The UK needs to explore compromises on state aid

As UK–EU future-relationship talks start up again this week, both sides need movement if they are to avoid the same result as last week. Nowhere is this more the case than on the big issues of the ‘level playing field’ – and specifically, on the rules governing state aid and their enforcement.

While the EU’s chief negotiator, Michel Barnier, has hinted at a compromise on the EU side,[1] recent suggestions for a 'middle way' have been seemingly rejected by his UK counterpart, David Frost. The UK has put forward no alternatives. It may well be too early for the UK and the EU to show their hands in full, but the UK needs to signal where the space is to negotiate.

Both sides’ current positions are likely to be untenable

The EU’s position has been that if the UK wants preferential trading terms, it must adopt EU state aid law to constrain the use of government subsidies, and accept the jurisdiction of the European Commission and the European Court of Justice (ECJ). This is to guard against the UK subsidising businesses in ways that damage firms in the EU. The UK is instead proposing that the two sides rely on the World Trade Organization’s – much weaker – Agreement on Subsidies and Countervailing Measures.

Barnier has indicated the EU might soften its demands, specifically with regard to the role of the ECJ. After all the UK has a point: to accept the authority of EU institutions when no longer a member of the single market or customs union would be an unbalanced arrangement. But for the EU, the WTO offer is too far the other way. It does not, for example, restrict government subsidies to the service sector (which state aid law does), and its system for resolving disputes is largely ineffective (due to the US’ blockade of the system for resolving disputes).

Lastly, though the UK claims it is asking for an ‘off the shelf’ free-trade agreement – that is, one based on deals the EU has with Canada or Japan – the reality it is asking for better terms than either on trade, while offering the same on subsidies. This is not lost on the EU. If the EU is prepared to move its position on the ECJ, the UK should be prepared to show willing, too.  

A ‘middle ground’ has been suggested

One compromise mooted would see the EU drop its insistence that the UK adopts EU rules and the jurisdiction of EU institutions on the condition that the UK sets up a similar enough system to self-regulate its own use of subsidies. The UK could still choose to diverge from that arrangement, but were it to do so the EU would be able to impose tariffs or suspend other parts of the UK–EU trade agreement.

Both sides gain something, politically, from such an agreement: the UK gets its much-prized autonomy; the EU can say it has secured meaningful commitments. But the details could derail the proposal. Imposing tariffs is a standard tool of trade policy when one side has broken the rules – but it is a blunt deterrent.

It is also complex. Any deal would need to address what level of subsidy would be permitted without the EU resorting to tariffs. There is likely to be a big dispute here. In the WTO system, a country needs to actively prove a subsidy has negatively affected its trade; the EU’s bar for what qualifies as ‘banned state aid’ is much lower.

The proposed remedy itself – tariffs – would also be likely to cause problems. Imposing tariffs on UK imports would create costs for the EU, raising the price of goods for EU businesses and consumers, so in each case, the EU would need to weigh up whether imposing tariffs was worth it.

The proposal is still a step in the right direction

Without some movement on both sides, the UK and EU’s current negotiating positions are incompatible. The two sides are moving towards a no deal that would have major economic costs for both, and would remove the ability to influence what subsidies the other offers completely.

Any compromise will have problems. But those must be weighed against the importance of the trade relationship to both. The EU must ask itself: is it likely that the UK will ‘out-subsidise’ the EU, either as a whole or in comparison to member states? The UK must ask itself: does it really want to extend business subsidies beyond the sorts of schemes currently offered elsewhere in the EU?

If the answer to these questions is no, a system that allows the UK to enforce its own anti-subsidy system should not be written off by the UK.