Making Green Industrial Policy Work for the Climate

The Climate, Trade, and Security Nexus

Three spheres of policy that until recently were thought of as more separate have been merging in ways that are reshaping the future of the energy transition in the United States and beyond. National security, economic policy, and climate policy are becoming increasingly interlinked as economic security becomes a priority in Washington and capitals around the world. Climate technology supply chains in particular have become more and more securitized. The Inflation Reduction Act (IRA) is a prime example of these dynamics: the law’s provisions are accelerating the deployment of low-carbon technologies in the United States even as they introduce measures to address competition with China that may increase certain costs and potentially affect the speed of the clean energy transition.

Trade, economic security, and competition with China are at the heart of the challenge. Many climate technologies, including solar panels and lithium-ion batteries, are largely produced in China. Decarbonization efforts could thus potentially increase trade dependencies on China at a time when interdependence is seen in some cases as a threat to economic security. Promoting diversification and domestic investment in manufacturing can help alleviate these concerns, but as Chinese companies respond to U.S. de-risking incentives by setting up production outside of China, including in the United States, some dependencies will remain.

The IRA already lays out a multipronged approach that incentivizes domestic manufacturing as well as international supply chain diversification (for example in the case of critical minerals used in batteries). However, moving forward, this approach will need to be more up front in addressing the role of Chinese firms as they internationalize. This will require stronger international cooperation, better frameworks to identify and evaluate risk, and more consideration for what kinds of policies and initiatives can best leverage foreign direct investment (FDI) from Chinese firms to maximize localization and reduce risky dependencies on China.

Looking at current trends in trade, macroeconomics, and climate, three issues appear increasingly important for U.S. policymakers and climate advocates to address.

  1. Chinese exports are on the rise, but prices are falling.

Due to a combination of factors, including low domestic demand, a flagging Chinese economy, and increased support for manufacturing in China, the past couple of years have witnessed a surge in exports from China. Even more concerning to policymakers is that the prices of certain goods made in China, including electric vehicles (EVs), solar panels, wind turbines, and batteries, have continued to fall as part of domestic price wars and possible overcapacity fueling a rapid increase in exports. The result is growing global tension, especially with regions that feel that their economic welfare is threatened by competition with China. For example, the EU Commission has launched anti-subsidy investigations into Chinese-made EVs and, more recently, a bid by a Chinese state-owned train manufacturing company.

Climate technology exports are becoming increasingly important to the Chinese economy: in 2023, solar panels, lithium-ion batteries, and EV exports accounted for 4.2 percent of China’s total exports, up from 1.5 percent in 2019, according to author calculations using Chinese customs data. To put this into perspective, all steel, iron, and related articles account for almost 5 percent of China’s exports. The demand for EVs, solar panels, batteries, and other climate technologies like electrolyzers, heat pumps, and wind turbines has been surging around the world. On the one hand, low-cost equipment that can help reduce emissions is highly desirable; on the other, price competition due to distorted market incentives that lead to increasing concentration of production in China is politically unsustainable and could have negative repercussions for the clean energy transition.

  1. Chinese climate technology companies are going global.

The internationalization of Chinese firms as they expand their production capacity outside their home country is a potentially transformative trend. Companies are responding positively to incentives put in place by the United States to diversify supply chains and by countries seeking to attract more FDI in emerging industries. Chinese firms are morphing into multinational companies and are now at the forefront of supply chain diversification.

The increased role of Chinese FDI in shaping climate supply chains is still not well understood. There are many outstanding questions regarding linkages between the party-state and companies in China and their political implications as well as the presence of subsidies at home that could give them an unfair advantage. However, there is also a distinct possibility that these kinds of investments could help achieve geographic and, in some cases, ownership diversification while enabling some tech diffusion, especially if combined with careful and strategic policymaking by host countries. They are also often welcomed by countries that are seeking to expand their manufacturing bases.

Different technologies and conditions will require different approaches and assessments of the risks and potential benefits that might derive from Chinese investments. However, it is increasingly true that in the field of climate technologies, Chinese companies have advanced technology and impressive manufacturing know-how and are likely to continue expanding regardless. The question isn’t whether they will internationalize, but rather under what conditions and where. U.S. policymakers and civil society should debate these issues with a careful assessment of real risks and balance the costs and benefits to develop a strategy that ensures that climate goals are pursued alongside economic and security ones.

  1. Global value chains still matter.

The low-carbon technologies that are reshaping countries’ energy mix today—from solar panels to batteries to wind turbines—reached maturity and commercialization at a time of increasing value chain integration and thanks to extensive flows of talent, capital, and technology. In an era of strategic U.S.-China competition, that model is no longer viable, but there is no clear blueprint for what comes next. Any new approach to bringing new and existing technologies to market, scaling production, and achieving cost reductions will be relatively untested. As policymakers and civil society work to develop a new approach, they will need to wrestle with how trade and FDI can be harnessed to have positive effects on climate and economic development.

Rethinking Climate Policy in a Geopolitical World

The United States will need to rely on global value chains if it wants to make progress on decarbonization. Surging Chinese exports present a challenge, but some opportunities may stem from the increasing international footprint of Chinese companies. An effective multipronged strategy will support domestic industry and global diversification efforts and take advantage of growing Chinese FDI globally to ensure that it comes along with real localization and enables technological diffusion.

Chinese and other foreign investment can help address the other challenge that emerges when deploying tariffs and industrial policy. While tariffs can be a useful tool to provide breathing space for key industries, they increase costs and reduce incentives for domestic companies to compete. If companies produce locally, they should face the same labor and other costs and restrictions as local companies, and if appropriate regulation is put in place or enforced, they will need to comply with enhanced transparency requirements.

International cooperation will also be an important piece of the solution. There are many opportunities for improving transatlantic cooperation, for example, that could start with better ways to reconcile different policy frameworks, standards, and regulation. Such an approach could also aim to revive multilateral engagement, especially through the World Trade Organization. Strengthening global governance could benefit the United States as it seeks to both address the challenges that stem from China’s policies and find pathways for cooperation with Beijing on issues including global standards, strengthening climate governance, and addressing climate adaptation in the developing world.

Climate advocates both in and outside of government find themselves in front of a new challenge. Climate is increasingly salient as a political issue in the United States and globally, but it is now inseparable from a broader discussion on economic security, domestic economic policy, and competition with China. Recognizing and better identifying the risks and opportunities associated with this new environment will be crucial to making progress on climate and economic security.

Ilaria Mazzocco is a senior fellow with the Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies in Washington, D.C.

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5Mazzocco
Senior Fellow, Trustee Chair in Chinese Business and Economics