1. Introduction: the need for a competitive framework
New energy, environment and climate-related issues are often cited as potential areas for constructive cooperation in a US-China relationship that since 2015 has become increasingly rivalrous. In principle this is clearly true, but in practice the obstacles are immense. Both China and the US are doubling down on industrial policy strategies designed to increase self-reliance and promote leadership by their domestic firms. China has embodied technological self-reliance in policies such as the Strategic Emerging Industries initiative (2010), Made in China 2025 (2015), the Innovation-Driven Development Strategy (2016) and the “dual circulation” economic policy (2020). The US has imposed formal and informal controls on inbound direct investment that have essentially stopped Chinese investment in US technology sectors. The political climate in Washington prohibits any formal, government sponsored cooperation with China in any technological field, since such cooperation would now be seen as aiding a strategic rival. In the US, Congress in 2022 is likely to pass legislation, incorporating elements of the Senate’s US Innovation and Competition Act and the House of Representatives’ COMPETES Act, which will substantially increase government R&D funding and tax incentives in many technological sectors including clean energy.
Some efforts at cooperation persist at the subnational level, notably through a memorandum of understanding between California and China’s Ministry of the Environment.1 US foundations, in particular the Energy Foundation, are still active in financing clean energy projects in China. And US companies continue to invest in clean energy in China: both venture-capital funds individual firms such as Tesla, which has a large electric vehicle factory in Shanghai that received substantial support from the Shanghai and central governments. However, the political constraints on such investments are likely to grow. It is probable that within the next few years the US will establish an outbound-investment screening mechanism—analogous to the Committee on Foreign Investment in the United States (CFIUS), which screens inbound direct investments—to vet direct investments by US corporations in countries such as China. Venture-capital and other portfolio investments may not be directly affected by this legislation, but could be subject to other forms of political pressure to reduce investments in China.
The scope of this analysis is limited to investment and technology flows between the US and China, but it is worth noting that similar trends towards inward-focused industrial policy and restrictions on investment flows are visible in Europe, and have been permanently exacerbated by the Russia-Ukraine war, which has drawn Europe closer to the US and caused it to view China as more of a strategic rival.
In this context of increased “securitization” of economic policy, and focus in all major economic blocs on increasing domestic production and decreasing reliance on imports, competition rather than cooperation is likely to be the major theme. Those interested in maximizing climate action and green energy investment should embrace this shift rather than opposing it. Where cooperation and coordination are feasible, they should certainly be pursued. But more effort should be put into ensuring that the inevitable great-power strategic competition is made as healthy and positive-sum as possible, and delivers the maximum possible climate benefits. This will mean, first, framing climate and new energy goals as a competitive “race to the top”, which will deliver specific domestic economic and security benefits, not just an abstract global benefit. Second, it will require a focus on ensuring that competition does not degrade into protectionism and autarky, which will slow the rate of technological change. To the degree possible, therefore, the climate/new energy agenda should also be an agenda for maximally free cross-border trade and investment in new energy goods and services.
2. China’s clean energy ambitions
China’s decarbonization aspirations are serious and the country is certain to become a leading producer of world-class new energy technologies. True, there has been recent backtracking as the result of energy shortages that arose from a too-aggressive closure of coal plants and insufficient investments in infrastructure that would ensure maximum usage of the nation’s large installed renewable energy base These include grid connectivity; storage solutions, whether batteries or pumped hydro; and flexible (mostly gas-fired) generating capacity to make up for the intermittency of renewable power generation. These setbacks are likely to be temporary. The strategic underpinnings of China’s climate strategy are robust and consist of three pillars.
Industrial policy. China perceives an opportunity to gain global leadership in most if not all new energy technology sectors. This aspiration is reflected in the “strategic emerging industries” (SEI) initiative of 2010, which has been refined in successive industrial policy documents. Of the 20 SEI sectors that have so far been defined, seven relate to new energy or the environment: energy efficient machinery, environmental protection equipment, recycling, wind, solar and biomass power, and electric vehicles.2 China is already the world’s dominant player in all segments of the solar power equipment sector, is globally competitive in batteries, and is fully self-sufficient in wind power equipment although its share of the non-China market is fairly small.3
Energy security. Since becoming a net oil importer in the mid-1990s, China has devoted substantial policy attention to energy security. Within the fossil fuel realm, this has mainly taken the form of diversifying sources of supply and minimizing reliance on seaborne resources that need to transit the Straits of Malacca, which could be interdicted by the US Navy. One of the main strategies has been the opening of oil and gas pipelines from Central Asia (Turkmenistan and Kazakhstan), Myanmar and Russia. Central Asia (Kazakhstan and Uzbekistan) is also likely to become an important supplier of uranium for China’s massive nuclear-power program.4 Nonetheless, given the scale of China’s requirements it will be impossible for China to source anywhere close to all of its oil, gas and uranium needs from “safe” suppliers. The only non-renewable fuel in which China is self-sufficient is coal, whose continued use at the present scale is unsustainable for environmental reasons. Renewable energy is attractive because it is by definition derived from domestic sources. China also controls most of the raw material supply chain for wind and solar power. China’s future energy security strategy will thus comprise: a) domestically sourced hydro and renewables; b) nuclear power with diversified sources of fuel supply;
c) natural gas increasingly supplied by pipeline from friendly sources; and d) huge domestic reserves of coal which can be tapped in emergencies.
Environmental protection. Chinese leaders are aware of the potential negative consequences to China of climate change, mainly via reduced waterflow from the Himalayan glaciers that feed its major rivers, and by sea-level rise in its heavily populated and prosperous coastal regions. They are interested in mitigating these long-run impacts; but such efforts (as in other countries) are often deferred when they conflict with shorter-term objectives. A more urgent concern is to control local air pollution, which is highly visible and a major degradation of quality of life for China’s rising urban middle class. Since 2014, when a huge cloud of industrial smog blanketed north China for weeks (the “airpocalypse”), improving the environment has been a significant priority of the CCP’s stated governance strategy, and hence a component of its legitimacy strategy.5
Thanks to its size, manufacturing capability, and disproportionate contribution to global CO2 emissions, and because of the three policy motivations just listed, China is already playing and will continue to play a large role in developing and producing clean energy and non-fossil (notably nuclear) energy technologies in the coming century. It will also play a large role in developing the supply chain for raw materials needed for these technologies. The only question is how much China’s efforts will be driven by the desire for self-sufficiency, and how much by the aspiration to create best-in-class technology. A self-sufficiency strategy will deliver second-best technologies and fewer positive spillovers to the rest of the world. A true innovation strategy, which accepts a high degree of supply chain interdependence, will deliver better technologies and more spillovers.
China’s technology strategy includes both self-sufficiency and innovation components. Recent analysis by the McKinsey Global Institute shows that even in cases where China has achieved a high degree of self-reliance in final goods, it remains deeply integrated in global supply chains. For instance, domestic producers supply nearly 100% of China’s demand for solar panels and wind turbines, and 95% of its electric vehicles. Yet in each of these industries, typically 25-30%, and sometimes more, of first-tier component suppliers are outside China. Conversely, the ability of Chinese producers to take a leading position in global markets is highly variable: they have a rest-of-world market share of over 50% in solar panels, but no more than 5% in wind, electric vehicles and batteries.6 Batteries is a good example of an industry where geographic interdependence will be almost impossible to escape. Because of their weight and volatility, batteries cannot be exported, but must be produced near the end-use sites (electric vehicle assemblers or power grids). As a result, globally competitive battery producers will need to set up production sites in many countries, and not all countries will find it practical to limit battery production to domestically-owned companies.
China has also been active in securing sources of the raw materials needed for clean and non-fossil energy technologies. It is essentially self-sufficient in silicon (for solar panels) and rare earths (where it controls a large majority of global processing capacity). It relies heavily on imports for the lithium and cobalt needed for batteries, and on uranium for nuclear plants. Strategies for securing these imported supplies include both long-term supply contracts and the purchase of mines and mining concessions. In some cases—notably cobalt, where global supplies are heavily concentrated in a single country, the Democratic Republic of the Congo—China’s investments have created anxiety that it will use its control over supplies of key resources as a tool for economic or political leverage, as it did in 2013-14 when it tried to restrict rare-earth exports to Japan during a territorial dispute.7
3. Outlook and recommendations
The prospects for meaningful cooperation, at the national government level, between the US and China on new energy or environmental technology are dim, now that the US has defined the relationship as essentially competitive and both sides are intent on domestic self-sufficiency in key technologies. Private-sector cooperation is possible only in one direction (US firms investing in China and developing partnerships and supply chains there), since US regulations make it effectively impossible for Chinese companies to invest in any technological industry in the US. It is reasonable to expect that US regulatory restrictions will increasingly impede the ability of US multinationals and venture capital firms to invest in China. Moreover, US restrictions are likely to be copied in lesser degrees by European countries, as pressure grows for creating a “secure and reliable supply chain” within the US alliance network. All of these movements will incur significant economic efficiency costs, but the political backing for them is formidable.
There is, however, a compelling global interest in the world’s two largest economies, and largest emitters of greenhouse gases, to jointly tackle the climate change problem. In the much more constrained political environment of strategic rivalry between the US and China, opportunities for joint work will be very limited. It is thus necessary to focus on efforts to maximize parallel progress by both countries. The main potential avenues are:
“Race to the top” competition. Historically, climate activists have been averse to this type of framing, stressing the need for cooperation and joint goal setting via the COP process. Unfortunately, the scope for progress under these mechanisms is limited, both because of the fragmentation of the world into rivalrous blocs, and because of the lack of enforcement mechanisms to impose accountability on long-run climate pledges. Especially in the US, reframing climate and clean-energy goals as not just a moral imperative but as an essential component of US national power and economic competitiveness will be needed to accelerate clean energy development. To the degree that this succeeds, it is likely to spur commensurate efforts by China, which will worry about falling behind in a race for technological leadership.
Opposition to restrictions on private-sector capital flows and research collaborations. Especially in the US, there is significant risk that legislation or executive action will seek to prevent or severely restrict flows of private capital, or exchanges of information, from the US to China in a range of technology fields including new energy and environment, on specious national security grounds.8 Because China is still a laggard in many technology fields, and because it is unusually good at creating large ecosystems in which new technologies can be scaled up, it is critical for global innovation in new energy that private companies and financiers from around the world should have maximum scope to invest in promising new ventures in China. Rapid development of new energy technologies in China poses no threat to the US and its allies nor to their firms; in fact quite the opposite. The ability of international firms to participate in China’s dynamic, large-scale market creates opportunities for enhanced innovation (although it must be acknowledged that these opportunities are not always realized). And even in cases where international firms are unable to compete effectively in the China market, the availability of low-cost clean technology products from China can accelerate deployment elsewhere—as we can already see in the case of solar panels—and thereby create incentives for second-order innovation in, for instance, grid design and storage.
Environmental accounting and standards. Creating standardized methods for calculating carbon content of goods and services will be essential for regulating cross-border trade in carbon intensive. The logical endpoint is a set of carbon border adjustment mechanisms (CBAM or carbon tariffs) which will prevent firms from arbitraging carbon regulatory regimes by moving production to locations with weaker rules. Most likely, these standards will be developed on a national or regional basis and at some point the various standards will need to be harmonized globally. The EU’s CBAM proposal is a good start. The US should develop its own such mechanisms. China will be anxious to avoid being shut out of developed country markets and this may be one area where a consultative approach could work, because it is backed by an implicit threat of economic force.
Develop robust and diversified supply chains for key materials. Competition for, or anxiety over, key materials for new energy technologies is already intense. This is notably the case for rare-earth metals (used in a wide range of high-tech products) and the elements needed for batteries, notably lithium and cobalt. Most likely, these goods will traded the way all other commodities are, by commercial actors (both private and state owned) in markets that are subject to distortion or manipulation when sources of supply are limited in size or location. To allay concerns that global supplies of key minerals could be controlled by a single country, barriers to extraction and processing capacity should be lowered. This will require some hard trade-offs. Processing of rare earths is notoriously environment-unfriendly. Many key mineral deposits are in poor countries with weak governance, where extraction can create severe environmental and equity problems. In tandem with lowering barriers to investment, appropriate environmental and governance safeguards should be negotiated. In the case of extraction in low-income countries, it will be necessary to find ways to engage China in discussions about environmental and governance standard-setting, which historically it has been reluctant to do.
Arthur R. Kroeber, Partner and head of research, Gavekal Dragonomics, Adjunct professor of international economics, NYU Stern School of Business