Institute for Research in Economic and Fiscal issues

IREF Europe - Institute for Research in Economic and Fiscal issues

Fiscal competition
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The Risky Business of Protectionism For Global Value Chains

Globalization is often associated with delocalization and unfair competition with emergent countries that are flooding us with cheap goods and services regardless of good environmental practices or social benefits these populations should enjoy, like in rich countries. Beyond this spurious assessment hinge the even more fallacious concept of reciprocity that justifies a new form of protectionism and trade tariffs. The last blow to international trade stems from Brussels and its decision to tax imports of Chinese solar panels – from 37% to 68% - even though this could beget a trade war.

But before going back into the details of this surprising decision, one has to understand the reality of international trade. This may seem as counter-intuitive, but the United States is the first Europe’s commercial partner, as well as its first competitor. As trade gets more global it also gets more local. Firstly, the share of international trade between southern countries is catching up with the one in northern countries. Secondly, the last technological revolution gave rise to a substantial increase in intra-firm and intra-sector commerce. Thirdly, once we compute trade in value added, the European Union represents one third of total trade of the United States. Adding Australia, Canada and Japan and it’s more than half of the domestic value added in the United States that comes from imports from industrialized countries. Finally, the structure of high-tech exports in the US or the EU is very similar. This means Europe competes in the same markets than the US.

However, Europe’s competitiveness is plummeting, despite strong a competitive advantage in specific high-tech sectors such as aviation or optics remains. But this has nothing to do with China subsidizing solar panels. Brussels should be more concerned with the growing productivity lag between Europe and its first competitor the United States. Between 1995 and 2005, the average labor productivity grew by 1,4% in the EU and by 2% in the US. The discrepancy is about the same for labor productivity in service and could, in the long run, have a huge cost on Europe’s competitiveness against the US.

To paraphrase Pascal Lamy, it is more important to add a lot of value to your exports than just to export a lot. The mercantile China is not a sustainable business model; instead, companies must increase the quality of the goods and services they are selling. Furthermore, China is facing huge internal imbalances that will take time to re-equilibrate that weigh on households demand and imports. For all that, we can doubt the EU has any real economic interest in risking a trade war with China in a sector where profits are so small that companies have to be sustained by their respective governments. Europe is in complete delusion in believing that a simple tariff will urge the Chinese to further change their mercantile model overnight.

As for the PV sector itself, it is in no better shape in China. Despite massive subsidies, it has low profitability is highly indebted – with an average debt-to-equity ratio reaching 80%, against 50% in Taiwan. Suntech, the Chinese giant of the sector went bankrupt within few days in late March 2013 after defaulting on convertible bonds. These predicaments are not solely due to new Chinese entrants in the market and slashed prices. More importantly, silicon prices nosed down from $400 per kilo in 2008 to less than 20 today, a 25-fold dive. And most companies are bound with long-term fixed-priced contracts. No wonder they are kicking out of business.

What we need to keep in mind is that with today’s global value chains, solar panel manufacturers do not buy intermediate goods only to domestic partners. A recent MIT Study on the Future of Solar Energy concludes, “Instead of national firms competing to produce end-product devices with exclusively domestic content, [the analysis showed that] a supply chain in which U.S. firms sell key manufacturing equipment and materials… to Chinese firms that make cells and modules for sale globally.” (WSJ, March 12, 2013) To reinforce these global value chains and trust globalization – as it was the usually the message purported by the EU commission – would be much more profitable for the struggling, but still growing, solar panel market. A trade war with China is, on the contrary, a step back and not way forward to stabilizing this market. Instead, it would put at risk these complex commercial relationships between thousands of enterprises around the world. In the end, free-trade opponents always seem to forget an important variable: globalization is dynamic process and it doesn’t wait for regulators to reshuffling the cards of international trade.

Lucas Léger

IREF researcher

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