The government’s new state aid proposals are the worst of all worlds

03 Dec 2019 By George Peretz KC

The European Union state aid rules are a keystone of the EU single market: by setting limits, enforced by the Commission, on the ability to subsidise domestic industries, they make it possible for member states fully to open their markets to each other’s goods and services, confident that their own producers will not face unfairly subsidised competition from producers elsewhere in the EU.

Last year, I wrote an article for Prospect which discussed the quiet consensus that the UK would retain these rules after Brexit. That quiet consensus was apparently shattered on Friday, when the Conservatives produced a paper in which they promised to get rid of the state aid rules and replace them with a new system based on World Trade Organisation anti-subsidy rules, which they claimed would allow the government “greater discretion” and provide “certainty” to investors.

On the right, the Institute of Economic Affairs, whose main criticism of the state aid rules is that they permit too much subsidy, immediately responded by denouncing the proposals as “support for cronyism.” And on the left, many “Lexiters” welcomed the proposals on the basis that, despite their own general inability to point to any actual Labour policy that would be frustrated by the state aid rules, they see them as a neoliberal plot to stop the interventionist plans of a socialist government.

But both sides may have made a mistake in taking too seriously the headline promise to scrap EU state aid rules. The reality is that the proposals are an incoherent mess.

The first issue is that the proposal is based on WTO anti-subsidy rules. There are two serious problems with those rules as a substitute for retaining the EU state aid regime.

– Far from bringing greater clarity, as promised, a switch to WTO anti-subsidy rules as the basis for a domestic system would introduce much greater uncertainty. There are areas of uncertainty in EU state aid law (as there are in much of English common law). But when I have to advise on what is a state aid, I have volumes of case-law to help me (just as, in the common law, I have volumes of case law to help me advise on what “negligence” means). In contrast, there is very little case-law on the equivalent WTO concept of subsidy (largely because WTO litigation is always state-to-state, and states are generally unwilling, for obvious reasons, to try to push the boundaries of what counts as a subsidy). Much though lawyers like me might benefit from extensive re-litigating of issues long settled in the current state aid regime, I cannot recommend the change as a means of increasing certainty.

– Further, peering through the uncertainty, the best guess is that changing from EU state aid rules to a regime modelled on the WTO concept of a subsidy would make little difference to what is prohibited. The basic texts and principles of the EU and WTO rules are very similar, including a wide approach to what counts as an aid or subsidy, including tax breaks, free use of government facilities that are normally paid for, and so on. So it is entirely possible—and in fact likely—that, after a lot of time and money is spent on working out what the new regime means, it turns out to be much the same as the old one.

The Conservatives do have a point when they say that the current system frequently involves some delay, as non-exempt state aid has to be notified to and cleared by the European Commission before it can lawfully be implemented, and there can then be further delays and uncertainty if the Commission’s decision is appealed. But the Conservatives’ claims are over-stated: the Commission approves genuinely urgent cases such as rescue aid very quickly—and anyway, in a post-Brexit state aid regime run domestically by UK institutions and courts, delays in approving state aid measures would be under UK control. And any control system, no matter how well-designed, has to give time for a proper hearing of those whose interests are affected by a subsidy proposal—the recipient, its competitors and others. If it doesn’t, good points are missed and you get unfair and bad decisions, with further delay when the courts end up having to sort out the mess.

The central weakness in the proposals, though, emerges when you notice how coy the Conservatives are about explaining why we should keep any anti-subsidy rules after Brexit: after all, if we are no longer in the single market, why do we need one of its keystones?

Part of the answer is to provide a discipline for all parts of government in the UK—and particularly the devolved governments with their wide spending and tax powers—from subsidies that have knock-on effects elsewhere in the UK. It is easier to rely on a rules-based system, with an independent arbiter, to control what the Scottish government can hand out to favoured sectors than it would be to rely on UK ministers issuing orders from Westminster.

But the heart of the answer (which the proposals simply ignore) is that the EU has made it clear that it will insist on retention of state aid controls as a condition of doing any trade deal with the UK (a point I explored in more detail here).

The EU’s determination to make sure that the UK stays within the state aid framework is shown by the startling provisions in Article 10 of the new Northern Ireland protocol to the current Withdrawal Agreement, accepted by the Johnson government without apparent demure (or perhaps without even realising, in the rush, what it had agreed to). That Article keeps the United Kingdom fully bound by the EU state aid rules—including enforcement by the Commission and Court of Justice of the EU—to the extent that any UK measure is a state aid that affects trade between Northern Ireland and the EU. That means that any general UK tax measure extending to Northern Ireland that favours a particular sector will almost certainly be subject to prior approval by the Commission, subject only to an appeal to the Court of Justice. But the control goes further: any UK government measure that affects Northern Ireland—for example a grant to an English company with significant Northern Ireland operations—may well, because of Article 10, fall under the Commission’s powers.

So there are two fundamental problems with the Conservatives’ approach.

– First, returning to the claimed objective of increasing clarity and simplicity, one has to wonder how operating two parallel systems (the new system in all cases, state aid where Northern Ireland is in issue) can be described as clear or simple. On the contrary, it looks like a sure recipe for complexity and muddle.

– Second, and perhaps most importantly, it creates a major road block in the way of the Conservatives’ already unrealistic promise to reach and ratify a final relationship agreement with the EU by 31st December 2020. Rather than offer to maintain the EU state aid rules, it looks as if the Conservatives plan to try to sell to the EU a new, unclear and untested system. That is not going, to put it gently, to be an easy sell: it will, with the most favourable winds, take time. And the Conservatives’ commitment not to extend the transition period means that time is precisely what they will not have.

So, the Conservatives’ plans for apparently major change in the UK’s controls on subsidies risk getting the worst of all worlds: making the task of negotiating a deal with the EU much more difficult, reducing clarity and business certainty, and not actually changing very much at the end of the day. When they realise that, and in the face of likely hostility from the EU, the best guess is that these proposals will be quietly dropped. But in the meantime they may well have achieved their immediate object of appealing to left-wing Brexiteers and erstwhile Labour voters who (usually for bad reasons) object to the state aid rules on principle and who regard getting rid of them as one of the important aspects of Brexit.

This article first appeared in Prospect Magazine. An edited version was also published in The Telegraph.