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Did the U.S. Just Start a Climate Trade War?

The Inflation Reduction Act subsidizes domestic production of electric vehicles and carbon-reducing technologies, but at the potential cost of angering America’s trade partners. Tuck trade economist Davin Chor explains. 

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Davin Chor is an associate professor in Tuck’s Economics group and a chair of Dartmouth’s globalization department. At Tuck, he teaches Global Economics for Managers.

President Biden’s signature legislative achievement, the Inflation Reduction Act (IRA), was signed into law this summer. While not immediately apparent from its name, the law includes a comprehensive package of policies aimed at mitigating climate change while simultaneously bolstering the U.S. economy. It plans to do this by spending $369 billion over the next 10 years on tax credits for electric vehicles, EV battery production, wind turbines, solar panels and other greenhouse-gas reducing technologies. But in order for manufacturers and consumers to be eligible for these tax credits, the products in question must be assembled and/or sourced within North America. 

The IRA’s generous subsidies for domestic manufacturing have not gone over well with the U.S.’s allies in the E.U. and parts of Asia. French President Emmanuel Macron called them super aggressive when he visited the White House in December. It’s easy to understand why Macron and other world leaders are upset. The EV tax credit, for example, will eventually be worth $7,500 per vehicle, making domestically produced EVs that much cheaper than those produced in the E.U. Foreign automakers will therefore be less competitive against domestic manufacturers.

Davin Chor, an associate professor of business administration and the Globalization Chair at Tuck and Dartmouth, has been following the rollout of the IRA and its reception in the U.S. and abroad. In the following interview, which has been edited and condensed, he explains what the IRA may mean for free trade and multilateral cooperation. 

Do you think the U.S. is committing trade protectionism with the domestic subsidies in the IRA?

It’s a matter of perspective. From the U.S.’s perspective, the Biden administration is trying to advance what they feel is an important domestic economic and environmental policy agenda. Where things get complicated is precisely the fact that we have these global supply chains for the production of just about everything. A lot of the minerals that go into EV batteries are mined overseas, and some of the largest producers of EV batteries and other components are based outside the U.S. Given that the subsidy has this very strong requirement that a significant percentage of assembly or sourcing of minerals has to be done in the U.S., it could distort existing patterns of production. This of course would be very detrimental to the countries where assembly and sourcing is currently conducted, which explains the unhappiness this has stirred in the E.U. and South Korea.

Does the IRA contravene free trade regulations governed by the World Trade Organization, and if so, what could the E.U. do about it?

If the U.S. were to go ahead with these subsidies, then my sense is that the E.U. would have reasonable cause to try to challenge these subsidies at the WTO, on the grounds that the subsidies are causing demonstrable harm to the E.U.’s domestic industries. That said, this is only one of several options the E.U. could pursue. They can lodge a formal WTO complaint, which several key E.U. lawmakers have threatened to do. Alternatively, they can pursue backroom negotiations to see if they can get some concessions from the U.S. One suspects that this would have been a topic in the closed-door conversations between Presidents Biden and Macron during Macron’s recent state visit. Or, the E.U. could implement on its own accord some aggressive subsidies for EV manufacturers in the E.U. My suspicion is you will probably see a combination of all three things happen in concert.

What could the E.U. gain out of backroom negotiations with the U.S.?

One could envision the U.S. lengthening the timeline of the switch to domestic U.S. production. Alternatively, though less likely, there could be discussions about a partial tax credit for EVs from friendly trade partners such as the E.U. 

If the U.S. subsidizes its own EV manufacturing, and the E.U. also has subsidies for their automakers, is that tantamount to a sort of trade war?

It’s a slightly unconventional trade war—one could call it a subsidy war—but it would be a trade war nonetheless! The E.U. would find this response entirely justifiable, as a subsidy to its domestic manufacturers would be a most direct way to try to level the playing feel. It’s this feeling that if the U.S. is doing it, then the E.U. can do it too. And in this particular context, the U.S. wouldn’t have the moral high ground to tell the E.U. not to do it. Of course, such subsidies would be very costly at a time when government fiscal resources in the E.U. are already strained. From a global perspective though, this may not be the worst thing. I’d be interested to see how this plays out, since a subsidy war could actually hasten us towards our environmental goals by encouraging the faster adoption of EVs both in the U.S. and the E.U.

As a trade economist, what do you find interesting about the IRA and its effects on free trade?

It’s come across very differently to domestic observers as opposed to international observers. 
There have been very different reactions. The IRA was uniformly praised on the American side, but for countries with significant automaking presence, that might be at a competitive disadvantage as a result of this, the push-back has been vigorous within the commerce and diplomatic circles. It hasn’t spilled out into blunt statements by country leaders, but clearly the tension is felt.

What does the IRA say about the U.S.’s stance on free trade and foreign relations?

The signal the U.S. has sent is that it still very much has an America-first agenda. This is not the freewheeling nature of the Trump Administration, where policies were announced all of a sudden and caught everyone by surprise. But the tone of the policy and the IRA is very clearly one of America-first. Things have improved with the Biden Administration in terms of tone, but foreign countries and observers are under no illusions that at this point in time, economic, trade and industrial policy in the U.S. is very much focused on the domestic audience and economy–trying to do what’s perceived to be best for American producers and consumers. 

Given the risks of angering the U.S.’s trade partners, do you think the IRA will ultimately be worth the cost?

I think it does two things at the same time: it encourages the EV transition, and it keeps the domestic auto industry happy. And it should be a win for American consumers. Now all we need is to make sure the EV charging capacity and fixed infrastructure comes into place. There is some skepticism over whether the U.S. can meet its goal of electric vehicles making up 50 percent of all new vehicles sold by 2030. I think that’s an ambitious goal, and I’m not sure we’ll meet it. But I think the IRA will get us close to that goal and that will be a victory in and of itself.