The Limitations of EC State Aids Control
Alberto Heimler and Frédéric Jenny*
Abstract
The European Union is one of the few jurisdictions in the world that has introduced specific
provisions for the control State aid. As a result European firms, constrained in their ability to
receive State aid, may be at a competitive disadvantage with respect to outside competitors. A
case can be made to extend to all jurisdictions a similar discipline, contributing to the
creation of a level playing field in the world economy. While existing WTO provisions against
State aid can be applied when subsidies affect exports only, a very rare event, European type
provisions are much more general. However the effectiveness of legal provisions depends very
much on the way they are enforced. To this end the role of economic analysis as an
interpretative tool is very important. And indeed the objective of the 2005 State Aid Action
Plan was to enhance the role of economic analysis in State aid policy. Unfortunately the
Commission did not go as far as suggesting that distortions of competition be noticeable
before a State measure is declared incompatible. As a result, EU policy continues to be over
extensive addressing cases where the distortions of competition are minimal. This is
particularly the case for restructuring aid, where the restoration of the healthiness of the firm
is the final objective of the aid. However in these cases, and recent decisions taken as a result
of the financial crisis confirm it, the Commission uses competition type considerations only to
overcome moral hazard by attaching a number of intrusive conditions to its authorization
decisions (prohibition of reducing prices before a competitor does, introduction of capacity or
sales caps, merger prohibitions, managers salaries caps, etc). Very often these conditions
reduce, not increase, the possibility of these companies to successfully restructure. Moral
hazard can only be eliminated by not allowing the aid, by limiting the aid to what is strictly
necessary or by making it sure that it is a once and for all option, not by constraining the
company from competing.
1. Introduction
The desirability of maintaining a competitive environment and introducing competition
oriented reforms is not diminished by the recent economic crisis. Contrary to common
wisdom, competition operates asymmetrically. It is pro-cyclical in periods of high growth, but
anti-cyclical in a crisis, the reason being that the opportunities created by greater competition
depend on the state of the economy. Therefore the effects of a given liberalization measure are
not expected to be the same in good and bad times. New initiatives are associated with
investment and at times of a crisis investors are much less optimistic. As a result, the degree
of new entry is much weaker in bad times and the speed by which inefficient producers leave
the market is much reduced. Investment however is higher than otherwise because of the new
opportunities created. Furthermore, once the economy picks up again, the more liberal rules in
place make it possible to immediately benefit from the changed economic outlook.
*
Scuola superiore della pubblica amministrazione Rome and ESSEC Paris respectively.
1
However, in the political debate on regulatory reform the effects of a liberalization measure
are supposed to be felt immediately, as if the state of the economy or the investment lag
would not matter. As a result, the destructive effects of competition are way overemphasized,
while creation is very much downplayed, also because the beneficiaries of regulatory reform,
often the new entrants, may not be in the market yet and have great difficulties in being heard
or being listened to.
This is why European wide liberalization are so important: domestic protectionist coalitions
are less likely to be successful when liberalization is decided centrally.
European pro-market instruments are numerous and a free trade regime would not have been
effective in creating the competitive environment Europe enjoys. The treaty guarantees within
the Union the respect of the four fundamental freedoms, i.e. the free movement of goods,
services, labor and capital, it introduces antitrust provisions and it impedes anticompetitive
subsidies. All these provisions are necessary to address private and government restraints that
segment national markets, thus potentially undermining the common market. No other
international organization or even no other sovereign country has a similar portfolio of
instruments aimed at achieving an integrated market.
While all these instruments are clearly beneficial in an expanding economy, there are doubts
often raised about them being appropriate at the time of a crisis. Jenny (… ) argues the
opposite with respect to antitrust provisions suggesting that they should be rigorously
enforced also at the time of an economic downturn. Heimler (2009) suggests that the drive
towards liberalization should not be weakened at the time of a crisis. The point of this paper
is that also State aid provisions should be applied rigorously at the time of the economic
crisis, completing a reform process initiated in 2005 and directed towards making sure that
economic analysis finds its way into European State aid control.
The paper starts with a brief discussion on the economics of State aid and on the reasons why
State aid control is necessary. It continues with a description of the EC regime and the general
approach taken with respect to restructuring aid. Section 4 describes the new development
that have taken place in the recent financial crisis, while section 5 concludes.
2. The economics of State subsidies
The economics of state aid is related both to public interventions and to strategic trade theory.
The international trade policy literature advocates free trade as an optimal policy under
competition (Bhagwati 1988). Brander and Spencer (Export subsidies and international
market share rivalry, Journal of international Economics 1985) however suggested that
imperfect competition gave a rationale for export subsidies because they can improve the
relative position of domestic firms in non cooperative rivalry with other firms, and allow them
to expand their market shares. The resulting expansion of exports can actually raise domestic
welfare by shifting profits from foreign firms to domestic firms. The strategic trade literature
expands on this view by looking at a number of oligopolistic situations and suggest that if the
subsidy is granted to a winner the rent shifting effect is likely to be greater than if the subsidy
is used to shore up a loser ( P Neary, Cost asymmetries in international subsidy games: should
governments help winners or losers?, Journal of International Economics, 1994). One of the
features of rent-shifting strategic trade policy oligopolistic models is the prisoners’ dilemma
faced by each government. Although each government has an incentive to cheat on any
agreement not to use subsidies, governments would be better off cooperating to agree not to
use such subsidies. However as some authors have pointed out ( cf for example, Armanda
2
Jose Garcia Pires, Losers, winners and prisoners dilemma in international subsidy wars,
CEPR discussion paper 5979, 2006) this is not the case if there are competitiveness shifting
effects associated with the subsidy and asymmetric competition. If, for example, one firm has
a first mover advantage in R&D, R&D subsidies can affect the innovative behavior of the
loser and therefore its competitiveness; R& D subsidies to the loser may turn it into a winner
and may increase the welfare of the subsidizing country as well as that of the trading country.
A possible application of such a model would be the Airbus European subsidies which helped
Airbus challenge Boeing.
As a long stream of economists have argued, the implementation of strategic trade policy is
made extremely complex by the fact that the results of any subsidy will very much depend on
the particular circumstances of the industry and the ability of government to assess a great
number of variables and elasticities. No generalization can be made. With this in mind, a
better alternative may be to integrate and promote competition on international markets while
prohibiting state aid or subsidies. This is the direction chosen by the European union to which
we now turn.
3. Why State aid control1
Europe is one of the few jurisdictions in the world that has introduced binding provisions
regulating State aid. In the US, where there is no State aid control, many have argued that
state aid control is not necessary since most subsidies (tax breaks) are meant to induce new
firms to locate in the subsidizing State. The argument goes as follows: since States compete
for firms to be localized in their territory, they should be allowed to offer all sorts of services
and competitive advantages: good infrastructure, good schools, good health services, etc. All
these are not considered State aid, even if they are provided for free. State aid is not that much
different, helping under resourced countries overcome their comparative disadvantage (at
least when State aid is of the form of locational aid)2. There is a market for firms locations
and countries should be able to use all sort of instruments (real and financial) to compete.
This argument cannot be dismissed prima facie and has some value. For example it could be
argued that in the United States where there is no State aid control, individual States operate
under a strict balanced budget constraint and are mostly responsible for their own finances. In
such instances, even if States grant aid to companies, the voting mechanism and the reduction
in the tax base originating from people leaving a bankrupt State can well discipline it, even in
the absence of State aid control at the Federal level.
However the argument is based on the assumption that the length of the political and the
economic cycle is the same. Should it be so, policy makers of a fiscal disciplined State would
not find it attractive to grant ineffective State aid for fear of them not being re-elected.
However, the political cycle is much shorter than the economic cycle and policy makers
maintain a positive incentive to grant an excessive amount of State aid (in comparison to real
advantages) even under a rigorous fiscal discipline. As a consequence, even in those
jurisdictions like the US where individual States operate under a strict balanced budget
For a more comprehensive analysis of State aid policy, see Heimler, Alberto (2010), “European State Aid
Policy in Search of a Standard: what is the Role of Economic Analysis”, in Hawk, Barry (Ed.) International
Antitrust Law and Policy, 2009, Juris Publishing.
1
See, for example, Groteke, F. (2007) Europäische Beihilfenkontrolle und
Standortwettbewerb – eine ökonomische Analyse, Stuttgart, pp. 182 ss.
2
3
constraint, the introduction of State aid control could therefore nonetheless be necessary to
impede an excessive amount of aid from being granted.
This is the more so in Europe. Member States do not operate under a strict balanced budget
constraint and especially now with the common currency any fiscal largesse is transferred to
other jurisdictions, for example as a result of a weaker EUR. The same is true for most local
governments that also do not operate under a strict budget constraint and, in case of need, are
bailed out by their national governments. Free riding can therefore lead to an excessive
amount of State aid. The control of State aid is therefore necessary, even for locational aid.
State aid provisions provide a discipline for member States. In the present circumstances aid
that remedies a serious disturbance in the economy can yes be exempted but only temporarily
and under a strict definition of what is a serious disturbance. The European Court of Justice
can play an active role by further disciplining member States. Nothing of this sort can even be
imagined in the US or in most other countries.
In other words the world as a whole would benefit from the introduction of State aid
provisions. However governments are reluctant to introduce disciplining devices on their
activity, unless they are forced to do so by some international treaty, like it has been the case
in the EC.
The WTO agreements for example contain a narrow definition of prohibited subsidies than
that contained in the EC Treaty: subsidies are prohibited only when they directly aim at
distorting international trade strictly defined. In particular they are always prohibited when
they are granted under the condition that recipients meet certain export targets, or use
domestic goods instead of imported goods. The WTO agreements recognize another category
of subsidies, so called actionable subsidies. These can be prohibited when the complaining
country shows that the subsidy has an adverse effect on its interests. Actionable subsidies are
much more difficult to prove. Under the WTO standard they can be prohibited when they
seriously injure: 1) the importing country domestic industry; 2) rival exporters in a third
country when they compete with a subsidized competing exporter; 3) exporters trying to
compete with domestic subsidized firms.
However, because of a number of difficulties associated with the enforcement of these rules
(what is a subsidy? What is a serious injure, etc.), the regulation of domestic subsidies in the
WTO system is still controversial and more of an exception than a rule. For example, as
Evenett (2007)3 recalls, four very poor African countries complained at the Ministerial
Conference held on Cancun in September 2003 that cotton subsidies were depressing the
world price of cotton and adversely affecting the livelihood of many of their citizens and
demanded action on the part of the United States, one of the major market players in cotton
and a heavy subsidizer. The reaction from the US delegation to such requests was to
encourage diversification of the four African economies concerned, rather than offering to cut
or even contemplate cutting the subsidies in question.
What this example shows is that the question of the way subsidies are treated in the WTO
agreement is still not solved, irrespective of the statement by WTO ministers at the Doha
Ministerial Meeting in November 2001, that "In the light of experience and of the increasing
application of these instruments by Members, we agree to negotiations aimed at clarifying and
improving disciplines under the Agreement on Subsidies and Countervailing Measures"
(paragraph 28 of the Doha Ministerial Declaration).
3
See Evenett, Simon (2007), “The trade startegy of the European Union: Time for a rethink?”, mimeo.
4
A more thorough regime along the lines of that contained in the European Treaty would be
much more appropriate even in the WTO system. In such a regime State subsidies would be
prohibited if they are anticompetitive and they affect international trade. The link with exports
would be much more indirect. States would be subject to a strict control over State aid and the
race towards subsidies that has characterized many declining industries (for example ship
building) in the past decades could have been avoided.
4. The EC policy on State aid, the optimal institutional setting and the new economic
approach
Article 107, paragraph 1, of the Treaty on the functioning of the European Union defines the
incompatibility of State aid with the common market:
“Save as otherwise provided in this Treaty, any aid granted by a Member State or through
State resources in any form whatsoever which distorts or threatens to distort competition by
favoring certain undertakings or the production of certain goods shall, in so far as it affects
trade between Member States, be incompatible with the common market”.
In order for a measure to fall within the scope of application of article 107, paragraph 1, five
cumulative criteria must therefore be met: 1) the use of State resources; 2) the measure must
confer an advantage to certain firms; 3) the advantage must be selective; 4) the measure must
distort competition and 5) affect trade between member States.
Without going into the details of State aid policy which is beyond the scope of this paper 4, it
is important to underline that the Commission and the European Courts, similarly to what
happened in the field of antitrust, have provided a wide definition of what is an advantage to
firms, defining as State aid not just a financial transfer from the State, but any advantage that
affects directly the budget charges of a firm. Furthermore, given the fact the government
ownership was widespread in Europe (at least until the late 1990's), the notion of State aid
was expanded in order to identify the circumstances when investment decisions in
government owned firms were incompatible with State aid legislation. The main instrument
developed was the private investor principle, introduced already in 19815 , according to which
no State aid is involved if it can be shown that the capital investment by the State would also
have been made by a private investor at market conditions, an easy standard to declare, but a
difficult one to enforce in a rigorous way. For example it is not clear what is the standard of
reference to be applied, the profitability of the additional investment or the overall returns that
the firm achieves otherwise. As von Wiszacker (2002) argues, the problem with the private
investor test adopted by the Commission is that the profitability is calculated with respect of
the addition of capital to an existing firm as if it would be a stand-alone investment. This is
not the right test for a company that the Government already owns. Indeed, “if the new capital
increases the value of the old capital, then the return which the owner achieves overall as the
result of the injection of new capital can be higher than the return which an outsider achieves
from injection of new capital into the enterprise under the same conditions”6
4
5
6
There are a number of textbooks on EU State aid policy. See for example Hancher, L., Ottervanger, T.R and
Slot, P.J. (2006), EC State Aid , Sweet&Maxwell; Flett, J. (2008), EC State Aid Law, Kluwer; Nicolaides, P.
(2008), State Aid Policy in the European Community: Principles and Practice, Kluwer.
Commission decision (ECSC) 2320/81 OJ L228/14 (the Steel Aid Code)
See Von Weiszacker Christian (2002), “Expert economic opinion on reasonable remuneration for the transfer
5
In order to overcome such difficulties, many shortcuts have been identified by the
Commission, for example that when a private investor participates to the capital investment at
the same conditions than the government it is not State aid, a short cut not always appropriate
because the private investor may participate just because of the protection that State
ownership guarantees. The test suggested by von Weiszacker is the only one appropriate.
However the fact that the aid allows a loss making firm to survive is not enough for ot to be
prohibited. According to article 107, paragraph 1, in order for an aid to be incompatible, it is
not sufficient that it favors certain firms or certain activities (selectivity), but it is also
necessary that it distorts competition. However, even if according to settled case law 7 State
aid measures are defined in terms of the effects they produce, not in terms of the objective
they pursue implicitly or explicitly, distortions of competition have always been presumed
from selectivity. As a result in the EU practice State aid decisions are not accompanied by a
market analysis nor by a thorough analysis of the distortionary effects of the measure (see
Heimler, 2010 cit).
The European case law in State aid in this respect is very different from that in antitrust where
presumptions that competition is distorted are used, at least in principle, only in a subset of
circumstances (hard core cartels). In State aid the presumption that selectivity leads to a
distortion of competition is universal. The definition of incompatible State aid under article
107, paragraph 1, is therefore quite wide and a competition analysis is undertaken very late in
the process.
Procedurally, once incompatibility is identified (and this is done without a reference to
competition), the Commission has to examine whether the State measure can be exempted
according to the criteria identified in article 107, paragraph 2 and 3. In the exemption
decisions under article 107, paragraph 3, (in article 107, paragraph 2, decisions there is no
discretion the Commission can exercise) competition issues are addressed by the Commission
only at the balancing stage, after the Commission has shown that the aid provides some
overall benefits. If distortions of competition are not too strong, the net effects originating
from the aid continue to be positive and it can be exempted. If there are no overall benefits
originating from the aid (just private benefits), as it happens in many circumstances, the
measure cannot be exempted and is declared incompatible with the common market even
when the distortions of competition are unnoticeable.
The exemption of incompatible State aid
EC policy in State aid was driven, at least in its early years, by specific circumstances. Like
what happened in antitrust with article 101, paragraph 3, on the exemption of otherwise
anticompetitive agreements, in the early years of application the Commission was overflown
with notifications of State aid measures by member States. As a result, Council regulation
994/98 empowered the Commission to declare by means of regulations that certain categories
of aid do not fulfill the criteria of article 87, paragraph 1, or that they are compatible with the
common market and exempted from the notification obligation.
A General Block Exemption Regulation (GBER), which unifies most previously enacted
regulations, was adopted in August 2008 and it authorizes subject to conditions the following
types of aid which is presumed to be beneficial:
of the Agency for the Promotion of Housing Construction to Westdeutsche Landesbank”, Case T-228/99
before the Court of First Instance of the European Commission, mimeo.
7
See for example Judgment of the Court of 2 July 1974. Italian Republic v Commission of the
European Communities. Family allowances in the textile industry. Case 173-73. ECR 709, paragraph 13.
6
 aid in favor of small and medium-sized enterprises (SMEs),
 aid for research and innovation,
 regional development aid,
 training aid,
 employment aid,
 aid in the form of risk capital,
 environmental aid,
 aid promoting entrepreneurship.
As described by the Commission in the recently published Vademecum on Community law on
State aid8, “(T)the GBER consolidates into one text and harmonises the rules previously
existing in different regulations. It also enlarges the area covered by notification exemptions
by five types of aid which have not been exempted so far (environmental aid, innovation aid,
research and development aid for large companies, aid in the form of risk capital and aid for
enterprises newly created by female entrepreneurs). The GBER applies only to transparent
aid, i.e. grants and interest rate subsidies, loans where gross grant equivalent takes account of
the reference rate, guarantee schemes, fiscal measures (with a cap) and repayable advances
under certain conditions. Aid is only allowed if it has an incentive effect. The GBER provides
different criteria for the verification of the incentive effect with ranging complexity: (i) for
certain types of measures, incentive effect is presumed; (ii) for SMEs, the incentive effect is
present if the application for aid was submitted prior to the start of the project; (iii) and for
large enterprises, in addition to the above, the Member State would have had to verify basic
conditions of the documentation.”9 All these exemption are granted presuming that the aid is
beneficial, overcoming what are perceived as very widely defined market failures, the only
questionable one being aid to SMEs.
In addition to these exemption based on some sort of substantive analysis, the de minimis
regulation10 excludes that aid below a given amount11 affects trade between member States or
distorts competition. Indeed the de minimis regulation identifies a threshold below which
competition is presumed not to be affected, but it does so in a very mechanical way: all
measures that fall below the de minimis threshold (defined in terms of the amount of the
granted aid), irrespective of the market share of the aided firm, do not fall within the area of
application of article 107, paragraph 1 and therefore do not need to be notified to the
Commission.
Should there be domestic control of State aid, the measures below the de minimis threshold
could be addressed by domestic legislation. For example, in 2010 Sweden enacted new
legislation according to which the State, a municipality or a county council that operates in a
market is prohibited from adopting conduct that distorts, by object or effect, the conditions for
effective competition in the market, or impede, by object or effect, the occurrence or the
8
10
Available at: http://ec.europa.eu/competition/state_aid/studies_reports/studies_reports.cfm
Page 19 and 20 of the Vademecum
Commission Regulation (EC) No 1998/2006 of 15 December 2006 on the application of Articles
and 108 of the Treaty to de minimis aid, Official Journal L 379 of 28.12.2006
11
EUR 200000 (cash grant equivalent) over any three fiscal year period
9
7
107
development of such competition. State aid therefore could be prohibited in Sweden even if it
falls under the de minimis block exemption, but only if it distorts competition, a standard quite
different from that applied at the Community level.
The new economic approach in State aid policy
All recent developments in State aid originate in the 2005 State Aid Action Plan (SAAP)12, the
document in which the Commission suggests a more refined economic approach in State aid
in order to “ensure a proper and more transparent evaluation of the distortions to competition
and trade associated with state aid measures.”13 However in SAAP, instead of suggesting a
more thorough analysis of the market where the aid is or will be producing its effects, the
Commission limits the economic approach to “the reasons why the market by itself does not
deliver the desired objectives of common interest and in consequence evaluate the benefits of
state aid measures in reaching these objectives.” In other words, instead of strengthening the
economic analysis of the distortions of competition originating from State aid, the
Commission suggests to use economic analysis to identify market failures that are meant to be
overcome by the aid.
Indeed, writes the Commission, “(I)in those cases, identifying the market failure at stake will
help evaluate better whether state aid could be justified and acceptable, would represent the
most appropriate solution, and how it should be implemented to achieve the desired objective
without distorting competition and trade to an extent contrary to the common interest.”14
According to the SAAP, selectivity is sufficient to define an incompatible State aid, like in the
past. The strengthened economic approach should only help the Commission in its exemption
capacity.
This was already clear from the Community framework for State aid for research and
development and innovation where the Commission first proposed its three-stage balancing
test for the evaluation of State aid measures. The first two steps address the positive effects of
State aid and the third is addressing the negative effects and resulting balancing of the positive
and negative effects:
“(1) Is the aid measure aimed at a well-defined objective of common interest (eg growth,
employment, cohesion, environment)?
(2) Is the aid well designed to deliver the objective of common interest i.e. does the proposed
aid address the market failure or other objective?
(i) Is State aid an appropriate policy instrument?
(ii) Is there an incentive effect, i.e. does the aid change the behaviour of firms?
(iii) Is the aid measure proportional, i.e. could the same change in behaviour be obtained with
less aid?
(3) Are the distortions of competition and effect on trade limited, so that the overall balance is
positive?”15
According to the Commission, this balancing test is applicable to the design of State aid rules
12
13
14
15
European Commission (2005) State aid action plan. Less and better targeted state aid: a roadmap for state
aid reform 2005–2009 (Consultation document) COM(2005) 107 final
SAAP, paragraph 22.
SAAP, paragraph 23.
European Commission (2006), “Community framework for State aid for research and development and
innovation”, Official Journal of the European Union: C 323/5
8
as well as for the assessment of specific cases. In a recent draft paper, “Common principles
for an economic assessment of the compatibility of State aid under article 87.3 (now
107.3)”16, the Commission clarifies the substantive test it will apply when evaluating whether
a State aid measure should be authorized. In particular “a balancing exercise naturally
requires a common framework to evaluate and compare the different elements being
weighted. Such framework is provided by the analysis of the impact that State aid has on the
welfare of all stakeholders and in particular on the welfare of the recipient, its competitors,
consumers but also input suppliers”17. It is thus first necessary to assess whether the aid is in
the common interest (elimination of market failures). Then whether the aid is well designed to
achieve it. Finally whether it does not lead to an unacceptable degree of distortion of
competition and of trade between Member States.
As a result, once a measure is defined as State aid under article 107, paragraph 1, a
competition analysis can only be performed in the final part of the exemption test and only if
the aid provides some overall general interest benefits. In other words, the analysis of the
effect of the aid on competition is only done when the suitability, necessity and adequacy of
State aid is to be assessed under the criteria of article 107, paragraph 3.
Many measures never arrive at the balancing stage. For example if the aid does not remove a
market failure or is not necessary to this end, the Commission would stop its analysis and
declare the aid incompatible.
The whole process would be different with a competition analysis in the initial appreciation of
State aid, when it would be most important since it would be one of the necessary conditions
for a measure to be defined as incompatible State aid in terms of article 107, paragraph 1. At
that stage, if the State has no effect on the competition process, even a selective measure
would not be considered State aid. Many cases of very little significance would not have been
subject to a scrutiny by the Commission and a few others would have been reversed.
Indeed the German Monopol Kommission suggests that “the objective likelihood that an aid
measure will noticeably distort competition … should be examined in the state aid control
procedure” under article 107, paragraph 1, all the time, not only when evaluating whether to
allow an incompatible aid18.
For example, in the Charleroi decision19, the Commission concluded that the reduction of
landing charges by the Walloon Region and of ground handling charges by the Brussels South
Cherleroi Airport all in favor of Rynair (the low cost Irish carrier) were incompatible with the
common market. According to the Commission, by favoring an Irish company, Belgium had
violated the State aid rules. As Heimler (2010) argues, “under a political economy perspective
this is quite surprising. The fact that one jurisdiction had granted incompatible State aid to a
firm of another jurisdiction should have raised some doubts on the part of the Commission
that the aid was not anti-competitive. If Ryanair would have been a Belgian company, at least
the political economy objective (the protection of national champions) and the State aid policy
16
Available at http://ec.europa.eu/competition/state_aid/reform/economic_assessment_en.pdf
Paragraph 11.
18
German Monopolies Commission (MonopolKommission) (2008), “The more economic approach in
European State aid control”, translated version of Chapter 6 of the biennial report 2006/2007. SSRN Working
Paper available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1332765
19
Commission decision of 12 February 2004 concerning advantages granted by the Walloon Region
and Brussels South Charleroi Airport to the airline Ryanair in connection with its establishment at Charleroi
(notified in Number C(2004) 516) (2004/393/EC)
17
9
objective (favor national champions) would have coincided. In the circumstance of the
Charleroi case, the political economy objective pursued by the Charleroi airport is unclear.”
There is a further much more substantive problem with that decision. Although there is no
question that the State measures favor Ryanair with respect to the other airlines serving the
Charleroi airport, it is at least questionable that these measures distort competition in the
relevant market where Ryanair operates. Indeed most competitors of Ryanair are not in
Charleroi as the Commission suggests but in Zaventem, the major Brussels airport20. Had the
relevant market been correctly established and had the competition analysis be carried out
before starting the case, the conditions offered to Rynair at Charleroi may have been
considered compatible wth the common market.
5. Restructuring aid
Aid for restructuring has been one of the most controversial issues in State aid. The major
reason is that subsidies for firms in financial distress are by definition selective and “are
applied only to those firms with the lowest quality or highest costs. Furthermore such
subsidies are correlated with the size of the loss of the assisted firm, weakening the incentives
on the firm to minimize that loss”21.
There is therefore a strong desire, especially by Commission officials, to declare restructuring
aid incompatible with the treaty. At the same time however, since these measures benefit large
companies with thousands of employees, there is a strong political incentive for granting
them. Therefore it has been mainly on restructuring aid that the contrast between the
Commission and member States has been more frequent. The reason is that these aids allow
inefficient firms to remain active in the market and, more importantly, to maintain excessive
capacity in an industry, hurting all competitors, often localized in other member States. The
first Report on Competition Policy by the European Commission of 1971 emphasized the
exceptional nature of restructuring aid, an unchanged guiding principle since then.
On the other hand, keeping a large company alive through a restructuring aid, especially if
this aid is once and for all, may be justified on competition grounds because it allows a large
competitor to remain in the market, thus keeping industry profit from increasing (in a Cournot
setting). Furthermore, since a firm may get bankrupt also because of the existence of
restrictive regulations both in product and in factor markets, restructuring aid may be a way to
ease the transition to a more competition friendly environment. Finally, under a
macroeconomic perspective, avoiding the bankruptcy of a large competitor may help to avoid
the disappearance of many small suppliers at the local level, maintaining an employment base
often much larger than that of the aided firm. The political pressures in favor of restructuring
aid can therefore be quite strong.
In order to resist this political pressure, the Commission had to clearly define its enforcement
approach. The 2004 Commission guidelines on restructuring aid22 confirm the “one time –
last time” principle. Rescue and restructuring aid should be given to specific firm only once
every ten years and cannot be provided to firms that have not repaid previous unlawful aid.
The guidelines explain that “(R)rescue aid is by nature temporary and reversible assistance.
For a thorough analysis of the Charleroi decision see Gröteke, F and Kerber, W. (2004), “The case of
Ryanair -EU State aid policy on the wrong runway”, Ordo, Vol. 55, pp. 313-332.
20
21
22
OECD (2001), page 34.
Communication from the Commission — Community guidelines on State aid for rescuing and restructuring
firms in difficulty Official Journal 244 , 01/10/2004 P. 0002 – 0017.
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Its primary objective is to make it possible to keep an ailing firm afloat for the time needed to
work out a restructuring or liquidation plan. The general principle is that rescue aid makes it
possible temporarily to support a company confronted with an important deterioration of its
financial situation reflected by an acute liquidity crisis or technical insolvency. Such
temporary support should allow time to analyze the circumstances which gave rise to the
difficulties and to develop an appropriate plan to remedy those difficulties. Moreover, the
rescue aid must be limited to the minimum necessary. In other words, rescue aid offers a short
respite, not exceeding six months, to a firm in difficulty. The aid must consist of reversible
liquidity support in the form of loan guarantees or loans, with an interest rate at least
comparable to those observed for loans to healthy firms and in particular the reference rates
adopted by the Commission. Structural measures which do not require immediate action, such
as the irremediable and automatic participation of the State in the own funds of the firm,
cannot be financed through rescue aid”23.
The restoration of the profitability of the firm is the final objective of restructuring aid.
Therefore the Commission maintains that it will approve the aid only if the member State can
show that there is a high probability that the aid will succeed in bringing the firm back into
profit. According to the Guidelines “(T)the provision of rescue or restructuring aid to firms in
difficulty may only be regarded as legitimate subject to certain conditions. It may be justified,
for instance, by social or regional policy considerations, by the need to take into account the
beneficial role played by small and medium-sized enterprises (SMEs) in the economy or,
exceptionally, by the desirability of maintaining a competitive market structure when the
demise of firms could lead to a monopoly or to a tight oligopolistic situation. On the other
hand, it would not be justified to keep a firm artificially alive in a sector with long-term
structural overcapacity or when it can only survive as a result of repeated State
interventions”24.
Furthermore, the Commission “will ensure that restructuring aid is limited to the minimum
required to restore viability while limiting distortion of competition”25 More specifically the
guidelines suggest that in order not to distort competition some “compensatory measures”
may be required. “These measures may comprise divestment of assets, reductions in capacity
or market presence and reduction of entry barriers on the markets concerned. When assessing
whether the compensatory measures are appropriate the Commission will take account of the
market structure and the conditions of competition to ensure that any such measure does not
lead to a deterioration in the structure of the market, for example by having the indirect effect
of creating a monopoly or a tight oligopolistic situation”26.
The actual application of these highly sensible principles to specific cases was unfortunately
quite different. In particular, these compensatory measures should be adapted to the form and
the substance of the aid. For example, in the case of financial injections into a firm capital, it
is highly unlikely that they would affect pricing decisions, unless the once and for all
principle is not credible. On the other hand if the aid is aimed at selectively reducing some
cost of production, prices are likely to be affected, but investment decisions not.
Unfortunately this is not the approach followed by the Commission. The aid is usually
authorized without any analysis of the type effects it might induce on the firm's behavior, i.e.
whether the aid would affect prices or investment decisions. As a result, the Commission
23
24
25
26
Paragraph 15.
Paragraph 8
Paragraph 7.
Pargaraph 39.
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adopts very broad behavioral remedies, a sort of last-resort control for moral hazard, that are
meant to impede too aggressive marketing strategies. Very often these remedies go much
beyond what would be necessary to restore competition and block the firm's competitive
strategies weakening, not strengthening, its restructuring possibilities.
The point is that moral hazard cannot be reduced by introducing behavioral remedies that are
independent on the effect the aid may have on firm behavior. By limiting the competition
possibilities of the restructuring firm, the possibility for it to successfully restructure is being
reduced. Moral hazard remains intact.
Broad and discretionary behavioral remedies cannot eliminate moral hazard. This should be
left to the once and for all clause. In case the threat could be made more credible, for example
by extending the time period of the freeze, but the introduction of behavioral remedies ex-post
is unable to modify the incentives ex-ante. It is just an impediment to competition and to the
company effectively to restructure.
For example, in 1997 the Italian government decided (through IRI, a State owned holding
company) to invest 2750 billion lire (around 1.5 billion EUR at today's lira/eur parity) in
Alitalia, the Italian State owned national carrier in order to support a restructuring plan aimed
at restoring the company financial viability during the period 1997-2000. The Commission,
by decision 97/789/EC27, considering that a private investor would not have undertaken that
capital injection, concluded that it was indeed a State aid measure. The interesting part of this
case are the conditions that the Commission imposed on Alitalia in order to declare the aid
compatible. Some of these conditions were sound under a competition perspective and fully
in line with the yet not issued 2004 Restructuring guidelines. In particular the Commission
required Italy “ not to give Alitalia priority in any way over other Community companies, in
particular as regards the allocation of traffic rights (including those for third countries in the
European Economic Area), slot allocation, ground-handling assistance and access to airport
facilities where preferential treatment would be contrary to Community law. Furthermore the
Commission imposed to Italy to “appoint a coordinator who does not have any link
whatsoever with Alitalia and acts completely independently of it” for the allocation of slots in
coordinated or fully-coordinated Italian airports. These two measures, i.e that Alitalia not be
favored in slot allocations and that the market regulator in air transport be independent from
Alitalia, are quite appropriate since they reduce barriers to entry and enhance competition.
Probably they should have also been imposed to all member States by a Regulation and not
just to Italy through a State aid case.
However the Commission in its decision limited significantly the freedom of Alitalia to
compete in air transport markets imposing that: “until 31 December 2000 the available
capacity of aircraft operated by Alitalia or by other carriers under agreements whereby Alitalia
assumes the commercial risk for such capacity (wet-leasing, block-space, joint venture
agreements, etc.) shall not exceed the following limits:
(a) the number of seats available shall not exceed 28 985, of which 26 350 shall be for
Alitalia's own fleet;
(b) the increase in the number of available seat-kilometres for each calendar year … shall not
exceed 2,7 %, on the understanding that no growth is to be authorised if the growth in the
corresponding markets remains lower than 2,7 %. However, if the growth rate in the
corresponding markets exceeds 5 %, supply may be increased above 2,7 %, by the margin of
27
OJ L. 322, 25.11.1997, p. 44.
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the increase beyond 5%”.
Furthermore “until 31 December 2000 Alitalia shall refrain from offering fares lower than
those offered by its competitors for an equivalent service supplied on the routes which it
operates;”
Finally, “Alitalia shall dispose of its shareholding in Malev (the Hungarian national carrier)
by […] at the latest.”
All these requirements, setting a ceiling to the number of seats Alitalia is allowed to offer,
impeding any autonomous price reduction and prohibiting any partial ownership of other
European carriers, instead of helping Alitalia becoming a more effective competitor, blocked
the restructuring possibilities of the company and were mainly directed to help its competitors
(at least in theory), quite the contrary of what the Commission should have done once it
approved the capital injection.
The practice of imposing “wrong” behavioral remedies on the part of the Commission is not
just history. The recent Communication from the Commission on the application of State aid
rules to measures taken in relation to financial institutions in the context of the current global
financial crisis28 suggests that banks that have received an aid should not further distort
competition. Among the compensatory measures envisaged to this end, the Commission
suggests that anticompetitive practices like aggressive advertising and aggressive pricing be
prohibited. In practice the aided company can only adopt reactive strategies, substantially
curtailing its possibility to compete and hence to restructure, considering that such remedies
would be introduced independently of any analysis as to whether the aid would actually affect
the pricing decisions of the aided bank.
6. The financial crisis and State aid
When inter-bank lending stopped in September 2008, governments all over the world started
to inject large amounts of aid into the banking sector in order to prevent the break down of the
financial system.
In Europe almost immediately concerns were raised that European State aid control would
impede necessary State intervention and thus lead to the collapse of the financial system. As a
result there were calls for a temporary suspension of State aid rules. The Commission rightly
resisted these demands and issued several communications that introduced greater flexibility
in the application of State aid rules. However, in order to make sure that such flexibility was
only temporary and exceptional, the Commission made reference to a practically never
invoked clause of article 87, paragraph 3, the existence of "a serious disturbance in the
economy" as the reason for the exempting incompatible aid.
This special and rarely used legal basis allowed to derogate to some provisions of the rescue
and restructuring guidelines. For instance, rescue aid was allowed in other forms than
liquidity and guarantees, such a capital injections; national schemes for large companies were
authorized; guarantees could cover not only short-term liabilities but also medium term debt
up to 3 years and partially to 5 years. Finally the Commission has suspended the “one time
28
Communication from the Commission - The application of State aid rules to measures taken in relation to
financial institutions in the context of the current global financial crisis – adopted on 13 October
2008.
Official Journal C 270, 25.10.2008, pages 8–14.
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last time” principle, reflecting inter alia the difficulties in designing comprehensive aid
package for complex and not fully transparent institutions and the uncertainty about the
recovery outlook.
As a result of the fact that the new approach was motivated by exceptional circumstances and
that it was based on legal provisions very seldom used, the general standard of assessing the
restrictiveness of State aid interventions was not changed. Furthermore the Commission
emphasized that State aid motivated by the existence of a serious disturbance in the economy
could only be granted to illiquid but otherwise fundamentally sound financial institutions. In
contrast, insolvent banks would fall under the general guidelines for rescue and restructuring
aid. It is true that the distinction is very difficult if not impossible to make in practice,
however the statement adds credibility to the fact that the standard of enforcing State aid
provisions did not change as a result of the crisis.
With respect to guarantee schemes, according to the Commission they are a legitimate public
policy response only if they protect retail deposits. In all other circumstances guarantees
should be subject to stringent conditions. However in the current crisis the liquidity problems
were not created by bank runs initiated by depositors, but by unexpected declines in the value
of financial assets and by the consequent reduction of interbank landing. So probably a less
stringent approach against guarantee measure could have been taken.
Furthermore, the Commission continues to believe that it can eliminate moral hazard, by
allowing the aid and simply by introducing behavioral restraints and by impeding aggressive
commercial conduct. For example in the communication on recapitalization measures, the
Commission maintains that any recapitalization should not allow the beneficiary to engage in
aggressive commercial strategies or expansion of its activities.
In a fourth Communication on “The return to viability and the assessment of restructuring
measures in the financial sector in the current crisis under the State aid rules" issued on July
23, 2009, the Commission explains how it will assess restructuring aid to banks by making
sure that long-term viability is restored, that the burden of restructuring is shared fairly by all
stakeholders and, more importantly for the purposes of this paper, that competition is not
distorted.
As for the restoration of long-term viability, the position expressed by the Commission, that
any accepted restructuring plan should provide a detailed demonstration on how to achieve it,
is fairly standard, even though some additional rigor is introduced by requiring that a stress
test be undertaken in order to prove the long-term viability of a bank. The same for burden
sharing. The Commission aims to make sure that the owners of the bank absorb losses with
available capital and pay an adequate remuneration for State interventions. As a result the
Commission would not allow State aid to be used to “remunerate own funds”.
Finally, the Commission sets up its views on the distortions of competition associated with
State aid to financial companies in distress. In particular, the general approach followed by
the Commission is coherent with the experience of competition authorities in antitrust and
“measures to limit the distortion of competition should be tailor-made to address the
distortions identified on the markets where the beneficiary bank operates following its return
to viability post restructuring, while at the same time adhering to a common policy and
principles”. As for the general principles to be followed, the Commission rightly suggests
that the higher the expected rate of return, the lower the aid element of the intervention,
because only expected returns below market level will be considered to constitute State aid.
As for structural measures to be undertaken, banks benefiting from State aid may be required
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to divest subsidiaries or branches, portfolios of customers or business units.
However, according to the Commission, measures must be taken to limit the ability of banks
to use State aid for anti-competitive behavior. In particular mergers are banned for aid
recipients and “for a period of at least three years … (they) must not acquire competitors”,
even though a case can be made in exceptional circumstances that a merger is necessary “to
restore financial stability or to ensure effective competition”. In addition, State aid should not
be used to offer terms and conditions that cannot be matched by competitors who are not aid
recipients.
Contrary to what the Commission believes, these behavioral measures unnecessarily
constraint the market response possibilities of aid receiving banks and effectively reduce
competition instead of enhancing it. In particular, mergers and aggressive pricing benefit
consumers and should not be prohibited unless they lead to violation of the antitrust laws. In
some way, the Commission instead of protecting competition, i. e. asking what would happen
to the market if a particular bank would not be granted the aid, is making sure that the bank
would not need more aid in the future, forgetting that this is the objective of the once and for
all clause. Furthermore, just prohibiting mergers or aggressive pricing is hardly likely to affect
ex-ante moral hazard in corporate strategies.
For example, in order to authorize State aids measures to ING and ABN Amro/Fortis, the
Commission prohibited them from offering more favorable prices than its three best priced
direct competitors for a period of three years. Irrespective of other considerations on the
effectiveness of these measures for promoting recovery, these bans were imposed on two of
the three major players in the Dutch banking markets. The average price that is supposed to
constrain them is therefore practically indeterminate.
As for other ex-post measures taken to reduce moral hazard on the part of the managers of the
aided financial institutions, the Commission is equally ineffective. Through behavioral
constraints affecting the action of managers, the Commission is trying to ensure stability over
excessive risk taking. The approach is in some way simplistic and a bit naïve. For example in
the Commerzbank case (N 625/2008) the Commission imposed limitations on managers’
compensations and severance packages. The reason for this cap is unclear. If the constraint
imposed by the Commission is binding, then good managers of subsidized institutions would
leave for better jobs elsewhere, leading to worse results overall and to a slower recovery of
the aided company. If the constraint is not binding it is of course useless. As a result, capping
managers pay does not lead to speedier recovery, to the contrary.
7. Conclusion
The European Union is one of the very few jurisdictions in the world that has introduced an
active policy against State aid. The objective of the treaty, creating an integrated economic
area within the Union, could not be achieved by free trade only, even by an extended free
trade regime, i.e. the free movement of goods, services capital and people. Antitrust
provisions were meant to impede private restraints of trade, while State aid provision to make
sure that member States governments would not subsidize their firms to the detriment of
competitors. Considering that the treaty entered into force on January 1958, it is a set of
extraordinary forward-looking policy instruments.
Treaty provisions on antitrust and State aid were silent on the objective pursued and at the
beginning fairness seemed the most natural choice and this is the way the provision of article
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107, paragraph 1, according to which a State aid measure is incompatible with the common
market only if it also distorts competition, was interpreted. Unfortunately, there is no
requirement in the treaty nor in subsequent regulations that the distortion of competition
required for a State aid measure to be incompatible with the common market be noticeable.
The most controversial decisions on State aid are those related to the aid for the rescue and
restructuring of firms in difficulty. The restoration of the healthiness of the firm is the final
objective of restructuring aid and competition has a very minimal role to play. And indeed the
Commission maintains that it will approve the aid only if the member State can show that
there is a high probability that the aid will succeed in bringing the firm back into profit. Moral
hazard is impeded by the once and for all clause, according to which restructuring aid can be
granted only once every ten years and by making sure that the aid is strictly proportionate to
the objectives it pursues. Nonetheless the Commission attaches a number of very intrusive
behavioral conditions to its authorization decision. These conditions, for example the ban of
price leadership, of the possibility of merging or the introduction of capacity constraints,
reduce, not increase, the possibility of restructuring companies to compete, contradicting the
objective of restructuring aid. What is striking is that there is no market analysis in these
decisions and, more importantly, there is a presumption that without these behavioral
remedies restructuring companies would become very aggressive players, a highly speculative
assumption.
The financial crisis has led the Commission to relax its State aid policy, but in order to make
sure that the added flexibility was only temporary and exceptional, the Commission made
reference to a practically never invoked clause of article 107, paragraph 3, the existence of "a
serious disturbance in the economy" as the reason for the exempting incompatible aid.
Although greater flexibility was added, the general approach of the Commission in the
enforcement of State aid provisions did not change. In particular, competition type remedies
are introduced in order to eliminate moral hazard.
In particular mergers are banned for aid recipients and “for a period of at least three years …
(they) must not acquire competitors”, even though a case can be made in exceptional
circumstances that a merger is necessary “to restore financial stability or to ensure effective
competition”. In addition, State aid should not be used to offer terms and conditions that
cannot be matched by competitors who are not aid recipients. However these behavioral
measures, often applied by the Commission, unnecessarily constraint the market response
possibilities of aid receiving banks and effectively reduce competition instead of enhancing it.
A less regulatory approach would certainly help competition.
In general there is no question that without the ban on State aid, the economy of EU member
States would have been much more subsidized than it actually is. Other jurisdictions are much
more lenient, irrespective of the existence of the WTO rules on subsidies that are much more
limited in scope. A welfare enhancing reform would be to negotiate for the world EC type
provisions banning anticompetitive State aid.
However there is a long road for improvement in European State aid policy. The most urgent
reform is for the Commission to carry out a competition analysis early on, so that only anticompetitive aid is investigated. Furthermore, once an aid is found to be incompatible,
remedies should be fine tuned to the form of the aid itself, so that only the anti-competitive
features of the aid are eliminated.
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