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A year after the passing of the US Inflation Reduction Act, the British government is formulating an “advanced manufacturing plan.” While the specifics remain unclear, this plan is part of a growing trend of industrial policies following America’s substantial incentives package that impacts various sectors, including electric vehicles and green hydrogen production.
New factories are springing up throughout the United States. However, economists are skeptical about the long-term effects due to the extensive government intervention and provisions that prioritize domestic production. Trying to replicate global supply chains for green technology and batteries domestically is a challenging task. Shifting production away from where it is most efficient leads to waste and increased costs, and it also invites retaliatory actions.
First and foremost, any economic strategy should focus on creating a favorable business environment that promotes competition and allows existing strengths to thrive. This involves investments in modern infrastructure, the establishment of an effective training system, and the design of an immigration policy that attracts global talent. Additionally, promoting trade openness, ensuring a stable long-term policy environment, and minimizing bureaucratic obstacles will support investment decisions and enable industries to achieve scale. Currently, the Inflation Reduction Act is facing challenges such as a shortage of skilled workers and lengthy planning delays.
Furthermore, targeted assistance should be provided in specific cases. This includes building capabilities related to national security, such as defense, and securing critical material supplies. Additionally, interventions can address market failures. For example, renewable infrastructure may require initial support when the private sector is uncertain about future demand but long lead times necessitate preparation in the present.
Targeted interventions should not aim to recreate entire global supply chains domestically. Instead, the focus should be on developing a strategic foothold in specific sectors. This approach helps minimize wasteful spending and accusations of unfair trading practices. Additionally, time-limited support is crucial. Current forecasts indicate that the Inflation Reduction Act’s open-ended tax credits could exceed $1 trillion.
The choice of policy tool should align with the specific issue being addressed. For instance, green energy projects benefit from a guaranteed market price and public-private partnerships that mitigate risks for battery or semiconductor plants, where there is no existing foothold. Financial incentives like tax credits can also play a significant role in encouraging the reallocation of resources from low to high productivity industries. They are particularly effective and less distorting when applied across sectors to promote investment in training, research and development, machinery, and the adoption of existing technologies.
Above all, industrial policy should not exclude competition. Productivity growth has been driven by globalization, which relies on international supply chains connected through national specializations. Protectionist measures, such as local content rules in the Inflation Reduction Act, undermine this by excessively supporting domestic manufacturing and triggering retaliatory measures. “Friendshoring,” or free trade between allied nations, presents a viable alternative to trading with malign states.
Addressing the challenges posed by the climate transition, technological advancements, and unstable geopolitics requires targeted and well-designed interventions from national governments. However, if leaders increasingly override free markets and open trade, they will encounter greater difficulties in achieving their goals.
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