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Europe and the world should use green subsidies cooperatively

The risk now is a harmful subsidy race between the world’s largest economies to lure green investment

Governments across the world are using subsidies to support the green transition. Green subsidies can be helpful where there are market failures. When carbon emissions are underpriced in relation to their true cost to society or preferable policy solutions (such as carbon pricing) are not in place, subsidies can steer businesses and consumers towards clean technologies that are less polluting while also lowering the costs of those technologies.

But subsidies should be carefully targeted to correct market failures and they should not discriminate between firms, be they foreign or domestic, old or new, large or small. They must be consistent with World Trade Organisation rules, too.

The risk now is a harmful subsidy race between the world’s largest economies to lure green investment. This could undermine the level playing field in global trade, contribute to geoeconomic fragmentation and impose large fiscal costs. It would ultimately reduce efficiency and undermine the rules-based global trading system that has served the world economy well over several decades.

Richer nations with greater fiscal firepower might emerge as winners in a subsidy race even if the global economy is worse off. Emerging market and developing economies with scarcer fiscal resources would find it particularly difficult to compete for investments with advanced economies in a more protectionist world, which could also hinder the transfer of technology to these nations. Ultimately, the cost of the green transition might go up.

Europe’s Green Deal

The European Union is discussing a Green Deal industrial plan, proposed by the Commission in January, some elements of which have been adopted already. The plan relaxes European competition rules temporarily to allow for expanded subsidies to clean-tech firms. This was partly a response to some measures in the US Inflation Reduction Act, which the EU fears will put its firms at an increasing cost disadvantage and lead to an exodus of companies to the country that provides the largest tax break or subsidy.

As policymakers develop the EU’s Green Deal, they could take several steps to maximize its benefits and avoid pitfalls.

The EU should continue to work with other countries to develop a common, inclusive multilateral approach to stopping climate change. This could take the form of a climate club or international carbon price floor. It could also take the form of an agreement on the appropriate use and design of subsidies, underpinned by thorough analysis of the effects of various types of subsidies on climate and economic outcomes, including competitiveness, resource allocation, and cross-border trade. In the interim, green subsidies can be used cooperatively through open and nondiscriminatory plurilateral initiatives.

Preserving the integrity of the EU’s single market is paramount. EU state aid rules rightly put strict limits on the support governments can provide to their companies to ensure a level playing field. This prevents bigger EU countries, or those with more financial heft, from providing more generous support to their companies to the detriment of competitors elsewhere in the bloc. The relaxation of state aid rules should thus be limited in scope, duration and size. It should be coupled with some EU-level funding to help address the differing ability of members to deploy subsidies. Coordinating fiscal support for clean-tech industries across EU countries, perhaps under a centrally funded scheme, could be an option. Over the medium term, the EU would also benefit from creating a climate investment fund to help coordinate and finance the additional public investment needed to achieve emission-reduction goals more cost effectively.

The EU should focus any subsidies on activities where the interventions might have the largest climate benefits. This includes subsidizing the creation of new clean technologies and the deployment of existing ones that are still in their infancy.

To support and accelerate the green transition, capital, labour and knowledge must flow freely to where they are most needed in the single market. The Commission has estimated that an additional 4 trillion euros in investment is needed between 2021 and 2030 to meet the EU’s 2030 emission-reduction goals, three-quarters of which needs to be privately financed. Faster progress towards a strong Capital Markets Union remains a priority as it would help ensure sufficient private-sector financing for the green transition across the bloc. On the labor side, the Commission’s plan is encouraging as it would help better integrate labor markets within the EU and provide more training in clean-tech sectors. These aims are critical, as the green transition will require workers to have the right mix of skills and are able to move from shrinking industries to growing ones. It is also welcome that the EU has reaffirmed its commitment to using part of the new carbon pricing revenues from the road transport and building sectors for a new Social Climate Fund, which will support vulnerable households during the energy transition.

https://blogs.imf.org/