Memo

Mar 21, 2023

Europe’s Green Industrial Policy and the United States’ IRA

Reducing Dependence on China
Photo of the Environment Council meeting room on March 16, 2023
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Two proposals released by the European Commission on March 16 are central to the EU’s green industrial policy. While these plans differ from their US counterparts, they share the goal of reducing dependence. The European Union’s internal production targets, however, oscillate between creating a necessary security buffer from monopoly suppliers and dirigiste protectionism. The EU should prioritize ensuring energy security through diversification and regulatory streamlining and avoid the overapplication of planned targets.

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On March 16, the European Commission presented two parts of its Green Deal Industrial Plan: the Net Zero Industry Act (NZIA) to build green industry in Europe and the Critical Raw Materials Act (CRMA) to secure the materials needed to do it. These initiatives constitute the European Union’s response to the Inflation Reduction Act (IRA) of the United States and the strategic policy of China to use subsidies and domestic content restrictions to dominate green manufacturing. The IRA allocates $369 billion to help the United States boost domestic investment in green technology and the jobs associated with it. Despite differing approaches, the United States and EU both seek to boost their green industry and mineral supplies to reduce dependence on China. While the United States is driven primarily by strategic rivalry, the EU is arguably leaning further toward reducing dependence on energy imports – a lesson learned from Russia’s war of aggression in Ukraine.

Green Manufacturing

The Net Zero Industry Act sets the regulatory framework for the EU’s “net zero” manufacturing. Net-zero technologies – including electric vehicle batteries, solar panels, and wind turbines – are required for Europe to reach carbon neutrality. China currently dominates global manufacturing capacity for most of these. The NZIA sets objectives and mechanisms to help the EU address this.

The NZIA sets a broad target to have 40 percent of the EU’s annual green deployment manufactured in Europe. A leaked draft held some technology-specific targets as high as 85 percent. However, opposition against these targets seemingly resulted in them being watered down. On the one hand, such targets can help clarify long-term direction for investors, which may offer a degree of economic certainty. Yet on the other, targets are difficult to justify and may well be perceived as protectionism relative to third countries, which may reduce competition and waste money.

The NZIA also addresses vulnerabilities at specific segments in the value chain by focusing on component suppliers. Rather than setting arbitrary production targets, the related provision in the NZIA only becomes relevant when a third country without a free trade agreement (FTA) becomes the near-monopoly supplier. This provision is less protectionist and a discernible step in the EU’s efforts to diversify its suppliers of components.

The IRA, in contrast, has no broad production targets, which is both less prescriptive and more conducive to competition. While energy projects favoring local content give US manufacturers an edge, they are still obliged to compete with global players. The IRA combines investment and power production credits favoring local steel, iron, or manufactured components – pairing the reshoring of steel production with the build-up of green industry. Unlike Europe’s initiatives, the IRA focuses on value added. By basing its industrial policy on share of total project costs, the United States aims to capture high value segments instead of building an entire supply chain. While being protectionist, this still allows trading partners to provide other components or subcomponents.

Electric vehicles are an exception: IRA credits require their full assembly in North America. While this does not cover component production, it pushes automakers to relocate assembly. Battery credits extend to manufacturing, aiming for 100 percent production and/or assembly on the continent by 2028. This is contentious because batteries account for 30 to 40 percent of a vehicle’s cost, which shows a continued focus on value added. However, battery credits also qualify for FTA partners, alleviating some discontent. This also helps the IRA target Chinese dominance in battery production, which is supported by provisions that restrict the use of components from “foreign entities of concern.”


Raw Materials

While materials already form the backbone of Europe’s economy, serving as the physical basis for most economic goods, the green transition will increase their importance. Batteries, for example, are expected to raise global lithium demand by 500 to 800 percent by 2030. The Critical Raw Material Act focuses on the supply of critical raw materials; the term “critical” applies to 30 materials of high economic importance with significant supply risk. The EU imports 100 percent of 14 of these, and Germany imports 100 percent of 20 – some exclusively from China.

The CRMA addresses such dependencies by encouraging self-sufficiency across the value chain. It aims for the EU to extract 10 percent, process 40 percent, and recycle 15 percent of its respective annual mineral demand by 2030. While targets can be good, these are prescriptive and may well be unrealistic to achieve at reasonable costs. Europe’s geology, cost of labor, and environmental standards might be less economically viable than those of other regions. It may be impossible to scale up recycling by 2030 because this market depends on existing green projects retiring fast enough to supply the demand. Like the NZIA, the CRMA targets China’s dominance over mineral supply chains by aiming to reduce dependencies from countries supplying over 65 percent of a material.

The IRA, in contrast, mentions materials sparingly. One mention refers to energy projects, encouraging mining in the United States for the most valuable minerals; a second refers to critical minerals used in batteries. For batteries, local content requirements reach 80 percent by 2027 – a tall order. FTA partners qualify as a source of extracted, refined, or recycled materials. The United States leverages this through the Mineral Security Partnership to develop global supply chains with allies and mineral-rich countries. Critical mineral FTAs allow the United States to secure materials while offering access to tax credits. The EU and the US are negotiating such an arrangement. However, this approach also risks creating a bifurcated mineral ecosystem with two markets – one in China and the other circulating the advanced economies of the Organization for Economic Cooperation and Development (OECD).

Regulatory Changes and Funding in the NZIA and CRMA

Both the NZIA and CRMA aim to enable market access by improving the regulatory environment through expediting and streamlining measures. They require member states to establish single points of contact – “one stop shops” – to coordinate the process of granting permits and issuing decisions within fixed timeframes. They also establish the European Critical Raw Materials Board and the Net-Zero Europe Platform. These new bodies will help govern regulatory changes and coordinate member state action into a coherent European strategy. This includes managing the pipeline for highly “strategic” projects.

While neither act offers new funding, leftover funds from existing EU programs such as the Recovery and Resilience Facility, InvestEU, or the Innovation Fund can be recycled for net-zero projects. Additionally, the updated Temporary Crisis and Transition Framework marks another loosening of EU State Aid rules to allow member states to subsidize NZIA and CRMA projects. A new provision even allows them to match subsidies by third countries when there is a risk of investment being diverted away from Europe. Meanwhile, the discussion of a European Sovereignty Fund – key to leveling the EU playing field – has been deferred until July, when the EU’s long-term budget is due to be revised.

Conclusion

Comparing the IRA of the United States with the NZIA and CRMA of the European Union reveals some similarities but also substantially different approaches to reducing dependence on Chinese imports. It is worth noting that the EU’s approach sets many targets for domestic production. These targets may not only help achieve relatively low costs but also constitute an act of protectionism relative to third countries. However, limiting imports of critical components and material from countries – especially China – when market import shares exceed high double-digit percentages makes more sense as a way of addressing energy security risks. Europe needs to be prepared to pay short-term costs for long-term security.