Thursday, August 12, 2010

China's green subsidies are an investment. America's are an expense.

Here's one for my fellow finance geeks...

Having emerged from the recent global recession relatively unscathed, China has launched what appears to be an all-out assault in its ambitions to become a major player in the future of green technology. As one of the most polluted places on the planet, China’s motivation seems natural and unsurprising. However, there is a much more important motive than cleaning the environment behind China’s drive to dominate this sector. China understands very well that the world’s developed countries are prepared to shame each other into doing whatever is necessary to mitigate climate change. Whoever is able to develop these cutting-edge technologies, or to make existing technologies more affordable, stands to generate a lot of revenue.

When we see such news as the recent announcement that China is committing upwards of $15 billion toward “green” cars, we need to understand that, from China’s perspective, this is not just about cleaning up China. It is an investment in China’s future.

But could we not view America’s investments in the same manner? In a word, no. There is a big difference.

During the late 1990s / early 2000s, under the leadership of Jiang Zemin and Zhu Rongji, China embarked on a far-reaching program of privatization. Under Zhu’s direction, thousands of state-owned enterprises (SOEs) were closed, privatized or downsized, and over 40 million SOE workers lost their jobs (many to be reabsorbed by the private sector). But under the leadership of Hu Jintao, China has pulled back from the brink of privatization and begun to consolidate and solidify the role of the state in China’s most important industries.

And even in industries where private and state-owned enterprises compete, such as China’s automobile industry, the private players are typically beholden to local governments in a mutually beneficial relationship. The private enterprises provide employment and tax revenue while the local state provides land, tax breaks, and free or cheap utilities. Furthermore, when private enterprises in important industries become large enough, and are seen to be following the desired policies of Beijing, China’s central government has been more than willing to step in and provide assistance in the form of subsidies or easy access to credit.

Large loans by the state-owned Bank of China last year to BYD and Geely, two “private” auto manufacturers serve to underscore this point. BYD is seen by many to be on the cutting edge of development in electric vehicles, and Geely recently completed its acquisition of Volvo. In both cases, the central government was willing to lend a hand (and more importantly, yuan) to help these two companies in pursuit of Bejing’s auto policies.

Why is China’s government willing to support private companies that compete with its state-owned giants? Because ultimately, the returns on the state’s investments, whether they go to private or state-owned enterprises, are Chinese. Ultimately, technology developed (or copied) in China finds its way into the hands of massive state-owned enterprises. And ultimately, the profits generated by these massive SOEs finds its way into the hands of their owners: the state.

So when China subsidizes its companies to develop new green technologies – or to “borrow” and tweak such technologies from abroad – the goal is to generate a return on China’s investment.

By contrast, when the federal government of the U.S. chooses to channel $69 billion in subsidies, tax credits, low-interest loans and grants to green technology companies, most of which (with the glaring exception of General Motors) are in the private sector, the state is not generating a return for itself. The ultimate beneficiaries of U.S. generosity, assuming the recipients of government largesse are ultimately successful, will be the shareholders of the companies receiving the money.

In short, whether they are actually accounted for this way or not, China’s industry subsidies are an asset on its balance sheet and America’s are an expense on its P&L. But does the accounting really matter? I would argue that, in the short- to medium-term, it does.

In a country that faces major demographic challenges during the next decade or so (as retirees begin to significantly outnumber workers), China’s leaders fully understand that they need to generate as much economic growth as possible now while it is still relatively easy. Cash banked now will help to create the massive welfare state that China will eventually be forced to build.

China’s investments in green technology are not about cleaning up pollution or mitigating global warming, though these will surely be positive side-effects; they are about preparing China for an uncertain future. This is a battle that China’s state-owned enterprises have to win. By contrast, it is a battle that the U.S. government only hopes its private sector can win.