In August 2022, US President Biden signed a bill into law called the Inflation Reduction Act (IRA). The bill’s name had been chosen to ensure public support (since inflation was at the forefront of public awareness at the time). Yet, the bill’s actual focus was to invest in clean technologies, to the tune of $370 billion plus another $130 billion in clean tech tax breaks for individuals and businesses.
While indeed a historic investment due to its magnitude alone, the Act will also be remembered for changing the future of electric vehicles (EV) in America and the footprint of the supply chain globally. The Act expanded an up-to-$7,500 demand-side incentive for EV buyers by removing the existing 200,000 vehicles-per-manufacturer cap from 1 Jan 2023. Yet, it created three new criteria, among others, that changed the industry almost overnight:
Half of the $7,500 is contingent on a certain percentage of battery components being manufactured or assembled in North America.
The other half of the $7,500 is contingent on a certain percentage of battery minerals (cobalt, lithium, copper, etc.) being sourced domestically or from ‘free-trade’ partners -- any country with which the US has a free trade agreement, which does not include Europe.
The vehicle must go through final assembly in North America to be eligible for any incentive.
The first two requirements are phased in over several years; however, the final requirement became effective immediately in August 2022, giving automakers very little time to react to what would be a massive disruption to the American EV market.
Instantly, many foreign-assembled vehicles would have an effective price increase of as much as $7,500, causing demand for those vehicles to stall while pushing those automakers to cut prices and profits substantially. Just a few months later, at the start of 2023, Tesla and GM vehicles would see the opposite effect, with many cars becoming re-eligible for the $7,500 price decrease, as both OEMs previously had their incentives phased out after hitting the 200,000 unit sales cap in January 2020 and January 2019, respectively. Toyota had also recently hit the sales cap with credits expected to expire around October 2023.This demonstrates the price/profit advantage that the IRA creates for vehicles assembled in the USA.
This isn’t by accident, of course. The EV-specific goals of the IRA are: 1) Incentivize automakers to build EVs in the USA, 2) Encourage consumers to buy EVs, and 3) Ensure battery and mineral supply chains are secure and more distributed. The third point specifically intends to reduce China’s current monopolization of the battery supply chain and prevent certain other mineral-rich countries from creating an economic or security risk for the US auto industry in the future. In addition to incentivizing EV production in the US through a consumer-focused incentive, the IRA also provides tax credits and loan guarantees for companies that produce battery components or critical minerals in the US, making the US a financially-attractive location for new mines and factories.
Unintended Side Effects
However, these lucrative incentives designed to support electrification have had some immediate unintended consequences. Perhaps most notable is the anger the IRA ignited in European political and automotive circles. While the Act may have targeted China’s EV and battery exports, it also affects exports from other countries currently working (as-is the USA) to establish a foothold against China’s early-mover advantage.
The anger and disappointment from Europe were made clear by several top offices, including European Council president Charles Michel, French President Emmanuel Macron, and Germany’s economy minister, Robert Habeck, to name a few. Several of the complaints suggest that the US IRA violates WTO rules. Belgian PM De Croo went further and accused the Act of aggressively courting European companies in a bid to take industry from Europe. As a representative of the European auto industry, ACEA decried the IRA in a press release on the basis that the more restrictive criteria for purchase incentives would lead to a slowdown in EV adoption.
Several European leaders suggest that the problem is not the IRA’s actions but the EU’s lack of competitive action. The thinking here is that if we intend to support electrification as nations concerned about the environment, we shouldn’t criticize other countries’ incentives but match them with our own. This will support a faster EV transition while ensuring that national and regional supply chains are well-distributed. However, this concept requires each government to compete economically or develop agreements on appropriate spending levels to ensure fair trade and measured EV industry and market growth. Yet in late 2022, no such agreement existed.
The EU's concerns are not without merit, as the IRA led to immediate results, with several announcements being made in the ensuing months related to establishing new vehicle and battery production facilities. For example, Honda and LG announced a $4.4B battery plant joint venture in Ohio. Reuters reports that Audi, Volkswagen, Stellantis, and Tesla have confirmed plans to shift EV and/or battery production to the US. And as a shock to the industry, battery maker Northvolt (backed by VW) has paused its plans to begin construction on a new plant in Sweden until they hear more about how the EU plans to compete with the US’s attractive incentives. Volkswagen themselves said one of their Eastern European battery plants is being reconsidered because they would stand to save $10.5B by moving it to the US.
On 26 October 2022, European Commission president Ursula von der Leyen’s office met with US Deputy National Security Advisor, Mike Pyle, to discuss the IRA, among other critical issues. The two agreed to establish a US-EU Task Force to specifically focus on how to address the concerns created by the IRA. While the task force was getting off the ground, the EU began to draft a competitive legislation roadmap called A Green Deal Industrial Plan for the Net Zero Age, which would form the basis of the EU’s pushback against the US IRA. On 10 March 2023, von der Leyen and US President Biden met in person to review the task force’s progress and establish the next steps for easing the trade tensions. The pair agreed that the EU and US shared goals around electrification and establishing distributed regional supply chains. Yet, the approaches and methodologies had not been well-aligned and could therefore lead to “zero-sum competition.”
Moving forward, Biden agreed to add an exception to the IRA that would allow critical European minerals to count toward an automaker’s sourcing requirement. This was a substantial win for the EU, although Biden stopped short of offering the same exception for battery components, likely for fear of disrupting the already burgeoning American battery sector. Perhaps most importantly, von der Leyen agreed to work with EU member states to incentivize European mineral, battery, and EV production at sufficient levels so that European and American EV industries can prosper without disrupting transatlantic trade. Shortly after the meeting, the EU published the NZIA (Net Zero Industry Act), which creates a framework for member states to incentivize European green tech production competitively.
In an ideal scenario, the US and EU could have synchronized their industrial plans to prevent chaos and uncertainty from developing on both sides of the ocean, yet Asian governments may have seen this as exclusionist. In addition, the EU tends to delegate industrial strategies to member states, while the US is well-versed in industrial policy, making it difficult for disparate governance personalities to see eye-to-eye. Yet despite the challenges, the pair have come to an arrangement that should be yet another accelerating force for EV adoption while making the supply chain more resilient to disruption.
Will there be backlash from China? China’s strategic industrial planning is unprecedented on the global stage, and its current leadership in electrification and component supply is a clear testament to that planning. Beijing likely isn’t too concerned about the immediate effects of the IRA, given the magnitude of scale difference between the Chinese and Western industries at present. Yet, with many Chinese OEMs planning to enter (or already entering) Western markets, the IRA and the EU’s NZIA may well attract some battery and vehicle manufacturing away from China. Given the existing tensions between China and some Western countries (notably the US), it’s likely that these policies will play a significant role in geopolitics from now on. Ignoring, for a moment, the political ramifications, EV enthusiasts, automakers, and environmentalists should breathe a sigh of relief as world leaders ramp up their support of green technologies.