The world is embroiled in a megacrisis comprising the COVID-19 pandemic, Russia’s war in Ukraine, high inflation, recession fears, and rising debt distress across emerging markets and developing countries. The last thing we need is an additional source of economic harm. But that is’s what we may get, in the form of another destructive trade war.
Trade wars are immensely damaging because the countries involved tend to retaliate by erecting ever-higher trade barriers. This vicious cycle was blamed for greatly prolonging the Great Depression in the 1930s, which is why the United States led the effort to develop a new world trading system after 1945, setting the stage for the most successful period of global economic growth in history. For 70 years, global commerce was underpinned by the rule of law, with an international organization — the General Agreement on Tariffs and Trade, which was succeeded by the World Trade Organization — ensuring impartial adjudication of disputes.
But starting in 2017, Donald Trump’s administration effectively withdrew US support for the WTO and started a trade war with China. In addition to slapping discriminatory tariffs on imports, it also imposed more sweeping levies on items such as steel and aluminum, dubiously citing “national security” concerns. Though most trade lawyers believed these measures to be illegal under WTO rules, US trading partners abstained from retaliation in the hope that the next administration would roll back Trump’s protectionist policies.
Unfortunately, US President Joe Biden’s administration has neither rescinded Trump’s trade measures nor restored important WTO functions such as the dispute-settlement mechanism. And if that was not bad enough, this year’s US Inflation Reduction Act (IRA) and CHIPS and Science Act will inflict so much damage on major trading partners and allies that they will almost certainly have to retaliate. The US will then find itself in a trade war not only with China but also with its own allies, and the world will be confronted with yet another major crisis: the breakdown of the international trading system.
Both the IRA and the CHIPS Act are openly protectionist and discriminatory, violating agreements that the US has made through successive rounds of multilateral tariff-reduction negotiations. For example, the IRA provides a $7,500 subsidy to US purchasers of electric vehicles, provided that they are both made in America and composed predominantly of American parts (and these components must include batteries, which constitute 40 percent of EVs’ cost. Similarly, the CHIPS Act allocates $52 billion to finance investment in ‘fabs’ (chip-making factories) built by private companies in the US.
It is doubtful that the EV subsidy, which strongly discriminates against foreign-made cars (as well as batteries and other auto components) from the European Union, the United Kingdom, Japan, and South Korea, is warranted. Nor is it likely to fulfill its intended purpose of ‘creating good jobs’ and accelerating the shift away from internal combustion engines. The CHIPS Act is even less likely to achieve its backers’ desired results. There is already a looming semiconductor supply glut, and that has led some leading producers (both American and foreign) to declare that they will follow through on plans to build new production facilities only if they receive subsidies.
From the perspective of foreign political leaders, the auto industry is too economically important for them to stand by and do nothing in the face of unfair US practices. They simply cannot allow their own auto-assembly plants to lose market share as a result of US subsidies. As French President Emmanuel Macron made clear to Biden during his recent state visit at the White House, America’s unilateral protectionism risks triggering a broader trade war. Equally, other governments are under mounting political pressure to subsidize chip production in response to the recent US moves, and several foreign manufacturers are announcing plans to build factories in the US to avoid the unfair competition.
If the IRA and CHIPS Act go into effect on January 1, as planned, America’s allies will almost certainly retaliate, which in turn will invite US counter moves. And far from being confined to autos and semiconductors, this tit-for-tat escalation could affect more and more export categories, increasing the scale of the economic damage. Macron has already indicated that Europe should start discriminating in favor of its industries.
The world’s major trading powers must act quickly to prevent the eruption of a full-blown trade war. The chips issue should be taken to the WTO, and the US should abide by a likely ruling that the subsidies are illegal. Chip producers could jointly agree on a pact specifying export rules for machinery and chips and an enforcement mechanism. The US could substitute much-needed additional investment in education and training, which would enable domestic producers to hire well-trained workers more readily, for some of the physical investment now contemplated.
The new facilities under construction are for chips already in production, and inventories of those chips could be built up in lieu of investment in new fabs, especially now when demand for chips seems to have fallen. It is highly unlikely that all of the machinery and know-how embodied in other countries’ production of machines to make chips and of chips themselves can in any event be brought back to the US. Any of these measures would almost certainly achieve results closer to the US objectives than the subsidies currently envisaged.
For EVs and batteries, too, foreign and domestic producers must compete on a level playing field. Car-exporting countries could subsidize all purchasers of new EVs by the same amount as the Americans; the Biden administration could seek an amendment to the law to provide subsidies to purchases of all EVs, including imports. In addition, the American domestic content requirements for batteries would also need to be adjusted.
As with chips, any of these measures would enable a far superior outcome for the global economy. Protectionism sets the bar low.
Anne O. Krueger
A former World Bank chief economist, she is 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.