The most important political achievement of the Biden administration, at least so far, has been the Inflation Reduction Act. Despite its deliberately misleading name, it is primarily a climate law. In particular, its aim is to combat climate change through an industrial policy that offers subsidies to companies and consumers for the introduction of environmentally friendly technologies. The prime example is electric vehicles powered by renewable energy sources.
The news so far is that companies appear to be rushing to take advantage of the aid, so the bill’s budgetary cost is likely to be much higher than expected, perhaps hundreds of billions of dollars more. On the other hand, the protectionist aspects of the legislation, which heavily favor domestic production, have angered other countries, and Europeans in particular are talking about a Green Deal industrial plan tantamount to a subsidies war with the United States, although so far they haven’t taken many steps undertaken in this direction. In other words, early indications are that the Inflation Reduction Act will be a great success.
Readers of a certain age may recall that there was a great debate about industrial policy in the United States in the 1980s and early 1990s. There was a sense that the United States was falling behind Japan and possibly Europe, fueled by books like Lester Thurow’s 1992 bestseller War in the 21st Century. Many analysts attributed the former’s economic growth to its industrial policies, that is, the government’s efforts to boost the industries of the future. Numerous experts believed that the USA should fight this with its own industrial policy.
However, skeptics argued that there was little evidence that industry stimulus policies were behind Japan’s success and that governments are probably not good at “picking winners”. And just to be clear, proponents of the industry’s stimulus measures were known for a time as “Atari Democrats” (in fact, Atari, which helped build the video game industry, failed miserably).
And Japan has gone from giant to cautionary tale (although in reality its economy has fared better than most people realize; its slow growth can be largely attributed to demographics). But now the US is finally stepping into industrial policy through the front door. Are we repeating old mistakes? No. This industrial policy is different.
Unlike previous proposals to boost the industry, this is not an attempt to accelerate economic growth by picking winners. Rather, it is about reshaping the economy in a way that limits climate change. The main reason for achieving this through subsidies and industrial policies, rather than the measures that Economics would initially recommend, such as carbon taxes, is political. Emissions taxes would never be passed by an evenly divided Senate, where Joe Manchin had effective veto power, but legislation that would increase industrial production was in the political realm.
And the provisions on buying American products, which will establish a clear link between green investment and jobs in the United States, were a crucial element of the agreement, although they will make the transition more costly and create tensions with our trading partners. When the goal is to deal with an environmental threat to life, efficiency goes a long way. In this case, however, the government may be able to choose the winners. The reason we can make great strides in climate protection using the carrot rather than the stick is that green technology has evolved at an incredibly fast rate, consistently exceeding official projections. And there’s good reason to believe that clean energy is on a steep learning curve, so subsidizing the green transition will accelerate the technological advances that enable that transition even faster.
But that’s the icing on the cake. The main compensation for the new American industrial policy will not result in job creation or even improved technology, but in limiting the damage of climate change.
And so a subsidy war with Europe, if it happens at all, would be a good thing. We want other countries to get involved in climate protection, even if this actually implies a certain degree of protectionism.
Let’s see, I understand that some economists are alarmed. The creation of a relatively open world trading system with comparatively low tariffs over the past three generations has been a major diplomatic and economic achievement, and I understand that some economists I respect fear that economic nationalism might jeopardize it.
But I believe that in the face of a terrible environmental crisis, we must do everything we can to limit the damage. We don’t want to say, “We may have ruined the planet, but at least we obeyed the rules of the World Trade Organization.”
The same general logic applies to budget costs. Assuming the Inflation Reduction Act ends up costing a trillion dollars more than expected, it would spur trillions worth of green investment because it also attracts a lot of money from the private sector. This would also mean higher financial costs in the future. The Congressional Budget Office projects the government will spend 3.6% of GDP on interest through 2033. At current interest rates, $1 trillion more debt would translate into about $35 billion per year in additional interest payments, for an overall rate hike from 3.6% to 3.7%. That seems to me a pretty low price to pay for being much better at preventing a climate catastrophe.
As I said earlier, the signs that the Biden administration’s climate policies are likely to cost more than expected and could lead to a subsidies war with Europe are actually good news. They show that, depending on the really important parameters, the measures may deliver better results than expected.
Paul Krugman is a Nobel laureate in economics. © The New York Times, 2023. Translated from news clips.
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