A US Inflation Reduction Act for Europe

The United States’ recently enacted Inflation Reduction Act (IRA), which includes hundreds of billions in federal subsidies for green technologies and renewable energies, marks a long-overdue shift in US climate policy
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But while the US decision to join the global fight against climate change has been well received in the European Union, some leaders have voiced concerns that the bill focuses too much on domestic production and might discriminate against EU-based companies.

In a recent policy paper, I argue that Europe should not resist the new US approach to climate policy. Instead, European countries should welcome it and develop a better version of their own.

One reason Europeans should embrace the IRA is that it goes beyond the somewhat simplistic approach to climate change that often dominates policy discussions. The EU’s current approach, exemplified by its Fit for 55 initiative, adheres to a market-based paradigm that relies on carbon pricing to ensure self-regulation by emitters. The IRA, by contrast, assumes that a forward-looking government can accelerate the transition to a green economy through targeted investment subsidies to people and companies. Moreover, the IRA has a clear pro-worker bent, focusing on domestic employment and attempting to boost wages by making some tax credits conditional on companies’ commitment to pay prevailing wages.

While the IRA represents a green industrial policy with the potential to create millions of good clean-energy jobs, the EU’s market-liberal approach is bound to fail, because the economic theory that underpins it neglects two crucial features of human societies: individual adjustment costs and economic power relationships. And while European policymakers seem enthralled by the fairytale world of free markets, the IRA’s targeted, government-focused approach is based on sound economic reasoning.

The IRA has the additional advantage of offering a positive narrative. Pro-market economists’ main policy instrument to make people embrace sustainability is to punish them for environmentally irresponsible behavior. In addition, the pro-market approach reduces the social dimension of climate policies to transfer payments to the so-called «losers» of the transition to net-zero emissions. But most people do not enjoy punishment, do not want to receive government handouts, and certainly do not like being called losers. Most people want a green economy that provides decent, well-paying jobs, and they expect governments to help create the conditions for it.

But while the IRA’s overall approach to climate policy is sound, it does have one major flaw. Simply put, the US lacks the labor institutions necessary to translate a pro-worker government agenda into actual policy. Addressing the structural power asymmetry between workers and employers requires well-organized unions, work councils, and stronger enforcement of minimum-wage laws.

Clearly, when it comes to developing a labor-friendly climate agenda, many European countries have an advantage over the US that they can and must leverage. For starters, the IRA’s concept of «prevailing wage» is somewhat fuzzy and would be difficult to enforce. In most EU countries, industrial wages are covered by collective-bargaining agreements, and union wages could easily be used as benchmarks in other sectors. Countries like France and Germany could lead on this issue. Given that Germany already plans to set a decent-pay condition for all federal contractors this year, applying similar requirements for green investment subsidies does not seem far-fetched.

In addition, worker-training programs must be an integral part of any green agenda. The IRA aims to support the creation of a high-skilled workforce by offering tax credits to companies that provide apprenticeships. But the success of these programs depends on the availability of high-quality teaching that works together with employers. Such arrangements exist only in some parts of the US, whereas Germany and several other EU countries have a long tradition of using apprenticeships and retraining programs to support workers in acquiring the technical skills needed for most industrial jobs.

But industrial policy will do little to boost wages in the service sector, which is why minimum-wage laws are essential to any pro-worker policy agenda. EU countries must use the green-energy transition as an opportunity to set a fair minimum wage that provides a decent standard of living.

The German government recently took an important step in this direction when it raised the minimum wage from €10,45 to €12 (about $16 in purchasing power parity terms), even though much of this minimum-wage hike will be nullified by high inflation. In line with the EU’s recent declaration on minimum wages, Germany must raise its minimum wage to at least €16 as soon as possible. By doing so, it could help push the whole EU toward a robust pro-worker response to the IRA.

Tom Krebs, Professor of Economics at Mannheim University, is a research fellow at the Forum New Economy and a member of the German Minimum Wage Commission

© Project Syndicate 1995-2023 

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