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1. Section 232 reloaded: the false promise of the transatlantic ‘climate club’ for steel and aluminium

Author:
David Kleimann
Publication Date:
07-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
In using the removal of Section 232 ‘national security’ tariffs on steel and aluminium imports as a bargaining chip, the United States demands that the European Union engage in negotiations on “global steel and aluminium arrangements to restore market-oriented conditions and address carbon intensity”. The US demand has reportedly been inspired by a blueprint that would establish an international institutional arrangement – labelled a ‘climate club’ – which would externalise market-access restrictions afforded by US Section 232 tariffs to the customs borders of club members. While the declared objective is to incentivise non-members to adopt low-carbon steel (and aluminium) production methods the US blueprint suffers from various design flaws including inefficient incentives, WTO inconsistency and incompatibility with the EU Carbon Border Adjustment Mechanism. The effectiveness of the proposed US scheme is severely compromised by the plethora of policy objectives it pursues, which go far beyond the goal of incentivising industrial decarbonisation in third countries, including secondary (ie protectionism) and tertiary (ie global power competition with China) objectives. The initial negotiation proposal submitted by the United States Trade Representative (USTR) to European Commission trade negotiators incorporates many if not all the problematic elements of this blueprint, setting the US on a collision course with the negotiation proposal put forward by the European Commission. This paper concludes that the adoption of the scheme proposed by USTR would result in a step backwards for international climate and trade cooperation, whereas not adopting the EU proposal would make for a missed opportunity. Given the sharply diverging negotiation positions and associated respective domestic constraints on both sides, however, policymakers should start to engage stakeholders now to manage expectations towards a low-ambition negotiation result, if any.
Topic:
Security, Climate Change, Industrial Policy, Governance, European Union, Economy, Trade Policy, and Transatlantic Relations
Political Geography:
Global Focus

2. What should be done about Google’s quasi-monopoly in search? Mandatory data sharing versus AI-driven technological competition

Author:
Bertin Martens
Publication Date:
07-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The first part of this paper focuses on competition between search engines that match user queries with webpages. User welfare, as measured by click-through rates on top-ranked pages, increases when network effects attract more users and generate economies of scale in data aggregation. However, network effects trigger welfare concerns when a search engine reaches a dominant market position. The EU Digital Markets Act (DMA) imposes asymmetric data sharing obligations on very large search engines to facilitate competition from smaller competitors. We conclude from the available empirical literature on search-engine efficiency that asymmetric data sharing may increase competition but may also reduce scale and user welfare, depending on the slope of the search-data learning curve. We propose policy recommendations to reduce tension between competition and welfare, including (a) symmetric data sharing between all search engines irrespective of size, and (b) facilitate user real-time search history and profile-data portability to competing search engines. The second part of the paper focuses on the impact of recent generative AI models, such as Large Language Models (LLMs), chatbots and answer engines, on competition in search markets. LLMs are pre-trained on very large text datasets, prior to usage. They do not depend on user-driven network effects. That avoids winner-takes-all markets. However, high fixed algorithmic learning costs and input markets bottlenecks (webpage indexes, copyright-protected data and hyperscale cloud infrastructure) make entry more difficult. LLMs produce semantic responses (rather than web pages) in response to a query. That reduces cognitive processing costs for users but may also increase ex-post uncertainty about the quality of the output. User responses to this trade-off will determine the degree of substitution or complementarity between search and chatbots. We conclude that, under certain conditions, a competitive chatbot markets could crowd out a monopolistic search engine market and may make DMA-style regulatory intervention in search engines redundant.
Topic:
Science and Technology, Governance, European Union, Digital Economy, Innovation, Artificial Intelligence, and Competition
Political Geography:
Europe

3. What would Europeans want a European defence union to look like?

Author:
Francesco Nicoli, Brian Burgoon, and David Van der Duin
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
While the Russian invasion of Ukraine has created a new momentum for EU defence integration, the political feasibility of such integration remains disputed, as it may entail both additional financial costs and a loss of sovereignty. Furthermore, design of defence integration is inherently multidimensional, differing in terms of scope and level, governance and sources of financing, among other dimensions. To determine the extent of public support for European security cooperation, we conducted the first conjoint experiment ever fielded on public support for alternative defence union designs. We carried out a pre-registered, randomised conjoint experiment on a highly representative sample of the French, German, Italian, Dutch and Spanish populations in November 2022. This multidimensional conjoint experiment allows us to determine the causal link between policy features of potential defence pacts, and public support or opposition to such policy. Our results show that policy packages receiving the most support require joint EU-level governance, joint purchases of military equipment through joint procurement, and repurposing of existing national expenditure as the preferred form of financing. All in all, our results show not only that there is considerable cross-border support for defence integration in Western Europe, but also that citizens in different Western European countries have generally aligned preferences regarding the actual design of such policy, indicating that a compromise policy is feasible and publicly supported. Furthermore, our results support ongoing research on the nature of European solidarity at times of crisis, suggesting that European citizens are willing to support the creation of joint institutions and policies to face issues of common concern, and therefore indicating that major crises open important windows of opportunity to re-shape EU-level policies and institutions.
Topic:
Defense Policy, Governance, European Union, and Regional Security
Political Geography:
Europe

4. China’s quest for innovation: progress and bottlenecks

Author:
Alicia Garcia-Herrero and Robin Schindowski
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
As the Chinese economy continues to decelerate, the central government is investing heavily in innovation, doubling down on research and development (R&D) spending and STEM-oriented human capital. In this paper, we assess China’s progress so far, looking at the inputs to innovation (R&D and human capital) as well as intermediate targets, such as scientific research and patents. We then evaluate how China has fared with respect to the ultimate goal of commercialising this progress, by looking at the value-added of Chinese exports and the overall productivity of the economy. We identify three potential bottlenecks that might be hindering the translation of China’s innovation efforts into productivity growth.
Topic:
Industrial Policy, European Union, Economic Growth, Innovation, and COVID-19
Political Geography:
China, Europe, and Asia

5. Antitrust issues raised by answer engines

Author:
Christophe Carugati
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Rapid development of generative artificial intelligence chatbots like ChatGPT is leading search engine providers to move from search to answer engines. Unlike search engines, which provide search results in the form of blue links to content creators, answer engines generate personalised answers through a conversation with end users. This revolution impacts the internet ecosystem of content creators and the digital advertising market. This paper outlines some early antitrust issues related to answer engines, from the transition from search to answer engines (sections 2 and 3) and the response competition authorities should adopt (section 4). It finds that search and answer engines complement and compete with each other. While the answer-engine market is still at an early stage of development, it already raises some competition issues in relation to data scraping, vertical integration and unfair terms and conditions. Intervention by competition authorities is more likely than not to prevent market power in this new market. In this regard, competition authorities should act to preserve dynamic competition and minimise adverse effects on content creators. Finally, the paper concludes with several research questions for future research (section 5).
Topic:
Science and Technology, Governance, European Union, Digital Economy, Innovation, Artificial Intelligence, and Competition
Political Geography:
Europe

6. A new measure of aggregate trade restrictions: cyclical drivers and macro effects

Author:
Julia Estefania-Flores, Davide Furceri, Swarnali A. Hannan, Jonathan Ostry, and Andrew K. Rose
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
This paper presents a new measure of aggregate trade restrictions (MATR) using data from the International Monetary Fund’s Annual Report on Exchange Arrangements and Exchange Restrictions. MATR is strongly correlated with existing measures of trade restrictiveness but is more comprehensive in terms of country and time coverage. It is available for an unbalanced sample of up to 157 countries during 1949-2019. We use MATR to re-examine how trade restrictiveness varies with the business cycle, and how the macroeconomy looks in the aftermath of changes in trade restrictiveness. For the sample as a whole, MATR is typically a-cyclical but this average finding is heterogeneous across income groups: aggregate trade restrictions are a-cyclical in advanced economies but are counter-cyclical in emerging market and developing economies, especially in response to increases in unemployment. As to macroeconomic effects, increases in MATR are robustly associated with declines in GDP and in labour productivity (as well as being adverse for a range of other macroeconomic indicators).
Topic:
Industrial Policy, Economy, Multilateralism, and Trade Policy
Political Geography:
Global Focus

7. Employer perspectives on employee work location: collaboration, culture and control

Author:
Diane Mulcahy and Tatiana Andreeva
Publication Date:
05-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
This paper discusses employers’ experience of working fully remotely during the pandemic, and their approaches to returning to the office following the pandemic. We chose to focus on the point of view of the employer since it is relatively less explored; much more is available and written on the views and opinions of employees about remote work and return to office. To understand the employer’s perspective, we reviewed existing research evidence, and carried out eleven structured interviews with corporate leaders about their experiences with remote, in-office and hybrid work. Our literature review suggests that remote work does not have negative effects on performance. Similarly, the small sample of employers we interviewed experienced very strong company and employee performance while operating their businesses fully remotely. All employers we interviewed are implementing a hybrid return-to-office policy, although the specifics of the policies are different for each company. No employer was returning to full in-office work. We focused our literature review and interviews on the impact of remote work on employee collaboration, firm culture and manager control, which we call ‘the 3 Cs’. We found that leaders maintain a belief that employee collaboration is negatively impacted by remote work, but the evidence to support this assumption is mixed. Firm culture is often cited by employers as an important rationale for bringing employees back to the office, but the research evidence and our interviewees suggest that the notion of culture is vague and the idea that better culture is supported by in-office work is not supported by any data. Finally, the shift to remote work caused corporate leaders and front-line managers to worry about effectively managing employees they couldn’t see every day. We found that companies did not widely begin implementing employee monitoring systems in lieu of onsite management. Our interviews suggest that much learning remains to transition managers and leaders to effectively managing remote or hybrid employees and teams.
Topic:
Science and Technology, Employment, Innovation, Labor Market, and Remote Work
Political Geography:
Global Focus

8. Global trends in countries‘ perceptions of the Belt and Road Initiative

Author:
Alicia Garcia-Herrero and Robin Schindowski
Publication Date:
04-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Drawing on global media reports, we conduct a sentiment analysis of the image of China’s Belt and Road Initiative (BRI) and the evolution of its image over time. Our main finding is that perceptions of the initiative deteriorated significantly in many geographies from 2017 to 2022. The notable exception is in sub-Saharan Africa where the BRI’s image remains positive, even if slightly less so than in the past. This is notwithstanding increases in debt levels with China, much of which now face potential restructuring. Furthermore, we find significant inter- and intra-regional differences in the average sentiment towards China’s landmark project, as well as a much worse image of the initiative in countries which, until today, are not part of the BRI. Finally, we focus on the European Union, Africa and China’s immediate neighbourhood to better understand the complexities behind the perceived benefits and challenges associated with China’s Belt and Road Initiative.
Topic:
Bilateral Relations, European Union, Geopolitics, Economy, and Trade
Political Geography:
China, Europe, and Asia

9. Artificial intelligence adoption in the public sector: a case study

Author:
Laura Nurski
Publication Date:
03-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
This case study illustrates the drivers of and barriers to artificial intelligence adoption by organisations, and acceptance of AI by workers in the public sector. Several factors were crucial in the successful adoption of a human-centred approach to AI, including a fast discovery phase that involved workers (or end users) in the development early on, and aligning human resources, information technology and business processes. Subsidy support mechanisms were also specifically targeted and acquired to support the adoption. However, making AI support available to workers proved insufficient to ensure its widespread usage throughout the organisation. The slow adaptation of existing work processes and legacy IT systems was a barrier to the optimal usage of the technology. Moreover, the usefulness of the technology depended on both the task routineness and worker experience, thereby necessitating a rethinking of the work division between technology and workers, and between junior and senior workers. Successful human-centred roll-out of AI in Europe will therefore depend on the availability of, or investments in, complementary intangible organisational capital. Very little is currently known about these investments.
Topic:
Digital Economy, Economic Growth, Public Sector, Innovation, Artificial Intelligence, Inclusion, and Work
Political Geography:
Global Focus

10. The hidden inequalities of digitalisation in the post-pandemic context

Author:
Cristiano Cadagnone and Maria Savona
Publication Date:
01-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Digitalisation has a ‘hidden’ impact on employment, particularly on the invisible conditions of some jobs, as perceived by workers, that are relatively less explored in the literature and that could represent a substantial social cost, particularly in the aftermath of the financial crisis and the COVID-19 pandemic. We start by summarising a few main challenges of digitalisation, with a focus on the additional challenges brought about by the pandemic, the rise of platforms and alternative work arrangements, and the current attempts to regulate these. We then discuss the hidden aspects of inequality linked to the unmeasured side effects of digitalisation. Mental health in particular should be taken into account, particularly in the post-pandemic context, which has led to a significant amount of working from home. Also, the reduction of tasks previously done in the workplace in favour of remote working might limit social interactions, creativity and innovation potential. We conclude by suggesting areas for policy interventions.
Topic:
Labor Issues, Economy, Automation, and COVID-19
Political Geography:
Europe and Global Focus

11. Pro- and anti-competitive provisions in the proposed European Union Data Act

Author:
Bertin Martens
Publication Date:
01-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The proposed European Union Data Act gives users access and portability rights to the data generated by their use of tangible digital products and devices. This pro-competitive measure weakens the de-facto monopolistic control product manufacturers have over product data. However, the Data Act would also grant manufacturers a de-jure right to monopolistic pricing of data transfers to third-party service providers, restoring their control over data markets. Other anti-competitive provisions include restrictions on the use of data for competition purposes and a prohibition on transfering data to platforms identified as gatekeepers under the EU Digital Markets Act. Unnecessarily fuzzy definitions of products and data that fall under the Data Act would create uncertainty in implementation and incoherence with other EU data regulations. The Data Act should be simplified by dropping anti-competitive provisions and granting users and third-parties selected by users free access to all data generated by the use of a product or a service. This would increase competition in data-driven services and prevent users paying twice for their data. It would not disincentivise producers from investing in data-driven products and services. A further step could be the creation of a level playing field between producers and users in data-access rights. This can be achieved by introducing the principle of mutual exhaustion of data rights at point of sale. This would put all data co-generating parties in a position to generate economies of scale and scope in data aggregation, or data-driven externalities, to maximise innovation.
Topic:
Markets, Governance, European Union, and Digital Economy
Political Geography:
Europe

12. The EU can manage without Russian liquified natural gas

Author:
Ben McWilliams, Giovanni Sgaravatti, Simone Tagliapietra, and Georg Zachmann
Publication Date:
06-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The European Union has committed to eliminate all Russian fossil-fuel imports by 2027. Progress has been made, with sanctions on oil and coal already introduced. The glaring exception is natural gas, on which the EU has so far refrained from imposing limitations, owing to greater dependence on Russia. Nevertheless, pipeline gas imports have fallen by four-fifths following Russia’s weaponisation of gas supplies. However, Russia’s exports of liquified natural gas (LNG) to the EU have increased since the invasion of Ukraine. The EU needs a coherent strategy for these LNG imports. Our analysis shows that the EU can manage without Russian LNG. Anticipated impacts are not comparable to those felt in 2022 as Russian pipeline gas dried up. The regional impact would be most significant for the Iberian Peninsula, which has the highest share of Russian LNG in total gas supply. Meanwhile, the global LNG market is tight, and we anticipate that Russia would find new buyers for cargos that no longer enter Europe. We discuss the options available to the EU. Wait-and-see implies delaying any action until 2027, while soft sanctions would discourage additional purchases but not break long-term contracts. We argue instead for an EU embargo on Russian LNG, to reduce exposure to an unreliable and adversarial entity, and to limit the extent to which EU consumers fund the Russian state. The embargo may be designed to allow purchases only if they are coordinated via the EU’s Energy Platform, with limited volumes and below market prices. This could be accompanied by the implementation of a price cap on Russian LNG cargos that use EU or G7 trans-shipment, insurance or shipping services.
Topic:
European Union, Gas, Energy, and Green Economy
Political Geography:
Russia and Europe

13. Rebooting the European Union’s Net Zero Industry Act

Author:
Simone Tagliapietra, Reinhilde Veugelers, and Jeromin Zettelmeyer
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
In March 2023, the European Commission published a legislative proposal for an EU response to the US Inflation Reduction Act: the Net Zero Industry Act (NZIA). It is an unconvincing policy proposal, both for what is in it and for what is not in it. The proposal has five problematic aspects. First, it takes a top-down approach, in which specific technologies are selected for preferential treatment. Preferable would be a technology-neutral approach open to all current and future technologies that help tackle the net-zero challenge. Second, its blanket 40 percent self-sufficiency benchmark for EU domestic cleantech manufacturing by 2030 sends a protectionist signal, is poorly defined and does not reflect the differences in EU capacity in the cleantech sector. Third, it relies on the acceleration of permitting procedures as the main policy instrument, although this is not the main obstacle to cleantech investment in the EU. Fourth, it proposes more strategic use of public procurement. While this is an objective to be supported, the specific proposals are likely to be ineffective because of the way they are designed. Fifth and not least, the NZIA would lack a governance structure that would ensure effective implementation. In addition, the NZIA does not tackle three critical issues. It does not address investment obstacles related to failures of the single market. It does not tackle the coordination problem at the core of developing an EU green industrial policy. Finally, it does not develop an EU-level funding strategy, but rather relies on state aid, with the related risk of fragmentation. The European Parliament and EU countries in the Council of the EU should reboot the proposal and refocus its objectives, sharpening its limited instruments, improving its governance, and adding financial incentives to ensure implementation. In parallel, the EU should develop a broader green industrial policy strategy that leverages the single market in a credible manner, building a solid new governance framework and a new EU-level funding approach.
Topic:
Climate Change, Industrial Policy, Governance, European Union, Trade Policy, and Industry
Political Geography:
Europe

14. Can Chinese growth defy gravity?

Author:
Alicia Garcia-Herrero
Publication Date:
06-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
Chinese growth, astounding since the beginning of the reform era, has slowed in the last decade. We offer a baseline estimate (based on the current trend) of China’s medium-term growth rate, which we project to fall to 2.4 percent by 2035. Several factors create uncertainty around this baseline. China’s rapid aging is already incorporated into our long-term growth scenario, but its impact on growth will depend on how China’s remaining urbanisation process spreads over time, how the shrinking labour supply affects labour productivity and whether the decline in total factor productivity growth, reflecting the lack of reform during the last decade and possibly the rising role of the state, can be reversed. Investment in China, for decades the largest factor in China’s growth, is expected to contribute less to growth given the increasingly low return on assets, particularly on state-led investment. The rapid piling up of public debt is also becoming a heavy burden for the Chinese economy. Finally, the COVID-19 pandemic may have left significant scarring effects, such as structurally high youth unemployment and low investment confidence. On the upside for China, the rise in human capital and research and development expenditure may support innovation and growth, but the magnitude of this effect is uncertain, because it is unclear if higher innovation will translate into higher total factor productivity, and because of the United States’s push to contain China technologically.
Topic:
Industrial Policy, European Union, Economic Growth, and COVID-19
Political Geography:
China, Europe, and Asia

15. The value added of central bank digital currencies: a view from the euro area

Author:
Maria Demertzis and Catarina Martins
Publication Date:
06-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Different jurisdictions have set out different reasons for creating central bank digital currencies (CBDCs). Some countries, particularly those with already-operational CBDCs for retail purposes, aim to to promote financial inclusion. But in countries where most citizens have access to financial services, central banks are interested in CBDCs as an aspect of the increasing digitalisation of finance. Central banks could also choose to use CBDCs to guarantee in full citizen’s holdings (currently, deposits in commercial bank are only partially guaranteed), but this would trigger major changes in the financial system in terms of the role of commercial banks in intermediation and the role of fiat money. So far, central banks have not opted to go this way. In the euro area, consumers have multiple payment options and a very efficient retail payments system. The currency enjoys high levels of trust and is not challenged by the emergence of private currencies, such as Bitcoin, or by the risk that cash, a monetary system’s anchor, will disappear. Therefore, creating a CBDC for retail purposes in the euro area offers little obvious value added, at least for the foreseeable future. However, there is a strong case for building a CBDC that banks could use for cross-border wholesale purposes (ie with other currencies). Wholesale CBDCs could revolutionise the way that cross-border, cross-currency payments are made for two reasons. Cross-border payments are currently slow and inefficient. Pilot projects have shown that wholesale payments with CBDCs can generate substantial time and cost savings. Any two central banks that have operational wholesale CBDCs could settle transactions between themselves. This would be very different from the current system, as most settlements today are done via the dollar (and then the euro) infrastructure and use correspondent banks. The euro area and the United States would have to consider carefully from a geopolitical perspective how wholesale CBDCs might affect their global economic standing. By developing a CBDC for wholesale purposes, the European Union would be able to contribute to developing the global standard.
Topic:
Monetary Policy, Governance, Regulation, Central Bank, Digital Currency, and Euro
Political Geography:
Europe

16. The rising cost of European Union borrowing and what to do about it

Author:
Gregory Claeys and Conor McCaffrey
Publication Date:
05-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Debt issuance by the European Commission on behalf of the European Union has increased massively. Of the approximately €400 billion in outstanding EU debt as of May 2023, 85 percent has arisen from borrowing since 2020. Large-scale borrowing is expected to continue until 2026 to fund the remainder of NextGenerationEU, and concessional loans to support Ukraine. When these programmes were launched, interest rates were at historic lows – even negative for maturities below 10 years. However, interest rates rose sharply in 2022. Beyond the widespread rise in euro-denominated interest rates due to monetary tightening by the European Central Bank in response to the inflation surge, the EU has also faced a widening of the spread between its yields and those of major European issuers, including France and Germany. This widening is driven by a combination of market features, circumstantial factors and institutional features. The EU cannot affect the overall cyclical movement of interest rates and will have to learn to live with it, like sovereigns do. However, the European Commission should continue to try to narrow the spread with major European sovereigns by further developing the relevant market infrastructure and improving its issuance strategy. The Commission will not be able to do this alone. Institutional developments, including progress on the development of new own resources and a long-term substantial presence in the bond market, will be necessary to fully reap the benefits of EU borrowing. A large share of EU borrowing (around €421 billion in total by the end of 2026, in current prices) is intended to finance unprecedented non-repayable support: Recovery and Resilience Fund grants and additional funding for existing EU programmes under the EU budget. The interest costs associated with this part of the debt lie with the EU budget. Our estimates suggest that, because of the high current and expected levels of interest rates, this cost could be twice as high as what was initially estimated at the start of the EU’s 2021-27 budget cycle. As a result, because interest costs for the borrowing of the non-repayable support are accounted for under the EU budget’s ‘expenditure ceiling’, this will exert further pressure on the funding of important EU programmes, which are already affected by inflation. The EU should thus quickly review how interest costs are accounted for in its budget and financial framework.
Topic:
Debt, Budget, European Union, and European Commission
Political Geography:
Europe

17. Adjusting to the energy shock: the right policies for European industry

Author:
Giovanni Sgaravatti, Simone Tagliapietra, and Georg Zachmann
Publication Date:
05-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
In 2022, overall European Union industrial employment and output increased above 2021 levels, despite rocketing energy prices. However, output declined from energy-intensive industries including basic metals, chemicals, non-metallic minerals and paper, for which energy costs represent a much bigger share of production costs than for less energy-intensive manufacturing. Energy prices are likely to remain above historic levels for the foreseeable future. In its industrial strategy response to this context, the EU must ask first whether the energy-intensive parts of the value chain should be outsourced permanently. Conditional on the answer being no, the second question is how to reduce energy prices to ensure the competitiveness of the energy-intensive productions stages that remain in the EU. First, the EU could bridge the high energy price period with unconditional subsidies, which seems to be the preferred strategy currently. This will avoid irreversible large-scale relocation abroad but is expensive, does not help to drive down energy prices and poses risks of fragmentation within the EU. It will only succeed if internationally competitive energy supplies are made available quickly. Second, the EU could support decarbonised production processes built on large-scale deployment of domestic renewables, grid interconnectors and storage. This would accelerate the green transition and reduce clean-tech prices worldwide. However, EU taxpayers would bear the cost of new technologies, without any guarantee of solving the current cost-competitiveness issue. Third, the EU could facilitate imports of energy-intensive products, while helping EU industry move to higher value-added parts of the value chain. Subsidies could be given directly to industrial sectors that have not become structurally uncompetitive, while bringing down energy demand and thus energy prices. However, this strategy would result in temporarily higher unemployment and factory closures in energy-intensive industries, would need to accommodate concerns over excessive reliance on imports and would need to be engineered to address carbon leakage. Policymakers should implement a mix of these policies. The EU should subsidise existing energy-intensive industries only in clearly justified cases, while deciding which energy-intensive products can be left to international market forces. By choosing which decarbonisation investments should be supported in Europe, the EU can combine industrial competitiveness and environmental sustainability.
Topic:
Industrial Policy, European Union, Value Chains, Energy, and Green Economy
Political Geography:
Europe

18. The longer-term fiscal challenges facing the European Union

Author:
Jeromin Zettelmeyer, Gregory Claeys, Zsolt Darvas, Lennard Welslau, and Stavros Zenios
Publication Date:
04-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The pandemic and subsequent price shocks triggered by Russia’s invasion of Ukraine, have increased longer-term fiscal pressures in the European Union through higher debt, higher expected real interest rates and higher public investment needs. This Policy Brief makes some simple quantitative assessments of those effects and discusses policy implications, with the following results. First, long-term increases in primary fiscal balances required to offset higher debt and higher expected real interest rates are in the range of 0.5 percent to 1.5 percent of GDP for most EU countries. However, because of pre-existing differences in fiscal space, not all countries will need to undertake that adjustment, while some countries may need to adjust by substantially more. Among the 21 EU countries for which we have data to undertake this analysis, 14 will need to adjust by more than they were planning to do by 2025. Second, the required additional fiscal adjustment looks manageable, although it is substantial in some cases. To achieve medium-term debt-reducing primary balances, several EU countries will need to raise primary balances by more than 2 percent of GDP above their 2025 target, but no country will need additional fiscal adjustment of more than 3 percent of GDP. Third, market data suggests that the future path of real interest rates is very uncertain. Compared to the period immediately preceding the pandemic, longer-term expected real interest rates have increased by about 2 percentage points but remain low on average, at about 1 percent in real terms. Future developments depend on whether the structural factors that led to low interest rates in the first place persist or unwind. While interest rates might decline again, fiscal policymakers should not make plans that assume such a decline. Fourth, public spending needs for additional defence and climate spending run well above 1 percent of GDP per year. These needs do not appear to have been incorporated into current fiscal baselines, and hence will come on top of the adjustment described above. To ensure that fiscal adjustment does not defeat its purpose by slowing growth, it is essential that it is conducted gradually. In countries that require such adjustment, it should start as soon as cyclical conditions allow.
Topic:
Governance, European Union, Finance, and Fiscal Policy
Political Geography:
Europe

19. Decentralised finance: good technology, bad finance

Author:
Maria Demertzis and Catarina Martins
Publication Date:
04-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The emergence of cryptocurrencies/crypto assets has allowed the provision of a new form of financial services, including payments and loans, known as decentralised finance (DeFi). Crypto assets currently represent only about 1 percent of total global financial assets and it is unlikely, in its current form, that DeFi will become a substitute for the traditional financial system, for three reasons. First, while decentralisation is very innovative, in practice the technology required to replace the role of intermediary is slow and costly in terms of energy use. This has led some crypto networks to adopt more centralised solutions to the problem of verification. Second, the automaticity behind the transactions does not allow for any legal recourse. If something goes wrong, there is no way to stop or reverse a transaction once it has been initiated. It is very difficult to imagine DeFi scaling up without the ability to challenge outcomes. Third, and perhaps most importantly, DeFi is for the most part self-referential. Crypto assets are exchanged for other crypto assets without being employed in activities that stimulate economic growth by creating jobs or facilitating investment. It is not likely for DeFi to grow enough to replace traditional finance unless it helps growth. Nevertheless, the technology that enables DeFi and crypto assets, distributed ledger technology (DLT), is very innovative and has managed to remove the intermediary without compromising the safety and finality of financial transactions. Hence, it is likely that the technology behind crypto assets and DeFi will feed into the mainstream and offer efficiency gains.
Topic:
Science and Technology, Regulation, Finance, Digitalization, and Digital Currency
Political Geography:
Global Focus

20. Will China’s new financial regulatory reform be enough to meet the challenges?

Author:
Martin Chorzempa and Nicolas Veron
Publication Date:
03-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
Effective financial supervision plays a crucial role in maintaining financial stability and a healthy financial system. China’s leadership has made financial risk a core priority, and in reforms approved in March 2023, it reassigned regulatory responsibilities, creating a new supervisory body that will take over some responsibilities from the central bank, the banking and insurance regulator, and the securities regulator. The aim is that a change to the financial supervisory architecture (who does what in financial supervision) will make China’s system more effective and stable. In this policy brief, we argue that this incremental reform will not solve the core issues China faces in financial supervisory effectiveness. We provide an overview of China’s large and complex financial system, including its largely state-owned banks (some of which are the largest in the world by assets), securities markets and other financial intermediaries. Traditional divisions between different types of activities and institutions have been blurred by the rise of large financial conglomerates, risk-transfer techniques and internet-based finance. Reforms in 2018 to China’s supervisory architecture did not eliminate perceived shortcomings, including failures to effectively regulate financial conglomerates, fintech and regional banks. We then survey global benchmarks against which China’s financial supervisory architecture can be compared, including the United States and European Union. China’s supervisory system is already more streamlined, at least on paper, than either of these most comparable global counterparts. Like them, China’s system does not correspond exactly to any of the three textbook archetypes of supervision: sectoral, twin-peaks or integrated supervision. Ultimately, the effectiveness of China’s financial supervisory architecture suffers from excessive state intervention in the financial system through other channels, including through the unique and pervasive influence of the communist party, which hampers supervisory independence and makes it difficult to establish accountability for regulatory failures. While the recently announced reform may improve coordination across supervisory bodies, coordination within the new quasi-integrated supervisor, across central departments, and between them and local branches, will remain a challenge.
Topic:
Reform, Regulation, Finance, and Financial Stability
Political Geography:
China and Asia

21. The potential of sovereign sustainability-linked bonds in the drive for net-zero

Author:
Alexander Lehmann and Catarina Martins
Publication Date:
03-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
European Union governments have for some years issued green bonds that raise funds for climate-related spending. These bonds have been received well in capital markets but because they promise a certain use of proceeds, they complicate budget management and may not match investors’ claims of having an impact on national climate policies. Public commitments made by major investors and asset owners suggest that limiting climate transition risks and the assessment of the alignment of sovereigns with net-zero targets will now become key determinants of portfolio allocation. Yield differentials in bond markets are already beginning to reflect transition risks that arise from the inadequate pursuit by issuers of climate targets. Unlike standard green bonds, sustainability-linked bonds (SLBs) create a link between performance (outcome) indicators and the financial terms of the bonds. SLBs have grown rapidly in importance in private markets and are now being assessed by sovereign issuers. We show that sovereign SLBs could help incentivise climate policies in EU countries, and accelerate emission reductions. They would be an effective tool for signalling commitment. A common EU framework for issuance by EU countries would enhance capital market integration and the transparency of national policies, and would limit climate transition risks in EU capital markets more broadly.
Topic:
Climate Change, European Union, Finance, Carbon Emissions, and Sovereign Bonds
Political Geography:
Europe

22. Phased European Union electricity market reform

Author:
Georg Zachmann and Conall Heussaff
Publication Date:
03-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
In an environment of record-breaking electricity prices driven by a gas supply shock and below-average electricity generation, reforming the design of the European electricity market is seen as a means to delink consumer costs from volatility in short-term power markets. Electricity markets should meet three objectives: fairness, optimal investment and optimal operation. The current market design has achieved these objectives to varying degrees. Faced with the unprecedented shock, the electricity system has operated well, but electricity markets have struggled to achieve fair outcomes and investments have not been driven by market-based cashflows. Further complicating market reform, the power system is being changed radically by decarbonisation. The electricity system is becoming more decentralised and digitalised, with an active demand side. These transformations will have consequences for the optimal electricity market design in the later stages of the energy transition. Reform proposals have focused on increasing the share of long-term contracts in the remuneration of generation technologies. Different long-term contracting regimes have structural implications for the functioning of electricity markets, especially in relation to the roles of the state and the market, and the responsibilities of national governments and European Union institutions. A phased approach should be taken to EU electricity market design reform. In the near-term, reform should seek to protect consumers and drive investment. An assessment should also be made of what market design will best meet the fairness, investment and operational objectives in a decarbonised system, and what the conceptual role of electricity markets should be during the transition. This process should start as soon as possible so well thought-through proposals are available when the next European Commission takes office.
Topic:
Markets, Reform, European Union, Electricity, and Green Economy
Political Geography:
Europe

23. A model for a participative approach to digital competition regulation

Author:
Christophe Carugati
Publication Date:
02-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
Digital competition regulations often put in place participative approaches to ensure competition in digital markets. The participative approach aims to involve regulated firms, stakeholders and regulators in the design of compliance measures. The approach is particularly relevant in complex and fast-evolving digital markets, where whole industries often depend on the behaviours of the regulated firms. The participative approach enables stakeholders and regulated firms to design compliance measures that are optimal for all because they ensure legal certainty for regulated firms, save time for regulators and take into account the views of stakeholders. However, the participative approach is subject to regulatory capture. The regulated firms and stakeholders might try to promote their interests to the regulator. This could result in endless discussions at best, and the adoption of inappropriate solutions following intense lobbying at worst. A governance model is necessary to ensure that the participative approach works without risks of regulatory capture. The model should define clearly each participant's role, duties and rights. There should be: 1) equal and transparent access of all stakeholders to the dialogue; 2) the presentation of tangible and evidence-based solutions from stakeholders and regulated firms; 3) public decisions from the regulator that contain assessments of the proposed solutions, with guidance to clarify rules; and 4) compliance measures proposed by the regulated firm in line with the guidance. The model should provide an assessment framework for the proposed solutions to identify the most effective. The assessment should rely on the principle of proportionality to assess whether the proposed compliance measure is proportionate, to ensure the effectiveness of the regulation. Finally, the model should safeguard against regulatory capture thanks to transparency rules and external monitoring.
Topic:
Regulation, Digital Economy, Innovation, Stakeholders, and Competition
Political Geography:
Global Focus

24. How Europe should answer the US Inflation Reduction Act

Author:
David Kleimann, Niclas Poitiers, André Sapir, Simone Tagliapietra, Nicolas Veron, Reinhilde Veugelers, and Jeromin Zettelmeyer
Publication Date:
02-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The 2022 United States Inflation Reduction Act (IRA) is a significant and welcome climate law. It also includes trade-distortive subsidies, including local-content requirements prohibited under World Trade Organisation rules – the first time the US has done this and a blow to the international trading system that could trigger protectionism in other countries. The expected IRA green subsidies are of similar size to those available in the European Union, except in renewable energy production, where EU subsidies remain far larger. However, there are important qualitative differences. Some IRA subsidies discriminate against foreign producers while EU subsidies do not. IRA clean-tech subsidies are simpler and less fragmented, and they focus mainly on mass deployment of green technologies rather than innovation. The IRA will likely harm Europe through its competitiveness effect, while it will likely benefit climate transition in Europe and most of the rest of the world. However, the magnitude of both effects is very uncertain, partly because the IRA will induce substitution away from Chinese inputs. By forcing the reorganisation of supply chains, the IRA may make the EU and other economies more competitive relative to China. It may also initially slow the green transition. But in the longer run, this effect should be outweighed by the reduction in the cost of clean tech driven by the IRA. In responding to the IRA, the EU should not just seek to protect its competitiveness relative to the US but to pursue broader aims, including competitiveness in general, speedy decarbonisation and broad foreign policy and development policy goals. These aims imply that the EU should not impose local-content requirements of its own, should not loosen state-aid rules and should not mimic the IRA’s approach to manufacturing subsidies. Rather, it should focus on boosting its structural competitiveness, formulate a trade policy response that includes reform of the international subsidies regime, and develop an instrument for EU-level subsidies that focuses on early-stage development and increasing EU resilience to trade disruptions.
Topic:
Governance, European Union, Inflation, and Trade
Political Geography:
Europe

25. Climate versus trade? Reconciling international subsidy rules with industrial decarbonisation

Author:
David Kleimann
Publication Date:
02-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The vast environmental subsidies that may be required for the transition to net-zero greenhouse gas emissions are starting to generate international trade and political frictions between the world’s largest economies. This puts (supra-)national industrial decarbonisation efforts on a collision course with international subsidies rules and national countervailing duty (ie anti-foreign subsidy) laws and regulations. International cooperation will be essential to defuse such tensions before they escalate and impede effective climate policy rollouts, and before they lead to economic countermeasures that create new barriers to trade in environmental goods. This requires agreement on permissible environmental subsidy practices that minimise distortions. Meanwhile, it will be crucial to provide financial transfers to assist poorer economies with industrial decarbonisation at the same time as those poorer economies are suffering from the cross-border negative economic impacts of otherwise net-global-welfare enhancing environmental subsidies paid out by wealthy countries. Various forums can host the technical and political negotiations necessary to set the parameters of net global-welfare enhancing subsidies. These include the G7, the G20, the Organisation for Economic Co-operation and Development, the World Trade Organisation’s Trade and Environment Committee and WTO Trade and Environmental Sustainability Structured Discussions, and the Coalition of Trade Ministers on Climate.
Topic:
Climate Change, Political Economy, Trade, Carbon Emissions, Subsidies, and Decarbonization
Political Geography:
Global Focus

26. How best to ensure international digital competition cooperation

Author:
Christophe Carugati
Publication Date:
02-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
Large digital firms pose similar competition issues worldwide, such as promoting their own services over those of rivals, or imposing unfair terms and conditions. Competition authorities have opened several antitrust investigations and policymakers have proposed digital competition regulations to tackle these issues. G7 competition authorities have called for several years for international cooperation on digital markets. They want competition cases and laws around the world that are consistent and work together. However, the question of how this can be done remains. A toolbox for international cooperation in competition enforcement already exists, but it does not provide for cooperation in competition policy and has shortcomings in relation to competition enforcement. Current and proposed legislation targets the largest digital firms to tackle the characteristics of digital markets, such as multi-sidedness, and the same or very similar behaviours, such as self-preferencing. Legislation in different jurisdictions addresses these issues with similar rules. While there is some convergence, some rules diverge in substance and some are at high risk of divergence in interpretation. Inconsistency is thus likely to arise from a divergence of interpretation rather than substance. The solution would be to ensure a coherent approach to competition in digital markets. This could be done by developing a framework based on four elements: (1) adoption of common legal phases for future digital competition laws to ensure clarity; (2) adoption of a common legal interpretation through guidance drafted by international forums, such as the International Competition Network (ICN); (3) adoption of common technical requirements developed in the context of ICN technical workshops, when the rules require it; and (4) the implementation of an international monitoring committee within the ICN to evaluate whether competition authorities and courts enforce the rules consistently. The impact of the framework might be limited because of the non-binding nature of the approach, and the focus on specific competition-related legislation, excluding laws that can also address the issues, such as civil law. Countries can overcome these limitations if they are willing to cooperate to ensure a consistent approach.
Topic:
Markets, Digital Economy, Digital Cooperation, and Competition
Political Geography:
Global Focus

27. Preparing for the next winter: Europe’s gas outlook for 2023

Author:
Ben McWilliams, Simone Tagliapietra, Georg Zachmann, and Thierry Deschuyteneer
Publication Date:
02-2023
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The European Union has so far weathered the energy crisis brought on by Russia’s invasion of Ukraine in February 2022 and will manage winter 2022/23 even if Russia abruptly halts all pipeline gas flows. However, preparations must be made for winter 2023-24. In particular, gas storage facilities should be 90 percent full by 1 October 2023. We assess the demand reduction needed if the 90 percent storage target is to be achieved. Our assessment takes into account EU imports, exports to refill gas storage facilities in Ukraine and Moldova, the weather and the situation in power markets, where gas demand is highly dependent on non-gas energy sources. Assuming limited Russian exports continue, and weather conditions are typical, demand up to 1 October 2023 must remain 13 percent lower than the previous five-year average. The EU should therefore extend its demand-reduction target, which is currently set to expire on 31 March 2023. Two variables will determine how easily the target can be met: 1) liquified natural gas (LNG) supply, and 2) the nature of demand reductions. Plans for rapid deployment of regasification units will alleviate concerns over LNG import infrastructure capacity. However, the EU will continue to compete internationally for LNG cargoes, and will remain vulnerable to global dynamics. Strong economic growth in China, for example, could further tighten markets. The way demand is reduced will determine the economic consequences. So far, large reductions in industrial gas demand have not been accompanied by dramatic drops in industrial output, suggesting good substitution options. However, hardly any gas was saved in the power sector last year, because of weak nuclear and hydro output. The return of French nuclear output will therefore be a huge positive. Finally, households have reduced gas demand, partly driven by warmer than usual weather. Record numbers of heat pumps were deployed in 2022, suggesting the start of a structural shift away from gas demand for heating. Policy should support a continued structural shift away from gas. This involves enabling rapid deployment of renewables and the accompanying grid infrastructure, energy-efficiency measures, help for households that want to switch to cleaner heating, and collaboration with industry to accelerate adoption of new low-carbon production methods.
Topic:
Security, Gas, Energy, Russia-Ukraine War, and Green Economy
Political Geography:
Europe