The New Paradigm Papers of the Month of November

The Effects of “Buy American”: Electric Vehicles and the Inflation Reduction Act

Hunt Allcott, Reigner Kane, Max Maydanchik, Joseph S. Shapiro, Felix Tintelno

Using new data on vehicle prices and purchasing decisions, the authors analyse the welfare effects of the recent massive subsidies for electric vehicles in the United States. As a key component of the Inflation Reduction Act (IRA), tax credits of up to USD 7,500 were granted for the purchase of new electric cars manufactured in North America from 2022. The preliminary results of the UC Berkeley working paper show that these subsidies have noticeably promoted the switch to e-cars. Compared to the tax credits that applied before the IRA, the IRA credits increased sales of EVs by 90,000 units per year. Overall, the authors calculate a positive welfare effect: for every USD in government spending, USD 1.87 in positive effects were triggered for the economy and the environment. However, they also emphasise that three quarters of the subsidies went to consumers who would have bought an electric vehicle anyway. The authors also criticise the fact that the subsidy also promoted energy- and material-intensive luxury cars. They therefore see room for improvement in the design of the IRA and recommend, among other things, more targeted support for energy-efficient car models.

The full study

Industrial Policy in the Global Semiconductor Sector

Pinelopi K. Goldberg, Réka Juhász, Nathan J. Lane, Giulia Lo Forte, Jeff Thurk

Due to their central importance for national security, semiconductors play an important role in the industrial policy strategy of many countries. The German government, for example, is spending a lot of money trying to attract semiconductor manufacturers to Germany. But what effect do these efforts have on the development of the industry? In a new paper, a group of researchers compares industrial policy measures worldwide. The authors show that in the past, government action has in many cases been the driving force behind the initial development of the semiconductor industry. Whether in the United States, Taiwan, South Korea or Japan: in almost all countries with a significant semiconductor industry, this was supported by the state in the 2010s – with around 1.5 billion US dollars annually (on average per country in the period from 2010 to 2022). At the same time, it was clear that subsidies alone were no guarantee of success. Cross-border knowledge exchange was also needed. For example, Taiwanese and South Korean chip manufacturers have been more successful than Chinese chip manufacturers due to closer cooperation with the United States and access to US technologies. In the authors’ view, this is the decisive factor for the fact that China’s manufacturers have not become technology leaders despite extensive state support.

The full study

Minimum Wages in the 21st Century

Arindrajit Dube & Attila S. Lindner

Since many countries reintroduced minimum wages at the beginning of the 21st century, the long-standing fundamental criticism of such legal stipulations by orthodox economists has become quieter. The empirical findings of Nobel Prize winner David Card, who has shown that such minimum wages equalise an imbalance of power in poorly paid work, have also contributed to this. In their paper, Arindraijit Dube and Attila Lindner now summarise the latest findings on how minimum wages have actually affected labour markets in the low-wage sector. According to the paper, practice disproves the neoclassical assumption that employment falls after the introduction or increase of a minimum wage. The authors explain this by saying, among other things, that minimum wages help employees to stay in their jobs for longer and that there is therefore less fluctuation and familiarisation time for companies. This increases productivity and prevents companies from passing on higher labour costs to consumers. International experience also shows that higher minimum wages tend to reduce wage inequality in the lower half of the wage distribution. According to a recent study for Germany, half of the recent decline in wage inequality in this country can be attributed to the introduction of the minimum wage.

The full study

Fiscal Consolidation And Its Growth Effects In Euro Area Countries

Philipp Heimberger

The new EU fiscal rules, which have been in force since April 2024, will necessitate significant austerity measures in some European countries. Based on an analysis of the effects of budget consolidation since the early 1990s, Viennese economist Philipp Heimberger warns against such austerity measures in this paper. Because economic growth is slowed down by consolidation, this in turn has a negative impact on public finances. Using simulations, the author projects that debt ratios in the eurozone will therefore not fall as much between 2025 and 2028 as expected by the European Commission. The Brussels authority is underestimating the negative growth effects of consolidation. Among other things, the author relies on an empirical analysis by the International Monetary Fund (WEO 2023), which shows that budget consolidation in industrialised countries does not automatically lead to the desired debt reduction, but only if certain conditions (such as a favourable economic environment and an appropriate mix of tax increases and spending cuts) are met. Heimberger also discussed these effects in our New Economy Short Cut from May 2023 with IMF economist Adrian Peralta-Alva (re-live here).

The full study

The Economics of Water. Valuing the Hydrological Cycle as a Global Common Good

Mariana Mazzucato, Tharman Shanmugaratnam, Ngozi Okonjo-Iweala, Johan Rockström

Alongside climate change and biodiversity loss, water scarcity is one of the key ecological problems of our time. In its report, the Global Commission on the Economics of Water states that the value of water cycles and their components (forests, etc.) has not yet been sufficiently recognised in economic terms. According to the authors, who include renowned researchers such as Mariana Mazzucato and Johan Rockström, progressive deforestation and water pollution will not only have a major impact on water cycles in the future, but also on economic cycles. According to the study, this could result in a global loss of 8% of gross domestic product by 2050. In addition, half of the world’s food production would be jeopardised. Around three billion people already suffer from inadequate access to drinking water. As global warming increases, more and more people will be confronted with the consequences of water scarcity. The authors therefore call for a ‘water economy’ in which prices, regulation, subsidies and other incentives are coordinated in such a way as to ensure more efficient, fairer and more sustainable water use. Among other things, the Commission proposes a pricing system that would reduce overuse by certain industries and ensure free access to drinking water in underserved areas. In Mazzucato’s opinion, all of this can only be achieved by rethinking the economy – in terms of an economic policy that not only reacts to market failures, but also proactively shapes the economy in the interests of the common good.

The full report