Photo credits hpgruesen from pixabay

The US Inflation Reduction Act (IRA), adopted by both houses of Congress and signed into law in August 2022, has sent shockwaves across Europe. While the investment boost for the clean energy sector can well be regarded as a significant step for the US to move towards the Paris targets, the circumstances and its impacts on the rest of the world (most notably Europe) make the IRA controversial.

This is not the first green stimulus by the Biden administration. The Infrastructure Investment and Jobs Act (IIJA) was adopted in November 2021 with US$ 550 billion in federal funding over 2022-2026 for the transport and energy sectors. Besides transport infrastructure, provisions included investment into renewable energy, carbon capture and storage, hydrogen research and battery manufacturing, and the IRA builds on these. Worries and excitement in Europe were much lower at that time.

What makes the IRA so contested, and what is all the excitement about?

The IRA is considered one of the most consequential bills in recent US history and the subject of fierce debate in the European Union. Half the US$ 739 billion spending bill provides for US$ 369 billion investment into energy security and combatting climate change (the second half extends healthcare spending under the Affordable Care Act). The IRA does not rely on new debt; it is to be financed by the 15 % corporate minimum tax, stricter tax enforcement, and prescription drug pricing reform.

Two types of subsidies are included: for companies and consumers. While most of the money is handed out through the US tax system, some grants and loans are in the mix. The analysis by McKinsey provides a detailed overview of the measures with their links to the IIJA, with an outlook on their expected impact. It also shows that most climate funding is slated for private companies, which will receive about $216bn of the tax credits.

The law has many progressive incentives. Manufacturing facilities are only eligible for full IRA tax credits if they meet prevailing wage and apprenticeship requirements, including more robust, diverse science, technology, engineering, and math (STEM) talent pipelines.

The contested elements are those where IRA tax incentives also contain scaling domestic production or domestic-procurement requirements. The perception in Europe is that the IRA has changed the rules of the industrial game and might make companies re-prioritise their investment plans in Europe towards the US. For example, for an electric vehicle (EV) to be eligible for the full tax credit, it has to be made in North America, and specific percentages of its battery components and critical minerals have to be extracted or processed in the US or countries with a trade agreement with the US. The battery must have also been manufactured or assembled in North America.

For EVs and batteries, the risk is that ongoing investment projects – and, therefore, Europe’s electromobility targets – get delayed. The trouble is that investments would go elsewhere for critical metals and their processing, where Europe is only starting to catch up. There are already examples of new investments into battery factories and new mines in the US, and electric vehicle sales have mushroomed in North America. This is in response to the requirement that 40% of battery metals come from the US and half of all battery components made in North America from 2024 for the entire EV tax credit to apply. The battery supply chain of an electric car will receive up to USD 50 subsidy per each kWh of battery or over a third of the total battery costs today.

As the NGO Transport & Environment argues, the main concern with the IRA should not be on electric car tax credits (the EU is not expected to export large numbers of electric cars into the US). The real risk is the long-term and bankable production tax credits, worth hundreds of billions of dollars, given to batteries and the critical metals supply chain until 2032.

The main problem for Europe is that the IRA has exposed its vulnerability and weaknesses on several fronts.         

It is not so much about the magnitude of the support, as the EU has also launched extensive support programs, e.g. the €800bn NextGenerationEU. The problem is less about the lack of money but the complexity in getting it: the approval processes are often slow (with deadlines unknown), bureaucratic and not bankable in the same way as the US IRA production credits are. Many funding programmes are annual and lack the long-term certainty needed.

The real challenge posed by the IRA measures for Europe is not about electric cars but much more about the battery values chain and critical raw materials.

Green Deal Industrial Plan

In response to the IRA, on February 1st, 2023, the Commission presented its Green Deal Industrial Plan with the objective ‘to enhance the competitiveness of Europe's net-zero industry and support the fast transition to climate neutrality’.

The Industrial Plan identifies goals for net-zero industrial capacity and provides a regulatory framework to speed up European strategic projects, not least by fast-track permission procedures and deregulation.

The framework will be complemented by the Critical Raw Materials Act (planned for 14 March), which is expected to set high-level supply targets by 2030, backed up by a list of “Strategic Projects” in conformity with high social and environmental standards. It will also focus on refining and processing, as well as on scaling the European recycling capacity and extracting metals from existing mining waste sites across Europe. The reform of the electricity market design to make electricity prices less dependent on fossil energy prices will also be part of the package.

The second pillar of the plan aims at streamlining state aid rules, focusing on production aid for electric vehicles, renewables, and raw materials businesses directly affected by the US IRA. The objective is to speed up investment and financing for clean technology development in Europe. Under competition policy, the Commission aims to guarantee a level playing field within the Single Market while making it easier for the Member States to grant necessary aid to speed up the green transition. For this, the Commission will consult the Member States on an amended Temporary State aid Crisis and Transition Framework. It will revise the General Block Exemption Regulation in light of the Green Deal and simplify the approval of Important Projects of Common European Interest.

The Commission will also facilitate using existing EU funds to finance clean tech innovation, manufacturing and deployment. For the mid-term, the Commission “intends to give a structural answer to the investment needs by proposing a European Sovereignty Fund to review the multi-annual financial framework before summer 2023”.

Some lessons to be drawn

There are many problems with and around the IRA, and these go much beyond the EU-US trade relations.

First, there is a factor behind this industrial rivalry that is not part of the IRA. This is the fossil-fuel-based competitive advantage the US industry is benefitting from. This is in complete contradiction with the otherwise progressive spirit of the IRA. With the US being the number one global oil producer and a significant gas producer due not least to the broad use of fracking technology, energy prices are a fraction of Europe`s. This price competitiveness is further amplified by the tax incentives and domestic production clauses provided by the IRA.

Second, the spirit of domestic production requirements puts the national interest first in the context of the global challenge of climate change that can only be addressed cooperatively worldwide. Putting high environmental and labour standards as qualifying criteria for green investment subsidies would have been the preferred way. It is also regrettable that the response of the EU is based on the US national interest logic, not even mentioning such an alternative. As a result, the EU-US debate and rivalry around the IRA and clean technology competitiveness is completely ignoring the interests of the rest of the world, most notably of climate-vulnerable developing countries in the global South. This attitude will not help rise global climate ambition and progress towards the Paris targets.

Third, the conflict around the IRA exposes long-term vulnerabilities and weaknesses of the EU with a reminder of the Eurozone crisis. Indeed, there are problems with existing state aid rules and related bureaucracy. But simplifying state aid rules is not enough as it would only benefit member states with sizeable fiscal capacity, deepening cleavages within Europe. Moreover, member states with much fiscal space are not necessarily having the best potential for metals processing or renewables as it depends on geology, natural resources and innovative ideas. The question is once again about European solitary, how and whether member states can act together and, yes, with common European debt issuance. The vague formulation in the industrial plan communication proposing a European Sovereign Fund reflects the uncertainty of how such a step could be implemented. Germany, the Netherlands, Belgium and seven other member states have already signalled that such a fund would be unacceptable.

Social partners reaction

IndustriAll Europe and the ETUC, while welcoming the Commission`s Green Deal Industrial Plan as a swift and coordinated response to the United States Inflation Reduction Act, strongly criticise that the proposal does not include any social conditions on the funding which would ensure it is used to create quality jobs and apprenticeships. It also mentions that this lack of labour standards starkly contrasts with the IRA, which includes such conditionality. IndustriAll and the ETUC also express their concern that the deregulatory drive of relaxing state aid rules might also put downward pressure on working conditions.  ETUC General Secretary Esther Lynch said: “The green deal is an opportunity to curb carbon at the same time as raising pay, but this announcement is a blank cheque for CEOs printed on recycled paper.

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