DG Competition of the European Commission publishes several studies evaluating State aid rules provided by a consortium with the participation of the DIW Berlin

Report of June 18, 2020

On 2 June 2020 DG Competition of the European Commission published several support studies on the retrospective evaluation of State aid rules. This “Fitness check” will serve as a basis for future Commission’s decisions about whether to further prolong or update the rules expiring in 2020.

The consortium of DIW Berlin, Lear, Sheppard Mullin and UEA Consulting under the leadership of E.CA Economics provided several of these evaluation studies. The team of the Firms and Markets department at the DIW Berlin participated on three of them in the areas of regional state aid, state aid for access to finance for SMEs, and state aid rules for operating aid under the EU aviation framework.

Evaluation of the Regional State Aid Framework

Link: https://ec.europa.eu/competition/state_aid/modernisation/RAF_study.zip.

The firms and Markets department at the DIW Berlin participated to the retrospective evaluation of the Regional State Aid framework in collaboration with the team leader E.CA Economics and Sheppard Mullin.

The overall aim of regional aid is to promote regional development in disadvantaged EU regions. The EU Commission sets the rules under which such aid may be granted in order to avoid or minimize any distortion of competition. These rules constitute the Regional Aid Framework (RAF) which includes the Guidelines on Regional State Aid (RAG) and the provisions applicable to regional aid in the General Block Exemption Regulation (GBER). The RAF was updated in 2014. Some of the major changes introduced by this reform were the reduction in maximum allowed aid intensities, the change in the eligibility of regions to receive aid, and a more restrictive approach towards aid for Large Enterprises (LE), by forbidding aid for follow-on investments, as opposed to greenfield, in more developed eligible areas.

The objective of the study was to provide the Commission with an independent evidence-based assessment of the implementation of the RAF 2014 and its effects on regional development and competition. In particular, the study evaluates:  (1) to what extent regional investment aid has provided a real incentive for companies to locate their investments in disadvantaged areas of the EU (“effectiveness of the RAF 2014”).  (2) To what extent the RAF 2014 has allowed the Commission to focus on the potentially most distortive cases (“efficiency of the RAF 2014”). (3) To what extent regional investment aid has been a relevant factor for companies to locate in the EU’s disadvantaged regions in a global context (“relevance of the RAF 2014”). (4) To what extent the RAF 2014 has been consistent with the EU structural funds legislation (“coherence of the RAF 2014”). (5) to what extent the RAF 2014 has reduced the risk of subsidy races in the EU (“EU added value of the RAF 2014”).

The study team employed multiple research methods including an in-depth literature review, a web-based survey of 66 aid-granting authorities, several case studies as well as interviews with experts, and an econometric analysis based on regional data and different identification strategies.

Concerning the effectiveness of the RAF 2014, the evidence collected in this study confirms that the availability of regional investment aid in the EU’s disadvantaged regions does attract investments to those regions. The relative importance of regional aid as an incentive to attract investment varies depending on the stage in the decision process, the type of investment, enterprise, sector and the eligibility status of the region. This conclusion comes robustly from the econometric analysis, the survey of aid granting authorities, literature review and the expert interviews.

Specifically, the econometric analysis shows that large enterprises in the more developed assisted areas exposed to the greatest changes in the RAF were most affected by the reform. Investment rate of LEs was significantly lower in those areas than in counterfactual areas. This is consistent with the views expressed by aid granting authorities from these areas. Yet, the results also show that the investment levels in the least developed areas were not impacted by the RAF 2014 reform. Neither were SMEs affected by any of these changes.

The efficiency of the RAF 2014 was assessed mainly by case studies, which assessed the balance between the ex ante risk of the aid measure to negatively distort competition and affect trade between Member States and the expected effort required from the stakeholders involved in notifying and assessing a case under the RAG 2014. For the less developed assisted areas (“‘a’ areas”), the study found that the effort was balanced with the ex ante risk in all notified cases. For the more developed assisted areas (“‘c’ areas”), we found that the effort was often not balanced. 

The study assessed the relevance of the RAF 2014 by examining whether, and if so to what extent, regional aid has contributed to attracting Foreign Direct Investment (“FDI”) to the disadvantaged regions of the EU.  Overall, the descriptive analysis of FDI data does not provide indications of a clear relation between the maximum aid intensity and the share in worldwide FDI inflows. At the EU28-level, both maximum aid intensities and the share in FDI flows have decreased over the period 2007 to 2017. Comparing the levels of FDI flows and maximum aid intensities of the individual Member States reveals that there is a negative correlation between the (average) maximum aid intensity and the share in FDI inflows. This illustrates that the RAF 2014 targets precisely those Member States with slow developing regions. The study further looked at time development of FDI inflows and maximum aid intensities and it found a weak positive relationship between average maximum aid intensities and FDI flows. However, this correlation appears to be driven by developed countries that prior to the RAG 2014 had a low average maximum aid intensity and thus it is likely unrelated to regional aid availability.

Concerning coherence of the RAF 2014, the descriptive analysis and the survey of aid-granting authorities show some differences between the RAF 2014 and the ESI Funds provisions, in particular in terms of scope of application (geographic and sectoral), definitions of terms and criteria for approval. However, these differences are mainly about some extra burden for the beneficiaries and aid-granting authorities rather than contradictions that would make the two sets of rules irreconcilable.

Regional aid rules can bring added value to the Member States and the EU by preventing wasteful subsidy races, when regional authorities compete with each other to attract investment to their region. The RAF 2014 reduced regional State aid eligibility and maximum aid intensities compared to the previous regional aid rules and it prohibited State aid from relocating existing investment between Member States. In theory, these measures restricted aid granting authorities in their ability to bid for investments against other EU regions. In practice, the study looked at regional State aid cases reviewed with a location scenario under both RAG. These cases do not cover all subsidy races: cases under GBER and investments moving away of the EU are not included, so it is not possible to conclude about the overall change in the frequency of regions in the EU competing against each other since 2014. Focusing on cases with location scenario only, they were reviewed under the RAG 2014 more frequently compared to the previous RAG period.

Evaluation support study on the EU rules on State aid for access to finance for SMEs

Link: https://ec.europa.eu/competition/state_aid/modernisation/risk_finance_study.zip

The firms and Markets department at the DIW Berlin carried out this study in collaboration with Lear and Sheppard Mullin.

Small and medium-sized enterprises are the backbone of the European economy, representing 99.8% of non-financial enterprises in the EU. SMEs contribute significantly to European job creation and economic growth. Yet, SMEs may still face difficulties in obtaining access to finance due mostly to a problem of asymmetric information. These problems are magnified for young and innovative firms, which typically lack the operational track records that banks employ to assess creditworthiness and/or may entail a significant degree of risk without being able to provide collaterals. This can lead to a situation where SMEs are inefficiently underfunded and unable to fulfil their growth potential, to the detriment of the European economy.

The study relies on three main sources of evidence to analyze whether the existing state aid framework is helping reducing this market failure: interviews with stakeholders, a review of the relevant economic literature and of publicly available data sources, as well as five case studies analyzing in depth aid schemes implemented by five different Member States (Finland, Germany, Italy, Netherlands, and United Kingdom).

The study documents that access to finance is the least mentioned among pressing problems as of 2018, and the percentage of SMEs that have identified access to finance as their most pressing problem has decreased not only on average (EU28) but also in each Member State between 2014 and 2018. Yet, the study also confirms that some Member States are lagging behind. While the situation for SMEs as regards access to finance has improved in recent years, market failures still persist in specific areas. The types of firms most affected by the market failure are: (i) young businesses with 0-2 years and 2-5 years of activity; (ii) high-growth firms and gazelles; and (iii) firms investing in innovation activities. In terms of instruments, despite the improvement in the availability of equity capital, its use by European SMEs decreased between 2014 and 2018, suggesting that SMEs struggle finding sources of equity financing.

For technology firms, fast-growing companies and young firms, equity is often the most suitable form of capital. To meet these equity needs, both the presence of formal venture capital (“VC”) investors and business angels (“BAs”) and a well-developed capital market are required. The Study shows that the funds raised and the investments made by private equity (“PE”) and VC funds increased markedly between 2014 and 2018, and that the increase has mainly been driven by investments in SMEs. Further, the supply of funds by BAs (to all firms and not only SMEs) has increased steadily since 2014. However, a comparison with the US reveals that Europe is still lagging behind. Case studies confirm an improvement in the availability of PE and VC funds also in the context of State measures.

Alternative trading platforms represent a tool that can facilitate the matching between SMEs in need of equity finance and institutional investors such as venture capitalists and BAs. Since 2017, six new alternative trading platforms have been set up in the EU area. While the study confirms the effectiveness of alternative trading platforms in reducing the market failure, they are not perceived by stakeholders to play an important role in providing additional capital to SMEs yet.

Both stakeholder interviews and case studies have revealed a general satisfaction with the State Aid Rules, which are broadly found as still relevant and well designed to address the identified market failure. Yet, certain features of the eligibility criteria still attract some criticism. The evidence collected throughout the study suggests that the Rules may have been effective, and that their possible negative effects are limited. As compared to the previous framework this positive effect has been driven by the fact that the current Rules are less strict and more flexible and that certain limits have been broadened. Moreover, the evidence collected does not support the existence of a significant crowding-out effect, i.e. public money displacing private provision. Nonetheless, the European VC market has remained fragmented, and sizeable differences in the development of the VC markets prevail.

Support study for the evaluation of the rules for operating aid under the EU aviation framework

Link: https://ec.europa.eu/competition/state_aid/modernisation/aviation_study.zip

The firms and Markets department at the DIW Berlin carried out this study in collaboration with Lear and  Sheppard Mullin.

Under the Aviation Guidelines, the Commission considers that airports should normally bear their operating costs. Nevertheless, regional airports (with annual passenger traffic of up to 3 million), in the light of their contribution to the connectivity of citizens and regional development, can receive operating aid only for a transitional period of ten years that will end on 3 April 2024. This measure is meant to enable small airports to adjust to the phasing out of operating aid, in consideration of the many changes that the industry has undergo since the liberalization of air transport in 1997.  The Commission identifies five groups of airports based on the annual passenger traffic (“classes”): Class 1: 0-200,000; Class 2: 200,001-700,000; Class 3: 700,001-1 million; Class 4: 1,000,001-3,000,000; and Class 5: above 3 million. The rules under the Aviation Guidelines link the maximum intensity of operating aid permitted during the transitional period to the number of airport passengers and smaller airports could benefit from higher aid intensity than larger airports. Moreover, in 2017, the Commission has extended the scope of the General Block Exemption Regulation (“GBER”) to operating aid granted to airports below 200,000 annual passenger traffic. Therefore, since 2017, operating aid to these airports is considered compatible with the EU internal market.

This study aims to assess whether the State aid rules on operating aid to regional airports set out in the 2014 Aviation Guidelines remain fit for purpose. First, the existing literature provides evidence that air traffic has a positive impact on regional development, especially in the service industries. The effects seem to be more pronounced for the most remote and economically depressed areas.

Second, while the transitional period (2014-2024) for the phasing out of aid seems adequate for regional airports with more than 700,000 passengers per annum; many airports below this threshold will not be able to cover their operating costs by 2024, mostly the smallest ones. In fact, using survey data at the airport level, this study finds that all larger airports and a majority of airports with annual passengers between 200,001 and 700,000, should be able to fully cover their operating costs by 2024. On the contrary, only 38% of the airports up to 200,000 passengers are expected to cover their operating costs by 2024, although this group falls under the General Block Exemption Regulation since 2017 and is not exposed to the phasing out of operating aid.

Third, current maximum aid intensity regimes seem appropriate for the majority of airports. Indeed, data shows that actual funding needs are expected to exceed maximum aid entitlement only for 23% of all airports between 200,001 and 700,000 passengers (these are also the airports that are not expected to reach equilibrium by 2024).

Fourth, the analysis shows that passengers are an important predictor of profitability. Other determinants of profitability may provide additional insights, but most of them (e.g. the share of low-cost carriers) depend on airports’ strategical choices. Therefore, they may be more apt to condition aid upon and be less suitable to help defining the need of aid.

Finally, the evidence suggests that a finer passenger-based categorization might be a better predictor of airports’ ability to cover operating costs.