In recent months, the United States and European Union have introduced green subsidy schemes aimed at accelerating renewable technologies. While the US Inflation Reduction Act and EU Green Deal Investment Plan encourage private sector innovation, some people fear they could threaten developing economies and worsen global trade tensions.
In particular, the Inflation Reduction Act’s local-content requirements for electric vehicle components and batteries have provoked concern among US trade allies, including the European Union, South Korea and Japan, who fear that their companies will be incentivised to relocate their operations to North America. Volkswagen, one of Europe’s largest carmakers, has already paused plans to build a new factory in Eastern Europe and announced plans to instead shift its focus to a similar plant in North America, the Financial Times reported.
Amid these tensions, the United States and Japan announced an agreement that will eliminate export duties on critical materials used to make electric vehicle batteries. The agreement opens the door for a wider framework under which key US trade partners could gain access to the Inflation Reduction Act’s generous tax breaks.
Commenting on the agreement with Japan, US Trade Representative Katherine Tai said: “Today’s announcement is proof of President Biden’s commitment to building resilient and secure supply chains. This is a welcome moment as the United States continues to work with our allies and partners to strengthen supply chains for critical minerals, including through the Inflation Reduction Act.”
As the US Inflation Reduction Act and EU Green Deal Investment Plan take shape, experts at the World Economic Forum are considering what green subsidies could mean for the future of global trade, climate change and supply chains.
Here’s what they think we can expect.
More government intervention in trade policy
Kimberley Botwright, Head, Sustainable Trade
In responding to the economic slump caused by the Covid-19 pandemic, governments around the world provided support for businesses and workers to maintain economic activity. Emerging from the pandemic, increased focus on the value of supply chain resilience led to further government interventions with the aim of increasing autonomy. The ever more urgent need to decarbonize our economies has prompted further state intervention. A World Economic Forum whitepaper – published as this trend began to emerge – highlighted the international competitive challenges of industrial policy and the need to rethink global rules.
Recently, the US, has pursued local content requirements as part of the support mechanisms for clean technologies in the Inflation Reduction Act (IRA). The EU has set a political target of 40% local production for net-zero technologies by 2030. These measures may drive market shifts, but also risk slowing the green transition. By making it less competitive, the best technologies lose out. Meanwhile, fossil fuel subsidies hit record levels in 2022, according to the International Energy Agency. International cooperation is greatly needed to establish criteria that recognise “good” subsidies, supporting global priorities, but limit trade distortions and phase down harmful subsidies.
Higher demand for critical materials behind clean technologies
Chido Munyati, Head of Regional Agenda, Africa
The green subsidies introduced by the US and EU will result in a significant increase in demand for critical minerals. More specifically, the International Energy Agency forecasts that 40 times more lithium, and around 20-25 times more graphite, cobalt and nickel will be needed to meet the requirements for clean energy technologies by 2040.
Notably, Africa holds 30% of the world’s mineral reserves, and a high concentration of the minerals critical to renewable and low-carbon technologies. For example, South Africa and Democratic Republic of the Congo are responsible for some 70% of global production of platinum and cobalt respectively, and Zimbabwe has the potential supply 20 percent of the world’s lithium.
However, these subsidies, will likely undermine the region’s efforts to move up the value chain, for example, to produce EV batteries. Africa is already at significant disadvantage when it comes to manufacturing, with higher costs for capital, and these subsidise could make it prohibitively expensive to manufacture clean technology components in Africa.
Moreover, a provision of the Inflation Reduction Act requires that at least 40% of the critical minerals in batteries are extracted or processed in the United States or a country with a US free-trade agreement. The United States does not have a free trade agreement in force with any individual Africa country, however, the African Growth and Opportunity Act (AGOA) and the Africa Continental Free Trade Area could provide a framework to strengthen collaboration on the green technology value chains.
Finally, although these subsidies are targeted domestically, they’ll likely have the effect of lowering the cost of green technologies, thus enabling the region to accelerate its energy transition.
Some green subsidies can have unintended consequences on natural ecosystems
Jack Hurd, Executive Director, Tropical Forest Alliance
We should embrace the types of subsidies that create and sustain jobs, conserve and restore nature and combat climate change. Subsidies that target regenerative agriculture, sustainable fisheries, reforestation and the greening of supply chains are examples of the types of investments that we should be encouraging. The US Inflation Reduction Act shows promise in that it invests in forests as a climate solution domestically, in both urban and rural landscapes.
However, some subsidies can also have unintended consequences on natural ecosystems, particularly in developing economies. For example, accelerating demand for key components in electric vehicle batteries, such as nickel and copper, has the potential to create challenges in resource-rich countries. In such cases the anticipated growth in mining may conflict with other national objectives such as slowing and halting deforestation. It is important for policy makers to understand the impact of, and safeguard against, such consequences at home and abroad.
Increased competition with China
Shouqing Zhu, Head, China Climate Action
Chinese governmental and non-governmental entities believe that the American Inflation Reduction Act and EU’s Net-Zero Industrial Act and Critical Materials Act have protectionist bias towards trade. With the IRA in particular, there is relatively little discussion of the EU’s Net Zero Industry Act and Critical Raw Materials Act.
Many people believe that green subsidies from the EU and the US will in the long-term push China’s green technologies forward, and that competition between the three major world economies could lead to a reduction in the cost of green technologies, thus contributing to the achievement of the global net zero goal. However, in the short term, although China is dominant in the international market in terms of photovoltaic (PV) production and exports, it still lags behind in some key technologies, like green hydrogen storage and transport. Therefore, China will face enormous pressure in green technology development as a result of these subsidies.
The development of green technologies in China, the US and Europe will objectively bring about emission reduction effects, but the protectionism associated green subsidies will have a profound impact on global trade rules. These American and EU rules are to some extent motivated by geo-economic considerations and will work against China’s green development. That is why Chinese Foreign Minister Qin Gang indicated that these regulatory measures will disrupt the globalised supply chain. Moreover, not all economies can afford to subsidise their green sectors, and competition for green subsidies could widen the gap between the North and the Global South.
Green investment in developing economies could drop
Boris Brkovic, Clean Technology Acceleration Lead, First Movers Coalition
With the Inflation Reduction Act, the US has introduced sweeping tax incentives and grants programmes aimed at reducing carbon emissions across multiple industries. The IRA could position the United States as a leader in the low-carbon economy. However, this legislation also includes trade-distortive subsidies, such as local-content requirements, which prohibited under World Trade Organisation rules. This marks the first time the US has violated local-content requirement rules.
While the impact of both policies on their respective local economies and climate targets is projected to be positive, the influence of these subsidies on the rest of the world is not clear.
It is possible, and there are early indications, that these subsidies could lead to a reduction in “green” foreign direct investment in developing and emerging economies. The question remains open on how the EU and US incentives impact the Global South in their decarbonization journey and will these result in a global net-positive when it comes to tackling climate change?
This article was originally published in the World Economic Forum.
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