A tale of two industrial policies

The Foreign Affairs magazine has published an article analysing how America and Europe can turn trade tensions into climate progress. Caliber.Az reprints the article.

Tensions roiled the annual World Economic Forum meetings in Davos earlier this month. Anxious diplomats and business leaders wondered whether China and the United States might de-escalate their confrontation and bury the hatchet. While continuing to endure a pandemic that has upended everyday life for years, Europeans have grappled with the ramifications of Russia’s invasion of Ukraine in the form of an unprecedented cost-of-living crisis.

But the forum also witnessed a more surprising confrontation. The United States and its European allies found themselves at odds over recent US economic legislation. European policymakers accosted Senator Joe Manchin, Democrat of West Virginia, for his role in finalizing US President Joe Biden’s Inflation Reduction Act. In addition to expanding the federal government’s tax collection capacity and greenlighting some drug price controls, the IRA authorized at least $369 billion in subsidies for clean energy projects and products. Europeans object to the law’s fine print, which requires the companies that receive many of these subsidies to produce in the United States. Manchin responded by chiding Europeans for their already high tariffs on US cars and for privileging regulation and the taxation of dirty industries over providing incentives to develop cleaner ones.

The dustup reflected much deeper divides. Proponents of the IRA in the United States celebrate the bill for providing public investment to boost whole sectors of a new green economy. European reactions to this American embrace of a more proactive role for government in the economy are, at best, split.

Since the US Congress passed the IRA, in late 2022, some Europeans have sounded the alarm, accusing the United States of starting a new trade war. This reaction was a bit surprising given Europe’s long-held desire for the United States to more seriously address climate change. However, European critics of the bill feared that Biden’s chosen method of decarbonizing the US economy would threaten European businesses already hard hit by the Ukraine war. In December, French President Emmanuel Macron frostily warned of European job losses, saying that the IRA would “fragment the West.”

Other European leaders have since jumped on the bandwagon. Most prominently, European Commission President Ursula von der Leyen pledged to match US efforts with an EU-wide plan that would encourage the generation and use of clean energy on the continent. But this proposal faces several hurdles, as smaller countries within the EU are worried that their own firms and workers will not benefit from the program and that Germany, the wealthiest EU member state, does not want to underwrite a continental effort. Others, such as the Netherlands, object in principle to more EU spending.

Some observers may see in these tensions and simmering conflict the decline of the international economic order, brought about by the shocks of the presidency of Donald Trump, the United Kingdom’s exit from the EU, and the Russian invasion of Ukraine. But the picture need not be so bleak. Democracies on both sides of the Atlantic can work through today’s disputes, marrying greater state involvement in markets at home with new forms of cooperation abroad. It will not be easy, but Europeans could make good on von der Leyen’s pledge to match the kind of pro-green investments to which the United States has committed, and G-7 countries could begin working together in transitioning to green economies, prioritizing the needs of workers, and building economic resilience across allied democracies.

THE VIRTUE OF SPENDING

Politicians around the world have learned the hard way that globalization didn’t work. Over the last 30 years, living standards rose for many people but inequalities widened within countries. Neoliberals imagined that democratic reforms would spread on the coattails of free trade, and that the likes of China, Russia, and other autocratic countries would become more democratic and better integrated into the liberal international order. Instead, the opposite happened: autocrats have grown stronger in recent years and now seek to revise the order to their benefit. In the United States, in much of Europe, and also in developing democracies such as Brazil and India, democratic structures have been hollowed out. Neoliberalism allowed capital to run rampant and produced an extended period of rising inequality, the loss of manufacturing jobs, and growing anger and political polarization that have fueled and empowered the far right everywhere.

Biden has for years understood the damage done by the evisceration of US manufacturing. As vice president in the wake of the 2008–9 financial crisis, he was tasked to lead the rebuilding of US manufacturing and the safeguarding of the middle class. As president, he has sought to use tax dollars to support carbon-free goods produced in the United States. Biden’s reformist approach builds on the work of a number of important academics and researchers, including Joseph Stiglitz, Dani Rodrik, and Mariana Mazzucato. They have long argued that greater state investment in the productive capacities of Western economies is critical to reducing inequality, boosting the resilience of supply chains, and jump-starting the clean energy transition. They all agreed that trade deals that simply lower barriers on terms favorable to multinationals were at best insufficient and at worst deeply harmful, insofar as they tend to redistribute income upward. Pushed by young voters and social movements that called for a progressive climate agenda, Biden and his team embraced these ideas during the 2020 election cycle, especially when it came to figuring out how to sell climate action to the US public.

To tackle climate change, the Biden administration has focused less on regulation and more on public spending. It did so in part because of US institutional weakness. Defects in American democracy—including the debilitating influence of corporate lobbying and electioneering by the fossil fuel industry, as well as a Supreme Court choked by lifetime appointments that has evinced a growing hostility to environmental regulation—have allowed the Republican Party to become resolutely committed to blocking any climate regulation. Thanks to this implacable opposition, proactive policy on climate change can succeed in the near term only if it incentivizes the public and private sectors to change their behavior, rather than by simply imposing limits on what those sectors can do.

Along with other legislation passed under the Biden administration, including the 2022 CHIPS and Science Act and the 2021 Bipartisan Infrastructure Law, the IRA offers consumers and producers payments and incentives to transition away from fossil fuels and to buy or manufacture goods in the United States. This legislation aims to foster a manufacturing renaissance that helps rebuild communities across the United States left behind globalization, in turn hoping to create good jobs, nurture competitive industries, and facilitate the thorough decarbonization of the US economy. An emphasis on public investment also helps guide the administration’s climate policy past the roadblocks of political opposition. To avoid the antiquated Senate filibuster, climate legislation has to take a spending-focused approach. The Supreme Court, now dominated by conservatives, has struck down many forms of regulation, but it has never struck down a piece of federal spending legislation.

A EUROPEAN RIPOSTE

The new American industrial policy has found admirers in Europe. For years, Europeans have mulled both carbon pricing schemes and subsidies that would push consumers to buy green goods made both in Europe and elsewhere. But French Finance Minister Bruno Le Maire announced last week that Europe “must do the same thing” as the United States: “If we want to compete, we must have a very strong, effective, swift industrial policy.” Likewise, European businesses and investors have praised the IRA for its ambition and simplicity, while chiding European policymakers for criticizing the IRA rather than streamlining and expanding their own policies.

Von der Leyen’s announcements of a comparable EU green industrial policy are a promising start. This new industrial policy will have four pillars. First, Europe will speed the deployment of clean energy by accelerating permitting processes in certain key areas, such as in wind energy, solar energy, heat pumps, and clean hydrogen. The second pillar is financial, with a raft of new subsidies and regulatory changes that would allow member states to support their domestic producers without running afoul of EU spending restrictions. Less wealthy member states can dip into a European Sovereignty Fund for further resources. The third and fourth planks of Von der Leyen’s proposal are improved job training for workers and measures to protect Europe from what it perceives as unfair Chinese trade practices.

These are encouraging signs. A new era of public investment can make climate progress feasible in both political and logistical terms. In the United States, at least 44 states and 141 congressional districts already have facilities that are or could readily be producing goods for green energy supply chains. With a total of 50 states and 435 congressional districts in the country, the United States is already well on its way to finding a basis for bipartisan support for clean energy action in both chambers. Europe has long wanted a reliable ally in the United States on climate. If green energy benefits and green jobs become part of the economy in red and purple US states as well as in blue ones, American climate policy will stabilize even as one of the two major political parties denies the reality of climate change. Within Europe, the move toward more centralized EU financing will remove one of the key obstacles to action on the European side.

In contrast to European fears, the IRA could benefit European firms and workers. Biden’s push to “Make in America” does not require products to be made in America by American companies. Firms from over 20 countries make up the US supply chain of clean energy products, including many European subsidiaries in the United States; these firms and others stand to benefit from the IRA’s new tax credits and they will have new opportunities to grow. New European legislation can do the same for US companies operating in Europe. These benefits can also extend to workers. Economic research suggests that some foreign direct investments can help fuel job creation back home, such as when companies achieve economies of scale that generate revenue that can then be shared with workers. And more broadly, robust, publicly funded industrial policies will benefit European workers by allowing greater democratic say on the structure of markets that otherwise just operate with the interest of maximizing profit.

Europe and the United States can help each other in the enactment of their respective green industrial policies. New rules could be developed in both to buttress these policy pivots. Consider the Global Arrangement on Sustainable Steel and Aluminum, a deal currently in development. This joint US-EU initiative promises to leverage the size of the transatlantic market to reward metal producers who reduce or eliminate their carbon emissions and penalize those who don’t. US and EU steel producers are cleaner than the global average, so this new arrangement will reward their firms and workers. In December, the United States shared with the EU a first draft of a “high ambition” Global Arrangement that would levy tariffs on products from China and elsewhere that have been made with high levels of carbon. The EU has responded warmly, and both sides should work to finalize this deal in 2023.

Europe should embrace this initiative for the sake of its own exporters and producers, and the United States and the EU should work to replicate this model in other carbon-intensive sectors, perhaps through joint carbon tariffs for a wider range of products. Some of these measures may fall afoul of WTO trading rules that forbid treating foreign producers less favorably than domestic ones. But either the WTO adapts or its intransigence will fuel further calls and pressure for the body’s fundamental reform.

BETTER TOGETHER

Whether the United States and the EU embrace a genuine collaborative effort or find themselves in a competitive race to the top depends in part on whether Europeans pick up Washington’s olive branch and accept US policymakers’ insistence that they are not steering the country toward isolationism. Given that industries such as green hydrogen and floating offshore wind energy are still in their infancy, markets are years away from being flooded with too many green products. The United States and Europe could fashion a “green peace” on subsidies, accepting rather than warring over each other’s schemes until zero-carbon industries achieve the necessary reach and scope to meet consumer demand. A joint US-EU task force established last year to resolve differences should steer discussions in this direction. If a number of key countries in the G-7 and OECD agree, this effort could even be scaled up to the level of the WTO.

To compete, however, Europe will need to continue its halting progress toward raising and delivering funds at the continental level. Rich individuals and rich countries need to bear their fair share of the burdens and ensure that low-income member states have the funds they need. And it is critical that any international consensus on climate and trade incentivize fair labor and production practices and deliver finance to the world's developing and poor countries. If the United States and its European allies reach a green peace on subsidies and on carbon tariffs, they must have in mind economic incentives and political outreach to countries outside of the G-7. In this respect, the commitment made at the last annual UN climate summit to deliver greater funds to developing countries is a welcome change.

The Biden administration’s vision is laudable. Left to the whims of the market, green technologies and energy would probably not grow as rapidly and at the necessary scale needed to meaningfully combat climate change. Washington is seeking to create a global economy that differs in important ways from that which prevailed before the pandemic: one that uses less carbon and is more dynamic and more equal. Government investment is necessary to steer the private sector and to move the entire world economy out of the secular stagnation and rising inequality that plagued much of the last two decades. But the United States cannot engineer such change on its own. Getting Europe on board will be a crucial first step toward forging a stronger international order and ultimately decarbonizing the world.