European Perspective on The Inflation Reduction Act of 2022

In the second week of March, President Biden and head of the European Commission Ursula von der Leyen met in Washington to “address shared economic and national security challenges”. Top of the list was The Inflation Reduction Act (IRA), the Biden administration’s flagship initiative whose massive public subsidies risk leading to an exodus of industrial projects away from the EU and in favor of the United States. The EU is still reeling from two years of pandemic and European economies are mobilizing to implement the ambitious Green Deal, even as they bear the brunt of necessary sanctions taken in response to Russia’s invasion of Ukraine. In this context, the IRA threatens to sap the EU’s effort to redirect industrial capabilities and technical know-how to decarbonize the continent.

In response, the EU is trying to negotiate with its US partner to limit the impact of the IRA on European industry, while also trying to set up a similar plan, albeit one that will likely never match the scale of the US measure given lingering internal divisions between EU member states.

EU fear and trepidation

The headline number of $400 billion in government subsidies to incentive investment in green technologies and renewable energy production was a clear sign that the Biden administration is serious about greening the US economy.

The majority view in Europe is that the IRA jeopardizes the EU’s efforts to attract new investments critical to the success of the Green Deal, notably in fields like battery production, renewable energies, and the extraction of critical minerals. The EU’s industrial competitiveness has already taken a hit from the consequences of the Russian war in Ukraine. The end of Russian gas supply to Europe has led to a major rise in energy prices that are now twice as high in Europe as they are in the United States.

Most EU countries share these concerns. During his December 2022 trip to Washington, Emmanuel Macron criticized the IRA, warning that it would “fragment the West”, and pushed for European products to qualify for the text’s tax incentives. In January, the Spanish prime minister attributed Europe’s difficult time to “the war (in Ukraine)” but also to “trade decisions taken by Europe’s allies like the United States”. In a barely veiled reference to the US measure, all EU leaders requested in February that the European Commission “urgently” move forward to strengthen Europe’s competitiveness.

The automotive sector has been a particularly acute point of transatlantic contention. The IRA offers major fiscal incentives to American consumers who buy an electric vehicle produced in the United States. This notably means that 40% of the critical raw materials in the vehicle’s battery must have been extracted or processed in the US.

Europeans know that the anticipated spike in the domestic demand for electric vehicles will lead car manufacturers to lower the size of their investments in the EU as they shift their resources to North America. According to a recent study published by a European NGO specialized in transportation public policies, more than two-thirds of battery production currently planned for Europe is at risk of being “delayed, scaled down or cancelled”. Case in point, Volkswagen put a planned European battery plant on hold earlier this month after estimating it could “receive €10bn US incentives”.

Pushing back

Given how sensitive the IRA is for European economies, the EU, and its member states led by France and Germany, are actively negotiating with the Biden administration in the hopes of coming to a mutually beneficial compromise, especially in the automotive sector. Following their March 10 meeting, Joe Biden and Ursula von der Leyen agreed to “immediately begin negotiations” on an agreement that would allow vehicles composed of minerals extracted or processed in the EU to qualify for the IRA’s clean vehicle tax credits. With one senior official at the European Commission calling the arrangement a “NATO for critical materials”, the EU seems intent on enticing the United States with a framing conducive to Washington’s economic rivalry with China while also benefitting European companies.

At the same time, with member states and various industrial actors clamoring for a stronger reaction, the European Commission is working on less conciliatory measures. In early February, President von der Leyen presented a global strategy designed to streamline the EU’s regulatory environment and to make it easier for member states to support their economies with public funds. The recently announced Critical Raw Materials Act meant to secure access to key materials, like rare earths, is part and parcel of this strategy. The global plan also works in tandem with the ongoing reform of the EU’s state aid rules, with Competition Commissioner Margrethe Vestager suggesting to make it easier for member states to support sectors directly affected by the IRA, such as “batteries […] or wind turbines”.

Lastly, President von der Leyen just presented the EU’s own “Net-Zero industry Act” to facilitate investments in key technological sectors and to pave the way for the bloc to produce at least 40% of identified clean technologies internally by 2030. However, so far, none of these ambitious EU initiatives have been attributed any new funds by the bloc’s member states.

Internal divisions

This flurry of activity in response to the IRA has reactivated some of the EU’s longstanding internal divisions. For months, smaller, more economically liberal, and in some cases more fiscally conservative member states have been pushing back against larger countries that have long favored more state intervention in the economy.

For instance, member states like Italy, Denmark, Sweden, or the Netherlands are concerned that larger countries like France and Germany who are actively advocating for the relaxing of state aid rules will be the main beneficiaries of any change. Smaller member states fear that larger EU countries will use relaxed state aid rules to reproduce the IRA’s negative externalities inside the single market and use large subsidies to unfairly tilt Europe’s industrial landscape in their favor. EU officials have tried to straddle the line between both camps. For instance, Margrethe Vestager insisted that her suggested revisions to state aid rules be temporary only, recalling the centrality of the single market to European prosperity and stressing above all the need to “avoid a subsidy race”.

Another idea that has been hindered by the EU’s internal divisions is the “European Sovereignty Fund” announced by von der Leyen in September 2022. The fund was intended to pool member states’ resources to invest in key technologies at the European level. In this case, so-called frugal member states, notably including the Netherlands, have pushed back against what they consider to be excessive public spending that runs counter to free market principles. As a result, the European Commission has so far only been able to use existing funds, like those approved during the pandemic, for its green re-industrialization endeavors.

What comes next

Despite internal disagreements, the “European Sovereignty Fund” or even the idea of a “Buy European Act” will likely keep floating around in Brussels until the EU’s concerns about the IRA are assuaged. A new summit of European leaders is planned on March 23 and will likely bring new measures meant to foster the EU’s green re-industrialization. The United States has a critical role to play here. Tangible progress on the items agreed upon during von der Leyen’s March visit to Washington will go a long way to pacifying European partners and smoothing over transatlantic friction. Absent such progress, the United States runs the risk of triggering a new trade war at a time when, more than ever, democracies need to stick together.