April 13. 2024. 6:26

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EU response to Inflation Reduction Act must not damage competitive markets

Europe’s green subsidy splurge risks increasing market concentration through capture by large corporations. The EU must seek to ensure that its relaxed state aid framework benefit a wide set of companies, not just big business, argues Max von Thun.

The Biden administration’s Inflation Reduction Act (IRA) has led to something of a panic in Europe, due to concerns that the IRA’s incentives for US manufacturing of clean technologies will disadvantage European businesses.

In response, the European Commission has set out its own “Green Deal Industrial Plan” proposing, among other things, a significant relaxation of the EU’s state aid rules when it comes to investment in green technology.

The rise of green industrial policy, both in Europe and the US, is in principle a good thing.

The sheer urgency of the need to tackle climate change, combined with the inability (or unwillingness) of the private sector to move fast enough, are compelling reasons for a splurge in public investment.

Moreover, the COVID-19 pandemic and Russia’s invasion of Ukraine have demonstrated the vulnerability of our globalised, just-in-time supply chains to sudden shocks, and the subsequent need for less concentrated – and more resilient – production of critical goods, including those needed for the green transition.

Here, as well, there is an obvious role for public investment in accelerating and coordinating this process.

Yet the shift does not come without risks. The biggest criticism of the Commission’s increasingly laissez-faire attitude to state aid is that it undermines the EU’s level playing field.

The worry is that flexible state aid rules primarily benefit the largest EU member states with substantial fiscal firepower – think France and Germany – at the expense of smaller countries, thereby distorting trade and competition within the Single Market.

A recent and oft-cited statistic showed that the Franco-German duo monopolised almost 80% of the €672 billion in state aid granted since March 2022.

These fears are undoubtedly valid and need to be handled carefully by the Commission. But there is a related and potentially greater threat to the Single Market posed by the loosening of the subsidy floodgates.

This is the risk that increased state aid is captured by a narrow subset of dominant firms, leading to weaker competition and increased market concentration within and across member states.

This problem is closely linked with that of the level playing field between member states, as Europe’s biggest companies typically come from its largest countries.

The political nature of subsidies means they are often disproportionately allocated to the very largest firms, who have the resources, administrative know-how and lobbying clout to secure funding, even when there are more deserving recipients elsewhere.

While it is true that investment in the green transition often requires a certain degree of scale, many emerging (as opposed to mature) technologies – from carbon capture to hydrogen – are being driven by startups and SMEs, not incumbents.

A green subsidy splurge that overwhelmingly favours large firms would likely lead to higher costs, less choice and less innovation, and leave us with less competition in the industries of the future. As a recent Commission study put it: “state aid to SMEs is less likely to distort competition and affect trade between Member States”.

Large, profitable multinationals are also much better-placed than smaller players to make major investments without public support, which means subsidies risk replacing rather than adding to total investment. Such firms typically demand greater quantities of funding, limiting the pool of public capital available for SMEs.

And they have the clout needed to play governments off against each other in ‘subsidy races’ that benefit them at the expense of taxpayers. Intel’s planned semiconductor plant in Germany, for which it is requesting almost €10 billion (up from €6.8 billion originally) in state aid, is a good illustration of all these downsides.

Instead of letting the biggest firms get bigger and allowing the monopolisation of the green industries of the future, the EU’s state aid framework should instead support a diversity of small, medium and large-sized companies.

In areas where a certain degree of scale is necessary, such as the installation of renewable energy infrastructure or the laying of EV charging infrastructure, subsidising large companies may make sense.

But the focus of public funding should be in basic research and piloting of early-stage technologies, where much of the activity is led by innovative startups and SMEs with limited resources to bring products to market at scale.

There are a number of practical ways this could be done.

The Commission could give governments a duty to ensure subsidies do not promote market concentration, for example by limiting the share of public funding that can be allocated to large companies. Its little-known, user-unfriendly state aid public database should be revamped to make it easier for civil society to scrutinise how public funds are being spent.

And the EU should encourage member states to invest directly through channels that benefit a wider set of players, such as tax incentives and public support for early-stage R&D, and to target sectors or technologies rather than subsidising individual firms.

The Commission can hopefully count on political backing from national governments themselves, with the latest European Council conclusions stating that when it comes to state aid, a “strong focus should also be placed on preserving the competitiveness of SMEs”.

The result of these efforts will be a diverse and competitive green supply chain that strengthens Europe’s resilience to external shocks, while ensuring the benefits of the green revolution are not captured by a narrow few.