President Emmanuel Macron is right.

 

Story by Bojan Pancevski, Noemie Bisserbe

 Europe is bracing for a confrontation with Washington over a new law that encourages businesses to invest more in the U.S., an initiative European officials say threatens the region’s economy as it teeters on the verge of a recession.

 President Biden and French President Emmanuel Macron discussed the issue in Washington last week, and Mr. Biden signaled he was open to talks but made no commitment to amend the legislation. European leaders are now considering their response.

At issue is the Inflation Reduction Act, which offers subsidies to U.S. and international companies that invest in the U.S. in certain sectors, including clean energy. The Europeans argue that the act is a beggar-thy-neighbor scheme designed to lure investors away from Europe.

The trans-Atlantic split complicates the West’s efforts to find a common stance on confronting China. It also comes at a vulnerable time for the EU, which is facing high inflation, uncertainties about its energy supplies and an economic war with Russia.

During their talks, Mr. Macron sought to convince Mr. Biden that it wasn’t in the U.S.’s interest to weaken Europe at this time, French officials said, stressing that both sides wanted a transition to greener energy and less dependence on China.

“By the beginning of next year, we have to be able to settle this issue,” Mr. Macron said in New Orleans on Friday.

U.S. officials say they didn’t intend to weaken European industry and were open to talks. The presidents discussed the possibility of creating exemptions to some of the IRA’s domestic-content requirements, according to people close to the discussions. 

Yet Mr. Biden didn’t make any specific commitment and European officials noted that the U.S. president had ruled out sending the act back to Congress, a necessity if it were to undergo any substantial change, such as adding an exemption for European companies. 

The European Commission, the EU’s executive body which negotiates directly with The European Commission, the EU’s executive body which negotiates directly with Washington in trade matters, has floated the creation of a European sovereignty fund. On Sunday, Commission President Ursula von der Leyen said the EU would look at modifying the bloc’s rules for government subsidies and consider new funding for industry in response to the IRA.

Another option would be for the EU to take the case to the World Trade Organization, the global trade watchdog, but it may take the organization more than a year to adjudicate the complaint.

Complicating the trans-Atlantic dialogue is the fact that the EU is preparing protectionist measures of its own, including a border tax on carbon emissions, which essentially slaps tariffs on some non-European goods whose manufacturing contributes to climate change.

So far, the European Union’s two largest economies—France and Germany—have yet to agree on a response. 

Paris has taken a more aggressive stance, suggesting an EU-wide subsidies program that would rival the Biden administration’s plan. 

Berlin is worried that its export-driven economy would suffer from the added trade friction and is balking at the cost of the potential subsidies. 

Germany has already pledged to spend almost 300 billion euros, the equivalent of $316 billion, to shield businesses and households from rocketing energy prices, and its officials worry a subsidy scheme would stretch its public finances and those of more indebted nations, such as Italy and France.

Another German concern is that an EU subsidy scheme could be in breach of WTO rules, sending the wrong signal just as Europe is urging Russia and China to respect international norms, according to German officials.

German Chancellor Olaf Scholz said he believes that a trade agreement—or a targeted deal on customs and tariffs—would offer a better way than subsidies to defuse the conflict. An earlier attempt by the EU and the U.S. to negotiate a comprehensive trade and investment agreement collapsed after years of talks, following grass-roots opposition from European environmentalist groups and trade unions.

In any case, German officials said it was crucial to avoid a full-blown trade conflict between the EU and the U.S. as trans-Atlantic cohesion is required to contain Russia.

“We are in full agreement that we have a gigantic problem that must be solved,” a senior European official involved in the negotiations said in reference to the IRA.

EU officials involved in the negotiations with Washington, however, said it was likely Europe would introduce some form of subsidies in response but that the effort wouldn’t match the scale of the U.S. scheme.

Kim Mackrael in Brussels contributed to this article.

 

Write to Bojan Pancevski at bojan.pancevski@wsj.com and Noemie Bisserbe at noemie.bisserbe@wsj.com