Europe’s timid response to the Inflation Reduction Act
At the end of March the European Commission published its response to President Biden’s plans to stimulate large scale investment in a range of low carbon activities in the United States. In contrast to the Inflation Reduction Act (IRA) which was the most extensive piece of climate legislation produced anywhere in the world – committing $ 369 bn over ten years to support the key elements of the energy transition – from the development of hydrogen and new nuclear to essential infrastructure, the Commission’s proposals were limited and will do little to secure Europe’s position in the competition for low carbon industrial development. Responsibility for ensuring that Europe’s strong policy commitment to reduce emissions is not overwhelmingly reliant on imported products – from wind turbines to electric vehicles – now lies clearly with the individual nation states.
The Net Zero Industry Act which is the centrepiece of a set of proposals put forward by the Commission has been condemned by the authoritative European economic think tank Bruegel as a “pseudo consensus” – a statement of high ambition which is not supported by the necessary detailed delivery mechanism. The proposals made include
– A relaxation of state aid rules to allow national governments to fund low carbon industrial development
– The establishment of a minimum domestic production target of 40 per cent for clean technologies by 2030.
– The removal or reduction of regulatory barriers which currently delay such developments giving them public interest status and allowing authorities the ability to override local objections and environmental impact considerations.
– Special measures to reduce external dependence for supplies of minerals critical for the energy transition, with a new European Critical Raw Materials Board designed as a common purchasing agency, and the goal of new strategic partnership agreements with countries with strong mineral resources such as Chile and Australia to reduce the current levels of dependence on supplies from China.
This would represent a reasonable response to the IRA if it were backed with substance. In contrast to the IRA however, the documents are remarkably silent on any commitment to funding. The EU Net Zero Industry Act is free of any numbers with the Euro sign attached.
The European Union’s resources are strictly limited and already overcommitted. Additional funding would need to come from the member states many of whom face huge debts built up during the Covid pandemic when public funding was used to support individuals and businesses hit by the loss of economic activity. Countries such as France and Italy have debt to GDP ratios over 100 per cent. In many countries particularly in Northern Europe, including Germany, the ratios are lower and there is strong political resistance to taking on more debt.
This leaves the climate agenda reliant on the use of regulatory changes which can stimulate private sector investment. In some cases that might work but private capital is unlikely to fund the extensive new infrastructure required for the transition or to help individual businesses and households faced with substantial up front capital costs as they scrap their existing factories, cars and home heating systems. As the IRA is demonstrating public finance is crucial if the transition is to be made in time to avoid even more serious climate disruption.
Lack of money is one problem. The second is that while there is a broad European consensus behind the goal of reaching net zero by the 2040s there is no agreement on how to get to that objective. Energy policy has been and remains predominantly a matter for the 28 nation states which make up the EU. A few led by France believe that nuclear power is key to the future, but most do not and the Net Zero Industry Act therefore omits large scale nuclear power from the list of supported technologies. Many of the 28, especially in Eastern Europe, still rely on substantial use of coal in industry and in power generation. In Western and Northern Europe coal is being eliminated.
Nor is there European consensus around the target of 40 per cent domestic content which the Commission is advocating. Many commentators, again including Bruegel, see this as an act of “unadulterated protectionism” designed to shift production of basic products such as solar panels and wind turbines to Europe regardless of the fact that they are readily available at a lower cost elsewhere. Critics fear that mercantilism of this sort will only serve to delay and to increase the cost of the transition.
The Commission’s proposals will need to be argued out between the different European Governments and within the European Parliament. That means that in contrast to commitments in the IRA they are no more than proposals and cannot provide a secure basis of policy against which private companies can invest.
Perhaps the most serious problem exposed by the Commission’s proposals is the lack of a clear industrial strategy. Europe has lost out over the last three decades in the tech and communications sectors because it did not have private sector companies capable of becoming global leaders. The result is that Europe has no equivalents to Intel, Google, Apple, Microsoft, Amazon, eBay, Facebook or TikTok. The grave danger now is that this failure will be repeated in the low carbon sector.
There are of course a host of companies working on low carbon issues with great skills and high potential. The problem is that they are small and locally focused. They risk being picked off by some of the large scale industrial players from the US who are entering the sector.
Strategically Europe lacks focus. Unless wages are to be cut Europe is not likely to become competitive with emerging economies in producing solar panels, basic turbines or batteries for electric vehicles. The opportunities for Europe to secure genuine competitive advantage lie in high level manufacturing and advanced technology. Europe should be a world leader in research but lacks the national laboratories which give the US such fundamental strength in science and engineering. The best labs in Europe are probably in the UK but Britain has chosen to step out of the scientific collaboration schemes created by the EU and British labs remain starved of the sort of funding required for sustained long term research and development work.
These realities will dawn on European policies makers as the centre of gravity of the low carbon Industrial Revolution moves to the US. The Net Zero Industry Act will then be seen as no more than a rough draft of what is really needed if Europe is to be competitive.
For the moment the initiative will remain with individual Member states. Germany has already committed billions to the development of hydrogen and uniquely has the industrial base not least in the auto sector capable of seizing the opportunity to develop globally competitive products. But German policies also have to win local support – from partners within the coalition Government and from key communities across the country not least in the areas of Eastern Germany most resistant to change. Similar calculations are being made in all Member states. The result is that change will be complex and slow and in the each case subject to challenge and political competition. There is a common European objective of net zero but we are a long way from common European policies to deliver that objective. This is an inevitable and unavoidable consequence of Europe’s construction as a confederation rather than as a single state. As a result when it comes to contest from global industrial leadership with China and the United States the European Union is likely to come a disappointing third.