As the transition away from fossil fuels accelerates, world leaders have perhaps never been so ambitious about targets for clean energy. So it may be surprising – especially to many in China – to see Western governments that have long advanced free-trade agendas rushing to impose protective tariffs on clean-energy technologies.
To protect their own industries, both the US and Europe have recently imposed new tariffs on imported electric vehicles (EVs) and solar, especially for those made by China. This is the country that now dominates the manufacture of solar, batteries, EVs and, to some extent, wind power. Tariffs would seemingly make the clean-energy transition more expensive, even if they were successful at re-shoring or diversifying supply chains.
Tariffs and related policies are often justified using simplistic arguments about creating a level playing field for competition. The story goes that Western companies have the tech, they just can’t compete with subsidies and cheap labour. This argument ignores key aspects of industrial policy that have enabled China to dominate the clean-energy industry today.
My recent paper, “Clean energy innovation in China”, shows that the dominance came about through a combination of many different policies, of which subsidies and state planning were an important but not necessarily controlling aspect. Rather, over long periods, China has explicitly sought to master and localise clean-energy tech as a strategy for local and national economic development. Its toolbox included both explicit and implicit aspects of industrial policy, and its rise to dominance of clean energy was hardly a simple story of comparative advantage under free trade.
Subsidies: Scaling up and localising
China has employed subsidies as one of its industrial policy tools. In many cases, these were adapted from models already employed in the west. For example, the feed-in tariff paid to domestic solar and wind plants, which was set above that paid to coal plants, was adapted from the model employed a decade earlier in Germany. Prior to the adoption of feed-in tariffs, China’s wind industry benefitted from subsidies under the United Nations Clean Development Mechanism (CDM). Feed-in tariff and CDM subsidies were critical to scaling up manufacturing in those two fields. But once they were no longer needed, China removed subsidies for new domestic projects.
Often, subsidies have been tied directly to localisation of technologies. In the case of wind projects supported by the CDM, China established a domestic content requirement to ensure foreign companies did not simply capture all of the revenue and economic benefit. For feed-in tariffs, foreign project developers or equipment providers were unlikely to obtain approval for projects, and local governments may even have steered project approvals to companies with local connections, such as state-owned enterprises.
Subsidies in the battery and EV space were even more directed. Initially, EV subsidies were tied to locally produced batteries. The incentives were subsequently refined to require local players to master all three of the central technologies involved in EVs: batteries, motors, and control systems. A white list was established for companies qualified to receive subsidies, and no foreign company ever made it on, until shortly before the list itself was abolished.
Industrial policy: Manufacturing clusters
Beyond subsidies, however, China’s central government has relied on industrial policy to encourage entrepreneurship and innovation in clean energy – often working together with local governments eager to promote investment in strategic fields with strong growth prospects. The result has been the creation of regional manufacturing clusters around solar and batteries. These clusters did not emerge purely by chance.
In the past, Chinese regions have sometimes adopted copycat development policies, resulting in duplication and waste, and even provincial protectionism. To guard against this, China established requirements for EV pilot regions, limiting some policy incentives to regions selected on the basis of their existing manufacturing base, local policy incentives to promote EVs, and charging infrastructure.
Manufacturing clusters are also a major priority of local governments. In the case of Guangdong, local officials not only encouraged solar manufacturers to set up production, but offered to move suppliers into nearby industry parks, in some cases forcing existing industrial tenants out to make way. In Shanghai, the local government lobbied Beijing to relax its joint-venture requirement to enable Tesla to establish a gigafactory in the city, then encouraged Chinese EV component manufacturers to locate nearby and to seek qualification as Tesla suppliers. Once local suppliers attained the quality levels needed to compete internationally, the entire domestic EV industry would benefit. One senior official memorably called it the ‘Catfish effect’: throw a catfish into the pond, and all the little fish have to swim faster.
Market-oriented innovation: From catfished to catfish
Policy has not been the only determinant of supply-chain concentration, however. Market forces also played a role. By the early 2010s, China dominated the manufacturing of solar cells and modules, though by mid-decade it was still lagging in making the complex and costly tools needed to manufacture those items. Fierce competition to drive down costs was already driving change. Local equipment providers may not have provided the quality of international players, and their equipment sometimes broke. But common language and physical proximity helped speed solutions and, ultimately, helped local providers raise their game. Today, Chinese equipment providers dominate the worldwide supply of such tools.
This points to a critical advantage China has in clean-energy today, one that is almost never acknowledged openly in the West: innovation. China has caught up in many of the most readily quantifiable innovation metrics, such as patents, influential scientific publications, or R&D spending. But more importantly, the clustering of manufacturing has helped accelerate the pace of innovation in manufacturing-intensive goods, epitomised by solar cells, batteries, and wind turbine parts. While superficially the silicon solar cell has changed little since the 1950s, its efficiency has improved and manufacturing costs have broken through every floor ever imagined. It’s a similar story for batteries or permanent magnets. Economies of scale have been important to this, true, but another critical factor has been learning-by-doing and learning networks among equipment providers.
Individual companies and leading entrepreneurs have long been aware of this. BYD is an illustrative case. The company began in the early 2000s as a small player making chips and parts for leading mobile phone makers like Motorola and Nokia. But BYD found itself unable to meet quality and performance expectations without mastering each aspect of the manufacturing process. This led to key decisions to integrate vertically within its own space. Today, BYD reportedly sources 90% of its parts from its own company, and its strategy of vertical integration has resulted in the development of a major manufacturing cluster in Shenzhen, drawing on the region’s existing expertise in electronics and electrical equipment.
Chinese companies are also taking these lessons with them as they expand abroad. Battery manufacturing leader CATL recently announced plans to establish a USD 1.5 billion fund to invest in local parts and suppliers in Europe. CATL already makes batteries in Europe, but production and quality lag behind its facilities in China because local suppliers don’t meet its needs or can’t respond quickly enough to its requirements. In effect, CATL is becoming the catfish for the European battery industry.
Rethinking manufacturing clusters: Can we really do it?
Just as we should avoid a simplistic focus on Chinese clean-energy subsidies or technology transfer, when considering Western policy we shouldn’t only focus on tariffs. Other industrial policies are also being pursued, often closely resembling past Chinese requirements for localisation or mastery of key parts of the value chain.
China did not achieve its leadership in clean energy through free trade alone. Policies were at the coreAnders Hove
However, there does appear to be one important difference: less emphasis on manufacturing clusters as an explicit matter of policy. The typical Western corporate strategy focuses on mastering only a few aspects of core competence, and then seeking to disaggregate manufacturing to locations where labour, taxes, or logistics costs are low. This can include making batteries in Morocco, or solar in Southeast Asia – often involving Chinese players shifting production there as well. If Western companies cannot move quickly enough in their own countries, or if local labour and land costs are too high, companies reason that they can never compete with either the ‘China price’ or the ‘China speed’.
At the same time, however, disaggregating production hinders the development of rapidly evolving manufacturing clusters with concentrated capital, a base of skilled workers, and close networks of tacit learning among suppliers. This poses one of the biggest challenges to policies based on combining subsidies and tariffs. If manufacturing-intensive industries face an innovation and speed gap because of disaggregated production, then protection and subsidies will have to remain in place forever, and the warnings of a high-cost energy transition will likely prove true.
China did not achieve its leadership in clean energy through free trade alone. Policies were at the core. China’s clean-energy boom has been essential for the climate, bringing carbon neutrality within reach by dramatically reducing the cost of wind, solar, batteries, and EVs. Going forward, however, the solar and EV industries are large enough that scaling them worldwide will probably require some localisation in each major world region. If more regions can reach for the technology frontier, costs will fall faster and the energy transition will accelerate. However, doing so without raising costs will require more than protectionism or subsidies. Consistent policy and emphasis on industry clusters (as opposed to disaggregation) are likely necessary to create the conditions where multiple nations can compete in these technology fields.
