How to reduce the impact of the IRA on green investment in Europe

The EU’s current response to US Inflation Reduction Act (IRA) may be ineffective. It requires a unified strategy to attract green technology investment into Europe.

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There are vulnerabilities in Europe’s current industrial policy in response to US Inflation Reduction Act (IRA), according to the authors of a new EsadeGeo policy brief. Furthermore, the policy is fragmented and runs the risk of internal competition and market distortions among member states. The brief’s authors suggest three key areas to focus attention for the EU’s future strategy and reduce the impact of the US legislation. 

America first 

The package of measures contained within America’s Inflation Reduction Act (IRA) is estimated to be worth $370 billion. It includes sweeping reforms to the American tax system and will provide direct subsidies to companies investing in green technologies in North America. 

The current EU policy is fragmented and runs the risk of internal competition and market distortions

But while the legislation is set to reduce global greenhouse gas (GHG) emissions by 50 percent in 2030 (compared to 2005 levels), it has been met with concern by the EU. Easier access to subsidies, the protectionist nature of the reforms, and the high volume of funding are all likely to divert investment into green technologies from Europe to the US, officials claim. And, as well as the impact on competition, such a diversion could reduce the likelihood of the EU meeting its own climate targets. 

IRA funding is primarily delivered through tax subsidies, which provide direct and immediate funding to investors and households. The official amount of IRA funding is estimated to be $370 billion, but because the system is operated through uncapped tax credits, this figure could rise to as much as $1.2 trillion.  

By contrast, EU programs are project-based and require lengthy application procedures and tendering processes. As well as requiring significant resources to go through the process — with no guarantee of funds at the end of it — the design of the programs prohibits most small and medium-sized enterprises from qualifying. 

A rift about the rule book

The EU argues the use of uncapped subsidies is a direct breach of the WTO Agreement on Subsidies and Countervailing Measures, claiming that the IRA legislation “contains provisions with clearly discriminatory domestic content requirements.” It also says that the aim to reduce US reliance on Chinese-produced clean technologies — a key facet of the IRA — will inadvertently exclude trade with Europe in a further breach of WTO rules.  

The major differences in the political structures between the US and the EU make a level playing field impossible

The volume of funding available in the US presents a further headache for the EU. As well as the uncapped tax subsidies, the US has invested an estimated €21.7 billion into clean technology start-ups. Since the IRA was implemented, EU investment in the same area stands at around €8.7 billion.  

Budgets aside, the major differences in the political structures between the US and the EU make a level playing field impossible. Where the US has a unified approach with its direct subsidies, the EU as an institution must operate alongside the legal frameworks of individual member states. 

Playing the long game

The programs used by the European Commission to deliver funding — including the Green Deal Industrial Plan and the as-yet-unapproved Net Zero Industry Act (NZIA) — are subject to the variables of political constraints, economic capacity, varying timeframes and the differing climate objectives of member states.  

This fragmented policy presents the risk of internal competition and market distortions, further fuelling the exodus of investment to the US. 

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To address these challenges, the policy brief recommends a coherent and unified industrial strategy focused on three key areas: 

  • The creation of an EU-level budget for green industrial policy, with appropriate measures to ensure fair distribution across all member states  
  • Reducing bureaucratic burdens with the development of common financing instruments and a move away from project-based funding 
  • An improved configuration for the NZIA, with the necessary tools for effective joint governance and a focus on collaborative effort-sharing, multi-country projects and advisory functions for state aid. 

While the situation is unlikely to change in the short term, developing a harmonious and collaborative approach will help to ensure EU competitiveness and redress the imbalance caused by the IRA, the policy brief suggests. 

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