The fracturing of the global trading system was the subject of much earnest debate last week at Davos. Taking centre stage was how the EU would respond to the contentious US Inflation Reduction Act — a $369bn package which aims to stimulate its green energy and electric vehicle industries. European Commission president Ursula von der Leyen weighed in with plans to temporarily water down state aid regulations and pump cash into strategic climate-friendly businesses. Her announcement underscored a new era of green and technological rivalry between the major trading partners. How healthy that contest will be, not just for them but for the global economy, will hinge on whether both can co-operate in setting the rules of the game.
Since the IRA was passed in August, it has drawn concern in Europe. It contains elements that are an affront to free trade — even if these were a product of horse-trading to get the bill through rather than a deliberate aim. But it is also unapologetically ambitious in channelling funds rapidly towards tackling climate change, something the EU has long urged the US to do. Both of these elements, and the competitive threat to European industry, added pressure on the EU to start pulling together its own response. The IRA was, no doubt, a wake-up call for Europe to go further on its existing climate change efforts, but if the collateral damage is a collapse in the US and EU’s relationship, and a race to the bottom on competition rules, it will come at a severe cost.
The biggest bones of contention over the IRA are subsidies and tax credits for US-manufactured products ranging from solar panels to electric vehicles. The domestic content requirements appear to run counter to the World Trade Organization’s rules on trading without discrimination. They skew the competitive playing field, encourage self-sufficiency and risk inspiring a retaliatory subsidy race in kind. Where such discrimination prevails it attracts production to where it is less efficient, while the innovative hand of competitive forces from imports would be subdued, which would undermine domestic strategic aims.
In a splintering geopolitical environment, the US and EU need to be working together and not engaging 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 own internal market.) A fallout on trade risks stifling EU and US collaboration on issues of global importance, including climate change, debt distress and the stance towards China. Subsidies are nonetheless set to play a big part in how both shore up efforts to reduce emissions, harness new technologies and support national security, which makes co-operation vital.
Avoiding distortionary subsidies, and having clear rules on the boundaries of what support is acceptable, is key. Reform of the WTO would be a starting point but given its broad membership and the US’s blockage of appointments to the appellate body, that will not be straightforward. This places greater emphasis on regular bilateral dialogue between the US and EU to help avoid the risk of hobbling each other or sparking undesirable competitive practices. Negotiations for EU exemptions to the IRA’s domestic content requirements for electric vehicle batteries, among other issues, are at least taking place and offer hope of collaboration.
Navigating the line between supporting domestic goals while avoiding beggar-thy-neighbour measures will be challenging. Success will depend on the strength of dialogue over the ground rules. As the EU trade commissioner Valdis Dombrovskis said in Davos, the EU and US should be “building transatlantic value chains, not breaking them apart”.
