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  • Writer's pictureThe San Juan Daily Star

How to think about green industrial policy


By Paul Krugman


The Biden administration’s signature policy achievement, at least so far, has been the Inflation Reduction Act, enacted last August. Despite its deliberately misleading name, the act was mostly a climate bill. Specifically, it sought to fight climate change with industrial policy, offering businesses and consumers a variety of subsidies to adopt green technologies, with the quintessential example being electric vehicles ultimately powered by renewable energy sources.


The news so far is that businesses appear to be rushing to take advantage of those subsidies, so the budget cost of the act is likely to be substantially higher than projected — maybe hundreds of billions of dollars higher. At the same time, the protectionist aspects of the legislation, which strongly favors domestic production, have irked other nations, with Europeans in particular talking about — although so far not taking much action on — a Green Deal Industrial Plan that would amount to a subsidy war with the United States.


In other words, early indications are that the Inflation Reduction Act will be an enormous success story.


Readers of a certain age — well, a fairly advanced age — may recall that there was a big U.S. debate about industrial policy in the 1980s and early 1990s. There was a widespread perception, fed by books like Lester Thurow’s 1992 bestseller “Head to Head,” that America was falling behind Japan and possibly Europe. Many analysts attributed Japan’s economic growth to its industrial policy — that is, government efforts to promote the industries of the future.


America, a significant number of pundits argued, needed to push back with an industrial policy of its own.


Skeptics argued, however, that there was little evidence that industrial policy was behind Japan’s success and that governments were unlikely to be very good at “picking winners.” As if to drive this point home, political supporters of industrial policy came for a time to be known as “Atari Democrats”; sure enough, Atari, which helped create the video game industry, eventually failed spectacularly.


And Japan went from seemingly unstoppable juggernaut to cautionary tale (although Japan’s economy has actually performed better than most people realize; most of its slow growth can be attributed to demographics).


Now, however, America is finally going into industrial policy in a big way. Are we repeating old mistakes? No. This industrial policy is different.


The Inflation Reduction Act, unlike earlier proposed industrial policies, isn’t an attempt to accelerate economic growth by picking winners. It is instead about reshaping the economy to limit climate change. The main reason for doing this via subsidies and industrial policy, rather than through Econ 101-recommended policies like carbon taxes, is political. Emissions taxes were never going to pass an evenly divided Senate in which Joe Manchin had effective veto power, but legislation that would lead to a surge in manufacturing — which is already happening, by the way — was, if only barely, within the realm of the politically possible.


And the buy-American provisions, which will create a clear link between green investment and U.S. jobs, were a crucial part of the deal, even though they will make the transition more costly and create friction with our trading partners. When your overriding goal is to confront an existential environmental threat, efficiency is very much a secondary consideration.


Now, as it turns out, this may be a case in which the government will be successful in picking winners after all. The reason we’re able to make major progress on climate using carrots rather than sticks — subsidies rather than taxes or quotas — is that green technology has been advancing at an incredible rate, consistently outpacing official projections. And there are good reasons to believe that clean energy is subject to steep learning curves, so subsidizing a green transition will cause the technological progress making such a transition possible to advance even faster.


But this is icing on the cake. The main payoff to America’s new industrial policy will come not from job creation or even improved technology, but from limiting the damage from climate change.


And this is why a subsidy war with Europe, if it happens, will actually be a good thing. We want other countries to take action on climate, even if it involves some de facto protectionism.


Look, I understand why some economists are concerned. The creation of a relatively open world trading system over the past three generations, with most tariffs relatively low, was an enormous diplomatic and economic achievement, and I appreciate why some economists I respect are worried that economic nationalism is putting this achievement at risk.


But my view is that in the face of a terrifying environmental crisis, we have to do whatever it takes to limit the damage. We don’t want to find ourselves saying, “Well, we cooked the planet, but at least we preserved the rules of the World Trade Organization.”


The same general logic applies to the budgetary costs. Suppose that the Inflation Reduction Act ends up costing $1 trillion more than expected — which would mean that it spurred several trillion dollars of green investment, because it would be bringing in a lot of private-sector money, too. This would mean higher future interest costs. The Congressional Budget Office currently projects that by 2033, the government will be spending 3.6% of gross domestic product on interest. At current interest rates, an extra $1 trillion in debt would mean around $35 billion a year in additional interest payments — raising the total from 3.6% to 3.7%. That sounds to me like a pretty low price for a significantly better chance of avoiding climate catastrophe.


So as I said, indications that the Biden administration’s climate policy is likely to cost more than expected and may provoke a subsidy war with Europe are actually good news. They’re evidence that, by the measure that truly matters, the policy may be working even better than expected.

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