The United States Trade Representative’s Annual Report to Congress on China’s WTO Compliance in February 2024 repeated the same lines it does each year: ‘China continues to provide massive subsidies to its domestic industries, which have caused injury to U.S. industries and the industries of other WTO Members’.
The USTR did so without a hint of irony given the massive subsidies deployed under the Inflation Reduction Act and CHIPS and Science Act since August 2022.
Estimates of the cost of the US subsidies, which come in the form of tax credits with no caps, range from US$391 billion to US$1.2 trillion for the IRA and US$280 billion for the CHIPS and Science Act.
Not to be outdone on irony, on 28 March this year China challenged the legality of US subsidies in the WTO, invoking three WTO agreements.
Those US subsidies aim to curb inflation, win the clean energy competition with China, bring back manufacturing to the US heartland, lower healthcare costs, boost US semiconductor manufacturing and boost scientific research. So much for the Tinbergen rule of one policy tool for each policy target.
Chinese industrial subsidies have been an issue of contention for manufacturing and technology competitors in the United States, Europe and Japan. Now the US subsidies have started a global race to the bottom. This development has significant implications for the rest of the world.
To counter competition from China, the United States is becoming more like China. Even countries that don’t have the fiscal capacity or firepower, like Australia and Japan, have joined the game. Japan has record-high public debt but is spending like it did in the 1980s in the name of economic security. Australia’s Albanese government has unveiled its Future Made in Australia program, targeting multiple objectives. Industrial subsidies are costly, distort markets and have a bad record of success.
To be sure, communities are demanding more from their governments. It seemed as if markets failed communities with disruptions to supply during the pandemic lockdowns, even though it was market forces that rapidly resolved those shortfalls and governments that frequently exacerbated them. Across the world, governments are facing the challenges of climate change, heightened geopolitical risk, new technologies, the weaponisation of trade and economic policy and high inflation. Many of these risks feed off each other. The easiest tools to grasp for are the blunt instruments of subsidies and trade restrictions.
There are simple and well understood frameworks to understand what should be subsidised and what should be taxed. Negative externalities or spillovers, like pollution, should be taxed so the costs on society are internalised by those producing the pollution. Activities like research and knowledge creation have positive spillovers on society and should be subsidised. Failing to understand this framework and doing the opposite — subsidising a negative externality like the production of fossil fuels while trying to cut carbon emissions — is harmful.
There’s an argument for subsidising renewable energy production and green technologies in the absence of a price on carbon. And we are in a second-best world of policy choices without a proper price on carbon. That does not mean third and fourth best policy options, like taxing low-cost goods for carbon abatement, should be adopted.
The problem with the US IRA is that it is designed to favour the use of domestic over imported goods. When subsidies may be extended to companies from countries on friendly terms with the United States, they are voided if the goods they produce have Chinese input. Indonesian companies are unable to access IRA subsidies, for example, because Indonesia’s downstreaming policies restrict the export of nickel to attract Chinese investment into downstream processing.
There are better ways to influence Indonesian companies and effect the global energy transition. US subsidies could be made available to Indonesian and any companies if they have high environmental credentials, for example, and help foster a race to the top in clean energy practices.
Protectionist subsidies can be more damaging than welfare-reducing import tariffs. The United States is now deploying both on scale, having quadrupled tariffs on Chinese electric vehicles to 100 per cent, along with lifting a raft of other tariffs, this month.
As Mandy Meng Fang explains in this week’s lead article, ‘China claims that the IRA contains illegal trade-related investment measures and prohibited subsidies’. The Chinese argument is that the US measures breach the ‘WTO’s cornerstone principles of national treatment and most favoured nation treatment’.
If the US arguments against Chinese subsidies are anything to go by, it won’t have much of a case in the WTO. But the WTO rules are not enforceable because the United States neutered the dispute settlement body of the multilateral trading body. USTR has also trashed the WTO’s ruling against US steel and aluminium tariffs in the name of national security.
The world is in a race to the bottom. The starting point in correcting this damaging trajectory is leadership in getting the thinking right domestically. The hope is to do so before the costs start to mount and become prohibitive.
The United States and China (and the follower European Union) might be intent on making everything at home and using taxpayer funds for very low returns, sapping productivity and growth potential, but that does not mean the rest of the world need blindly follow.
The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.