The lesson for Europe in the Inflation Reduction Act? Invest smarter.

The Inflation Reduction Act represents perhaps the most significant shift in green investment in the 21st century. GAM examines the implications of the Act for Europe and why the European Union’s response to the legislation presents an opportunity.

21 April 2023

This article was first published by Context (Thomson Reuters Foundation).

The European Union’s (EU) response to the Inflation Reduction Act in the US is one of the most important stories of 2023 – with more and more companies enticed by US green subsidies, the future of Europe’s green tech market and transition path hangs in the balance.

Ever since it was signed in the summer of 2022, President Biden’s Inflation Reduction Act has been on the minds of investors and policymakers around the world. The legislation represented perhaps the most significant shift in green investment in the 21st century, marshalling unprecedented capital into solar panels, electric vehicles and more nascent low carbon technologies such as hydrogen. According to some projections, the content of this bill alone could reduce US emissions by 37-41% by 2030 compared to its 2003 peak.

In the minds of European policymakers, this represents a direct challenge to the EU’s leadership in sustainability and green innovation. The Inflation Reduction Act subsidies are generous and the potential effects wide ranging, and the fact that this money will only be available to companies that manufacture in America led to widespread protest by EU leaders. They argue that the availability of these subsidies in the US will severely damage green industry globally by creating an incentive for companies to relocate their operations to the US.

Already, we are seeing some of these fears come to fruition. Volkswagen has warned the EU that US subsidies have led the firm to slow down its expansion in Europe, stating that Europe is being overtaken by the US in the race to attract large investments. We have seen similar announcements across the tech sector, including by Tesla, and new EU start up Marvel Fusion. It has become clear that to maintain a growing green tech sector on the continent, a European response to the Inflation Reduction Act is deeply necessary.

A race to the top

Much of how the EU intends to respond is still unknown, though it has set out a broad framework, its ‘Green Deal Industrial Plan’ in February and a further net zero industry act in mid-March. European Commission President Ursula von der Leyen has stated the EU’s intention for Europe to remain front and centre in the competitive field of addressing the transition to net zero.

It means we could now see a race to the top in terms of being able to attract the investment, business, jobs and innovation required for the net zero transition.

So far the EU has signalled that it will work to create a positive and consistent regulatory environment for green technology and investment, working to make it easier for companies to operate across borders within the bloc and to expedite necessary construction. Secondly, the EU hopes to create faster access to funding by loosening its requirements on state aid, as well as investing directly in key strategic industries.

Already, the EU has authorised member states to match any subsidy offered by the US to entice green tech companies to stay and the bloc seems primed to step up further incentives. It is hoped that the new legislation, in combination with existing ‘Green New Deal’ targets, will create up to 2.5 million additional jobs by 2030, bolstering development and the growth of the green economy.

The European response: Get smarter

The EU’s response to the Inflation Reduction Act represents an opportunity to create funding in a smarter and more targeted fashion. While hugely ambitious, critics have rightly highlighted that the Inflation Reduction Act includes many provisions that counterproductively benefit fossil fuels. In addition, there is a strong argument that many of the subsidies in the bill will be funnelled towards large, existing companies that do not necessarily need funding, rather than nurturing small and medium size enterprises (SMEs) where additional capital could be instrumental in their survival and success.

Given the EU is home to the world’s largest and most robust carbon market, which is set to expand with recent reforms announced on Tuesday, as well as subsidy programmes such as RePowerEU, Europe has a solid foundation for a world-class green investment platform. It already invests nearly €72 billion annually in green tech projects. Building on these existing mechanisms through smart, coordinated policy and financing will be instrumental in helping the EU maintain its competitive edge.

With smart policy – ambitious and efficient – that boosts key areas of the green economy and sticks to its commitment to a just transition, the EU has the opportunity, perhaps its only opportunity, to become a global centre of green tech innovation and competition. While it cannot match the US in economic heft, the EU can be better in the targeting and implementation of green policy. By supporting strategic SMEs and truly sustainable green tech, the EU can avoid the pitfalls of the Inflation Reduction Act. Markets will be looking closely at the detail, but on both sides of the Atlantic, the opportunity is clear: there has never been a better time to invest in the transition.