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A decade after China started to explore water basin eco-compensation, the first inter-provincial payments for improvements in the Yellow River basin have been made. Experts hope it provides a path toward incentivizing green behavior

By Wang Yan , Chen Shulian Updated Oct.1

Pictured is a section of the Yellow River in Taohuayu, Zhengzhou, capital of Henan Province, June 14, 2020. Taohuayu is where the lower reaches of the Yellow River begin

The first ever ecological compensation payment for improvements in Yellow River water quality was paid recently. On July 5, Shandong Province announced it would pay Henan Province 126 million yuan (US$18.66m) after Henan delivered on water quality goals the two provinces set in 2021. Had Henan failed, it would have to pay Shandong. 

Eco-compensation is an incentive-based system for improving the environment. The World Bank defines it as a “method of fiscal transfer for natural resources management.” The Henan-Shandong agreement is the first ecological compensation mechanism along the mainstream of one of China’s major rivers, and it was seen as a major move toward a market-based system of eco-compensation for watershed services and conservation, and a model for incentive-based green policymaking.  

In 2021, Henan Province, split in two by the middle and lower reaches of the Yellow River, and Shandong Province, where the river enters the Bohai Sea in an expansive delta, signed the Ecological Protection Compensation Agreement of the Yellow River Basin (HenanShandong Section). According to the agreement, if the water quality in the Henan section of the Yellow River improved by one level from Class III (see sidebar) over the course of one year, Shandong will pay Henan 60 million yuan (US$8.89 million), and if the water quality worsened by one level, Henan must pay Shandong 60 million yuan.  

In addition, Shandong will pay Henan 1 million yuan (US$148,000) for every one percentage point decrease in the annual key pollutant index, which includes measurements of chemical oxygen demand, ammonia, nitrogen and phosphorus. Reciprocally, Henan will pay Shandong 1 million yuan in compensation for every one percentage point increase in the annual pollutant index, with a ceiling of 40 million yuan (US$5.92m).  

Netizens called the agreement an “expensive bet.” As the “bet” has been set for over a year, and the water quality of the Yellow River flowing into Shandong remained above Class II, Shandong, which benefited from an improved environment, paid 126 million yuan (US$18.66m) in ecological compensation to Henan as promised. 

Setting the Deal 
The Yellow River flows through nine provinces and autonomous regions from China’s west to east, with a length of 5,464 kilometers. It passes through important ecological and agricultural areas. The basin is an important energy, chemical, raw material and industrial base for the country. However, since the 1990s, the Yellow River basin has faced prominent ecological and environmental problems, with almost all the main tributaries seriously polluted. The main river saw medium pollution.  

Both Henan and Shandong have suffered from pollution caused by upstream discharges. In response, the State set up an online water quality monitoring system on important river junctions, and set water quality assessment targets for each section, such as the Liuzhuang section between Henan and Shandong provinces.  

In 2020, the Ministry of Finance, Ministry of Ecology and Environment, Ministry of Water Resources, and National Forestry and Grassland Administration issued the Implementation Plan for Supporting and Guiding Pilot Implementation of a Horizontal Eco-compensation Mechanism in the Entire Yellow River, which directed local governments to “jointly shoulder protection, make joint environmental governance and enjoy joint ecological benefit sharing,” to encourage models for ecological compensation for the whole river basin.  

Soon after, Shandong and Henan signed the first inter-provincial horizontal ecological protection compensation agreement of the Yellow River Basin in May 2021. Their mechanism was based on the water quality monitoring results of the Liuzhuang section.  

As the agreement allowed for two-way payments according to results, ecological compensation becomes more impartial. It ensures the rights and responsibilities of both sides, and stimulates passion and enthusiasm for ecological restoration initiatives. 

Henan was in it to win it from the start. It launched the Yellow River basin ecological environment management scheme, set up water pollutant discharge standards, implemented up to a hundred comprehensive improvement projects, and cut heavy industry emissions, including steel and cement production.  

According to local water quality monitoring data, after water pollution management, the Manghe River branch of the Yellow River in Henan Province improved from Class V – the most polluted – in 2018, to Class III now. 

Fulfilling Compensation 
The payment shows that Henan’s efforts in the past two years have paid off. 
“The eco-compensation payment covers two years, 2021 and 2022, of which 76.23 million yuan (US$11.29m) was for 2021 and 50.05 million yuan (US$7.41m) for 2022,” a staff member from Shandong Provincial Department of Finance, Natural Resources and Ecological Environment, told dahe.cn, a news portal in Henan Province, on July 14. 

According to the employee, water quality at Liuzhuang, which is in Henan, was at an average Class II in 2020, thus Shandong would pay 600 million yuan to Henan. In addition, the key pollutant index at Liuzhuang was 0.955 (above 1 means polluted) down by 16.23 percent from 2019. According to the compensation standard of 1 million yuan for every 1 percentage point drop, Shandong should give Henan an additional 16.23 million yuan (US$18.66m). Therefore, the total eco-compensation Shandong paid to Henan in 2021 added up to 76.23 million yuan (US$11.29m).  

Water annual quality also reached Class II in 2021, so Shandong should pay Henan 60 million yuan (US$8.89m). However, the key pollutant index at Liuzhuang was 1.050 in 2021, an increase of 9.95 percent from 2020, so Henan had to instead compensate Shandong 9.95 million yuan (US$1.47m). Therefore, Shandong paid less overall in 2022, as Henan failed to completely meet all the water quality standards it promised. 

“The amounts of compensation from the downstream region to the upstream one significantly exceeded the amounts paid the other way around, which reflects an overall improvement in upstream water quality,” said Yu Wenxuan, director of the Institute of Environmental and Resource Law at the China University of Political Science and Law. “From this result, we can see the ‘deal’ is indeed a win-win situation for the two parties.”  

Yu said that ecological protection of the Yellow River basin has achieved remarkable results, and the water quality both inside the province and at its border has improved significantly. Henan Province received eco-compensation funds, so it gained economically too. “This is the innovation of the horizontal ecological compensation model of the inter-provincial river basin,” Yu said. 

A view of the Xin’an River, Anhui Province, March 23, 2017

An aerial photo of the Yellow River as it flows near Jinan, capital of Shandong Province, May 14, 2022

Continuous Exploration 
Although the first project on a major river, eco-compensation has been practiced in China for years.  

It is easier to establish an ecological compensation mechanism within a province. At present, 11 provinces, including Shandong and Henan, have established provincial compensation mechanisms for ecological protection in river basins within their borders. Shandong took the lead in rolling out eco-compensation in all 133 counties within river basins. Progress on inter-provincial eco-compensation, however, is comparatively slow. 

At the end of 2010, government agencies gave 50 million yuan (US$7.4m) to Anhui Province to launch the first inter-provincial horizontal eco-compensation program along the Xin’an River, which flows from Anhui to Zhejiang Province, an early example of the scheme. In 2011, Anhui and Zhejiang started the “Xin’an River model” composed of central financial compensation plus local compensation. It was the first inter-provincial river basin eco-compensation mechanism in China. Since 2012, central government funding provided incentive to Anhui to improve the river’s water quality. If it met the agreed standard, Zhejiang would pay Anhui about 100 million yuan (US$14.8m) that year. According to the Anhui-based Huangshan Daily on July 19, water quality in the river had matched the metrics set in the agreement for 11 years in a row and reached Class II to III in different parts.  

In 2011, the governments of four cities in Shaanxi Province including capital Xi’an, as well as a national agri-tech park, and two cities in neighboring Gansu Province signed the Framework Agreement on the Wei River Basin Environmental Protection Cities Alliance, later issuing a series of river basin protection regulations.  

In 2016, the Ministry of Finance and other central government departments issued “Guiding Suggestions for Speeding up of Establishment of River Basin Upstream and Downstream Horizontal Ecological Protection Compensation Mechanism,” requiring all provinces and regions to set up horizontal ecological protection compensation mechanisms by 2020, and explore pilot programs for ecological compensation along cross-provincial rivers. By 2025, the schemes are expected to expand.  

So far, according to the Ministry of Ecology and Environment (MEE), it has coordinated with 18 provinces and signed 13 inter-provincial watershed horizontal eco-compensation agreements, half of which have fulfilled at least one round of compensation agreements.  

Addressing the significance of the eco-compensation between Shandong and Henan, Jin Leshan, director of the China Ecological Compensation Policy Research Center, told the Beijing News in early July that most ecological compensation practices for river basins centered on southern China, especially the Yangtze River basin. The Shandong-Henan scheme shifts the focus north and to the main stream of the Yellow River rather than tributaries.  

However, there are still many challenges to these schemes. According to Yu Wenxuan, China has not yet formulated a specific law, with legal provisions scattered in the Law of Environmental Protection, the Yangtze River Protection Law, and the Forest Law of China.  

These laws advocate for and encourage regulation, but they lack provisions on the scope, object, subject demarcation, funding source, compensation standard and fund management. Some government departments suggested plans. However, environmental experts said these documents are mostly advisory and carry little legal weight.  

Yu said the most common way the scheme works is through direct cash payments. However, this method does not ensure the long-term effectiveness and stability of the ecological compensation. The timely placement of compensation funds also directly affects implementation. Also, some ecological interests are difficult to quantify through money, which makes determining compensation standards more difficult. “There are also no clear norms on the ways and procedures of eco-compensation,” Yu added. 

Innovative Measures 
How to explore the ecological compensation model and establish a cross-regional environmental protection governance cooperation mechanism according to local conditions has always been the focus for stakeholders.  

“Strict ecological compensation of the river basin is quite complex. It requires value accounting of upstream and downstream ecological products,” said Zhang Bo, director general of the Department of Water Ecology and Environment under the MEE in January 2022 during a press conference. Zhang said that a unified national eco-compensation standard is not ideal, considering the conditions of different regions and river basins. Standards should adapt to local conditions.  

The current approach, Zhang said, is to adopt some points that are easily accepted by the upstream and downstream governments of the river basin, such as the water quality target of the junction section between upstream and downstream provinces. “We’ll start with the easier approach before taking the much more difficult one so we can promote the smooth development of horizontal ecological compensation,” he said. 

Some new measures have started pilot programs in river basins such as the Xin’an River. Anhui and Zhejiang provinces have set up the country’s first inter-provincial watershed green development fund, and are exploring ways to build green industry cooperation demonstration zones in the Xin’an River Basin.  

“This is not limited to the financial compensation model anymore, and through industrial cooperation, [the two provinces] are to form a mutually beneficial ecological compensation mechanism,” Zhang said.  

The next step, according to Zhang, is for the MEE and the Ministry of Finance to continue to support the construction of ecological compensation mechanism and encourage all localities to take part in pilot programs.  

He Daixin, director of the financial research office of the Academy of Financial Strategy of the Chinese Academy of Social Sciences, suggested that market mechanisms could be adopted to stimulate the enthusiasm for ecological protection.  

“It would be best for a compensation system for ecological protection to combine the effective market with behavioral government. Compensation itself reflects the economic costs and benefits. It will no longer solve the ecological protection problem completely through government, but it will work through a more transparent and quantitative market mechanism to establish a multi-party compensation mechanism,” He said.  

Yu Wenxuan suggested trying policy compensation, physical compensation, technical compensation, service purchase and training for professionals to achieve targeted outcomes for watershed improvements.  

“We should also strengthen the management of ecological protection compensation funds, and stipulate legal responsibilities for illegal misappropriation or interception of compensation funds, and strengthen the accountability system,” Yu said.