THE U.S. CHALLENGE TO THE SUBSIDIES REGIME

The challenges posed to the international trading system from subsidies are not new. A 2006 report examining the link between subsidies, trade, and the WTO found that in 2003, just twenty-one developed countries spent $250 billion on subsidies, with total global spending estimated at $350 billion.40 Some estimates even suggest global subsidies could total over $3 trillion a year, or about 4 percent of global gross domestic product (GDP) in 2006.41 A more recent study found that since the global financial crisis, subsidies have been “the most frequent form of intervention . . . surpassing measures such as tariffs and other non-tariff measures,” accounting for almost half of all interventions.42 The spike in government spending is not limited to the financial crisis; subsidies have more than tripled since then.

Globally, the United States, China, and the European Union are responsible for more than half of all subsidy measures, prompting concerns over global equity, particularly regarding access to technology. In fact, a study by Global Trade Alert found that 37.6 percent of world trade in goods faced competitive distortions due to subsidies granted by the three largest markets to their own import-competing firms.43 The breadth of those subsidies is also alarming. According to economists Simon J. Evenett and Johannes Fritz, before the start of the COVID19 pandemic, “62% of global goods trade was in products and on trade routes where subsidised American, Chinese, and European firms compete.”44 Furthermore, 28 percent of all global goods are touched by U.S. and EU subsidies alone. Those numbers raise concerns about market access and fair competition globally.

Although governments have always used subsidies as tools to achieve certain policy aims, their proliferation over the last fifteen years is worrisome. A 2022 report by the OECD, the IMF, the World Bank,

and the WTO found that “subsidies appear to be widespread, growing, and often poorly targeted at their intended policy objectives” and that “this situation is spurring the use of unilateral trade defense measures, eroding public support for open trade, and contributing to severe trade tensions that impede progress on other global trade priorities.”45 More recent and growing U.S. support for using subsidies and “Buy American” policies has amplified that concern. A good example of the latter is the Build America, Buy America Act, part of the Infrastructure Investment and Jobs Act of 2021, which includes a domestic content procurement preference for federal infrastructure projects. The Biden administration had to waive those requirements due to the complexity of implementing the local content rules, which many in the construction industry oppose.46 However, in his 2023 State of the Union address, Biden doubled down on his Buy American plans and embraced what is being called a modern industrial strategy, irking U.S. trading partners and sowing fears of a global subsidies race.47

Two of the Biden administration’s signature legislative initiatives, the IRA and the CHIPS and Science Act, provide a first look at the new industrial policy and highlight the challenges it could pose to international subsidy disciplines and U.S. trading relationships more broadly.

THE INFLATION REDUCTION ACT

The IRA is the Biden administration’s signature climate action.48 With $370 billion in spending and tax credits to fight climate change and invest in low-emission energy sources, the IRA aspires to reduce greenhouse gas emissions by 40 percent below 2005 levels by 2030. Its tax credits incentivize consumers to purchase electric vehicles (EVs) and green their homes, and utility companies to invest in cleaner energy sources such as wind and solar. Funds are also set aside for a “green bank” to invest in clean energy projects throughout the United States, focusing on poor communities, and oil and gas companies will now be subject to fees for excess methane leakage. The IRA is a broad spending package that Biden described as “the most significant investment ever to tackle the climate crisis.”49

Though the IRA has generated bipartisan support, it has not been without controversy. Some U.S. allies, although welcoming of U.S. actions to do something on climate, have felt snubbed for not being consulted on certain provisions that discriminate against imports and prevent them from fully supporting the U.S. green transition. For example, one of the IRA’s most discussed provisions includes a

Rethinking International Rules on Subsidies

tax credit for consumers for certain qualifying electric vehicles that are assembled in the United States, Canada, or Mexico. Initially, that provision allowed a tax credit only for EVs assembled in the United States, but after a successful push from Canada and Mexico to account for the integrated North American auto supply chain, Congress adjusted the language.50 However, the provision still looks like a local content requirement, which is prohibited under WTO subsidy rules—meaning Americans who choose to purchase EVs assembled in Japan, South Korea, or Europe would not be eligible for the tax credit. Of course, the devil is in the details of the implementing rules—which could allow some foreign components to be included in final assembly, for instance. In December 2022, the U.S. Department of the Treasury released a white paper outlining the direction of upcoming guidance on how the critical mineral and battery component would be calculated, suggesting flexibility in implementation.51 Then, in April 2023, after receiving public comments, Treasury published a Notice of Proposed Rulemaking that further clarified that guidance.52 The new rule relaxes the content requirements and includes general criteria for a “free trade agreement” partner, opening the way for Japanese manufacturers to benefit after USTR negotiated a deal with Japan on critical minerals.53 The European Union and others are pushing for similar deals. However, those deals, and the new rule, remain contested.54

Another caveat to the EV tax credit is that for consumers to qualify for the entire $7,500 credit, the EV needs to include a battery in which 40 percent of the critical minerals and 50 percent of its components come from the United States or countries with which it has a trade agreement. That percentage will increase to 80 percent for critical minerals and 100 percent for components by 2029. The aim is to reduce reliance on China, which has 61 percent of the world’s lithium refining capacity and 90 percent of anode and electrolyte production—both important battery components.55 However, other countries have already been working toward securing critical mineral supply chains, and the United States does not have trade agreements with all of them. In particular, the EU, a major trading partner, would be excluded, though the Biden administration is attempting to ameliorate this gap with a critical minerals deal with select countries. European leaders are also concerned that U.S. spending will drive investment and jobs out of Europe and, more broadly, that “protectionism hinders competition and innovation and is detrimental to climate change mitigation.”56

The U.S. Challenge to the Subsidies Regime

Before the IRA, the Biden administration claimed a bipartisan victory for industrial policy with the CHIPS and Science Act, which features a $52.7 billion investment in semiconductor manufacturing, research, and development, as well as workforce development.57 Semiconductors are a critical component of the modern technological world; they power everything from smartphones to cars and washing machines to advanced weapons systems.

In the last eight years, U.S. semiconductor manufacturing capacity has declined by more than 10 percent.58 The figure used by the Biden administration is that the U.S share of global semiconductor manufacturing has decreased from 37 percent in 1990 to just 12 percent in 2021.59 Yet that widely cited figure only tells part of the story. A study by the Peterson Institute for International Economics notes that the U.S. share of global revenue from semiconductor manufacturing witnessed a much smaller decline in that same time period, from 25 to 20 percent.60 In the design phase, the United States is still dominant, accounting for 46 percent of the market as of 2020.61 Even so, although those firms are designing them in the United States, semiconductors are largely being made elsewhere.62

Taiwan is the global leader in semiconductor production, with 22 percent of the world’s market share, followed by South Korea (21 percent), then Japan and China (at 15 percent each). Security concerns about Taiwan have only increased U.S. anxiety over market concentration and strengthened the push for a diversification strategy. Roughly 85 percent of advanced semiconductor chip production—those chips used primarily for smartphones, high-end computers, and military technologies—happens in Taiwan. In contrast, no advanced semiconductor chip production happens in the United States. For legacy semiconductor chip production (chips used in some vehicles and other consumer electronics), the United States accounts for 8 percent of total global production.63

Given how far behind the United States lags, building up a domestic semiconductor manufacturing base will be challenging and expensive. For example, over a ten-year period, the cost of ownership of a new manufacturing plant located in the United States is around 30 percent higher than in Singapore, South Korea, and Taiwan, and 37 to 50 percent higher than in China.64

Two aspects of the CHIPS and Science Act are of particular interest in the trade context. First are the geographical restrictions on funding.

Rethinking International Rules on Subsidies

Recipients of CHIPS and Science Act funds cannot direct those funds to expand manufacturing in China or a list of other countries considered a national security concern to the United States. Though China has proven to be a less attractive destination for U.S. investment in the semiconductor industry than Japan, Singapore, Taiwan, and Europe, the number of Chinese chips deals involving U.S. private investors has increased in recent years.65

Second, the spending blitz could be insufficient.66 Taiwan is now spending $120 billion and has twenty new plants under construction or completed.67 Korea has a $452 billion investment toward its own “K semiconductor belt strategy” to compete with Chinese and U.S. investments.68 EU member states have also agreed to invest $44.4 billion to help reach their goal of producing 20 percent of the world’s semiconductors by 2030.69 India has invested $30 billion to bolster its domestic semiconductor and technology supply chains.70 China, on the other hand—still reeling from the economic consequences of its COVID-19 lockdown strategy—has paused recent semiconductor investments, including a planned $145 billion investment, due to their high costs and disappointing results.71

The other issue to consider is that constructing new fabrication plants is a major endeavor, requiring massive resources and a tremendous amount of labor. For instance, Intel is currently building two facilities in Chandler, Arizona, for $20 billion, which is expected to take three years and five thousand skilled construction workers to complete.72 Those investments could create many jobs and will require a skilled tech workforce to maintain over the long run.

Governments also face major challenges in subsidies’ effectiveness due to the increasingly complex nature of the global semiconductor supply chain. Items needed for chipmaking come from many countries, with some critical minerals for the semiconductor supply chain originating in China.73 Thus, subsidizing the domestic semiconductor industry within multiple countries could lead to the inefficient allocation of resources, and cooperation across countries will be necessary.

Furthermore, not only could those large investments and lack of international coordination lead to a supply glut of semiconductors, but they could also fail to solve the narrow market failure for which they seek to correct, and they could create unnecessary trade conflicts along the way.74 The supply-chain disruptions brought on by the COVID-19 pandemic have minimized over time, and the high demand for semiconductor products has cooled down, which has led to a supply surplus and some companies scaling back their orders.75

The U.S. Challenge to the Subsidies Regime