Wharton’s Mauro Guillen and Mary E. Lovely from Syracuse University discuss the aircraft subsidy dispute between the U.S. and the EU.

Consumers in the U.S. will end up paying in an escalating battle between the U.S. and the European Union over subsidies enjoyed by their respective aircraft makers, Boeing and Airbus, according to experts at Wharton and Syracuse University. Beginning on October 18, the U.S. is set to impose tariffs of 10% on imports from the European Union of large civil aircraft by U.S. airlines, and 25% tariffs on agricultural and other products including Irish and Scotch whiskies, cheeses and olives.

The proposed U.S. tariffs follow a World Trade Organization ruling earlier this month that the EU violated its rules by providing subsidies to Airbus, hurting Boeing. The ruling allows the U.S. to levy $7.5 billion in tariffs on European goods annually. On Monday, the U.S. secured final WTO approval to proceed with its proposed tariffs.

Mary E. Lovely, economics professor at Syracuse University and a senior fellow at the Peterson Institute for International Economics, hoped the current dispute would make way for a fairer international trade environment. “I hope it’s the beginning of a broader discussion about the role of industrial subsidies and the willingness of the global system to limit them in the name of creating of a level playing field for trade,” she said.

Both Airbus and Boeing receive indirect subsidies, and it is time both sides accepted that fact, said Wharton management professor Mauro Guillen. “At the end of the day, we all benefit from having two companies that make excellent planes, because aircraft have become more fuel efficient, quieter and have just gotten better over the last 30 or 40 years,” he said. “It would be bad for the airlines and also for consumers if we only had one major producer in the world. I’m happy with that duopoly. This is just another skirmish. It will lead to a few frictions here and there between Europe and the U.S., but hopefully we can move on.”

Lovely and Guillen discussed the broader implications of the aircraft subsidy clash between the EU and the U.S. on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

“I hope it’s the beginning of a broader discussion about the role of industrial subsidies and the willingness of the global system to limit them in the name of creating of a level playing field for trade.” –Mary E. Lovely

An Interwoven Global Supply Chain

Aircraft components are sourced from all over the world, and no one country has the wherewithal to manufacture planes without depending on global supply chains, both Lovely and Guillen emphasized. In fact, the U.S. Trade Representative has chosen to levy tariffs on imports of Airbus airplanes, but not on imports of parts, Lovely pointed out, adding that some of those parts go to the Airbus assembly plant in Alabama. With an interwoven global economy, “this desire by governments [to have production done] in their own country is extremely short-sighted,” she said. “[That view] doesn’t see the benefits for consumers that Mauro was talking about; it doesn’t see the necessity of having vigorous competition in the industry, and it doesn’t see the value of global supply chains.”

Guillen referred to a chart showing how the Boeing 787 Dreamliner is put together not entirely from components made in the U.S. “The horizontal stabilizer in the back of the plane is made in Italy … the engines in the U.K., parts of the fuselage in Japan, the entry doors in France, the landing gear also in the U.K.; the container for the engines in Canada, and parts of the wing in Korea and Japan,” he said. “So, it’s not really a 100% U.S. plane. If you go to an Airbus, it’s the same story.”

Airbus has tried to make its case against the imminent tariffs around the imperative of a global supply chain. “[The] potential consequences of such tariffs would be a barrier against free trade and would have a negative impact on not only U.S. airlines, but also U.S. jobs, suppliers and air travelers,” Airbus CEO Guillaume Faury stated. Close to 40% of Airbus’s aircraft-related procurement comes from U.S. aerospace suppliers, he noted. “This U.S. supply chain supports 275,000 American jobs in 40 states through spending that has totaled $50 billion in the last three years alone.”

Focus on Consumer Interests 

Against that backdrop, Guillen said “it is important to try to avoid populist arguments about trade, and try to see if we can be a little bit more rational and especially think about the consumer, and what is best for the consumer.”

Lovely noted that consumers will eventually pay in the fallout of the subsidy dispute between Airbus and Boeing. Delta Air Lines will take a direct hit from the 10% tariff on aircraft imports. Delta described the 10% tariff as “an unfair tax on U.S. consumers and companies” in a statement to FlightGlobal, an online publication on aviation and aerospace. The airline has 246 Airbus aircraft on order, which are produced and assembled in Europe and would be subject to the additional tariff.

“What that means is Delta is going to pay the entire tariff, and that that is going to be passed on to passengers,” said Lovely. Delta hopes for a resolution, though.  “We hope that the [Trump] administration and the EU are able to resolve this 15-year trade dispute in a manner that respects existing contractual rights,” the company stated.

Getting Pragmatic about Subsidies

Lovely said it’s hard to know the precise amount of subsidies that governments on either side bestow, “because many subsidies are hidden.” In the U.S., subsidies are implicit in Department of Defense contracts to Boeing that allow Boeing to innovate and create new technology that they can then deploy in their commercial aircraft, Lovely noted. In fact, the U.S. Trade Representative (USTR) acknowledged state-level subsidies to Boeing. “The WTO found that only a single Washington State tax measure that provided Boeing with additional pricing flexibility was inconsistent with WTO rules,” the USTR said in its statement on the latest WTO ruling.

Some types of subsidies are readily acceptable. The EU’s use of special funds to try to develop less developed parts of the union, or regional subsidies “are OK, [since they] don’t target particular industries,” Lovely said.

“At the end of the day, we all benefit from having two companies that make excellent planes….” –Mauro Guillen

However, a broader discussion is necessary because there isn’t enough specificity within WTO rules on what subsidies are acceptable, Lovely said. WTO member countries had years ago agreed to limit direct export subsidies. “[But] it doesn’t cover [actions] that may give firms a big boost like reduced taxes, access to land, governments preparing sites for factories, or even talent subsidies,” she said.

Governments have good reasons to boost development in certain regions to help them overcome handicaps they may face, and therefore, it would be hard to reach an accord over those subsidies, she added.

“We all need to be realistic here,” said Guillen. He pointed out that it is expensive to develop new types of aircraft, and that everybody benefits from those efforts.  “Sometimes, subsidies are needed the same way that subsidies are needed for train transportation,” he added. “The airline industry is also subsidized, and municipalities and governments invest in airports.” He thought the EU and the U.S. “should calm down a little bit, and agree on some basic rules [over subsidies].”

Guillen described the issue as “more of a distributional one … either we pay for the development of [aircraft manufacturing technology] through our airline tickets or we pay for it through general taxation in some indirect way.”

The China Factor

The stakes get bigger with China emerging as a potential rival to Boeing with its nascent aircraft manufacturing company. The Commercial Aircraft Corporation of China has built two jets so far, according to a BBC report. Guillen noted that China is subsidizing its aircraft industry, and that would perhaps make the industry a bit too crowded. “I’m not sure that there is room in the global market for three large producers of aircraft,” he said, pointing out that Boeing acquired the ailing McDonnell Douglas in 1996.

Lovely added that as the aircraft manufacturing industry would change with China’s entry, it is important that the EU and the U.S. end their “unnecessary fight, and look to discipline industrial subsidies through multilateral negotiations.”

“Maybe the U.S. is counting on all of those tractors being driven down the Champs-Elysees in Paris and causing some traffic jams.” –Mauro Guillen

A Costly Dispute

The EU has said that in its parallel case alleging illegal subsidies for Boeing, it would have the right to impose countermeasures against the U.S. Even ahead of that expected ruling, the EU is considering revoking a 2006 settlement with the U.S. over tax exemptions used by Boeing and other U.S. companies known as foreign-sales corporations, the Wall Street Journal reported. Such a move could affect some $4 billion worth of U.S. exports, but also risks unraveling decades of similar trade settlements. “The mutual imposition of countermeasures, however, would only inflict damage on businesses and citizens on both sides of the Atlantic, and harm global trade and the broader aviation industry at a sensitive time,” the EU statement added.

According to Lovely, as the U.S. and the EU battle it out with tit-for-tat actions on tariffs, the casualty will be competition. “We each have our own domestic champion, our own local monopolist, who’s been forced to play in a world with two players so that they build better aircraft, hopefully at lower prices,” she added. “But now we’re giving them more space to exercise their monopoly power.” What is immediately visible to the general public is the ability of the U.S. or the EU to retain more jobs, she said. “What they don’t see is the impact on productivity, quality of the aircraft, and ultimately the benefit to the passenger.”

Olives, wines, cheeses and other agricultural products will take the collateral damage of the broader fight over aircraft manufacturing subsidies. “There’s a lot of symbolism there,” said Guillen, adding that agricultural interests could be expected to protest the proposed U.S. tariffs on those imports from the EU. “Maybe the U.S. is counting on all of those tractors being driven down the Champs-Elysees in Paris and causing some traffic jams.”

Guillen advised both sides to focus on trying to find peace instead of trying to persist with the issue of subsidies for aircraft manufacture. “The EU and the U.S. should be agreeing on these matters as opposed to fighting them out, especially over such a long period of time,” he said.