Quelling the Flames or Fighting Fire with Fire? The EU’s Two Approaches to Foreign Subsidies

By Pierfrancesco Mattiolo, University of Antwerp

At the base of the EU State aid regime is the principle that Member States cannot grant subsidies to their companies unless authorized by the European Commission. Subsidies are frowned upon by the EU Treaties since they may distort the internal market and create disparities between the Member States with more financial resources and the ones with less. There are also many economic arguments against the use of subsidies, which are usually not considered an efficient policy choice.

A new example of this deep-rooted European scepticism towards subsidies is Regulation 2022/2560 on foreign subsidies distorting the internal market (Foreign Subsidies Regulation or FSR). This new tool extends the principles and EU State aid to the subsidies granted by third countries. This policy initiative took its first steps in 2020, while the fires of international subsidization started to grow, amidst trade tensions and the economic crisis caused by Covid, and the ideal ‘firefighter’, the WTO, was unable to act.

To face the crisis and perceived inadequacy of the current WTO framework, the EU decided to create a new, ‘autonomous’, tool to address the problem. The FSR joins a trade policy toolbox that also features other ‘defensive’ instruments, i.e. instruments that aim to restore the level playing field by countering the distortion or the injury caused by foreign subsidies. Nonetheless, in the last years, the EU has also been considering, and developing, new ‘offensive’ tools to make it easier to grant State aid or, more limitedly, subsidies funded by EU resources. In other words, fighting ‘fire with fire’. This choice may appear in contrast with the EU’s aversion towards subsidization. To understand if this two-prong strategy is coherent and effective, we should examine more closely this composite toolbox of defensive and offensive tools.

Quelling the flame: the Foreign Subsidies Regulation

The new Regulation legislative process was launched by a Commission’s White Paper in 2020. The year before, the EU had just defined China as a ‘systemic rival’ and renewed its governing bodies. The new Von der Leyen Commission had in mind an open, sustainable and assertive trade policy, inspired by the open strategic autonomy.  The new Regulation aims to (explicitly) address a regulatory gap in EU and WTO rules and (implicitly) answer to the challenges posed by Chinese state-owned or state-sponsored companies. The FSR complements and interacts with several other disciplines: EU antitrust and merger control rules, the WTO Agreement on Subsidies and Countervailing Measures (ASCM), EU trade defence tools, investment screening, and public procurement.

The notion of subsidy defined by Art. 3 FSR is indicative of its close relation with other domains of EU law. If we look at the five elements that compose the notion:

‘… a foreign subsidy shall be deemed to exist where

1. a third country provides, directly or indirectly,
2. a financial contribution
3. which confers a benefit on
4. an undertaking
5. engaging in an economic activity in the internal market and
6. which is limited, in law or in fact, to one or more undertakings or industries’;

we can notice a certain parallelism with Art. 107 TFEU:

‘Any aid granted

1. by a Member State or through State resources
2. in any form whatsoever
3. which distorts or threatens to distort competition
4. by favouring
5. certain undertakings or the production of certain goods shall,
6. in so far as it affects trade between Member States,

be incompatible with the internal market’.

The financial contributions under the scope of the FSR encompass practices beyond the ASCM scope, even if the content and language of Art. 3(2) FSR overlap almost entirely with Art. 1.1 ASCM. These contributions may be transfers of funds, foregoing of due revenues, provision or purchase of products. Even if Art. 107 TFEU uses a more general category (‘through State resources in any form’), it ends up covering a similar range of situations.  The main innovation introduced by the FSR is set in Art. 3(2), second subparagraph, indent (c): the Regulation applies also to financial contributions provided by ‘a private entity whose actions can be attributed to the third country, taking into account all relevant circumstances’. This provision aims to encompass all those practices of State capitalism that remain out of the current ASCM notion of ‘public body’. Another innovation in the FSR is the fact that it covers subsidies in the field of trade in services and capital investments.

Other instances of the ‘defensive’ approach

While the FSR goes beyond the WTO framework, other tools aim to apply WTO rules in the EU jurisdiction. Foreign subsidies can be contrasted through Regulations 2016/1036 (the ‘Basic Anti-Dumping Regulation’, BADR) and  2016/1037 (the ‘Basic Anti-Subsidies Regulation’, BASR). These two tools apply only to subsidies that affect trade in goods, leaving out of scope subsidies that are now covered by the FSR. On the other hand, the FSR will not be used for subsidies to trade in goods already handled under the BASR and the BADR.

The EU has also tried to address the inadequacy of ASCM rules by advocating its reform. The issue has been framed as a matter of ‘industrial subsidies’ and state-owned enterprises. Agricultural subsidies are a different matter in WTO negotiations since the EU provides huge aid to its farmers through its Common Agricultural Policy. The EU has been cooperating with the US and Japan on the matter and the partners used to meet in periodical ‘Trilateral Meetings’. This effort produced some reform proposals, especially on the notion of ‘public body’ under Art. 1.1 ASCM, but reform at the multilateral level cannot succeed as long as the WTO is paralyzed, both in its rulemaking and dispute resolution pillars.

Therefore, it comes as no surprise that the EU is implementing these ideas through autonomous tools, such as the FSR, or bilateral agreements. More recent EU partnership and trade agreements often include chapters on subsidies that establish WTO+ frameworks or rules equivalent to the internal State aid regime.

Fighting fire with fire: allowing more State (and EU) aid

In apparent contrast with this effort to reduce subsidies at the international level, the EU has been considering making it easier for Member States to grant aid, given the geoeconomic challenges that the EU economy has been facing over the last few years. On the one side, severe economic crises: Covid, semiconductor scarcity, and the energy crisis that followed the war in Ukraine. On the other, the renewed competition from China and now also the US, with the massive subsidies granted under the Inflation Reduction Act (IRA) by the Biden Administration. Certain Member States are especially vocal in Brussels in demanding more flexibility in the enforcement of State aid (and competition) rules. To face these unprecedented crises and foreign subsidies, European countries should be able to use their own subsidies.

Some available tools were ‘rediscovered’ and may be used more frequently now. For example, the Important Projects of Common European Interest (IPCEIs), approved by the Commission under Art. 107(3)(b) TFEU, for micro-electronics, batteries and hydrogen technology.  Another example is the recently revised Framework for state aid for research and development and innovation, which contains a ‘matching clause’ that allows for increased State aid if companies outside the Union have received subsidies as well. Another revised tool, the Temporary Crisis and Transition Framework, is also based on the idea of ‘matching subsidies’, if the subsidy granted by a third country may divert investment from the EU.

These tools do not pursue only trade goals. They are part of a broader EU quest for strategic autonomy which involves different policy goals, such as economic and technological sovereignty, national security, etc. Regardless, these tools may stress the principles enshrined in Art. 107 TFEU and pose serious challenges for the cohesion of the internal market since industrial policy rests mostly upon the shoulders of the Member States and a few of them heavily outspend the others. A potential solution is represented by EU-funded programmes, i.e. NextGenerationEU or the ‘Chips for Europe Initiative’.  These initiatives may be considered a form of industrial policy at the EU level.

A controlled burn or the sparks of a subsidy war?

With its combination of defensive and offensive tools, the EU strategy towards foreign subsidization appears ambiguous, at least. It could be argued that such a strategy is contradictory and may benefit from a more systemic and coordinated approach to the different policy tools. Another issue is that, by using offensive or autonomous tools, it may become more difficult to find multilateral solutions later. Trade tensions may escalate, leading potentially to a subsidy war, and the WTO may be hollowed out of its role.

How the EU strategy will play out depends on its next concrete choices. First, the implementation of the FSR. The legislation gives certain discretionary powers and flexibility to the Commission. Also, it is unclear if the ‘FSR unit’ at DG COMP will have enough resources to operate as envisioned by the Commission itself (145 full-time officers and a global expenditure of circa 90 million euros). Second, we will see if the EU will continue to reform (or bend) its State aid rules. And how it intends to muster the financial resources to match the subsidy packages deployed by Washington and Beijing. In a subsidy race, Brussels risks to end up short of breath. The subsidy race may also play out inside the EU, among Member States, with dire consequences.

Pending further assessment of its effectiveness and compatibility with WTO principles, the FSR offers an interesting alternative to the offensive approach and may strengthen the defensive side of the toolbox. These instruments have the merit of ‘disarming’ subsidies as a trade policy weapon and may indeed restore the level playing field, in line with the EU’s ambition to be the champion of the multilateral, rule-based, trade system.

This post is partially based on an article published by Prof. Jan Blockx and the post’s author in the European Foreign Affairs Review. For a broader and deeper coverage of the topic, refer to:

Jan Blockx, Pierfrancesco Mattiolo, The Foreign Subsidies Regulation: Calling Foul While Upping the Ante?, (2023), 28, European Foreign Affairs Review, Issue SI, pp. 53-74, https://kluwerlawonline.com/journalarticle/European+Foreign+Affairs+Review/28.SI/EERR2023014