The current debate in Europe on risk reduction in trade tends to address the issue in general terms, although different types of trade pose very different risks. A more nuanced approach would distinguish between the inputs the economy needs to function and those needed to build future production capacity.
MILAN – Trade always implies a mutual dependence: if both parties benefit from the exchange of goods and services, they also lose when the transactions are suspended. Until relatively recently, policymakers focused on the benefits, opportunities and efficiencies that trade brings, but in an era of intensifying geopolitical conflict, the risks – especially supply disruptions – they are increasingly at the center of the scene. The strategy proposed by the President of the European Commission, Ursula von der Leyen, to reduce trade risks is a clear example.
The problem with the current discussion is that it tends to address the issue in general terms, even though the risks associated with different types of trade are very different. A more nuanced approach would start by distinguishing between the inputs the economy needs to function (for example, raw materials like natural gas or minerals) and those needed to build future productive capacity (like solar panels).
There is a relatively straightforward way to eliminate risk in mineral trading: strategic reserves. Because it is generally easy to store minerals, the cost of a reserve—for example, equivalent to one year of consumption—would be equal only to the interest on the initial investment. For example, at current interest rates, the European Union could store a year’s worth of rare earths for less than €5 million ($5.5 million), given that the total import in 2021 was €120 million. .
Natural gas storage is much more expensive. The EU panicked last year over possible gas shortages over the winter, due to reduced Russian supplies, because it could only store 3-4 months of consumption. Of course, the EU got through the winter without shortages thanks to the limited but invaluable storage it did have, and the unusually mild temperatures (Russia then lost the “energy war”). Still, it is clear that storage alone cannot de-risk the natural gas trade.
That’s where substitution comes into play. Substitutes exist for almost all raw materials. In the case of natural gas, oil can be used for industrial activities and coal (or renewable energy) for electricity generation; for rare earths, a different combination of metals could be used. The alternatives are often more expensive – otherwise they would be the first choice – but some substitution could significantly reduce supply constraints, including by lowering the price of the first choice material.
Europe demonstrated this last winter when, by using substitutes and shifting production to less energy-intensive sectors, the industry managed to maintain the same level of production and use 15-20% less gas. This led to the price of gas returning to pre-war levels.
In 2010-11, when China banned rare earth exports to Japan as part of a geopolitical dispute, its price increased tenfold. Japan then rushed to diversify its supply of rare earths and recycle them, or use substitutes. Prices quickly returned to the original level.
Although a combination of substitution and storage could significantly reduce raw material sourcing risks, capital goods are another matter. China dominates the production of solar panels and often applies trade restrictions to politically pressure other countries, especially when it believes they are interfering in its affairs. We could then imagine a scenario in which the Chinese authorities ban the export of solar panels to Europe.
Given that risk, Europe is under increasing pressure to reduce its dependence on imported solar panels. The European Commission recently announced the European Photovoltaic Industry Alliance, which seeks to scale up production technology to establish a “made in Europe” solar value chain.
But since solar panels are not inputs for current solar power production, a Chinese ban would not have a significant impact on the European economy. Existing solar capacity would continue to offer the same amount of electricity at no cost.
The effect of the ban would be to slow down – at least temporarily – the expansion of renewable energy in Europe, but this would hurt both Europe and the world community, including China, because it would hinder European efforts to reduce emissions.
In addition, the cost of hedging against this risk through the substitution of cheap imported solar panels with locally produced ones would be considerable. Recent estimates suggest that European-made panels would cost approximately 35% more than Chinese ones. If the EU imports €11 billion worth of solar panels, as it did in 2021, producing them locally would cost more than €15 billion a year. With the increase in demand – it is very likely that the import in 2022 will have exceeded that of 2021 – the costs would continue to rise.
It’s also worth remembering that the EU’s anti-dumping duties on Chinese solar panel imports – imposed more than a decade ago – were short-lived due to their high cost to Europe and the threat of Chinese retaliation. This episode illustrates how difficult it would be for the EU to limit the import of solar panels from China without breaking global trade rules.
The official presentation by the European Photovoltaic Industry Alliance offered no clues as to how it could meet its ambitious production goals (six-fold the annual production of each solar component by 2025), but it does signal a change in procurement rules. public to favor European producers, even if they are not competitive in terms of costs. That would also be inconsistent with World Trade Organization rules.
All this suggests that it is not advisable to reduce the risk of trade in photovoltaic products and components by subsidizing local production. Instead, Europe should put the savings from cheap imports into research to develop the next generation of green technologies.
Reducing business risk is clearly not a task to which the same approach can always be applied. The dominance of geopolitical considerations should not prevent policy makers from seeking economically sound solutions.
The author
He is director of the Institute for European Policies at Bocconi University.
Copyright: Project Syndicate, 1995 – 2023
