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Inflation Reduction Act Roils South Korea-US Relations

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Inflation Reduction Act Roils South Korea-US Relations

The EV provisions of the IRA are seen by South Korea as both a violation of trade rules and contrary to the deepening economic partnership between the two countries.

Inflation Reduction Act Roils South Korea-US Relations
Credit: Korean Ministry of Foreign Affairs

Despite being one of U.S. President Joe Biden’s biggest domestic wins, the Inflation Reduction Act (IRA) is causing unexpected discord in South Korea-U.S. relations.

Designed to salvage some of the Biden administration’s “Build Back Better” initiative, the IRA was the result of Senator Joe Manchin’s insistence that any new legislation be crafted to reduce domestic inflation. While the legislation utilizes new taxes and negotiating powers to put pressure on some of the sources of inflation, it also provides significant funds to address climate change. One of the key components to that end are tax credits to support the adoption of electric vehicles (EVs) in the United States, but these provisions have also become a source of friction with South Korea.

The EV provisions of the Inflation Reduction Act are seen by South Korea as both a violation of trade rules and contrary to the deepening economic partnership between the two countries. One South Korean official called the legislation a “betrayal” and suggested that it could damage cooperation in other areas of the relationship. National Assembly Speaker Kim Jin-pyo has suggested the legislation, along with the CHIPS and Science Act, could make it difficult for South Korean firms to fulfill their investment pledges in the United States, while a Korean columnist argued that Biden’s trade policy is no better than former President Donald Trump’s “Make America Great Again” policies.

Multiple senior Korean officials have traveled to the United States to raise this issue with Congress and their U.S. counterparts. The issue is also likely to be raised to the presidential level.

The United States has thus far responded positively to Seoul’s call to discuss the issues around the IRA further. Undersecretary of State for Economic Growth, Energy, and the Environment Jose W. Fernandez, for example, said, “We take the Republic of Korea’s concerns seriously and stand ready for serious consultations.” However, U.S. officials have not yet suggested what they may be able to do to ease South Korean concerns.

What the Inflation Reduction Act Does

The Inflation Reduction Act is the most significant piece of climate change legislation in U.S. history. It is expected to reduce U.S. greenhouse gas emissions between 37-41 percent from 2005 levels by 2030. If successful, the legislation would be an important step by the United States toward the global goal of reducing emissions enough by 2050 to prevent global temperatures from rising more than 1.5 degrees Celsius.

However, it is the provisions related to EVs and EV batteries that are of the most concern to South Korea.

The Inflation Reduction Act provides a $7,500 tax credit for EVs assembled in the United States. Currently, 26 of the 32 EV models sold in the United States are assembled domestically. Of those, only the Nissan Leaf and a handful of European models are built in the United States. All of the EVs sold by Kia and Hyundai are currently built overseas, making them ineligible for the tax credit.

Beginning in 2023, additional restrictions are added to the tax credit. Vehicles will still need to be produced in the United States, but new requirements are added for the mineral content and components of the EV batteries. To be eligible for $3,750 of the tax credit, 40 percent of an EV battery’s minerals will need to come from the United States or U.S. FTA partners. Similarly, 50 percent of the components will need come from the United States or U.S. FTA partners to be eligible for the remaining $3,750 of the overall tax credit. This requirement rises to 80 percent for minerals by 2027 and 100 percent for components by 2029. However, by 2025 vehicles with minerals or components from foreign entities of concern will no longer be eligible for the EV tax credit.

The EV battery provisions are designed to help spur supply chains in the United States and among U.S. FTA partners, as China is currently the dominant miner or processer of many of the minerals needed to produce EV batteries. For example, while Australia mines around 50 percent of the world’s lithium, over 60 percent is processed in China.

As the example of lithium suggests, meeting these requirements will be challenging for any EV battery maker. In the case of South Korea, more than 80 percent of its imported lithium, cobalt, and graphite – all three critical minerals in EV batteries – are from China. According to the International Energy Agency, China produces 85 percent of the world’s battery anodes and 70 percent of the world’s cathodes. South Korea imports nearly 85 percent of the anodes its EV batteries uses and 73 percent of its cathodes from China.

Why the IRA Is Causing Tensions With South Korea

South Korea’s concerns extend beyond the details of the Inflation Reduction Act. Seoul has worked with the Biden administration to deepen the economic relationship between the United States and South Korea, specifically on supply chain resilience, semiconductors, and climate change. As a result, South Korean firms have made a series of significant investment commitments in the United States.

During the 2021 South Korea-U.S. Summit, Samsung announced its intention to invest $17 billion in a new foundry in the United States to address U.S. concerns about semiconductors, while SK Hynix announced this year that it would invest $15 billion in R&D and a materials and packaging facility.

Investments in EVs have also been an area of increasing collaboration between U.S. and South Korean firms. South Korean firms are responsible for much of the investment in EV battery production in the United States and will be providing EV batteries for not just Korean automakers, but American, Japanese, and European producers as well. All told, South Korean firms will invest more than $13 billion in the United States by 2025 to boost EV battery production.

In addition to the investments in EV batteries, earlier this year Hyundai and Kia announced that they would invest $5.5 billion in joint EV and EV battery production facility in Georgia. The new plant is expected to be able to produce 300,000 EVs a year once it comes online in 2025.

These investments related to EVs are expected to create 35,400 jobs, more than the investments in the EV sector by any other country.

While there are concerns that the IRA’s requirement that EVs be assembled in the United States has put Korean firms at a disadvantage, these concerns have been magnified by Seoul’s efforts to deepen economic cooperation with Washington. They are also contrary to the national treatment provisions in the KORUS FTA.

The Inflation Reduction Act was primarily designed to focus on U.S. domestic concerns related to inflation and addressing climate change but has had the unintended consequence of creating friction in South Korea-U.S. relations. In the medium term, the IRA could actually benefit South Korean firms by locking up the U.S. EV battery market as they develop new supply chains to meet the requirements against components and minerals from foreign entities of concern. But in the short term, it has damaged the prospects for South Korean EVs in the U.S. market and, most importantly, damaged relations with a key partner for the United States.