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Matthews Asia Weekly



Beijing still battling toxic smog

Pollution and China's Economic Transformation

Week of February 05, 2016

In the winter, many parts of China tend to experience heavier smog than usual. In fact, in major cities like Beijing, the air has become so toxic and unbearable that the government has issued public red alerts—the highest alert level of a four-color scale—which has forced the closure of factories and schools. I frequently return to China, where I’m from, and while I am excited to see the newly built skyscrapers, airports and high-speed railways, I am deeply worried about the consequences of the heavily polluted air, water and land. China has come a long way to become the world's second-largest economy. However, the development phase that relied on high energy consumption and caused severe environmental damage is largely coming to an end, and China is once again facing a major transformation in its economic structure.
 
China's air pollution has made frequent headlines recently. Thick smog commonly smothers cities for days. People feel very frustrated to have to live their lives under such a harmful environment. Traffic, coal-fired power plants, and poor enforcement of environmental laws are frequently blamed for the pollution. 
 
The government has implemented various measures in attempts to alleviate the situation. For example, in mega cities, such as Beijing and Shanghai, municipal authorities curb car ownership by limiting license plate issuance through different quota systems. Beijing adopted a lottery system with a preferential treatment for new energy vehicles. In addition, Beijing also enforces driving restrictions based on the last digits of license numbers during workdays. Shanghai, on the other hand, allocates its quota through monthly auctions, with the latest auction price reaching as high as US$13,028 (about 84,500 renminbi) per license plate. To reduce coal consumption, Beijing has started to replace traditional coal-fired power plants and boilers with those powered by natural gas, aiming to slash the city's coal consumption in half within two years. 
 
However, much more work needs to be done in order to solve China’s pollution woes, and it requires enduring necessary pains and overcoming tough obstacles. After decades of capacity build-up, China has become the largest energy consumer in the world. China accounts for approximately half of all global steel and aluminum production, approximately 60% of world cement capacity and about half of world’s coal demand. The imbalance between supply and demand in many industries has become even more acute in the face of the country’s economic slowdown, and overcapacity issues have depressed both product prices and corporate profits. Nevertheless, a reduction in production and capacity shutdowns are easier said than done as they involve massive layoffs and some related social issues, given that many workers of traditional state-owned enterprises (SOEs) are older and unlikely to be easily retrained. Moreover, local governments may face declines in both economic growth and tax revenues, at least over the short term.  
 
China is facing a critical juncture in its economic development, and any large-scale stimulus package from the government could risk further exacerbating the intolerable pollution and excessive capacity. In search of a solution, the central government has encouraged entrepreneurship and innovation, seeking new technology and industries that can generate a number of improved job opportunities. In the meantime, top leaders have pushed for SOE reform and excessive capacity cuts. If history is any guide, while market-oriented reforms may cause short-term pain in certain economic sectors, they can also put China back on a more sustainable, long-term growth path. 

Henry Zhang, CFA 
Portfolio Manager
Matthews Asia

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information. Investing in small- and mid-size companies is more risky than investing in large companies as they may be more volatile and less liquid than large companies.