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China-Induced Global Overcapacity an Increasing Threat to High-Tech Industries

China-Induced Global Overcapacity an Increasing Threat to High-Tech Industries

February 27, 2018

Industrial overcapacity traditionally has been an issue confronting heavy-capital goods industries such as steel and aluminum, shipbuilding, or heavy construction equipment. Yet overcapacity increasingly affects advanced-technology industries such as solar panels, semiconductors, and electric-vehicle batteries: high-tech industries where the United States and like-minded trading partners such as Canada, Europe, Japan, and others should enjoy natural comparative advantage. The innovation mercantilist policies which lie at the heart of China’s model of state-led capitalism have been the central force driving this overcapacity across an ever-growing number of industries.

As the Information Technology and Innovation Foundation (ITIF) has argued, Chinese policymakers fundamentally reject the principle of “comparative advantage”—the classic trade notion that countries should specialize in production of goods or services at which they are the most efficient and then trade for the rest—and rather seek absolute advantage (for purposes of serving both domestic and international markets) across a range of industries—from high-speed rail and steel to semiconductors, vitamins, and solar panels.

As George and Usha Haley document in their fine book, Subsidies to Chinese Industry: State Capitalism, Business Strategy, and Trade Policy, China’s game plan has long been to “aggressively subsidize targeted industries to dominate global markets.” As they document, in the 2000s, China provided almost $100 billion in subsidies to just three industries alone: $33 billion for paper, $28 billion for auto parts, and $27 billion for steel. And despite the fact that labor accounted for just 2 to 7 percent of costs (raw materials and energy accounted for much more) in these industries, and that most producers were small and inefficient, Chinese products in these sectors routinely sold for 25 to 30 percent less than those from American or European competitors. In fact, since China joined the WTO in 2001, subsidies have annually financed 20 percent of China’s manufacturing capacity.

In steel, China’s share of world output grew from just 15 percent in 2000 to 50 percent by 2015, as America’s share fell by half (from about 12 to 6 percent), Japan’s by roughly equivalent amounts, and Europe’s cratered from 22 to 10 percent. From 2008 to 2015, Chinese overseas shipments of steel doubled, to 112 million tonnes annually by 2015, more than America’s total consumption of steel in a single year. There are now two Chinese steel producers who produce more steel than Japan does in a given year. It’s estimated that there’s already enough installed industrial capacity to cover the world’s steel needs for the next twenty years, with at least half the global overcapacity residing in China. And while China may say it now intends to reduce its steel overcapacity (though it’s averred this many times before), significant damage has been inflicted on steel producers in the United States, Europe, and Japan. In fact, since as early as 2003, a series of top-down government plans claiming to address China’s steel overcapacity have instead operated as disguised industrial subsidy programs. And as similar dynamics played out in the aluminum sector, the number of U.S. aluminum smelters fell from 14 in 2011 to just five today, with only two producing at full capacity.

But China’s strategy reached its apotheosis with solar panels. China’s share of global solar panel exports grew from just 5 percent in the mid-2000s to 67 percent today, with Chinese solar output turbocharged by at least $42 billion of subsidies from 2010 to 2012 alone. This instigated a global glut that saw world prices for solar panels crash by 80 percent from 2008 to 2013, bankrupting most of the more-innovative foreign competitors and setting up Chinese producers for a final coup de grace: using their government-enabled profits to try to buy bankrupt U.S. solar firms in order to strip out their remaining technology and send it back to China. Again, similar dynamics exist in the wind industry, with China now accounting for 50 percent of the world’s wind turbine production.

China now wants to replicate this exact same strategy in other advanced-technology industries, such as semiconductors and electric batteries. For instance, China’s National Integrated Circuit (IC) Strategy calls for at least $160 billion in likely market-distorting subsidies to create a completely closed-loop semiconductor industry in China, including explicit plans to halve Chinese imports of U.S.-manufactured semiconductors by 2025 and eliminate them entirely by 2035. China’s game plan is clear: build and shield domestic industries, massively subsidize their manufacturing capacity—enabling them to grow and compete domestically, then internationally—and use overcapacity as a cudgel to disrupt the economics of innovation-based industries (i.e., that they have to earn reasonable profits from one generation of innovation to reinvest in future generations of innovation) and thus weaken foreign competitors. China’s Tsinghua Unigroup’s recent announcement that it will build a $30 billion DRAM (memory chip) plant in Nanjing, atop another $24 billion in facility in Wuhan, signals that global overcapacity may soon be coming to the semiconductor sector. Meanwhile, China’s “Made in China 2025 Strategy,” supported by some 800 state-guided funds to the tune of more than $350 billion, indicates other sectors where a similar strategy will be coming, including electric vehicles, advanced-battery manufacturing, wide-body aircraft, and robotics.

Accordingly, the Trump administration is right to investigate such practices and seek remedies—as the Obama administration did in bringing an aluminum subsidies case against China at the WTO in its final weeks—but it’s imperative that several tenets guide this process. First, any countermeasures need to be targeted to address a specific infringing action, be tailored, and be time-limited, in that they persist so long as the infringing action does. Applying blanket, indiscriminate tariffs across entire sectors—whether on ICTs or steel (as some media reports have suggested)—would only raise costs for those goods without genuinely boosting U.S. competitiveness in these sectors but while inviting countervailing actions. Further, if such blanket tariffs were applied across a broad range of trade partners, this would only make it more difficult to forge a broad coalition of nations to contest Chinese government-subsidized overcapacity that represents the core challenge. Second, tariffs should not be based on overcapacity per se, but on government-subsidized overcapacity. U.S. policy should focus foremost on going after the systemic mercantilists: there’s a difference between a government subsidizing industries to the tune of tens of billions of dollars and companies which pursue “an aggressive downward pricing strategy.” Moreover, if such tariffs are invoked using the “national security” rationale from Section 232 of the 1962 Trade Expansion Act, this would throw the door open for other countries to potentially close large swaths of their markets on the dubious grounds of national security.

Finally, it’s imperative that any Trump administration trade remedies not be predicated on U.S. protectionism. Indeed, America’s trade strategy should not be to “protect” our industries; it should be to eliminate foreign unfair trade practices that keep U.S. industries (and particularly advanced-technology ones) from competing equitably in global markets. And to the extent the administration’s trade strategy is about protecting, it should be about protecting the global trade system and upholding truly rules-based, market-determined, enterprise-led trade in accordance with the foundational World Trade Organization (WTO) principles of non-discrimination, reciprocity, and national treatment. And as ITIF writes in “Stopping China's Mercantilism: A Doctrine of Constructive, Alliance-Backed Confrontation,” that means America must convince like-minded countries to align with us in the cause of contesting Chinese unfair trade practices. Here, a constructive first step would be to get all major WTO partners to require that China comply with the WTO subsidy disclosure (i.e., transparency) regime, as China is consistently and woefully late and lacking in full subsidies notification (and also translation into multiple languages, as required by the WTO).

The Trump administration is right that Chinese innovation mercantilism is one of—if not the—most fundamental threats to the global economy as well as to advanced-technology industries in the United States, Europe, Japan, and elsewhere. ITIF welcomes Chinese economic success, and the success of its enterprises which compete through genuine innovation, but this must be achieved in accordance with the commitments China signed up into joining the WTO—and this means abiding by not just the letter, but also the spirit, of WTO rules. Thus, the Trump administration and like-minded global trade partners should adopt a new strategic narrative on Chinese trade mercantilism. It could be called simply “Contain and Roll Back.”

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