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A Better Alternative to the EU State Aid Regime

brexit liberty
Written by David Collins

Professor David Collins describes a way out of the current stand-off between the UK and EU on the issue of state-aid rules for subsidies to private firms. The EU wants to lock the UK into their regime but WTO rules on subsidies are a better way forward, especially if a UK:EU free trade agreement incorporates suggested reforms to the WTO rules.

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The EU has not articulated a reasonable justification for the insistence on the UK retaining “level playing field” obligations in relation to state aid as specified in the Northern Ireland Protocol. Nor have they explained why they are not satisfied by existing international regimes for government support of the private sector.

Specifically, it is not clear why the WTO Agreement on Subsidies and Countervailing Measures (SCM), to which the UK is bound as a Member of the WTO is not sufficient to address competitive distortions resulting from subsidization. Once the UK fully leaves the EU it becomes a foreign country after 31 December 2020 It will be bound by the SCM irrespective of a whether an FTA with the EU is concluded. The SCM should be able to deal with any trade-distorting subsidies which the UK may seek to use to the detriment of EU companies or those from anywhere else.
It must be recognized that EU state aid law is designed to deal with distortions within the Internal Market. It is therefore focused on competition – how a country creates a level playing field amongst its own companies operating within its own domestic market for the benefit of consumers. EU state aid law has no place in an FTA with an independent country.

This is a serious concern because, under the provisions of the Northern Ireland Protocol, the EU’s state aid rules arguably extend to the entirety of the UK. The limitation on the scope of application of the EU’s state aid regime is not by reference to the geographical location of aid recipients, but solely by reference to whether the aid, wherever it is given, may “affect” trade under the Protocol. This represents a potentially severe and ongoing restriction on the capacity of the UK government to support its economy. It is an encroachment on UK sovereignty which may have been underappreciated at the time.

In contrast to state aid, subsidies are about international trade and necessarily involve commitments enforceable under international law, such as is contained in FTAs or the WTO Agreements. As soon as state support distorts the prices of a good on international markets, the WTO’s SCM operates. However, there is an argument to be made that the SCM in its current form is deficient. Indeed, in a Joint Statement from the Trade Ministers of Japan, the US, and the EU (made in January 2020), the three countries outlined ways to strengthen WTO rules on subsidies.
Specifically, they suggested that:

The current list of prohibited subsidies provided for in Article 3.1 of the SCM is insufficient to tackle market and trade distorting subsidization existing in certain jurisdictions. Therefore, new types of unconditionally prohibited subsidies need to be added including: unlimited guarantees; subsidies to an insolvent or ailing enterprise in the absence of a credible restructuring plan; subsidies to enterprises unable to obtain long-term financing or investment from independent commercial sources; and certain direct forgiveness of debt.

The proposal also noted that certain types of subsidies have such a harmful effect that they warrant a reversal of the burden of proof so that the subsidizing Member must demonstrate that there are no serious negative trade or capacity effects. This would include things like excessively large subsidies; subsidies that prop up uncompetitive firms; subsidies creating massive manufacturing capacity without private commercial participation; and subsidies that lower input prices domestically in comparison to export prices.

The EU (along with the US and Japan) also complained that the current rules of the SCM do not provide for any incentive for WTO Members to properly notify their subsidies. This may explain why the notification for subsidies through the WTO has been quite poor. Accordingly, they recommend non-notification resulting in the presumption that the subsidy is prohibited.

The three countries were also disconcerted that the current rules of the SCM are insufficiently prescriptive when it comes to the determination of the proper benchmark for subsidies when ascertaining things like the provision of goods or services or the purchase of goods by the government. They want the SCM to be amended to describe the circumstances in which domestic prices can be rejected and how a proper pricing benchmark can be established, including the use prices outside of the market of the subsidizing Member.

Finally the EU, Japan and the US want greater clarity regarding what constitutes a “public body” under the SCM. They agreed that the interpretation of “public body” by the WTO Appellate Body in several reports undermines the effectiveness of WTO subsidy rules. Many of these recommendations bear close consideration and the UK may wish to take this up at the WTO at some point in the future. More importantly from the perspective of EU relations, to the extent that these complaints explain why the EU does not see the SCM as good enough to discipline the UK’s use of subsidies, why not simply put these recommendations into the text of a subsidies chapter of the new EU-UK FTA? There is no reason to insist on the UK sticking to EU state aid law when a subsidies chapter in an FTA could achieve this.

In fact, the EU has already done this with the Subsidies Chapter in the EU-Japan Economic Partnership Agreement (JEPA). The JEPA has a detailed subsidies chapter that addresses some (but not all) of the concerns noted above – in fact, much of the three-party statement by the US/EU/Japan alluded to above is repeated verbatim. There is material on improved notification, greater clarification of what constitutes an injury and an expanded list of prohibited subsidies. There is also room for subsidies aimed at addressing national emergencies, potentially covering matters such as disease pandemics.

It should be noted that the UK’s Draft EU FTA contained a subsidy chapter with enhanced notification material, but there was not much else. This is an area where the UK could be, and should be, prepared to concede more, perhaps along the lines of the reforms suggested above or including material such as contained in JEPA or the Comprehensive Economic and Trade Agreement (CETA) with Canada, mostly dealing with improved notifications and other clarifications. This need not include oversight of the European Court of Justice, which neither the CETA nor the Japan agreements do.

As a final point, one of the missing elements from the WTO’s SCM is that it deals with trade subsidies, not investment ones. In particular, it does not cover investment incentives. After all, the WTO is a trade body, not an investment one. There are no global rules on investment incentives, something which the WTO might turn its attention to at another time.

However, there are non-derogation obligations in modern FTAs. These are found CETA and JEPA, for example. Here signatories promise not to lower their standards on issues such as labour / environment and so on in order to attract investment. These provisions could be extended to curtail subsidies offered to foreign firms to attract them into the UK. Such incentives tend to be economically inefficient anyway, so signing up to a bilateral system for the control of such measures would make sense. Again, these rules need not have ECJ oversight, but rather conventional dispute settlement through a binational arbitration panel.

To conclude, it seems as though the real reason that the EU will not include such material in an FTA is because they seek to exploit what may have been a strategic error on the part of the UK in committing to keeping EU state aid rules in the Withdrawal Agreement. In other words, the EU is less interested in controlling trade-distorting subsidies than it is in retaining a significant degree of oversight over the UK economy.
On the other hand, subsidies may be an area where the UK and the EU can cooperate in terms of agenda setting at the WTO, especially in light of the US’s current lack of leadership at the global level. A robust subsidies chapter in the UK-EU FTA accommodating some of the issues discussed above which were raised by the EU, the US and Japan could lead the way in subsidies reform multilaterally. In that sense, the current tension between the UK and the EU over the level playing field and state aid could be viewed as an opportunity to be seized.

David Collins is Professor of International Economic Law at City, University of London

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David Collins