China's Renewable Energy Push and Rare Earth Materials

Rutgers University From the SelectedWorks of Kyle Herman 2015 China's Renewable Energy Push and Rare Earth Materials Kyle Herman Available at: http...
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Rutgers University From the SelectedWorks of Kyle Herman

2015

China's Renewable Energy Push and Rare Earth Materials Kyle Herman

Available at: http://works.bepress.com/kyle_herman/16/

Renewable Energy Industrial Policy: China and Rare-Earth Materials

Abstract This paper looks at the political and economic implications of China’s renewable energy industrial policy (REIP) within the context of trade policy. Clean energy technologies, including renewable energy and energy efficiency products, represent new territory for global policy and the World Trade Organization (WTO). It is important to look at what role the WTO plays in clean energy products because its facilitation or obstruction of these might ultimately determine the success of renewable energy technologies and, subsequently, climate change policy.

1 Why is this research important? Renewable energy production is, by its very nature, intricately intertwined with government economy. Whereas the securing and processing of conventional fossil fuels, whether originating abroad or domestically, remained integrated into government decision-making throughout the 20th century, renewable energy, with its potential to source access, production, and maintenance domestically, will quickly become the new strategic asset for countries around the world. It may, as some experts suggest, become an integral part to Strategic Trade Theory (STT) for certain countries. In the past governments had to wage war, heavily subsidize giant oil conglomerates, and incessantly appease domestic constituents opposed to gregarious environmental destruction by conventional energy; now governments must find ways to produce, introduce, monitor, and scale-up renewable energy technology in a manner consistent with WTO rules. This is why the ruling of the WTO on renewable energy production, trade, subsidies, and tariffs is so crucial to understanding the global political economy of the 21st century.

1.1 Renewable Energy Industrial Policy (REIP) and the WTO A number of cases related to renewable energy have been brought before the WTO appellate body including: Argentina’s claim the EU illegally markets biodiesel products (DS459, 2013), U.S. claim against Indian Solar Energy (DS456, 2013), China’s complaint against the EU for generating renewable energy (DS452, 2012), Japan’s claim Canada illegally supports domestic installation of renewable energy (DS412, 2010), and the U.S. complaint against China’s Wind Power Equipment Sector (DS419), 2010). These cases are very important for REIP because they help shape the burgeoning industry which, in the absence of any international agreement (UN climate negotiations continues to stall), the WTO might very well be left guiding international climate change policy via renewable energy technology rules enforcement. 1.2 Objective of the Research Therefore, the objective of this paper is to examine the effectiveness of the WTO’s dispute settlement mechanism by looking at China’s REIP and a subsequent DSU brought before the WTO appellate body. I do this by looking at a dispute between China and the U.S. because these are the two biggest players in the energy market, the global economy, and emissions production (hence, climate mitigation). Furthermore, both countries impose a large amount of tariffs on each other’s renewable energy (RE) products, which constrains growth in the industry (US imposes tariffs up to 5.2%, while China imposes tariffs on all but two product categories maxing out at 35%).1 These tariffs are an impediment to trade 1 See Stewart et al., 2009. Also note the U.S. has recently imposed tariffs on Chinese renewable energy products averaging 26% (renewableenergyworld.com).

and hinder the spread and development of clean technologies. Examining renewable energy disputes settled between China and the U.S. have ripple effects through the entire industry.

1.3 Structure of the Paper After gaining insight into Chinese REIP, this paper introduces and examines the WTO case involving rare-earth materials with U.S. as the complainant against China. I find the WTO fulfilled its tasks sufficiently and expediently, allowing markets to adjust while consequently facilitating the production of renewable energy industries. Following that analysis, I briefly introduce several cases which are still ongoing and will contribute to the bedrock forming within this field and WTO rulings. The objective of this examination is to show that, despite the nuanced characteristics of REIP, the WTO remains the most able international institution to facilitate global advancements in RE.

2 Hard and Soft Industrial Policy Governments may pursue Industrial Policies (IP) for many reasons. Primarily, governments use industrial policy to increase domestic manufacturing, either primed for export, aimed at domestic implementation or some combination thereof. Governments may also want to introduce new industries to capture economies of scale (i.e. endogenous resources can produce profit if traded in global markets), to increase global power and hegemony (i.e. military industrial policy), or to play “catch-up” with other national economies (i.e. the automobile industry). In its most rudimentary form, IP is a strategy to “revitalize, improve, and develop a particular industry” (Brown and Carbaugh 2012: 3) For developing countries, industrial policy is given more leeway because most developed countries agree they need to have more flexible tools to scale up infant industries. (This theory is also echoed in WTO agreements concerning subsidies discussed in detail below). Hard industrial policy might epitomize the direct and overt subsidization by the government of a targeted industry in order to capture a specified market (as in Japan's steel industry fifty years ago or its aircraft industry today). Meanwhile, soft industrial policy entails scaling up an infant industry (or generating Öscal revenue2) by way of integrating private, public, and financial actors, sometimes in the form of public-privatepartnerships, by using deliberate government programs and guidance.3 In this paper I focus specifically on hard industrial policy though I also point out China has pursued a combination of both in its REIP. This aspect of Chinese REIP obfuscates its domestic policy, further aggravating understanding of its substantial government support for the industry.

2.2 Renewable Energy Industrial Policy? Renewable Energy Industrial Policy (REIP) involves specific government policy to incubate advances 2 See: Harrison and Rodriguez-Clare 2010, pp. 402 3 Harrison and Rodriguez-Clare 2010: 404

in renewable energy technology production, trade, implementation, and innovation. Renewable energy technology, for the purposes of this paper, includes solar-thermal, solar photovoltaic, wind turbines, geothermal energy technology, wave/tidal energy, biofuels (only if end product is a net-energy gain), and hydropower. Successful REIPs encourage short-term rents to increase market share until that share is reasonably acceptable. Under WTO law, subsidies should be phased out after 3.5% of global share, at which point the country has eight years to phase out all subsidies for that industry.

2.3 WTO rules applicable to renewable energy industrial policy The WTO has developed into one of the most widely respected international institutions, not least because it can implement binding agreements enforcing acceptance of its decisions. The WTO is seen as an international organization with teeth because, in comparison to the United Nations, it receives high levels of compliance by enforcing trade restrictions (which have immediate impacts on local citizens and moderate impacts on local politicians). The WTO may enforce a ruling by implementing what is referred to as “trade remedy legislation” (Malawer 2014: 2). Countries may face WTO trade restrictions if they are found to violate WTO principles (discussed below). Trade remedy legislation relies on WTO's most powerful instrument: the Dispute Settlement Understanding (or Mechanism).

2.4 Dispute Settlement Understanding (DSU) An important instrument in the WTO is the dispute settlement mechanism, or dispute settlement understanding. If a certain trade issue is raised by country A against country B, country A may report this to the WTO. Within a short time-frame, if the parties do not reach an agreement, the case is ruled on by the judicial body of the WTO and in most cases respected, because penalties involve import tariffs against country B and even full trade restrictions. Trade restrictions are summarily supported by all WTO members, effective immediately. These mechanisms are of increasing importance for the production and deployment of renewable energy technology because a particular company or country quickly loses market share if it faces negative trade restrictions.4 2.5 WTO and Subsidies Outright subsidies are banned under WTO rules yet often used by domestic industrial policies, especially in infant industries.5 This becomes somewhat problematic for REIP, mostly an infant industry in many countries around the world, because “determining whether a specific green energy subsidy is prohibited or actionable under the […] depends to a critical degree on the exact design of the measure” (Wilke 2011: 9). Whereas prohibited subsidies under WTO law are in violation of WTO 4 See: Lewis 2013: pp. 7: “Even if governments are increasingly aware of potential challenges they may face, as the use of renewable energy policies increases, and tensions over competition in renewables markets increase, the use of WTO dispute mechanisms and CVDs are also likely to increase.” 5 See Coughlin et. al. If a country cannot achieve Ricardo's “comparative advantage” because it is entering a new industry, it is reasonable to allow that country to support local companies until it can compete with foreign competitors on the open market. Immediately after market equilibrium is reached, the country should remove all “infant industry” subsidies.

agreements and illegal under WTO rules, actionable subsidies require a WTO case to interpret their potential legality; however, if an actionable subsidy is ruled illegal, the host country is simply forced to remove the subsidy. No further action is required and no penalties are enforced. Thus there exists a wide scale for interpretation here while compliance remains weak because fines for non-compliance do not exist. This is even further misconstrued by such an opaque definition for subsidies embodied in WTO rules: WTO Definition for subsidies:

http://www.wto.org/english/tratop_e/scm_e/subs_e.htm

The basic principle is that a subsidy that distorts the allocation of resources within an economy should be subject to discipline. Where a subsidy is widely available within an economy, such a distortion in the allocation of resources is presumed not to occur. Thus, only “specific” subsidies are subject to the SCM Agreement disciplines. There are four types of “specificity” within the meaning of the SCM Agreement: Enterprise-specificity. A government targets a particular company or companies for subsidization; (1) Industryspecificity. A government targets a particular sector or sectors for subsidization; (2) Regional specificity. A government targets producers in specified parts of its territory for subsidization. (3) Prohibited subsidies. A government targets export goods or goods using domestic inputs for subsidization.

2.6 China’s Renewable Energy Industrial Policy China has demonstrated astounding growth in production of renewable energy technology within a very short time period. In just ten years, or the span of two 5-year-plans in China, it has become the mecca for the production of solar and wind energy technologies with active government support for export.6 Meanwhile, Chinese RE companies have gone from small players to dominating the market. China's REIP is not too dissimilar from Japan's industrial policy in car making or high-tech industries during the 1980s. China began to develop its RE industrial policy through soft industrial policy including grants, tax rebates, and R&D subsidies, and local content laws (Cabaugh and St. Brown 2012: 5). China now accounts for more than 50% share of solar photovoltaic industry (note WTO requires removal of subsidies after 3.5% world market share). By 2012, nine of the fifteen largest Solar PV companies in the world were Chinese, and most of these companies were entirely “vertically integrated”, or able to produce many of their own components along the supply chain in-house. They are vertically integrated because of local content laws requiring Chinese companies to, when possible, source components from domestic industry. Some countries recognized both the rapid acceleration of China’s renewable energy industry and their increasingly high density of domestic integration. This recognition was blurred by the financial crisis whereby only economics were the focus of mostly all countries around the world. Meanwhile, during the financial crisis the Chinese “doubled down” on REIP, and further scaled up the industry. 6 See China’s 12th Five year plan: “An 11.4 percent increase in the share of non-fossil energy in total energy use. A 17 percent reduction in carbon intensity (carbon emissions per unit of GDP). A 16 percent reduction in energy intensity (energy consumption per unit of GDP). See also: de las Heras 2013: p. 13

However, after the global financial crisis (roughly 2007-2009), solar PV companies in China were left with substantial oversupply (because Western markets could not implement RE due to financial constraints). In order to protect the industry from collapse, the Chinese government employed a number of subsidies and policies to prop it up. The policies aimed at “explicit export subsidies to sustain employment and social stability, as well as export performance” (Iizuka 2013: 14). Other policies overtly and explicitly issued subsidies to prevent the failure of renewable energy companies.7 Soon after the financial crisis subsided, a number of illegal activities in China’s REIP were brought to the attention of the WTO. One of the foremost of these was the U.S.’s assertion China was unfairly placing quotas and tariffs on rare-earth materials.

3 WTO and rare earths: Setting the stage for renewable energy diplomacy In August 2014 the WTO ruled against China and in favor of the U.S. in “Measures Related to the Exportation of Rare Earths.” This ruling combined three separate WTO cases because they were closely related.8 Rare earth materials are critical for the production of renewable energy products (rare earths represent 50% cost for wind turbines). This marked a monumental case for the WTO in terms of global REIP. First, by ruling against China, trade in rare-earth materials increased as its tariffs were withdrawn (a public “good” for renewable energy). Any decrease in tariffs for renewable energy raw materials is a positive result for the industry. Second, it demonstrated the WTO has the capacity to understand complex scientific processes involved in industrial policy, and summarily judge fairly based on the latter. The WTO gathered information about the subject, understood its acute importance in technology products, while subsequently deducing that China expressly supported many technologies composed of rare earth materials, to eventually reach a ruling that was respected by all parties. Proof of compliance is in China’s immediate withdrawal of tariffs (though the cost of rare-earths didn’t fall to levels before tariffs were implemented).9 China appealed on the grounds that it was restricting export of rare-earths because of environmental concerns. However, the WTO against ruled against China by understanding the appeal as an unsubstantiated response. Similarly, although China continued to argue it should be able to apply quotas to limit the amount of rare-earths exported within a targeted time period, the WTO continued to uphold its original decision. The appellate body, in contrast to its argument that it was placing quotas on rare-earths in order to “conserve an exhaustible natural resource,” found that “China’s export quotas 7 Some specific policies include (2012): “Interim measures on renewable energy development fund imposition and management”, “Solar industry twelfth five year development plan”, “Renewable energy tariff surcharge grant funds management approach”; (2011): “Twelfth five year plan for renewable energy in Beijing”; (2010): “Building integrated solar PV program, “Interim feed-in tariff for four Ningxia solar projects”; (2009): “Rooftop subsidy program”, “Golden sun demonstration program” (Iizuka 2013: 15). 8 DS432 and DS433, brought by the European Union and Japan, respectively. The Appellate Body consolidated the appellate proceedings in DS431, DS432, and DS433 before a single Appellate Body Division 9 At the DSB meeting on 26 September 2014, China stated that it intended to implement the DSB's recommendations and ruling in a manner that respects its WTO obligations.

were designed to achieve industrial policy goals rather than conservation.” 10 Under WTO rules a sovereign country may limit or halt exportation of a natural resource for conservation purpose only if it applies restrictions equally to domestic companies. The panel concluded China was supporting its domestic industry, by allowing it cheap access to rare-earths, while severely penalizing foreign buyers: “the Panel concluded that the overall effect of the foreign and domestic restrictions is to encourage domestic extraction and secure preferential use of those materials by Chinese manufacturers” (ibid). Thus, this set the precedent that, despite the fact that RE is a new industry still needing preferential government support, the WTO does not allow countries to severely impede access to raw materials for building renewable energy technologies. Lastly, this case revealed the overall efficacy of the machinery at work within the WTO Dispute Settlement Understanding. By combining related cases, reaching an agreement within a short period, and receiving affirmation that the Chinese government would comply, this ruling added substantial legitimacy to the WTO in resolving REIP related disputes. This offers proof the WTO will continue to be the global forerunner in upholding pertinent global renewable energy policies.

4 Results and Discussion The WTO DSU presented above yields a wide array of data for REIP and the global political economy in general. It first shows the expansive effects of the renewable energy industry. China, a country that has over 90% of rare-earth materials, has rapidly scaled up the production of renewable energy. Western countries, Europe especially, have at the same time scaled up renewable energy policy, requiring substantial implementation of renewable energy production domestically. Meanwhile, all countries want to receive both the “energetic” and “economic” benefit from both the production and use of renewable energy technologies. Furthermore, these technologies confer a political and strategic benefit. Each kWh of energy produced domestically is a unit of kWh not imported. Therefore, it is reasonably easy to understand why China implemented such policies and difficult to discern exactly which are illegal and for what reasons under WTO law. Yet, the rulings and the basis for such rulings proved resilient and, most importantly, wielded immediate compliance. Yet the question still lingers: was China using strategic trade theory to promote its RE? Strategic trade theory (STT) suggest governments can and should actively foster infant industries, especially in new technology fields. Oftentimes these new industries are dominated by just a few oligopolistic firms, characterized by their tendency to concentrate supply chains and vertically integrate all operations within the same corporation (Gilpin 2001). Governments employing STT are inclined to pursue policies which give it “first mover advantage”, in other words a leg up on competitors from other countries because they've developed and mostly mastered a product first. However, STT is seen by the majority of economists and policymakers as a threat to global trade. Thus, 10 See: World Trade Organization Appellate Body. “China-Measures related to the exportation of rare earths, tungsten, and molybdenum. AB-2014-3, AB-2014-5, AB-2014-6. 2014.

if we find China has used STT within its RE industrial policies, it implies China is not helping advance the renewable energy industry but rather slow it down. In objection to China's policies, and a direct accusation that China indeed used STT in the renewable energy sector, US Steelworkers appealed to the WTO for help mitigating this monumental trade threat. The US Steelworker were responsible for blowing the whistle on a number of Chinese STT policies, including its hording of rare-earth materials and its illegal subsidies to the wind tower industry.11 Considering these implications, it is evident the subject of renewable energy industrial policy needs to be well understood by governments in order to facilitate and capitalize on the massive transition to renewable energy technologies already taking place in the early part of the 21st century. The WTO must strengthen its dispute mechanisms to add to its already satisfactory compliance mechanisms in order to form a robust authority over these matters. If trade is restricted in any part of the renewable energy production value chain, i.e. rare-earth materials, global production of renewable energy will suffer. In the end this is a net loss for the global commons because the rapid and intelligent spread of renewable energy will play a massive part in mitigating climate change, among the myriad related governance challenges related to energy around the world.

5 Conclusions and Further research avenues This paper makes only a small dent in REIP research by using the example of Chinese REIP and the mechanisms at work reigning in its government policy in order for trade to promote the spread of renewable energy rather than act as a deterrent, and impede deployment of it. In a sense, more questions are raised than are answered here. The field is so new, and yet so prescient, it begs analysis. Where government policy and economy was dictated by locating energy over the past century, even over the past four centuries (invading foreign lands for timber for energy and building); it is now shifting to locating raw-materials to make energy. After materials are located, renewable energy can be made domestically, without the need to advance armies to secure more fuel. The principle questions raised in this paper hint at the need for governments around the world to realize the extent to which industrial policy will shape the renewable energy industry. Whereas Europe and the US seem intent on shaping renewable energy policy, China appears to be shaping renewable energy production. Though both are highly important, and one might not exist without the other, they are fundamentally different. Policies and policy implications might easily separate winners and losers. Yet what is needed here is not winner takes all competition, but fair competition which allows firms to consistently fight to innovate for the next best renewable energy technology. This can only occur in a world able to encompass the free movement of goods and services in renewable energy technology which, in turn, can best be facilitated by the WTO. However, the WTO is appearing to show some weaknesses, primarily in its still relatively weak fines for violating trade restrictions (China simply removed rare-earth tariffs), which means a new round of negotiations will be 11 For a detailed analysis of the US Steelworker petition see: “The United Steel, Paper and Forestry, Rubber, Manufacturing and Energy, Allied Industrial and Service Workers International Union”: China's Policies Affecting Trade and Investment in Green Technology (2010)

necessary. Alternatively a newer, more slimmer version of the WTO might be needed to deal explicitly with this subject, due to both its enormous geopolitical, climatic, and economic consequences. Nevertheless, the fact that the WTO managed to change China's REIP and eliminate RE trade barriers marks a significant turn in the industry. Though we will certainly see increasing legislation amid this burgeoning industry, this is not reason to worry. This only implies both the legitimacy of the WTO, which only a decade earlier was tending towards becoming a normative power, and the renewable energy industry, which even five years ago was seen as an environmentalist obsession.

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