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The EU should welcome a green subsidy race

To IRA or not to IRA? That is the question for EU leaders as they try to agree on how to respond to the Inflation Reduction Act, Washington’s belated but punchy commitment to subsidise the green transition.

Europeans are at loggerheads. French and German ministers want a new green industrial policy and European Commission president Ursula von der Leyen has called for “our European IRA”. Frugal free-traders such as Sweden and the Netherlands resist further subsidies. The commission itself is divided on how interventionist to be. It has challenged the US’s most egregious protectionism and promised to loosen subsidy rules somewhat. A “sovereignty fund” for EU-level subsidies is endorsed by European Council president Charles Michel but is hotly contested among member states.

The disagreements all revolve around one big difference of judgment as to which of two dangers is the greatest: the competitive threat to EU industry or a subsidy race to the bottom? The problem for cogent decision-making is that both “dangers” are misconceived.

To see US spending on greening its energy, industry and transport as a threat reveals a European inferiority complex. The real threat is that the US fails to make good on its belated intention to address climate change. With debt ceiling politics kneecapping Washington’s ability to spend even what it has already budgeted, it is misplaced to fear it is doing too much.

European leaders already worry that internet services are dominated by US giants. If European business leads America’s green tech transformation, why not celebrate that the tables are turned? Or would they prefer it the other way round? Surely not, seeing how they fret at China’s ambitious construction of battery factories in the EU. Nobody in their right mind would think that those threaten Chinese competitiveness.

The tacit presupposition is that European companies can only invest in one place, and if that place is America then European economies will fall behind (though European shareholders would not). But the idea that there is only so much investment to go around in the world is a lump of investment fallacy. Even where true for any particular capital-constrained company, it is not true in aggregate. If too little capital flows to the European economy, it’s the flipside of domestic policies that have for too long resulted in export surpluses rather than higher domestic investment.

The task is not to stop a European company from building a wind farm, battery factory or electric vehicle plant in the US, but to ensure they get built in Europe regardless. Europe has the wherewithal to do so: a firm commitment to phasing out carbon-intensive activities, a carbon pricing system, soon a carbon border tax and — yes — subsidies that range from the post-Covid recovery fund to EU-financed “important projects of common European interest” in such sectors as batteries and hydrogen.

What the EU needs is to make these types of tools more efficient, faster to access and better funded. Further raising the cost of emissions while subsidising that of decarbonising more will accelerate the necessary investments, IRA or not. That means expanding the carbon pricing and tariff policies. But it also means boosting public money for research, capacity and production.

Sceptics of new funds are right that the priority is to get money already granted out the door faster. But they should not oppose more subsidies too. Unlike some other sectors keen on subsidies, such as commoditised semiconductors, the world is nowhere near saturated with green technology and infrastructure. Climate change is the biggest market failure the world has ever known and a subsidy race in green tech and carbon-free energy would be a race to the top not the bottom. Europe’s embrace of carbon pricing means such subsidies can have a greater effect than on the other side of the Atlantic.

The most valid complaint by business is that Europe’s financial support is too cumbersome, whereas US-style tax credits are virtually automatic. Tax credits are no silver bullet: they only help companies in a position to pay tax, which favours established players over newcomers. But they are quick and easy. The EU is hamstrung, as tax remains a national prerogative. Still, all members can treat green investment much more generously in their tax codes. Swift EU effort to co-ordinate and encourage such action, through better state aid and fiscal rules, would be a good idea.

The job of EU leaders is to make business confident of a big and growing market for green solutions. There is no reason why the IRA should make that harder.

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