UK has most to gain from Brexit state aid compromise

Move to end the bitter Brexit wrangling will be welcomed by those who feared the state aid issue could scupper any hopes of a trade deal

Chess
State aid and fishing rights have proved stumbling blocks in UK-EU trade negotiations

For many traditional Conservatives, the idea that a government’s right to pump money into private companies could become such an important element of the Brexit negotiations is extraordinary.

They will therefore have breathed a sigh of relief when Lord Frost, the chief Brexit negotiator, said on Wednesday that the issue had taken a back seat to fisheries as a stumbling block to a deal.

The close Johnson ally admitted to a Lords’ committee that the UK would benefit from strong dispute settlement measures on state aid, and that “other EU countries subsidise quite often more than we do”.

It was a significant shift. Previously, the Government had indicated that there would be no replacement for the EU’s state aid regime, which Brussels had wanted the UK to stick to under the supervision of the European Court of Justice – anathema to some Brexiteers.

As the talks enter a critical week, ahead of a highly anticipated meeting of European leaders on Thursday and Friday, Michael Gove, the Cabinet Secretary, said there was “cause for steady optimism”.

The UK has been reluctant to put its hand in its pocket compared to European rivals in the controversial area of state aid. But the Prime Minister’s chief adviser Dominic Cummings has said more freedom from Brussels would mean the Government could boost technology firms and encourage research and development.

Since the 1970s, the idea of “picking winners” as part of industrial policy has been regarded as unsuccessful and un-British by governments of both colours. As Stephanie Rickard, professor of political science at the London School of Economics, puts it: “The UK has been an overcomplier and undersupplier of subsidies.”

By 2018, the UK spent only 0.4pc of GDP on state aid, compared to an EU average of twice that. Ten member states – including Germany – spent more than 1pc.

Even during the pandemic, only one British firm has been reported to have received emergency state funding via Project Birch, the Government’s bail-out fund for “strategically important” companies. “If anything, the UK is being disadvantaged by other countries that follow the rules less assiduously,” Ms Rickard says.

Lord Frost’s comments were important because they were the first acknowledgement that the UK was willing to go further on subsidy control than in its provisional trade deal with Japan, which itself was a turning point – the first time Britain conceded it would commit on the issue at all.

George Peretz, a lawyer at Monckton Chambers in London, says the concessions to Japan were inevitable, making it “almost inevitable we’d have to offer those at the very least to the EU”.

However, he adds that they failed to cover “the most harmful types of subsidies – things like huge grants to persuade companies to locate in the UK – things which the EU is concerned about”.

Ms Rickard says speculation that the concessions to Japan, made before any were offered to the EU on state aid, were an indication of a rift between Mr Gove and Liz Truss, the Trade Secretary, is a “red herring”, given the implausibility of a deal with Tokyo without them. But despite Lord Frost’s announcement, there remain many unanswered questions.

It is unclear, for example, whether part of the reason the Government wants more flexibility on state aid is that the current EU rules on tax concessions clash with its ambitions for free ports. Thomas Pope, a senior economist at the Institute for Government, speculates that the Thames free port bid would “probably be problematic” given the rules only allow support for regions poor enough to qualify.

It is also unclear what dispute settlement measures – now there is an indication there might be some – would look like, or how they would be enforced.

Mr Pope argues that the UK having its own system of subsidy control would be better than the EU’s, which is administratively cumbersome. “A subsidy doesn’t have to be big before it has to jump through hoops to qualify,” he says. “It doesn’t normally mean a subsidy is prevented but you have to get a lawyer in to help with the design.”

It would also be better than relying on the World Trade Organization, whose remedy for subsidy violations is tariffs, he says: “If you have to impose a tariff on another country, that harms you too because your consumers have to pay higher prices. The idea of the aid being repaid (as under the EU system) reverses the subsidy so it’s a more complete remedy.”

In a mark of the divisions in Whitehall, the Department for Business, Energy and Industrial Strategy (BEIS) still claims “the UK will follow World Trade Organization subsidy rules and other international commitments after the end of the transition period”, the default position.

But Ms Rickard adds that without its own state aid rules, the UK risks a subsidy race between the devolved nations, which could make Scottish independence more attractive. “You end up with a situation like you have in the US where states give huge subsidies for businesses to move from Kansas to Nebraska and actually it creates very few jobs,” she says.

The IfG suggests that the Competition and Markets Authority should mimic the EU system when Britain leaves the single market and customs union at the end of the year, until a new system is designed.

The think-tank argues that having its own domestic subsidy control regime would also help the UK calm the furore over the Internal Market Bill by making it possible to override the application of Article 10 of the Northern Ireland Protocol that gives the EU Commission jurisdiction over subsidies that affect the trade in goods between Northern Ireland and the continent.

Senior officials say the Government will ultimately commit to a regime that is “recognisable” to the EU, which should suffice, given Brussels has conceded that the UK needs only to “approximate” its own state aid rules, according to Mujtaba Rahman, of the consultancy Eurasia Group.

The question of governance is hairier but the “landing zone” seems to be in sight – enough so that Lord Frost insisted to a separate parliamentary hearing on Wednesday that fish is now “the most difficult issue remaining”.

It’s harder, Mr Rahman says, because “Johnson can’t sell the status quo to the Tory right”. He adds: “But if the PM delivers a deal that increases market share for Scottish fishermen, he’ll be better equipped in next year’s Holyrood elections – and this could arrest some of the momentum behind independence.”

If the EU fails to match the UK’s move on state aid by budging on fish, British negotiators are preparing for a trade-off between the two issues so that Britain can blame any breakdown in talks on the EU, Mr Rahman says. Brussels officials tell him such tactics are “fishy”.

In any case, that the Government appears ready to compromise on state aid is welcome news to many. As Mr Peretz says: “The idea that this would be a hill a Conservative government would want to die on – that could stop us getting a free-trade agreement with the EU – seems to be extraordinary.”