soviet bloc in the early 1990s. Why did they pay so little attention to the popular antipathy to the old regimes' tolerance of pollution? Why did they then ignore the ease with which those countries reduced emissions of dangerous substances by as much as 90 percent, without much effect on total production? Now environmental depredations spawn increasingly intense protests. Why is there no coherent response?

The usual explanation from experts is that the environment only becomes a concern after standards of living rise to a relatively high level. There is probably some truth in that, although even dirt-poor peasants object to their children suffering brain damage from ingesting toxic chemicals. In any case, the Chinese government now lags the people in their dedication to reducing pollution.

Economic analysis should be helpful. Unfortunately, economists are actually part of the problem. Two of the most popular analytic techniques work against the raising of environmental consciousness among policymakers.

Purely financial analysis is particularly harmful. Economists of this persuasion, some of whom are influential in China, fixate on interest rates, fantasize about inflation and parse financial markets. This approach is probably ill-suited for a developing market such as China, since the relations between the financial and the real productive economy are structurally unstable. In any case, financial analysis is certainly counterproductive for environmental matters. Since pollution abatement costs money and no one pays directly for environmental desecration, lower standards tend to make financial measures of production and profit look healthier.

What might be called the standard growth model is not as malign as the purely financial approach, but not exactly helpful. The technique, associated with the International Monetary Fund and widely followed in China, treats the economy as a machine which turns the inputs of labor, investment and natural resources - expressed as "total factor productivity" and the "savings rate" - into the outputs of Gross Domestic Product.

The standard approach reduces the economy to bulk categories. Pollution is on the long list of factors that are not considered worthy of separate measurement. In its most recent 75-page report on China, the IMF mentions pollution only twice, and only in passing. Conceptually, environmental disruption could be included as a cost or pollution abatement as a desired output. However, the mechanical models rely on market prices, and there is no way to assign a monetary value to clean air and water.

Economists could be more helpful, if policymakers turned to the right school. The institutional approach helps explain why pollution abatement has made so little progress, and how that can be changed.

As the name implies, institutionalists study political, economic and cultural institutions - including regulatory systems. Even proponents of financial and standard economic theory admit that this sort of analysis, favored by the World Bank, is very helpful in the study of developing economics. Without strong institutions, labor and savings will be wasted. Nonetheless, it has relatively little following in China.

Institutionally, the fight against pollution in poor countries is very difficult. The problem is that it is so tempting to increase profit by violating environmental regulations. To be effective, regulatory institutions have to respected and competent enough to be able to force rich and generally well connected industrialists to obey the law.

The respect comes from society. In the 1970s, American captains of industry started to feel ostracized by their polluting ways; they quickly added emission reductions to the list of corporate goals. China may now have reached that level of popular disapproval, although the lack of political democracy and the strict limits on non-governmental organizations make it hard to tell. The competence comes from the people. There must be enough regulatory workers who are honest enough to resist pressure and bribes and skilled enough to keep up with the wiles of regulated enterprises.

In a developed economy such as the United States, there is usually a surplus of this regulatory capacity. It is quite different in developing economies, where the necessary integrity and skills are in short supply. Regulators must compete with producers and among themselves for scarce human resources.

In China, environmental regulators have been losing that fight. The institutionalists have an answer: change priorities. The forthcoming leadership transition is an opportunity. The new men should breathe deeply, and dedicate more of the nation's resources to the reduction of pollution.

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