China's FDI Policy and Pollution Haven Debate

FOREIGN DIRECT INVESTMENT POLICY AND
POLLUTION HAVEN IN CHINA
GRADUATE RESEARCH PAPER
ECON 662
TIMEA GREGO
RENO, APRIL 2012

CONTENTS
I. INTRODUCTION.........................................................................................................................................2
Aim of the Investigation...............................................................................................................3
Explanation of the Research Approach........................................................................................3
II. THE POLLUTION HAVEN HYPOTHESIS..................................................................................................4
Theory of Pollution Havens..........................................................................................................4
International examples and evidence............................................................................................5
III. CHINA'S POLLUTION PROBLEMS..........................................................................................................7
IV. ECONOMIC REFORM AND FDI..............................................................................................................9
a. Background of Economic Reform............................................................................................9
1. Reform of the micro-management institution....................................................................10
2. Reform of the banking system............................................................................................12
3. Success of the Economic Reform.......................................................................................13
4. Problems with the Reform..................................................................................................13
b. The link between International Openness, Trade, and FDI....................................................14
c. China's Accession to the WTO...............................................................................................16
V. IS CHINA A POLLUTION HAVEN?.........................................................................................................17
a.How has reform affected pollution?........................................................................................17
b. Which industries are investing in China?...............................................................................18
c. Is the FDI the cause of pollution?...........................................................................................20
d. How does WTO accession affect the protection of global environment?..............................23
1. The link between environmental issues and the obligation of WTO rules.........................23
VI. POLICY RECOMMENDATIONS.............................................................................................................25
VII. CONCLUSION......................................................................................................................................25
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I. INTRODUCTION
This research paper focuses on the linkage between China’s economic reforms, export oriented
FDI policies, and its respond to China’s heavy coal dependence.
Since Mao’s heavy industry strategy, China has experienced a remarkable economic
development. As the consequence of the rapid industrialisation, its primary energy powered
economy is booming in an extent that can be dangerous for the global economy and the
unexpected environmental degradations that accompanied it.
One of the core driving forces of the global economy is the international trade and
relationship. The interaction of trade liberalisation and environmental protection are important
aspects in the global economy. The global flow of merchandise goods through intra- and
interregional trade was $ 12,178 billion although this accounts for a 12% decline in 2009; due to
a 2.4% fall in the world GDP. Many factors have contributed to the sharp decline for instance the
global economic crises and decline in consumer demand. The leading major economies in
exported merchandised goods were China, Germany and the U.S.A. in 2009. Additional to this,
China increased its world share in imported merchandised goods by 1.0% in 2009 compare to the
previous year. As a consequence of the increase, China has become not only the world largest
exporter but also the second largest importer. The U.S.A. kept its third position as an exporter of
merchandised goods and leads the international trade as an importer (International Trade Statistic,
WTO 2010). As can be seen from the above example, international trade is one of the driving
engines of the global economic development. Therefore, it is very important to analyse the
linkage between trade liberalisation and environmental degradations.
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Aim of the Investigation
It has become clear after an interdisciplinary literature review, that there is little precedence for
investigating the linkage between China’s export focused FDI policy and the pollution haven
hypotheses. Therefore, the immediate motivation for this research is to explore the impact of
China FDI policy on the global environment, and how China has become the cheap energy haven
of the World Trade.
Explanation of the Research Approach
The present study will analyse China’s open market approach by analysing the complexity of
China’s FDI policy and its serious consequences on the global environment. In additional to this,
the research paper will highlight a missing relationship of the pollution haven theory which sees
the pollution haven perspective from a different view.
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II. THE POLLUTION HAVEN HYPOTHESIS
Theory of Pollution Havens
One of the most significant debates of international relations, trade liberalisation and
environmental protection is whether a country without a strict environmental protection program
when other countries do it increases their comparative advantage in the production of
merchandised goods and services that are harmful for the environment. Under trade liberalisation,
the hypothesis predicts that there is precedence that multinational companies will relocate to
developing countries to utilise their weak environmental regulations. According to Baumol and
Oates (1998), developing countries, for instance China and India, do not limit environmental
pollution to improve their economic status, they specialise in its comparative advantage and “will
become the respiratory of the world’s dirty industries”. Research often draws the linkage between
China as a pollution haven (e.g. the energy use related increased CO2 emission) and its
unregulated environmental program as one of the main reason of the country’s rapid economic
development. In addition to this, numerous works have been published on the connection
between the foreign direct investment and the environmental degradation in China in regional
dimension (Dean and Wang, 2004; MacDermott, 2009; Smarzynska and Wei-Jin, 2004).
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International examples and evidence
The initial aim of this section was to provide international examples and evidences for supporting
the pollution haven hypothesis. However, after conducting an interdisciplinary literature review,
it has become clear that researchers mainly took the economist perspective to analyse the
credibility of the hypothesis, and failed to point out a very important factor behind the debate, is
the cheap energy resource. There have been numerous empirical studies on the interaction
between economic growth, environmental degradation and the existence or non-existence of
pollution havens. Much of the work has, to date, focused on the differentiations in environmental
regulations between countries and the possible relocations of firms; analysed the capital intensity
of pollution intensive sectors (Cole and Elliott, 2005); the site choices of equity joint venture
(EJV) project in China (Dean, Lovely, and Wang, 2004); or analysed the bilateral trade flows of
merchandised goods with different pollution intensities in trading blocs (Kahn and Yoshino,
2004). The majority of the existing empirical and theoretical studies of the pollution haven
hypothesis highlight the lax environmental regulations of the foreign country as one of the main
reasons of the debate. The numerous published works on the pollution haven hypothesis have not
fully analysed and focused on the link between foreign direct investment (FDI) flow into energy
intensive industries; location choices of energy intensive industries; and the low cost energy
resource dependence of these industries.
Therefore, this research paper intends to redefine the phenomenon of pollution haven
hypothesis. One of the most controversial debates today is whether pollution-intensive industries
search locations with lax environmental principles and turning these locations into pollution
havens.
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First of all, these industries are energy intensive and the production life-cycle of merchandised
goods will become pollution intensive. Secondly, energy intensive industries may seek locations
with cheap energy resources such as fossil fuels (e.g. coal).
Thirdly, the majority of the emerging developing countries’ (e.g. China and India) energy supply
is highly dependent on coal. Fourthly, signatory countries to the Kyoto Protocol argue that non-
Annex I countries (e.g. China) do not have legally binding emissions cap under the Protocol thus
these countries can increase their comparative advantage in the production of pollution intensive
goods. This statement requires some corrections; as a result of the trade liberalisation and a sharp
increase in the consumption/production and export/import ratios, Non-Annex I countries increase
the production of high energy intensive goods because of the FDI inflow and that energy
intensive industries may shift of their production facilities by increasing the capacity at a new site
or by outsourcing their production stages to countries with low cost energy resources. Therefore,
the emerging developing countries (e.g. China) are cheap energy havens and will become
pollution havens at the end of the production life-cycle because of their abundance in coal; as a
result of this their comparative advantage mainly lies in the cheap energy resource. The cheap
energy haven countries are those developing states in which high energy intensive industries
search locations with low cost of energy resources.
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III. CHINA'S POLLUTION PROBLEMS
One of the major global environmental issues of the 21st Century is the ever-increasing
greenhouse gases content, especially carbon dioxide (CO2), in the atmosphere and its negative
impact on the global economy and environment. According to the IPCC Fourth Assessment
Report (AR4), the current concentration of atmospheric CO2 has been rising and exceeded its
value since the pre-industrialised era (Solomon, Qin, Manning, Chen, Marquis, Averyt, Tignor,
& Miller (2007). The current trend of atmospheric CO2 concentration shows a sharp increase
from the pre-industrial level of 228ppm to 389.78 ppm in 2010 (Solomon et al., 2007; NOAA).
This increase is mainly due to the overutilization of primary energy sources, as a consequence of
this the Earth’s surface as a whole is warming up. IPPC AR4 report predicted that the likely range
of global average atmospheric warming is 2.4-6.4°C and this will lead to more sever regional and
global climate changes (Solomon, 2007) that impose major economic, social and developmental
costs to the world economy.
China is the most populous country on Earth and the second largest energy user. Thus the
county’s environmental performance has become the focus of global attention. The rapid
economic growth, industrialization, and urbanisation of China over the last thirty years has
improved the people’s wellbeing, and lifted 400 million people out of poverty. As a result of this,
resource utilisation and energy efficiency has greatly improved. Moreover, the ambient air
concentrations of particulate matter (PM) and the level of sulphur dioxide (SO2) in the
atmosphere have decreased over the last 25 years (Nygard, J, 2007). China’s estimated real
growth rate of GDP was 10.3 % in 2010 (CIA). At the same time, China is still faced with
environmental challenges and the degradation of its environment.
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Total fossil fuel energy consumption was 86.4% between 2006 and 2010 and it is less likely that
there will be decrease over the year (The World Bank). According to the, International Energy
Agency’s (Figure 1.), China’s demand for primary energy sources will increase by 75% between
2008 and 2035. In addition to this, the primary energy sources will still be the main energy
supply in global level in 2035 (The Economist, 2010).
As China is heavily populated it suffers from not just the increased CO2 emissions but also from
several other major environmental problems. These are the following:
· About one-third of the country suffers from soil erosion (Pei, 2002);
· Almost all of its wastewater (80%) is discharged untreated (Pei, 2002);
· More than two-thirds of its lakes and about half of its rivers have been polluted (Pei, 2002);
· At least six of the world’s worst polluted cities were located in China in 2007
(Block et al., 2007);
· Two-thirds of China’s 660 cities are surrounded by illegal rubbish dumps
(Chan, 2005);
· The Yellow River water quality does not meet with China’s water quality standard, the
river is highly polluted and deadly for the Chinese civilisation (Pei, 2002);
· Sixty percent of its potable water does not meet with the World Health Organisation’s
(WHO) minimum acceptable standard (Pei, 2002);
· The mortality rate of respiratory diseases is very high (Pei, 2002).
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IV. ECONOMIC REFORM AND FDI
Since Mao’s heavy industrial strategy, China has gone through a remarkable economic
revolution. The rapid economic development of the country has significantly contributed to
improving the people’s well-being, reducing poverty and increasing the life expectancy.
However, China is still considered to be one of the low-income economies in the international
arena even though its rising economic power. One of the most important challenges of the 21st
century is facing U.S.A. and the whole world economy to get a better understanding of the
reasons behind the Red Star’s rise as an economic superpower and a dominant political body
(Bergsten, Gill, Lardy, & Mitchell, 2006).
According to Bergsten et al. (2006), five factors have contributed to China’s rapid economic
growth: increasing its comparative advantage in the production of goods and services therefore,
attracting more market force; transition from a closed economy to an open one and encouraging
foreign direct investment; better and more systematic allocation of labor force; and achieving an
improved primary school education. Although this “complex”, “contradictory” and “confusing”
country has achieved remarkable growth since the dead of Chairman Mao Zedong in 1976, there
are several issues to be worried about of a rising China (Bergsten et al., 2006). Therefore, the
section is organised around the following major components: the economic reform of the
country; the linkage between international openness, trade and FDI; and China’s accession to the
WTO.
a. Background of Economic Reform
China’s Great Leap Forward strategy had serious consequences on the country’s overall
economic performance. As a result of the economic development that has slowed down, the
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social welfare did not improve significantly and people were still living under the poverty line.
One of the most significant problems of the adoption of heavy industry based strategy was that
China did not specialise in its comparative advantage; the cheap labor endowment (Lin, Cai, &
Li, 2003). In contrast, Japan and the four Little Dragons attained a fast pace economic and social
development between 1965 and 1984 however all of these countries are influenced by the
Confucius ideology; the philosophy emphasis commitment to work and thrift. From the economic
point of view, the success of Japan and the four Little Dragons listed in their open market
approach, less price manipulation, and more efficient factors endowment allocation. On the other
hand, the Asian financial crisis in 1997 deeply affected the “East Asian Miracle” economies, and
there were fears for a world economy meltdown (Lin et al., 2003).
1. Reform of the micro-management institution
It was not until the dead of Chairman Mao that China had gave up the leap-forward strategy and
Deng Xiaoping broke with the traditional economic system and fundamentally reformed the
China’s economic structure in 1978. The first important aspect of the reform was that firms and
farmers were given more production quotas and more self-governance (Lin et al., 2003).
Secondly during the reform period, there often were conflicts between the micro- (e.g. the
household responsibility system and SOEs) and ‘macro-policy environment’. Institutional
regression occurred a number of times, due to the inefficient resource allocation and continuous
price manipulation.
Therefore, the second step was to introduce a better resource allocation policy and macro
environment strategy that helped to improve the sphere of micro management units (Lin et al.,
2003). The State-Owned Enterprise (SOE) reform started in 1979 and included three periods;
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1979-1984, 1984-1986, and 1988-present. During the first phase, SOEs were guaranteed more
power to achieve higher efficiency. Two important aspects of this reform were all SOEs expenses
were paid back by the government and the profits earned by SOEs were rendered to the state
(profit-retention). Problem solving strategy of the profit retention-system was done by
introducing the profit-quota system. Under this program, some of the SOEs’ profit was shared
between the government, and the remained share was utilised by SOEs or split up between SOEs
and the state. Although this reform period had positive consequences it also had a short lived
success which occurred from the undefined autonomy of SOEs, and SOEs misconducted the state
plane and did not complete with the pre-setted requirements (Lin et al., 2003).
The second phase of the reform focused on simplifying administrative control and
decentralising authority of SOEs (Lin et al., 2003). The third phase of the SOEs reform aim was
to improve the management mechanism of SOEs by adopting a management responsibility
system. International trade reform took place in three stages between 1978 and 1991 to present.
The aim of the first period (1978-1986) was to give greater foreign trade power of SOEs. As a
result of this the government implemented the foreign-trade responsibility system. Moreover,
under this phase a foreign exchange retention system was introduced that was managed under the
central management (Lin et al., 2003).
The second stage of the reform took place in 1987-1990, with the aim of encouraging the bloom
of foreign-trade responsibility system. Under the third stage (1991-present) of the reform export
subsidies were abolished and the ratio of foreign exchange retention was raised. The goal of
foreign trade reform was to give support to export and gain foreign exchange for the import of
capital intensive goods.
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2. Reform of the banking system
It is necessary to mention the monetary system reform, which started in 1984, in China in which
the monopoly of The People’s Bank of China was restructured and become a new central bank
(Cargill & Parker, 2001). The central government had established several other banks; the
Agricultural Bank of China, the Bank of China, and the Industrial and Commercial Bank of
China (ICBC). The People’s Bank of China was the core element of the mono banking system,
and responsible of the nation money supply. Also, it managed business by providing commercial
loans and insurance (Lin et al., 2003).
The Bank of China was responsible for foreign exchange business and loans. The ICBC was self-governing
bank from the Central Government and had its own business operation system in
place. Additional to this, the China People’s Insurance Company was established with the aim of
managing deposits, loans and oversees the account of industrial and commercial firms.
Furthermore, the credit management-, interest rate management-, and credit system was reformed
(Lin et al., 2003).
In October, 1992 at the 14th National Congress of the Chinese Communist Party (CCP) Deng
Xiaoping has announced a new economic system, the “Socialist Market Economy”. This
capitalist market economy approach resulted in the separation of the banks into commercial
banks, and “policy banks” (Cargill & Parker, 2001). Parker also states that only three more
national banks have been established since the reform erupted; Everbright Bank (1992), Huaxia
Bank (1992), and Capital Iron and Steel. In 1995, Minsheng Bank was opened which is the only
non-governmental owned bank in China, and the first bank that engaged the service of an
internationally recognised accounting firm.
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3. Success of the Economic Reform
Since the economic liberalisation, China has seen increasingly rapid economic development that
made the country the second largest economy and trading state in the world. During the post-
Maoist market improvements, the People’s Republic of China (PRC) has specialised in labor
endowment in which the country is abundant, and has witnessed a sharp increase in international
trade. As a result of the market orientated reform, the PRC became leader of foreign exchange
reserve and gold (CIA-The World Factbook: Reserves of Foreign Exchange and Gold).
According to Parker (2001), China’s banking reform has lead to a monetary system that exhibits
similarities to the Japanese financial system that is the comparative-advantage-following strategy
that could lead to serious problems in the long run.
4. Problems with the Reform
In the previous chapter the reasons for China’s economic reform and its success was discussed.
The Chinese economy has been growing rapidly since the economic reform stared in 1979.
Although China had given up Mao’s self-reliance policy and adopted a more market-driven
reform regime, the economic system of China is still faces with some obstacles to provide
sustainable economic growth. According to Bergsten et al. (2006), there are three major
challenges facing China, to carry forward and finish with the reform of SEOs; to improve the
capital allocation system; and to develop a better macro-policy environment that can tackle with
the rent-seeking firms due to the dual price system and corruption. Lin et al. (2003) has
highlighted other problems lying in front of China, for instance the ever increasing income
inequity among urban and rural areas; and to meet with the demand for grain production.
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Additional to this, there is one more significant issue relates to the fast pace economic
development of China, that is its environmental degradation and to provide access to safe,
reliable and sustainable energy supply for everybody. Another problem is China’s undervalued
currency exchange rate that causes a huge trade deficit between USA and China (Lin et al.,
2003).
Furthermore, the Chinese economists’ point of view is that the SOEs are in serious trouble.
Parker (2001) stated that China took as an example the Japanese monetary regime and liberalised
its post-Maoist economy. According to him, this system can only perform well in the short-run
but will cause severe economic problems in the long-run. He takes the Asian financial crisis as an
example to get a better understanding of the problems and consequences associated with the
financial liberalisation (Cargill & Parker, 2001).
b. The link between International Openness, Trade, and FDI
Since the unification of the country, China was a strong state ruled by a single, robust individual
and a strong central government. China is still a very contradictive state although the country has
gone through a remarkable political, economic, social, and cultural revolution since the death
of Chairman Mao Zedong in 1976. In 1978, Deng Xiaoping the ‘paramount leader’ has give
up with Mao’s Leap Forward Strategy and fundamentally modernized the country’s
economy which leads to rapid growth and improved living standard. Deng Xiaoping was a
committed political reformist who had a strong opinion to make the country economically
and politically powerful in the international arena. Although China is undergoing a
transition its communist political system is still highly bureaucratic and lacking some
important aspects of democracy.
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One of the most significant obstacles of political democratization of China is the role
of factions in the politics (Shih, 2004). Shih highlighted the importance of the informal
personal networks ties in the allotment of scare resources (loans and investment) in the
Chinese political system. Therefore, pattern of factions have shaped many political and
economical outcomes in China (Liberthal, 2004). Schurmann and Dittmer (2004) sated that
factions are permanent and that their existence is dependent on constituencies for support;
informal politics (Liberthal, 2004).
Since 1978 to the present, China has experienced nationalism, dual economy, Open Door
policy and become a member of the global economy (Faust et al., 1995). Deng knew that
China’s future relied not only on the market based capitalism, but also on its current
membership in the global economic system, for instance World Bank, International
Monetary Fund (IMF), and the General Agreement on Trade and Tariffs (GATTs) (Faust
et al., 1995). As a result of his philosophy, he abolished Mao’s self-reliance approach in
support of the Open Door policy in 1978 by which China opened up to the international
trade and investment system. In 1980, the special economic zones (SEZs) were established
as part of Den’s economic reform in Guandong, Shenzhen, Zhuhai, Shantou and Xiamen
(Faust et al., 1995). SEZs were designed after Taiwan’s SEZs, and their policy allowed
foreign investors to experience special trading rights with less trading barriers and taxes
(Faust et al., 1995). In June 1979, the government passed the Equity Joint Venture Law by
which foreign direct investment (FDI) was allowed in China for the first time. This law was
one of the major elements of the Open Door Policy, as a result equity joint ventures,
cooperative, processing and assembly, and joint oil projects were created (Mackerras,
1998).
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c. China's Accession to the WTO
World Trade Organisation was established in 1995, replacing the General Agreement on Tariffs
and Trade (GATT). The aim of WTO is reducing trade barriers among members, encouraging the
liberalisation of international trade, and negotiating trade agreements. The member states of the
organisation have a legally binding obligation to WTO agreements. In 1948, China was one of
the founding bodies of GATT but withdrew its membership in 1950. It has taken more than 10
years of complex negotiations to achieve WTO membership in December 2001, which was a
milestone to China’s recent economic susses. In addition to this, the international trade pattern
has changed drastically since China accession to WTO (Lin et al., 2003). According to the
international trade theory, comparative advantage is the main reason for trade among countries.
This means a country will specialise in a production of a good in which the country has
comparative advantage. For instance, USA has comparative advantage in producing capital
intensive goods because the country is abundant in capital versus China, which has comparative
advantage in the production of manufacturing goods because the country is the paradise of labor
endowment.
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V. IS CHINA A POLLUTION HAVEN?
Section III described China’s energy and environmental degradation in terms of air pollution,
water pollution, and increased man-made CO2 emissions. This part of the paper will deal only
with coal consumption related atmospheric air pollution (CO2) in China that is primarily linked
with the pollution haven hypothesis. In addition to this, a quantitative analysis is provided for
China’s increased coal demand and electricity generation since China become member of the
WTO.
a.How has reform affected pollution?
China’s international openness and trade related increased production and consumption activities
require the utilisation of more primary energy sources which severely affects the global
environment in forms of air pollution and ever increasing CO2 emission. This environmental
externality has negative affect on peoples well-being on national and international level, can
contribute to market failure, alter global trade pattern and the country can loses its leading
position as the largest exporter of the world trade. Figure 1. Show, China’ coal production
between 1976 and 2010. Peak consumption and production Figure 2. with periods such on the
1970s Economic Reform, China’s accession to the WTO (Dec 2001), and the late 2000s
recession. Since the WTO membership, China consumed almost 2.5 times more coal in 2010
(1713.5 Mtoe) than in 2001 (751.9 Mtoe). A similar pattern can be said about China’s coal
production; China consumed 809.5 Mtoe coal in 2001 and 1800.4 Mtoe in 2010 which is a
122.40% increase. Figure 3. represents China’s CO2 emission from fossil fuel utilisation between
1976 and 2010. The peak emission periods can be divided into four stages from the late 1970s to
the mid-1980s; from the mid-1980s to the millennium; from 2001 to the late world recession and
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from 2007 to present. In the last 10 year, China’s CO2 emission increased by 123% or 4595.5
million tonnes CO2 (BP Historical Data 1965-2010).
b. Which industries are investing in China?
Due to the lack of access to China Statistical Yearbooks on Foreign Direct Investment (FDI)
inflow by sectors, this section provides an overview of FDI inflow by origin and investment
vehicle in China.
Since the economic reform and adoption of open door policy, China has attracted large amount of
foreign direct investment. Between 2011 and 2010, China’s utilized non-financial FDI amount
was $706.4 billion dollars Table 1, of which US direct investment accounted for $30 billion
dollar. In 2010, the non-financial FDI inflows increased by 2.1% compared to the previous year
Table 1. According to the National Bureau of Statistics of China, non-financial overseas direct
investment by Chinese investors accounted for $59 billion dollars which is a 36.3% increase
compared to 2009 (NBS). As can be seen from Table 2., the majority of the contracted FDI
projects (22,085) were done by wholly foreign-owned enterprises (WFOEs) in 2010 and its
utilized FDI value was $81 billion dollars. The second most favoured non-financial FDI
investment by vehicle type is equity joint ventures (Table 2.). The sharp difference between the
numbers of contracted projects by the two vehicles types and operated by an overseas investors,
and the investors receive all profits but take all the risk associated with operating the enterprise.
In addition to this, the other difference which favours the WFOEs investment vehicle against EJV
is the capital contribution to the establishment or investment of the enterprise (USCBC). In
contrast establishment of EJVs, requires a Chinese and a foreign investor that collaborate by joint
operation and ownership of a limited liability corporation.
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Profits, loses and losses of the venture are shared between them according to their capital
investment (The US-China Business Council). In 2008 and 2009 Asian investors led China’s FDI
inflows (Table 3.). Leading investor is Hong Kong, followed by Taiwan, Japan, and Singapore.
The largest non-financial FDI flows (245.7%) were achieved by Taiwan in 2009 compare to the
previous year (Table 3.). USA ranked fifth according to its FDI investment in China, at nearly $4
billion dollar with a 21.5% in 2009.
As was mentioned before, this section cannot provide an updated and detailed sectoral
distribution of FDI in China due to the access restriction to China’s Statistical Yearbooks.
Therefore Table 5. is adopted from Broadman and Sun (1997) to give a general idea about the
sectoral distribution of Chinese FDI. The authors highlighted the gap in the accurate quantitative
analysis of FDI inflow to the country’s industrial sectors. As a consequence of this, further
analysis will be required to get a richer picture about industrial distribution of FDI in China.
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c. Is the FDI the cause of pollution?
This section set out to investigate the relationship between China’ FDI policy and the country’s
increasing CO2 emission that causes irreversible global environmental externalities. In addition to
this, this section provides a new hypothesis for the relationship between FDI and pollution haven
theory.
Foreign Direct Investment policies in China
One of the most significant elements of China’s economic boom has been the encouragement of
foreign direct investment. Since the pre-Deng period, China adopted to a more open economy
policy for foreign enterprises and has attracted an ever increasing FDI inflow. During this time,
China’s FDI policy has undergone various changes.
Between 1978 and 1984 (First phase of the economy reform), preferential government polices are
permitted joint ventures using Chinese and foreign direct investment, and setting up Special
Economic Zones (SEZs) and ‘Open Cities’ (Fung, Iizaka, & Tong, 2002.). In July 1979, The Law
of the People’s Republic of China on Joint Venture using Chinese and Foreign Investment come
into force, the Chinese Government legally allowed foreign investment in China. During the
second phase of the economic reform (1984-1988), to open up the country to more foreign capital
and technology, another fourteen major coastal cities opened to foreign trades and Hainan Island
province become the fifth and largest SEZ in 1988 (Fung et al., 2002).
In 1986, to improve the investment environment in China and attract further FDI inflow, equity
joint ventures, contractual joint ventures and wholly foreign-owned enterprises were allowed.
Moreover, the State Council’s provision for foreign investment specially focused on export
orientated production-type enterprises, and technologically advanced enterprise. The Article 22
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Provisions provided Enterprises with Foreign Investment with preferential tax policies,
eliminated the barriers to import inputs used in production for or instance; raw materials,
machinery and equipment. In addition, the State Council guaranteed priority access to water,
electricity supply and transportation services and fast track access to RMB loans (NovexCn). The
next milestone was in 1986 the adoption of The Law of The People's Republic of China on
Enterprises Operated Exclusively with Foreign Capital which was amended by the 18th Session
of the Standing Committee of the 9th National People's Congress on October 31, 2000 (Lehman,
Lee, & Xu, 2000). The Article 3 provision states to boost the development of China’s economy
the State Council allowed and encouraged foreign investors to establish export-oriented or utilize
advance technology wholly foreign-owned enterprises. As can be seen from Table 2., the
majority of the contracted FDI projects (22,085) were done by wholly foreign-owned enterprises
(WFOEs) in 2010.
In June 1995, The Provisional Guidelines for Foreign Investment Projects come into force and
the State Council encouraged non-financial FDI project in the agricultural-, energy-,
transportation-, telecommunications sectors, basis raw materials, and high technology industries.
Moreover foreign invested projects, that would utilise the advantage of the rich natural resources
(e.g. cheap electricity generation from coal) and the country’s abundance of labor endowment in
the central and northwest regions were highly supported. Catalogue for The Guidance of Foreign
Investment Industries provides the basis for the assessment and approval of encouraged,
restricted, prohibited, and permitted non-financial FDI projects (Fung et al., 2002). Encouraged
project for foreign investment are for instance in agriculture, coal and power industry.
As was described in this section, one of the major reasons behind China’s blossoming economy is
the FDI policy of the country which encourages the establishment of export (production) oriented
foreign firms. It is necessary to mentioned that researchers are or were contentiously
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investigating the relationship between the pollution haven hypothesis and inward FDI inflow to
manufacturing industries (Chen, & Démurger, 2002), the capital intensity of “dirty” sectors
(Cole, & Elliott., 2005), relocation of pollution intensive industries to China (Dean, Lovely, &
Wang, 2004.) but found little or no evidence to support this linkage for the pollution haven
hypothesis. According to the theory, a country that has a less developed environmental
regulations in force increase its comparative advantage in the production of merchandised goods,
and services that are harmful for the environment and become the haven of the world pollutions.
As was mentioned before, there is a fear that under trade liberalisation, the multinational
companies will relocate to developing countries to utilise their weak environmental regulations.
Winters and Wang (2001) noted that environmental cost associated with production activities
account for less than 5% of sales for most industries. Therefore, this research paper argues that
developed countries would off-shore their production facilities to developing countries with the
aim of increasing their competitive advantage only because of the developed country’s laxer
environmental regulations.
This research paper presume that the FDI inflow is not the reason of the increased pollution
concentration in China; the major reasons that supports of the pollution haven hypothesis are
China’s FDI policy, which encourages export oriented foreign investment, China’s reliance on
cheap electricity generation from coal, and abundance in labor. It has become clear, after
conducting a broad ranging literature review, that currently there is no evidence for investigating
the linkage between China’s exports focused FDI policy, cheap electricity production and the
pollution haven hypothesis.
TIMEA GREGO 22

d. How does WTO accession affect the protection of global environment?
1. The link between environmental issues and the obligation of WTO rules
Managing environmental degradation in the international trade arena is a cluster of complex
relationships between global economy, environmental policies and sustainable utilisation of the
environment resources which requires an interdisciplinary (political, economical and
environmental) solution (Baumol et al., 1998). The aim of this section is to highlights the
prospective barriers of implementing any global environmental policies concerned with the
reduction of environmental degradation associated with international trade under current GATT
regulations. Some of the main obstacles of the GATT for reducing global environmental
degradation (GATT, 1998):
Article I. General Most-Favoured-Nation Treatment requires contracting countries not to
discriminate between their trading partners’ product originating in or destined for other member
countries.
Article II. Duties or charges imposed on imported goods require member states to set equalised
fees or other charges, and ban tariffs above that level.
Article III. National Treatment on Internal Taxation and Regulation prohibits the contracted
member states to apply “internal taxes and other internal charges, and laws, regulations and
requirements affecting the internal sale, offering for sale, purchase, transportation, distribution or
use of products . . . to imported or domestic products so as to afford protection to domestic
production”.
TIMEA GREGO 23

Article III/2. Internal tax or other internal charges prohibits any contracting parties to apply any
“internal taxes or other internal charges of any kind in excess of those applied, directly or
indirectly, to like domestic products”. In addition to this “no contracting party shall otherwise
apply internal taxes or other internal charges to imported or domestic products in a manner
contrary”
Article XI. General Elimination of Quantitative Restriction prohibits member states to impose
quotas, on imports of products from other contracting members, except in special circumstances
for instance food shortage.
Article XX. General Expectations to the requirements. The two relevant expectation are Article
XX (b) and (g) allow contracting parties to protect human, animal or plant life or health, or if the
measures relate to the conservation of exhaustible natural resources.
It is important to note that WTO agreements do not deal with environmental issues; multilateral
environmental agreements are negotiated and agreed to mange international environmental
problems (Feenstra et al., 2008). However, the major trading nations are members of the WTO
and under current WTO/GATT rules any strict environmental standard can impose a trading
barrier against the trading partners. There is little precedence for analysing the consequences of
the relationship between China’s trade liberalisation and its impact on the global environment or
investigating the bilateral free trade agreements between China and WTO members.
TIMEA GREGO 24

VI. POLICY RECOMMENDATIONS
To implement the most suitable economic instruments for reducing trade related carbon dioxide
emission is a cluster of complex relationship between environmental policies, global economy
and sustainable utilisation of the environment resources in international trade which requires an
interdisciplinary (political, economical and environmental) solutions. China’s admission to the
WTO makes the linkage between trade liberalisation and environmental degradation more
complex. Section V/d. outlined the potential barriers against free trade related environmental
protection actions applied by WTO member countries. Indeed, there is a need for economic
instruments to eliminate the impacts of coal combustion on the global environmental. Therefore,
further attempt is required to understand the empirical links between China’s FDI policy and
environmental consequences of its export oriented international trade. Possible policy solution
could be restriction of free trade and application of monitoring system on the way goods have
been produced.
VII. CONCLUSION
The aim of the research paper was to investigate the linkage between China’s exports focused
FDI policy and the pollution haven hypotheses. The research paper presumes that the ongoing
international debate about pollution havens hypothesis could be solved by studying the link
between foreign direct investment policy and export oriented production growth in China. If the
linkage empirically can be verified, a new pollution haven hypothesis will be formed which states
TIMEA GREGO 25

that developing countries (e.g. China and India) are export oriented and mainly utilising low cost
energy source (e.g. coal) for the production and selling of goods and services so that these
developing countries are the cheap energy and inexpensive labor haven states. Their comparative
advantage built on energy generation from coal and large endowment of labor.
TIMEA GREGO 26

APPENDICES
TIMEA GREGO

FIGURE 1. WORLD PRIMARY ENERGY DEMAND
(Adopted from: ‘Energy demand: Never Enough’. The Economist Nov 9th 2010, 14:10 by The
Economist online
viewed on 11th Dec 2011)
TIMEA GREGO

TABLE 1. NON-FINANCIAL FOREIGN DIRECT INVESTMENT (FDI) INFLOWS, 2001-10
YEAR 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Total FDI
Number of
projects
26,140 34,171 41,081 43,664 44,001 41,485 37,871 27,514 23,435 27,406
Growth
(%)
17.0d 30.7 20.2 6.3 0.8 -5.7 -8.7 -27.3 -14.8 16.9
Utilized
FDI ($
billion)
46.9 52.7 53.5 60.6 60.3 69.5 74.8 92.4 90.0 105.7
Growth
(%)
15.1 12.5 1.4 13.3 -0.5 4.5 18.6 23.6 -2.6 17.4
US direct investment
Number of
projects
2,594 3,363 4,060 3,925 3,741 3,205 2,627 1,772 NA NA
Growth
(%)
-0.6 29.6 20.7 -3.3 -4.7 -14.3 -18.0 -32.5 NA NA
Utilized
FDI ($
billion)
4.9 5.4 4.2 3.9 3.1 3.0 2.6 2.9 NA NA
Growth
(%)
11.4 10.2 -22.2 -7.1 -20.5 -3.2 -12.8 12.5 NA NA
US share
of utilized
investment
(%)
10.4 10.2 7.9 6.5 5.1 4.1 3.5 3.2 NA NA
NA = not available
Source: adopted from The US-China Business Council (viewed on 1st Jan 2012)
TIMEA GREGO

TABLE 2. NON-FINANCIAL FOREIGN DIRECT INVESTMENT BY VEHICLE TYPE
Number of Projects Utilized FDI Value ($ billion)
2009 2010 % Change 2009 2010 % Change
Total FDI 23,435 27,406 16.9 91.8 108.8 18.6
EJVs 4,283 4,970 16.0 17.3 22.5 30.2
CJVs 390 300 -23.1 2.0 -1.6 -20.5
WFOEs 18,741 22,085 17.8 68.7 81.0 17.9
Foreign-invested
shareholding
21 51 142.9 2.0 0.6 -68.4
ventures
EJVs = equity joint ventures; CJVs = cooperative joint ventures; WFOEs = wholly foreign-owned
enterprises.
Source: adopted from The US-China Business Council
https://www.uschina.org/statistics/fdi_cumulative.html (viewed on 1st Jan 2012)
TABLE 3. TOP 10 ORIGINS OF NON-FINANCIAL FDI
Country/Region
of Origin
Amount Invested 2008
($ billion)
Amount Invested 2009
($ billion)
Year-on-Year
Growth**
(%)
Hong Kong 41.0 54.0 31.6
Taiwan 1.9 6.6 245.7
Japan 3.7 4.1 12.7
Singapore 4.4 3.9 -12.4
United States 2.9 3.6 21.5
South Korea 3.1 2.7 -13.8
United Kingdom 0.9 1.5 60.7
Germany 0.9 1.2 36.3
Macao 0.6 1.0 71.9
Canada 0.5 1.0 76.5
*Note: 2009 data includes investments sourced in these countries but made through
Barbados, the British Virgin Islands, the Cayman Islands, Mauritius, and Western Samoa.
**Calculated by USCBC using unrounded numbers.
Source: adopted from The US-China Business Council
https://www.uschina.org/statistics/fdi_cumulative.html (viewed on 1st Jan 2012)
TIMEA GREGO

TABLE 4. TOTAL VALUE OF FOREIGN DIRECT INVESTMENT IN
NON-FINANCIAL SECTORS AND THE GROWTH RATES IN 2010
Sector Enterprises Increase over
2009 (%)
Actually Utilized
Value
100 million USD
Increase over
2009 (%)
Total 27406 16.9 1057.4 17.4
Of which:
Manufacturing 11047 13.1 495.9 6.0
Production and
Supply of
Electricity, Gas and
210 -11.8 21.2 0.6
Water
Transport, Storage,
Post and
Telecommunicatio
n Services
396 0.3 22.4 -11.2
Information
Transmission,
Computer Services
and Software
1046 -3.2 24.9 10.7
Wholesales &
Retail Trade 6786 33.1 66.0 22.4
Real Estate 689 21.1 239.9 42.8
Leasing and
Business Services;
Services to
3418 19.3 71.3 17.3
Households and
Other Services 217 4.8 20.5 29.4
Source: Statistical Communiqué of the People's Republic of China on the 2010 National Economic and Social
Development; National Bureau of Statistics of China February 28, 2011 (viewed on 1st Jan 2012)
TIMEA GREGO

TABLE 5. SECTORAL DISTRIBUTION OF FDI IN 1993; CHINA 1984, 1988, AND 1993
Source: adopted from (Broadman and Sun, 1997 p. 356).
TIMEA GREGO

FIGURE 1. CHINA’S COAL CONSUMPTION (MILLION TONNES OIL EQUIVALENT)
(1976-2010)
China's Coal Consumption
(1976-2010)
1800,0
1600,0
1400,0
1200,0
1000,0
800,0
600,0
400,0
200,0
0,0
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Years
Coal Consumption (Mtoe)
(Source: World Energy consumption Historical Data http://www.bp.com/sectiongenericarticle800.do?categoryId=9037185&contentId=7068613)
1978 China’ market policy reform
1986 Export oriented production
December 2001 China’s WTO accession
December 2007 Global recession has started
TIMEA GREGO

FIGURE 2. CHINA’S COAL PRODUCTION (MILLION TONNES OIL EQUIVALENT)
(1981-2010)
2000,0
1800,0
1600,0
1400,0
1200,0
1000,0
800,0
600,0
400,0
200,0
TIMEA GREGO
China's coal production
(1981-2010, Mtoe)
0,0
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
Years
Coal Production (Mtoe)

FIGURE 3. CHINA’S CO2 EMISSION FROM PRIMARY ENERGY SOURCES
(1976-2010)
China's Carbon dioxide emission from primary energy sources (1976-2010)
9000,0
8000,0
7000,0
6000,0
5000,0
4000,0
3000,0
2000,0
1000,0
-
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Years
(Million tonnes CO2)
CO2 emission
TIMEA GREGO

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