Subsidy wars heat up with US allies forced to pay up or lose out

Late one night in May, some bad news landed in Jason Roe's inbox. About 60 members of his union, who were putting up steel beams for an electric-vehicle battery plant in the Canadian city of Windsor, were getting laid off.

That came as a shock because the factory, a $4.1 billion joint venture by Stellantis NV and LG Energy Solution Ltd., had been announced with great fanfare by Prime Minister Justin Trudeau's government only a year earlier — and backed by dollops of public cash. But suddenly the C$1 billion ($759 million) of federal and provincial grants on offer weren't going to be enough.

What changed the calculus — and upended the plans of governments and businesses across the world — was President Joe Biden's sweeping new industrial policy in the US. How it plays out may determine not just Biden's electoral fate but that of political leaders around the globe.

Locked in a fight with China for global dominance, the Biden administration is pouring subsidies into local manufacturing via landmark measures including last year's Inflation Reduction Act. The goal is to entrench American leadership in industries of the future like clean energy and semiconductors, and create well-paid jobs at home. 

The effect has been to kickstart a global contest that's straining alliances, threatening budgets and channeling unprecedented amounts of public cash into private companies.

The latest example of how it's warping economies came on Monday with the news that Germany was readying subsidies for high-end chip plants totaling some €20 billion ($22 billion). A few days earlier, the UK government — previously adamant that it wouldn't get into a subsidy race — was celebrating when Tata Group picked Britain ahead of rivals as the site of a new EV battery plant, after securing a promise of financial help estimated at more than £500 million ($645 million).

Precisely how much cash is being deployed to fuel investment is hard to calculate, because the support takes many forms including tax breaks, cheap loans and grants. Morgan Stanley analysts estimate that governments worldwide have pumped more than $500 billion in direct subsidies for manufacturing low-carbon equipment.

"The debate is about how to intervene, not whether intervention is necessary," says economist Réka Juhász, co-founder of the Industrial Policy Group, a research center that attempts to keep track of all these government moves. Critics of the US shift should acknowledge the failure of market-driven approaches to tackling climate change and supply-chain security, she says.  "The market won't magically deliver this in and of itself."

'Black Hole'

In Canada, a standoff over subsidies left Stellantis threatening to build its plant in the US instead. The company, which owns the Chrysler and Jeep brands, said it needed a "level playing field" to bring down the cost of EVs and compete with other automakers getting IRA-sized money. And it was potentially eligible for US tax credits worth almost 20 times what Canada was offering.  

"The beauty of the IRA is, there's lots of competition in that space now," says Mark Stewart, the carmaker's chief operating officer for North America. Stellantis wasn't short of US options. "We already had incentive packages put together from quite a few states," Stewart says. "We would've done a substitution."

But losing the factory would have been disastrous for Trudeau's government, which saw the project as crucial for Canada to keep its share of the North American auto industry — not to mention thousands of jobs, including at suppliers of materials and parts.

After initially balking at the fiscal cost, Ottawa relented and agreed to an additional package worth up to C$15 billion, the largest in national history for a single factory. Construction resumed at Windsor – just across the river from America's Motor City, Detroit — and Roe's ironworkers were back on the job. Trudeau's ministers were left to wonder how many more such deals the country could afford — a question that's been top of mind ever since the US legislation passed last August. At one budget update, a top official called the IRA a "black hole sucking investment into the United States."

The US defense of its new policy direction is clear-cut: If there's a subsidy war under way then China started it, and America's allies should all share an interest in pushing back against Beijing. The Biden administration is working "to harmonize these clean energy incentives with partners around the world," the White House said in a report this month. The twin goals of using state aid to create jobs at home while maintaining a technological lead over China fuse into what US National Security Advisor Jake Sullivan calls a "foreign policy for the middle class."

It's true that China has far outspent its rivals. In 2019, before the pandemic and Russia's war in Ukraine upended the world economy, Chinese outlays on industrial policy were about $250 billion, according to a study by the Center for Strategic and International Studies. As a share of the economy, that was about four times more than the US, which also lagged behind allies like Korea and Germany back then, though perhaps not anymore.Click and drag to move

Beijing's Made in China 2025 program, which targets global leadership in key areas from robotics to medical devices, was a key trigger for the US-China trade war launched by President Donald Trump and broadly continued by Biden.

'Bordering on Hypocritical'

Still, plenty of economists question the wisdom of adopting the same state-led approach, and bucking decades of consensus that governments aren't good at picking business winners.

It's "ironic, bordering on hypocritical," says Stephen Roach, a Yale University senior fellow. The US has been "so critical of China, and now we're wading into the same waters." For Roach, a former chief economist at Morgan Stanley, it amounts to "rethinking the open architecture of market-driven globalization."

It's already clear that the new landscape is one in which only those with means can thrive. Winners and losers are starting to emerge.

In the US, the Treasury published a June report celebrating a boom in US factory-building since the passage of Biden's  CHIPS and Science Act, which offers $52 billion for semiconductor manufacturing, and the IRA. "The same surge in manufacturing construction is not apparent in other advanced economies," it noted.

In Europe, one senior official says the US has effectively left the rules-based order, and a global race is under way that's allowing companies to go "subsidy shopping." The problem for the EU is that it has neither America's leverage nor China's deep pockets, and public aid is propping up companies and business models that would otherwise struggle, the official says.

The European Union has a direct response to Biden's industrial policy, through the €43 billion Chips Act —  enacted this week — and the Green Deal Industrial Plan. But some companies are already complaining about the money being offered to rivals, while individual countries differ dramatically in their ability to compete — raising concerns in Brussels that the EU's founding principle of a level playing field for member states will be under threat.

So Germany, the world's fourth-largest economy and the bloc's dominant power, can afford to spend big to secure battery plants and chip fabs. It came up with €10 billion for an Intel Corp. facility, roughly €1 million for each of the 10,000 jobs envisaged. Berlin also convinced Swedish battery maker Northvolt AB to locate a plant in Germany rather than the US, with a pledge of some €1 billion toward the €4.5 billion investment. "If the opponent pushes and the referee doesn't whistle, then you have to push back to win the game," is how Economy Minister Robert Habeck describes the subsidy drive.

French President Emmanuel Macron wants green industry measures that are "fast and spectacular," according to an official with knowledge of his position. His government announced €2.9 billion of support for chipmakers GlobalFoundries Inc. and STMicroelectronics, and is luring companies to develop a battery corridor in the country's north, a region synonymous with industrial decline.

But even wealthy countries face a fight to keep their companies from shifting output to the US. Take Norway, which boasts the world's highest proportion of electric vehicles. It put forward a green industrial strategy last June, backed by about 60 billion kroner ($5.4 billion) in state loans, guarantees and equity to support private investments through 2025.

'The World Is Worried'

That hasn't prevented Norwegian companies such as fertilizer maker Yara International ASA and Freyr Battery SA moving ahead with plans to invest in US production as a result of the IRA. The government was forced to consider expanding its own incentives — though Trade and Industry Minister Jan Christian Vestre warned on June 30: "We won't compete to be the cheapest or the most subsidized."

Spain, meanwhile, lost out to the UK on Tata's Jaguar Land Rover plant, and Tesla Inc. opted against building a factory in Valencia.

It's "not a bad thing in itself" that governments are directing all this support to the green transition, says Cecilia Malmström, a former European Union trade commissioner. The risk is that "subsidies from one country hurt other countries," she says. "That's what I think the world is worried about."

In Asia, some of the main US allies have a long history of government backing for strategic industries, and they're ready to ramp it up now. South Korea's government is teaming up with its key companies, like the memory chip-making giants Samsung Electronics Co. and SK Hynix Inc., on an investment plan worth more than $400 billion, which includes support for batteries, robots, EVs and biotechnology. President Yoon Suk Yeol says the country needs to compete with rivals that are "sparing nothing in large-scale subsidies."

The picture is generally bleaker for low-income countries, though some have a shot at getting IRA funds available to nations that have free-trade deals with Washington, such as Mexico. That's creating tensions too. For example, Argentina is the world's fastest-growing producer of lithium — a key metal for EV battery production — but it doesn't have a free-trade deal with the US, unlike the top two suppliers of the metal, Australia and Chile. It's been furiously lobbying the Biden administration for access to the US market.

In the end, a global subsidy war would likely bring "a fair amount of waste, an increase in economic distortions, and an uncertain set of ultimate outcomes," says Stephen Olson, a former US trade negotiator. But that's the way the ground is shifting.

Not so long ago, industrial policy was a pejorative term "that brought to mind failed Soviet apparatchiks trying to dictate how many shoes a factory should produce," Olson says. "Today we find ourselves in a completely different world. The intellectual and philosophical change is mind-bending.''

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement