Inflation Reduction Act: good for the planet, bad for diplomacy

Landmark legislation has sparked international debate over industrial policy

Since it was signed into law in August 2022, reception of the US Inflation Reduction Act has been divided across the Atlantic. For Americans, the bill is a ground-breaking step towards financing the sustainable transition. From a European perspective, however, the landmark legislation appears more like an industrial policy plan shrouded in protectionism.

Arguably, it is both. The IRA provides $391bn in state expenditures, subsidies and tax incentives to US companies for their transition to clean energy and to promote innovation in clean technologies. This has proven controversial for European leaders. European Commission President Ursula von der Leyen stated in a December 2022 speech that the European Union ‘must take action to rebalance the playing field where the IRA and other measures create distortions’. Subsequent communications from the Commission have criticised the legislation for its discriminatory practices as it unfairly disadvantages EU companies.

What are the controversial elements? First, there are the pragmatic issues on trade and investment affecting foreign producers’ access to the US market. The manufacturing of electric vehicles remains a salient issue for Europe. To qualify for the federal tax credit under the clean vehicle provisions of the act, 40% of the critical mineral and battery components for vehicles produced before 2024 must be made in the US or a country with which the US has signed a free trade agreement. This threshold increases by 10 percentage points annually, reaching 100% in 2028.

Amid political tensions between Brussels and the Donald Trump administration, the ambitious Transatlantic Trade and Investment Partnership negotiations stalled in 2017. But in the absence of an FTA with the US, EU member states do not qualify within these provisions. This has led to renewed negotiations, with European leaders seeking to mitigate ‘competitive disadvantages’ to Europe caused by the IRA.

Second, it has been a point of pride for Europe that the continent has led in sustainability and climate legislation for the past decades. The EU taxonomy for sustainable activities and the Sustainable Finance Disclosure Regulation have paved the way for global initiatives like the Task Force on Climate-related Financial Disclosures and the International Sustainability Standards Board. In addition, the EU has long been a proponent of multilateral trade agreements via the World Trade Organization, rather than bilateral and exclusionary deals.

But the unprecedented level of state-funded climate financing facilitated by the IRA has EU leaders playing catch-up. EU heads of government met in Brussels on 9 February to plan their response. The tone of their answer will depend on the perception of European policy-makers. If market distortions are seen as an unintended consequence of an otherwise welcome effort to advance climate efforts, deepening transatlantic co-operation seems feasible. But if the IRA is seen as an intentional effort on behalf of the US to antagonise Europe and upset the ‘level playing field’, it could induce a tit-for-tat response. This would certainly undermine co-operation at the global level on climate ambitions.

Finally, the IRA is forcing the EU to reconsider its state aid competition law, which prevents member countries from adopting state-driven, strategic investment growth models pursued most famously by many East Asian economies and, increasingly, by the US. It remains to be seen whether they are able to reach an agreement which would allow EU countries to relax state-aid rules to support green investment.

For now, many officials remain hopeful that there is a ‘win-win’ solution to be found. At an OMFIF roundtable, a European policy expert maintained, ‘We’ve decided to take a glass-half-full approach for this piece of legislation, and we are convinced that it’s a good thing that the US is investing into renewables and achieving carbon neutrality.’ They asserted, ‘our self-interest is not as asymmetric as some make it out to be,’ and that the ‘EU welcomes access to US subsidy schemes for commercial vehicles’.

Despite this narrative, failure to resolve some of the key tensions could put transatlantic relations on ice. In an increasingly fragmented international economy, protectionism in the form of state aid may be good for the planet, but it will make reaching multilateral progress on climate change much more difficult.

Taylor Pearce is Economist at OMFIF.

Join Today

Connect with our membership team

Scroll to Top