Feb 08, 2023

The EU’s Hasty Response to US Subsidies Is a Major Mistake in the Making

Enacting the EU’s precipitous Green Deal Industrial Plan in response to the US Inflation Reduction Act (IRA) would be a grave error. It would transform a modest transatlantic friction into a disorderly intra-European industrial confrontation.

European Commission President Ursula von der Leyen presents a "communication" detailing the EU's "Green Deal Industrial Plan" to ensure the bloc plays a leading role in clean tech production, partly in EU's response to the U.S. Inflation Reduction Act, which will provide $369 billion of subsidies for electric vehicles and other green products, in Brussels, Belgium February 1, 2023.

After more than a decade pressing the United States for bold climate action, the European Union is realizing that US climate policy will not be the sort that Europe would have liked. Far from adopting a carbon pricing and taxing model, the US has embarked on a set of bills combining industrial and trade policy with potentially far-reaching consequences. The actual impact is hard to assess, in large part because the actual size and ramifications of the US Inflation Reduction Act are difficult to come by but also because the EU has not conducted a thorough impact assessment. However, the IRA’s potency does not solely rest on subsidies. The local content rules that will support “Made in America” provisions are the real kicker and will contribute to renationalizing the American green industry.

However, over the last decade the EU and its member states have together provided far more than the US in subsidies to support renewables and green transition. Since 2015, Europeans have provided more than €170 billion per year in energy subsidies of which €50 billion are for the fossil fuel industry. In 2020, the European Recovery and Resilience Facility committed some €525 billion of new investments, of which 40 percent are directed at climate and energy transition.

But Europeans, faithful to their free trade mantra and cognizant of their need for cheap technology available elsewhere never attached local content rules to their support schemes. As a result, while these subsidies have certainly accelerated the EU’s transition, they have also predominantly benefited China. Beijing is realizing today that the tremendous advance of its green tech industry offers leverage it can use by now threatening to introduce export controls rules on some of this technology. This would make its solar, hydrogen electrolyzers, or wind technology far more expensive to the EU than it is today.

A Dangerous Tit-For-Tat

This creates a stranglehold that is a real policy challenge to the EU’s transition objectives and its industrial future. But out of panic, the EU risks a precipitous and hazardous response. The Green Deal Industrial Plan presented last week by the European Commission to be discussed this week at a Special European Council intends to loosen State Aid rules in order to enable EU member states to support their industry, in particular by enabling tax credits by individual member states like the IRA does.

While opposed by some parts of the commission, this tit-for-tat, encouraged by intense corporate lobbying, is dangerous because it is not properly calibrated (the State Aid is not capped for each member state), not adequately targeted (it is not limited to industries who can use this support productively), and not sufficiently limited in time. Finally, in the absence of local content rules, the subsidies will inexorably leak to other countries, first and foremost to China.

More importantly, this will create a subsidies race within Europe that will create profound distortions of the single market. It is precisely because some Europeans understand this risk that they have advocated in parallel for the creation of a European Sovereignty Fund to level the playing field. But it is becoming clearer by the day that this European Sovereignty Fund will be too small and will come too late, if at all. By then countries with limited fiscal space and industrial capacity will be dangerously lagging behind. In the meantime, repurposing the Recovery and Resilience Facility funds to engineer subsidies to businesses is a fig leaf and potentially a step backward from a program that was rightly designed to boost public investment in infrastructure and renewables.

Given the amount of State Aid currently under review and their geographical breakdown, it is already obvious who will benefit most. This package, if approved, will contribute greatly to fueling intra-European competitiveness divergences. Concretely, Germany, which has more fiscal power and a stronger industrial base, will deepen its lead over the rest of the Europe, thereby fueling a yet greater polarization and agglomeration of capital and highly skilled labor, accelerating the deindustrialization of the rest of Europe.

This is the reason why southern member states like Italy and Spain have started to oppose this move behind the scenes with the unusual support of northern European countries more attached to the single market (Denmark, Finland, Ireland, the Netherlands, Poland, and Sweden). But given the haste, they have not been heard. France is naively pushing along with Germany, due to the hubristic view that it has the fiscal space and the industrial base to match German support. It is liable to discover only too late that its precipitous reaction will actually weaken its relative position in Europe, while not even ensuring that the EU can compete with the US.

European leaders should strongly oppose this precipitous Franco-German push and take the time to come up with a more robust and truly European green industrial policy at their March European Council and accompany it with a meaningful reform of the EU’s fiscal rules.  

Shahin Vallée is a senior research fellow at the German Council on Foreign Relation’s (DGAP) Center for Geopolitics, Geoeconomics, and Technology.

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