Focus
September 01, 2023 | 13:39
America’s Industrial Policy Play in Three Acts
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
America’s Industrial Policy Play in Three Acts |
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Last month marked the one-year anniversary of the Inflation Reduction Act along with CHIPS and Science Act. President Biden signed them into law last August 16 and August 9, respectively. Nine months before (November 15, 2021), he did the same for the Infrastructure Investment and Jobs Act. These three sets of complementary industrial policy actions are bringing to bear more than $2.2 trillion of multiyear fiscal support. The intention is to transform the U.S. economy by repairing existing infrastructure, building new infrastructure, increasing semiconductor industry capacity, boosting R&D and the STEM workforce, along with shifting energy production and consumption patterns to help achieve America’s climate ambitions. Infrastructure Investment and Jobs Act (IIJA) |
The IIJA is worth $1.2 trillion, made up of $630 billion of baseline funding for surface transportation programs over eight years. This was a 29% increase over the annual amount that Congress had previously authorized for the fiscal 2016-2020 period that had been extended. The remaining roughly $550 billion is for new infrastructure programs over five years (Table 1). Transportation infrastructure gets the most money. Old bridges, the ‘poster child’ for inadequate investment, might finally get revitalized or rebuilt (7.5% of the nation’s 617,000 bridges are considered structurally deficient or in “poor” condition according to the American Society of Civil Engineers). And there’s a ‘green theme’ running through the Act, with support to build 500,000 EV charging stations across the country and electrify school and transit buses, and “the single largest investment in clean energy transmission in American history” according to the Administration. Indeed, McKinsey & Company reckoned there is some $70 billion of clean-energy measures in the IIJA. |
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IIJA-related spending on infrastructure by the federal government, along with state and local governments and the private sector, is going to end up being much more than $1.2 trillion over the interval. Some of these funds are intended for public-private partnerships (PPPs). Meanwhile, state and local governments regularly co-fund infrastructure projects with the federal government. For example, those levels of government typically cover about three-quarters of highway and road funding, with the federal level kicking in the rest. The Act contains a mishmash of offsets to help pay for the outlays; according to the Congressional Budget Office (CBO), the IIJA will add a net $256 billion to the 10-year budget deficit before considering regular surface transportation funding. The Committee for a Responsible Federal Budget estimates the full impact at just under $400 billion [1]. CHIPS and Science ActThe marquee measure in the Creating Helpful Incentives to Produce Semiconductors (CHIPS) and Science Act is the $53 billion to subsidize increased semiconductor manufacturing over the coming decade. It’s considered the marquee measure because of the recent microchip shortage and technology trade issues with China, and the fact that the Act included emergency appropriations to pay for it. But it wasn’t the biggest piece of the $280 billion pie. The ‘science’ side saw $200 billion authorized across several departments and agencies to boost R&D and the STEM workforce over the coming decade. There is also a 25% investment tax credit for the next five years, which the CBO estimates will cost almost $25 billion. The Act contains no offsets, so this will all augment the 10-year deficit. The CHIPS and Science Act’s legislative path began in late 2019 and garnered momentum the next year as U.S. officials started wooing Taiwanese chipmakers. According to The Economist, since 2020 (and through August 2023), chipmakers have announced more than $200 billion worth of U.S. investments. The U.S. Chamber of Commerce puts the tally at $166 billion since enactment. Inflation Reduction Act (IRA)The IRA contains about $500 billion in combined spending on health care (just under $110 billion) and support for clean energy (just over $390 billion), the latter mostly via tax incentives. It’s called the Inflation “Reduction” Act because offsets total some $738 billion, causing the 10-year deficit to decline by $268 billion according to the initial scoring by the CBO and Joint Committee on Taxation (JCT). The Administration and congressional Democrats assume that lower deficits will help reduce inflation. (Note that unlike the IIJA and the CHIPS and Science Act, this was not a bipartisan effort.) The offsets include $457 billion in higher taxes, such as a 15% corporate minimum tax ($222 billion) and the proceeds from increased IRS tax enforcement funding ($101 billion), along with $281 billion in health savings. The higher taxes will offset some of the IRA’s economic benefits but not its environmental advantages. |
The use of cumulatively large tax breaks and subsidies to guide more production and consumption of clean energy is necessary to achieve America’s climate ambitions in the absence of a national carbon-pricing scheme. The tax incentives were predominately tax credits (but also included tax deductions) that the JCT originally scored as worth $270 billion. The credits all had sunsets, some as short as end-2024, some as long as end-2034, and most at 2032-end. But the credits have no caps. And, as the rules and regulations rolled out, Treasury seemed to take a (surprisingly) expansive approach. For example, the $7,500 EV tax credit was not intended for people earning above $300,000 and intended for sales prices below $55,000 for cars and $80,000 for SUVs and trucks. Treasury ruled that these (and even domestic content regulations) didn’t apply to leased vehicles. As EV sales have been rising over the past year (Chart 1), so too has leasing’s share (not surprisingly). |
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The steady climb in EV sales and their expected path (partly given overseas precedents) was already ramping up battery production and assembly plant modification before the IRA. The IRA simply steepened the ramp. Take-up of many of the ‘production’ credits was also surprising. So, when the JCT re-estimated the cost of the tax incentives in April (which didn’t include EV tax credits), it had almost doubled to $526 billion (and extending the projection period by two years to 2033 lifted the new 10-year tally to $570 billion). A second revised estimate in June lifted it 16% further to $663 billion. |
The IRA will likely end up adding meaningfully to the cumulative budget shortfall, if the recent trend is any guide. Through July, the 12-month deficit was $2.26 trillion or $1.61 trillion on a fiscal-year-to-date basis, with two months to go. The CBO’s May baseline projection, subsequently adjusted for the (debt limit lifting) Fiscal Responsibility Act (FRA), is $1.53 trillion for this year and $1.50 trillion for next year (Chart 2). Note that the May baseline includes legislation in force as of March 30, 2023 (apart from the FRA). BuildoutThe White House is reporting that these three pieces of legislation have funded $511 billion of announced private investment and $300 billion of announced public infrastructure spending, for a total of $811 billion so far. As these announced projects commence, the construction sector and its allied industries have been experiencing a surge in activity. Spending on non-residential construction was an annualized $1.08 trillion in July, up 16.5% y/y, with private spending at $670 billion (+19.8% y/y) and public outlays at $414 billion (+11.6%) (Chart 3). Private manufacturing has been the strongest, with growth topping 70% y/y to an annualized $201 billion; think of all those new factories making microchips, batteries and solar cells. However, these are nominal amounts and the initial escalation in construction activity also reflected rising rates of inflation. The yearly change in (final demand) PPI construction prices topped 20% in July 2022, with non-residential industrial buildings topping 27% y/y. Adjusting for inflation, the initial surge in total non-residential spending, particularly outside the manufacturing space, appears to have been largely inflation-driven. However, the growth in total real outlays has since turned positive, currently clocking in at a strong 11.9% y/y and paced by a whopping 65% y/y gain on the manufacturing front (Chart 4). (Note that despite the pickup in real construction outlays, the level of nonresidential investment in structures is still below its pre-pandemic level, even excluding the oil and gas sector.) It’s also likely the case that construction activity is restrained by red tape and labour shortages. Getting regulatory approval for some infrastructure projects has proven more difficult under heightened environmental and equity standards. And shortages of skilled workers are problematic for all investments, not only for the construction phase but also for the subsequent operating phase. For example, Taiwan Semiconductor Manufacturing Co. (TSMC) is investing $40 billion in two chip fabrication plants in Arizona. But the lack of skilled workers has restrained construction progress, with TSMC considering bringing in workers from its home country, causing a tussle with labour unions. And once these and other ‘fabs’ are completed, there’s the shortage of technical workers to contend with. A study by the Semiconductor Industry Association and Oxford Economics concluded that the sector will be short 67,000 technicians, computer scientists and engineers by 2030, and by 1.4 million in the broader economy (which the IRA is also attempting to remedy). |
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Concerns over the fiscal deficit, red tape and labour shortages aside, America’s three-pronged industrial policy is already resulting in stronger economic growth and employment outcomes than would otherwise be the case. This, in turn, is contributing to economic resiliency and the chances of achieving a soft landing (and a sturdy takeoff afterwards). While this incremental economic activity is also likely contributing, at the margin, to the stubbornness of underlying inflation, the Fed and most economists will look past this. Productive capacity is being expanded and enhanced, which raises the prospects for faster non-inflationary economic growth down the road. Endnote:[1] The CBO’s scoring does not normally account for economic growth effects on the budget balance (a.k.a. dynamic scoring), which would lower the cumulative impact, or incremental interest costs, which would raise it. [^] |