Europe is missing the point on climate spending

, by Alonso Campos

Europe is missing the point on climate spending
Credit: Nick Humphries,

On August 16th, 2022, United States President Joe Biden signed into law the Inflation Reduction Act (IRA), after a year-long fight within the Democratic Party over its climate provisions. While sold as an aid against the record-high inflation the country was facing, the bill was actually the largest climate action bill ever passed by the US Congress. Its $391 billion in climate spending covers everything from renewable energy subsidies to climate-smart agriculture, from electric cars to nuclear power, and much more. All in all, it is the largest climate package ever passed in the US, and it has been estimated that it could help reduce 2030 US emissions by 40% compared to 2005, putting the country on track to achieve the Paris Agreement 1.5°C goals.

Crucially, most of the subsidies and tax breaks considered in the bill are aimed not only at reducing emissions, but at strengthening the American industrial base, by establishing requirements that the subsidies may only apply if certain fractions of the products are made within the US or its free trade partners (in principle, only Canada and Mexico). With these incentives, at least $75 billion in private investment has already been mobilized for green economy manufacturing, with much more yet to come. From the other side of the Atlantic, the European Union and its member States have watched these developments in shock. Not only had the Biden Administration challenged the EU’s position as the global frontrunner in climate and sustainability issues, but had done so in a way that threatened to lure away much of the same green industry investments and jobs the EU was trying to court.

For decades, the EU’s sustainability approach had been to regulate, set goals and standards, and then let the free market work. The EU’s Emission Trading System (ETS, the world’s first large carbon market) was successful in reducing CO2 emissions up to 10% over 7 years, for example. The current “Fit for 55” legislative package will expand and enhance the ETS, and set new energy and fuel efficiency standards, among other things, in its objective of a 61% emissions decrease by 2030. These regulations are good in providing incentives to reduce emissions, but the EU and its members no longer want to simply decrease emissions: while not so in the past, there is currently a lot of money to be made with the new green technologies, and everyone wants a piece of the pie. Europe will decrease its emissions, but will the batteries and solar panels be made in Europe, or in the US and China? The Europeans’ fears are that the IRA will ensure that they will be produced across the Atlantic.

Missing the point

The months since the IRA’s passing have significantly reinforced those fears. Battery manufacturer Northvolt is the poster child of the issue: founded in Sweden in 2015, it received funding from the European Investment Bank, opened factories in Sweden and Germany and is now going to abandon plans for a new German factory and build in the US instead. The problem spans all green technologies and the whole value chain: with the IRA’s subsidies and tax credits, the United States is much more attractive for both European and third-country manufacturers.

Backed into a corner, European politicians moved from denial and anger to bargaining. The main focus: to get a US carve out for Europe’s car-makers, the crown jewel of European industry and crucial in multiple member States such as Germany and Spain. The IRA gives significant subsidies to electric cars whose batteries are manufactured at least 40% in the United States or its free trade partners Canada and Mexico, and Europe wants to be considered a “free trade partner” so its cars qualify for the subsidies. There is willingness among the Biden Administration to accommodate this, and a deal appears close, but Europe’s complaints of being unfairly targeted by the IRA are increasingly being met with a “it’s your issue, you figure it out” from both inside and outside the EU.

And those voices are not wrong. The European Union has spent the last two decades (correctly) complaining that the US lacked in climate commitments, so the new US impulse on climate should be welcomed, and any issues with the legislation discussed with the Americans maturely. Instead, many European leaders have reacted with shock and called offense on the United States. The fear of losing the new green industries to the US has since caused a reckoning in EU institutions and member States, with traditional free trader and laissez-faire supporter Germany being drawn to France’s State interventionism. Both countries, and the European Commission, are now calling for significant reforms to State aid rules. Response from many within the EU has been irate, decrying that the changes would open the door to subsidy races, market distortions, and other problems. Dutch Ambassador Robert De Groot in particular has been quoted as saying that the new Commission plans are “like Marx on steroids”.

While the draft proposal was by no means perfect, comparing looser state aid rules to “Marx on steroids” is not par for the course of reasonable political discourse. Instead, it betrays the uncomfortableness of those who still cling to the free market dogma in a world that is rapidly shifting to industrial policy and governmental planning: the subsidy race is already here, and Europe is losing it. And weakly complaining to the US about its own subsidies will not solve it. Opponents of State intervention are also heavily missing the point: we should want a subsidy race in climate investment, we should want to distort every market with cheap green technologies. Climate change is the biggest threat humanity faces, and the best thing that could happen for the planet is for Europe, the United States and China to compete in building the green technology industrial base.

Especially when those technologies (solar panels, batteries, etc.) are market-proven and will be the future of our economies and energy systems. This is not sinking money into unproven industries, but rather speeding up an economic transition that is going to happen regardless of market forces alone. The only question remaining is how fast it will be, and where those green technologies will be manufactured.

Insisting on market orthodoxy in the face of these facts is simply refusing to see the writing on the wall: if they ever worked, free-market non-interventionist approaches will fail in the current scenario, and even if they did not, we should be doing everything in our hands to accelerate the green transition.

Bigger States, smaller States

The one concern the anti-subsidies camp has that bears more attention is their fear that, if state aid rules were loosened, bigger and richer member states such as France and Germany would flood their economies with new subsidies, leaving everyone else in the EU behind (as happened during the pandemic, where they accumulated 80% of all EU aid between them).

While concern over the fragmentation of the single market is more than reasonable, this should not be taken as an excuse to not reform State aid rules – rather, the reform should take this into account. In particular, new State aid proposals should still require approval by the European Commission and be automatically dismissed should a country’s share of total State aid grow bigger than its share of total EU GDP.

Then, if a big State wishes to give more state aid, it should partner with other member States for cross-border projects where it fronts more money than its companies receive back, with the difference helping to pay for the subsidies to the companies in the other member States. That way, the big country’s total state aid is limited, and they help subsidize the subsidies of smaller, poorer member States. This would have the additional advantage of increasing the cohesion of the Single Market, as these cross-border projects would help build pan-European green technologies supply chains.

Alternatively, those states surpassing their share of allowed state aid could put money in a pan-European investment fund to offset their new state aid, with the common fund then investing that money in countries with lower state aid levels. This common fund could be the European Investment Bank, or the newly proposed European Sovereignty Fund.

Together with other measures to support European tech and climate startups and small and medium enterprises (SMEs), such as promoting both public and private venture capital support, this would set the foundation for the re-industrialization of Europe through the green economy, with lower regional inequality, and a stronger Single Market. A new joint European debt emission would also further strengthen the EU’s common commitments to climate action and industry, and could be used to shore up the funds for all the common investment instruments, or establish pan-European IRA-style tax credits for green technologies (a move now favoured by EU conservatives).

In the last months, the tune in Brussels and the European capitals seems to be changing towards more State support for the private sector. With the draft proposals for the Net Zero Industries Act and the Critical Raw Materials Act, the Commission hopes to set domestic production targets for the technologies and raw materials necessary for the green transition, cut permitting times for new projects, and facilitate State aid for strategic projects. While these are positive developments, a careless change to State aid rules could fragment the Single Market, and breed resentment towards the EU’s biggest economies and the EU itself. But if the EU can chart a path towards a regionally balanced aid regime, it will be in a great position to challenge the US and China for the industries of the future.

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