The dynamics of institution building: State aids, the European commission, and the court of justice of the European Union

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Highlights

  • We study how decisions are made by key decision makers in the European Union regarding “state aids”, i.e., public supports to corporations by local or national governments in the framework of their policies.

  • State aids, challenge the establishment of a level playing field necessary to achieve the single market; a key dimension of the European project and decisions on the matter are an essential dimension of the EU competition policy

  • State aids are the consequences of the principle of subsidiarity enshrined in the founding treaties of the EU, which recognizes the legitimacy of sovereign states in promoting specific socio-political preferences.

  • The European Commission has the power to accept or reject the state aids programs put forth by member states, depending on their impact on the openness of markets and on the fairness of competition.

  • Based on all the cases, submitted to the European Commission between 2000 and 2017, we highlight that it tends to be more likely to reject programs from countries that are less compliant with EU mandates, which is in accordance with its mission to foster EU integration.

  • Appeals to these decisions are submitted to the Court of Justice of the European Union, which correct the bias of the European Commission and accept (eligible) state aids even from countries that are less compliant with EU regulations; in line with the Court's mission to guarantee the rule of law.

  • The revealed policy choices of both the executive and judiciary branches of the European Union can be interpreted as the result of their will to reinforce their respective legitimacy (toward Member States and the citizens) by complying with their mandate.

  • This results into an interaction allowing both branches to mutually reinforce their legitimacy and independence, triggering an institutional reinforcement over time and providing a case study of how institutions can be self-reinforcing (to use Greif's terminology).

  • This case study is central to the understanding of how an adequate institutional dynamic could solve the puzzle of the clash of logics between sovereignty and integration, which characterize any process of economic and policy integration among sovereign states.

Abstract

This paper studies the interactions between European Union institutions and the Member States with regard to state aid control. The mandate of the European Commission includes the maintenance and strengthening of economic integration, and as such it may discipline any Member States that undermine the single market. Relying on an original database covering all state aid applications with rulings between 2000 and 2017, we show that, on the one hand, the Commission tends to reject programs originating from countries that are resistant to EU integration, which is proxied by the transposition deficit. On the other hand, when firms or national governments appeal the decisions made by the Commission, the reversal of the Commission's rejection decisions by the Court of Justice of the European Union is positively correlated with the transposition deficit. This evidence suggests that while the Commission is biased against countries with greater resistance to integration, the Court corrects this bias since its mandate is to guarantee the rule of law in the EU system of governance. We argue that these revealed policy preferences are consistent with the assumption that these two bodies attempt to strengthen their legitimacy by making decisions in line with their mandates. Moreover, the interaction between these twin pursuits of legitimacy reinforces the overall legitimacy of the Union, suggesting another driver of evolution in an equilibrium approach of institutions.

Introduction

The European Union was initially designed to be a confederation whose goals included the establishment of an internal market in which people, labor and capital would flow freely. The single market was aimed at triggering further political integration. This objective has been acceptable to nation-states and their citizens since, at first blush, it promises economic benefits without requiring too great a loss of sovereignty. The EU treaties were very careful in delineating the powers conferred to the EU and the Member States, as the Union aimed to preserve the latter's sovereignty. The authority granted to each level of government might, however, be subject to interpretation and could evolve over time. Such ambiguities may lead to conflicts between European institutions and Member States, even if the main policy decisions are voted by representatives of national governments and are implemented by national public administrations.1 The Member States tend to have a complex relationship with the EU system of government. On the one hand, the substantial benefits of European integration in terms of wealth and global political influence may make Member States more likely to compromise. On the other hand, national politicians and voters would like to minimize the costs incurred by adapting their national 'social contracts', which can lead to slowness in implementing reforms and imperfect compliance with EU commitments. This resistance to integration can also be caused by differences in the endowments of the various socioeconomic groups and local communities, which lead to imbalances in the distribution of the costs and benefits of integration within each Member State.

It is not an overstatement to say that at the heart of the European Union lies a fundamental conflict between the objectives of the European Commission and those of the Member States. Moreover, no clear solution to this conflict appears to exist at present. The mandate of the Commission is to build a more integrated Europe through policies that mainly aim to promote the single market. National governments and parliaments, however, respond to their fellow citizens, to whom they are accountable. While EU and national objectives are aligned in principle, at least in a long-run perspective, voters tend to be more short-sighted and care mainly about their own personal and local interests. They may not believe that the long-term benefits of integration offset the short-term cost of adaptation. Moreover, since the leveling of the playing field creates winners and losers, the latter might form coalitions to resist integration. These considerations lead national political systems (i.e. politicians and public bureaucracies) to take action to protect these interest groups against integration, which may be more palatable than managing active redistribution and supporting those who have to adapt. These divergences between 'national' (and sub-national) interests are the raison d’être of the European Institutions. They exist to tie the hands of national governments facing such dilemmas of collective action. If interests were aligned at every level, there would be no need for central and federal levels of government in the first place, and the best outcome would be achieved for all parties.2

The clash of objectives is well illustrated by state aid control, which is a part of EU competition policy. Competition policy is the most effective tool granted to the Commission, whose mandate is to remove barriers to trade and market protections. National governments have agreed to relinquish sovereignty in this matter since it is essential to building the single market and enjoying the putative benefits of larger, more open markets, including greater scale for producers, supply-side incentives, easier entry for innovators, and higher quality and lower prices for customers. National and sub-national governments retain control over many other dimensions of public policies that are considered to be crucial dimensions of sovereignty, such as choice of energy mix, organization of transportation systems, regulation of utilities, and regional development. This results in numerous biases that hinder further economic integration and has led the Member States to give authority to the Commission to check whether 'state aids' – i.e. any subsidy in the form of grants or tax cuts offered to investors and businesses – create unfair competitive conditions. Each Member State is eager to support its own industries or specific local interests, but such aid could tilt the playing field and thus go against the principle of the European single market and related fair competitive conditions. State aids are thus not allowed by the Commission. However, major categories of exemptions include support for cultural activities, recession-hit industries, local employment, or social and territorial cohesion. The right to obtain an exemption is not crystal-clear and every case, from earmarked support to a predefined program, has to be submitted to the Commission, which may or may not approve it. The Commission clearly benefits from discretionary power in making these decisions and is likely to forbid or reshape any aid that tilts the level playing field. While the Commission does have the benefit of alternative levers to bargain with national and sub-national governments (such as the management of 'structural funds'), it may rely on its authority to approve state aids to achieve certain political aims.

The exercise of the Commission's authority is, however, checked by the Court of Justice of the European Union (hereafter, the Court), which was established to ensure that the Commission decisions are in line with European treaties and laws. The Court is not a political instrument of national governments to resist the policies of the Commission. Rather, it was established as a credible court of justice, and the appointed judges have strong career incentives to establish their reputation as independent and skilled judges that uphold due process and the rule of law.

The European Commission was established with a clear mandate to advance harmonization and integration among the Member States. It is designed as a trustee and not simply an agent of its stakeholders (Majone, 2001). The authority granted to the Commission by the Member States allows it to impose decisions on the latter regarding the implementation of the European treaties. This trusteeship system results from the need for Member States to credibly commit to the integration. The Commission's mandate thus includes promoting integration, which in practice amounts to an extension of authority over national sovereignty. The Commissioners therefore tend to be driven by their ability to show to their peers (the politicians and top-tier bureaucrats in the system of transnational governance) their ability to navigate the complex political environment of the EU political game, which is characterized by persisting tension between national (sometimes local) interests and the mandate to build a stronger Union. , The Court and its judges, on their end, have incentives to demonstrate and grow their credibility in establishing and guaranteeing the rule of law. Thus, while the Commission seeks to expand its authority over the Member States, the Court corrects any infringements of the latter's rights. These back-and-forth interactions, together with the Member States, drive changes in the institutional equilibrium within the European Union.3 This may, therefore, represent a virtuous loop: bit by bit, the Commission might succeed in expanding its power and the Court might reinforce its independence.

These interactions could reinforce the legitimacy of both organizations, resulting in a stronger, more credible EU institutional framework. The above-described dynamics might partly be unintentional. When Robert Schuman launched the process that led to the establishment of the European Union, his idea was to make war not only unthinkable but also materially impossible. More than 60 years after the formation of the European Coal and Steel Community led to additional dialogue and closer relations among European countries, the European Union has evolved and reached a level of complexity that could not have been foreseen at the outset. While complete success may still take many years to achieve, it has undoubtedly laid the foundations of stable and strong institutions. The fact that it remains a system of government under development also makes it a stimulating environment to study the decision-making process and its institutional dynamics. Despite their careful design and implementation, institutional systems will not necessarily perform as envisaged by those who crafted and implemented them. Competition between the different components of a power system offers some insight into the creation and performance of political and economic institutions (Weingast, 2018), as does the dynamic through which their legitimacy is progressively established. Greif and Rubin (2014) aptly address the latter in their discussion of endogenous political legitimacy. Henry VIII of England empowered the parliament, which limited his political discretion, though he in turn, benefited from the legitimacy provided by Parliament's recognition of the British Crown. The power of Parliament gradually encroached on that of the Crown and even dethroned two kings, in 1640 and 1688. While certainly unplanned by the Tudor dynasty, this development contributed to the construction of arguably the most stable and successful constitutional monarchy in world history.

In this paper, we use state aid cases to explore whether a similar dynamic is currently at play in the EU. Indeed, any overreaching by the Commission relative to the sovereignty of the Member States should be halted by the Court. Fair and independent judgments have gradually established the Court as a respectful arbitrator. Meanwhile, any green light by the Court establishes the Commission's status as the legitimate leader of European integration. European institutions might thus be built through the repeated interactions between the Commission, the Court, the Member States, and the private sector. Given its mandate to promote economic integration, the Commission should be more resolute in dealing with those Member States who are less open to European integration. Conversely, the European Court of Justice should correct any bias in the Commission's decisions when they do not comply with EU law.

It is important to note that these interactions do not occur only among politicians such as EU commissioners, national heads of governments or regional/municipal leaders. Public bureaucracies play a strong role in the process of state aid decisions, which are highly technical matters: in practice, these are sophisticated funding schemes where it is necessary to assess the extent to which they hinder competition and whether the resulting costs are justified by the collective benefits (e.g. positive externalities). Moreover, any accompanying measures aimed at mitigating the potential negative effects of a given aid must also be considered. Detailed application files are thus prepared by national authorities and reviewed by the EU bureaucracy in Brussels. The incentives of civil servants on both sides are important, as it might be expected that bureaucrats take their organization's interests into account. In a Weberian logic, career concerns matter, as does the ethos developed in organizations dominated by long-term, if not lifetime, employment. At the national and sub-national levels, bureaucrats tend to consider the possibility of pressure from citizens and interest groups, as their work is mediated by politicians, lobbies and all kinds of veto players that might form coalitions to hinder the power and the discretion of the public bureaucracy if it does not align with their preferences. National and sub-national bureaucracies have the additional incentive of not wishing to be overshadowed by the EU bureaucracy as policy implementers. EU institutions, for their part, are populated by bureaucrats that have a clear interest in strengthening the EU system of power and its political legitimacy. Thus, even if state aid files are technical cases dealt with by technocrats, the latter have incentives to consider the political climate beyond the technical aspects; even if bureaucratic legitimacy derives from the skillful and impersonal management of procedures and files.

The same principles come into play when considering the decisions made by judges at the court level. Career concerns lead judges to stick to their mandate of judging impartially based on the evidence and the law. Unlike EU and national bureaucrats, they have strong incentives to ignore the political context in which state aid schemes are elaborated and approved or rejected in Brussels.

Empirical study of this dynamic is challenging. First, no systematic database is available to analyze the decisions of both the Commission and the Court. Second, the decision-making processes at work in individual cases are not always the same. State aid decisions can be reversed at different steps and it takes substantial effort to track the timeline of each case. Finally, establishing connections between the Commission's verdicts on state aids and their judicial reviews by the Court is not a straightforward task. In this study, we construct, to the best of our ability, a complete data set covering all state aid applications approved or rejected by the Commission from 2000 to 2017. We then rely on a Probit model, where the dependent variable is whether the state aid program is green-lighted, to estimate the conditional probability of approval at the Commission stage.

We find that favorable decisions by the Commission are negatively correlated with transposition deficit, which we use as a proxy for resistance to European integration at the governmental level. Next, we collect the cases appealed to the Court and find that the Court is more likely to reverse rejections of re state aid cases originating from states with a higher transposition deficit. Since the Commission's action precedes that of the Court, this result supports the hypothesis that the Commission is biased against integration-resistant Member States while the Court corrects this bias to a certain extent.

We supplement our analysis by investigating whether Court decisions are influenced by the appellants’ characteristics. However, neither the ’nationality’ of the grant nor the economic strength of the grantee significantly explains their likelihood of success, suggesting that the Court is sufficiently independent when rendering judgments.

The paper proceeds as follows. We examine the dynamics of institutions as explained by a game among various stakeholders and discuss how this can be applied to understanding EU institution building in Section 2. We provide an overview of the mechanism of state aid control in the European Union and the roles of the different players involved in this game in Section 3. A description of the data and the regression results follow in Sections 4 and 5, respectively. We discuss the results and their policy implications in Section 6 and then offer some final remarks in the Conclusion.

Section snippets

Legitimacy in institution building

As pointed out by Greif and Kingston (2011), there are two main approaches to institutional analysis in the literature. In the first, institutions are sets of rules designed, for instance, by political rulers or entrepreneurs, and institutional evolution is then triggered by new constraints or opportunities in the political or economic arenas. This orientation characterizes, for instance, the work of North (1991) and Acemoglu et al. (2005). In the second, institutions are understood as

State aids and the single market policy

When examining state aids, it is instructive to analyze the interactions among the various stakeholders — both within and outside of EU institutions — involved in the dynamic of the EU system of governance. The Commission is in charge of approving or rejecting the proposed subsidies, and its decisions can be scrutinized by the Court. The Member States and European firms are also players in the game because they grant or benefit from the aids. The Commission and the Court are the institutions

The data

We undertake two complementary analyses to understand state aid control in the European Union. The first aggregates state aid cases subject to review by the Commission. The second analyzes the cases that were appealed to the Court in an attempt to overturn the Commission's decisions. In the following subsections, we present the two data sets in greater detail, along with their main variables.

Empirical strategy

In brief, the Member States may have to go through two stages to get a state aid program approved. Governments first notify the Commission, which decides whether the aid program meets the exemptions laid out in Article 107 and Article 108. If the answer is positive, the beneficiary's competitors have the legal right to sue the Commission in the Court to have the decision repealed. If the answer is negative or conditional, the beneficiary can also demand a judicial review by the Court.

Is the court influenced by the private sector?

The previous section investigated whether the Court corrects any bias introduced by the Commission's preferences, but does demonstrate that the Court is, in fact, independent and solid. It may yield, for example, to the financial influence of the applicants. In this section, we modify our regression analysis as follows. First, the dependent variable is now a binary variable equal to one if the applicants obtain a favorable decision by the Court, and zero otherwise. Here, a favorable decision by

Conclusion

Although the conflicting objectives of the European Commission and the Member States have frequently been the subject of academic research, little effort has been made to systematically study state aid control. Yet, the latter lies at the heart of interactions between the Commission, the Court and the Member States. This paper takes the view that the European institutions are continuously evolving and striving for both power and legitimacy. The Commission pursues its own political aims through

Acknowledgment

This research was funded by the “Governance & Regulation” Chair at the University Paris-Dauphine|PSL. Support was also provided by the PSL-funded project “Governance Analytics” through Grant # ANR-10-IDEX_0001-02 PSL in the framework of the Program “Investissement d'Avenir” from the Agence Nationale de la Recherche (ANR).

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