The Increasing Cost of Air Pollution to Hong Kong and its competitiveness

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Anor drops

9 min readOct 16, 2016

“The presence of contaminants or pollutant substances in the air that interfere with human health or welfare, or produce other harmful environmental effects.”

Notice the key words, human health and welfare. Air pollution has been interfering with the former two words since the industrial revolution, but is it time to change the word from interfering to damaging. This article will be discussing the effects of air pollution in Hong Kong from a public finance perspective, which is a perspective where we put government spendings and their effectiveness to reduce damage to human health or welfare by reducing air pollution under the microscope.

What are the costs of contaminants or pollutants in the air?

Numerous articles, organizations, NGOs and initiatives have urged and pleaded the Hong Kong government to prioritize improving air quality in Hong Kong. Why?

We all know Hong Kong is a global financial center with great infrastructure, world-class safety, that iconic skyline and a behemoth of an economic power right at its doorstep, so its to noones surprize Hong Kong has been a popular destination for multinationals and others to get a taste of Asia. But is the “grow first, clean up later” approach finally catching up with Hong Kong?

Recent study by The University of Hong Kong (HKU) and Civic Exchange shows that 3200 people die annually specifically of poor air quality, i.e. they would not have died had the air quality been better. That is more than swine flue and SARs. Now one can argue, well most of them might have been elderly, had other exposures to air pollution outside Hong Kong.

This allows to bring in another study by HKU called the Hedley Index. The index shows that the last 2 years have an accumulated HK$79,261 million of economic loss to the community in Hong Kong, pollution-related burden of disease and lost productivity. And not only that, a similar study asked graduates from Hong Kong 18 months ago2 versus 2 years ago, whether thay would continue to look for a career in Hong Kong or look gor greener grasses, literally, and the response had been 10% decrease in the number of graduates wanting to pursue their career in Hong Kong — that is your main talent pool of fresh, energetic, young future leaders leaving.

Staying on the matter of talent, multinational corporations are already feeling the throats constricting, a number of firms stated that they had to increase their hardship allowances by 10% in order to attract foreign talent into Hong Kong3. So combining the fact that local talent is leaving, foreign talent is pulling their hand away from Hong Kong, has the clean up process finally begun?

Hong Kong Budget

The budget has been argued by many to be a very vague one, with very little strong initiatives or new ideas for long term solutions. In summary a bunch of one-off subsidies that do not look like they will affect anything. Head 44, pages 211–213 give a much more detailed description of the budget allocated to fighting air pollution.

In the face of billions of surplus in the reserve, HK$662.1 billion to be exact, the government is still passive and ignorant in allocating resources to deal with Hong Kong’s air pollution problem. The amount earmarked for improving air quality in 2012 accounts for only 0.2 percent of the overall government budget, an even lower figure than the average amount for the past five years (0.22 percent), HK$626.7 million to be exact. But should they increase?

Spending on air quality vs. improvement in air quality

Questions have been asked whether government spending on air pollution reduction has any real effect on air pollution. A study by Clean Air Network (CAN)5 showing expenditures on air quality improvement from 1998 till 2011 has shown a definitive result. The following graph demonstrates that when the Government spent more money on improving air quality, fewer hours of reduced visibility were recorded, indicating a direct and positive effect on air quality.

Now that we have definitive proof that increased government spending is inversely correlated with improved air quality, let us see whether this has spurred the government to increase its spending on improving air quality.

How much has the government spent on air quality improvement?

The last 10 years has seen fluctuated allocations from the government to reduce air pollution, ranging from HK$243 million to HK$609 million (note there is a difference between allocation and spending, realization of the allocated fund is very important). The following table summarizes the allocation.

https://airtable.com/tbl7O2YBmTa52VENu/viwtaHkniAxcVZdxf

Coincidentally, the Environmental Protection Department (EPD) recently announced the adoption of a set of new air quality standards, called Air Quality Objectives (AQOs), together with a package of air quality improvement measures. Although the new AQOs still lag far behind the WHO’s recommended air quality guidelines, a recent study sponsored by the EPD and done by Fossil Consultants shows that the annualized cost of meeting the AQO beared by the community would be HK$600 million, which is a substantial amount — larger than this year’s allocated amount, but more importantly, the same community would benefit in economic gains in the amounts of HK$1.2 billion. Basically for every 1 dollar spend, you get 2 back. But this initaitive has not been as actively promoted as hoped.

This bears to ask a simple question, if it is proved that increased spending in improving air quality actually improves air quality, why hasn’t the government increased spending? The issue is less so the amount allocated, but the amount used. Although a considerable amount of money has been set aside for air pollution reduction projects, less than 45% of the funds have actually been put to use from 1999 to 2010.

Carbon Permit Market

The 2 largest air polluters in Hong Kong — the power plants (70%) and vehicles (25%)8 are not bearing any of these costs, at least directly, yet. And both are privately operated, hence they incur and take into account only private costs, i.e. not taking societal marginal cost into account when considering production and operation quantity.

This obviously creates externalities — external negative byproducts of production, which costs are not borne by the producer, but by the whole society. Sufficient quantity of externalities leads to market failure.

The following figure simplifies the whole concept of externalities:

When it comes to correcting the market failure of negative externalities, governments have several options. The most interventionist approaches may involve placing strict limits on the amount of a pollutant firms are allowed to emit and fining them for exceeding this limit, taxing firms that pollute in order to increase their costs and decrease market supply, reducing output and increasing price closer to a socially optimal level. Such interfering approaches to externality reduction require a complex bureaucracy to administer, monitor, execute and enforce especially the 2 parties at stake being privately produced impure public goods — transport and electricity.

Since there numerous complexities involved in pursuing the method mentioned, why not approach it from a market-based perspective. The solution I propose is to entirely create a new market: one in which the right to pollute is bought and sold by firms. This may sound crazy at first but bear with me.

The Hong Kong government creates a department, or gives the function to EPD, of evaluating acceptable amount of pollution in a particular region (New Territories, Hong Kong Island, Kowloon, Outer Islands) and issues permits that firms can purchase giving them the right to pollute. Each permit will allow a certain amount of pollution. The total supply of permits is perfectly inelastic since it is decided by the EPD, which is a government body.

The demand for the permits will be sloping downwards, since at high prices of cost of pollution, firms will pollute less by either acquiring pollution-abatement equipment, which is more attractive when the pollution rights are expensive, or once again have to buy more permits, which decreases margins either way. On the other hand, if the cost of pollution is cheap, then firms will just chose to buy permits rather than acquiring expensive equipment in order to upgrade to a greener technology, nevertheless this still keeps a check on the private cost of production (i.e. private cost has increased).
In the case of price to pollute is too low, hence allowing firms not to bear the full environmental costs, the government can just shift the supple line. Decreasing number of permits, increasing price of permits.

The advantages to this market-oriented solution have almost all the advantages of a fully-functional market, i.e. price determined by supply and demand, invisible hand, etc. In addition to specific benefits:

It reduces the cost society has to bear because pollution rights can be bought and sold. Some firms will find it cheaper to buy the rights than to acquire abatement equipment; other firms can sell their rights because they may be able to reduce pollution at a lower cost. The incentive for all firms is to reduce their own pollution and sell the permits they no longer need, adding to the profits of greener firms, consider this as an investment opportunity with immediate benefits.
Individuals and various other organizations can buy permits as well as producers, i.e. you do not need to be a polluter to buy. This allows for a unique situation: if these entities wish to make it more expensive for firms to pollute, they can just buy permits and hold them. This dries up supply, drives up the price of remaining permits, increasing the cost of production, further encouraging polluters to reduce emissions. In addition to the societal benefits an individual could predict the price of the permits going up, hence make a profit of buying low and selling high, which is on line with the Hong Kong financial center culture.
The revenue the Hong Kong government makes from the sale of pollution rights could be used to improve the environment or subsidies more environmentally friendly methods of production. Since we have already proven the fact that increased government spending in this sector directly affects air quality, this would be a great way to increase spending.

Conclusion

A market for carbon permits minimizes the role the government must play in managing the production and emission practices of the economies big polluters. Furthermore, if the permits are auctioned off from the beginning, billions can earned in revenue for the government, which in theory could be used to subsidize the research and development of pollution abatement technologies and green energy solutions like wind and solar power.
While it still may seem weird that Hong Kong government is giving firms the right to pollute, the logic of such a plan makes sense once the picture is clear. Markets work, even when they’re being used to correct a market failure. The markets had made Hong Kong the most competitive city in Asia until recently, the markets for capital, talent and real estate are some of the world’s best. Why not implement the same model for an issue being faced by Hong Kongers — air quality. We can then change our perception of “grow first, clean up later” to a combination of both: