This article examines how the incentive effect of state aid is defined and measured.
It also considers how the use of the incentive effect may impact on the behaviour of aid recipients. The availability of state aid would naturally induce them to undertake riskier projects that are not normally included in business plans which tend to be conservative.
Therefore, if business plans (looking into future) are the benchmark by which the incentive effect of state aid is established, then this benchmark may be a too easy test of the existence of the incentive effect.
The article also argues that the timing of the assessment of the need for state aid has aÂ decisive impact on the determination of whether aid has an incentive effect or not. The timing of the assessment of the need for state aid is critical. Even projects that have already started may deserve to receive state aid if the aid can ensure that they are not abandoned.
This is highlighted by an analysis of the case of training aid to DHL. The Commission believes that training aid should not be used to induce companies to undertake regional investment. Commercial reality suggests that companies take into account the total amount of aid they expect to receive at different locations. The article examines this Commission Decision on the proposed training aid to DHL and suggests that that aid could have had an incentive effect, if it were offered to DHL before it made its decision to establish a logistics centre in Leipzig  .
State aid must have an “incentive effect”. But it may induce beneficiaries to undertake riskier projects and investment in riskier projects may not be in the interest of society at large.
The incentive effect of state aid means that undertakings are expected to do something extra with the aid. That “extra” must go beyond their normal practices. This has recently been confirmed by the CFI in the Kronoply case: Case T-162/06, Kronoply GmbH & Co. KG v Commission of the European Communities (2009)  .
The Commission has defined how the incentive effect is to be understood and measured in aÂ number of recent policy documents, most notably the
Commission Regulation (EC) No 800/2008 of 6 August 2008 declaring certain categories of aid compatible with the common market in application of Articles 87 and 88 of the Treaty (General block exemption Regulation) – Recital 28, Article 8;
Framework on Research and Innovation (the R&D&I Framework): Community framework for state aid for research and development and innovation (OJ C 323, 30/12/2006, p. 0001 – 0026) – 1.3.4.;
Guidelines on Risk Capital: Community guidelines on state aid to promote risk capital investments in small and medium-sized enterprises (OJ C 194, 18/8/2006, p. 0002 – 0021) – 1.3.4.;
Guidelines on Environmental Protection: Community guidelines on state aid for environmental protection (OJ C 082, 01/04/2008, p. 0001 – 0033) – Recitals 27, 28;
Guidelines on the Assessment of Large Regional Projects: Commission Communication criteria for an in-depth assessment of regional aid to large investment projects, 24/6/2009 [not yet published in OJ],
The incentive effect is established at three levels of assessment that may be termed “standard”, “additional” and “detailed” (note that all guidelines use these three levels):
at the “standard” level which applies to all cases, state aid lacks an incentive effect and it is therefore unnecessary when it is granted after a project or investment has been initiated. [see Art 8(2) of the block exemption Regulation, chapter 6 of the R&D&I Framework, chapter 3 of Environmental Guidelines, point 17 of the Guidelines on the Individual Assessment of Large Regional Projects];
at the “additional” level of assessment, undertakings [primarily large] which apply for aid before they start a project or investment, must also demonstrate that they do something extra by showing that they go beyond their normal practice as defined by their annual reports, or business plans OR other typical or benchmark behaviour for the industry in question in terms of output, expenditure, jobs, etc. [see chapter 6 of the R&D&I Framework, chapter 3 of Environmental Guidelines, point 19 of the Guidelines on the Individual Assessment of Large Regional Projects].
at the “detailed” level of assessment [for aid amounts above certain thresholds], undertakings [primarily large] must further show that in the absence of aid they would not carry out the project or investment. They must also demonstrate that the project or investment itself is uneconomic or too risky. [see chapter 7 of the R&D&I Framework, chapter 5 of the Environmental Guidelines and point 23 of the Guidelines on the Individual Assessment of Large Regional Projects].
Phedon Nicolaides, Michael Kekelekis: An Economic Analysis of EC Guidelines on State Aid for the Rescue and Restructuring of Companies in Difficulty, Intereconomics, July/August 2004, 9p.
The Rescue and Restructuring State Aid Guidelines 1999 to expire on 9 October 2004.
This article mentions certain inconsistencies and proposes how to improve the next guidelines.
COM itself was aware of certain problems, namely:
What is the definition of “firm in difficulties”?
How to assess group of companies (allocation of costs within the group)?
Urgency issue: when the state aid is granted prior to COM approval.
One time, last time principle – rescue aid is a one-off operation
Different time limits in the current framework
What compensatory measures are sufficient?
There are 3 internal inconsistencies in the Guidelines:
99% of companies are SMEs, but state aids for SMEs are exempted from state aids notification if lower than 10 mil. EUR + if purpose of rescuing companies is to prevent their surviving competitors dominating the market, then SMEs would not need to be rescued;
why to ask firms facing bankruptcy to reduce their output?;
if every company that receives restructuring aid has more than a fair chance to become profitable (return to viability), why then do private investors need any state aid?
ECJ has repeatedly ruled (e.g. in case C-730/79 Phillip Morris v. COM, paras. 16-17): “State aid is allowed for the purposes of inducing firms to do something they would not otherwise do under free market conditions.”
The article further analyses 3 hypothetical plans for restructuring (to reduce workforce from 300 to 200, 100 OR 50) and assesses how minimising social cost is taken and should be taken into account by the COM.
60 % of EU awards were for just 4 MS (Germany, France, Spain and Italy): Are the firms in other countries immune from financial problems OR are the governments of these countries less willing to bail out firms in financial difficulty?
It is not for the COM to tell MS how to spend their money wisely. However, there must be an upper limit to the amount of authorised aid -> the social costs of letting the company go bankrupt. On the other hand, there is cost for owners (redundancy payments) which can be avoided, if they can save the company. It should be up to the beneficiary company to argue the case and provide convincing evidence.
The authors welcome simplified procedure proposed for the new guidelines for “urgency aids”. Urgency aids (to be repaid in 6 months) replace “rescue aids” (to be repaid in 12 months). But they are not happy, that no restructuring plan is required for SMEs. The money contributed by owners must be at least 25% for small enterprises, 40% for medium-sized enterprises and 50% for large enterprises.
The new guidelines also do not require MS to grant socially optimum amounts of aid. The aid per employee varies from 4,000 EUR to 755,000 EUR  . The market shares vary from 0.8% to 61%. Number of employees varies from 20 to 64,000.