A/14540

Original Message From: HPiffaut@lecg.com [mailto:HPiffaut@lecg.com] Sent: Monday, June 15, 2009 10:52 PM To: COMP STATE AID GREFFE Cc: ILiedorp@lecg.com; PKalmus@lecg.com; UHaegler@lecg.com Subject: HT 1727 - comments on economic assessment of state aid

Dear Sir, Madam,

Please find attached our comments on DG Competition's Draft Common Principles for an economic assessment of the compatibility of state aid under art.87.3. We acknowledge that our comments are late but hope that they will still be taken into account for the drafting of the final document on this topic.

Best regards,

Henri Piffaut/Philiip Kalmus/Urs Haegler/Ingrid Liedorp

(See attached file: memo_lecg response consultation 090615_clean.pdf)

Henri Piffaut

Director Direct: +32 (0) 2 517 62 85 Mobile: +32 473 82 14 26 hpiffaut@lecg.com www.lecgcp.com

LECG Consulting Belgium S.A./N.V. Rue des Colonies 11/11 Koloniënstraat, B-1000 Brussels, Belgium Main: +32 2 788 12 10, Fax: +32 2 788 12 11

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Common Principles for an economic assessment of the compatibility of state aid under Article 87.3

Comments on DG Competition’s draft Common Principles

Reference HT 1727 Henri Piffaut, Philip Kalmus, Urs Haegler and Ingrid Liedorp1

11 June 2009

1. Introduction

In Spring 2009 DG Competition presented its Draft Common Principles for an economic assessment of the compatibility of state aid under Article 87.3 (hereafter the ‘draft Common Principles’).2 This non-paper is aimed at creating more transparency around the balancing test which is performed when deciding whether a certain aid measure can be expected on the basis of Article 87.3 from the prohibition laid out under Article 87.1.

LECG is an economic consultancy firm active in all areas of competition economics. We welcome the further guidance that DG Competition wishes to provide through these Common Principles. Based on our experience in State aid matters, we have a number of comments to make on the current draft.

• To articulate any State aid assessment in terms of market failure and cost/benefit analysis of the best way to address them certainly brings more clarity and objectivity to the State aid practice of the Commission. However, the flexibility that the draft Common Principles attributes to the Commission in weighting the various steps on the investigation will increase the risk of type I and type II errors.3 By adopting conformity on weight and degree of detail, the risk of such errors can be minimised or at least reduced.

• The draft Common Principles should only require a substantiation of market failures when it can offer a method with which this can be done in a practically

1 The authors are economists at LECG Consulting Belgium, S.A.-N.V., Park Atrium, 11 Rue des Colonies/11 Koloniënstraat, B-1000 Brussels, Belgium, tel +32 2 788 12 10. 2 European Commission. 2009. Staff working paper. Common Principles for an economic assessment of the compatibility of state aid under Article 87.3. Available at: http://ec.europa.eu/competition/state_aid/reform/economic_assessment_en.pdf 3 The notion of type I and II errors originate from statistical decision making processes. A type I error refers to the rejection of the null-hypothesis whereas the null-hypothesis is true. A type II error refers to the inverse situation: the failure to reject the null-hypothesis whereas it is false. In the case of state aid, the null-hypothesis would be to block the aid, as this is what Article 87.1 EC prescribes. Type I errors are therefore those decisions in which an aid measure is approved whereas there are net negative effects and type II errors are decisions in which the Commission has not exempted the state aid from the prohibition in Article 87.1 whereas actually the aid would have brought net positive effects.

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implementable way. In the current draft, such a method is not presented. In the absence of any workable methodology with which to quantify market failures, a qualitative description of the present market failures seems to be better justified. This would however jeopardise the implementation of the balancing test.

• The appropriateness test should take a tougher stance regarding the burden of proof of Member States. However, more guidance is needed in order to prevent that the burden of proof with respect to the comparison of different intervention methods becomes disproportionate.

• The guidance on the profitability analysis of the incentive effect test is limited. We recommend the inclusion of a number of methodologies with explanations as well as stylized examples. Moreover, the use of sensitivity analyses should be recognised and encouraged in reaction to the numerous uncertainties inherent in estimations of this type. Finally, the draft Common Principles can devote some attention to cases in which the aid has positive spillover effects on connected activities which would become less expensive as a result. As the cash flows of these activities fall outside the scope of the project under assessment, these benefits will not be properly taken into account.

• The proportionality test can benefit from a proposed methodology to determine a benchmark value for the market return on investment. In addition, another dimension of proportionality could have been added by comparing the extent of the aid with the value of the market failure. If the aid would be greater than the public benefit, it could be argued that it is not proportionate.

• State aid control is by nature a prospective analysis. Guidance would be welcomed on the type of evidence that is considered useful to prove the effect on competition of changes in behaviour. Moreover, the assessment of competitive distortions depends crucially on the type of welfare standard chosen.

• The choice for a social welfare standard over a consumer or total welfare standard is not sufficiently explained. ‘Social welfare’ reflects the aggregation of the welfare of various categories of stakeholders such as the aid beneficiary, competitors, consumers and input suppliers. However, there is an entire spectrum of ways in which such aggregation can, in principle, be accomplished. At one end of the spectrum, one would simply add up welfare (or utility) levels of individuals or individual stakeholder groups, regardless of distributional aspects. At the other extreme, the welfare levels of those that are worst off have absolute priority, whereas those of others are secondary. The draft Common Principles should provide guidance on how such aggregation would be implemented. Absent such guidance, the adoption of a social welfare standard may be entirely subjective, and ultimately driven by socio-political considerations on the impact of state aid, rather than objective economic benchmarks,

• Instead of providing a list of possible remedies, the draft Common Principles could present how remedial measures would be assessed and decided upon.

• The proper implementation of State aid control would require having recourse to information from various sources in order to be able to quantify the various elements of the analysis but also to be able to cross-check the information that has been provided. The Commission currently lacks the investigative powers to collect such information from parties distinct from the Member States. This increases the risk that

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State aid procedures would lead to too many (type I) errors and will be harmful for society as a whole.

The present note discusses the above points in more detail. First, we will present our comments regarding the additional legal certainty that the draft Common Principles is aimed to create. Next, the report will present our comments regarding the objective of the aid, the appropriateness test, the incentive effect test, proportionality, the distortions on competition and the balancing test respectively. A final part will include some general remarks regarding the draft Common Principles.

2. Legal certainty

The Common Principles aim to provide clarifications regarding the consecutive steps that the Commission will normally undertake during an investigation: (i) the objective of the aid; (ii) the appropriateness of the aid; (iii) the incentive effect of the aid; (iv) the proportionality of the aid; (v) the negative effects of the aid; and (vi) a balancing test. However, instead of increasing transparency on the balancing test, confusion might arise from the flexibility that the draft Common Principles grants to DG Competition in the economic assessment of a state aid case. The draft Common Principles not only indicates that the weight attributed to the different steps in the investigation can vary, but also that the degree of detail can be different in each case.4 This is problematic for several reasons:

First, the flexibility on the side of DG Competition does take away a great deal of legal certainty for Member States, recipients of the aid and third parties as there is no clarity on the exact scrutiny of the Commission. Expensive resources might be spent to collect sufficient evidence with the aim to prove the net overall balance of the aid, even though some information might then be disregarded due to the lower weight that may arbitrarily be placed on certain parts of the investigation.

Second, the weight and degree of detail that are placed on the different steps in an investigation also determine the risk of type I and II errors.5 For instance, when a lower standard of evidence is required to prove the existence of positive effects than to prove negative effects (or when positive effects are more highly valued than negative effects), the risk of type I errors increases. The converse, a lower standard of evidence with respect to the determination of negative effects will give leeway to the existence of type II errors. Decision rules or guidelines should be designed to minimize either type of error. The risk of type I and type II errors can be reduced by adopting conformity in the weight that is placed on the different steps of the investigation and the degree of detail in which each step is assessed.

4 Draft Common Principles, para.7. 5 The notion of type I and II errors originate from statistical decision making processes. A type I error refers to the rejection of the null-hypothesis whereas the null-hypothesis is true. A type II error refers to the inverse situation: the failure to reject the null-hypothesis whereas it is false. In the case of state aid, the null-hypothesis would be to block the aid, as this is what Article 87.1 EC prescribes. Type I errors are therefore those decisions in which an aid measure is approved whereas there are net negative effects and type II errors are decisions in which the Commission has not exempted the state aid from the prohibition in Article 87.1 whereas actually the aid would have brought net positive effects.

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Third, in light of the existence of several other, more specific, guidelines on the balancing act in State aid investigations6, it is important to guarantee consistency between these documents. For instance, the draft Common Principles distinguishes three types of competitive distortions that can arise as a result of an aid measure. These are (i) long-term dynamic effects on incentives to invest and compete, which might lead to less choice and potentially lower quality or higher price for consumers; (ii) responses by competitors, which might reduce their own sales and investment plans; and (iii) affected competition in input markets and the location of investment.7 The categorisations of competitive distortions found in other guidelines for more specific aid measures, whilst bearing some similarity with that above, are different.8 Moreover, the distinction between effect (i) and (ii) may seem artificial, as both effects come down to the crowding out of competitors. It would be recommendable to define the same types of competitive distortions in the general Common Principles as in the more specific guidelines per type of state aid.

Fourth, pre-existing regulations and frameworks should be adjusted to reflect the substance of the Common Principles, once adopted. Otherwise, it is conceivable that the investigations regarding two projects with only a slight difference in, say, the aid intensity would lead to opposite conclusions with the outcome depending on whether a particular case was covered by the Common Principles or not.

Fifth, the fact that the Common Principles does not contribute substantially to an increase in legal certainty is not in line with the Commission’s State Aid Action Plan (SAAP)9 with which it wants to create more transparency and predictability. The Commission notes in that same SAAP that it wants to “make state aid control more predictable and user-friendly, thereby minimising legal uncertainty and the administrative burden both for the Commission and for Member States.”10 The provision of clear and

6 See for instance the framework for state aid to Research & Development & Innovation (European Commission. 2006. Community Framework for state aid for research and development and innovation. OJ 2006/C 323/01); the guidelines on state aid for rescuing and restructuring firms in difficulty (European Commission. 2004. Community guidelines on State aid for rescuing and restructuring firms in difficulty. OJ 2004/C 244/02); the guidelines on national regional aid (European Commission. 2006. Guidelines on national regional aid for 2007-2013. OJ 2006/C 54/08); as well as other guidance on state aid for environmental protection (European Commission. 2007. Community guidelines on state aid for environmental protection. OJ 2008/C 82/01); state aid to promote risk capital investments in SMEs (European Commission. 2006. Community guidelines on state aid to promote risk capital investments in small and medium-sized enterprises. OJ 2006/C 194/02); state aid for Services of General Economic Interest (SGEI) (Commission decision of 28 November 2005 on the application of Article 86(2) of the EC Treaty to State aid in the form of public service compensation granted to certain undertakings entrusted with the operation of services of general economic interest. OJ 2005/842/EC); and a draft guidance on regional aid to large investments (European Commission. Commission working document. Guidance on the in-depth assessment of regional aid to large investment projects. Available at: http://ec.europa.eu/competition/state_aid/reform/consultation_large_investment_projects.pdf) 7 Draft Common Principles, paras.46-48. 8 For instance, the draft guidance on aid to large investments distinguishes between the negative effects (i) the risk of crowding out; and (ii) effects on trade and location (e.g. the relocation of an investment rather than the creation of new economic activity). The framework for R&D&I specifies (a) distortion of dynamic incentives; (b) creation of market power; and (c) the maintaining of inefficient market structures. 9 European Commission. 2005. Consultation document State aid action plan - less and better targeted state aid: a roadmap for state aid reform 2005-2009. SEC(2005) 795, 7 June 2005. 10 European Commission. 2005. Consultation document State aid action plan - less and better targeted state aid: a roadmap for state aid reform 2005-2009. SEC(2005) 795, 7 June 2005, para.17.

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detailed guidance in order to improve transparency and predictability is all the more important considering the distinct position that State aid control has in comparison with other pillars of competition policy, i.e., Article 81 , Article 82 and the Merger Regulation. First of all, Member States rather than undertakings are the actors that possibly cause a distortion of competition. In addition, both efficiency and equity objectives are taken into account in the assessment of a state aid measure, whereas usually, social objectives are left aside.

We now turn to the review of the guidance on the steps of the balancing test individually, which are the objective of the aid, the appropriateness of the aid, the incentive effect test, the competitive distortions and finally the balancing test itself.

3. Objective of the aid and market failures

In response to the guidance that the draft Common Principles provides in relation to the objective of the aid, we have two main concerns. First, we consider that the objectives of common interest are not that well-defined, such that there is not enough clarity on what they might consist of in practice. Second, we believe that these objectives should rather focus on proven market failures, as this is what causes the deviation between the actual and the optimal investment level.

“Well-defined objective of common interest”

The first part of an investigation assesses the positive effects of the state aid. The draft Common Principles indicates that the aid should be aimed at a “well-defined objective of common interest”.11 However, it is not clear what such a well-defined objective is. In its “Standard form for notification of State aids pursuant to Article 88 (3) EC Treaty and for the provision of information on unlawful aid”, the Commission specifies a number of possible objectives at which state aid may be aimed. Nevertheless, these objectives are very broad, including goals such as ‘research and development’, ‘SMEs’, ‘sector development’ and ‘remedy for a serious disturbance in the economy’.12

We consider that the adoption of such ‘well-defined objectives’ do not address the right issues. After all, what matters is the presence of market failures which lead an investor to decide that he does not invest up to the optimal investment level. For that reason, objectives that are focussed and based on proven market failures would be better justified.

11 Draft common principles, para.9. 12 The other objectives specified in the “Standard form for notification of State aids pursuant to Article 88 (3) EC Treaty and for the provision of information on unlawful aid” are: regional development, environmental protection, rescuing firms in difficulty, restructuring firms in difficulty, employment, training, risk capital, promotion of export and internationalisation, services of general economic interest, social support to individual consumers, compensation of damage caused by natural disasters or exceptional occurrences, execution of an important project of common European interest, heritage conservation, and culture.

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Quantification of market failures

The draft Common Principles document is correct in taking the presence of market failures into account as a justification for the granting of State aid. More important, it is right in stating that the presence of positive spillovers does not automatically lead to the conclusion that there is a market failure.13 After all, most investment will be surrounded by some externalities or some information asymmetries. In other words, the draft Common Principles indicates that the market failure should be substantial enough to affect investment decisions in such a way that, from an efficiency perspective, investments would not be at an optimal level. The draft Common Principles considers that the stimulation of additional investment by State aid is efficient “when the cost of the activity is high enough to wipe out the profit of the undertaking, but still lower than the overall benefit for society”.14 This can be translated into the following two cumulative criteria:

• private profitability of the project absent any aid < 0;15

• cost of the activity < overall benefit for society.

In other words, the project is worth undertaking from a society’s point of view (private and social benefits are greater than the cost of the investment), but is not profitable at a private level, due to the existence of market failures. The difference between private benefits and social benefits is exactly the size of the market failure, which one should estimate, as it is the change in welfare that results from the presence of the market failure.

It is important to note that the two conditions above do not characterise what should be the optimal (maximum) level of the State aid. The first condition provides a lower level for the State aid: below that level the project is not privately profitable. However, the second condition does not identify an upper level of the State aid. It states that the sum of the private profit and public profit must be greater than zero. The effect of the State aid is the reallocation of profits between the private investor and the public. The greater the State aid, the greater the private profit and the lower the public profit. In the present situation, the second condition appears to be independent of the level of State aid.

Despite the acknowledgement in the draft Common Principles that it is necessary to substantiate market failures16, such a quantification exercise is easier in theory than in practice. As mentioned above, the value of a market failure is determined by the difference in the private value of an investment and its social value. Especially the quantification of this social value, which is an aggregation of values for various groups of stakeholders, is an extremely difficult, if not impossible, exercise. The draft Common Principles does not give much guidance on how to quantify or substantiate market failures. Rather, it specifies a number of criteria that “may be relevant to identify more specific market failures”17 which is only a first step in the analysis.

13 Draft common principles, para.23. 14 Footnote 23 of the draft Common Principles. 15 A minimum level of profitability (consistent with private investors’ expectations) would be more appropriate than a simple wiping out of profits. 16 Draft Common Principles, para.19. 17 Draft Common Principles, para. 25.

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We acknowledge, as the draft Common Principles does18, the difficulties inherent in the quantification of market failures. However, we are of the opinion that the draft Common Principles should only require a substantiation of market failures when it can offer a method with which this can be done in a practically implementable way. In the absence of any workable methodology with which to quantify market failures, a qualitative description of the present market failures seems to be justified. This would however jeopardise the implementation of the balancing test.

4. Appropriateness of the aid

A second step in the Commission’s proposed analysis is to determine whether the aid is an appropriate method to reach the objective of common interest. The draft Common Principles considers that a measure constitutes an “appropriate instrument, where the Member State has considered other policy options and where the advantages of using a selective instrument such as State aid are established and demonstrated to the Commission.”19

However, the draft Common Principles does not suggest criteria to assess the appropriateness of a State measure. In addition, it is unclear whether appropriateness is evaluated against other State interventions including other types of State aids or excluding these. The limited guidance seems to suggest that the appropriateness of an aid measure is not usually assessed in great detail. This could result in manifest errors. The draft Common Principles should either provide further guidance to determine appropriateness against other policy instruments, or reserve detailed examinations for the comparison of various State aid measures only and consider these appropriate against other policy instruments as long as they address a market failure. The second alternative is probably best as the need to study the effectiveness of more general measures in comparison with the aid measure would imply a full blown balancing exercise for each of the conceivable policy instruments which can be envisaged to reach the objective of common interest. Such an analysis seems disproportionate.

5. Incentive effect of the aid

In order for the aid to have an incentive effect, the draft Common Principles notes that the aid must lead to a change of behaviour by the beneficiary “in such a way that it engages in activity that contributes to the achievement of a public-interest objective that (i) it would not carry out without the aid, or (ii) which it would carry out in a restricted or different manner”.20

These two situations compose the counterfactual against which the granting of aid should be assessed. However, one may wonder whether this is a limiting principle. By definition, any public funding will change the behaviour of the beneficiary such that it will undertake activities in a different way. The necessary qualitative assessment in which is determined whether the intended change of behaviour is “likely to lead to the

18 Draft Common Principles, para.24. 19 Draft Common Principles, para.31. 20 Draft Common Principles, para.32.

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achievement of the targeted policy objective pursued”,21 is made in the part in which the positive effects of the aid measure are summarised. These positive effects are relevant when they contribute to the overall objective of the aid measure, such as R&D or regional development, and will thereby limit the scope of the sought after ‘change in behaviour’.

The incentive effect test therefore only comprises the part in which the change in behaviour needs to be determined by comparing between a situation with aid and one without aid. Alternatively, a situation with aid in one region can be compared with a situation without aid in another region. It would consist of a quantitative analysis on the profitability of the project or the cost differentials resulting from a specific location choice.

The guidance on the incentive effect test is limited regarding the profitability analysis of the aid. The draft Common Principles presents no guidance whatsoever on how a profitability analysis of this sort should be undertaken, for instance with guidance on the type of methodologies typically used. Whilst these methodologies are mentioned in the draft guidance on aid for large investments22 and include “methods to evaluate the Net Present Value of the project (NPV), the internal rate of return (IRR) or the return on capital employed (ROCE)”23, they should – as a matter of principle – also be included in these general guidelines.

Additional difficulties in the profitability analysis might arise from the estimation of a proper discount factor and due to the uncertainty of future cash flows. The use of sensitivity analyses should be encouraged in this context. Additional guidance could be included to make Member States aware of these possibilities.

Finally, in addition to effects on the project under assessment, aid might have positive spillover effects on connected activities. Externalities of this type may, for instance, have the effect of reducing the cost of those activities. In the common profitability analysis, such benefits would not be taken into account as they are not reflected in the cash flows of the investment project. More guidance would be welcomed on how these and similar types of benefits should be included in the incentive effect test.

6. Proportionality

The draft Common Principles states that “[a]id is considered to be proportionate only if the same result could not be reached with less aid and less distortion.”24 This test seems to be focussed on addressing instances where the aid would lead to excessive profits on the activity concerned. For such assessment, a benchmark level should be defined on what should be a market return on investment. A proposed methodology for that purpose would have been useful.

21 Draft Common Principles, para 33. 22 European Commission. Commission working document. Guidance on the in-depth assessment of regional aid to large investment projects. Available at: http://ec.europa.eu/competition/state_aid/reform/consultation_large_investment_projects.pdf 23 European Commission. Commission working document. Guidance on the in-depth assessment of regional aid to large investment projects, para.24. 24 Draft Common Principles, para.39.

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Another dimension of proportionality would have been to evaluate the extent of the aid vis-à-vis the value of the market failure.25 If the aid would be greater than the public benefit, it could be argued that it is not proportionate.

7. Distortions of competition

After having determined the positive effects of the aid, the Commission will also assess whether the aid might have any negative effects, such as distortions on competition.

The draft Common Principles identifies three possible effects: on long term incentives to invest, on competitors decisions in the market (crowding out) and on the input market.26

As an example of such negative effects, the draft Common Principles assesses the effects of aid that stimulates market entry by covering entry costs.27 The draft Common Principles points at the risk of crowding out of private investments as competitors of the beneficiary of the aid may have a smaller incentive to invest in the wake of subsidised entry. It notes that these negative effects will be even larger when efficient competitors are forced to exit the market. However, the draft Common Principles could place greater emphasis on the potential positive effects from such subsidised market entry. It is acknowledged that entry might lead to an increase in overall output and competition. The draft Common Principles considers these positive effects to have a short-run effect at best. It is not clear why the draft Common Principles a priori excludes the possibility that such positive effects may be more persistent in nature. After all, if the beneficiary of the aid is more efficient than the current market players28, it can be expected that its entry will increase incentives to invest and innovate as a result of more intense competition. These positive effects of increased competition will materialise both in the short run as well as in the long run. It is therefore important that for each type of aid, including aid that stimulates market entry, both potential positive and negative effects are assessed. As can be seen in the example of market entry, the sign of the effects depends crucially on the relative efficiency of the beneficiary of the aid.

Another important point to bear in mind is that the analysis of the possible distortive effects of the aid is by nature a prospective analysis. As illustrated in merger control, such analysis depends heavily on the underlying assumptions, the quality of the data collected and is subject to high standards of proof. It could be considered useful to indicate what would be the kind of evidence necessary to prove absence or existence of the ability and incentives to invest, be present in a market, etc. as well as the effect on competition of such changes in behaviour.

25 See also Subsection ‘Quantification of Market Failure’. 26 Draft Common Principles, paras.46-48. 27 Draft Common Principles, para. 17, Box 1. 28 It can be argued that more efficient players would not need State aid in order to cover entry costs, as they can recoup entry costs by the (relatively high) expected profits made during the competitive process after entry. However, if the entry costs are substantially high and can be characterised as fixed costs, even relatively efficient entrants might be reluctant to invest and enter the market without state aid, whereas its marginal costs of production are lower than the other market players.

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Protecting competitors or competition?

In the assessment of the negative effects, it is important to distinguish between the direct effects of the aid and the more indirect effects on final consumers. For instance, competitors might delay investment decisions and see their market shares drop due to a crowding out effect following from the state aid. Whether this effect as such can be a reason to prohibit the State aid in a definite way depends on the type of welfare standard that is adopted in State aid control. For instance, under a consumer welfare standard, the crowding out effect cannot on its own be a reason to block the State aid. In that event the impact on consumer welfare should be used as a decisive factor. In the assessment of negative effects, therefore, the criteria against which negative effects are measured become all-important.

8. Balancing test

When all evidence is collected, both positive and negative effects are set out in the balancing test. It is clear from the draft Common Principles that the Commission looks at both the short run as well as the long run to assess effects. The draft Common Principles also recognises that, obviously, short run effects can be estimated with much more certainty than long run effects.29

The preceding steps in the analysis should have produced estimates of - or at least identified - positive effects and negative effects. Positive effects include the impact on the welfare of the recipient of the aid and the achievement of the public benefit associated with the correction of a market failure. Negative effects include the loss of welfare for various stakeholders (other than the taxpayer burdened with the financing of the aid) such as input suppliers, competitors and consumers. The balancing of those positive and negative effects may produce (when quantifiable) a positive or negative net effect. It is not clear what role the value of the aid will then play. It can be argued that if the net effect is lower than the amount of the aid then it is doubtful that it is worth for the Member State in question to invest in such activity in that form.

Welfare standard

In the balancing test, DG Competition applies a social welfare standard. A social welfare standard takes into account not only the sum of Consumer Surplus and Producer Surplus but also how welfare is distributed across countries and citizens. It thereby integrates both efficiency and equity considerations.30

The social welfare standard is not at all a common welfare standard in economics. Rather, it is the consumer welfare standard which is applied in the competition policy framework in the EU. The most logical alternative to this standard would be the total welfare standard, which is for instance used in Canada in combination with the consumer welfare standard.

The draft Common Principles does not sufficiently explain the choice for a social welfare standard to balance the effects of state aid. Friederiszick et al. (2006) try to justify this

29 Draft Common Principles, para.64. 30 Draft Common Principles, footnote 41.

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choice by arguing that a social welfare standard does take into account both efficiency and equity considerations such that the aid is in the ‘common interest’ which is pursued.31 However, the draft Common Principles does not define which type of social welfare standard should be used, which again does not contribute to the legal certainty that the Commission seeks to establish. Examples of social welfare standards are for instance the purely utilitarian, the Paretian or the Rawlsian standards, which each employ different parameters with which to decide whether a certain measure is ‘good’ or ‘bad’. Considering that State aid control does also take equity objectives into account, a pure utilitarian welfare standard, which simply tries to maximise welfare without being occupied with the distributional impact of actions, seems not to be a logical option. Moreover, the use of any social welfare standard includes a danger of using economics as a veil to hide any socio-political view on the impact of State aid. Rather than creating consistency, such a welfare standard introduces a degree of subjectivity as a result of value judgements.

There is also a danger of perception in the introduction of quantitative balancing through a social welfare function. Aggregation of individual utilities can only be achieved through additional assumptions or policy views. Without the knowledge of this limitation on the balancing of preferences, one might end up with reports that claim that a particular case of State aid “increased social welfare by €xx”. Such a report might seem the result of an economic analysis, when in fact it would necessarily be the result of a policy judgement on the importance of different stakeholder groups. The danger is that the choices in policy views and assumptions that underlie a quantitative result of the benefits of a State aid intervention remain obscure and are lost. Indeed, it might be possible that a (in the strict sense impossible) quantification might be used to veil and cloud the true intentions of a particular stakeholder group.

Economics should not be asked to deliver more than it can logically do. Forcing economics to deliver something that it cannot is likely, in the long term, to undermine the useful contributions that economics can make. These contributions lie in understanding with a degree of quantitative precision the impact on stakeholders, markets and member states, to highlight the uncertainty of outcomes from state aid and to reveal the degree of aid by quantifying the additional amount necessary to make a project viable. They do not lie in quantifying and balancing the social impact of aid. Economics can only be an aid, but not a substitute for the political decision of granting state aid.

Remedial measures

The draft Common Principles suggests a number of possible remedies depending on whether the emphasis is laid on the design of the aid or the distortions brought by the measure.32 Instead of providing a list of possible remedies, the draft Common Principles could present how remedial measures would be assessed and decided upon. For instance, a given remedial measure could be assessed in terms of its impact on the ability and incentives of third-party stakeholders to behave in the markets considered. In the end, remedial measures should alter the balancing test so that it becomes positive according to the chosen welfare standard.

31 Friederiszick, H.W., L.-H. Röller and V.Verouden. EC State aid control: an economic perspective. In (ed.) Rydelski, M.S. 2006. The EC State aid regime; Distortive effects of state aid on competition and trade. Chapter 8, pp.145-182. 32 Draft Common Principles, paras.73-75.

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9. General remarks

After having done the balancing test, DG Competition can decide to block or to approve the granting of aid by the Member State. However, it might be possible that a wrong decision is made. We have seen that the critical assessment is important at all stages to limit the presence of type I and type II errors. The proper implementation of State aid control would require having recourse to information from various sources in order to be able to quantify the various elements of the analysis but also to be able to cross-check the information that has been provided. This is because Member States might have an incentive to submit information in a biased manner, thereby increasing the probability that the granted state aid will be approved, leading to type I errors. The Commission currently lacks the investigative powers to collect such information from parties distinct from the Member States. This increases the risk that State aid procedures would lead to too many (type I) errors and will be harmful for society as a whole.

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