European Perspectives on the Inflation Reduction Act, with Milan Elkerbout

Notable Quotes

• Inflation Reduction Act made a splash across the pond: “It was … genuinely a bit of a surprise to see the United States finally acting with a very large, significant federal climate policy.” (6:09)
• Inflation Reduction Act emphasizes domestic production through subsidies: “The way the Inflation Reduction Act is set up is quite novel, because the European Union has a very small budget. Most of the money comes from the member states, and the type of subsidies that the IRA gives are quite hard to copy at the EU level. Then, we saw that the more that happens in the United States with local sourcing, the more generous these subsidies become. That really seemed to give an advantage to domestic US producers, which was seen as coming at the cost of European producers.” (8:40)
• New climate policies in the European Union since the Inflation Reduction Act passed: “One is called the Green Deal Industrial Plan. It is about the energy-intensive industries, but much more about just having an industry to produce low-carbon or climate-friendly technology—all the batteries and renewables, et cetera, ideally within Europe. That’s quite similar, I think, to what the Inflation Reduction Act tries to do.” (16:16)
• Concerns about protectionism: “This is a risk that a lot of people in Europe also want to guard against. I don’t mean this in a way that we should move away from the industrial policies that are being passed now. I think even the very generous tax credits of the Inflation Reduction Act can have a lot of positive spillovers well beyond the United States, but there is a bit of a risk of fragmenting the trade system very much and thereby also creating barriers in the trade system for the diffusion of low-carbon technology.” (22:08)

Top of the Stack

• “The New Economics of Industrial Policy” by Réka Juhász, Nathan Lane, and Dani Rodrik

The Full Transcript

Kristin Hayes: Hello and welcome to Resources Radio, a weekly podcast from Resources for the Future (RFF). I'm your host, Kristin Hayes. My guest today is Milan Elkerbout, most recently a research fellow and head of the climate policy program at the Centre for European Policy Studies (CEPS), which is a leading think tank and forum for debate on EU affairs. He has been working in Brussels in the climate and energy unit of CEPS since late 2014, but I'm very pleased to report that he'll be joining RFF as one of our newest fellows in October of 2023. Milan's research focuses on EU climate policy—in particular on the EU Emissions Trading System (ETS) and on industrial decarbonization policies.

Today, we're going to introduce you, our wonderful listeners, to Milan, and then spend the bulk of our time talking about the European Union’s reaction to the Inflation Reduction Act (IRA). It's been a bit of a wild ride, I'd say, over the past year as the European Union has responded to the IRA, and we'll hear more about it from someone who has followed those developments closely. Stay with us.

Hi, Milan. Welcome to Resources Radio and to Resources for the Future. It's really great to be able to introduce you to our listeners, who I think will probably see more and more of your name.

Milan Elkerbout: Hi, Kristin. It's really great to be here and also at RFF, in general. I’m really excited.

Kristin Hayes: Great, great. Well, this is a bit of a special type of episode in that we're introducing both you and your areas of expertise. Given that, I want to start with two welcome questions, which is one more than I usually give myself. But first let me start with the usual one, which is about your background and how you ended up working on climate policy in particular.

Milan Elkerbout: Sure. So about 10 years ago, I was doing my master's in London in political economy, and I had to pick a topic, and, after some hesitation, where I initially wanted to write about the Eurozone crisis, I ended up with the system called the Emissions Trading System—the biggest EU climate policy—and then started writing about how allowances for the certificates are allocated in that system. That was quite a consequential choice, as it proved to be later. After finishing my master's, I started an internship at CEPS, and the ETS was my main topic to work on there. I stayed for quite some time at CEPS—right up until September of this year, actually.

The ETS is a very important climate policy for the European Union, and about half of the emissions that that system covers in the European Union relate to energy-intensive industries—steels, chemicals, and other basic-material producers. It quickly became obvious that, when you talk about those industries, you need to consider much more than just how a carbon price signal is working and that you might need a much broader policy mix to actually get those sectors to net-zero emissions by 2050, which for a while has been the long-term objective of EU climate policy. So, we started talking more about industrial policy, as well, and all sorts of other mechanisms that can help these sectors decarbonize.

Kristin Hayes: Fantastic. Now, I'm going to turn to my second introductory question—knowing that we'll get to talk about the substance of the EU ETS and industrial decarbonization in a bit. I'm very curious, since you are coming to Washington, DC, from Brussels—what are you most excited about in terms of moving here to Washington, DC? I'm purposely not making this a work-related question, so of course you're welcome to answer in terms of the work that you'll be doing here at RFF, but you can feel free to answer however you'd like.

Milan Elkerbout: Sure. I'm just really excited to discover Washington, DC, as a city. I actually don't know the city very well yet. It's my second trip here now after visiting for a few days in March. I guess, like Brussels, Washington, DC, is a major political hub but also a very vibrant and international city, and that's always great to live in. I've been to the United States quite a few times but never really this part of the country. So, I’m also just really looking forward to discover what it's like.

Kristin Hayes: Awesome. All right. Well, I'm a little jealous, to be honest. I've lived here a long time and it's always fun to be someplace new. There's definitely an energy in that, so welcome.

Well, let's talk about the EU response to the Inflation Reduction Act, or IRA, and that is the main substance of our conversation today. We're just past the one-year anniversary of the passage of the Inflation Reduction Act, which is really—I think it's fair to say—a seminal US climate policy, but I think it's also fair to say that it's ruffled a few feathers in the European Union, even as the Biden administration has really been celebrating its passage. Let me start by asking— overall, how would you characterize the European Union's response to the IRA?

Milan Elkerbout: The initial reaction was a bit embarrassing, I thought, from the European side. The IRA was passed sometime in August, then, when most of Europe is very quiet, and then throughout September and October you heard increasing discussion and rumors, and it was all very negative, because most of the discussion was about how these tremendous subsidies and tax credits would make it much more difficult for European producers to compete. Some Europeans also had a little bit of a smugness that Europe was the only major economic bloc passing very serious climate policy. It was also genuinely a bit of a surprise to see the United States finally acting with a very large, significant federal climate policy. But then, Europeans weren't really acknowledging that it's actually very good that that is happening, even if it might create some challenges for the European Union.

Luckily, after a few months that debate became a lot more balanced, and there was also a bit more emphasis on the fact that even if the United States is subsidizing some technologies, there might be other countries in the world benefiting from that and maybe also that European producers can benefit directly from some of the tax credits. In addition, the European Union came up with their own political strategy—not officially in response to the IRA, but it really was a response—

Kristin Hayes: But really actually in response to the IRA.

Milan Elkerbout: Exactly. It's not just about the IRA, because we also had an energy crisis in Europe at the same time that was more linked to Russia's invasion of Ukraine. But there's a lot of good things in those proposals—also a few bad things—but altogether I think it will make European and global climate policy stronger over time.

Kristin Hayes: Well, I definitely want to talk a little bit more about the response and, in particular, the kinds of policy reactions that the European Union had. Let's start there.

It sounds like it was a mixed response, and it sounds like folks in the European Union were particularly frustrated with the IRA's buy-American provisions, which really give preference to American producers and materials that are developed in the United States. Can you just say a little bit more about those provisions in particular and which industries they're most likely to affect?

Milan Elkerbout: Absolutely. For us, the way the IRA is set up is quite novel, because the European Union has a very small budget. Most of the money comes from the member states, and the type of subsidies that the IRA gives are quite hard to copy at the EU level. Then, we saw that the more that happens in the United States with local sourcing, the more generous these subsidies become. That really seemed to give an advantage to domestic US producers, which was seen as coming at the cost of European producers.

This was particularly relevant for the electric vehicle (EV) tax credits, and this is also exactly where Europeans see European producers as being particularly strong—the German car industry is the pride of its country. But France, Italy, and a lot of other member states have at least part of the automotive value chain. Here, the more protectionist elements of the Inflation Reduction Act were definitely quite controversial.

Kristin Hayes: Were they surprising? I feel like there has been enough of a conversation happening in the United States that perhaps it shouldn't have been as much of a surprise that there were these multiple policy goals that the Biden administration was trying to meet with the IRA—but if they were frustrating, did they also come as a surprise, or were folks just kind of sorry to see them ultimately, but ultimately not that surprised to see them?

Milan Elkerbout: No, it's a good question. I think there still was some genuine surprise, but maybe it's also just that we as Europeans didn't pay enough attention. But there still was the expectation that the United States is the ultimate free trade economy. The old Washington consensus and how the World Trade Organization operates—a lot of the IRA provisions really seem to go right against that old sort of 1990s consensus. So, it was still a bit of a shock, but it's also true that there was a lot of discussion on the elements related to having more manufacturing in the United States, which is a priority—that European policymakers have just as many anti-China elements as the IRA. There might be some differences there between the United States and Europe.

Kristin Hayes: Interesting. Well, you've started mentioning a little bit of some of the industries that might be affected. Can you go into a little bit more detail about what the European Union sees as the potential negative outcomes of these provisions? Just tell us what they're most afraid of— that, of course, is negative from an EU perspective.

Milan Elkerbout: In a very simple way, the European Union sees itself as having had pretty ambitious climate policy for 20 or 30 years already. It also wants to have the economic benefits of supporting these incipient green industries. Then, particularly for the automotive industry, since there's still quite a few significant European car producers, they would very much want future electric vehicles to also be produced in Europe.

There's also a quite recent example of something that turned out a bit painfully for the European Union—namely, renewables and solar photovoltaics in particular—in that it was really European subsidies that created the initial market for it and brought down the costs, but then, all the manufacturing very quickly moved to China. That was really an example where some of the more populist parties in Europe could easily attack European climate and energy policy as just being wasteful—especially if you don't care too much about the emissions-reduction aspect.

Kristin Hayes: They were concerned that shifting of manufacturing would in fact move to the United States this time—not to China—but a similar phenomenon would take place?

Milan Elkerbout: Exactly. China has never been a country economically aligned with Western countries and with countries in the Organization for Economic Cooperation and Development, even though there's ever more trade. But then, the United States again was seen as being one of the pillars of the free trade system. If we then even need to worry about the United States and the United Kingdom already having taken a different turn with Brexit, it sort of announced a very different international trade system.

Kristin Hayes: Well, so let's go back to that question then of how the European Union responded. You mentioned that there was, in fact, a reaction. There were some new policy ideas floated—potentially even some new things that became law. How did the European Union as a whole—in the short term, in the medium term, or maybe even as individual member countries—respond, and did they adapt existing policies or take whole new approaches under consideration in response?

Milan Elkerbout: A bit of both, actually. The structure of the European Union becomes quite important here, because when we say the European Union, we often mean these supranational institutions—the European Commission and Parliament—who can, together with the member states, make laws that apply to all European countries, or at least the members. But the European Union does not have that much money in and of itself.

So, when we talk about European subsidies, a lot of times those are provided by member states themselves from their national budgets—something we call “state aid.” State aid, since the 1950s, is considered a bad thing, because the larger and richer countries can easily outcompete the very small ones like Estonia, for example, and many others. So, we always had rules in place that tried to prevent member states from subsidizing their own industries. In the pandemic, a lot of these rules got suspended, because that was necessary anyway to keep the whole economy afloat.

But then, it became very attractive to start subsidizing more—and with the United States doing massive subsidies with the Inflation Reduction Act, a lot of member states are doing the same now, especially Germany, France, and the Netherlands. But the member states that do not have pockets as deep as these northwestern European countries are protesting against it, and they want to see subsidies at the EU level so that everyone can benefit from it.

There's also been a few altogether new proposals. One is called the Green Deal Industrial Plan, and it is about the energy-intensive industries, but much more about just having an industry to produce low-carbon or climate-friendly technology—all the batteries and renewables, et cetera, ideally within Europe. That's quite similar, I think, to what the Inflation Reduction Act tries to do.

There's two components to it. One is related to critical raw materials, where there's also a bit of a geopolitical dimension with the war in Ukraine and the Net-Zero Industry Act, which really focuses a lot on permitting and on other internal market rules that should make it easier to invest and deploy these technologies. On subsidies, then, it is going to be easier for member states to give IRA-like subsidies if they want, but there's also the idea with many analysts that we perhaps shouldn't give as many subsidies, because we already have a carbon price signal with the ETS. If we make the polluters pay for their CO2 emissions, is it then really necessary to give the same amount of subsidies? Because, ideally, the ETS already makes it more attractive to invest in the new low-carbon technologies. Not everyone agrees with that point of view, but we also now see a mechanism that's quite clever that tries to combine a bit of both so-called carbon contracts for difference. You give a subsidy, but you correct it for the carbon price that already exists so that it can fluctuate and also make it more cost-effective.

Kristin Hayes: It sounds like a number of proposals have been put forward. Are these still just ideas that are out in the mix, or are certain ones rising to the top at this point and likely to actually turn into the implementation phase?

Milan Elkerbout: That's an important point. There are legislative proposals. Usually an EU legislative proposal takes about a year to pass, sometimes two. It needs to go to the slow grinder of EU policymaking. That's not done yet, but I'm quite confident it will happen. But there's still some intensive political discussions on the scope and which technology should be favored, for example, by the Net-Zero Industry Act. Carbon capture is explicitly listed. Not all member states like that. For example, a country like France would also like to always support nuclear energy, but others are very much against that. Then, on state aid, member states can do that whenever they want, but it also really depends on the economic conditions and the political conditions in different member states.

Kristin Hayes: How many of these ideas that are being floated in the European Union right now are in fact ideas that had been circulating but just didn't have a lot of momentum behind them, versus things that were really envisioned directly as a response to the IRA? If that question makes sense. Were these only envisioned in reaction to US actions, or did that just sort of give them a nudge to have more momentum?

Milan Elkerbout: It seems like a question that will make a beautiful thesis at some point. You're absolutely right that some ideas have been floating around for some time, and France and Germany, as the most powerful EU countries, have been wanting to have a more muscular EU industrial policy for five years, and they put out so-called “non-papers” really pushing the Commission in that direction. But a lot of other member states and the European Commission were dead set against it, because the European Union isn't really supposed to do industrial policy according to the EU treaties.

It's been controversial, and competition policy, a part of it, is something where the European Union is very strong, but if you want to do more subsidies, et cetera, you also make your competition policy just a bit more generous, not as strict, and not everyone agrees with that.

There's also a few ideas which definitely are 100 percent in response to the Inflation Reduction Act. The most obvious example is that, with the state aid rules, if I'm a member state, I can point to any other country, saying, "Well, look, the United States is giving a subsidy of this amount," then that member state can just mirror it and do the same thing. That's an easy way to give subsidies. That definitely would've been illegal in the past.

Kristin Hayes: Interesting. This is all very fascinating.

I want to ask another kind of big-picture question, then. You mentioned at the beginning that you have studied and are particularly interested in political-economy questions, and I think this counts as a political-economy question. I wanted to ask—in your view, do you think that these developments, the passage of what can be seen as an industrial policy in the United States, the reaction from the European Union, the more muscular industrial policies that are coming out across the board—could that signal or perhaps even spur a new era of protectionism?

Milan Elkerbout: Yes, absolutely. This is a risk that a lot of people in Europe also want to guard against. I don't mean this in a way that we should move away from the industrial policies that are being passed now. I think even the very generous tax credits of the IRA can have a lot of positive spillovers well beyond the United States, but there is a bit of a risk of fragmenting the trade system very much and thereby also creating barriers in the trade system for the diffusion of low-carbon technology.

Ideally, I would hope that both the European Union, the United States, Japan, South Korea, and all other significant industrial economies definitely still get together in multilateral fora, maybe agree on certain rules and standards for low-carbon technology that facilitate their deployment, and maybe also so that we can limit the more retaliatory policies in the European Union. We have a carbon border adjustment mechanism now that's also in place, because Europe is moving with a very strong carbon pricing system that applies to its own industries. But if everyone starts doing the same thing with very generous subsidies, there is the potential for just wasting taxpayer resources, which comes at a cost. So, industrial policy is good, but it needs to be balanced.

Kristin Hayes: What are those fora in which these kinds of thorny issues can get discussed? Obviously, one of the things that you and I have been talking about is there are these international climate negotiation processes that kind of culminate in the UN Conference of the Parties every year. I don't know enough about organizations like the World Trade Organization to know what the flow of trade conversations look like, but are there actually avenues, whether super formal or informal, just between the United States and the European Union, that, even as they're passing these policies, provide avenues to discuss how ultimately to harmonize and to have the rising tide lift all those boats together?

Milan Elkerbout: I think with formal institutions such as the World Trade Organization, it's just not that time anymore. At the moment, that type of multilateralism is very difficult in the current geopolitics, but more informal arrangements will be very good.

Between the United States and the European Union, there are these so-called Global Arrangement on Sustainable Steel and Aluminum talks on steel and aluminum tariffs that were first introduced by Trump but maintained by Biden. They can have a stronger climate dimension, and that could also be expanded into something sometimes called a “climate club” or “climate alliance,” which I know RFF is also working on. It doesn't have to be super formalized, but there are many aspects of things like steel decarbonization where agreement on what certain concepts mean, how you measure embedded carbon, can make other policies a lot more streamlined. Those types of informal arrangements I would definitely hope keep on being supported.

Kristin Hayes: Great. All right. Well, definitely a topic to watch. This is certainly something that, as you noted, we are watching very closely at RFF, and I think even more so with your arrival in just a little while here. Thank you so much for taking the time to talk with me.

I do want to close the podcast with our regular feature, which we call Top of the Stack, and I would love to invite you to recommend some content that our listeners might want to enjoy. It could be content of any type on this topic or otherwise, but let me wrap up by asking you, Milan: What's on the top of your stack?

Milan Elkerbout: Sure. I mean, given that we talked a lot about industrial policy today, there is one quite well-known economist who's been writing about industrial policy for far longer than it's been popular, which is Dani Rodrik, and together with two other academics, Juhász and Lane, he's written an article called “The New Economics of Industrial Policy,” and that seems incredibly relevant in the current discussion. It also looks at East Asia's experience in the 1970s. I guess there's a lot to learn from that.

Kristin Hayes: Great. All right. Well, thanks, welcome, and I'll talk to you again soon.

Milan Elkerbout: Thanks a lot, Kristin.

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