Europe, And the World, Should Use Green Subsidies Cooperatively

IMF Blog, May 11, 2023

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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.
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.
Subsidies must be consistent with World Trade Organization rules.

A harmful subsidy race between the world’s largest economies to lure green investment could:
- undermine the level playing field in global trade;
- contribute to geoeconomic fragmentation;
- impose large fiscal costs;
- reduce efficiency and undermine the rules-based global trading system.
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, which could hinder the transfer of technology and raise the cost of the green transition.

The European Union is discussing a Green Deal industrial plan proposed by the Commission in January; some elements have already been adopted.
The plan relaxes European competition rules temporarily to allow for expanded subsidies to clean-tech firms, partly in response to measures in the US Inflation Reduction Act.
Key principles for EU policy design:
- Continue working with other countries to develop a common, inclusive multilateral approach (examples include a climate club or an international carbon price floor).
- Consider an agreement on the appropriate use and design of subsidies, underpinned by thorough analysis of their effects on climate and economic outcomes, including competitiveness, resource allocation, and cross-border trade.
- Use green subsidies cooperatively in the interim through open and nondiscriminatory plurilateral initiatives.
- Preserve the integrity of the EU’s single market; limit any relaxation of state aid rules in scope, duration and size.
- Couple temporary state aid relaxations with some EU-level funding to address differing abilities of members to deploy subsidies.
- Coordinate fiscal support for clean-tech industries across EU countries, perhaps under a centrally funded scheme.
- Over the medium term, create a climate investment fund to help coordinate and finance the additional public investment needed to achieve emission-reduction goals more cost effectively.

Focus subsidies on activities with the largest potential climate benefits, including:
- creation of new clean technologies;
- deployment of existing technologies that are still in their infancy.

The Commission has estimated that an additional 4 trillion euros in investment is needed between 2021 and 2030 to meet the EU’s 2030 emission-reduction goals, three-quarters of which needs to be privately financed.
Policy priorities to mobilize financing:
- Faster progress toward a strong Capital Markets Union to help ensure sufficient private-sector financing across the bloc.
- Consider EU-level coordinated financing mechanisms (for example, a centrally funded scheme or a climate investment fund).

Capital, labor and knowledge must flow freely to where they are most needed in the single market to support the green transition.
The Commission’s plan promotes better integration of labor markets within the EU and more training in clean-tech sectors to enable workers to move from shrinking industries to growing ones.
The EU reaffirmed its commitment to using part of the new carbon pricing revenues from the road transport and building sectors for a new Social Climate Fund to support vulnerable households during the energy transition.

Alfred Kammer, May 11, 2023