From trade war to subsidy war

By Anne O. Krueger

To the dismay of many economists, U.S. President Joe Biden's administration has retained most of its predecessor's tariffs and trade barriers. 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 U.S. imposed a 25 percent tariff on steel imports and a 10 percent tariff on imported aluminum. Trump's administration initiated a trade war with China, withdrew from the Trans-Pacific Partnership (TPP) that former U.S. 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 U.S. allies. The Biden administration, however, has gone even further, fully embracing industrial policy by enacting the $430 billion Inflation Reduction Act (IRA), which includes hundreds of billions of dollars in subsidies for green technologies and renewable energies, and the $280 billion CHIPS and Science Act, aimed at fostering a robust U.S. 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 $52 billion to research and development and workforce training and provides a 25 percent tax credit to domestic manufacturers. By subsidizing U.S.-based companies, however, the bill effectively discriminates against foreign and overseas producers. Similarly, the IRA provides a $7,500 subsidy to purchasers of U.S.-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 damage 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 ($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 U.S. 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, a founder of the Taiwan Semiconductor Manufacturing Company, has recently estimated that chip manufacturing is 50 percent more expensive in the U.S. than in China's Taiwan region, where more than 90 percent of the world's high-end chips are currently produced. Chang is skeptical that the existing U.S. 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, U.S. 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, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is a Senior Research Professor of International Economics at the Johns Hopkins University School of Advanced International Studies and Senior Fellow at the Center for International Development at Stanford University.