• The passing of the US Inflation Reduction Act, which contained provisions to encourage domestic production and purchase of electric vehicles (EVs), kicked off a global subsidy race.

• In response, the EU has proposed the Net-Zero Industry act to retain firms and green investment within the EU.

• This led to tensions between Western allies, which have been seeking to project a united stance since Russia began its invasion of Ukraine. 

• As a result, the US and EU have begun negotiations on several areas of automotive technology in an attempt to align their policies and counter Chinese dominance of the EV sector.

The US and EU have started negotiations towards an agreement that would allow critical minerals extracted or processed in the EU to count towards requirements for clean-vehicle tax credits under the US Inflation Reduction Act (IRA). If approved, this would be a breakthrough in an increasingly divisive dispute, reaffirming EU-US trade relations that had been soured by the restrictive sourcing requirements under the IRA. It would help Western allies to counter China’s control over supply chains in the global EV market and reduce costs, by giving EU and US automakers more flexibility over their sourcing decisions.

The IRA is being weakened by disputes

This policy convergence comes after a period of dissonance. In August 2022 the US inadvertently kicked off a global subsidy race by passing the Inflation Reduction Act (IRA), which contains provisions to encourage domestic production and purchase of EVs. Under the law, only EVs assembled in North America qualify for the buyer incentive. To gain the full incentive of US$7,500, moreover, their batteries must contain a rising percentage of components extracted or processed in North America or in countries with free-trade agreements with the US (a category that includes Japan and South Korea but not the EU).

In response, earlier this year, the EU proposed the Net-Zero Industry Act, a new regulation that aims to support clean-tech production and investment in Europe. The legislation is likely to include tax-break models as well as additional financing under the European Sovereignty Fund, to help firms invest in green initiatives. This proposed new measure aims to simplify fiscal-aid rules for green projects, and include “anti-relocation investment aid” to retain firms in the EU. Both sides have also introduced their own Chips Acts to encourage investment in semiconductors, while the EU has proposed legislation on critical minerals to match an Act passed by the US to secure its EV supply chains. 

Transatlantic divisions have widened

The EU policy moves are intended to reassure battery investors such as Tesla (US) and Northvolt (Sweden), which had halted their plans to build new battery plants in Germany after the IRA was passed. In addition, the EU is also debating introducing a new temporary state-aid framework allowing member states to introduce their own investment incentives. While France and Germany are in favour, central and eastern European economies as well as the Nordic countries are more sceptical, for fear of being outcompeted by bigger EU economies.

Even if these proposals are approved, however, EIU expects that Europe will struggle to compete with the US$369bn subsidy package on offer to green investors in the US, particularly given Germany’s reluctance to issue new EU debt. Moreover, some countries are going further. In May France revealed plans to implement new prerequisites for EV subsidies, similar to the US’s IRA. The French government will specifically reward buyers of European-made electric cars, becoming the first European country to do so, and calling on others to follow suit. 

Efforts to bridge the divide

Amid fears of a widening trans-Atlantic rift, on May 31st the US and the EU concluded the fourth ministerial round of their Trade and Technology Council (TTC) by calling for greater cooperation on renewable energy, artificial intelligence and standard-setting. The US and EU are also starting negotiations around a critical minerals agreement, which would allow relevant critical minerals extracted/processed in the EU to count towards requirements for clean vehicle tax credits under the US IRA. 

The EU and US are also aligning policies on semiconductor subsidies under their respective Chips Acts, passed in 2022 and 2021 respectively. In addition, the US is considering introducing its own version of the EU’s Carbon Border Adjustment Mechanism, which will make it harder for companies in carbon-intensive sectors such as steel-making to move their supply chains out of Europe, by imposing extra penalties for producing in higher-emission countries. 

How will this affect China?

Efforts to repair the trans-Atlantic rift will reassure Western automakers who worried that China would benefit from US-EU squabbles. However, China has long dominated the global EV sector, not just because of its large home-grown market for these vehicles, but also through its heavy investment into battery production and its control over supplies of critical minerals as well as rare earth metals. The Asian giant is also expanding its exports of EVs beyond developing countries, with European markets a particular target. However, Chinese EVs made up less than 10% of EV sales in the EU in 2022, according to data from KPMG, a professional-services firm.

Even so, given China’s dominance in other markets as well as in the technology itself, the US and EU have a greater chance by working together to hold off Chinese competition and ensure that their own automakers have access to batteries and key materials. However, both sides are also recognising that without Chinese co-operation they are unlikely to reach their EV goals. Language towards China has softened noticeably in recent months, with the EU maintaining its so-called strategic autonomy and pushing for a policy of “derisking from China” rather than the more draconian “decoupling”. Even so, the push to gain a greater share of EV investment remains crucial for both the US and the EU.

The analysis and forecasts featured in this piece can be found in EIU’s Country Analysis service. This integrated solution provides unmatched global insights covering the economic, political and policy outlook for nearly 200 countries, helping organisations identify prospective opportunities and potential risks.