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State aid to industry: Lifeline or gravy train?

The debate on EU industrial subsidies in the face of the US Inflation Reduction Act and against the backdrop of the Emissions Trading System (EU ETS) and Carbon Border Adjustment Mechanism (CBAM) deals raises some uncomfortable questions.

The passage of the US Inflation Reduction Act (IRA) has had an impact on the final contours of the EU Emissions Trading System (ETS) and Carbon Border Adjustment Mechanism (CBAM), especially on the slow phasing out of the free allocation of pollution permits. Together with the energy price crunch caused by the Russian war in Ukraine, it was frequently cited as a reason why the EU’s Fit for 55 package in general, and these two specific pieces of legislation in particular, could not go ahead as originally envisaged. From the perspective of climate policy, especially the realities we know for staying within 1.5°C limit, this has been frustrating.

Due to the IRA, industrial relocation is no longer just discussed in connection with the risk of ‘carbon leakage’ – industry going where it is cheaper to continue polluting – but with regard to going where it is more feasible or lucrative to switch to greener production. The image of a veritable exodus is being cast.

Yet there is some fogginess about the industries that are really affected, and so we should take the arguments deployed regarding the ETS and CBAM with a pinch of salt. The IRA worries electric vehicle manufacturers (and electronic chip makers) foremost, but heavy industry seems to be opportunistically jumping on the same bandwagon. According to The Economist, “Several European industrial giants have unveiled plans to invest in America, rather than at home”, but who are they? And are these plans just ploys for counter-enticements from the EU? Belgian PM Alexander De Croo indicated that Belgian chemical and steel companies were approached, but who approached whom and to what effect, remains unknown. Apparently, the pressure for a new EU-wide industrial strategy is motivated by “avoiding de-industrialisation and helping big-emitting companies decarbonise amid high energy prices”, according to Carbon Pulse. But there is something wrong with this framing. The voices now calling for decarbonisation support are the same or similar to the ones who helped weaken and even derail efforts to properly reform the EU’s primary tool for industrial decarbonisation, the ETS.

The reaction to the IRA has put industrial policy back high on the EU political agenda – the quest to support certain technologies or even specific companies (“corporate champions”) in the energy transition or the supposed need to respond with an equivalent subsidy package.

The approaches of the USA and the EU to tackling climate change and bringing about the energy transition are often seen as contrasting: subsidies v regulation. Most conspicuously, the EU has a cap-and-trade system to price carbon, whereas a federal carbon pricing system is a political improbability in the United States, with its bipartisan divide and Republicans (and some Democrats) heavily on the side of fossil fuel interests. However, the EU has by no means been a stranger to industrial subsidies, be it through its various funding programmes or by allowing its member states to give grants and preferential loans to companies. And it is worth taking a critical look at some of the ideas being put forward in the run-up to the new industrial policy proposal (Net-Zero Industry Act) being discussed at the special European Council on 9-10 February.

More or better subsidies

The Biden administration has strengthened ‘buy American’ commitments in federal procurement rules, and some of the tax credits offered under the IRA will only be available to firms that meet thresholds for domestic content and production. This is why critics consider the programme to be discriminatory. We know that this will potentially affect European electric vehicle producers, but, while it also adds competitive pressures to industries covered by the ETS, it doesn’t make their relocation to the US the best option, and extra subsidies won’t cure their high energy demand and high energy prices. Besides, these already receive massive state aid.

Heavy industry has received about €200 billion in free pollution permits since the ETS was established and will receive another €400 billion in the decade to 2030. Moreover, the EU Innovation Fund is endowed with more than €38 billion financed from the auctioning of EU ETS allowances, and to be used to help companies decarbonise and transition to the green economy. In addition, a significant share of the EU’s €800-billion COVID-19 recovery package and the €300-billion RePowerEU package has gone or will go to EU heavy industry. Then, there is the protection against the bogeyman of carbon leakage afforded by the CBAM.

Those who demand a European response are ignoring the reality that the EU already lavishes its industry with subsidies, while the European institutions act as though their existing subsidies have so far been non-discriminatory and that any additional ones might only be allowed, according to Politico, “if they match big foreign cash injections”.

European Commission President Ursula von der Leyen has already thrown her weight behind a more cautious response to the IRA: No crude retaliation, but careful consideration of the actual impact of the IRA and whether there is truly a need for further subsidies in Europe. In the case there is a need, she favours a very clear definition of what constitutes the ‘clean tech sector’, very targeted subsidies combined with strenuous efforts to work things out with the United States, and certainly no litigation. The Commission communication on a New Green Industrial Strategy, published 1 February, confirms that more state aid will be only one element of four, and that it will be very much targeted at “green and tech industries”.

And where should more money come from anyway?

The $739-billion IRA (with some $369 billion in low-carbon subsidies including to manufacturing and industry) was designed not to increase the US’s federal debt burden, i.e. to be covered by shifting public spending and by targeted tax increases for highly profitable corporations.

In the EU, the controversy is over France and Germany having already gone ahead with huge subsidy programmes following a temporary loosening of EU state aid rules. France and Germany accounted for almost 80% of the €540.2 billion in pandemic-related subsidies granted under the temporary crisis framework. The European Commission is trying to counter this threat of the disintegration of the single market by working to propose an EU sovereign fund, which would ensure that subsidies are available to all member states, including those with smaller coffers. Eastern European countries want it to be debt-funded. Scandinavian countries see flexibilities in the current EU budget.

Where the money for such a sovereign fund (which is still some way down the line) would come from is still a matter of debate. It would be politically neat for it to replace or integrate the Next Generation EU facility (of which 37% was dedicated to the Green Transition) and the RepowerEU fund. These incidentally are a reminder that the EU is not mooting subsidies afresh in response to the IRA but that subsidies are already a tool in its kit. Given the precedent of these two funds, the Sovereign Fund is likely to look again to the EU borrowing on the money market and to using revenues from existing sources such as ETS auctioning revenues. The latter would be a bad idea as ETS revenues are under rules earmarking them 100% for climate action.

Cutting off your nose to spite your face

The irony here is that the continued existence of free allowances on the ETS deprives one of the EU’s most important industrial decarbonisation tools of tens of billions of euros in revenue.

The Innovation Fund (IF) receives the proceedings of a share of the auctioned allowances and a share of otherwise freely allocated allowances. The revised ETS will increase the number of allowances assigned to this fund from both sources. All the free allowances that are progressively not allocated to sectors included in the CBAM are set to be channelled into the fund. This means that ETS sectors will benefit from over € 40 billion in public funding for innovative clean projects over the period 2023-2030.

However, had the EU decided to phase out all freebies, the Innovation Fund would have had more than three times that amount. Even if the inadequate initial European Commission proposal on how to phase out free allowances and introduce CBAM were kept, the IF could have received up to €70 billion over this period.

The difference of € 30 billion does, of course, not make up for the enormity of the IRA package but when taken in conjunction with the COVID-19 recovery funds, which were meant to complement climate goals, and RePowerEU, the amount of potential subsidies for the clean transition is substantial, even if a significant portion is being squandered on fossil fuels. 

Breathing space and exhaling climate action

European Parliament rapporteur Peter Liese praised the deal struck on the ETS last December, especially the slow phase-out of free allocation together with the slow phase-in of CBAM, as a “breathing space for industry”. What is in the making now with the industrial policy package will rather be an additional supply of oxygen to industry. However, whether industry will soon after be able to breathe naturally and exhale something that is good for the climate is doubtful. Countering this requires a breath of regulatory fresh air, namely including absolute CO2 emission limits in the Industrial Emissions’ Directive in its ongoing review. After all, it is hard to distinguish between actual industry woes which truly require help and opportunistic profiteering.

The ETS can be a keystone in EU industrial policy, and industrial policy where polluting industries are concerned certainly has to be subordinate to climate policy. In the EU, we need to ‘pick winners’, i.e. the most capable and demonstrably willing to change their mode of production to one that is compatible with saving the climate. The Commission is right in saying that additional subsidies should be based on a most careful needs assessment. And the EU must also be willing to ‘let losers go’ – those that grab at any pretext not to tackle their transition, hang on to any means by which to make money from business as usual, or are happy to factor any potential subsidy into their business model. We need an industrial policy which spurs climate-compatible dynamism, not one that extends the lives of fossilised industries.

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