AMERICA´S INWARD TURN ON TRADE / PROJECT SYNDICATE

America’s Inward Turn on Trade

America’s efforts to use renewables subsidies to protect domestic manufacturing interests will not only bring higher costs. Because they flout World Trade Organization rules, they could also have significant political repercussions.

Daniel Gros

ROME – Given that the Inflation Reduction Act promises the largest investment in the fight against climate change ever made by the United States, one might expect the European Union to welcome it. 

But, while EU leaders undoubtedly applaud America’s strengthening commitment to the green transition, they do have important – and legitimate – misgivings about the IRA.

The IRA commits $385 billion for green subsidies – over-financed by $750 billion of tax increases and revenue savings – over the next decade. 

While this is significant for the US, the annual total – less than $40 billion – is less than half the amount spent by EU countries on renewables alone (€80 billion, or $84.5 billion, in 2021), which amounts to about 0.5% of EU GDP, compared to a projected 0.2% for the US.

But the scale of spending is not the EU’s main concern about the IRA. 

The real issue is that the US is becoming the first major economy explicitly to link renewable-energy subsidies to local-content requirements that are clearly incompatible with World Trade Organization rules prohibiting discrimination against products based on their country of origin. 

EU leaders fear that the IRA’s provisions on domestic content will hamper European industry.

The IRA contains a wide variety of provisions, but European misgivings center largely on a relatively small one: the so-called clean-vehicle credit. 

American consumers who purchase new electric vehicles are eligible to receive a tax credit of up to $7,500, for which the IRA budgets $50 billion over ten years.

What irks Europeans – and other car-producing countries, like South Korea – is that the credit applies only to cars assembled in North America (including Canada or Mexico). 

For a car costing $50,000, negating a subsidy of $7,500 amounts essentially to slapping a hefty 15% tax on imports from outside North America.

But the EU should refrain from complaining too much about the IRA’s clean-vehicle credit. 

After all, it imposes a 10% tariff on all imported cars (but only 2.7% on batteries). 

The IRA’s other conditions – such as that the car’s battery should not contain critical elements from foreign “entities of concern” – are not of much concern to US allies, as these provisions effectively target China.

In any case, the quantitatively more important subsidies contained in the IRA are those aimed at the renewables sector with $250 billion in expenditure. 

Investors in new installations can obtain a subsidy worth 30% of the total investment, or $0.03 per kilowatt-hour produced. 

Although three cents per kWh might appear small, it represents almost 40% of the average US wholesale price of electric power – 7.8 cents.

But there are additional benefits available only under local-content conditions. 

If all the steel or iron, and at least 40% of manufactured products, used in a new facility were produced in the US, the subsidies are increased to 40% of the total investment or 3.3 cents per kWh. 

That is the equivalent of imposing a 25% import tariff, because domestically produced products can be that much more expensive than imports without putting the investor at a cost disadvantage.

The implicit tariffs in the IRA are as unlikely to spawn new advanced manufacturing in the US as the explicit ones, of about the same size, that the US previously imposed on imports of steel and Chinese goods. 

Because wind turbines and photovoltaic panels are mature technologies, one cannot expect any lasting first-mover advantage. 

Europe learned this the hard way, when its indigenous solar-panel industry – the product of generous subsidies a decade ago – could not compete with Asian, especially Chinese, businesses on cost.

Something similar is likely to happen in the US. An industry whose development is enabled by protection against foreign competition is unlikely ever to become competitive. 

The low percentage of US domestic inputs required to qualify for the additional subsidy shows that even the IRA’s backers expect renewable investment to be dominated by imports. 

Moreover, whatever resources are being used to provide parts for the American renewables industry are resources that cannot be used elsewhere. 

It is thus unlikely that the IRA will succeed in revitalizing the US manufacturing sector.

The US may not even be able to finance all the subsidies the IRA promises. 

One study estimates that investment in renewables (mostly solar and wind) will grow to $180 billion by 2024 and reach $380 billion by 2032, when the IRA provisions are set to expire. 

That is a total investment of more than $5 trillion over the next decade.

But the $250 billion the IRA anticipates for renewables would be sufficient to cover a 40% subsidy on less than $700 billion in investments. 

The US is thus likely to follow in Europe’s footsteps, with the government curtailing subsidies when the costs grow too high.

Ultimately, the IRA does provide generous incentives for renewables and significant protection for domestic inputs. 

But America’s European and other partners might be best served by dialing down their criticism of the unfair subsidies to North American car producers, and instead focusing on the opportunities a $5 trillion market for renewable investment represents. 

After all, most of those opportunities will remain open to foreign competition.

US leaders, however, should look more critically at their approach. 

The protection of domestic manufacturing interests will mean higher costs, which might slow down the green transition. 

It could also have significant political repercussions. 

By flouting WTO rules – which the US, in its role as a “benevolent hegemon,” helped to write – the IRA could be the final nail in the coffin of American global economic leadership.

This is why Europe should not follow the US’s example. For countries around the world, China, whose economic system allows it to combine formal adherence to the rules with a maze of indirect subsidies and other mechanisms for favoring domestic enterprises, is not a credible alternative to the US on trade issues. 

But the EU is. 

Europe should step up to defend the WTO, not to advance its own industry, but to reaffirm non-discrimination in global trade.

Daniel Gros is a member of the board and a distinguished fellow at the Centre for European Policy Studies.