Industrial policy and global public goods provision: rethinking the environmental trade agreement

Many countries have used protectionist measures, such as local content requirements or anti-dumping tariffs, to develop or protect their domestic industries producing low-carbon technologies such as solar panels. This paper asks if there could be global long-term benefits to an industrial policy that allows a potential supplier country to realise its potential and catch up with countries already producing clean technologies competitively. The paper presents a simple model showing when this may be the case.

Two countries – one with an advanced (or ‘frontier’) and one with a not-yet-competitive (or ‘laggard’) clean technology-producing firm – play a two-stage game and decide whether or not to trade. Reaching the technological frontier requires learning-by-doing. If subsidies are not used and the difference in initial production costs is large, then operating in a state of self-reliance, or autarky, in Stage 1 can improve social welfare globally by increasing market competition in Stage 2. However, greater competitive benefits can be achieved by using producer subsidies, which avoid the cost of protection.

The paper also highlights how the more advanced country can use its market power to extract rents from a laggard country and may therefore prefer that the laggard country cannot compete, even though this reduces consumer surplus and positive externalities/public goods provision. The higher the global positive externalities (such as avoided damaging impacts from climate change) from using the technology, the more closely countries’ preferences should align with one another’s.

Overall, the analysis suggests that an environmental trade agreement would be most beneficial globally if measures supporting producers upstream were permitted.

Key points for decision-makers

  • Countries around the world increase the downstream cost of low-carbon technologies using anti-dumping duties and local content requirements, while simultaneously blaming inadequate efforts to address climate change on the economic cost of doing so.
  • This paper shows how allowing an initially laggard country to catch up, even at the cost of temporary protectionist measures, could increase the deployment of a clean technology long-term and have a positive impact globally on social welfare. Producer subsidies can achieve the same competitive effects while avoiding the cost of protectionism.
  • Such subsidies are currently susceptible to challenge under global trade law, as exemplified in the US– and EU–China solar trade wars. The paper speaks to the broader challenge of reviewing World Trade Organization rules to ensure they are compatible with climate goals.
  • China’s entry into the solar photovoltaics market was enabled by targeted support to equipment manufacturers. It is also credited with dramatically increasing competition and reducing solar panel prices globally.