EU Poised To Copy US Subsidies For Green Technology  New Evidence From China Shows How It Could Backfire

EU Proposes Abandoning State Aid Restrictions to Compete with US and China in Green Tech

The European Union (EU) is looking to abandon its long-standing restrictions on state aid in an effort to compete with the subsidies offered by the US and China for green technologies. European Commission President, Ursula von der Leyen, is leading the charge for a new commitment from EU leaders to “act decisively to ensure its long-term competitiveness, prosperity, and role on the global stage.”

The Need to Counter Chinese Subsidies

Von der Leyen has emphasized the need to counteract the hidden subsidies provided by China, both in green technology and other sectors. The trigger for the EU’s new approach is the US President Joe Biden’s Inflation Reduction Act (IRA), which commits the US to a record $369 billion to green its economy, including using tax breaks and subsidies. This act effectively breaks the international consensus on not using state aid, embracing what the US has railed against for years. The Economist has said that globalization is no longer about racing, but racing and tripping others.

The EU’s Proposal

The EU is proposing to introduce its own tax credits and subsidies for cleantech companies, as well as fast-tracking regulations in this area. Meanwhile, the UK is under pressure from car manufacturers to respond. So far, it has been trying to find exemptions to the US’s general approach of only offering incentives to products made in America, while also claiming that the UK has no need to subsidize these kinds of areas because it is already ahead.

The Economics of Protectionism

The drift towards protectionism has worrying economic implications. Recent research on the effects of state subsidies in China suggests that such policies could do more harm than good to the US and EU economies overall. States have played a significant role in developing their economies since the dawn of the industrial revolution, with China being the most recent example. The government is paying half the cost of making computer chips, among other incentives, to encourage investment in different sectors.

Government Procurement and Infant Industries

Government procurement has driven many world-changing innovations, with whole sectors like biotech and information technology relying on it to get started. America’s Silicon Valley originally grew on the back of military contracts, for instance. Research in this area acknowledges a case for subsidizing infant industries in which a country wants to specialize. China’s state subsidies in the steel and solar panel industries would be a good example. However, the money a government spends means that less will be available for helping its citizens in other ways, as Brazil’s wheat-industry subsidies in the 1980s demonstrated.

Consequences of New Green Subsidies

The new green subsidies will create winners and losers at different levels. Within the EU, it will un-level the playing field between member states, with those that can afford to spend more on their green tech industries potentially crowding out those with less. Even within a country, there’s unlikely to be a win-win. Our research team recently published a paper about China’s subsidies, using a new approach that makes it possible to estimate the direct and indirect effects on subsidized and non-subsidized firms at the same time.

The Negative Effects of Subsidies

We found that subsidized firms become relatively more productive, thus making them more competitive, while non-subsidized firms can see their productivity growth reduced. The determining factor is whether they operate in a geographical cluster alongside subsidized firms. When more than a quarter of firms in a cluster in China were being subsidized, the remainder suffered. Those losing out were typically foreign-owned firms and those owned by the Chinese state, while private Chinese firms were the beneficiaries.

Conclusion

Subsidies are not without problems, even for China. The last decade has shown us what “losers” can do to an economy and a society. Populist movements and autocratic tendencies can emerge when certain groups feel left behind or unfairly treated. Therefore, it is crucial for governments to carefully weigh the potential benefits and costs of subsidies before implementing them. They should also design policies that can prepare for and mitigate the negative impacts on potential “losers”. The new green subsidies proposed by the EU and the US could have winners and losers, and policymakers must be mindful of the unintended consequences of these policies. Overall, a nuanced and cautious approach to subsidies is necessary to foster sustainable and equitable economic growth.