| bibo:abstract |
Ⅰ. Understanding the Inflation Reduction Act (IRA) of 2022
Ⅱ. Issues and Implications from the Inflation Reduction Act (IRA)
Ⅲ. Korea’s Response and Economic Security Strategy
Ⅰ. Understanding the Inflation Reduction Act (IRA) of 2022
The Inflation Reduction Act (IRA), signed into law by President Joe Biden on August 16, 2022, aims to curb inflation by directing a total of $773 billion in federal funding for beefing up climate efforts, reducing healthcare costs, and implementing corporate tax reform. $433 billion will be spent on fostering the renewable energy industry, providing “clean vehicle” tax cuts, and formulating responses to climate change with government spending and tax breaks. The IRA, which includes President Biden and the Democratic Party’s key policy initiatives, embodies the thrust of his administration’s “Build Back Better Act (BBB)” aimed at implementing Biden’s presidential pledges, which can be said to have rolled back the $3.5 trillion budget package of the BBB bill, focusing on the environment and health sectors.
Prior to the enactment of IRA, the Biden administration signed into law the “CHIPS and Science Act of 2022” on August 9. The CHIPS Act allocates a total of $280 billion to strengthen U.S. competitiveness in cutting-edge technologies, ultimately seeking to facilitate job creation, promote industrial competitiveness, and bolster American global leadership. Of the budget allocated, $52.7 billion will be invested in the semiconductor sector, including direct subsidies to build semiconductor manufacturing facilities, boost advanced semiconductor manufacturing R&D, and provide tax credits for investment in semiconductor facilities and equipment. The CHIPS Act also contains a ‘guard rail’ provision that prohibits U.S. and foreign semiconductor manufacturers subsidized by the U.S. government from expanding or constructing new production facilities in ‘countries of concern’, such as China. This means that South Korean companies operating semiconductor plants in China cannot expand existing production lines or upgrade their technologies. Since these investment restrictions are arbitrary in nature, they can cause a supply-demand mismatch in the semiconductor industry, consequently destabilizing the global semiconductor market. However, observers also pinpoint that IRA’s guard rail provision does not significantly affect South Korean companies’ semiconductor plants in China. And from a long-term perspective, South Korean semiconductor manufacturers may also benefit from the Biden administration’s containment policy against China’s economic rise.
In accordance with IRA, electric vehicles (EVs) must be produced in the North American region to qualify for government subsidies and tax incentives, which stokes concerns about discriminatory treatment of foreign-made electric vehicles. The imposition of discriminatory measures comes from the fact that U.S. and foreign-made EVs are competing against each other in the U.S. market, with the market share of South Korean EVs in the U.S. ranking second in 2021. Moreover, certain critical materials required to make EV batteries which are sourced by China account for more than 90 percent, heightening Washington’s concerns over excessive reliance on foreign supply chains. On the other hand, U.S. semiconductor companies are competitive in the design of semiconductors and manufacturing equipment, while foreign semiconductor manufacturers are more competitive in the fabrication process. As the U.S. has yet to perfect its domestic supply chains for manufacturing semiconductors, it needs to forge and deepen cooperation with countries that have advanced semiconductor manufacturing technologies such as Korea and Taiwan, and boost the domestic industry by attracting investments through tax credits and subsidies. In the case of EV batteries, IRA aims to create a more level playing field by offering incentives to domestic companies since external competitors are all vying for market dominance with aggressive industrial policies and subsidization. What is noteworthy is that, IRA, unlike the CHIPS Act, was legislated quite covertly without going through the normal process of gathering opinions from interested parties, partly due to the reason that the legislation contains President Biden’s priority policy objectives involving climate change and labor issues, particularly ahead of the U.S. midterm elections in November 2022.
Ⅱ. Issues and Implications from the Inflation Reduction Act (IRA)
Under IRA, a $433 billion budget to tackle climate change will be spent on incentives to spur investments, providing tax credits and rebates to lower energy costs for U.S. consumers, promote domestic manufacturing of energy production and storage facilities, and boost sales of eco-friendly vehicles. The problem is that only electric vehicles manufactured in the North American region can be eligible for incentives offered to boost sales of EVs. Specifically, IRA stipulates that in order to be eligible for tax credits, the final assembly of EVs should take place in the U.S., Canada, and Mexico. In addition, EVs have to contain certain proportions of critical minerals that are extracted or processed in the U.S. or a country which has a free trade agreement with the U.S., or recycled in North America. IRA also requires certain proportions of battery input materials to be extracted and processed locally in the U.S. in order to be eligible for tax cuts. The final assembly requirement will immediately take effect in 2022. Starting from 2023, the critical mineral and battery material requirements will apply, with the proportion of critical minerals required to take more than 40% in 2023, 50% in 2024, 60% in 2025, 70% in 2026, and 80% from 2027. As for battery input materials, locally supplied input has to account for more than 50% in 2023, and will be incrementally increased to 100% in 2029. Furthermore, EVs that contain any critical minerals (taking effect in January 2025) or materials (taking effect in January 2024) that are imported from China cannot be eligible for subsidies or tax breaks.
Under WTO rules, subsidies that have the effect of substituting the imports of WTO members with domestic production are prohibited per se. The IRA requirements for final assembly in North America and for sourcing critical minerals and materials for EV batteries mainly from local sources all have the effect as well as the intent of replacing foreign imports with domestic goods. As a consequence, countries that are negatively affected from the IRA legislation, such as Korea, can raise issue with the U.S. regarding the law’s discriminatory impact on EV sales and exports from foreign companies within the U.S. market.
Unfortunately, contrary to the Biden administration’s declared goal of building a more resilient supply chain with its allies and partners, IRA is imposing discriminatory treatment against the its critical supply chain partners. The law puts American interests above all else; it contains a number of requirements that violate multilateral trade rules and bilateral trade agreements. This runs afoul of the Biden administration’s policy drive to work with U.S. allies and partners to create a strong and resilient supply chain, and to some extent represents a disregard for the very idea that enabled cooperation among partners in the first place: delivering benefits to all parties. An arrangement that only benefits particular countries will eventually fail to materialize, and even if it does take shape, it will not be sustainable in the long run. Korea, a vital partner to pursue the Biden administration’s drive to strengthen its supply chains, has promised strategic cooperation with the U.S. through various economic initiatives, ranging from the Indo-Pacific Economic Framework (IPEF), Minerals Security Partnership (MSP), to the prospective Chip 4 alliance, in order to establish a stable and secure supply chain network of critical minerals and essential technologies. But IRA’s discriminatory clauses have caught Korea off guard, and the law would not only weaken the momentum for cooperation but also hinder the two sides’ efforts to translate various economic cooperation commitments into action.
IRA might have greater ramifications in the context of the international trade order. In addition to signing into law the CHIPS Act and IRA, President Biden recently issued an executive order for strengthening its domestic biotechnology industry through various incentive programs. While the package of subsidies might help boost the competitiveness of U.S. domestic producers in the short run, these efforts could eventually backfire and lead to an escalating ‘subsidies war’ among U.S. trading partners. Relying on industrial subsidies as a key policy measure to reinvigorate certain domestic sectors can eventually trigger a ‘race to the bottom’, which is no different from a ‘beggar-thy-neighbor’ policy that seeks to protect its domestic economy at the expense of others. Offering massive subsidies to support clean technology industries under the pretext of ‘economic security’ may also be part of the U.S. strategy to strengthen American competitiveness and solidify its global hegemony. The WTO’s rules regulating the use of environmental subsidies remain unclear, creating loopholes that countries could use to justify their actions. The Biden administration’s policy agenda for climate change is also being used as its justification to provide huge amounts of environment subsidies under IRA. With the U.S. resorting to government subsidies in the name of combating climate issues, other countries may also be tempted to use subsidization policies more vigorously in order to achieve their own emissions reduction goals. Going forward, countries might also initiate policies that could discriminate against foreign goods or replace imports with domestic products without much restraint from enforceable multilateral trade rules.
Ⅲ. Korea’s Response and Economic Security Strategy
The Korean government has used various channels through political, diplomatic, and economic engagement to voice concerns and raise issue about IRA’s negative impact on Korean companies and how it stands in violation of the Korea-U.S. Free Trade Agreement (KORUS FTA) as well as WTO trade rules. Some possible solutions would be: demanding revision of IRA; requesting to delay the implementation of the law; or exempt Korean companies from immediate application. Among the options, demanding the revision of the law does not seem to be a practical idea, in particular at this point of time when the mid-term elections are around the corner. IRA is a legislative issue that needs to be resolved by the U.S. Congress, as the law has been passed only after obtaining a Congressional approval. On top of that, requesting the U.S. to roll back one of President Biden’s largest political achievements may not be a viable option. Therefore, the Korean government’s request to postpone the implementation of IRA until Hyundai Motors completes its construction of the Georgia factory in 2025 will be challenging, making it difficult to present a powerful argument that could persuade the administration into revising its landmark law that has already taken effect. A more realistic solution would be demanding for exemptions for the Korean companies that have pledged to make heavy investments in building production facilities for EVs and batteries in the U.S., which will have a strong job creation effect to the benefit of the U.S. government. Recently, the EU hinted at the possibility of granting the U.S. an exemption from its Carbon Border Adjustment Mechanism (CBAM), using it as leverage to exempt EU-made EVs from the IRA requirements in turn. The Korean government, for its part, needs to establish a more realistic approach to steer future negotiations with the U.S. in consideration of its own economic security purposes. The Korean government should consider what concessions it could give in a reasonable and reciprocal manner, in exchange for the U.S. exemptions provided to Korean firms.
As it moves to broaden and deepen bilateral economic cooperation with the U.S., the Korean government must be aware that Seoul and Washington could have different positions in terms of ‘economic security’. In a broader context, advancing an economic security alliance with the U.S. is a reasonable choice both in political and diplomatic terms. But the best path forward is to cooperate with the U.S. in a way that puts Korea’s national interest first. While the U.S. is a global leader in a broad range of areas with a large-sized domestic market, Korea remains an export-oriented economy with a relatively small-sized domestic market. For this reason, Korea’s economic security policy may not necessarily align with that of the U.S. In its bid to slow Beijing’s advances, the Biden administration has been formulating a set of policies that could potentially harm the interests of U.S. allies including Korea. Korean policymakers must brace for any potential impact of Washington’s drive to contain China on the Korean economy and come up with effective responses to deal with legislative actions taken by U.S. Congress in line with a fundamental shift in U.S. trade policy. The Biden administration expects to ink a deal with allies to bring them on board with a set of U.S. export controls, including tightly restricting Chinese access to critical chipmaking technology. Korea will likely be asked to side with the U.S. and impose similar controls, but this fundamentally represents a trade protectionist approach that is hardly conducive to Korea’s national interests, especially given the country’s heavily export-dependent economy.
Korea has a window of opportunity to negotiate as the Biden administration is currently working to write the rules and guidelines for implementing IRA. Through bilateral engagement channels, Korean officials should engage in serious consultation with their counterparts in the U.S. government as well as Congress to make sure that EV subsidies under IRA do not put Korean firms at a disadvantage compared to rival automakers. As noted above, the Korean government could demand the Biden administration to drop measures that are discriminatory against Korean firms in exchange for Korean companies delivering on their promises to make heavy investments in the EV battery and semiconductor industries in the U.S. Moreover, Korean officials should underscore that the U.S. should create a favorable investment climate for Korean businesses and give them institutional support to further incentivize Korea’s participation in the Biden administration’s drive to strengthen its semiconductor supply chain. As the Biden administration appears set to bolster domestic policies aimed at realigning supply chains that serve American interests, the Korean government should also push for the establishment of mechanisms that would bring the U.S. and its key supply chain partners together for consultations prior to any U.S. legislative or administrative actions.
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