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Shedding Light on the Solar Crisis

After Suntech Power Holdings Co. Ltd., a Wuxi-headquartered photovoltaic cell producer, went public on the New York Stock Exchange in 2005, China’s solar industry grew at an astonishing speed. More than 200 photovoltaic product manufacturers are operating in Zhejiang province alone, and most are less than five years old.

After the global financial crisis in 2008, solar producers suffered from dwindling demand and increasing supply. This seriously challenged industry development.

In 2011, there was a sharp turn for the worse as the price of polysilicon, crucial to production of modern solar cells, plunged. It’s now in the range of US$20 to US$30 per kilogram compared with US$500 per kilogram in 2008.

Currently, the industry is overrun with excess stock and capital risk. Ten major Chinese solar companies that are publicly traded abroad, including Suntech, Jiangxi LDK Solar Hi-Tech Co. Ltd., and Yingli Solar Group, posted total losses of US$612 million in the first quarter.

LDK Solar’s predicament offers an example of the problems facing the industry. Between 2007 and 2011, the company’s debt ballooned to US$6 billion from US$617 million. At the end of March, total assets stood at 33.7 billion yuan against some 29.3 billion yuan in liabilities, of which 23.1 billion yuan were current liabilities.

LDK is clearly in a perilous financial condition. But according to a recent media report, a city government mobilized its budget to help LDK pay off debt, creating a public backlash.

In my opinion, local governments that bail out solar companies are very much to blame for the industry’s predicament.

Harmful Incentives

First, local government officials commonly pursue grand business projects. They are motivated by a system that evaluates and promotes or demotes officials based on economic performance.

By investing heavily in the solar industry, local governments could generate higher GDP figures while at the same time get credit for promoting an environmentally friendly cause. The solar industry also became a key development industry in the eyes of officials looking to comply with the central government’s policy of economic transformation toward high-tech manufacturing and service industries.

Cities such as Ge’ermu in Qinghai province, Suihua in Heilongjiang, and Xinyu in Jiangxi vowed to build “solar towns”—industrial parks where photovoltaic product manufacturers could cluster.

Second, local governments provided the wrong incentives leading to excessive development. The rapid emergence of the Chinese solar industry is not because the country leads in photovoltaic technological innovation, but in part simply because the costs of polluting in China are very low. The solar industry, whose primary input is electricity, has been further distorted by heavy subsidies for electricity provided by local governments.

Owing to this misguided government backing, the Chinese solar industry has a cost advantage that European and American firms can hardly dream of.

Chinese solar firms have commonly adopted extremely basic manufacturing techniques that eat up huge quantities of electricity. From the production of raw silicon to the finished solar cell, the entire process wastes around 2.2 million kilowatt hours. It also severely pollutes.

Since 98 percent of Chinese solar cells are shipped abroad, this is equivalent to exporting a vast quantity of China’s already tight energy supply. One could argue that our solar industry is “blackening China’s environment” to help the United States and Europe “go green.”

At the root of the current crisis is the over-investment and overcapacity that has been sustained by local governments. In 2011, China’s annual output of photovoltaic modules measured a total capacity of 30 gigawatts. Meanwhile, global demand for new installations in 2012 is forecast at only 20 GW. Clearly, supply has far outstripped demand.

Furthermore, local governments are hindering the much-needed “survival of the fittest” that would cut the industry down to size. Unwilling to let companies they supported fail, local officials have taken to using government resources to keep them alive.

As a result, companies that would die a quick and certain death in the free market are able to struggle along, continuing the problem of overcapacity with no end in sight. At the end of the day, all Chinese solar firms, both the strong ones suffering from weak profits due to oversupply and weak firms struggling despite subsidies, are being slowly tortured in the sheltered shadow of local governments.

The situation goes beyond simple concerns over losing face. In dire cases, the solar industry has effectively “hijacked” entire local economies and their fiscal revenues.

LDK, based in Xinyu, Jiangxi province, paid more than 600 million yuan in taxes during the first five months of 2011. In Xinyu, LDK is responsible for more than 93 percent of all tax receipts from the solar sector. It is also the city’s single largest taxpayer.

According to the Southern Weekly, LDK filed for bankruptcy protection. However, the Jiangxi government rejected the filing because it can’t bear the loss of such a large company.

Any thorough analysis of solar industry global overcapacity would reveal that the crisis we are witnessing today was inevitable. At first, there was the distortion of the market and the creation of perverse incentives for over-investment by local governments. Now officials, unable to wean themselves from reliance on large solar producers, are keeping them alive and preventing the natural “survival of the fittest” phenomenon.

From the perspective of individual solar firms, local governments may well appear to be their saviors. But from the perspective of the industry as a whole, local governments are clearly the main culprits in this crisis.

China’s solar crisis has exposed a number of underlying problems with the country’s economic development model:

First local governments, in pursuing GDP targets, have indulged highly polluting industrial activities. On the one hand, these firms have enjoyed competitive advantages from a subsidized market, but on the other they have dumped on society. In the long run, this kind of economic growth at the expense of the environment is not in line with the public interest.

Second, without democratic monitoring of the fiscal system in place, there is serious moral hazard since governments can waste taxpayer money. Currently, the fiscal system lacks transparency and the public has limited access to the details of how money is spent. Even budget restrictions drawn up by the National People’s Congress are a mere formality. A dangerous tendency has emerged among government officials that “if there is money to spend we’ll spend it as we please.” Ultimately, society foots the bill.

Finally, since China integrates politics and economic decision-making, local governments have become excessively involved in economic affairs. Although they pursue GDP growth rather than profits, many local governments have started to resemble corporations. Not only has this led to marginalizing for other important considerations, such as environmental protection and food safety, but it risks undermining the rule of law and contributing to corruption.

China’s solar crisis is an opportunity to push for the democratization of the country’s fiscal system for the sake of the economy’s health and sustainable development.

Liu Shengjun is honorary president of the China Society of Economic Reform.

Caixin Media Company Limited is a media group dedicated to providing high-quality and authoritative financial and business news and information. Through periodicals, online content, mobile apps,...
From the Caixin Editors

The Chinese economy’s unique blend of market controls and entrepreneurial spirit is being tested like never before in the solar power sector. The future looked bright five years ago when banks, encouraged by central government orders to pursue “new energy” investment, offered easy credit to all new manufacturers of silicon wafers and panels. Local governments were intimately involved in the investment rush, which created jobs and contributed mightily to GDP growth. Soaring solar panel demand in Europe and the United States, many said, justified the boom. The tide started turning late last year, though, as exports fell and the central government cut tariffs for solar-generated power to one-sixth the 2007 level. Analysts say consolidations and shutdowns may eliminate all but a handful of the nation’s hundreds of solar manufacturers by 2020. A snapshot of the shakeout—and ensuing debates about the wisdom of government involvement in the sector—can be found in the city of Xinyu, the home of LDK Solar. Here’s an economist’s analysis of the LDK demise and a news story about the fallout.

By Liu Shengjun

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