stap for A moment in the ancient past. The year is 2016. United States Trade Representative Michael Froman is making a provocative call to arms. American workers and businesses are competing against firms that receive subsidies and other favors from their governments. “The question”, he says, “is what do we do about it? Do we accept the status quo, or do we actively work to change it?” Mr. Froman’s choice, in line with his country’s decades of trade policies, is the latter: try to reduce subsidies that hurt American exporters and reduce global trade.
Now, return to the present – with a bang. America’s answer to Mr. Froman’s question has been reversed. Instead of trying to cut subsidies to other countries, the Biden administration’s unrelenting focus is on building its own subsidy architecture, complete with the kinds of local-content regulations that US officials once opposed. . Thanks to landmark legislation passed last year, the government is set to shower cash on semiconductors, renewable energy and other green technologies — potentially more than $1 trillion over the next decade. Officials are beginning to consider how to distribute the cash; Some new rules have become effective from January 1.
For many in Washington – both Democrats and Republicans – this new approach is common sense. They believe that this is the only way America can protect its industrial base, meet the challenge from a rising China, and reorient the economy toward green growth. But for America’s allies, from Europe to Asia, it is a startling change. The country they used to count as a stalwart of the open trading world is instead taking a big step in the direction of protectionism. In turn, they have to decide whether to fight with the money, increasing their subsidies to match the US. If the result is a global subsidy race, downsides could include a fragmented international trading system, higher costs for consumers, greater barriers to innovation and new threats to political cooperation.
The first major crack in America’s commitment to free trade came when Donald Trump imposed tariffs on products from around the world. However, in some ways, it is the second crackdown—the current increase in subsidies—that does more damage. “Free trade is dead”, is the stark assessment of a senior Asian diplomat in Washington. “It is basic game principle. When one side breaks the rules, soon the other side also breaks the rules. If you stand still, you will most likely lose.
Although subsidies have long been a part of America’s economic landscape, the new plans are notable for both their scale and their America-first emphasis. It’s impossible to put an exact price tag on them because most subsidies will come in the form of tax credits, the total size of which will depend on how much the companies produce. Yet the cumulative effect would be huge. If the federal government’s investment spree reaches $100bn a year over the next decade, as many expect, it will almost double its total subsidies in the pre-pandemic decade. Credit Suisse, a bank, thinks US solar panels could be the cheapest in the world by the end of 2020.
To advocates of free trade, subsidies are bad in themselves: they make goods produced by a country artificially cheap, reducing economic efficiency. America’s new subsidies are much more objectionable because in many cases they require recipients to meet local-content limits. To receive the $7,500 credit for the purchase of an electric vehicle, consumers need to purchase a car assembled in North America. At least half of the battery components in eligible cars must also be made in North America. Wind, solar and geothermal projects would receive heavy subsidies if they used American steel and iron. About half of their manufactured parts must also be made in the US. And so the list goes on.
There are many reasons for America’s protectionist turn. China’s rise is the starting point. American leaders once believed they could rein in China for the worst of its industrial policies. These hopes were dashed, leading to the idea that the US needed its own industrial policies to avoid becoming dependent on a rival in tomorrow’s technologies. Politicians’ concerns about disruption to supply chains at the start of the COVID-19 pandemic strengthened this view, as did a desire to boost middle-class jobs. Climate change is another reason: Spending on renewable energy is expected to drastically reduce America’s carbon emissions.
The economic thinking that underpins much of this argument is questionable. Still, its political momentum is inexorable for the time being. This gives rise to two important questions for countries around the world. How big an economic threat are American subsidies? And how should they respond?
killing me brutally
As the main target of US measures, the answers are clear for China. Coupled with export controls and sanctions, US subsidies are designed to attract business from China. It reinforces the Chinese government’s commitment to greater self-reliance, including its own massive industrial subsidies.
For America’s friends, though, the answers are more complicated. in August when Joe Biden signed off on America’s green-tech subsidies (via the Inflation Reduction Act, or IRA), he was admired in Europe. America has finally joined the fight against climate change. And since everything from cars to supermarkets is bigger in America, Mr. Biden’s economic bigotry was seen as just doing things the American way. is no more. Trade experts in Europe warned that US subsidies spell trouble for the continent’s green-tech ambitions. These concerns were soon dispelled. French President Emmanuel Macron called in December IRA A “killer for our industry”. Criticism has been more muted from America’s allies in Asia, but policymakers there are also dismayed by the turn to nationality-based subsidies.
The angry reaction in Europe is partly due to its vulnerable position. The energy crisis triggered by Russia’s war on Ukraine has hit European firms hard. The continent has scrambled to replace cheaper piped gas with costlier liquefied gas. With its abundant natural resources, the US currently has the advantage of low energy prices. New subsidies could also make it cheaper renewable energy. There is significant evidence that Europe is already losing investment. Swedish manufacturer, Northvolt, is reviewing its plans for a factory in Germany in favor of its existing US operations. others will follow.
This readjustment is also a source of concern for some businesses. Morris Chang, Founder tmc, a Taiwanese chipmaker, estimates that manufacturing costs in the US are 55% higher than in Taiwan. Work will be duplicated rather than simply distributed separately. Chip-making giants fret about breaking up the networks of expertise in their most advanced manufacturing and surrendering the technological leadership that sustains their existence. Research by Boston Consulting Group suggests that creating multiple self-sustaining semiconductor supply chains around the world would require investments of between $900bn and $1.2trn, with annual operating costs rising to between $45bn and $125bn.
At least US semiconductor subsidies don’t have the same local-content regulations as green-tech subsidies. America’s allies are now trying to persuade it to soften the latter. President Biden modestly suggested that the US “does not intend to exclude those who were cooperating with us”. In practice, however, it is not easy to recreate the rules. The law was precisely worded, specifying dollar amounts, deadlines, and conditions. Congress would need to pass formal amendments—a tall order at the best of times and unthinkable when the House of Representatives is inactive. Any adjustments are likely to be minor.
Governments could theoretically take the US into the World Trade Organization (world trade organization, world trade organizationThe prohibition against subsidies involving local content requirements is clear. So far, however, there has been little appetite for such a challenge. If the US loses, it can appeal against the decision, which would effectively end the case. world trade organization No longer a viable appellate body (thanks to US decision to block appointments). Another recourse would be to impose tariffs on US exports that benefit from unfair subsidies. However, this can get very messy. Everything from cars to solar panels and hydrogen to semiconductors will be in play.
get into the game
Instead, governments elsewhere face an insidious choice about whether or not to join the subsidy race. There is an economic argument for living on the sidelines. When America pays for technologies at enormous cost to its taxpayers, over time these technologies should become affordable for all. No matter how much America spends on its companies, it cannot get a comparative advantage in all products. Some officials in Asia are clinging to the hope that their governments and those in Europe will exercise restraint. “That way all non-Americans can have a level playing field with each other,” says a Japanese official.
But voices demanding more subsidies seem to be getting louder. South Korea’s environment ministry has reportedly informed carmakers that domestic subsidies for electric vehicles may be limited to firms that run their own service centers in the country, excluding most foreign companies. Japan is making efforts to revive the manufacturing of advanced semiconductors. Eight domestic firms, including Toyota, a carmaker, and Sony, an electronics firm, recently announced the formation of a new chip-making firm, Rapidus. In November the government pledged ¥70bn ($500m) in funding for the firm’s semiconductor research.
Politicians and businesses in Europe want to adjust stricter state aid rules, so that governments can support industry more generously. These regulations are one of the biggest success stories of the European market, helping to ensure fierce competition. Yet the economy ministers of France and Germany, Bruno Le Maire and Robert Habeck, argued in a joint paper in December that changes were needed to allow more aid to flow more quickly to strategic sectors.
Americans who helped craft the country’s traditional trade strategy worry its new approach will boomerang. Susan Schwab, trade representative from 2006 to 2009, argues that many people in Europe and Asia would be very happy to see the doors open for industrial subsidies. “We’re never going to give as many subsidies or put up as many barriers as our trading partners,” she says. be implemented.”
That opinion is hardly heard today in the halls of power in Washington. Catherine Tay, the current Trade Representative, is a firm believer in subsidies. It calls on the US and its allies to coordinate their investments to maximize their impact. In theory, this is a reasonable idea. The US wants its allies in Asia and Europe to join its tough line on China; Meanwhile, its allies want to remain under America’s security umbrella and support the country in confronting climate change.
Yet in all fairness, coordination is bound to be brutally difficult. Just as the US wants to be at the forefront of semiconductor production, so too are governments in Asia and Europe. All have national champions, not to mention scores of startups vying for a piece of the action. As the US and its allies offer more aid, these firms will be only too happy to gobble it up. In the process, there will be duplication of efforts across borders, wastage of public money and recriminations between cooperating countries. It may take hundreds of billions of dollars to find out why America was never a supporter of subsidies, not an opponent.