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The Inflation Reduction Act: Protectionist Policy or a Global Climate Game-changer?

Isabella Notarpietro | Climate Fellow

Image credit: Andreas Gücklhorn via Unsplash

Just months before the November 2022 US mid-term elections, which saw the Democrats lose the House of Representatives, the Biden Administration passed the biggest piece of climate legislation in US history. The Inflation Reduction Act (IRA) commits USD$369 billion to climate change and energy security initiatives over the next decade, with the ultimate goal of establishing the US as the “global leader in clean energy technology, manufacturing, and innovation”. Some have heralded the IRA as a global climate game-changer, with the chief of the International Energy Agency (IEA) declaring the Act the “most important climate action after the Paris 2015 agreement”. Others, including many US allies, are concerned that the new policy is protectionist, has infeasible implementation timelines and is hypocritical in light of the US’ global climate financing commitments. The US should take these concerns seriously and engage more closely with international partners to ensure that the IRA’s global emissions reduction potential is realised.

What is the IRA?

The IRA provides heavy investment in clean technologies, primarily in the form of corporate and consumer tax credits. While these will apply to a broad range of industries, sector-based analysis by McKinsey indicates that energy is the biggest funding winner, set to receive over USD$250 billion of federal funds. This investment will largely derive from corporate tax and drug pricing reforms which are expected to reduce the budget deficit by more than USD$260 billion.

Modelling shows that this investment in clean technologies will have important climate impacts, reducing the US’ emissions by over 1,000 million metric tonnes of CO2e by 2030; a 40 per cent reduction from 2005 levels. This will take the US two thirds of the way to the 50-52 per cent 2030 reduction target promised at the start of the Biden administration. US officials argue that the bill will also yield global decarbonisation benefits by increasing pressure on advanced economies to implement similar financial packages to remain competitive and reducing the cost of clean technologies for the Global South.

Protectionism, Practicalities and Promises – Criticisms of the IRA

Despite these claims, many countries are sceptical of the global benefits that such a domestically oriented climate policy will produce. The IRA has attracted significant criticism internationally, particularly due to its protectionist tendencies, impractical timelines, and sheer magnitude compared to international climate finance.

India’s G20 Sherpa characterises the IRA as “the most protectionist act ever drafted in the world”. His critique stems from the IRA’s heavily skewed domestic sourcing and production requirements. For example, the USD$7,500 EV consumer tax credit requires that a significant proportion of an EV battery’s critical materials are sourced from the US or one of its free trade agreements (FTA) partners and that the EV is assembled in North America. The EU has raised concerns that these types of conditions will render EU products uncompetitive and incentivise industry relocation and capital reallocation to the US. There are also concerns the massive tax credits available for some clean technologies will distort global markets for existing and emerging green industries. For example, Australia has expressed concerns that the significant tax credits available for clean hydrogen (up to USD$3/kg) will make its own future hydrogen export industry uncompetitive.

There is also substantive criticism of the feasibility of the IRA's domestic supply chain approach. The Economist has noted that US-based production of clean technologies will make the transition more expensive while finding enough workers to meet construction requirements will be challenging given the US’ record low unemployment. The IRA’s domestic material sourcing quotas, while understandably aimed at strengthening US supply chains and manufacturing capabilities, are unlikely to be achievable within the legislated timeframes.

For example, the EV credits require that by 2023 at least 40 per cent of critical minerals are sourced or processed in the US (or an FTA partner) and 50 per cent of battery components are produced in North America. These thresholds increase on a sliding scale up to 80 per cent and 100 per cent respectively by 2029. From 2024, no battery components can be manufactured or assembled from “foreign entities of concern” such as China, Russia, and Iran. With the US currently having very limited critical mineral infrastructure and accounting for just 10% of EV assembly and 7% of battery production globally, there are valid concerns the country will not be able to meet domestic demand. While the FTA “ally shoring” approach aims to address this problem, China currently produces the vast majority of the world’s rare earth metals and assembles over 75 per cent of batteries. Combined with the 400-600 per cent demand increase expected for some critical minerals over the coming decades, FTA partners alone may not be able to fill the gaps. If demand were to outrun supply, decarbonisation efforts could be slowed rather than accelerated.

Finally, the IRA has raised questions over global climate justice and broken climate financing pledges. Some in the Global South have drawn attention to the hypocrisy of the US making such a significant domestic investment while failing to meet their international climate financing commitments: only USD$1 billion of the USD$11.4 billion Biden pledged to help Global South economies transition to clean energy had been approved by Congress by the end of 2022. Even if the full USD$11.4 billion had been approved, the amount is miserly compared to the hundreds of billions committed to domestic climate goals.

What Needs to Change?

The US should address the concerns of international partners and identify opportunities for mutual benefit and the acceleration of global emission reductions. A more collaborative approach would address problems with the feasibility of implementation timelines while enabling the economic benefits of the transition to net zero to be distributed more globally. With many non-FTA-partnered emerging economies, including many in South-East Asia, holding significant critical mineral deposits, there are significant opportunities for new trade partnerships to be formed. If these partnerships are designed so that emerging economies develop high value-add processing infrastructures domestically, the economic and social benefits for these countries—as well as the US—could be substantial.

The US should also better match its domestic climate ambitions with stronger global leadership on climate financing. The clean technology cost reductions catalysed by the IRA will take years to be realised. With the Global South currently experiencing a climate financing gap exceeding $565 billion, the US must not neglect its international climate financing commitments and the crucial role these can play in reducing global emissions.

The IRA provides a clear signal that the US is vying to be a global leader on climate action. However, with climate change a global problem requiring global solutions, the country will need to engage more collaboratively with international partners and look harder for opportunities to marry domestic policy with global objectives.

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