The EU’s internal policy on control of state aids faces three kinds of difficulty:

• First, there has been no coherent application of the principles of subsidiarity to this domain of policy. The EU hesitates between considering that the control of state aid is important to prevent member states from inflicting damage on each other, and treating it as a kind of medicine that should be taken for member states' own good. This means that the principles used to analyse cases are often conflicting, emphasizing sometimes the damage caused by state aid to other firms, and sometimes the uneconomic use of the resources concerned.

In the application of state aid policy to the new German Lander, there has been no attempt to focus attention on the cases that have cross-border effects from those that merely waste taxpayers' funds. The waste of taxpayers' funds is certainly a matter of concern, but there are domestic political mechanisms for the expression of such concern. Sometimes democratically elected governments choose to use state aids in a way that is foolish, but causes little damage outside their own borders. For the Commission to seek to restrain them is not only legally doubtful, but may put at risk the admirable efforts the Commission has made in recent years to accommodate the fears expressed in many members states about the pace of European integration and the possible loss of local autonomy.

• Second, the EU has a large and growing case-load of state aid notifications to deal with. But its ability to control aid levels is very limited. The proportion of cases that culminate in a negative decision has fallen from between 2% and 5% in the late 1980s to under 1.5% since 1991.

There are some benefits from this growing workload: in particular, as a result of Commission efforts there is now much better and clearer information available to member states themselves about the levels of state aid granted. These reveal major differences between member states and go some way towards creating pressures to justify the expenditures to the taxpayers that finance them. However, because of the overload on the Commission's staff it is doubtful whether the cases to which they object are necessarily the ones that are most damaging, either to member states or to the single market as a whole.

• Third, the lack of clear principles behind the Commission's involvement in the control of state aid are an invitation to lobbying and to the use of the judicial process as a strategic tool against competitors. Since the firms that are the most important recipients of state aid usually have powerful political connections (which is usually why they received the aid in the first place), state aid decisions by the Commission are among the most controversial of all, and create powerful incentives for the exercise of pressure by member states themselves.

This pressure is not only in the direction of allowing aid: member states may use the procedure to bring pressure to bear on competitors to their own firms. And the process is an invitation to litigation: in 1996 around 80 cases were pending before the Court of Justice and the Court of First Instance. In its efforts to reduce the flow of money into the pockets of industrialists, the Commission should not provoke large flows of money into the pockets of lawyers.

How should the countries of Central and Eastern Europe react to these developments?

• Overall, a better control of the allocation of state aid to industry is indeed in the interests of these countries. They should therefore welcome EU attention to the issue, if only because it provides a welcome inducement to improving the transparency of their procedures and their ability to direct scarce tax resources to the most important uses. However, they should also be aware of the risks that the state aid rules may be used by EU firms (as anti-dumping procedures have certainly been used) merely to stifle competition from firms in Central and Eastern Europe.

The best way forward, both for these countries and for the EU itself, is to distinguish much more carefully aid that creates identifiable cross-border distortions to competition from aid that is merely irritating to competitors or a waste of taxpayers' money. A policy that could make this distinction is a long way from being implemented, either inside or outside the European Union, but the need for it is real.

Paul Seabright is a Senior Research Fellow in Economics at Churchill College, University of Cambridge and a Research Fellow in CEPR’s Industrial Organization and Transition Economics programmes. Further research related to his talk can be found in his book (with John Fingleton, Eleanor Fox and Damien Neven), Competition Policy and the Transformation of Central Europe, CEPR (1996).

The Centre for Economic Policy Research (CEPR) was established in 1983. It is a non-profit network of over 450 Research Fellows based throughout Europe, who collaborate through the Centre in research and its dissemination. CEPR helps its Fellows develop projects, obtain their funding, administer them and disseminate their results. The Centre’s research ranges from open economy macroeconomics to trade policy, from the economic transformation of Central and Eastern Europe to European competition policy, with particular emphasis on all aspects of European integration. For further information about CEPR, please contact Rita Gilbert, External Relations Manager, CEPR, Tel (44 20) 7878 2900, Fax (44 20) 7878 2999 or email rgilbert@cepr.org

CEPR gratefully acknowledges the underlying support for research provided by the UK Foreign & Commonwealth Office.

The Institute for EastWest Studies, founded in 1981 as a trans-Atlantic partnership, serves as a catalyst to build sustainable democratic market societies in Central and Eastern Europe and to facilitate their achieving peaceful and productive interstate relations together with full integration into the community of open societies. IEWS operates through a network of centers, including New York, Prague, Budapest, Ko› ice, Kyiv and Brussels and collaborates with individuals and institutions in order to link Central and Eastern Europe and the Newly Independent States with Western Europe and the United States.

The Economic Policy Initiative (EPI) aims to strengthen and multilateralize the public policy process in the Associated Countries, and assists in their preparation for accession to the EU. It operates in seven EU Associated countries – Bulgaria, the Czech Republic, Hungary, Poland, Romania, the Slovak Republic and Slovenia – where local partner institutes coordinate activities within their own country. In the first phase of the project, participants from Estonia, Latvia, Lithuania, Russian and the Ukraine are involved as observers. Funding for the Initiative is provided by the Ford Foundation, the Pew Charitable Trust and the EU’s Phare Programme.