Cable is wrong on state aid rules and his plan for a business bank

Andrew Lilico
ONE of the best aspects of the EU is that under the so-called “state aid rules” member states are forbidden from subsidising businesses through grants, tax breaks and soft loans. State aid invariably distorts competition and trade: protecting businesses from foreign competition, or propping up failing businesses, whose failure would create space for value-generating alternatives.

EU state aid rules have been enormously valuable in liberalising industries across the EU. Many EU member states had had long traditions of picking winners, having national champions and favouring politically connected vested producer interests.

Without the pressure of EU rules enabling their governments to pre-commit to the principle of no state aid, short-term political pressures inexorably drag governments into more and more subsidies. A similar principle applies to other EU rules, such as procurement rules preventing governments from only buying domestic products. Such liberalisation has been to the benefit of British exporters, by giving them access to markets that would otherwise be closed to them.

Sometimes such pre-commitment to EU rules is presented as if it were an outrage against democracy. “Who is the EU to tell us we can’t subsidise the industries we want?” But pre-commitment is not really so odd in a democracy. When the government sets an inflation target, it pre-commits to interest rates being at the level required to meet that target. Or when the government makes a deficit reduction, or greenhouse gas emissions cut, or child poverty reduction target, it pre-commits to the principle of doing what is necessary to meet that target. In the same way, EU state aid rules involve the government pre-committing to a principle of avoiding subsidising businesses.

Yesterday, Vince Cable proposed that the government should stop being “defensive” about EU state aid and procurement rules, and be willing to focus support on key economic sectors – thinking more “strategically” about buying British goods. In particular, he has in mind that the government should provide soft loans to large, complex long-term projects.

This is a terrible idea. Governments are appallingly badly placed to assess the long-term risks of major projects, and government involvement in projects is notorious for meaning they go over-budget or turn into white elephants. Are we really to believe the solution to the country’s economic difficulties is a fourth nationalised bank – as if the three we already have (Northern Rock, Lloyds and RBS) aren’t quite enough? Does anyone think it plausible that there is currently insufficient government financial commitment to the UK banking sector?

In fact, Cable’s proposed “British Business Bank” is not a bank at all, but a portal to access schemes such as the inefficient and ineffective Regional Growth Fund. Be thankful for small mercies. Nationalised lenders have a disastrous record. Spain and Italy’s woeful economic performances in the 1960s and 1970s was not unrelated to their large nationalised banks.

Government backed investment banks are, if anything, even more disastrous than nationalised retail banks. Is the lesson of the past few years really that having a UK Fannie Mae and Freddie Mac is the way forward? Japan had three specialist long-term lenders: Long Term Credit Bank (LTCB), Nippon Credit Bank (NCB), and Industrial Bank of Japan (IBJ). In the late 1990s LTCB and NCB were taken over by the government, ruined by bad debts; while IBJ had a private sector takeover. These are not examples to follow.

If the British government says it no longer cares about state aid rules, who in Europe will? Will Cable be pleased when the Bulgarians subsidise their coal, the French their cars and the Italians their fashion? Will other British businesses thank him for recommending we be more relaxed and less “defensive” about strict adherence to EU competition and trade principles?

Government soft loans and subsidies have a long and ineffectual history as a means of assisting depressed regions or promoting new innovations. The notion that they are a tool of economic development had, we thought, gone out with the proverbial 1970s Ark.

The government would like us to believe it has a “modernising” philosophy. But state aid from nationalised banks, directed at favoured industries, is as retro as it gets.

Andrew Lilico is chairman of Europe Economics.