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Europe, And the World, Should Use Green Subsidies Cooperatively

A coordinated approach, including toward subsidies, is needed to tackle climate change successfully

Governments across the world are using subsidies to support the green transition. Green subsidies can be helpful where there are market failures. When carbon emissions are underpriced in relation to their true cost to society or preferable policy solutions (such as carbon pricing) are not in place, subsidies can steer businesses and consumers towards clean technologies that are less polluting while also lowering the costs of those technologies.

But subsidies should be carefully targeted to correct market failures and they should not discriminate between firms, be they foreign or domestic, old or new, large or small. They must be consistent with World Trade Organization rules, too.

The risk now is a harmful subsidy race between the world’s largest economies to lure green investment. This could undermine the level playing field in global trade, contribute to geoeconomic fragmentation and impose large fiscal costs. It would ultimately reduce efficiency and undermine the rules-based global trading system that has served the world economy well over several decades.

Richer nations with greater fiscal firepower might emerge as winners in a subsidy race even if the global economy is worse off. Emerging market and developing economies with scarcer fiscal resources would find it particularly difficult to compete for investments with advanced economies in a more protectionist world, which could also hinder the transfer of technology to these nations. Ultimately, the cost of the green transition might go up.

Europe’s Green Deal

The European Union is discussing a Green Deal industrial plan, proposed by the Commission in January, some elements of which have been adopted already. The plan relaxes European competition rules temporarily to allow for expanded subsidies to clean-tech firms. This was partly a response to some measures in the US Inflation Reduction Act, which the EU fears will put its firms at an increasing cost disadvantage and lead to an exodus of companies to the country that provides the largest tax break or subsidy.

As policymakers develop the EU’s Green Deal, they could take several steps to maximize its benefits and avoid pitfalls.