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Don’t Miss the Forest for the Trees

U.S. Investment in Clean Energy at Home Is the Best Response to China’s Protectionism

SOURCE: AP/Muhammed Muheisen

Some companies, like California's Coda Automotive pictured here at their factory in China, have managed to cross China's protectionist barrier because their primary market is the United States. But a larger problem remains for American companies: the lack of develpoment at home leaves little opportunity to actually invest here.

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Foreign governments’ and businesses’ frustration and disgruntlement over China’s restrictions on trade and foreign investment is reaching fever pitch. First it was Jeff Immelt, the chief executive of General Electric in a speech in Rome earlier this month raising the question of whether China “want[s] any of us to win, or any of us to be successful.” Then it was the chief executives of BASF and Siemens together with German chancellor Angela Merkel in an exchange with Chinese Premier Wen Jiabao last weekend in Beijing, who all reportedly used pointed language to call China’s restrictive foreign investment and trade policies to question. These complaints, while valid, point to a larger problem here in the United States—we give the Chinese government leverage by not giving companies valid market alternatives.

There has been particular attention on Chinese government policies in the clean energy sector that favor domestic companies and products over their foreign counterparts. This is a new industry and represents a rapidly growing market for foreign firms. But there is also a widely held notion in the international business community that clean energy should be more open to foreign competition since it doesn’t raise the same national security concerns as tightly held industries such as defense or telecommunications.

Despite a substantial 19.6 percent rise in foreign investments into China over the first six months of this year, there is still a growing question whether China is using industrial policy beyond legitimate means of promoting domestic development of fledgling industries, and actively shutting out foreign competition so as to cultivate national champions. After all, China’s Medium-to-Long Term National Plan for Science and Technology Development, or S&T Plan, released in 2006, does explicitly call for the “the country’s reliance on foreign technology [to] decline to 30 percent or below.”

The frontlines of this debate lie in the Chinese government’s policies to promote homegrown innovation, or “indigenous innovation” as it is called. The National Indigenous Innovation Accreditation Program, initially announced last November, directs Chinese government agencies and provincial governments to procure products listed in a newly created product catalog covering six categories from companies that meet certain criteria. The release had foreign businesses up in arms. Foreign companies rightly charge that the criteria used to determine whether or not a firm’s product qualifies for the catalog discriminates against their products and excludes them from potentially lucrative Chinese government procurement contracts.

Excellent overviews of the details surrounding these government procurement guidelines are available elsewhere, but several points are worth bearing in mind. First, what the Chinese government is doing is not unique and the use of government procurement to promote innovation is a legitimate policy tool. The U.S. government itself grants some degree of preferential access to government procurement contracts for American businesses for national security reasons, but also to stimulate innovation in small businesses. And the American Recovery and Reinvestment Act also contains “buy American” provisions. Although numerous waivers to the provisions are allowed, they demonstrate the propensity to favor American businesses over foreign.

Second, the Chinese government has demonstrated flexibility in response to international diplomacy. After the Chinese government announced the initial catalog in November 2009, written comments from a number of international trade groups led to a revised set of guidelines released in April 2010 that significantly reduced, but did not completely eliminate these foreign concerns. Still, this outcome shows that the Chinese are not impervious to external pressure and sets a positive precedent for further diplomacy to address some of the other restrictive policies.

Third, China has just submitted a proposal to join the Government Procurement Agreement under the World Trade Organization, which if accepted by its trading partners would bar China from discriminating against products in government procurement solely because they are foreign in origin. Some doubt that China’s proposal will be robust enough to win approval—the Chinese would certainly seek to carve out a fair number of exceptions to the application of nondiscriminatory treatment, and China has previously had a proposal to join the GPA rejected in 2007—but the submission does signify China’s desire to be integrated into a rules-based trading system.

The indigenous innovation product certification regime is just one of a range of protectionist measures that the Chinese government has employed to encourage indigenous innovation and support the development of domestic clean energy companies. Other measures include domestic content requirements, technical standards setting that may favor domestically produced technologies over foreign ones, and consistent failure to award foreign firms bid contracts in government-run wind projects.

Still, there are success stories of American companies such as eSolar and American Superconductor making headway into the Chinese market. These companies offer world-class technologies or designs that domestic firms do not offer. And the Chinese government is again revising its foreign investment catalogue to encourage foreign firms to invest in China in selected sectors that are generally hi-tech in nature, including clean energy. This revision also follows new policy guidance this April by China’s State Council that encourages a shift in foreign direct investment from traditional manufacturing sectors to high-tech industries and higher value-added services.

But even a perfect set of policies is not enough. It is also important for Chinese authorities to implement and enforce those policies, and this is no more true than in intellectual property protection. If China is serious about learning from other countries, it has to get serious about protecting foreign investments to increase investor confidence so that the best technologies can be brought to home soil.

Top Chinese leaders understand this—Vice President Xi Jinping acknowledged earlier this year that “proper protection of intellectual property rights” is critical for technology transfer from developed to developing countries, while Minister of Commerce Cheng Deming has on the same note observed that “a nation will not be innovative without the protection of the intellectual property right[s].” It is also in the international community’s best interests to help China build capacity in this area.

But the international community has to realize that market access is not everything. International firms should not lose sight of the full range of opportunities that the Chinese economy presents beyond the direct sale of products and services, such as using China as a research and development base to tap into their abundant skilled engineering talent and as an operating base through joint ventures with domestic companies to gain access to low-cost capital from state-owned banks; or sourcing manufactured components at competitive prices; or licensing world-class Chinese technology for use in non-Chinese markets.

Take Coda Automotive, for example—a company whose China operations CAP visited this April. Coda is a California startup that aims to be among the first companies to commercialize a pure electric vehicle. Coda’s target market is California, but it manufactures its car batteries and assembles its final product in China with various Chinese partners for final export to California. It also takes advantage of China’s auto supply chain by sourcing other key components, but continues to import 35 percent of its parts from the United States because the best quality parts are still here. The primary reasons for locating its operations in China are the ability to rapidly build out manufacturing infrastructure, the availability of low-cost capital in the form of generous financial incentives and credit lines provided by the local government, and China’s skilled technicians and existing auto supply chain. Coda has taken advantage of many of China’s benefits yet encountered none of the market access barriers because their ultimate market is the United States. (Encouragingly, Coda has just announced its intent to open a manufacturing plant in Ohio.)

But this discussion in some ways risks losing the forest for the trees. The aggressiveness of Chinese industrial policy is a symptom of a larger ill. The larger ill is that the United States has “protected” its own clean energy market by failing to develop it in the first place, leaving American clean energy companies with few opportunities for investment at home.

The United States risks falling behind China, as well as other Asian and EU countries, because of its failure to create a long-term vision for clean energy development and a stable policy framework to realize that vision. What the United States has instead is a patchwork of differing state and local policies paired with federal policy tools that are temporary and unpredictable. The result is that the United Sates has been tremendously successful in inventing many important clean energy technologies, but has faired less well in mass production and commercialization relative to the size of its economy. We found in our previous report “Out of the Running?” that the United States had just over 2 watts per $1,000 of gross domestic product of installed renewable power capacity by the end of 2008, for example, compared to 9 in Germany, 14 in Spain, and 18 in China.

We are seeing evidence that creating stable markets for clean energy technologies ultimately attracts other parts of the value chain, including manufacturing and research and development, which is most threatening to America’s traditional strength in innovation. China is a case in point. One message rings consistently clear—their decision to locate factories or research and development centers in China is not primarily motivated by any domestic content requirement or tax benefits or discounted land prices. It’s driven by a desire to be close to the single largest and fastest growing market for clean energy technologies in the world—a market created by the Chinese government’s clear, long-term commitment through stable, comprehensive policies.

Financial Times’ Beijing-based columnist Geoff Dyer characterizes the situation well, saying, “Multinationals have a choice…They can complain as loud as they like about Chinese industrial policies, but if they continue to behave as if there is no alternative [to getting fair access to China’s markets], Beijing will keep calling their bluff.”

Some U.S. legislators and policymakers are quick to shift blame for America’s lopsided trade deficits to other countries’ industrial and trade practices. But the core problem lies within—at least in the case of the clean energy sector. We just choose to ignore it at our own peril.

This column is based on excerpts of CAP Action’s Senior Policy Analyst Julian L. Wong’s full written testimony to the U.S.-China Economic and Security Review Commission on July 14.

Julian L. Wong also blogs on Chinese energy and environmental issues at http://greenleapforward.com.

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