International Trade: Long-Term Viability of U.S.-European Union Aircraft
Agreement Uncertain (Chapter Report, 12/19/94, GAO/GGD-95-45).
An objective of the 1979 Agreement on Trade in Civil Aircraft was to
liberalize world trade in the civil aircraft industry through the
removal of tariffs and other trade obstacles such as quotas,
preferential technical standards, and export subsidies. However, trade
tension between the United States and the European Union (EU) over the
civil aircraft industry continued in the 1990s, due especially to U.S.
concerns about continuing government support to EU large civil aircraft
manufacturers. In July 1992, the United States and the EU entered into a
bilateral agreement aimed at reducing government support to
manufacturers of large civil aircraft--planes with a capacity of 100 or
more passengers. This report assesses the (1) extent to which the
agreement has proved viable in operation, (2) potential impact of
changes in government support on the competitiveness of the U.S. large
civil aircraft industry, and (3) the efforts of the United States and
the European Union to extend coverage of the agreement to other nations
with aerospace industries and to related aerospace products.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: GGD-95-45
TITLE: International Trade: Long-Term Viability of U.S.-European
Union Aircraft Agreement Uncertain
DATE: 12/19/94
SUBJECT: International agreements
International trade
International cooperation
International relations
Aircraft industry
Information disclosure
Aerospace industry
Aerospace research
Foreign governments
International economic relations
IDENTIFIER: European Union
North American Free Trade Agreement
NAFTA
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Cover
================================================================ COVER
Report to the Honorable
Richard Gephardt, Majority Leader, House of Representatives
December 1994
INTERNATIONAL TRADE - LONG-TERM
VIABILITY OF U.S.-EUROPEAN UNION
AIRCRAFT AGREEMENT UNCERTAIN
GAO/GGD-95-45
International Trade
(280044)
Abbreviations
=============================================================== ABBREV
CASA - Construcciones Aeron�uticas S.A.
CPA - critical project appraisal
CRS - Congressional Research Service
CVD - countervailing duty
DOD - Department of Defense
EU - European Union
GATT - General Agreement on Tariffs and Trade
G.I.E. - groupement d'int�r�t �conomique
HSCT - high speed civil transport
ITC - International Trade Commission
LCA - large civil aircraft
NASA - National Aeronautics and Space Administration
SST - Supersonic Transport
USTR - Office of the U.S. Trade Representative
VLCT - very large civil transport
Letter
=============================================================== LETTER
B-253697
December 19, 1994
The Honorable Richard Gephardt
Majority Leader
House of Representatives
Dear Mr. Gephardt:
This report responds to your request that we review the details and
implications of the 1992 U.S.-European Union bilateral aircraft
agreement. Specifically, we assessed (1) the extent to which the
agreement has proved viable in operation, (2) the potential impact of
changes in government support on the competitiveness of the U.S.
large civil aircraft industry, and (3) the efforts of the United
States and the European Union to extend coverage of the agreement to
other nations with aerospace industries and to related aerospace
products.
As you requested, we plan no further distribution of this report
until 30 days from its issue date unless you publicly announce its
contents earlier. At that time we will send copies to the U.S.
Trade Representative, the Secretary of Commerce, and other interested
parties. Copies will also be made available to others on request.
Please contact me on (202) 512-4812 if you have any questions
concerning this report. The major contributors to this report are
listed in the appendix.
Sincerely yours,
Allan I. Mendelowitz, Managing Director
International Trade, Finance, and Competitiveness
EXECUTIVE SUMMARY
============================================================ Chapter 0
PURPOSE
---------------------------------------------------------- Chapter 0:1
An objective of the 1979 Agreement on Trade in Civil Aircraft was to
liberalize world trade in the civil aircraft industry through the
removal of tariffs and other trade obstacles such as quotas,
preferential technical standards, and export subsidies. Despite the
1979 aircraft agreement, trade tension between the United States and
the European Union (EU) regarding the civil aircraft industry
continued during the 1980s and early 1990s, due especially to U.S.
concerns about continuing government support to EU large civil
aircraft manufacturers. In July 1992 the United States and the EU
entered into a bilateral agreement aimed at reducing government
support to manufacturers of large civil aircraft, that is, aircraft
with a capacity of 100 or more passengers.
The Majority Leader of the House of Representatives asked GAO to
review the details and implications of the 1992 bilateral agreement.
In this report, GAO assesses (1) the extent to which the agreement
has proved viable in operation, (2) the potential impact of changes
in government support on the competitiveness of the U.S. large civil
aircraft industry, and (3) the efforts of the United States and the
European Union to extend coverage of the agreement to other nations
with aerospace industries and to related aerospace products.
BACKGROUND
---------------------------------------------------------- Chapter 0:2
Three large civil aircraft manufacturers account for 90 percent of
global deliveries outside the former Soviet Union. These are the
Boeing Company and the McDonnell Douglas Corporation in the United
States; and Airbus Industrie, G.I.E. (groupement d'int�r�t
�conomique), a consortium of four European producers (A�rospatiale of
France, Deutsche Aerospace of Germany, British Aerospace of the
United Kingdom, and Construcciones Aeron�uticas S.A. of Spain). The
civil aircraft industry is one of the United States' leading
exporters and generated a net trade surplus in civil aircraft for the
United States of more than $16 billion in 1993. However, there has
been a downturn in the airline industry in the last several years,
and all three manufacturers have seen significant decreases in new
orders.
Despite the 1979 multilateral aircraft agreement reached during the
Tokyo Round (1973-79) of multilateral trade negotiations under the
auspices of the General Agreement on Tariffs and Trade (GATT), trade
tension over civil aircraft continued between the United States and
the EU. A source of trade tension has been the issue of government
support to their civil aircraft industries, especially direct support
provided by the EU to Airbus to develop and produce new large civil
aircraft. By the mid-1980s, the United States considered initiating
trade action against Airbus based on U.S. trade laws. The two
parties began negotiations on the issue of government support to the
civil aircraft industries in 1986, and the talks continued
intermittently over the next 5 years. After the bilateral talks
broke down in early 1991, the United States initiated a GATT dispute
settlement procedure challenging the EU's overall subsidies to
Airbus. According to U.S. government officials, the United States
agreed to suspend its case on overall subsidies to Airbus in exchange
for renewed efforts to conclude a bilateral agreement.\1
The United States and the EU entered into an agreement in July 1992
that limited several forms of government support to large civil
aircraft manufacturers and restricted the U.S. ability to use
national trade laws to pursue action against Airbus for its prior
government support. The agreement's constraints on government
support included (1) banning all future production support, (2)
placing limits on government support for the development of new
aircraft and imposing a requirement that the support be repaid at
interest rates near the government cost of borrowing, (3) limiting
identifiable benefits from indirect support resulting from
government-funded research, and (4) requiring that any changes in
repayment terms of past supports not be more favorable than past
terms.
--------------------
\1 It should be noted that, also in connection with subsidies to
Airbus, in 1989 the United States initiated a GATT dispute settlement
procedure with respect to a German exchange rate guarantee program.
In January 1992, a GATT panel ruled in favor of the United States.
RESULTS IN BRIEF
---------------------------------------------------------- Chapter 0:3
Certain provisions of the bilateral agreement are the source of
ongoing disagreement between the two parties, and GAO believes the
parties may disagree over a number of other provisions in the future.
The bilateral agreement does not contain a formal dispute settlement
mechanism, but rather calls for consultations between the two parties
when there is disagreement. Thus, the effectiveness of the agreement
depends on the two parties acting in good faith to implement their
commitments. Because of this, and given the ongoing and potential
disagreements, GAO believes the long-term viability of the agreement
is uncertain. However, according to the chief U.S. negotiator for
aircraft, the benefits provided by the bilateral
agreement--constraints on direct support provided to Airbus, in the
case of the United States, and a reduction in the threat of trade
action in the case of the EU--are reasonably strong incentives for
them to stay in the agreement.
The bilateral agreement has been in effect for too short a period to
discern any definitive changes in government support to the large
civil aircraft industry. However, if European government support to
Airbus were reduced due to the constraints on direct support, the
U.S. large civil aircraft industry would benefit. Possibly
offsetting this potential benefit, if the indirect support
constraints were to limit future U.S. research and development
expenditures on civil aerospace, then the pace of technology
development and introduction in the industry might be slowed.
However, U.S. negotiators have indicated that the indirect support
provisions, as negotiated, should not impinge on anticipated levels
of U.S. research programs.
The United States and the EU have viewed such countries as Japan,
Russia, and China as potential competitors in the market for large
civil aircraft. As provided for in the bilateral agreement, the
United States and the EU have tried to "multilateralize" the
agreement, that is, to encourage other countries with aerospace
industries to agree to limits on government support similar to those
in the bilateral agreement. However, a new multilateral aircraft
agreement has yet to be concluded. Multilateral negotiations on
aircraft are continuing under GATT. Nonetheless, based on GAO's
discussions with U.S. and EU government and industry officials, GAO
believes that such an agreement is not viewed by other countries as
being in their interests. For this and other reasons, GAO believes
that it is not likely that a new multilateral aircraft agreement will
be reached in the near future.
GAO'S ANALYSIS
---------------------------------------------------------- Chapter 0:4
DISAGREEMENTS MARK OPERATION
OF THE BILATERAL AGREEMENT
-------------------------------------------------------- Chapter 0:4.1
Two provisions in the bilateral agreement--article 3, covering
production support, and article 5, dealing with indirect government
support--have been the subject of ongoing disagreement between the
two parties. Moreover, GAO believes the parties may disagree over a
number of other provisions in the future. These disputes have
contributed to a contentious relationship between the two parties.
In the case of article 3, the two parties have openly disagreed on
the definition of "production support" and have had discussions
concerning this difference. The U.S. government views production
support as anything other than development or research support. The
EU, in contrast, has indicated that the agreement pertains only to
support that is dedicated to the production of a specific aircraft
program. An official from the Office of the U.S. Trade
Representative said that the U.S. government has not observed any
new general production support to Airbus since the agreement was
concluded but would view any such activity as a violation of the
agreement.
In the case of article 5, dealing with limits on identifiable
benefits from indirect government support, the two sides have
strongly disagreed over the appropriate methodology for measuring
such benefits. According to EU manufacturers, the inclusion of
disciplines on indirect support was important to them. In March
1993, using its methodology, the EU submitted estimates that the
United States might have exceeded the indirect support constraints of
article 5 during 1992. In sharp contrast, the United States
reported, in July 1993, that there were no identifiable benefits from
indirect support during the first year of the agreement and noted
that the language of the agreement clearly supported its methodology.
Article 2 of the bilateral agreement, concerning prior government
commitments of support, is one of the provisions that may engender
potential disagreement between the two parties. The article notes
that government support to current programs, committed before July
17, 1992, is not subject to the constraints of the agreement.
However, the agreement provides that the "terms and conditions on
which such support is granted shall not be modified in such a manner
as to render it more favorable to the recipients." In its June 9,
1993, letter to the House Majority Leader,\2 GAO noted that the
United States was limited in its ability to determine whether the
terms and conditions of prior European government support were being
modified. The United States was not provided with information about
the terms and conditions of the EU's prior government support.
Although the bilateral agreement did not require that those terms and
conditions be provided, the absence of this information means that
the United States lacks a baseline from which to analyze potential
future changes in these terms.
The bilateral agreement does not contain a formal dispute settlement
mechanism, but rather calls for consultations between the two parties
when there is disagreement. Thus, the effectiveness of the agreement
depends on the two parties acting in good faith to implement their
commitments. Because of this, and given the ongoing and potential
disagreements, GAO believes the long-term viability of the agreement
is uncertain. However, according to the chief U.S. negotiator for
aircraft, the benefits provided by the bilateral
agreement--constraints on direct support provided to Airbus, in the
case of the United States, and a reduction in the threat of trade
action in the case of the EU--are reasonably strong incentives for
them to stay in the agreement.
--------------------
\2 See U.S.-EC Aircraft Agreement (GAO/GGD-93-41R, June 9, 1993).
THE AGREEMENT MAY ENHANCE
THE COMPETITIVENESS OF U.S
MANUFACTURERS
-------------------------------------------------------- Chapter 0:4.2
An important U.S. goal of the 1992 bilateral agreement was to reduce
the substantial EU government support for its large civil aircraft
manufacturers. Although the constraints of the bilateral agreement
are potentially significant, the agreement has been in effect for too
short a period to discern any definitive changes in government
support to the industry. However, GAO analyzed the potential impact
on the U.S. large civil aircraft industry, assuming that the
agreement remains in effect.
Both production and development support have been important sources
of funding to Airbus in the past. The agreement provides for the
elimination of all future production support and for substantial
reductions of development support from the pre-agreement level
provided to Airbus. To the extent that these reductions in direct EU
support are realized, the long-term prospects of U.S. manufacturers
would be enhanced.
Possibly offsetting this potential benefit, if the indirect support
constraints were to limit future U.S. research and development
expenditures on civil aerospace, then the pace of technology
development and introduction in the industry might be slowed.
However, U.S. negotiators have stated that the indirect support
provisions, as negotiated, should not impinge on anticipated levels
of U.S. research programs.
EU manufacturers have expressed an increased interest in receiving
indirect government support and, in July 1994, the German government
announced a new $800-million domestic aerospace research program,
funded equally by the government and private industry. To the extent
that the EU offsets reductions in direct support to European large
civil aircraft manufacturers by increasing indirect support,
potential gains from the agreement to the U.S. large civil aircraft
industry could be reduced. However, since the annual commercial
sales of the EU large civil aircraft industry are substantially lower
than that of the U.S. industry, the negotiated ceiling on indirect
support, which is a percentage of the civil aircraft industry
turnover, would be substantially lower for the EU as well.
EFFORTS TO MULTILATERALIZE
AGREEMENT HAVE NOT SUCCEEDED
THUS FAR
-------------------------------------------------------- Chapter 0:4.3
The United States and the EU have regarded Japan (a signatory of the
1979 aircraft agreement), and Russia, China, South Korea, and Taiwan
(nonsignatories) as potential competitors and so agreed to try to
multilateralize the bilateral agreement. Thus far, their efforts
have been unsuccessful.
Near the conclusion of the 7-year Uruguay Round negotiations, the EU
attempted to link the multilateral aircraft discussions with efforts
to complete the GATT agreement, by December 15, 1993. U.S. industry
strongly opposed efforts to hastily agree to a text submitted
November 19 by the Chairman of the GATT Subcommittee on Trade in
Civil Aircraft, the forum in which the multilateral discussions were
taking place. Although no multilateral aircraft agreement was
reached, at the conclusion of the Uruguay Round a broader agreement
on subsidies and countervailing measures was obtained that would
strengthen multilateral rules on subsidies. With a few exceptions,
the agreement would clearly apply to trade in aerospace products and
thus meet a major objective of the U.S. aerospace industry.
Although it was agreed that multilateral negotiations on aircraft
would continue, the U.S. aerospace industry has expressed
satisfaction with the coverage of civil aviation provided by the new
GATT rules on subsidies in conjunction with the bilateral aircraft
agreement. Based on GAO's discussions with U.S. and EU government
and industry officials, GAO believes that such an agreement is not
viewed by other countries as being in their long-term interests.
Furthermore, Canada and Japan, key participants in the negotiations,
have not agreed with the support-based disciplines contained in the
bilateral agreement. For these reasons, it is not likely that a
revised multilateral agreement will be reached in the near future.
RECOMMENDATIONS
---------------------------------------------------------- Chapter 0:5
GAO is making no recommendations in this report.
AGENCY COMMENTS
---------------------------------------------------------- Chapter 0:6
On November 17, 1994, GAO discussed the contents of this report with
officials of the Office of the U.S. Trade Representative, including
the Assistant U.S. Trade Representative for Industry, and with
officials of the Department of Commerce, including the Director of
Policy and Analysis, Office of Aerospace, and the Director of the
Office of European Union and Regional Affairs, Trade Policy Division.
The agency officials agreed that the report was generally factually
accurate. They offered technical clarifications that GAO
incorporated as appropriate. The agency officials did not comment on
GAO's observations regarding the status of the agreement.
INTRODUCTION
============================================================ Chapter 1
Two U.S. companies (the Boeing Company and the McDonnell Douglas
Corporation) and one European company (Airbus Industrie, G.I.E.
(groupement d'int�r�t �conomique))\1 dominate the world market in
large civil aircraft (LCA).\2 During the last few years, there has
been a recession in the worldwide airline industry, and the industry
lost more than $11 billion between 1990 and 1992. This loss has
resulted in significant decreases in new aircraft orders and some
cancellations of previously placed orders. The LCA manufacturers
have been forced to reduce employment, and the competition among the
three companies has been especially intense, increasing trade tension
between the United States and the European Union (EU).\3 Concerns
were raised regarding government support to LCA manufacturers,
especially direct support provided by the EU to Airbus. An attempt
to resolve this trade dispute resulted in the Bilateral Agreement
Concerning the Application of the General Agreement on Tariffs and
Trade's (GATT) Agreement on Trade in Civil Aircraft, signed on July
17, 1992.
--------------------
\1 Airbus Industrie, G.I.E., is a consortium of four European
producers--A�rospatiale of France, Deutsche Aerospace of Germany,
British Aerospace of the United Kingdom, and Construcciones
Aeron�uticas S.A. of Spain. Airbus is a "groupement d'int�r�t
�conomique," a type of joint venture under French law. According to
the U.S. International Trade Commission (ITC) report on Global
Competitiveness of U.S. Advanced-Technology Manufacturing
Industries: Large Civil Aircraft, publication 2667 (Washington,
D.C.: Aug. 1993), a G.I.E. is not required to report financial
results to the public. Moreover, while the partner companies are
subject to taxation, the G.I.E. is not liable to pay taxes on its
profits unless it so elects. U.S. manufacturers are subject to tax
requirements and disclosure standards imposed by the Securities and
Exchange Commission.
\2 Large civil aircraft (LCA) are defined in the bilateral agreement
as aircraft "that are designed for passenger or cargo transportation
and have 100 or more passenger seats or its equivalent in cargo
configuration."
\3 The European Union is the successor to the European Community.
The European Community changed its name to "European Union" after
November 1, 1993. In this report, we use EU, even though it was the
EC that had entered into the bilateral agreement with the United
States.
BACKGROUND
---------------------------------------------------------- Chapter 1:1
The U.S. civilian aircraft industry is one of the country's leading
exporters and ran a net trade surplus of $16.1 billion in 1993.
Boeing and McDonnell Douglas had commercial aircraft revenues in 1993
of $20.6 billion and $4.8 billion, respectively. Employment in the
LCA divisions of Boeing and McDonnell Douglas were 75,000 and 11,000,
respectively, in 1993. The 1993 commercial aircraft revenue of
Airbus was $6.6 billion, with an employment level of 27,000.
The two U.S. LCA manufacturers, along with Airbus Industrie, G.I.E.,
typically accounted for 90 percent of global deliveries of LCA
outside the former Soviet Union. Due especially to a downturn in the
airline industry, Boeing and McDonnell Douglas have seen significant
decreases in new orders during the last few years. Consequently,
they have had to reduce their employment. Airbus, similarly, has
seen a decrease in its orders, and the Airbus partners have also had
to reduce their employment. Because of the smaller demand for new
aircraft, the competition among the three major LCA manufacturers has
been intense and has exacerbated existing trade tension. However,
U.S. concerns about Airbus subsidies predate the recent downturn in
the airline and LCA industries.
GOVERNMENT SUPPORT HAS HAD AN
EFFECT ON THE COMPETITIVENESS
OF THE LCA INDUSTRY
---------------------------------------------------------- Chapter 1:2
Through the 1960s, U.S. LCA manufacturers dominated the world
market. This dominance was due in part to the commercial failure of
several European large aircraft programs. In an effort to establish
a successful West European aircraft program, the governments of the
United Kingdom and France funded and codeveloped the Supersonic
Transport (SST) or "Concorde" program. The Concorde, while a
technical success, was ultimately a financial disaster, and only 14
aircraft went into service. In the late 1960s, the governments of
France, West Germany, and the United Kingdom initiated discussions
aimed at creating a West European LCA competitor for U.S. LCA
producers. In December 1970, Airbus Industrie formally began
operations with A�rospatiale of France and Deutsche Aerospace as the
major partners. Construcciones Aeron�uticas S.A. (CASA) of Spain
joined in December 1971, and British Aerospace became a partner in
January 1979. The French and German partners each own 37.9 percent
of the company, the United Kingdom partner owns 20 percent, and the
Spanish partner owns 4.2 percent.
Two major studies have examined the issue of government support to
Airbus, and each has concluded that Airbus has received billions of
dollars in support from its member governments. According to a
September 1990 study prepared by Gellman Research Associates, Inc.,
for the U.S. Department of Commerce, Airbus would not have been
commercially viable without the substantial amount of direct support
it had received from its member governments since it was
established.\4 According to the study, government funding to Airbus
consisted principally of loans to support the development of Airbus
aircraft, but little of this aid had in fact been repaid.\5 The
Gellman study estimated that the net support committed to Airbus was
$13.1 billion (i.e., $7.7 billion in launch aid, and approximately
$5.8 billion in other support disbursed or to be disbursed minus
repayments to date). The Gellman study also calculated what it
called the "opportunity cost" or "true value" of these government
supports, thereby increasing the value of net support committed to
$25.8 billion.
According to the August 1993 ITC report,\6 Airbus and the EU
disagreed with some of the conclusions and figures contained in the
Gellman report. Airbus called the $25.8-billion figure "a gross
exaggeration," noting that the total amount of development loans
received by Airbus members was "only a fraction of that amount," and
added that the loans were being repaid. According to ITC, however,
neither Airbus nor the governments of the consortium members had
directly refuted the Gellman report's conclusions on launch aid
disbursed or provided an alternative figure. ITC stated that
although certain slight downward adjustments of figures in the
Gellman report were justified, the report appeared accurate with
respect to launch aid disbursed and to be disbursed by European
governments. ITC noted that information from other independent
sources, including government agencies in the countries of the Airbus
consortium member companies, was consistent with the conclusions of
the Gellman study. Although ITC noted that it was difficult to
ascertain the legitimacy of adjusting the figure for pledged and
disbursed funds to reflect the true value derived from such funds, it
concluded that with or without such an adjustment, government support
for Airbus consortium members had been substantial.
The EU commissioned a November 1991 report prepared by Arnold &
Porter that said that the U.S. commercial aircraft industry would
not have achieved its dominant competitive position in world markets
without huge amounts of indirect support from the U.S. government.\7
The study also stated that "[t]he government and the industry have
been operating in a close, cooperative fashion for so long that they
have developed many kinds of ties that are rarely, if ever, held up
to public scrutiny." According to the study, the indirect support
came through Department of Defense (DOD) and National Aeronautics and
Space Administration (NASA) research and development programs and
through the U.S. tax system. The indirect support was calculated to
be between $18 billion and $22 billion in actual dollars (and between
$33.5 billion and $41.5 billion in constant dollars) during the
period from 1976 to 1990.
In March 1992, the U.S. government officially responded to the
EU-commissioned study by Arnold & Porter, stating that the latter was
"an attempt to deflect attention from the fundamental issue of the
ongoing U.S.-EC negotiations on aircraft: the huge direct government
subsidies provided by certain member states of the European community
to develop and produce Airbus airplanes." The U.S response noted
"factual and methodological errors" in the Arnold & Porter study and
concluded that the report fell "far short of demonstrating
significant large subsidies through military- and aerospace-related
procurement and research contracts." The U.S. response said that the
Arnold & Porter study "greatly exaggerated" potential crossover
benefits to the U.S. aircraft industry while "totally ignoring" the
potential for similar or greater research and development crossover
advantages for Airbus. It should be noted that the 1993 ITC report
concluded that accurate measurement of indirect supports was
impossible until mutually agreeable terms of definition were
developed.
--------------------
\4 An Economic and Financial Review of Airbus Industrie, Gellman
Research Associates, Inc. (Jenkintown, PA: Sept. 4, 1990).
\5 Our March 1994 study, European Aeronautics: Strong Government
Presence in Industry Structure and Research and Development Support
(GAO/NSIAD-94-71, Mar. 23, 1994), reported that as of August 1993,
an estimated $3.5 billion in Airbus supports had been repaid, up from
less than $500 million when the Gellman study was published in 1990.
However, as discussed in chapter 2, repayments by Deutsche Aerospace
to the German government have been suspended indefinitely.
\6 Global Competitiveness of U.S. Advanced-Technology Manufacturing
Industries.
\7 U.S. Government Support of the Commercial Aircraft Industry,
Arnold & Porter (Washington, D.C.: Nov. 1991).
1979 GATT AGREEMENT ON CIVIL
AIRCRAFT DID NOT ADDRESS ISSUE
OF GOVERNMENT SUPPORT TO
INDUSTRY
---------------------------------------------------------- Chapter 1:3
The economies of scale and scope in producing LCA are huge, and it
has been estimated that as many as 600 units of a new aircraft must
be sold before the breakeven point is reached.\8
Consequently, exports have long been critical to both U.S. LCA
manufacturers and the Airbus consortium. As Airbus began to make
sales in the United States in the late 1970s, the U.S. government
considered imposing a countervailing duty (CVD)\9 to offset export
subsidies provided by the Europeans. According to Tyson,\10 CVD
relief was blocked as a result of the argument by the U.S. air
carriers that they stood to benefit from Airbus' aggressive selling
tactics.\11 U.S. LCA manufacturers, however, became more vocal not
only about European export subsidies, but also about industrial
policy support provided to the Airbus members. According to Tyson,
U.S. LCA manufacturers, within the context of the Tokyo Round's GATT
discussions, called for a sectoral agreement to address the issues
peculiar to trade in aircraft. U.S. manufacturers wanted "not only
a `free trade' agreement that eliminated traditional trade barriers,
but also a `free market' agreement that constrained European
industrial policy support."
The purpose of the 1979 GATT Agreement on Trade in Civil Aircraft was
to liberalize aircraft trade; tariffs, quotas, and preferential
technical standards were to be eliminated, licensing requirements
prohibited, and discriminatory procurement practices banned.
However, according to a Congressional Research Service (CRS)
report,\12 the agreement did not include clear rules covering
aircraft subsidies. The issue of government support to the LCA
industry continued to be a source of trade friction between the two
parties.
--------------------
\8 See Laura D'Andrea Tyson, "Industrial Policy and Trade Management
in the Commercial Aircraft Industry," Who's Bashing Whom? Trade
Conflict in High Technology Industries, Institute for International
Economics (Washington D.C.: Nov. 1992).
\9 A CVD is an extra duty upon importation of a subsidized product
equal in measure to the amount of the subsidy. The Tariff Act of
1930 (19 U.S.C. 1671), as amended, provides for the imposition of
such a duty if a subsidy is provided with respect to the manufacture,
production, or exportation of a class or kind of merchandise imported
into the United States and if a U.S. industry is materially injured
or threatened with material injury by reason of imports of that
merchandise.
\10 Who's Bashing Whom?
\11 As noted in the following sentences, U.S. LCA manufacturers were
also reluctant to pursue relief under U.S. trade laws for fear that
such actions would provoke retaliation, such as through reduced sales
of U.S. LCA to European airlines.
\12 Airbus Industrie: An Economic and Trade Perspective, CRS Report
for Congress, The Library of Congress (Washington, D.C.: Feb. 20,
1992).
THE THREAT OF U.S. TRADE
ACTION HELPED RESTART
NEGOTIATIONS
---------------------------------------------------------- Chapter 1:4
During the 1980s, Airbus continued to make inroads into the U.S.
market as well as in other markets. Furthermore, the 1984 launch of
the A320,\13 which embodied new technology, represented a new
competitive challenge to U.S. LCA manufacturers. After 1986, the
United States and the EU held intermittent bilateral talks on trade
in civilian aircraft. Although the U.S. government repeatedly
considered initiating Section 301\14 trade actions or CVD relief
against Airbus, U.S. LCA manufacturers repeatedly opposed such
actions. Europe represented a significant export market for U.S.
LCA producers, and they feared retaliation from the European
governments.
In late 1989, the United States initiated a GATT dispute settlement
procedure against a German government program on exchange rate
guarantees for its Airbus partner,\15 calling it a violation of the
GATT subsidies code, which bans export subsidies. Although the
United States and the EU appeared to have been moving toward a
compromise with respect to the amount of development support that
would be allowable, the bilateral talks had broken down in early
1991. In May 1991, the United States initiated a second GATT dispute
settlement procedure with respect to Airbus, challenging the overall
government subsidies it had previously received. The United States
agreed to suspend its case on overall subsidies to Airbus in exchange
for renewed efforts to conclude a bilateral agreement. A GATT panel
ultimately ruled in favor of the United States in January 1992 with
respect to the German exchange rate program. Although the European
Commission refused to accept the GATT panel report, the German
government terminated the exchange rate subsidy on January 1, 1992.
--------------------
\13 The various LCA manufacturers have striven to have a range of
different aircraft, filling various market niches. The A320,
launched by Airbus in March 1984, is considered a direct competitor
to the Boeing 737 and the McDonnell Douglas MD-80 series. It has a
range of over 2,800 nautical miles and carries 150 passengers.
\14 Section 301 of the Trade Act of 1974 (19 U.S.C. 2411), as
amended, provides the President with the authority to enforce U.S.
rights under international trade agreements and to respond to
unjustifiable or discriminatory foreign government practices that
burden or restrict U.S. commerce.
\15 In 1988, reflecting increased concern over the costs of the
Airbus program, the German government decided to sell
Messerschmitt-Boelkow-Blohm, the German state-owned member of the
Airbus consortium, to Daimler-Benz. As part of the terms, the German
government made several major concessions to Daimler-Benz, including
guaranteeing against losses on export sales resulting from exchange
rate changes.
BILATERAL AGREEMENT WAS
GENERALLY WELL RECEIVED BY ALL
PARTIES
---------------------------------------------------------- Chapter 1:5
After more than 5 years of intermittent negotiations, on July 17,
1992, the United States and the European Union signed the "Agreement
Concerning the Application of the GATT Agreement on Trade in Civil
Aircraft." The preamble of the bilateral agreement noted the pursuit
of the two parties in "their common goal of preventing trade
distortions resulting from direct or indirect government support for
the development and production of large civil aircraft and of
introducing greater disciplines on such support." With the bilateral
agreement, the two parties agreed that a reduction in government
support to the industry would help prevent trade distortions.
The agreement established specific limits on direct development
support for new large civil aircraft. The allowable support rate of
33 percent of total development costs represented a considerable
reduction from prior development support levels to Airbus, which had
been estimated by the Gellman study to be approximately 75 percent.
The agreement's prohibition on future production support was also a
gain for the United States.
The agreement also placed constraints on the "identifiable benefits"
from indirect support. EU negotiators saw the inclusion of these
constraints as extremely important and noted that it was the first
international recognition that there needed to be some limitations
placed on indirect support. Moreover, the agreement provided the EU
with some protection against U.S. government trade action due to
past EU government support to Airbus.
According to Department of Commerce and U.S. Trade Representative
(USTR) officials, the bilateral agreement was not a tradeoff between
constraints on EU direct support for Airbus in return for constraints
on U.S. indirect support for the LCA industry. Rather, the
agreement was a tradeoff between constraints on EU direct support in
return for "grandfathering" of past EU support and agreement by the
United States not to pursue a GATT complaint on overall subsidies to
Airbus. EU officials and Airbus officials, on the other hand, have
stressed the tradeoff between constraints on direct and indirect
support. U.S. government officials have told us that not until the
last few months before the signing of the agreement was the indirect
support issue a significant part of the negotiations and that EU
negotiators did not express strong interest in numeric indirect
support disciplines until that time.
The U.S. civil aircraft industry generally supported the agreement,
with a common industry view that it was a useful first step in
eliminating EU government support for production of large civil
aircraft. Airbus generally supported the agreement as well.
According to Tyson, the success of Airbus was a major consideration
in ultimately reaching agreement, since by 1992 Airbus' market share
had grown significantly, and its need for future government support
was considerably reduced.
OBJECTIVES, SCOPE, AND
METHODOLOGY
---------------------------------------------------------- Chapter 1:6
Representative Richard Gephardt, the House Majority Leader, asked us
to review the details and implications of the July 17, 1992,
agreement between the United States and the EU on trade in large
civil aircraft. Specifically, our objectives were to assess (1) the
extent to which the agreement has proved viable in operation, (2) the
potential impact of changes in government support on the
competitiveness of the U.S. LCA industry, and (3) the efforts of the
two parties to extend coverage of the agreement to other nations with
aerospace industries and to related aerospace products.
In addressing the first objective, we interviewed U.S. government
officials from the Office of the U.S. Trade Representative and the
Department of Commerce who were primarily responsible for negotiating
the bilateral agreement. We also interviewed officials from the
Departments of State and Defense who monitored the bilateral
agreement. To get the perspective of U.S. industry, we interviewed
officials of the two major LCA producers in the United States (the
Boeing Company and the McDonnell Douglas Corporation), one of the two
major engine companies (General Electric), and the Aerospace
Industries Association.\16
To obtain information about the EU, we interviewed officials of the
European Commission in Washington, D.C., and in Brussels, Belgium,
including the chief negotiator for aircraft, and French government
officials in Paris, France. For the EU industry perspective, we
interviewed officials of Airbus Industrie, G.I.E., in Toulouse,
France, and Washington, D.C., and officials of the three primary
member companies of the four-member Airbus consortium (A�rospatiale
in Paris, France; Deutsche Aerospace in Hamburg, Germany; and British
Aerospace in Brussels, Belgium). We also interviewed European trade
association officials (the European Aerospace Industry Association)
in Brussels, Belgium. Information on foreign law in this report does
not reflect our independent legal analysis but is based on interviews
and secondary sources.
In addition, we reviewed official documents of the U.S. government
and the EU, including the submissions of information by each party to
the other party in conformance with the provisions of the bilateral
agreement dealing with the exchange of information (transparency).
We reviewed selected portions of the U.S. negotiating history
leading to the signing of the bilateral agreement. We reviewed
documents concerning the methodology for calculating indirect
government support to the LCA industry and held extensive discussions
with the key parties in this regard. We also reviewed studies
prepared by CRS, ITC, and the National Commission to Ensure a Strong
Competitive Airline Industry, as well as studies prepared by
consultants for the U.S. government and the European Commission and
by academic experts in the field.
In addressing the second objective, an analysis of the potential
impact of the agreement on the U.S. civil aircraft industry, we
considered the extent to which government support may be reduced due
to the agreement. We reviewed several economic studies that analyzed
the market conditions of the civil aircraft industry. We also
reviewed reports prepared for both the U.S. government and the EU
that analyzed past government support to the industry. We compared
the restrictions on government support contained within the agreement
with past government support to the industry.
In addressing the third objective, an assessment of efforts to
multilateralize and expand the product coverage of the bilateral
agreement, we interviewed the same U.S. and European government and
industry officials previously mentioned. We also reviewed official
GATT documents, including proposals of the United States, the EU,
Canada, Japan, Norway, and Sweden concerning a new multilateral
agreement on aircraft.
On November 17, 1994, we discussed the contents of this report with
officials of the Office of the U.S. Trade Representative, including
the Assistant U.S. Trade Representative for Industry, and with
officials of the Department of Commerce, including the Director of
Policy and Analysis, Office of Aerospace, and the Director of the
Office of European Union and Regional Affairs, Trade Policy Division.
The agency officials agreed that the report was generally factually
accurate. They offered technical clarifications that we incorporated
as appropriate. The agency officials did not comment on our
observations regarding the status of the agreement.
We did our work between March 1993 and August 1994 in accordance with
generally accepted government auditing standards.
--------------------
\16 The Aerospace Industries Association is the nonprofit trade
association representing U.S. manufacturers of commercial, military,
and business aircraft; helicopters; aircraft engines; missiles;
spacecraft; and related components and equipment.
DISAGREEMENTS MARK OPERATION OF
THE BILATERAL AGREEMENT
============================================================ Chapter 2
Two provisions of the bilateral agreement are the source of ongoing
disagreement between the United States and the EU. Moreover, we
believe the parties may disagree over several other provisions in the
future. The bilateral agreement does not contain a formal dispute
settlement mechanism, but rather calls for consultations between the
two parties when there is disagreement. Thus, the effectiveness of
the agreement depends on the two parties acting in good faith to
implement their commitments. Because of this, and given the ongoing
and potential disagreements, we believe the long-term viability of
the agreement is uncertain. However, according to the chief U.S.
negotiator for aircraft, the benefits provided by the bilateral
agreement--constraints on direct support provided to Airbus, in the
case of the United States, and a reduction in the threat of trade
action in the case of the EU--are reasonably strong incentives for
them to stay in the agreement.
A NUMBER OF ARTICLES ARE THE
SOURCE OF ACTUAL OR POTENTIAL
DISAGREEMENT
---------------------------------------------------------- Chapter 2:1
Two provisions--article 3, covering production support, and article
5, dealing with indirect government support--have been the subject of
ongoing disagreement between the United States and the EU. Four
other provisions--article 2, dealing with the reporting of prior
government support; article 4, covering development support; article
7 involving equity infusions; and article 8, concerning
transparency--could be a source of potential disagreement. A
discussion of these six articles, in the order they appear in the
agreement, follows.
DETERMINING WHETHER TERMS OF
PRIOR GOVERNMENT SUPPORT
WERE MODIFIED HAS BEEN
DIFFICULT
-------------------------------------------------------- Chapter 2:1.1
While the bilateral agreement was primarily concerned with limiting
future government support, article 2 addressed the issue of prior
government support. Article 2 noted that "government support to
current large civil aircraft programs, committed prior to the date of
entry into force of this agreement, is not subject to the provisions
of this agreement." However, the article also noted that the "terms
and conditions on which such support is granted shall not be modified
in such a manner as to render it more favorable to the recipients."
Minor modifications, however, were not to be considered inconsistent
with the provision.
The agreement stated that with respect to prior government
commitments, a "complete list of such commitments by the Parties to
this agreement already disbursed or committed shall be separately
provided, including information on the type of repayment obligation
and the planned period of repayment." On July 16, 1992, the EU
provided the United States with a list of such commitments.
In our June 9, 1993, letter to the House Majority Leader,\1 we noted
that the United States was limited in its ability to determine
whether the terms and conditions of prior European government support
were being modified to render them more favorable to the recipients.
This limitation was due to the fact that the July 16, 1992, list
provided by the EU to the United States did not contain key terms and
conditions of prior support provided by the French, German, British,
and Spanish governments to the respective Airbus consortium members.
We noted that, although the bilateral agreement does not require the
exchange of such information, without knowing key terms and
conditions of prior support the United States lacks a baseline from
which to establish EU adherence to the agreement's provisions on
prior support. However, a USTR official told us that it would be
difficult for the member governments to modify the repayment terms
and conditions of the Airbus partners without attracting public
and/or parliamentary scrutiny.
An example of the problem due to the absence of key terms and
conditions concerns Deutsche Aerospace. Before the signing of the
bilateral agreement, with approval of the German government, Deutsche
Aerospace suspended repayment of prior government support for Airbus
programs. In April 1993 testimony before ITC, an Airbus official
acknowledged that there had been a virtual suspension of repayments
to the German government. It now appears that repayment will begin
again only upon a determination by Deutsche Aerospace as to its own
profitability. The U.S. government has been unable to determine
whether this relaxation in repayment for Deutsche Aerospace was
consistent with the terms and conditions of the loans it received.
On the basis of the information provided under the agreement, it
would be difficult for the United States to independently assess
compliance with this provision in the future.\2
--------------------
\1 See U.S.-EC Aircraft Agreement (GAO/GGD-93-41R, June 9, 1993).
\2 The payment suspension occurred just before the signing of the
bilateral agreement and, therefore, was not covered by its
provisions. However, the Deutsche Aerospace example is useful in
demonstrating the difficulty the U.S. government would have in
monitoring any future changes in prior government support by the EU.
INTERPRETATION OF THE
PRODUCTION SUPPORT
PROVISIONS HAS BEEN SUBJECT
TO DISAGREEMENT
-------------------------------------------------------- Chapter 2:1.2
Article 3 of the bilateral agreement states that "as of entry into
force of this agreement, Parties shall not grant direct government
support other than what has already been firmly committed for the
production of large civil aircraft. This prohibition shall apply
both to existing and to future programs." The agreement defines
"production" as all manufacturing, marketing, and sales activities,
except for export credit financing consistent with the 1985 Large
Aircraft Sector Understanding\3 and certain other development
activities listed in the agreement.
According to the 1990 study prepared by Gellman Research Associates
for the Department of Commerce, the principal form of support
received by Airbus has been development support. However, the report
also provided examples of production support, such as loans to
Deutsche Aerospace guaranteed by the German government to ensure
production. New loans of this type may now be prohibited by the
bilateral agreement.
There has not been any allegation by either party of violations of
the agreement with respect to the prohibition against production
support. However, the two parties have openly disagreed on the
definition of "production support" and have had discussions
concerning this difference.
According to a Commerce Department official, the U.S. government
views production support as anything other than development or
research support. The EU, in contrast, has indicated that the
agreement pertains only to support that is dedicated to the
production of a specific aircraft program. The issue arose after the
United States made an inquiry during a bilateral consultation
regarding German exchange rate guarantees (see ch. 1). The EU
informed the United States that the guarantees were not program
specific and therefore not subject to the bilateral agreement. U.S.
government officials disagreed with the EU interpretation of the
agreement.
An EU official considered the discussion of this issue unnecessary
since the EU has no plans to use this type of subsidy. An Airbus
official noted that the EU is concerned that the United States will
use its "extensive" interpretation of the production support
constraints to consider loans from state-owned banks to Airbus at
commercial rates to be a violation of the agreement. A USTR official
said that the U.S. government has not observed any new general
production support to Airbus but would view any such activity as a
violation of the agreement.
--------------------
\3 The Large Aircraft Sector Understanding is a 1985 Organization for
Economic Cooperation and Development agreement that establishes
constraints on loans that governments may offer for the purchase of
large commercial aircraft.
DEVELOPMENT SUPPORT
CONSTRAINTS HAVE NOT YET
BEEN TESTED
-------------------------------------------------------- Chapter 2:1.3
Article 4 of the bilateral agreement addresses the issue of
development support. The three subsections of this article describe
the terms and conditions under which either signatory can provide
repayable, direct government support for the development of a new
aircraft program. The support cannot exceed 33 percent of the
estimated total development costs of the new program and is to be
paid back within 17 years, at a rate that is approximately the
government's rate of borrowing. At the time that support is
provided, the government is to establish that there is a reasonable
expectation of recoupment of the direct support through a "critical
project appraisal" (CPA) using conservative assumptions. Some
"nonproprietary" elements of the CPA are to be provided to the other
party, if requested.
According to a McDonnell Douglas official, the principal focus of the
company during the negotiations on the 1992 bilateral agreement was
on controlling the development support received by Airbus. He said
that the agreement provides limits in areas where there previously
were none. According to the Gellman study, development support had
been the primary form of government support provided to the Airbus
members in the past. The Gellman study estimated that the
development support level for previous Airbus programs has been
approximately 75 percent, which is considerably higher than the
constraints allowed in the bilateral agreement.
Although the development support provisions of the agreement
potentially constrain Airbus and its member companies, they are
untried in practice. The launch of a totally new aircraft program is
very expensive and takes a substantial amount of time.\4 The
agreement's impact on development support will not be tested until
such a program is launched. However, since the agreement has taken
effect, Airbus has launched a derivative program, the A319. The A319
is a smaller version of the A320, which was launched in 1984, and is
expected to require substantially fewer resources than would be
necessary for a completely new aircraft model. Both EU government
and Airbus member company officials told us that there are currently
no plans to provide government support for the A319 program.
The credibility and accuracy of the CPA is essential to the effective
implementation of the development support provisions. The 33-percent
limit is to be based on the CPA's forecast of the total development
costs of the supported program. According to the 1993 ITC report,
U.S. LCA producers have expressed concern that the agreement will
permit Airbus to skew the forecasts associated with government
support programs to its advantage.
The two U.S. LCA producers have expressed a desire to further reduce
the allowable level of development support below the limits
established in the bilateral agreement as part of any future
multilateral aircraft agreement. Boeing has also stated that as part
of any future multilateral agreement there should be a requirement
that the CPA forecast be fully supported and reviewed by an impartial
panel.
--------------------
\4 For example, the development of a super-jumbo aircraft (550 or
more passengers) has been estimated by Boeing and Airbus to cost
between $10 billion and $20 billion, with production of aircraft
beginning around the year 2000.
DETERMINATION OF
IDENTIFIABLE BENEFITS FROM
INDIRECT SUPPORT HAS BEEN
SUBJECT TO DIFFERENT
INTERPRETATIONS
-------------------------------------------------------- Chapter 2:1.4
Article 5 of the bilateral agreement places constraints on the
identifiable benefits from indirect government support.\5 EU
manufacturers took the position that the establishment of constraints
on indirect support was an important negotiation objective for the
EU. According to the 1991 study prepared by Arnold & Porter for the
EU, the U.S. government had provided substantial support to the U.S.
LCA industry indirectly, such as through DOD and NASA research and
development contracts.
In response to the Arnold & Porter study, the Department of Commerce
stated that the study fell far short of demonstrating significant
large subsidies to U.S. commercial aircraft manufacturers through
military- and aerospace-related procurement and research contracts.
U.S. manufacturers also disagreed about the importance of
government-sponsored research. In March 1994 congressional
testimony, a Boeing official said that "the Boeing Company believes
that government-sponsored research activities have a negligible
effect on trade flows and subsequently should not be subject to trade
remedies."
Article 5.2 of the agreement limits the identifiable benefits from
indirect support to 3 percent of the annual "commercial turnover"\6
of the total civil aircraft industry of each party, or 4 percent of
the annual commercial turnover of any one firm.
The analytical basis for the 3-percent and 4-percent constraints is
difficult to establish clearly. An Airbus spokesman said that the
two figures were arrived at through the negotiation process and not
through any independent analysis. An EU official said that 3 percent
of total turnover in the industry equated roughly to NASA's 1991
budget and that this amount provided some basis for the 3-percent
figure. A U.S. LCA industry official said that after being
presented with the two values, the industry considered them and
believed it could live with them. He went on to say he believed that
historically, the actual amounts of identifiable benefits from
indirect support were not close to the two constraints, and in the
future they would not be close as well.
An EU official explained that these constraints provided only a rough
"economic equivalence" with the direct support constraints imposed on
Airbus. He said that the commercial turnover of the U.S. aircraft
industry is much greater than that of Airbus.\7 He added that the
constraints were "politically equivalent" and were the first
international recognition of the need for limits on indirect support.
Commerce officials told us, however, that the United States never
accepted the EU view of equivalence between direct and indirect
supports.
Despite the fact that the two parties reached agreement on the
language of the indirect support provision, the issue has been the
source of substantial strife between the two parties since the
signing of the agreement. In April 1993, a Commerce Department
official described the two parties as being "180 degrees" apart in
their interpretations of the provisions regarding indirect support.
As of June 30, 1994, the two parties had made very little progress in
reaching agreement on this issue.
On March 31, 1993, the two parties had the first formal consultation
regarding the agreement.\8 At this meeting, the EU submitted a series
of tables in conformance with the transparency requirements of the
bilateral agreement. The United States did not provide its own
estimates at that time, indicating instead that the information was
being developed and would be provided in July, since the United
States views the agreement year as July to June. The EU submission
included an EU estimate of the dollar amount of identifiable benefits
from indirect support to the European civil aircraft industry during
the first year of the agreement as well as its own estimate of the
U.S. government's indirect support to the U.S. civil aircraft
industry.
--------------------
\5 Indirect government support is defined in annex II of the 1992
agreement as "[F]inancial support provided by a government or by any
public body within the territory of a Party for aeronautical
applications, including research and development, demonstration
projects and development of military aircraft, which provide an
identifiable benefit to the development or production of one or more
specific large civil aircraft programs."
\6 Commercial turnover is not defined in the agreement but, according
to a U.S. government official, is equivalent to the total commercial
sales of a company.
\7 The 1992 commercial turnovers of the United States and EU LCA
industries were approximately $23.2 billion and $6 billion,
respectively. Using the 3-percent constraint of the bilateral
agreement, the limits in 1992 of identifiable benefits from indirect
support would have been approximately $700 million for the United
States and $180 million for the EU.
\8 The two sides also had met informally several times previously, as
part of the multilateralization process. See chapter 4 for
additional details regarding these consultations.
THE EU METHODOLOGY
-------------------------------------------------------- Chapter 2:1.5
The EU estimated that in 1992 the European LCA industry received
identifiable benefits from indirect government support of between
1.02 percent and 1.32 percent of total commercial turnover.\9 This
estimate was within the constraints of the agreement. The EU also
estimated that the U.S. LCA industry received indirect government
support of between 4.4 percent and 5.8 percent of commercial turnover
in 1992. The EU estimate indicated that the United States was in
violation of the bilateral agreement.\10 The EU methodology consisted
of adding up the budgetary appropriations given by the governments
for aeronautics research and development for large aircraft. In the
case of the United States, this amount included the 1992 budgetary
authorizations for NASA Aeronautics and Transatmospheric Research,
NASA Independent Research and Development, and DOD funding for the
national aerospace plane.
The United States strongly disagreed with the EU methodology. A USTR
official said that the EU was clearly overlooking the requirement
that only "identifiable benefits" to specific large civil aircraft
programs be counted against the percentage limits. Commerce
officials told us that the EU was "re-interpreting" the language of
the agreement and this interpretation did not conform in any way with
the actual language of the agreement. According to a July 1993 State
Department cable, "[w]hile the U.S. government does fund a large
amount of research in the aeronautics area, only a small portion of
that research provides large civil aircraft producers with spillover
benefits for their civil aircraft programs. Much government-funded
R&D [research and development] goes to companies that do not produce
civil aircraft. In addition, most contracts are not linked to
specific programs, and the results of much of this research are
generally made widely available."\11
--------------------
\9 The EU's calculation of indirect support was done using two
different values for annual commercial turnover (the denominator of
the indirect support constraint ratio). The lower estimated level of
indirect support included the engine companies and non-Airbus
aeronautics companies in the calculation of annual commercial
turnover. The higher estimated level of indirect support included
the annual commercial turnover of Airbus partners only.
\10 The EU indicated that its estimate understated the magnitude of
indirect benefits received by the United States since it was unable
to make a full appraisal of DOD's aeronautics research and
development budget.
\11 The agreement excludes from the indirect support constraints
research and development that had been "made available on a
non-discriminatory basis to large civil aircraft manufacturers of the
parties."
THE U.S. METHODOLOGY
-------------------------------------------------------- Chapter 2:1.6
The Department of Commerce, in conjunction with the two U.S. LCA
producers, devised a methodology for determining identifiable
benefits from indirect support for the bilateral agreement. The U.S.
methodology was to identify potential benefits from
government-sponsored aeronautical research and development that may
have "flowed to the development or production of one or more specific
large civil aircraft programs." Each aircraft manufacturer was asked
to assess individually the identifiable reductions in the cost of its
LCA programs resulting from technology obtained through
government-funded research for which results have not been made
publicly available. After conducting this analysis, the two U.S.
manufacturers reported that there were no identifiable benefits from
indirect support during the first year of the agreement. The U.S.
government's explanation for this zero value was that "the absence of
identifiable benefits during the first year was expected, as the
agreement calls for identifiable benefits to be calculated with
respect to research performed after entry into force of the agreement
and research programs typically take a number of years to yield
commercial results."
The U.S. government submitted this calculation to the EU on July 8,
1993. The head of the EU delegation said at the time that he viewed
the U.S. calculation as a "decision on the part of the U.S.
administration to void the indirect support discipline of all
content." He said that he would have to bring this situation to the
attention of member states at the political level. A European
industry official said that he believed the U.S. submission was
evidence of "bad faith" in complying with the agreement.
The two parties met on October 7 and 8, 1993, for further bilateral
agreement discussions. The EU presented to the United States a
series of complaints regarding the U.S. methodology for measuring
identifiable benefits from indirect support:
(1) The method used was too cumbersome, especially in the way it
accounted for "identifiable benefits."
(2) The method relied too heavily on the analysis of the industry in
order to make the necessary calculations. This reliance was a
potential source of bias in the methodology.
(3) The analysis was limited to existing programs only, not
considering conceptual (future) programs, such as the high speed
civil transport (HSCT) or the super-jumbo aircraft.
(4) The analysis was limited to Boeing and McDonnell Douglas and did
not include government contracts with other aerospace firms.
(5) The United States did not give any value to "dead-end" research,
despite the fact that the determination that a certain research path
is fruitless may nevertheless provide useful and valuable
information.
For these reasons, the EU considered its methodology of using the
total contract value of government-supported aerospace research and
development more appropriate and easier to implement. The EU argued
that by including all contracts in its calculation, it was able to
encompass the potential benefits of conceptual programs.\12
In response, the United States contended that the language of the
agreement clearly supported the approach that it took. U.S.
negotiators argued that there is no reason to expect that
government-sponsored research by companies other than Boeing and
McDonnell Douglas would benefit Boeing or McDonnell Douglas, since
any resultant application would be commercially available to all
aircraft manufacturers, including Airbus. The United States
considered the valuation of "dead-end" research to be a nebulous
concept, since it is doubtful that U.S. manufacturers would
independently undertake research projects for which the company did
not foresee a commercial application. While refusing to renegotiate
the language of the bilateral agreement, the U.S. negotiators did
agree to further discussions with the EU on the measurement of
conceptual programs in the context of the indirect support issue.\13
The language of the indirect support provisions is not specific as to
methodology and does not offer much guidance on the formulation of a
compromise. A Commerce Department official noted that one intention
of the negotiators "was to be vague" with respect to indirect
support. An Airbus official said that the vagueness of article 5 is
partly due to ambivalence on the part of the EU at the time of the
negotiations. Some members of the European aerospace industry saw a
potential benefit in keeping the discussion of the issue somewhat
nebulous in order to allow the industry the option of receiving more
of this form of support in the future. According to a European
industry official, the vagueness in language was also due to the lack
of input from technically experienced "experts" during the
negotiation of the agreement. An Airbus official told us that the EU
is beginning to believe that the indirect support provisions of the
bilateral agreement were not well drafted, since they do not appear
to constrain the United States' use of indirect support.
--------------------
\12 The U.S. methodology only included benefits that have accrued to
already existing or announced programs. Current research for
hypothetical future programs, such as the HSCT, were not scored. The
negotiators referred to these hypothetical programs as "conceptual
programs." One of the U.S. LCA manufacturers has expressed an
interest in scoring conceptual programs as part of the U.S.
methodology in the future. An official of this company said that his
firm does not want to be placed in a position where all the benefits
of a new program are scored in 1 year. A Commerce Department
official noted that there is shared concern by both the United States
and the EU that if conceptual programs are not counted in the current
year, then there might be a "bunching" of indirect benefits in the
year when the program is eventually launched. A U.S. LCA
manufacturer suggested that a way to account for indirect benefits to
a conceptual program is if a particular government-sponsored
aeronautical research and development contract has a probability
greater than X percent (X to be decided, perhaps equal to 10 percent)
that a benefit would eventually result, then it should be scored. A
USTR official noted that the scoring of government-funded research
benefits for conceptual programs could hypothetically lead to a
company being over the indirect support limit provided under the
agreement, even though the conceptual program never becomes an actual
program, and therefore, no actual benefits are received.
\13 The United States submitted to the EU in September 1994 the value
of identifiable benefits from indirect support for the July 1993-June
1994 period. The United States concluded that there were no
identifiable benefits to existing large aircraft programs. However,
the United States also included a value for the potential benefits to
conceptual large civil aircraft projects. This value was well within
the constraints of the agreement. As of November 1994, the EU had
not officially commented on the U.S. submission.
DISCIPLINE ON EQUITY
INFUSIONS GENERALLY EXCLUDED
FROM AGREEMENT
-------------------------------------------------------- Chapter 2:1.7
Article 7 of the bilateral agreement addresses the issue of equity
infusions. An equity infusion by a government to a commercial
manufacturing facility usually means the purchase by the state of
shares in the enterprise. As such, this form of support occurs only
where there is a desire to establish some level of state ownership in
an enterprise, or to increase that ownership from its existing level.
The agreement states that
"[E]quity infusions are excluded from the scope of this
Agreement. Equity infusions will not, however, be provided in
such a manner as to undermine the disciplines foreseen in the
Agreement."
Of the three primary Airbus partners (A�rospatiale, British
Aerospace, and Deutsche Aerospace), British Aerospace and Deutsche
Aerospace are now private companies. However, the Government of
France owns a substantial majority of A�rospatiale and uses equity
infusions as a form of support to the firm.
Since the agreement was signed in July 1992, A�rospatiale has
received one equity infusion. A second equity infusion is planned.
In the fall of 1992, Cr�dit Lyonnais, a French bank, purchased a
20-percent share of A�rospatiale. The Government of France owns a
majority of Cr�dit Lyonnais and thus was indirectly involved in the
equity infusion into A�rospatiale.\14 The infusion was estimated by
the U.S. State Department to be worth 1.4 billion francs
(approximately $275 million). In February 1994, the Government of
France announced its intention to infuse an additional 2 billion
francs ($340 million) of equity into A�rospatiale. The EU ruled that
the first infusion was consistent with its rules on state aid; but as
of June 1994, it had yet to rule on the second infusion announcement.
An Airbus official informed us that if the second infusion is
approved by the EU, it will be a general infusion to A�rospatiale and
not explicitly designated to help its Airbus component.\15 He went on
to say that he did not believe the equity infusion would undermine
the disciplines of the agreement. The official noted that Airbus and
A�rospatiale maintain a fixed-price relationship, whereby Airbus pays
A�rospatiale a previously determined amount of money for the
components A�rospatiale supplies for each Airbus aircraft. He said
the equity infusion will not allow A�rospatiale to lower this already
negotiated price. We pointed out the possibility that the existing
pricing relationship between Airbus and A�rospatiale may be
unprofitable to A�rospatiale and thus may require periodic equity
infusions for the company to continue operation, but the Airbus
official disagreed.
One U.S. LCA manufacturer expressed both dissatisfaction with the
disciplines on equity infusions and an interest in tightening them as
part of a future multilateral agreement. The issue was discussed in
the multilateral negotiations, and several countries expressed an
interest in strengthening the discipline concerning equity infusions
beyond those that are contained in the bilateral agreement. In the
absence of a tightening of these rules, it remains to be seen if this
issue will be a further source of strain on the agreement.
--------------------
\14 In March 1994, the Government of France announced the intention
of providing an additional 3.5 billion francs ($608.3 million) of
capital to Cr�dit Lyonnais.
\15 In addition to Airbus activities, A�rospatiale manufactures
military aircraft, helicopters, tactical missiles, ballistic and
space systems, and other aerospace products.
ALL PARTIES HAVE EXPRESSED
CONCERNS ABOUT THE
LIMITATIONS OF TRANSPARENCY
PROVISIONS
-------------------------------------------------------- Chapter 2:1.8
Article 8 of the bilateral agreement covers the issue of
"transparency." The 12 subsections of this article outline the
reporting requirements of the two signatories of the agreement.
These requirements include providing information on prior government
commitments for LCA programs, future development support, indirect
support, and equity infusions. Most of the information is required
to be exchanged on an annual basis.
The U.S. LCA manufacturers considered an increased exchange of
information as one of the most important goals of the agreement. A
Commerce Department official explained that before the agreement,
information on Airbus was buried in the annual reports of the member
companies, and the origin and uses of funds for A�rospatiale were
hard to decipher. Also, the G.I.E. structure of Airbus permits the
company to not report financial results to the public. The U.S.
government has encouraged Airbus to provide annual reports with
information similar to that provided by Boeing and McDonnell Douglas
to the U.S. Securities and Exchange Commission. An Airbus
representative said that the company is in favor of publishing its
accounts but that the decision ultimately rests with the Airbus
partners.
The initial exchange of information occurred on July 16, 1992, 1 day
before the agreement was signed. In accordance with article 8.2 of
the agreement, the EU provided the U.S. government with information
on the prior government commitments to the four members of Airbus.\16
An official of the Commerce Department explained that representatives
of the U.S. government were able to analyze the data only briefly
before the signing of the agreement. Subsequently the U.S.
government representatives gave it a more thorough examination. The
official described the submission as satisfying the requirements of
the agreement.
The second submission of data occurred on March 31, 1993. At that
time, the U.S. negotiators provided the EU with some general
information about the NASA aeronautics research and development
budget and communicated their intention to provide an official
submission on indirect support in July. The EU negotiators provided
the United States with information for 1992 regarding a number of
different transparency articles. The information in the EU
submission included (1) aggregate data on government disbursements
and repayments related to Airbus, (2) a formal statement that there
had been no changes in the terms and conditions of prior government
support since the signing of the agreement, (3) a formal statement
that there had been no new commitment of government support to
Airbus, (4) a report on a change in the French government's equity
holdings of A�rospatiale, (5) data on indirect government support
received by Airbus, and (6) an EU estimate of indirect support
provided to the U.S. LCA manufacturers by the U.S. government.
The U.S. submission of July 1993 consisted of information on
aeronautical research contracts between U.S. government agencies and
the two U.S. LCA manufacturers. As previously mentioned, the
conclusion of the analysis was that the two companies had received no
identifiable benefits from indirect support provided in the first
year in which the agreement was in effect.
The ongoing disagreement on the methodology for measuring
identifiable benefits from indirect support has highlighted some
dissatisfaction on the part of the EU with the transparency features
of the agreement. An official of Deutsche Aerospace explained that
his company saw the agreement as a means for getting increased
transparency with respect to indirect support from the United States,
but the official now believes the two signatories are not providing a
comparable amount of information. An Airbus official said that not
enough information is being provided to the EU.
The U.S. side has also expressed dissatisfaction with the
transparency features of the agreement. A McDonnell Douglas official
said that the agreement does not provide for enough transparency
regarding the cash flow and balance sheets of the member companies of
Airbus. He said that an increased focus on the transparency
provisions would be most helpful to U.S. industry in achieving a
level playing field with Airbus. Boeing urged USTR to enhance the
transparency requirements of the bilateral agreement as part of any
future multilateral agreement. Boeing requested the inclusion of
detailed information on manufacturer finances and increased public
scrutiny of any information provided.\17 However, a USTR official
told us that although the bilateral agreement does not provide for a
perfect information exchange, USTR believes that the information
provided through the agreement, plus information provided by other
sources at its disposal, enables it to monitor the implementation of
the agreement effectively.
--------------------
\16 The requirement did not apply to the U.S. government since it
had not provided direct support to the LCA industry.
\17 The agreement provides that any information that is not already
in the public domain may be considered proprietary at the request of
the party supplying the information.
CONSULTATION AND AMENDMENT
PROVISIONS ARE IMPORTANT TO THE
SUCCESS OF THE AGREEMENT
---------------------------------------------------------- Chapter 2:2
Although they are not the subject of disagreement, two provisions
bear directly on whether the agreement will remain viable. The two
parties agreed to try to resolve disputes through a consultation
process. The two parties can also mutually agree to amend the
agreement.
THE TWO PARTIES AGREED TO
CONSULT ON A PERIODIC BASIS
-------------------------------------------------------- Chapter 2:2.1
In article 11 of the agreement, the two parties agreed to regular
consultations, with a minimum of two a year, to ensure the correct
functioning of the agreement. In the first year of the agreement,
the two parties had one official consultation devoted to the
bilateral agreement, although several additional meetings occurred
within the context of the multilateral negotiations.
Since the agreement has no formal dispute resolution mechanism,
consultation is the only method available to the two parties to
resolve their differences. In the event that one party requests a
consultation, the agreement stipulates that it must be held no later
than 30 days after the request is received. The parties agreed to
seek resolution of any disputes within 3 months of the initial
request for consultations. The dispute on indirect support has been
continuing for more than a year since the first formal consultation
in late March 1993.
WITH MUTUAL CONSENT, THE
AGREEMENT CAN BE AMENDED
-------------------------------------------------------- Chapter 2:2.2
Article 13 of the agreement, "Final Provisions," contains two
important features regarding the agreement's viability, neither of
which has been tested in practice. These provisions highlight the
importance of consultations between the United States and the EU.
With mutual consent, the two parties may amend the agreement to take
into account any new situation that may arise. Also, a party can
choose to withdraw from the agreement 12 months after giving written
notice of its intent.
Both elements are relevant to the ongoing and potential disputes
involving the bilateral agreement. If, for example, the two parties
agree to strengthen the discipline on equity infusions, the agreement
can be amended to reflect this circumstance. However, termination of
the agreement is permissible if one or more disputes remain
unresolved and one party chooses to withdraw. The ease with which
withdrawal from the agreement can be accomplished reinforces the
importance of having the two sides mutually agree on the
interpretation of the agreement if it is to remain viable.
BILATERAL AGREEMENT'S
EFFECTIVENESS DEPENDS ON GOOD
FAITH EFFORTS OF BOTH PARTIES
TO MAKE IT WORK
---------------------------------------------------------- Chapter 2:3
The bilateral agreement, unlike other major trade agreements such as
the GATT Uruguay Round agreement or the North American Free Trade
Agreement, does not contain a formal dispute settlement mechanism.
Rather, the agreement calls for consultations between the two parties
in case of dispute. Thus, the effectiveness of the agreement depends
on the two parties acting in good faith to implement their
commitments. Because of this, and given the ongoing and potential
disagreements, we believe the long-term viability of the agreement is
uncertain. However, according to the chief U.S. negotiator for
aircraft, the benefits provided by the bilateral
agreement--constraints on direct support provided to Airbus, in the
case of the United States, and a reduction in the threat of trade
action in the case of the EU--are reasonably strong incentives for
them to stay in the agreement.
THE BILATERAL AGREEMENT MAY
ENHANCE THE COMPETITIVENESS OF THE
U.S. LCA INDUSTRY
============================================================ Chapter 3
An important goal of the 1992 bilateral agreement was to reduce
government support to LCA manufacturers. Although the constraints of
the bilateral agreement are potentially significant, the agreement
has been in effect for too short a period to discern any definitive
changes in government support to the industry. However, the U.S.
LCA industry would benefit if direct government support to Airbus
were reduced from its previous high levels.
One possible offset of this potential benefit would occur if the
indirect support constraints were to limit future U.S. research and
development expenditures on civil aerospace, resulting in a slower
pace of technology development and introduction in the industry.
However, U.S. negotiators have said that the indirect support
provisions, as negotiated, should not impinge on anticipated levels
of U.S. research programs.
EU manufacturers have expressed an increased interest in receiving
indirect government support. To the extent that the EU were to
offset reductions in direct support to European LCA manufacturers by
increasing indirect support, any potential gain to the U.S. LCA
industry could be reduced. However, since the annual commercial
sales of the EU large civil aircraft industry are substantially lower
than those of the U.S. industry, the ceiling on indirect support,
which is a percentage of the civil aircraft industry turnover, would
be substantially lower for the EU as well.
GOVERNMENT SUPPORT IS
INFLUENCED BY MANY FACTORS
---------------------------------------------------------- Chapter 3:1
National governments have traditionally shown great interest in their
domestic aerospace industry (both military and civilian). Whether
they were motivated by concerns for national defense, international
prestige, increased high-wage employment, or other concerns,
governments have been willing to support their aerospace industries.
In general, when a government chooses to provide support to a firm, a
number of market effects can occur. The support may lower the cost
of production, allowing the firm to underprice its competitors and
increase its market share at the expense of its unsubsidized
competition. The firm may choose to invest in research and
development, potentially establishing a technological edge compared
to its competition.\1 If the firm is inefficient or uses outdated
technology, the support may permit the company to stay in business
rather than cease operation. The firm may also use the support to
pursue goals not necessarily consistent with market efficiency, such
as providing increased employment or higher wages.
The nature of the support may alter the type and magnitude of the
effects that might occur. A direct transfer of money from the
government to the firm could allow the firm to use the resources to
pursue whatever strategies are most consistent with its market
success and thus present the greatest challenge to its competitors.
Support can also be provided through the government's financing of
projects that are not directly related to the firm's current
commercial activity, such as military research and development. Such
indirect support can be beneficial to a firm to the extent that the
firm is able to assimilate a new technology or use research funding
for other purposes. The competitive effect of indirect government
support varies depending on the commercial relevance of the research
and its compatibility with the plans of the firm.
From the perspective of the firm and its employees, government
support is usually desirable, providing it with advantages and
opportunities beyond what is available through its own resources.
However, the imposition of any goals or requirements on the use of
such support can lessen its attractiveness. Moreover, to the extent
that government support negatively affects the long-run efficiency of
a firm, its ability to successfully compete against unsupported firms
may erode. For the taxpayer, the cost of such support (which is
alleged to have been quite high in the case of the LCA industry, as
discussed in ch. 1) must be weighed against its possible benefits,
such as developing a more advanced technology or providing less
expensive products.
The economics of the LCA industry provides an additional
consideration relevant to the issue of government support. It has
been hypothesized that without government intervention, the LCA
industry would develop a monopolistic structure (i.e., one firm
only).\2 In her book on government policy and international trade,
Laura Tyson noted that "[j]udged solely on the criterion of
production efficiency . . . the large jet aircraft industry tends
toward a natural monopoly."\3 In an academic study on the economics
of the aircraft industry, economists Richard Baldwin and Paul Krugman
stated that "the world market in no case supports more than two firms
producing aircraft that are close substitutes in demand, and perhaps
only supports one without government intervention."\4
In an academic study of the market structure of the aircraft
industry, economist Gernot Klepper stated that an important
motivation of the European governments in supporting the LCA industry
was to avoid a potential U.S. monopoly.\5
The market structure of the LCA industry complicates any analysis of
the impact of government support on the industry, especially from the
U.S. perspective. According to Tyson, it is important for the
United States to balance the possible adverse effects of foreign
government support against its possible beneficial effects. The
potential adverse effects include a reduced production efficiency and
profit to U.S. LCA manufacturers, reduced national wage and
employment opportunities, and diminished national research and
development. The possible beneficial effects accrue to U.S.
consumers through enhanced competition on the basis of price, product
differentiation, and product innovation.
Two studies have had a central role in the debate between the United
States and the EU concerning government support to the LCA industry.
The 1990 study prepared by Gellman Research Associates for the U.S.
Department of Commerce stated that Airbus had received billions of
dollars in direct support from its member governments since it was
established in 1968. The 1991 study prepared by Arnold & Porter for
the EU claimed that the U.S. aerospace industry had received
billions of dollars in indirect support from the U.S. government
since the mid-1970s.\6
According to Baldwin and Krugman, government support to Airbus was
detrimental to aggregate U.S. welfare since the increased
competition among aircraft manufacturers resulted in large forgone
profits to the U.S. LCA industry, although consumers in the United
States and worldwide benefited by the increased competition.
Klepper's analysis reached a similar conclusion.
Tyson said that indirect support to the U.S. LCA industry was no
longer nearly as important as it has been in the past, but due to the
economics of the LCA industry, the benefits of prior support are
still being realized. Tyson believed that given the industry's
economics, Airbus' only chance to compete with the U.S. LCA industry
was through massive government support.
Government support to any aircraft manufacturer is perceived as
detrimental by its competitors in the industry and, according to
allegations by both sides to the agreement, has been very expensive.
In signing the bilateral agreement, the two sides agreed to constrain
future government support and reduce the trade distortions they
believe result from it.
--------------------
\1 From the perspective of the national economy, government support
for research and development may be desirable even if the benefits of
certain research do not justify its cost to an individual firm or
industry. This situation could occur if the benefits of the research
cannot be appropriated by the firm conducting the research, but
accrue to the economy as a whole.
\2 The LCA industry is characterized as one that experiences
"increasing returns to scale," where production efficiency increases
with greater output. The hypothesis is that the output level that
would exhaust these anticipated gains in production efficiency is
higher than the total world demand for a particular aircraft model.
This characteristic, along with very expensive start-up costs and a
long development cycle, contributes to the monopolistic tendencies of
the industry.
\3 Who's Bashing Whom? p. 166. Ms. Tyson's commercial aircraft
chapter contains an overview of the literature on the economics of
the LCA industry, along with her own analysis.
\4 Richard Baldwin and Paul Krugman, "Industrial Policy and
International Competition in Wide-Bodied Jet Aircraft," Trade Policy
Issues and Empirical Analysis, ed. Robert E. Baldwin (Chicago: The
University of Chicago Press, 1988), p. 71.
\5 Gernot Klepper, "Entry Into The Market For Large Transport
Aircraft," European Economic Review 34 (1990).
\6 See chapter 1 for a full discussion of the two studies.
AGREEMENT'S IMPACT ON U.S.
INDUSTRY DEPENDS ON THE EXTENT
THAT SUPPORT IS CONSTRAINED
---------------------------------------------------------- Chapter 3:2
The implications of the agreement for the competitiveness of the U.S.
LCA industry depend on the changes in government support that result
from it. It is impossible to assess the competitive implications of
the agreement at this point, since the agreement has not been in
effect long enough to establish any definitive changes. However,
given the constraints on government support within the agreement, we
can analyze the types of changes in support that may occur, as well
as their potential competitive impact.
To the extent that direct EU support is reduced by the agreement, the
long-term prospects of the U.S. LCA industry will be enhanced.
However, there are a few assumptions underpinning this conclusion
that are discussed in the following analysis.
-- We assume, in this section, that the agreement will remain in
effect for a sufficient duration to have an impact on the U.S.
and EU LCA industries. However, as discussed in chapter 2,
disagreements may threaten the long-term viability of the
bilateral agreement.
-- We also assume that the agreement enhances the competitiveness
of the U.S. LCA industry through a reduction in direct EU
support to Airbus. This reduction would result in a higher
price and/or lower technological advancement for future Airbus
aircraft programs compared with what would be likely if no
reduction in support to Airbus were to occur.
-- Finally, we assume that the EU will not substitute other forms
of support for the direct support constrained by the agreement.
As discussed in the following section, EU manufacturers have
requested an increased level of indirect support from their
member governments. To the extent that increased indirect
support were to offset reductions in direct support to European
LCA manufacturers, then any potential gain to the U.S. LCA
industry realized through the agreement could eventually be
lessened.
The agreement attempts to set disciplines for three types of
government support: production, development, and indirect support.
The agreement prohibits all future production support, except for
what has already been committed for the production of large civil
aircraft. Development support is permitted in the form of loans at a
rate near the government cost of borrowing, up to 33 percent of the
total expected development costs of the project. These two forms of
government support are considered "direct," with government resources
allocated outright to the receiving firm to support commercial
activity. Both production and development support have been
important sources of funding for Airbus in the past.
Despite some disagreement regarding prohibited production support, a
new allocation of this form of direct support to Airbus seems
unlikely in the future. The Gellman study noted that "there does not
appear to be any further need for additional financial support for AI
[Airbus Industrie] programs from the governments of the AI-member
firms" due to a projected positive future cash flow to the company.\7
This statement was made almost 2 years before the bilateral agreement
was signed. The agreement, therefore, may have served to formalize a
change in the financial condition of Airbus that had already been
established.\8
The agreement's impact on development support will not be tested
until a new aircraft program is launched. Since the agreement has
been signed, Airbus has launched a derivative program, the A319.
This, however, is not a true test of the agreement's constraints
since the A319 is a smaller version of the A320 and is to utilize an
already established technology and design. The development of the
A319 is expected to require substantially fewer resources than what
would be necessary for a completely new aircraft model. A European
official and two Airbus member companies told us that there are
currently no plans to request government support for the project.
According to an official of Deutsche Aerospace, the form of direct
government support that is acceptable under the bilateral agreement
is "not very interesting" to the company. He said that Deutsche
Aerospace currently has a very good credit rating and would benefit
very little from loans set at the government's rate of borrowing.
However, this official told us that the firm might have requested
direct support from the German government if the bilateral agreement
had not been in effect. This circumstance may be considered a
hopeful sign of the future importance of the bilateral agreement for
U.S. LCA manufacturers. However, the current budgetary difficulties
of both the French and German governments were also cited by several
EU industry and government officials as an additional reason why new,
direct government support has not been committed to Airbus members.\9
The agreement states that the identifiable benefits from indirect
government support are not to exceed 3 percent of the annual
commercial turnover (sales) of the civil aircraft industry of each
party or 4 percent of the annual turnover of any one firm. Both the
historical and the current importance of indirect support have been
disputed by the two parties to the agreement, but each believes the
other has benefited from it.
If the indirect support constraints were to limit future U.S.
research and development expenditures on civil aerospace, then the
pace of technology development and introduction in the industry may
be slowed. However, U.S. negotiators have said that the indirect
support provisions, as negotiated, should not impinge on anticipated
levels of U.S. research programs.
Since the agreement has been signed, EU manufacturers have expressed
strong interest in this form of support. In December 1993, French
aerospace manufacturers called for the EU to switch from direct to
indirect support. In January 1994, the President of and space
research from the German government. In July 1994, the German
government announced a new $800-million domestic aerospace research
program, jointly funded by the government and private industry.
Any benefits received by Airbus from such research may reduce any
gain to U.S. companies realized through the agreement's restrictions
on direct support. However, as mentioned in chapter 2, the
commercial turnover of the U.S. LCA industry is substantially higher
than the EU's (more than three times greater in 1992). Since the
limits on indirect support are based on a percentage of annual
commercial turnover, the ceiling on identifiable benefits from
indirect support would be substantially lower for the EU than for the
United States.
Equity infusions have been a traditional method of support used by
the French government for A�rospatiale. As noted in chapter 2, there
are indications that this behavior is continuing. If this method of
support were to become a substitute for other forms of support
constrained by the bilateral agreement, then any potential
competitive gains to the U.S. LCA industry might be jeopardized.
--------------------
\7 An Economic and Financial Review of Airbus Industrie, ch. 4, p.
7.
\8 The Gellman analysis was completed before the recent downturn in
demand experienced by the LCA industry. The severity and duration of
the decline may require a reassessment of Airbus' financial health
and need for direct government support for existing programs.
However, we have had no indications of renewed interest in production
support by the Airbus members.
\9 Although the United States has refrained from providing direct
government support to LCA manufacturers in the past, future
development support is allowed up to the amount permitted in the
agreement. We have no evidence that this action is under
consideration by the U.S. government, nor did U.S. manufacturers
express to us any interest in being directly supported.
POTENTIAL CHANGES IN THE
STRUCTURE OF THE INDUSTRY MAY
AFFECT THE AGREEMENT
---------------------------------------------------------- Chapter 3:3
Changes in the international structure of the civil aerospace sector
may affect the significance of the bilateral agreement. Boeing and
the Airbus partners are jointly exploring the economic and technical
feasibility of a very large civil transport program (VLCT--an
approximately 550-passenger aircraft). Given the enormous expected
cost of VLCT and the relatively modest demand for such an aircraft,
the expectation is that only one producer could profitably go forward
with this program. The joint development of this new aircraft would
enable both Boeing and the Airbus partners to realize the possible
profits of the program while avoiding direct and potentially costly
competition.
A number of serious problems would have to be overcome before the
partnership could go forward, however. The initial issue is a
determination of the feasibility of VLCT from an economic and
technical standpoint. If this barrier is overcome, several
complicated coordination issues would remain. Aircraft purchasers
generally prefer procuring aircraft that have some degree of
"commonality" with their existing fleets in order to lower operating
costs.\10 Any commonality between VLCT and an existing Boeing or
Airbus aircraft would provide that company with an advantage over its
rival. Further, the marketing of VLCT may be complicated because
some of its potential business may come at the expense of existing
and future Boeing and Airbus aircraft. The establishment of an
international aircraft monopoly in this market niche may also raise
antitrust concerns in the United States and abroad.
If, despite these and other difficulties, Boeing and the Airbus
partners proceed with a joint effort to produce VLCT, the bilateral
agreement may be considered an impediment to the program from the
perspective of the aircraft manufacturers. A VLCT program is
expected to be very expensive, and government support in excess of
the limits of the bilateral agreement may be sought. As previously
discussed, the EU was motivated to support Airbus in part to avoid a
potential U.S. monopoly. It is far too early to predict whether the
member governments would agree to provide support to an international
aircraft monopoly, even if it were limited to only one segment of the
LCA market.
One purpose of the bilateral agreement was to reduce trade
distortions resulting from government support to aircraft
manufacturing. An international consortium of U.S. and EU
manufacturers to produce VLCT would mean that the participants would
not compete against each other in this market niche and therefore
would not have the same "trade distortion" concerns as in the market
niches where they do compete. A representative of Airbus said that
the two sides could negotiate for a relaxation from the constraints
of the bilateral agreement for the VLCT program if they deem it
necessary.\11 However, the two sides may have difficulty garnering
public approval for providing government support to an international
aircraft monopoly.
--------------------
\10 "Commonality" refers to the degree of overlap in parts and
systems between different aircraft programs. The greater the
overlap, the lower the overall maintenance and training costs are to
an airline compared to a set of aircraft with less commonality.
\11 If a multilateral aircraft agreement is successfully negotiated,
the ability of the two parties to the bilateral agreement to relax
its constraints on government support may be curtailed. See chapter
4 for a discussion of the multilateral negotiations.
EFFORTS TO EXTEND THE AGREEMENT TO
OTHER NATIONS HAVE NOT SUCCEEDED
TO DATE
============================================================ Chapter 4
Article 12 of the 1992 bilateral agreement called for efforts by the
United States and the EU to "multilateralize" the agreement, that is,
to extend it to other countries. Other signatories of the 1979
aircraft agreement such as Japan,\1 and nonsignatories such as
Russia, China, South Korea, and Taiwan, were viewed as potential
competitors to the United States and the EU in the LCA sector over
the long term. A multilateral agreement with disciplines similar to
those in the bilateral agreement was seen as being in the long-term
interest of both parties. Thus far, however, a new multilateral
aircraft agreement has yet to be concluded.
The multilateral negotiations began in Geneva in October 1992 within
the forum of the GATT Subcommittee on Trade in Civil Aircraft.
According to the chief USTR negotiator for aircraft, it became clear
early in the negotiations that Canada and Japan, active participants
in the talks, did not agree with the "support-based" disciplines\2 of
the bilateral agreement. During the last 2 months of 1993, there was
a flurry of activity in the multilateral negotiations. The EU
attempted to link the aircraft discussions with efforts to complete,
by December 15, the Uruguay Round of GATT. U.S. industry strongly
opposed efforts to hastily agree to a November 19, 1993, text
submitted by the Chairman of the GATT Subcommittee on Trade in Civil
Aircraft, less than 1 month before the December 15 deadline.
The Uruguay Round agreement, which was concluded December 15, did not
include a new agreement on civil aircraft. However, the new
Agreement on Subsidies and Countervailing Measures,\3 unlike the old
subsidies code, would clearly apply to the aerospace industry,
including civil aircraft, with a few exceptions outlined in footnotes
to the new agreement. This application had been a major objective of
the United States, and U.S. government and industry officials
indicated they were quite pleased with the outcome of the
negotiations in this regard.
At the conclusion of the Uruguay Round, the United States and the EU
agreed that multilateral negotiations on aircraft would continue.
Although U.S. LCA manufacturers would like other parties to agree to
the support-based disciplines of the bilateral agreement, the U.S.
aerospace industry has indicated its overall satisfaction with the
status quo. It is questionable to what extent the United States will
proceed with negotiations for a new multilateral aircraft agreement
without the strong backing of U.S. industry. Moreover, based on our
discussions with U.S. and EU government and industry officials, we
believe there are no real incentives for other countries to
participate in a multilateral agreement with disciplines similar to
those in the bilateral agreement. Also, given the ongoing
disagreement between the United States and the EU on certain
provisions of the bilateral agreement, it is perhaps not surprising
that other parties did not embrace the agreement. Consequently, we
believe that prospects for reaching a multilateral agreement with
disciplines similar to those in the bilateral agreement are not
likely in the near future.
--------------------
\1 There were 22 signatories of the 1979 aircraft agreement. These
included the United States, the EU, the 12 member states of the EU
(Belgium, Denmark, France, Germany, Greece, Ireland, Italy,
Luxembourg, the Netherlands, Portugal, Spain, and the United
Kingdom), Austria, Canada, Egypt, Japan, Norway, Romania, Sweden, and
Switzerland.
\2 The United States has explained that "support-based" constraints
are appropriate for the LCA industry due to the long-term nature of
new aircraft programs: "The amount of subsidization and its effects
may not become evident until many years after the initial decisions
by governments to grant support. Therefore, there is a need for
rules to address these decisions at their inception by establishing
the conditions and maximum levels for the use of such support. A
support-based discipline would achieve this."
\3 The old subsidies code was part of the GATT Tokyo Round agreement
of 1979. The new Agreement on Subsidies and Countervailing Measures
is part of the overall GATT Uruguay Round agreement.
MULTILATERAL DISCUSSIONS
LANGUISHED FOR MORE THAN A YEAR
---------------------------------------------------------- Chapter 4:1
The first formal meeting of the GATT Subcommittee on Trade in Civil
Aircraft took place in October 1992. According to the chief aircraft
negotiator at USTR, from the outset the main players in the
multilateral discussions were the United States, the EU, Canada,
Japan, and to a lesser extent, Sweden and Norway. Not all 22
signatories of the 1979 aircraft agreement have participated in the
negotiations, but several nonsignatories, including Russia and
Brazil, have participated as observers.
The EU and the United States both submitted proposals in November
1992. A high priority for the EU was to conclude an agreement that
would function as a special law for trade in aircraft, essentially
excluding aircraft from coverage of other GATT laws. The EU proposal
called for a provision to be inserted into the Uruguay Round's
Agreement on Subsidies and Countervailing Measures (still under
consideration at that time) to the effect that, for signatories of
the new aircraft agreement, the new subsidies agreement would not
apply to aircraft as defined in the 1979 Agreement on Trade in Civil
Aircraft. The United States strongly opposed the EU position,
stating that the new subsidies agreement should apply to the civil
aircraft sector, just as, in its view, the old subsidies code had.
The November 1992 U.S. proposal noted that the ultimate objective
should be "the progressive reduction and eventual elimination of
trade-distortive government support." In accordance with article 12
of the 1992 bilateral agreement,\4 the November U.S. proposal also
stated that product coverage should, "at the minimum, encompass all
those products and services currently covered by the existing
Aircraft Agreement." According to a U.S. engine company official,
although the company had supported the exclusion of civil aircraft
and components from the basic research "green light" (nonactionable)
category of the draft subsidies code being considered in the Uruguay
Round (see the following section), the company had little interest in
the indirect support language of the bilateral agreement.
Reflecting the concerns of U.S. industry, the April 1993 U.S.
proposal called for a two-track approach to the negotiations:
Negotiations should be concluded on large civil aircraft before
proceeding on rules for other products such as engines, smaller
commuter aircraft, and helicopters. The United States argued that
the situation for other products was complicated by the greater range
of products, the greater number of countries involved, and the
relative lack of information on the nature of government support for
these products.
According to U.S. government negotiators, the EU responded with
little enthusiasm to the two-track approach of the United States.
Similarly, according to press reports, other countries did not
support this approach. The objectives of the EU were unclear with
respect to the expansion of the coverage of the bilateral agreement
to include engines. According to an Airbus official, only one of the
three major EU engine companies actively pursued having engines
covered by disciplines similar to those contained in the bilateral
agreement. A U.S. engine company official noted that all engine
companies have one or more international partners on their newer
commercial engine programs and indicated that his company felt that
the flow of indirect support to U.S. and EU engine companies was
roughly comparable and not trade distorting.
The April 1993 U.S. proposal also called for a reduction in the
limit on direct support for development of new LCA programs from 33
percent to 20 percent. European government officials reacted
negatively to the U.S. call for a further reduction of direct
support.
After a July 1993 meeting of the GATT subcommittee, the chief USTR
aircraft negotiator told us that the basic problem was that there was
still no agreement for a framework for the negotiations. Canada and
others did not embrace the support-based approach of the bilateral
agreement. Moreover, there was widening disagreement between the
United States and the EU with respect to the interpretation of
provisions of the bilateral agreement, especially on indirect support
(see ch. 2). Not surprisingly, negotiators indicated their
increasing pessimism as to whether the agreement could be
multilateralized.
--------------------
\4 Article 12 had also called for the United States and the EU to
make efforts to expand the coverage of the disciplines of the
bilateral agreement to all of the products covered in the 1979 GATT
aircraft agreement, that is, to all civil aircraft, engines, parts,
components, and other items.
CONCLUSION OF A NEW AIRCRAFT
AGREEMENT BECAME LINKED TO
OVERALL URUGUAY ROUND AGREEMENT
---------------------------------------------------------- Chapter 4:2
According to the chief USTR aircraft negotiator, the EU presented the
ongoing deadlock in the multilateral aircraft negotiations as an
impediment for concluding the entire Uruguay Round of GATT. Thus,
while there had been some linkage previously between the aircraft
negotiations and the overall Uruguay Round, the linkage became more
pronounced. Indeed, press articles noted the importance of reaching
an agreement in aircraft if there were to be a successful conclusion
to the Uruguay Round.
As the Uruguay Round was drawing to its scheduled conclusion of
December 15, it appeared that a new Agreement on Subsidies and
Countervailing Measures would be part of the overall agreement. A
high priority of the EU was to obtain exclusion of the aircraft
sector from the new subsidies agreement. Conversely, a major U.S.
objective was for the new subsidies agreement to cover all aerospace
products, including LCA. The draft subsidies agreement then under
consideration in the Uruguay Round included a footnote to a section
concerning nonactionable (permitted) subsidies with respect to
research and precompetitive development. The footnote said that
aircraft was excluded, that is, aircraft subsidies for research and
precompetitive development could be a violation of the subsidies
agreement. The inclusion of this footnote in the text was important
to the United States since, as noted by a USTR official, the
implication was that aircraft was clearly covered by all other
provisions in the subsidies agreement.
In the middle of November 1993, the Chairman of the GATT aircraft
subcommittee submitted two texts for a "Revised Agreement on Trade in
Civil Aircraft." The action was prompted by what he wrote was a
"shared view of the participants" in the aircraft negotiations to
resolve, before the scheduled completion of the Uruguay Round, some
difficult issues linked to the subsidies agreement. The draft texts
were transmitted by U.S. negotiators to U.S. industry officials,
who expressed concern about the potential implications for the
industry. According to the USTR negotiator, U.S. industry officials
expressed misgivings regarding the haste of the negotiation process,
and they objected to certain elements of the text that was still
under consideration.\5
--------------------
\5 U.S. industry officials were concerned with the treatment of
research and development under article 9 (labelled "Certain
Subsidies") of the text under consideration. They were also
concerned that under article 10, royalty-based financing committed
before the new agreement, including such financing received by the
Airbus consortium members, would have been "grandfathered" and
protected from future trade actions under GATT.
U.S. INDUSTRY WAS ULTIMATELY
PLEASED WITH OUTCOME OF THE
URUGUAY ROUND
---------------------------------------------------------- Chapter 4:3
After several weeks, the United States refused to continue to
negotiate on the text under consideration. At that time, the GATT
Secretariat closed discussions on the subsidies agreement, which
still included the footnote that exempted aircraft from the
nonactionable subsidies category for research and precompetitive
development activities. In an effort to reflect some of the EU
demands that civil aircraft be exempted from disciplines in the new
subsidies agreement, the GATT subcommittee Chairman proposed two
additional footnotes. U.S. negotiators, after suggesting some small
changes, endorsed the Chairman's proposal.
The two footnotes were related to article 6.1 of the subsidies
agreement, which dealt with "serious prejudice."\6 The first footnote
stated that "since it is anticipated that civil aircraft will be
subject to specific multilateral rules," government subsidies to LCA
manufacturers that exceed 5 percent of the cost of developing a new
aircraft will not constitute a presumption of serious prejudice.
According to a USTR official, the inclusion of this footnote was a
concession to the EU. A U.S. industry official indicated that
although U.S. industry would have preferred to retain the 5 percent
serious prejudice test for civil aircraft, they agreed to the
concession.
The second footnote stated that "where royalty-based financing for a
civil aircraft program is not being fully repaid due to the level of
actual sales falling below the level of forecast sales, this does not
in itself constitute serious prejudice." The inclusion of this
footnote was significant because royalty-based financing, which is
the primary method used by European governments to provide support
for Airbus, requires a company to pay back loans from the government
based on the sales of its products.
In short, the addition of the two footnotes to the subsidies
agreement represented a compromise between the United States and the
EU. The United States had originally demanded that the aircraft
sector be covered by all the disciplines of the subsidies agreement,
while the EU had sought a complete exemption of the sector from that
agreement.
U.S. industry representatives have said that the industry was
largely pleased with the ultimate outcome of the Uruguay Round
negotiations with respect to aircraft. A major objective, the
coverage of aircraft by the subsidies agreement, was essentially
achieved, with the exceptions outlined in the footnotes. The GATT
subcommittee Chairman's text for a new multilateral aircraft
agreement, which was highly objectionable to U.S. industry, was
rejected. Nonetheless, U.S. negotiators did commit themselves to
continue negotiations and to conclude, within a year, a multilateral
agreement based on the Chairman's text and "on other proposals."
--------------------
\6 "Serious prejudice" refers to a situation in which a country's use
of subsidies adversely affects another country's trade interests. If
there is a determination of serious prejudice, the country is
obligated to withdraw the subsidy or remove the adverse effects when
they are identified.
INCENTIVES FOR CONCLUDING A
MULTILATERAL AGREEMENT HAVE
LESSENED CONSIDERABLY
---------------------------------------------------------- Chapter 4:4
The chief USTR negotiator for aircraft summed up the situation as
follows. The U.S.-EU bilateral aircraft agreement is still in
effect. The Uruguay Round subsidies agreement, to take effect July
1, 1995, has stronger disciplines than the Tokyo Round subsidies
code, and it clearly applies to aircraft. This situation would be
better from the U.S. point of view. The 1979 aircraft agreement is
also still in effect. The U.S. aerospace industry achieved its most
important objective, the inclusion of civil aircraft in the new
subsidies agreement, and it has indicated that is not anxious to
pursue further negotiations. A Commerce Department negotiator added
that while the LCA manufacturers would probably like other countries
to sign on to the disciplines of the U.S.-EU bilateral agreement, the
chances are slim that the agreement will be multilateralized.
An Airbus official told us of his disappointment that a multilateral
agreement had not been reached. However, provided that the U.S.-EU
bilateral agreement remains in effect, and in light of the modified
subsidies agreement, the European aircraft industry views the present
situation as an acceptable interim solution. The Airbus official
noted that, as a result of the outcome of the Uruguay Round in
December 1993, nonsignatories of the bilateral agreement have more
freedom to subsidize their civil aerospace industries than the United
States or the EU. He said that this fact would lessen the motivation
of other countries, such as Japan, Canada, or Sweden to reach a
multilateral agreement.
We believe that prospects for reaching a multilateral agreement with
disciplines similar to those in the bilateral agreement are very
unlikely in the near future. The U.S. civil aircraft industry is
generally satisfied with the status quo, assuming the Uruguay Round
is ratified. It is questionable to what extent the United States
will actively pursue negotiations for a new multilateral aircraft
agreement without the strong backing of U.S. industry. More
significantly, Canada, Japan, and others were not interested in
signing on to the support-based disciplines of the bilateral
agreement, and there is less motivation for them to do so now. The
chief USTR negotiator for aircraft had told us in early 1993 that
other signatories of the 1979 aircraft agreement were interested in
strengthening that agreement. He also noted that since both China
and Taiwan wanted to become members of GATT, some leverage could
perhaps be placed on them to subscribe to a multilateralized
agreement. Nonetheless, based on our discussions with U.S. and EU
government and industry officials, we believe there are no real
incentives for other countries to be parties to a multilateralized
agreement. Also, given the ongoing disagreement between the United
States and the EU on certain disciplines of the bilateral agreement,
it is perhaps not surprising that other parties did not embrace such
disciplines. For all these reasons, it is unlikely that a revised
multilateral aircraft agreement will be reached in the near future.
MAJOR CONTRIBUTORS TO THIS REPORT
==================================================== Appendix APPENDIX
GENERAL GOVERNMENT DIVISION,
WASHINGTON, D.C.
-------------------------------------------------- Appendix APPENDIX:1
James M. McDermott, Assistant Director
Elizabeth J. Sirois, Assistant Director
Stanton J. Rothouse, Project Manager
Thomas Melito, Senior Economist
Susan S. Westin, Senior Economist
Rona H. Mendelsohn, Evaluator
OFFICE OF THE CHIEF ECONOMIST,
WASHINGTON, D.C.
-------------------------------------------------- Appendix APPENDIX:2
Loren Yager, Assistant Director
OFFICE OF THE GENERAL COUNSEL,
WASHINGTON, D.C.
-------------------------------------------------- Appendix APPENDIX:3
Sheila K. Ratzenberger, Assistant General Counsel
Richard R. Perruso, Attorney-Adviser
LOS ANGELES REGIONAL OFFICE
-------------------------------------------------- Appendix APPENDIX:4
Gretchen E. Bornhop, Senior Evaluator
EUROPEAN OFFICE
-------------------------------------------------- Appendix APPENDIX:5
Mary R. Offerdahl, Evaluator
*** End of document. ***