The adoption of the US Inflation Reduction Act in 2022 has raised concerns among trading partners regarding its impact on global production and trade. This analysis examines the potential effects of the Act on various sectors and countries, focusing on the implications of its domestic content requirements.
The US Inflation Reduction Act (IRA) is designed to combat climate change and promote the adoption of green technologies in the United States. It offers financial incentives, such as tax credits for electric vehicles (EVs) and investments in renewable energy equipment, but these incentives are conditional on specific domestic content requirements. For instance, EVs must undergo final assembly in North America, and a significant portion of battery components and minerals must be manufactured or assembled in North America or in countries with which the US has a free trade agreement. Similarly, investments in renewable energy development require a certain proportion of components to be produced in North America. These provisions, while aimed at boosting domestic green production, could impact third countries through trade and relocation channels.
Modeling the Spillover Effects To estimate the potential economic effects of the Inflation Reduction Act, a model developed by Baqaee and Farhi (2023) is employed. This model considers higher trade barriers and the reactions of producers and consumers in a global economy. The analysis focuses on two key provisions of the IRA: tax credits for EVs and bonuses for investments in renewable energy equipment, both tied to domestic content requirements. These measures are modeled as trade cost reductions, benefiting USMCA producers and decreasing prices for US consumers when purchasing from them. Additionally, the analysis examines the impact of domestic content requirements for intermediate inputs used by USMCA producers of EVs, batteries, and renewable energy equipment, imposing trade cost shocks on imports from non-USMCA suppliers.
The magnitude of these shocks is scaled using International Energy Agency (IEA) projections for 2030, considering different scenarios: conservative, accelerated, and net zero, reflecting varying speeds of the green transition. Higher trade elasticities and lower elasticities of substitution for critical minerals and high-end technologies are applied in the accelerated and net zero scenarios. Additionally, the IRA’s aim to attract green investments that lead to productivity growth is accounted for by introducing an exogenous total factor productivity (TFP) shock.
Trade and Relocation Effects The analysis reveals limited global trade losses, ranging from 0.2% in the conservative scenario to 0.9% in the net zero scenario. This is due to the fact that the trade impact primarily originates from the US, with minimal effect on its largest trade partners (Mexico and Canada) and limited to specific sectors. Instead of trade destruction, the IRA induces trade flow reallocation. However, sectoral losses can be significant in targeted sectors, such as electrical and optical equipment, where global trade losses could reach 6% in the net zero scenario.
Concerns arise for US trade partners, including China and the EU, as they face potential losses in exports to the USMCA region. China could see a 10% to 50% reduction in its exports of electrical and optical equipment, while the EU may experience a 10% to 45% reduction.
Furthermore, second-round effects are observed, with production losses stemming from lower exports to the USMCA region leading to reduced exports to other countries. This results in excess supply in the sector and decreased demand for upstream products.
Conclusion Policies aimed at accelerating the green transition, coupled with trade barriers, can distort trade flows and prompt production reallocation driven by financial incentives rather than comparative advantage. Retaliatory measures by trading partners could exacerbate these issues, hindering the global diffusion of green technologies. International cooperation remains crucial in addressing climate change, given its global nature.
However, the assessment also recognizes the importance of reevaluating domestic security priorities, especially in light of the industrial and technological revolution brought about by the green transition. Countries seek investments to gain a competitive edge in future key sectors. Therefore, the economic effects discussed here likely represent a lower bound for both winners and losers, considering the broader strategic implications of the green transition.
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