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Conservative Home op-ed – How Britain can prosper in an age of subsidies

May 2, 2023

This was first published on Conservative Home – 02nd May 2023

There is a distinction between a subsidies war and a trade war. The former is “a good thing” in the case of green subsidies, as it’ll help accelerate the transition to renewable technologies. That was the message from the former US Treasury Secretary, Larry Summers, towards the end of January’s Davos meetings.

The subsidy war he was referring to was Joe Biden’s Inflation Reduction Act (IRA). This is one of the most important pieces of legislation implemented in recent years in any major economy. While its focus was naturally on the US, it has global implications.

First, let’s understand the Act. The IRA is a piece of industrial policy aimed at both cutting emissions and boosting domestic clean technology capacity. The subsidies are to attract investment and generate jobs in the US, including generous tax breaks aimed at electric vehicles and advanced manufacturing.

It includes $370 billion in spending on climate and energy policies. However, even the Brookings Institute has suggested the total cost of the IRA could top $780 billion, more than twice the original plans.

The positive aspect of the Act is its focus on clean energy as an important aspect of a pro-growth agenda. In a world economy where the fear is that the West is moving towards secular stagnation of low growth and low productivity, this is important and others may follow this lead.

Given the environmental focus of the policy, one might ask why it has caused so much adverse reaction outside of the US?

The reason is that it has already led firms in other parts of the world to say that they will be tempted to invest, and perhaps relocat, in the US to receive the subsidies. It points towards protectionism. Also at its heart is the idea that the state intervention is the primary route to take, not the market through competition and free and fair trade.

Effectively, it is a National Industrial Policy aimed at giving help to firms that create jobs in the US. Donald Trump talked about America first: Biden is executing policies to ensure it.

In turn, others, such as the EU, have opted to respond with their own subsidy policy. After all ,many firms based there are either contemplating investment in the US or complaining that their competitors may gain.

All this is a sign of how the world is changing. I highlighted in a previous column how post-pandemic the focus has shifted away from globalisation towards fragmentation. There is now a greater focus on onshoring, or at least friendshoring, especially in sectors deemed strategic.

The IRA has led to calls for the UK to do more. But what?

The post-IRA debate has been in part about addressing our poor energy policy. The UK already has an industrial policy and a proactive green agenda, which is boosting our renewable energy mix. In fact, the October 2021 UK Net Zero agenda has triggered much activity at a regional level.

There has also been a sea change in the City during the last few years, with financial firms across the board seeking to boost green investments, alongside more transparency in how they report their green credentials. Expect more capital to be allocated towards green assets.

The Chancellor recently said that the UK should not go “toe-to-toe” with the US in a global subsidy race. I agree with him on this. Yet while subsidies shouldn’t become entrenched the reality is we need to be pragmatic.

Just take the last few years concerning gigafactories. The technology for these lie largely in East Asia, in China, South Korea and Japan. To attract gigafactories, countries across Western Europe have been involved already in a subsidy war.

In 2021, the German authorities offered Elon Musk a €1.14 billion subsidy for an electric vehicle factory near Berlin. Tesla opted to turn this down. But the story of such factories across Western Europe is largely one of subsidies, and we have already gone down that route with government help for a gigafactory in Coventry.

But we do not have deep pockets, hence the need to be selective on the occasions we use them. Help to business – whether through grants, subsidies, tax breaks or other government interventions – has been an ongoing policy issue for much of the post-war era. Interventions such as these can distort the market and have to be paid for, adding to the tax take.

The institutional view, too, of the Treasury is that the UK, as a medium-sized economy, can benefit from the spillovers that other countries subsidies lead to.

Despite the support offered to gigafactories, in the UK there has been an aversion to the idea that the state can somehow pick winners. It’s hard to disagree, even though there have been successes, such as Rolls Royce during the 1970s or since then in the support offered to attract Nissan and others to the UK.

Some are calling for the UK to copy the US. But, as the UK is such an open economy, there would be huge leakages. That is, the benefits of such policies might not be felt fully here in the UK, instead benefitting other countries domestic industries. During the 1960s and 70s, for example, it was commonplace to hear pushbacks against active fiscal policies as these would lead to leakage through increased imports and a deterioration in the trade deficit. Such arguments are obviously less, although perhaps still not absent, in larger economies such as the US.

Perhaps, too, there is not enough appreciation of how many subsidies we already have in the UK – albeit spanning the personal as well as the corporate sector. For instance, in January, the UK’s subsidy control regime came into effect. As the Government states: “It enables public authorities, including devolved administrations and local authorities, to give subsidies that are tailored to their local needs, and that drive economic growth while minimising distortions to UK competition and protecting our international obligations.”

The breakdown of the statistics on tax reliefs shows there are many hundreds of them, which in part helps explain why our tax code is so large and complex nowadays. Pensions tax relief is the highest, estimated at a mammoth £42.7 billion in 2020/21. When it comes to firms, the intentions may be the right ones, but they come at a hefty price too. There were, for instance, 85,900 claims for R&D tax credit in 2019/20, the latest year for which data is available.

We can’t determine what the US or others do, but we can control our own controllabes. Incentives matter. Subsidies and tax breaks may have short-term appeal, favoured by those who lobbied for them and those who gain.

Perhaps the debate around subsidies and the changing global landscape should refocus our policy on the factors that are need to improve the investment outlook.

Importantly we already know that these include the following – sound macro polices and the level, predictability and simplicity of tax. Also, areas we focus on already but need to deliver more fully on such as a skilled labour force and a functioning and supportive infrastructure spanning technology and transport. Plus reducing the cost of regulation, including less bureaucracy.

Firms too need to be confident about future growth and demand. However tempting a subsidies war may be, it is not the route to take. But if we don’t take it and others do, then it should focus our attention on ensuring we are competitive, and look appealing in other ways.