Why the New Climate Bill Is Also about Competition with China

Legislative action to compete with China seems to have defined the summer in Washington this year. The CHIPS and Science Act aims to revive semiconductor manufacturing in the United States to address the risks that come from having so much manufacturing capacity concentrated in Taiwan and the gradual rise of China’s own chip production abilities. And last week, after many twists and turns, Democrats in Congress finally succeeded in passing a bill tackling climate change. The Inflation Reduction Act (IRA) contains many provisions, including on healthcare and corporate taxes, but its measures to foster decarbonization and support clean energy technologies make it the most ambitious climate bill ever to be passed in the United States. Some models estimate it could cause greenhouse gas emissions in the United States to fall by over 40 percent by 2030.

This is a real win for U.S. climate advocates, but much of the bill is also aimed squarely at enhancing competition with China. China has long been perceived as the largest commercial beneficiary of the clean energy transition thanks to its centrality in clean energy technology supply chains. To address the concern that decarbonization efforts in the United States may create business opportunities and jobs in China rather than domestically, the $369 billion allocated for climate also includes some clear industrial policy provisions that could improve the odds for U.S. manufacturing of clean energy technologies. However, expanding U.S. manufacturing to the point where it will replace Chinese production of technologies central to achieving decarbonization will take time, measured in decades and not months, and, as a result, Washington will have to grapple with China’s importance in global supply chains for years to come.

The Manufacturing and Supply Chain Challenges

Among other things, the IRA provides tax incentives, estimated to add up to $30 billion over the next decade, to stimulate U.S. manufacturing of solar modules, wind turbines, inverters, batteries for electric vehicles (EV) and power storage, and the extraction and refining of critical minerals. Another $20 billion will finance loans that will be issued by the Department of Energy to support domestic electric vehicle (EV) manufacturing. Finally, the investment tax credit, another $10 billion, will incentivize the production of EV, wind turbine, and solar panel factories.

These incentives are unprecedented in size and duration in the United States, and they are expected to have a transformative impact on the domestic clean energy technology landscape. More manufacturing, mining, and refining in the United States could help diversify supply chains and improve the country’s domestic manufacturing ecosystem. Domestic content requirements may also trigger more inward foreign investment. The effectiveness of the incentives will, however, depend on whether they can change the economic calculus for investors. It remains to be seen, however, just how successful they will be and whether there may be some significant variation by sector.

Stimulating demand alongside supply will help. The IRA includes extensive economic incentives to support the deployment of zero-emission electricity sources and energy efficiency. According to one estimate, the IRA will result in a rise in clean energy generation as a share of total electric generation from 40 percent today to 60–81 percent in 2030. Without the IRA, estimates hovered at 46–72 percent. This will mean a rapid increase in demand for solar modules and wind turbines, as well as support for other technologies, which will in turn stimulate domestic production. The important factor here is that growing demand can have a transformative effect on costs by creating economies of scale. Past examples of this include more established renewable technologies like solar and wind whose prices have declined dramatically in recent years. It may apply to others, including green hydrogen, in the future. But can the United States ensure that it captures the benefits for its own companies while also moving rapidly toward decarbonization?

Maintaining Realistic Expectations

The IRA is good news for U.S. prospects in countering climate change and expanding its clean energy technology manufacturing base. But some realism is needed in understanding how it fits into the broader competition with China, a country that has outspent the United States when it comes to clean energy for the better part of the 2010s.

The Chinese government has deployed both supply-side and demand-side mechanisms to support solar, wind, and EV companies for over a decade that range from direct subsidies to loan guarantees, to low-cost land concessions or tax breaks. Clean energy technology companies in China have also benefited generally from a system supportive of manufacturing, including muscular local government support and measures to attract foreign investment.

Moreover, the supply chains that support these industries are often tied to components produced in China. Take solar cells, a key component in solar panels. According to the International Energy Agency (IEA), 85 percent of solar cell manufacturing capacity is located in China, while only 0.6 percent is in North America. The battery industry functions very differently than the solar PV one, but China is similarly dominant. The IEA estimates that China produces three-quarters of all lithium-ion batteries and holds 70 percent of the production capacity for cathodes and 85 percent for anodes. Both are key components for battery production. This means that even batteries produced outside of China are likely to rely on components made in China (by Chinese or international companies).

The United States should pursue diversification of supply chains by strengthening domestic manufacturing, but it should also consider more seriously what supporting alternative supply chains outside of China will mean in practice. Many in the United States government privately and publicly recognize that it is unrealistic to fully reshore supply chains and that the United States will also have to rely on production in politically reliable partner countries. Yet, despite this administration repeatedly discussing the benefits of relying on supply chains in friendly countries, the IRA seems to do little to achieve that goal. In fact, according to the new law, a set share of the value chain must be produced domestically to qualify for clean energy incentives, something that some have noted may violate World Trade Organization rules.

Finally, diversification should come with a realistic assessment that in the short term it will be difficult to avoid Chinese supply chains. The IRA will likely have an effect on future investments but not on current production and supply chains, which could take years to develop domestically. This may even create a mismatch as demand soars but domestic supply struggles to keep up. The demands imposed by climate change are such that recognition of the challenge is urgent. One consistent problem is that the dearth of reliable supply chain certification which could ensure that imported goods are not relying on forced labor and comply with U.S. law and tariffs. Chinese government obstructionism and lack of expertise are making it hard to ramp up this kind of auditing. It would be wise to find creative ways to address this rather than assume that imports will automatically be replaced by domestic supplies.

The IRA will likely help the United States come closer to meeting its climate targets and become a stronger climate leader, but global supply chains will likely continue to run through China for still some time. This will require carefully managing the U.S.-China trade relationship, including all the risks associated with it, even in the context of climate change. It may also be a reminder that while diversification of supply chains is imperative, absolute self-reliance is not feasible nor desirable.

Ilaria Mazzocco is a fellow with the Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Senior Fellow, Trustee Chair in Chinese Business and Economics