Subsidy Race, Onshoring And Higher For Longer Inflation
Shankkar Aiyar |
BQ Prime |Opinion | 24 Apr 2023, 07:46 AM IST
The surge across advanced economies to onshore capacity, jobs and growth will engender inefficiencies, raise costs and worsen fragmentation. The rule-based world order cannot sustain on a selective engagement nor can it survive a beggar thy ally proposition.
Earlier this week a World Trade Organisation panel held that India had violated global trading rules by imposing import duties of between 7.5% and 20% on a range of IT products including mobile phones and components. Poignantly, the order will rest in peace. Remarkably the appellate body is dysfunctional as the posts of judges are vacant since 2020.
Be that as it may the parade of ironies is remarkable. Among the complainants is the European Union. Last year the EU set aside nearly 300 billion Euros to subsidise consumers. Even if one sets that aside the stance of the EU in the WTO is ideologically convenient to say the least. The EU has a $ 47 billion plan for the semiconductor industry, a Fit for 55 package, a 100 billion Euros programme for green initiatives and offers companies in the dominion a long laundry list of programmes, subsidies worth $ 369 billion, grants, loans, guarantees and even equity.
Across the Atlantic Across the Atlantic, the United States under the creatively titled Inflation Reduction Act is funding research and accelerating onshoring or reshoring investments.. The $280 billion Chips and Science Act commits $ 200 billion for research, $ 52 billion to woo investors to set up shop in the US and $24 billion in tax credits. The Inflation Reduction Act commits a sum of $ 370 billion is worth a read for the magnitude of interventions it offers individuals and companies. Indeed ten top car makers are shortlisted for subsidies and every buyer who chooses to buy an electric vehicle manufactured in the US a rebate of up to $ 7500.
Indeed the Biden Harris Administration has committed to invest $7.5 billion in EV charging, $10 billion in clean transportation, and over $7 billion in EV battery components, critical minerals, and materials. The IRA has already drawn investments worth over $ 200 billion in onshoring of capacity as companies race to set up plants to manufacture semiconductors, electric vehicles, battery plants and projects producing backward and forward linkages for solar and other green initiatives.
The convulsions of the compulsive race downhill are manifested in sharp utterances and schisms within and outside trade blocs. Indeed, French President Emanuel Macron chose the occasion of his visit to China to urge Europe to adopt “strategic autonomy” to avoid EU states turning into vassals. Elsewhere countries which own strategic minerals and materials vital for production are legislating export controls.
The ideological pivot on subsidies on both sides of the Atlantic is in stark variance with stated positions on state interventionism. The stance hitherto was that companies would determine the comparative advantages of investment and locations on the basis of efficiencies and that state inducements are not kosher. That seems to be out of vogue. It is as if David Ricardo’s observations on comparative advantage have been shelved and Adam Smith’s thesis on division of labour has been muted. The programmes are verily new avatars of the once critiqued industrial policy thinking.
The pandemic revealed to the world that what it deemed as a global supply chain was essentially a Chinese supply chain. Ergo it is arguable that on shoring or friend-shoring (an idea propelled by US Treasury Secretary Janet Yellen) is aimed at inducting supply resilience — and from a national security perspective prepare for the “what if ‘’ moment when China makes its move on Taiwan. Above all there is the political urge to address populist calls.
What is problematic is the scale and nature of intervention. Studies have established that globalisation has delivered lower costs and lower inflation in many domains in the past decade and more. The disinflation or cost-savings stem from efficiencies of a globally competitive supply chain. Grand subsidies result in fiscal expansion, will add costs, engender inefficiencies, will result in the corralling of trade and widen the existing geopolitical fault lines.
Already China is in on the middle ground and flexing its diplomatic clout. The Saudi-Iran détente is just one example of China’s ambitions and must wake up the votaries of the rule based world order. Worse the fragmentation of international trade will alienate natural allies and accelerate the formation of transactional and unnatural blocs and fuel the rise of authoritarian regimes.
In his 1973 book The World in Depression 1929–1939, economist Charles Kindleberger, citing the Hubert Henderson Papers, argues that economic nationalism — “imposition of tariffs, the collapse of world trade, bilateralism and preferences and disregard of the advice of the League of Nations” — played a significant role in creating the conditions and intensity of the great depression. The seminal tome chronicles the factors which accentuated the great depression.
The context is not dissimilar. In 2023 it is a raft of rebates in the U.S. and the EU is gearing up for the new-fangled carbon border adjustment tax to ring fence its industries. In 1922 the US passed the Fordney-McCumber Tariff Act and the Smoot-Hawley Tariff Act in 1930 raising import duties to protect American businesses and farmers. The United Kingdom introduced the Macmillan Tariff law in 1931, imposing a preferential regime of duties — home producer first, empire producer second and foreigners last — on a wide range of goods designed to protect British industries.
In Europe Germany imposed Obertarif, Japan’s trade policy favoured domestic producers and those from the imperial bloc. Spain signed conditional most favoured nation accords and imposed retaliatory tariffs. Italy imposed regulations that required a minimum level of Italian intermediate inputs and protectionist import regime to protect locals.
The past is not necessarily the prologue. As the world finds itself on the verge of a recession Kindleberger’s thesis has a certain resonance. History may not always repeat but it definitely rhymes. The world economy is at the crossroads of risks once again as geopolitics is triggering deglobalisation or slowbalisation following the war in Ukraine.
The risks of geopolitics on geo-economics were manifest in words and in forecasts at the World Bank-IMF Spring Meetings in Washington earlier this month. IMF Managing Director Kristalina Georgieva warned that “economic fragmentation has implications for trade and capital flows and downside risks have increased”.
The IMF has projected that global growth would be under 3 per cent this year and only around 3 per cent for the next five years. The World Bank fears worse and has points out that forces that powered growth are fading and that “between 2022 and 2030 average global potential GDP growth is expected to decline by roughly a third from the rate that prevailed in the first decade of this century — to 2.2% a year.”
Even as growth is tapering below potential global inflation is persistently high and sticky. It is expected to slide from 8.8 per cent to 6.6 per cent which is way above target levels. The perpetuation of subsidies will only exacerbate the fears of stagflation or “slowcession” and worsen the sustainability of debt for most economies. Much depends on how advanced economies in particular and the world in general calibrate policies to sustain internationalism.
This summer financial markets are obsessed with a parlour game: what will the US Federal Reserve do come May 6. The question is not so much about whether it will raise rates or not but what it will do thereafter. Will it pause? Will it pause and then hike rates? Will it pause and pause longer in keeping with the higher for longer thesis? Will it pause and then cut rates? However it plays out risks to lives and livelihoods will be accentuated.
The rule-based world order cannot be sustained by selective engagements resting on convenient convictions, nor can it survive a beggar thy ally proposition. The circumstance calls for a re-visit of Kindleberger’s observations of what happened 100 years back.
Shankkar Aiyar, political-economy analyst, is the author of ‘The Gated Republic –India’s Public Policy Failures and Private Solutions’, ‘Aadhaar: A Biometric History of India’s 12-Digit Revolution’; and ‘Accidental India’.
You can email him at shankkar.aiyar@gmail.com and follow him on Twitter. This column was first published here. Previous columns can be found at Thought Capital.
