Last week, at the meeting between President Joe Biden and European Commission President Ursula von der Leyen, the US and EU reached a truce in the very public spat over the impact of the Inflation Reduction Act (IRA) on the two allies’ economic and strategic relations. While no actual deal was announced, the two sides agreed to launch in-depth negotiations to produce an agreement to (partially) respond to the EU’s complaints. To review briefly, the $369 billion IRA provides tax credits of up to $7,500 for new and unused electric vehicles assembled in North America and for nations—20 in total—with which the US has free trade agreements (FTAs). It also provides $3,750 worth of credits for critical battery minerals with the same limitations. Key US allies such as the EU, Japan, and the UK don’t have FTAs with the US.

For some months, Secretary of the Treasury Janet Yellen, who administers the tax credits, has suggested a workaround that entails a looser definition of what constitutes a free trade agreement. Treasury is now suggesting that the US could enter into more limited bilateral pacts that could be accomplished through executive agreements and bypass formal congressional approval. A critical minerals pact will form the basis for the future US-EU deal, opening European companies to eligibility under these provisions of the IRA—and also form the basis for potential deals with Japan and the UK.

This narrative will continue to unfold in the coming months, but here are preliminary observations.

First, though von der Leyen expressed great satisfaction with the deal, it really represents a step down for EU ambitions as it applies only to the critical materials provisions of the IRA and not to the entire compass of US exclusions from tax credits and other subsidies. One critic has labeled the results a new paradigm for US-EU trade relations: “ex-post co-ordination” in which the US expresses understanding of EU complaints, gives a little, but “in the process succeed(s) in getting almost everything it wants.”

In any case, it will be some time before an agreement comes into force, as the Commission must get a sign off from all 27 EU member states. On a related front back in Brussels, the Commission has run into opposition over its recently announced proposals to match US green technology subsidy programs. Opposition has surfaced from more traditional liberal states—Sweden, Denmark, the Netherlands, and Ireland—against targeting a small list of technologies for EU-wide support and relaxing state aid rules for individual EU nations. Smaller EU states fear that the big economies—Germany and France—will use their outsized resources to attract companies away from their smaller neighbors.

More broadly, there is still disagreement over the actual impact of the IRA on future EU clean energy investment. Some analysts, such as the respected Rhodium Group, downplay the actual negative consequences, arguing that the actual impact of US incentives on EU manufacturing will be “considerably lower” than some recent reporting suggests. EU political leaders, however, remain spooked by a stream of announcements by EU-based companies that they are planning or executing new factory investment in the US—the latest being Volkswagen’s decision to take advantage of the IRA with a new battery plant in Canada.

For the US, there are also challenges ahead. After granting access to Europe, Japan, and the UK through the executive order “workaround,” what will the Biden administration do when other nations vital to US foreign policy interests also request exemptions from IRA restrictions—particularly nations in the Indo-Pacific now being pressed to join the Biden administration’s Indo-Pacific Economic Framework. Further, though the plan to add environment and labor provisions to the proposed executive order will not alienate the EU, developing countries, whom the US may want to woo for access to critical minerals through exceptions to the IRA, may well shy away from commitments to US-dictated environmental or labor standards.

In sum, one can applaud last week’s harmony, while being clear-eyed on future potholes.

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