The USA and the European Union appear to be making little progress in their efforts to avert a trade war over subsidies, with attempts to link Airbus A350 launch aid to the Boeing 787 threatening to derail negotiations. Can the talks be rescued?

Two-thirds of the way through their self-imposed 90-day window for negotiating an agreement to end subsidies for large civil aircraft, the European Union and USA appear to be making little progress towards averting a trade war. Negotiators on both sides are saying nothing on the record, and public comments by concerned parties on both sides are treading well-worn paths, with neither showing signs of movement.

Negotiations may even be going b­ack­wards, or at least sideways, the US camp fears, saying Europe has proposed a "bifurcated" agreement that would deal initially with the reduction or equalisation of government support for the Airbus A350 and Boeing 787 while delaying a comprehensive agreement to eliminate subsidies. European Commission officials will not comment on whether such a proposal has been presented, but trade commissioner Peter Mandelson said earlier this month he was "prepared to see modifications of upcoming production programmes of both companies. We can put everything else on the table at a later date."

Boeing sources close to the negotiations say such a proposal is unacceptable to the US side, which views it as a "major departure" from the terms for talks agreed by the EU and USA, which call for "a comprehensive agreement to end subsidies to large civil aircraft producers". While the US side is prepared to let previous European government subsidies to stay in place, including for the A380, it is unwilling to "grandfather" launch aid for the A350 by accepting Europe's justification that it is Airbus's response to the 787, the sources say.

Efforts to link A350 launch aid to the 787, rather than accepting the US view that the 787 should be compared to the A380 in subsidy talks, threaten to derail the negotiations, the Boeing sources say. The Europeans defined a 90-day negotiating period so as not to delay development of the A350, which would qualify for launch aid under existing rules, and argue the disputed aid for the 787 has already been pledged. "Clearly we cannot have the A350 constrained if the 787 needs equal constraints," says a senior aide to Mandelson.

Boeing argues that the 787 and A380, while distinctly different aircraft, should be equated in the subsidy debate because they reflect the companies' differing views of the same long-haul market – the US manufacturer promoting a point-to-point model while Airbus adheres to the hub-to-hub concept. In addition, Boeing says, both the A380 and the 787 were launched before the World Trade Organisation (WTO) cases were filed, while the A350 has yet to be launched industrially. Europe clearly sees things differently.

The long-brewing prospect of a trade war over aircraft subsidies took a step toward reality in October last year, when the USA filed a WTO case against the EU, and Europe retaliated by filing a case against the USA. The 90-day negotiating period was agreed on the eve of the deadline for requesting that a WTO panel be established to rule on the dispute. Failure to agree a deal, or extend the negotiations, risks restarting the WTO dispute resolution process.

At the same time that it filed the WTO case, the USA terminated the 1992 bilateral agreement that limited government support for large civil aircraft. This agreement limited launch aid to one-third of the aircraft's development costs, which became either the standard or the ceiling for subsidies depending on the viewpoint. The transparency and enforcement failings of the 1992 agreement are now seen as major contributors to the current dispute.

Search for subsidy

The US Trade Representative (USTR) took action after Boeing completed two years of research into the government support received by Airbus. Based on a search of publicly available documents in Europe, the information provided by Boeing to the USTR identified a total of $15 billion in launch aid from the French, German, Spanish and UK governments, plus another $1.7 billion in infrastructure subsidies. The documents also detailed billions in capital injections, debt forgiveness and other direct government subsidies Boeing claims Airbus has received.

In filing its WTO case against the EU, the USTR alleged that, in addition to the $3.2 billion in launch aid provided for the A380, other loans and infrastructure support have pushed the total amount of subsidies for the ultra-large airliner to roughly $6.5 billion. This includes local government support of more than $1.5 billion, the USTR claims, among it $800 million spent by the city of Hamburg on expansion of the Airbus production facility.

The EU has retaliated with a two-pronged attack: accusing Boeing of receiving $23 billion in US government subsidies since 1992 through research and development contracts with NASA, the US Department of Defense and other agencies; and alleging the 787 programme will receive $3.2 billion in subsidies in the form of tax reductions and infrastructure support from Washington state. "We believe that in the past BCA [Boeing Commercial Airplanes] has had an unfair advantage, because the DoD, NASA and other agencies funded important basic research," says the Mandelson aide.

European negotiators have yet to present evidence backing the $23 billion subsidy claim, say the Boeing sources, who believe the figure was arrived at by attributing $1 of benefit to BCA for every $1 in NASA and DoD aeronautics R&D funding provided to Boeing since 1992. The EC, meanwhile, cites composite materials developed for the Space Shuttle and military programmes as one example of technology finding its way into civil products. "We will give them a long list of dirty laundry that they are not happy hanging out in public; but their list of subsidies is very short," says the Mandelson aide.

Under the negotiating terms, both sides agreed to use the WTO's definition of subsidies, but with fewer than 30 days remaining the Boeing sources say there is no agreement yet on which subsidies will be prohibited, which actionable and which permitted – which the Mandelson aide likens to a "red, amber, green approach". If the negotiations fail, or are not extended, then it could be left to the WTO to decide which of the many forms of support received by both sides are allowed and which are illegal.

Unsurprisingly, both the EU and USA are confident their own support mechanisms and their case against the other will withstand WTO scrutiny. The EU argues that launch aid is a repayable advance that is allowed under WTO rules. To make its case against launch aid, the USA must prove three things:

* First, that the European governments have provided support that is not available on the commercial market, and without adequate remuneration. The US argues that interest on launch aid is below market rates; that the aid is a success-dependent loan that would not be available commercially without a steep risk premium; and that repayment is "backloaded" to reduce royalties early in the programme. Any one of these three is enough to make launch aid a subsidy in WTO terms, the USA believes.

* Second, the USA must show the subsidy has caused harm to competition, through loss of market share, price suppression or other effect. The US side points to the increase in Airbus's share of the market to more than 50% at the expense of Boeing's share. The EU is likely to blame Boeing's decline on its consistently lower spending than Airbus on commercial-aircraft R&D. "It is not all subsidies," admits a Boeing source, "but enough of it is caused by subsidies".

* Third, a causal connection must be made between the subsidy and the harm to competition. The USA believes the link will be easy to prove because Airbus and Boeing are a duopoly. "There is no question the US case will meet the three prongs [of a WTO case against Airbus subsidies]," says the Boeing source.

Europe, in turn, must prove benefit to Boeing and harm to Airbus from US subsidies. The central plank of the EC's case will be its yet-to-be-detailed evidence of support for Boeing's commercial-aircraft business from DoD as well as NASA R&D contracts. Europe's list of alleged US subsidies will include a lot of "grey areas", the Mandelson aide acknowledges. "However, with an annual [US] defence budget of around $400 billion, there clearly has to be some seepage into civilian projects."

The EC believes the problems with the 1992 agreement began following Boeing's merger with McDonnell Douglas in 1997, which created a large integrated civil and military aerospace company, and points to Boeing's defence sales of more than $30 billion last year, mostly to the US government. The US side points to the defence revenues of Airbus's two shareholders. BAE Systems, with 20% of Airbus, had defence revenues of £10.6 billion ($20.4 billion) last year, while 80% stakeholder EADS had non-Airbus revenues of €11.5 billion ($15.5 billion), mostly from defence sales. In addition, Boeing argues, BAE's planned $4.2 billion acquisition of US armoured vehicle manufacturer United Defense Industries will make the DoD its biggest customer.

While it does not accept the European argument that there is benefit to the commercial business from defence sales, the USA believes any indirect support to be essentially the same on both sides. This may be difficult to prove or disprove, because Europe and the USA account for defence R&D in different ways. In the USA, the Pentagon awards development and production contracts separately, and there is a mechanism for companies' independent R&D to be reimbursed by the DoD Europe tends to bundle development and production into long-term contracts.

Research scrutiny

A WTO case could also bring EU and US funding for civil aeronautics research under scrutiny. In the USA, NASA's aeronautics research has been in decline for several years, and is set for fall another 20% under the fiscal year 2006 budget plan released last month (see table). Over the same period, EU funding for aeronautics R&D has increased dramatically (see table). Additionally, the US argues, European funding is guided by a strategic research agenda drawn up by industry and academia and is targeted at near- and medium-term technologies that will directly benefit Airbus.

More vulnerable to attack in the WTO could be the state and foreign support Boeing gathered to launch the 787. High on the EU's list as the "most flagrant violation" is the incentives package provided by Washington state to secure final assembly of the new widebody at Boeing's Everett site. The largest part of the package is a reduction in the business and occupation tax rate for companies in the state engaged in manufacturing or selling commercial aircraft or their component parts. A value of $3.2 billion over 20 years has been has been put on the tax reduction.

While the tax break was introduced to secure 787 final assembly, and will be triggered by the start of production in 2007, it is not limited to Boeing or the 787. Although Boeing will be the biggest beneficiary as the reduced tax rate will apply to all of its civil aircraft revenues, the company sources say, any commercial aerospace firm in the state – whether a Boeing or an Airbus supplier – will benefit. In addition, the sources say, the tax break may be offered to EADS North America to persuade the company to locate an A330 aerial-refuelling tanker assembly plant in Washington state.

While some trade experts believe the Washington tax break to be actionable under WTO rules because it is a production subsidy, Boeing argues it is a reduction in the future cost of doing business in the state and not a direct cash injection like launch aid or an infrastructure investment like Hamburg's spending on the Airbus plant. Of other state incentives offered, a $500 million bond issue authorised by Kansas for the 787 has not been taken up by Boeing, the company sources say. With the sale of Boeing's Wichita commercial-aircraft plant to Onex, it is possible the new Canadian owner could take advantage of the bond issue.

The EU has also targeted Japanese industry's investment in the 787 as a risk-sharing partner as it will be supported by loans from the Japanese government. The Boeing sources say the USA has deliberately avoided bringing supplier subsidies into the battle as both companies benefit, and the negotiating terms call for a bilateral deal covering Airbus and Boeing, with both parties to work together subsequently to broaden the agreement to other countries. An invitation from Mandelson to join the EU-US negotiations was rebuffed by Japanese trade officials.

As the clock ticks down to the 11 April deadline for negotiation of an agreement to end subsidies, and the threat of a trade war again looms, both sides say they want a deal. "We need a new agreement," says Allan McArtor, chairman of Airbus North America. "It is impractical to think that either government is going to stop supporting its aerospace industry. We need to get together and figure out acceptable limits." The stakes are high. "If it gets into a WTO-litigated deal it will be bad for all the suppliers and will have a backlash to much more important trade and geopolitical issues."



Source: Flight International