China’s cost advantage is exaggerated by lax pollution controls

An interesting story in the NY Times today discussed growing popular resistance in China to new industrial projects due to the burden of pollution these projects create. Over the past several years, I’ve seen many stories on the nearly-intolerable state of air quality in China’s largest cities and about the increasing scarcity of drinking water.

In the West, government regulations require pollution controls. These are costly. I’ve seen estimates that such controls may cost two percent of revenues (which means that a company with operating margins of 10% could have margins of 12% if they were not saddled with environmental regulations).

In China, there is a near absence of pollution controls. Even when the central government has attempted to limit dirty and inefficient fuel burning or industrial production, such edicts have been largely ignored.

The result is that Chinese profitability is exaggerated. When pollution becomes severe enough to truly be intolerable such that environmental laws are not only passed, they are actually enforced, this will create a substantial drag on profitability. (Or, companies will be required to charge more to cover the costs of being more eco-friendly, leading to inflation and/or decreased competitiveness). Further, once things get out of hand (as arguably they are now in China), the cost to implement changes is far greater than the steady state costs, and the costs of clean-up of existing (and growing) pollution problems present yet another burden.

Even not taking into account the cost of cleaning up after past bad behavior, the lack of pollution control provides a clear cost advantage for China. If pressure is building to fix this, it will certainly be a good thing for generations in the future, but it is one more potential strain in an already fragile economy.

While lax pollution controls allow emerging economies to grow more rapidly, the pollution they produce results in serious environmental damage with ramifications that could persist for decades, especially as the pollution burden for the globe in its entirety increases to a point of saturation.

source: NY Times: In China, Spending on Industrial Projects Stirs Growing Resistance

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