For years, the European Union bemoaned the failure of the United States to assume a leadership role in the fight against climate change. Then the U.S. passed the largest public investment in decarbonization on record, directing hundreds of billions of dollars in subsidies to clean energy and green-technology firms, measures that will substantially reduce the country’s carbon emissions by 2030.
The E.U. went apoplectic.
European officials have decried Joe Biden’s Inflation Reduction Act as “protectionist,” inconsistent “with the principles of free trade and fair competition,” and downright China-like in its contempt for World Trade Organization rules.
They have a point: The IRA doesn’t just aim to reduce U.S. carbon emissions but also to increase its share of global manufacturing employment. The law simultaneously expands the reach of the country’s electric-vehicle tax credit, (by removing a cap on the number of eligible vehicles) and narrows its applicability by stipulating that the tax credit can be used only for the purchase of electric vehicles assembled in North America.
In practice, this means an American consumer purchasing an American-made EV will be able to put $7,500 of its cost on Uncle Sam’s tab, while one purchasing a German-made EV will need to cover the full price. Thus European electric vehicles will be systematically disadvantaged in the world’s largest consumer market. This is no small thing. European officials have long been anxious about precisely where the bloc will fit into the emerging global economic order, and assuming a dominant role in the electric-vehicle sector has been central to the E.U.’s vision for securing a favorable position. If the U.S. effectively reserves its EV market for domestic producers, Europe’s vision of green export-led growth loses some of its luster.
Furthermore, the IRA includes similar “Buy American” provisions for EV batteries. By 2029, in order for a car to qualify for the full tax credit, its battery will need to be made entirely from components manufactured or assembled in North America. In other words, the law doesn’t only aim to cultivate a dominant American EV industry but also to establish an almost entirely North American supply chain for it.
One need not be a Volkswagen executive to question the wisdom of the IRA’s more nationalistic provisions. If the U.S. genuinely considers climate change an “existential threat,” it would be wise to prioritize rapid decarbonization over other economic goals. It’s quite likely that removing all “Buy American” requirements from the EV tax credit would expedite a green transition in the automotive sector since doing so would foster a more competitive EV market and, thus, more affordable vehicle options.
But just because a complaint is reasonable doesn’t make it productive. It is inconceivable that Congress will revise the IRA to make it less favorable to American business interests. The WTO era is over; the age of green industrial policy has begun.
Europe can still prosper under this new paradigm, but doing so will require resolving the bloc’s energy crisis, expanding the E.U.’s capacities for economic governance, and increasing the purchasing power of the union’s consumers. By providing an impetus for reform, the IRA could ultimately help the E.U. achieve those latter objectives.
The days of the U.S. as a guarantor of “free trade” are finished.
If Biden’s foray into industrial policy were an aberration, the E.U. might be wise to contest its legitimacy, but the president’s commitment to promoting domestic manufacturing reflects an ascendant bipartisan consensus. Although Republicans opposed the IRA, they scarcely did so in the name of free-market globalization. To the contrary, several prominent GOP senators explicitly argued for an embrace of industrial policy, and the party has helped Biden subsidize American semiconductor manufacturing.
Using fiscal and regulatory policies to favor domestic industries is largely verboten under the WTO. Biden’s agenda therefore constitutes a tacit repudiation of the very trade regime the U.S. largely authored.
This paradigm shift was born of (at least) three developments. One was China’s thoroughgoing subversion of WTO rules and its simultaneous economic ascent. Many U.S. politicians, liberal and conservative alike, came to believe the country was at risk of losing its supremacy in advanced technologies because it refused to emulate China’s subsidization of critical industries. Given that many such technologies have martial implications, Uncle Sam’s reluctance to bankroll strategic industries came to be seen as a national security threat. And in the U.S., there is no surer foundation for bipartisan consensus than the Pentagon’s anxieties.
The protectionist turn also had a political impetus. After Donald Trump’s “America First” campaign wrested control of the GOP away from the Bush family — and then key Rust Belt battlegrounds from Blue America — both parties loosened their attachment to free trade and redoubled their advocacy for U.S. manufacturing. Among the liberal elite, Trump’s 2016 victory heightened the consciousness of the white working class’s discontent. And the demagogue’s inroads with union voters made the Democratic Party more eager to demonstrate its utility to organized labor. Whatever the idea’s accuracy, many Democratic power brokers came to believe that increasing employment opportunities in high-value manufacturing industries was vital for beating back the tide of right-wing nationalism.
Finally, the pandemic alerted U.S. policy-makers to both the hazards of reliance on global supply chains and the viability of industrial policy. In the early days of the COVID crisis, the U.S. was confronted with its limited capacity to manufacture PPE and ventilators along with the unreliability of foreign suppliers, which, in a time of crisis, revealed a greater loyalty to their home nations than to the free market.
“Everybody retreated to the national during the pandemic. And then some nations had the capacity to produce the things they needed, and some nations didn’t,” said Nils Gilman, a historian of globalization. “Meanwhile, we also saw during the pandemic that intentional industrial strategy can be very effective. Operation Warp Speed and its analogs in Europe produced a radical change in our industrial capacity. Governments guaranteed a market for breakthrough vaccines, and we got those vaccines. And that revealed that we could actually have industrial policy for lots of other things.”
None of these realities — America’s geopolitical rivalry with China, the Democrats’ political imperative to generate employment opportunities for non-college-educated workers, or the historical memory of the pandemic’s economic lessons — is going away anytime soon. So U.S. contempt for the old rules of globalization won’t be going away either, no matter how loudly Brussels protests.
The E.U.’s biggest economic challenges have little to do with the U.S.
Europe’s disdain for the IRA’s nationalist provisions is understandable. But the truth is that the E.U.’s economic model would still be imperiled in the absence of those measures. If the U.S. had merely made itself a favorable place for green manufacturing through subsidies while refraining from overt discrimination against European firms, green industry would be running westward across the Atlantic anyway.
European industry’s fundamental problem is the continent’s high energy costs. The E.U.’s resistance to Russia’s war in Ukraine led Vladimir Putin’s regime to choke off Russian gas exports to Europe. Across the E.U.’s 27 member states, gas prices were nearly 90 percent higher last year than they had been in 2021.
The E.U. has mounted heroic efforts to replace the energy it lost to the war in Ukraine, and these have been sufficient to spare Europeans from shivering through the winter. Yet they haven’t been enough to keep Europe’s energy prices globally competitive. For energy-intensive manufacturers such as makers of cars, steel, fertilizer, and feedstock, the costs of maintaining production in the E.U. — rather than relocating it to the U.S. — generally outweigh the benefits. “It’s a no-brainer to go and do [business] in the United States,” Ahmed El-Hoshy, chief executive of the Amsterdam-based chemical firm OCI NV, told The Wall Street Journal in September, shortly after expanding his company’s Texas operations.
This predicament informed Europe’s uproar over the IRA’s protectionism. With firms already fleeing the E.U. for the U.S., the legislation’s “Buy American” provisions felt gratuitous, as if they were effectively kicking Europe while it was down.
Yet Europe’s preexisting energy crisis undermines the notion that what ails E.U. industry is U.S. policy. Whatever the details of the IRA, Europe would still be suffering from its collective failure to develop an energy system independent of Russian fossil fuels. The U.S. should do what it can to mitigate Europe’s energy problems, but E.U. nations must avoid self-inflicted injuries such as the decommissioning of well-functioning nuclear plants.
Beyond energy woes, the European economy faces other internal challenges. Even before the IRA’s passage, the E.U. was excessively dependent on exports for growth. As Matthew Klein and Michael Pettis argue in their 2020 book Trade Wars Are Class Wars, in the wake of the 2008 crisis, E.U. nations in general (and Germany in particular) discouraged domestic consumption through fiscal austerity and wage suppression. This policy paradigm was good for Europe’s export industries in that it kept labor costs and interest rates low. But it left E.U. firms deeply reliant on foreign markets for demand, exacerbated imbalances in global trade flow, and fueled domestic inequality.
In other words, before the U.S. embraced green industrial policy, Europe already had good reason to reorient its economy away from exports and toward domestic consumption. Increasing labor’s share of income would reduce both social inequality in E.U. nations and European firms’ reliance on U.S. customers.
“I think it would be good for the world if Europeans focus a little less on these super-high-value-added, energy-intensive industries, a little more on building shopping malls,” said Yakov Feygin, associate director of the Berggruen Institute.
To the extent that the IRA’s protectionism forces the E.U. to pursue wage-led growth, it will do Europe a favor.
A spoonful of anti-Americanism may help Europe swallow fiscal integration.
The E.U.’s other major internal challenge has been its limited capacity for taking collective economic action.
To their credit, European officials have largely recognized that the best way to counter the IRA is to imitate it. At the World Economic Forum in Davos on Tuesday, European Commission head Ursula von der Leyen announced the E.U.’s intention to subsidize green-energy development and ensure “Europe’s strategic autonomy” through the creation of an E.U.-wide sovereignty fund and the Net-Zero Industry Act.
These are promising developments, but it remains to be seen whether the E.U. can translate these ambitions into policy realities.
“We’re seeing a lot of voices that want Europe to have more statelike features — more ability to engage in common borrowing and common spending — really pushing hard for a European industrial policy,” said Ben Judah, a senior fellow at the Atlantic Council’s Europe Center. “But that’s going to be difficult because of this question at the heart of the European political economy: Who’s subsidizing who? And for what? Whose industries are competitive, and whose aren’t?”
On these questions, Europe’s strategic imperatives may come into conflict with governing necessities. If the E.U.’s nations were as thoroughly integrated as U.S. states, it could pursue global economic competitiveness while making only minor concessions to parochial interests — which is to say it could direct subsidies to the highest performing and most productive firms in the union, even if these happened to be predominantly German. But that would be politically nonviable in the E.U. Any European industrial policy will need to direct some amount of subsidy to nations with low-performing manufacturing sectors, and the dubious economic wisdom of such investments could strengthen political resistance among tax-averse voters in the bloc’s wealthier nations.
In the past, such complexities have generally preempted ambitious E.U.-wide fiscal policies. By raising the stakes of inaction, the IRA may provide Europe with the impetus it needs to overcome the political obstacles to a European industrial policy. Certainly, the E.U. has never been closer to achieving such a policy than it is today.
Critics of the IRA argue that it could set off a “race to the bottom” in which nations bid against one another for manufacturing employment, offering multinational corporations increasingly favorable tax deals in the process. But this nightmare scenario doesn’t sound all that different from the pre-IRA status quo, in which nations already competed for capital investment on the basis of low tax rates and labor costs.
The risk that a U.S. retreat from free trade will trigger invidious forms of economic nationalism and geopolitical conflict is a real one. Yet as the E.U.’s fledgling steps toward a green industrial policy suggest, there is also a real possibility that the IRA will have beneficent global effects. It would be good for America’s competitors to ramp up public investment in much-needed green technologies and retreat from growth strategies centered on suppressing domestic wages.
Europe’s old economic model is dying. But if the E.U. can resolve its energy crisis and internal political problems, a new and better model could soon be born.
