China - Urban environmental service management

Report No. 1 3073-CHA China Urban Environmental Service Management December 31, 1994 Environment and Urban Development Division China and Mongolia Department East Asia and Pacific Regional Office Document of the World Bank  CURRENCY EQUIVALENTS (January 1, 1995) Currency = Renminbi Currency Unit = Yuan (Y) Y 1.00 = 100 fen Y 1.00 = $0.12 $1.00 = Y 8.5 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System PRINCIPAL ABBREVIATIONS AND ACRONYMS USED As - Arsenic BOD - Biological Oxygen Demand BOT - Build-Operate-Transfer Cd - Cadmium CPI - Consumer Price Index COD - Chemical Oxygen Demand COPD - Chronic Obstructive Pulmonary Disease Cr - Chromium CWSA - China Water Supply Association EIA - Environmental Impact Assessment EPB - Environmental Protection Bureau GDP - Gross Domestic Product Hg - Mercury ISW - Industrial Solid Waste m 3 - Cubic Meter MCon - Ministry of Construction mg - Milligram MSW - Municipal Solid Waste NEPA - National Environmental Protection Agency NO. - Nitrogen Oxide NPC - National People's Congress O&M - Operation and Maintenance Pb - Lead SO2 - Sulfur Dioxide SOE - State-Owned Enterprise SSB - State Statistical Bureau TSP - Total Suspended Particles TVE - Township and Village Enterprise UfW - Unaccounted-for Water UN - United Nations WHO - World Health Organization  CONTENTS Preface .m........ . .. . . .. . .. . . .. . . .. . . .. . . .. . . .. . . Executive Summary ..................... V 1 Urban China: Threatened Environment ................... 1 A. Introduction .................................. 1 B. Urban China ................................. 2 C. The Urban Environment .......................... 6 D. Reform and Urban Governance ...................... 11 2 Urban Environmental Management ...................... 14 A. Introduction .................................. 14 B. Municipal EPB Structure and Functioning ................ 14 C. Issues ...................................... 16 D. Conclusion ................................... 23 3 Urban Environmental Services ......................... 24 A. Introduction .................................. 24 B. Urban Environmental Services: Organization and Financing .... 24 C. Water Supply ................................. 30 D. Sewerage and Wastewater Treatment ................... 40 E. Solid Waste .................................. 45 F. Paying for a Healthy Environment .................... 48 G. Efficient Organization and Regulatory Relationships ... ...... 50 Endnotes ......................................... 57  - 11 - TABLES IN TExr 1.1 Size Distribution of Chinese Cities, 1992 ...... . . . 3 1.2 Capital, Profits, and Financial Revenue in Chinese Cities .. . . 6 1.3 Annual Health Impact of TSP in Urban China ...... . . 8 1.4 Pollutant Discharges from SOEs, 1981-92 ...... . . 9 2.1 TVE Contributions to National Pollution Loads ..... ....... . . . . 17 2.2 Pollution Loads at Da Qiao ........ . . . .......... . . . . . . . 18 3.1 Municipal Service Company Performance (1991) .... ........ . . . 26 3.2 Sources of Funds for Urban Maintenance and Construction, 1991 .... . 28 3.3 Application of Funds for Urban Maintenance and Construction, By Type of Service, 1991 ....... . . ......... . . . . . . . 29 3.4 Per Capita Supply of Domestic Water from Municipal Systems ..... . 30 3.5 Water Supply by City Size, Municipal and Enterprise Systems, 1991 . . . 31 3.6 Length and Density of Municipal Drains and Sewers ... ........ . . 41 3.7 Number and Capacity of Municipal Wastewater Treatment Plants .... . 44 3.8 Municipal Solid Waste and Nightsoil Disposal ..... ........ . . . . 46 BOXES IN TExT 1.1 Urban Populations, Towns, and Cities ...................... 2 2.1 The Organization and Staffing of EPBs ..................... 15 3.1 On-Budget versus Off-Budget Income and Expenditures .. ....... . . 26 3.2 Water Price Reform in Jinzhou ....... . . . ......... . . . . . . . 35 3.3 Wastewater Pollutant Removal Efficiencies ...... ......... . . . . 43 FIGURES IN TExT 1.1 Municipal Govemment Organization (Shenyang, Liaoning Province) . . . 5 1.2 Urban TSP, SO2 and NO, Levels, Northem and Southem China, 1981-92 7 1.3 Municipal and Industrial Wastewater Discharges ...... . . . . . . . . . 10 3.1 Urban Water Consumption, 1990: Selected Cities (Population: > 1 Million) and Some International Comparisons .. ........ . 33 3.2 Altemative Demand Scenarios ....... . . .......... . . . . . . . 37 3.3 Bogota, Colombia and Shanghai, China: Water Price and Consumption ........ . .. . ............ . . . . . . . 39  - iii - PREFACE This report is based on the work of a team staffed by Lee Travers (Iask Manager), Edouard Motte, Andrew Hamer, Sun Chongwu, Guillermo Yepes, Jeremy Warford, Jodi Felberg (Bank), David Jackson, Ma Xiaoying, Li Qun and Michael Einhorn (Consultants). Valuable assistance and insights were provided to the team by the staff of the Ministry of Construction, the lead Chinese counterpart agency, especially Mr. Zhang Yaoru, Director, and Ms. Liu Yuming, Engineer, and by the staff of the National Environmental Protection Agency, including Mr. Liu Chunyu, Deputy Director, and Mr. Tang Dingding, Division Chief. Missions in October 1993 and March 1994 visited the cities of Kunming and Wuhan and express their appreciation for the contribution of the governments of those cities and of Yunnan and Hubei Provinces for their support of this effort. With Norwegian government support, gratefully acknowledged, the consulting firm Norplan A.S, analyzed the delivery of urban environmental services in the cities of Kunming and Wuhan, providing additional insight into the issues addressed in this study. Working papers on Chinese practices, copies of which are available in the files, were prepared on (a) The Financing of Urban Infrastructure Services, (b) The Environmental Protection System, (c) Solid Waste Management, and (d) Public Utility Services.  - Al -  EXECUTIVE SUMMMARY i. China must strengthen government intervention to protect the environment as the transition to a market economy continues, for markets alone fail to reflect the social costs of pollution. Environmental deterioration will be avoided during this period of rapid industrial growth only if the government can continue to improve and implement environmental regulations and pricing, credit control, and direct investment. For urban environmental management, this report recommends augmenting existing strategies in the following ways: (a) increase the financial and social cost of violating environmental standards, while strengthening public participation and environmental education; (b) assert effective regulatory control over township and village enterprises (TVEs); (c) enact and enforce hazardous waste legislation; (d) expand collective treatment of wastewater and solid waste; and (e) charge tariffs for water supply, wastewater treatment, and solid waste disposal that encourage careful use and provide resources for sustainable, high quality, service delivery. ii. This report finds Chinese urban environmental services generally to be underpriced, resulting in excess demand, unsustainable levels of pollution, and inadequate funds to meet investment needs. To meet social and individual service needs, this report recommends: (a) adjusting water tariffs to produce positive real rates of return on revalued assets, an action that would double average tariffs but would also save Y 4.5 billion per year in investment costs by the year 2000; (b) adjusting sewerage use fees for full cost recovery from domestic, commercial, and enterprise users. For cities requiring primary treatment, this would add approximately Y 0.40 per m3 to water bills; and (c) setting solid waste collection and disposal fees to cover the cost of collection, properly designed landfills, or other safe disposal methods. This would increase the typical household solid waste charge by about Y 3 per month.  - vi - iii. Urban Chinese residents and enterprises have the financial resources to meet the full cost of environmental services. However, this report emphasizes the need to deliver these services with the highest possible level of managerial efficiency and draws on international experience with incentive regulation to suggest means of enhancing that efficiency. A. BACKGROUND iv. China's increased spending on pollution control, from 0.40 percent of GDP in 1980 to 0.67 percent in 1992, coupled with improved environmental regulation, has allowed advances in some areas of pollution control, yet remains insufficient to deal with the nearly threefold increase in the output of heavy industry over the same period. Dangerous levels of total suspended particulates (TSP) have been reduced, as have state- owned enterprise (SOE) discharges of heavy metals to rivers and lakes. Nevertheless, these achievements have only slowed, not stopped, deterioration of highly industrialized urban areas. TSP levels remain well above levels considered unsafe by the World Health Organization (WHO), sulfur dioxide (SO2) concentrations exceed the lowest Chinese air quality standard, few urban rivers reach the lowest acceptable Chinese water quality standard, groundwater quality continues to fall at an alarming rate, and petroleum discharges to surface waters are increasing after an initial decline. Growing pollution from TVEs lacks effective regulation and, perhaps most troubling, rates of industry compliance with environmental regulations appear to be dropping. v. Institutional responsibility for urban environmental management rests with two groups: the municipal EPBs, which implement national and local environmental policies under the guidance of municipal government and the National Environmental Protection Agency (NEPA); and the city bureaus and companies responsible for water supply, sewerage, wastewater treatment, and solid waste collection and disposal under the guidance of the Municipal Construction Commission and the Ministry of Construction (MCon). However, these institutions have not been given sufficient authority or permitted sustainable financial arrangements to efficiently manage China's urban environment. Efficient urban environmental management requires a policy environment that provides rules and incentives to control pollution at source (through cleaner production processes and in-plant treatment of pollutants) or, if more economic, to collectively treat waste streams (through wastewater treatment plants, landfills, etc.), and institutions powerful enough to enforce the rules. B. URBAN CHINA vi. China has the world's largest urban population, at over 324 million people, and is growing at 4.6 percent annually. Thirty-two cities have populations of over 1 million, while the largest, Shanghai, has 8.8 million. Chinese cities have long had powerful, stable administrative structures responsible for planning and implementing urban development. This power has grown markedly over the past decade, as national and provincial governments decentralized expenditure authority to city administrations, which resulted in an 11 percent annual increase in real municipal expenditures per capita. At the  - vii - same time, real urban incomes per capita grew at 6 percent per year, making Chinese cities and citizens much wealthier than they were a decade ago. vii. Although the ongoing reforms have strengthened cities, new pressures have required frequent adjustments to urban strategies. Several reforms will directly impact the environmental sector, including the further separation of state-owned enterprises (SOEs) from government control, hardening SOE budget constraints, greater regulatory control by EPBs, and tax reforms to shift an increasing share of revenues from cities to the central government. Under the new reforms, township and village enterprises (TVEs) have grown rapidly and have created special regulatory difficulties. Moreover, the failure to reform prices for urban environmental services, such as water supply and wastewater treatment, have slowed investment and quality gains in these critical areas, whereas price reforms for energy have aided environmental management efforts. This report recommends several market reforms to improve the management of key environmental services. C. ENVIRONMENTAL MANAGEMENT viii. Ineffective regulatory control and economic disincentives undermine environmental management in urban China. This report recommends several policy improvements to address these weaknesses: ix. Raise the Cost of Violating Standards. SOE water pollution control equipment operates at about 50 percent efficiency because low fines, low monitoring rates, and hardening budget constraints make pollution violations an attractive alternative for plant managers. Pollution fees and fines, if levied at all, total no more than Y 0.40/i3, whereas in-plant wastewater treatment costs Y 0.70-0.80/m3. Chinese firms will have no economic incentive to improve pollution control efficiency unless the expected cost of violations is raised through substantially higher fines and more frequent monitoring. x. Strengthen Public Participation and Environmental Education. China must encourage citizen monitoring of polluters and broadly publicize how cases of firms caught violating standards are resolved. Citizen monitoring complements EPB monitoring by increasing the social cost of polluting to enterprises. Pollution already draws public complaints: 130,000 complaints against polluters were filed at EPBs in 1991, and this number is growing. However, effective implementation of environmental controls will require more than just citizen monitoring-it will require public understanding and support. Education can play a role in explaining how compliance with regulations and increased costs for environmental services can protect the environment; publicity campaigns can equate good corporate citizenship with effective pollution abatement. International experience shows that education and campaign efforts work best when accompanied by increasing financial costs of noncompliance. Furthermore, to enhance public participation and education, the government must continue to give EPBs a high level of political legitimacy. Although some provinces are considering reducing the EPB rank in the government hierarchy as part of their restructuring efforts, this report finds that such action would send the wrong message to urban residents and firms about government priorities.  - viii - xi. Assert Effective Regulatory Control Over TVEs. Small, dispersed TVEs concentrate in peri-urban areas and pollute the same air and watersheds as urban industries. TVE industrial growth and pollution are rapidly increasing. TVEs produced 37 percent of industrial output in 1992, and are estimated to produce 22 percent of wastewater output and 19 percent of air pollution. However, unlike urban enterprises, TVEs remain essentially unregulated because they are difficult to monitor. But because TVE pollution is concentrated in a few industries (such as coke production, leather tanning, chemical production, electroplating, and pulp and paper production), this report recommends that NEPA publish expected pollution coefficients for the few alternative technologies that these industries use. In the absence of specific abatement technologies, EPB authorities could levy presumptive pollution fees based on production rather than on direct monitoring. If firms believe they outperform the presumptive benchmarks, they can be given the option to pay for direct monitoring to establish that fact. Municipal and county EPBs must collaborate to develop a mass-based pollution permit system for implementation in urban and peri-urban areas. Moreover, county EPBs will need institutional strengthening, a process that will be facilitated by working with the municipal EPBs. xii. Approve and Implement Hazardous Waste Legislation. Chinese industry is required to process or safely store 50 million tons of hazardous waste which it generates each year. But no agency is responsible for hazardous waste monitoring and, as a result, violations become known only after an accident results in injury or immediate economic loss. In 1991, 2,800 recorded pollution accidents resulted in nearly 1,900 injuries. But these numbers pale in comparison to the potential damage that could be done to the ambient environment and human health by hazardous waste pollution. Draft legislation which gives EPBs regulatory authority over hazardous wastes should be implemented with no further delay. xiii. Develop Municipal Wastewater Treatment. Many urban lakes and rivers are condemned to serve as waste sinks because of excessive volumes of municipal wastewater and inadequately pretreated industrial wastewater. Only 4.5 percent of combined municipal and industrial wastewaters receive collective treatment, and 15 percent receive pretreatment. Collective treatment works can economically treat municipal wastewater and may be the most efficient means of treating many industrial waste streams. This report recommends that treatment plants, which must continuously monitor their influent, are better placed to enforce discharge standards than the EPBs. Treatment tariffs based on waste loads, with surcharges for violations of agreed levels, will encourage treatment plants to accurately measure loads. Treatment plants, in turn, should be monitored by the provincial EPB to ensure compliance with discharge standards. D. MuNIcIPAL SERVICES xiv. Municipal environmental services-which need not be municipally owned- provide community access to and control of natural resources, and colleciively treat pollutant discharges within the community. Efficient management of these services supplies them at or near the socially optimal level. However, this is not the case in urban China. Low water prices encourage excess demand and result in financially unsustainable  - ix - water companies that must be subsidized to remain operational. Low prices for sewerage, wastewater treatment, and solid waste handling and treatment lead to excess effluent and insufficient revenues. Unlike water, these services do not receive correspondingly large municipal subsidies to meet investment and operational needs. Correct pricing of municipal services will manage demand and reduce pollution, while improved sector organization and incentives will encourage efficient service delivery. Water Supply xv. Municipalities directly provide about 80 percent of piped domestic water and 30 percent of enterprise water, with the remainder supplied by enterprises themselves. Nearly 90 percent of the urban population is served by water systems (97 percent in large cities), 24-hour supply is common and water plant output generally meets quality guidelines. Building-level metering is universal and customer arrears are extremely low, as are commercial losses through illegal connections or malfunctioning meters. However, low construction and material quality, combined with inadequate plant and system maintenance, substantially reduce system service life and increase the long-run cost of supply. xvi. Overexploitation and Falling Real Prices. China has per capita raw water supplies below international averages, yet total industrial and domestic per capita urban consumption rivals that of water abundant countries like Canada. Enterprises consume water at levels two to three times international best practice, despite water quotas and increased recycling. Per capita domestic consumption, which rose 35 percent over the 1980s, and industrial use levels have been sustained in part by the very striking fall in the real price of water since 1980. By 1989, inflation had driven the real price of water to half the 1980 level. At the same time, supply costs rose. By the late 1980s, many cities had overexploited or polluted nearby raw water sources and the need to tap distant sources drove up the real costs of new supply by over 7 percent per year. Recognizing an imminent water crisis, some cities began tariff increases in the late 1980s and recaptured some, but far from all, of the real revenue losses. On the whole, current water prices remain about half the average level needed for self-sustaining water company operations, and even farther below the socially optimal price, itself equal to the rapidly rising long run marginal cost of supply. xvii. Managing Water Demand. The estimated 10 million m3/day shortfall in urban water supply can be reduced, future investment needs constrained, efficient industrial water use encouraged, and system quality and quantity improvements financed if Chinese cities aggressively use price as a water demand management tool. Little research has been done on Chinese household water price and income elasticities of demand. However, one study estimated domestic water demand in Shanghai and found a price elasticity of -0.38 and an income elasticity of 0.22, both consistent with international experience. Industrial demand elasticities have not been estimated because binding water use quotas, rather than price, have heretofore determined consumption for most firms. Until prices rise to the point where they balance enterprise supply and demand, their price elasticities will be low; however, above that point, they can be expected to be large. International experience  x shows that firms typically have long-run price elasticities of demand for water well above those of households. To be sure, price increases will not end the need for new investment in water supply. The severe water shortages in North China, where 1992 domestic supplies fell below 40 liters per day in 18 cities, can be effectively addressed only by a combination of improved pricing and investment in supply. xviii. Water quotas are economically inefficient and should be abandoned in favor of price-based water demand management. As the first step toward socially optimal pricing, this report recommends a demand management policy that sets water tariffs to ensure a positive rate of return on revalued assets and enable capital market access for investment needs. Ground and surface water must be protected from overexploitation by increasing enterprise raw water extraction fees to a level that, on average, equates their self-supply costs to municipal supply costs. A water demand management program of this type would reduce sector investment needs by an estimated Y 4.5 billion annually by the year 2000, free enterprises from input quotas, and allow cities to reallocate the 12 percent of municipal urban infrastructure budget that currently finances water investments. Sewerage and Wastewater Treatment xix. Inadequate Protection. Low sewerage system coverage and inadequate treatment levels result in contaminated groundwater and polluted urban surface water. Nearly 40 percent of urban China is unserved by sewers, with wastewater going directly into lakes and rivers. According to current municipal investment plans, 30 percent of urban China will still remain unserved in the year 2000. Only 4.5 percent of municipal wastewater flows receive treatment of any kind, while industrial pretreatment raises overall treatment rates to 17 percent. The year 2000 goal is a modest 25 percent. Low sewerage coverage and inadequate treatment levels destroy ambient water quality, and, based on international experience, disproportionately burden the poor, who are less likely to have access to safe water supplies. xx. Lack of Funding. Chinese cities have little incentive to invest in sewerage and wastewater treatment because they receive little or no income for handling wastewater discharges. Current regulations permit enterprises to be charged for sewerage use, but not households, and the recommended fee does not allow full recovery of operational and investment costs. Only half of China's cities have assessed sewerage use fees, most at the recommended rate of Y 0.08/m3 (based on 80 percent of water use). EPBs have recently been authorized to charge enterprises a separate wastewater damage fee of Y 0.08/m3 (unless they are already paying more under the pollution levy fee system). However, the latter fee cannot be used for sewerage system maintenance, construction, or operations because EPB charges remain within the environmental protection system. Perhaps because untreated wastewater affects downstream cities more than the producing city, municipal wastewater handling and treatment have lagged behind national needs. xxi. A Program of Intervention. Given the low quality of urban surface waters, known downstream effects, and widespread aquifer pollution, the national government should require the 203 largest and medium-size cities to provide primary treatment (with provision for expansion to secondary) within ten years for any discharge that reduces receiving water quality to below irrigation use standards. Such treatment would reduce  - xi - pollution loads by some 30 percent from those cities, which account for over 80 percent of total loads. All cities should be required to design and develop sewerage systems that facilitate the later addition of treatment works, and which provide immediate treatment if receiving water quality cannot meet either irrigation use standards within 3 kilometers of wastewater discharge points, or standards for domestic raw water at the nearest downstream community extraction point. xxii. The estimated cost of this wastewater investment program is Y 4.3 billion per year ($490 million) over the next 10 years, or about three times the current annual investment in sewerage systems. The implied 15 percent increase in the annual urban infrastructure construction program would be offset by the drop in water supply investment resulting from the new water demand management program. Under the wastewater treatment program, user fees would cover all costs, with the possible exception of storm drainage services, which could be covered from general revenues. Sewerage tariffs for households and small enterprises would continue to be levied against 80 percent of water use but charges for larger enterprises would be based on metered loads. Water users in untreated parts of the system would also pay the full treatment fee to reflect the damage caused by untreated wastewater. User fees in a primary treatment system would total about Y 0.40/mi of water consumed, a level close to the current average price of water. The combined impact of the water and sewerage tariff increases would triple average effective water prices. That new price would accurately reflect the true cost of delivering safe water and collecting and treating wastewater. It would encourage water-saving behavior, postpone investment in new supply, and promote sewerage and treatment systems that are economically sized. Any delay in implementing the program will simply force the construction of larger and more costly systems in the future. Solid Waste xxiii. Good Collection, Poor Disposal. Solid waste collection operations are run well for a country at China's income level. Municipal and district governments, and neighborhood committees, share responsibility for domestic solid waste collection and disposal services, with districts generally responsible for transportation and disposal. Households carry wastes to neighborhood collection points, with pickup 3 to 7 times per week in core urban areas. Private and municipal recycling firms recover much of the marketable waste, but estimates of individual city recycling rates range widely from 5 to 35 percent. Recycling aside, disposal services in urban China are poor. Most municipal solid waste is disposed of in unmanaged dumps that have no provision for leachate control or methane flaring or use. Leachates from these dumps have contaminated surface waters and aquifers in many cities. xxiv. The improper disposal of industrial solid wastes exacerbates these problems. In 1992, industries dumped over 10 million tons of solid waste into urban rivers and lakes. Because industries make their own disposal arrangements, effective regulation is difficult. While continuing to allow free contracting for waste hauling, mandatory use of licensed sanitary landfills would protect society from random dumping. xxv. The Sanitary Landfill Response. While some landfills are well run, most are poorly controlled, fail to meet government standards, and inadequately handle leachates  - xii - and methane. The single largest improvement in solid waste handling would be the provision of adequately engineered and managed landfills, and the requirement to use them. Landfill operations enjoy large economies of scale, which argues for municipal operation in large cities and regional landfills near concentrations of smaller cities. Land availability largely determines landfill costs. In Tianjin, for example, the cost of pickup, transfer, and disposal to a high-standard landfill is Y 55/ton, or about Y 16/capita/year. If these costs are representative, then the typical charge for domestic waste of Y 5/capita/year would have to triple to fully fund proper solid waste handling and disposal. Industrial waste disposal fees would also rise as unmanaged dumps are closed. Intensive education, careful monitoring of illegal dumping, and high fines imposed on violators will encourage acceptance of these solid waste policies. Paying for an Improved Environment xxvi. Tariffs supporting improved environmental services will reassign the costs of treatment to polluters and, in the long run, reduce social costs by improving the quality of water and land. Much of the relocation of raw water supplies going on today would have been avoided had wastewater and solid waste been handled properly over the past two decades. Still, the suggested tariffs will substantially increase the cost of water, wastewater, and solid waste handling to enterprises and consumers. For enterprises, the impact on production costs will depend on current water use efficiency and management's ability to adjust to the new price regime. In most urban industries, water contributes a very small proportion of total production cost, usually under 1 percent, and the impact of even large price increases need not have a large impact on output prices. Solid waste cost increases would have an even smaller impact. xxvii. Analysis shows that urban consumers are well positioned to absorb both the indirect and direct costs of an improved environment. Under current pricing policies, the water bill takes only 0.4 percent of total income for the poorest 5 percent of urban households. Their total utility bill, which includes water, fuel, electricity, and waste collection, takes 4.6 percent of total income. The recommended water, wastewater, and solid waste charges would increase the total utility outlay among this income group to about 5.8 percent of total income. By comparison, on average they spend 6.3 percent of their income on cigarettes, alcohol, and tea. Moreover, real income growth rates for the poorest 5 percent households have matched those of their wealthier counterparts for most of the past decade. Therefore, the proposed cost increase for environmental services could be recaptured through real income growth in a single year. The one group that may need special protection from the proposed tariff increases is the 0.5 percent of China's urban population that lives below the poverty line. They generally rely on government income supplements for their subsistence and this report recommends that the supplements be increased to maintain their consumption levels. Increasing Sector Efficiency xxviii. The proposed tariff increases would provide the means for a substantial increase in the quality of services, but rising costs will put pressure on cities to simultaneously improve operating and managerial efficiency. An important step toward increasing sector efficiency will be to operate all municipal services on an independent  - xiii - accounting basis. Simultaneously, managers must be trained on cost accounting techniques, so that they can make use of China's new enterprise accounting system to identify cost savings in their operations. xxix. International experience provides valuable lessons for increasing sector efficiency. Companies must be provided a stable regulatory environment that uses pricing as the basis for demand management. Regulators must allow efficient companies to maintain their real income even in periods of high inflation. To reduce political pressure, municipal regulators should avoid case-by-case tariff increases in favor of pricing formulas that include automatic inflation adjustors. The formulas can be based on agreed investment and management goals and structured to encourage efficiency gains rather than simply pass costs through to consumers. As the market economy matures, cities may want to experiment with a competitive bidding process to contract out the management of water systems. In Shanghai and other cities, BOT (build-operate-transfer) operations of new water plants are being considered to mobilize capital and managerial expertise. xxx. The operation of sewerage and solid waste systems by government bureaus generally suits the current level of system development. However, managerial demands will increase as systems expand, treatment plants are built, and independent accounting is adopted. In larger cities, enterprise organization and an incentive-driven regulatory environment will be justified. In most countries, urban solid waste operations tend to remain under municipal bureau control. However, these bureaus often play only a coordinating role, contracting out collection, and sometimes disposal services, to independent firms. Many Chinese cities already have experience in contracting out for nightsoil collection, and the principles are no different for solid waste. However, the operation of landfills requires special attention because the social cost of improper management is high. Privately run landfills must be carefully regulated, an expensive process that leads many cities to opt for self-operation to ensure proper control. Conclusion xxxi. China now has an urgent need to reorient the provision of urban environmental services toward the market economy. The failure to do so would condemn urban residents to a deteriorating environment and poor quality, but increasingly expensive, services that do not protect them from the growing stream of urban domestic and industrial pollutants. While the imposition of user fees may be politically difficult, city leaders must recognize that the costs will be paid directly or indirectly, and that the current choice to rely on indirect payment leads to excess demand, on the one hand, and an inability to meet needs, on the other. The result in the end is greater pollution and higher total costs for the service provided. The avoidance of adequate user fees also denies city leaders full use of a powerful and efficient tool, collective treatment of pollutants, as they seek the most cost-effective means of sustaining an environment supportive of economic growth.  x X  - 1 - 1. URBAN CHINA: THREATENED ENVIRONMENT A. INTRODUCnION 1.1 Efficient urban environmental management complements the control of pollution at source with the collective treatment of particular waste streams to hold overall pollution loads to sustainable levels. Because markets alone will rarely induce firms or consumers to restrict sufficiently their polluting outputs, governments turn to regulation, taxation, or other instruments to provide the needed signals. In many cases, and here wastewater and solid waste stand out, the most efficient control may require a combination of source and collective treatment of the waste stream. In other cases, such as air pollution, collective treatment options are generally uneconomic and govemment relies on source control alone. 1.2 A 1992 Bank sector study, China: Environmental Strategy Paper (Report No. 9669-CHA), analyzed China's rural and urban environmental problems, environmental management systems, and the mix of command and control and economic instruments used to control pollution at its source. That study identified opportunities to improve management strategies and move closer to the least-cost mix of policy instruments. In response to those opportunities, the Chinese govemment developed a program of policy research and experimentation and ecological monitoring funded by an IDA credit (Credit 2522). The policy work focuses on improving economic instruments, particularly pollution taxes, and experimenting with cleaner production alternatives to end- of-pipe treatment for pollution abatement. Other recommendations of the strategy paper, particularly in support of local environmental master planning, have been incorporated in Bank- and IDA-funded urban environmental projects such as the Beijing Environmental Project (Loan 3415/Credit 2312) and the Shanghai Environment Project (Loan 3711). 1.3 The current study revisits, for urban China, a subset of the source-control issues, but concentrates on the collective treatment of wastewater and solid waste that was outside the scope of the previous study. Because water supply and policy influence wastewater outcomes so directly, that sector, too, has been included in this study.' Chapter 1 highlights features of urban China critical to regulation and collective service provision, particularly municipal organization and financial resources. It then characterizes the changes in ambient environmental indicators over the past decade and concludes by noting recent economic reforms expected to strongly influence urban environmental regulation or collective services. Chapter 2 analyzes urban environmental regulation, recommends measures to improve regulation of township and village enterprises (TVEs); and calls for approval and implementation of pending hazardous waste legislation; increased investment in sewerage and wastewater treatment; strengthened environmental monitoring; and increased public education and participation. Chapter 3 shows the  - 2 - importance of price-based demand management in improving and sustaining water, sewerage, and solid waste services and discusses organizational and incentive regulation strategies cities can use to increase service efficiency. Box 1.1: URBAN POPULATIONS, TOWNS, AND CITIES In 1992, 746 million people, or 64 percent of the national population, lived within the political boundaries of China's 517 cities. However, the cities incorporate rural hinterlands of varying size and only 164 million of the city population held the coveted 'nonagricultural residence permit' that gave them full rights to residence and services in urban neighborhoods. The others retained use rights to agricultural land and settlement rights in associated villages and were defined as rural, regardless of the type or location of their employment. Both population concepts differ from the Chinese census definition of urban, which yields an official urban population of 324 million, the 28 percent of the population noted in this report. Urban people live in either towns or cities. Towns, which may be located within city boundaries, numbered over 14,000 in 1992 and held about a third of the registered nonagricultural population and a larger proportion of people working in nonagricultural employment. Designation as a town or city increases a jurisdiction's financial and administrative power, with cities having much more autonomy than towns. The seat of county government automatically gains town status, while villages with over 10 percent of their population, at least 2,000 people, holding nonagricultural residence status can request town designation. Towns fall under county government jurisdiction for planning and other administrative purposes. Cities become such through State Council approval. Towns may confidently seek city status if their nonagricultural population exceeds 80,000, their total output value exceeds Y 600 million, and they function as the center of the local economy. Cities have either county-level, prefectural-level, or provincial status. The prefectural-level cities, which numbered 191 in 1992, incorporate rural counties and, in the urban core, city districts, each with county-level government status. County-level cities are smaller, less wealthy, and have less concentrated populations. They also have fewer administrative and financial powers than prefectural-level cities. China's three largest cities, Shanghai, Beijing, and Tianjin, with nonagricultural populations of 8.8 million, 6.6 million, and 5 million, respectively, have provincial-level status. This gives them legislative independence and fiscal powers not enjoyed by other cities. The large migrant population holding official residence status in one place (usually a rural area) and living and working in another (most often urban or peri-urban), boosts actual urban populations above reported levels. Recent estimates put the migrant population at about 100 million, although many live and work in peri-urban areas, rather than in the urban core. B. URBAN CEINA 1.4 Population. China has the world's largest urban population, at 324 million in 1992, but an urbanization rate of only 28 percent (Box 1.1). The low urbanization rate is a relic of the urban policy in place from the late 1950s through the mid-1980s that sought to maximize resources available for industrial investment by increasing labor force participation rates while holding down urban infrastructure investment. The policy had as its centerpiece the careful control of population movement through residence permits coupled with grain rationing. The latter gave cities sufficient power over both housing and  - 3 - grain markets that unsanctioned migration became very difficult. With accelerating economic growth and a relaxation of control on migration, urban growth rates averaged 4.2 percent through the 1980s, lagged with the economic slowdown from 1989 to 1991, and then jumped to nearly 6 percent with the economic boom in 1992. With the recognition that cities are functioning as growth poles, and with the need to find jobs for an estimated 100 million underemployed rural people, the debate in China has shifted from whether to allow urban growth to how to accommodate it. Over the next two decades, urban jobs are expected to absorb most of the increment to the national labor force. 1.5 The 517 Chinese cities range widely in size. The largest, Shanghai, with a nonagricultural population of 8.8 million, is one of 32 Chinese cities with populations over 1 million people. The smallest city, Wanding in Yunnan Province, has but 3,500 nonagricultural residents and gained city status because of its strategic, international border location. The cities are concentrated in the eastern half of China, particularly on the seaboard and lower Yangtze River Valley. Their overall size distribution is shown in Table 1.1. Table 1.1: SIZE DISRBUTION OF CHINESE CITIES, 1992 Population >2 million 1-2 million 500,000- 200,000- < 200,000 _ _ _ _ 4 _ _ 1 million 500,000 _ Number of 10 22 30 141 314 Cities _ _ _ _ _ _ __ __ Source: Ministry of Construction (MCon). 1.6 Administration. China's development strategy from the 1950s through the late 1970s sought to create locally self-sufficient economies centered on industrial cities. Based on the expectation of large-scale nuclear war, this strategy fostered stable, powerful administrative structures. Local leaders were given broad latitude in the execution of relevant national and provincial policy and local administrations were expected to plan and undertake their own development. National plans and budgets aggregated and complemented those local plans. Enterprise tax and profit flows passed through municipal or county government coffers, with municipalities retaining a local share of about one third and remitting the remainder to the provincial governments, which in turn remitted the central government share.2 Centrally and provincially owned enterprises, as well as poorer areas, were supported through operating or investment reflows from the center and provinces, funded by surpluses from more prosperous areas. In poorer regions, greater dependence on higher-level funding reduced administrative independence, but the latter nonetheless remained substantial. 1.7 Although China's development approach changed over the 1980s and now supports economic integration and the flow of resources to higher-return areas, municipal power has not weakened. Of the Y 361 billion in 1991 nationwide budgetary revenue, Y 140 billion accrued to the central government and Y 139 billion accrued to the then 479 city governments (the remaining Y 82 billion went to county, prefectural, and provincial  governments).3 By 1991, municipal governments retained two thirds of their on-budget revenues and, directly or through their subordinate enterprises, now remain responsible for the bulk of all new investment and control most urban employment. 1.8 Cities have well-staffed administrations. In addition to employing staff to undertake the regulatory, police, and administrative work typical of cities everywhere, Chinese cities must staff bureaus that supervise city industrial and commercial enterprises as well as manage the flow of new investments (see Figure 1.1). Some environmental services, particularly water and gas, are provided by municipally owned corporations supervised by the Construction Commission or Public Utility Bureau, while others such as municipal solid waste disposal are provided directly by city bureaus. Municipal Environmental Protection Bureaus (EPBs) oversee enterprise compliance with environmental laws and regulations and manage the use of pollution levy fee loans and grants for pollution control investments. 1.9 To ease administration, medium and large cities are divided into districts, each with its own government and budget. In turn, districts are divided into neighborhood committees, which have elected leaders and very modest budgets, but are considered citizen organizations rather than government offices (hence neighborhood committee employees are not on the city payroll). District organization parallels that of the city, with district counterparts to the city's legal, administrative, public utility, and other organizations. District offices undertake much of the daily work of govemment, including, among the environmental services, drainage and sewerage, and solid waste collection and disposal. District governments themselves rely on neighborhood committees for some services, such as street sweeping. District governments may run businesses and earn revenue through fees for their services.4 The degree of district financial self-sufficiency varies throughout the country, with some districts wholly self-financing and others needing transfer payments. 1.10 Counties under cities operate with independent budgets, controlling their own revenues and expenditures, although revenues typically include transfers from the urban core. For strategic planning purposes, the counties are subordinate to the urban core, which can help cities solve transboundary problems. However, the urban core control is not absolute and county officials may successfully demand offsetting investment or other privileges if they forgo opportunities on behalf of the urban core. For example, after Shanghai decreed an industrial exclusion zone along the upper Huangpu River to protect water supplies, they assisted Qingpu county with industrial investment outside the exclusion zone to offset lost investment opportunities within it. 1.11 Wealth and Income. Table 1.2 shows the remarkable consistency of the per capita stock of industrial capital across city size, and that capital is somewhat more profitable in cities with over 1 million people. The latter cities generated 48 percent of all profit and tax revenue from 40 percent of the capital base in 1992. As a consequence, their on-budget financial revenue share ran over 24 percent above their population share. By contrast, the 314 smallest cities averaged per capita on-budget financial revenues less than two thirds those of the larger cities.  - 5 - Figure 1.1: MuNICIPAL GOVERNmENT ORGANIZATION (SHENYANG, LIAONING PRovINcE) Shenyang Bureau Import Company Bur'eCaugr* WPlannin avin oreign con iea rban n uragl Con- ShEducan Shnang Sc|eces& Teh anutry Prouon onenelPro Be rolsbu C oesiss on I Lred Compani trction CoB isi Compn Cion m pan PEletrolnic W ior"g Phenrdscg heEduction yeang1 _aBur* *u _ Tr*Cmp gny Cupanyu gricultal o OMchanical Eqpt | Shnyang burbua Matchlurgicn Import & Export C c Bureau Company Company Public Health| LihtInut ShLnggCt Induotr Shenyang ministrai _Proodn ExporMt inTrnsport Bureau laport Co pany Bureau D i Irural ti- Bureau ~~urea Wu r ng MetSl T Minorl Shenyang Envi- Sood rain Satno S; Indu!try _ Productz rotnantal Pro - Bus |Trolle busl Agriculture| Burtr au Cod iny tacsniration Bureau |Ctpany CoBureau Electronics 9 Uvn Pi:ducts| Sh n ng M Htoorological I Industry & q Ilcport E E Sport hnPlanng o B Bureau Bureau l CoBpany u uBureau q Weights Public Material | A[gr!cultur&lI Food & Oil. l Shenyang UXrban B | ubli a*urt| H chi... Imlport i. Export Conntructiou I Bureau l Company l |Buruu r Bureau Civil Adui.. | | Light Indust; | | Shnyang Con- | | llbood l [ Bureau r 1 Bureau Adtinistrgesi c 9tructiof Surb r eintn hst Bureau p vee Bureau o 75 on p t pop tio tural alvctra- domestic wateruse was barely halflarge-city leve ls.5 In the lgest cities, 5fi6.tion puruen I I Trsd i Co_orc | [Shenyang Con- have a e togas forcookin, bruction the smallest citis on 63 p t hv gsi(mtivs l~~~~~~-1 I il Bureau |rl Bureal| u*u 1 . 5uru Rurs l c Sall TR i dShennang Lond v 6 Poodp n mrin-r litionnl Scur- a u Industry Adeini t t Adrinistrhtiou b c eureu A c ity s urfau tration Bur vau c l Bureau 5 l~~~~~~~~~~~~~~~ansrt |- -tati tic 1 Labor LlAd ini trti.n AdBnsrto Bureau Jru | Bureau | Bureau F .. . .. . To rr H te il P i Bureau B lureau | W ight. L Mae- |_ ate;rial | Audit Bureau 1.12 Higher municipal income translates into higher levels of urban services. In the nine largest cities, 97 percent of urban residents have access to tap water, but in smaller cities, tap water supplies reach only 75 percent of the population and average domestic water use was barely half large-city levels.' In the largest cities, 56.6 percent have access to gas for cooking, but in the smallest cities only 6.3 percent have gas (most use coal). Residents of smaller cities do have 16 percent more living space per capita and use more electricity than residents of the largest cities.' All city sizes showed significant increases in service levels over the past 1S years.  - 6 - Table 1.2: CAPrIAL, PRoFiTs, AND FINANCIAL REVENE iN CNESE CrrES (as a percentage of all cities, 1992) Population >2 1-2 million 500,000 - 200,000 - < 200,000 million 1 million 500,000 Nonagricultural 22.5 18.5 13.1 24.4 21.5 population _ Enterprise 21.3 18.4 14.4 27.9 17.9 Capital Enterprise 27.5 20.6 13.5 20.8 17.6 Profits plus Taxes City On-Budget 30.9 20.0 10.9 21.5 16.6 Revenue Note: The enterprise capital totals do not reflect depreciation. Source: SSB, Zhongguo Chengshi Tongji Nianjian, 1992, SSB Publishing House, Beijing, 1992. 1.13 Urban residents enjoy incomes reflecting the high national income share generated in cities. Urban Chinese incomes average 3.1 times those of rural people, a gap that has been growing in recent years. And in-kind income and subsidies boost urban income another 50 percent above average nominal wages.7 Urban Chinese own an average of 74 color televisions per 100 families, have 52 refrigerators, and 83 washing machines, while rural households have only 8, 2, and 12, respectively. Urban personal savings account balances totaled Y 1,558 per capita in 1991, a cushion equal to 91 percent of annual average cash income. Housing space is tight, with only 7.1 m' per capita, but has doubled since 1980.9 The relatively high and rising incomes and assets of urban people make the application of beneficiary financing to collective urban services both practical and necessary. C. THE URBAN ENONMENT 1.14 The 9.2 percent annual growth of urban industrial output since 1981 has created much of the wealth reported above. Over the same period, a very active pollution source control program coordinated by the National Environmental Protection Agency (NEPA) has allowed the growth to occur without equally rapid increases in ambient pollution loads. Although some important types of pollution have been reduced, many ambient indicators remain at unacceptably high levels and much remains to be done in each of air, water, and solid waste pollution.  Figure 1.2: URBAN TSP, SO2 AND NOX LEvELs, NORTHERN AND SOURN CHINA, 1981-92 TSP LEVELS: NORTHERN AND SOUTHERN CHINA 1981-1992 mg/rm3 0.8 0.6 _ 0.41 0.2 _ 1 82 83 84 86 86 87 88 89 90 91 on Year - North -South SO. LEVELS: NORTHERN AND SOUTHERN CHINA 1981-1992 an/m s 0.14 0 . O 6 _s / O S 0.04 0.02 _ 1 82 83 84 86 88 87 88 89 90 91t 92 Year - North )* South NO. LEVELS: NORTHERN AND SOUTHERN CHINA 1981-1992 ms/m3 30 - 20 - 10_