By Karsten Neuhoff (DIW Berlin), Mats Engström (European Council on Foreign Relations), Timo Gerres (IIT-Commilias, Madrid), Merve Kucuk (DIW Berlin), Pedro Linares (IIT-Commilias, Madrid), Aleksander Sniegocki (Reform Institute, Warszaw)

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The EU wants to get serious about advancing its net-zero industry: Earlier this year the Commission announced the Green Deal Industrial Plan and the Net-Zero Industry Act with the aim to scale up the EU’s manufacturing of net-zero technologies and products. The Act proposes a simplified regulatory environment, accelerated access to financing, skill development, and tailored trade policies for eight net-zero energy technologies.

While the plan and act are welcome, we argue that more is needed to decarbonize the EU economy and build a strong manufacturing base in Europe. We propose three guiding principles to fill the gaps:

Principle 1. A comprehensive approach to the Greening of European Industry

Two-thirds of industrial emissions are linked to basic material production; therefore, net-zero basic materials and their efficient and circular usage are equally important as the eight net-zero technologies proposed in the Net-Zero Industry Act. Europe should broaden the scope of the Net-Zero industry act to include basic material production and use. For example, according to the European Commission’s Directorate-General for Research and Innovation, the EU has the highest share (32%) of companies worldwide active in circular economy technologies, and can use these to enhance resillience of material supply to the EU economy.

Principle 2. Mobilizing new financial resources by closing the carbon pricing gap

Existing funding for the industry transition is limited and will not be enough to respond to industrial needs. The Industrial Plan recognizes these limitations and includes the possibility of launching a new EU Sovereign Wealth Fund that could provide capital by 2025. The challenge remains how to secure EU-scale refinancing for the Fund.

The recent EU Emission Trading System (ETS) reform as part of the Fit for 55 Package closes two major carbon pricing gaps in Europe by introducing ETS2 for buildings, transport and small industrial installations and committing to phasing out free allocation, replacing it with the CBAM. However, the phase-out of process for free allocation runs at least until 2035, leaving a gap of more than a decade before a full carbon price on producing basic materials is in place. This results both in a lack of EU-scale funding from auction revenue and increased public support needs for near-zero technologies as only a fraction of carbon costs will be reflected in prices of basic materials.

A practical solution to close the carbon pricing gap exists and was already prepared by the Commission in the CBAM context: a charge on basic materials like steel, cement clinker, aluminium or high-value chemicals. It would be passed through to all manufactured products, and hence extended to all domestic and imported industrial products. It would be implemented similarly to an excise charge and levied symmetrically on imports (including manufactured products) and waved on exports of materials and products comprising these materials, ensuring WTO and ASCM compatibility and administrative feasibility.

The charge would raise EU-scale funding of €50 billion annually in 2025 (at an EU ETS price of 75 €/tCO2), then decline in parallel as free allowances are gradually reduced. The distributional effect would be progressive, e.g. cost increase relative to expenditure is 0.4% for poor and 0.5% for rich consumers in 2025 (75 €/tCO2). If linked to the EU ETS carbon price, the charge incentivizes efficient material use and recycling, combining emission reductions with a slight GDP increase. The charge could be implemented as an EU environmental regulation with qualified majority voting.

Closing this last major carbon pricing gap could solve the challenge of raising funds for the EU’s net-zero industry, while providing incentives for consumers.

Principle 3. Robust governance and planning covering both investments and reforms

In recent years, the EU has repeatedly managed to solve a triple problem which also occurs in the case of financing the EU green industry ambitions: 1) unequal financial capacity of the Member States, 2) repeated delays in national-level structural reforms and 3) a lack of willingness by several Member States to launch new EU-wide funding schemes without robust monitoring of their efficiency. This triple problem was tackled by member states jointly agreeing to prepare plans covering investments supported by the funds and complementary reforms, first in the case of National Recovery and Resilience Plans and then with Social Climate Plans.

The same logic can be applied to the new EU sovereignty fund. Mutual agreement by Member States to present a coherent reform agenda which covers 1) developing a green manufacturing base, 2) decarbonizing industrial policies, and 3) more efficient and circular use of materials would close important gaps in the current governance framework.