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Bridging the political divides over industrial strategy

Industrial policy / COMMENTARY
Frederico Mollet

Date: 17/03/2021
The upcoming industrial strategy update needs to reconcile political differences over how the EU should approach strategic autonomy and open supply chains, as well as competition and greater state aid. The update must be open about the trade-offs involved, move past false dichotomies, and commit to distributing the associated costs and benefits fairly.

The Commission launched its Industrial Strategy on 10 March 2020, one day after Italy went into its first national lockdown.  In the year since, the European economy has been wrecked by COVID-19, and industrial investment has plummeted. Pre-existing structural trends, whether it is digitalisation, growing regional inequalities, climate change, or rising foreign competition, have either continued unabated or have been accelerating. On 27 April, the Commission is expected to update its industrial strategy to respond to these disruptions. 

Although the update has to address a range of issues, it risks being hamstrung by member states’ conflicts over fundamental strategic questions. In particular, the EU’s approach to strategic autonomy and open supply chains, and the role of public subsidies and competition, remain deeply contested. There are reports these disagreements have already delayed the update’s publication.

To bridge these divides, the update must be honest about the costs and trade-offs of pursuing strategic autonomy. It must outline mechanisms to mitigate costs where possible and ensure transparent decision-making. It should also commit to distributing these costs fairly, and more generally, it must ensure that companies in large member states are not privileged over those in smaller member states. It can also reconcile some of the conceptual tensions by avoiding the false dichotomy between competition and greater use of state aid.  Doing so may help build political consensus whilst still developing clear principles to guide policy implementation.

Strategic autonomy and open supply chains 

Despite several disruptions, the intricate network of global supply chains proved much more resilient in the face of the pandemic than was initially feared. However, it also brought into plain view the many potential chokepoints in the global production structure. In parallel, the US’s liberal use of trade sanctions against China made it abundantly clear how vulnerable Europe could be if it were ever the target of deliberate interference.  In an age of rising geopolitical tension, this has strengthened the case for greater strategic autonomy in critical sectors.

The potential costs of efforts in that direction are significant, though. European industry benefits substantially from access to low-cost and varied products. Powerful economic forces have, over decades, shaped the current configuration of supply chains, and attempts to restructure them have been met with resistance from the private sector. Many member states are also unlikely to benefit much from any reshoring efforts and fear they will have to shoulder the higher input costs.

Furthermore, there are different policy options to enhance strategic autonomy, and member states disagree on which should be adopted as a first resort. Reshoring is one option; diversifying and strengthening supply chains another, as outlined in the Trade Policy Review. Greater stockpiling and enhancing the circular economy will also play a role.

Mitigating the costs

The optimal course of action will vary on a case-by-case basis, different for every sector or product. But the update could engender political buy-in by committing to a rigorous assessment methodology to select the most cost-effective option. Transparent criteria that incorporate the potential spill-over costs and rigorously justify the benefits of strategic autonomy, applied consistently across member states, may assuage concerns over covert national protectionism. If necessary, the update could also propose to develop cost-sharing mechanisms to address concerns from member state governments and companies alike, who fear they will ultimately pay higher production costs.

Managing these tensions will also be made easier by incorporating mutual interdependence into the Commission’s review. Europe occupies its own key positions in various global supply chains and ecosystems. Analysing individual supply chains in isolation would miss crucial sources of leverage that can mitigate the risks of third-country dependence. Industrial policy can strengthen and develop new high-value sectors that enhance the EU’s global position without abandoning the advantages of open supply chains - the Battery Alliance is a pertinent example. It is no panacea, but it could help align strategic autonomy goals with the broader economic objectives of industrial policy.

State aid and competition   

The second field of tension is state aid and competition. Even before the pandemic, there was a rise in the number of EU policy instruments, such as Important Projects of Common European Interest (IPCEIs) and industrial alliances, and a heated debate over how to reform competition rules. The growth of China’s state capitalist model, which decimated industries like solar through subsidies and economies of scale, was a major factor driving this trend. Europe’s prolonged economic underperformance, combined with the imperatives of the green and digital transitions, convinced many European leaders that greater policy support or even scaled-up ‘national champions’ were needed. The pandemic has exacerbated these issues, with an expected shortfall in private investment of €831 bn over 2021 and 2022, which will have to be made up if the green and digital transitions are to succeed. The EU is not alone - the new US administration has also seen a resurgence of industrial policy, particularly in relation to combating climate change.

However, smaller and less economically advantaged member states are rightly concerned about unfair competition from large, deep-pocketed member states. Further complicating the matter is the state aid rolled out during the pandemic, and the question of how and when measures should be rolled back to preserve the level playing field. 

Avoiding false dichotomies

The update can address these concerns by moving past the false dichotomy between competition and greater state aid. Whilst the latter may be necessary to overcome market failures and scale-up firms, as restrictions begin to ease competition can enhance the effectiveness of subsidies by ensuring they are not wasted on inefficient firms. China is an illustrative example. Despite its reputation for ‘national champions’, its industrial policy often explicitly seeks to foster widespread competition to ensure the most efficient companies are the ones that scale-up. Empirical evidence confirms that appropriately designed subsidy schemes can increase competition and productivity growth, and that the impact of subsidies is greater the more competitive the sector. Of course, unfair subsidies can still distort competition, but the Commission’s proposals to protect the internal market and provide export credits should help address this concern.

There may be areas where the internal market is not large enough to enable economies of scale alongside fierce domestic competition. In that case, state aid should be explicitly linked to exports to maintain competitive discipline. Boeing-Airbus is a de facto example of this principle. The Commission’s proposal to explore export credits could be the mechanism for implementing such a policy.

The update should furthermore commit to ensuring that state aid and EU support is fairly distributed among companies and member states in a way that fosters fair competition. As emergency support tapers off, member states will have varying levels of fiscal resources available to support firms through the recovery, distorting the level playing field. Measures that further ‘Europeanise’ state aid, such as the proposed expansion of member states in IPCEIs, will reduce these distortions without completely cutting off badly needed support. The proposed new instrument for Multi-Country Projects should also incorporate these principles in its design. There may still be a case for reforming certain aspects of competition policy, but industrial policies should be designed to promote competition in targeted sectors nonetheless.

In the face of extensive challenges, Europe needs an assertive industrial strategy. The update cannot settle for the lowest common denominator. Nevertheless, the suggestions outlined here may help reconcile some of the central tensions: by honestly accounting for the costs of strategic autonomy and finding ways to mitigate or share the burden; by aligning, wherever possible, the goals of strategic autonomy with economic value; and by ensuring that the design of industrial policy promotes healthy competition and benefits all member states equally.

Frederico Mollet is a Policy Analyst in the Europe’s Political Economy programme.

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