The UK’s replacement for state aid rules will affect UK-EU relations in the years to come

Thomas Pope | Jun 2021

UK government must get its new subsidy control system right if it wants to avoid frequent cross-channel subsidy disputes in the next few years.

The freedom to replace EU state aid rules became a priority for UK negotiators in Brexit talks last year. The deal agreed gave the UK the freedom to design its own regime to regulate subsidies provided by governments to businesses. But it does impose some conditions on what subsidies can be offered. The UK will shortly unveil its new subsidy control system, and the choices it makes could determine whether subsidies will be a theatre for UK-EU disputes over the next few years.

In a recent Institute for Government report, we highlight that the UK does have an opportunity to design a more effective system than state aid rules for the UK. The EU system can often be slow and inflexible, in part because of the need to control subsidies in 27 different countries. A UK domestic system can and should be more flexible. It does not need to have a regulator with the same powers as the commission, and so it should be possible to approve subsidies more quickly and give governments in the UK more freedom to design subsidies in the way they see fit.

However, that report also highlights risks with the UK government’s current approach, which prioritises flexibility. The UK-EU trade deal requires that subsidies must comply with six broad principles (for example, that the measure must contribute towards a public policy objective and that benefits must outweigh costs). The current UK proposals are that public bodies can self-assess whether their proposed subsidy satisfies these principles, with no regulator to check their homework. Subsidies could then be challenged in court, but only then would the reasoning be tested and even then courts are likely to give deference to the granting authority.

The report highlights several problems with this approach, including that it would create legal uncertainty and would not guarantee that harmful subsidies are prevented. A looser domestic UK system is also more likely to trigger a challenge from the EU – something the UK-EU deal makes provision for. If the EU suspects that a subsidy violates the principles it can trigger a process that ends – should no other resolution be found – with “remedial measures”, which could include tariffs on the subsidised products.

Subsidies promise to take on a more important public policy role over the next few years, including to meet objectives like ‘net zero’ and to ‘level up’ poorer UK regions. For example, the UK has already announced plans for low regulation freeports that provide more perks to businesses than would likely have been permitted in the EU. If the EU does not view the UK system as rigorous and robust, challenges from across the channel are much more likely.

EU involvement in UK subsidy control may also come through a different route. Article 10 of the controversial Northern Ireland protocol states that subsidies which affect goods trade between Northern Ireland and the EU must still comply with state aid rules. The UK and EU disagree on the scope of this provision – the UK argues that it will almost always apply only to subsidies to Northern Ireland businesses, but the Commission has argued that subsidies to Great Britain companies with a presence in Northern Ireland may also be subject to EU rules.

This provision of the protocol – originally in place to protect the EU in case of no deal – threatens to undermine a new UK system. It could mean that many of the most important UK subsidies require EU approval, negating most of the benefits of a bespoke UK system. It also provides another route by which the EU might try to influence UK subsidy policy if it is unhappy with the operation of the UK regime.

We recommend that the UK develop a system with clear guidance and regulations and an advisory role for a respected and impartial regulator to ensure the system is effective and achieves the UK’s domestic objectives. Such a system would also help to satisfy the EU that it is not at risk of aggressive and unfair subsidisation from a close competitor. This would help to avoid frequent disputes and may, over time, allow a renegotiation of the protocol to limit or eliminate the scope of the state aid provisions.

However, if the UK persists with its plan for a lax system, subsidy disputes – both via the provisions of the trade deal and the Northern Ireland protocol – are likely to emerge with regularity and contribute to a rocky UK-EU relationship. All eyes, then, on the upcoming UK subsidy control bill to see where the government lands.