Dear Fellow Tentative Theater Returnees,
Relations between the West and China seem to worsen every day. Trade, investment, and technology ties are fraying. But as several columnists have noted (here and here), the last place we’ll see decoupling is with James Bond. Past Bond films saw 007 fight agents from every other Western adversary – Soviet goons, Latin American Narcotraffickers, Mideast extremists, and of course Ernst Stavro Blofeld; but the latest Bond, like all the others, doesn’t mention China as a potential adversary at all. That’s unsurprising; China’s a huge entertainment market, and No Time To Die cost $300 million to make.
So, that’s exciting: our industry has something in common with James Bond. We will both be the last to decouple from China. China is simply too important to aviation’s growth story. But the situation will get complicated as Sino-Western relations continue to deteriorate, straining aviation industry ties. Here are four things to keep in mind as this process unfolds:
1. China is less of an aviation prize than it once was. Good news first: China’s CAAC has just established a clear path to re-certify the 737MAX early in 2022. Over 100 already-built MAXs are for Chinese carriers, and China is a very significant part of the MAX order book – perhaps 20%, but not a transparent number. In 2018, at its peak, China accounted for 23% of all Airbus and Boeing deliveries, and many Western aero executives opined that it was headed to 30% of the market.
Bad news: China’s aviation market slowdown pre-dates the Covid pandemic, and their need for these new jets has declined too. China Air travel demand growth fell from over 12% y-o-y in late 2018 to just 5.3% in late 2019. Jet deliveries to China fell by 50% between 2018 and 2019. This wasn’t just the MAX cutoff; Airbus deliveries to China fell noticeably too. Also, the Chinese fleet is relatively young, so even with expensive fuel there’s less of a case to be made for replacing older, thirstier jets with more efficient MAXs and Neos. And as decoupling continues, China’s twin aisle needs will stagnate, at best – demand will remain 85% single aisles.
This China aviation slowdown fits with the growing narrative of a rising power that is starting to peak, and then decline, as described in numerous analyses (see here for a good one). Burdened by massive debt loads, terrible demographics, and a growing global consensus that they are not the best trading partner, China is also turning away from a market economy, towards a slow-growth Marxist one. Productivity and economic growth, are falling. In October, Bank of America cut its 2022 China GDP growth forecast to just 4%.
For the aviation industry, the real challenge might not be decoupling; the decline of the once-great China growth story is bad enough on its own.
2. Europe, and Airbus, probably can’t or won’t take advantage of this situation. Even though Airbus deliveries to China fell pre-pandemic, there is the possibility that they’ll benefit from this situation; tensions between the EU and China might not be as bad as between the US and China. French Finance Minister Bruno Le Maire recently said, “The United States wants to confront China. The European Union wants to engage China.” Airbus’s Tianjin FACO helps too.
Yet, Europe has been moving towards a tougher line on Taiwan, Uyghur oppression, and other China issues (see here for an assessment). UK and French naval ships have increased their presence in the Pacific. The Biden administration has prioritized keeping Europe aligned with the US’s China policy, which appears to be achieving results. Perhaps most of all, the bulk of supplier content on Chinese aircraft is from US companies, not European ones. That brings us to the next point.
3. Chinese jets aren’t a valid alternative to Western ones, since they aren’t really Chinese. In my June 2020 letter, I wrote, “It has become increasingly clear that China’s jetliner industry isn’t geared towards competing in the world; rather, it’s aimed at a future where China stops importing strategic goods, and relies on its own products.” A big complication has since arisen.
In December, Trump’s Commerce Department issued a new Military End User (MEU) export list, prohibiting technology exports to entities that “represent an unacceptable risk of use in or diversion to a ‘military end use’” in China and other countries. COMAC isn’t on this list, but its parent and partner companies are. Nobody is sure what this means, but the Biden administration hasn’t changed it. This vagueness is probably a feature, not a bug – it represents both a stick and a carrot in trade negotiations. In September, Canada basically forced China to shelve its turboprop, the MA700, by withholding PW150 export approval (presumably for the same reasons that the US created the MEU list). Nobody knows the MA700’s future, but The Air Current has a superb update here. It doesn’t look good. MEU restrictions might also explain the C919’s absence from Zhuhai in September.
The problem is that China’s much-vaunted aircraft are thin veneers of locally-built structures housing the real added value – Western engines, avionics, and systems. China could replace Western content with Russian and/or local content, but that would produce terrible aircraft, and it would take over ten years and tens of billions of dollars. So, China isn’t holding a strong hand here. The weakened China market may need fewer jets, but for years to come they’ll still need Western jets.
4. There are many possible outcomes, and no base case scenario. The headlines look dire, but the numbers tell us mixed stories. US-China Foreign Direct Investment and bilateral technology investment have collapsed, and financial trade is declining, with some high-profile equities market de-listings, but China remains the US’s largest trade partner. Western companies are looking to diversify or re-think their Chinese supply chains, but there’s no rush for the exits. Perhaps the most notable decoupling over the past year has been with technology – LinkedIn exited China in October, following Facebook and Twitter. It’s a fair bet that very few people in the PRC will read this.
Will PRC aggression against Taiwan result in a broader conflagration, or sanctions? Will there be Cold War 2.0, with a Cold War in the skies (I wrote about this possibility here)? Will there be a Great Reset, with a series of grand trade deals? Will the PRC try hostage diplomacy again? Western aviation companies can only plan for a broad range of possibilities and outcomes.
Despite these uncertainties, the bottom line is that Bond might decouple before aviation does. The confrontational tone between China and the West might make a 007 showdown with PRC spooks inevitable, particularly if censorship makes the PRC entertainment market inaccessible anyway. But for aviation, even though growth is slowing, China is still the biggest national market outside the US, and they can’t use their new jets to achieve autarky. The Sino-Western trade cliché is true for aviation: It’s a bad marriage with no possibility of divorce.
Yours ‘til The SPECTREjet RJ Enters Service,
Richard Aboulafia