Subsidies and Competitiveness

I usually don't read Newsweek, Time and the US magazines, largely because I have too much other stuff to read. I read three newspapers a day (Handelsblatt, FAZ and the FT), as well as 2 Austrian dailies on their respective web sites.

I did, however, see this article on the Newsweek web site. Woops, just tried to link to it and I don't know how.

It's by Robert J. Samuelson and it's called "No Free Launch". It's one of the better pieces I've read on subsidies in terms of making airplanes.

I'm going to expand on this briefly.

Fundamentally, Airbus and EADS are the product of European industrial policy. The French, Germans and the UK decided that they did not want to lose their aerospace industry: so they created Airbus to develop new aircraft and - and this is the critical point - they put their money behind it. Airbus has, according to Samuelson, spent something like $15 bn in taxpayer monies in order to develop aircraft.

First of all, Airbus does make nice planes: they have more or less identical cockpits, meaning that once you as a pilot get your multiengine license and have gone through training for one Airbus aircraft, you don't have to go through a lot to fly a different Airbus. This isn't the case for Boeing or Lockheed aircraft: you need to go through some new training to be certified for a 747 when you've been flying 757s.

But while the planes are nice, the methodology behind them isn't. The European aircraft industry hasn't had the greatest history of success when out there with private money and was well on its way to failure in the market place. Boeing, Lockheed, McDonnel-Douglas in the 1960s and into the 1970s had overwhelming market presence.

Airbus is heavily subsidized, and in more ways than one. It gets money up front for design and development, one-third of which is repayable only if the airplane is a commercial success, and the rest of which is loaned at below-market rates (i.e. there are government guarantees involved, which means that any credit risks involved are reduced to sovereign risk, which in this case is basically irrelevant, meaning that Airbus has its seed money well below market rates.

This is the first market distortion and a critical one.

Secondly, aircraft sales are never at list price, but are rather a highly political issue, especially when you are competing based on market share, rather than actually making money at what you are doing. Usually, and this applies to US sales as well, no one actually knows (outside of the parties involved) what the prices for new aircraft are, since this tells competitors what sort of prices and finances their competitors are playing with. In dealing with closed investment funds, I've seen a number of aircraft financed in Germany, mostly Airbus planes, but also 747s and some smaller machines, and know that these prices vary widely for what appear to be the same machines.

Further, there are often serious tax advantages to leasing planes rather than buying them. A very large number of aircraft out there don't belong to airlines, but rather obscure (at least to the general public) leasing companies that don't advertise much and certainly don't talk much about what they are doing.

Because the market is intransparent - sellers and buyers have asymmetrical information - it means that when one competitor enjoys essentially unlimited pockets for subsidizing their sales, the market will tend to buy those planes. While everyone in the industry gives price and other breaks to close deals, Airbus isn't primarily interested in making money, but rather in achieving at least market share parity with US makers, meaning Boeing.

This means that Airbus' subsidies have distorted the market.

Airbus counterclaims that US companies benefit from subsidies from NASA and the military. There is a difference, and this is fundamental: NASA and the military pay for maintaining research and design capabilities by funding research and design efforts on an ongoing basis. The government gets something for the money: what the government does with this is another question. The 747, for instance, was designed for the US government as the Air Force was looking for a large cargo plane: it was Boeing's entry that lost to Lockheed's C-5 design.

But Boeing didn't get paid to design a commercial aircraft that was to compete with foreign companies: it got paid to design a plane that was to be used to transport large numbers of heavy items. It then went on to bet the company that it would be a commercial success, and it was. Others, like Lockheed with its three-engine L-1011 failed and either went out of the commercial aircraft business or merged with others to survive in the defense industry.

So US taxpayers didn't fund Boeing and the others to keep the industry around, but rather because the US government has an industrial policy that relies on competition in the marketplace to come up with the best design.

Airbus distorts the market to achieve the same thing.

Boeing in its design and building of its new plane - the 7E7 - also uses subsidies. The Japanese government is giving Boeing and its suppliers tax breaks so that a significant portion of the 7E7 is made in Japan. Localities are also giving tax breaks and infrastructure support to attract jobs from Boeing.

What's difference? Boeing's subsidies do not distort the market. They might grant Boeing better designs or competence, but do not grant Boeing commercial advantages via capital at rates that no other commercial company has access to. To repeat: subsidizing market share distorts markets directly; subsidizing research and development by funding research and development doesn't distort the markets for the products involved.

Why is this important? Airbus doesn't understand the US subsidies as being different than their own: they see them as being fundamentally the same. That's because industrial policy in Europe doesn't deal with markets, but rather the players in the markets. France decides it needs to have a maker of mainframe computers and then spends billions over the years to keep Bull alive; it ends up with a money hole and no market player, since Bull ultimately became very, very good at getting subsidies and pretty bad about making computers.

The Europeans sees such subsidies as the natural order of things: in order to achieve success in markets, you need to either distort the markets or you need to eliminate the competition. The sad thing is that this is the natural order of things in European markets. That's why the European Union sees nothing wrong with its subsidies for Airbus.

But enough for now: suffice to say that this will be a major point of contention over the next several years as things now stand.

John