US Industrial Policy and Southeast Asia: Interview w/ Kevin Chen

[Editor’s Note: The following is a Q&A interview with Kevin Chen, Associate Research Fellow at the S. Rajaratnam School of International Studies at Nanyang Technological University in Singapore. He tracks the intersection of US industrial policy and Southeast Asia more closely than anyone I know, and he had a great piece in The Diplomat called “For Southeast Asia, US Industrial Policy Might Be a Risky Bet.” It raised a number of issues about the geopolitical side of the Inflation Reduction Act (IRA). You can find Kevin on Twitter @kxachen]

Even if some Southeast Asian firms can benefit from the IRA—and America’s embrace of industrial policy—the changes it brings as a whole seem to work against the interests of small trading nations. Do you agree with that statement, or would you amend it in some way?

Kevin: I agree with that statement for the most part, in that the IRA’s implications largely work against the interests of small trading nations.

The IRA requires Electric Vehicles (EVs) to be assembled in or mostly contain battery components from the US or its free trade partners to be eligible for the US$7,500 tax credit, and it is worth noting that most Southeast Asian countries do not have free trade agreements with the US. Consequently, we might see a shift in EV-related foreign direct investment (FDI) away from Southeast Asian economies and towards the US, as firms aim to take advantage of these tax credits.

Now, it is possible that the IRA could spur Southeast Asian economies to create more competitive EVs or EV parts. Consider what happened with Japanese cars back in the 1980s, when Japan imposed a voluntary export restraint (VER) that constricted supply and raised the price of Japanese car exports to the US. Rather than taking it lying down, Japanese carmakers upped their game and increased the quality of their offerings (Feenstra, 1988). With the right partners, Southeast Asian carmakers or EV parts manufacturers could follow the same playbook.

However, a significant problem that the IRA exacerbates is the fragmentation of globalisation along political lines. It is one thing to make investment or market access decisions based on a country’s economic fundamentals, and another to base it on whether the country has the right friends, so to speak.

Access to external export markets might become more restricted, stifling the development of their fledgling industries. Countries might also feel compelled to invest in massive EV factories in the US or its free trade partners out of political expediency instead of economic sense, preventing their local populations from gaining from technological transfers.

In other words, the flow of investments and expertise that could help to develop their economies might slow to a trickle due to the IRA and its implications.

Southeast Asia is home to several electric vehicle manufacturers. What’s their relationship to China—and does eligibility for IRA tax credits force them to “choose” either China or the US?

Many Southeast Asian economies have set goals to move away from internal combustion engine (ICE) cars and towards the production and sale of EVs.

Thailand, Southeast Asia’s biggest car producer and exporter, aims to have EVs account for 30% of its car production numbers by 2030. Indonesia aims to sell only EVs by 2050, while Singapore aims to stop registering new ICE vehicles after 2030.

Amid these tight deadlines, it’s not an exaggeration to say that China is an indispensable partner for Southeast Asian EV manufacturers. This is not only for things like batteries and the mining of battery components, which China has a clear dominance in, but for the development of parts such as the chassis as well.

VinFast, for example, has partnered with Chinese company Gotion High-Tech to build a lithium iron phosphate (LFP) battery plant in Vietnam, and is working with Contemporary Amperex Technology (CATL) on chassis and battery development. In Thailand, investments by Chinese carmakers such as BYD and Great Wall Motor are challenging the traditional dominance of Japanese carmakers.

Chinese companies, for their part, are drawn in by factors such as the existing logistical base of countries such as Thailand, the mineral wealth of places like nickel-rich Indonesia, and the general readiness of host governments throughout the region to provide incentives.

As for whether eligibility for IRA tax credits forces the countries to “choose”, I think the answer is “hopefully not.” Southeast Asian economies would want nothing more than to reap the benefits of collaboration with Chinese companies to build their local EV industries while entering the US market for sales and support via tax credits. That is probably the approach taken by VinFast, which just broke ground on a US$4 billion manufacturing complex in North Carolina while maintaining its partnerships with Chinese firms.

If push came to shove and their eligibility for IRA tax credits came on the line due to their closeness with China, however, I imagine that Southeast Asian economies would prefer to maintain their partnerships with Chinese firms while hoping for cooler heads to prevail in Washington.

What is Southeast Asia’s capacity to do its own industrial policy in green tech manufacturing and related sectors?

Southeast Asia is no stranger to industrial policy, which, borrowing the International Monetary Fund’s definition, refers to “government efforts to shape the economy by targeting specific industries, firms, or economic activities.” Malaysia, for example, had its whole effort to promote its domestic car manufacturing industry with Proton and Perodua and the electronics industry in Penang.

The question is not whether the governments are willing to undertake policies to promote specific industries such as by offering incentives, tax breaks and the like, but whether they can attract the necessary partners to support the development of their green tech manufacturing and related sectors.

Many of the “rules” of IRA implementation are not part of law but rather left to agencies of the Executive Branch. Within the IRA as written, what do you see as the critical uncertainties it introduces for Southeast Asia (firms or governments)?  

The biggest uncertainty for Southeast Asian firms and governments alike will be Section 30D(d)(7) of the IRA, which states how vehicles with battery components extracted, processed, or recycled by “foreign [entities] of concern,” as well as batteries manufactured or assembled by said entities, will be ineligible for the tax credit.

The text of the IRA refers readers to Section 40207(a)(5) of the Infrastructure Investment and Jobs Act, which goes on to define a “foreign entity of concern” as any foreign entity “owned by, controlled by, or subject to the jurisdiction or direction of a government of a covered nation” (namely China, Russia, North Korea, and Iran).

There is a great deal of uncertainty surrounding this definition. While the US Treasury Department published a guidance document on EV tax credit eligibility under the IRA in late March 2023, it did not answer the all-important question of what counts as a “foreign entity of concern.” Indeed, there are many permutations and possibilities of what kind of firms may be allowed.

The worst-case scenario for Southeast Asian firms and governments would be if the Treasury Department adopts the strict interpretation of “foreign entities of concern” that the CHIPS Act subscribes to. Under this definition, the label would be applied to any EV which has even a small amount of the critical minerals for its battery “extracted, processed, or recycled” in China or by a firm which is more than 25% owned by a Chinese state-owned company, or is assembled and manufactured in China or by such a company.

Such an interpretation would effectively render most, if not all, Southeast Asian EV firms ineligible for the IRA tax credit. There are hopes that the Treasury Department will adopt a narrower definition of “foreign entities of concern,” but as I mentioned in my piece in The Diplomat, the risks are high.

How exposed are Southeast Asian firms if a future Republican Congress decides to no longer permit IRA tax credits for foreign firms?

A move to bar foreign firms from IRA tax credits seems quite drastic, but the Southeast Asian firm with the most on the line would be VinFast, what with its manufacturing complex in North Carolina.

For a rough comparison, the new VinFast VF8 City Edition reportedly retails at around US$55,000, while a Tesla Model Y retails for about US$53,000. Without the tax credit, it will be hard to convince US consumers to opt for this car model, and harder yet to justify the massive investment that VinFast just made.

For most of the other Southeast Asian firms, the inability to receive IRA tax credits will be a disappointment, but not a crippling one. Governments would instead focus on improving their regulatory environment or offering perks for foreign investors to invest in their domestic EV industries. China, which has invested heavily in the Southeast Asian EV market over the past few years, would be well positioned to extend its dominance here.

Trump recently announced a plan to impose a “global minimum tariff” on all imports. He may not become president, but he’s the Republican Party’s agenda setter. How would the proposed universal 10% tariff impact Southeast Asian economies? 

I believe Adam Posen, President of the Peterson Institute for International Economics, put it best when he called the idea of a global minimum tariff “lunacy” and “horrifying.”

As he points out, the US currently imposes an average tariff on imports of around 3 percent, though the number is higher for certain countries; raising this to 10 percent would set off a chain reaction that would likely cause widespread unemployment and economic chaos within the US.

Southeast Asian export markets would take a massive hit since many of them count the US within their top three export markets. FDI flows might be diverted from the region if Southeast Asian products become less competitive in the US market, limiting their development.

One would also have to consider such a universal tariff as the opening salvo to a more devastating trade war. Unlike the previous trade war, in which Southeast Asian countries such as Vietnam were able to benefit to a certain extent from firms looking to relocate their manufacturing operations, it would be much harder to remain unscathed this time as governments reassess their trade relationships.