Massive green industrial policy interventions in China and the United States have put Europe and Germany under pressure: they must reposition themselves to be more competitive and innovative. To avoid the risk of Europe responding with protectionism, an unproductive subsidy race, and national solutions, it needs to pursue a different strategy. Europe needs to foster innovation through an investment offensive in research and development that will strengthen competition on the continent and in the world and deepen the single market instead of national go-it-alone solutions. In particular, Germany has a lot to do here.
The subsidy package of US President Joe Biden – the Inflation Reduction Act or IRA for short – has caused great concern. At its core, the package can be seen as not only a US response to China’s subsidization of green technology, but also the security risks that would result if China were to structurally dominate this sector through subsidies. China already dominates world markets in solar and wind energy, with market shares in some cases exceeding 80 percent. On the one hand, it is true that the West benefits from cheap Chinese products. On the other, this causes the West to make itself vulnerable – especially if confrontation between the two superpowers were to intensify. Consequently, the United States is trying to build up its own production capacities with its subsidy program.
The subsidy programs in China and the United States, which include local production requirements, are now leading to new competition for production sites. Europe has already launched major investment programs in recent years that focus on ecological transformation, for example Next Generation EU (NGEU), a program to support EU member states in their measures for sustainable recovery worth almost 800 billion euros, and Repower EU, which helps save energy and generate cleaner energy. These programs rely heavily on building infrastructure, but – in line with World Trade Organization (WTO) rules – they contain no requirements to produce domestically.
So, where should things go from here? Germany and Europe should not get into a contest to outbid China and the United States on subsidies. Rather, Europe must find its own path that takes its special characteristics and strengths into account. A path that also does not lose sight of possible security risks.
We worry that the cries of business interests for more subsidies are being heard and that policy-makers are attempting to tread the misguided path of cementing the status quo. We also worry that policy-makers are supporting “national champions” that are not internationally competitive. Such a strategy will fail to make Europe and Germany fit for the future, to achieve goals related to climate protection, and to secure Europe as a business location with many good jobs. Furthermore, if old systems continue to dominate, security interests will only be satisfied to a limited extent. Yet, at the same time, a simple call for diversifying supply chains is not enough. Especially if this is structurally prevented by subsidies and local production requirements in the United States and China.
Europe and Germany Should Pursue an Industrial Strategy with Three Essential Elements
1. Strengthening competition: Europe and Germany should do more to put the focus on and promote competition – both within Europe and globally. Establishing strategic sovereignty through purely regional supply chains is and remains an illusion not only for Europe but also for China and the United States. Thus, the goal of this strategy cannot be to anchor all elements of supply chains deemed to be critically important geographically in Europe.
Rather, Europe must demand a return to fair competition from China and the United States within the framework of the WTO. But since this is unlikely to lead to the necessary changes in either superpower, Europe must also reduce its dependencies on both. It should make its supply chains more resilient through a strong expansion of cooperation with third countries – for example, those in Latin America. If it tries to achieve pure European sovereignty instead, this would have damaging consequences. Europe would massively increase costs and make its companies less competitive, not more. Leaning on the WTO, however, would avoid an excessive reduction of international competition in Europe because third countries would not be affected.
2. An investment offensive for innovation in Europe: To this end, the EU and its member states should make a significantly greater effort in research and development. The examples of strategically significant activities cited in the framework of the Important Project of Common European Interest (IPCEI) – whose stated goal is to develop world-leading technologies – make it a promising instrument. Indeed, this instrument should be strengthened. Subsidizing production can also be expedient under certain conditions and should be combined with stipulations that ensure that some subsidies go to research and development. This also requires close coordination with measures related to climate policy, such as CO2 price, the border adjustment mechanism, and the allocation of emission allowances.
Moreover, the primary focus should not be on subsidies for companies. Instead and above all, better framework conditions for private investment should be created. In other words: it is not money that creates innovation and competitiveness but the totality of all conditions. This is the only way to be innovative, and it includes good infrastructure, an excellent public research landscape, skilled workers, less bureaucracy and regulation, and the completion of the European single market for services – especially the Capital Markets Union.
3. A European answer: So far, the German government seems to be relying more on a national design for industrial policy. The softening of state aid law, which prohibits subsidies and other benefits that could distort competition, would be a particularly dangerous path for Europe. It would result in unproductive subsidy races that would weaken the internal market and further increase existing inequalities in Europe. Furthermore, it would also weaken competition, worsening innovation and the attractiveness of Germany and Europe as a business location.
A European Fund for Green Industrial Policy
The EU Commission and the German government should ensure that the necessary funds are mobilized throughout Europe and are equally available everywhere. A European fund would promote competition and growth by providing funding according to merit-based principles to where the technological potential is greatest. This fund could be filled by existing money from the structural funds and NGEU and, if necessary, supplemented with additional funds.
Europe needs a smart industrial strategy that focuses on protecting the environment and does not lose sight of strategic security interests while it also secures Europe’s competitiveness. Trying to solve problems only with national subsidies can create more problems than it solves. A new strategy must feature the capacity to ensure competitiveness and innovation as central elements. It must pursue a European approach, and, in particular, maintain international competition.
The more the United States and China refuse to accept these principles of competition, the more important Europe’s cooperation with and openness to third countries will become. In Europe itself, it is vital to prevent politics from cementing old industrial structures instead of allowing innovation through painful change.
