A Conversation With Hosuk Lee-Makiyama
EU-US Tensions, Industrial Policy, Inflation Reduction Act
Hosuk Lee-Makiyama is the director of the European Centre for International Political Economy (ECIPE). He regularly writes on trade, the digital economy, EU-East Asia relations, and intellectual property. We talked to him to understand what the current tensions between the EU and the US mean for the future of the transatlantic partnership, and the role they could play in pushing the European economy on uncharted paths.
The Inflation Reduction Act was signed into law by President Biden on August 16, 2022. Almost six months later, it remains a focal point of criticisms for European politicians, who complain that it will unfairly penalize domestic industry. Are European leaders right to fear the IRA as a major economic risk? What European interests are at stake?
The IRA signals that the US has practically abandoned the WTO rulebook as the US Congress didn’t even bother to consult its trade negotiators to ensure compatibility with WTO rules.
Meanwhile, the conflict on batteries and vehicles is something that can be sorted out. Only seven foreign firms are affected by these subsidies, and serendipitously, they all manufacture electrical vehicles in the United States. While solutions may not be found through government-to-government talks, direct negotiation between the executive branch and the business can negotiate a waiver. Foreign manufacturers will easily lean on state governments and say ‘Look, we want to continue producing cars in your state and If you want to save those jobs, you’ll call Department of Transport right now on behalf of your workers.’
Instead, the key concern with the IRA is the subsidies for hydrogen deployment, which may create an entirely new economic reality. Energy costs matters in manufacturing and two-sided federal subsidies for both production and purchase of US-produced hydrogen will bring attract investments and create a cost-advantage for US industry in a time when EU industries is facing huge price hike in energy prices. Even the LNG (liquified natural gas) the EU buys from the US comes at a significant markup.
The IRA has led to a push within Europe for reviving industrial policy, which could include far-reaching change, such as relaxed state aid rules. At first glance, the debate seems familiar, with France championing reform and Northern European states defending single market principles. Have economic and political conditions changed enough to justify re-assessing the possibility of industrial policy?
I prefer to speak in concrete terms rather than in the abstract. Industrial policy means governments spending money to seed industries, supporting specific actors or restructuring industries by paying people to leave. The EU does not do that. We subsidise regions, or industry-wide R&D. But our subsidies don’t pick winners and are non-discriminatory.
Grossly simplified, a EU-level direct support could entail Danish taxpayer money being spent to support a French company to eliminate Danish competition. Very few Danish taxpayers would agree to that, or vice-versa. The EU — based on the least common denominator — is not prone to undertaking such policies.
It makes sense that we engage in industrial policy primarily on national, rather than EU-level. Therefore relaxation of the state aid rules is what is actually on the table, rather than a full-fledged EU-wide industrial policy. However, a EU sovereign wealth fund could break away from such inhibitions.
Is it something that you would look forward to?
Subsidised companies tend to lose competitiveness, simply because they don’t have to compete. In this case, it is easy to fall into a vicious circle of state aid leading to demands for protection, leading to less competitiveness, leading to a withdrawal from international markets.
If we look at previous eras of state activism, we see that they are rarely effective except in industries where there are very high upfront fixed costs. Market interventions are rarely short-term: For example, many of the short-term measures from the first 1973 oil shock are still with us to this day, creating new market failures. It’s a little adopting a puppy. Once the government begins to feed industries, it’s stuck with them for life. And I say that as a dog owner.
The European Commission’s three executive VPs – Dombrovskis, Timmermans, Vestager – penned an op-ed in the FT on 26 January where they warn about the risks of a subsidies race. They caution against the risk of “self-harm” that a “tit-for-tat” reaction could bring about. They suggest that reforms, improvements in training, and deepening of the capital markets union are a better path forward. What do you think of this position?
They correctly point to long-term solutions we need to have in place – with or without the IRA, or rising energy prices. Why doesn’t Europe have any unicorns? Because we don’t have a functioning capital market.
To begin with, the industrial funding in EU comes mainly through the banking system and arm’s length financing. Banks and financial institutions retain control of our industries. This is a stark contrast to the US where there is better access to, and a diversity of capital for private sector investments that no public institution or no government in the world could ever beat. The US can allocate massive amounts of private capital into risky projects that start out in a garage and end up dominating the world.
Whether we’re looking at capital or product markets, Europe is well regulated. Unfortunately, it also means we have eliminated market risks. Without risks, there are no returns on capital. Moreover, if banks are forbidden to take risks, then future innovations cannot get off the ground. With no reward for risk takers, there is no innovation in life sciences or IT. I’m hardly a neoliberal, but there is a downside to the perfectly safe and risk-averse capitalism.
Another EU response to the IRA also emphasise upskilling of the European labour force. The productivity gap between the US and Europe is explained by better IT training in the US. An average US worker produces 10% more than the European because the US worker is better trained for a digitized work environment, and this has been the case since the 1990s.
These are just two long-term structural problems that the EU suffers from.
How do you explain the persistence of conflict over trade and industrial policy between the EU and the US, two years after the end of the Trump Presidency, and even as both sides are cooperating closely on Ukraine? Is there a structural divergence of interests?
It depends what you mean by “structural divergence.” Pundits often simplify the transatlantic relationship into some superhero cartoon. It is not an alliance of western democracies against the bad guys: it is also about national interest. The transatlantic partnership may be the closest aligned relationship in the world, but it doesn’t change the fact that we are also our worst commercial rivals. We compete in same products and services, at the same level of economic development. As we are the most diversified economies in the world, we compete in more sectors than, say, with China.
From the perspective of Washington, Europe is a much more dangerous adversary than China because of our normative power that legitimizes protectionist policies which can go against US interests around the world. What the EU does in the area of agricultural or digital policy is often used as a pretext by other countries to impose similar policies, often in much cruder and protectionist ways.
While it goes without saying that this relationship has never been easy, we have always agreed on the rules of engagement, the terms of that competition. Here is where a new structural divergence emerges as the US and China begin to diverge, as they don’t even pretend to adhere to WTO rules.
With Europe seemingly more dependent than ever on America for her security, what space exists for articulating distinct foreign and trade policies, especially in relation to China? For instance, when it comes to US trade restrictions with China, Washington has been accused of treating European companies more harshly than American ones, as in the case of ASML. What are Europe’s options here?
There is no easy answer to the question, I don’t think there is a general playbook we should follow. I’m definitely not saying that we must always follow the US, or always do business with China; or even that the third way somewhere in between is always the right approach. It is a case-by-case decision.
Europe is far more sensitive to emerging economies entering international markets. On one hand, if you look at what Europe is good at – we export cars, chemicals, textiles, machineries – essentially a cluster of light manufacturing that are typically items that developing countries begin their journey to industrialisation. Japan, Korea and the Asian Tigers entered these sectors, followed by China. We are always overexposed to price competition from developing countries.
On the other hand, the fact that we have never graduated from the export-led growth in items like machinery poses some level of strategic risk, since we become overly dependent on demand from emerging markets.
Are you saying that Europe has missed the tech and high-end electronics revolution?
Not necessarily. Looking at the evolution of the US and Japan, we see that these two countries have moved from export-led economies to investment-driven internationalisation. In the case of Japan, it was partly due to demographics and higher wages — Japan had to invest in other countries. To keep on making electronics, they had to build factories in ASEAN and China. Now, countries move up the value chain so fast that you can’t even have these factories in China anymore. In the same way, the US economy is extremely investment-driven rather than trade-driven. That graduation towards an investment-led internationalization has never fully happened in Europe.
What should Europeans understand about the younger generation of American policymakers? In what key areas do their beliefs differ from what Europeans expect or wish?
The current generation in both the US and Europe have a lot of energy and idealism — which is really admirable. But there is always a risk of going down paths we have tried before, or to make mistakes we already paid a hefty price for. There is a good reason why the history of the western world may not repeat itself, but it certainly rhymes.
If you look at transatlantic relations, or western diplomacy with the Indo-Pacific, there is an oversimplification that is outright dangerous. Young cadres in the Biden administration is beginning to understand that solely promoting its self-interest is contrary to alliance-building; that transatlanticism is a beast of its own.
Similarly, young European romantics deem Europe to be superior, and that the EU model for international cooperation is superior. In many ways it is – but the EU way is not the only way for global governance. Of course, our jobs would be easier if we could teach Americans or Asians to think like the EU does. But that’s a futile endeavor.
This interview was conducted by Maxence de la Rochère. We want to thank Hosuk Lee-Makiyama for his time.