L’Inflation Reduction Act (IRA), adopted in August 2022 by the United States Congress, put in place tax incentives for the production and use of clean energy by programming federal funding over ten years. These tax advantages are given to businesses or households in return for an obligation to produce locally and/or to have local content in the goods used in their production.
This text quickly aroused the concern of Europeans. The subsidies and tax credits that this law offers have made them fear that this will lead to an increase in foreign direct investment (FDI) in green sectors in the United States to the detriment of Europe. Are these fears justified?
The many works on the determinants of FDI allow us to see this more clearly. Grants and tax credits are obviously attractive factors, but the clauses that define the local content of the IRA complicate the task for investors. A local content clause can only act in the direction of an increase in production costs, without which the investor would already have had recourse to this local content. Furthermore, the criteria included in the IRA are binding. Above all, local content clauses and tax advantages are not the only determinants of FDI.
The EU also has strengths
It is indeed also necessary to consider the determinants which have a positive effect on FDI (economic size of the countries of origin and destination, economic growth, human capital, financial development, quality of communication and transport infrastructures or respect for ownership of the country of destination), as well as those that have a negative effect (distance between the two countries, unit labor costs, corporate tax rates).
As for customs duties, they can, when applied to a transformed product such as an electric car, encourage investors to locate in the country rather than export (tariff-jumping). On the contrary, when they relate to imports of intermediate goods (the battery of an electric car or its components), dissuade them.
The table below, which compares measures of these determinants in the world’s three largest economic powers, illustrates the strengths available to the European Union (EU) to attract FDI. It is a large market, with high-quality logistics infrastructure, respected rules of law and public subsidies as a proportion of GDP that far exceed those offered by the United States. As for the 10% customs duty on electric vehicles, it may encourage foreign companies to tariff-jumping.
This table also makes it possible to identify the directions which would make it possible to improve the attractiveness of the EU by acting on the structural factors of competitiveness.
A key policy is the reduction of energy prices by accelerating the deployment of renewable energies: the time required to obtain permits can be shortened and the feed-in tariffs (guaranteed price above the market price to an electricity producer for a given period) are an attractive formula for companies in the sector.
[Près de 80 000 lecteurs font confiance à la newsletter de The Conversation pour mieux comprendre les grands enjeux du monde. Abonnez-vous aujourd’hui]
Public subsidies could be increased, but above all, their effectiveness can be improved: by authorizing subsidies for ten years in green sectors in a less fragmented form than they currently are; by shortening and simplifying the time required for obtaining them; by carrying out a continuous evaluation of their performance and by privileging not only subsidies for innovation, but also those accelerating the deployment of existing technologies.
The training of a workforce with the skills necessary for the development of green sectors, as well as better access to credit and private sources of financing, would also encourage FDI in the EU.
The WTO once again destabilized
Finally, the ongoing negotiation of regional trade agreements could facilitate access to critical minerals: EU agreements with Australia, Chile, Mercosur (whose permanent members are Brazil, Argentina, Paraguay and Uruguay)… In addition, it would be possible to simplify the obtaining of permits for the extraction and processing of critical minerals in Europe, while respecting a charter to limit harmful effects on the environment.
As for the protectionist solution, should it be considered? It could consist of local content clauses, the advantages and disadvantages of which are known, or the reservation of European markets, for example public contracts, to European companies. It would be a bet on the fact that this will increase their competitiveness in the green sectors through economies of scale and that this will encourage them to invest more in R&D.
This choice would have a budgetary cost and would also imply additional destabilization of the World Trade Organization (WTO). However, the potential disappearance of this institution would have a long-term cost. Under these conditions, for the EU, and given the very different positions within it between Northern and Southern countries, the response proposed by the Commission on 1is February 2023 is going in the right direction: subsidies are made more accessible, while remaining in compliance with the commitments made at the WTO.
