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Here’s a glimpse of the EU response to the Inflation Reduction Act

After almost six months of discussions and debate in the European Union, the trading bloc’s response to the Inflation Reduction Act is finally taking shape.

A crowd with a person holding an EU flag

 Image via Pexels/Son Tung Tran

Ever since President Joe Biden signed the Inflation Reduction Act into law Aug. 6, it’s been ruffling feathers across the Atlantic in the European Union. While many may be pleased to see the U.S. taking leading action in the fight against climate change, the bill has sparked debate between EU officials, including those in the EU parliament, over how the trading bloc should respond to what some see as discriminatory elements of the IRA, designed to benefit U.S.-based climate tech manufacturers.

The essence of the debate in the EU is this: In the face of the $369 billion worth of tax breaks and subsidies set aside to boost green technology and energy security in the U.S., how can the EU maintain a leading position in cleantech industries moving forward?

In some respects, the EU has good reason to be concerned. One major target of the legislation, for example, is the production of electric vehicles (EVs). Currently, Europe is responsible for over a quarter of global EV production, while the U.S. produces just 10 percent. Now, under the IRA, EV manufacturers can only benefit from the full subsidy scheme — $7,500 per vehicle for consumers buying them — if they adhere to the following: First, 40 percent of critical components used in the batteries must be extracted in the U.S. (or countries that have a free trade agreement with the U.S.), rising to 80 percent by 2026; second, 50 percent of the batteries must be assembled in the U.S. (or free trade partners), rising to 100 percent by 2028.  

Essentially, this will force companies to shift their supply chains onto U.S. soil if they wish to compete in U.S. and international markets. With similar incentives available for businesses in clean hydrogen, carbon capture and wind and solar industries, the fear is that many green companies looking to invest in the EU will have to jump ship to remain competitive.

Indeed, this has already begun to happen. In January, reports emerged that EU startup Marvel Fusion, a company hoping to deliver zero-carbon fusion power, is being pushed by investors to relocate to the U.S. Meanwhile, Tesla announced way back in September that it would be pausing its plans to make battery cells in Germany as it looks to take advantage of the U.S. tax credits instead.

While EU leaders have been in agreement that they must act to stay competitive, just how they planned to do this remained unclear — until now, that is.  

During her speech to the World Economic Forum in Davos, Switzerland, Ursula von der Leyen, president of the European Commission, began to outline just how the EU planned to incentivize green industries over the coming years. "Our plan is to make Europe the home of cleantech and industrial innovation on the road to net zero," von der Leyen said, before setting out the four pillars that the plan will focus on: the regulatory environment, financing, skills and trade.

Pillar 1: The regulatory environment

The first of the key focus points is about cutting red tape, or as von der Leyen put it, "speed and access." To help scale up wind, heat pumps, solar, clean hydrogen, carbon storage and other industries set to play an essential role in the EU’s net-zero strategy, the Commission president pledged a new Green Deal Industrial Plan, which will place a strategic focus on fast-tracking and simplifying permits for climate tech production sites, such as factories.

The Net Zero Industry Act will go "hand-in-hand" with another key piece of legislation, the Critical Raw Materials Act. With the World Bank predicting the clean energy transition will cause demand for some key minerals to rise by as much as 500 percent by 2050, the EU is looking to cash in on this growth. The Critical Raw Materials Act, which is in part a response to the IRA, is widely regarded as a policy designed to reduce Europe’s dependency on China, which provides 98 percent of the EU’s supply of these rare earth elements.     

Pillar 2: Funding

The fastest way for the EU to raise funds for green sectors, supported by France and Germany, is to loosen its state aid rules. State aid is any mechanism by which a company may receive support or gain a distortive advantage over competitors as a result of government intervention, and it is tightly legislated for in the EU to maintain a level playing field.    

But the assessment of some smaller economies, expressed by the Prime Minister of Belgium during an interview at the WEF, is that loosening state aid only stands to benefit those with the deepest pockets. A recent letter from EU competition chief Margrethe Vestager to European finance ministers bolstered this argument. In the letter, Vestager pointed out that under a similar scheme designed as a support package in response to the war in Ukraine, over two-thirds of the $727 billion of approved state aid had been dished out by France and Germany alone.

There have been fears that the IRA could lead to a damaging transatlantic trade war on climate tech, although these have mostly been quelled by officials in the EU.

In an attempt to appease both sides, von der Leyen suggested "temporarily" adapting state aid rules in the short term, while preparing a European Sovereignty Fund to benefit businesses across the EU in the medium term. Draft conclusions seen by Reuters ahead of a summit in February suggest leaders are set to back this initiative, although this could change in the face of objections from some northern European countries that believe such a move is premature.

Pillars 3 and 4: Skills and trade

There’s been little detail on exactly how the final two pillars of the EU’s planned response will work. On skills, von der Leyen stated that "the best transition is only as good as the skilled workers that operate it." With the EU anticipating creating 2.5 million additional jobs by 2030 if it meets its Green Deal targets, a significant growth in the number of skilled green workers will be needed.

On trade, the EU is looking to make the most out of existing trade agreements — for example with Canada and the United Kingdom. Meanwhile, the EU is looking to finalize agreements with Mexico, New Zealand and Australia. These trade deals set out the rules for the buying and selling of goods and services between the EU and other countries. By doing so, trade becomes easier and less restricted, which in turn allows for supply chains, including those in climate tech sectors, to be transnational at a more competitive cost. 

The picture for green business

There have been fears that the IRA could lead to a damaging transatlantic trade war on climate tech, although these have mostly been quelled by officials in the EU. In a recent interview, Valdis Dombrovskis, European commissioner for trade, said any EU response was "not about saber rattling" and that he believed the EU and U.S. should be "building transatlantic value chains, not breaking them apart."

The IRA is certainly more inward-facing than the EU would have liked, especially given how China is moving forward on climate tech innovation and manufacturing as a priority in its five-year plan.

Regardless, what the IRA, China’s five-year plan and subsequent response from the EU represent is a field day of subsidies and investment incentives to boost growth in key climate-friendly sectors — it’s go time for green business across the globe.

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