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Combating China’s Trade Subsidies Isn’t the Entire Answer

Solar Subsidy Case Shines Light on China’s Extensive Industrial Strategies

SOURCE: AP/Andy Wong

Solar energy company CEOs speak during a November 2011 press briefing in Beijing, China, after a group of China's biggest solar energy companies rejected a U.S. trade complaint that they are unfairly supported by the Chinese government.  

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See also: Filling in the Gaps in Our Trade Intelligence by Sabina Dewan; The Complexities of the U.S. Decision on Chinese Solar Panel Imports by Melanie Hart and Kate Gordon

The U.S. Department of Commerce early next week will rule on whether the Chinese government illegally subsidized exports of solar panels to the United States. However the decision comes down, one thing remains clear—the United States cannot simply rely on strong enforcement measures of international trading rules to ensure the sustained competitiveness of the U.S. economy.

Whatever unfair or prohibited practices China’s government may be deploying, it is also doing things that are both legal and extremely effective at cultivating the development of increasingly efficient and advanced manufacturing industries. Taken as a whole, these policies pursued throughout the different levels of China’s government—national, provincial, and local—constitute an effective economic strategy. In comparison, the policies and institutions in place in the United States are not yet modernized to address today’s world economy.

China’s economic success does not merely result from evading the global rules of the game. Take China’s undervalued exchange rate, for example, which has been at the forefront of political and policy debates for nearly a decade. China’s policymakers began appreciating their currency against the dollar in June 2005. Since then, the undervalued currency has climbed in value by nearly 40 percent in inflation-adjusted terms. But rather than rebalancing our trading relationship with China, the U.S. trade deficit with China instead deepened by 32 percent, relative to the size of our economy.

China’s currency is still undervalued, but its economic strategy is yielding real productivity, efficiency, and quality gains beyond what mere production subsidies can provide. If Americans want to compete—not just with China but also with other industrial nations that understand the importance of manufacturing for overall economic health—we need to understand how China’s industrial economy works and put in place the policies that will once again encourage manufacturing to flourish here, rather than continue to move offshore.

First, China’s financial system succeeds in mobilizing substantial resources for investment, while in the United States business investment was wallowing near historically low levels even before the Great Recession and the global financial crisis. Investment is the stuff that economic growth is made of, and in China the rate of investment accelerated from 35 percent of gross domestic product—the total value of goods and services produced in the economy—to 49 percent between 2000 and 2010. Meanwhile, the U.S. investment rate fell from 18 percent in 2000 to 16 percent in 2007 before plunging further during the recession and financial crisis.

Conventional wisdom in the United States holds that state-owned Chinese financial institutions are funneling loans to state-owned Chinese enterprises on noncommercial terms. This is true but explains only a minority of China’s investment. More than three-quarters of investment in China is being funded not by central plans in Beijing but rather by business taxes collected by local governments, the retained profits of businesses under control of local governments, and other revenue sources within the domains of local government officials. Although local officials, operating with great autonomy, are supplying these substantial resources to support industrial development, they do so often in joint-venture partnerships with private and foreign companies, operating in fiercely competitive markets and political environments.

Big business in the United States suffers no shortage of low-cost capital, holding more than $2 trillion of uninvested cash reserves and enjoying negative real interest rates in commercial paper markets for several years running. But U.S. nonfinancial corporations seem more interested in playing financial games than making real investments—spending an average of 108 percent of profits to prop up their stock prices by buying their own shares and issuing dividends to investors. In 2011 U.S. nonfinancial corporations—we’re not talking Wall Street here—owned more financial assets than factories, equipment, and other real assets combined.

Second, government support for industry in China does not merely provide production subsidies to inefficient companies that would not otherwise survive. Hard evidence on subsidies and other supports are limited, but it is clear that a main objective of supports is to help emerging companies with the costs of:

  • Adopting and commercializing new technologies
  • Discovering and learning how to sell into new markets
  • Attracting and coordinating complementary investments where one company’s success may be interdependent with others in a supply chain

Such efforts are consistent with solving a number of “market failures” identified in economics research and look suspiciously like programs that have operated for years in federal, state, and local governments in the United States, which have been under assault in recent budget battles.

Finally, China’s government remains committed to macroeconomic policies that strive for full-employment and public investments in education, science, and infrastructure. Such investments improve skills and knowledge in the workforce and lower costs that make businesses more competitive. These types of investments also help the Chinese economy maintain a high level of demand and employment that give businesses confidence to invest and allow them to operate with more efficient economies of scale and to increase productivity through “learning by doing” on the factory floor.

It’s not just China that makes this productive range of investments in its own economy. Germany, Japan, and countless other countries have strategies for their industrial economies. The United States does not.

To be sure, U.S.-based producers do face problems with unfair competition from China and other countries pursuing economic strategies for industrial development. Rigorous enforcement of trading rules is needed, and to his credit, President Barack Obama and his administration have brought more major trade cases against China than any of his predecessors, and even moved this month to create a proactive interagency trade enforcement task force.

But if we are not prepared to play this game, we cannot win by just appealing to the referee. Instead, we need to up our own game by:

  • Modernizing our basic infrastructure to allow businesses to more effectively collaborate and compete in domestic and international markets
  • Investing in more science and math education and workforce development to ensure our workers are able to participate fully in a technology-driven economy
  • Crafting finance policies to make more public and private capital available to innovators and bolster our culture of entrepreneurship
  • Honing our research and development policies so that we invest not just in basic research but also in the full innovation lifecycle, from invention to development to commercialization
  • Retooling our government’s approach to trade and competitiveness to encourage our nation’s unique competitive strengths

The Obama administration is pursuing many of these strategies but is unable to do so completely due to congressional inaction, inertia, and, at times, simple intransigence, especially in the House of Representatives. The forthcoming Department of Commerce decision on Chinese solar panel subsidies is just the latest reminder that our failure to implement a cohesive competitiveness strategy forces American workers and businesses to compete with one hand tied behind their backs.

Adam S. Hersh is an Economist at the Center for American Progress.

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