Industrial policy under the Inflation Reduction Act is repeatedly presented as a role model in Germany, most recently in an article in the Handelsblatt. There are good reasons to doubt this.
Different ways to protect the climate
The Handelsblatt recently reported very positively on the American Inflation Reduction Act. āThe US funding program is working,ā is stated at the beginning of the article, supported by a graphic that shows how American investments in green technologies have increased from just over 150 billion euros per year since 2015 to now around 270 billion euros are. Thatās true, but in the same graph you can also see that the corresponding investments of the EU-27 countries in 2023 were still a good 100 billion higher.
The USA is catching up, but is still far from leading the marathon towards climate neutrality. The reason for this is their politics. First of all, because for a long time climate protection was not a high political priority in the USA. This was not only true recently under Trump; The Obama administration had also done much less on climate policy than its rhetoric signaled.
In addition, regulations or even emissions trading are politically more difficult to implement in the American Congress than was the case with the IRA. This could be used as a so-called as part of the budget process Budget Reconciliation Act be decided. For such laws, a simple majority is enough in the Senate, while other new laws on climate protection would need a qualified majority of 60 percent to pass a notorious one Filibuster to overrule. In the USA, climate protection through subsidies is politically feasible due to this detail, but it is unlikely to be possible through regulatory law and nationwide emissions trading.
In this respect, we have to imagine the IRA on the part of the USA as a clever political emergency solution, not as an efficient silver bullet to climate neutrality. And so the actually remarkable increase in green investments by companies in the USA that we are currently seeing represents a catch-up compared to Europe. Here we have emissions trading that covers more and more sectors over time and we have nolens Volens also strong regulatory interventions in the decisions of companies and consumers.
The USA and Europe are on different paths to climate protection. Given that the mix of measures is different from the outset, it would be a short circuit to simply point to the USAās high subsidies and claim that we should do the same. Because most economists consider emissions trading to be the more efficient system. And if you already have this and are continuously improving it, then there are fewer good arguments for adding even higher subsidies. We do not have to focus on climate protection through subsidies because we have better instruments at our disposal.
Subsidies in Europe
Nevertheless, we should not forget that Europe is already heavily subsidized. Not only does the EU itself provide within its framework European Green Deal significant resources are available for the path to climate neutrality. In addition, through relaxed state aid rules, it also allows member states to subsidize their companies more than before, provided these subsidies can be supported by a green justification. This represents a break with previous policy in the internal market.
In its history, the EU has made great achievements, particularly in the area of āāstate aid control. The inefficient intra-European subsidy race was curbed, thus protecting the internal market from political distortions. Unfortunately, Brussels is increasingly moving away from this principle. As a result, economics ministers in the member states have more frequent opportunities to make acclaimed appearances in which they present funding notices to the workforce of uncompetitive companies.
This is good for the short-term popularity of economic ministers, but less good for the long-term growth prospects of their economies. Subsidizing steel companies, for example, which will probably never produce green steel competitively at German energy prices, means that labor and capital are tied up there and no longer available elsewhere where they could be used more efficiently and in a more future-oriented manner stand.
Politicians too often still think in a model with high levels of involuntary unemployment and large unused capacities. In such a model, one can still argue that the real opportunity costs of maintaining subsidized non-competitive production are low ā the production factors have no other use there. In todayās world, however, this is no longer the case. Anyone who artificially maintains inefficient structures or subsidizes new production that is unlikely to be competitive is thus ensuring that the use of labor and capital is inhibiting growth. We canāt really afford that in sluggish Europe, and certainly not in stagnating Germany.
One may still accuse Europe of not subsidizing too little, but of doing so incorrectly. For companies in the USA, the risk of calculating subsidies from the IRA is manageable. The requirements are defined in the law and anyone who meets them automatically receives their funds in the form of tax credits. This is a reliable and low-bureaucracy process.
On the European side, there are complex individual applications that take a lot of time, sometimes years, to prepare and process until the final decision is made. The procedures can be so complex that an entire service industry has now formed that offers funding advice for companies. This is another way to create jobs, although their overall economic productivity is doubtful. Once funding has been approved, extensive reporting requirements usually follow.
However, the American model also has a crucial disadvantage: it is not capped. All figures about the size of the IRA are initially only estimates, as no one knows exactly to what extent companies will ultimately take advantage of the funding offers. The costs to American taxpayers may therefore drastically exceed all current estimates.
And the debt?
It is very likely that the US will only maintain its IRA program for a limited rather than broad period of time. The best way to interpret the IRA is as an attempt in some possible way before the upcoming presidential election Swing States to trigger another economic fireworks display. Perhaps the Trump Prevention Act would have been an appropriate name for the IRA. The graph below shows the development of the interest payments that the American federal government has to pay to its creditors each year (source: St. Louis Fed).
The current developments are dramatic. Here we can no longer say that faster growth and higher tax revenues overcompensate for the growth in interest expenses. With limited political scope for tax increases, the USA is heading towards a situation in which interest payments will noticeably limit the current scope for spending.
It is clear that there can be no question of sustainable development here. Despite all its privileges on the capital market, the USA cannot continue to take on new debt every year to the same extent as it currently does. However, it is at least very doubtful whether the IRA will survive in its current form if there is a consolidation of public finances in the USA. There is actually not much to support the expectation that the IRA can work as a lasting industrial policy strategy.
Sustainable capital stock?
Finally, there is also the question of how effective the subsidies actually are for building a sustainable capital stock in companies. The Handelsblatt reports that a large part of the investments are in e-mobility. The German companies Mercedes-Benz, VW and BMW mentioned in the report primarily cite the modernization and expansion of existing plants in the USA as projects. This is symptomatic: In addition to the development of new capacities, there are generally also large deadweight effects with the IRA: replacement investments that would have been due anyway are now co-financed by the taxpayer.
For this reason alone, one should not allow oneself to be driven so easily crazy on the European side. By no means every IRA-sponsored investment by a European company in the USA represents an outflow of production from Europe. In addition, in sectors such as e-mobility, the IRA promotes investments in areas where there is currently excess capacity and whose growth prospects appear bleaker than a few years ago.
Perhaps much more could be achieved with a much smaller amount of money. For example, one could invest in basic research in battery technology rather than in building capacity for the production of current technology. Then the next generation of batteries could be used to build cars that eliminate existing barriers on the demand side. So you wouldnāt spend a lot of money creating more excess capacity with stagnating demand for e-mobility, but rather you would shift the demand curve to the right with a lot less money.
We will only be able to judge how successful the IRA really is when we see in ten years which production facilities are still working and at full capacity. And the question of additionality will also have to be critically discussed among the companies that are still operating: What investments would there have been without the IRA? Was the effort worth it? Could these enormous public resources have been more beneficial if used differently?
Conclusion
Celebratory reports about the supposedly highly effective IRA are snapshots that only focus on the investment and funding amounts, both of which are high at first glance. It would be nice to take a somewhat more comprehensive perspective when assessing the efficiency of the IRA in the future. The program is fiscally expensive and its long-term effectiveness remains unclear. The character of the IRA as a second-best solution when there is a political blockage of more efficient climate policy mechanisms is unfortunately underexposed in discussions on our side of the Atlantic. Precisely because one only stares at the subsidy amounts instead of comparing the mix of measures as a whole with regard to their climate and industrial policy effectiveness, one runs the risk of politically motivating an economically damaging subsidy race. However, leaving future generations with higher debts and an inefficient climate and industrial policy is certainly not desirable.
Brandenburg Technical University of Cottbus