Henry Sanderson
During the depths of the COVID-19 pandemic, former U.S. President Donald Trump called for a complete “decoupling” from China. Similar proposals came from Europe and Japan, where there was also a growing desire to re-shore supply chains, to end reliance on China for medical equipment such as masks and personal protective equipment. Western leaders no longer speak in these terms. Now they have agreed, instead, to “de-risk” global supply chains linked to China. This means maintaining trading ties and being open to cooperation with Beijing in multiple areas such as climate change while also giving government support and protection to essential homegrown industries. One of those critical industries, it has become clear, is clean energy technologies, an area that China dominates.
But when it comes to clean energy, the difficulty of successfully de-risking with respect to China has not been adequately understood by Western leaders or communicated to the public. Ever-larger subsidies and financial support has been offered to companies to stimulate domestic manufacturing. Although the aim of accelerating clean energy manufacturing is welcome, the strategy is not sustainable. The West needs a more refined approach, and the answer cannot be subsidies alone. If Western governments begin an all-out subsidy war against each other, that will only shift investment to the highest bidder. Nor would subsidies achieve their purpose. Attempting to compete with China on cost in every sector would likely waste taxpayer money, delay the energy transition, and lead to greater damage from climate change, with minimal geopolitical gain. Instead, Western governments should think carefully about how to compete with Beijing for the long haul.
To do so, the West should clarify which sectors it must absolutely support at a loss in order to reduce its reliance on China for national security reasons. These sectors include rare earths, for example, which have military uses. For other sectors, careful thought will be required to determine how to compete with China on costs. The answer cannot simply be subsidizing the cost difference with taxpayer money or banning Chinese imports; those actions will just increase the cost of clean energy. Tariffs on Chinese solar panel imports, for example, have helped support domestic suppliers, by restricting price competition, but have also increased the price of solar installations in the United States. To compete with China, low-cost, scalable, and sustainable innovations are required in mining, processing, and manufacturing, and these must be supported by customers rather than just subsidies.
When it comes to clean energy industries, the West lags far behind China. China is at the forefront not just in production and deployment of clean energy technologies but also now in innovation. If that situation continues, the world will be reliant on China for not only current technologies but future ones, too—and the West will lose out in one of this century’s largest economic opportunities. The West is right to focus on de-risking its supply chains with China. But a subsidy war between countries and direct competition with China, especially in terms of cost, in every area, are not contests that the West can win. It must, instead, focus on priority areas in which it relies excessively on China or sectors in which it can realistically compete. Finally, the West must push customers and the market to support Western supply chains rather than relying on government subsidies alone to support homegrown producers.
WHEN THE WEST LOST ITS CHANCE
It did not have to be this way. The West invented all the key clean energy technologies: the silicon solar cell was produced at Bell Labs in the United States in 1954; the lithium-ion battery was pioneered at ExxonMobil and the University of Oxford in the 1970s and 1980s; the wind turbine industry was developed in Denmark; and General Motors helped invent the rare-earth permanent magnet, which is used in electric motors, in the 1980s. But the West never truly capitalized on these inventions, squandering its early lead.
This was not because of a lack of popular interest in these technologies. In fact, as oil prices soared in the 1970s, there was strong support for clean energy among governments and the public. But that support dried up when oil prices fell in the 1980s. The oil companies, the major investors in solar power, exited the sector and began to spread disinformation about climate change. Exxon got rid of its battery efforts in the early 1980s, and GM’s rare-earth permanent magnet business was sold to China in 1995. Production of the magnets in the United States ended soon after.
Not only did the West squander its lead in clean energy technologies but it also helped China—then a poor developing country—get started in that sector. In the 1980s, a Danish government grant supported the building of wind turbines in Xinjiang. In the early 2000s, German companies went to Chinese solar plants to teach them how to produce solar cells and modules. China, having taken advantage of Western knowledge, then began to innovate just as the West began to lose enthusiasm for climate action. The Obama administration’s 2009 Recovery Act earmarked more than $90 billion for clean energy initiatives, out of a total of around $800 billion. But Congress frustrated the administration’s attempts to pass climate legislation, and many of the era’s startups went bankrupt and were bought by Chinese companies. The United States’ opportunity was lost.
De-risking with China is not adequately understood by Western leaders.
In contrast, Beijing proactively stimulated its domestic market. The government heavily subsidized electric vehicles and domestic solar installations. The result is China’s current position as a leader in the manufacture and deployment of both technologies. But that feat is not solely a result of subsidies. In many cases, the Chinese scaled up and manufactured better products than Western companies. Some Chinese firms have been pioneers: the manufacturing company BYD launched its first plug-in hybrid electric vehicle in 2008, at a time when most global automakers believed electric vehicles to be a costly fantasy.
Recent Western tariffs and import restrictions have done little to dent Beijing’s dominance in clean energy manufacturing. China is simply too far ahead now and its advantage in critical minerals and solar power is too great to make meaningful decoupling possible in this decade. China produces almost 70 percent of the world’s graphite for batteries, processes over 90 percent of the manganese for batteries, produces most of the world’s polysilicon for solar cells, and manufactures almost 90 percent of the world’s permanent rare-earth magnets. The main material used in an electric vehicle battery by volume is graphite—and over 90 percent of the type used in batteries is made in China.
China believes that its dominance enables it to overpower Western competition, and the country’s leader, Xi Jinping, has already acted to take advantage of this situation. This year, he announced tighter export restrictions on certain minerals needed for clean energy industries, including gallium, germanium, and graphite. Beijing has also increased rare-earth production quotas, despite declining prices. China has built up significant capacity and investment in clean energy supply chains—enough to provide the whole world with batteries and solar panels for a decade. That excess capacity will put further pressure on prices, making it even harder for Western companies to compete. It will also increase the pressure on Chinese companies to invest overseas and seek new markets, encouraging them to find loopholes in Western policies designed to keep them out.
LESS MONEY, MORE SUCCESS
There is a fundamental tension in the clean energy economy between what is good for the planet and what is good for business. Lower prices for batteries, solar module panels, and wind turbines help drive down the costs of clean energy. But they reduce margins for producers, making it impossible for many such companies in the West to succeed. Europe’s solar industry, in particular, is being overwhelmed by a flood of solar modules from China. The industry’s main lobbying group recently appealed to the European Commission for help, citing “a deeply precarious situation for European solar PV [photovoltaic] manufacturers.” The Obama administration faced a similar situation in the 2010s, when Chinese solar panels overwhelmed global markets. As former U.S. Energy Secretary Steven Chu has said, even a subsidized plant will not be profitable if the supply is not needed by the market. “A finished solar factory, due to overinvestment, it’s not going to be used,” he said in 2020.
Even with subsidies, a Western company will struggle to compete. For example, if China produces 90 percent of a processed mineral needed for electric vehicles and has a 10-to-15-year head start, then entering that market as a Western startup will be difficult. A Western company would need to raise funds for upfront costs at a time of higher interest rates. And in any case, it would likely take two to three years for a customer such as a major automaker to test and qualify any new material as safe and of sufficient quality to be used in mass production. Adding in the time necessary to get permits, it is unlikely that this company could meet U.S. and European demand until the latter half of the decade. By that time, Chinese production may have moved further down the cost curve.
Automakers, then, must choose whether to spend money buying cheaper materials from China to produce lower-cost electric vehicles now, helping the world reduce emissions, or bet on new Western plants with unproven results. At the moment, cost is winning out. As a result, companies are incentivized to hide their Chinese involvement so they can get the materials. Instead of greenwashing, the practice of marketing oneself as more green than one actually is, companies will engage in “China-washing.” They will carefully arrange their equity ownership shares or shift their investments to certain eligible countries to comply with U.S. and European subsidies, but without reducing their dependence on Chinese products.
MAKING UP FOR LOST TIME
In the battle over clean energy technologies, the West has a few advantages. Countries such as Canada, Norway and Sweden rely on electricity from hydropower that can lower the cost as well as the carbon footprint of producing clean energy technologies and processing critical minerals. Although Chinese companies are increasingly relocating to provinces with hydropower resources, it will take many years to change their large, incumbent industry. Western companies also have the advantage that, when planning a new plant, they do not need to copy the technology that China uses, which can be damaging to the environment. Battery production and processing of battery materials in China is often energy-intensive and in the case of critical minerals such as graphite, uses environmentally harmful chemicals including hydrofluoric acid. In the West, minerals can be processed without acids, and batteries produced without certain energy-intensive processes. This makes Western manufacturing more environmentally sustainable and, potentially, cost efficient. If the West can scale up technologies where innovation results in a reduction in the cost of producing an existing technology, then that would give its companies a strong competitive edge. It could also reduce the environmental cost of producing clean energy.
Still, innovations that are insufficiently cost competitive will not succeed. Consumers will not pay a high premium just to support a homegrown producer, and they should not be expected to. But Western governments can use industrial policy to enable their markets to pay slightly more for a more sustainable supply chain. This should also help lower the cost of capital for its clean energy companies. The European Union has adopted this approach by mandating sustainability and recycling criteria for batteries imported or produced in Europe. The market must then move toward introducing a green premium, whereby buyers pay slightly more for a greener product. Of course, China can do the same and also improve the sustainability of its supply chain, but this will take time, and many Chinese customers may be unwilling to pay a premium for a lower-carbon product. Western automotive companies, by contrast, are already starting to advertise the environmental footprint of their vehicles and their use of responsibly sourced minerals.
The West faces a conundrum: it cannot decarbonize without China. To achieve its climate aims, the West needs to buy goods from a country that it views as a key strategic competitor. At the same time, if Western taxpayer money is spent with nothing to show for it, or if Western government money merely ends up in the coffers of Chinese companies, there will be a voter backlash. There are already ominous signs that Western consumers may be unwilling to bear the costs of incentivizing a shift toward clean energy: earlier this year, the United Kingdom watered down its climate targets to pander to voters uninterested in bearing the costs of the climate transition. In Germany, too, there is opposition and the right-wing party Alternative for Germany has criticized green government policies as “eco-dictatorship.”
To create hundreds of thousands of new green jobs, Western governments will need to make viable investments in clean energy manufacturing that are supported by the market and customers. That is the only way to really build up popular backing for climate action. Starting a clean energy trade war, which would likely provoke China into taking retaliatory action, or overpromising on industrial policies is not the solution. The West should keep in mind this tricky balancing act when designing a strategy for China.
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