The Impact of the US Inflation Reduction Act on European Industry
A detailed analysis suggests that the handicap for European producers in the US market will be limited. This small negative effect is likely to be overwhelmed by the much-increased market, implying that the IRA leads to increased opportunities for exports of electric vehicles and renewable inputs to the US. Our calculations suggest that over time the US market for electric vehicles could increase by a factor of 4 and renewables installations should also increase by hundreds of percent. A commentary by Daniel Gros.
The Inflation Reduction Act (IRA), which was finally signed into law by US President Joe Biden almost a year ago (August 2022), represents the first major piece of legislation to combat climate change that the US House of Representatives has passed.
The IRA has had a particularly strong eco in Europe because of its clear intent to give the US leadership in key green technologies using local content provisions that are in all likelihood not compatible with WTO rules. This discrimination against imports has ignited a heated discussion in Europe about whether the EU needs to ‘respond’ to the IRA.
European ‘fear of missing out’ relative to the IRA is based on the headline figure of $ 380 billion budgeted over the next 10 years. But this amounts only to $ 38 billion per year, while the support for renewables alone costs each year about € 80 billion in the EU, much more than what the US has budgeted (not yet spent) for the IRA.
Support for renewables thus remains stronger in the EU than in the US even if a large part of these € 80 billion represents excessive feed-in tariffs granted to solar power installations granted around 2010.
Looking closer at the various provisions of the IRA reveals that its buy-American provisions are of minor importance compared to the huge step in terms of climate policy and market opportunities for EU producers. The accompanying Working Paper describes in more detail the key constituent elements of the IRA.
Three elements of the IRA have been particularly criticized in Europe:
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A subsidy of $ 7 500 for electric vehicles is available only for cars produced in North America.
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Renewables installations that use at least 40 % of US products for their manufacturing inputs receive a 10 % higher subsidy.
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The domestic production of certain elements for batteries and renewables receives generous support.
Looking closer at these provisions we find the following:
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The subsidy for electric vehicles amounts to only about 10 % of the purchase price. The disadvantage for EU producers on the US market is thus equivalent to the disadvantage of US producers on the EU market because the EU has a 10 % import tariff on cars. Moreover, the requirement that the electrical vehicle must be produced in North America to qualify for the subsidy is waived for vehicles sold under leasing arrangements and the majority of the high-end cars exported from the EU to the US are leased. The ‘Buy American’ provision for electrical vehicles thus appears largely meaningless for EU producers.
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The local content requirement for renewables is equivalent to about 5 % of the total cost since the small subsidy provided by the IRA (about 16 euro per MWh) is worth only one-half of the price of electric power in the US. Moreover, many renewable projects in the US, including those of EU companies, already satisfy the local content requirement.
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The domestic support for batteries promised by the IRA is similar to that already provided by the EU under the umbrella of the European Battery Alliance (€ 6 billion so far). Moreover, these domestic production subsidies will be available only for a limited time (until 2029).
The clamor for a European reaction risks legitimizing open-ended support for certain industries that will be very costly and unlikely to have lasting effects
New opportunities for EU firms
This detailed analysis suggests that the handicap for European producers in the US market will be limited. This small negative effect is likely to be overwhelmed by the much-increased market, implying that the IRA leads to increased opportunities for exports of electric vehicles and renewable inputs to the US. Our calculations suggest that over time the US market for electric vehicles could increase by a factor of 4 and renewables installations should also increase by hundreds of percent.
EU companies are likely to satisfy part of the expanding US demand by increasing production in the US. EU companies produce already today more cars in the US than they are exporting there from the EU. This means the European companies might invest more in the US. But there is no reason for them to reduce investments in the EU as it is highly unlikely that it would be profitable to export electric vehicles, or renewable inputs, from the US to Europe.
All in all, the IRA thus appears to be like a rose with only very small thorns. EU policy makers should stop complaining about the minor irritants in the IRA.
EU green industry has another reason for being thankful to the IRA: it has given them useful pressure points to ask for more subsidies from both national governments and the EU.
This might turn out to be the real danger of the IRA: the clamour for a European reaction risks legitimising open-ended support for certain industries that will be very costly and as unlikely to have lasting effects as the previous attempts to establish a European leadership in renewables.
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
