Free Market Fundamentalist

Responding to American Protectionism Has Downsides for Europe

Joe Biden’s “buy American” policy is a threat, but matching protectionism with protectionism is worse.

Joe Biden Emmanuel Macron
American president Joe Biden greets French president Emmanuel Macron during the opening session of the United Nations Climate Change Conference in Glasgow, Scotland, November 1, 2021 (White House/Adam Schultz)

Europe has no good options to respond to American subsidies for green energy and electric cars.

Politicians are right to worry that the tax breaks and buy-American provisions of the Inflation Reduction Act, coupled with high energy prices due to the war in Ukraine, could convince European companies to make the jump across the Atlantic.

But duplicating American protectionism would make things worse.

What is the Inflation Reduction Act

The Inflation Reduction Act (IRA) isn’t really about reducing inflation. It is a $369 billion law that does everything from lowering drug costs for retirees to raising spending on nuclear power plants.

The IRA includes tax credits for electric cars and offshore wind farms. To qualify, companies must source their materials almost entirely in the United States — “buy American”. The sourcing requirements for electric cars are so strict that not a single vehicle currently on the market would meet them.

The hope is that the IRA will cut American greenhouse gas emissions by 31 to 44 percent in 2030 compared to 2005.

It is partially funded by a 15-percent minimum tax on the largest corporations.

Why Europe is worried

In proportional terms, the IRA is worth half the clean-energy subsidies of Europe. The tax breaks and subsidies, spread over ten years, aren’t the main worry.

It’s the buy-American rule, which could have lasting consequences. American manufacturers of electric cars and wind turbines could stop importing European parts. European companies may even relocate factories to the United States.

What are Europe’s options

Europe has broadly three options to respond:

  1. Create a European “sovereignty fund” to match the IRA, modeled on the EU’s coronavirus recovery fund.
  2. Lift or relax restrictions on state aid.
  3. Declare a buy-European preference in public procurement.

Germany, the Netherlands and other Atlanticist and free-trading nations are wary of all three options. Especially the first two, and especially if EU subsidies are funded by eurobonds: shared European debts. They agreed to joint funding of the COVID-19 recovery fund on the condition that it would be a one-off. Shockingly, high-debt nations in the south of Europe consider it a precedent.

All three options have downsides

A “sovereignty fund” would be duplicative of:

  • The €750 billion coronavirus recovery fund, Next Generation EU;
  • The €100 billion Horizon Europe program to fund scientific research and technological innovation;
  • InvestEU, a €21 billion investment vehicle that also leverages private capital;
  • The Just Transition Fund to up- and reskill workers for the green economy; and
  • EU agricultural subsidies for innovation and rural development.

Allowing governments to prop up companies or industries would undermine the European single market and violate recently-signed trade deals with Canada and Japan.

Giving preference to European companies and products in public procurement may be the easiest option politically, but it would also be the most blatantly protectionist and may invite retaliation from other trading partners.

There is a better way

The IRA makes allowances for Canada and Mexico, which have a separate trade deal with the United States (the former NAFTA). Europe should lobby for the same.

Even better would be a transatlantic “NAFTA” that bans discrimination in procurement, frees movement of workers across the Atlantic, harmonizes licensing requirements and product standards, and lifts most remaining tariffs.

Negotiations for such a trade pact, the Transatlantic Trade and Investment Partnership, broke down under President Donald Trump. Joe Biden should give them another chance.