Are we witnessing a paradigm shift in industrial policy or are the Plaza Accords rebalancing architecture in our future?

A combination global crisis: the climate change crisis, the new geopolitical realignment and conflicts disrupting global trade, and the revolution in renewables technology are proving to be a benign testing ground for an industrial policy away from the liberal free trade ideology dominant since the Thatcher-Reagan revolution in the 1980s.

The view that nationalist-protectionist industrial program, exemplified by countries behind the socialist wall, will lag behind the market economies has become established in many people’s minds. F. Fukuyama wrote The End of History as the death anthem of the polar challenge of the central planned economies.

Forty years later, a new and more assertive champion of the old mercantilist heresy has arisen to challenge the neo-liberal hegemon. Mercantilism reminiscent of the old days, and about which Adam Smith raged against, is alive and seemingly thriving. This new champion, Red China, had become not just the second largest economy in the world but is showing designs of toppling the top hegemon in the world. This emergence has shifted from labor-intensive to technological sophistication (semiconductors, supercomputers, EVs, and batteries), which promises to fuel even greater progress in the future. The big difference is that its dynamism is anchored in a very vigorous domestic market economy unlike the old central planning. More interestingly, it had transitioned from the defuse industrial policy delivered by currency undervaluation to the massive direct fiscal subsidy to select industries. The result has been spectacular.

Two decades (2005-2023) is all it took for Red China to overtake the current hegemon in total exports to the world. The export surge that started out among light labor-intensive goods, toys, and gadgets in the 1980s-1990s, all in keeping with Heckscher-Ohlin paradigm and riding on a massively undervalued yuan, gave China considerable advantage in light manufactures. The undervalued yuan was set in 1994 (CN¥8.28/US$) and stoutly defended but eventually allowed to appreciate 16% to CN¥6.11/US$ to assuage Western restiveness when the consensus was at least 25% devaluation.

China then found another way: the undervalued yuan was replaced by a massive direct fiscal subsidy to a select few industries which would serve a new deeper challenge and a new spur to its hegemonic challenge. Highly sophisticated technical marvels such as EVs, solar panels, and semiconductors delivered on the backs of massive direct fiscal subsidies are now the new face of Chinese exports. This continued surge led to the deindustrialization of, and destitution in, the American and other western industrial heartlands. The USA became the chief importer from and chief debtor to the world ($35 trillion to date), largely enabled by its privilege of being the issuer of the global medium of exchange. This dominance is understood in the West as a result of heavy subsidies for EV Manufacturing in China (F. Bickenbach, D. Dhse, Rolf Langghammer and Wan-Hsin Liu, 2024).

Studies also show that this exorbitant privilege allows the US per capita income to rise by 17% plus. To counter the privilege, many countries try to become currency manipulators, risking the ire of the US Treasury. Both former US president and now Republican presidential nominee Donald Trump and his choice for vice-president JD Vance have both advocated a weaker dollar during the Plaza Accords.

The mad rush to renewables in transport since the 1990s was first seen as doing the global community a favor in the global warming crisis rather than as an assault on industrial hegemony. But the deindustrialization and consequent destitution in the rest of the world could not be ignored indefinitely.

USA RESPONDS: THE INFLATION REDUCTION ACT AND THE SCIENCE AND CHIP ACT
The Inflation Reduction Act represents the largest investment ($369 trillion in August 2022 and up to $3 trillion with private investment channeled over the next decade) towards reducing dependence on China. The USA has committed $53 billion to the Chips and Science Act to reshore US investment in semiconductor research and manufacturing; $39 billion of this is to build, modernize and expand chip fabrication as well as a 25% investment tax credit. Raising the import tariff on semiconductors 100% is a critical part of the come-ons to protect new home-bound investments. As one commentator observed: “The IR Act marked a paradigm shift in green industrial policy for the US, diverging markedly from free-trade neoliberal policies that had enjoyed bipartisan congressional support since the Reagan era.” (M. Lyons, “Climate Justice: Friendshoring, China’s Supremacy and America’s IR Act,” www.lowyinstitute.org/the-interpreter/climate-justice-friendshoring-china-s-supremacy-america-s-ir-act )

Before this, programs to improve industrial competitiveness and reduce the trade deficit were poohpoohed as “industrial policy,” a rather pejorative term in the lexicon of the liberal free trade circles in the USA.

China is beginning in a big way to assault the Western dominance in the EV car market; it has accounted for 80% of solar manufacturing and 60% of wind and battery production. China’s dominance and control of critical mineral production looms large and threatening. The net zero Paris commitment is proving a convenient cover for sideswiping the accepted global trade architecture of the world.

As response, the USA has committed $53 billion. President Joe Biden’s 100% tariff on imported EVs from China was intended to dent China’s unfair trade practices and protect local investment. Although the 100% tariff will be insufficient to keep Chinese EVs out in the low end of the spectrum ($10,000 or less); it will protect the high-end EVs like Tesla and heavier EV truck size bread-and-butter vehicles of US manufacturers.

WESTERN EUROPE RESPONDS
In June 2024, the European Union (EU) responded to this belief by also imposing a tariff of 17.4% to 38.1% against a range of high-tech products from China following the Biden administration’s lead in May 2024 (100% on EVs and 25% on batteries).

Chinese EVs have benefited from massive industrial policy subsidies. The massive home market allows massive economies of scale in production, which contributes to lower costs. The types of support range from below-market credit to state-owned and -operated corporations, rebates, sales tax exemptions, infrastructure subsidies, research and development funds, government procurement bias, and below-market land sales which, in 2023 alone, totaled to $45.3 billion according to the CSIS.

From 2009 to 2023 a total of $230 billion may have been granted as subsidies. This is far higher than industrial subsidies in Western countries as a percentage of GDP (China’s was about 1.73% in 2019 vs. say, South Korea’s 0.67%, Germany’s 0.41%, and the USA’s 0.39% of GDP). Purchase subsidies paid to producers for vehicles made in China not for imports and not to consumers amounted to €4.2 billion in 2022 but ended then. BYD received €1.6 trillion in 2022. The subsidy to CATL alone, the chief battery technology company in China in 2023 reached $809 billion. Regional government subsidies to EV manufacturers are also substantial but quite hidden.

Meanwhile, defenders of the Chinese challenge could point to the fact that EV vehicular subsidies as a percentage of total sales has dropped to 40% from 140% in early years. The average support per vehicle has dropped from $13,800 in 2018 to $4,800 less than the credit going to qualifying vehicles to buyers in the USA which is $7,500, under the Inflation Reduction Act of the USA.

Why not try the Plaza Accord Agreement solution? The Plaza Accord Countries agreed in 1986-87 to address the imbalance in favor of the raging Japanese economy by forcing a massive appreciation of the Japanese yen. But the world is different now. While China is posing a direct challenge to the USA as a new polar hegemon; Japan was clearly well within the fold of the US hegemon; Japan could be nudged towards an appreciation of its currency (up to 200%) even at the further appreciation cost of a prolonged recession. China has long resisted the drastic appreciation of the Yuan and will refuse a deflationary outcome to prevent social unrest; and, more importantly, its designs on the old hegemonic ranking will suffer. It is not as docile as Japan in the 1980s.

The Plaza Accords rebalancing is not in the cards.

Raul V. Fabella is a retired professor of the UP School of Economics, a member of the National Academy of Science and Technology, and an honorary professor of the Asian Institute of Management. He gets his dopamine fix from tending flowers with wife Teena, bicycling, and assiduously, if with little success, courting the guitar.