The strange survival of the EU state aid rules

State aid rules stop governments giving unfair handouts. Britain has pledged to keep them after Brexit, but how to build a regime that works?

November 01, 2018
Theresa May and Donald Tusk in Brussels. Photo: POOL CHRISTOPHE LICOPPE/Belga/PA Images
Theresa May and Donald Tusk in Brussels. Photo: POOL CHRISTOPHE LICOPPE/Belga/PA Images

State aid rules are a major feature of the EU internal market. They confer large powers on the Commission to prevent member states from giving unfair handouts to firms. They can affect very many aspects of national policy, from tax policy to industrial strategy. One might have thought that, post-Brexit, they would vanish from the UK. After all, Britain is seeking a looser relationship with Europe.

But, on the contrary, a quiet consensus has emerged that they will stay: and stay even if there is “no deal.” This has not been widely discussed—but it matters. The issue speaks directly to the role of the state in the economy. How has that quiet consensus emerged, and what does it mean for the UK?

An obvious problem arises when countries open themselves up to trade with each other: what happens when the government of country A starts handing out large subsidies to its own industries, which can then flood in at low prices to country B, forcing it either to replicate those subsidies to its own industry or to accept the hit to its own producers?

WTO anti-subsidy rules allow country B to impose tariffs (“countervailing measures”) in those circumstances. But the EU state aid rules go further: all subsidies and tax breaks to support specific companies, sectors, or regions are subject to control by the Commission, exercised either through specific exemptions (which in practice deal with most of the support given to industry by member states) or by approving specific measures notified to the Commission before they are put into effect. The test for approval essentially involves balancing the public policy gains against distortive effects on competition. That regime is backed up by a rule—that is superior to any national rule—that state aid which is neither exempt, nor notified and approved, is unlawful, and if given has to be repaid with compound interest.

Where does the UK fit in? Under all governments since 1973, the UK has supported enforcement of the state aid rules: the UK grants much less state aid per head than many other EU countries, and has a very good record of compliance.

But there was certainly no guarantee that Britain would retain them post-Brexit. The state aid rules impose a routine constraint on government policy. Many types of public/private cooperation can be subject to the rules if they can be seen as giving an advantage to private companies. The rules can also affect the design of tax measures, since some apply differently to different businesses. The problem is that if the state aid rules apply, or may apply, and none of the exemptions apply, the measure has to be delayed while the Commission looks at it: no well-advised private company will get involved with a project that could involve unlawful aid, given the risk of being forced to repay any aid given with interest. This takes time, and can be a major problem for a minister keen to get a project off the ground quickly. Indeed, I was once told by a senior Whitehall lawyer (and it is consistent with my own experience) that the state aid rules were one of the aspects of EU law that caused the most day-to-day grief under all governments. So it is no wonder that some argue Britain should seek to abandon them.

Criticism of the state aid rules from the right has concentrated on the extent to which they give the Commission powers over tax policy. There has been considerable criticism of the Commission’s current enthusiasm, in cases like Ireland/Apple, for applying the rules to tax decisions. However, since the right is generally unfavourable to state intervention in the economy, the rules have tended to come some way down its list of criticisms.

On the other side of politics, however, the state aid rules have been at the forefront of left-wing criticism of the EU. Some of this is manifestly wrong-headed, such as the complaint—which I have actually heard—that the EU state aid rules prevent the UK from adopting a German-style industrial policy (think about it): and suggestions that the state aid rules would have prevented implementation of any aspect of Labour’s 2017 manifesto have been comprehensively taken apart. EU state aid exemptions and Commission decisions permit regional aid, support for local banks and public investment banks. In response, arguments by “Lexit” writers are conspicuous for their preference for vague complaints about neo-liberalism overspecific examples of policy proposals that a Labour government (even a “radical” one) might actually adopt that would fall foul of EU state aid rules.

A couple of further factors help to make a left-wing case to retain the state aid rules. First, a central objective of anti-subsidy rules is to prevent “subsidy races” and tax breaks to favoured companies. The US does not have any form of state aid regime: and one result of that is that individual states end up spending billions of dollars in tax breaks to large corporations in return for locating in their state. It is hard to see anything left-wing in that. But the only way of preventing it is some form of agreement between states that they will not yield to that temptation.

Second, even without EU or domestic state aid rules, WTO rules would be a major constraint on a hypothetical Labour government determined to throw subsidies at favoured industries. WTO rules allow countries to impose tariffs on imports from countries that subsidise: and the EU would be determined, if the UK had no state aid rules, to take action under the anti-subsidy rules whenever it could. The very real threat of countervailing measures would in most cases be a powerful deterrent.

In any event, the government has said that it will hold onto the state aid rules, and the Labour Party has made no fuss about that. For what reasons?

Two principal factors seem to have been at play. First, the EU has made it very clear that any future trade relationship will have to include state aid commitments from the UK. From the EU perspective, the UK is simply too large and too close for any form of open trade relationship to be acceptable unless the UK is constrained in its ability to subsidise its domestic industry.

Second, the UK government has accepted that the current devolution settlement assumes that the devolved governments would be bound by EU state aid rules. So there was no need to write into the devolution Acts provisions that, for example, would stop them indulging in subsidy races. But, post-Brexit, the possibility of such harmful competition for favours from big business between the devolved administrations becomes a real one (a point forcefully made by the Labour First Minister of Wales, Carwyn Jones, in answer to a question from me at a talk in London earlier this year). That means that there is a domestic interest in preserving the state aid rules in some form.

From the Conservative government’s point of view, the concession that the UK would maintain state aid rules has not, for reasons I explained above, been too difficult, particularly as the proposal is to set up a purely domestic regime. So the government has made it clear not only that it will accept the state aid rules as part of a trade deal with the EU (even a “Canada +++” deal) but issued a “no deal” notice stating that even in the event of no deal the UK would proceed to operate its own domestic state aid regime.

As for the Labour Party, the background of its leader would suggest that he has some sympathy with the Lexit critique of the state aid rules. On the other hand, many in the party share the concern about “beggar my neighbour” subsidies and tax breaks if the rules are abandoned. So there might have been an interesting internal debate inside the Labour Party. But any such debate has effectively been pre-empted by the party’s support for a customs union with the EU. That policy is entirely inconsistent with abandoning the state aid rules.

So there is a quiet consensus. That consensus conceals, however, the very real difficulties in devising a domestic state aid regime. One set of technical issues surrounds re-writing a regime designed to deal with measures that affect trade between member states in a purely domestic threshold. But there are three key policy issues. Who should enforce the new regime? What do you do about state aid in the form of legislation? How does the domestic regime relate to the EU’s?

As for enforcement, the government has wisely decided that, despite its evident lack of enthusiasm, the body tasked with administering the new regime should be the Competition and Markets Authority, which has the necessary economic expertise and a solid reputation for independence.

The CMA could be forgiven for seeing the task as a poisoned chalice. Ultimately, state aid control means interrogating politicians’ pet projects. And those projects do not always stand up to detailed examination. Further, the ultimate trade-off between distortion of competition and the benefits of a project involves a judgment on public policy. The CMA is therefore likely to find itself in conflict with ministers and devolved and local politicians.

That brings me to the second problem: legislation. To take a simple example, a law that provides for a reduced rate of corporation tax for widget makers is state aid for the widget industry. While the UK is in the EU, the supremacy of EU law means that such legislation is not worth the parchment it is written on: the Commission and national courts can order its suspension. But outside the EU, parliament is supreme. The CMA is not going to be given powers to dispense with legislation and impose tax that were taken from the Stuart kings after two revolutions. That, however, raises difficult questions about what should happen when the CMA finds that tax legislation involves an unlawful aid.

As to the third problem, EU law is likely to remain an authoritative, though not binding, source of case-law. The UK would, though, be free to design procedures that improve on the EU’s: they could be quicker, and the rights of the grantee of aid (a notorious weak spot in the EU regime, despite the very adverse consequences to the grantee if it is found to have received unlawful aid) could be better protected. The difficult issue concerns policy. The Commission has a policy approach that it develops in close liaison with the member states. However, outside the EU, the UK will lose the considerable influence that it has had on that policy, so that some policy divergence between the EU and UK is likely.

That divergence is not in itself unhealthy: indeed, the existence of a well-resourced source of state aid policy independent of the Commission could be useful in testing alternative approaches. But too great a divergence is unlikely to be acceptable to the EU: and some form of arrangement will have to be agreed to manage disagreement.

State aid is often regarded as a technical area. Indeed, even many specialist EU lawyers steer clear of it. But it can raise profound issues about the role of the state in the economy and about the relationship between regulators and politicians. What now seems clear is that those issues will not disappear after Brexit: rather, they will need to be played out and resolved in a different context.