The disintegration of the global trading system was the subject of serious discussion last week in Davos. Center stage has been how the European Union responded to the controversial US Inflation Reduction Act — a $369 billion package aimed at stimulating the green energy and electric car industries. European Commission President Ursula von der Leyen has focused on plans to temporarily ease state aid regulations and pour money into strategic climate-friendly business. Its announcement has highlighted a new era of green and technology competition between the major trading partners. How healthy this competition is, not only for them but for the global economy, will hinge on whether they can both cooperate in setting the rules of the game.
Since the IRA was approved in August, it has raised alarm in Europe. It contains elements that are an affront to free trade—even if it is the product of horse-trading for the bill rather than a deliberate intent. But it’s also unapologetically ambitious in directing money quickly toward tackling climate change, something the European Union has long urged the United States to do. These two elements, and the competitive threat to European industry, have added pressure on the EU to begin assembling its response. The IRA was, without question, a wake-up call for Europe to press ahead with its current climate change efforts, but if the collateral damage is a breakdown in the US-EU relationship, and a race to the bottom on competition rules, it will come at a huge cost.
The biggest points of contention about the IRA are subsidies and tax breaks for US-made products ranging from solar panels to electric cars. Local content requirements appear to contravene WTO rules on indiscriminate trade. They distort the competitive playing field, encourage self-sufficiency and risk provoking a retaliatory subsidy race in kind. Wherever such discrimination prevails, it will attract production to where it is less efficient, while the innovative hand of competitive forces from imports will be dulled, which would undermine local strategic objectives.
In a fractured geopolitical environment, the United States and the European Union need to work together and not engage in a wasteful battle to draw business and investment away from each other. (The EU also needs to ensure a level playing field within its internal market.) The fallout from trade risks is stifling cooperation between the EU and the US on issues of global importance, including climate change, debt distress and attitude toward China. However, subsidies are set to play a large role in how we support efforts to reduce emissions, harness new technologies and support national security, making cooperation vital.
Avoiding distorting subsidies, and having clear rules about acceptable support limits, is key. Reforming the WTO would be a starting point, but given its broad membership and the US blocking of appointments to the Appellate Body, it would not be straightforward. This places more emphasis on regular bilateral dialogue between the United States and the European Union to help avoid the risks of blocking each other or provoking unwanted competitive practices. Negotiations on EU exemptions from the IRA’s domestic content requirements for electric vehicle batteries, among other things, are at least underway and offer hope for cooperation.
Crossing the line between supporting domestic goals while avoiding neighbor begging actions will be difficult. Success depends on the strength of dialogue around ground rules. As EU Trade Commissioner Valdis Dombrovskis said in Davos, the EU and the US should “build transatlantic value chains, not dismantle them”.