Tuesday, November 30, 2004

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Boeing, Airbus, and the WTO

The Economist has an update on the brutal competition between Airbus and Boeing. The highlights:

It is always the way with Airbuses: you wait for years, and then three come along at once. In January, the European aircraft manufacturer will roll out the first of its A380 super-jumbos, in preparation for its first test flight by the end of March. Before that, however, it is set to unveil plans for two versions of a smaller, wide-bodied plane, aimed at the mid-sized market.

The rivalry between Boeing and Airbus, the big commercial-aircraft duopoly, has never been more intense. While Boeing struggles to persuade mainstream airlines to buy its latest offering, the 250-seater 7E7, Airbus will soon announce two versions of a new plane, dubbed the A350, to attack it head on....

At its next meeting, on December 10th, the board of the parent company of Airbus, European Aeronautic Defence and Space company (EADS), is expected to rubber-stamp a decision to launch two souped-up versions of its A330, fitted with new wings and engines to increase the range and carrying capacity and so compete with Boeing’s plane. Boeing’s new design claims to offer savings of 15-20% on fuel by making extensive use of lightweight composite materials instead of the usual aluminium.

Anticipating Airbus’s response, last month Boeing persuaded the American government to complain to the World Trade Organisation (WTO) about the subsidies Airbus receives from European governments. Refundable launch aid from Germany, France, Britain and Spain could cover one-third of the over €3 billion cost of developing the A350. Crucially, this aid does not have to be repaid if a plane flops, giving Airbus an unfair advantage in product development, which it has ruthlessly exploited in the past decade.

Boeing is spending almost $6 billion to develop the 7E7, with further contributions from its partners in Japan and Italy. The European Union is counter-protesting to the WTO that Boeing gets all sorts of indirect aid from the American government.

The likeliest result is that both sides are found guilty of breaking the rules but that subsidy continues to flow.

I suspect the Economist is correct. The trouble with this case is that the fixed costs for commercial aircraft are high enough to ensure increasing returns to scale for the entire market. Which means that this may be one of those situations where strategic trade theory applies.

Which means that the WTO is ill-suited to resolving this dispute.

posted by Dan on 11.30.04 at 10:03 PM


Strategic trade theory? Is that like starving your taxpayers now so the other sides taxpayers starve later?

posted by: ignorant joe on 11.30.04 at 10:03 PM [permalink]

One has to wonder whether the weak dollar isn't significantly undercutting Airbus' competitiveness even with the application of national subsidies?

posted by: Lurking Observer on 11.30.04 at 10:03 PM [permalink]

This is a case the WTO did not want to hear. A dispute where the two largest trading powers are both in the wrong will further undermine support of the dispute settlement system in the respective polities, and make for a more contentious negotiating atmosphere in the Doha Round. Combine this with unresolved issues in beef, corporate taxes, the Byrd Amendment and others, one must question if the dispute settlement system will serve the interest of the WTO in the coming years in terms of liberalizing global trade. The inclusion of trade-peripheral issues in the WTO (intellectual property, for example) and the normative nature of many disagreements, further de-legitimizes the panel system. Judicial activism and incoherent and illogical decisions do not help matters (see the recent US-adverse gambling dispute panel ruling). The power of the dispute settlement element of the WTO tempts members to expand the subject matter therein, mainly because other institutions lack the ability to swing the proverbial stick (see WIPO and the ILO, for instance). The end conclusion is that there is no real alternative to the WTO DS system, and members must work together in the Doha negotiations to make its structure more predictable and representative of negotiated agreements.

posted by: Rob on 11.30.04 at 10:03 PM [permalink]

I think Rob and Dan are more right on this. The dispute settlement process is not especially well-equipped to deal with economic superpower spats. Hopefully the EU and US will be able to resolve this dispute among themselves.

posted by: Guy on 11.30.04 at 10:03 PM [permalink]

I used to work for the "Lazy-B", as a lot of the younger employees called it before getting laid off (I managed to leave on my own).

I'm not sure I really understand the basis for Boeing's complaint though. If European governments find it beneficial to fund Airbus from the perspective that it will pay off dividends in other places by having lower-priced aircrafts coming out of the European factories, then they should be able to do that. Is there something specific in WTO rules that bans that?

It was always known among the folks I worked with (I only ever worked in the commercial aircraft side) that the commercial aircraft division never turned a profit in the history of the company. It was always space and defense spending from the U.S. government that kept them profitable.

From what I've heard though, from folks that have spent time working in both places, is that Airbus is becoming as slow a company as Boeing (and Boeing is one slow, old, company now, hence the "Lazy-B"). The real crime may be that there's not much of a chance for any company to challenge this duopoly. Unless, of course, they build something revolutionary, something neither Boeing nor Airbus has done in years.

posted by: thehim on 11.30.04 at 10:03 PM [permalink]

In many ways this debate is unreal. The national governments involved can always prop up their respective champions with defense work and the airlines will cooperate in funnelling enough work to both companies to keep them in business.

posted by: msj on 11.30.04 at 10:03 PM [permalink]

> A dispute where the two largest trading
> powers are both in the wrong

As far as I can see Airbus is doing exactly what it was intended to do: break the US monopoly in transport aircraft (Russia and the Ukraine not being seriously considered outside former SovBloc national airlines), reduce European dependence on the US for certain key technologies, and put a stick in the eye of Washington (DC that is, not State, although them too).

That is what Airbus was designed to do, that is what it is doing, and that is what all the EU entities involved want it to do. Look at the A400 project for pity's sake. The airplanes are available off-the-shelf from the US or Ukraine, but noooooooo - EADS has to build their own.

Economic or legal analysis will never touch this: it is pure political hardball.


posted by: Cranky Observer on 11.30.04 at 10:03 PM [permalink]

Fixed costs are also endogenous to a large extent, see John Sutton's (quirky) work on endogenous fixed costs in aeroengines and airplanes for examples.

Clearly, the extent of subsidies has allowed a massive fixed cost arms-race to occur in airplanes.

But finding ourselves in a situation where fixed costs are huge, we do have to deal with that situation, and the best outcome would be for the WTO to gently try to disarm the two players.

posted by: Gavin Cameron on 11.30.04 at 10:03 PM [permalink]

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