America, China and the solar power conundrum

Center for American Progress

The US Department of Commerce early next week will issue a preliminary verdict on a trade petition filed by SolarWorld Industries America, Inc. That petition alleges that the Chinese government unfairly subsidises crystalline silicon photovoltaic solar cells and modules by providing cash grants, tax rebates, cheap loans, and other benefits designed to artificially suppress Chinese export prices and drive US competitors out of the market.

As a remedy SolarWorld wants the Commerce Department to levy import tariffs to alleviate damage from these artificially cheap panels on solar panel manufacturers in the United States. At first glance this would seem to be a reasonable solution. A sustained look yields the same conclusion. But it is important to understand the dynamics of the US solar panel market – where labour skills and ability to innovate are strong but where demand for solar panels is low due to the lack of any national commitment to lower carbon emissions or to diversify sources of energy – to comprehend why import tariffs are not the only solution.

Indeed, this petition, along with a second action brought by SolarWorld accusing China of ‘dumping’ its cheap solar panels into the US market, has generated major controversy in the fledgling US solar industry. Just about everyone seems to believe that Chinese officials are probably violating trade rules in this sector but there is substantial disagreement over what, if anything, the United States should actually do about it.

America’s current trade institutions address illegal subsidies by levying import tariffs on imported subsidised goods. In theory when trade partners artificially suppress prices and export those underpriced goods to the US, import tariffs should level the playing field by raising prices back up to natural market levels. In theory these tariffs are lowered over time and finally eliminated as the trade partner phases out its subsidies.

In the current case, SolarWorld alleges that the Chinese government uses dumping and a variety of subsidies to artificially suppress solar panel export prices by a margin of at least 100 per cent. SolarWorld has asked the Commerce Department to levy a comparable tariff to eliminate that price discrepancy.

Everyone agrees that imposing import tariffs on Chinese solar panels should benefit the US solar module manufacturing industry. Solar panel prices fell 50 per cent in 2011, and that unusually steep price drop has eroded profit margins worldwide. Cheap Chinese manufacturing appears to have contributed to the price drop, so reducing the impact of Chinese prices on the US market should slow the price decrease to a more sustainable rate and increase profit margins for US manufacturers. US tariffs on Chinese solar panels would also help manufacturers in other countries that do not provide these subsidies, such as some in the European Union, because those manufacturers also export to the United States and compete for US market share.

What is less clear is how tariffs would affect the demand side in the United States. Many US solar installation companies, which purchase solar panels and therefore benefit from low Chinese prices, fear that import tariffs will erode their profit margins, slow industry growth across the value chain, and make it even harder for solar energy to compete with traditional fossil fuels. Some of these solar installation firms are so concerned that they have formed an opposition group to push back against SolarWorld’s trade petitions. That group – the Coalition for Affordable Solar Energy – claims that imposing high import tariffs on Chinese-manufactured solar panels would decimate the US solar installation industry and eliminate thousands of jobs in that sector.

Solar energy already faces an uphill battle in the United States. The combination of heavy fossil-fuel subsidies and weak national-level political support for policies to spur demand for renewable energy can make it hard for emerging energy technologies to compete in our country. Some politicians have even attacked the few solar-industry development policies America does have in an attempt to reduce federal government spending on clean energy across the board.

The clean energy advocates who have supported solar industry development throughout these political battles certainly do not want to throw more obstacles in the path of the solar installation industry. But that does not mean that the United States needs cheap Chinese solar panels so badly that we should just roll over and let a foreign government break enforceable international trade rules. If the US Department of Commerce finds that the Chinese government has acted illegally, then the Chinese government and the industry it is subsidising should pay a price for that behaviour. Under the current trade system that price is tariffs.

If the US Commerce Department finds that Chinese government dumping and subsidies artificially suppressed prices by a significant amount and that the price decreases harmed the US manufacturing industry, then it is possible that the resultant tariffs could be 100 per cent or above. Contrary to what the Coalition for Affordable Solar Energy is claiming, that is not a reason to panic.

For one thing, many different factors are contributing to declining global solar prices. Chinese manufacturing certainly plays a role, but innovation is also important. Solar panels are becoming increasingly efficient (generating more energy per module), and manufacturers are steadily improving production processes to bring down costs. The US solar manufacturing market is already fiercely competitive, so even without discounted Chinese imports, other US manufacturers – and other solar-panel exporters to the United States – should still have strong incentives to keep innovating to bring down costs.

It is possible that imposing import tariffs may slow the price decline or even create a temporary price bump in the US market if American customers shift orders from Chinese to non-Chinese manufacturers and the latter cannot keep up with demand. It is important to note, however, that one of the biggest problems facing solar-module markets worldwide is oversupply, so it should not be difficult to fill any gaps produced by a shift away from Chinese solar panels.

Furthermore, Chinese manufacturers would likely respond to import tariffs by shifting production to the United States or other overseas markets where the tariffs would no longer apply, so they would not be out of the game for long. They would, though, be investing in the United States or at least in countries, such as in the European Union, where trade standards are more comparable.

If Chinese companies do begin manufacturing in America, they will find that the United States is in a strong competitive position to manufacture solar panels because of the skilled labour force, domestic supply of silicon, and strong manufacturing infrastructure. It certainly helps that China’s own labour costs are increasing: Boston Consulting Group recently estimated that within five years China’s manufacturing wages will be within 25 per cent of those in the lowest-wage US states (South Carolina, Alabama, and Tennessee).

Chinese leaders look at the United States and want what we have. They want to become a global research and development powerhouse that creates and exports cutting edge technologies with big profit margins. China’s traditional command-and-control economic system was not good at creating those innovation incentives, so they are working to reform that system, but reform takes time.

In the meantime they are trying to fill the gap with heavy government subsidies. Problem is, that approach can actually reduce innovation, not only in China, but also in the United States. Bureaucrats are not adept at picking winning companies and winning technology standards. When Chinese officials heavily subsidise their favourite domestic solar manufacturers, those subsidies can reduce prices to levels that other firms cannot match, thus driving competitors out of the market and reducing incentives for innovation. When China exports those products to the United States, the same dynamic can play out here.

The long-term result is that a small number of heavily subsidised Chinese manufacturers could dominate the global solar market. That may make Chinese leaders happy, but if those firms are not producing the best solar technologies – for example, if their solar panels are not as efficient as they need to be to compete with traditional fossil fuels – that can slow solar market development worldwide.

To keep this market growing, the best thing the US government can do is to create a good environment for technology innovation, and that will require a combination of demand-side policies and protection from adverse price incentives.

This is an edited version of an article originally published by the Center for American Progress – americanprogress.org. Reproduced with permission.