Industrial Subsidies & the Politics of World Trade

Note: I don intend to star a A vs B war and thats least i expect, but to put forth the reality abt the 7E7 ….. but do remember that EU is no better when playing dirty and when they meet their match in the game, reports from either side come out.

I am not posting the entire one, but some parts of the article…. if possible i’ll do it some other time, but for now some introduction part and some charts.

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Industrial Subsidies and the Politics of World Trade: The Case of the Boeing 7e7

(From, The Industrial Geographer, Volume 1, Issue 2, pp. 57-73. © 2004 Pritchard & MacPherson)

David Pritchard

Canada-United States Trade
Center Department of Geography
State University of New York
Buffalo, NY 14261

Alan MacPherson

Canada-United States Trade Center
Department of Geography
State University of New York
Buffalo, NY 14261

ABSTRACT

This paper offers a critical commentary on the launch process for a large commercial aircraft (LCA). Using the Boeing 7e7 as an example, we argue that the contemporary launch process bears little resemblance to previous practices. Specifically, the launch process involves both domestic and foreign subsidies because US production is now organized under a ‘systems integration’ basis. Under systems integration, the lead company (Boeing) spreads risk across a network of suppliers and production partners. Although final assembly takes place inside the US, much of the value-added is shared across the production network (as much as 70 percent). This has clear implications for US trade and employment, in that international subcontracting boosts foreign imports and reduces the need for domestic production workers. From a trade perspective, however, a potentially more troubling feature of the launch process is that major public subsidies are involved. While some of these subsidies are permitted under the World Trade Organization’s (WTO) subsidy rules (e.g., certain types of pre-production R&D support), other types of subsidies clearly violate the WTO’s regulations (e.g., infrastructure and production subsidies). This paper reviews the types of subsidies that Boeing has sought in the planning process for the 7e7 launch. Our evidence suggests that Boeing’s launch process contravenes existing international agreements on production subsidies. This does not bode well for the US commercial aerospace sector, especially in light of Boeing’s urgent need for a new aircraft program to compete with Airbus.

INTRODUCTION

The commercial aerospace sector is a critical part of the US industrial base in terms of skilled production jobs, applied research, foreign exports, and inter-industry multiplier effects (US International Trade Commission, 2001). With the rise of Airbus, however, the sole remaining US producer of large passenger jets (Boeing) has opted for a ‘systems integration’ mode of production to reduce unit costs, simplify assembly procedures, and speed up the product development process (MacPherson andPritchard, 2003). Under systems integration, risk and costs are spread across a network of domestic and foreign partners. While the final product is assembled inside the US, major parts of the airframe are subcontracted to foreign suppliers. In the past, international outsourcing was guided in large part by industrial offset agreements that provided guaranteed sales for new aircraft. Today, however, the costs associated with launching a new aircraft in the large commercial aircraft (LCA) category are so high that systems integrationbased on cost-minimization makes good financial sense — at least over the shortrun. A disadvantage of systems integration is that outsourcing production also implies ‘outsourcing profit’ (Hart-Smith, 1998). A further disadvantage is that core technology must be transferred to outside suppliers in order to make the final assembly task feasible (Pritchard, 2001).

From a trade and employment perspective, systems integration on a global basis implies increased US imports and reduced domestic labor demand. If Japan were to make the wings for Boeing’s proposed 7e7 ‘Dreamliner’, then presumably Boeing would not need to retain skilled production workers that currently have expertise in wing milling and fabrication. This said, a potentially more serious concern from a trade perspective is that a new LCA launch by Boeing would likely proceed on the basis of substantial public subsidies (both foreign and domestic). Domestic subsidies could range from state-level incentives to encourage assembly-based investments to indirect national subsidies for the production process. Foreign subsidies might follow precisely the same lines for parts production in offshore locations. This raises the question of whether a new LCA launch by Boeing might contravene the World Trade Organization’s (WTO) rules regarding ‘subsidies and countervailing measures’. A litigation by the WTO would surely alarm potential customers (airlines), as well as add extra complexity to the launch process.

Set against this context, this paper reviews the planning process that has thus far been developed to set the stage for a 7e7 launch. The arguments advanced in our analysis are not dependent upon whether or not Boeing decides to launch this aircraft. Nor does our analysis hinge upon the precise distribution of production or assembly locations inside or outside the United States. Rather, the analysis simply uses the 7e7 as an example of how the launch process couldbe derailed or delayed by international regulatory conditions (i.e., WTO litigations). Further, it should be stressed that our paper does not purport to make any contributions to current or emerging theories of international business, economic geography, or industrial organization. Instead, our goal is to characterize the launch process for a new LCA in light of a number of fundamental changes that have recently taken place within the US aerospace sector. Prior to an examination of the subsidy issue, however, it is first necessary to supply a research context for the discussion. Why has Boeing opted for a systems integration mode of production? What are the advantages and disadvantages of this type of business model? And, what does systems integration imply for US employment and trade?

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TRENDS IN US LCA PRODUCTION

The commercial aircraft industry has been an evolution of technologies for the past fifty years. A new product launch rarely represents a technological breakthrough or geopolitical change, but the proposed 7e7 comes remarkably close. Traditionally, the US commercial air-framers would launch comparable models within a few years of each other (e.g., the DC-9 versus the Boeing 737). These models would have similar if not identical manufacturing processes, the same domestic and foreign subcontractors, and similar selling tactics. The US commercial aircraft manufacturers dominated the world with over 90% of global market share in the 1960s for aircraft with over 100 seats. During the past 25 years international subcontracting of subassemblies has become more prevalent with Boeing and the ex-McDonnell Douglas, but the US prime contractors were always in control of the design, manufacturing procedures, and core technologies of 1,000s of first, second and third tier suppliers. An increasingly common practice for Boeing was to boost international cooperation for new LCA launches to secure foreign customers (Eriksson, 1995). While the work content moved away from the US, this industrial offset approach did have advantages for Boeing in reducing capital expenditures for tooling, equipment, and facility infrastructure. However, core technological knowledge always resided within the company. Boeing had the engineeringand management experience to develop and control the manufacturing processes for new programs, as well as coordinate a vast supplier base to successfully launch new products.

Today, Boeing is no longer the number one LCA manufacturer in the world. Airbus holds that prestigious position in every measurable category, including new orders, backlogs, deliveries, product technology, and advanced manufacturing procedures. Boeing enjoyed more than a 70% market share after the company purchased McDonnell Douglas in the mid 1990s (Commission of the Future of the US Aerospace Industry, 2002). This share has now fallen below 50%, and the company faces serious problems with aging product lines (i.e., average aircraft design vintages of 28 years).

Table 1 shows that Boeing’s commercial product line has 5 out of the 6 aircraft currently in production with technologies dating back to the 1960s and 1970s (only the 777 has new technologies from the 1990s). The aging Boeing commercial aircraft family has not sold well during the current industry downturn, which has Boeing’s production numbers slashed from 620 aircraft deliveries in 1999 to only 280 in 2003. The backlog numbers for 4 of the 6 aircraft models are dangerously low, which causes alarm for the airlines regarding the longevity of each model in making their future fleet acquisition decisions. The announced closing of the 757 production lines in October 2003 has exasperated this concern.

Boeing has been diversifying away from the commercial side of the aerospace business since the launch of the 777 in the early 1990s (commercial sales dropped below 50% of total revenues in 2002). The company has been moving into defense sectors with purchases of several hightechnology firms in the 1990s (e.g. Rockwell). Boeing also has a future vision to become an aviation services provider in fieldssuch as engine repair, aircraft maintenance, flight crew training, used airplane remarketing, and airport and route services (see MacPherson and Pritchard, 2003). The probability of the 7e7 actually being launched can be debated by the visible lack of new investment in the commercial product line over the past 8 years, along with the risk averting attitude of the current Boeing Board of Directors (many of whom are averse to investing billions of dollars into a new airplane launch to service a mature market segment that only yields a 2-5% profit margin). This has the industry questioning Boeing’s appetite to compete against Airbus, a company with a growing stable of newer aircraft that feature advanced technologies. With the resignation of Boeing’s longstanding CEO (Phil Condit) on December 1, 2003, moreover, many Boeing employees fear that the company’s new CEO (Harry Stonecipher) will continue to position the firm within high-margin fields outside the commercial aerospace domain (e.g., defense applications, aviation services, telecommunications).

This said, the 7e7 proposed by Boeing will be looking to change or “break” the rules on how a new aircraft is launched by redefining where the work elements will be done, as well as changing the methods of funding not only for product development but also the production process itself (disregarding the company’s traditional methods of assembling). One might consider this as “clean sheet of paper approach” for Boeing, which needs a radically new strategy to compete with Airbus. In several important respects, however, Boeing is disregarding the “rules” of engagement for the commercial aircraft world. One of those rules pertains to the 1992 US/EU Agreement on Trade in Large Civil Aircraft, while the other pertains to the 1994 WTO Agreement on Subsidies and Countervailing Measures