The Hidden Advantage of Chinese Subsidies

By Usha C. V. Haley and George T. Haley

How did China move so swiftly in capital-intense industries without labour-cost or scale advantage from bit player to the largest manufacturer and exporter in the world? Below, Usha and George Haley argue that subsidies contributed significantly to China’s success.

China provided “easy access to capital,” Michael McCarthy, Director at Evergreen Solar told us on a wintry February morning as the company started moving all production of solar panels from Massachusetts to a joint venture in Wuhan, China. Earlier, in January 2011, Evergreen Solar had closed its main U.S. factory and laid off 800 workers. In the previous three years, with the Massachusetts government’s loans and tax credits and its proprietary technology, Evergreen had become the United States’ third-largest solar-panel manufacturer. The company cited plunging solar-panel prices worldwide, coupled with much higher Chinese government subsidies (financial transfers from the government that provided benefits) as reasons for its move. Evergreen’s CEO El-Hillow told The New York Times that the Chinese governments’ and state-owned banks’ considerable subsidies had helped Chinese manufacturers to keep costs very low; the Chinese were now offering him similar massive subsidies that would keep Evergreen competitive. These subsidies, rather than low Chinese labour costs, influenced his move, he elaborated, as labour formed just a tiny part of his manufacturing costs. “Therein lies the hidden advantage of being in China,” El-Hillow said.

Our book, Subsidies to Chinese Industry: State Capitalism Business Strategy and Trade Policy, five years in the writing and excerpted in this article, provides a theoretical basis and empirical analyses for understanding the hidden advantage of Chinese production subsidies. Rather than aberrations, in China subsidies form central parts of what sociologist Neil Fligstein called “conceptions of control,” important ways in which Chinese businesses and governments produce, stabilise and create common understanding of their markets. Flows of subsidies reflect interactions and struggles between critical Chinese actors such as central and provincial governments and state-owned enterprises with different resources, interests, and visions of markets. As we describe in our book, Evergreen’s story has resurfaced across other industries including steel, glass, paper and auto-parts. In all these capital-intensive industries where labour costs play minor roles, and in the space of approximately five years, China rose from a net importer to among the largest producers and exporters in the world.

How did subsidies aid China in becoming so apparently competitive in capital-intensive products for which it enjoyed no comparative advantage a decade prior? What are the implications for firms and other countries in the face of this hidden advantage? Economic theories of comparative advantage offer limited insights into questions involving Chinese manufacturing subsidies, but we saw that understanding imperfect markets, state capitalism, business policy and strategic trade policy could offer more.

 

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Subsidies: Transcending the Theoretical

First, in our book, we provide a complex theoretical explanation for industrial subsidies that in key Chinese manufacturing industries appear in dollar terms to exceed over thirty per cent of industrial output. Analyses of manufacturing subsidies have mostly surfaced in economic theories; and, economic theories have mostly portrayed subsidies as distortive, redistributing and reallocating resources according to non-market criteria and resulting in economically inefficient allocations of these resources. Unless in special circumstances (such as with infant industries), economists have generally ignored the view that subsidies may contribute significantly to aspects of a country’s comparative advantage, and not just disadvantage. However, China’s state capitalist regime has used subsidies as a tool to promote the governments’ and the Communist Party of China’s (CPC’s) interests. The state has willingly paid the price of economic inefficiency to accomplish the CPC’s political, social, economic and diplomatic goals. These considerations regarding subsidies have immediacy that abruptly transcends the purely theoretical because of China’s sudden heft in international trade and manufacturing.

Rather than aberrations, in China subsidies form central parts of what sociologist Neil Fligstein called “conceptions of control”, important ways in which Chinese businesses and governments produce, stabilise and create common understanding of their markets.

 

Second, we develop independent measures of industrial subsidies using publicly reported data at company and industrial levels and from diverse sources. Generally, researchers have a notoriously hard time measuring subsidies — and Chinese subsidies even more so. As we describe in our book, for institutional and strategic reasons, the information on manufacturing subsidies that the Chinese government provides has rampant missing and misreported data; also, few consistent definitions exist for the data. In addition, the Chinese government does not report subsidies to domestic industrial companies, many of which are major players in their global industries. Yet, researchers and analysts as well as governments around the world have depended solely on Chinese self-reported data for analyses of effects on welfare, industries and trade. For our analyses, we used data from industrial analysts, non-governmental organisations and companies to obtain end-user and reference prices. We gathered data that companies relied on to cost out their products. We analysed policy statements and reports specifying government subsidies. For many subsidies, we used price-gap analysis to develop our estimates. Though incomplete, for the first time we used multifaceted data that inincorporates organisational variables and estimates, not just Chinese governmental reports to measure subsidies.

Third, we explore the strategic aspect of subsidies for businesses and governments. We expand on instruments of trade policy to include networks of regulation such as indigenous innovation that advance the goals of state capitalism, not of market efficiencies. We separate business strategies into those affected by and shaping consumption and production subsidies. Other theorists have explored businesses’ and strategic groups’ responses to trade policy, including subsidies. We extend their analyses by examining generic market (competitive) and non-market (political) strategies that businesses may undertake.

Over the last five years, research in this book on several industries including steel, glass, paper, auto-parts and solar has been incorporated into regulation and business strategy both in the United States and the European Union. The letters from members of U.S. Congress and the Office of the President in the book’s Appendix indicate how some of this research has been used. However, though the practical aspects appeared obvious, we still lacked an adequate understanding of the theoretical context of Chinese industrial subsidies. We see this book as a step in that direction. The rest of this article provides some highlights from our research on China’s steel, glass, paper and auto-parts industries.

Steel

We tracked subsidies to China’s steel industry from 2000 to 2007 and the industry’s sudden transformation from net importer to the largest producer and exporter in the world. In 2007, China was the largest producer and consumer of steel in the world, with forty per cent of the global market. In 2005, China went from a net steel importer to a steel exporter. In 2006, China became the largest steel exporter in the world, up from fifth-largest in 2005. In 2007, energy subsidies to Chinese steel were estimated at approximately $15.7 billion, showing a 3800 per cent increase since 2000. The central government’s policies of consolidating the steel industry had failed and the Chinese steel industry had become more fragmented. With no discernible cost advantage, Chinese steel still sold for twenty five per cent less than U.S. and European steel. From 2000 to mid-year 2007, total energy subsidies to Chinese steel reached $27.11 billion, including subsidies to thermal-coal of $11.16 billion, to coking-coal of $15.29 billion, to electricity of $916.39 million and to natural gas of $54.12 million.

Glass

We also documented the Chinese glass industry’s explosive growth and exports and the government subsidies that had bolstered it from 2004 to 2008. In 2009, with over 31 per cent of global glass production, China was the largest producer of glass and glass products, had the greatest number of glass-producing enterprises, and had the largest number of float-glass production lines in the world. China was also the largest consumer of glass. However, because of existing and planned production capacity, glass exports from China were expected to outpace greatly projected increases in domestic demand. Since 2003, glass production in China had more than doubled. Concurrently, production capacity in China has also doubled since 2003 and increased more than threefold since 2000. China’s glass industry enjoyed no economies of scale or scope. The industry also displayed geographic fragmentation, with manufacturers in 29 of the 32 provinces. Because of poor data, analysis took place at the level of the flat-glass sector that received approximately $4.8 billion in subsidies from 2004 to 2008. Extrapolating to the glass industry as a whole, China’s glass and glass-products industry received at least $30.3 billion in subsidies from 2004 to 2008. The subsidies spanned heavy oil, coal, electricity, and soda ash and had been growing steadily in this period, reaching about 35 per cent of gross industrial output value of glass in 2008.

Our findings contradict the widespread belief that China’s enormous success as an exporting nation derives primarily from low labour costs and deliberate currency undervaluation.

 

Paper

We covered China’s rapid rise in the global paper industry, fuelled by over $33.1 billion in government subsidies from 2002 to 2009. Since 2000, China tripled its paper production. In 2008, China overtook the United States to become the world’s largest producer of paper and paper products. China’s paper industry has limited economies of scale or scope and is geographically fragmented, operating in 30 provinces. China also has among the smallest forest bases in the world per capita. Consequently, it is the largest importer in the world of major industrial inputs, pulp and recycled paper. Labour makes up about four per cent of the costs in this industry; in contrast, imported recycled paper and pulp comprise over 35 per cent of the costs. Yet, Chinese paper sells at a substantial discount compared to U.S. or European paper. Governmental policies have systematically aimed to reduce China’s dependence on imported raw materials and to subsidise the paper industry’s restructuring. Subsidies measured from 2002 to 2009 include those for electricity ($778 million), coal ($3 billion), pulp ($25 billion), recycled paper ($1.7 billion), subsidy income reported by companies ($442 million), and loan-interest subsidies ($2 billion). Missing data prevented calculation of pulp or recycled paper subsidies for three years.

Auto-parts

We highlighted how from 2001 to 2011, the Chinese auto-parts industry received $27.5 billion in subsidies, helping to make it one of the largest producers and exporters in the world. As a “pillar industry”, auto-parts has received strong support from the Chinese government. The industry has grown more than 150 per cent since 2004, but remains highly fragmented with more than 10,000 registered and 15,000 unregistered manufacturers. U.S. global auto strategy has centred on manufacturing in China and exporting back home. Consequently, China’s exports of auto-parts to the United States are three times those of its next highest trading destination, Japan. Though missing data prevented calculations across all years, specific subsidies included $2.3 billion reported by 73 companies; $1 billion for coal; $0.6 billion for electricity; $0.3 billion for natural gas; $1.6 billion for glass; $3.2 billion for cold-rolled steel; and $18.4 billion for technology development and industrial restructuring. For the next decade, the government has committed an additional $10.9 billion in subsidies for technology development.

 

Conclusions – What Next?

Our findings contradict the widespread belief that China’s enormous success as an exporting nation derives primarily from low labour costs and deliberate currency undervaluation. The subsidy practices we covered have impact beyond the five industries on which we focused. Business strategies include lobbying for subsidies, advocating for protection from subsidised foreign competitors as well as adroit managing of supply chains to guard against the whiplash effects generated by uncoordinated subsidies. Free trade may lead to sub-optimal outcomes and protectionism can increase national income by raising firms’ profitability in imperfect markets. With an open U.S. market and closed China market, Chinese firms could achieve more efficient scale via sales volume domestically and abroad, while squeezing U.S. competitors into a portion of their domestic market. Once foreign firms fall behind, recovering profitability would become unlikely and so rather than competitive strategy, strategic trade policy would rationally become managers’ top priority. Subsidies to Chinese manufacturing have many implications for firms including manufacturing location and technology development. For the global economy, regular boom and bust cycles may now become the new normal and these call for informed negotiation via trade blocs and bilaterally. Meanwhile, Chinese government subsidies will continue, contributing substantially to their firms’ competitiveness in global markets.

This article is excerpted with publisher’s permission from their book, Subsidies to Chinese Industry: State Capitalism, Business Strategy and Trade Policy, Oxford University Press, 2013.

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About the Authors

Usha Haley is Professor of Management, West Virginia University and George Haley is Professor of Marketing and Director of the Center for International Industry Competitiveness, University of New Haven. The authors may be contacted through [email protected] More information on the book and their research may be found at www.ChinaSubsidies.com.

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