Foreign Firms, Investment, and Environmental Regulation in the People's Republic of China
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Foreign Firms, Investment, and Environmental Regulation in the People's Republic of China

Phillip Stalley

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Foreign Firms, Investment, and Environmental Regulation in the People's Republic of China

Phillip Stalley

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About This Book

This new book takes as its focus a simple yet critical question: Does foreign direct investment lead to weakened environmental regulation, thereby turning developing countries into "pollution havens"? The debate over this question has never before been the focus of a book about China. Phillip Stalley examines the development of Chinese law governing the environmental impact of foreign investors, describes how regional competition for investment has influenced environmental regulation, and analyzes the environmental practices of foreign and Chinese companies. He finds only modest evidence that integration with the global economy has transformed China into a pollution haven. Indeed, after China opened its domestic market, the entry of foreign films largely strengthened the environmental protection regime, including the oversight of foreign firms' environmental practices. Nevertheless, foreign firms (and the competition to lure them) have posed new challenges to controlling industrial pollution. Stalley identifies the conditions under which foreign investment contributes to and undermines environmental protection, offering readers a solid understanding of China's environmental challenges. He also builds on existing theory and provides hypotheses that can be tested with other developing nations.

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1 To Go Green Is Glorious? China, Foreign Investment, and Environmental Regulation

To get rich is glorious. This motto, of uncertain origin but often attributed to the late Deng Xiaoping, succinctly captures the feverish desire for economic development that has gripped China since the launch of the reform and opening era in 1978. No country has moved up the economic ladder as quickly as China. Over the last three decades, China's 9 percent per annum growth is faster than that of any country in history. This growth has lifted 250 million people out of poverty and made China a major producer and consumer of goods that just a generation ago were beyond imagination for most Chinese. From 2002 to 2006, for instance, the number of air conditioners in China tripled (Fergusson 2009). As late as 1990, only 42,000 cars were produced in China (Kelly Gallagher 2006). By 2007, the figure was 8.8 million (Associated Press 2008).
As the name “reform and opening” indicates, a major pillar of Beijing's get-rich strategy has involved opening China to foreign direct investment (FDI). Initially viewed with suspicion, especially by China's more conservative cadres, Beijing began setting up special economic zones to attract FDI in the late 1970s. Although investment was modest through the 1980s, after Deng's southern journey in 1992 FDI skyrocketed. Today China leads all developing countries in attracting foreign investment, and in recent years China has annually attracted more FDI than all of Central and South America combined. Between the years 2000 and 2003, foreign firms built 60,000 manufacturing plants in China (Palmisano 2006). By 2007 China was receiving almost $75 billion in FDI per year, which translates into just under 38,000 individual foreign-investment projects.1 The result of this investment inflow is that today foreign firms account for a considerable portion of economic activity in China. In 1990, foreign-invested enterprises produced 2.3 percent of industrial output. By 2002, the figure had increased to a whopping 33.4 percent. One-third of China's industrial production comes from foreign-invested enterprises (National Bureau of Statistics 1994–2004).
To go green is glorious? To my knowledge no Chinese policymaker has ever uttered these words, but one would hardly be surprised to see this phrase on a billboard in China. The language of environmentalism has unmistakably entered the Chinese vocabulary. In 2008, when the State Environmental Protection Administration (SEPA) was promoted to the Ministry of Environmental Protection (MEP), the announcement indicated that China's central leadership was on a “green drive” to address environmental deterioration (Sun 2008e). Over the last few years Beijing has experimented with a “green GDP” that would employ environmental criteria in assessments of government officials' performance. In 2007, SEPA announced the launching of a “green credit policy” to prevent bank loans to industries in energy- and pollution-intensive sectors. A year later this was followed up with a “green insurance” program intended to compel companies to purchase insurance for industrial accidents and a “green securities” scheme that requires companies raising funds in Chinese capital markets to disclose environmental data.
Driven by concerns over product safety and “green trade barriers” that limit the access of Chinese companies to overseas markets, Beijing has also actively been promoting “green label” and “green food” programs to help domestic companies demonstrate their environmental credentials. In 2006, Beijing announced a “green procurement policy” that obliges government agencies at all jurisdictional levels to select products from a “green purchasing list.” Since 2000, Shanghai has maintained a “Green 110” telephone hotline to collect complaints about environmental issues. And perhaps most famously, to deliver on its promise of a “green Olympics” Beijing spent $15 billion and took drastic steps such as restricting heavy industry in five neighboring provinces, banning construction, limiting driving privileges, and closing factories in the immediate Beijing area. One county government in southern China, in a highly unusual attempt to heed Beijing's calls for greater emphasis on environmental protection, spent $56,000 to paint the side of a mountain green (Associated Press 2007). Few things, it seems, hold more cachet in “red China” than the color green.
This green push from Beijing is in large part a reaction to the severe environmental strain produced by China's breakneck economic growth. Over the last three decades China has emerged as one of the most polluted nations on earth. It is difficult to overstate the seriousness of China's environmental challenge. Sixteen of the twenty most polluted cities in the world are in China (Economy 2004, 72). China has the world's highest rate of chronic respiratory disease, with a mortality rate five times that of the United States (Dexter Roberts 2003). Air pollution is estimated to contribute to somewhere on the order of 750,000 premature deaths every year (World Bank 2007). Half the population drinks water that is at least partially polluted and more than half of China's cities are affected by acid rain (Shi 2005b). Already environmental degradation is estimated to cost China somewhere between 8 and 12 percent of its GDP each year (Economy 2004, 88).2
Much of China's ample pollution is the result of industrial production. In 2000, SEPA estimated that 40 percent of water pollution and 80 percent of air pollution stemmed from industry (Wang Hua et al. 2004). In 2003, it was estimated that industry accounts for 83 percent of China's sulfur dioxide (SO2) emissions and more than 80 percent of total particulate emissions (Shi and Zhang 2006, 271). Industry also contributes to pollution problems through environmental accidents, which are all too common in Chinese factories. In December 2005, a chemical company made headlines when it spilled thousands of tons of benzene into the Songhua River, which created an international incident, as it not only affected the drinking supply of millions of Chinese, but also threatened downstream cities in Russia. In the ten months following the benzene incident, China experienced another 130 spills into water supplies, which is the equivalent of one every two to three days (Associated Press 2006; Reuters 2006b).
The strain on the environment contributes to a host of social challenges including increasing internal migration, rising public health costs, and environmental protests, which although scattered are common in China's rural areas (Jing 2000). In 2005, the number of environmental protests increased by 30 percent to more than 50,000, including one in Zhejiang Province that involved more than 30,000 demonstrators protesting against thirteen chemical plants. Two months later residents of another Zhejiang village marched on a foreign-invested battery factory and locked over one thousand workers inside the facility. Again, the issue was pollution, as villagers claimed the factory was contributing to abnormally high levels of lead poisoning (Savadove 2005). In 2007, thousands of citizens protested the construction of a chemical factory in Xiamen, eventually forcing the suspension of the project (Tatlow and Kwok 2005). Incidents like these led Zhou Shengxian, currently head of the MEP, to refer to China's pollution problem as the “blasting fuse of social instability” (Beck 2006). As Zhou's comment implies, China's current rate of environmental damage is not sustainable and threatens to reverse many of the achievements of the reform period. In that respect it is hardly surprising that China's leaders have attempted to green China and strengthen industrial environmental regulation.3
Just as has been the case with China's attempt to “get rich,” attracting foreign capital has also been an integral part of China's push to “go green.” The National Eleventh Five-year Plan for the Environment (FYP), which lays out environmental targets and broad policy guidelines, declares that in the 2006–2010 period China “will expand the channels for using foreign capital.” Part of this “foreign capital” strategy involves sustaining a high level of FDI into the Chinese manufacturing sector, which Chinese leaders have long argued has an environmental protection dividend. For much of the reform and opening period, for example, it has been common to hear Chinese leaders declare that, aside from providing the income growth necessary to strengthen environmental protection, trade and investment liberalization also facilitates access to advanced clean production technology and compels China to adopt more stringent environmental standards as foreign investors demand better environmental protection (Asian Economic News 1999; Jahiel 2006, 315). In 1992, for instance, Qu Geping, the former director of China's National Environmental Protection Administration (NEPA)—a forerunner to the current MEP—stated that economic development demands pollution prevention: “Foreign investors would be hesitant to invest in a heavily polluted area because the cost of cleaning up would be much higher than the cost of prevention” (Kent Chen 1992).
This argument was echoed in the period around China's entrance into the World Trade Organization (WTO) in 2002, when government officials and analysts asserted that the increased openness of China's economy would compel stricter environmental regulation to avoid an influx of pollution-intensive products and encourage the adoption of stringent international standards for corporate environmental management. This view that foreign investment brings with it an environmental benefit is often echoed by foreign companies operating in China. According to the Business Roundtable, an association of CEOs of leading U.S. companies that collectively represents $4.5 trillion in annual revenues and more than 10 million employees: “China's liberalization of its trade and investment controls has opened the door for American companies to invest in China. U.S. companies operating in China typically bring environmental ‘best practices' and habits of good corporate citizenship with them. This sets a good example for Chinese companies to emulate” (2009). The assumption underlying the assertions of both Chinese leaders and the international business community is that foreign investment and environmental protection are positively correlated. Attracting foreign investment leads to better environmental regulation.
This assertion is not without scholarly support. Numerous studies have shown that foreign investors, particularly multinational corporations (MNCs), often use a common set of environmental management standards in their developing-country operations. Because multinational firms have facilities in a large number of countries, they value predictability and stability and prefer to use a single set of environmental standards. This reduces the transaction costs associated with adapting environmental policy to different regulatory settings (Glen et al. 2000; Wheeler 2001). These standards have been developed in the MNC's home country and so typically surpass the requirements of the developing host country. Along the same lines, several scholars point out that MNCs tend to use the latest technology, which is typically cleaner (Bhagwati 2004). This increases the likelihood that MNCs' own operations meet environmental regulatory requirements.4 Several empirical studies have found a positive correlation between foreign ownership and environmental performance standards (Christmann and Taylor 2001; Glen et al. 2000; UNCTAD Secretariat 2002; Wang and Jin 2002). Christmann and Taylor (2001), for example, show that foreign-invested enterprises in China report that they are more likely than domestic companies to comply with environmental regulation and even to go beyond compliance.5
Many have presented cases in which MNCs, and foreign investment more broadly, contribute to environmental regulation via an influence on government officials and domestic firms.6 Already equipped to comply with strict standards, MNCs may have an incentive to press local governments in less stringent nations for tougher regulations in order to achieve reputation gains and possibly disadvantage domestic competitors that are less equipped to meet higher standards. In this case, “desire for a level playing field in time produces a higher-quality field” (Braithwaite and Drahos 2000, 281). Foreign firms may also exert a salutary influence on the environmental policies of domestic partners. For instance, to the extent that foreign investors transfer clean technology to domestic firms in their host country, they contribute to local environmental regulation (Andonova 2003). Indeed, facilitating local firms' access to advanced foreign technology, which is typically less pollution-intensive, is one of the more common justifications for promoting investment liberalization in developing countries (Drezner 2000, 66). In China the opportunity to acquire new, clean production technology was a highly anticipated and frequently cited benefit of WTO membership prior to China's admission in 2002 (Jahiel 2006, 314; Zhao Yuhong 2007, 81).
Just as important as the transfer of technology is the diffusion of corporate environmentalism norms facilitated by foreign investment. Since the 1980s there has been a marked enhancement in the approach to environmental protection within the business community in the developed world (Hoffman 2000, 2001; Prakash 2000). The result is that leading companies routinely publish environmental data in annual reports, conduct environmental audits of overseas facilities, seek third-party certification of their environmental management systems, and often seek to go “beyond compliance” with regulation. Some have argued that MNCs promote these environmental norms in their operations abroad and “export environmentalism” to developing-country governments and firms (Bailey 1993, 142; Christmann and Taylor 2001; Florida 1996; Garcia-Johnson 2000; Hutson 2004; Rosen 1999, 152). The reasons for exporting environmentalism include: a desire to lessen the cost advantage domestic competitors gain by shirking pollution abatement, an attempt to enhance the company's reputation and minimize legal liability, and a genuine belief in the importance of corporate environmental stewardship. Efforts to promote corporate environmentalism are often part of a multinational's “green supply chain” policy, through which it screens a potential domestic supplier's environmental record and management system prior to the signing of commercial contracts (Christmann and Taylor 2006).
But not everyone agrees that foreign investors help a country go green. A highly contested strand of academic theory argues that the quest for foreign investment can create a downward pressure on environmental regulation. Those arguing in this vein are united by a shared concern that a fundamental characteristic of globalization is a transfer of power from governments to corporations. The logic of this position is straightforward. In today's world of international production, corporations can pick and choose among a number of locations in which to set up operations. IBM, the quintessential American company, has over 40,000 of its approximately 320,000 employees in India. A typical Dell computer sold in the United States will have each of its critical components—microprocessor, memory, hard drive, battery, keyboard—produced in a different country, and altogether the manufacturing process can involve four hundred companies in North America, Europe, and Asia (Friedman 2006, 515–20). As companies have more choices about where to produce and supply, the fear is that they are becoming footloose and less subject to government control. The diminishment of government authority is not just a result of capital mobility, but also stems from developing countries' increasing reliance on foreign investment. In 1990, inward FDI was approximately 10 percent of the GDP for developing countries. By 2003, that number had increased almost threefold to 28 percent. For countries particularly open to foreign investment, such as Chile, the figure approached 70 percent ( UNCTAD 2006). Capital is thus both more desired and more mobile, a situation that logically increases the weight of industry at the expense of government.
In this context of enhanced corporate authority, the fear is that foreign investor environmental strategy is more often characterized as “exploitative” rather than “responsible.” Child and Tsai provide a useful definition of these ideal types: “A socially responsible strategy would devote substantial resources towards ensuring environmental protection, possibly on the expectation that superior long-term revenues will compensate for the additional costs. An exploitative strategy would be manifest in a policy of short-term profit maximization that minimized environmental protection measures on the grounds of their costs” (2005, 101). There are many examples of foreign investors adopting environmental strategies that tend toward the “exploitative” end of the continuum. Rosenberg and Mischenko (2002) argue that oil MNCs in Russia often ignored local environmental laws. Clapp and Dauvergne describe the poor record of transnational corporations in developing countries, especially those in extractive industries (2005, 169–74). Focusing on the logging industry in the Asia-Pacific region, Dauvergne argues that “both domestic and foreign firms continue to rely on networks of state and local allies to skirt regulations—such as forging export documents or smuggling logs overseas” (2005, 191). Kelly Gallagher provides an overview of foreign investment in China's automobile sectors and finds there has been minimal transfer of environmental technology from foreign to Chinese companies. The net result of China's dependence on foreign direct investment is that China has been “‘locked in' to outdated, inefficient, and polluting vehicle technologies for many years” (2006, 125). Several other studies focusing on China have found examples of foreign investors in pollution-intensive industries either shifting production to China in order to take advantage of lax environmental laws or entering into joint ventures with local township and village enterprises, which tend to be beyond the reach of environmental officials (Richardson 2004a). In a similar vein, some have argued that in order to escape the costs of pollution abatement, foreign firms operating in the developing world simply contract out pollution-intensive products to domestic suppliers and then turn a blind eye (Leonard 1988; Mabey et al. 2003).
Not only are there questions about the environmental performance of foreign-invested enterprises (FIEs); a related concern is that the contest to attract foreign investors leads developing-country governments to weaken, avoid tightening, or disregard transgressions of environmental standards. Eager for investment, developing-country governments accede to investors' demands or take unilateral initiatives to lower the cost of business by relaxing the regulatory setting. This phenomenon, in which a combination of pressure from firms and government concerns about investment competitiveness results in weaker environmental regulation, goes by a variety of labels. When fear of capital loss or a desire to enhance attractiveness to mobile capital results in a jurisdiction failing to enhance standa...

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