A new era of green industrial policy?

A new era of green industrial policy?

Industrial policy, until recently relegated to the sidelines of economic policy, is back with a vengeance.

Data from the Global Trade Alert initiative show that in 2023 alone, around 1,700 policy industrial policy interventions affecting trade were deployed globally. Around 80% of these were in the form of subsidies, and a third of these “green” industrial subsidies were directed at climate change mitigation.  One such initiative with a high profile is the US Inflation Reduction Act.   

We recently held a webinar to discuss the US Inflation Reduction Act (IRA) in the context of global industrial policy developments, and specifically in relation to European and UK policy positions. Our speakers: Marie-Laure Hicks (Aldersgate group), AJ Goulding (London Economics International), Klaus-Dieter Borchardt (Baker McKenzie), Ralf Rank (Brookfield) and audience provided an insightful analysis of the issues. Here, we condense some key points from our discussion, highlighting the contrasting approaches in the US and Europe and implications for future economic strategies.

The US is investing heavily in green technology

While the IRA has multiple objectives, it has a special focus on green industrial policy marked by its focus on low carbon energy technologies. It prioritises sectors like wind, solar, energy storage, and electric mobility, and seeks to bolster the US domestic competitiveness in these value chains, and reduce reliance on imports, particularly from China and Europe. Central to its strategy are tax credits, grants, and the use of local content requirements, which collectively aim to stimulate investment and production in these critical industries, and increase the share of domestic value added in these value chains.

Tax credits under the IRA present a potent tool, offering investors and producers significant incentives. They come in two forms: investment credits, applicable upon qualifying investments, and production credits, tied to actual output. This simplicity makes them attractive, especially in comparison to the more complex grant application processes. However, concerns linger regarding their additionality and impact on public finances, particularly if they benefit investors already active in the US.  

Grants, though available, pose challenges due to their stringent criteria and application processes. Despite these hurdles, the initial effect of the IRA is to reinforce a trend observed over the last 3-4 years, driven by various other policy and economic drivers, of businesses reshoring production signalling a resurgence in domestic manufacturing.

Can Europe respond effectively?

The European Commission's Net Zero Industries Act (NZIA) is seen by many as a response to the IRA.  It is aimed at accelerating the EU's transition to climate neutrality and bolstering its manufacturing capacity for net-zero technologies. Key facets of the NZIA include increasing the strategic net-zero technologies' manufacturing capacity to meet at least 40% of the EU's annual deployment needs by 2030, promoting investments in net-zero technology manufacturing projects, and enhancing skills through dedicated training programs.  Importantly the NZIA also includes specific public procurement provisions which require that public authorities consider sustainability and resilience (to reduce third country dependence) criteria when conducting public procurement or auctions.

More generally, in contrast to the IRA, Europe's approach to green industrial policy centres on explicitly pricing emissions, environmental regulation and grants. For example, the European Emission Trading Scheme (EU ETS) penalises polluting technologies, while various regulations discourage the use of combustion engines in favor of greener alternatives. Although energy and environmental State Aid is available, it is subject to EU regulations, constraining member states' autonomy in incentivising clean technologies. Noting that the EU has no authority over taxation it would not be able to match US style tax credits and this limits the measures it can take broadly to those which it already deployed prior to the IRA.

From an investor perspective, the European regime can be harder to navigate, given the focus on regulation and the need to consider multiple policy layers spanning the EC and national and regional governments.  Nevertheless, and despite the allure of US tax credits, sophisticated investors continue to find opportunities in Europe, considering long-term asset lifetimes and supply chains.

Europe had been a first mover in promoting new low carbon energy technologies. While it is hard to say whether through the IRA the US merely catches up with Europe or overtakes Europe, the IRA clearly intensifies competition between the US and EU in low carbon technologies. The EU has thus far steered away from hard-core protectionist measures, although it is notable that, the Net Zero Industries Act does allow for some local content requirements in relation to public procurement. It’s approach to green industrial policy also needs to be read in the broader context of its pursuit of “strategic autonomy”, which favours an enhanced use of trade measures in response to what it perceives as distortive measures in trade partners.   Set in the context of rising industrial policy activism globally, the competing sets of measures taken by the US and the EU may raise concerns about protectionism and the fragmentation of global trade and value chains. The key question is whether such fragmentation will lead to economic costs making the low carbon transitions more costly?

What about the UK?

The UK has been pushing ahead with the green transition, and has developed support regimes in many key areas, including across low carbon electricity, industrial decarbonisation, electric vehicles, CCUS and low carbon heating. These regimes have been largely maintained so far, even under challenging fiscal conditions. However, a more expansionary IRA-style regime seems unlikely. Moreover, the UK’s subsidy control regime, together with the provisions of the UK-EU Trade and Cooperation Agreement, may in practice mean that it may find itself aligning closely with EU strategies, despite aspirations for a more autonomous stance.

Can onshoring and efficient energy transition work together?

Both the US and the EU have similar objectives: they want to pursue low carbon transitions, establish positions of strength to secure a share of value added in key technologies, notably through pre-qualification criteria limiting non-EU content. The means they have chosen to pursue these ambitions differ significantly.

The main challenge both the US and the EU face is that the multiplicity of objectives may impose trade-offs. The key consideration is the extent to which there is a tension between industrial policy objectives aimed at increasing the share of domestic value added and ensuring that low carbon transitions occur efficiently and at low cost.  Key issues for policymakers to consider include an assessment of the extent to which the inclusion of local content requirements could give rise to increased costs, and whether there may be lost productivity benefits that could come from specialisation, and which could be lost in a more fragmented context. Policy makers may also need to consider whether a ratcheting up of policy rivalry could adversely affect the investment climate and reduce prospects for global cooperation. Taken together, it is clear that work is required to ensure that that the correct policies target the correct policy outcomes.

Click here to watch the full webinar.

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