China’s Purchasing Power Advantage & Wright’s Law Mean Its Green Investments Go A Lot Further

beijingwalker · Jan 31, 2023

China’s Purchasing Power Advantage & Wright’s Law Mean Its Green Investments Go A Lot Further

China spent $546 billion of 2022’s $1.1 trillion USD global green investment, but China is getting about a trillion USD in value out of its investment.

By Michael Barnard
Published January 30 2023

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A bunch of headlines have been quite reasonably celebrating the $1.1 trillion in green investments globally in 2022. A few more have been pointing out that almost half, $546 billion, was in China alone. But that’s deeply understating what’s actually going on. China is spending even more than the raw statistics show, and has deep competitive advantages that are masked by the coarse numbers. And while China is mostly spending wisely, there are reasons to think that the west isn’t to the same degree.

So let’s talk PPP vs GDP. GDP and PPP are two acronyms that are often used to measure the economic success of a country. GDP stands for Gross Domestic Product and is essentially a way of measuring how busy everyone was in the country during any given period of time by calculating the total value of all the goods and services produced. PPP stands for Purchasing Power Parity and is a way of comparing the relative value of one currency to another, especially in domestic transactions.

There’s been an interesting divergence in the world since at least 2007, when China’s contribution to the world’s economic growth if measured in PPP was bigger than the USA’s. Around the middle of the 2010s, China’s PPP, not just its growth rate, was greater than the USA’s. That mean that the average person in China could buy more TVs, cars, food and financial services than the average person in the USA with the same amount of money in absolute terms.

Had $100 USD in yuan in China, about ¥680? It went further than $100 did in the USA. It was a subtle shift, and missed by most, including me. To be clear, while I’m not a fan of Graham Allison’s book, Destined for War, I did learn about the PPP shift from it. The first chapter of that book is well worth reading. The rest, not so much.

Fast forward to 2023.

That looks…odd. What does it mean that ‘western’ economies are mostly flat-lining around the USA while China has mostly climbed? Well, it means a few things.

Lets think about how PPP works. A basket of goods is considered, just like any cost of living assessment. Let’s assume the basket has garlic, pork, toilet paper, gasoline, and yogurt in it. Yeah, weird basket. The same basket is purchased in China and the USA. The basket in China is purchased in yuan. The basket in the USA in purchased in dollars.

The basket in the USA costs $100. If China’s purchasing power was the same and the exchange rate was a yuan being worth $0.15 USD, then the same basket would cost ¥680 yuan or thereabouts. But it doesn’t. It costs around ¥400. Same goods and services, lower real costs, about 40% lower.

We can fuss about a bit of stuff on this that has merit (unlike at least one Investopedia article on the subject which brought in a bunch of Sinophobic irrelevancies). China pegged the yuan to the USD in 1983, and while it’s adjusted it a bit over the years, it’s still maintaining a somewhat artificially low currency to enable foreign trade. And while China has taken 850 million people out of abject poverty since 1978, there is still a lot of cheap labor in the country. China is currently only #5 on the global list of automation as a ratio of GDP, although it has made robotics a national priority recently.

But the exchange rate is mostly relevant to foreign trade. Domestic trade is different. And China does an awful lot of trade and investment internally in yuan.

Back to ¥680 vs ¥400. Let’s take Tesla’s Gigafactories in Nevada and Shanghai. Let’s say that they need a million USD in steel for the cars. In the USA, that would cost a million USD. In China, it would cost 40% less in ‘real’ money. That’s 40% to add to profits or take off price, or some optimized version of the two. Tesla operates in both countries. It can see this from its internal costs to revenue metrics.

But what about companies that manufacture mostly in the west, like GE and Vestas’ wind turbine concerns? Well, they have turbines that cost more to manufacture than Chinese ones. That’s why Vestas and GE are suffering, and a bunch of people are pretending Chinese wind turbines are inferior. No, Chinese turbines are fine, they are just cheaper because of the PPP variance. You’ll note that the tempest in a teapot of a small number of turbines collapsing globally among the hundreds of thousands of them operating just fine is occurring with GE, Vestas, and Siemens turbines, not Goldwind or Sinovel, per BNEF. (Of course, Chinese turbines have mostly been installed in China until recently, so to be scrupulously fair they could be falling over in equal while still irrelevant numbers but simply be unreported outside of China.)

China can manufacture wind turbines of equal quality for 60% of the cost. Chinese firms’ expenses are almost entirely internal to China, so they get the PPP benefit with every purchase that they make.

And there’s something else going on. China rarely does one or even small numbers of anything. It manufactures, distributes, constructs, and operates massive numbers of green technologies, especially in renewables and electric vehicles, from tiny scooters to cars to buses to trucks to trains. As a result, it experiences the benefits of Wright’s Law, which BCG renamed the experience curve and Flyvbjerg abstracts up to modularity as he applies it to megaprojects.

What’s Wright’s Law? It says that anything you manufacture gets 20-27% cheaper for every doubling of volume. That kicks in after the initial design headaches and ramping up of production, so doesn’t really occur until you’ve already made dozens of something. But supposed you’ve manufactured 1,000 widgets for an average of a dollar. The next thousand widgets are likely to cost you $0.73-0.80. And the two thousand widgets after that are likely to cost you $0.53-0.64. You’ll notice the gain is smaller in absolute terms. It’s an s-curve that’s flat for a few dozen, then steep for a while, then it flattens out again. If you’ve made a million of something, you aren’t going to be getting many more efficiency bumps. Washers, screws, and clothespins are as cheap to manufacture as they are going to get for the companies which own those markets. Among other things, that’s why BCG’s advice to companies was to be ruthless in growth so that their competitive advantage could never be challenged.

Let’s take electric buses. There are about 500,000 of them running on the roads of China’s cities. There are three dominant manufacturers of electric buses in China — Yutong, BYD, and CRRC. They have 50% of the market between them. Yutong alone has 25%. That means it has manufactured and delivered in the range of 125,000 electric buses. That’s about 10 doublings of manufacturing volumes after the first few dozen.

Yutong has a bunch of committed suppliers which are selling it raw materials and manufactured components in high volumes with good discounts. It has worked all the kinks out of its assembly lines. It likely makes electric buses more cheaply than any company with the possible exception of BYD, which has 15% of China’s market.

Now let’s look at New Flyer, the dominant North American manufacturer of transit buses. It peaked at about 6,500 internal combustion buses delivered in a single year. It’s starting to ramp up low-emission bus manufacturing, and it’s competing with a bunch of startups like Proterra in the space. It’s wasting a bunch of its time with hydrogen fuel cell buses and hybrid diesel electric buses instead of getting down to the business of building lots and lots of battery-electric buses. While it’s reasonably far down the experience curve for transit buses with internal combustion engines, it’s at the beginning of the battery-electric drivetrain curve.

Nova Bus, a Volvo subsidiary, seems to have a handle on the future and appears to be focused on electric buses, but it’s still in the phase when it’s just delivering the first few dozen. It too is reasonably far along the experience curve for transit buses, but not for electric drivetrains. As I said to the person in Translink responsible for the electrification of its fleet prior to COVID when I was doing some initial consulting with it, if they aren’t talking to Chinese manufacturers and visiting China for lessons learned, they are going to spend an awful lot more than they need to and would transition a lot more slowly than is required. And that’s what’s happening.

As with electric buses, so with the 400,000 or so electric trucks on China’s roads. So with the high-speed, grid-tied electric trains zipping freight and passengers along the 40,000 km of track it has built since 2007. So with the many pumped hydro facilities it has under construction. So with the tens of thousands of kilometers of HVDC lines it has efficiently transmitting renewable electricity around the country and increasingly into neighboring countries.

China starts with about a 40% cost advantage in any green investment it makes. Then it leans heavily into repeating successes at massive scales, getting all the economies of scaling by numbers. In wind turbines, it can sell them at half the cost and greater profit margins than Vestas or GE as a result. That’s why western turbine manufacturers are in trouble. BYD has started shipping its electric vehicles globally, including buying seven car delivery deepwater ships for the purpose, vertically integrating its distribution and squeezing out more efficiencies. Remember that BCG guidance about owning markets by scaling? The western companies trying to compete with Chinese firms are finding out what that really means, hence a lot of the protectionism popping up in the west.

All of this means that when you see headlines or charts about China having spent half of 2022’s $1.1 trillion USD global green investment, understand that China is getting closer to a trillion USD in value out of its investment. And as the New Flyer digressions and things like the $504 million USD for a green hydrogen generation facility in Utah show, the developed world isn’t getting as much value out of its perhaps $500 billion in spending as it should.