Addressing Competitiveness Concerns of EU exporters with Industrial Policy: The Role of Innovation Support

With the recent passage of the Carbon Border Adjustment Mechanism (CBAM), the free allocation of emission permits under the EU Emissions Trading System (EU ETS) that currently acts as a safeguard against emissions leakage and industrial relocation will progressively be phased out. Because the CBAM only covers imports, however, European goods exported into global markets stand to become more vulnerable to emissions leakage. Different policy options have been discussed to counter such export-related leakage, but they variously face concerns regarding their environmental, political, and legal implications. We describe and evaluate the three most important policy options based on their potential to reduce export-related leakage, support the net-zero transformation in Europe as well as globally, ensure conformity with international trade law, secure administrative feasibility, and foster political acceptance by affected trade partners. While no single option outperforms its alternatives on all criteria, our analysis identifies targeted innovation support as a promising option because it minimizes legal and political risks while also offering climate benefits beyond leakage protection for European industry. We then discuss the sectors that are most likely to require innovation support, the policy instruments that could serve to operationalize such support, and potential funding sources. We conclude with guiding principles for technology support measures, reflecting on the implications of the current surge in industrial policy within Europe and beyond.