ON January 12, residents of Beijing woke up to air so thick with pollution that pedestrians could barely see a few feet in front of them.

The levels of particulates smaller than 2.5 micrometers (PM2.5) - fine air particulates that pose the biggest health risk, which are considered safe at readings of around 25 parts per million - reached almost 900.

Following the pollution of the past winter, the pressure to clean up China's air has never been so acute. "The government has been left with no choice but to respond and take action," says Wei Huang, an air pollution specialist at Greenpeace in Beijing.

The economics of environmental cleanup, however, are unclear.

According to experts, a lasting policy would demand a shift in the types of industry that drive the country's economy and involves a potential slowdown in GDP growth.

And, while the recipe for cleaner air could cause some industries to suffer, others are expecting a potential windfall with the rollout of new environmental measures.

The difficulty in putting a number on the economic costs and benefits of tackling China's air pollution comes from both sides of the issue - the economic losses due to pollution and the cost of cleaning it up.

In a study released last year, Greenpeace pegged the cost of pollution in Beijing at around US$328 million, based on levels measured in 2010. In Shanghai, the cost was even higher, at US$420 million.

This estimate, however, is based only on the number of premature deaths due to air pollution. Other costs - such as those related to chronic illness, lost productivity and environmental degradation - were so difficult to measure with existing data that Greenpeace left them out of its metric entirely.

Although pollution sources vary regionally, the 2012 Greenpeace report places a majority of the blame for China's air pollution on coal and automobile exhaust fumes.

Any plan for a clean-up must take into account energy production and China's expanding population of automobile owners.

In a report released by Deutsche Bank in March, experts encouraged an aggressive approach to tackling pollution in the next five years. China needs "big bang measures," according to the Deutsche Bank report.

Among the suggestions listed in the report was a reduction in average coal consumption growth by half from the years 2013 to 2017, lowering expectations from 4 percent annual growth to 2 percent.

Clean energy

According to the report, this measure could be complimented with an increase in the annual growth rate of clean energy sources and a deployment of clean coal technologies that could help reduce emissions from coal-fired power plants by up to 70 percent.

In addition, the Deutsche Bank report suggests lowering expectations for future growth in the sales of passenger vehicles and regulations that increase fuel efficiency.

The report suggests increasing investment in public transportation options such as rail and subway lines.

The report predicts this can all be done while maintaining an economic growth rate of 6.8 percent annually - a slight reduction from China's current projections of a 7.5 percent growth rate for 2013. While this seems simple enough, it is predicated on China cutting its energy intensity per unit of economic output in half - a move that would enable economic growth to continue while increases in energy use slow. But that would require a shift from energy-intensive manufacturing toward an increase in the high-tech and service industries.

Fuel efficiency of new cars

China's ongoing efforts to increase the fuel efficiency of new cars are an example of the challenges regulators face in tackling the economic issues inherent in pollution cleanup.

At first glance, increasing fuel efficiency is a much easier issue to tackle than overall energy consumption. In fact, many of these programs are paired with economic stimulus, offering money to consumers to trade in their older vehicles for new ones that meet higher fuel-efficiency standards.

This is already being done by municipalities and cities throughout China, says David Vance Wagner, a senior researcher at the International Council on Clean Transportation (ICCT).

"China has moved aggressively on implementing new standards for vehicles," Wagner notes. "Today, a vehicle that is five or 10 years old can emit as much as 40 times more pollution than a new vehicle. (Increasing the number of newer vehicles on the road is) a very efficient way to clean up the air."

Scrappage program

The exchange - money for old cars - is typically called a "scrappage program" and has been carried out on a national and local level.

Nationally, China offered US$3,000 for old vehicles from 2009 to 2010 - not enough, according to Wagner, to really incentivize people.

Earlier this year, Hong Kong announced that it was dedicating around US$1.3 billion to removing 88,000 older vehicles from city streets, offering subsidies worth about 30 percent of the value of a new vehicle.

Beijing has its own scrappage program aimed at getting rid of half a million older vehicles by the end of 2015. Doing scrappage at a local level, however, is not ideal.

The challenge to implementing a national program, however, is fuel. Vehicles manufactured to meet more stringent emissions standards require a higher quality of fuel than is typically available at the Chinese pump. Low-quality fuel can ruin certain parts of the engine. Refining high-quality fuel, however, costs money. "Someone," says Wagner, "has to bear that cost."

In China, the price of fuel is set by the National Development and Reform Commission, while the cost of refining is borne by large state-owned enterprises like PetroChina and Sinopec.

The Ministry of Environmental Protection has jurisdiction only over vehicle standards. And, without the ability to pass the cost of refining higher-quality fuel to customers, the state-owned enterprises have no incentive to improve their fuel.

In the US, Wagner notes, fuel standards can be set by the Environmental Protection Agency. Fuel companies can then choose to change their gasoline prices and defer that cost to customers at the pump.

But in China, it took the January 12 pollution event, which attracted the attention of China's top leaders, to finally reach an agreement on setting standards.

New standards

By the end of February, China's government released a time table, mandating that new fuel quality standards for diesel and gasoline be issued by the end of this year, in order to be implemented by the end of 2014 for the first phase of improvements, and 2017 for a second phase.

The ICCT estimates these fuel improvements will end up increasing the cost of fuel by 0.1 yuan per liter of gasoline.

"They haven't said how they're going to pay for it," Wagner notes.

One possible option is requiring that the NDRC change the price of fuel at the pump, allowing refineries to transfer the cost.

"More likely, we'll see a tax adjustment," says Wagner.

In this scenario PetroChina and Sinopec would be taxed at a lower rate for higher-quality fuel.

"The other big component of this is the actual vehicle standards," Wagner says. "They have a few key steps to take and then the fuel quality is going to be there. Then, they can move forward with vehicle standards."

This, he adds, would pave the way for a larger scrappage program.

Adapted from China Knowledge@Wharton, http://www.knowledgeatwharton.com.cn. To read the original, please visit: http://www.knowledgeatwharton.com.cn/index.cfm?fa=article&articleid=2763