Authors: Sejal Sahu & Sarah Xaxa
Second year law students at Hidayatullah National Law University, Raipur
I. Introduction
The current situation between the United States of America ("USA") and China’s disagreement over the Inflation Reduction Act ("IRA") is a vivid example of remarkable tensions in international trade. The dispute raised by China in the World Trade Organization ("WTO") on 26 March 2024 is against the IRA subsidies that prefer domestic manufacturing and sourcing to imports, especially from China. The IRA is designed to lower the cost of renewable energy production, balance climate change, and catalyze spending on electric vehicles ("EVs"). It includes stringent Local Content Requirements ("LCR") as a condition that clean energy products such as EVs and the renewable technology it subsidizes must contain American components.
China contends that these provisions conflict with fundamental WTO principles, particularly, specific clauses of the General Agreement on Tariffs and Trade ("GATT"), Trade-Related Investment Measures ("TRIMs"), and Agreement on Subsidies and Countervailing Measures ("SCM") rules. China contends that the IRA is protectionist and anti-free trade. Through this article, the authors will first discuss the sources of China’s complaints in the Dispute Settlement Body of WTO. Second, we will analyze how the IRA violates the multilateral agreements of WTO and its impact on other competitors. Last, we suggest practical solutions that address American concerns while ensuring fair trade on an international scale.
II. Tax Credits, Trade Wars, and a Dash of Green: Analysing the IRA’s Intriguing Tale
The provisions of Inflation Reduction Act envisage a gradual annual rise in the minimum threshold of critical minerals and components from the USA in EV production. It appears to contradict WTO’s basic principles of Most Favoured Nation ("MFN") Treatment and National Treatment. The explicit norm of World Trade Organization is MFN, a rule under Article I of General Agreements on Tariffs and Trade, that requires every WTO member country to give all trading partners equally favorable terms so they do not unfairly favor certain partners.
However, it is evident that IRA’s selective eligibility criteria for tax incentives, only for partners on the USA free-trade deals can be viewed as exclusionary, particularly in countries such as China without a Free Trade Agreement ("FTA") with the USA. This means that while companies from Canada, Mexico, and South Korea benefit from these incentives, other non-FTA members, including Chinese companies, are locked out even though they offer similar or even cheaper products than their FTA counterparts.
Under the National Treatment principle [Article III], imported products should compete fairly with domestic products. However, the IRA’s incentives conflict with this principle, as preference is given to goods manufactured in USA through subsidies. Therefore, even if a foreign-based product has better competitive qualities than a domestic product, the latter would be preferred primarily with the subsidy.
This preferential treatment distorts the market access opportunities and prevents some WTO members from accessing the market on equal terms. It is further revealed that this approach leads to the fragmentation of global supply chains, thus raising artificial barriers to trade in a sector that largely relies on international integration. Reduction in the number of eligible suppliers for the US market through the IRA, as analyzed, could diminish the supply chain of critical minerals and components for clean energy technologies. This solution may make clean energy technologies even more expensive.
III. Subsidies Under Siege: The IRA’s Trade Conundrum
Article 2.1 of the Trade Related Investment Measures enforces the National Treatment principle of General Agreement on Tariffs and Trade ("GATT") and any investment or trade that violates this principle of GATT will be inconsistent. However, the IRA requires that local sourcing of EV batteries, critical minerals, and renewable energy products violates this principle because they implicitly favor the US inputs rather than the global market.
The IRA has a carefully embedded form of ‘eco-protectionism’, which unites environmentalism and economic nationalism as strategic partners to build a domestic market while defining international competitors as second-tier suppliers. It contemplates strict domestic sourcing rules that limit supply-chain access to competing international inputs under the cover of environmentalism, which jeopardizes delicate global supply chains for clean energy. This dynamic effect places pressure on companies to set up production in the USA, which constitutes ‘forced localization’. In this, companies are compelled to set up production in USA if they want the benefit of the tax credit. While the IRA itself does not include direct quotas on foreign investment, effectively the indirect quantitative restrictions act as incentives requiring purchases of USA-sourced components and, to an extent, inputs from a selected number of FTA partners.
Furthermore, such policies, aimed at supporting local content, result in creating an innovation barrier upon the development of cleaner energy. They restrict cross-boundary partnerships that can hinder the technology progression. The unanticipated consequence, therefore, is to exclude foreign investment and innovation contrary to the principles of TRIMs.
To build on this, the IRA’s Local Content Requirement limits the portion of market access that foreign suppliers can command, tantamount to a quota. It safeguards domestic inputs and restrains foreign inputs in violation of Article 2.2 of Trade Related Investment Measures. As such, the IRA redirects supply chains internationally, insisting that firms use only suppliers friendly to the USA even if those overseas are more effective or environmentally friendly. This artificial resource channelling creates inefficiencies that TRIMs aim to eliminate, thus eradicating trade neutrality. Moreover, the IRA discriminates against Non-Free Trade Agreement WTO members, promoting a conceivable segmented market based more on geopolitical affiliations than free trade.
IV. Favouring Friends: How IRA Subsidies Skew SCM Rules And Limit China’s Access
The IRA violates the principles of Articles 3.1(b) and 3.2 of Agreement on Subsidies and Countervailing Measures as it prevents the non-FTA nations, especially China, from equal participation in Electronic Vehicle industry. Article 3.1(b), more generally, prohibits subsidies ‘contingent on the use of domestic over imported goods.’ Article 3.2 reinforces it by prohibiting such subsidies. The favoritism of the IRA fosters a situation where local industries are supported, and products from other countries are excluded, which makes the SCM fail in the goal of eradicating national trade barriers. With the subsidies, the Inflation Reduction Act effectively steers both investments and supply chain leasing away from international sources and grants domestic industries a competitive advantage in clean energy. This not only affects foreign suppliers but could extend to other unrelated areas as affected countries look for ways to counter-balance the loss inflicted on them by the IRA subsidies.
The IRA creates a conflict in trade between the United States of America and China. With the LCR in place, China’s participation is systematically disqualified. The USA has free trade agreements with twenty nations and is keen on providing the tax credit through IRA to these particular nations. China, not being party to these agreements, is excluded from the benefit provided by IRA.
China is a leading factor in the Electronic Vehicle industry. When any player is barred from collaboration with American units, it could reduce the rate of development that could otherwise be achieved. IRA here plays a negative function.
V. Eco-Diplomacy: Rethinking IRA for Global Compliance and Progress
To solve the quandary in discussion, we suggest certain measures. These alternatives present a proactive diplomatic resolve. First, a general and reasonable margin for fuel residue or pollutant emission can be created in place of providing the particular tax credit, which is inapplicable to certain WTO members. A routine checkup, with a carbon tax in mind, irrespective of the origin of production, will more effectively ensure monitoring of pollutant emissions. Contingent upon this, taxation must be evaluated based on total carbon emissions. This will also ensure equitable implementation of the emission control provision of IRA and promote technological advancement.
Second, in line with the IRA’s core objective, that is, sustainability and ecological protection in the long term, the USA could consider implementing domestic rules reducing carbon emissions, maintaining the ecology, and producing renewable energy sources. The ecological burden of emissions on USA is bound to increase if it plans to implement the LCR, which would mean more pollutant emissions accrue to local manufacturing. This would increase the emission burden, making it difficult for the USA to fulfill its goal of climate sustainability. By opting for foreign commodities, the carbon emission credit will be distributed to more countries.
V. Conclusion and A Way Forward
The dispute over the IRA concerns both an international consortium and the domestic policy foreplay. The LCR, with the initial motive of encouraging domestic players to participate meaningfully in clean energy production, has shown its mal-effect by jeopardizing fair competition. This holds a larger political significance, any matter sidelined is likely to face severe repercussions, such as fragmentation of global chains, hindered improvement, and pessimistically speaking, war. This, in no way, helps the cause of environmental sustainability and growth.
Thus, a plausible way forward could be a truce, since it all started with a dispute resolution mechanism. The USA should consider amending the IRA, proactively including foreign players, and upholding fair trade principles. An appropriate measure of subsidy, inviting participation, and a thorough review of its policy would invariably settle the dispute with China and other such party-nations. By and large, this would inevitably, and for the best, lead to a collective global effort at a future that is well sustained with clean energy.
Note: This article has been reviewed by Mr.Steve Levitsky (Merger Clearance and Antitrust Counseling, Manhattan, New York, United States) at the Tier II Stage.