Green Trade Tensions: Green Industrial Policy Will Drive Decarbonization, but at What Cost to Trade?



Noah Kaufman, Sagatom Saha & Christopher Bataille | Finance & Development, IMF

It would be naive to think that the intersection of trade and climate policies will lessen — and not accelerate — with time.

The resurgent popularity of green industrial policy is a double-edged sword. On one hand, the protectionist provisions in the Inflation Reduction Act (IRA) were critical to the passage of the most significant US investment in climate action ever. Without the IRA’s domestic sourcing and final assembly requirements, President Joe Biden’s pledge of reducing US emissions 50–52 percent by 2030 would be out of reach. On the other hand, the same protectionist provisions have deeply frustrated US trade partners and aggressively bend—if not altogether break—international trade rules under the World Trade Organization (WTO) regarding equal treatment of foreign and domestic suppliers.

The Biden administration is working toward assuaging concerns over the IRA, which caught close US allies by surprise. However, this friction may be only the opening salvo in a decade marked by green trade tensions. It would be naive to think that the intersection of trade and climate policies will lessen—and not accelerate—with time.

The world should embrace the IRA and other green industrial policies, which are substantial, durable actions to meet climate commitments under the Paris Agreement. Still, they come with risk. For their part, the United States and others should establish guardrails to preserve the international trade rules that have underpinned global prosperity since World War II.

Domestic politics, international rules

The US brand of climate action laced with industrial policy is not a one-off. The political incentives that shaped the IRA are not unique to the United States. For many more countries, crafting ambitious climate policy that doesn’t erode key domestic support requires a mix of subsidies, tariffs, and regulations that current trade rules would heavily discourage if not outright disallow. The IRA’s expected pull on global clean energy investment is already encouraging others to follow suit.

For example, the European response—the Green Deal Industrial Plan and the Net-Zero Industry Act (NZIA), the legislation designed to realize the plan—bear a remarkable similarity to the IRA. The NZIA would further loosen state aid rules, the EU regulations regarding allowable domestic subsidies, to cover more types of clean energy projects. The European Union previously relaxed state aid rules at the start of the COVID-19 pandemic and again after Russia invaded Ukraine. The Green Deal Industrial Plan will also feature various funding measures and prioritizes workforce training to prepare European workers for maximum employability in the energy transition.

Importantly, Europe will also provide its own subsidies for domestic manufacturing in the form of a proposed European Sovereignty Fund, which would finance industrial policy initiatives, and an Innovation Fund to finance innovative demonstration projects. The plan emphasizes ambitious domestic manufacturing targets for a broad swath of clean energy technologies, including wind turbines, solar photovoltaic panels, heat pumps, batteries, and electrolyzers.

The European plan reflects reasonable worries among EU countries that their domestic firms will relocate to the North American market to chase the IRA’s generous subsidies. These worries coincide with high energy prices—driven, in part, by Russia’s war in Ukraine—that threaten to shrink major European industrial firms, such as German chemicals giant BASF SE and steelmaker ArcelorMittal. The IRA’s massive pull toward the US market will mean billions in new clean energy investment but could also redirect billions away from the clean manufacturing agenda in Europe and elsewhere, including in emerging markets.

At the same time, a fight over carbon tariffs is looming on the horizon. In December of last year, the EU finalized its carbon border adjustment tariff mechanism (CBAM), which extends the EU carbon price to imported greenhouse-gas-intensive products. As proposed, it will eventually impose tariffs on a broad swath of countries that do not have a domestic carbon price, including the United States and most developing economies. The EU’s CBAM, although designed to comply with existing international trade rules, has already provoked negative responses among policymakers around the world. US proposals to impose tariffs on the carbon embedded in imports, including the Biden administration’s Global Arrangement on Sustainable Steel and Aluminum (GASSA), are sure to elicit fury from the developing world as well, given the lack of comparable fees on domestic producers in the United States. These countries’ call for increased climate financing, including for loss and damage as a result of climate change—which gained momentum at COP27—only further compounds the ire. Developing economies, unable to compete with subsidy packages of their own, may instead limit imports of clean energy technologies and impose export controls on raw materials, and especially on critical minerals, for the political and economic leverage they provide, in an effort to move up the value chain.

The controversies over green subsidies and carbon tariffs could portend even more intractable conflicts at the intersection of climate, trade, and industrial policy throughout the decade. IMF chief Kristalina Georgieva has already cautioned against this trend, urging that green subsidies “be carefully designed to avoid wasteful spending or trade tensions, and to make sure that technology is shared with the developing world.”

If the momentum toward protectionism continues, the United States, the European Union, and others could drift into walled markets in which low-cost clean technologies cannot easily diffuse across borders, making it harder to decarbonize globally. This will be exacerbated by the limited capacity for emerging market economies to compete in a subsidy arms race. A worst-case scenario might involve a deluge of tit-for-tat cases at the WTO and retaliatory tariffs that fragment the global clean technologies market and decelerate climate action.


Bataille (1)


Noah Kaufman is a senior research scholar with the Center on Global Energy Policy at Columbia University’s School of International and Public Affairs, where Sagatom Saha is an adjunct research scholar and Christopher Bataille an adjunct research fellow 

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