New green alliance of EU and US against China? About the consequences of the Inflation Reduction Act

Tobias Gehrke, senior policy fellow at the European Council for Foreign Relations who leads ECFR’s Geoeconomics Initiative, talks about the political consequences of the Inflation Reduction Act for the EU with Michal Wojtylo.

M. Wojtylo: What do you think is the current state of EU-US economic relations? There is a wide-spread concern in Europe concerning the Inflation Reduction Act that is being implemented in the US. Can the anxiety about the EU losing competitiveness to the US in the area of green technologies be an impulse for a new transatlantic economic partnership?

T. Gehrke: In the past, transatlantic cooperation was born out of deep trade disputes. It did not happen because we were all very happy to do it and we were like-minded friends. It does not work like that. It always starts with a dispute which grows so large that there is a big pressure to sit together at the table to find a solution. When things get tough, it might be just the beginning of closer cooperation.

The discussion about the Inflation Reduction Act was pretty rough before Christmas, especially in Germany and France. Now it is cooling down. I think in the EU there comes a realisation that the Americans are doing something quite good for the climate and that there is no other way but to try to coordinate our approaches, create some form of green industrial cooperation.

However, the path to that is tricky. We have to remember that we have very different approaches concerning climate action, for example in the case of the carbon border taxes. It is a huge issue that is going to be a challenge in transatlantic relations as well as the currently debated IRA.

Pushed by the conflict of interest, the EU and the US can come together and form some sort of green economy alliance, where we set common principles and boundaries on how to proceed with the green transition. It is a tough challenge, especially with very volatile politics – we do not know if this would be possible with a Republican taking the White House as well as we do not know how the Republicans would deal with the IRA and so on.

Maybe this important factor for the common response is going to be China. A lot of what we do in green technologies comes from China, e.g. critical raw materials and solar panels. Is there some kind of way out for EU-US cooperation when it comes to breaking our dependence on China in the green industries supply chain?

Yes, that narrative is what I think is necessary and it is already gaining popularity. For example, Ursula von der Leyen has really tried to reframe the debate about the IRA response, so it becomes very much about China. In Davos, she said that the IRA is a challenge but the much, bigger one is the current and future dependency on China.

There is still too little focus in the EU on the kind of risks we face in green technology supply chains, green transition and industrial competitiveness that come from China. There’s only a fraction of understanding of what the Chinese are doing in so many green industries and how are they trying to dominate certain sectors, especially in the green technology. We do not talk about it enough.

However, focusing too much on Beijing is also a bit of a danger as Europe should not jump blindly on an anti-China train that the US is on. There are many risks and China is part of these risks but not all of them. We really have to switch more to thoroughly analysing liabilities in the European economy.

The strategic competition between China and America as a guiding principle for Europe to have a proper discussion about green industries would be important to develop a narrative of how do we (in Europe) see the global economy of the future. We need to really talk about big-picture topics and develop a bigger idea. Otherwise, we will always just be responding to policies. Strategic autonomy was one but no one had really ownership of it and everyone understood it differently.

Let’s jump into the internal EU dynamics of the IRA issue. It is a common narrative of the European Commission that the European Green Deal is going to make the EU a leader of the green transition that is going to push other regions of the world in the direction of climate neutrality. However, when recently the US did just that and went boldly on a green path with its Inflation Reduction Act we can hear from inside the EU that IRA is the existential threat to the EU. Why was the reaction to IRA in Brussels in the past weeks so full of concern?

We have to remember that the IRA was concluded in August. The initial EU’s reception of the IRA was positive. Only after a couple of months the Commission really became publicly very outspoken about the threat to competitiveness coming from the IRA. The main reason why it changed – not only in Brussels, but especially in Berlin and Paris which are driving a lot of the debate – was the energy crisis. In Autumn, we saw energy prices rising drastically and the industrial and manufacturing sector around Europe was really struggling to cope with it.

In the public debate, there was a collision of issues – the threat of the IRA was mixed up with the threat of rising energy prices and the competitiveness on the common market. The hysteria peaked before Christmas, driven mainly by France, in the Commission Thierry Breton and business associations. In the Western European media, we could hear all these anecdotes about individual businesses saying they might leave. There was a lot of pressure on politicians. Also, surveys were published, for example, the German PDI, the most powerful business association in Germany, had a survey of enterprises which said that they are really concerned.

Also, before Christmas, we saw that it was Germany and France who drove this debate to a conclusion that there needs to be a response. Paris and Berlin brought out a joint position paper on why the EU needs a new approach to the industrial policy. It was mostly in response to the energy crisis but the IRA was also mentioned. Again, it is very difficult to separate these two because many actors use these issues in tandem.

Does the dramatic reaction show some kind of realisation that the US is implementing more efficient green transition policies and can outpace Europe in the development of green technologies?

The EU has been a leader and still is a leader in many green industries (e.g. wind farms). Undoubtedly, the EU has developed a typical EU approach that is a lot about regulation and using ‘the stick’. That is because of the way Europe works and what Brussels is able to do. Basically, the European Green Deal is about obliging importers to do X, Y, Z and if they do not want to do it they are punished.

Now, with the Inflation Reduction Act, the Americans really turned the rhetoric around. They presented a very different approach to green transition, and that was also a wake-up call for the EU to consider other, very different approaches.

The US is giving incentives for anyone who wants to decarbonize and they are giving a broad-scale subsidisation across the entire industry and energy sector to allow for mass commercialization. For example, there are a lot of subsidies for the prices of green electricity, that are subsidized so that companies can use it without a loss of competitiveness and scale their products. The EU has also something similar – e.g. through tax breaks for green energy production – but it is very much done at the member state level. But it is very much all over the place as there is no coordinated plan and Member States do whatever they want.

What the EU is mostly doing is a lot about research and development, where the EU is quite powerful and has a lot of research money. The EU policy is very much geared towards pushing more money into the research of green technologies. The Americans are much more about commercialization and scale. I think the difference brought a lot of concern in Brussels and triggered questions about choosing the right direction and finding a way of accommodating the differing approaches.

In the EU, for years, there has been a problem of the successful commercialisation of research. Does the wake-up call, that you mentioned, mean pumping more money into the later step when you already have the technology and want to commercialise and scale it up?

There are many voices who say just that after seeing what Washington is doing. They are really scaling a whole industry by, for example, subsidizing green electricity to produce massive amounts of green hydrogen (which takes a lot of energy and is not really cost-efficient yet). The IRA just price caps the electricity to produce hydrogen. All of a sudden you have a business case, you can produce it at scale because the government pays for it.

Then came the Green Deal Industrial Plan and the talk about the need for a new common EU fund with additional common borrowing, similar to the Recovery and Resilience Fund. What is the current state of affairs in the IRA debate? I heard there are some concerns that the new Commission’s proposal is going to give Berlin and Paris an advantage over the rest of the EU.

Yeah, there is a lot of concern in the EU over the possible reaction to the IRA. However, everything is still on the table. The Green Deal Industrial Plan, you mentioned, is only a communication, not even a proposal yet. It is just laying out possible directions without having negotiated them yet.

But of course, the teams are already in place. Germany and France pretty much agree on the 4 main issues. Number one is more funding for strategic instruments for the implementation of the European Union Industrial Strategy (Important Projects of Common European Interest) that are too small for current needs. That is very uncontroversial and I am sure this will happen.

Number two is the national state aid. That is the tricky one. Germany and France want laxer rules on state aid that they can spend nationally. They are asking the Commission to adapt its state aid rules so the process of applying is easier and shorter. The third main issue is 'Buy European’ which is a bit of a French thing. France wants to have public tenders so when the government buys something, it can put criteria that exclude certain external players. Germany does not fully like that, but they agreed that this is something possible to explore.

Finally, the big elephant in the room is common finance. France is more ambivalent about it, I think they would like to have some sort of common finance, but it is not crucial for them. Germany is mostly against it. However, even Berlin’s view is complex because the German debate on the issue is difficult the Liberals that run the Finance Ministry are strongly against it, whereas the Economy Ministry under the Greens leadership has been equivocal.

There are also other national coalitions that are forming. There was a letter by 7 EU member states who are very much opposed to new finances and lax national fiscal rules, including the frugal states. Germany and France seem quite isolated at the moment. There’s not really anyone else who would wish for national state aid to be lax without a common financing instrument.

How does the Commission want to bridge the divisions between Member States?

The Commission is in a pretty difficult spot as it has been very vocal about supporting some sort of new common financing instrument, including the ‘sovereignty fund’. Some commissioners, including Paolo Gentiloni and Valdis Dombrovskis, were saying that there cannot be any changes without creating the common instrument.

However, the Commission has to give something to Germany and France first. If they give them too much leeway in national state aid the risk is that Berlin and Paris will just spend the money and then they would not have any interest in pursuing the common instrument.

So the Commission published a very broad Green Deal Industrial Plan and is really trying to say 'yes, but’. I think that in actual proposal there is going to be more state aid possible but with very specific conditions – it will have to be temporary, with subsidy amount limits and focused on specific sectors. This legal, political and regulatory battle about the details will continue at least until the summer.

You said the commission is trying to give something to Berlin and Paris. And what does the commission want to give the other side of the dispute, the ones that are expecting common financing? Is there going to be only the broader state aid acceptance?

No, there is more to it. But the state aid is kind of the first issue. The commission wants to have more common money that can be used by all of the Member States. However, the main goal of the Commission seems to be not the sovereignty fund – because that is already dead – but to get more money in its normal budget. The way you can do that is through a mid-term review of the seven-year budget this summer, when the Commission can renegotiate it a little bit by saying – ‘things have changed, so we need to shift the budgets around to get more money that we can use for industrial policy.’

Also, the commission will get more money for research. It will say – ‘look, we need more money for research because we need to really support green technology research as a response to the IRA.’

Is one of the main sources of the money for industrial policy and research going to be the Recovery and Resilience Fund? Some of it was not paid out to Member States which had problems with getting their National Recovery Plans accepted.

Yes, that looks very likely. This seems to be a middle ground that that is emerging. There is a lot of money still available and the Commission is now pushing for data on how much money there is left.

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