How China built its ship-building industry, and why.
Smith: When you estimate how much China subsidized the shipbuilding industry, you get something like $90 billion between 2006 and 2013. I'm wondering if you can put that in context for me and explain what China got for that investment in their shipbuilding industry.
Barwick: So, $90 billion sounds like a lot, but it's important to recognize that a big portion of that is driven by entry subsidies. Entry subsidies are mostly in the form of free land. Valuable coastal regions were given to those shipyards for a very low price or sometimes even free. The total subsidy was $90 billion. And entry subsidies were roughly $70 billion. And the rest were $20 billion of production subsidies and investment subsidies. Production subsidies were roughly $20 billion in the form of the cheap input and buyer financing—in the form of a collateral loan given to potential buyers because ships cost millions of dollars, sometimes tens of millions of dollars. Having a collateral loan from the government is very attractive for potential buyers. Investment subsidies were around $5 billion, and that is primarily in the form of low-interest, long-term loans, as well as tax policies that allow firms to expedite their capital depreciation.
Smith: So it sounds like there's a number of different ways that China is subsidizing its shipbuilding industry. I think an interesting question is which types did you find seem to be the most efficient?
Myrto Kalouptsidi: Overall, I think we do find large support for the industry. Our main finding is that they get very little in terms of pure economic returns. I think we have a negative return of 80 percent. So you give $1, you get back $0.20. Because the entry subsidies are such a big chunk of it, this negative return is driven by these entry subsidies. In retrospect, this is a very intuitive finding, because what's happening is if you give a subsidy to a firm to enter, this means you're lowering the threshold that a firm needs to overcome in order to enter. So a firm thinks, how much money do I need to make to enter? How much am I going to pay? And there's going to be some firms that are marginal, that are expecting to make just below the cost. And all of a sudden you're lowering the cost, which means that it becomes profitable for these firms to enter. But of course, if these are the firms that have the lowest expected profitability, they are the least productive firms. So all of a sudden when you lower entry costs, you allow the least productive firms to enter. And because an important feature of this industry is its high volatility—demand spikes and demand busts—you have all these unproductive firms who are exacerbating excess capacity. They're bringing prices down. They're making volatility worse. This was a big reason behind this low return that we're finding.
Smith: What role did timing play on the effectiveness of these subsidies? When is the best time to subsidize an industry?
Kalouptsidi: This is also related to the volatile nature of the industry and the fact that it undergoes these booms and busts, the so-called shipping cycle. We realized that in the case of China, subsidies were largely pro-cyclical, which means that the biggest subsidy boom happened in 2006, which was actually a period of very high demand. This is a period where China is growing really fast. It imports a bunch of raw materials and exports manufactured goods. There was a massive increase in demand. Actually, the spike in shipping rates at the time were higher than those during COVID for certain types of products. At that point, I think the backlog of new ships increased eightfold within a couple of years. And then in 2008, the Great Recession hit, and you had a historical bust of the industry. So the subsidies came on right when demand was peaking. But what happens when you subsidize during a boom is that you're kind of giving incentives for firms to produce more and enter when production costs are higher, because all of these firms are now producing close to capacity, which means they're producing at a high cost. In contrast, if you subsidized during the bust, this is a period of very low utilization and idleness. So you would be utilizing resources that are sitting around. We find that the return is much higher if you subsidize during the bust compared to a boom. ….
Barwick: Also, in China’s setting, I think to their credit, the government was nimble and able to change policies. From 2006, there was massive policy support. But in 2009, it was clear that the industry had over-expanded. So they put in place an entry ban right at the peak in 2009 and 2010 and then shifted the policy quite quickly from subsidizing everybody to focusing on incumbents. Then in 2013, they implemented the so-called “White list” policy that focused on not just incumbents but also high-quality incumbents. So I think the ability to change directions is also an important lesson.
Source: American Economic Association
First, as China became the world’s biggest exporter and a close second largest importer during our sample period, transport cost reductions from increased shipbuilding and reduced shipping costs can lead to substantial increases in its trade volume. China’s imports consist mainly of raw materials and are carried by bulk carriers and tankers, while its exports are mostly manufactured goods and are transported in containerships. To evaluate this argument, we carry out a back-of- the-envelope calculation of the subsidies’ impact on China’s trade flows. Shipbuilding subsidies reduced bulk carrier freight rates by 6 percent and containership freight rates by 2 percent between 2006 and 2013. Using trade elasticities from the literature (Brancaccio, Kalouptsidi, and Papageorgiou 2020; Jeon 2022), the industrial policy raised China’s annual trade volume by 5 percent ($144 billion) between 2006 and 2013. This increase in trade was certainly large relative to the size of the subsidies (which averaged $11.3 billion annually between 2006 and 2013). Of course, “more trade” does not translate directly into economic well-being, but the relative magnitudes are suggestive.
Barwick, Panle Jia, Myrto Kalouptsidi, and Nahim Bin Zahur. 2024. "Industrial Policy: Lessons from Shipbuilding." Journal of Economic Perspectives, 38 (4): 55–80.
Source: American Economic Association