The federal government faces a difficult task in its March 28 budget: get its climate policy on track while stemming the flow of low carbon investment dollars south driven by the U.S.’s Inflation Reduction Act (IRA).

Competition for climate-related industries will be top of mind when U.S. President Joe Biden visits Ottawa this week. With IRA, the U.S. has not only restored its climate credibility, but also changed the rules. Using generous producer subsidies to drive down domestic decarbonization costs, America is now a big investor in the global low-emissions sector. Canada will need to raise its game to compete for climate dollars.

Contrary to common refrain, Canada can match the U.S.’s big spend on climate—it would take about $12 billion per year to match IRA’s anticipated 10% emissions cuts. With restraint on other spending items, this is within federal and provincial fiscal capacity.

But it’s about more than money—it’s about where Canada can compete strategically. Matching IRA’s depth and breadth risks exhausting the funding envelope with limited impact on the Canadian economy. Crucially, Canada’s emissions structure is different from the U.S.; mimicking IRA will not cut emissions to the degree it will south of the border.

Canada needs a smart new playbook to leverage its unique ability to spur global energy transition. Doing so in a few strategic sectors will help capture the value-added industry associated with made-in-Canada technology and drive down emissions.

Canada’s climate checklist

  • ~$18 billion vs $35 billion

    2022 transition investment vs annual need for 2030 targets

  • $12 billion per year

    New federal spending needed to match IRA

  • Electricity, oil & gas, transportation

    Sectors where most spending is needed to meet 2030 goals

  • $19 vs $21 per tonne

    Canada vs U.S. spending on energy transition (2021)

Canada needs a climate-smart industrial policy. Industrial policy seeks to leverage advantages to grab big economic gains and create positive knock-on effects. In the era of climate action, it involves taking inherently risky bets on sectors and technologies that will drive global decarbonization.

Ottawa should consider both technologies that cut current emissions but also those that stimulate new low-carbon industries. Its support should be based on how unique Canada’s expertise is, how much it can drive down global decarbonization costs, and how other countries are competing for those sectors. All the while keeping an eye on Net Zero targets.

Here’s how Canada can win in the post-IRA economy.

1. Treat IRA as a climate enabler, not a competitor

IRA is not a competition for emissions reductions. Canada’s starting position on climate policy is strong, with robust carbon pricing, regulations, and existing spending. Still, current policy isn’t enough to reach 2030 targets, and Canada needs to start planning for the harder cuts needed shortly after 2030. That’s where Canada can borrow some of the IRA approach to close the gap.

IRA offers strong upstream support for clean energy like hydrogen, electricity, and renewable fuels that can support decarbonization across sectors. Subsidizing production spurs private investment and cuts costs for households and industrial consumers. This improves the case for adopting technology that runs on clean energy and cuts U.S. emissions.

While Canada’s carbon price will spur investment too, technological uncertainty, lack of infrastructure, and other barriers could prevent sufficient technology deployment to improve costs and drive down emissions in time. Canadian policy needs to consider IRA-type actions that drive a systems-wide approach to decarbonization, recognizing that IRA’s investments will already shoulder at least some of the burden. Electricity could be one such critical system: removing barriers to electrical infrastructure development can lower grid emissions, support lower transition costs, and keep energy affordable.

These measures would make decarbonization easier. But they can also lay the foundation for new emissions-free sectors and new investments in emissions-conscious industries that lead to intellectual property development, export potential, and ability to capture new economic opportunities.

2. Play to Canada’s advantages

Strategy is the name of the game. An expansive industrial policy that wages a subsidy war on too many fronts risks bad outcomes, including slower global decarbonization. Canada need not play ball in all sectors. It should pick high-value economic activities where it enjoys sectoral advantages globally.

IRA has amplified Canada’s advantages, too, by giving us access to rapidly growing U.S. markets. Think of hard-fought concessions on a North American EV supply chain. But in some cases, it’s made capturing value more challenging as generous U.S. incentives pull investment south.

Carbon capture is a good example: Canadian startups have strong incumbency advantages, and Canada’s geology for carbon sequestration is plentiful.

Through support for domestic deployment of carbon capture technology, Canada can cut emissions, further improve the technology, and develop a domestic industry that exports carbon capture equipment and expertise globally.

These advantages could be right under our noses. Existing heavy industry is located here for a reason: Canada’s an attractive place to produce and sell steel, cement, and chemicals. Once decarbonized, these sectors could enjoy strong, low-carbon economic prospects, and would count as definitive emissions cuts.

Other sectors where Canada has an incumbency advantage include research and innovation in clean technology, electricity-heavy manufacturing (since Canada’s clean grid offers Scope 2 advantages), critical minerals supply chains, and renewable fuels.

3. Develop structures that can sustain additional value

Canada should aspire to go beyond areas in the value chain where it enjoys incumbent advantages. Finding new high value-added sectors is critical to insure against declining real incomes as Canada’s traditional sectors transition.

But competition will be fierce in areas where Canada’s advantages are marginal—our response will need to be fiercer. This is clear in the burgeoning battery supply chain, where subsidies for battery plants are rampant. By some measures, U.S. tax credits for a single gigafactory could total $2 billion per year.

Canada will bargain away any economic lift unless it can link this spending to its advantaged sectors since network effects will make it easier to capture upstream or downstream parts of the value chain. Developing skilled labour or R&D will boost Canada’s business case for capturing those parts.

The critical minerals supply chain offers a compelling case. Canada has strong advantages in mining and strong refining potential facilitated by our clean grid. Cell manufacturing and battery assembly are key value-added sectors that could lift demand for Canadian minerals and feed downstream assembly. Given global competition, we’ll need to sweeten the deal at first. But investments in upgrading skills, a battery innovation infrastructure, and Canada’s access to U.S. markets could make us a logical location for future sites without a major fiscal lift.

4. Use broad, transparent tools in targeted sectors

One of IRA’s major advantages is its use of the speed and transparency of the tax system to spur investment and lending decisions. Certain and transparent tax credits in the U.S. contrast with the uncertain and volatile carbon credit prices and opaque government grant programs in Canada. The former are easier to lend against, and help mobilize private finance toward climate action.

Government should avoid using slow-moving, bespoke tools like the Strategic Innovation Fund, and instead fund specific tax measures that support development of key sectors more broadly. It would also allow Canadians to see what they’re paying for and coalesce around a new economic strategy.

Cynthia Leach helps shape the narratives and research agenda around the RBC Economics and Thought Leadership team’s forward-looking economic and policy analysis. She joined the team in 2020. Previously, Cynthia was an executive at Finance Canada, most recently heading a team responsible for housing finance policy.

Colin Guldimann joined RBC in 2019 as an economist. He holds a Bachelor’s degree in Economics from the University of Ottawa, and Master of Arts in Economics from the University of British Columbia. Prior to joining RBC, Colin worked on mortgage, housing, and economic policy at the Department of Finance Canada.

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