More on decarbonisation and climate finance

Following the debates on carbon emission reductions, one could easily come away with the feeling that the main issue in question was a technical challenge, how to find the resources to finance green investments. These debates skirt the important deeply contentious practical issues of who’ll bear the costs of climate transition and how to overcome the political economy opposition. 

This is highlighted in the ongoing US Presidential elections where the Republican candidate is openly campaigning for expanding fossil fuel use. Here’s a snippet from a NYT report about one of President Trump’s fundraising dinners.

Mr. Trump repeated his public promises to delete Mr. Biden’s pollution controls, telling the attendees that they should donate heavily to help him beat Mr. Biden because his policies would help their industries… Mr. McKenna said the former president’s appeal to the fossil fuel industry could be summed up as: “Look, you want me to win. You might not even like me, but your other choice is four more years of these guys,” referring to the Biden administration… Karoline Leavitt, a spokeswoman for the Trump campaign, did not address the specifics of what Mr. Trump was described as saying at the dinner. In a statement, she attacked President Biden as controlled “by environmental extremists who are trying to implement the most radical energy agenda in history and force Americans to purchase electric vehicles they can’t afford,” and that Mr. Trump is “supported by people who share his vision of American energy dominance to protect our national security and bring down the cost of living for all Americans.”… the former president told executives that he was determined to squash what he considered anti-business policies, and that the oil industry should therefore want him to win and should raise $1 billion to ensure his success. He told the executives that the amount of money they would save in taxes and legal expenses after he repealed regulations would more than cover a billion dollar contribution, the people said.

The political challenges are mirrored on the economic/market side. 

The much-hyped transition to Electric Vehicles has run into rough weather even before it has begun. EV car demand appears to have hit a plateau and sales have slowed everywhere (except China). Manufacturers have been cutting prices frantically in a race that has slashed margins. Competition from the heavily subsidised EV exports from China has only compounded matters. 

Inadequate charging infrastructure and more importantly high prices have meant that the demand for EVs has peaked, at least for now, quickly. The limits to rapid energy transition in automobiles have been exposed. 

The result has been a spike in the demand for hybrids, which were only till recently considered a needless distraction. 

Global carmakers are stepping up their investment in hybrid technologies as consumers’ growing wariness over fully electric vehicles forces the industry to rapidly shift gear, according to top executives… Electric car sales growth slowed in the US and Europe last year, prompting carmakers to offer discounts… For many carmakers, the slower switch is allowing them to continue to squeeze profits from traditional engines while also providing more financial firepower to develop electric vehicle technology.

The lesson from the example of EV is important. Energy transitions cannot be squeezed into the short time frames we want. Legacy investments cannot be junked without someone bearing its costs. The green alternatives must become affordable enough for the customers to switch. These alternatives must develop the ecosystem required to become the new norm. Finally, the political economy of such transitions needs to be considered.

If the developed economies with their much higher levels of incomes cannot afford to rapidly and directly substitute away from ICE to EV, then it’s both unfair and unrealistic to expect the developing economies to undertake the ambitious energy transitions that are being thrust on them. 

The EVs are only the latest example. The transition from fossil fuels to renewable energy generation is another example. Just as hybrids might be a practical intermediate stage in the green transition, substitution towards natural gas should be seen as a step in the right direction and encouraged. 

Consider a few other data points. As this FT article shows, while climate change mitigation may be the professed policy of the US and other governments, there’s an increasing dichotomy between the policies and outcomes. 

Biden made tackling climate change a central priority for his administration and vowed to crack down on America’s oil and gas industry. He has brought in environmental rules that range from endangered species protections and a clampdown on methane leaks to restrictions on offshore leasing and the suspension of new licences for the multibillion-dollar terminals needed to liquefy American gas and ship it abroad… On his first day in office he signed an order revoking a crucial permit for the Keystone XL pipeline — in effect killing an $8bn project designed to shuttle oil from Alberta, Canada, to Gulf Coast refineries.  More policies followed: a temporary suspension of drilling on public lands; freezing and then scrapping leases in an Arctic wildlife refuge; and introducing a charge on methane leaks, the country’s first nationwide fee on a greenhouse gas, to the delight of environmental groups… 

America’s oil and gas industry has flourished under Biden. At more than 13mn b/d, production is at record levels, exports of American hydrocarbons have surged and the scale of annual profits has been unprecedented — largely driven by a jump in commodity prices following Russia’s full-scale invasion of Ukraine in 2022.   Investors in the industry have reaped rewards too, as cash-rich producers showered them with returns. Shares in ExxonMobil have more than doubled since Biden took office and, emboldened by high prices, the industry has also splurged on mergers and acquisitions, making some of the biggest deals in decades…. As a result of higher prices, 2022 was the most profitable year on record for publicly traded US oil companies. 

The first graphic informs that the US oil and gas production has been consistently rising since 2010 and is now at record levels.

The second graph shows that contrary to a discount on fossil fuels, the profits of the biggest oil companies have risen sharply. 

There might be a problem with the framing of the technical challenge of mobilising finances for the green transition. 

Two graphics below puts the climate finance mobilisation challenge in perspective. The first show the extent of climate finance currently available and how it compares with other expenditures and fossil fuel subsidies

The second shows the requirement over the coming years.

The requirement estimated is staggering. 

I’ll be very surprised if anything like the amounts indicated in the graphs can come in the foreseeable future. In this report, we highlighted the near impossibility of mobilising financing of this scale. I’m also not sure whether we even need such amounts. It may therefore be useful to revisit some of these numbers which may have emerged through high-level assessments of the kinds that consultants make. 

It’s perhaps the case that at least some of the proponents of these numbers also see these numbers as a strategy to shock and awe governments to focus on resource mobilisation. But the size of the numbers being thrown around may also have made any meaningful engagement impossible. If a gun is placed on your head and you are asked to run 100 metres within 10 seconds, you are more likely to give up than even try the race! The sheer impossibility of the numbers in estimates like that in the Stern-Songwe report may have perversely enough turned off serious policymakers from even attempting to mobilise them. 

Thoughts on Affordable Housing - VII

Gentrification is a uniquely housing market problem. It describes the phenomenon of lower-income inhabitants of an area being displaced directly or indirectly by higher-income residents during the process of regeneration or redevelopment of the locality. The desired development happens (and property prices go up), but at the cost of the existing inhabitants. 

In the latest edition of Works in Progress, Anya Martin explores the issue of gentrification and writes about the surprisingly counter-intuitive evidence.

There is an apparent mystery in gentrification studies: many of them show very little displacement impact. One reason for this may be that poorer residents often exert huge effort to stay in place when rich new residents move in, because they too want to benefit from the additional amenities that come with this. Some studies show lower rates of evictions in neighborhoods considered to be gentrifying.

Moving is more often driven by personal conditions than neighborhood trends. Most people move a number of times throughout their lives because of changes to what they can afford, where they work, or how much space they need. Poorer people move at especially high rates, regardless of whether or not their neighborhood is gentrifying. Even in neighborhoods that are a long way from being gentrified, the most disadvantaged people are frequently forced to move away from their communities by unfortunate circumstances and the demands of their landlords. This high background churn helps explain why existing residents do not seem to move much more out of neighborhoods seeing rising numbers of college-educated residents and increasing house prices – that is, places that are gentrifying – than others. The base rate of people moving out is already high. For example, according to a 2019 study in the USA 60 percent of lower-educated renters move out of non-gentrifying areas in any ten year period, while 66 percent move out of gentrifying areas.In other words, the vast majority of these movers are moving because of their own personal circumstances, not because of gentrification per se. The study also finds that the people who do move tend to move to neighborhoods with similar characteristics to their old one – there isn’t a clear pattern of people downgrading to less desirable neighborhoods. 

But the displacement while generally small across the US, is likely to be significant in cities with limited supply and large demand, and large differential between prices and construction costs. In these cities, invariably some of the biggest metropolises, the renters tend to get pushed out of gentrifying areas and to neighbourhoods with lower school quality and higher crime rates. However, low-income homeowners tend to remain and benefit from the higher prices. 

The nature of the demand across market segments in the housing market in large cities (where supply is generally scarce) is such that any marginal supply will invariably get absorbed by the most well-off in those respective market segments. In fact, given the exorbitant housing costs (property prices and rents) in most global cities, it’s perhaps not incorrect to say that any marginal supply in any market segment will be unaffordable for all but the well-off. 

Even with well-meaning redevelopment programs that try to keep the incumbents in the area, it’s almost impossible to prevent the existing inhabitants from selling out and relocating to a less expensive area or suburb. In other words, regeneration and gentrification tend to go together. While I cannot point to studies, I’m inclined to believe this is the likely trend in most cities across the developing world.

But this does not make the case against redevelopment, for the absence of regeneration creates a vicious spiral of immiseration. The neighbourhood remains entrapped in its poor quality of infrastructure, services, retail traders, jobs, and quality of life. Some level of gentrification (and associated displacement) is therefore desirable to create the conditions that can trigger improvements in these areas. But controlling gentrification to limit displacement can be daunting.

Housing colonies in the better-off (or central parts of cities) areas will always struggle to retain the original allottees. Certain conditions and safeguards only delay the inevitable displacement. 

In theory, increased supply due to redevelopment, even with displacement, should set in motion a cascade of demand-supply dynamics across the entire housing market. But in practice, as I have blogged here, there’s a strong possibility that the shifts in the housing market are confined to the top end. It’s likely that on the net, like with free-trade, regeneration and gentrification end up leaving the incumbents worse-off. 

Consider the latest data point from India, where even as the property market enjoys a boom, the sales of affordable housing units (below Rs 40 lakh) have been declining over the past five years in top cities. 

While home sales climbed sharply from 2019 to 2023, the share of affordable housing dropped from 38% to 19% during the period. In January-March of 2024, the sales share stayed flattish, at 20%. Not just sales, budget housing supply or new launches too shrank from 40% to 18% in the same period. The decline of affordable housing became increasingly apparent after the pandemic, as larger, premium homes gained favour... the sales share of luxury homes jumped from 7% in 2019 to 25% in 2023. In January-March 2024, this was at 21%, but it is expected to pick up during the year. Of all the cities, Mumbai Metropolitan Region (MMR) has seen the most traction in this segment.

The biggest Indian cities do not have a market-driven supply problem for upper middle-income and high-income housing. The market supply problem is confined to the affordable housing and lower-income housing. And that has been the case for years. For the lower income housing segment, given the exorbitant land prices in cities, some form of subsidised housing can be the only solution. 

Ultimately the only strategy to mitigate gentrification is to ensure any regeneration comes with a sharply increased supply. 

If supply is elastic enough, new housing can alleviate or even prevent the forces that push existing residents out of an area. The more new homes you have, the more rising demand from higher-income movers can be absorbed, and the more low-income households are able to trade up into better housing. This can feel counterintuitive to many, because nothing looks more like gentrification than new-build housing, which is typically built to higher standards than existing stock. But if new higher-income residents want to move to an area – for work, education, family, or simply because they themselves have been priced out of somewhere else – and they aren’t moving into new builds, then they outbid others for existing stock.

Further, gentrification can have fascinating longer term consequences. 

Using the Finnish whole population register, Cristina Bratu, Oskari Harjunen, and Tuukka Saarimaatracked who moved into newly built units and, crucially, who took the homes they left. They found that while newly built homes were initially occupied by higher-income households, this triggered moving chains where middle- and lower-income families eventually moved into the higher-quality homes that had been freed up by the higher-income ones. Even more interestingly, while the first residents of newly built homes were often higher income, after those first inhabitants moved out, the newer homes were then occupied by those on lower incomes. Ultimately the study finds that for every 100 new centrally located market units that are built within a neighborhood, 66 become available for below-average-income households through vacancies within just two years. Far from pushing lower-income households out, the new homes make space for more of them.

Since 2018 London has been experimenting with a scheme for the regeneration of social housing estates (owned by local government or housing associations) where residents can vote to go for redevelopment.

These estate ballots give current social housing tenants and owners of homes on the estate a choice of whether they would prefer things to stay as is, or whether they would prefer a brand-new – and usually larger – apartment or house on a new estate. The quid pro quo is potentially years of disruption while it is built, as well as hundreds or thousands of new private renters or homeowners moving in next door – the cost of the regeneration is funded through the development of new homes which are sold or let privately. Estates can increase enormously in density: in Tower Hamlets, affordable housing provider One Housing is redeveloping 24 homes into 202, of which 50 percent will be rented at below-market rates. All 24 existing households will get new, higher-quality homes, and 84 percent of residents approved the proposals with 100 percent turnout. In Lambeth, 135 homes are being redeveloped by Riverside Group into 441 larger and higher-quality homes, of which almost half are submarket. This was approved by existing residents at 67 percent with an 87 percent turnout. The development comes with not only new homes, but new amenities like a gym, a community center, cycle parking spaces, and a new communal outdoor space.

Such regeneration schemes of slum redevelopment (and squatters on public lands) have been widely attempted in Indian cities but with limited success. Their failures have to do with difficulties in distinguishing between house owners and tenants, lack of agreement among residents resulting in litigations, poor or inadequate temporary accommodation facilities, exploitation by local builders and developers in cahoots with politicians and officials, delays in construction and handing over, poor credibility of governments, and so on. 

A big challenge in adopting the UK’s social housing redevelopment model is the high density of slums in countries like India. For a start, given the low prevailing per capita space, accommodating all the residents and also finding enough units for commercial sale becomes difficult. This is further exacerbated by the large number of tenants. Indian slums, especially in the largest cities, are characterised by heavily overcrowded housing units with multiple tenants in one room itself. Further, once a proposal is floated to redevelop the slum, several new tenant claimants emerge.

Though governments typically try to address the problem by mandating that only those residing before a cut-off date and for more than a certain number of years are eligible, its validation runs into several practical difficulties. The claims and counter-claims invariably get entangled in the local politics, thereby making it difficult to move ahead. 

My earlier posts in this series are here, here, here, here, here, and here. This is an earlier post on the issue of slum redevelopment in the context of Vijayawada.

Weekend reading links

1. Kyle Chan proposes taking a leaf out of China's playbook to catalyse EV manufacturing in India. He argues that GoI should adopt a carrot-and-stick policy of offering incentives and playing off foreign companies against each other to strike favourable deals going forward. 

He overlooks an important difference between China and India. The latter does not have anywhere even remotely close to the domestic demand for EVs as in China. For example.

Before the Shanghai Gigafactory, Tesla was already selling close to 15,000 cars in China, making up 17% of Tesla’s 2017 revenue.

Tesla and other foreign manufacturers have now realised that India does not have anywhere near the same domestic demand that merited their investments in China. It's therefore natural for them to hedge their bets and wait out.

2. David Leonhardt writes that a "new centrism" of bipartisanship may be emerging in US politics amidst the deepening political polarisation.

During the Covid pandemic, Democrats and Republicans in Congress came together to pass emergency responses. Under President Biden, bipartisan majorities have passed major laws on infrastructure and semiconductor chips, as well as laws on veterans’ health, gun violence, the Postal Service, the aviation system, same-sex marriage, anti-Asian hate crimes and the electoral process. On trade, the Biden administration has kept some of the Trump administration’s signature policies and even expanded them. The trend has continued over the past month, first with the passage of a bipartisan bill to aid Ukraine and other allies and to force a sale of TikTok by its Chinese owner...Last week, the House advanced another bipartisan bill, on disaster relief, using a rare procedural technique to get around party-line votes...

The new centrism is a response to these developments. It is a recognition that neoliberalism failed to deliver... In its place has risen a new worldview. Call it neopopulism. Both Democrats and Republicans have grown skeptical of free trade; on Tuesday, Biden announced increased tariffs on several Chinese-made goods, in response to Beijing’s subsidies. Democrats and a slice of Republicans have also come to support industrial policy, in which the government tries to address the market’s shortcomings. The infrastructure and semiconductor laws are examples. These policies feel more consistent with the presidencies of Dwight Eisenhower or Franklin Roosevelt than those of Ronald Reagan or Bill Clinton. The term neopopulism is apt partly because polls show these new policies to be more popular than the planks of the Washington Consensus ever were.

China and the emerging Cold War has become a glue that binds the new bipartisanship. In any case, this new centrism also marks the end of Reaganism. Ironically, the rise of Donald Trump may have played a role in bringing the curtain down on Reaganism.

The ascent of Trump changed this dynamic. He won the Republican nomination in 2016 while discarding key parts of Reaganism... he did move his party toward the middle on several big economic issues. Unlike the Reaganites, Trump criticized free trade and praised government programs like Medicare. He once described himself as “a popularist.” To the shock of other Republicans, his rejection of free-market economics did not hurt him politically. It helped him win the nomination, and in the general election he won working-class voters who had previously backed Obama. Trump’s victory made both parties recognize that the Washington Consensus was less popular than they had thought. “Donald Trump has widened the aperture for policy discussions in the United States,” Neera Tanden, then the president of the Center for American Progress, a liberal think tank, and now Biden’s domestic policy adviser, said in 2018...Trump’s heresy on trade and government intervention has made it easier for other Republicans to moderate their own positions.

Leonhardt also pays tribute to President Biden

Whatever Biden’s weaknesses as president, his record of signing bipartisan legislation exceeds that of any recent predecessor... When he entered the White House vowing to pass bipartisan legislation, many political analysts scoffed. The country, they said, was too polarized. But Biden persisted, often working in the background. A bill’s chance of passage was higher, he believed, if he could avoid becoming the face of the bill.

Finally, Leonhardt points to the diverging dominant popular perspectives on the economy and society.

Americans lean left on economic policy. Polls show that they support restrictions on trade, higher taxes on the wealthy and a strong safety net. Most Americans are not socialists, but they do favor policies to hold down the cost of living and create good-paying jobs... The story is different on social and cultural issues. Americans lean right on many of those issues, polls show (albeit not as far right as the Republican Party has moved on abortion)... The clearest example in the Biden era is immigration. A core tenet of neoliberalism, once supported by both parties, is high immigration. Along with the freer movement of goods and capital, neoliberalism calls for the freer movement of people. Most voters, especially working-class voters, feel differently. The soaring level of immigration during Biden’s presidency, much of it illegal, has become a political liability, and it nearly led to another piece of neopopulist legislation this year. Senate Democrats and Republicans put together a plan to strengthen border security. It was the mirror image of Republicans’ agreeing to support the semiconductor and infrastructure bills: This time, some Democrats abandoned a policy stance that was out of step with public opinion.

3. Very good set of graphics about the renewable energy transition in 2023 from Ember, via Adam Tooze. 

4. Food safety standards compliance by India's private companies has always been a problem. Livemint has a good long read. It informs that 16% of the 4.3 lakh food samples tested by FSSAI have been found to be unsafe or substandard. 

Unsurprisingly the article blames the regulator and its lack of capabilities and corruption, but does not discuss the central issue - the general norm of non-compliance and cutting corners by India's private companies. Enforcement works only at the margins. If the norm is to deviate, enforcement becomes blunt. 

The masala makers MDH and Everest had turnovers of Rs 1775 Cr in 2022 and Rs 1683 Cr in 2022-23 respectively. These are large listed companies and industry leaders. While they have denied any wrongdoing, it cannot be denied that masala adulteration has been an ongoing concern, there have been lingering doubts about these companies, and two credible foreign regulators have found unacceptable traces of ethylene oxide, a cancer-causing chemical. The Spices Board are now testing samples of the two companies. 

5. Some important data points on the impact of corporate tax reduction from Vivek Kaul

Data of more than 5,000 listed companies from the Centre for Monitoring Indian Economy suggests that from 2018-19 to 2022-23, the net sales of these companies went up 52%, corporate taxes paid went up only 36% and their net profit rose sharply by 187%. In comparison, between 2014-15 and 2018-19, net sales had gone up 30%, corporate taxes by a higher 38% and net profit in 2018-19 was around 90% of the profit in 2014-15. Clearly, among other things, lower taxes have helped spruce up profits of listed companies, pushing up stock prices.

6. Stephen Walt has a very good summary of the critique of Israel's actions in Gaza and makes the realist case against any US support for Israel. 

Realists’ criticisms of the war in Gaza arise in part from their appreciation of the limits of military power and the importance of nationalism. Realists’ criticisms of the war in Gaza arise in part from their appreciation of the limits of military power and the importance of nationalism. They are acutely aware of the difficulties foreign invaders typically face when attempting to dominate or destroy another people with armed force, which is why they concluded that Israel’s attempt to destroy Hamas by bombing and invading Gaza was doomed to fail. It is increasingly clear that Hamas is going to survive Israel’s onslaught, and even if it doesn’t, new resistance organizations are bound to emerge as long as Palestinians are occupied, denied basic political rights, and gradually dispossessed of their lands.

Equally important, realists oppose Israel’s actions (and U.S. complicity in them) because the combination is undermining America’s global position. The war in Gaza has made it clear that America’s commitment to a “rules-based order” is meaningless; it is frankly hard to believe that U.S. officials can still utter that phrase with a straight face... Public opinion polls also suggest U.S. popularity has declined sharply in the Middle East and slightly in Europe, while support for China, Russia, and Iran has risen... Moreover, it seems that Iran has been a major beneficiary of this war... And the war isn’t cheap. The U.S. Congress has authorized billions of dollars of additional aid to help Israel decimate Gaza, along with $320 million for that floating pier the United States had to construct because the “ally” we are backing wouldn’t let relief agencies send trucks in to deliver humanitarian aid. U.S. military forces have been using up expensive missiles and bombs against the Houthis in Yemen, who began to terrorize ships in and around the Red Sea in protest to what Israel is doing... The war is also burning up vast amounts of top officials’ time, energy, and attention... The time U.S. leaders have devoted to a conflict between roughly 15 million people in Israel and Palestine is time that they could not spend visiting key allies elsewhere, devising a better policy in Ukraine, developing an effective economic strategy for Asia, marshaling global support to address climate change, or any number of far more important issues.

The big winners? Russia and China, of course. For many people around the world—and especially much of the global south—the carnage in Gaza validates Russian President Vladimir Putin and Chinese President Xi Jinping’s recurring charge that global U.S. “leadership” sows conflict and suffering and that the world would be better off in a multipolar order where power was shared more evenly. You may not agree with that argument, but millions of people already do, and our current policy makes it look a lot more credible... Lastly, realists object to what Israel is doing because it brings the United States precisely zero strategic benefits... the Cold War ended more than 30 years ago, and unconditional support for Israel is not making Americans more secure today. Some of Israel’s defenders now claim it is a powerful bulwark against Iran and a valuable partner against terror; what they fail to mention is that our relationship with Israel is one of the reasons the United States has a bad relationship with Iran and one of the reasons that terrorists like al Qaeda decided to attack the United States.

7. Even as the property market enjoys a boom, the sales of affordable housing units (below Rs 40 lakh) have been declining over the past five years in top cities. 

While home sales climbed sharply from 2019 to 2023, the share of affordable housing dropped from 38% to 19% during the period. In January-March of 2024, the sales share stayed flattish, at 20%. Not just sales, budget housing supply or new launches too shrank from 40% to 18% in the same period. The decline of affordable housing became increasingly apparent after the pandemic, as larger, premium homes gained favour... the sales share of luxury homes jumped from 7% in 2019 to 25% in 2023. In January-March 2024, this was at 21%, but it is expected to pick up during the year. Of all the cities, Mumbai Metropolitan Region (MMR) has seen the most traction in this segment.

8. FT long read on the dangers of ultra-processed food items - industrial creations made by breaking down natural food into chemical parts, modifying them and recombining them with flavouring, artificial colours, and other additives. 

When the Brazilian nutritional scientist Carlos Monteiro coined the term “ultra-processed foods” 15 years ago, he established what he calls a “new paradigm” for assessing the impact of diet on health. Monteiro had noticed that although Brazilian households were spending less on sugar and oil, obesity rates were going up. The paradox could be explained by increased consumption of food that had undergone high levels of processing, such as the addition of preservatives and flavourings or the removal or addition of nutrients. But health authorities and food companies resisted the link... Monteiro’s food classification system, “Nova”, assessed not only the nutritional content of foods but also the processes they undergo before reaching our plates. 

The system laid the groundwork for two decades of scientific research linking the consumption of UPFs to obesity, cancer and diabetes. Studies of UPFs show that these processes create the kinds of food — from snack bars to breakfast cereals to ready meals — that encourage overeating but may leave the eater undernourished. A recipe might, for example, contain a level of carbohydrate and fat that triggers the brain’s reward system, meaning you have to consume more to sustain the pleasure of eating it. In 2019, American metabolic scientist Kevin Hall carried out a randomised study comparing people who ate an unprocessed diet with those who followed a UPF diet over two weeks. Hall found that the subjects who ate the ultra-processed diet consumed around 500 more calories per day, more fat and carbohydrates, less protein — and gained weight... Just a handful of countries, including Belgium, Israel and Brazil, currently refer to UPFs in their dietary guidelines. But as the weight of evidence about UPFs grows, public health experts say the only question now is how, if at all, it is translated into regulation.

9. FT visualisation on the five possible battlegrounds that could determine the course of a US-China war on Taiwan.

10. The northern European countries build the most housing among developed countries.

11. It's a sign of the times that the capital of the fossil fuel industry in the US, Texas has overtaken California to become the leading solar generator. 

Besides, it now generates more power from solar than thermal.

What makes the achievement even more significant is the state that Texas pushed into second place: California. A progressive stronghold that has mandated clean energy targets for more than 20 years and built up a dominant lead in utility-scale solar energy, it was outshone by a Republican-led fossil fuel powerhouse, governed by a serial obstructor of clean energy legislation. As recently as five years ago this would have been unthinkable. In 2019, Texas had just over 2GW of large-scale solar plants to California’s 13GW. Since then, however, the Lone Star State has entered into a solar boom. As of this month it has deployed 23.6GW of utility-scale solar to California’s 21.2GW... Texas will have added more solar capacity per capita in a single year than any US state and any country in the world, according to data from energy think-tank Ember. Almost overnight, a state synonymous with dirty fuels has become America’s clean energy giant, and the trend is still accelerating.

Trade, Economic Theory, and China

The front end of the emerging new Cold War is trade. Specifically, the protectionist walls that are emerging around the world, led by the United States, against Chinese goods and services. It has naturally riled those who believe in the orthodoxy of free-trade. 

In that context, Rana Faroohar asks a couple of incisive questions.

What’s the point of trying to tally up the potential economic costs of tariffs based on models that assume an even global playing field, when no country, certainly not a rich one with decent environmental and labour standards, could compete on price with China in any area of production? Why argue that the world should simply accept massive Chinese dumping of clean tech as a solution to global warming, when the true carbon cost of producing such goods with coal power, as well as the emissions involved in shipping them, aren’t even factored into those calculations? Transport emissions from durable goods are the second-largest source of global emissions after China itself.

This post will make the case that the conventional free trade theories don’t hold when we are talking about China. 

The theory of comparative advantage refers to a country’s ability to produce a good or service more efficiently and competitively (or at a lower opportunity cost) than its peers. It informs that everyone benefits if countries produce those goods/services in which they have a comparative advantage and trade among themselves. The case for free trade rests on the theory of comparative advantage. 

There are several assumptions implicit here. There are specifically five that concern me, each disturbed by the uniqueness of China.

First, the most important assumption in the case for free trade is that each country has a comparative advantage in some goods they can trade. But what if one country has a competitive advantage in too many goods, leaving others with a competitive advantage in too few? Would the former sacrifice its competitive advantages across industry segments and focus only on the few where its advantages are the highest?

It’s no good for an economy if all it does is import at lower prices from another economy and has little in turn to export. Michael Pettis makes an important point in the context of a Paul Krugman oped where he alludes to “cheap imports” making a country richer.

The wealth of a nation, as Adam Smith reminded us, is the value of goods and services produced by the residents of that nation, and the only thing that makes a nation richer is an increase in that value. "Cheap" imports help only to the extent that they increase the real value of goods and services produced domestically, but that can only happen if imports are paid for by exports of goods and services, and not by exports of claims on domestic assets. That is why comparative advantage makes everyone richer, while competitive advantage, based on suppressing domestic wages, makes the world poorer (although the surplus nation richer).

There’s overwhelming empirical evidence from across developed and developing countries that cheap Chinese imports have weakened, and in many cases decimated, the domestic manufacturing bases and inflicted massive job losses. While cheap imports benefit consumers with lower prices, their indirect benefits hardly offset the costs. While there is a David Autor et al study that anchors the argument in the case of the US, there will be several similar examples (however not yet rigorously researched and published) from across the world that bear testament to the damage done to local communities and whole industries by the flood of Chinese imports. 

Simplistic concepts and toy models that work well in small and simple systems cannot be blindly extrapolated to explain the complex world economy and justify decisions that have far-reaching economic and political consequences for the world as a whole.

Second, a related assumption is that there’s a level playing field among competitors across countries, without trade-distorting subsidies. What if one economy unfairly subsidises its companies as to give them an unfair advantage over foreign competitors? 

This issue manifests in the nature of Chinese subsidies. While it supports domestic manufacturers with copious direct subsidies, they are supplemented with indirect subsidies that amplify the problems. 

China’s support for its electric-vehicle industry included clever inducements to demand, such as reduced parking fees and free licence plates. Buyers are still able to benefit from a tax break worth up to 30,000 yuan ($4,100). Other subsidies were not directed at consumers, but could be passed on to them through lower prices. Together, they increased demand as well as supply, bolstering capacity utilisation and profits. China’s purchases of conventional cars, powered by internal-combustion engines, used to soak up almost all domestic production. Owing to the success of electric vehicles, that is no longer the case, meaning subsidies in one area have contributed to excess capacity in another. Conventional carmakers, many of them including joint ventures with foreign firms, have therefore turned to customers abroad. 

Third, it’s also possible that one country has an interest in keeping the playing field tilted. What if one country consciously pursues an industrial policy of global dominance in certain sectors for whatever reasons (for strategic reasons or to off-load its excess capacity)? 

While all countries pursue industrial policy, China does it at a scale and discipline that no other country can match. Besides, over-capacity arising from investment and export competition is part of a conscious industrial policy strategy. It’s also aligned with the traditional Chinese policy of overshooting targets. 

The Times has a good summary of the Chinese economic strategy

Regulators restrict the investment options of Chinese households, which have little choice but to deposit enormous sums of money into banks at low interest rates. The banks then lend the money at low rates to start-ups and other businesses. According to China’s central bank, net lending for industry swelled to $670 billion last year from $83 billion in 2019. Beijing instructs local governments to help the chosen industries. The assistance takes the form of cheap land for factories, new highways for freight trucks, bullet train lines and other infrastructure. The Kiel Institute for the World Economy in Kiel, Germany, calculated in a study that more than 99 percent of Chinese companies whose stock traded publicly received direct government subsidies in 2022. China keeps factory wages low, which helps the competitiveness of its manufacturers. Residence permits limit the ability of rural families to move permanently to cities, where they would qualify for better job benefits. Independent labor unions are barred, and would-be organizers are detained by the police.

This is a summary of how China built up its automobile manufacturing capabilities by pursuing the aforesaid strategy.

By 2011, Beijing had begun requiring Western companies to transfer key technologies to operations in China if they wanted consumers in China to receive the same subsidies for imported electric cars that were being offered for cars made in China. Without the subsidies, automakers like General Motors and Ford Motor could not compete with electric cars made in China. Multinational automakers responded by pressuring their South Korean suppliers, which at the time led the electric car battery industry to build factories in China. Beijing went further in 2016 and declared that even electric cars made in China would qualify for consumer subsidies only if they used batteries from factories owned by Chinese companies. Even automakers like South Korea’s Hyundai abandoned the Chinese factories of South Korean battery manufacturers and switched their contracts to Chinese battery companies like CATL. Chinese companies now produce the majority of the world’s electric car batteries… 

According to a new report from the Atlantic Council, a research group in Washington, China’s exports of lithium-ion batteries leaped to $65 billion last year from $13 billion in 2019. Nearly two-thirds of these exports went to Europe and North America. Much of the rest went to East Asia, where the batteries are often assembled into products that end up being sold to Europe or North America.

This is a similar summary of how China came to dominate the solar panels industry.

A tenfold expansion of China’s solar panel manufacturing capacityfrom 2008 to 2012 caused the world price of solar panels to drop about 75 percent. Many American and European factories closed. Three of China’s largest solar panel producers suffered financial collapses of their own as prices plunged, saddling banks with losses on loans. Smaller rivals in China were able to buy their factories for fractions of the original construction cost. This second generation of companies was then able to make panels more cheaply and invest in cutting-edge research. Chinese companies make almost all of the world’s solar panels. The country’s exports of solar cells, which the Biden administration is raising tariffs on, have more than doubled in the past four years, to $44 billion last year. China is ramping up twice as fast its exports of solar wafers, a key component.

The brilliant graphic below shows “the family resemblance in China’s early high-speed train models with their respective foreign JV partners”.

The industrial policy is complemented with measures that only a country like China can pull off. Consider these examples. The government can informally direct the business priorities and strategies of its firms - to shift from one part of the value chain to another or pivot from one sector to another. It can mobilise consumer opinion to shift from a foreign brand to a domestic brand. It can nurture local champions with a wink and a nod to banks and local governments. It can issue informal diktats and have local party cadres across all levels of the multinational corporation, including in the Boards. All these are deeply distorting and anti-competitive, but not illegal only because such practices are so unimaginable in any other country that they were never even considered possible when trade laws were formulated. 

Fourth, what if the nature of the technologies, skills, and market structure is such that the comparative advantage and market dominance in certain industries give a country a head start in dominating another industry? What if there’s a self-reinforcing dynamic to such dominance that also prevents any decoupling or even diversification from the dominant country?

China has perfected an industrial policy strategy where they entice foreign firms with the allure of the massive domestic market and limited conditions to start with, gradually insist on technology transfers and joint ventures, and finally promote their firms to dominance in the market segment. 

Kyle Chan has a very good article on how Chinese firms have come to become important and potentially dominant suppliers in the iPhone supply-chain - YMTC in NAND flash memory (gradually displacing Samsung and SK Hynix), Sunny Optical and AAC Technologies in camera lens (gradually eating into Largan Precision and GSEO), and Lens Technology for cover glass (squeezing out Samsung etc). On contract manufacturing, Chinese firms like Luxshare and Wingtech are already strong competitors to the Taiwanese trio of Foxconn, Pegatron, and Wistron. 

Luxshare began by making cables and connectors for Apple’s products and later moved into iPhone production by acquiring Wistron’s iPhone plant in Kunshan in 2020. Apple itself has been helping China turn Luxshare into a “national champion,” sending engineers to help train Luxshare’s staff for years. Today, Luxshare is not only Foxconn’s primary competitor for iPhone production but was also selected by Apple as the exclusive manufacturer for its Vision Pro… Chinese officials got Apple CEO Tim Cook to sign a secret $275 billion deal in 2016 to help Apple’s Chinese suppliers move up the value chain… As “China’s biggest smartphone assembler,” Wingtech began by doing assembly work for smartphone brands like Vivo and Oppo as well as laptop brands like HP, Dell, and Lenovo. Now Wingtech is starting to make Apple products in its rapidly expanding production facilities in Kunming.

This trend is also accompanied by a trend to move across industries. 

Chinese contract manufacturers are also moving deeper into the supply chain, into areas such as semiconductors. Wingtech bought Dutch chipmaker Nexperia in 2019 and then bought the UK’s largest chipmaker Newport Wafer Fab in 2021, which it later had to sell due to UK national security concerns. Luxshare has been building up its chip packaging capabilities by hiring Taiwanese semiconductor engineers. AirPods maker Goertek recently spun off its own chipmaking unit. These efforts are aimed not only at winning a greater share of the smartphone market but also at gearing up for EV production. For example, Luxshare is already partnering with Chinese automakers like Chery to make EVs.

The Chinese prowess in carbon-intensive heavy industry has been a critical contributor to driving the country’s clean technology advances. 

Electric vehicles rely on a lot of aluminum… Overall, plug-in hybrids (PHEVs) and full battery electric vehicles (BEVs) tend to use around 25% more aluminum than traditional gas-powered cars due to its lightweight properties… Chinese EV makers benefit from access to China’s vast aluminum industry, which makes up more than half of global production. This helps lower material costs, which are a significant factor in keeping overall costs low. And Chinese EV makers benefit from being able to work directly with producers of aluminum and aluminum products to develop specialized alloys and ensure stable supplies. Chinese state automaker SAIC partnered with Chinese state-owned Chalco, the world’s largest aluminum producer, to “jointly develop technologies to apply new aluminum materials to automobile parts.” BYD benefits from its close relationship with its top supplier for battery enclosures, Chongqing-based New Aluminum Era… EV parts like windows, seats, door panels, and bumpers are typically made from petrochemical products, like fiberglass… EV charging infrastructure also requires similar heavy industry commodities, like steel, aluminum, and cement. EV factories themselves require a lot of specialized metal alloys, such as for industrial robots and machine tools…

The construction of wind and solar plants relies on large amounts of heavy industry commodities, like steel and aluminum. According to analysis by BloombergNEF, solar requires around 33 tons of steel and 15 tons of aluminum for every megawatt of output… examples of industrial policy spillovers is the connection between steel, shipbuilding, and offshore wind. China’s heavily state-supported steel industry benefits its heavily state-supported shipbuilding industry, which makes up over half of global shipbuilding. China’s vast shipbuilding industry, in turn, allows it to make highly specialized, supermassive offshore wind turbine installation vessels (WTIV) that are large enough to transport and install wind turbine blades that can stretch over 100 meters. Of the WTIVs under construction, close to 90% are being made in China. China’s strength in steel and shipbuilding also helps it build specialized roll-on, roll-off (RORO) car-carrier ships for exporting Chinese EVs around the world. Chinese EV makers such as BYD have already launched their own car-carrier ships to transport thousands of vehicles to markets like Europe and Brazil… we can see a virtuous cycle forming between China’s heavy industry and its clean tech sectors. China’s heavy industry enables the production of EVs, solar panels, wind farms, power lines, and batteries.

BYD, now the country’s largest car maker, was more famous as an iPhone supplier than as a car maker and is s large contract manufacturer of iPads. This article explains how Tesla helped China develop its dominant EV manufacturing ecosystem.

China agreed to make special concessions to convince Tesla to build a plant in China. China changed its rules to allow the Shanghai Gigafactory to be a wholly foreign-owned subsidiary rather than a joint venture with a Chinese firm, as was previously required for all foreign automakers… this deal also benefited China’s own domestic EV industry by building up Chinese suppliers, such as Chinese battery giant CATL… The case of LK Group serves as a striking example. Tesla worked with LK Group, a Chinese maker of manufacturing equipment, to produce gigantic casting machines for what Tesla calls “gigacasting.” These casting machines allow Tesla to manufacture large auto components as a single continuous piece, which saves time, factory space, labor, and materials that would normally be needed to weld together many separate pieces. LK Group then went on to sell similar “gigacasting” machines to six Chinese firms, likely other automakers. Today, 95% of the components used in Tesla’s Shanghai Gigafactory are from China, and Chinese firms make up almost 40% of Tesla’s global EV battery supply chain… Tesla’s plant in China helped to turbocharge its domestic industry, creating not only jobs for Chinese workers at the Shanghai Gigafactory but also an upgraded supplier ecosystem for China’s own homegrown EV brands.

Tesla was the rainmaker for China’s EV industry.

Chan writes about the decoupling conundrum.

As companies like Apple move lower-end production out of China, China is moving up Apple’s production value chain into high-tech, high-value components. This echoes a similar finding from a Rhodium Group report: “Diversification has been taking place for years in these industries, but it has been obscured by a concomitant expansion of manufacturing value chains in China.”… As China moves up the value chain, this might create room at the lower end for countries like India and Vietnam to step in. But will the competitiveness of Chinese firms in the middle levels of the value chain create a ceiling on how far up other countries can go?… 

One last thing to note is the virtuous cycle between Chinese brands and China’s broader manufacturing ecosystem. Much has been written on why it’s so hard for Apple to move iPhone production away from China, citing China’s vast and nimble supplier base. This supplier base, which Apple and Foxconn helped to develop, later empowered China’s own smartphone companies like Huawei, Xiaomi, and Oppo. Apple’s suppliers in China—like Samsung, SK hynix, Sunny Optical, and Lens Technology—supply similar components to its Chinese smartphone competitors. The kicker is that even as companies like Apple try to move away from China, China’s manufacturing ecosystem will continue to be supported and pushed forward by its own homegrown smartphone companies. And now these same Chinese suppliers are already supporting China’s expansion into other industries, like semiconductors and EVs.

The Chinese industrial policy is generating multiplier effects across industrial segments.

China’s solar industry benefited from its R&D on semiconductors. China’s high-speed rail built on its aerospace research. Chinese EVs draw directly on China’s smartphone supply chain. Many of the Chinese suppliers to Apple I discussed in my High Capacity piece overlap with the EV industry. These supply chain overlaps and technological spillovers are only growing as Chinese EVs increasingly become “smartphones on wheels.”… the companies now producing China’s most competitive EVs emerged directly from its electronics industry. Xiaomi, after all makes 15% of the world’s smartphones. CATL - now widely seen as the world’s best EV battery maker - began as a spin-off of Amperex Technology Ltd, or ATL, which makes smartphone batteries. The iPhone is in a sense the younger sister of the Chinese-made Volvo EX30: Both are Western-designed consumer electronics that are made in Chinese factories, through Chinese engineering expertise. 

Finally, what if there are national security and other strategic considerations that dominate economic benefits in trade and other relationships?

The Cold War 2.0 is already on us. Nobody doubts China’s aggressive intentions of global dominance. China’s actions on the foreign policy front - border skirmishes with neighbours, the now routine transgressions of international coastal boundaries in the South China Sea, bullying of countries like Canada and Australia, political and industrial espionage in the US and Europe, interference in the domestic politics of several countries, the clandestine influence activities of the United Front Work Department, Wolf warrior diplomacy etc., - raises serious doubts about whether any engagement on good faith with China is even possible. It’s already a power fully convinced that biding the time is over, and the time has arrived for China to step up and recover its Middle Kingdom role. It’s therefore difficult to imagine the struggle between the US and China abating. 

Faroohar again

There’s the elephant in the room: the fact that China has thrown its autocratic weight behind some of the world’s most repressive regimes, from Russia to Iran. These regimes are the enemies of all liberally minded people. Given this, do we really want to count on Beijing for essential goods? And even if China’s communist party wasn’t taking this road, haven’t the pandemic, the war in Ukraine, the threat of conflict around Taiwan, shipping blockages in the Red Sea and any number of natural disasters provoking supply chain chaos over the past few years shown us that it’s not a good idea for the world to keep all its production eggs in one basket?

The pandemic has made everyone acutely aware of the dangers and risks of excessive dependence on China for manufactured goods. The diversification away from China is already underway among all major economies and multinational corporations operating in China. These measures are only going to tighten going forward.

Amidst all this, there’s a popular view going around that Chinese subsidies and exports of green technologies are great for climate change and should therefore not be discouraged. Dani Rodrik critiques those who rail against Chinese green energy subsidies, arguing that they have dramatically reduced the prices of green technologies and expanded its access manifold. He argues that the need of the hour is more industrial policy and subsidies by all countries to make green technologies more affordable and accessible. He describes the case for subsidising green industries like China has done as "impeccable". However, he does acknowledge the problems with China's subsidies.

Countries have other interests besides the climate, of course. They can harbor legitimate concerns about the consequences of other countries’ green-industrial policies for jobs and innovative capacity at home. If they judge that these costs outweigh the climate and consumer benefits, they should be free to impose countervailing tariffs on imports, as trade rules already allow. It would be better for the world overall if they didn’t react that way, but nobody can or should stop them.

The problem is with the last line on overall benefits and costs. While the Chinese green power subsidies have achieved tremendous success in mainstreaming green technologies, it has come at the cost of destroying local green industries elsewhere and making all countries chronically dependent on China for green technologies. Given green technologies are a major share of today's and future manufacturing, the destruction of the domestic manufacturing bases across countries due to cheap Chinese exports is a prohibitive and unacceptable price to pay. It becomes a serious, almost existential, national security risk when there's a Cold War raging and the near-certain weaponisation of its dominance in these frontier technologies by the Chinese government. 

The manufacturing trends in green technologies are an encore of what has happened across the manufacturing sectors in the last two decades. Thanks to the cheap Chinese imports, the manufacturing base that's essential to create the good jobs that Dani Rodrik frequently writes about has been seriously weakened across developed and developing countries. Besides, the world has become excessively dependent on China for even basic manufacturing, as the Covid 19 painfully exposed. 

Economists should consider this trend in manufacturing as a failure of comparative advantage. If there's a strong Matthew Effect, whereby the dominant producer is able to strengthen their position with economies of scale and subsidies, and the nature of technology linkages across sectors, then comparative advantage and trade end up enriching the dominant producer while leaving the world economy worse off besides engendering unmitigable national security risks. 

In the latest update on the Chinese economy, I blogged here that instead of rebalancing its economy China has sought to continue its investment-driven strategy, this time by exporting its way out of its current economic problems. Given the already rising suspicions and geopolitical tensions, this is bound to fuel protectionism in its trade partners. 

Finally, since we discussed trade theory and China, I will conclude the post by drawing attention to the paradigm shift in the Western policies against China during the Trump administration, one that has continued and strengthened under the Biden administration. The views held by President Trump’s Trade Representative, Robert Lighthizer, were central to the shift. Derided by his own peers and influential experts then as a mediocre and journeyman economist, Litghthizer’s views have now become the bipartisan mainstream. He has said that it’s worth trading higher consumer prices for increased manufacturing employment. 

“If all you chase is efficiency — if you think the person is better off on the unemployment line with a third 40-inch television than he is working with only two — then you’re not going to agree with me. There’s a group of people who think that consumption is the end. And my view is production is the end, and safe and happy communities are the end. You should be willing to pay a price for that.”

A recent WSJ article captured his views.

“I have migrated from thinking we need superficial fair trade to realizing that that is unachievable, and what we really need is balanced trade,” Lighthizer said in an interview in Palm Beach, Fla., where he lives a few miles from Mar-a-Lago. “Not balanced every year and with every country, but over time and globally.” He added: “Every country should be exporting in order to import. If you’re running chronic surpluses for decades, then you are by definition a protectionist. You’re engaging in industrial policy to help yourself, you’re transferring resources from your consumers to your producers, you’re trying to … acquire other countries’ assets.” These used to be called beggar-thy-neighbor policies, he said, “and they have to stop.”.. Mainstream thought has moved in Lighthizer’s direction. Even economists acknowledge that the shrinking U.S. manufacturing base, partly due to trade, has had collateral costs: “deaths of despair” in communities devastated by lost factory jobs, and dependence on China for products vital to economic and military security…

Lighthizer agrees that deficits reflect savings differentials, but not that they are natural. Rather, they result from other countries’ policies that suppress consumption and subsidize exports. An example: Germany’s early-2000s labor reforms which, along with the adoption of the euro, suppressed German wages and rewarded exporters. An important influence is Peking University finance professor Michael Pettis, who has written extensively on how China’s suppression of consumption dictates that it run a trade surplus and other countries run deficits. As deficit countries lose incomes, they must either accept higher unemployment or increase debt to replace lost spending power. Mainstream economists increasingly agree China’s surpluses are harmful. “When the global market is flooded by artificially cheap Chinese products, the viability of American and other foreign firms is put into question,” U.S. Treasury Secretary Janet Yellen, an economist, said in Beijing last month… Lighthizer said a surplus results from a range of policies such as the banking system, the labor system and industrial policy. That’s why he backs Trump’s proposed universal tariff of 10% plus a higher tariff on China, not as a bargaining chip over a specific trade barrier, but to eliminate the U.S.’s structural deficit.

Lighthizer hardly gets the credit he deserves. In fifty years when we can take a more dispassionate view of what’s happening today, I’m inclined to believe that Lighthizer’s role in recalibrating the global views on China will be acknowledged.