Saturday, June 9, 2007

China’s Environmental Response to Westernization: The Right Trade Off or a Long Term Deal Breaker?

What got me thinking…
Something I observed during my first day in China haunted me through out the trip and still occupies my thoughts: the air quality.
At our visit at Tiananmen Square, the landmark’s history should have taken center stage but instead I was focused with what appeared to be “visible grayish humidity” which hung over us. In jest, we speculated this was smog and continued on our merry way, but on the second and third day it was less humorous. A few of us developed a slight cough, while others no longer attempted to run outside. For myself, I had developed a cough, sore throat, and was amazed by the grayish mucous I had started to cough up.
If this happened in a matter of days, what was happening to the Chinese locals who lived here? If the air is a problem, what else is polluted? With Westernization’s growing sense of responsibility to Mother Earth, how will China stack up? Will multinational companies let China play or tell her to go home?


What I uncovered…
In probing further, China’s air pollution issue just scratches the surface. In fact problems exist in every possible area where pollutants could occur.


Here are environmental statistics for China:
· China has environmental issues in four key areas: Water, Energy, Soil Erosion and Air Pollution · 5 of the world’s 10 most polluted cities are in China[1]
· China grades water into 5 categories. With 5 being the worst, over half of the major river systems are level 4 or higher and are not for human consumption.
· 116 million people breathe air considered to be very danger[2]
· 400K people prematurely die from air pollution every year (heart and lung related diseases)
· Over 40% of China has a soil erosion issue; 1.6B tons of topsoil wash into the Yellow River every year and the Chinese desert now has its sights set on Beijing…
· China plans to double its coal consumption by 2020 to accommodate city consumption (2.5 times the energy per capita more than rural citizens), and will exceed the Kyoto Agreement's standards by five times[3]


To paint a picture, check out the picture from NASA. From space, China's air pollution can be seen. NASA described the pollution as so bad that Beijing could not be seen anymore...



Why should multi-nationals care?
Anyone who thinks a country’s environmental dilemmas and doing business in that country are mutually exclusive, think again. Typically costs are only thought of when following environmental regulation, but in actuality, the lack of environmental regulation can be even more costly. Consider the above environmental statistics and read on to gauge the economic and commercial implications to China:

· 10% of its annual GDP is the loss estimate to China’s economy from not having an environmental agenda in place[4]
· The cost to fix the environmental damage would wash out the booming commercial growth of 8% a year
· $36B in lost industrial output occurs from a lack of water to run facilities
· $13B is the loss estimate from the damage and health impact of acid rain
· $6B is the loss estimate from the spread of desert regions

There are plenty of dollar signs for the multi-nationals to care. Well fix it then, right? Not so fast. Who regulates all of the resources? The government! To add to the complexity is the need for multinationals to practice “Guanxi” with the government. Sustaining and fostering a relationship with the Chinese government is essential to continued successes in China. How does a multinational successfully build Guanxi AND work towards environmental standards, when the multiple levels of the Chinese government have conflicting views on environmental regulation? To truly appreciate the bureaucracy, recall there are five levels in China’s political system:
1. National
2. Provincial
3. Municipal
4. County
5. Township

There’s a real struggle to connect the dots between economic growth and protecting the environment. The light bulb has gone off (somewhat) at the national level but has yet to at the lower levels. The existing incentive structure for annual performance does not encourage support for the environment. What matters is how much did the government contribute to GDP growth for the respective jurisdiction. When measured in these terms, time spent on environmental regulation falls through the cracks and the local officials have no incentive to discuss it.

Exploitation by the West?
Aside from the obvious bottom line concerns, Western corporations need to care about environmental compliancy to keep their corporate reputations intact. Some companies are struggling with the temptations of maintaining western environmental standards which is hurting the image of multinationals.
Multinationals already receive such scrutiny from the Chinese Media related to environmental standards. When a multinational enters China, the first reason which comes to mind is for the company to enjoy the lax environmental policies which are typically found in its origin country. The ability to use outdated equipment and processes can be environmentally harmful but achieve lower operating costs which makes moving to China very appealing. If this is the case and a multinational company is caught, the ramifications are not only to its reputation in China but globally as well. A few companies recently highlighted as water pollutant offenders in China are Nestle and Pepsi, who have both now been blacklisted in China.

What the China government is doing and what still needs doing…
In China’s 11th 5 Year Plan (which extends from 2006 to 2010) $175 B investment is planned for infrastructure and technology geared to assist local officials to enforce environment cooperation. This is an enormous investment and a clear message from the Chinese government. In conjunction, the government needs to overhaul the incentive structure and legal structure of the local offices. Without changing the performance metrics, no incentives exist for the lower levels to help Mother Earth. The current legal system is also not conducive to enforcing environmental offenders. In 2006, only 500 of the 700K environmental violations had been tried. The fact that there’s an overlap (i.e. conflict of interest) between the judges, government and local business owners makes trying environmental offenders even more impossible. To change the local incentive structure and legal system would require a drastic change on multiple fronts for the Chinese government. It’s possible the Beijing Olympics will highlight some of the air pollutant issues which could drive additional reform, but outside of that, major progress on these two fronts will most likely not occur in the immediate future.
Bottom line; don’t count on the Chinese government to have this figured out before you enter the Chinese market.

What can the multinationals do?
While Chinese governmental reform is not fully within anyone’s circle of influence, there are steps multinationals can take to hedge environmental risk and influence the Chinese government.
Experts indicate there are 2 options for multinationals to follow
First Option - Two Pronged Defensive path


First Prong - Avoid causing harm.


a) Participate in all industry wide standards and associations to prevent negative publicity.


Second Prong- Minimize the environmental “footprint”


a) Not only focus on multinational compliance to environmental standards but also reach out and influence the supply chain partners to strive for global environmental standards


b) E.g. Mattel upgraded its process on how to paint the Barbie Doll’s eyes. The results are eliminating residual hazardous waste and introducing a cleaner environment for the Chinese workers. Just by upgrading from a paint gun!


Second Option- Be Proactive
a) Establish programs centered on developing technologies the national Chinese government requires for the environment. This can be done through community work or actual partnering with local universities or scientists.
b) Some companies opting for a proactive approach to environmental reform are GE and Royal Dutch Shell
c) The proactive approach is truly the win win as there’s an opportunity to build Guanxi by helping the Chinese government meet its outlined environmental standards, with the added bonus of reaping First Mover Advantage benefits.



What lies ahead…
There’s a great opportunity to influence and work with the Chinese Government. Speculation is the Chinese government looks to the west to help take the lead in Environmental Reform. A common theme from the GIE visits with the Ministry of Education, Peking University Hospital, and CCTV; China recognizes that collaboration and understanding Best in Class models increase success. Environmental reform is no different.
A critical key is how the multinational companies take the lead in its environmental relationship with the Chinese government. Regardless of whether the multinationals are more knowledgeable on Mother Earth, there’s the importance of “saving face” and the art of Guanxi will be heavily relied upon when working with the Chinese government.
A possible accelerator to environmental reform is the Beijing Olympics in 2008. The agreement to have the Olympics in Beijing was freedom of the press. Beijing will be open to all news reporters and it’s highly possible the topic of Beijing’s air pollution will be reported. How China responds to these reports could accelerate future environmental reform. In other areas, China has evolved and surpassed the world's expectations. Time will tell if we see a similar response to the environment.

- Alyssa Williams


[1] “Scorched Earth; Will Environmental Risks in China Overwhelm its Opportunities?” Harvard Business Review. June 2007. Elizabeth Economy and Kenneth Lieberthal.
[2] “Shifting Nature.”China from the Inside Series. Part 3.
[3] Pollution From Chinese Coal Casts a Global Shadow. The Energy Challenge. New York Times. June 11, 2006. Keith Bradsher and David Barboz..
[4] China's Pollution Threat. Business Week June 23, 2006.

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