No-Deal Brexit Over State Aid Would Be a UK Own Goal

UK Policy Prosperity

No-Deal Brexit Over State Aid Would Be a UK Own Goal

Posted on: 2nd September 2020
Anton Spisak
Senior Fellow, UK Policy

If the Brexit negotiations end with no trade deal and a cliff-edge for businesses at the end of this year, it will be because of disagreements over a seemingly niche but vitally important issue: state aid.

When David Frost, UK chief negotiator, last time met with his EU counterpart, Michel Barnier, in Brussels, he indicated to his colleague that he will recommend that Britain leaves without a trade deal unless the EU drops demands the UK continue to align with EU state aid rules. Yet, for all the bravado on display in the Berlaymont, the UK government should think twice before it decides to take this irreversible step. Not only would this risk a trade deal with the EU, but it would also come back to bite Britain back twice as hard – because last year’s Northern Ireland deal provides backdoor for EU state aid rules into the UK.

A free-for-all on state aid is not possible because of Northern Ireland

The UK prime minister has said to the EU that he wants to avoid any curbs by future EU rules on Britain’s ability to subsidise domestic businesses. Nor does he want Britain to be under any international obligation that would limit what Britain can do to support businesses as a sovereign nation. Downing Street says that it is a matter of principle, not something for discussion.

Yet, however much the UK government wants to avoid curbs on its ability to subside businesses in the trade deal with the EU, it is a mistake to think that Britain can have complete freedom from EU state aid rules in future. The legal reality is that the withdrawal treaty that took the UK out of the EU in January makes that impossible.

When Boris Johnson made his grand bargain with the EU last autumn, he secured Northern Ireland’s special status in the EU single market for goods, allowing Northern Ireland to maintain frictionless trade with the bloc of the 27 countries in the future while avoiding a new border on the island of Ireland. The quid-pro-quo was that Northern Ireland would continue to abide by a suite of EU laws even though the UK will have no influence over them. Buried in the text is also the commitment that binds the UK as a whole to EU state aid rules where any future subsidies “affect trade” in goods between Northern Ireland and the EU.

However, this commitment is so broad that the EU’s state aid rules will apply not just to Northern Irish firms, but also to the rest of the UK. The withdrawal treaty sets only one condition on what subsidies fall under these rules – they must have “effect on trade” between NI and the EU. This is a very low bar, meaning a wide range of state aid will likely be caught by the rules. In practice, for example, if the government awarded a subsidy to Nissan, a GB-based car manufacturer, this would very likely fall under the rules, just as would a UK-wide furlough scheme of recent months.

More generally, there are at least four different ways in which this might happen:

  1. If the UK government gives subsidy to a company based in Great Britain with a subsidiary in Northern Ireland (because extra funds could give a NI subsidiary an advantage over EU companies competing in NI);
  2. Subsidy to a company in GB producing goods which are exported to NI (such as cars assembled in GB, because cheaper goods could unfairly displace EU imports into NI);
  3. Subsidy for a service provided by a company in GB which leads to a lower price of a good in NI (such as government subsidy to a GB bank with a NI client);
  4. UK-wide subsidy benefiting to NI companies and/or consumers (such as a tax benefit for energy consumers).

Furthermore, if future subsidies were deemed to distort trade with the EU, Brussels could launch investigations, ask the government to recover the subsidy from its beneficiary, and even take the UK to the European Court of Justice. And, if the ministers felt compelled to ignore the rules, the withdrawal treaty states that the EU could retaliate against Britain in any area of the withdrawal settlement, or indeed any future treaties between the UK and the EU. If this reads like speculative dystopia, read Articles 10, 11 and 12 of the Northern Ireland protocol – one of the small number of provisions which the Johnson government renegotiated last autumn.

A UK-wide state-aid regime can save the government from its own trap

If this is the backdrop for the current negotiation, threatening to walk away with no trade deal over state aid is both naive and irresponsible. It is naive because Downing Street dismisses the legal reality of the withdrawal treaty in the hope of securing an unattainable goal of full control of the post-Brexit state-aid policy. It is downright irresponsible because the government, aware of the risk that would impose both a significant economic cost of no-deal and an extraterritorial limit on its ability to subsidise its businesses, actively chooses to consider this option.

The prime minister’s advisers might hope to convince Brussels to amend the withdrawal treaty in order to mitigate these risks. But expecting Brussels to drop the stick over state aid while the UK is threatening to walk away from the trade talks over the same issue is bound to fail.

The UK’s best hope – if it wants to avoid the damaging consequences of its own choices from last year – is to establish a robust subsidy control regime at home. There is a strong case for this from a domestic perspective anyway, not least to protect taxpayers’ money from being wasted on ministerial pet projects and to prevent a race to the bottom on subsidies among UK regions. Such a regime, if independently regulated, would give the EU assurance that the post-Brexit state-aid policy will not damage the bloc’s single market from the outside.

If this is a hard reality to accept, it is because it is hard to understand how Mr Johnson agreed to such a constraint on the UK’s sovereignty in the withdrawal treaty whilst boasting about having ended the years of “vassalage” by Brussels. Yet the prime minister needs to acknowledge this reality. There won’t be a deal until the UK engages with the EU’s concerns more constructively and shows that the government will develop credible state aid rules at home. Nor can the UK walk away with no-deal without risking that the EU will, in future, use every opportunity it has – including through the Northern Ireland protocol – to fine the UK over harmful subsidies and even to take the government to the European Court of Justice.

A failure to acknowledge this reality would lead the UK prime minister to his biggest own goal on Brexit yet: a disruptive and irresponsible no-deal and an immense extraterritorial constraint on the UK’s post-Brexit state-aid policy. This would be not just a failure of statecraft, but amateurism on the part of the prime minister and his advisers. Yet it is a glimpse into Boris Johnson’s future outside the single market – and with no trade deal with the EU.

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