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The second part of the Lithuanian measure on the LNG terminal was scheduled to be published this week. In view of the referendum in favour of exit of the UK from the EU, the second part of the Lithuanian measure will be published next week. Instead, this week the focus is on the impact of Brexit on State aid.

 

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Introduction

The unthinkable has happened. The United Kingdom has decided to quit the European Union. Article 50 of the Treaty on the European Union stipulates that the EU treaties will cease to apply when the withdrawal agreement comes into force, or two years after the UK notifies the European Council of its intention to withdraw from the EU. Whether EU State aid rules will also cease to apply will depend on the terms of the withdrawal agreement and also on the terms of any other agreement on the future relations between the UK and the EU.

The options

Commentators speculating on the nature of post-exit relations between the UK and the EU outline of two possible scenarios: an association involving some kind of preferential market access and MFN treatment.

Association agreements and most, if not all, of the EU’s bilateral trade agreements contain provisions on competition, including rules on subsidies, which mirror to a large extent the EU’s own State aid rules. The main difference between the system of subsidy control set up by these bilateral arrangements and the EU’s system of State aid control is that the enforcement of the rules is left to the respective institutions of each side. In this connection, the European Economic Area agreement stands out because it has uniquely established the EFTA Surveillance Authority which carries out supranational enforcement in the EFTA countries participating in the EEA: Norway, Iceland and Lichtenstein. If the UK acquires an associate status, it will continue to comply with EU State aid rules, but it will have to self-enforce them. It is rather unlikely that the country that has voted to “take back control” would be willing to subject itself to a new kind of supranational supervision.

If the UK leaves without any agreement with the EU, it can demand and receive only MFN treatment from the EU because the UK is a member of the WTO in its own right. In this case, the UK will still have to comply with some anti-subsidy rules for the simple reason that the WTO has its own provisions on subsidies. These provisions are much weaker than the EU rules on State aid. But again the big difference is the institutional arrangements. The WTO has no enforcement mechanism of its own. An aggrieved member can take anti-subsidy action, or adopt countervailing measures as they are called in the WTO’s jargon, only when another member subsidises its exports. Export subsidies are completely banned in the EU, so the UK will not really have any grounds to impose any countervailing duties against EU products. The same will apply to the EU, if the UK does not grant export subsidies.

However, the subsidies which are currently granted in the EU, and which exceed EUR 100 billion per year, are mostly for investment purposes such as investment in new technologies,  in less prosperous regions, in environmentally friendly processes or in SMEs, for example. These subsidies and other incentives have a significant impact on the investment decisions and choice of location of mobile companies. In an integrated world, the shifting of investment from one location to another or from one technology to another can have a non-negligible effect on the level of economic activity of a region or even a country.

In the immediate aftermath of the referendum in favour of exit of the UK from the EU, a decision that companies will have to make is whether to invest in the UK or in alternative locations in the EU. Subsidies will affect those decisions. It will be in the mutual interest of both sides to agree to be bound by limits on how much they can spend to attract investors. If no such agreement can be reached, then the only option open to the UK will be to take unilateral action or initiate the dispute settlement procedure of the WTO. But as mentioned above, WTO rules are weaker than EU rules. The WTO procedure takes much longer – there is no Commission with powers to act quickly. More importantly, even if the WTO finds in favour of the UK, it will be left to the UK to “punish” the EU. The WTO has no institution that can impose fines on a non-complying member. This means that not only will the UK suffer harm from an EU subsidy, but it will also have to impose retaliatory measures which will cause more harm on its economy. In the WTO system, if your finger hurts, you chop off your hand. It is neither an effective, nor an efficient system.

Should the UK want to enforce the EU’s State aid rules?

The latest version of the State aid scoreboard of the European Commission shows that the EU as a whole granted EUR 101 billion of aid. In the same period, the total State aid granted by the UK was less than EUR 8 billion. The rest of the EU can outmatch the UK in any subsidy war. It would in the interest of both sides to agree not to hurt each other. The EU’s State aid control system is nothing else by a mutual disarmament agreement which allows aid only when it is justified and when it does not harm the common interest.

There are two other reasons why the UK when it stops being a member of the EU would want to keep the EU’s rules on State aid or at least rules which are similar to those currently in force in the EU. First, there are many public authorities that grant State aid within the UK. They compete against each other to attract investors and promote new technologies in their regions. EU rules impose discipline on State aid measures. It is in the UK’s interest to prevent wasteful subsidy races between different public authorities, especially in view of the fact that the four nations of the UK, England, Scotland, Wales and Northern Ireland, have considerable discretion in granting State aid.

Second, EU rules prevent “bad” aid. They allow “good” aid that remedies market failure and incentivises investment in technologies and regions where the market is unwilling to commit funds. EU rules prohibit “bad” aid which merely subsidises normal day-to-day costs or investments that a company would anyway make or aid that goes beyond what is necessary. Bad aid is wasted public resources that could be more usefully utilised elsewhere. The UK will not suffer by continuing to assess its own State aid on the basis of EU rules.

Would the UK want to adjust or revise those rules? Perhaps yes. EU State aid rules are designed to fit the needs and capacity of 28 countries. The UK may decide that in the future it may have to adjust the rules to fit its own needs and specific conditions. But I very much doubt that it would want to depart radically from them. Member States often complain that EU rules are too strict. However, I have never seen a measure that addressed a genuine market failure to be prohibited by the European Commission. By contrast, the record shows that Member States implemented or were about to implement hundreds, perhaps thousands, of measures that were devoid of any economic logic. The European Commission justifiably put an end to them and saved taxpayers from billions of wasted euros.

But the mere fact that the UK will have discretion to adjust the rules will cause uncertainty. Nothing will happen next week or the week after. The UK will still be a member and for the aid-granting authorities it will be “business as usual”. But as the two-year period envisaged in Article 50 nears its end or as the withdrawal negotiations progress to completion, I expect that both public authorities and companies will start thinking how the rules may change and whether it would be worth waiting for any new rules to come into force. The period of uncertainty and of postponement of decisions and investments, at least in the field of State aid and in other public policies involving subsidies, will come in about 18 months’ time.

Impact on the EU

It is very unlikely that the EU will change its rules as a result of the UK’s withdrawal. But the imminent exit of the UK is a cause for concern and a cause for regret for the EU. It is a cause for concern because the extensive commercial relations between the two sides can be affected by State aid. The EU would want the UK to continue to comply with State aid discipline for the reasons that have been explained in the previous sections.

The UK exit is also a cause for regret. The UK has been exemplary in its compliance with Union law, not just in the field of State aid. There have hardly been any cases of recovery of incompatible State aid in the UK.

The assessment of the need for State aid in the various British regions has been subject to national rules and procedures that have been mostly stricter and more rigorous than those of the EU. The UK has been a source of “best practices” that have been copied by many other Member States.

The UK has also contributed extensively to the shaping of the rules. It has pushed for the development of new guidelines such as those on risk finance and financial engineering instruments. The UK’s “liberal” approach has lent support to the European Commission to place State aid rules on economically more rational base in the 2005 and 2014 revision. The absence of the UK will surely be felt in the forthcoming revision in 2019.

And, perhaps, one should also mention that English has become the language of choice in DG Competition. During the height of the financial crisis, decisions were adopted solely in English and Member States voluntarily waived their right to have decisions in their national language in order to get Commission decisions quickly. The rescuing and restructuring of banks ushered in many strange terms that had not be used before in Commission decisions on State aid. The simple fact of relying on English terminology and of not having to translate documents, not only expedited authorisation procedures but also prevented confusion from the use of distinct terms whose meaning varies in different languages.

Conclusions

The UK has voted to leave the EU and “take back control”. It wants to determine its own policies. In an interdependent world the privilege of deciding on your own policy can also be risky. The decisions of other countries over which you have no influence may hurt you. A case in point is State aid. The EU has set up a system to control State aid precisely in order to prevent policies that advance local or national interests at the expense of others. As long as the UK continues to trade with the EU, it can benefit from the discipline imposed by State aid rules.

The accusation which is often hurled against the EU that its rules do not allow Member States to do what is good for them does not stand up to scrutiny in the case of State aid. This is because EU rules permit “good” aid while prohibiting “bad” aid. The EU does not prevent its Member States from supporting investments which are beneficial for their long-term growth.

The UK will soon discover, first, that exit does not mean that it will have to discard all of EU policies and, second, that as long as it trades with the EU, some form of a mutually agreed restraint on subsidies will be in its own interests. Ironically, it will have to give back a bit of the control it wants to retake.

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[Photo credit frankieleon from flickr.com]

 



Comments

by Alexander Rose, Tuesday, 28 June 2016, 21:02:43

Phedon, an interesting and insightful article. I'm pleased that you recognise the contribution that the UK has made during its membership. I also feel that the UK has been a strong contributor, particularly when it comes to State Aid law, in sharing best practice and putting forward novel initiatives which have later been adopted in other Member States. It is important to note that the referendum question was very narrow and leaves the UK parliament wide discretion as to what model to pursue in the future. Indeed, I don't think a European wide competition authority would necessarily be opposed by the UK - after all companies operate across borders and it is important that subsidy regulation / enforcement has the same reach. It should also be noted that in 2013 when the UK government consulted domestic stakeholders about State Aid law the feedback (as set out in the Balance of Competencies report) was wholly positive. Change is inevitable in light of the referendum, but I would hope that the UK and EU could cooperate to keep the rules that both parties want in place after Brexit.



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Professor at the College of Europe, Bruges, and at the University of Maastricht, and Academic Director at lexxion training

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