Paving the way for the EU's green industrial policy for the net zero age

Transformation and resilience – A strategy for the EU’s green industrial policy
The generational challenge of the green transformation requires an active role of policy to guide and support investment in new, carbon-neutral technologies. At the same time, increasing geopolitical insecurity endangers the resilience of globalized value chains. In result, a more proactive industrial policy approach is required. While the USA have passed the US Inflation Reduction Act (IRA) as their answer to these challenges, the debate on the EU’s green industrial policy response is ongoing at high intensity. As a contribution to this ongoing debate, the study “Transformation and resilience – A strategy for the EU’s green industrial policy” puts forward ideas for a differentiated approach the EU could pursue, comprising a broad transformation policy and a targeted resilience policy. It builds on and expands an earlier study that analyzed the EU’s Green Deal Industrial Plan (GDIP) and Net-Zero Industry Act (NZIA) and put forward a set of conclusions on how the GDIP could be improved.

The triple challenge for the EU’s green industrial policy

When developing and further elaborating its green industrial policy approach, the EU has to address a triple challenge: a challenge to its transformation approach, resilience, and energy costs. In addition, green industrial policy should be developed and analyzed with respect to the green industrial value chain. We propose this concept of a macro-level value chain consists of three stages, green manufacturing (i.e., the manufacturing of the equipment required for the green transformation), green energy (i.e., the generation of renewable (green) energy), and green production (i.e., the production of industrial products using renewable (green) energy). In addressing the triple challenge, the key decision will be which value chain stages to target with appropriate measures for the specific challenges.

Can the IRA be a blueprint for an EU industrial policy?

An analysis of the potential of the IRA to serve as a blueprint for EU industrial policy finds that the IRA approach is not suitable for the EU: It is fiscally too risky, particularly in the complex brownfield situation in the EU with possible interactions with the many existing policy instruments. Also, the tax credit instrument cannot be copied by the EU with 27 Member States with their own tax regimes. Finally, while the IRA’s value chain approach relies on a cascade of subsidies within the green manufacturing and green energy stages of the green industrial value chain. The latter should not be the focus of EU support measures, as it would likely discriminate against efficient and necessary imports of green energy.

A differentiated EU green industrial policy approach

Instead, the EU’s policy response to the IRA should consist of two main arms and should be implemented through a revision of the GDIP and its ancillary documents: First, a broad transformation policy addressing the decarbonization of industry by focusing on green production, and second, a targeted resilience policy addressing the weakest links within green manufacturing supply chains.

A broad EU transformation policy

The broad transformation policy should be a response to the challenge to the EU’s transformation approach brought about by subsidy-based approaches in other countries that make green production cheap, rather than fossil-based production expensive. A Carbon Contracts for Difference (CCfD) scheme at EU level, supporting industrial decarbonization in the green production stage, should be considered as the centerpiece of the broad transformation policy. This scheme should be modelled along the lines of the scheme currently under development in Germany and address hard-to-abate sectors with significant downstream relevance.

A targeted EU resilience policy

The targeted resilience policy should address the weakest links within green manufacturing supply chains, based on a systematic risk assessment: Attention to individual stages of the supply chains is required to avoid missing out on vulnerabilities by only looking at final products. A systematic, data-driven risk assessment should be developed that separately considers two main dimensions of risk: Global supply risk as the ramp-up of global supply may fall short of global demand and dependency on a single supplier. The results of the risk assessment and an evaluation of the competitiveness of EU production should guide the choice of policy instruments for the at-risk stages of supply chains.

Download the study “Transformation and resilience: A strategy for the EU’s green industrial policy” for more information and more results.

The previous study "IRA and the net-zero race - How EU industrial policy should respond", published on 23 March 2023, analyzed the GDIP and NZIA in more detail and found that the plans and policies are too complex and fragmented. It also derived initial ideas on what path the EU could take for its green industrial policy against a set of considerations.

The EU's green leadership and the Inflation Reduction Act

For a long time, the EU has been the global benchmark for pursuing ambitious climate action and setting policies aimed at reducing greenhouse gas emissions. Amid geopolitical rifts around the role of free trade and the security of supply chains, more and more countries are embracing the net-zero transition as an opportunity to transform their economies and secure their prosperity. In recent months, several countries around the world have unveiled national plans to advance their net-zero capabilities through different industrial policy measures. The IRA, whilst a very positive step for climate protection, poses a challenge to the EU by providing substantial subsidies for the development of green value chains in the form of transparent and easy-to-understand tax credits.

The need for a green industrial policy for Europe

The US approach, based on subsidizing carbon-free products, is a new challenge for the EU. With the Green Deal Industrial Plan (GDIP), the EU has responded to this and other challenges, especially the need to reduce import dependencies in critical goods and raw materials. The GDIP is a highly complex policy approach with the main objective of developing green value chains in the EU, both to protect the industrial base of the EU’s prosperity and to increase the resilience of the EU against global trade disruptions. The plan emphasizes simplifying regulations (e.g., by speeding up approval procedures) and financing for green value chains (e.g., by relaxing state aid rules at the national level and using existing EU funds at the EU-level).

Required: A fast market ramp-up of net-zero technologies

In most cases, an analysis of the development of key elements of green value chains shows that a much faster growth of production and generation capacities in the EU is needed. At the present speed of adding generation capacities, the 2030 REPowerEU targets would be missed:

• by 258 GW for solar power capacity

• by 231 GW for wind power capacity

The European Commission's proposed “Net Zero Industry Act” includes a target for EU manufacturing capacity to approach or reach 40% of the Union's annual deployment needs by 2030. For manufacturing of photovoltaics, this would require a sixfold increase in current production. For both hydrogen and batteries, large ramp-ups of production capacities are needed as these value chains are just beginning to be built. The announced projects for manufacturing electrolyzers and batteries would be sufficient to meet or even exceed expected demand. However, there is a serious risk that IRA subsidies might attract investments in these new green-energy and electric-vehicle (EV) value chains to the US, or at least lead to a de-prioritization of investments in the EU.

Green value chains are a source of future prosperity

Green value chains in manufacturing should be a key part of the foundation of the EU's future prosperity. Ensuring that green value chains will be located in the EU is important for securing the future industrial base of the EU. The risks of not developing such value chains in the EU appear to outweigh the fiscal costs of industrial policy support.

Furthermore, a successful green transformation and meeting the EU's goals of fully decarbonizing its economy by 2050 and reducing emissions by 55% by 2030 compared to 1990 will require that critical investment goods for greening value chains are available to EU industry. It is possible that such goods will become scarce on the world market as a result of global decarbonization efforts or due to geopolitical issues.

EU industrial policy should be simple and smart

Overall, an ambitious EU industrial policy appears justified in the light of current challenges. An evaluation of the current EU proposals on industrial policies, informed by a consultation of leading companies in green value chains, reveals that while the general approach to focus on green value chains is highly welcome, several issues should be addressed. In particular, the complexity of the GDIP does not provide the necessary direction and simplification required from an EU response to the IRA. Selected conclusions on how the GDIP could be improved:

  • More focus on EU-level instruments would further promote the simplicity and efficiency of the GDIP. Ideally, this would be achieved by giving the Innovation Fund a much larger role than currently envisaged. As a second best option, the IPCEIs could be reformed to be more user-friendly and given a greater role as a harmonized instrument at national level with a transnational component.

  • Smart subsidies such as auctions and Contracts for Difference (CfDs) should be preferred to nominally fixed benefits such as tax credits, but will only be successful if they are designed in a lean way.

  • Instead of proposing new instruments, existing ones should be streamlined and simplified. Too many conditionalities, compliance requirements and reporting rules make the system difficult to use.

  • The EU should continue its effort to reduce energy costs. An appropriate new design of the electricity market, which takes advantage of the price-lowering effect of renewables, and improved authorization procedures are needed to accelerate the build-up of renewable energy in the electricity system. 

Download the study “IRA and the net-zero race – How EU industrial policy should respond" for more information and more detailed results. 

Contact

Prof. Dr. Bernhard Lorentz

Global Consulting Sustainability & Climate Leader
Managing Partner Deloitte Sustainability & Climate GmbH

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