Promoting competitiveness or competition?

The recent vote by the Scottish Parliament on 8 December 2004, to reject, at least temporarily, the Executive's proposals to meet new EU maritime transport competition rules by putting out to tender Caledonian Macbrayne's west coast ferries has brought the question of the application of EU state aids rules into sharp relief.

European heads of government have in recent years committed themselves to making substantial cuts in state aids payments across the EU under the Lisbon and Gothenburg summit commitments, to deliver substantial improvements in the competitiveness and performance of the EU economy. The UK has been among the states calling loudest for a substantial reduction in such state aids, motivated by concerns about the way German and French Governments have sought to use state aids to provide subsidies to industries such as Ruhrkohle (the Ruhr coal mining conglomerate) and Air France which allow them to compete unfairly with other European companies.

The concerns of those who opposed the Executive's proposals on Caledonian Macbrayne, however, are that the effect of a decision to accept a lower tender than one provided by the community-based lifeline ferry service operated by Caledonian Macbrayne would be to substantially damage the economies of the most remote islands by taking away local jobs and by consequence to weaken rather than strengthen the competitiveness of the area.

The whole question of the extent to which state aids promote or undermine public economic objectives is one which is attaining increased importance in quasi-judicial decision making by the Commission on individual state aids issues, and is one which is worth the attention of Scottish lawyers working on European competition law.

What is state aid?

Article 87 of the EC Treaty prohibits any aid granted by a member state or through state resources in any form whatsoever which distorts or threatens to distort competition by favouring certain firms or the production of certain goods. The aid in question can take a variety of forms as, for instance: state grants; interest relief; tax relief; state guarantee or holding; or provision by the state of goods and services on preferential terms. Fundamentally, three types of state aid exist: sector aid, regional aid and horizontal aid. Sector aid is aimed at relieving the burdens for sectors in recession by e.g. supporting restructuring of the sector and retraining the sector’s labour force. Regional aid is targeted on developing the poorest regions in Europe, creating the foundation for expansion and modernisation of the regions and thereby contributing to the overall EU goal of economic and social cohesion in Europe. Horizontal aid is aimed at reducing market failures by subsidising e.g. environmental action or R&D activities in private firms. However, state aid also has some detrimental effects which can lead to potentially large economic costs. State aid can distort competition and lead to inoptimal use of society’s resources by e.g. supporting an outdated industrial structure and delaying a necessary restructuring process in firms.

Most of the Commission's responsibilities for state aids are carried out by DG Competition, now headed by the Dutch Commissioner Nellie Kroes, but her sectoral colleagues run sector-specific state aids regimes for particular areas, notably agriculture and fisheries, transport, and coal. In transport guidelines exist on the application of articles 92 and 93 of the EC Treaty and article 61 of the EEA agreement to state aids in the aviation sector (94/C 350/07); on state aid to maritime transport (Commission communication C(2004) 43, Official Journal C 013, 17 January 2004, 0003-0012); as well as rules concerning inland, road and rail transport.

Aid granted in conformity with all the conditions set out in these regulations is automatically considered compatible with the common market. Where a state (or its responsible authorities, such as the Scottish Executive) is in any doubt as to whether a proposed subsidy is covered by the guidelines or not, or where it clearly is not, the authority is under an obligation to notify that aid to the Commission. Where it does not, the Commission may instigate an investigation, often inspired by a complaint from a third party or another member state. Whether notified or not, the Commission may find such aid incompatible with the common market and oblige the state to ensure repayment of part or all of the aid in question by the recipient body, including interest. The Scottish Executive has recognised the importance of respecting this regime and has set up a unit in ETLLD in Glasgow (http://www.stateaidscotland.gov.uk) to advise public sector and other bodies on how to meet EU rules, which works in close cooperation with the parallel UK body in the Department of Trade and Industry.

Recent policy developments

A significant number of changes have been made recently to state aids procedures. In a recent speech, "A reformed competition policy: achievements and challenges for the future", Center for European Reform Brussels, 28 October 2004, the outgoing Competition Commissioner Mario Monti highlighted a series of changes to simplify and modernise procedures, including new provisions regarding notification forms, standardised reporting, the interest rate to be used for recovery of illegally granted aid and rules relating to time limits. He also drew attention to the use of enhanced economic methods of investigation as key elements in improving the economic underpinning of decisions. In order to enable scarce resources to be concentrated on cases which give rise to important competition concerns, new instruments were being developed to allow for the very simplified treatment of cases which do not give rise to significant concerns as regards distortion of competition or effect on trade. Discussions were also underway in Brussels on revisions to certain guidelines on state aids, notably a new framework on rescue and restructuring, and a new framework on the application of the State aid rules to the provision of compensation for the cost of providing services of general economic interest. (This point on services of general economic interest is of particular application to the Caledonian Macbrayne case, in that the recent ECJ Altmark decision has established ground rules on how a public sector obligation can be applied to provide subsidy to an undertaking of public interest as long as no overcompensation is applied. See Case C-280/00 Altmark Trans GmbH, judgment of 24 July 2003; and interesting discussion by Alan Boyd and Joanne Teale of McGrigor Law on http://www.mcgrigors.com/pdfdocs/pl_state_aid_paper.pdf .)

Finally, and of significant interest to Scotland, the framework for regional aid is currently being reworked, with early indications of Commission thinking being that they intend to ban aid to large firms altogether except in Objective 1 regions, which post-2007 will be almost exclusively in the new member states of Central Europe and the Baltic states.

Economic Impact Studies

The Danish Ministry of Economic and Business Affairs has recently carried out useful work on improving policymakers’ foundation for making decisions by undertaking a number of case studies on existing or earlier state aid schemes. (See http://www.ks.dk/english/stateaid/publication/analyse .) The key findings are that the negative effects of state aid are:
· Distorted competition by giving some firms a competitive advantage over others;
· Excessive profits to excessive investments in subsidised sectors, thereby distorting investment patterns;
· Excessive wages: labour is fixed in less efficient firms at the expense of more efficient firms;
· Low productivity: there is a risk that state aid can delay necessary renewal, innovation, product development and lead to lower productivity growth. In the long run, state aid can tie resources in unproductive firms and sectors;
· Outdated industrial structure: state aid can support an industrial structure with many small firms. Such a structure might be preferable, e.g. from a regional perspective, but at the same time could conflict with the potential for economies of scale by concentrating production on fewer plants. A case study of transport aid paid to firms to compensate for the extra costs of shipping goods from the Danish Island of Samsoe showed that the payment of aid for a time-limited period did not help restructuring, since the plants closed when the aid was stopped.
· Direct costs, administrative costs and distortionary taxes: financing public expenses leads to higher taxes with potential distortions on e.g. labour supply and investment.

On the other hand, where the aid scheme is thought through, defensible in economic terms and proportionate to the aim of the public policy, it is more likely to achieve its objectives. The parallel case study on Danish Government subsidies to energy saving investments in industries and subsidies to cover CO2 taxes in certain firms (voluntary agreements) showed that in both cases the purposes of the schemes, part of a larger package, did not distort competition unfairly and indeed served a purpose in helping to raise (or at least maintain) the international competitiveness of Danish firms. So, with the Altmark case in mind, where the economic rationale behind a scheme can be demonstrated, it is more likely that the Commission will judge a scheme to be acceptable.

The recent Commission decision, IP/04/157, 3 February 2004, on subsidies to Ryanair by the Walloon Government to provide air services from Charleroi, so much derided by the Ryanair chief executive, in practice allowed support to the development of new routes from underused regional airports and allowed Ryanair to keep 11 million out of the 15 million euros it has been awarded. The 4 million euro repayment Ryanair was ordered to make by the Commission (and which it has said it will contest in the ECJ) applied to discounted airport charges which went beyond the discounts made available by the Government to other carriers and to certain route development payments made without reference to the economics of the route in question.

Implications for Scotland

What does all this mean for Scotland? First, in the specific case of Caledonian Macbrayne, the Commission guidelines allow public service obligations (PSOs) to be imposed for scheduled services to ports serving peripheral regions of the Community or thinly served routes considered vital for the economic development of that region, in cases where the operation of market forces would not ensure a sufficient service level. But the Commission has also made it clear that for public service contracts to be consistent with the common market and not to constitute state aid, the Commission expects public tenders to be made, as the development and implementation of schemes must be transparent and allow for the development of competition. Exceptions can be allowed in exceptional cases involving regular ferry services, but only where the economic case can be demonstrated clearly that the aid involved is not overcompensation (see Altmark above) and that competition is not being hindered, either now or in the future.

The difficulty the Executive faced in this case was twofold: there was no practical way they could demonstrate the true cost of the subsidy required without going to tender; and the UK Government’s policy on state aids was not to seek a conflict with the Commission if an alternative route could achieve the same effect. It remains to be seen whether there is any room for renegotiation or whether the Commission will insist on the tender going ahead. For the future of the ferry services a key consideration on the way in which the public service obligation is operated will be the extent to which the islands of Scotland are regarded as being a peripheral region of the Community in need of special treatment on economic grounds - at this stage there is no formal recognition of this in Community law since the Highlands and Islands have lost their status as an Objective 1 region for the purposes of structural funds and the position for the next round of structural funds to come into force from 2007 is still to be decided.

This issue will also have a major bearing on the extent to which regional aid can be paid by the enterprise agencies, the Scottish Executive and local authorities to businesses in the Highlands and Islands and other deprived parts of Scotland from 2007 onwards. Currently, with the accession of the new member states of Central and Eastern Europe, the expectation is that the focus of EU regional policy, both in terms of European structural funding and regional state aids guidelines, will be on the new member states in Central and Eastern Europe where GDP per head in deprived regions can be as little as 25% of the EU average. Under current Commission proposals no state aid to large firms in Scotland will be permissible at all, and other forms of aid will be limited to support for SMEs and research and development. Aid will be permissible for derelict land reclamation and environmental protection, but questions still remain to be asked about the extent to which such aid will act to support the regeneration of employment blackspots in Central Scotland, and more widely the Executive's declared intention to promote sustainable economic development, which may require a degree of continuing public subsidy in order to promote environmental as well as economic goals.

As far as the remote parts of the Highlands and Islands are concerned, it is a matter of concern that the proposals do not seem to give them any special status - while it is perfectly reasonable to assume that the more central parts of the Highlands and Islands, especially the area around Inverness, do not need any special treatment compared with other parts of Eastern Scotland now that they are fully integrated into the Scottish transport system, it is difficult to envisage the same regime being conducive to the development of sustainable businesses in the more remote parts of the west coast and the islands. This analysis of trends in state aids decision-making shows that the best way to safeguard public support for economic development in these remote areas is to devise a case for continuing support which makes economic sense, can be sustainable over time and can be demonstrated to promote competition in the long run.

Colin Imrie

Colin Imrie is a former UK diplomat and Commission official who was Head of the EU JHA Team and Access to Justice Division in the Scottish Executive Justice Department till September 2004. He is now Director of EUsolution.com Ltd, an Edinburgh-based consultancy services firm working on EU policy and funding and on market development in the new EU member states.