The team expects a political agreement to emerge that loosens state aid rules for clean technology and repurposes some 300 billion euros of existing funding lines to help governments with less fiscal firepower compete with the U.S.

Scaled-up subsidies and increasingly protectionist policies add to the risks of higher inflation in the medium term, the authors warn, and the UK could be hurt by the IRA as well as by its structural economic consequences and Europe’s response. On the equity-strategy front, key concerns are how European companies’ competitiveness will be affected and a potential shift in corporate capital allocation into the U.S. But while some sectors could face a net negative from the IRA, the authors see a net positive elsewhere, with individual sectors and stocks explored in the full note.

The EU’s dilemma

The authors describe the EU’s “business model” as promoting free trade, strict competition rules and soft power. But doubts about that model now abound given the economic fallout from the Russia-Ukraine conflict and the need to accelerate Europe’s energy transition. The pain of Europe weaning itself off Russian gas has raised concerns about other critical economic dependencies, while massive subsidies to clean industries in China and the U.S. have created fears of deindustrialization if Europe doesn’t follow a similar course.

EU leaders have discussed how to respond, but the authors suspect that response will prove modest due to the EU’s own complexities, such as balancing between large and small member states and between free-trade promoters and more interventionist governments. There have also been sharp disagreements about how to fund scaled-up support for developing green industries.

In examining the IRA, the authors note that while the IRA’s stated goal is to accelerate the reduction of carbon emissions, it also aims at bringing manufacturing back to the U.S. Most of the foreseen spending is in the form of tax credits, with the majority going to corporations in energy, transport or manufacturing. As the authors note, it’s helpful to differentiate between the IRA’s subsidies and protectionist aspects as two sets of policies serving different goals. How much the IRA accelerates green investments may depend on the extent to which subsidies lead to additive investment at the global level rather than diverting investment to the U.S. from elsewhere.

The EU has criticized these discriminatory provisions as giving U.S. manufacturers an unfair advantage, as well as for going against global trade rules and diverting industrial plants away from Europe. For the EU, the risk is twofold: IRA subsidies may drive key industrial sectors away from the EU when its industrial competitiveness is already suffering; and a U.S. turn to protectionism poses a more fundamental challenge to core tenets of the EU business model. This leaves the EU with an uncomfortable choice, the authors note: stick with its consensus economic principles and risk losing industrial competitiveness, or rethink its economic model, with all the complications that could ensue.

Potential responses

Discussions under way about an EU “Green Deal Industrial Plan” are likely to extend into the spring. The authors think a political agreement is likely in the first half of this year, one that would outline a short-term response. That response is likely to include minor tweaks to the IRA’s implementation (though Washington’s room to do so is limited), looser EU rules governing state aid for clean tech, faster procedures for EU projects, and greater availability of EU funding.

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