June 2023 Letter

Dear Fellow Semi-Willing IFE Viewers,

Per last month’s letter, the world has changed greatly over the past few years: de-globalization, proliferating industrial policies, re-regulation. Last month I looked at the impact of these changes on the military side of the industry; this month I’ll cover the civil side, divided into three buckets: Supply, Demand, and China.

The first Supply Side change is misinvestment, and lots of it. Governments aren’t great at allocating capital. The private sector isn’t stellar at it either, but with all the US and EU green industrial policy schemes out there, to say nothing of funding for semiconductors and whatever else, governments have tons of capital to misinvest. Some level of government funding for high-risk concepts makes sense, but when “some” becomes a flood, well, remember the 1960s SST funding race? Concorde won, but the UK and French taxpayers lost, big time. And now, Airbus’s much-hyped and well-funded hydrogen project is being followed by NASA/Boeing’s Truss-Braced Wing. “Hey! It’s a high-aspect ratio wing! We had no idea it existed! Let’s spend $500 million on it!”

Some clever companies will find ways to turn this wave of government cash into a source of profit (as with Ethanol, for example). That might not be all bad – SAFs are a promising green technology and a business opportunity, too. But on the other hand, all this government money means that troubled (and even doomed) aircraft programs will last longer, lingering like wounded squirrels under the porch, despite market logic. Many Advanced Air Mobility companies are pursuing military and government work. This might work out as a pump primer for some, but mostly it will merely keep bad ideas alive. Even Boom Supersonic somehow has an Air Force contract. Who says Air Force officers don’t have a sense of humor?

Misinvestment goes beyond aircraft. I asked Martha Neubauer, our alternative fuels lead, for an example. Quoth Martha, “Europe’s Clean Aviation program funds over €700M for green aviation, mostly for hydrogen fuel cell and hydrogen combustion. ZeroAvia and Universal Hydrogen have each raised over €100M, bringing global hydrogen aircraft investments to over €1B. Hydrogen may be the future, but will only have a marginal impact on aviation emissions through 2050. Wouldn’t we get better and faster results if cash was redirected to nearer-time, lower-risk technologies such as SAF?”

The Second Supply Side change is that government misinvestment will likely be accompanied by protectionism and other forms of economic intervention. As governments seek to create new technologies, they’ll be tempted to protect them, with further subsidies, and with trade barriers designed to hinder imported competing technologies.

And remember commercial offsets? Demands for local production work, or other economic sweeteners, tied to purchases, are still a feature of the arms trade, but they largely disappeared years ago in the jetliner marketplace. This is because they were forbidden by the GATT/WTO Agreement on Trade in Civil Aircraft, or ATCA (I once wrote a chapter about ATCA in an academic work, here). But in the new global economic order, governments will likely find the idea of commercial offsets irresistible again.

The result will be proliferating production sources. Free trade may be under pressure, but more countries want to build parts for aircraft, which will always be a global industry. Governments are happy to provide the necessary subsidies to help make this happen. India will be the big test case: for decades it was a relatively free market, at least as far as jetliners are concerned. But a combination of factors – Modi’s economic nationalism, fast market growth, China’s eclipse as a market and as a production source (see below) – are all lining up to create offset demands. We might see a worst-case scenario, where the government demands a FACO line from Airbus or Boeing in exchange for sales. By the way, India, like China, has ATCA observer status, and isn’t a full signatory.

The Third Supply Side Change will be politicized jetliner sales. Governments once routinely got involved in sales campaigns. Thirty years ago, for example, both the US and France heavily lobbied Saudi Arabia to buy Boeing/McDonnell and Airbus. The US won. The ATCA treaty forbade this nonsense, and there have since been few, if any, politicized jetliner sales battles (China has been an exception; they have observer status in ATCA, rather than full signatory status). But now, US officials are taking credit for the recent Saudi Boeing sales agreements. Will France and the Euros respond in kind? Oh mais oui, perhaps in India, and certainly in China.And how long before the US and Europe resume mandating that their national airlines buy locally-built jets? The bad old days may be back.

The Demand Side is more straightforward, and less mixed. It’s mostly bad. I asked Jonas Murby, our chief forecaster, to summarize how macro factors are impacting demand: “We’ve taken for granted air travel’s key exponential growth drivers for decades: open skies, a global climate of trust, international trade expansion, declining operating and capital costs, and plentiful cheap energy. But as the global order changes and fragments, these critical elements are reversing. So, it is tough to see a future where air travel repeats or even approaches the growth rates enjoyed in the past.”

That nails it. The only thing I’d add is that a lot of the fantastic growth we’ve enjoyed came from countries escaping the Middle-Income Trap. Many Pacific Rim and other countries did this with export-driven economies. But as trade slows and protectionism and subsidies support production in wealthy, mature economies, this export-driven growth strategy will get harder. Consequently, air travel demand growth will further slow. 3.5% growth rates are the new 5% growth rates.

Speaking of countries likely to be stuck in the Middle-Income Trap, there’s China, again, big enough to deserve its own category. President Xi Political Thought, actually more of a national frontal lobotomy, promotes a Maoist emphasis on state-owned enterprise and the marginalization of the trade-driven private sector that propelled China to middle-income status. The result will be slower economic and air travel demand growth in China, as we saw before the Covid pandemic began. And when China does buy jets, per above, it will be more politicized than ever.

On the production side, China will also see big changes. Whatever minimal growth we saw in China as a parts producer will disappear as OEMs de-risk supply chains (with MRO work likely to persist). But China’s aircraft programs will likely get a boost, as will schemes to replace the Western systems and technologies on these planes with Chinese ones.In short, lots of cash for very wasteful ideas.

That might be an accurate, if unfortunate, phrase to end this letter with. But I’ll end on a hopeful note. I’m writing this from Indonesia, which, 30 years ago, had a political economy embodying every bad idea: political/religious oppression, protectionism, myriad wasteful government economic schemes, and a state-owned aircraft company from hell. Yet they made it through, and the country today may have issues, but it’s a vibrant democracy with more open borders and much less corruption. There’s hope.

Yours, Until Adam Smith’s Ghost Saves Us,

Richard Aboulafia