Certainly, the global energy market has already been turned upside down since the invasion of Ukraine as Europe moved to stop buying Russian energy.
Russia has been forced to redirect its energy exports to friendlier nations such as China and India, sold at a discount to global prices. In Europe, the short term solution has been to cut back energy consumption and scramble to install infrastructure to replace Russian pipelines with LNG terminals.
However, the disruption to global energy supplies has accelerated the energy transition as countries aim to become more self-sufficient with investment in renewables.
The Inflation Reduction Act in the US contains large subsidies worth $369 billion for companies operating in the clean energy sector. This example of fiscal activism (see part two of the series, Regime shift: the return of “fiscal activism”) also includes protectionist policies. Among these are requirements to purchase locally-produced equipment rather than importing goods from China, which currently dominates the manufacture of clean energy products.
The threat posed by large subsidies in the US is also set to be met with new industrial policies for the energy transition in Europe. A green subsidy race is taking shape in the West.
Governments are also offering inducements for companies to reshore production in key industries. For example, the US CHIPS and Science Act that was signed into law in 2022 offers around $280 billion in new funding for the research and manufacturing of semiconductors in the US, including large tax credits for capital expenditure in the sector. That has already seen major players such as Taiwan Semiconductor Manufacturing Company(TSMC) unveil plans for new foundries in the US.
MNCs are also likely to consider moving operations in countries such as China to destinations that offer greater protection from geopolitical risks or trade tariffs. And disruption to GVCs that have caused shortages of key goods in recent years means that “just in case” is replacing “just in time” as the guiding principle for inventory management.
Some emerging markets could gain market share as companies leave China
Estimates from the McKinsey Global Institute suggest that 15-25% of global goods trade could shift to different countries over the next five years. Several Asian EM rank well as replacement low-cost manufacturing destinations for industries currently producing relatively low-value goods in China. They have a combination of either relatively attractive business environments, high governance standards, and/or productive workforces with low labour costs.
These countries include India, Malaysia, the Philippines, Thailand, Vietnam and Indonesia, although with contrasting strengths and weaknesses, which would play a role in determining the kind of industry they might attract.
For example, many companies would surely find India’s relatively large and low-cost working age population appealing. And while India does score relatively poorly when it comes to its business environment, positive change may be afoot. Covid-19 has forced the government of Narendra Modi to start pushing through reforms in areas such as the labour market and agriculture, which could eventually improve operating conditions for companies.
Like India, the Covid crisis has also forced Indonesia to revive long overdue structural reforms with the recently approved Omnibus Law. The country ranks well on the basis of its relatively large and young population which will act to suppress labour costs.
If these countries are successful in attracting a significant influx of manufacturers, there could be substantially positive economic impacts. In the short-term, economic growth would be boosted by capital inflows to fund investment and the construction of factories and infrastructure.
In the longer-term, an increase in manufactured exports would lift productivity and thus potential GDP growth. This would likely lead to an improvement in the balance of payments, a decline in structural interest rates and better exchange rate dynamics. All of this would be supportive for the performance of their domestic financial markets.
Accelerated energy transition may benefit high-value industries in EM and producers of raw materials needed in the transition
As we’ve seen, China has facilitated the energy transition to date in the advanced economies of the West. So it is already a major producer of equipment used to generate clean, renewable energy and now controls the lion’s share of solar panel production, for instance.
However,green subsidies in Europe and the US are designed to increase self-sufficiency in green technologies and “buy local” requirements will dampen the spillover of increased investment from here. The really big EM winners going forwards seem destined to be the countries and companies that manufacture key energy transition products where they have a clear competitive advantage. So, the global semiconductor duopoly that is Samsung in South Korea and TSMC of Taiwan seems likely to serve these two countries very well.
However, the manufactured end products are only part of the story as the energy transition will require huge amounts of natural resources. And this presents new vulnerabilities for markets such as Europe and the US. This is because many of the countries that are major exporters of the industrial metals needed for most new energy technologies have so far leaned towards the China side of the fault line.
Supply chains for the raw materials needed in the transition are more geographically concentrated than that of oil or natural gas. For example, the global production of lithium, cobalt and rare earth elements is controlled by a few countries (see chart 3). China itself accounts for around 60% of global production of “rare earths” and dominates the production of graphite, a critical battery component.
It has also invested heavy in regions such as Africa in recent years, where many supplies are located. The Democratic Republic of Congo (DRC), for instance, is responsible for around 70% of global cobalt supply.
Whereas oil exporters in the GCC could conceivably lose influence on the global stage in the long term, countries that dominate the production of in-demand metals may gain influence and become another source of long-term tensions between China and the US.
