Why Europe is quietly mad about the US climate bill

The landmark Inflation Reduction Act is the largest U.S. contribution yet to meeting global emissions reduction goals. And the American allies are not happy about it.

Certainly, they are happy to see that the United States is (finally) spending hundreds of billions of dollars to move its economy away from the fossil fuels that cause climate change.

The problem is that the American approach to decarbonization relies heavily on subsidies to push industries towards renewable energies. That means financial support for big automakers to turn their factories into electric cars and tax credits for consumers who buy them. And that support largely depends on how much of the production of those vehicles was done in the United States, Mexico, or Canada.

IIn other words, an electric Ford, GM or Tesla can cost $7,500 less than a clean Volkswagen or Hyundai, depending on where and how the cars were made.

Europe, as well as Japan and South Korea, have their own cleantech and automotive industries, and they see this type of industrial policy (with some justification) as a violation of international trade rules regarding the government support for key industries. French President Emmanuel Macron, on a state visit to the United States last week, spoke openly about the unfair treatment between American and European companies, which do not benefit from a free trade agreement.

For all the pleasures of the state dinner the weekend, with its Beef calotte served with shallot marmaladethe real action takes place today (December 5) at EU-US Trade Negotiations. US President Joe Biden says he is confident that concerns about the deal can be resolved through a special US-EU task force.

Can US green subsidies work with global trade rules?

In the past, these issues could have been settled at the World Trade Organization, but this bureaucracy is slow and probably broken— hence the bilateral talks.

Another option would be to conclude a free trade agreement between Europe (or Japan) and the United States, but this is also a long process and would invite other controversies, from agricultural rules to digital speech regulations.

Another possibility, supported by Macron, is to create an equivalent framework for the EU to subsidize its own transport and renewable energy sectors. It could help solve both the economic and climate problem, but economists will note that it’s not exactly effective at a time when the world needs to commit as many resources as possible to decarbonization. There is a fine line between creating incentives for renewable energy and wasting money on a trade war.

“Overall, this combination of policies would likely be bad for the world,” said Chad Bown, an economist at the Peterson Institute for International Economics. said last week on the Trade negotiations podcast. “[Automative] plant sizes may end up being smaller if companies cannot take advantage of the economies of scale in their domestic markets alone. And ultimately, that could mean electric vehicles end up being more expensive and there are fewer of them, and we’re not tackling the climate crisis as quickly as we might have otherwise.

In the short term, the best outcome may be for US regulators to carefully analyze the bill and write the rules to implement it in such a way that foreign companies are not excluded from all US subsidies, something Biden hinted recently.

This is the start of the IRA

Predicting how government interventions will affect a market is not always easy. As Bown noted, it is possible that US subsidies will not actually be big enough to convince American automakers and battery manufacturers to divest themselves of their China-centric supply chains. And, if the policy succeeds in driving U.S. companies significantly away from these suppliers, European companies may reap the benefits of cheaper clean-tech components thanks to lower demand.

Global reaction to the legislation has been fairly subdued because this money will, after all, help reduce US carbon emissions — a good thing for humanity as a whole. But it underscores the challenge of moving the global economy away from fossil fuels: the transition could make fortunes or destroy communities whose prosperity depends on industries that can’t transition or transition too late. It is a large-scale coordination problem, and it is not certain that the institutions to solve it still exist.