Accelerating the clean energy revolution by working with China

It has become obvious in Washington that America must take a tougher stand against China. This is evident in clean energy, a critical future industry in which Chinese suppliers are treated as an existential threat rather than crucial to America’s success.

This approach will backfire. America already lags behind China in many respects. Cooperation and competition, not hostility, is how we can catch up with the world’s largest supplier of clean technology products. Large tariffs and barriers on Chinese companies doing business in the United States will undermine this strategy. These anti-China policies are already making it harder for American companies to keep pace with the world’s best innovations and redefine the technological frontier with their own ideas. Ultimately, isolating ourselves from China will not only fail, but will also harm American companies, workers, and innovators. Moreover, it will raise the costs of green technologies, making it even more difficult to clean up the global energy system.

The U.S. strategy should help U.S. companies compete on the border while avoiding overdependence on China. Success requires understanding how China has become so dominant in so many clean technologies and how trade and investment can help advance American industries, workers and communities.

Understanding China’s dominance and our dependence

There is no doubt that the world has become too dependent on China, especially for the raw materials that make up the clean energy economy. China refines 60% of the world’s lithium and almost 90% of rare earth metals (used in magnets for engines and generators, such as wind turbines). The demand for such minerals will grow rapidly as the clean energy revolution progresses.

The big opportunities for competition and cooperation lie not in the ingredients, but in the products – this is where China really leads with innovation and excellence in design and manufacturing. China’s battery and solar power producers are world-class producers – they operate and increasingly set the global frontier. Their competitiveness comes from manufacturing innovations aimed at producing huge volumes with minimal costs and minimal defects. For example, leading Chinese manufacturers have all their automated battery and electric vehicle production lines because workers cannot ensure quality unless they manage, rather than compete with, the robots. If, for example, only a few percent of batteries are damaged by defects, the plant cannot compete with the best in the world. In fact, Chinese factories are often more automated than their Western competitors because Chinese equipment is newer.

Understanding how China achieved such a dominant position is key to developing American strategy. China’s industrial policy, including heavy subsidies, has laid the groundwork for productivity surges. Local governments in China attract companies and entrepreneurs through lucrative tax breaks and other benefits such as free land and expedited approvals for facility construction – policies that can be very effective in creating local industrial ecosystems that attract even more companies in complementary industries. Competition in clean energy technologies is fierce in China and is spreading to other markets (e.g. robots supplying automakers); As China becomes increasingly competitive, global impacts have been seen as other companies such as Tesla have been forced to cut margins in some markets and provide better quality to customers. These local subsidies have benefits, but China is not alone in adopting such policies. Incentives related to the location of industrial facilities, mainly in the form of tax breaks, are widespread in the United States. At the federal level, the United States has its own industrial policy – ​​centered on the Inflation Reduction Act and other federal regulations that involve enormous spending.

Response to Chinese domination

A strategy to profit from trade with China is not the same as opening the border to crush competition, but the right response to Chinese dominance is not high tariffs – Washington’s bipartisan strategy. Donald Trump called for 100% tariffs on Chinese electric vehicles in March, and the Biden administration more or less implemented what Trump wanted last month. The administration is also preparing further tariffs and retaliation.

Tariffs certainly play a role, especially when countries use dominant positions and a history of heavy subsidies to push products onto world markets – actions that undermine competition in many ways, including the extinction of competing firms by allowing monopolistic behavior. However, the United States has allowed this proper role to get out of control by imposing massive tariffs on entire industries. A much narrower approach to tariff retaliation – along with an approach consistent with World Trade Organization rules, in which the United States is also unhelpfully obstructionist – would be much wiser.

Tariffs hurt the United States in two ways. First, by raising the cost of Chinese imports, tariffs make it harder to reduce emissions for anyone who wants to use solar panels or batteries. Along the way, these tariffs temporarily increase the profitability of some U.S. companies, but the main effect so far has been to encourage Chinese companies to shift their supply chains – first to Southeast Asia and now around the world. Second, and more harmful, tariffs are politically destabilizing. When the United States attacks Chinese supply chains from Vietnam to Mexico, it undermines our trade relationships with important trading partners. And as China retaliates, trade wars over batteries and lithium diversions hurt exports of other products, such as soybeans, where U.S. producers have a big advantage.

Even more shortsighted are the growing barriers to Chinese companies investing in America. When Chinese companies cooperate with local expert American companies, both sides learn and local communities benefit from investments and jobs. The United States learned this lesson when it faced the threat of competition from Japan around 1990 – a dose of managed trade along with allowing (even encouraging) joint ventures created value here at home.

However, in the United States, there are many obstacles to this type of productive collaboration. In the electric vehicle sector, for example, an opaquely applied rule known as foreign entities of interest, an obscure element of the Inflation Reduction Act (IRA), prohibits any company in which Chinese ownership exceeds 25% or any control of Chinese executives from receiving U.S. subsidies. No one really knows how it will work or whether the letter of the rule can be trusted. Many states are also introducing their own legislation that inappropriately targets Chinese residents and investors. The result: Chinese companies that could compete in one of the world’s largest clean energy markets are avoiding America.

The right industrial policy

The ongoing cleantech subsidy race has breathed life into climate policy ambitions. However, subsidy-rich industrial policy faces both fiscal and political constraints, weakens the power of markets, and creates friction with our closest clean technology trading partners. It is in our common interest to focus industrial policy on areas where markets have failed, for example in encouraging adequate investment in innovation and early-stage technology demonstration. (By this standard, the IRA role still has a long way to go.)

Many of these innovation opportunities would benefit from U.S.-China cooperation, including academic cooperation. Tentative early signs of a possible thaw between the United States and China include promises of advanced cooperation on clean energy such as carbon capture, although these remain politically unstable in both countries. One benefit of better geopolitical relations between the U.S. and China could be a forum where the two countries discuss curbing excessive subsidies — much as the U.S., Europe and other countries have done for decades in agriculture. In terms of subsidy reform, the United States will exert some pressure on China’s open door. In the early years of the clean technology revolution, China’s central government supported Chinese industries with local regulations and a range of subsidies, including loans from state-linked banks; much of this support is now unnecessary and is beginning to be phased out.

We must diversify global suppliers of the ingredients for the clean energy revolution. This will require international cooperation and the use of the market, not anti-China mandates. (The market already provides some supply – the recent volatility in lithium prices has resulted in an increase in supply, mostly not in China, for example). We must also demand, like Europe, that Chinese supply chains meet the same environmental standards as supply chains in the West. Chinese battery manufacturers already know this and are implementing the monitoring systems necessary to ensure compliance.

It is also important that we pay close attention to places where the Chinese government may be manipulating supplies and threatening national security. Some manipulation is already visible in the markets for graphite (used in batteries) and rare earth elements. The best way for America to secure its supply chains is to work with other countries that want greater security of key minerals, to encourage diversity in global suppliers and to monitor the market for abuses. Lithium is not a new oil; Shifting lithium supplies onshore, even if it were feasible, is a much less effective and costly way to secure supplies. Moreover, today’s “America First” approach too easily leads to overreactions because every Chinese behavior is treated as a threat to national security.

Learn from China

Instead of erecting barriers, we should emulate China’s approach. By allowing reforms – an area where the emerging bilateralism is making some progress – we should reduce red tape in projects and plants. For example, solar panel factories are much smaller than China’s giant wafer, cell and module factories. Increasingly larger plants offer enormous economies of scale. Removing obstacles to – and even encouraging – American communities to adopt newer Chinese technologies and production methods will also help push local companies to the global frontier.

The clean energy revolution is already underway and gaining momentum – in both red and blue states. To gain the most from this revolution, we must quickly catch up to the world’s technological frontier by learning from Beijing, not blocking it.