Pricing Industrial Pollution in China: An Economic Analysis of the Levy System

Abstract

The authors analyze China's experience with the water pollution levy, an emissions charge system that covers hundreds of thousands of factories. The levy experience has not been studied systematically, but anecdotal critiques have suggested that the system is arbitrarily administered and ineffective in controlling pollution. Enforcement is thought to vary widely, so that factories in different regions face different penalties for polluting. And it is widely believed that the levy provides little incentive to control pollution because official rates are below marginal abatement costs. The authors test the conventional critique of the levy system using solid new province-level data for 1987-93. Their results suggest that the water pollution levy system is neither arbitrary nor ineffective. During 1987-93, rapid development in many provinces led to sharp increases in the effective rate. Their results also suggest that the emissions intensity of Chinese industry was highly responsive to those increases, because marginal abatement costs were often lower than levy rates. And from 1987 to 1993, provincial pollution intensities fell at a median rate of 50 percent, and total discharges at a median rate of 22 percent. The results suggest several lessons for regulators in developing countries: 1) local enforcement of national standards will determine the effective price of pollution in each area; 2) the locally enforced price of pollution rises with industrial development; and 3) early in the regulatory process, industrial emissions intensity is highly responsive to changes in the price of pollution, mainly because marginal costs are often quite low in low to medium abatement ranges. In China, provincial adjustments of effective levy rates and other regulatory instruments have been sufficient to induce sharp declines in emissions intensity and reductions in total emissions from registered factories during a period of rapid industrial growth.