07 October 2020

EPC: The end of the level playing field?

The level playing field is under severe strain, both inside and outside the EU. But instead of abandoning the idea of an open and fair economy... the EU must go beyond the concept of the Single Market – its own version of a level playing field – and create a Single Economic Territory.

The concept of a level playing field (LPF) has been a core foundation of European economic integration, not only in the way the EU has interacted with the rest of the world but also, more crucially, how it has governed economic interactions between member states. The principle is deceptively simple: All economic actors should be bound by the same set of rules and conditions to ensure that there is fair competition between them.

However, the principle was already under strain before the pandemic hit, aggravated further by reactions to the economic challenges of COVID-19, both internationally and within the EU.

The global rules-based system in limbo

A level playing field relies on a common set of rules which are arbitrated consistently. Internationally, this has been a challenge. The World Trade Organization (WTO) has played an important role in setting up a global system. However, given its reliance on consent from all participating countries, the further development of the global trading framework has had its limitations. More recently, the WTO’s arbitration system, the Appellate Body, has become effectively inoperative due to the US’ refusal to appoint additional members, which leaves it unable to exercise its function.

In part, this was driven by an assessment from the Trump administration that the WTO no longer served its interests, thus clashing with its political aim of ‘America First’. But the challenge to the system not only comes from the US. China has, for several years, effectively favoured domestic firms, both in the Chinese market and through its assistance for international expansion; imposed restrictions on foreign direct investment; and prevented foreign firms’ full access to the Chinese market. Chinese firms’ objective to dominate certain global markets with the support of the Chinese Government clearly underlies the ‘Made in China’ strategy.

Within this environment, EU member states have become increasingly concerned that their companies might face a competitive disadvantage if the same kind of support is not provided to them. There are also fears that innovation cannot be supported effectively without a specific level of protection, or that certain competition rules might need to be relaxed to foster European champions that can compete in this global, winner-takes-all environment.

A world of second best

With the recent limitations of the rules-based system, the global environment will be more challenging than ever. This is a world of second-best policymaking, where well-intentioned policy interventions can produce unintended adverse consequences. With increasing divergence away from a common rules-based system, it becomes more difficult for the EU to determine its optimal policy response. Correcting an imbalance in one area or with one country might skew competition with another.

This also applies within the EU: the internal and external LPFs are closely intertwined. Actions taken to address global imbalances might well impact internal competition. For instance, to face the distorted global competition and enhance the technological leadership of its companies, a member state might provide additional support, including state aid. This, however, distorts the internal level playing field, as other EU companies do not receive the same support. In those circumstances, the EU must determine which market distortion would have a greater impact, thus risking unbalancing either the internal or external LPF.

Uneven support can also potentially create a challenge for regions, particularly those that struggle to withstand global competition. In a world without a LPF, even the most competitive and advanced regions might require additional support to correct the imbalances created by public interventions elsewhere. This could lead to other EU regions falling behind even further with undesirable social, economic and political consequences.

Justified protection

LPF distortions can also arise from legitimate limitations on trade and competition, in the pursuit of overarching public policy objectives. When it comes to security and protection, favouring domestic companies over international competition has always been a feature of the international system.

In addition, there are public policy objectives whose pursuit can legitimise a distortion of trade, for instance, when it comes to protecting public health, labour standards or the environment. However, the challenge here is to differentiate between a legitimate exception and a provision intended to distort competition (i.e. a nontariff barrier; NTB). Therefore, independent arbitration is crucial for a LPF.

The Single Market

The EU’s Single Market (SM) has been built around the concept of a level playing field, going further than the rules which exist to govern global interactions. There is an extensive body of law that ensures that European companies face the same conditions no matter which member state’s markets they enter, with EU institutions executing supranational implementation, arbitration and enforcement.

Within the SM, there continue to be disputes around policies that distort trade, and whether they pursue legitimate policy objectives or are NTBs. But in the end, it is the European Court of Justice that decides what is and is not allowed. In addition, member states’ use of support mechanisms for their companies is constrained. State aid, for instance, is limited by European rules and enforcement.

In recent years, there has been a growing concern over how to ensure consistency between the internal and external dimensions of the SM. For example, does the strict enforcement of merger rules at the EU level disadvantage European companies in international competition, as global competitors do not abide by the same structures? In addition, achieving policy objectives like environmental protection and dealing with climate change, strategic autonomy and security, and the transition to a digital economy can require policy interventions that distort competition.

A distorted economy post-COVID-19

From the outset of the COVID-19 pandemic, there were challenges to the SM: difficulties in providing goods and services across hardening internal barriers to free movement, member states’ differential support to their domestic companies, or challenges in securing a supply of goods and services vital for the health sector. While these challenges were difficult to deal with, the SM recovered rather quickly in most areas thanks to the European Commission.

Nevertheless, the real challenge is still to come. The COVID-19 economic crisis will not only distort the SM in the short term but also have long-term consequences. It will inevitably alter global markets and supply chains. Structural changes will benefit certain sectors while others will face significantly lower demand, permanently. Restrictions on activities that involve face-to-face contact and/or travel (e.g. tourism) will alter patterns of economic activity. This will have distributional consequences, aggravating the imbalance and inequalities that are already present in the SM.

Another consequence of the crisis is that big government is back, not only in countries that are prone to intervene in their economy but across the board. This is not only in terms of providing financial support to companies, particularly employment. Governments are adopting a more proactive role in influencing business decisions (e.g. the development of vaccines), and the restructuring measures deemed necessary to take in supported companies.

This needs to be seen in the context of the enormous state aids some EU countries, especially Germany, are mobilising to support their industries through the worst of the COVID-19 economic slowdown. Clearly, this is a legitimate aim and, rightfully, the European Commission has allowed such state aids, with very few limitations. However, it also inevitably distorts the LPF and implies a selection of which companies will be saved, given member states’ differences in capability and willingness to use state aids. It also opens the EU up to accusations from trading partners that the Union is now using state aids to distort the market, which is something the EU always admonished with others.

The post-COVID-19 ‘new normal’

The choices countries around the world have made in response to the COVID-19 economic crisis have accelerated and aggravated many of the challenging global trends that were present before the pandemic. The ‘my country first’ mentality is evident everywhere. In many countries, there has been a call to ‘reshore’, or bring back the production of certain goods to the domestic economy, particularly, but not only, in healthcare. The drive towards strategic autonomy or technological sovereignty has also been accelerated in response to a fear of overdependence on particular (untrustworthy) suppliers.

At the same time, the EU started to realise even before the pandemic that the major transitions it must face – achieving greater sustainability, catching up to the digital age – will not happen in the absence of interventions. Facilitating these transitions, as well as a step-change in how the EU deals with public health, has become critical since COVID-19 hit.

These are legitimate policy objectives, given the challenges aggravated by the crisis. But this should be done cautiously to limit the interventions’ negative impact on competition. Additionally, they pose a particular danger for the SM: Reshoring and building technological sovereignty and strategic autonomy will inevitably focus on a specific member state’s industry, not least since the competences for issues like security and public health are primarily national, not European.

A return to normality?

The European Commission has stipulated that the EU will return to its normal control of state aids once the worst of the pandemic has passed. This misses the point. By the time we reach post-COVID-19, which will be some time yet, the recovery aid will have already cemented some of the differences. In a world of lower demand, companies will have to consolidate, and they will favour locations where they receive ongoing support. Governments are also becoming deeply involved in many sectors, making it unlikely that they will simply cease their support from one day to another.

In addition, intense rivalries and an uneven LPF will continue to characterise global geopolitics, even if a Biden victory eases some of the EU-US trade tensions and reinvigorates the multilateral agenda. The EU also faces a difficult neighbour on its own doorstep: The EU-UK relationship will likely create friction in areas like state aid, with LPF concerns already playing a significant role in the ongoing Brexit negotiations. Enforcing legitimate public policy aims, such as sustainability or the digital transformation, will also still be on the agenda, with the pre-COVID-19 hurdles remaining.

Goodbye to the level playing field?

So, should the EU abandon the level playing field completely? That would be a mistake. In the end, Europe is a great beneficiary of global free trade and exchange, and the Single Market remains the crown jewel of economic integration. A protectionist Europe that attempts to isolate its economies from global competition would impoverish itself rather than empower its companies.

However, in the post-COVID-19 period, where the LPF has receded further than ever, we will need to go beyond the concept of the SM and create a Single Economic Territory (SET). This entails a joined-up microeconomic policy approach to ensure that the EU can collectively reach its overarching objectives and support its businesses in a global environment of distorted competition.

For the SET to work, the EU and its member states would have to define and implement common objectives (e.g. state aid). Only a coordinated approach at the European level can minimise LPF distortions. The starting point should be an EU-wide industrial strategy which explicitly accounts for cross-border effects as well as encapsulates the EU’s strategic objectives, including the digital and sustainability transformations. All proposed member state interventions should be tested on their compatibility and consistency with such a strategy, before considering an exemption to the usual SM rules.

The recovery plan for Europe can underpin such an approach, balancing out divergent fiscal capabilities. National recovery plans should be assessed to determine their EU-wide impact, and adjusted, if necessary, to ensure that any SM distortions are evaluated (and addressed).

When dealing with third countries, a common approach is necessary to ensure a consistent EU-wide line on state interventions and their trade-distorting effects, given that some EU member states are intervening heavily in their own economies. Only a common EU approach encapsulated in an industrial strategy, based on transparent objectives and challengeable in courts, can ensure that the Union is not seen as simply reverting to national protectionist instincts.

No way back

Taking a common approach would be in the interest of all EU member states. It would ensure that the countries most affected by the economic implications of COVID-19 do not become permanently dependent on hand-outs, and continue to compete in and integrate within the SM instead. It would defuse the political dynamite that is being created by Germany’s capacity to support its industry, thus making the country’s approach more sustainable, both politically and economically. For small, open economies, supporting the creation of a SET should be of highest priority given their dependence on free trade within the level playing field of the SM.

The EU must examine its range of policies and adapt them to the post-COVID-19 world. It needs to recognise these new challenges, which can only be addressed by refining and reforming core policies (e.g. competition policy) and taking a strategic approach, inter alia, to the Single Market, trade and industrial policy. The LPF can only be saved if it is adapted, reformed and made relevant for the new world Europeans are facing in the aftermath of the pandemic.

Fabian Zuleeg is Chief Executive of the EPC.

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