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Rishi Sunak has been warned by a leading think-tank against entering a “subsidy race” with the US and EU in an attempt to defend the British car industry.

The UK is locked in a subsidy battle with Spain, as the prime minister tries to persuade Indian conglomerate Tata to build a new gigafactory in Britain to supply batteries to its Jaguar Land Rover range.

But Policy Exchange, a think-tank set up by senior Conservatives including levelling-up secretary Michael Gove, argued in a report published on Friday that ministers should improve the business climate in the UK rather than try to protect the auto industry with subsidies.

Sir Geoffrey Owen, author of the report and a former Financial Times editor, said: “The UK should not engage in a subsidy race with the EU and the US.”

Owen said strategic planning was crucial along with targeting specific problems facing the car industry: “Where there are obstacles which discourage investment, such as high energy costs, the government should seek to remove or mitigate them.”

Owen lamented the “erratic conduct of UK industrial policy over the last two years”, arguing that the scrapping of former prime minister Theresa May’s industrial strategy in 2021 had been confusing for business and bad for investment.

The report said a greater degree of stability in government policy was needed and that any support to the auto industry should be realistic and based on how the UK can best compete in the world market.

It argued that the scale of the EU market gives the 27-member bloc an advantage in luring investment from Asian companies, now that Britain has left the single market and customs union.

Tata is expected to choose in the near future between building a new battery gigafactory in Spain or at a site near Bridgwater in Somerset, with UK ministers confident the project will come to Britain.

A subsidy package of at least £500mn is expected to be put on the table, along with an open-ended commitment to cut the energy bills for the factory and other energy-intensive users.

Separately, Britain has raised concerns about the operation of US president Joe Biden’s Inflation Reduction Act, a $369bn package of subsidies intended to boost green energy projects in the US.

Kemi Badenoch, business and trade secretary, has led calls on Washington to ensure that companies based in Britain and other western allies can benefit from the subsidies without moving their operations to the US.

Sunak will meet Biden in Washington next week but the British prime minister’s allies said they did not expect the operation of the so-called IRA to be “high on the agenda”.

The prime minister’s focus has recently been on the opportunities and risks presented by artificial intelligence and he will discuss those issues with Biden.

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