The European approach to building climate-friendly industries is “superior” to the USA’s Inflation Reduction Act (IRA), German and French economists have argued in a new paper, calling for less panic in the response to the US subsidies.
Since the US launched its flagship subsidy plan for green industries just over a year ago, EU policymakers have feared that European manufacturers will relocate production across the Atlantic, investing in new sites on US soil as opposed to in the bloc.
However, German and French government advisers have now called for less alarmism, arguing that the EU’s green industrial policy is “clearly a superior approach”.
Concerns of relocation are often overestimated, the French and German Councils of Economic Experts argue in a joint statement, saying that “the IRA is likely to have relatively small effects on US production and production shifts to the United States”.
While the US is mostly relying on subsidies to build up climate-friendly industry production, the EU’s main policy instrument is the Emissions Trading System (EU ETS), which puts a price on the carbon emissions of traditional CO2-emitting industries – the revenue of which is also used to promote the uptake of clean production.
“Investment and production subsidies alone are less effective in addressing environmental externalities than the European approach,” the economists note.
“Without carbon pricing, the amount of subsidies required to achieve a decarbonisation goal becomes higher,” the experts add.
Reducing carbon emissions with a double approach of carrots and sticks, as Europe does, could thereby be five to six times cheaper than relying on subsidies alone, the experts write.
Bidenomics vs Emissions Trading
The massive use of subsidies in the US is part of Joe Biden’s approach of “Bidenomics”, which aims to combine investments in the green transition with incentives to bring industrial production back to the US, notably to reduce dependence on China.
It is also seen as a response to the failure to introduce any carbon pricing, which in the US faces much more resistance than in Europe.
The EU, in contrast, has recently adopted a drastic tightening of its carbon market, which is expected to drive up prices for both CO2-heavy industrial production and heating and transport fuels.
Revenues from the carbon market, which mostly go to national budgets and partly into funds organised by the EU, are also used to promote the uptake of green technologies. However, those uptake programmes are often too complicated, the experts note.
“Europe should learn from the simplicity and expediency of the IRA approach,” the experts write, adding that “the IRA tax credits and the conditions under which a firm qualifies to obtain them are easy to understand and predict”.
“EU subsidies, in contrast, are typically awarded through an application process the outcome of which is by design uncertain,” they add.
Therefore, the EU and its member states should increase efforts to reduce bureaucratic efforts for companies to benefit from funding programmes like the EU’s innovation fund, the EU’s Recovery and Resilience facility (“Next Generation EU”) and national subsidy schemes.
However, in total, “the overall funding level of EU programs is comparable to the IRA” and would “already outpace the IRA in their financial support for renewable energy”, the experts note.
Relax, EU is ahead
While the IRA has triggered concerns of Europe falling behind in green industry sectors, EU manufacturers would in fact be leading on technologies like electric cars (EVs) and electrolysers for hydrogen production, the experts argue.
“Europe is ahead of the US in the EV sector,” they note, adding that “we don’t expect the expansion of the US market for electric vehicles to lure substantial demand or production away from Europe”.
As most cars would not be shipped over long distances to where they are sold anyway, due to high transportation costs, production sites for cars to be sold in Europe would likely also remain in Europe, the experts argue.
Similarly, “German manufacturers are technological leaders in the production of efficient electrolysers”, which are needed to produce hydrogen. The US subsidy scheme to promote hydrogen production would therefore also benefit European companies, as it will “provide a demand stimulus for European high technology”.
As a result, the European policy response to the US should only focus on a few sectors “for which EU countries have comparative advantages and that generate significant externalities”, instead of rushing into a broad subsidy race with the US.
A bigger concern for European policymakers should be energy prices, which are likely to continue being higher in Europe than in the US for a longer period.
“Joint efforts to reduce energy prices in Europe are thus of first-order importance,” the experts argue, adding that “energy supply needs to expand rapidly by accelerating the expansion of renewable energy supply”.
To facilitate this, Germany and France should also settle their ongoing conflict on the use of nuclear power and instead “support each other in these efforts”, the experts note.
[Edited by János Allenbach-Ammann/Nathalie Weatherald]
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