Long read: Does the EU stop Britain from using state aid to help its economy?

kitty walkerSome argue that when it is no longer constrained by the EU’s state aid rules, Britain will be able to pursue a more interventionist economic strategy. Kitty Stewart (LSE) asks whether this claim stacks up.

A series of EU regulations restrict state intervention in the economy in EU member states, including complex state aid rules aimed at promoting competition. The original aim of these rules was to stop countries subsidising domestic businesses to outcompete those in other member states. They also serve to prevent multinational corporations from touring Member States in search of subsidies or favourable tax treatment in return for investment; for example, the European Commission ruled against tax rulings given by Ireland to Apple and by Luxembourg to Amazon. But critics have argued that the rules restrict Member States from more interventionist economic strategies, meaning Brexit offers the opportunity to run the economy differently. Here I briefly discuss four main issues with relevance to social policy – nationalisation and public ownership in relation to the railways; competitive tendering of healthcare services; public procurement rules more generally; and industrial strategy.

br door

Photo: John K Thorne. Public domain

The Labour party’s manifesto for the 2017 general election included a pledge to take the railways back into public hands, a move that Joe Guinan and Thomas Hanna argue would be virtually impossible within the EU. It is true that EU rail policy has sought to impose a ‘vertical separation‘ principle, separating the management of rail infrastructure from the provision of services in an attempt to end the idea of ail companies as natural monopolies. The state can own and manage the rail infrastructure, but this needs to be separate from the provision of services. Services themselves can be provided by state-owned operators, but normally these operators would be expected to win contracts competitively. It should be underlined, though, that in this regard the EU is following the lead set by the UK. There is an obvious irony in the fact that leaving the EU would offer the UK the freedom to abandon an approach that it has been pursuing unilaterally for many years.

Further, the extent to which competition is enforced remains lower under new EU rules than the UK’s current set-up, even under the most recent set of reforms, the ‘Fourth Railway Package‘. The Commission was pushed back by Member States from their original proposals, which would have introduced mandatory competitive tendering for all rail contracts – as happens in Britain. Currently, most domestic rail lines across the EU are operated under public service contracts, with countries often directly awarding contracts to the local incumbent. The wording in the agreement reached by the European Parliament in December 2016, after five years of negotiations, will allow any company to bid to compete on a commercially viable EU network from 2020, and from 2026 for contracts on lines that are not as profitable. But governments will still be able to award contracts directly where they can make a case that this would mean better quality of service or cost efficiency, on condition that contracts include performance and quality targets.

The second issue concerns the application of EU competition law to healthcare services. A 2017 briefing from the British Medical Association, which has long-standing concerns about the increasing role of private sector providers in publicly funded healthcare, argues that Brexit presents an opportunity for the UK to extricate itself from EU competition rules as they apply to the health sector. Under these rules, where there is a purchaser-provider split, providers must be allowed to compete on an equal footing, and co-operation between providers and commissioners of services that might limit competition is ruled out. However, as the briefing points out, existing domestic legislation, including the English Health and Social Care Act 2012, enforces competition within healthcare services entirely separately to EU law. Further, the EU rules apply only where there is a purchaser-provider split, as in the English NHS, but not where the purchaser-provider split does not apply, as in the Welsh and Scottish NHS, which have restricted the extent of competition.

The BMA’s argument is that were there to be domestic movement away from a
preference for competition between providers in England – and they note that the 2017 Conservative Party manifesto included a commitment to review the operation of the internal market – EU regulations would make it more difficult for the UK to repeal its own legislation protecting competition. As with rail nationalisation, leaving the Single Market may now be the only way to roll back legislation that the UK pursued unilaterally. Note, however, that even as a non-member, the UK could be required to follow EU rules on procurement and competition as a condition of a European trade deal.

On the other hand, if a trade deal with the EU is not reached quickly, the NHS could become vulnerable in wider trade negotiations with other countries. There was widespread concern that the Transatlantic Trade and Investment Partnership (TTIP) deal between the EU and the USA would further open up publicly funded healthcare to market forces, though senior EU politicians have given repeated assurances of their intention to make sure health services remained exempt and protected. but an exemption for the NHS was assured. Moving forwards, it is not obvious that the UK would have the same ability to secure such an exemption in a UK-US trade deal, given a potentially weaker negotiating position.

Third, we consider public procurement more generally. Guinan and Hanna
highlight that all procurement contracts must be open to all bidders across the EU, that public authorities must advertise contracts widely to bidders in other EU countries, and that among the key criteria for awarding work are “lowest price” and “most economically advantageous tender”, which takes into account quality and reliability as well as cost (MEAT). Their concern is that this reduces the ability of local governments to use their significant spending power to meet local and social needs, for example by awarding contracts to local companies or to small businesses, and they suggest that Brexit could offer opportunities to use large-scale public procurement

“to rebuild and transform communities, cities and regions… In this way, public funds can be made to do ‘double duty’; anchoring jobs and building community wealth, reversing long-term economic decline” (p.23).

The decision to award the contract for the post-Brexit blue British passports to a French company is an example: this decision would have been made on a MEAT basis, while outside the EU’s rules, the government could have decided to use non-economic criteria to make such an award, perhaps balancing cost against other goals like protecting British jobs. As the preferred passport supply bid is reported to represent a saving of £120m to the taxpayer during the contract’s lifetime, there might of course be other effective ways to use the money to achieve these goals, but this would have been a decision the Home Office was free to make.

There are two reservations about the extent to which Brexit will create new freedoms to use public money to do ‘double duty’. First, as noted in relation to health, it is very possible that in order to gain access to EU markets after Brexit, the UK will be required to sign up to both EU procurement and state aid rules. These rules are integral to the functioning of the single market, and a trade deal on goods would almost certainly be conditional on the UK agreeing to continue to abide by them.

Second, the restrictions imposed by procurement law can be exaggerated. For one thing, as David Allen Green points out, there is no requirement to put passport production (or anything else) out to tender; passports can be produced in-house, as is done in France, and cleaning, catering and other services can also be done in-house, allowing local governments to use their spending power directly. (Similarly, there is no requirement to separate health providers from purchasers, as discussed above.) EU public procurement law provides for what happens when things are put out to tender; it does not force tendering to take place.

Further, tenders can in practice be designed in ways that make it easier for small businesses or those with good employment practices to participate. For example, in Germany energy efficiency is one of the mandatory criteria under which contracts are awarded, while procurement law requires large contracts to be divided into smaller lots, to make it easier for smaller companies to compete. The Swedish National Public Procurement Strategy makes it clear that social criteria can be used in awarding contracts, if these are stated in the tender, such as rewarding firms that promote employment opportunities for disadvantaged groups. The Swedish strategy also underlines that all suppliers must be required to guarantee reasonable working conditions for employees. In short, where services are put out to tender awards must be made on a competitive basis on the basis of the best ratio of cost to quality, without preferred providers in a particular sector or location. But there is quite a lot of scope to use quality criteria to promote socially or environmentally desirable practices.

A final area of concern is the restriction that state aid rules place on Member States’ ability to support struggling industries through difficult times. Guinan and Hanna argue that these restrictions rule out a proactive industrial strategy – “the deliberate direction of capital to sectors, localities, and regions, so as to balance out market trends and prevent communities from falling into decay” (p.22). The UK government was not able to decide to subsidise the steel industry, for example, to protect jobs in Port Talbot.

State aid is generally prohibited in the Single Market so as to ensure a level playing field for firms from different countries. However, there are a series of exceptions and exemptions. Countries can notify the Commission that they seek an exemption and the case is then assessed. There are a series of ‘block exempted’ areas, including innovation and research, regional aid, broadband, aviation, energy and the environment. There are also forms of aid which do not need to be notified if they meet certain criteria: national public investment in roads, waterways, rail, water distribution, hospitals, old age homes, culture and heritage organisations fall under this heading. If notification is required, Member States must demonstrate that state aid is aimed at an improvement that the market alone would not deliver, is limited to the minimum action required to achieve the outcome, and that the benefits outweigh the costs in terms of damage to trade (i.e. that it will not distort competition, damaging producers in other member states).

Andrea Biondi and Andy Tarrant argue that in general the state aid rules have meant ‘horizontal’ rather than ‘vertical’ industrial policy, but not a withdrawal of the state from support for industry. The state is not able to pick particular winners but is able to provide more general support to all applicants, such as through R&D subsidies or support to help firms meet environmental standards. It can also use state investment to pursue progressive priorities such as reducing regional inequalities and supporting small businesses. As things stand, the UK spends considerably less on state aid than most other EU countries. In 2016 the UK spent 0.36% of GDP on state aid excluding railways compared to 0.65% in France and 1.31% in Germany. Only five countries spent less.

In sum, after Brexit some forms of state intervention in the economy may become possible which are currently outlawed – including full-scale nationalisation of the railways, some forms of targeted industrial strategy, and public procurement approaches which explicitly favour (for example) the charitable sector or local or national firms. Brexit could in principle also offer an opportunity to limit the extent of competition involving private providers in the NHS in England. However, a wide range of actions are currently possible within the EU to support national industries and pursue progressive goals. To date the UK has used these abilities to a lesser extent than other countries, such as Germany, raising questions about how different British policy will be on the outside. Indeed, in some areas, such as the imposition of competitive tendering in the rail industry, and the insistence on competition between providers where there is a purchaser-provider split in health care, EU policy is adopting practices that have long been pursued unilaterally in the UK.

Furthermore, it is not at all certain – in fact rather unlikely – that the UK will end up with full freedom to make its own decisions in these areas, even if it opts to leave the Single Market. Accepting EU competition laws, including state aid rules, may very well be a condition of an EU-UK trade deal. And in the absence of such a deal, the NHS in particular may become vulnerable to a further opening to competitive pressures in trade negotiations with the US.

This post represents the views of the authors and not those of the Brexit blog, nor the LSE. It is an edited extract from What does Brexit mean for social policy in the UK? by Kitty Stewart, Kerris Cooper and Isabel Shutes, SPDO research paper 3, Centre for Analysis of Social Exclusion/ Nuffield Foundation.

Kitty Stewart is Associate Professor of Social Policy and Associate Director of the Centre for Analysis of Social Exclusion (CASE).

Source: blogs.lse.ac.uk

Long read: Does the EU stop Britain from using state aid to help its economy?