The bankruptcy of Chinese solar energy company Suntech Wuxi is being depicted in the media as a sign of chaos in the solar industry.

The industry is said to be suffering from disastrous price falls created by over-capacity, and harmed by the US imposition of tariffs. These were justified by the US as punishing “green mercantilism” on the part of Chinese central and provincial governments.

Meanwhile the Chinese central planners have sent out confusing signals, winding back subsidies at the same time as they are ramping up feed-in tariffs.

What on earth is going on?

The birth pangs of a capitalist industry

What we’re seeing is the birth pangs of a new, capitalist industry. We should be rejoicing that some companies are going bankrupt – it shows that the industry really is competitive, and not subject to arbitrary state control.

There have been comparable episodes at the birth of every major industry. Detroit boasted hundreds of auto companies in the 1910s and 1920s before bankruptcies and consolidation led to the creation of the Big Three – Ford, General Motors and Chrysler. Likewise in electronics and computers. Now it is the turn of solar photovoltaics.

China has created an astonishingly successful solar photovoltaic industry, far beyond the imaginings of commentators even ten years ago. A decision was taken at the highest levels that China needed to promote renewable energy industries to complement and offset its rapid escalation of coal-burning and fossil fuel driven industrialisation.

Total reliance on fossil fuels would lead to political dependence on unstable Middle Eastern regimes and severe energy insecurity – which could be balanced only by developing domestic industries that would generate power without imported fuels.

In the 11th Five Year Plan, covering the years 2006 to 2010, solar photovoltaic energy (along with wind power) was singled out for attention, and grew rapidly through local subsidies and low-interest loans from state banks. Targets were rapidly increased, with the industry anticipated to grow by 10 GW this coming year, and reaching 35 GW by 2015 – making it by far the world’s largest producer and ousting Germany this year as largest consumer as well.

The most important decision was to allow open access to the industry for entrepreneurial firms – and in China’s wildly entrepreneurial culture that meant that hundreds of firms flocked in.

China as a latecomer made a strategic decision to focus on the dominant technology of crystalline silicon and drive down its costs through scaling up production – the time-honoured formula that had been applied in the US by the auto giants. As production expanded, making China the epicentre of the world solar PV industry, the costs tumbled.

AAP/Photovoltaic manufacturing

And as the costs were driven down, so Chinese exports of solar PV cells grew. Not through “dumping” (as alleged by the US) but through the learning curve associated with market expansion. Chinese firms like Suntech became the dominant suppliers to the Western markets, where subsidies and feed-in tariffs were driving consumption – in Germany, Spain, Italy and the US, as well as Australia.

But in this fevered atmosphere, the slightest downward trend in demand provokes destabilisation of supply – and the most leveraged of Chinese producers are now starting to feel the pinch, led by Suntech, whose Wuxi subsidiary has now declared bankruptcy. Doubtless the Wuxi municipal holding company will step in to clean up the mess, and some foreign bond holders who invested in expectation of future profits will have to “take a haircut”.

Well, that’s capitalism.

The future of Chinese solar

Meanwhile the Chinese authorities are seeking to bring some order to the new industry by expanding domestic demand, in line with the 12th Five Year Plan. In this spirit they are introducing some feed-in tariffs, modelled on Germany’s extremely successful system. This encourages growth not just in demand for renewables but also in supply, through supporting decentralised independent power producers like farmers and householders to supply to the grid.

China’s typical approach, consistent with social science, is to try out these policy initiatives on a small and local scale and then gradually ramp them up. So the feed-in tariffs are currently confined to some cities and provinces – but the signs are that they are working as expected.

At the same time, the National Development and Reform Commission (NDRC) wants to reform the provision of subsidies to the PV sector to complement feed-in tariffs. Subsidisation of large producers is being wound back (excessive support would provoke further overcapacity) and subsidies are being focused on smaller producers, who can make a real dent (in terms of power production) on coal dependence. Promotion is shifting from support for capacity additions (in terms of kW) to support for decentralised renewable energy generation (in terms of kWh). That is rational and sensible.

Meanwhile the Chinese authorities recognise that the cost reductions in crystalline silicon technology will necessarily moderate (costs have fallen by 75% over the last four years) and so new technologies will have to be scaled up. The next generation is already known: thin film wafers which can be “printed” on rolls of plastic, using materials like cadmium and tellurium, or the less-toxic copper, indium, gallium and selenide.

There is still a chance for Australian firms to get involved in the production and export of next-generation solar technology – and capitalise on the fact that the technology was actually invented here (at University of NSW). But it needs strong and determined support for this to happen – on a scale that would match the support that is already being offered in China.