Government backing in several forms tilts the odds in favor of China throughout the global aluminum value chain

May 2019 - Few, if any, consumers of industrial volumes of aluminum would dispute that there is a preponderance of low-cost supply from China. Many, if not most, downstream manufacturers welcome low-cost inputs in order to make their own products more economically. What they might not understand, however, is the complex variables that lead to the low-cost formulas from which this cheaper aluminum is exported worldwide.

Earlier this year, the Organization of Economic Cooperation and Development (OECD), Paris, put out a trade policy paper, “Measuring Distortions in International Markets: The Aluminum Value Chain,” that breaks down the complexity both to provide greater transparency and as a call to consider changes in global trade rules.

“There is growing interest in updating the international trade rulebook to better address concerns about fair competition in the global economy,” the 121-page paper begins.

The aluminum sector has seen major changes over the last 15 years, “notably the rise of China as the leading producer by a wide margin in most segments of the value chain.” This unprecedented increase in output fuels concerns about excess capacity that depresses aluminum prices and “threatens the viability of producers worldwide.”

To understand whether this increase in capacity is due to non-market forces, the report examined 17 of the largest aluminum companies that together make up more than half of global smelting capacity.

Findings

OECD listed several key findings. First, total government support for the 17 companies accumulated to U.S. $70 billion from 2013 through 2017.

Second, there are important differences in the nature and scale of support received. Chinese aluminum companies obtained all of their support from Chinese authorities, notably in the form of direct or cash subsidies. Together with energy and input subsidies, these measures accounted for the vast majority of all support in China.

By contrast, most other firms in the study are multinational corporations that obtained support in the different places in which they operate (such as Australia, Brazil, Canada), predominantly in the form of indirect support (like energy subsidies) and in lesser amounts.

The vast majority of financial support was provided by China’s state-owned banks to Chinese aluminum state-owned enterprises (SOEs), including the world’s largest producer of primary aluminum and China’s largest producer of extrusions.

“Subsidies upstream confer significant support to downstream activities,” the paper’s authors wrote. “Direct support at the smelting stage is important, but trade measures also matter. China’s export taxes on primary aluminum, as well as its incomplete value-added tax (VAT) rebates on exports of certain aluminum products, discourage exports of primary aluminum and encourage production (and export) of semis and fabricated articles of aluminum.

“Access to cheap inputs enables Chinese producers of semis to expand production and compete in global markets at lower cost,” they said.

“While governments participate in the aluminum value chain via SOEs, state influence is at least as important as ownership, including because SOEs are both recipients and providers of support—especially in China,” where SOEs provide other SOEs and private producers alike with below-market-cost inputs and loans.

Intervention

OECD surmised that non-market forces, and government support in particular, appear to explain some of the large capacity increases in aluminum production in recent years.

Excess capacity in aluminum has “implications for global competition and the design of trade rules disciplining government support,” according to the paper.

The international agency noted that its study took the view that government support in the aluminum industry is best calculated and understood “at the level of individual firms at all stages along the aluminum value chain. This approach has enabled the identification of more support measures than would have otherwise been possible.” (See table, “Matrix of Support Measures,” page 29.)

Taken together, the matrix and the data collected form a “heat map” that helps identify where government support measures (and trade distortions more generally) concentrate in the aluminum value chain.

Government interventions in aluminum appear “widespread,” the paper’s authors said.

Aluminum smelting, in particular, receives significant support in the form of energy subsidies and concessional finance. The effects of support at the smelting stage have repercussions at various points in the value chain, particularly in the manufacture of semi-fabricated products of aluminum (semis).

Government ownership is prevalent all along the aluminum value chain, across a range of countries.

Cost advantage

The effect of support for smelting is “most pronounced in China, due to both its export restrictions (Chinese firms account for almost 60 percent of world output by volume) and much larger domestic support.”

The combined effect is to make aluminum cheaper in China than it would otherwise have been, which in turn confers a cost advantage to Chinese semis producers. “It is therefore not surprising to observe that China’s exports of semis have grown very rapidly, on the back of unit costs that are much lower than competitors,” the authors write.

The effects that government support and other policies (such as export restrictions) have all along the aluminum value chain “suggest that trade rules may need to be revisited to better account for the greater complexity of international production. Subsidy rules need to better account for the influence of the state.”

Government ownership is prevalent all along the aluminum value chain, across a range of countries. Evidence points to the role of state influence in orienting production and investment decisions, in particular through government management of input prices and the flow of credit to aluminum producers.

The authors found a lack of transparency where the relationship between the state and enterprise commingles. “The definition of government support itself becomes blurry where the government is heavily involved in day-to-day financing and company management, making it difficult to identify the precise policy actions and documents that underlie the support provided, where they exist at all.”

Price gaps

With heavy state management of the economy making it more difficult to connect government support to individual policies, improving information on subsidies and other forms of support may need to also draw upon the estimation of price gaps.

Price-gap estimates can provide a more accurate and all-encompassing picture of government support in areas such as energy inputs and concessional finance. The authors concede there are limitations in price gap analysis, saying greater efforts should be devoted to refining the approach and defining best practices for appropriate guidelines and disciplines.

The data on government support collected for the OECD study show that some of the increases in smelting capacity were “excessive in a structural sense. By causing market distortions, government support affects investment decisions and results in more capacity than would otherwise be the case under normal market conditions.”

Implications

Excess capacity has implications for global competition as production moves to where governments offer the most support. “To the extent this does not coincide with a natural comparative advantage in energy-intensive industries, government support has wider implications in terms of economic efficiency and, potentially, even environmental outcomes,” the authors added.

The evidence they found “has implications for the design of trade rules designed to discipline government support,” notably in terms of the need to account for the impact of actions along the value chain, to consider the role of the state and to prioritize increasing transparency. MM