Tanker Wars: Why Boeing Thinks Subsidies Matter
(Source: The Lexington Institute; issued Nov. 9, 2009)

(© The Lexington Institute; reproduced by permission)
(See rebuttal at bottom—Ed.)

By Loren M. Thompson, Ph.D.

The Air Force's plan to conduct an expeditious re-competition of its future tanker program has run into trouble. An initial award was overturned when the Government Accountability Office found major irregularities in the way proposals by Boeing and Northrop Grumman were evaluated. So now the two teams are back for a rematch under a radically revised acquisition strategy.

But the Northrop Grumman team is complaining that the new approach is stacked in Boeing's favor because it levels all non-cost factors, resulting in a "price shootout" that Boeing's smaller, cheaper plane is likely to win. Sen. John McCain has sent a private letter to Obama Administration officials weighing in on Northrop's side.

Boeing, on the other hand, is complaining that the defense department must take into account a recent ruling by the World Trade Organization finding that the Airbus plane Northrop proposes to use for its tanker received billions of dollars in illegal subsidies. Under existing free-trade rules, government-funded launch aid is prohibited if it does harm to competitors and if it is contingent on export performance.

Both restrictions seem to apply to the $5.7 billion that European governments gave Airbus to develop the A330 widebody airliner, the plane at the heart of Northrop's tanker proposal. Dozens of congressmen have weighed in on Boeing's side in a November 2 letter to President Obama.

It isn't easy for outsiders to sort out what is going on here, because each team is so good at pitching its side of the story. In addition, key documents like the WTO ruling and the McCain letter have not been released to the public.

Northrop Grumman argues with some justification that it wouldn't be fair for the government to burden its tanker proposal with the WTO findings when those findings are still subject to appeal, and a companion case lodged against Boeing hasn't yet been adjudicated. Boeing responds that the WTO seldom reverses preliminary findings, that the Airbus subsidies are a matter of public record, and that the U.S. Trade Representative has challenged the legality of the subsidies for many years.

It is important to recognize that the argument over illegal subsidies is really between Boeing and Airbus (or between the United States government and the European Union), and that Northrop Grumman is a bystander that has been dragged in because Airbus made the plane it wants to use for its tanker. But once the controversy is seen for what it is -- a trade dispute -- it becomes obvious that Boeing is right and Airbus is wrong.

European governments have violated free-trade rules by subsidizing Airbus for decades, providing benefits that an impartial panel of trade experts has determined to be illegal, and as a result of those benefits U.S. companies have lost hundreds of billions of dollars in sales. America's share of the global market for airliners has been cut in half as a direct result of these unfair practices.

Boeing and the U.S. Trade Representative argue convincingly that the availability of illegal launch subsidies has given Airbus huge pricing advantages in competing against Boeing in commercial markets -- advantages that are worth many times the original face value of the subsidies. The Airbus rejoinder that Boeing gets unfair advantages from military work or state and local aid is not convincing, since Airbus gets those benefits too. In fact, the year the WTO case was brought, Boeing and Airbus had roughly equal military sales. And Boeing makes another persuasive point too: how can the Pentagon simply ignore the position of the U.S. Trade Representative, when trade deficits are destroying the value of the dollar and the military is planning to conduct many more competitions for weapons systems based on commercial products available from overseas sources? (ends)

Trade Expert Disputes Interpretation of Tanker Subsidies Issue
(Source: The Lexington Institute; issued Nov. 9, 2009)
(© The Lexington Institute; reproduced by permission)
Noted trade expert and aerospace analyst Joel Johnson thinks I've missed the boat -- or the widebody -- in my recent blog posting on how Airbus subsidies should play in the Air Force tanker competition. He sent us the following point-by-point response to my posting. Johnson has held a number of senior positions in the federal government and the private sector, and currently advises several companies including Northrop Grumman. (signed) Loren B. Thompson, Ph.D.

By Joel Johnson

The Lexington Institute’s December fourth “information” piece entitled “Tanker Wars: Boeing Says Law on its Side in Subsidies Dispute” does not simply report on Boeing’s arguments, but seems to take ownership of those assertions as well. But most of those assertions do not stand up to even moderately rigorous analysis. Let’s look at them one by one.

First, the paper notes an asymmetry as to Northrop Grumman and Boeing reactions to the draft tanker RFP. Northrop Grumman complains about the acquisition strategy, Boeing focuses on alleged subsidies to Airbus. This is not surprising.

Given all five air forces that have evaluated the 767-based tanker versus the A330-based tanker have gone with the latter, Northrop Grumman is concerned that the Air Force criteria seems to ignore quality, and simply demand that it can replace a fifty year old tanker with a comparable tanker for the next fifty years. Boeing, having a less attractive product, focuses on a different issue. An old political adage is if you can’t win an argument on the merits, change the subject.

Second, the paper seems to assert that because of subsidies to Airbus, it can price the A330 lower than it could otherwise. The WTO case will explicitly address the issues of whether launch aid allowed Airbus to launch a product earlier than might otherwise have been possible with strictly commercial financing, and whether launch aid seemed to affect pricing. As the WTO report is still officially confidential, we don’t know how it ruled on the A330. But it is also true that economies of scale (a much higher production rate for the A330 with a backlog of over 400 aircraft vs. the 767) and more modern methods of manufacture of a plane that is 15 years newer than the 767 will also affect price.

Third, the paper notes that a final WTO ruling, if it finds “illegal” subsidies, would give the US “a right to take remedial action.” Boeing trade lawyers, of whom it hires large numbers inside and outside the company, know full well that is patently untrue. In the first place, there is no such thing as an “illegal” subsidy, only “prohibited”, “actionable”, and allowable subsidies. Again, we don’t know what the WTO ruled on specific allegations in the EU case, but it is likely that most subsidies in the US case against the EU and the EU case against the US will be found to be “actionable”, not “prohibited”.

However, that is irrelevant to the issue of taking preemptive action before the entire WTO process has been completed, including appeals, a period for possible negotiations of a settlement or a change a in policy, and eventually a ruling on allowable sanctions. In the recent WTO Dispute Settlement Case of Korea versus the EC (DS301), concluded on June 20, 2005, the WTO found that the EC was in violation of the subsidy code for taking such preemptive action. Anyone interested can check the USTR home page on disputes, or the World Trade Organization home page.

A good explanation of the WTO dispute settlement process can be found in a Congressional Research Service article by Jeanne Grimmett, Legislative Attorney, dated September 8, 2009. She specifically points out that the US, in its Uruguay Round Statement of Administrative Action (H.Doc 103-316), noted that the USTR would use its statutory discretion to implement Section 301 (retaliating against unfair trade practices) of the Trade Act of 1974, in a way that was in conformity with WTO obligations. This would appear to reinforce the notion that the US should not short-circuit the WTO dispute settlement process.

Finally, the Lexington Institute report says the Federal Acquisition Regulations (FAR) require contracting officers to consider “any potentially unfair competitive advantage” that an offeror may have by making adjustments to its acquisition strategy.

Note, first, that the section is permissive (“should consider”), not mandatory. Second, this admonition is not limited to foreign offerors. If contracting officers are to consider alleged (or on issue of a final report, affirmed) subsidies to Airbus, they would presumably have to do so for Boeing as well. The WTO has concluded that Boeing received “prohibited” subsidies on every aircraft it exported for thirty-two years. Given our reciprocal procurement MOUs with France, Germany, Spain, and the UK, DoD would be required to treat Boeing the same way as Northrop-Grumman and its international partners.

The “bottom line” is not that the WTO has given the U.S. government “a green light” to take subsidies into account in the tanker competition, but rather than it must await the entire WTO process to play itself out, and then treat offerors equally in terms of weighing any affirmed subsidies.

Perhaps the Lexington Institute would be better advised to find that the “bottom line” is that the US Air Force should be allowed to purchase the tanker that provides the military the best value for price, and that civil trade disputes should be settled in the process provided by the WTO and approved by the US Congress.


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