RichardAboulafia.com 

:: October 2002 Newsletter ::

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Dear Level Playing Field Players,

One of the great pleasures of living in downtown Washington is the protests. Rather than just watch them on TV, I occasionally get to see them up close on my way to work. And as this is written, I gather there is yet another anti-WTO protest a-brewing. These protestors are generally noisy, dirty, unruly, clueless people. Yet there’s something I don’t quite like about them.

The WTO, like the equally despised IMF and World Bank, may badly need reform, but they actually do a lot of good in this industry. They keep stupid planes from happening. A classic example of this was the IMF-induced shutdown of IPTN’s N-250 turboprop as a precondition to the Indonesian bailout a few years ago. I still have an old N-250 pamphlet, entitled “An Answer To The Need For Feederliner” [sic]. This, of course, was a purely delusional need, based on high import barriers put up by the Indonesian government. These barriers were part of the same superb economic policies that ensured that Indonesia was the one Asian Tiger economy that basically stayed melted down after the ’97 meltdown.

Let’s look at China, another wonderful country cursed with a really dubious government. The PRC government is definitely in cahoots with those black-clad, unwashed protestors. It would love to entice investment on the strength of a closed market. This is best seen in the recent agreement with Embraer to build ERJs with AVIC II/Harbin. This proposal links the production agreement to a planned order for 30 planes (from an unknown customer). But for the plan to work, the WTO would need to go away. As of September 2001, China is a WTO signatory, and putting up barriers to civil aircraft imports is a very definite no-no for WTO signatories. Making the big assumption that China will live up to its WTO promise, it can’t even give preference to aircraft with local content. Its airlines must remain independent, and be able to choose airplanes on the basis of productivity, value, or a nice lunch at an air show chalet.

Don’t believe me? I don’t blame you. Check it yourself at http://www.wto.org/english/docs_e/legal_e/air-79_e.pdf (the lengthy web address in no way reflects the impossible bureaucratese language in which the document is written). You might also want to check out the China-specific WTO agreement, http://www.wto.org/english/news_e/pres01_e/pr243_e.htm, which promises swift reductions in manufactured import tariffs (currently 22% for aircraft).

Embraer, like countless aviation companies that have signed earlier agreements with the PRC government, will invest whatever it takes to circumvent barriers that should disappear anyway. As countries modernize, links between aircraft builders and users also disappear. US Airways doesn’t care that its A319s are built in Europe. Air France doesn’t care that its 777s are built in the US.

Therefore, at the end of the day, the responsible Chinese officials will sit back and reward Embraer for its diligent investment with…exactly nothing. Certainly that’s the past precedent. The single biggest aviation investor in China over the past two decades was McDonnell Douglas. They have been the only Western manufacturer to actually set up a separate transport production line there, at considerable expense. Guess which of the big three garnered the lowest market share in China? Total China production was 37 MD-80s and -90s, some of which were exported back, winding up at TWA. Chinese airline executives were not coerced into buying them, nor even encouraged to buy them. Some stated that they weren’t even aware they could buy jets made in-country.

The failed McDonnell China Trunkliner effort at least addressed a growing market. But RJs in China? Economic and population growth in China is heavily concentrated in fewer than ten areas. The other areas are stagnant, at best. China’s internal routes call for large A300-sized planes, and the country has fewer than 50 regional jets. Not to worry. China’s government has market analysts, just like me. Like me, these market analysts study historical and current trends. Like me, they have messy, paper-covered desks and over-worked computers. But unlike me, the Chinese government analysts have concluded that the total market for RJs in China over the next 20 years is 571 PLANES. Again unlike me, these market analysts must do their job on mind-altering drugs (which, according to the WTO, can be subject to tariffs). Embraer’s China RJ forecast, by the way, is a more reasonable 250.

So, China doesn’t really need the planes, but they’re willing to pay for the technology transfer, right? Wrong. If China wanted RJ tech transfer, they merely needed to buy Fairchild Dornier’s 728 family, currently on the market for scrap value. They could get the tooling, the prototypes, and the intellectual property for their own family of 50-110 seat jets, all for a song. The reason they weren’t even vaguely interested (despite earlier hopes for an agreement with Fairchild Dornier that looked a lot like the new agreement with Embraer) is simple. Despite the low acquisition costs, continuing the 728 family’s development would have required the Chinese government to spend lots of money. And spending money is for loser non-Chinese companies that think they can get something that the Chinese government can’t (or won’t) give them.

Similarly, Chinese economic trends suggest diminishing interest in aircraft. The country’s economy is growing (albeit at overstated rates) because of its private sector, which wants nothing to do with grand aircraft plans. The state-owned industries that do care about big government-led aircraft projects are basically a parasitic drain on this vibrant private sector, and are gradually losing their importance. Back in 1980, they rolled out their Y-10, a copy of Boeing’s 707 developed after a ten year program. Is there a Chinese aerospace company or ministry with the resources to do that kind of thing today?

Back to those scrawny anti-WTO protestors. Unless they succeed, China’s Government will eventually have to stop this nonsense. But by then Embraer, and any other gullible companies with their eyes wide shut, will have made their investments and walked away empty handed. And if China is lying about its WTO obligations, are they really trustworthy industry partners?

On to aircraft reports. This month’s supplement updates the Citation (a few new small models), C-5 (bright RERP outlook), 717 (well, they’ve got a few years to pull off a miracle), Premier One (problems and a sluggish market), and others. Next month we’ll update the EH 101, NH 90, Su-27/30, F-2, and some small turboprops. Enjoy the autumn.

Yours, ‘Til The Field Gets Leveled,

Richard Aboulafia

 

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