In this post, George Peretz Q.C. of Monckton Chambers assesses whether the subsidies provisions in the EU/Japan and UK/Japan free trade agreements provide a suitable model for any future UK/EU free trade agreement.
As is well-known, one of the major obstacles to the achievement of a Free Trade Agreement (FTA) between the UK and EU after the end of the transition period is the question of whether the FTA should require the UK to operate a subsidy control regime comparable to the EU State aid regime. Although the current government made commitments in paragraph 77 of the Political Declaration to “maintain a robust and comprehensive framework for … state aid control that prevents undue distortion of trade and competition”, and indeed promised during the election campaign and subsequently to develop a regime “that the EU will recognise as a robust system”, the current position is that no such regime will be announced (let alone in place) until some undefined time well after the end of transition, with the UK merely respecting the very limited WTO regime in the meantime. Moreover, the UK negotiating position offered no substantive commitments on subsidies at all, beyond notification and consultation obligations. But the EU sees that position as wholly inadequate, not least because, absent a comparable regime of its own, the UK will continue to be able to free ride on the EU’s State aid regime (which limits the ability of Member States to subsidise in ways that could harm the UK) while subsidising freely itself – and given the size and proximity of the UK, UK subsidies are likely to have adverse effects on the EU, many of which cannot be dealt with easily or at all by the standard WTO tool-kit (for example, the WTO regime does not cover services or the use of subsidies to purchase corporate assets).
It is now being reported that the UK negotiating position has shifted, in that the UK is now prepared to offer the additional – and substantive – commitments on subsidies contained in the EU/Japan Economic Partnership Agreement, which has apparently been “rolled over” into the UK/Japan FTA agreed last month (the text of that agreement is not yet public). That movement was probably inevitable – there could be no rational explanation of why the UK was prepared to make subsidy commitments to Japan that it was not prepared to make to the EU – but is it enough to deal with the EU’s concerns?
The substantive provisions in the EU/Japan ETA – which go beyond consultation and notification – are in Article 12.7. Article 12.7(a) prohibits public guarantees that are unlimited in amount or duration, while Article 12.7(b) prohibits aid to restructure failing or insolvent enterprises without a credible restructuring plan and a significant contribution from the business concerned or its shareholders. In both cases, the prohibition applies if the measures have or could have a significant negative effect on trade or investment between the parties. Finally, Article 12.8 prohibits businesses from using subsidies except for the purposes for which they were granted. In my view, implementing that obligation in the UK will require legislation (either primary legislation or by regulations under clause 2 of the Trade Bill once it is enacted). Such legislation would simply need to prohibit all measures that fall within the UK/EU equivalent of Article 12.7 and all misuse of subsidies contrary to the equivalent of Article 12.8.
However, it is hard to see that those commitments meet the EU’s concerns. They would not, for example, prohibit the UK from throwing large amounts of money at a company in return for locating production or facilities in the UK – the type of subsidy that generates subsidy races (contests between different jurisdictions to see who is prepared to pay most to win the business of multinational companies – contests in which the only winners are the fortunate multinationals). Nor would they prevent tax breaks for favoured companies. Rather, the Japan commitments focus on a limited subset of subsidies that can always be regarded as harmful, while leaving most subsidies – and most harmful subsidies – untouched. (Interestingly, Article 12.9 provides that the “general exceptions” provisions in Article XX GATT (and Article XXIV GATS) apply for the purposes of the subsidies chapter. But it is hard to see in practice how subsidies falling under Article 12.7 (or misuse under Article 12.8) would ever fall within these general exceptions.)
The difficulty with a wider prohibition is that it will cover types of subsidies that can in some cases be harmful but in other cases can be entirely justified. Examples of harmful grants and tax breaks were provided above: but a grant to a company to locate in a disadvantaged area may well be necessary to overcome market failures that hinder private investment in that area, and a tax break to a company to take up “green” technologies may well be needed to overcome the market failure that the company may otherwise have no incentive to reduce its use of polluting technologies that impose costs on others. So any wider prohibition needs some independent and consistent way of verifying whether a particular grant or tax break is harmful or not: that is to say, it needs an independent regulator with rule-making and decision-making powers. Finally, given that the EU may take the view that the UK regulator has been too permissive of subsidies that adversely affect the EU, the EU will want some form of dispute resolution mechanism to deal with those cases. (It should be noted that the UK would also benefit from such a provision, since it would allow the UK to obtain dispute resolution in cases where the Commission approves State aid in a case that adversely affects the UK – an important UK interest that does not appear to date to have played much of a part in the current government’s thinking.)
It is therefore unlikely that a UK agreement to write the equivalent of Article 12.7 of the EU/Japan ETA into the UK/EU FTA will resolve the present impasse. Rather, any likely landing zone will involve a UK regime that deals with all types of subsidies: and such a regime will require some form of independent regulator and effective enforcement mechanisms to ensure that subsidies that could be harmful are properly considered. Such a regime would not require replication of the EU’s State aid rules: indeed, as the authors of a public letter to the Prime Minister (including the present writer as well as others across the spectrum of views on Brexit) pointed out, such a regime could build on the WTO concept of “subsidy” and “could provide significant benefits to the UK internal market” and be “an exciting opportunity” to lead the way in dealing with the threats that unconstrained subsidies pose for global trade.
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