How the Green Economy Grows

Generals are often accused of fighting the last war. The shift in US and, increasingly, European politics toward industrial policy in reaction to Chinese growth is beginning to look like an economic instance of the same phenomenon. The dominant narrative for many years has been that China accepted inward foreign direct investment in order to copy Western technology while undercutting Western wages and building domestic manufacturing capacity to flood export markets. Therefore, from a US perspective the policy answer has been to bring production back onshore, providing jobs for American workers and stemming the outflow of capital and intellectual property. This narrative and the proffered solution have, however, become outdated. It is China, with high unemployment, that is making greenfield investments outside its borders, while the US is already providing jobs for American workers at close to full employment — not least because of foreign investment in American manufacturing. The old narrative doesn’t apply anymore, so solutions that are based on that narrative are not likely to work.

China’s outward direct investment (ODI) was up by 13 percent in the first quarter of 2024, reaching an eight-year high. But in the second quarter it was up by an extraordinary 80 percent. There has been a striking focus on green-economy sectors. Chinese production of electric vehicles, solar panels and so on has reached the point of satisfying much of domestic Chinese demand. But rather than dump products on foreign markets, Chinese companies have been locating production overseas. Chinese companies are, or will be, making electric vehicles in Thailand, Brazil and Spain. While this will certainly create jobs, the most important effect is the transfer of technology. The greening of the global economy is increasingly being led by Chinese companies outside China.

This is not quite what China’s Communist government had in mind. A more immediately profitable outcome would have been to sell directly into rich-world markets. But of course the US and now Europe — with new tariffs approved this week — have been erecting barriers to Chinese exports. Like Japanese auto exports in the 1980s, Chinese green-economy exports threaten to undermine or even eliminate rich-world production of those same goods. Tariff walls go up accordingly.

The traditional result in this situation has been that the blocked manufacturers would jump the tariff wall and begin producing in the protected country in order to access its consumers. (Geoffrey Jones’s 2005 Multinationals and Global Capitalism is a must read on this.) A century ago, high US tariffs caused European companies to invest in America, a reality that has featured prominently in China’s thinking about its own growth trajectory. The 1980s backlash against Japanese cars brought Japanese investment in the US. Even today, Japan is the single largest foreign investor in US manufacturing.

But in the current landscape of globalization and geopolitical competition, the untraditional result is that Chinese ODI is not so much jumping the rich-world tariff walls — although there is some of that — as going sideways into places like Thailand and Brazil. Yes, part of the goal is to proceed by an indirect route into US and European markets. But Chinese capital is also building a presence in green-economy markets in middle- and low-income countries — while depriving the US and Europe of the technology-transfer benefits that would come from straightforward Chinese ODI in these wealthier markets. In several ways, then, rich-world markets are losing out on the benefits of Chinese green-economy innovation, while other parts of the world are gaining them. In particular, Chinese companies are investing in Southeast Asia. Chinese manufacturing investments in the region quadrupled in 2023, matching those of the US, Japan and South Korea combined.

Meanwhile the US is trying to build domestic green-economy production in an era of both low domestic unemployment and a severe shortage of the skilled labor needed for ramped-up manufacturing. Retirements, in particular, are driving down the supply of native-born skilled labor. This means, of course, that the salvation of US industrial isolationism will almost certainly lie in … increased immigration, which is no more popular in the US than it is in China.

These are all pretty perverse results, from a market-efficiency perspective, but they do offer opportunities. Publicly traded Chinese green-economy companies investing outside China are one. US and European companies investing in green-economy manufacturing outside their home markets are another. Southeast Asian companies positioning themselves to take advantage of Chinese technology transfers are a third. The dominance of political drivers in shaping this global economic landscape makes change unpredictable, but then that has been true since Columbus took a wrong turn in search of India and the modern world economy began.

Multilateralism’s Long Goodbye?

The regiments of black SUVS and the delighted faces of shopkeepers on Madison and Park avenues in Manhattan this week contrasted sharply with what International Crisis Group’s Richard Gowan characterized as “the real sense of worry and gloom that is quite prevalent in Turtle Bay at the moment,” Turtle Bay being the Upper East Side neighborhood where the UN has its headquarters. The annual UN General Assembly meeting is the only must-do on the global diplomatic calendar, and it was supplemented this year by Climate Week. (There were said to be over 1,000 meet-and-greet events just around Climate Week, with champagne, smoked salmon and a heavy carbon footprint: a harvest of good business for NYC caterers.) The massive attendance in itself suggested a felt need for global, and even globalist, political conversations. Nonetheless, news events and the varied and numerous meetings SIG participated in during the week supported the view of Secretary-General Antonio Guterres that multilateralism in its post-1945 forms is in an accelerating crisis with no clear routes forward.

Familiar items on the UN agenda remained unchanged. Israel and the United States, Hamas and Hezbollah, and other regional actors continued to enact their policies without important reference to the United Nations, including the US-backed ceasefire proposal of June. Ukraine’s defense of its territory against Russian arms continued much as it has been, with a slow extension of the battle into Russian territory, Russian pushback, and no near prospect of victory or diplomatic resolution for either side. Guterres’s dire warnings about the climate crisis were generally thought to be hyperbolic. The desperate situation in Sudan was much discussed but there was very little sense that the available multilateral mechanisms were going to be able to advance peace.

President Biden’s farewell speech received polite but modest attention. Vladimir Putin, of course, did not attend, nor did Xi Jinping. (They sent their foreign ministers. Xi had already met with Guterres in Beijing earlier in the month.) The domestic political vulnerabilities of Keir Starmer and Emmanuel Macron tempered enthusiasm for their own speeches, which were in any case unremarkable. Such was the UNGA-week presence of the veto-wielding Permanent Five (P5) of the Security Council, the only members of the council with serious power and the generators of any successful council resolutions. France called, as it has before, for Security Council reforms to re-legitimize the council politically by broadening its membership beyond domination by the victors of World War II and modifying its rules. Any momentum for such reform remains doubtful.

What was happening beyond the Upper East Side frame of UNGA was more significant. On the weekend prior, President Biden focused on the Quad meeting — India, Australia, Japan and the US — at his home in Delaware. This type of security-driven minilateralism has only grown in importance during the Biden presidency. It is not necessarily to the administration’s taste, and in 2021 Biden had committed, as Obama had 12 years before, to a revival of multilateral engagement, including at the UN. But the significance and productivity of the four-nation grouping did form a contrast to those of the General Assembly with its 193 member states.

On the economic front, the dominant theme of the week was protectionism. It is telling that Keir Starmer positioned his announcement of Britain’s return to internationalism in terms of British “self-interest.” Donald Trump and Kamala Harris both ignored the internationalist week with calls for “a new American industrialism” (Trump on Wednesday)  followeed by Harris’s promise on Thursday of $100 billion in new government spending aimed at the same goal by different means. Meanwhile China put forward massive new government plans to stimulate production and consumption in its own economy. In such ways the retreat by major powers from open global markets continued even in this week of internationalism.

Fascinatingly, though, the odd nation out during the week was the United Arab Emirates. On one hand, the UAE has come under growing criticism for its backing of one side in the Sudanese civil war. On the other hand, the UAE’s unusual political creativity and energy made it an outsized player in the Climate Week events and in UNGA side meetings. The UAE has become, in a short time, a significant player in the ongoing refurbishment of internationalism, while hardly big enough (except in its budget and ambitions) to begin to qualify as a “middling power.” Among other things, the UAE’s talent for navigating a middle way between the US and China (part of a trend sometimes called “active non-alignment”) was on display, as was that government’s commitment to fielding senior women ministers in international fora.

The prospect of Persian Gulf emirates as pioneers of a future-oriented multilateralism does not seem obvious. Multilateralism since 1919, if not 1815, has been Western-based both conceptually and in operational terms. A revival of that model seemed no more likely in New York this week than it has for the past decade or more. There are several reasons for this, but fundamentally, peoples and nations of the world increasingly want to chart their own paths, and increasingly simply do not agree on philosophies, policies and actions. The operational norms governing issues from aircraft movement to satellite positioning remain, but the development of new norms has stalled.

This has a number of implications for investors. One is that UN-based multilateral initiatives in areas like climate change and artificial intelligence are not likely to shape the sociopolitical or investment landscape in the near future. Another is that the momentum for open markets will probably come as much from the middling and less-than-middling powers seeking recognition and economic advantage as it will from the greater ones, a reversal of the pattern that held into the Obama administration. With each party fundamentally pursuing its own interests, the need for multilateralism grows but the means for its achievement shrink. Finding investment opportunities then depends less on identifying global patterns than on following the more difficult strategy of betting dynamically on different horses.

The Energy-Transition Paradox

At this point it seems safe to say that the Green Revolution is not going as planned. In particular, mineral resource extraction was meant to decline as part of the energy transition away from fossil fuels, but it is doing the opposite — even as fossil-fuel consumption also hit a new high last year. Wind and solar power are mineral-intensive.  Mineral resources like manganese, graphite, cobalt and lithium are critical to the batteries used in electric vehicles; electric vehicles are critical to the energy transition; therefore the mining of these minerals, which can be a very environmentally damaging process, is expected to take place on a large scale, damaging the environment in order to save it.

The other main driver for increased mining is digital technology. Part of this is again demand for batteries. Rechargeable batteries require lithium and cobalt. Without them there is no mobile Internet, no laptops or mobile phones. But digital technology also uses other minerals, like rare earths, and above all it uses minerals that produce energy. The data-center infrastructure that digital communications have come to depend on is making huge energy demands that are expected to increase in order to support energy-intensive artificial-intelligence computing. The digital revolution was meant to be good for the planet. All those books and newspapers that would no longer have to be printed, transported, and sold by retailers. All those carbon-footprint business trips that could be replaced by meetings online. Yet digitization seems to be resulting in more rather than less resource extraction. The digital world is damaging the physical world while pretending to transcend it.

The energy transition seems to be entering an era of paradox. It isn’t simply that green and digital technologies are dirty. It is that they are getting dirtier because major states seek both energy independence and secure high-technology supply chains. Climate change, it is often said, is a global problem requiring global solutions. But if the solutions are to be found, it appears that they will be found through the complete opposite of global cooperation. The Biden administration has just announced plans to spend more than $3 billion trying to secure US supply chains of critical minerals and build upstream capacity. That means, for example, $225 million toward the mining of lithium in Arkansas, and $166 million to help extract manganese in Arizona.

As US National Economic Adviser Lael Brainard explained, the goal is “an end-to-end supply chain for batteries and critical minerals here in America, from mining to processing to manufacturing and recycling, which is vital to reduce China's dominance of this critical sector." If a nation other than China were producing 77 percent of the world’s  graphite supply or 60 percent of its rare earths, the situation would be different. As it is, geopolitical circumstance are shaping the energy transition into forms it would not take on a market basis. The desire for national data security, combined with the energy needed for data processing, points in the same direction of nationalized production that is inherently inefficient. 

From an investor perspective, one clear option is to invest in extractives. However, the political risks can be high. If the US-China race to create mutually exclusive economies can be taken as a constant for the next generation or two, the specific policies will vary. If Donald Trump returns to the White House, he could well de-fund the EV battery projects, endangering new mining in Arizona and Arkansas. More interesting are investments that, in effect, eliminate political competition over a resource. For several years, electric-vehicle automakers have been trying to reduce their political exposure to Chinese dominance of rare-earths production. Of course one way to do that is through diversifying mineral supplies. A new project in Canada aims at just that. But another way is to engineer EV batteries that do not require rare earths. BMW in its newer EV lines has eliminated rare earths. In that instance, geopolitical supply-chain worries led to a reduction in resource extraction. Private-sector innovation could yet produce more ways of avoiding politically driven supply constraints. It would be a peculiar way to move toward the global transition away from carbon but it might be one way that really works.

Bipartisan Consensus on US-China Policy: Will Continuity Mean Instability?

The US presidential debate re-affirmed the centrality of an industrial policy aimed at confronting China. Donald Trump rightly pointed out that the Biden administration continued his China tariff policy. Kamala Harris attacked Trump for not having taken his own (Trump’s) policy a step further in the way Biden did — to cover semiconductor chips. The actionable point is that the two candidates were outdoing each other in advocating US industrial policy as a way to combat the rise of China and the Chinese Communist Party. Whatever else happens in the next presidential administration, this area of policy should remain roughly the same.

How is it likely to roll out? The benign version, advanced by both political parties, involves blocking the export of military technologies to China, keeping Chinese technology out of Western and allied markets and digital networks, and resisting Chinese dumping of export products that are subsidized by the government, such as electric vehicles. When the policy is expressed in these broad terms, it seems sensible and measured. It is not surprising that the House on Thursday voted through an extraordinary set of China bills that had been teed up for this first week after the Congressional recess. The proposed laws, covering biotechnology, drones, and more, will now go to the Senate. Most received bipartisan support in the House and are expected to pass in the Senate and be signed by President Biden.

Unfortunately, what seems straightforward as policy — keeping Chinese-made drones out of US skies, for example, sounds simple enough — will be extremely murky in its results. As discussed previously in SIGnal, the concept of “dual use” technologies — ones that have both civilian and, at least potentially, military uses — has become infinitely expandable. Keeping Chinese technology out of Western and allied markets is possible at the retail level but nearly impossible at the component level. And Chinese subsidization of electric-vehicle manufacture is both hard to distinguish from other governments’ subsidization of the green economy and a crucial source of support for green efforts on a global scale. Chinese companies like BYD (electric vehicles) and CATL (batteries) have been pioneers in developing technological solutions to address climate change. These advances cannot be undone or ignored.

That is why Europe’s leading car-making states (Germany and Spain) oppose shutting Europe off from Chinese electric vehicles as the US has done. In essence, European partnerships with Chinese companies make it possible for European companies to stay in the game, whether by using Chinese components, manufacturing in China itself, or selling to Chinese consumers. The current EU tariff proposal — up for a decision next month, with a term of five years — could very well result in an increase in Chinese exports to the European market, because Chinese EV-maker profit margins are sizable enough that companies could pass the tariffs on to consumers and still make money. Meanwhile higher prices are likely to dampen European consumer demand, slowing the green transition.

The proposed US biotech law could have a similar effect of driving up prices of drugs without pushing the Chinese government to any change in policy. Higher prices could shrink demand. US biotech corporate margins could be thinned, with negative effects on R&D and innovation.

It was only a decade or so ago that analysts were wondering whether Chinese companies would ever be able to get beyond copying (or stealing) Western technology and compete at innovation. That question has been answered. The terrible irony of current tariff and industrial-policy moves in Western markets is that they could have the effect of reducing Western innovation rather than increasing it. Meanwhile, Chinese companies look to demographically younger markets with increasingly empowered consumers — in Africa, Asia and Latin America — where wider margins make them more competitive than their Western counterparts.

For investors, the US bipartisan consensus on China and US industrial policy looks like a promise of continuity, and in the obvious sense it is. But in many other ways it is the opposite: It distorts market mechanisms to such a degree that the results are exceedingly difficult to predict. Investors not only have to integrate political and policy analysis into investment decisions, they also have to do so on a dynamic basis as the landscape is constantly changing. Chinese biotech, for example, was meant to be the sector that would be left alone, and it attracted Western FDI accordingly. But then it all changed.

Before the Debate: Could There Be a Harris Doctrine?

Kamala Harris’s campaign has been impressively disciplined at saying very little about her potential policies as president. This has left commentators scrambling to discover what her intentions might be. In foreign policy, for example, analysts have been reduced to sifting the published writings of two senior advisors, Philip Gordon and  Rebecca Lissner. But writing a book and making policy are radically different activities. Harris’s economic policies, as outlined this week, are much more articulated, but they are essentially continuations of Biden policies or, in the case of keeping tips free from income tax, borrowed from Trump. Her social policies are also continuous with Biden’s. Her biggest departures from Biden have been in her refusal to participate in “identity politics” or to position Trump as an imminent danger to democracy. At the same time, she has made it clear that she is running against Trump and not against Republican voters.  The lack of discipline in her first presidential campaign has been overturned. How does that happen?

First, it would be very difficult for a sitting vice president to run against the policies of her own administration. Second, depriving the Trump campaign of policy specifics to criticize could provoke it into making more personal attacks, which Harris seems to parry much more easily than Biden did. (She is unlikely to be baited into an argument about golf handicaps, for example, as Biden was.) Third, Harris did relatively little as vice president, as compared to recent holders of the office such as Al Gore or Dick Cheney. The one policy she was associated with was not really a policy so much as a hopeless errand: to address the ”root causes” of migration to the U.S. on a two-day trip to Central America.

Fourth, Harris’s four years as a junior senator from California were not strong on policy innovation. Rather, she was noted mainly for her ferocious attacks on the Trump administration, its policies and its nominees for office. She demonstrated a composed fearlessness, and a precision, that made her stand out. These qualities led her famously to attack Biden on the second night of the first Democratic debate in June 2019 after distinguishing herself by attacks on Trump. It was focused confrontation that built her national-level political career.

That might be expected from someone whose earlier career, from 1990 (when she was 26) to 2017, was almost entirely that of a prosecutor. As San Francisco district attorney and then California attorney general, both elected positions, Harris was innovative as well as forceful. But that was in the context of the legal profession, where there are many guardrails on innovation, and where a prosecutorial manner is a valued skill rather than a personal characteristic. It can be turned off as well as on.

This may help explain how Harris was able to go from being very forceful as a senator to being a loyal lieutenant as vice president.

Now she is having to shift again, potentially to a position of profound leadership that has to be creative as well as confrontational, and emollient as well as combative.

The debate on September 10 will be an opportunity to see whether Harris is able to hit these different registers.

From an investment point of view, the key thing to bear in mind is that Harris, while demonstrably unafraid of the power of the private sector when she was a prosecutor, does not have any known radical views or declared positions on reorganizing the existing distribution of economic power. Her declared policies are directed at expanding the middle class in the sense of providing a stronger floor for working people (especially with health care and child care) and increasing opportunities for small businesses, to be paid for with moderately higher taxes on corporations and the wealthy, and to a modest degree on capital gains. These are essentially small-c conservative policy positions aimed at the aspirational working and middle classes, understood to be the core of the American economy and polity.  

In many ways the candidate Harris most resembles is Bill Clinton. Clinton used to refer to “doctrine” as “the D word.” Over eight years as president he resisted developing anything that could be called a Clinton Doctrine. Commentators are now searching for a Harris Doctrine. There is not likely to be one.