China's Pollution Should Be Reflected in GDP: William Pesek Jr.

Dec. 5 (Bloomberg) -- So you check in to the Grand Hyatt in Shanghai, touted as the tallest hotel in the world. That sinks in when the desk clerk says you're getting a coveted river-view room on the 81st floor.

As you zoom skyward in the elevator, you ponder the luck delivering you to what promises to be an amazing view. This, let's face it, is a dazzling city that can almost make New York seem sleepy. You think: ``Shanghai, 81st floor. Life is good.''

Once in your room, you make a beeline to the floor-to- ceiling windows, pull back the curtains to and what do you see? Nothing -- other than clouds of smog and soot obscuring the city of 17 million people below.

Such experiences get at an economic hazard few investors talk about: China's environment.

When pondering risks to China's outlook, investors tend to focus on nonperforming loans, trends in per capita income or the success of initial public offerings. Yet nothing captures the tension between China's rapid growth and need to maintain social stability as the environment.

A change in the way China measures its economy may help. Rather than getting straight measures of gross domestic product from regional governments, perhaps China should begin deducting environmental costs. That way, municipal leaders will have fewer incentives to boost growth at all costs.

Arms Race

Municipal leaders curry favor with Beijing by delivering rapid growth, leading to an infrastructure arms race. Each region aspires to be the next boomtown with an international airport, skyscrapers, six-lane highways, five-star hotels, major universities, an opera house and grand museums. It means China's building spree has only just begun and that its resources needs are sure to increase.

China already has six of the world's 10 most-polluted cities, according to the World Bank, which estimates environmental damage and health problems cost more than $54 billion a year. That's more than the $48.4 billion of foreign direct investment China had attracted this year as of November.

There are two things to keep in mind here. One, the World Bank's economic-cost estimate seems conservative. Two, pollution is a bigger risk to the Communist Party's credibility than investors may appreciate. It could be the thing that gets rural Chinese -- the vast majority of China's 1.3 billion people -- to turn on the government.

Harbin's Cautionary Tale

Recent events in the Chinese city of Harbin got considerable media coverage, and for good reason. A Nov. 25 explosion at PetroChina Co. poisoned the drinking water of 3 million people. Russia may cut off water supplies to 1 million people as soon as Dec. 14, when a toxic slick about 100 kilometers (62 miles) long reaches the Khabarovsk city's stretch of the Amur River.

``It's really just the tip of the iceberg,'' says Elizabeth Economy, director of Asia studies at the Council on Foreign Relations in New York. The Harbin case is a ``wake-up call'' to the government to focus more on environmental issues.

While the rise of every economic superpower comes with ugly environmental side-effects, China's -- thanks to its size and huge population -- is unprecedented and may have much bigger implications than those caused by development in Europe or the U.S.

GDP Fix

One reason: Globalization. Pollution in the world's fastest-growing major economy is ``causing serious economic losses, social conflicts and health costs within China,'' Jianguo Liu and Jared Diamond wrote in the June issue of Nature magazine. ``China's environmental problems are also slipping over into other countries, while other countries affect China's environment through globalization, pollution and resource exploitation.''

To address this, Morgan Stanley is pushing a novel idea: China should change how it calculates economic output to reflect all its costs -- including environmental ones -- to give the appropriate incentives to local governments.

That means the costs of work-related deaths and injuries would be deducted from GDP, both to shame regional officials and reduce their share of national expenditures. Morgan Stanley estimates 6 percent to 7 percent would be deducted from regional GDP if growth were adjusted in that way.

Rising Costs

Beijing has been toying with a so-called green GDP measure, though more as an economic indicator than a policy tool. And clearly, other nations should do the same, including the U.S.

China needs to get serious on the environmental. Otherwise, its pollution woes may act as a speed bump for a nation on which the economies and investors near and far are relying.

In late October, Zhang Lijun, vice minister of the State Environmental Protection Agency, told the Wall Street Journal that China's pollution levels may rise four times to five times in the next 15 years because of rising power generation and increasing use of automobiles. It sure makes you feel bad for the Olympic athletes competing in Beijing in 2008.

Zhang's warning that China won't be able to cope with such high pollution levels should be heeded. Moreover, the issue should be discussed at meetings of the Group of Seven nations. If China is held back by pollution, the global economy will suffer, too. If you think China has bad air now, just wait until 400 million Chinese have the money to buy cars.

``Recent environmental disasters suggest that China needs to find a better balance between growth and environmental protection,'' Morgan Stanley said in a recent report out of Hong Kong. ``The obsession with GDP has led to a neglect of growth quality issues.''