The EU should avoid a subsidy war with the US

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BrusselsReport.eu
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By Otto Brøns-Petersen, director for analysis, and Line Andersen, economist, Center for Political Studies (CEPOS).

The European Union should abstain from increasing state subsidies to green industries to “retaliate” against the US for its “Inflation Reduction Act” (IRA), subsidizing green industries in the US. Those US subsidies are mainly a burden on the Americans themselves, just as an EU response would be a burden on us Europeans. Subsidies are not the cost-effective way to promote green transition. Moreover, an escalation of the Transatlantic trade tensions is the last thing we need in the midst of the conflict between the West and Russia.

At the moment, the EU is already leading the US in new subsidy programmes for green industries and green transition. In a new study published by the Epicenter thinktank network, we estimate that current EU programmes, including the NextGenerationEU recovery package, spend 0.38% of GDP annually. This is more than twice the amount scheduled to be spent by the IRA, which corresponds to 0.15% of US GDP per annum. Combined with the recent proposal to increase state aid from the European Commission, the level of state aid in the EU would be three times the size of the IRA. This would not be a mere response, but a clear escalation.

In sum, the EU is already providing substantial state aid for the green transition. It is crucial to realize that direct state aid is not a cost-effective method for driving a green transition, and that the costs mainly affect the countries that provide the aid. When providing state aid, some companies and technologies are favoured at the expense of others, which can then allow for inefficient companies to survive on the expense of more efficient companies. Inefficiencies in the market result in higher prices for the consumers. The state aid provided for by the IRA will thus increase the price of the green transition for American consumers.

The cost-effective method to deal with the global climate problem is for the authorities to put a uniform price on CO2-emissions. This tool creates equal incentives for all green technologies, leading to the adoption by market forces of the most cost-effective ones. In the EU, the Emission Trading System (ETS) has for a long time been the most effective incentive to reduce GHG emissions by pricing emissions. Rather than undermining its effectiveness, by new direct subsidies, the ETS should be given an even more exclusive role. Furthermore, the EU should focus on putting pressure on the US to abandon discriminatory state aid.

For years, European politicians have criticized the US for being too unambitious with regard to green transition. It is ironic that politicians and lobbyists now blame the US for “stealing” green investments from Europe, as if global green investments were a fixed sum governments would have to compete for. If that were the case, green transition would make little sense in terms of influencing the global climate. Clearly, the IRA is bad climate policy, but criticizing the US for investing more in green transition is indeed very strange.

Moreover, responding to the IRA with state aid could result in an escalation of a trade conflict across the Atlantic, which would be especially poorly timed in terms of foreign and security policy given the Ukraine war and heightened tensions with China. On the contrary, the democratic West should strive towards greater unity.

 

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