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MCC Brussels inaugrual conference saw some of Europe's leading thinkers gather for an in-depth discussion on the crises facing the continient. One of our speakers from that event, Phil Mullan, explores below some of the dangers in the new mood of protectionism that seems to be gaining ground in EU discussions.
The US government's Inflation Reduction Act became law in August this year. The name is rather misleading as its most active provision is a $369 billion industrial subsidy scheme to support America's green industries over the next decade. In keeping with the increasingly protectionist stance of the Biden administration, one of the Act's most controversial features internationally is to limit subsidies for the purchase of electric vehicles to cars produced in North America, including in Mexico and Canada. Rather provocatively for foreign allies whose car manufacturers do not qualify for the credit, the Act specifies that vehicles "eligible for the credit include those made by qualified U.S. manufacturers and excludes those manufactured or assembled by a hostile foreign entity".
Both the European Union (EU) and the South Korean government complained that the subsidy package was discriminatory and would aid the American economy at the expense of its partners across the Atlantic and the Pacific. Thierry Breton, the European Commissioner for the Internal Market went so far as to warn that international businesses could be unfairly incentivised to shift their investment plans from Europe to the United States and that this posed an "existential challenge" to Europe's economy. The American government dismissed the criticisms, emphasising that the electric vehicle tax credit was justified as reducing US dependence on China and helping "create good-paying jobs and further advance U.S. leadership in the development of cutting-edge clean energy technology".
But having criticised the Americans for breaching "free trade" rules, the EU is now planning to reciprocate with an "emergency scheme" drawing upon a proposed "European Sovereignty Fund" to subsidise its own high-tech industries. Bretton explained that it was a matter of upmost urgency to reverse the "deindustrialization process taking place". This response is being justified as part of the effort to strengthen Europe's "strategic autonomy". There are two problems here. First, by retaliating with its own protectionist measures, the EU is escalating economic tensions across the Atlantic. Second, industrial subsidies are usually a blunt instrument that could aggravate, rather than overcome, Europe's weakened productivity growth.
The suitable response to other countries' adoption of protectionist measures is to call them out, and explain why protectionism is detrimental to the initiating countries and to the world overall, both economically and geopolitically. Economically, protectionist actions reverse the productivity benefits arising from specialisation and a more extensive international division of labour. Geopolitically, they incite inter-country animosities and make it harder to achieve collaborative solutions to common problems, economic and otherwise.
However, contrary to such a fitting rebuke to US protectionism, it was reported that the initial response from Brussels was to try to "cut a deal in which its companies can enjoy the same American benefits". It seems protectionism isn't such a problem as long as Europe is able to get inside the American-led economic fortress rather than being on the outside. But this EU stance was not surprising since it is consistent with the EU already being the most protectionist of advanced industrial traders, as illustrated by the levels of tariffs applied to imports.
And when the EU's suggestion fell on deaf American ears, Brussels moved to "rip up the classic free-trade rulebook and to play Washington at its own game" with state subsidies to promote its own green industries. Unless a late deal is struck, it looks like US protectionist regionalism will be met by EU protectionist regionalism.
Endorsing this approach, it is reported that the German government is now open to dropping its formal opposition to industrial subsidies. We should note, though, that this would not be that big a U-turn for Germany, since it is among the European states with the highest spending on state aid relative to the size of its economy.
In 2019, the last figures unaffected by Covid-19 measures, Germany's headline state-aid spending amounted to just over 1.5 per cent of GDP, about double the EU average of 0.81 per cent, and higher than "dirigiste" France's 0.8 per cent. Thus, Berlin's historic reluctance to endorse the principle of industrial subsidies is not driven by a consistent commitment to economic liberalism and the "free market". Rather it reflects the country's own commercial interests. The German government's previous opposition to subsidies conforms with seeking to constrain other European governments from subsidising their own national industrial companies to become stronger competitors to German ones.
With the EU now openly considering more tit-for-tat protectionist measures against the United States, Europe sees second problem being exacerbated. If EU countries are serious about strengthening their own economies, individually or regionally, then state handouts to particular firms is going in the wrong direction. Supporting incumbent businesses financially tends to reinforce the economic status quo which comes at the expense of economic restructuring, innovation and growth.
Whatever the intentions, government subsidies to companies tend to impede the creative destruction process that is essential to economic progress. While such industrial policies may encourage productivity gains in certain firms, they can also reduce overall economic growth by hampering the reallocation of resources to their most productive use. Government subsidies often blunt the value incentives for stronger businesses to undertake the risky but transformative investments without which productivity growth cannot thrive.
Even a spokesperson for the German Economy Ministry, who was sympathetic to coming up with "our own European response [to the new US measures] that puts our strengths first [...] and strengthen our own production capacities", warned that "protectionism cripples innovation". Additional EU protectionism is neither good for Europe's productivity growth nor for the international cooperation needed to address today's more confrontational world.
