File picture of the A320/A330 wing assembly building at the Airbus Group NV assembly plant in Broughton, UK. Aircraft makers are setting off a fresh storm in the already raging tariff spats. Image Credit: Bloomberg

The recent decision by a WTO dispute panel clearing the way for the US to impose tariffs on the EU as a penalty for its provision of illegal subsidies to Airbus ends a very short-lived trans-Atlantic economic courtship. Indeed, the WTO’s action was the largest such ruling in the organization’s history - it has ignited US-EU trade tensions to unprecedented levels.

Anyone who thought that the proposal for a grand US-EU free trade agreement, announced with much fanfare by President Donald Trump and European Commission President Jean-Claude Juncker in July 2018, would result in marriage anytime soon simply was not aware of the long and painful history of trade relations between America and Europe. The two-way bickering has long ensnared a number of sectors, from agricultural commodities and food products to liquor; from luxury items to clothing; and an array of industrial goods — most visibly, aircraft manufacturing.

One thing is clear: the tenor for conducting US-EU commerce is not going to get better anytime soon.

A $7.5b “pay-back”

The announcement by the White House in early October for the imposition of the WTO-sanctioned US tariffs of $7.5 billion constitute a damages award emanating from a series of disputes over the EU’s subsidies to Airbus that date back to 2004. The decision follows an earlier WTO ruling that Airbus was in fact enjoying subsidies that were illegal under the multilateral trading system.

Making matters even messier towards producing an environment where cooler trade policy heads can prevail in both Brussels and Washington is that the WTO will soon render a judgment in a parallel case on how much the EU can retaliate against the US for the illegal subsidies it was deemed by the WTO to be providing to Boeing.

In the meantime, the US has begun to impose its approved tariffs. It has targeted a variety of EU products, such as motorcycles, handbags, wine, whiskey, cheese and olives.

Boeing vs. Airbus subtext

The irony of this aircraft trade war is that not only are US airlines major consumers of Airbus planes, but EU carriers also purchase a significant amount of Boeing equipment. One might argue then, that at least within the trans-Atlantic airline sector, although irrational in structure, there is some degree of a joint sharing of the pains and benefits between the two jurisdictions.

Of course, in the years when Airbus garners greater sales in the US market than Boeing does in the EU, or the converse, the imbalanced sharing engenders frictions. However, there are other significant markets in which the two manufacturers compete — namely sales to the numerous domestic airlines outside of the US and EU.

When the gains and losses in those geographies do not balance out between Airbus and Boeing, the flames that are fanned are largely out of the control of both Brussels and Washington.

The peculiarity of the competitive market structure for the manufacturing of aircraft is no small element driving the type of conduct carried out by both the two firms as well as their respective governments. The immense set-up costs required and the drive to capitalize on the large economies of scale and scope inherent in a production and assembly process in such a complex sector generally yields a situation where the commercial survival of only a few firms is possible.

This is why the global aircraft industry has long been, in effect, a duopoly, with only a limited number of competitors beyond the two companies. Is this a more competitive outcome with fewer market distortions arising than if there were only one aircraft producer - that is, if the market structure was a monopoly?

Most economists would probably agree with that proposition. The dilemma, however, is that the market would likely be unable to support the existence of three producers. Indeed, even in the case of the current duopoly, some subsidies from the public sector appear necessary to ensure commercial viability.

Thus, the question: how much should be allowed to be subsidized?

Some degree of support

Measuring the sources and levels of subsidies embodied in the production process of complex industrial sectors like aircraft is not a trivial exercise. Both Airbus and Boing airplanes are comprised of parts manufactured across a wide range of countries. Moreover, their assembly is not fully completed under one roof.

By the same token, determining what portion of such subsidies falls outside those permitted under WTO disciplines — that is, what constitutes “illegal subsidies”— is equally challenging.

To take an obvious example, medical services in the EU are largely provided by the public sector; that is the system under which most Airbus employees receive healthcare. In contrast, the vast majority of Boeing workers reside in the US, where the private sector is the main healthcare supplier.

In lieu of hurling tariffs at one another, most trade negotiators like myself believe it is now high time for the US and the EU to hammer out a new Agreement on “Large Civil Aircraft” — one that would specify robust rules to govern the extent and transparency of subsidies that the two manufacturers would be able to access. While Brussels and Washington have been in discussions about such a framework since 2004, in fact, little progress has been made.

Given the increasingly apparent fragility of the global economy, punctuated by the strain it is already under as a result of China-US trade hostilities, perhaps this time a Trans-Atlantic breakthrough might arise.

Harry G. Broadman is a Partner and Chair of the Emerging Markets Practice at Berkeley Research Group LLC and a faculty member of Johns Hopkins University. He is former U.S. Assistant Trade Representative.