I will pick up from Monty [Graham] on the rationale for subsidies. I will then broaden the discussion to consider the wider context of US-EU relations. Finally, I will consider some of the elements of a settlement.

I. Why subsidize?

If you look at the Airbus website you will see a number of photos from the revealing of the A380. It’s a beautiful plane, and the material on the website conveys the sense of excitement and pride at the revealing.

But what’s striking is the presence of four political leaders at the revealing of the 380--President Chirac, Prime Minister Blair, Chancellor Schroeder, and Prime Minister Zapatero from Spain.

I had a hard time thinking of good analogue for the United States. Did anyone think that President Clinton would have shown up at the launch of Windows 95? Or does anyone expect President Bush to attend the unveiling of the 787? Sure, state governors and Members of Congress cut ribbons and issue statements, but it’s hard to see this as worthy of Presidential time.

I mention this because it goes to the heart of the question about the rationale for subsidies to Airbus.

Let me first note that in everything I am about to say, I do not find “fault” with Airbus. One cannot blame Airbus for taking advantage of subsidies if they are offered, or for asking if they are available. There is no fault there any more than one could blame Boeing for playing off U.S. states against one another.

Also, I see no problem with hard-nosed business tactics. Obviously we would want transparency and strictures to avoid illegal acts, like outright bribery, and this would apply to everyone. But trying to get potential customers to hold off on one plane to wait for another is business decision-making. And in an industry with a substantial learning curve, it makes sense to offer discounts to initial customers to get up the curve. These are hard-nosed decisions, to be sure, but that’s life. It reminds me that somewhere up in my attic I’ve got a stack of installation disks for IBM’s OS/2 operating system.

Having said that, it’s hard to see the economic rationale for future subsidies. From the point of view of the EU taxpayer, these subsidies don’t look like great value for the money going forward. For job creation or spurring growth, the EU would do better to use its money to lower taxes or to buy off opponents of reforms like product and labor market regulations.

Let me be clear on what I mean by subsidies, and in particular the launch aid. The launch aid loans are a subsidy to the extent that Airbus could not obtain them on similar terms in an arms-length transaction. So there’s a bit of a two-edged sword to arguments saying that Airbus does not need the subsidies, because the more that Airbus is a financially successful company, then the smaller is the implicit subsidy. There’s still a subsidy, to be sure since commercial lenders would likely not offer the terms involved, but the subsidy is not the full amount of the loans. [One might even think of these loans as an equity investment in a spin-off – a 380-corp one might say. If 380-corp is successful then the equity partners get dividends (a.k.a. loan payments), and if not then they get nothing. So then the amount of the subsidy would be the difference in the cost of capital compared to going to the market. This would depend on the details of the loans. My overall point, though, is that the more successful Airbus is as a company, the lower is its cost of capital and thus the smaller is the implicit subsidy.][1]

These are the sorts of issues being discussed in the WTO subsidies talks. What is a subsidy? And what is a harmful subsidy? John Magnus will discuss this in more detail.

Even if the investment is successful--if like with past loans, the European governments get paid back and ongoing royalties, it’s hard to see these subsidies as a good deal for European taxpayers now that any externality from an infant-industry type of argument is well exhausted. Maybe this is the European version of the DC baseball stadium--it’s too important to be decided by cost-benefit analysis.

From the standpoint of overall U.S. welfare, the subsidies have pluses and minuses. On the one hand they mean more choices, lower prices, and probably more competitive behavior by Boeing. These are gains for the United States. But these gains are offset by several factors. These include the higher unit costs for Boeing from diminished scale economies, and a loss of the “rents” associated with the above-normal profits that would otherwise have accrued to a Boeing with more market power and loss of the any labor rents that might be embodied in above-normal wages paid to Boeing employees. We would need detailed work to figure out whether the U.S. gains or loses on net from subsidies. But suffice it to say that this is an exception to the typical case where trade economists would automatically say that an importing country should welcome subsidies.

For other countries that don’t produce aircraft--for global consumers--the subsidies are a great deal. They get more choices, lower prices, and probably more competitive behavior by Boeing. Going back to my initial question about why the EU provides these subsidies, it’s hard to imagine, though, that they are meant as a back door form of foreign assistance. It’s poorly targeted in the sense that it goes to countries like Singapore, which don’t really need it. I just don’t think this is development assistance disguised as industrial policy. It looks just like industrial policy. And this goes as well for subsidies to Boeing.

II. How to resolve the dispute?

So this brings me back to the four leaders attending the A380 unveiling. It’s hard to avoid the sense that the contemplated future launch subsidies are ultimately a political decision. By this I mean that it is a political dispute in that it is difficult to find an economic rationale for future subsidies. Past subsidies are in the past. But looking ahead, does Europe want to take the political decision to pursue a policy that does not seem to be to the benefit of Europe and therefore gives the unavoidable perception of being a political decision aimed at the United States?

Given the political nature of the decisions involved, the WTO seems poorly suited to resolving this case. I think of WTO as being a forum for resolving technical disputes about whether each side has met its obligations. As an institution, the WTO does not have the popular backing to resolve political disputes. This is different from, say, the International Monetary Fund or World Bank, which do have the institutional resiliency to force countries to undertake unpopular decisions that are in the countries own best interests.

In a system designed to handle technical disputes, cases that are fundamentally about larger issues do not get easily resolved. This is what we have seen with cases like FSC and bananas. It would be unfortunate to add another to this pile.

III. The broader picture of US-EU relations

This brings me to consider the broader picture of political and economic relations between the United States and the European Union.

Thinking about the economic side, there are so many balls up in the air between the U.S. and Europe, including a number of issues that just refuse to go away. These include bananas, FSC, genetically modified organisms, interest reporting regulations, Microsoft, zeroing, rice, and things like U.S. complaints about the decentralized European approach to customs disputes where U.S. firms still have to go to each of the individual countries.

On the national security side, the issues are well-known: Iraq, Iran, the way forward in the Middle East, the China arms embargo, etc. – and many of these are tangled up in the commercial disputes.

With so much potential conflict in the relationship, each side should be looking as much as possible to avoid additional irritants. With so many difficult issues on the table, who knows how many more difficult issues are needed to have more serious consequences such as slippage back to the sullen ill-will we had before the President’s recent trip.

IV. What might a solution involve?

This case was somewhat unusual in that the idea of going forward received wide support, including from economists who might normally object to trade actions such as anti-dumping and anti-subsidy measures that might normally be characterized as “anti-bargain laws.” After all, one might say that if Europe wants to subsidize U.S. imports, well, why not? One can imagine that part of the broad support for this case was the idea that a solution would involve lower subsidies on both sides. It could be that policymakers and industry are not completely on the same page here.

Could U.S. policymakers and companies live in a world with no subsidies? I don’t know.

In the United States, there are important issues of fiscal federalism. Could the federal government prohibit a state or locality from offering a subsidy? These sorts of issues are before the courts now.

Both here and in Europe there would also be difficult issues with circumvention. For example, perhaps military contracts are not used now as subsidies, but one could imagine this becoming more attractive to policymakers in a future where preferred vehicles were prohibited.

This does not mean we should not try to get as close to zero as possible. But we should be aware of the difficulties.

1 The bracketed material on thinking of the launch aid as being like an equity investment was omitted in the oral presentation. The next speaker, John Magnus, discussed this point.

Phillip L. Swagel is a resident scholar at AEI.