It’s too late to penalize China for acting like China

The finding this week by the U.S. Department of Commerce that China has been improperly subsidizing its solar panel industry is the first step in what promises to be a repeat of the U.S.-Japan trade frictions of the 1970s-80s. The Department is expected to follow up the finding of relatively small subsidies (3-4 percent) with complementary findings of dumping that could trigger substantial anti-dumping tariffs.

There is no doubt that China’s solar panel industry has been subsidized and protected in a variety of ways. The questions I have are whether this finding and a possible further anti-dumping finding are coming too late to make much difference to the structure of the global industry and why it takes so long to make these kinds of findings and to put counter measures in place.

The solar panel industry was identified by the Chinese government long ago as a target of special attention. Indeed, I recall being in a White House meeting in 2009 to discuss the prospects for the U.S. solar panel industry. I told the administration’s top economists then that unless they were prepared to match the enormous incentives China was planning to provide to its industry ,the U.S. industry would be blown out of the water. They weren’t prepared to match and the industry is, in fact, now being blown out of the water. Anyone who had had the experience with Japan or who had an ounce of understanding of how strategic industry targeting and export-led growth works could have foreseen exactly what has come to pass as China has poured about $34 billion of subsidies into its industry which exports about 95 percent of its production. That would be the loss of several thousand U.S. jobs and the bankruptcy so far of 12 U.S. companies. This is not to mention the inevitable reductions in R&D spending and innovation in the face of the tsunami of imports from China.

Perhaps the imposition of duties will save what is left of the U.S. industry, but why was it necessary for things to come to this pass before action could be authorized? The answer is that U.S. international economic policy is based on what we might call the free trade charade. It assumes that all U.S. trading partners in the World Trade Organization are committed to private enterprise driven laissez faire capitalism and comparative advantage driven free trade. Under this assumption no special subsidies and protections are supposed and the government waits for someone to complain before collecting any data or evaluating any impact on U.S. industry.

Once those investigations start, they take time during which the subsidized industry actually has an incentive to ramp up production and exports in order to destroy as many competitors as possible before any counter action can be taken. And the time can be prolonged because the U.S. subsidiaries of the Chinese producers, being legally U.S. citizens, are granted the privilege of contesting the findings and of arguing that no damage is done to the U.S. economy because they are creating longshoreman and trucking jobs to support the imports. So the fox in the hen house gets to argue, as he wipes blood from his lips, that he’s just trying to help the hens.

The root of the trouble here is that the fundamental assumption of private enterprise driven free markets and comparative advantage-driven free trade is wrong. When governments have five-year plans that target certain industries for development aided by a plethora of incentives, the assumptions of free trade are out the window. This is even more true when those governments have powerful bureaucracies with broad discretionary powers to administer "guidance." It is even more true when the governments are authoritarian, and it is even more true when state owned enterprises are involved. When this combination of forces is present, you can be sure that the outcome is not going to be determined by unfettered market forces. So we shouldn’t act like we think it will be.

Rather than pretend a free trade situation exists when it doesn’t, we should define a targeted industry category of trade and establish a special set of rules to govern it separately from standard WTO-style trade. This could be done within the WTO or bi-laterally with particular countries, but in either case it would allow immediate imposition of offsets to market distorting subsidies and protections based on the presence of industry targeting policies. There might be a system of the issuance of warnings and consultation and a scaling of the offsets. But there would be no long delays and also no bitter exchanges of insulting pejoratives about cheating and unfairness between the parties. It would all just be business.

"Ah, I see that you, government X, are targeting industry Y. That is certainly your privilege. I can understand that you think it an important industry for you to have in the future. We think it’s important too and while we are not especially targeting it we are invoking clause Z of the WTO to offset any negative impact on our industry of your policies. I’m sure you understand. Of course, we always stand ready to discuss the situation with you and to make appropriate adjustments. Many thanks for your understanding and cooperation."

Simple, polite, no lawyers, no expenses, no damages. Just business. That’s how it could be if we scrap the free trade charade.