On August 16 2022, President Joe Biden signed into law the Inflation Reduction Act (IRA), the largest green spending bill the US had ever seen. While the full effects of the legislation will not be felt for some time, just over a year later there is a lot to unpack. Perhaps the signature piece of “Bidenomics” legislation, the bill has already had far-reaching consequences both domestic and international. Though it has certainly boosted the US’ climate credentials, its effect on inflation is questionable and the bill hasn’t done much good for US foreign policy either.
The IRA rose from the ashes of Biden’s failed Build Back Better Act and is notable for its extensive provisions for clean energy and climate change policies. A political misnomer, the IRA was deemed likely to have statistically insignificant impact on inflation, and was named such to win over those who considered the original Build Back Better to be too inflationary. It did, however, include a number of measures to reduce the federal budget deficit, such as prescription drug price reform and increased taxes. The biggest spending commitments related to energy security and climate change worth $369 billion and – with many of the included schemes not capped – estimates of the full cost of the legislation range from hundreds of billions to over a trillion dollars.
The biggest impacts of the bill are felt domestically, where US companies and investors have made the most of the framework with a flurry of new announcements and spending commitments since the bill was signed.
Analysis by the Financial Times suggests that at least $224bn of projects have been announced in green technology and semiconductor manufacturing (the latter is a result of the smaller CHIPS Act). The ratings agency Moody’s estimated that spending on the construction of manufacturing plants in the US was up 55%. These announcements give hope of an industrial boom in the US down the line as the investments in manufacturing bear fruit.
Many of the tax credits and subsidy schemes include requirements for domestically sourced inputs, which promises to spur investment throughout clean energy supply chains. For example, purchasers of electric vehicles in the US are eligible for up to $7,500 in tax credits, provided that at least 40% of “critical minerals” in the batteries are extracted or processed in the US or its free trade partners (such as Canada and Mexico). This rises to 80% by 2027. There are even stricter requirements for parts classified as “battery components”, where parts must be made in the US.
This is a promising start, given the early stages of this bill, but its benefits will take years to be noticed and they are far from a foregone conclusion. Companies and investors will find it hard to complete the projects they have announced with the tight US labour market, which has been defying predictions all year by persistently adding jobs and keeping unemployment stubbornly low. While low unemployment and high wage growth are good for workers, they threaten to delay, denude or derail many projects, if firms cannot source the necessary labour to see their announcements through to completion. Additionally, many firms complain of permitting restrictions getting in the way of new projects.
The supply of critical minerals will also cause headaches for many manufacturers, since the global supply of these is dominated by China. Currently 80% of the world’s graphite is produced in China, with the country also accounting for over 50% of the processing of Lithium, Cobalt and Graphite; these are all key ingredients in the production of the battery cells necessary for electric vehicles.
The Biden administration has been recently convinced of the benefits of widening the eligibility for some of these tax credits. “Critical minerals agreements” with Japan and the EU allow them to be considered the same as free trade partners for the purpose of qualifying for subsidies. The administration has also reclassified anode and cathode materials as “critical minerals” rather than “battery components”, meaning they now have more relaxed requirements to be eligible for tax credits. This has reduced some of the outrage from US allies at the implementation of the IRA. They claim the bill undermines the level playing field concept, which many see as central to the advance of global free trade.
One of the biggest impacts of the IRA has been to spark discussion around the world of similar packages of support for domestic energy industries. The EU in particular has tried to counter some of the measures in place by outlining a Net Zero Industry Act that could bring new funding to EU clean energy projects. This proposal includes so-called “local content” rules, which would be similar to IRA’s supply chain stipulations. If implemented, these proposals could transform the European energy sector, as currently the vast majority of renewable energy projects require Chinese input.
The EU also relaxed state aid rules to allow governments to support their domestic industries more easily. Member states are yet to make widespread use of these relaxations, but they could be a cause for disagreements within the block as the larger nations such as France and Germany are better able to subsidise their domestic industries which could divert investment from other member states.
Another key impact has been to ignite an increase in investment from foreign countries into the US clean technology sector. South Korea has been the biggest source of investment since the signing of the IRA into law. LG Energy Solution, a South Korean company, has announced three battery factories alone in the US since the passage of the bill including a joint venture with the South Korean car manufacturer Hyundai. Europe and Japan have been the next two biggest sources of investment in the US sector.
All this talk of competition between the US and its allies over the production of clean technologies can be seen as counterproductive and needlessly protectionist. The benefits of diversifying supply chains away from nations that may be hostile to the US are clear from a national security and economic resilience standpoint, but this logic does not as easily extend to its allies and partners around the world.
Having seen the impact of Russia invading Ukraine and the ensuing sanctions have had on European and American economies, US politicians are justifiably concerned about the possibility of China invading Taiwan and the economic implications of such a catastrophe. Having the industries of the future become dependent on a nation you might end up at war with is not sensible policy.
However, allowing domestic industries to depend on your closest international partners, whose foreign policy objectives often align with your own, is not problematic. Indeed promoting free trade and a level playing field between allies only makes domestic industries more productive.
If the objective of the Inflation Reduction Act is to reduce inflation, then protectionist trade policy will not help; in fact it will drive up producers’ costs by restricting their choice of suppliers. If the objective is to reduce emissions and lessen the effect of climate change then preventing firms from using suppliers from abroad will not help.
For either objective it is better for Americans if they can purchase an electric car produced in Europe or Japan or South Korea and still be eligible for subsidies. Equally it is better for American firms if they can source their supplies from US partners without being excluded from state aid programmes.
Global warming and climate change should be spurring international cooperation, not causing countries to retreat from free trade. It is incredibly disheartening to watch the nations who built the post WWII international order abandon their close ties for short term economic gain over the pursuit of wider shared objectives.
Ultimately, the Inflation Reduction Act has had an immense impact in its first year. It has spurred huge investments in the US from both domestic and international sources, which will bring about large decreases in US emissions. It has also caused discussion around copycat legislation in other countries, which will surely result in further state aid towards renewables. This is a giant leap forward in the race to prevent catastrophic climate change, but it represents a depressing step away from free trade in what seems like a petty and needless protectionist act.