State aid rules update goes the wrong way

The new state aid framework, titled the Clean Industry State Aid Framework, is effectively a replacement for the temporary crisis and transition framework established after the start of Russia’s war of aggression against Ukraine. It also carries over the main elements from that framework, namely i) aid for new clean energy production, ii) aid for the decarbonisation of industry, and iii) aid for the production of products within certain clean technologies. One might well wonder what basis the Commission had when designing this very intrusive framework, as it has not been preceded by any impact assessment. And even if one might question whether the rules are necessary at all, given that there are already reasonable possibilities to provide aid for such investments within the regular framework, there are certain parts that are particularly worrying.

• Aid for the production of products within certain clean technologies. We are talking about aid for setting up mass production of products such as batteries, solar panels, heat pumps, etc. Thus, aid for products that are traded globally and where there is already significant overcapacity for some products. And the amount of aid can be quite substantial. If it concerns aid for investments in assisted areas within the EU, the aid can cover up to 35 percent of the total investment costs. If it concerns small companies, the aid can cover more than half of the costs.
• The Commission proposes that it should continue to be possible to provide so-called matching aid. This means support that matches the support a company can receive for a corresponding investment in a third country. This gives obvious incentives for companies to play countries against each other and create a state aid race. The matching support clause was introduced in the temporary crisis and transition framework as a response to the US Inflation Reduction Act. Now that investment conditions in the US for such investments have radically deteriorated, there is no longer any justification for retaining such a clause.

State involvement in business has been a recurring topic of discussion, both in Sweden and internationally. Throughout history, we have seen how states have stepped in to support, protect, and sometimes save companies, often with questionable long-term results where taxpayers ended up bearing financial losses. Currently, proposals are being presented that mean the state aid rules are being relaxed on a more permanent basis, paving the way for certain strong and supportive member states to favour their companies. There are also strong voices calling for an increase in the EU’s budgetary resources to achieve a range of policy goals – to support green transition, regional economic development, guarantee our security, increase competitiveness, and stimulate private investment. But can an active industrial policy really benefit the competitiveness of business in the long run?

Historically, Swedish industrial policy went from protecting domestic companies through tariffs to actively providing financial support to manage crises and promote growth. The state interventions in the steel and shipbuilding industries in the 1970s and 1980s led to massive losses for taxpayers. Since then, there has been much more restraint in introducing measures to support companies that have ended up in a crisis situation due to insufficient competitiveness (SAAB cars and Northvolt are recent example). This has indeed affected individuals who have lost their jobs. Thanks to a social safety net that can support the worker, they can cope with a temporary period of unemployment and have reasonable conditions to find a new job, sometimes through reskilling or further education. This allows for restructuring, where new companies emerge that are more productive.

At the same time, the state has indeed played an important role in promoting innovation. Historically, the state has been a driving force behind technological advances by funding basic research that is not commercially viable and therefore not conducted by private companies. Without state funding of basic research, we might not have had the internet or smartphones. In addition to basic research, the state can promote entrepreneurship and competitiveness by providing well-functioning infrastructure, good education, good healthcare, stable and reliable energy supply, and a fair and efficient public administration and rule of law.

Despite these advantages, there are significant risks with state intervention. Research shows that state aid can distort competition, create inefficient resource allocation, and lead to political corruption. If the state fails to choose the right sectors to invest in, it can lead to misinvestment and negative effects on economic development. The IMF has recently pointed out that state aid can yield positive results in large open economies if directed to sectors with good knowledge spillovers and if public administrative capacity is high. Particularly in green technology, well-designed industrial policy measures can reduce carbon emissions and simultaneously increase welfare, according to the OECD (2023). But for small open economy like Sweden, there are almost no positive welfare effects to speak of.

Industrial policy aimed solely at strengthening specific sectors, technologies, or companies – domestically or within the EU collectively – risks leading to subsidy races rather than positive and long-term growth.

Overall, state intervention in business should be exercised with restraint. The state can have a role in supporting innovation, but primarily in the form of supporting basic research and well-functioning institutions. The focus of industrial policy should be on creating better conditions for the market economy to function efficiently. If the state’s role becomes too extensive, it risks leading to failed industrial policy projects and the political focus being misplaced, namely on individual ”initiatives” rather than improving rules and institutions.

There is no easy answer to the question of the state’s role in business. But what we can learn from history and empirical research is that state intervention should be limited and only has the potential to work if it is well-balanced, cross-sectoral, measurable, and based on empirical evidence rather than short-term political interests. Therefore, it is quite worrying to follow the current development, where the public sector increasingly tries to convert tax money into productive investments, instead of trusting the business sector to achieve increased productivity and competitiveness. The proposed changes to the state aid framework, with proposed support for mass production, seem to be another step in the wrong direction.