The EU Green Deal and economic competitiveness

Andreas Goldthau
Franz Haniel Professor for Public Policy
Willy Brandt School of Public Policy, University of Erfurt
Germany

Research Group Leader, Energy Transition and the Global South
Institute for Advanced Sustainability Studies
Germany

Nick Sitter
Professor of Political Economy
Department of Law and Governance, BI Norwegian Business School
Norway

Professor of Public Policy
Department of Public Policy, Central European University
Hungary

Towards net-zero
The future is green – at least when it comes to the European Union’s new growth model. By 2030, the world’s second largest economic bloc aims to reduce emissions by 55 percent compared to 1990 levels. By 2050, it is to go carbon neutral, in line with the Paris goal of well-below 2 degrees of global warming.

The EU Green Deal amounts to a historic transition. Never before has a big trading bloc transformed its economic model so deeply and so quickly. The transition from feudalism to industrialized economies took a century and a half, as Europe went from biomass-energy to coal. The transition ahead will move the EU from high-carbon fueled production to low-carbon in less than three decades. This will shift Europe from a growth model built on resource overuse to one aimed at preserving the global ecosystem.

A low-carbon economic model will need to sustain the European welfare. This is essential if it is to maintain the ‘social license to operate’. It involves maintaining industrial-scale production and fostering innovation in strategic sectors, so as to fund social policies and deliver jobs. The EU Green Deal is therefore nothing less than a green industrial policy program, aimed at ensuring global economic competitiveness.

Economic competitiveness and the level playing field
Although the green economy clearly represents a competitive edge in the long run, there will be short- and medium-term costs. Ambitious climate policies entail higher costs for both industry and consumers, at least during a transition period. How these costs are distributed will be hotly contested. Within the EU, winners can be taxed and losers compensated.  However, if dirtier producers outside the EU can be more cost-competitive, companies will face incentives to move production from the EU to countries with lower climate ambitions. This problem is known as carbon leakage.

The danger for the EU is that it gets deindustrialization, but no reduction of greenhouse gas emissions. If the CO2 abated at home simply gets reimported in the shape of manufactured goods produced abroad, the EU Green Deal cannot work. Rather than helping the climate, stringent decarbonization policies may simply lower economic competitiveness and decrease domestic welfare.

The EU solution is to make trade policy conditional: adjusting for carbon content at the border can create a level playing field between goods produced under the EU’s green regime and outside it. The Carbon Border Adjustment Mechanism (CBAM) is set to become operational in 2026, and will target goods produced in countries with laxer climate regimes. It is designed as a levy, and will primarily hit energy intensive (high-carbon) goods such as aluminum, steel or fertilizer that are significantly affected by high carbon prices.

Economic competitiveness of EU trading partners
The case for leveling the playing field by adjusting for carbon at the border is strong. Not only is carbon leakage avoided; a CBAM also present an incentive for EU trading partners to raise their own climate ambition (because they, rather than the EU, will then reap the income from carbon pricing). However, for some third countries, it also raises the specter of decreasing economic competitiveness.

As recent research shows, countries that are highly exposed to a CBAM because of the combination of high levels of trade with the EU and the difficulty of decarbonizing their own energy systems, face very high policy risks (Apergi et al. 2021). A case in point is Ukraine, a country looking for stronger ties with the EU but suffering from an outdated high-carbon energy system. Moreover, countries that lag behind may get stuck in negative feedback loops, where lower economic competitiveness decreases their attractiveness for (clean) investment, which further undermines their ability to catch up (Eicke and Goldthau 2021).

Such dynamics will undermine the EU’s incentive system and its quest for rules-based, liberal international order. Worse still, they may translate into social tension and outright political instability in affected countries. EU trade policy must therefore be complemented by other policy tools.

The need for Green Deal Diplomacy
The key challenge for the EU lies in balancing the domestic imperative of competitiveness and the danger of negative external spillovers. Part of the answer lies in proper (external) economic impact assessment prior to the implementation of CBAM. Another part is complementing the EU Green Deal with Green Deal Diplomacy. So far, the latter is largely an empty shell. One of its key elements should be to support vulnerable economies in their clean transition, to improve both their economic competitiveness and their ability to benefit from trading with the EU. The EU Green Deal must not stop at the border. It must live up to the imperative of a just transition for all – inside and outside the Union. As a leading economic power, the EU can do its share. The best place to start is in its neighborhood and the Eastern Partnership – through financial support, know-how and technological assistance for clean energy.

E-mail: Andreas.goldthau@uni-erfurt.de, nick.sitter@bi.no
Twitter: @goldthau, @SitterNick

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