The purpose of this report is to shed light on Swedish competitiveness in the electricity-intensive industry by comparing business environment and framework conditions in Sweden and Germany.

The report uses economic theory and empirical research with the following starting points:

• (I) Germany is our most important trading partner with a similar industrial structure.
• (ii) Sweden has comparative advantages in both electricity production and electricity-intensive industries where we find large export values.
• (iii) We expect higher price of electricity in Sweden through the Europeanisation of the electricity market and an increase in domestic demand for electricity.
• (iv) Germany appears to have maintained its competitiveness in electricity-intensive industry despite, on average, higher electricity prices.
• (v) Germany has chosen a complex package of different exemptions and special rules to protect their electricity-intensive industry, while Sweden uses more general exemptions in energy taxation, allocation of electricity certificates and certain subsidies (e.g. Klimatklivet).

Should Sweden (at least partially) adopt the German model? Our analysis leads us to answer this question in the negative. The report contains four policy proposals:

1. Adhere to the current Swedish State aid principles
2. Do not adopt the German support model for electricity-intensive industry.
3. Abolish energy taxes on electricity and fuel
4. Affirm free trade in electricity.

The Swedish principles for state aid (Prop. 1999/2000:140 (page 169)) are, in short, (i) restrictiveness (ii) EU-wide rules (iii) effective and transparent regulatory frameworks. A policy that generally avoids targeted aid is restrictive. Common rules aim to avoid special solutions, whether for individual countries, regions, or companies. Non-transparent regulations make control and follow-up more difficult. We adhere to these principles and believe that we our emphasis should be placed on fostering widespread support for research and development (R&D).

Introducing the German model means a return to old sins; Sweden has had a similar system with complex and detailed regulations, particularly within competitive industries. Support systems today means that electricity price paid by various electricity-intensive industries likely exhibit greater variation in Germany than in Sweden. The Swedish model therefore has a head start in efficiency terms. However, the German model offers opportunities for targeted aid and can therefore take into account distributional effects and reduce the risk of carbon leakage more precisely.[1]

Brännlund & Kriström (2020) argued for the abolition of energy taxes on electricity and fuel for all users. The arguments for implementing such a reform in Sweden are stronger today, due to some major changes. First, the EU's Fit for 55-climate package means that climate emissions in large parts of the economy will be subject to a cap at the EU level. Abolishing the energy tax on fossil fuels will likely have a minimal effect on the climate.[2] Conversely, the elimination of the electricity tax is projected to result in efficiency gains. In general, it is advantageous to replace narrow tax bases with broader (here energy tax with VAT). Furthermore, low-income households will benefit from the proposal. Second, there seems to have been a certain relaxation of the state aid rules since Brännlund & Kriström (2020) presented their proposal, which makes the proposal more realistic today.

Our fourth proposal regards free trade in electricity. From an efficiency perspective, the user who wants to pay the most should receive the electricity, including foreign users.

Capital market imperfections can motive state aid. More generally, phenomena that the market economy cannot cope with in the best way can motivate state aid. These are known as market failures in the economics literature. EU cooperation in R&D can be a way to improve the efficiency of research activities and address potential R&D market failures.

EUs State aid rules limit the possibilities for business support, although the German example (and other contemporary examples following the Covid pandemic and the war in Ukraine) shows that supporting electricity-intensive industry has been allowed. However, we do not see any efficiency gains by adopting the German model. Rather, there are opportunities for further efficiency gains by completely abolishing energy taxes on electricity and fuel in general.

We have studied data at sector level in detail regarding cost shares and found that Sweden and Germany have similar industrial structures. Data clearly shows that German electricity prices are higher overall, but it is important to remember that we only have access to average prices.

Competitiveness is a multifaceted concept, involving factors such as proximity to markets and the education level of the labor force. For the Swedish forest industry, competitive advantages include good access to raw materials and low electricity prices. Germany’s most important comparative advantage is its geographical position. In the metallic-, iron- and steel industries, the competitive factors are the same as in the pulp and paper industry. Good access to raw materials (iron ore) and low energy prices have benefited Swedish industry, while German industry has benefited from proximity to the market. German steel industry has remained competitive despite higher electricity prices, possibly because its focus on volume and economies of scale, i.e., fewer employees per ton of steel. The Swedish steel industry is more niche-oriented and focuses on producing more expensive special steels with higher added value instead of investing in economies of scale and large volumes.

We have simulated the consequences of an electricity price increase for the Swedish economy with a computable general equilibrium model focusing efficiency. The model results show that free trade in electricity is the best option even if this poses significant challenges for electricity-intensive industry. We have therefore studied policies to mitigate the consequences of higher electricity prices. These policies include "Sweden prices" for electricity via an export restriction, and subsidies of output/labor. If the government wants to mitigate the consequences of higher domestic electricity prices due to free trade I electricity, then subsidies is preferable to “Sweden prices,” despite the distortions of the product/labor market such policies will imply. An important further development of the model is to include distributional issues on the household side.

In summary, Sweden and Germany have chosen different industrial policy paths to support electricity-intensive industry. We find no strong reason for Sweden to emulate the German model. Rather, we propose to make the energy tax system more transparent, efficient, and effective, following the proposal in Brännlund & Kriström (2020).

[1] The upcoming carbon tariffs (CBAM) are a new mechanism that will reduce the risk of carbon leakage. See https://taxation-customs.ec.europa.eu/carbon-border-adjustment-mechanism_en External link..

[2] The Swedish CO2 tax remains at emission sources not capped by EU-ETS.