US-China trade war morphs into tech subsidy war

Instead of lifting Donald Trump’s trade barriers, US President Joe Biden has fully embraced industrial policy, offering massive subsidies to domestic manufacturers. Although this might enhance manufacturing capacity in the short term, it also risks triggering a financially draining global subsidy war with no clear winners

Anne O. Krueger 18 Aug 2023

To the dismay of many economists, US President Joe Biden’s administration has retained most of its predecessor’s tariffs and trade barriers. In fact, contrary to most analysts’ expectations, the United States has imposed additional protectionist measures, such as Biden’s “buy American” policies, resulting in higher costs for American consumers and taxpayers.

During Donald Trump’s presidency, the US imposed a 25% tariff on steel imports and a 10% tariff on imported aluminium. Trump’s administration initiated a trade war with China, withdrew from the Trans-Pacific Partnership (TPP) that former US Presidents George W. Bush and Barack Obama negotiated with 12 Pacific Rim countries, and “renegotiated” the North American Free Trade Agreement, rebranding it as the United States-Mexico-Canada Agreement.

Trump chose to take these and other actions unilaterally, even though pursuing a multilateral approach through the World Trade Organization would have been far more effective and less likely to harm US allies. The Biden administration, however, has gone even further, fully embracing industrial policy by enacting the US$430 billion Inflation Reduction Act (IRA), which includes hundreds of billions of dollars in subsidies for green technologies and renewable energies, and the US$280 billion Chips and Science Act, aimed at fostering a robust US semiconductor industry.

According to the White House, the Chips Act will bolster domestic semiconductor production and create “tens of thousands of good-paying, union construction jobs and thousands more high-skilled manufacturing jobs” while mobilizing hundreds of billions of dollars in additional private investments. To facilitate the reshoring of chip production, the act allocates US$52 billion to research and development and workforce training and provides a 25% tax credit to domestic manufacturers. By subsidizing US-based companies, however, the bill effectively discriminates against foreign and overseas producers. Similarly, the IRA provides a US$7,500 subsidy to purchasers of US-made electric vehicles (EVs), giving American-made models an advantage over their Chinese and Japanese rivals.

But studies have repeatedly shown that subsidies often harm the countries implementing them. Such measures tend to reduce competition, stifle innovation, raise costs, and disadvantage exporters who rely on imported inputs. Worse yet, when one country introduces subsidies to enhance the competitiveness of domestic producers, other countries typically counter with protectionist policies of their own. And retaliation and tit-for-tat escalation damages the economies of other countries and their trading partners.

It is already clear that the coming subsidy war will have no clear winners. Depending on the size of retaliatory foreign subsidies, they may nullify some (if not all) of the competitive gains that the initial subsidy aimed to provide.

This dynamic is particularly evident in sectors such as semiconductors, batteries and EVs. In response to Biden’s industrial policies, for example, the European Union has recently greenlit a €43 billion (US$47 billion) plan to bolster its semiconductor industry, while South Korea and Japan have also rolled out plans to subsidize domestic chip production. Meanwhile, European, Japanese and South Korean companies are establishing or investing in US facilities to qualify for IRA subsidies and tax credits.

While Biden’s subsidies might enhance domestic semiconductor manufacturing capacity, especially given America’s ability to out-subsidize most rivals, this will come at a cost. Morris Chang, founder of the Taiwan Semiconductor Manufacturing Company, has recently estimated that chip manufacturing is 50% more expensive in the US than in Taiwan, where more than 90% of the world’s high-end chips are currently produced. Chang is sceptical that the existing US subsidies would be enough to close this cost gap. But as Adam Posen of the Peterson Institute for International Economics notes, the true price of economic decoupling is “not so much trade barriers, bad as they are, but reduced productivity growth”.

Moreover, a significant portion of the money spent on industrial subsidies will likely go to waste, increasing the burden on all taxpayers. Redirecting these funds toward education, job training, research, and infrastructure would do far more to enhance industrial competitiveness, both domestically and globally. Regrettably, US secretary of commerce Gina Raimondo has recently touted the Chips Act as a blueprint for supporting other domestic sectors. Given that other countries will almost certainly respond in kind, it appears that Trump’s trade war with China has morphed into a budget-busting global subsidy war that no one can win.

Anne O. Krueger is senior research professor of international economics at the Johns Hopkins University School of Advanced International Studies, a senior fellow at the Center for International Development at Stanford University, and a former World Bank chief economist and first deputy managing director of the International Monetary Fund.

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