Green subsidy race may be what the world needs

LONDON, Feb 6 (Reuters Breakingviews) - “Don’t let the best be the enemy of the good” is an adage that applies to the green transition as well as most aspects of human life.

Economists broadly agree that high carbon taxes applied all around the world would be the cheapest way to combat climate change. But that’s not politically realistic.

The European Union and the United Kingdom put a high price on carbon dioxide, though this doesn’t cover the entire economy. Elsewhere carbon taxes are low and patchy, as in China, or virtually non-existent, as in the United States. The second-best approach to stopping global warming is for governments to subsidise the production and consumption of renewable energy. That’s what the globe’s economic elephants – America, China and the EU – are doing.

Dishing out state aid comes with problems. It is often inefficient: for example, consumers may get subsidies to buy electric vehicles that they would have bought anyway. What’s more, the payments increase government spending, whereas carbon taxes bring in revenue.

Subsidies can also be protectionist and distort the market. That’s the problem with the $369 billion in climate aid the United States has promised as part of Joe Biden’s Inflation Reduction Act (IRA). Much of the money will go to industries located in America or countries with which it has free trade deals, such as Canada.

The bill therefore discriminates against manufacturers in the rest of the world, undermining one of the core principles of the World Trade Organization. Some European companies in industries from batteries to speciality chemicals have responded by planning to expand U.S. production, alarming the EU.

A classic riposte to protectionist subsidies is for the affected countries to impose anti-dumping tariffs on the offenders. The EU is dropping hints it may do just that for Chinese imports. But it is reluctant to do the same for America, given how much the United States is helping Ukraine defend itself against Russia.

Instead, the EU will crank up its own green subsidies. National leaders will this week consider a plan by the European Commission to redeploy nearly 270 billion euros, most of which was originally assigned for pandemic recovery plans. The Commission also wants to relax state aid rules so governments can more easily subsidise their green industries.

The plan risks undermining the EU’s single market as hardly any of the money will come in the form of grants from EU programmes. Governments with relatively little debt such as Germany will be in a better position to subsidise local companies than highly indebted ones such as Italy. Indeed, that was the experience when the EU relaxed state aid rules following Russia’s invasion of Ukraine. Germany accounted for over half the 672 billion euros in subsidies that the European Commission subsequently approved.

RACE TO THE TOP

That said, the prospects for combating climate change are much better now that America is throwing money at green technologies. Hefty dollops of state aid could set off a virtuous cycle of lowering costs in immature technologies that will benefit from large economies of scale. Generous subsidies for solar panels and wind turbines helped kick-start those technologies, lowering the cost of renewable power.

A subsidy race by the world’s three big economic blocs will accelerate the fall in costs, as each tries to grab a slice of the new green economy. This will speed the rollout of clean technology and further lower costs. Competition between China, the United States and the EU to supply this kit will also benefit consumers in other parts of the world.

In this sense, it’s a mistake to think that investment in green technology is a zero-sum game. It’s possible – and indeed necessary – to have lots more investment everywhere.

FAIR PLAY

Nevertheless, as the elephants distribute their subsidies, the risk is that they trample smaller countries which rightly want their people to have good employment opportunities in the industries of the future, as well as cheap products. So it is important to ensure as much fair play as possible.

One approach would be for the United States to expand the list of countries that can benefit from its subsidies beyond those with which it has formal trade agreements. After all, one of the purposes of the IRA is to reduce America’s dependence on Chinese technology.

The United States could align its green subsidies with its “friendshoring” plan, which aims to build up supply chains in friendly countries. Doing so wouldn’t just solidify relations with allies. Spreading production of clean technologies around a large number of countries would lead to greater economies of scale and lower costs.

America is already negotiating some changes in the IRA rules with the EU. These should be more ambitious than the “tweaks” President Biden has spoken of, and welcome other friendly countries such as the United Kingdom, Japan and South Korea into the tent.

For its part, the EU can ensure some fair play inside the bloc by offering more grants to poorer countries so they can keep up with Germany. It could also help by relaxing its limits on national budget deficits and government debt, which are currently under review. Countries such as Italy would then be able to tap more of the loans left over from the EU pandemic programme.

America and the EU could also make a bold offer to countries in the Global South. Rich nations already have a plan to help emerging countries such as Indonesia decarbonise their economies rapidly. Transferring some of the technology backed by their subsidies and opening up trade opportunities as part of the friendshoring push would further speed the process.

The EU is better placed to do this than America. It says trade is a priority in the battle against climate change, in part as it will help secure access to raw materials such as lithium. For example, the EU is aiming to rapidly conclude deals with Australia, Chile, Mexico and the Mercosur bloc that includes Brazil and Argentina.

Even with such supporting policies, a global green subsidy race will remain a second-best option. But it is a lot better than doing nothing.

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(The author is a Reuters Breakingviews columnist. The opinions expressed are his own.)

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