Project Syndicate's Gros: America’s Inward Turn on Trade

14 December 2022

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.

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.

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