The blind spots of a common EU industrial policy

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The economic case: the fallacies of horizontal industrial policy

Throughout the era of globalisation and liberalisation, policymakers assumed industrial policy should horizontally focus on creating favourable market conditions for industries – e.g. through improving access to energy, raw materials and human capital. Active industrial policy was denounced as a distortion of competition that picked winners. However, neoliberalism and globalisation are not only coming to an end. As the Four Asian Tigers (Singapore, Hong Kong, South Korea, and Taiwan) have demonstrated before, and the US and China show today: well-designed industrial policy using subsidy programmes in combination with the strategic protection of future industries and export promotion is not about picking winners, it is about creating winners. Horizontal industrial policy can support, but not replace, this objective. Businesses need clarity regarding the long-term development of technology paths. As long as uncertainty prevails, actors will hold back investments, as waiting becomes worthwhile. This is shown by economic theory, and also by surveys: more than 90% of manufacturing firms are concerned about uncertainty surrounding regulation, energy and carbon prices. Investments do not require deregulation – they require reliable and predictable regulation. The more clarity, the better. And this clarity is created through active industrial policy.

The geostrategic case: industrial policy as a tool to exert geopolitical power

Second, there is the geopolitical argument for industrial policy. Yet, this is not only about EU Member States reducing the geo-economic risks stemming from existing trade dependencies (de-risking). With the return of power politics, industrial policy using strategic export promotion can help EU Member States to transform lopsided trade relations into mutual dependencies to balance existing economic power imbalances, for example with China.

The green case: economic structural change with a deadline

Lastly, the transformation of the European economy has a deadline, fundamentally altering the logic of economic policy. Adjustment processes take time, even if one assumes markets lead to efficient outcomes. It takes time to train personnel, make investment decisions or wait for an investment window to replace a technology. The EU aims to be climate neutral by 2050. The EU Emissions Trading System (EU ETS) provides the necessary long-term price corridor. Still, the associated price uncertainties, combined with an asynchrony between short-term and long-term profitability of investments under CO² prices, slow these processes down. Industrial policy creates the reliability needed to accelerate investments.

A historic turn: Europe on the path to a common industrial policy

The Net-Zero Industry Act (NZIA), the relaxation of state aid rules, the Critical Raw Materials Act and STEP – all these pieces of legislation signal a historic shift that fundamentally changes the EU’s identity, which has traditionally focused on trade liberalisation and horizontal industrial support. Parts of the European Commission, particularly The Directorates-General for Internal Market, Industry, Entrepreneurship and SMEs (DG GROW), for Economic and Financial Affairs (DG ECFIN) and for Regional and Urban Policy (DG REGIO), have recognized the importance of industrial policy. It seems only a matter of time before other Directorates-General follow suit –such as the one for Trade (DG TRADE) and for Competition Policy (DG COMP), which currently struggle to reconcile their agendas with this European identity conflict. The European Commission’s Electric Vehicles probe is a first sign of this recognition.

However, the discussions so far have been more heat than light. The discrepancies remain high between ambition (NZIA resilience targets aiming to retain up to 40% of industries in Europe) and reality (€1.5 billion from the Strategic Technologies for Europe Platform for financing), between the EU’s position (strategic sovereignty) and EU Member States (Germany and France advocating for liberal trade relations with China), and between risk analysis (threats of internal market fragmentation) and effective risk mitigation (52% of state aid being granted by Germany).

If the EU, particularly its Member States, is serious about a common industrial policy, four central questions need to be directly addressed head on.

1. Geostrategic export promotion

The discussion on strategic sovereignty has so far focused primarily on EU imports. The import dependencies on solar modules, wafers and critical raw materials – primarily from China – pose a risk to the EU, which aims to address this by building domestic industries through industrial policy.

This discussion overlooks the fact that successful industrial policies have rarely been inward-looking and protectionist; instead, they focused on export promotion. An example of this is South Korea. A discussion on which sectors should fall under geostrategic export promotion would move the EU from a defensive to an offensive position. Instead of solely reacting to the US Inflation Reduction Act (IRA) and China, the EU could proactively, and in a forward-looking manner, create dependencies through which the EU can balance power imbalances in trade relations, such as those with China.

For this leverage to be effective, it is crucial that EU exports are existentially important for a partner’s economy. This is not the case for combustion engines, even though Germany would prefer it. However, China, for example, still imports a significant portion of its machinery from the EU, which could be one target. Beyond China, mechanical engineering will also be central to the electrification of global industries as part of decarbonization. With numerous patents and licenses, the EU is well positioned to lead the way.

2. European-wide standards for industrial policy tools

So far, industrial policy instruments have been thought of nationally, creating significant contradictions. If Germany offers climate protection contracts but Spain does not, green steel production may emerge in Germany, even though the availability of green hydrogen is more likely in Spain. This weakens the competitiveness of the entire European market and prevents regions with potential from catching up. The consequences of a lack of harmonisation can already being observed: Nyrstar had to close down production in the Netherlands due to tax benefits ending and high energy prices, while other EU Member States maintained the same benefits. ArcelorMittal made its investment decision dependent on whether subsidy arrangements in Belgium or France are more beneficial. The EU needs harmonised tools, like European-wide standards for tax credits, European-wide phase-outs of fossil fuel subsidies, European carbon contracts for difference or Europe-wide content rules per sector, for industrial policy to work.

3. Aligning industrial policy with cohesion policy

The greatest fear is that industrial policy will tear holes in the fabric of the single market and lead to a divergence of regions.

Two things are of crucial importance here. Firstly, as discussed at length elsewhere, it will be crucial to create opportunities for states with limited fiscal capacity to build industries, so they do not remain stuck in a development trap. This is important because many EU Member states otherwise lack the fiscal space to achieve climate goals, due to the 3% debt limit, without cuts elsewhere – Belgium, Poland, France, Romania, Finland, the Netherlands and Slovakia are examples.

Secondly, the EU needs a coordinated approach to industrial policy to determine which parts of value chains belong in which country. Each country has specific location conditions – whether skilled labour, wage levels, availability and prices of energy, or existing technological base. Based on these conditions, the European Commission, on the proposal of EU Member States, needs to discuss how to designate potential regions for segments of value chains where state aid would be automatically approved.

4. Making public administrations ready for industrial policy

The strategic development of dependencies depends on the ability to anticipate trends and strategically align economic development. The EU’s dependencies on China are the result of long-term planning by China, which gradually developed its industrial landscape until even highly complex goods such as electric vehicles can be produced. This capability requires personnel.

Similarly, coordination of industrial policy requires an administration capable of managing these complexities. The current units in DG GROW are not up to the task. With the last update on economic coordination – the European Semester – Directorates-General like DG ECFIN got entire departments dedicated to painting a full picture of the economic situation of every single EU Member State. Country desks prepare the annual country reports and serve as the interface between EU Member States and the European Commission. A similar approach could be pursued for DG GROW, which could have desks for the respective technologies of the NZIA, where competencies are bundled to advise the Net-Zero Industry Platform.

Thirdly, strong coordination between the involved DGs through a dedicated task force is needed. GROW, COMP, ECFIN, REGIO, ENER, EMPL and CLIMA, especially, should be part of this task force – industrial policy affects competition policy, is embedded in the fiscal policy of EU Member States and their macroeconomics, influences cohesion policy, and requires energy, skilled labour and integration with the EU’s climate goals. Without this coordination, inefficiencies and duplications arise, costing time and money.

Without adequately equipped administrations, governments risk reaching too far and permitting slow processes, leading to promises not being kept – and thus people and businesses being let down. The EU institutions are not a bloated bureaucracy where more personnel could not be considered. As an example: the European Commission accounts for 5% of the EU budget. In Germany, 8% of the budget is allocated to general financial administration alone.

Whatever it takes for an industrial policy worth its name

In 2012, Mario Draghi promised to do ‘whatever it takes’ to preserve the euro and saved the common currency. Twelve years later, the EU needs another Draghi moment to save European industry. EU Member States must boldly address the fundamental questions that will determine whether the EU retains its weight in the revived era of geopolitics and implements a common industrial policy worth its name.