Modern Climate Policy: lessons from the US for Europe

The focus on public investment as a climate policy strategy that we see with Biden’s Inflation Reduction Act (IRA) is in sharp contrast to the emphasis on carbon pricing that is usually predominant in European debates on climate policy. In view of the big challenges that we face with the green transition, such as driving down costs of low-carbon technologies, providing the necessary infrastructure, and ensuring social acceptance and a just transition: Can there be lessons drawn from the US approach for the EU and European countries? At the Berlin Summit, this question was hotly debated during the session ‘Modern Climate Policy-Lessons from the US for Europe’.

Recent data published by the ‘Clean Investment Monitor’ shows that the IRA has been effective so far in significantly increasing private investment in clean energy technologies, especially in zero-emission vehicles, battery manufacturing, and solar energy production. While in 2021, US cleantech investments stood at ~$140 billion, new investments in 2023 amounted to $240 billion. In contrast to this trend, annual clean energy investments in Europe are higher in total, but currently not increasing. While the EU offers substantial public spending on climate efforts as well, a lot of it is scattered across different EU programmes. The European Green Deal rather focuses on strengthening emissions trading. In response to the IRA, the EU adopted the Net-zero Industry Act, which defines strategic net-zero technologies, and reformed the EU state aid rules to allow member states more flexibility in supporting these cleantech sectors. Since the next EU budget cycle starts only in 2028, the creation of new investment incentives is currently up to member states.

As several of the discussants pointed out, the session’s key question is quite controversial: not only was the EU first in launching a ‘Green Deal’; it also has a much more comprehensive climate policy framework than the US, featuring a policy mix of subsidies, carbon pricing, and regulation. What is more, US clean energy sectors get a staggering two thirds of its inputs from the EU. Thus, is the EU not far ahead of the US in terms of climate policy?

First, the question sparked a discussion about the need to combine different policies to achieve ambitious climate goals. Overall, the US-American approach was considered one-sided: by solely relying on subsidies, the country is currently reaping the low-hanging fruits of carbon emission reduction. But this might not be enough to achieve net-zero in the long-term and leaves the real challenges for the future. Indeed, according to estimates, the IRA’s will only achieve emissions reductions of 35% by 2030 based on its current budget – 5% short of the US’ 40% reduction target.

The simplicity of the IRA and the easy access to funding it provides were seen as strong assets. However, the EU does not have the respective tax framework to achieve such simplicity.  A mix of multiple policy instruments, combining direct investment with carbon pricing and regulation, was seen as essential to achieve net-zero under these circumstances. This has different advantages: Complementing carbon pricing with investment policies reduces the pressure of having high prices. But carbon pricing also has a motivational role to play. As one of the session speakers puts it: “we can make the investment due to subsidies, we want to make the investment due to carbon pricing.” While discussants agreed that industrial policy is an important element of the climate policy mix, the real question then becomes: when do we use which policy instrument?

Nevertheless, the European climate policy mix can be further improved, and what stands out when looking at the US approach is that public spending via the IRA is quite targeted. In comparison, the EU has currently no clear financial strategy for supporting its clean energy sectors. Given the significant budget constraints, climate funding needs to be more coordinated, and target sectors that are key for the transformation of hard-to-abate industries like steel, cement, and chemicals – e.g., electrification, energy efficiency, green hydrogen, and Carbon Capture & Storage.

Another lesson from the US is the importance of flourishing domestic markets to achieve public acceptance of climate action. A swift implementation of the European Green Deal needs to be accompanied by the creation of thriving markets. Industrial policy has an important role to play in reaping the investment opportunity that the clean energy transition represents. As one of the discussants points out, “there has never been an investment boom based on pricing carbon emissions”. Instead, positive incentives are needed to change price elasticity of demand so as to create a perfect substitute for carbon-intensive options. It is important, however, to make a clear distinction between subsidies and protectionism. The IRA tax credits include requirements for the use of domestic content, which not only drives up the cost of production but also creates supply risks and can have significant international repercussions. The US missed out on complementing its domestic investment incentives with international strategies, such as providing finances abroad through a sort of ‘Marshall Climate Plan’, to allow for positive spillover effects – a mistake that the EU should not imitate.

Among the most important lessons from the US is the need for a compelling narrative related to climate policy. In the context of the IRA, climate protection has been framed as an opportunity, while in Europe, it tends to be perceived as a burden. Here, the predominant narrative has been that we need to make sacrifices to achieve net-zero. Partly, there have also been competing narratives across Government. Ensuring social acceptance requires a consistent narrative on climate policy that reflects a down-to-earth, progressive vision. A new, more accepted, narrative might be the framing of climate policy as security policy, i.e., obtaining energy independence from other countries.

Finally, the need for adequate compensation for the social impact of carbon pricing was a major topic during the discussion. Participants voiced concern over the social challenge that the introduction of ETS2 (expanding the EU-ETS to include buildings, small industry, and road transport sectors) is bound to bring about. The negative impact of an effective carbon price in these sectors on households might be massive, and the EU’s announced Social Climate Fund of around € 65 billion was considered far too little to buffer the shock. To ensure social cohesion in the EU during the introduction of ETS2, the revenues from emissions trading could be returned to poorer households via climate dividends. But it is also essential to create investment windows that specifically benefit low-income and vulnerable households.