Boeing vs. Airbus: Fighting the Last War

Generals are often chastised for fighting the last war, but corporate CEOs are capable of the same folly. Boeing and Airbus have sparred with one another since the 1970s-a private Thirty Years War, so to speak. The battlefield today is entirely different than in 1979, but the antagonists are the same. William Boeing created his namesake company in 1916, the beginning of the aviation age. From the get-go, Boeing was favored with federal contracts, usually with a military flavor. The Airbus consortium was launched in 1969 with generous public assistance from Germany, France, Spain, and the United Kingdom, long after Boeing had established a commanding lead in large civil aircraft.

European governments entertained two central goals for the Airbus consortium: to maintain a strong presence in a promising high-tech industry and to ensure competition in the world market for large civil aircraft. Public assistance was justified, so the Europeans argued, because Boeing (and a few other firms) had been nourished for decades by military contracts that fostered civil aircraft.

Since Airbus was created to compete with Boeing, it is hardly surprising that the firms and their governments did battle on both commercial and legal terrain. The commercial battle was fierce enough. The order book for large aircraft is a roller coaster all its own. In the 1970s and 1980s, US aircraft firms snared more than three-quarters of world sales for large civil aircraft. In the 1990s, the popular A300 series, launched with public support, put Airbus in the lead. In the 2000s, Boeing took steps to regain the top spot with its 787 model, while Airbus stumbled badly with the delayed debut of its A380.

Thirty Years War

Superimposed on the commercial battle was a transatlantic legal tangle. The first round of legal combat began in 1975, when US aircraft firms were flying high. Centered on export finance and other subsidies, this round concluded with two accords: the OECD Consensus on Export Credits in 1978 (specifically, the Large Aircraft Sector Understanding) and the GATT Agreement on Civil Aircraft, reached in 1979 as part of the Tokyo Round. The OECD consensus set minimum terms for officially supported export credit. The GATT agreement eliminated aircraft tariffs but made no attempt to abolish other public support; instead it simply preserved the rights of parties to invoke the GATT Agreement on Subsidies and Countervailing Measures.

In 1979, when the GATT agreement was concluded, both American and European negotiators realized that elimination of all public support to civil aviation was beyond reach. The previous year, Assistant Treasury Secretary C. Fred Bergsten, floated the idea of applying countervailing duties on the first Airbus models sold in the United States. After much internal debate, the administration of President Jimmy Carter decided that an "aircraft war" was too risky. European airlines were then (and remain today) large buyers of Boeing aircraft, and US airlines obviously welcomed Airbus as a new supplier. In the wake of the Carter administration's decision in 1978, the United States and Europe settled for a gentleman's standstill in the 1979 Tokyo Round Agreement on Civil Aircraft.

The second round of legal combat reflected mutual frustration over the extent of government support extended to the other side. Although they could have done so under the 1979 agreement, both Airbus and Boeing shied away from bringing trade remedy cases, for fear of disrupting commercial relations with their own customers and suppliers-airlines, engine manufacturers, and avionics firms on both sides of the Atlantic. Instead, a truce was called via the 1992 EC-US Agreement on Trade in Large Civil Aircraft, in which both sides promised to reduce government support and not to initiate countervailing duty or antidumping cases against the other country's practices.

As the 1990s wore on, and as Airbus gained a larger share of the order book with its popular A320, A330, and A330 family, Boeing grew increasingly dissatisfied with the workings of the 1992 EC-US agreement. In particular, Boeing attributed the success of Airbus to generous helpings of "launch aid" in the 1980s, and feared that fresh helpings in the 1990s would confer a major advantage to the new Airbus A-380. ("Launch aid" is finance publicly supplied or guaranteed, repayable as copies of the new aircraft are produced and sold.) Prompted by Boeing, the United States withdrew from the 1992 EC-US agreement in 2004 and opened consultations within the World Trade Organization (WTO) the same year, with a view to seeking relief under the WTO Agreement on Subsidies and Countervailing Measures. Thus began the third round in the Thirty Years War.

WTO consultations have now evolved into two dispute settlement panels, one for EU complaints about US federal and state subsidies to Boeing (NASA contracts and Washington state tax breaks) and the other panel for US complaints against EU member state subsidies to Airbus ("launch aid" being far and away the most important). Panel members were named in 2006 and opening complaints were filed in 2007. The final panel decision in the US complaint is scheduled for December 2007; the final decision in the EU complaint will be delivered in mid-2008. Both decisions will almost certainly be appealed, and the WTO Appellate Body is unlikely to rule before the end of 2008. To conduct this mammoth litigation, each side has prepared documents running to thousands of pages. The EU complaint alone, filed in March 2007, consists of 91 volumes.

New Players, New Marketplace

Meanwhile the realities of the marketplace are rapidly shifting-in ways that call for a new civil aviation pact. One big change since the onset of the Thirty Years War is that much of the value added in large civil aircraft-specifically the Boeing 787 and Airbus A380-is not generated by the assembly firms themselves. Final assembly is the visible icon of aircraft manufacture but often contributes less than 20 percent of the selling price. Big ticket components along the way are engines, avionics, and major components like tails and wings. These are supplied by firms other than Boeing and Airbus, and they are often manufactured outside the United States and Europe. In fact, Airbus probably purchases a third of each finished aircraft from suppliers outside Europe, many of them in America, and Boeing may purchase a similar proportion from suppliers outside the United States, some in Europe. Globalization of aircraft manufacture changes the shape of rivalry that was once a battle only between the United States and Europe. Japan and China, as well as Canada and Brazil, are now important rivals.

The related big change in the marketplace-dating from the 1990s-is that subsidies are often channeled to component suppliers by governments outside the European Union or the United States, particularly by the Japanese and Chinese governments. Japan has long sought to parlay expertise acquired in the manufacture of aircraft components into a stronger military capability. China harbors similar goals and has publicly declared its intention to become a maker of civil aircraft alongside Boeing and Airbus. Facilitating these ambitions, Boeing has outsourced a big percentage of its new 787, including high-technology work, to Japan and Italy. Airbus has likewise outsourced on a grand scale, some $10 billion of orders to US component suppliers and nascent assembly operations in China.

With these changes, the United States and Europe are becoming bystanders as well as participants in the global competition for the civil aviation industry. To their credit, the United States and Europe have never required that domestic carriers purchase new aircraft from domestic firms. Similar forbearance by China and Japan cannot be taken for granted. Important segments of the aircraft industry are already migrating to Asia, lured by the promise of subsidies and preferential purchase arrangements for the finished aircraft. In fact, Boeing CEO Jim McNerney recently predicted that China would become the third airplane maker to rival his firm and Airbus in the coming decades. If nothing else, this trend should prompt cooperation between US and EU authorities. Let me conclude with an observation about the Thirty Years War and a recommendation for the next truce.

Observation: WTO Litigation Alone Will Not Provide a Solution

The history of GATT and WTO disputes between Canada and Brazil, over their respective subsidies to manufacturers of regional aircraft, Bombardier and Embraer respectively, demonstrate that the litigation process must go hand in hand with negotiations. In the Canada-Brazil battle, which has gone through three rounds of panel proceedings, both sides won, both sides lost, and neither side fully complied with the panel rulings. Canada and Brazil never used the legal decisions as a platform to reach a negotiated settlement. A similar fate awaits the US-EU battle, if litigation goes all the way to the award of countermeasures by WTO arbitrators. Both Airbus and Boeing will be found to benefit from subsidies-though surely not in equal amounts-but both the United States and the European Union will find it commercially and politically difficult to apply countermeasures. At the end of the day, since no country will foreswear the use of public support for civil aviation, the only satisfactory outcome will be a new truce-shaped by WTO decisions as to the legality of various subsidies.

Recommendation: Combine Discipline with a Peace Clause

The elimination of subsidies is no more feasible in 2007 than it was in 1978 or 1992. What is achievable, however, is a truce that imposes greater discipline on public support. OECD experience with disciplining export credit subsidies shows the merit of combining minimum standards with real-time surveillance and appropriate penalties-plus a peace clause to reward compliance. To work, the next truce will require a small aircraft directorate housed in the WTO, analogous to the export credit group in the OECD. The pact itself will need several key elements:

• The core must be a pact between the United States and the European Union that other aircraft-producing countries, namely Brazil, Canada, China, and Japan are invited to join. Affected subfederal governments and aircraft manufacturers should be allowed to participate as observers.
• Signatories and participating observers would be obliged to notify the WTO aircraft directorate in advance of all proposed subsidies. This information would be shared with all parties to the agreement. Other parties would then have a chance to match the subsidy in question.
• Public support of all kinds would be subject to agreed strictures that reflect the WTO legal decisions. Setting the disciplines is crucial and would entail very hard bargaining: If too liberal, the strictures are meaningless; if too conservative, they are unacceptable. The public support disciplines are the heart of the pact, just as with OECD discipline on export credits. Compliance with the standards, once agreed, would be determined by the WTO aircraft directorate, using calculations similar to those used to determine the aggregate measure of support in agriculture.
• Subsidies in excess of the agreed standards would be subject in total (not just the excess) to WTO countermeasures, including mandatory repayment. Any subsidy that is not properly notified would be "traced" to the final aircraft (e.g., the A-380 or the Boeing 787), and the assembly firm itself would be subject to countermeasures.
• Subsidies properly notified that are less than the agreed standards would not be actionable in the WTO-in other words, a peace clause under the Agreement on Subsidies and Countervailing Measures in exchange for compliance with the terms of the new pact.

The proposed system of reporting, punishment, and rewards is designed to encourage aircraft "newcomers," such as China and Japan, to join and cooperate. By doing so, they would benefit from the exchange of information. This would help the governments to keep public support within reasonable bounds and not "overpay" to attract pieces of the civil aviation industry. On the other hand, if governments stay out of the agreement and refuse to disclose their subsidies to the WTO aircraft directorate, they run the risk that their customers-for the next decade, Boeing and Airbus, plus Bombardier and Embraer-will be penalized in full for subsidies "traced" to them through the purchase of components. The "newcomers" might cry foul, but would they have a legitimate gripe? The WTO penalty would apply not to them but rather to their customers-the big aircraft manufacturers-which, under this plan, would all subscribe to the new disciplines.

The proposed truce would not, of course, be the last word in limiting public support for civil aviation or bringing peace to a contentious industry. But a new pact would be vastly superior to years of WTO litigation that leads to a trade war in civil aviation, a grand "battle of the skies" where everyone gets shot down.