Europe’s answer to the Inflation Reduction Act should be global cooperation – EURACTIV.com | Popgen Tech

The Inflation Reduction Act aims to make the US the best place for green investment by linking subsidies and tax breaks to home production. To remain competitive, Europe must focus on what it does best: set rules and use its large domestic market, argue Karsten Neuhoff and Andreas Goldthau.

Karsten Neuhoff is Head of Climate Research at the German Institute for Economic Research and Professor of Economics at the Technical University of Berlin. Andreas Goldthau is director at the Willy Brandt School of Public Policy, professor at the University of Erfurt, and research group leader at the Institute for Advanced Sustainability Studies in Potsdam.

A green industrial program of some $400 billion in federal funding, the IRA caught Europe wrong.

The consequences of Russia’s Ukraine war – strained public budgets and an ailing economy – shifted policy priorities and temporarily put climate policy on the back burner. What’s more, while the EU is traditionally good at promoting market competition, including in clean energy, it is less so at nurturing green champions.

In response to the IRA, EU Commission President Von der Leyen announced relaxation of state aid rules for European governments to counter US fiscal sweeteners for green investment.

However, this measure misses the point. It pits the EU against the US and promotes a subsidy race within the Union, which will be won by those with the deepest pockets. It also falls short of what is needed to promote the European economy and clean energy policy worldwide.

Europe’s selling point has always been a rules-based and reliable policy framework, which has made local and international investors to promote the latest technology in telecommunications, automotive or green energy.

The EU’s energy and climate policy outlines a coherent and generally agreed vision for the future European economic model. Concerted policy action must build on that in response to US efforts to relocate clean technologies.

Rather than a skewed focus on state aid rules, a number of key policy files will need to be linked to ensure sufficient investment at the EU scale and to remain an attractive partner internationally.

First, policies aimed at encouraging industrial production in high carbon price environments need to be redesigned. It is clear that the merits of the Carbon Boundary Adjustment Mechanism (CBAM), the EU’s protective levy targeting carbon-heavy imports, lie in bringing global attention to emissions pricing.

Yet it fails to generate similar disbursements and financial support for industrial decarbonisation at the EU level as the IRA. As a result, countries such as Germany, the Netherlands, France and Sweden are likely to increase their national carbon contracts for difference to support green investment, especially in basic materials, which risks balkanizing the EU market.

An effective CBAM to fund and incentivize EU industrial modernization would require a different design option: a climate contribution specific to the type of product, not the location.

What sounds too technical essentially amounts to a carbon levy on both domestic production and imports. Industrial competitiveness is ensured by floating the levy for exports.

At current carbon prices, such a levy would generate around 40 billion each year, and – unlike the IRA – offer a long-term investment prospect. It sets incentives for industrial emission reductions across the EU by simultaneously creating revenue and addressing concerns about carbon leakage.

Second, Europe needs to focus its public funding strategy on fully unlocking its wind and solar potential across the continent. Appropriate financial arrangements are central here. The EU Commission has announced a review of the market design to include contracts for differences and location pricing.

Both elements will be essential to protect investors from regulatory risk and energy users from financial risks of power purchase agreements. Already by 2030, it will reduce the financing costs for the deployment of renewable energy, thus reducing energy costs for industry and households to 8 billion per year, while improving the protection against price increases.

Third, Europe needs to adapt its gas market model and make it fit for purpose. As the world’s largest import bloc, Europe – unlike the US – is excessively exposed to geopolitical and market uncertainties, which also cause transition risks on the path to clean fuels.

Going back to long-term gas contracts is hardly an option, also given the specter of carbon sequestration. Contractual changes and price controls alone will not do the trick.

Instead, the EU should complement price-based market adjustments with effective supply protocol. As recently outlined by 18 European economists, such a protocol could combine national gas savings targets and a gas allocation mechanism with a price cap by obliging gas transmission system operators to pay a limited price for supply shortfalls.

The benefit lies in establishing clarity about regulatory choices during emergency situations, thus reducing costs and risks for gas producers and consumers during the transition period.

It will also keep global LPG prices in check, benefiting consumers with lower purchasing power, eg in East Asia. Such measures could save EU gas customers – or the governments currently financing gas price relief programs – more than 200 billion per year during the crisis, which could instead be invested in the energy transition.

Finally, Europe will need to build on cooperation. It is a combination of fair and predictable rules, funding for solidarity and an attractive shared vision that has determined the success of the European Union as well as its latest major project, the EU Green Deal.

Globally, it will probably also do this when it comes to cooperation with crucial emerging economies such as India, Brazil, Indonesia or South Africa on the green transition.

These nations will sign a joint climate and industrial policy if it is built on a robust framework. A climate alliance can then reward ambitious action at home by sharing in financial flows; breakthrough alliances can transform select sectors such as steel or cement; energy transition partnerships can outline joint areas of technology cooperation.

To this end, the EU policy frameworks should be aligned with the needs of such global cooperation. The funding that supports global climate alliances and partnerships, including for industrial transition, can be secured through climate contributions collected among participating economic blocs.

Rather than participating in a global green race that is exclusive and focused on industrial relocation, Europe needs to make smart choices aimed at accelerating the domestic energy transition, mobilizing funds and global rules-based cooperation strengthen.

The ultimate effect will be a more sustainable and lasting transformation and one that buys rather than rivals the future economic powerhouses of the global south.