Reduction of Chinese subsidies for energy might affect manufacturing competitiveness
2008/07/16 in Tumblr blog imports
I recently read some research (from americanmanufacturing.org) that changed the way that I viewed China’s comparative advantage in manufacturing, and highlighted the ways in which China has successfully competed globally by supporting industry. In summary, the study concluded that total Chinese energy subsidies over the past 7 years have amounted to over $27 billion, a majority of which went to coal-fired energy producers.
One industry in particular that has benefited extensively from energy subsidies has been the steel industry in China. As of 2007, China was able to produce and sell steel for about 20% less price than US or European companies. At first glance, the casual observer would say “yeah so, of course China is cheaper because of lower labor costs”. But, in steel production, labor costs are nearly insignificant, accounting for less that 10% of producing Chinese steel. According to the study, the Chinese steel industry has neither an advantage from economies of scale, nor better use of technology or supply chains. The report highlights that energy subsidies passed along form the base of the cost advantage of these steel producers.
While the report by “American Manufacturing” might be biased (it probably is biased against the Chinese), it does bring up some very interesting concerns for global business leaders, investors, and entrepreneurs. First of all, it is important to understand the real cost structure and source of comparative advantage of China (or any country) before committing to investment, or massive changes in global supply chains. It is critical that you understand which elements are fundamental (long-term, and lasting), and which elements are artificial (such as government subsidies which are subject to change).
As political and economic forces change in China, there will surely be changes that will affect business. Just make sure that the long-term business plans you put in place are secure enough to withstand potential changes.
Will the subsidies regime change?
With international pressure mounting, and WTO rules such as the 2007subsidy-reduction agreement (between US and China) coming into effect, we are seeing shifts in subsidies that could have an impact on the global competitiveness of Chinese firms.
In other energy markets, we have seen recent changes in the manner in which the Chinese control the oil industry. The national oil refineries in China were loosing money big time as the cost of oil internationally reached record highs, but the Chinese government kept price controls on the local market pricing structures. In a surprise move to reduce pressure on the national oil refineries, the Chinese government eased price controls (and subsidies)
The danger for foreign firms, however, is that many are not aware of the important role that energy subsidies have played in China’s cost advantage in global business, and they are therefore not aware of the risks that changes in these subsidy regimes could play to global supply chains.
For more discussion about the changes occurring in China, please visit: Changes are happening in China