Low-Energy Fridays: Why Domestic Energy Subsidies Still Go to Foreign Companies

A recent Wall Street Journal article noted that even though the Inflation Reduction Act (IRA) intended to foster a domestic clean energy manufacturing revolution, much of the subsidies are going to Chinese companies that position just enough of their production in the United States to qualify for them. This is, though, exactly what politicians should have expected to happen. Two interesting points to consider as a result are the effects of the subsidies and if they are worth their cost.

Politicians, and people generally, like to think of a product as produced in one country. They see a “made in America” label and assume that buying the product results in a benefit to a U.S. producer. But production and supply chains are much more complicated. Automobiles are a good example. Ford is an American car company, and one of their most popular vehicles is the Ford Explorer, which is produced at Ford’s Chicago plant. One would think this is an American-made vehicle, and indeed it was lauded as one of the most American-made vehicles—but less than half of its content is manufactured in the United States. Automobile manufacturing supply chains are complex beasts that span the world.

Energy-related products can be similar. Solar panels, for example, utilize several components and minerals that may be produced in various places. China, for its part, has a comparative advantage in producing solar panels, and 80 percent of global solar panels come from China.

Since the Obama administration, politicians have touted that clean energy subsidies support an American clean energy industry and a way for the United States to be the center of a global economic boom. But this was always a fool’s errand because the rhetoric ignored the reality: China has advantages in producing lower-cost clean energy products. They have a monopoly on much of the natural resources needed for clean energy, and lower labor costs due to low wages and, in some cases, slave labor. Subsidies do not undo the truth that some foreign competitors can produce goods at a lower cost than our domestic producers.

Generally, when the United States subsidizes clean energy, even if that subsidy is only eligible to domestic manufacturers, producers are making a calculation. They have to determine whether it is more profitable to retain the lower-cost elements of their supply chain or move them to a higher-cost-but-subsidized region where the value of the subsidy exceeds the lost profit from increased manufacturing cost—exactly the dynamic The Wall Street Journal observed about Chinese solar companies. We therefore see that the effect of the IRA subsidies is a transfer of wealth from taxpayers to producers, so the beneficiaries are investors and workers at the subsidized locations.

At the end of the line, the subsidies incentivize a shifting around of production to capture the subsidy, but the overall efficiency of the production chain is worsened. The subsidy doesn’t make things better; it just transfers the increased cost of less-efficient production onto taxpayers. Although this isn’t the effect of subsidies that politicians like to talk about, it is the expected result. To the extent that consumption of clean energy would occur absent the subsidy, the potential environmental benefits of increased capital in the clean energy industry are blunted.

But what’s really revealed is that there is a heterogeneity of preferences for the outcome of subsidies. Proponents of the subsidies may not care that they are inefficient or result in some corporate welfare, so long as the renewable energy industry is kept flush with cash. Others may be more concerned that the subsidies might reward the use of slave labor or may view the economic harm from the subsidies as outweighing any potential environmental benefit. For our part at R Street, we know that there are non-subsidy policies that would benefit the clean energy industry more than subsidies do, and it would be better for policymakers to appreciate that subsidies aren’t always the answer.