Chinese FDI in Europe – 2020 Update

This report, from Rhodium Group and MERICS, summarizes China’s investment footprint in the EU-27 and the United Kingdom (UK) in 2020, analysing the fallout from the pandemic as well as policy developments in Europe and China. Below are the main findings and a link to the full report:

China’s global outbound investment hit a 13-year low in 2020: Concerns that the Covid-19 global pandemic slump might trigger another round of Chinese distressed asset-buying proved unfounded. Instead, China’s global outbound M&A activity dropped to a 13-year low, as completed merger and acquisition (M&A) transactions totaled just EUR 25 billion, down 45 percent from 2019.

China’s FDI in Europe continued to fall, to a 10-year low: Shrinking M&A activity meant the EU-27 and the United Kingdom saw a 45 percent decline in completed Chinese foreign direct investment (FDI) last year, down to EUR 6.5 billion from EUR 11.7 billion in 2019, taking investment in Europe to a 10-year low. However, greenfield Chinese investment reached its highest level since 2016 at nearly EUR 1.3 billion.

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The “Big-3” reclaimed their top spot, Poland emerged as a key recipient: More than half of total Chinese investment in Europe went to the “Big Three” economies – Germany, the UK and France. However, the UK saw Chinese investment plummet by 77 percent. Poland rose to become the second most popular destination, though inflows of EUR 815 million were largely concentrated on one acquisition.

China’s state-owned enterprises (SOEs) took a higher share in a quiet market: SOEs were responsible for 18 percent of total Chinese FDI to Europe, higher than 11 percent 2019 but still significantly below historical averages. Their investment stayed relatively stable in absolute terms, however, concentrating in energy, infrastructure and basic materials. Private sector investment dropped by almost 50 percent.

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Chinese investment was spread more evenly across sectors: Small- and mid- size transactions dominated in 2020, with no major billion-dollar acquisitions as in 2019. As a result, Chinese investment was spread more evenly across sectors. Infrastructure, ICT and electronics were the top three sectors, attracting 51 percent of the total.

Chinese FDI faces greater scrutiny by EU member states: The Covid-19 crisis prompted the EU to issue guidelines stepping up scrutiny of FDI in Europe’s critical assets. 14 EU member states, including Italy, France, Poland and Hungary, have updated their FDI screening mechanisms last year. Member states have also moved to block several acquisitions by Chinese firms.

Headwinds to Chinese investment in Europe will grow in 2021: Chinese FDI activity into Europe continued to fall in the first quarter of 2021 and has remained weak elsewhere, even as global M&A activity has recovered and surged to a 10- year high of EUR 1.08 trillion. Europe remains an attractive investment location. However, continued disruption from Covid-19, high barriers to outward capital flows in China and rising regulatory barriers to foreign investment in Europe have all contributed to low levels of Chinese investments. Deteriorating EU-China relations will create additional headwinds for Chinese investors going forward.

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Two-Way Street – US-China Investment Trends – 2021 Update

The US-China Investment Project tracks and analyzes investment flows between the world’s two largest economies. This report summarizes key developments in 2020, an unusually volatile year due to the COVID-19 pandemic, and analyzes the outlook for 2021 as the world slowly emerges from this period of crisis and a new US administration settles in. The key findings of the report are:

Foreign direct investment (FDI) between the US and China fell to $15.9 billion in 2020 amid pandemic related disruptions and rising tensions in the US-China relationship. This was the lowest level for two-way flows since 2009.

Completed Chinese FDI in the United States reached $7.2 billion in 2020, a slight increase from $6.3 billion in 2019. This was driven by a handful of large acquisitions, including Tencent’s purchase of a share in Universal Music Group and Harbin Pharmaceutical Group’s acquisition of GNC Holdings. M&A transaction volumes remained low, and acquisitions were mostly confined to consumer-oriented sectors. Greenfield investments did not see a meaningful uptick.

US FDI in China dropped to $8.7 billion in 2020, a fall of roughly a third from the previous year, and the lowest level since 2004. Greenfield investment was disrupted by the pandemic in the first half of the year but picked up strongly in the second half as China’s economy stabilized and COVID-19 related restrictions eased. Compared to previous years, US investors launched fewer significant greenfield projects. The slowdown in acquisitions was more acute, with only a handful of medium-sized takeovers in consumer products and financial services.

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Two-way venture capital (VC) investments also declined slightly in terms of both total value and number of funding rounds. Chinese VC in the US increased slightly and exceeded flows in the other direction for the first time ever, but only marginally so. In contrast, US VC in China dropped to the lowest level in five years.

Chinese venture capital investment in the US increased to $3.2 billion in 2020, from $2.3 billion in 2019, despite stricter regulatory scrutiny tied to Chinese venture investors participated in 249 unique funding rounds for US startups, which was lower than the previous year (305). But investment totals were larger due to several later stage transactions with high valuations. More than half of all transactions (132) occurred in the Health, Pharmaceuticals and Biotechnology sector, followed by Financial and Business Services (43) and Information and Communications Technology (26).

US to China venture capital deals dropped in terms of value and deal count. In 2020 there were 247 unique funding rounds, down from last year’s total of 306. Total investment value dropped more sharply to $2.5 billion, just half of last year’s total and a fraction of the almost $20 billion recorded in 2018. Financial and Business Services and Health, Pharmaceuticals and Biotech were the most common targets for US VC investors, with 54 and 52 transactions each. Consumer Products and Services deals fell from 52 to 31.

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The post-pandemic recovery could lead to a rebound in two-way flows but policy developments in Washington and Beijing are a wild card.

In China, the balance that leaders strike between domestic financial stability and openness to the outside world will shape the investment landscape. Throughout the pandemic, Beijing prioritized stability, refusing to loosen restrictions on outbound investment by private companies despite a massive trade surplus and upward pressure on its currency. On the inflow side, the outlook hinges on whether Beijing delivers on its promises to level the playing field for foreign firms and how its “dual circulation” strategy and industrial policy push to replace foreign technology suppliers with domestic firms progresses. A more challenging environment for traditional FDI could also encourage foreign investors in certain sectors to seek greater exposure to Chinese assets through portfolio investment.

In the United States, the Biden administration has signaled that it will maintain key elements of the restrictive policies deployed in past year. But a change in style, that seeks to restore confidence in due process, transparency and non-discriminatory openness to foreign investment, seems likely. A shift away from aggressive decoupling rhetoric could also help instill confidence. Among the key questions are how US officials will implement and enforce new rules for foreign investment reviews (FIRRMA) and export controls (ECRA). Supply chain safety rules, next generation antitrust policies, and new initiatives to protect personal data could all have a profound effect on Chinese companies and investors.

Aside from national policies, broader geopolitical dynamics will likely shape the environment for bilateral investment. The arrival of a new US administration that is prioritizing cooperation with allies could lead to more coordinated action among advanced economies in areas like investment screening, export controls and human rights. If such convergence brings more transparency and predictability around national security-related concerns, then it could support US-China investment in non-sensitive areas. But greater market economy convergence could also trigger a broader rethink that incentivizes US and Chinese investors to shift their focus.

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The Economic Benefits of Carbon Capture: Investment and Employment Estimates for the Contiguous United States

Carbon capture technology is a viable strategy to move the industrial and power sectors towards decarbonization. Carbon capture is well-positioned to tackle industrial combustion and process emissions from the production of materials, such as steel and cement. In the electric power sector, carbon capture provides a rare opportunity for fossil fuels to play a role in a decarbonized world.

The Great Plains Institute (GPI) commissioned Rhodium Group to conduct an independent analysis exploring the economic benefits associated with carbon capture retrofit opportunities at existing plants in the US. Phase I of this study is a state-by-state analysis focused on opportunities in 21 of the states participating in the Regional Carbon Capture Deployment Initiative. GPI identified the industrial and electric power facilities examined in this phase as carbon capture projects with near- to intermediate-term feasibility. In Phase II of this analysis, we explore the industrial opportunities in the remaining lower-48 states. Rhodium identified the facilities in Phase II as near- to intermediate-term carbon capture retrofit opportunities. Finally, in Phase III of this analysis, we explore the national opportunities at industrial and electric power facilities through mid-century. In addition to using the near-to intermediate-term facilities from the previous phases, Rhodium identified a separate group of long-term opportunities with carbon capture retrofit feasibility by 2050.

The direct economic benefits considered include private sector investment and employment opportunities associated with the construction and operation of carbon capture retrofits. The results show how individual states can play to their existing and unique strengths on their separate paths to decarbonization.

Read the Phase I  Report (Oct. 15, 2020)Read the Phase I Report (Oct. 15, 2020) Read the Phase II Report (Jan. 28, 2021)Read the Phase II Report (Jan. 28, 2021) Read the Phase III Report (Apr. 20, 2021)Read the Phase III Report (Apr. 20, 2021)

Home Advantage: How China’s Protected Market Threatens Europe’s Economic Power

At the tail end of 2020, the European Commission and the Chinese government announced the conclusion in principle of a Comprehensive Agreement on Investment (CAI). When sharing news of the deal, Brussels took pains to underline the commitments it had obtained from Beijing to open up more of China’s market and industries to European firms. Sectors due to open up included healthcare, ‘new energy vehicles’, and financial and cloud computing services. For years, European businesses had been complaining about China’s protection of a range of sectors that are partially or fully closed to foreign competition. Their complaint was that a lack of reciprocal openness in trade and investment relations has meant that European companies have missed out on opportunities in the huge and fast- growing Chinese market. Firms had pinned their hopes on an ambitious investment agreement to open the Chinese market further.

These concerns are valid – but they miss part of the picture. A protected Chinese home market has important consequences beyond revenues foregone. It is also an opportunity for Chinese firms to leverage the vast size of China’s market to build scale, amass profit, and improve productivity, technical capabilities, and product design and quality – all with limited or no pressure from foreign competition. This then enables some of these firms to enter foreign markets on a strong financial footing and to sell tried-and-tested, more tailored products at highly competitive or below-market prices. And it facilitates further international expansion and pursuit of global market share, at the expense of European firms.

Cultivating a large, protected home market as a beachhead for international expansion is hardly a new idea – it was the development model of many industrialised economies in the nineteenth and twentieth centuries, from Germany to Japan. Many of these practices were eventually rolled back due to external pressure, and because of their mixed track-record of producing truly competitive national champions in the long term.

But, for Western countries and businesses, waiting for China to ‘normalise’ its behaviour and open up its economy is a risky choice. Firstly, the size of China’s market – the largest globally for a wide range of goods and services – means that such practices have the potential to do significant permanent damage to European firms. Just over a decade ago, Chinese solar panel manufacturers decimated the German photovoltaic industry by offering their products at extremely low prices. Most of that price advantage derived not from state support but from significant economies of scale that these manufacturers secured as part of a large, protected home market. China’s scale is not a problem in itself. But, combined with restrictions on foreign participation, it can do lasting damage to foreign firms and markets.

Secondly, while many of China’s local industries are open to foreign competition, and not all sectors display higherefficiency as they grow in size or scale, market protections in China tend to be stronger and more prevalent in strategichigh-tech industries – many of whose efficiency does increase with scale. The large and protected Chinese home market could, therefore, have particularly severe consequences for a string of sectors that are key to Europe’s future, from greentechnologies to connectivity equipment, to digital industries. In any case, China’s latest policy announcements, including itsrecently published 14th Five Year Plan, make clear that Beijing intends to continue protecting and promoting local firms instrategic sectors, curbing hopes for short- or even medium- term normalisation.

Thus, it is time for the European Union to integrate an understanding of China’s ‘protected home market advantage’ – the advantages that derive from the combination of a large and restricted home market – into how it defends and promotes European industrial competitiveness and economic prosperity. Despite the implications of this advantage, it is not yet fully embedded into the European Commission’s work on how Chinese market distortions affect the European market. It does not formally fall within the scope of last year’s Commission white paper on foreign subsidies, for example, despite the fact that the distortions arising from this advantage have much the same effects. Nor is it resolved by the CAI, which secures formal openings in some sectors but leaves many either closed or partially closed and includes myriad exceptions. In any case, the agreement’s effectiveness depends on whether China is ultimately willing to implement its commitments to a level playing field. And, of course, given recent EU-China tensions, the agreement may not even be ratified.

This paper, a joint project from Rhodium Group and the European Council on Foreign Relations, introduces and describes the advantages Chinese firms derive from the combination of a large and protected home market in strategic sectors. It seeks to contribute to European policymakers’ thinking about how China’s market distortions affect EU firms and consumers. It does so, firstly, by providing a short overview of the key features of China’s protected home market advantage. It then points to how this advantage plays out in three industries in China. Finally, it lays out the ways that the EU might respond to this challenge. The paper aims to raise awareness of the issue as European decision-makers consider one of the major challenges of our time – how to manage Europe’s economic engagement with China in the twenty-first century.

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Understanding US-China Decoupling: Macro Trends and Industry Impacts

Conceived in 2019, this study seeks to illuminate the costs of decoupling for the United States. The analysis has been complicated over the past year by a shifting landscape. Tensions between the U.S. and China have grown in the aftermath of the COVID-19 outbreak, triggering a broader debate about supply chains, reshoring, and resilience. In truth, because of the many variables at play, it is beyond the capacity of economics to deliver a precise answer regarding the costs of decoupling. Nonetheless, this study offers what we believe is a valuable perspective on the magnitude and range of economic effects that the Biden administration should consider as it weighs its policy agenda with China. The study highlights the potential costs of decoupling from two perspectives: the aggregate costs to the U.S. economy and the industry-level costs in four areas important to the national interest.

Key findings of our assessment of the aggregate costs of decoupling to the U.S. economy include the following:

  • In the trade channel, if 25% tariffs were expanded to cover all two-way trade, the U.S. would forgo $190 billion in GDP annually by 2025. The stakes are even higher when accounting for how lost U.S. market access in China today creates revenue and job losses, lost economies of scale, smaller research and development (R&D) budgets, and diminished competitiveness.
  • In the investment channel, if decoupling leads to the sale of half of the U.S. foreign direct investment (FDI) stock in China, U.S. investors would lose $25 billion per year in capital gains, and models point to one-time GDP losses of up to $500 billion. Reduced FDI from China to the U.S. would add to the costs and—by flowing elsewhere instead—likely benefit U.S. competitors.
  • In people flows, the COVID-19 pandemic has demonstrated the economic impact from lost Chinese tourism and education spending. If future flows are reduced by half from their pre-COVID levels, the U.S. would lose between $15 billion and $30 billion per year in services trade exports.
  • In idea flows, decoupling would undermine U.S. productivity and innovation, but quantification in this regard is difficult. U.S. business R&D at home to support operations in China would fall and companies from other countries would reduce R&D spending related to their China ambitions in the U.S. The longer-term implications could include supply chain diversion away from U.S. players, less attraction for venture capital investment in U.S. innovation, and global innovation competition as other nations try to fill the gap.

In terms of industry-level costs, we find the following:

  • For the U.S. aviation industry, decoupling would mean reduced aircraft sales resulting in lower U.S. manufacturing output, falling revenues for the firms involved, and thus U.S. job losses and reduced R&D spending—leading to diminished U.S. competitiveness. We estimate that a complete loss of access to China’s market for U.S. aircraft and commercial aviation services would create U.S. output losses ranging from $38 billion to $51 billion annually. Cumulatively, lost market share impacts would add up to $875 billion by 2038.
  • For the U.S. semiconductor industry, forgoing the China market would mean lower economies of scale and R&D spending—and a less central role in the full web of global technology supply chains. Decoupling would prompt some foreign firms to “de-Americanize” their semiconductor activities, putting to the test whether that is possible and further motivating China to seek self-sufficiency. Lost access to Chinese customers would cause the U.S. industry $54 billion to $124 billion in lost output, risking more than 100,000 jobs, $12 billion in R&D spending, and $13 billion in capital spending.
  • For the U.S. chemicals industry, decoupling would mean a smaller U.S. share in China’s growing market, diversification by China and others from U.S. suppliers, lost competitiveness, and lower R&D spending. This decrease would offset the newfound competitive advantages the U.S. enjoys from lower feedstock costs, thanks to improved extraction technologies. From the imposition of tariffs alone, the potential cost ranges from $10.2 billion in U.S. payroll and output reductions and 26,000 lost jobs to more than $30 billion in output losses and nearly 100,000 lost jobs.
  • For the U.S. medical devices industry, decoupling would mean the added cost of reshoring supply chains and restricted product and intermediate input imports from China, along with retaliation against U.S. exports by Beijing. Abandoned market share in China would go to competitors, boosting their economies of scale and handing them future revenue from the market in China, where both rising incomes and an aging population are driving demand for medical devices. U.S. lost market share is valued at $23.6 billion in annual revenue, amounting to lost revenue exceeding $479 billion over a decade.

These estimations are derived from economic models of “normal” before the COVID-19 pandemic; the macroeconomic assumptions about future supply and demand that such models depend on must now be viewed with great skepticism. Moreover, they explore only the economic welfare effects: they do not attempt to price in the costs or benefits to U.S. security, which is a critical factor in the rethink of engagement with China. But the analysis does point to a number of important takeaways for U.S. policymakers, even with the caveats about the limits of economic modeling amid a global disruption:

  • First, data analysis is critical to policymaking. China policy requires economic impact assessment, cost-benefit analysis, and a process of public debate and discovery.
  • Second, even based on our rough assessment, we can see that the costs of anything approaching “full” decoupling are uncomfortably high. Alternative approaches—including mitigation and in many cases forbearance—would complement any decoupling scenario.
  • Third, many elements merit inclusion in a comprehensive U.S.-China policy program, from promoting industry and innovation and technology to preserving the rules-based, open market order and its institutions, and protecting systemically and strategically important assets and industries from threats. In the policy reengineering to come, the central role of market forces in determining winners, and governments’ finite capacity to redistribute resources to ease the process, must be respected.
  • Finally, working with like-minded partners on a plurilateral basis to harmonize regulatory approaches in priority areas and to take coordinated actions that address shared concerns over China’s practices is essential to minimizing the costs to the U.S. economy and preventing the erosion of U.S. comparative advantage that would occur if decoupling policies are implemented solely on a unilateral basis.
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2020 Green Stimulus Spending in the World’s Major Economies

January 30, 2021 marks one year since the Director-General of the World Health Organization (WHO) declared the novel coronavirus outbreak a public health emergency of international concern. Since that declaration, Rhodium Group has been tracking how the pandemic has impacted economic activity in the highest greenhouse gas (GHG) emitting sectors of the world’s four largest emitters—the United States, the European Union, China, and India—and the degree to which their stimulus spending has been directed toward green measures that can reduce the GHG intensity of the recovery. In our September 2020 report, It’s Not Easy Being Green: Stimulus Spending in the World’s Major Economies, we provided a snapshot of the scale of green stimulus spending across these four major economies. In this report, we provide an update on green stimulus spending at the one-year milestone of the COVID-19 pandemic.

In our updated assessment, we find that only the EU has committed to green a meaningful share of its stimulus—15%. The US, India, and China have allocated a negligible share (around 1% or less) of COVID-specific spending toward green measures. Experience in the first full year of the pandemic reveals that relying on emergency measures alone is likely insufficient to adequately prioritize a green recovery. As in the EU, long-term climate policy frameworks and clean energy investment and innovation plans are critical to chart the course in times of crisis.

An unprecedented global economic crisis

2020 has proven to be the worst global recession in the post-World War II period, with estimates of global GDP contraction of 3.5% (Figure 1). Unlike the Global Financial Crisis of 2008-2009—when global GDP dropped only 0.1%—every region of the world was hit by the pandemic and the resulting economic downturn.

Figure 1

The economic hit to the US in 2020 was on par with the global economy, contracting 3.5% according to the most recent Bloomberg estimate. While significantly less drastic than the IMF’s April forecast of an 8% contraction, it goes well beyond the 2.5% contraction the US experienced during the Global Financial Crisis of 2009. With earlier and more extensive lockdowns, the EU experienced a 7.4% contraction in 2020, far surpassing the 2009 hit of 4.2%.

China and India weathered the Global Financial Crisis in 2009 largely unscathed, with GDP growth of 9.4% and 8.5%, respectively. But that luck did not hold in 2020. China managed to cling to positive territory, growing 2.1% according to the most recent estimates. India, as a result of one of the severest lockdowns among major economies, contracted by around 8%.

In response, countries invested heavily in government spending to jump-start growth. According to the IMF, global fiscal support reached nearly $14 trillion, with $7.8 trillion in additional spending and $6 trillion in equity injections, loans and guarantees. The approach to stimulus—both the form and scale—has varied significantly across economies. In advanced economies, higher deficits were driven both by increased spending and a drop in revenues, whereas emerging economies have spent less on average, with deficits stemming largely from a slump in revenues as economic activity declined.

In this report, we provide an overview of the discretionary stimulus measures taken by the world’s four largest emitters—which together make up two-thirds of global GDP and over 50% of global greenhouse gas (GHG) emissions. We also assess the extent to which these economies prioritized green, climate-related spending, which we define as any measure that supports energy efficiency, zero-emission energy generation or equipment (e.g., renewable energy investments, subsidies for electric or zero-emission vehicles) as well as infrastructure necessary for reaching long-term net-zero targets (e.g., transit and rail investments, EV charging infrastructure, and forest restoration).

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US-China Financial Investment: Current Scope and Future Potential

While direct investment and venture capital flows between the United States and China have declined since 2016, “passive” investment in equity and debt has grown. The inclusion of Chinese securities in international bond and equity indices points to additional growth, but policy headwinds are blowing hard from both sides of the Pacific. Recent decisions by the US administration, including an executive order banning American investment in firms with ties to China’s military and the forced delisting of certain Chinese firms from US stock exchanges, demonstrate that US policymakers view financial investment restrictions as part of their toolbox for resetting US-China economic relations. Beijing is allowing more foreign participation in domestic financial markets but only within tightly controlled parameters, and it maintains heavy controls on outflows. The abrupt decision to cancel the initial public offering of Ant Group in Hong Kong shows that political interventions extend to offshore financial markets. As policymakers navigate the complex questions around two-way financial investments, it is important for them to have reliable, comprehensive data on cross-border holdings. This report, by Rhodium Group for the National Committee on US-China Relations (NCUSCR), clarifies the scope and patterns of two-way financial investment in equity and debt securities and discusses key policy questions on both sides. The findings are:

China is a latecomer to financial globalization, but cross-border holdings of bonds and equities are growing faster than traditional capital flows. Beijing lags major economies when it comes to global financial integration due to its reluctance to liberalize short-term capital flows. However, China’s financial ties with the world have grown rapidly from a low base over the past decade as investors have found creative ways around capital controls and Beijing has started to gradually liberalize certain channels. Official statistics do not accurately capture the full scope of China’s external financial investment.

The United States is China’s most important financial counterpart, save for Hong Kong. US markets have been critical to Chinese company fundraising, and America is where government and household savers seek to reinvest surpluses and savings. We estimate there was as much as $3.3 trillion in US-China two-way equity and bond holdings (including securities held in central banks’ reserves) at the end of 2020 — nearly double the official figure of $1.8 trillion. Official under-reporting reflects the complex, multi-modal structures that are often used for international securities investments and the challenges statistical agencies have determining securities issuers’ and owners’ nationalities.

US holdings of Chinese securities neared $1.2 trillion at the end of 2020. We estimate that US investors held $1.1 trillion in equity and $100 billion in debt securities issued by Chinese entities at the end of 2020. That is about five times the holdings captured in official US data, which shows $211 billion in equity and $29 billion in debt holdings as of September 2020. Most of the disparity is accounted for by firms from China using complex legal structures to issue shares out of tax havens that trade on US exchanges. These practices continue despite legal peril in China and US regulatory pressure: in 2020 Chinese equity issuance on US exchanges was higher than in any year except 2014. US holdings of Chinese debt securities are smaller but are growing rapidly thanks to China’s efforts to improve access to its onshore bond market and to widening US-China interest rate differentials.

Chinese holdings of US securities reached as much as $2.1 trillion. We estimate Chinese investors held $700 billion in equity and $1.4 trillion in debt securities issued by US entities at the end of 2020. In comparison, official US data show $240 billion of equity and $1.3 trillion of debt holdings as of September 2020. Most of this difference is accounted for by equity investments misclassified in official sources due to investor efforts to circumvent Beijing’s capital controls or the use of Hong Kong as an investment intermediary. Debt securities account for the bulk of Chinese holdings. These are primarily US Treasury securities and agency bonds held by China’s central bank as reserves. While US investors have tended to prefer ownership of Chinese equities (and been rewarded with higher relative returns), Chinese investors in US securities have preferred lending to the US government and US corporations at relatively low interest rates. They account for a low share of foreign ownership of US equities.

US-China financial integration is at an early stage but faces powerful policy headwinds. Under normal conditions, there would be room for trillions of dollars in additional US-China financial investment before balances reached levels typical of advanced economy pairs. A few years ago, such expansion seemed likely, but policy-related hurdles are rising. Measures have proliferated on both sides which, if current trends persist, could greatly diminish growth prospects. Beijing has stated its preference for greater financial opening to the world but needs to enact far-reaching reforms before it can truly open its capital account without guardrails. Washington has traditionally taken a very liberal approach to financial globalization but a new era of “strategic competition” with China has led to a redrawing of national security boundaries, including in the economic and financial space. A new US administration is unlikely to fully reverse this shift but may strike a better balance between mitigating national security risks, incentivizing good financial governance, and preserving the benefits from benign linkages.

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Closing the Transportation Emissions Gap with Clean Fuels

Federal and state policies adopted over the past two decades have done a great deal to bend the curve of greenhouse gas (GHG) emissions from the US transportation sector. However with 1.6 billion tons of CO2-equivalent projected to come from the transportation sector in 2030, we are still a long way from being on track to net-zero emissions by 2050, or from reducing transportation-related pollutants like NOx, particulate matter, and ozone, which disproportionately impact communities of color and low-income communities.

To achieve economy-wide net-zero emissions, we find that, in the transportation sector, a portfolio of strategies is the lowest cost and most likely to succeed. While efficiency improvements and vehicle electrification can cut transport emissions by up to two-thirds by 2050, low-GHG liquid fuels are needed to fill the remaining gap and achieve net-zero emissions in the transportation sector by mid-century.

Transportation will continue to be one of the largest sources of US emissions

Transportation is the largest source of GHG emissions in the US, accounting for 33% of the economy-wide total in 2019. While transport emissions declined 6% between 2005 and 2019, the majority of reductions have come from the passenger vehicle fleet (light-duty vehicles). Between 2005 and 2019, emissions from freight vehicles rose 5%, and aviation emissions rose by 14%.

Looking forward, under current policy, passenger vehicle emissions are projected to be 20% lower in 2030 than they were in 2019, largely due to increased electrification. However, the same progress is not projected for freight transportation and air travel. Freight emissions are projected to decline by 9%, while aviation emissions are expected to increase by about 1% in 2030 (ES Figure 1).

Figure 1

Electric vehicles alone will not get the US to net-zero by 2050

Under a scenario of modest electrification of light-duty vehicles (LDVs), we project that over 700 million metric tons of emissions will remain in 2050, from fuels that need to be decarbonized or displaced through mobility strategies that reduce vehicle usage (low electrification in ES Figure 3). Under this scenario, electric vehicle sales come in at the lower end of aggressive projections, reaching 35% of LDV sales in 2030 and 77% in 2040.  Even with increased LDV electrification (ES Figure 2), where more than half of all LDV sales nationally are electric by 2030 and nearly 90% by 2035, 525 million tons of GHG emissions, 34% of emissions still remain in the transportation sector in 2050. The remaining emission reductions will need to come from fuel decarbonization and mobility solutions. Increasing mobility will reduce vehicle miles traveled but cannot decarbonize the remaining emissions from the transportation sector. Clean fuels will be needed to close the transportation emissions gap.

ES Figure 2
ES Figure 3

A portfolio of clean fuels is needed to close the transportation emissions gap

Achieving net-zero emissions in the transportation sector in 2050 will require not just electrification but other strategies as well, including aggressive federal action to deploy a portfolio of clean fuels. We find in our modeling that a combination of advanced biofuels, electrofuels, and carbon-neutral fossil fuels can successfully close the transportation emissions gap and get the sector to net-zero emissions by 2050.

The optimal portfolio of clean fuels will depend on technology cost, feedstock availability and will vary regionally based on local air quality issues, availability of high-quality wind and solar resources and characteristics of the local agricultural economy.

Federal policies to drive clean fuel deployment

Achieving net-zero emissions in 2050 will require aggressive federal action to reduce transportation demand, electrify vehicles, and develop and deploy clean fuels. A portfolio of policies can drive emissions reductions across transportation modes and amplify reductions from policies enacted at the state and local level. The federal government plays a large role in determining the US fuel mix. Research funding, fiscal incentives, market-based policies, and GHG and air quality targets all shape the portfolio of fuel consumed across the country. Rather than relying on existing policies, the federal government can take action to accelerate the deployment and market penetration of the clean fuels needed to achieve net-zero emissions by 2050.

Federal transportation policy should support research and development of clean fuels through funding and investments in transformational fuel technology. Moreover, the federal government can accelerate deployment and development of clean fuels through fiscal incentives aimed at fuel manufacturers and fuel consumers to incentive the production and consumpti0n of clean fuels. Federal procurement policies can also increase market penetration as bulk purchases can increase economies of scale. Ultimately, deep market penetration of clean fuels, required to achieve net-zero emissions by 2050, will require durable price signals and robust federal policies.

This report begins with projections of transportation emissions under current policy, to identify the emission reductions that will be needed to achieve net-zero emissions by 2050. Next, we identify the portfolio of strategies that can achieve net-zero transportation emissions, including a wide range of clean fuels to complement electrification, efficiency, and increased mobility. The report then shifts to the economic and environmental merits of a wide range of clean fuels and the federal policy tools that can drive development and market penetration of clean fuels to achieve net-zero transportation emissions by 2050.

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The China Dashboard – Winter 2021

The idea of a “dashboard” to gauge Beijing’s progress in implementing its economic reform plans was born from the hopeful Sixty Decisions of the Chinese Communist Party (CCP) issued in November 2013. The Party Decisions, accompanied by a personal essay by President Xi Jinping explaining them, committed to make markets the “decisive” factor in the country’s long-term economic direction. As optimists cheered and pessimists snickered, Rhodium Group and the Asia Society Policy Institute set out to track implementation to see if China actually did it. We began in late 2015 with design work and then published quarterly evaluations from the fall of 2017. This winter 2020–2021 edition is the last in a five-year program. We offer final observations on the march from 2013 pledges to 2020 deadlines, a look at new policy announcements at the margin today, and our perspective on the future.  

Yesterday: Avoid the Blind Alley

Observers were unsure what to expect of Xi Jinping when he came to power in 2012. The global financial crisis had disrupted growth, triggering a wave of stimulative debt that was undermining productivity. Internal politics were a challenge, with powerful vested interests able to block needed reforms just as the middle-income trap arrived. Some intellectuals advocated liberal solutions for the economy administered by a regulatory state. Other so-called ”new left” voices counseled a more doctrinaire course emphasizing China’s brand of Marxist-Leninist authority. President Xi’s inaugural economic plan issued in November 2013, discussed at length in our report Avoiding the Blind Alley, had something for both sides. There were hundreds of pro-market objectives, but a commanding role for the state was retained as well. On the whole, the plan’s liberal elements were a surprise on the upside. We surmised this was intentional: expectations like these are not set by accident or as a feint.

Seven years have passed since then. Efforts to make good on the Decisions have come and gone, and in some cases come again. Reforms have generally been halted when they led to instability, which is most of the time. Industrial policies such as Made in China 2025 grew ever more heavily weighted in explaining China’s directions as the counterbalancing role of reform diminished. And over these seven years, with China breaking the $10 trillion GDP mark in 2014 (approaching $15 trillion today) and now taking off as a global direct investor, the less-liberal forces shaping outcomes inside China have begun spilling ever more quickly abroad.

Of the 10 clusters into which we consolidated the many commitments in the Party’s 2013 Decisions, six have seen reform run backwards (or stalled) on net, while four have seen some modest advancement.

The Good

Fiscal affairs, cross-border investment, innovation, and environment are the four areas that showed some progress. In fiscal affairs, the biggest improvement came from moving local government financing on the balance sheet by shifting from shadow financing to local government bond financing. While local bonds were introduced in 2015, bond financing did not take off until 2018 to offset the reduction in illicit financing due to deleveraging. This has helped bridge the local fiscal gap with more revenue and increased transparency and has helped with overall debt sustainability.

The improvement in cross-border investment is recent. Two-way capital flows relative to GDP fell consistently from 2016 to early 2019, but they have picked up in the past four quarters due to reduced barriers to inbound portfolio investment – reinforced by a dearth of opportunities worth investing in elsewhere in the world.

In innovation policy, China also achieved consistent progress. This reflects the strong state role in driving investment and rapid growth in innovation-intensive activities, but all at the cost of low investment efficiency, overcapacity, and market discrimination.

In environmental reform, China has reduced air and water pollution since 2015, though progress stalled in 2020 during the government’s response to the Covid-induced economic downturn. Water quality laws and local enforcement and testing have improved water quality, and this is likely to last. Beijing is trumpeting long-term carbon neutrality goals by 2060. Nonetheless, China simultaneously has been undermining those goals in the near-term by building extra coal power capacity and weakening environmental enforcement to stoke growth.

Reform progressed in these areas out of necessity: this is the overarching story of China’s reform implementation to date. The massive 2009–2010 stimulus left local governments with a decade of unprofitable legacy investments, and the proliferation of informal financing starting in 2013 meant authorities had little visibility into how localities funded activity. This is a recipe for crisis if left unchecked, and cleaning up local balance sheets was necessary to avoid that. Beijing dragged its feet on cross-border investment liberalization for years but finally accepted that it could not otherwise attract the capital it needed for the long-term balancing of China’s current account. Air and water pollution got bad enough to threaten Party legitimacy before it was addressed, with worldwide attention adding pressure. In innovation, the change is yet to come: ostensibly it is still improving, China’s technology prowess has drawn a global pushback that is rapidly changing production chains, with huge consequences still to come.

The Bad

This progress was outweighed by significant problems emerging in other critical areas of economic reform announced in the 2013 blueprint. Labor system improvement – defined as workers benefiting proportionally or better than economic growth – has seen the least progress. The gap between wage and GDP growth is larger than ever. Migrant workers still experience slower wage growth, and government spending on social welfare as a percentage of GDP has declined from 2015 levels. This was not for lack of effort. The government relaxed household registration (hukou)restrictions in mid-size cities. Beijing is making progress on pension fund centralization, expanding health insurance coverage, and raising social security contribution requirements from state-owned enterprises. Beijing assumed some welfare spending obligations from local governments and pushed the bureaucracy to spend more efficiently. But all these efforts have failed to increase worker compensation, job security and protections, and shared welfare.

Beijing remains far from realizing its 2013 state-owned enterprise (SOE) reform goals. SOEs were to be kept in “key and pillar” industries but removed from normal “commercial” sectors of the economy. Restructuring SOEs to ensure they operate efficiently was a goal, as was increasing their contributions to the social safety net. Actions taken so far have diluted state shareholding in a number of SOEs, reduced SOE financial leverage, linked SOE employee salaries to productivity, and forced SOEs to transfer 10% of state equity to social security funds. However, SOE presence across industries has barely changed, their efficiency has not improved, and more than 70% of the dividends they pay were reinvested back into SOEs themselves, not used for social spending.

Land reform never got off the ground. While the 2013 Third Plenum promised to allow rural residents to sell their land through markets, authorities have only piloted this reform in 33 counties, accounting for just 0.1% of China’s total rural nonagricultural land. These pilots concluded with a modest revision of the Land Management Law last year, which removed the main legal obstacles for transferring rural land in the urban market but reinforced the strong governmental role. Beijing even delegated more power to provincial governments to speed up the urban land use approval process in 2020, which may give them more room to profit from land sales at the expense of rural residents.

These reform failures share a common theme: China’s financial and economic institutions at this stage are too weak to overpower politically entrenched interests.  Fiscal imbalances constrain labor reforms, and despite progress on the revenue side, local governments are still overburdened by unfunded spending mandates imposed by the center. Changing local government incentives is the only way to redirect spending to China’s workforce. SOE reforms have failed because SOEs lack incentives to leave commercial industries to more competitive private firms. On land reform, there is no sign that Beijing is prepared to unleash rural households, and any attempt to do so would face strong resistance from local governments that have become more reliant on land sales than they were five years ago. These problems are systemic, not individual.

Today: Winter/2Q2020 Arguments

The eight years from 2013 to 2020 have been tumultuous. Xi Jinping did not so much avoid market reform as retreat in the face of instability. The important question is not whether China established a record of reform over the past decade, but whether the lessons it learned trying are being applied today. Crises present a chance to push ahead with difficult changes. The COVID-19 pandemic presented such an opportunity. The virus lockdown offered a compelling reason to adjust policy, while the strength of the current recovery presents an opening to build momentum. With reform promises behind schedule and potential growth slowing, proof of market-friendly intentions could convince foreign and private firms to remain engaged.

But despite a robust economic performance in the second-half of 2020 that puts the United States to shame, Beijing is not using the moment to invigorate its policy agenda. On the contrary, it is signaling rising reliance on statist solutions.  The role of SOEs is resurgent, and the dual circulation campaign emphasizes self-reliance over openness and a free, international market. Furthermore, the state’s response to the ANT Financial float, and the opening of an anti-monopoly case against it, sends a message that China’s party-state is intolerant of private firms becoming too influential.

Each quarter we have looked at these policy dimensions through two lenses to reach a fair assessment that reasonable readers from outside and inside China could embrace: first a strict tally of outcomes using data alone and then a broader review of the policy landscape. By-the-numbers, the most negative story is now labor. The positive indicators are cross-border investment, fiscal, environment, and innovation.

In terms of policy pledges, the 2020 picture is bright despite COVID-19. Many reform initiatives were announced, responding to foreign pressure and domestic urgency. In April and May, guidelines once again promised “market allocation of factors of production” – land, labor, capital, and data. Beijing’s inclusion of data as a production factor is novel. The notion of a major government just now turning to the task of creating allocation mechanisms for everything that flows through the economy is ponderous. Many other ostensibly reform-oriented pronouncements were made this year as well. The new Shenzhen Comprehensive Reform pilot, introduced in October, sends a reform message to private investors but is little different from past efforts. The Party’s Guidelines for the 14th Five-Year Plan (FYP) released in early November for the next five-year period elevated “reform” as a priority, second only to growth among the 14th FYP’s primary goals (after being absent in 2015).

Financial sector opening has gotten the most credit for demonstrating reform this year. With a wider door to securities investment and high COVID-era yields, portfolio inflows surged in 2Q2020-3Q2020. With current conditions driving capital inflows enough to greater strengthen the renminbi, Beijing has an opportunity to open further, but risks of a financial reversal are accelerating too, and reform could bring more pain than Beijing can tolerate.

The pattern of statist signals overshadowing market messages is evident today, as it has been since 2013. The SOEs are the firms stepping up to support recovery. Their footprint remains in commercial sectors where state influence was to be rolled back. In September, the Party and State Council jointly issued Opinions on strengthening “United Front Work” to bolster Party influence over private businesses. The focus has shifted from reducing state presence to making it more efficient and “market economy like.” Ideology is increasingly broadcast into the private sector. The last-minute intervention in the listing of Ant Financial reveals the primitive state of financial maturation. Foreign demand for high-yield Chinese debt is elevated, but this is not the sort of moderate-risk value proposition that will attract long-term investment at scale.

We save for last the major new policy design that emerged two quarters ago: the dual circulation strategy. Should this be classed as positive or negative for reform? Like many signature Chinese economic policy campaigns, the dual circulation strategy has become a Rorschach test for commentators.

The concept involves driving growth momentum through domestic demand, domesticized supply chains, and indigenous innovation, with both “external circulation” (accessing global demand and foreign capital and technology) and “internal circulation” (domestic demand and domestically developed technology). Engineering such a shift in sources of growth is sure to be difficult, and despite the rhetorical importance the campaign has been given by leaders as an elixir to China’s challenges, it has not been well defined. So far, it is impossible for economists to say how it will play out. On balance, its core organizing principle appears to be national self-reliance, rather than a robust re-commitment to the next generation of market-based reforms.

Tomorrow: Systemic Convergence or Divergence?

Some believe China’s leaders do not have economic reform in their DNA, and that World Trade Organization accession and the commitments like the 2013 Sixty Decisions were smokescreens. If nothing else, our Dashboard experiment has shown this to be wrong. Beijing has come up short on its reform pledges, true, but in a number of areas it has tried.

This seemingly modest assertion is crucial to the future. If China has tried to shift economic policy in a market-oriented direction in the past, it may well have motive and opportunity to do so again tomorrow. What compelled China to reform in the past was the historical evidence that illiberal, politicized economies have stagnated and become less productive, tied with the boldness of its leaders in trying to avoid that dead end. The historical record remains, especially when one takes a hard look at the recent and present record of China’s performance and acknowledges the likelihood of growth overstatement, risk underestimation and the enduring role of the state rather than the market.

In our 2015–2020 Dashboard, we measured China against its self-stated goal of moving to decisive markets. Since the premise of economic convergence is not on the table at present in Beijing or, increasingly, in open market economy capitals, the yardstick going forward will not be Beijing’s stated goals, but the gap between China and the norms of market-orientation as defined by the market economies themselves. There will very likely be points of convergence and points of divergence. China appears committed to opening to global capital inflows despite its resurgent preference for state planning.

Finally, it will be crucial to consider that we do not have to be like-minded in our economic systems to recognize we are in the same global boat, and on many matters, we must work together closely regardless of our systemic differences. The great majority of products for which China or the United States has clear comparative advantage are not strategically concerning to either.  This is a point well worth remembering as policymakers contemplating decoupling (in the United States) or dual circulation (in China) consider closing doors on engagement.

Click here for the full Winter 2021 China Dashboard reportClick here for the full Winter 2021 China Dashboard report

Clean Products Standard: A New Approach to Industrial Decarbonization

In the US, there has been growing interest in sector-specific market-based performance standards as pathways to decarbonization, but a major gap in the sectoral standard landscape is industry. The industrial sector is one of the most difficult parts of the economy to decarbonize, and it’s on track to becoming the largest source of US greenhouse gas (GHG) emissions within the next ten years. Emissions from manufacturing comprise more than 60% of total industrial emissions in the US. Though manufacturing is a diverse subsector, a majority of emissions come from the production of a small set of GHG-intensive products, including basic chemicals, iron and steel, cement, aluminum, glass, and paper. In this report, we propose a novel market-based standard for manufacturing, a clean products standard (CPS), which could reduce emissions from the manufacture of these GHG-intensive products.

A CPS would establish the maximum amount of GHGs per unit of material produced that can be emitted in the production of covered industrial products sold in the US. In developing and implementing a CPS, policymakers will be faced with a set of key design choices, which we outline in this report. Most of these choices require a balance between the ambition of the policy and the administrative complexity of its implementation. Other design choices can help maintain US manufacturer competitiveness and prevent emissions leakage. Key design elements of a CPS include product coverage, compliance metrics, point of obligation, accounting for imports and exports, use of covered products as intermediate inputs, and flexibility options.

The policy shift to sectoral standards

Following the failure of cap-and-trade legislation to pass the US Senate in 2010 and continued challenges in generating legislative support for an economy-wide carbon tax, many in the climate policy community have begun looking for other options. There is growing interest in sectoral market-based performance standards as an alternative to carbon pricing. Performance standards already play a significant role in the transportation and buildings sectors at both the state and federal level. These include federal Corporate Average Fuel Economy (CAFE) and carbon dioxide emissions standards and state-level zero-emission vehicle standards for light-duty vehicles, as well as efficiency standards for appliances. A growing number of states have adopted clean energy standards (CES) for the electric power sector, and a number of CES bills have been introduced in Congress.

A major gap in the sectoral standard landscape is industry. Under current policy, Rhodium estimates industry will surpass transportation and the power sector and become the largest source of US GHG emissions within the next ten years (Figure 1). Under most carbon pricing proposals, industrial decarbonization is achieved by imposing a tax (or allowance purchase requirement) on industrial emitters, but also on importers of GHG-intensive manufactured goods to prevent a decline in US competitiveness or “leakage” of emissions overseas. As focus has shifted from economy-wide carbon pricing to sectoral performance standards, very little work has gone into developing a strategy for industrial decarbonization that could fit within this new framework.

Figure 1

Introducing a clean products standard

A clean products standard (CPS) is a novel proposal to create a technology-neutral, market-based sectoral standard to decarbonize the production of a set of basic manufactured materials. A CPS establishes the maximum amount of greenhouse gases (GHGs) per unit of material produced that can be emitted in the production of covered industrial products sold in the US. Covered products can include steel, cement, glass, and chemicals. Manufacturers can employ any technological or process-based solutions that allow them to meet the emissions limit. These solutions include the use of low-carbon electricity, liquid fuels, and feedstocks, as well as process and efficiency improvements and deployment of carbon capture systems. The stringency of the standard for each product category tightens over time, creating regulatory certainty for an ambitious but achievable path toward deep decarbonization. The breadth of products covered by the standard can also expand over time.

To avoid the potential for adverse competitiveness effects and emissions leakage, a CPS applies to all designated products sold—not just produced—in the US. A CPS could also be expanded to encompass final consumer products that rely heavily on CPS-regulated inputs. A CPS allows for trading of CPS compliance credits, similar to other market-based policies like a cap-and-trade policy or a clean energy standard. We discuss important design considerations and trade-offs relating to a number of these factors in greater detail in the full report.

[1] Emissions from Rhodium’s Taking Stock 2020 V-shaped economic recovery scenario

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This nonpartisan, independent research was with support from Breakthrough Energy. The results presented in this report reflect the views of the authors and not necessarily those of the supporting organization.