By John Lavelle

In 2022, inflation was certainly a hot topic amongst economists worldwide. Central banks and governments throughout the world have tried, to various degrees of success, to tame inflation and its effects. Nations such as India, Canada, and those in the Euro area have seen lower inflations rates from the previous year, but all remain at higher levels than before Covid-19. Nations such as Mexico and Japan have seen higher inflation in 2022, but by small increments.  Most nations outside the G20 have had growing inflation rates this past year such as Algeria, Vietnam, and Slovenia.

Apart from raising interest rates, the most notable and prevalent policy to curb inflation in the United States is the American Inflation Reduction Act of 2022 (IRA). Passed in August and in effect as of January 1st, the bill aims to cut inflation by lowering the federal deficit and health care costs while also promoting clean energy through tax credits for U.S. individuals and companies. The bill is partisan, with great Democratic support and Republican dissension, and economists are split over its effect on inflation. However, most agree that the bill will increase American trade through its $369 billion green subsidies for companies that manufacture and sell ‘green’ products and offer ‘green’ apprenticeships. Although a definite boost for American trade and its economy, this bill has Europe scrambling.  Many EU companies have stated that they will invest and allocate funds for production in America instead of Europe. In response, the EU, along with other nations in the international community, have demanded that America change the IRA bill to eliminate the possible unfair tilt of the trade playing field and prevent a trade war and export subsidy race. So will the Biden Administration stay its course at the risk of angering American allies, or reverse the campaign promise of incentivizing a greener economy? And how will Europe respond to the American decision?

The American Perspective

The bill does more than support American businesses, as households that own or use a variety of green appliances such as and including rooftop solar panels, insulation and air sealing, electric stoves or ovens, and much more will also receive tax credits. These sections of the IRA bill are actually supported by the European Union and other foreign nations, as many believe this will lower the average American’s carbon footprint. The internal section of the bill will not be changed soon. The only possibility of the internal section being altered or rejected is if the Republicans win the presidential election in 2024 and either pass another bill that contradicts the IRA bill or call and win a revote on the bill.  The earliest this hypothetical situation can occur is 2025 and is considered to be highly unlikely.

The trade and international sections of the IRA bill serves to help American green energy companies and encourage foreign investment in America’s green sector. America would greatly benefit if these intended effects come to fruition as their energy sector would greatly advance and develop. Many analysts and experts see no reason why the expected will not occur without a significant response via policy by the EU. Wealthy individuals and companies enjoy cutting costs and receiving subsidies while receiving quality PR and an excellent chance at a positive return on investment.  Overnight, America’s green energy sector could more than double in size and scope and increase its electric vehicles production from 10% to 25% of the entire world.   

In response to the gripes of the EU, American officials have responded that the U.S. is footing the green energy research and development costs bill for everyone else. John Kerry, the former Secretary of State under Obama and the current U.S. climate envoy, has stated

“It falls upon the most able countries in the world, including the United States, to make the investments that will commercialize these technologies and lower their costs for the rest of the world… By the time 2030 approaches, folks, we’re going to have made clean technologies much more accessible, much more affordable for the rest of the world”.

            It is evident that America does not want to make many, if any, concessions on the IRA bill. This bill is popular amongst the American people, regardless of party, and the Biden administration is delivering on its promise to make America green.  The bill will also increase America’s GDP and trade, both of which have been lagging since Covid-19. The only ‘cost’ in Biden’s eye is continuing the slight deterioration in Euro-American relations. However, as many in the administration have expressed, America is merely enacting serious climate-friendly policies, actions Europe has been demanding for the past twenty years.

The European Perspective

Europe has shown to generally favor the spirit of the bill, as this is a long overdue first step for transferring the American industry sector from fossil fuels to carbon free resources. However, many European economic analysts and advisors have expressed major concern over American over-involvement in the natural market forces.  By incentivizing American investment, this bill is naturally going to take away from the rest of the world, mainly Europe.

As an example, under the stipulations of the IRA, electric vehicle companies can only benefit from the full subsidy scheme – a total of $7500 per vehicle – if they meet two conditions: first, that at least 40% of the critical raw materials used in the electric battery are extracted in the US or in a country with which the US has a trade agreement (though this threshold will increase to 80% by 2026); second, that at least 50% of the battery components are made or assembled in the US, Canada and Mexico threshold will increase to 100% by 2029).

For the companies that want to continue receiving subsidies beyond 2025, they would need to relocate to the U.S. – or at the very least, have US-integrated supply chains. Similarly, US consumers can buy European EVs but they would only benefit from IRA tax breaks if they buy cars that are “Made in America“. This prospect, combined with low U.S. energy prices, probably explains why Tesla announced in September that it was opening a battery plant in the U.S., rather than Germany. Iberdrola, the Spanish energy firm, and Safran, the French multinational company specializing in aviation, defense and space markets, have also relocated part of their activity to the U.S..

Companies are already moving to the United States with their innovations, tax dollars, and products. Europe can only respond by raising tariffs on U.S. products to bring the Biden administration to the negotiation table or enact their own subsidies to keep companies investing in Europe.

What the Future Might Hold

Similar in every situation, no know can know exact what will come of the IRA bill and Euro-American relations. However, given the current state of affairs as well as the known and outspoken positions of the parties involved, a well-informed conjecture can be hypothesized.

It is quite unlikely that America will make any significant alterations to the IRA, if any whatsoever. Not only is Biden committing his campaign platform, as it is estimated that these incentives will allow America to achieve almost two thirds of their Paris Climate Agreement goals and cut annual emissions by 44% by 2030; this deal also greatly supports and develops the American economy and energy sector. What is more unclear is how Europe, and perhaps the world, will respond.  A core reason for this uncertainty is due to how sudden and quick this bill was proposed, passed, and put into effect.  This entire process took less than fifteen months, which is abnormally quick given the fact that the FairTax Act of 2021 has not even been voted on yet. Due to the quick political moves by an usually lethargic Congress, Europe now must scramble to respond.

Realistically, Europe has only three options.  The first two, the trade war and new European subsidies, have previously been mentioned and discussed.  The third option is to wait and see if America will make changes without a direct confrontation. Maybe the IRA is not as effective as the experts believe or there will be a major Red Wave in 2024 where the Republicans win the presidency and both Houses of Congress. 

None of the options are attractive for the European Union as they will lose an ally in the first case, spend more money and lose tax dollars in the second, and look weak and indecisive in the last. Realistically, the EU will most likely develop a green subsidy of its own and have green tax credits for individuals and companies alike. This will take months to formulate, pass, and exercise, but even Ursula von der Leyen, the President of the European Commission, has stated the need for an “European IRA”. Regardless, the EU summit occurring on February 9^th and 10^th will be telling in Europe’s response to the IRA bill.

The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.

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