The problem is widespread—capacity utilization rates in China have declined over the past couple of years in every surveyed manufacturing sector except non-ferrous metals. Products linked to the property sector, such as plastics and non-metal minerals, are experiencing severe overcapacity because of weak demand in their downstream markets. But many other sectors are seeing declining capacity utilization, too, from machinery to food, textiles, chemicals, and pharmaceuticals.

Growing imbalances

The under-utilization of production capacity in China is concerning in its own right for foreign policymakers and businesses. It incentivizes firms to lower their prices in search of a market for their excess capacity. In the past, this has led to global over-supply, price declines, weak profitability, bankruptcies, and job losses.

But the drop in capacity utilization rates observed in the past few years is only one aspect of a more profound phenomenon that should draw equal concern for policymakers in Brussels and other economies—China’s growing domestic production surplus. Chinese companies, across a wide range of sectors, now produce far more than domestic consumption can absorb. This domestic surplus can produce low factory utilization rates. But it can also find its way into foreign markets, creating a growing trade surplus and, at times, global redundancies that threaten industrial ecosystems in other countries.

Those imbalances are not new, but they have reached unprecedented levels since the pandemic. In 2020, as COVID hit the global economy, China launched a stimulus program to boost industrial companies, with little support for household consumption. Beijing rolled out substantial tax credits, production subsidies, and interest rate cuts to keep struggling companies afloat and workers employed. When economic growth continued to disappoint in 2023, Beijing’s policy support kept the emphasis on producers, as their bias against “welfarism” kept policymakers from stimulating consumption.

China’s growing support for its companies resulted in rapidly growing production capacity across many industrial sectors. From 2016 to 2020, investment and production capacity growth was concentrated in strategic sectors linked to the Made in China 2025 strategy, such as advanced electronics, particularly chips, and clean technology sectors. In other areas of the economy, the focus was instead on reducing capacity in the supply-side structural reform campaign from 2015 to 2019. However, this changed in 2020, with renewed growth across all manufacturing sectors, including non-strategic ones like steel products, household refrigerators, fertilizers, microcomputers, and machine tools.

This capacity build-up was supply-driven, and most often not matched by equivalent domestic demand. With little support from the government, household consumption labored under strict zero-COVID restrictions and failed to pick up enough in 2023 to deliver a consumption-led recovery. The property market downturn played a role, dampening demand for a wide range of goods, from machinery to plastics and furniture. As a result, consumption did not grow nearly as fast as industrial production and investment.

Déjà vu with a twist

Current growing overcapacity and domestic surplus is similar to previous occurrences, but it differs in three important ways. The first is timing. The previous wave of overcapacity and domestic surplus hit China six whole years after the 2008 investment boom because domestic demand was strong enough to absorb the capacity expansion until 2014. This time around, China’s investment boom immediately hit a wall because of the weakness of domestic demand.

The second difference is the list of affected sectors. China’s 2008 stimulus focused on construction, infrastructure, heavy industry, and mining. In recent years, however, support for infrastructure and construction was derailed by China’s acute property crisis starting in the second half of 2021. Distress in the property sector diverted credit to other industrial sectors—with the effect of concentrating China’s recent investment boom in manufacturing.

One last difference is how much support central and local governments have given failing enterprises with little consideration of profit and efficiency. In addition to generous credit and tax support measures, struggling companies were granted credit forbearances during COVID to help them face liquidity crunches and operational disruptions. Government support and prevention of market exit boosted the number of loss-making companies. In a crowded environment, with loose budget constraints, firms lowered prices and accepted razor-thin margins to retain market share. Perversely, it also pushed them to build additional capacity in hopes of offsetting lower margins with higher volumes, and because they knew from prior episodes that if authorities ultimately forced a market consolidation, survival would be determined based on scale, not financial health.

Trade spillovers: Bracing for impact

Because China’s previous cycles of policy-driven capacity expansion severely affected global markets—especially in steel and aluminum, but also in promising sunrise industries like solar panels—advanced economies are watching with intense concern and evaluating response options. In 2023, the number of EVs exported from China was already 7 times greater than in 2019 and 1.7 times greater year-on-year. China’s exports of solar cells in 2023 were five times larger than in 2018, and 40% above 2022 levels. These surges are potentially devastating to market-constrained producers in advanced economies.

The growing mismatch between fast-paced capacity expansion and slow-growing domestic demand in China will have trade impacts beyond green technology sectors too. China’s share of global trade expanded by 1.5 percentage points in 2020, arguably in the context of global supply chain disruptions that put China at a global advantage. But, importantly, that share did not come down as COVID-19 restrictions retreated everywhere. In select sectors, Chinese firms have been gaining significant global export shares in the past four years. In the electronic machinery sector, for example, China’s share of global exports grew more than 5 percentage points between 2019 and 2022 in 18 of 46 HS-4 product categories. In 2016-2019, that was the case for only 7 out of 46 categories. In lower-technology sectors such as textiles and furniture, China has also been re-gaining market shares it had lost in previous years due to diversification of production and relocation to lower-cost destinations.

Export gains are not the only spillover channel for China’s rapidly growing production capacity. In sectors where China used to be a net importer, such as the petrochemical sector, the combination of domestic production capacity increase and weak demand in China resulted in sometimes drastic declines in Chinese imports, affecting firms in Europe and the United States.

Low prices are not the only factor behind Chinese firms’ ability to export their growing capacity abroad. Competitiveness is another one. By lowering firms’ costs, allowing them to scale up, and increasing their ability to improve products as they “learned by doing,” state support made some Chinese companies fiercely competitive in global markets. The electric vehicle sector is a case in point. The top Chinese exporters of EVs, BYD and SAIC, are not the most affected by overcapacity—they are close to working at full capacity. Still, these carmakers were able to leverage the supportive environment of the past four years to become more efficient and more technologically competitive than their rivals. Facing low profit margins in China today, and intense competition, they are uniquely equipped and motivated to capture growth and profits outside of China.

The effects of this new wave of policy-driven capacity expansion in China are not yet all visible. In certain industries, the timeline from investment to production can stretch over years, meaning that funds allocated in 2021-2022 might only begin to materialize into market-ready products or services several years later, with a delayed impact on Chinese and global markets.

What’s more, although overcapacity created strong deflationary pressure within China, it has not yet impacted global prices to the same extent. In fact, China’s export prices were up in most sectors in 2023 compared to 2021, and the prices of imports from China rose more quickly than the prices of imports from other extra-EU countries in 2021-2022, before decelerating in 2023.

This is because many Chinese firms are still using overseas markets to make up for lower prices, margins, or even losses on the China market. But this China-world price discrepancy also means that Chinese firms could lower their export prices further in the future to gain market access, weed out competitors, or make up for new tariff barriers in the EU or the US.

Outlook

In the last two quarters of 2023, China’s capacity utilization rates have picked up, reaching 75.9%—a level similar to 2018-2019. However, China’s capacity expansion in manufacturing sectors will likely stay elevated in the long run, creating episodes of overcapacity and further effects on global trade.

In previous overcapacity cycles, cheap Chinese exports contributed to rising trade tensions and a series of anti-dumping investigations, such as the EU investigations on Chinese steel in 2016. Overcapacity also hurt Chinese companies’ profits and came with unsustainable debt growth. Reducing overcapacity thus became a priority for the Chinese government in 2016.

This time around, the Chinese government is also expressing awareness of the issue. The Government Work Report in March 2024, for example, mentioned strengthening “investment guidance for key sectors to prevent overcapacity, poor quality, and redundant development.” However, the solutions adopted will likely center on retiring obsolete capacity and letting the most uncompetitive companies shut down while continuing to support capacity expansion, innovation, and exports in others.

This policy mix is part of a broader economic strategy that emphasizes manufacturing and exports as key growth drivers. Beijing has made clear in recent years that it wants to prevent China from de-industrializing, including in low-tech industries that would otherwise naturally migrate to lower labor-cost countries. Since the 14th Five-Year Plan in 2021, Beijing has vowed to stabilize the share of the manufacturing sector in GDP—a reversal of a decade-long trend. Several key local governments have since announced quantified objectives for their share of manufacturing in the economy.

Beijing is also desperately looking to rebalance the economy away from the infrastructure and property sectors and toward new growth drivers. Yet in the absence of a clear strategy to prop up consumption, this means supporting the manufacturing industry—particularly in emerging sectors such as renewable energy and electric vehicles—as a core engine of growth. China’s March 2024 NPC meeting set an explicit focus on industrial policy favoring high-technology industries, with very little fiscal policy support for household consumption. This policy mix will only compound the trade impacts of China’s growing state-supported industrial capacity.

This sets China, the EU, and the US on a dangerous course of trade confrontation in 2024, with a high probability of trade defense action cases. The systemic nature of China’s trade surplus and market distortions, not confined to specific sectors, may also motivate larger actions. Strong measures such as revoking the Permanent Normal Trade Relations status or introducing a new tariff column for China are already on the radar of US politicians during an election year. But China’s growing manufacturing surplus is not only a problem for the US and the EU. In fact, China’s trade surplus with G7 countries grew by a third between 2019 and 2023 while it more than tripled with developing economies, setting a daunting barrier as they try to nurture their own industrial sectors. The spillovers of China’s domestic imbalances are already compelling a response from a broader set of countries, including Brazil, India, Mexico, and South Africa. If China’s imbalances continue, this emerging market pushback will also likely intensify.

To read the full report as published by the Rhodium Group, click here.

To read the full report, click here.

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Can the trade system change? Radical changes have tended to reflect major shifts in geopolitics or macroeconomics. The Bretton Woods system of trade rules was shaped by the United States, which reflected the nation’s new role as a superpower following World War II and an interest in avoiding the mistakes following World War I; namely, the protectionist tariffs that fomented economic depression. The General Agreement on Tariffs and Trade grew into the World Trade Organization after many rounds of liberalizing trade by reducing tariff and non-tariff barriers, with the hope that the gains of trade would spread to the developing world in the era after the Cold War.

Today, geopolitical realities and the goals in the Paris Agreement may call for a further institutional overhaul of the global trade system. The global push to achieve net-zero emissions demands unprecedented action, albeit at different speeds in different countries, given the Paris Agreement’s bottom-up architecture based on nationally determined contributions, and the United Nations Framework Convention on Climate Change principle of “common but differentiated responsibilities.” The goals of the agreement require policy choices that are not easily reconciled with the trading system that has existed since 1989.

Climate and Trade: More Policies, More Policy Priorities?

As countries expand climate action to meet the Paris Agreement, a willingness to accept a wide diversity of approaches to climate policy from trade partners would be beneficial. Experimentation with various policies in the real world is crucial for nations to discover the policies that are most effective, efficient, and equitable. Policy approaches also inevitably will differ between regions, given constraints related to local economies, politics, and cultures, along with differences in legal systems. For example, the United States, which is backed by the Federal Reserve and the strength of the US dollar, will offer generous subsidies, while the European Union, which has decades of experience incrementally integrating dozens of national markets, will regulate and price greenhouse gas emissions.

The international trade system (and the institutions associated with the Washington Consensus, such as the World Bank and the International Monetary Fund) needs to evolve and enable policies that reflect new political and geopolitical priorities, if the trade system is to support the goals in the Paris Agreement. For example, a rekindled international trade system needs to reflect the legitimate role for industrial policy, given that industrial policy, though long maligned, has returned with a vengeance to nations in the West. This return of industrial policy requires a rethinking of subsidies; the traditional impulse is to constrain subsidies, rather than encourage a design with positive spillovers, such as innovation or regional development.

Some industrial policies are considered attractive—or even essential—climate policies, like subsidies that support reductions to the cost of clean energy technologies or trigger investments in firms that emit little or no greenhouse gases. But industrial policy in the 2020s has a mercantilist bent to it, as well. Some governments face electorates that reject the value of open trade. Governments also may face geopolitical tensions that encourage increased resilience against global economic shifts and perturbations, or motivate the domestic manufacturing of goods that are considered important to national security and the national economy. Industrial policies in these nations seem to aim to protect domestic economic interests above all else.

Border adjustment mechanisms are another type of climate policy that is potentially controversial. These policies, which impose fees, tariffs, or other costs on importers of a good based on the emissions associated with the production of that good, can be a way to both mitigate carbon leakage and incentivize other nations to mitigate emissions in response to the policy.

A reformed international trade system ideally would recognize the political motivations behind new green industrial policies and trade policies, while still encouraging restraint, fairness, and the scope of any policy to stay in proportion to its purpose. A tax credit in the Inflation Reduction Act may be a fantastic incentive to produce clean hydrogen, but if the tax credit becomes the sole business case for clean hydrogen, few countries will be able to compete with firms in the United States. Border adjustment mechanisms may be legally legitimate to level the playing field between firms that operate in nations with more stringent climate policies and firms in nations with less stringent climate policies, but the costs of complying with border adjustment mechanisms may be disproportionate, especially for countries in the Global South or for smaller producers. These challenges are not cause for such policies to be avoided or abandoned, but policymakers may want to account for the impacts of these policies on trade partners or political partners, as well.

When countries, individually or collectively, weigh the merits of industrial policy and policies that address climate and trade, they may not want to merely consider whether a policy is justified, as if justification were a dichotomy. The reductions in cost for renewables, including reductions spurred by subsidies, have provided a rare glimmer of hope for the achievement of lofty emissions-reduction goals. However, cost reductions also have been the result of China’s manufacturing prowess, given that China has a comparative advantage in scaling up manufacturing from certain industries such as solar energy. Replicating subsidies for other low-carbon technologies would not necessarily yield the same results as have been achieved for solar. In addition, some technologies inherently are better suited to rapid reductions in cost; for example, the commodification of components that are critical to production helps lead to economies of scale. For other technologies, such as carbon capture, for which customization and systems integration are more important, costs may not necessarily decline at the same pace.

Subsidies and industrial policies long have been deployed with the purpose of protecting industry incumbents. However, in a political environment where domestic interests and industrial competitiveness take priority, policies that compensate and protect incumbents may risk crowding out strategies of industrial policy that focus on investments and impacts that would benefit the climate or other societal goals. The economist Dani Rodrik, who has been more favorably disposed toward industrial policies than many other economists and politicians since before the current renaissance of these policies, emphasizes that the key consideration for industrial policy should be to “let the losers go [rather than] picking winners.” This attitude may be particularly crucial for climate policy, given that a low-carbon economy likely will be built on new forms of energy and industrial production that may be best suited to regions that differ from the regions where some industries currently are clustered.

What Is the Role of Multilateral Institutions?

International institutions could focus on more germane technical considerations. “Interoperability,” which is shorthand for the ability of nations to design climate and trade policies that affect trade without creating barriers to trade in terms of administrative costs, has become an oft-used keyword. International trade institutions, including the World Trade Organization, could contribute solutions to challenges regarding interoperability.

In the past, the coexistence of many different free trade agreements actually has led to a reduction in trade, due to the so-called “spaghetti bowl” effect: the costs of complying with overlapping agreements are higher for countries that are not party to these agreements. Free trade agreements also allow for deeper integration or alignment between nations, but reaching agreement on rules (or a larger set of rules) with a larger group of countries can become more difficult than with smaller groups.

The risk of a “green spaghetti bowl” emerges in the context of climate policy. (We apologize for the mental image this phrase may conjure.) Firms and importers have to navigate myriad border adjustment mechanisms; rules for subsidies; requirements for how much of a good must be produced domestically; product standards based on emissions intensity; and regulations in the domain of environmental, social, and corporate governance. These factors all contribute to the transaction costs that companies and importers have to deal with. While multinational firms are well-versed in navigating multiple complex regimes of regulations, smaller companies may see transaction costs rise to the extent that those companies stop trading internationally.

A desire undoubtedly exists among nations for a forum (or fora) to discuss interoperability and, ideally and eventually, some form of alignment on the many climate polices that affect international trade. The international community should continue to consider what the most appropriate venues could be, if this dialogue really is a priority. One of these venues could be the World Trade Organization, but this choice would require willingness both from current political leaders, who have critiqued how the organization currently is functioning, and traditional supporters of the organization, who would need to accept that member nations of the organization have policy goals that go beyond free and open trade. The United Nations Framework Convention on Climate Change might be another option for a venue, following the first-ever “Trade Day” at the 28th Conference of the Parties. Other intergovernmental initiatives such as the Climate Club might offer the most promising venue, though these initiatives may be insufficiently inclusive and comprise countries that already are like-minded, thereby not addressing the trade relationships in which interoperability might be most critical.

Finally, a particularly important role may exist for the world’s middle powers, such as Canada and Indonesia, in the ongoing debate about climate and trade. These nations are at risk of being squeezed in a subsidy race or a tariff tit for tat between the largest economies—the United States, China, and the European Union—while often being aligned with one of them. Middle powers can encourage economic superpowers to consider the better angels of their nature, practice restraint, and be measured when crafting policies that impact trade. Policies that fulfill these criteria can help extend the gains of trade to future generations while the trade system continues to support sustainable growth across the globe.

To read the full blog post as it appears the Resources for the Future website, click here.

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China wants to become a science, technology, and manufacturing superpower by upgrading and modernizing its industrial base and concentrating the nation’s innovation resources around strategic priorities. However, it is difficult for the state to integrate innovation resources because of the gap separating universities and research organizations from industry, which impedes the translation of scientific output into technological prowess. By contrast, Beijing has been much more successful at directing industrial development. As a result, achieving a modernized industrial base is now the dominant framework for Chinese policymakers as they pursue technological self-reliance.

The post Whole-of-Nation Innovation: Does China’s Socialist System Give It an Edge in Science and Technology? appeared first on WITA.

It is taking steps to rebalance its position in the global economy. While seeking to preserve the benefits of interdependence with the rest of the world, the European Union is contemplating policies that would induce change. One change seeks to alter the footprint of global production for certain goods, affecting whom it sources imports from and whom it sells exports to. It wants to decrease certain trade dependencies (which could be weaponized) and increase others (to encourage diversification). A second change is the enactment of new contingent policy instruments intended to allow the European Union to respond more quickly when policymakers in other countries act badly (or to establish a credible threat sufficient to deter them from doing so in the first place).

This paper describes how the European Union is seeking to use trade and industrial policy to achieve its economic security objectives. It identifies some of the economic costs and tradeoffs of using such policies. Because the issues it examines—many of which are noneconomic, for which reasonable estimates of costs and benefits are lacking—are evolving, the paper shies away from normative recommendations. Instead, it explores the political economy of what is emerging and why. The paper focuses on EU efforts to “de-risk” vis-à-vis China especially, given the emphasis EU policymakers now place on doing so.

The paper is organized as follows. Section 2 defines the concept of economic security and the events that led it to play such a sudden and prominent role in modern policy. It provides some early evidence to motivate the new policy interventions but emphasizes that much remains unknown, especially concerning their design.

Section 3 explores a case study that highlights the difficult choices the European Union faces in responding to threats to its economic security. The case study involves the electric vehicle (EV) industry, the European Union’s potential use of trade defense instruments (TDIs) to address unfairly subsidized imports from China, and China’s potential retaliatory response of placing export restrictions on graphite, a critical material needed to manufacture EV batteries. It also identifies unknowns facing policymakers seeking “a clear-eyed picture on what the risks are,” in the words of European Commission President Ursula von der Leyen. The section also explores empirically whether the European Union’s trade interdependence with China may be deepening—despite stated goals to de-risk—in part because of the third-country effects arising from the US– China trade war.

Section 4 introduces the policy instruments the European Union, its member states, and other governments are pursuing to address concerns about their economic security. They include stockpiling and inventory management, investment or production subsidies, various forms of tariffs, export controls, and regulations on foreign investment. This section also highlights proposals for new policy instruments, analyzes the associated tradeoffs, and briefly describes basic World Trade Organization (WTO) rules that might discipline such instruments.

Section 5 turns to the potential for selective international cooperation over the use of such policy instruments. It explores how countries facing common concerns over economic security have been acting in coordinated fashion— implicitly or explicitly—and the difficulties of doing so.

Section 6 concludes with some caveats and lessons from history.

Chad P. Bown is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics.

To read the abstract published by the Peterson Institute for International Economics, click here.

To read the full working paper, click here.

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For a number of overlapping reasons, today’s industrial policy seems different from policy in the past. It is often forcefully pursued by major highincome industrial economies, including the United States, the European Union, and Japan, as opposed to emerging economies. China’s use of industrial policy is both motivating these new users—sometimes to deploy industrial policy themselves, sometimes to defend their economies from China—and driving some of the associated WTO challenges. Today’s industrial policy objective is also often less about learning for the first time how to competitively produce a good or acquire the necessary technological absorptive capacity to do so, which is what often motivated past infant industry policies for developing countries. Instead, the objective appears aimed at returning parts of a supply chain for industries ranging from semiconductors to personal protective equipment (PPE) that were once present but that have since been offshored.

Industrial policy today is also sometimes motivated by objectives other than increasing firm-level productivity or generating spillovers to other sectors and thus enhancing national economic growth. Instead, industrial policy is aimed at diversification in the name of supply chain resilience, fear over the weaponization of exports by trading partners, maintenance of technological supremacy, or the desire to offer future policymakers more control over economic activity in response to expected shocks. In the presence of cross-border supply chains, some governments are seeking to coordinate their industrial policies with key partners, as opposed to implementing everything at the national level in an attempt at reshoring. Overlaying other considerations is the existential threat of climate change, an important driver behind many modern industrial policy initiatives.

To explore these interrelated motivations for today’s industrial policy and its numerous implications for the WTO, this paper is organized as follows. The next section briefly introduces the historical economic approach to industrial policy, borrowing from Harrison and Rodríguez-Clare (2010). The starting point of this literature is typically market failures, developing countries, and how industrial policy can improve firm-level productivity growth and possibly national economic growth.

Section 3 turns to the dominant economic framework motivating the WTO. It draws on Bagwell and Staiger (1999, 2002) as well as key WTO rules and the role of enforcement. The WTO is interpreted as providing an institutional setting for large countries to coordinate policies and set rules on behavior to neutralize the international externality implications of their actions and solve a prisoner’s dilemma problem. This section also explores the economic understanding of current subsidy rules with implications for industrial policy. It describes unease with the evolution of those rules, gaps in knowledge, and important data and measurement shortcomings.

The subsequent two sections form the heart of the paper. They introduce four areas in which modern industrial policy has emerged as a major issue for the WTO. Section 4 tackles the myriad challenges introduced by China. Section 5 examines areas of supply chain resilience, supply chain responsiveness, and climate change. The four issues are not cleanly separable; the last three are independent areas of concern, but China plays a critically important role in each. The last section concludes by motivating the need for further economic research.

Chad P. Bown is the Reginald Jones Senior Fellow at the Peterson Institute for International Economics.

To read the abstract published by the Peterson Institute for International Economics, click here.

To read the full working paper, click here.

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The BRI has had considerable influence on China, on BRI host countries and the world. It would be wrong to see it as a declining force simply because Beijing is allocating less finance to BRI projects: many of the BRI’s initial goals were achieved early on in its first decade. The BRI has evolved over time to suit Beijing’s strategic goals. This special edition of the tracker examines the BRI’s impact on trade flows through the ports sector – critical logistics nodes along the BRI. We look at the ports built, bought, operated and used by China’s state-owned national champions. 

First, Clark Banach maps out China’s footprint across global port ecosystems in a detailed map. Banach, who is MERICS Futures Fellow, explains the more deeply Chinese SOE’s are entrenched in a port, the more strongly it is pulled into China’s orbit at the expense of trade with other partners. 

Second, MERICS Lead Analyst Jacob Gunter builds on Banach’s quantitative analysis with a qualitative look at how China’s involvement in ports develops. Gunter details China’s presence in Mediterranean and Northern European shipping ecosystems and how ports can spread distortions emanating from China’s own economic model. He examines how port networks create potential dependency and influence risks. 

Banach and Gunter then take a closer look at four Mediterranean ports with Chinese participation. In each case study, they assess Chinese SOEs’ strategic and commercial success or failure. The case studies look at port holdings or operations in Greece, Spain, Algeria, and Israel and offer a way to benchmark Beijing’s desired outcomes and how far they are being achieved. 

Finally, they suggest what the future of the BRI might look like, drawing on President Xi Jinping’s speech to Third BRI Forum and their own research. The future BRI can be expected to leverage its extensive built infrastructure further, while shifting focus towards green energy and telecoms equipment. China’s green transition industries suffer from overcapacity, so they need export outlets, while telecoms giants like Huawei and ZTE must secure and expand their footprints in more neutral markets to compensate for restrictions on their activities in liberal democratic markets. 

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The report examines the growing reliance of the United States on using domestic subsidies to address global challenges: “the [Joe] Biden administration has maintained and expanded on the [Donald] Trump administration’s tariff policy, defended at the time as helping the United States compete globally against a rising China, by introducing major new subsidy programs. Importantly, the primary motivation for those efforts falls into two buckets—to counter China and to fight climate change.” That adoption of industrial policy “has prompted cries from across the globe that the United States is fostering unfair competition and breaking the rules it helped shape as part of the World Trade Organization (WTO).”

In the aftermath of simultaneous political and economic crises, “the perception of countries’ urgent need to build up their resiliency in critical goods and services, coupled with the existential threat of climate change, means that moving toward industrial policies and increasing subsidies is warranted and indeed essential,” Hillman and Manak write. “However, the urgency of the problems does not mean abandoning well-founded concerns that industrial policy—done wrong—can stifle innovation, create substantial inefficiencies, exacerbate the concentration of corporate power, waste precious taxpayer funds, and fuel crony capitalism.”

The authors outline the deficiencies of the current international rules governing subsidies and provide recommendations. In particular, Hillman and Manak highlight the failure of many WTO members to report their subsidies, the ineffective remedies available, and the lack of special recognition by WTO rules of beneficial subsidies aimed at tackling climate or public health challenges, among other issues.

To lead the charge on reforming the WTO rules, the authors propose that the United States should

• “revisit what constitutes good and bad subsidies and propose limiting overall subsidy levels while carving out areas in the common international interest”;
• “encourage countries to disclose their subsidies, both by using the incentive of a ‘safe harbor’ for subsidies that have been properly notified and enforcing penalties for those that consistently fail to make timely notifications of their subsidies”; and
• “strengthen the penalties for noncompliance with international subsidies rules.”

“At its core, one of the WTO’s critical roles is to help its members draw the line between protectionist measures and sound industrial policies, while ensuring that wherever that line is drawn, it does not unduly privilege some or harm others,” Hillman and Manak conclude. “To do that in the face of rising industrial policies across the globe, the WTO needs an updated toolbox.”

Jennifer Hillman is the Senior Fellow for Trade and International Political Economy and Inu Manak is the Fellow for Trade Policy at the Council on Foreign Relations.

To read the full Council Special Report, please click here.

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In using the removal of Section 232 ‘national security’ tariffs on steel and aluminium imports as a bargaining chip, the United States demands that the European Union engage in negotiations on “global steel and aluminium arrangements to restore market-oriented conditions and address carbon intensity”. The US demand has reportedly been inspired by a blueprint that would establish an international institutional arrangement – labelled a ‘climate club’ – which would externalise market-access restrictions afforded by US Section 232 tariffs to the customs borders of club members. While the declared objective is to incentivise non-members to adopt low-carbon steel (and aluminium) production methods the US blueprint suffers from various design flaws including inefficient incentives, WTO inconsistency and incompatibility with the EU Carbon Border Adjustment Mechanism.

The effectiveness of the proposed US scheme is severely compromised by the plethora of policy objectives it pursues, which go far beyond the goal of incentivising industrial decarbonisation in third countries, including secondary (ie protectionism) and tertiary (ie global power competition with China) objectives. The initial negotiation proposal submitted by the United States Trade Representative (USTR) to European Commission trade negotiators incorporates many if not all the problematic elements of this blueprint, setting the US on a collision course with the negotiation proposal put forward by the European Commission. This paper concludes that the adoption of the scheme proposed by USTR would result in a step backwards for international climate and trade cooperation, whereas not adopting the EU proposal would make for a missed opportunity. Given the sharply diverging negotiation positions and associated respective domestic constraints on both sides, however, policymakers should start to engage stakeholders now to manage expectations towards a low-ambition negotiation result, if any.

Introduction

On 31 October 2021, the European Union and the United States agreed on temporary measures to settle their dispute over US Section 232 ‘national security’ tariffs on EU steel and aluminium products. In addition to opening tariff rate quotas for historical EU export volumes, the joint EU-US statement mandates negotiations on a “global steel and aluminium arrangements to restore market oriented conditions and address carbon intensity”, with a deadline of 31 October 2023. The relevant paragraphs are an eclectic mix of transatlantic policy objectives in the areas of steel and aluminium decarbonisation, sectoral overcapacity, non-market practices and inbound investment screening:

“Compatible with international obligations and the multilateral rules, including potential rules to be jointly developed in the coming years, each participant in the arrangements would undertake the following actions: (i) restrict market access for non-participants that do not meet conditions of market orientation and that contribute to non-market excess capacity, through application of appropriate measures including trade defence instruments; (ii) restrict market access for non-participants that do not meet standards for low-carbon intensity; (iii) ensure that domestic policies support the objectives of the arrangements and support lowering carbon intensity across all modes of production; (iv) refrain from non-market practices that contribute to carbon-intensive, non-market oriented capacity; (v) consult on government investment in
decarbonization; and (vi) screen inward investments from non-market-oriented actors in accordance with their respective domestic legal frameworks.

“To enhance their cooperation and facilitate negotiations on a global sustainable steel and aluminum arrangements, the United States and the EU agree to form a technical working group. Through the working group, the United States and the EU will, among other things, confer on methodologies for calculating steel and aluminum carbon-intensity and share relevant data”.

At the time of writing – 20 months after the formal launch of negotiations and four months prior to the deadline, negotiators have set up two technical working groups – one covering the carbon intensity element and one covering the overcapacity element of the negotiations. They have also exchanged negotiation positions in the form of concept notes in December 2022 and January 2023 respectively.

On 10 March 2023, European Commission President Ursula von der Leyen and US President Joe Biden declared, as part of a further joint statement (The White House, 2023), that they were “committed to achieving an ambitious outcome in the Global Arrangement on Sustainable Steel and Aluminum negotiations by October 2023. The arrangement will ensure the long-term viability of our industries, encourage low-carbon intensity steel and aluminum production and trade, and restore marketoriented conditions globally and bilaterally. Together, we will incentivize emission reductions in these carbon-intensive sectors and level the playing field for our workers. The arrangement will be open to all partners demonstrating commitment to countering non-market excess capacity and reducing carbonintensity in these sectors”.

But beyond this declaration of joint ambition, US and EU perspectives and their initial negotiation proposals diverge sharply in terms of both policy design features and the overall approach, objectives and vision of transatlantic and international climate and trade cooperation. This paper sets out the EU and US perspectives on the ongoing negotiations and evaluates US and EU initial negotiation proposals as the transatlantic talks slowly but surely approach the 31 October 2023, deadline. The October deadline could mark either a breakdown of negotiations and automatic reinstatement of US Section 232 tariffs on imports of steel and aluminium from the EU, or a transatlantic agreement on a ‘Global Steel and Aluminium Arrangement’. An agreement could follow either the US or the EU’s vision for climate and trade cooperation, with all of the imaginable scenarios having considerable economic and climate policy implications for the US, the EU and the rest of the world.

As a benchmark for evaluation, Falkner et al (2022) noted that a prospective transatlantic climate club must be assessed on the basis of whether it adds or distracts from the multilateral climate regime or diverts resources away from crucial national abatement efforts. Here, we assess both the US and EU proposals for the arrangement against both the multilateral and the national benchmark, among others.

David Kleimann (PhD) is a trade expert with 15 years of experience in law, policy, and institutions governing EU and international trade.

To read full paper, please click here.

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The relationship between the United States and China is destined to be increasingly fractious. The two countries occupy geopolitical tectonic plates, the movement of one unavoidably generating friction with the other. It is an open question as to how much the world economy, where the market has largely determined trade flows to date, will be reshaped to reflect geopolitical forces.

Global trade figures in gross terms do not reflect the growing geopolitical rivalry.

Despite being strong allies of the United States, for Germany, Japan, and Korea, China is the largest trading partner. In this still undivided world economy, the US, EU, Japan, and the Republic of Korea accounted for 42% of Chinese merchandise exports in 2021. In 2022, the EU, Taiwan, the Republic of Korea, Japan, and US supplied 43% of Chinese imports. Not even the invasion of Ukraine by China’s closest friend, Russia, has caused the trading system to divide into two camps – one led by Beijing and the other by Washington.

The overall numbers tell only part of the story. While the volume of trade between the US and China remains high, bilateral strategic decoupling is proceeding. This is a US-China bilateral phenomenon. It is reflected in the trade of others only selectively. For America’s allies, the US-China trade war had been a spectator event only. Two exceptions began to occur – one for supplying geostrategic-relevant goods, services and technology, and a second the result of identifying sources of geostrategic relevant supplies. Where the US pressed Japan and the Netherlands to join in restricting exports to China of semiconductor production equipment, they have done so. Separately, learning from the European experience with excess dependency on Russia for fossil fuels, Western capitals have begun planning the diversification of sourcing of critical minerals, to avoid dependency on a single country, particularly China.

Any decoupling that does occur between China and the West will likely be substantially “made-in-China”, that is caused by China’s own policies. US preaching in favor of supply chain resilience would fall on deaf ears were there no concerns generated by China with respect to its reliability as a supplier of critical materials.

The general trade policies of the two rivals will also shape trade flows. China is aggressively moving to lower barriers to its trade with others, first through RCEP and then applying to join CPTPP. The United States has moved in the opposite direction, failing to deepen economic relationships with even its avowed friends. In fact, through its recent trade measures it has tended to alienate these trading partners.

Other factors, not traditionally the subject of trade agreements, will contribute to fragmenting the trading world. The contest over global standards has yet to play out – setting standards regarding 5G telecommunications, internet protocols, privacy, AI, electric vehicles and other products at the frontiers of technology may divide markets. Potential effects on trade can be expected as a result of the debt owed to China by the beneficiaries of the Belt and Road Initiative (BRI) and China’s other development programs. For example, the need to repay debt has enabled privileged Chinese access to raw materials, a phenomenon just beginning to be witnessed. The exponential growth of Chinese overseas investment, which will affect trade, is likewise at an early stage. Another factor is the RMB perhaps taking on a more central role as a global currency. All of these economic and financial variables may play a part in shaping world trade. 

None of the aforementioned influences may prove to be as consequential for world trade as the deterioration of the multilateral trading system itself. The immense increase in global economic prosperity made possible by international trade over the last three-quarters of a century has depended in very large part on the certainty provided by the rule of law. As the two largest trading countries begin to ignore the existing structure of rules, this could become a tipping point, seen in retrospect as the end of an era and the beginning of another, a darker one. If the rules are increasingly ignored, the new age would more likely than not be characterized by slower economic growth and fragmented trade.

This is not to suggest that either of the two contesting powers have a conscious plan to discard the current trading system. Neither appears to have reached the conclusion that an end to the multilateral trading system would be in its interest. It is possible that neither is fully conscious of the spreading damage caused by their acting at cross purposes with the current rules. But their conduct is telling. In the case of the US, the departure from the international rule of law is demonstrated by ending binding WTO dispute settlement by blocking Appellate Body appointments, applying tariffs at odds with its contractual commitments (tariffs on trade with China in general and embracing a national security rationale to restrict steel and aluminum imports from all sources), and unapologetically subsidizing domestic industries without regard to any international rules. China’s departure from the rules is at one and the same time more overt and more opaque. China uses trade measures for purposes of coercion and denies that market forces must govern competitive outcomes as it increases the role of the state and the Communist party in its economy.

Neither Washington nor Beijing has declared an end to its adherence to the WTO-administered multilateral trading system. The reverse is the case. Perhaps current conduct at odds with the system is an aberration. US officials state that there is no general policy of decoupling from the Chinese economy. China’s policy of working towards “dual circulation” has not been accompanied by it announcing a retreat from global trade. What is clear is that each wishes to be less reliant on trading with the other. The world has seen nothing like this in inter-hemispheric trade since US measures toward the Empire of Japan in 1940-41, and no analogy with the past is a sufficient guide to the future.

The game changers for the global trading system consist of the adoption by the United States and China, for domestic reasons, of economic nationalism as a controlling factor in formulating their foreign economic policies. In the US the Trump Administration embraced economic nationalism primarily with rhetoric. The Biden Administration made the rhetoric reality in its major economic legislative initiatives. For China, nationalist policies were evident in its statements about achieving dominance in key industries of the future and the episodic deployment of trade measures for purposes of coercion. China’s domestic concerns for regime stability and its contest with the United States led it to support Russia during its invasion of Ukraine. Its priorities blinded it to the inevitable Western reaction. Neither nation has room in its current world view for actively supporting multilateralism.

Most other countries continue to steer an uncertain, non-aligned course, which may increasingly be governed by ad hoc determinations of self-interest. The world’s largest trading bloc, the European Union, has called for a policy of “strategic autonomy”. Whatever this turns out to be, it is not a vote to join Beijing or Washington in a trading bloc, nor is it a declaration in favor of the multilateral trading system. As for some of the others, one would not expect to hear from India nor South Africa that adherence to the existing multilateral trading system is a national priority. Neither are there any indications whatsoever of any country, including these two, aspiring to join a trade bloc.

The bottom line: world trade is not at present coalescing into two trading blocs, but the center, the multilateral trading system, is under stress. The question increasingly asked in academic symposia is whether it will hold.

Alan Wm. Wolff is a distinguished visiting fellow at the Peterson Institute for International Economics. He was Deputy Director-General of the World Trade Organization, Deputy US Special Representative for Trade Negotiations (USTR), and USTR General Counsel. He was a principal draftsman for the administration of the Trade Act of 1974, which provided the basic US negotiating mandate for future US trade negotiations. His book, Revitalizing the World Trading System (Cambridge University Press), is being published this month.

To read the full paper, please click here.

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The resurgent popularity of green industrial policy is a double-edged sword. On one hand, the protectionist provisions in the Inflation Reduction Act (IRA) were critical to the passage of the most significant US investment in climate action ever. Without the IRA’s domestic sourcing and final assembly requirements, President Joe Biden’s pledge of reducing US emissions 50–52 percent by 2030 would be out of reach. On the other hand, the same protectionist provisions have deeply frustrated US trade partners and aggressively bend—if not altogether break—international trade rules under the World Trade Organization (WTO) regarding equal treatment of foreign and domestic suppliers.

The Biden administration is working toward assuaging concerns over the IRA, which caught close US allies by surprise. However, this friction may be only the opening salvo in a decade marked by green trade tensions. It would be naive to think that the intersection of trade and climate policies will lessen—and not accelerate—with time.

The world should embrace the IRA and other green industrial policies, which are substantial, durable actions to meet climate commitments under the Paris Agreement. Still, they come with risk. For their part, the United States and others should establish guardrails to preserve the international trade rules that have underpinned global prosperity since World War II.

Domestic politics, international rules

The US brand of climate action laced with industrial policy is not a one-off. The political incentives that shaped the IRA are not unique to the United States. For many more countries, crafting ambitious climate policy that doesn’t erode key domestic support requires a mix of subsidies, tariffs, and regulations that current trade rules would heavily discourage if not outright disallow. The IRA’s expected pull on global clean energy investment is already encouraging others to follow suit.

For example, the European response—the Green Deal Industrial Plan and the Net-Zero Industry Act (NZIA), the legislation designed to realize the plan—bear a remarkable similarity to the IRA. The NZIA would further loosen state aid rules, the EU regulations regarding allowable domestic subsidies, to cover more types of clean energy projects. The European Union previously relaxed state aid rules at the start of the COVID-19 pandemic and again after Russia invaded Ukraine. The Green Deal Industrial Plan will also feature various funding measures and prioritizes workforce training to prepare European workers for maximum employability in the energy transition.

Importantly, Europe will also provide its own subsidies for domestic manufacturing in the form of a proposed European Sovereignty Fund, which would finance industrial policy initiatives, and an Innovation Fund to finance innovative demonstration projects. The plan emphasizes ambitious domestic manufacturing targets for a broad swath of clean energy technologies, including wind turbines, solar photovoltaic panels, heat pumps, batteries, and electrolyzers.

The European plan reflects reasonable worries among EU countries that their domestic firms will relocate to the North American market to chase the IRA’s generous subsidies. These worries coincide with high energy prices—driven, in part, by Russia’s war in Ukraine—that threaten to shrink major European industrial firms, such as German chemicals giant BASF SE and steelmaker ArcelorMittal. The IRA’s massive pull toward the US market will mean billions in new clean energy investment but could also redirect billions away from the clean manufacturing agenda in Europe and elsewhere, including in emerging markets.

At the same time, a fight over carbon tariffs is looming on the horizon. In December of last year, the EU finalized its carbon border adjustment tariff mechanism (CBAM), which extends the EU carbon price to imported greenhouse-gas-intensive products. As proposed, it will eventually impose tariffs on a broad swath of countries that do not have a domestic carbon price, including the United States and most developing economies. The EU’s CBAM, although designed to comply with existing international trade rules, has already provoked negative responses among policymakers around the world. US proposals to impose tariffs on the carbon embedded in imports, including the Biden administration’s Global Arrangement on Sustainable Steel and Aluminum (GASSA), are sure to elicit fury from the developing world as well, given the lack of comparable fees on domestic producers in the United States. These countries’ call for increased climate financing, including for loss and damage as a result of climate change—which gained momentum at COP27—only further compounds the ire. Developing economies, unable to compete with subsidy packages of their own, may instead limit imports of clean energy technologies and impose export controls on raw materials, and especially on critical minerals, for the political and economic leverage they provide, in an effort to move up the value chain.

The controversies over green subsidies and carbon tariffs could portend even more intractable conflicts at the intersection of climate, trade, and industrial policy throughout the decade. IMF chief Kristalina Georgieva has already cautioned against this trend, urging that green subsidies “be carefully designed to avoid wasteful spending or trade tensions, and to make sure that technology is shared with the developing world.”

If the momentum toward protectionism continues, the United States, the European Union, and others could drift into walled markets in which low-cost clean technologies cannot easily diffuse across borders, making it harder to decarbonize globally. This will be exacerbated by the limited capacity for emerging market economies to compete in a subsidy arms race. A worst-case scenario might involve a deluge of tit-for-tat cases at the WTO and retaliatory tariffs that fragment the global clean technologies market and decelerate climate action.

Noah Kaufman is a senior research scholar with the Center on Global Energy Policy at Columbia University’s School of International and Public Affairs, where Sagatom Saha is an adjunct research scholar and Christopher Bataille an adjunct research fellow 

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