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The confluence of the climate crisis and a global economic crisis has driven demand for government action to support business and support the development of ‘climate-friendly’ economies. Recent developments in the US and the EU both entail significant consequences for the UK.
On 19th January 2023 we held a TaPP workshop to discuss recent developments in the US, EU, and UK, and consider the position of the UK within a world of green industrial strategies. This note summarises the discussion.
The turn towards green industrial policy in the US is driven by three motivations: the Biden administration are ‘true believers’ in industrial policy, which is a distinct shift away from the neoliberalism that characterised previous administrations. In particular, they are seeking to use trade policy to generate new employment within the US (the ‘worker-first’ trade policy); respond to genuine concern about the environment; and also undermine China’s development of new technologies. The Inflation Reduction Act (IRA) reflects all three motives.
Understanding these motives is important for the trade regime, not least as the rules of the WTO are accustomed to evaluating and assessing which industrial measures are reasonable and consistent with governments’ legal obligations. However, there is less clarity around measures taken for sustainability (traditionally defended under Article XX GATT) and national security (more recently used actively under Article XXI GATT). The mix of motives make it hard to assess compatibility of US green industrial policy with US commitments under the WTO (and comparable commitments under FTAs).
A key element of the IRA is US$400bn in subsidies for clean energy, including a wide range of products from solar panels to electric vehicles. There are concerns over the WTO legality of tax credits for electric vehicles, which are due to start in 2023. The policy is openly discriminatory as to qualify or tax credit, ‘final assembly’ must take place in North America; a specific percentage of the critical minerals used to make the battery must come from countries with whom the US has an FTA (which excludes China and the EU), starting with 40% by 2024 and rising to 80% by 2026; and specific entities – “foreign entities of concern” – are excluded from eligibility (a measure targeting China).
Currently no electric vehicle currently produced in North America meets these criteria, partly because China remains the major source of critical minerals globally. Given this, workshop participants raised the question of whether the policy will work on its own terms. Will the tax credits be sufficient to restructure supply chains and jobs and drive a shift to production and consumption of electric vehicles in North America, or are the criteria too stringent to be effective? Also, there is an exclusion for commercial vehicles, raising doubts as to how to classify a vehicle as ‘commercial’.
The US example highlights the challenges of designing green industrial policies that will deliver on environmental objectives, garner sufficient domestic political support to be enacted, and minimise negative spill overs for trade partners. How should one assess whether US policy is optimally designed and whether discrimination is justifiable? From a purely environmental perspective, non-discriminatory subsidies are likely to be more effective (and would be less trade distorting) but are unlikely to garner sufficient domestic political support to be enacted. Eliminating the discriminatory elements (thereby reducing trade distortions) might make the policies politically impossible to implement, making the best the enemy of the good.
Green industrial policy in the EU is evolving rapidly and there is a myriad of overlapping initiatives. Initiatives with substantial green industrial policy elements include the European Green Deal; the Fit For 55 Package; the revision of the EU emission trading scheme (ETS), including a strengthened Innovation Fund, and the adoption of a carbon border adjustment mechanism (CBAM); the EU’s recovery plan including its Recovery and Resilience Facility; the REPowerEU plan aimed at accelerating moves to diversify away from Russian energy supplies after the outbreak of the Ukraine war; NextGenerationEU Green Bonds; and, the newly announced ‘Green Deal Industrial Plan’.
Within the ‘Green Deal Industrial Plan’ and its pillar, a number of initiatives will be pursued, including: plans for a Net-Zero Industry Act which will set out clean technology objectives for 2030 and is designed to be the EU’s response to the US Inflation Reduction Act; a temporary adaptation of EU state aid rules potentially contemplating, inter alia, exemptions from state aid notification requirements under the General Block Exemption Regulation for hydrogen and electric-vehicle sectors and “anti-relocation” investment aid, including tax breaks, for green investments in strategic sectors to counteract the adverse distortions arising from US subsidies, particularly the risk that EU companies producing electric vehicles will be tempted to relocate to the US to benefit from US subsidies; and, a faster, easier to fund and simpler to access process for Projects of Common European Interest (PCEI) on clean tech. The plan will also complement and reinforce the efforts that the EU, like the US, is pursuing to shore up its supply chains in areas like critical minerals (under its Critical Raw Materials Act) and batteries for electric vehicles (under the European Chips Act), to reduce dependence on China.
In addition to EU-wide initiatives, member states are pursuing their own green initiatives, with Germany, France and the Netherlands spending an estimated US$100bn, US$55 and US$45, respectively. Coupled with spending by other member states, like Spain and Italy, the total spend by individual member states is an estimated US$250bn. Given the plethora of initiatives across the EU it is hard to assess exactly how much financing is being targeted to green subsidies, but the sums are vast. The EU is worried that wide differences in member states’ capacity for spending may lead to fragmentation of the EU market. To avoid that and support the transition across the whole Union, the launch of a new European Sovereignty Fund for green and digital initiatives was announced. Based on information currently available, the Fund should become operational as part of a wider mid-term EU budgetary review due in the Summer 2023.
It is also worth noting that the EU continues to pursue its wider green industrial agenda via its trade policy. This includes its preferential trade agreements which contain dedicated chapters on energy and raw materials, and looser cooperation initiatives, notably the EU-US ‘green steel and aluminium’ deal.
As the US and EU spend significant amounts on green industrial policies, where does this leave the UK? The UK needs to decide on its own green industrial strategy as well as how to respond to the impacts of policies pursued by its major trading partners, especially if the US and EU enter into a green subsidy race.
There are clear signs the UK government is interested in these issues. For instance, its Net-Zero Strategy includes public subsidy and investment initiatives, and it has pledged to phase out diesel and petrol vehicles by 2030. However, the UK lacks consistency and ambition. This is illustrated in the car industry, which having already lost investment post-Brexit, is now faced with the recent collapse of the start-up Britishvolt (which had planned to build a major plant manufacturing batteries for electric vehicles) and BMW’s decision to relocate the manufacture of the electric Mini from the UK to China. Overall, an ambitious UK green industrial policy faces serious headwinds. The UK is not a big enough economy to compete in a subsidy race; the government is distracted by other policies issues (not least ongoing industrial action across the public sector). Green industrial policy does not appear a priority with both the Conservative and Labour parties advocating different levels of fiscal conservatism that are unlikely to lead to a large scale green industrial policy.
In the absence of an ambitious domestic policy agenda, UK industry is likely to be negatively impacted by US and EU subsidies, particularly if (as seems likely) subsidies are designed in a discriminatory manner. The UK’s relevant weight in the global economy will make it far harder to insist its interests are considered in new US or EU schemes. In this case, will the UK choose to confront the US and EU? Will it challenge the discriminatory aspects of the IRA? And how will the UK respond if the EU loosens state aid rules, particularly at a time when the EU is also tightening its approach to foreign subsidies?
In considering its options, the UK needs to meet four core objectives: first, to protect UK business from the adverse impacts of subsidised goods; second, to avoid becoming side-lined as new ‘green’ supply chains are developed; third, meet its net-zero commitments; and fourth, as a middle power dependent on functioning institutions, to uphold (or at least not undermine) the rules-based multilateral trading system. All the while, the UK is rightly wary of being seen to align with China, further limiting its options.
It was proposed that the UK has four options (to be pursued in tandem):
We thank Geraldo Vidigal, Ilaria Espa, and Emily Lydgate for presentations during the workshop and input on this summary, and the workshop participants for their insights. Any errors or omissions are our own.
Emily Jones and Greg Messenger, TaPP co-directors
Indeed, the EU’s challenge of alleged local content requirements in UK subsidies via the WTO instead of TCA was widely considered a constructive move that reduced the entrenchment of positions to sensitivities over Brexit. (back to content)