State aid control and competition: the balancing act performed by European authorities (Note)

Purpose of the article: This note focuses on the relationship between the European authorities’ control of state aid and the desire for neutral competition within the internal market. It aims to provide a better understanding of how the state aid regime has evolved in response to the challenges posed by the Covid-19 crisis and the ecological transition.

Summary:

• Beyond protecting EU competition, European state aid regulators have gradually changed their approach to monitoring in order to better take into account the potential positive effects of state aid for member states.
• In response to the Covid-19 crisis, European authorities have relaxed state aid rules, leading to a significant increase in public aid to businesses. Already very uneven before the crisis, the unequal distribution of this aid among member countries has been exacerbated since the recessionary shock. For several economists, this observation suggests the occurrence of risks of competition distortions in the longer term.
• State aid is an essential part of the ecological transition. It is therefore incumbent on the European authorities to ensure that the state aid regime is as adaptable as possible in order to achieve the objectives of greening the economy. However, several regulatory challenges still need to be addressed.

According to the Ministry of Economy, Finance, and Recovery, « aid includes all forms of direct financial benefits, such as capital contributions, the provision of commercial and logistical assistance, or indirect benefits that reduce the normal costs of businesses: tax or social security exemptions, guarantees, and debt-to-equity conversions.« 

Given that they affect economic relations between European countries, aid from Member States to their companies can distort competition by favoring certain companies over others. To this end, the European authorities play a key role in regulating the latter within the European area. However, several studies have demonstrated the positive impact that such aid can have on European Union (EU) member states, as it acts as a crutch both when the market fails and in times of economic crisis.

The European Commission (EC), the main regulator of state aid, is therefore performing a balancing act: preserving a pro-competitive regime while ensuring flexibility in the regulatory framework to mitigate socio-economic damage in times of crisis (part 2 – Covid-19) and in the longer term (part 3 – ecological transition). European countries are striving to gear their policies more towards strategic objectives such as « green » transformation (notably France with the introduction of « environmental budgeting »[1]). This raises the question of whether European state aid control policy, in its current form, is appropriate in view of the challenges posed.

1. The link between state aid control and competition policy

1. From an antagonistic view…

Several traditional arguments against state intervention in the economy are worth mentioning (Aghion et al. 2011).

• The first argument is that, through state aid, governments undermine the market’s role in effectively selecting « winners. » This risks government aid allocation being suboptimal and subject to errors of judgment. For example, the windfall effect means that, even without public aid, the benefits of public policy would still have been realized. It reflects poor targeting or errors in the operationalization of public policy (e.g., conclusion of the evaluation report on the Research Tax Credit (CRI) by France Stratégie[2]).

• A second criticism highlights the risk of rent-seeking induced by state aid. Thus, state decisions would appear to be contrary to the objective of competitive neutrality within the internal market.

To this end, state aid is subject to strict regulations to ensure optimal competition within the EU market. Unless an exemption applies, Articles 107 and 108 of the Treaty on the Functioning of the European Union (TFEU) establish the principle of prohibiting state aid within the EU market[3].

1. … to a complementary vision

However, the European authorities’ view of state aid control has evolved significantly in recent years. Whereas previously the focus was solely on the negative effects that such aid can have, the European Commission has now relaxed its policy with the aim of gradually incorporating the positive effects of state aid for European countries into its control activities.

A multitude of econometric studies seek to highlight the positive effects of this aid on a range of economic variables, without undermining the principle of competition. According to Aghion et al. (2012), public subsidies allocated to competitive sectors have a positive and significant impact on multifactor productivity growth[4]. In the absence of industrial policy, companies may be tempted to operate in sectors where they face the least competition, leading to high sectoral concentration and low incentives to innovate. To this end, industrial policies that encourage companies to be active in the same sector (tax exemptions, etc.) would reduce concentration in less competitive sectors and strengthen incentives to innovate and thus the productivity of companies. This study therefore challenges the antagonistic view outlined above.

At the European level, analysis of the relationship between product market regulation (Nicoletti, Scarpetta 2000) and state aid accepted by the European Commission confirms this observation within the EU market. The Product Market Regulation (PMR) indicator is measured on a scale from [0] to [6], from the most competition-friendly regulatory regime (no regulatory barriers to competition) to the least favorable regime (significant regulatory barriers). We can see that state aid relative to GDP remains correlated with a low PMR value (Figure 1). In other words, when state aid accepted by the EC increases, regulatory barriers to competition within European countries do not increase accordingly. This can be explained by the fact that, before being approved, aid allocations are subject to assessment by the European authorities to ensure that they are compatible with EU competition rules. Conversely, countries with greater regulatory barriers to competition are those with the lowest relative aid-to-GDP ratio.

The challenge for the European authorities is therefore no longer simply to prohibit state aid, but to strike a balance between controlling aid and controlling competition in order to benefit from the positive effects of their complementarity on economic variables (growth, innovation, etc.).

Figure 1: Correlation between EU countries’ state aid expenditure (as a percentage of GDP) and the PMR indicator in 2019

Source: OECD, European Commission, BSI Economics

In 2013, the European authorities implemented a major modernization reform to refine their decision-making process. Among other things, this took the form of the introduction of a General Block Exemption Regulation (GBER)[5], which in certain specific cases exempts Member States from going through the full European Commission notification process when they wish to allocate aid.

The European Commission’s change in vision seemed necessary in order to adapt its aid control policy to modern challenges:  » promoting smart, sustainable and inclusive growth in a competitive internal market »[6] (see section 3).

1. Divergence in aid allocations between member states

Based on European Commission data, there was significant heterogeneity in state aid among member states prior to the Covid-19 crisis (Figure 2).

Figure 2: Member states’ state aid expenditure (excluding aid to agriculture, fisheries, and railways) as a percentage of their GDP in 2019

Source: European Commission, BSI Economics

It is therefore important to highlight the risk that this poses to competition within the internal market. As a reminder, aid is financed at the national level, which tends to favor European economies with greater budgetary leeway. It should be noted that some countries, with or without budgetary leeway, are nevertheless able to rely on other mechanisms (via guarantee funds, public or development banks, etc.) that allow them to provide public support without falling under the heading of « state aid. »

In the longer term, this intra-European variance could lead to distortions in the internal market, particularly as the crisis comes to an end (see section 2). When a country with a more comfortable budgetary cushion supports its companies in a particular sector, there is a risk that it will indirectly disadvantage competing companies from other member countries that do not receive aid. Given the high degree of interconnection between European economies, it should nevertheless be noted that positive externalities may arise. This is particularly the case when one country (A) allocates public aid and another (B) does not, stimulating demand for goods and services from country A in country B.

1. State aid control in the era of the Covid-19 crisis

2.1) Exceptional relaxation of regulations in response to the recessionary shock…

Like companies in non-European economies, companies in member countries were significantly impacted by the Covid-19 crisis in 2020. The severity of the recessionary shock led to an adjustment of European state aid policy. The European Commission thus adopted a « temporary framework » aimed at ensuring companies’ access to liquidity (European Commission 2020a, 2020b, 2020c)[7]. Member countries were thus authorized to provide exceptional compensation to companies in the most affected sectors (tourism, transport, hotels and restaurants, etc.) on condition that the aid was « necessary, appropriate and proportionate »[8].

The state aid control policy has thus proved to be essential in times of crisis, enabling member countries to equip themselves with the appropriate tools to respond to the shocks faced by their economies (direct subsidies, loan guarantees, credit insurance, etc.). The European Commission’s rapid response has once again confirmed the need for the state aid regime to be defined as flexible rather than a rigid dogma with the sole aim of controlling competition in the European area.

2.2) … requires attention to be paid to the risk of competitive distortions as the crisis ends

The uneven distribution of approved state aid among member states was exacerbated during the Covid-19 crisis[9]. The most advanced member states made more active use of state aid programs to overcome the Covid-19 crisis (see Figure 3).

According to the DG Comp report for 2020, Germany stands out from other member states (>16% of GDP), while the least intensive users of state aid during the crisis to date are Ireland, Luxembourg, and Cyprus, all of which are spending less than 2% of their GDP.

Analysts agree that this geographical divergence does not automatically imply a threat to competition in the internal market. Nevertheless, according to Van Hove (2020), the risk that it will ultimately distort competition on the European market is all the more likely given that the amount of aid remains rather limited in some countries that have been hit very hard by the crisis (e.g., Romania and Hungary). Companies in these economies may be at a greater disadvantage than their competitors from countries that have allocated more aid in response to the crisis.

The crisis exit strategy ultimately appears to be essential:

• Withdrawing aid too quickly could lead to the bankruptcy of certain companies and thus further weaken competition by increasing concentration in certain markets.
• Conversely, the risk of withdrawing public aid too late may make certain companies dependent and undermine their competitiveness and incentive to innovate. Motta and Peitz (2020) also point out that, in the long term, the generous allocation of public aid during the crisis could harm productivity within the internal market by creating « artificially more competitive » companies in certain countries. These companies could simultaneously relegate « equally or more efficient rival companies » from other Member States to niche markets or force them out of business.

Figure 3: Link between COVID-19-related state aid (as a percentage of GDP) and the economic damage caused by the first wave of COVID-19.

Source: Van Hove (2020)

1. The state aid regime and environmental objectives

State aid is an essential part of the ecological transition. Beyond controlling competition, it is therefore incumbent on the European authorities to ensure that the regulatory framework is as adaptable as possible in order to achieve the objectives of greening economies.

To date, the environmental conditionality of aid remains at the discretion of member countries. As a result, state aid expenditure on environmental protection and energy savings varies greatly between EU countries (Figure 4). According to a European Commission report[11], Germany (1.1% of national GDP), Denmark (0.9% of national GDP), and Malta (0.9% of national GDP) spent the most in 2019, while Spain, Italy, and Portugal devoted less than 0.2% of their GDP to this area. According to Hermet and De Francilieu (2020), without the introduction of strict conditionality, these countries risk « losing sight of the European objective of greening the economy. »

Figure 4: State aid expenditure on environmental protection and energy saving by member country, as a percentage of national GDP in 2019

Source: European Commission, BSI Economics

Furthermore, according to the same report, 78% of state aid expenditure on environmental protection and energy savings was notified, while only 22% followed the procedures laid down in the General Block Exemption Regulation (GBER). In response to this finding, on July 23, 2021, the European authorities adopted the extension of the scope of the GBER to certain state aid measures aimed at the ecological and digital transition in particular[12]. This development constitutes a significant simplification, as it will, in principle, enable faster implementation of these « green » measures by EU member countries.

In addition, another important element of the EU’s state aid framework is the Community principle of « technological neutrality. » This concept implies that European authorities must not favor the use of one technology over another when deciding whether or not to accept aid from countries. The reason behind the application of this principle is to ensure fairness between Member States and thus protect competition.

However, according to Renda and Sipiczki (2021), its application does not fully take into account the specific characteristics of the renewable energy sector and may hinder the achievement of the Green Deal’s ambitions. According to the authors, the application of this principle may lead to the continuation of various forms of fossil fuel production, or even to the disappearance of « clean » energy technologies which, without the continued financial support of member countries, would already have disappeared from the market. Consequently, the state aid regime and the principle of technological neutrality require « a reassessment in order to promote the deployment of green technologies. »[13]

Conclusion

Ultimately, while it is incumbent upon the internal market regulators not to lose sight of their mission to ensure competition, the flexibility of the state aid control framework has enabled Member States to respond quickly to the severity of the Covid-19 crisis.

This result demonstrates the gradual evolution of the European Commission’s vision, which aims to take greater account of the positive effects that state aid can have, particularly in times of crisis.

However, attention must be paid to the significant heterogeneity in the allocation of public aid, which has been exacerbated during the crisis (particularly aid targeted at environmental protection and energy savings).

For the time being, the aid control regime still leaves it to the discretion of Member States whether or not to allocate their aid to climate action. This leads us to question the optimality of the current regime in its ability to promote collective efforts to achieve the greening objectives of European economies. In response to this observation, several economists are calling for an EU-funded aid program, with a particular focus on the energy sectors.

Bibliography

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