What role might state aid play in a post-Brexit UK economy?

The fact that State Aid has emerged as a key stumbling block on the way to a Brexit has come as a surprise to some commentators. After all, the UK has not been a particularly keen user of State Aid provisions and gained considerably from the application of State Aid rules in sectors where the UK privatised early in the 1980s and sought to exploit the Single Market against many Member State enterprises.

The role that State Aid might play in a post-Brexit UK economy was previously a relatively small part of the Brexit debate and largely confined to the fringes of the Lexit (Left Brexit) community, who saw the potential to cast off State Aid provisions and use the State to rebuild the UK’s manufacturing base anew. While this position had its supporters, notably in the previous leadership of the Labour Party, it never really gained significant traction.

So why is State Aid now turning out to be such a problematic issue under a Conservative-led Government? Two developments have helped changed the situation. First, those areas of the country most likely to long for a rebuilt industrial base – the socially conservative and economically Statist so-called “Red Wall” across the North and North East of the country – switched to vote Conservative in the last UK general election. While this gave the Conservatives a Government majority, it also gives them a headache in balancing the demands and needs of enormously disparate voting blocs.

The second factor that has changed the dynamic significantly is the response required to the latest coronavirus pandemic: the State has stepped back in. The UK, like every other advanced economy, has had to put in place and maintain a massive platform of State spending and support across the entire economy. The term “unprecedented” has been thrown around a lot during this crisis, but it does apply here. The most recent parallel, the bank rescues and quantitative easing during the financial crisis of the 2000s, now pales into insignificance in terms of the breadth and impact of the State intervention.

Thus, as the deadline for a UK-EU trade deal approaches, the UK is in the unusual position of having a governing party that has of necessity gained a taste for State intervention, while having a significant new bloc of voters who rather like such intervention.

The newly aligned voting blocs also highlight perhaps the most important aspect of the State Aid discussions. State Aid focuses on financial or tax benefits accorded unfairly to an enterprise in a manner that will distort trade within the single market. Yet the EU is not the only single market. The UK is itself, after all, a single market of four constituent parts. Those constituent parts are all governed by a complex mix of devolved and reserved local and UK centred powers. The fact that each has some control of taxation, and will push for more, and has significantly different electoral expectations and political cultures – indicating that State Aid is not just a UK-EU problem, but also an intra-UK problem.

If one views the UK as a single market, what becomes apparent is that Scotland, Wales and Northern Ireland are economically more like New Zealand than they are like Southern England. They share economic structures with areas of the North of England, but not with the Midlands, which economically is more like Germany, or with London, whose economic structure is more like a Hong Kong or Singapore. This aspect of the “level playing field” will only grow in importance.

Northern Ireland has already been effectively hived off under the terms of the UK-EU withdrawal agreement as a semi-independent state for customs purposes, while Scotland is moving further away from England almost by the day. With health policy and expenditure a devolved matter, the Covid19 crisis has empowered and emboldened the devolved administrations. If the UK government sees the UK single market as the English single market, with troublesome fringes, the likelihood of significant upheaval cannot be underestimated. Scottish independence efforts will grow and Welsh independence will seem more attractive to residents.

The UK Government is bringing forward legislation to map out how it views the UK single market. It has floated the desire to remove barriers and retain power over State Aid within the UK to an as yet un-named branch of the UK Government in London – with the current administration being silent on whether this will be the Competition & Markets Authority (CMA), as had previously been stated. The centralisation of power in London is possibly an inevitable result of Brexit – and there are clearly influential figures within the present Government to whom having any constraints over this, let alone being legally tied to the EU State Aid regime, is unacceptable in principle.

Yet this runs counter to the general trend to devolved powers within the UK. Indeed, the current Government has made much of the “left behind” – devolving power, possibly departments of state and even the House of Lords, to the “regions”. Northern Ireland is a separate case, as under the Withdrawal Agreement it is tied into the EU State Aid regime for all intents and purposes. Given this complex web of problems, calling where the UK-EU discussions is going to be difficult.

The UK is now a third party from an EU perspective. I am not sure that, even now, the UK political community has fully understood this, particularly in terms of seeking continued access to the EU single market. The EU is used to discussing State Aid and other “level playing field” provisions with countries that are either seeking to join the EU, or seeking to enmesh their economies with the existing EU. No one has ever previously tried to extricate themselves from the EU regime – and this makes the standard options difficult to apply.

The EU is used to offering a “rule taker” option to applicants; where the negotiating partner essentially takes on board EU rules and applies them as if they are a Member State, without being one (Ukraine), or they offer some complex web that allows the EU final say, with minor changes (EEA). In all cases, the EU has the final say, and the rules are those of the EU. On the surface it therefore appears there is little room for manoeuvre.

The latitude for bespoke solutions is also undermined by other areas of policy. The EU, as any negotiating partner, takes a holistic view of what its negotiating partners do and say in related areas of policy. The apparent zeal in the UK government for WTO rules is, if anything, likely to raise more State Aid concerns than calm them. The desire to rely on the subsidy agreement only applies to goods, a small part of the UK and EU economy, and the Government Procurement Agreement covers only, well, government procurement.

From an EU perspective a UK economy with an ability to support service sectors while still accessing the EU procurement market is the stuff of nightmares. A loose application of a level playing field would allow the UK to create an offshore Tax Haven on the Thames, while at the same time developing a Mittelstand in the Midlands. Such a concern is deeply embedded in the State Aid worldview that, over time, has become increasingly complex and nuanced.

The recent focus on the use of tax policies to attract and benefit large multinationals by smaller Member States has particular resonance in a UK environment. The pre-Single Market wave of foreign investment into the UK economy, the tariff wall hopping of Nissan, Honda and the like, was used to target investment into smaller component parts of the UK itself, the areas with a declining industrial base. The fears the EU has with Ireland and the Netherlands are the fears the UK Government will have with Northern Ireland, Scotland and Wales.

State Aid matters accordingly both to the integrity of the EU single market and to the integrity of the UK single market. The latter problem may well end up being more difficult to solve than the former. In the case of the UK single market, the UK cannot fall back on a firmly established base of legal agreements and structures that exist in properly Federalised States, like the United State and Canada – although even there, both have very strong competition between States for investment with no real structures that allow them to control it.

The UK has been moving towards a more federalised structures, with Scotland and Northern Ireland in the vanguard and Wales and the English regions following some way behind. The question is whether State Aid controls will mirror this proto-federalised settlement, or seek to ignore it by reserving powers solely in the UK central government, as the current administration seems to be intending.

Either route offers political and economic peril of two main types: how are decisions made, and who makes them. If the more federalised route is chosen, there is the risk that Welsh and Scottish administrations will seek to offer aid to their relatively narrow industrial or agricultural bases that will not be available to farmers or industries on the other side of an invisible border. Hill farmers in Brecon or the Highlands may get transport subsidies that will not be available to farmers in Herefordshire or Northumberland. The tourism sector in Welsh and Scottish coastal communities may seek aid not available to their English counterparts.  

If the UK negotiates a US FTA and increases pressure on the agricultural sector, this example will emerge quickly. And what happens to a company like Airbus? It currently has 25 sites across the UK, with notable locations in Scotland and Wales. If, as seems likely, it will seek to retrench, what is to stop the Scottish and Welsh governments giving sweeteners to keep the investment in their locations and sacrifice English sites, or indeed vice versa?

Under proto-federalised or decentralised structures, decisions will be made by those closest to the problem, but what appeal or oversight mechanism will there be to ensure “beggar-thy-neighbour” decisions are not made? Under a centralised structure, decisions are made far away from the problem (in most instances). In such cases how do affected communities influence decision-makers? It is perhaps not a surprise that the initial clarity that State Aid powers would go to the CMA has become more clouded. As the scope of the problem has become clearer, so has the fact that any body making State Aid decisions will be deeply mired in tense and controversial political decisions against a base of specific and framing law that is far from settled and far from firm.

UK Ministers are nonetheless likely to want some form of buffer to allow them to take the bulk of the decisions while sharing out the responsibility among a broader range of bodies. Given this, it is difficult to see how the CMA can avoid being dragged into the process. However, that role may be limited to assessing whether actions by local and national authorities are consistent with the law.

Whichever body helps oversee the process may get State Aid units in each of their devolved offices, a bit like the Cartel Units or Phase II investigation teams that operate within the CMA: legally part of the CMA, but functionally separate for the purposes of making decisions. Recommendations would then be made to a Secretary of State or perhaps a Star Chamberesque committee of Ministers with responsibility for devolved administrations and UK economic policy. Of singular importance would be whether the devolved administrations are consulted only at the investigations level, or directly involved in that Star Chamber, or “represented” by Ministers based in London for any final decisions.

If the UK can work out its own internal Single Market problems, it may be able to negotiate an agreement with the EU. Doing both at the same time seems a tall order, and doing it within six months seems challenging. While most indicators seem to point to some sort of irrevocable rift with the EU on State Aid, the tradition of muddling along and cobbling together largely hidden workarounds is a strong one, for both sides. If there is a rift, then it is more likely the UK will seek to minimise friction on State Aid by offering some sort of parallel regime, with cordial discussions in the place of solid legal structures.

This is a significant gamble of course. The EU likes solid legal regimes and likes structures it can fall back on. Many on the EU side do not see the UK as a trusted interlocutor and if a rift does occur it will have burned many of the bridges it has sensibly to negotiate over. In such circumstances, the UK may be relying on the hope that it can win some sort of staring contest with the EU, with the latter waiting for the UK to do something wrong before it acts. To say this is a dangerous path is an understatement of some magnitude, but at this stage looks worryingly plausible.