The Solar Panel Trade War

There has been an ongoing conflict between the U.S. and China, taking place in WTO courts, private meetings, and policy debates in D.C. and Beijing, over China’s exports of solar panels to the United States. Basically, both China and the U.S. are WTO members. This means they’re both supposed to support free trade in the interest of overall global progress, and to eschew old-fashioned efforts to erect massive tariffs and trade barriers in the interest of helping their own domestic industries while hurting foreign ones. The basic theory, dating to David Ricardo, is that the world as a whole does best when everyone can freely trade, across borders, for goods in which other nations enjoy a comparative advantage, while exporting those goods in which they enjoy a comparative advantage. Trade barriers hurt human welfare by, most obviously, preventing us from making use of the best quality/best priced goods, if they happen to come from another country, and, over the long run, unnaturally distorting markets by artificially propping up particular industries in particular nations where they do not have a comparative advantage.

Recently, the U.S. has slapped substantial tariffs on imports of solar panels from China. China claims this is a WTO violation. However, the U.S. claims to be doing this only to cancel out the effect of Chinese state subsides on these panels — we, Washington claims, are not the aggressors in a trade war, but merely responding to China’s aggressions. With our tariffs, Chinese solar panels now reach American shores at the same price they would have sold for in the absence of Chinese state subsidies. Now the international law aspects of this are beyond my ken — one interesting point of contention is that, given the state’s ubiquitous involvement in the economy in China, it’s hard to clearly delineate the boundaries between the state and private firms, and consequently difficult to prove just how extensive Chinese subsidies to its solar industry are. But I want to avoid this legal debate, and take an economic approach to this trade war. My bottom line is that I do think the U.S.’s strategic response to China is justified here, but it is justified for reasons that are more complicated than the economically naive would assume, so exploring this issue will be educational.

First, why is it a problem, from the U.S.’s perspective, that China is subsidizing its solar exports? Let’s abstract away from this question. Suppose China were to massively subsidize its green-tea industry. This would, in my view, be an unquestionably good thing for the American economy. The reasons are very simple. I like green tea. A lot of us do. If we can get more of it, cheaper, that makes us better off. It’s as if China is just giving stuff away to us. If your friend gives you something for free, that’s a great thing from your perspective; and it’s the same with another country. It’s really that simple. Would anybody get hurt by this subsidized Chinese green tea? Yes: American domestic green-tea producers, and them alone. They would have more trouble competing with the lower-priced Chinese green-tea exports, and likely go out of business. Still, from the perspective of America as a whole, this is a good thing. If China is going to permanently produce lower-priced green tea than our domestic manufacturers will, regardless of whether that low price has to do with state subsidies or natural comparative advantage (superior climate, lower agricultural labor costs, etc.), then there’s no good reason for green-tea manufacturers to exist in the United States.

How are solar panels different? In a lot of ways it’s the same; in some ways, it’s an even better deal. With Chinese taxpayers subsidizing their solar exports, it’s as if China is just giving us some solar panels for free. And, indeed, given the threat of climate change, the use of solar panels has large positive externalities–that is, benefits that accrue to society as a whole, not just to individual users of solar panels. Since the cheaper solar panels become, the faster and more eagerly they should be adopted by domestic firms, China’s subsidized solar exports are good for the environment, too. If China wants to pay us to buy their solar panels, and if American consumers want to use them to reduce their carbon footprints, why on earth would we would want to stop any of them?

So this is a very serious argument that we should not only not fight Chinese solar subsidies, but actually be grateful for them.

But the Obama administration is pretty smart and environmentally conscious. So surely they must be aware of that argument, and must, in turn have a reason of their own for slapping these tariffs on. What are those reasons? There are two possible interpretations: one cynical and one more intellectual. The cynical interpretation is that America’s domestic green-tech industry is politically aligned with the Democratic party, and an important source of donations, & etc. So the Obama administration is seeking to protect its donors from foreign competition, even though America as a whole would benefit from being able to import solar panels more cheaply from China. As a pessimist/realist, I do think this is, descriptively, an important explanatory factor.

However, some more complex economic theory shows that there is a way in which Chinese solar subsidies could be bad for America in the long run, and protecting our solar industry could benefit us. This economic theory depends on the economics of “clusters,” which I have discussed in some of my other posts on economic geography.

Basically, the argument goes something like this: Energy is a very big deal. A bigger deal than green tea. The world runs on energy, and will require more and more of it as Asia and Africa develop. And because oil is non-renewable and threatens to exacerbate climate change, clean-tech is an even bigger deal. We can reasonably expect that in a few decades, green energy, particularly solar energy, will be incredibly important to the global economy. But this still doesn’t explain why we should dislike China’s subsidies: sure, clean tech is a big deal, but why not let the Chinese pay for this big deal thing as long as they want to?

This is where clusters come in. Industries tend to develop in clusters. The traditional example of this is how all of the Big Three auto manufacturers located in Detroit. Each had an incentive to locate there, because the city had workers with the knowledge and skills relevant to the auto industry — and those workers, in turn, had an incentive to stay in Detroit, where the auto employers all were. So this kept the American auto industry “locked in” in Detroit, and any other city that tried to, after this cluster developed, win back some of the auto business, was very, very hard pressed, and generally unsuccessful (until Japan competed with superior technology and human capital, and then China, particularly Shenzhen, used lower labor costs). We can expect the same of green tech. As more and more firms attempt to enter the green tech market, they will disproportionately want to locate in geographies that already have the workers with skills and experience in that industry. And those workers will increasingly move to geographies where those firms are located. Also, the “knowledge spillovers” between green-tech firms in that region will help those green-tech firms just do better, helping beat back foreign competitors.

So whichever country gets a “first-mover” advantage in developing a green-tech industrial cluster can hope to get “locked in” to a pretty permanent advantage in that industry, which will provide lots of employment for that country. This is why the U.S. and China are engaged in a trade war over solar panels, and why they would not get locked in a trade war over green tea. Each wants to get a “first mover” advantage in producing the major green-tech cluster within its own borders, in order to lock itself into advantages for a century or more to come, in an industry that we can expect to be really huge in the future.

There are also higher-level clustering externalities involved here. Green-tech firms tend to employ lots of highly-skilled, highly-educated people. and so they both (1) attract highly skilled foreigners and (2) provide incentives to Americans to pursue higher skill and educational levels. So clusters in high-skilled industries cause their local area to become more highly-educated, which makes pretty much everything else there better as well. (This is why, for example, Rochester, N.Y.’s decline has not been as bad as Detroit’s decline–both of them have lost major employers, but Rochester’s old industries had attracted more highly skilled workers, who were thus better equipped to create new firms and employment opportunities in the old firms’ wakes.)

So overall, I’ll make an exception here to my generally laissez-faire trade principles, and say that this is a situation in which the U.S. is justified in raising tariffs–the long-term stakes are high enough to justify the short-term costs this will impose on the American economy. But I can’t say I’m certain this will work out in the end. There are good theoretical reasons for America to try to nurture its green-tech industry. But what’s good in theory often flails in the government hands. Witness the complete boondoggle of biofuel in the U.S., which, in my understanding, hard-core environmentalists think is very bad for the environment, because the subsidies are so large that they, e.g., incentivize firms to use large quantities of non-renewable energy sources to make ethanol — complete, utter insanity. Every reasonable person seems to agree it’s a big boondoggle. But it’s hard to get rid of ethanol subsidies, because once you subsidize it once, you create entrenched incumbent interest groups who use their lobbyists to keep the money flowing. That kind of public-choice problem is definitely a risk in using industrial policy to nurture a solar-energy cluster in the U.S., and so we should be intensely aware of and guarded against that as we move forward.

One thought on “The Solar Panel Trade War

  1. Imho it is a clear WTO violation that the United States having those solar panel tariffs. Anyways, who cares, its an economic war going on! Just a small thing: Could you add subheadings in your articles? I think they are nice and this would give them a further structure 🙂

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