TCS Daily

Avoiding an Air War

By Claude Barfield - October 20, 2004 12:00 AM

The legal maxim that "hard cases make bad law" may well play out again in the developing high-stakes brawl between the U.S. and the EU over alleged subsidies to Boeing and Airbus in the construction and launch of new large-body commercial aircraft. On October 7, the U.S. initiated a case in the WTO against Airbus, alleging illegal subsidies amounting to $15 billion over the past decade; within hours, the EU countersued, alleging that $23 billion in illegal aid had been doled out to Boeing since 1992.

This is a conflict that has been brewing for some time, so observers have asked why has the United States thrown down the WTO gauntlet now? The EU maintains that this is merely a by-product of the U.S. presidential election and an attempt by the Bush administration to insulate itself from charges by the Kerry campaign that it has been too soft on U.S. competitors' violation of trade rules. It is entirely possible that presidential politics played some role (particularly in the exact timing before November 2); but it also true that there was an equally important substantive reason for the administration to act -- that is, to forestall the EU from granting large subsidies to a new Airbus aircraft that will compete directly with Boeing's planned 7E7, a fuel-efficient, midsized plane that has already attracted many early orders. Under the terms of a 1992 U.S./EU agreement, the EU would be allowed to subsidize up to 30 per cent of the development costs of this plane. When it initiated the WTO case, the United States in effect abrogated that agreement.

There are important separate facts and policies that need to be sorted out in judging the merits of the case for both sides. First, the United States is on firm ground in arguing that world competitive conditions have changed dramatically since 1992 when the original agreement was concluded. At that time, Airbus counted for only 30 percent of the world market, while Boeing and McDonnell-Douglas (later merged with Boeing) jointly held about 70 percent. Today, Airbus accounts for over 50 percent of worldwide sales of large commercial aircraft and 60 percent of future orders. It is no sense an "infant" industry.

Second, as to the various forms of the alleged direct and indirect subsidies, clearly the most obvious, egregious direct subsidy stems from the so-called launch aid given by the EU to Airbus. The U.S. charges that the risk-free loans that underpin this aid have amounted to some $15 billion in illegal subsides since 1992; and whether or not the exact amount is accurate, launch aid has been substantial and does have a direct bearing on price competitiveness. Ranking also high in the list of economically damaging subsidies are subsidies from state and local governments and from governments of international subcontractors. The EU points to the alleged $3.2 billion tax deductions to Boeing from the state of Washington, and it has sharply questioned the Japanese government about its plans to support a Japanese Boeing subcontractor to the 7E7 (This charge has ironic overtones, however, as the Italian government is also planning aid to an Italian Boeing subcontractor). The U.S. in turn points to similar aid to Airbus from European national, provincial and city governments, including plant construction aid from the city of Hamburg.

More problematical are the charges relating to subsidies from R&D grants and defense contracts. The EU maintains that Boeing has received $23 billion in such subsidies since 1992; but Boeing and the U.S. government point out that in 2003 Airbus' own parent companies (EADS and BAE Systems) had combined defense revenues that equaled Boeings defense revenues (just under $24 billion) and by logical extension equal subsidies. Whatever the validity of these numbers, the underlying economic case that spillovers from R&D grants and defense contracts constitute illegal subsidies is much less clearcut. Officials who wrote these portions of the 1992 agreement readily admit that the limitations had little economic foundation but were merely political compromises. Today most technological advances flow from commercial research to the military and not the reverse as was the case in the early days of the Cold War.

Against these realities, pushing this dispute through the WTO dispute process is political folly for two fundamental reasons. One, WTO rules give no real guidance on R&D and defense spillovers; and two, should the WTO rule for one or the other contender by "legislating" new subsidy restrictions, the backlash would be enormous -- and justified. Neither the U.S. nor the EU would sacrifice what it considers a strategic industry on the altar of flimsy and novel interpretations of international trade law.

The bottom line is that this dispute cries out for a comprehensive political settlement. For the EU and Airbus, it's time to move beyond the "infant industry" mindset: the infant is now a strapping adult. And for both the U.S. and the EU, it's time to acknowledge that, whatever the differing merits of the case for particular subsidies, all forms of government support should be placed on the table for negotiation, with the goal of eliminating or drastically reducing competition-distorting public aid.

Claude Barfield is Resident Scholar at the American Enterprise Institute.


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