As a hard or crash Brexit edges closer, it now seems there is no binary option between the EU Customs Union and WTO rules. The Americans are not making things any easier for the UK. Why would they?
The truth behind the Bombardier dispute revealed
In 2007 the Canadian aerospace company Bombardier (TSE:BBD.A) announced plans to develop a new ultra-fuel-efficient regional airliner – the C Series passenger jet. The global duopoly in airframe manufacture, Airbus (EPA:AIR) and Boeing (NYSE:BA) took this news very badly. This aircraft would compete directly with the Airbus A320 Neo and the Boeing 737 Max.
To date, Bombardier has orders for 360 C Series jets which come with a price tag of about US$80 million each – less than the price of the two competitor aircraft. This includes an order for 75 aircraft from Delta Airlines (NYSE:DAL) – one of the top three US airlines.
On 27 September the US Department of Commerce proposed imposing punitive tariffs on sales of the C Series further to a complaint by Boeing that Bombardier had received unfair state subsidies from the Canadian and UK governments – Bombardier has an important manufacturing unit in Northern Ireland. This is a particularly sensitive matter for the minority Conservative government in London which relies on support from the Democratic Unionist Party (DUP) at Westminster.
It should be noted that the aerospace industry globally is bedevilled by claims and counter-claims of state subsidy. Boeing has been pursuing a court case against Airbus for years and Boeing itself stands accused of state subsidy, being one of the largest defence contractors to the US Defence Department. It is alleged that profits from the military aircraft operation have been used to cross-subsidise the civil aircraft operation. That type of allegation, however, is very difficult to prove.
The US Commerce Department, in a preliminary ruling, said that US Tariffs of up to 220 percent should be imposed on the C Series. That would effectively scupper the Delta Airlines order and put the entire future of the new aircraft model in doubt. Down payments made by Delta would have to be repaid, causing cash flow problems for Bombardier – a company that has been running losses for years. According to the Financial Times[i], Bombardier has already spent US$5.4 billion in bringing the C Series to market.
Sources here in Washington (where I write this) tell me that the counter-tariffs will be struck down in the higher tribunals of either the US judicial system or NAFTA itself. I am told they are just for show. Apparently, the Trump administration was appalled by the Trudeau government’s demand that EU-style social chapters be added to the NAFTA framework. (Mr Trudeau is held in contempt by a significant segment of the Republican Party – as any reading of the Washington Post will confirm).
Also, the Americans want the UK to step up its defence contributions and are using the Bombardier tariffs as a bargaining chip.
But according to the influential US platform Aviation Week, America’s true target is not really Canada, but China and its aircraft industry[ii].
US Trade Representative Robert Lighthizer accuses China of subsidising its own aviation industry and forcing technology transfers. By 2036, China is projected to be the number one market in commercial aviation. Its national champion is the state-owned Commercial Aviation Corporation of China Ltd. (Comac), which manufactures the ARJ21 regional jet and the C919 narrow-body aircraft. It is also developing, in collaboration with Russia, the CR929 wide-body airliner. Beijing’s Made in China 2025 programme sets aggressive targets for its aircraft industry, tasking Comac with the conquest of ten percent of the domestic commercial airline market.
The Americans think that Bombardier is aiding and abetting China in its aviation strategy. Bombardier entered into an agreement with Comac in 2012 to explore synergies between the C Series and Comac’s C919, with the goal of challenging the Airbus-Boeing duopoly. Nothing concrete came out of that. Then Bombardier nearly went bankrupt in 2015 before receiving investments from Canadian provincial and federal government agencies of (so Aviation Week alleges) US$3 billion.
In May 2017, the Financial Times reported that Comac and Bombardier had held talks about Chinese entities buying a stake in Bombardier’s commercial aircraft subsidiary and thus the C Series. That would give the Chinese access to Bombardier’s technology as well as its marketing, distribution and support infrastructure.
As a Canadian company, Bombardier is entitled to preferential treatment under NAFTA rules. The US is therefore constrained in terms of what trade actions it can take so long as the product qualifies as of NAFTA origin. Canada has a right to resort to arbitration under NAFTA’s Section 19 in the C Series dispute before taking its case to the WTO. Significantly, the Trump administration wants to rip up Chapter 19 in the current renegotiation of NAFTA.
So long as components add up to 50 percent of transaction value or 60 percent of net cost, a product qualifies for NAFTA preference. But, the Americans are asking the question: what if Chinese aerospace companies gained access to those same NAFTA preferences?
America’s true target is not really Canada, but China and its aircraft industry
Even the Canadian media in the form of the National Post has questioned whether Canada needs an aerospace industry at all[iii]. As for the Americans, they ask why they have to put up with this kind of competition from their Northern neighbour and NAFTA partner. As if competing with Airbus, which has the combined heft of the EU behind it, was not bad enough.
Whatever the reality, the threat of sanctions has negatively impacted Bombardier’s share price, though there was some recovery over this last week (beginning 09 October). The dispute is unlikely to be resolved quickly. A second ruling is expected next year but this could be challenged at the WTO by the Canadian and-or UK governments. Meanwhile, Bombardier is intensively marketing the C Series in China.
The move by the US Department of Commerce has caused ructions across the UK political establishment. And on 11 October it was revealed that Canada is to buy used FA-18 fighters from Australia for the Royal Canadian Air Force – presumably as a gesture to Boeing that its stance will prove costly. There is yet much to play for. But we may assume that America’s special relationships with both Canada and the UK are subordinate to its battle for mastery with China.
Walking past the US Department of Commerce the other day I noticed the inscription above its main entrance – a quotation from Benjamin Franklin: Commerce among nations should be fair and equitable… An uplifting sentiment. There is no doubt that our American friends are inspired by lofty principle – and always play to win. That sometimes means taking prisoners.
Meanwhile at the WTO…
More bad news for the Brexit team. It seems that the US is leading a group of countries at the WTO to challenge Britain’s plans to retain powers currently controlled by the EU to restrict the import of agricultural goods, post-Brexit. Imports of agricultural products into the EU are protected by internationally agreed quotas which set limits on the amounts of each product that can be imported before tariffs are imposed.
The British government’s plan was that the UK would take a place at the WTO in Geneva on the morrow of Brexit and, as such, would enjoy a free hand in trade policy. They envisaged that the current EU quotas in force could be split between the UK and the EU-27, based on historical consumption patterns.
However, the US and six other major agricultural exporters have written to the EU and UK representatives at the WTO to say that they will not accept such a split without prior negotiation. They argue that a straight split of the existing EU quotas would be detrimental to the interests of other WTO members.
The problem is that, over time, each WTO member has been allocated Trade Rate Quotas (TRQ) whereby they may only impose tariffs above a certain level of imports of particular products – everything from New Zealand lamb to US corn. They are concerned that Britain would be allocated a lower level of TRQs and thus have the right to impose tariffs on their agricultural exports.
The letter was delivered on 26 September to Julian Braithwaite, the UK observer at the WTO in Geneva, and to Marc Vanheukelen, the EU representative. It was signed by the representatives of the missions of the USA, New Zealand, Canada, Brazil, Argentina, Thailand and Uruguay. New Zealand has previously formally objected to the splitting of the current EU TRQ as between the UK and the EU-27.
It is now clear that the issue will only be resolved by a process of negotiation with all parties in order to agree what is technically termed a rectification of the current WTO tariff regime – such that separate UK schedules can be introduced. It is by no means clear that these negotiations can be satisfactorily completed by D-Day – 29 March 2019 when Britain will leave the EU.
One interpretation of the US-led initiative is that the US sees Brexit as an opportunity to force open the door of the British market for agricultural products. This raises the possibility that the UK may be obliged to accept larger quantities of US agricultural exports – particularly chicken and meat – even before any “beautiful trade deal” (as Mr Trump has termed it) is concluded between the two countries.
Towards the zero option
The mood music coming out of both Brussels and London has been sombre this last week. The German employers’ federation, the BDI, has warned its members to prepare for a very hard Brexit. Mrs May told the House of Commons on 10 October in stark terms that Britain must prepare for all eventualities.
The British do not want to write a blank cheque to Europe for the Brexit Bill because to do so would be folly, not knowing what will be the dispensation post bellum. The EU directorate insist that there can be no progress without resolution of Britain’s obligations. There is very little room for compromise between negotiators who have such different premises as to what the negotiations are really about.
The mood music coming out of both Brussels and London has been sombre this last week.
Here in America, there is extremely little (if any) interest in the convolutions of the Brexit negotiations. There is just a sense (much as ordinary Americans love the Brits in general) that this might be an opportunity. Not least for the powerful farm lobby.
It turns out that when Britain escapes the EU or (depending on your point of view) crashes out of the EU on 29 March 2019, it may not just overnight start trading on WTO rules – because those rules, in respect of Britain, have yet to be determined. Leaving the EU, we now know, and as some of us suspected, is the political equivalent of a fly trying to escape from a spider’s silken cocoon.
Always look on the bright side of life…
In response to my piece last week as to why Brexit is just one of Europe’s many problems, amongst the emails I received was one from a UK aviation specialist. The correspondent wrote that, under WTO rules, there may be no tariffs on aviation components so that, in theory, the Airbus-BAe supply chains (from Broughton and so forth) should not be adversely disrupted. In fact I mentioned this in my article on The Aviation Revolution in the July edition of the Master Investor Magazine, though it is good to have it confirmed by an expert.
The other good news last week was that, despite Brexit (as the BBC always says) there are to be some upcoming mega-flotations on the London market. One of them is the Dutch business services company TMF Group. In a statement to the market on 05 October the Group stated that Brexit provided an additional reason to list in and to relocate to London[iv]. Oleg Deripaska’s Russia-based energy to metals group, En+, is also set to list in London despite Brexit.
A political problem
Another regular reader wrote to me last week, broadly in support of my stance, but asking: what should we do now?
Mrs May’s government does not have the political capital to withstand the political crisis that will follow the collapse of the talks.
If I were Mrs May (which I would not want to be, though the lady has my sympathy) I would take this moment to articulate in very simple terms what the British government and people really want. I think that what we want is to trade as far as possible as we did before – but to have control of our borders and the right to overrule the ECJ in non-trade matters. Is that simple enough? No doubt Messrs Barnier and Juncker regard that as impossible – but a more tractable European leadership might come round in due course.
In the meantime, we are heading for commercial disruption and market turbulence as a crash D-Day looms. That is one thing. But another is that Mrs May’s government does not have the political capital to withstand the political crisis that will follow the collapse of the talks. All the enemies of this Government, including those within its own ranks, will accuse Team May of screwing up. They will whip up as much hysteria as they can. If Team May were really united and coherent on their objectives (and whom they want as leader) they might survive the furore – but that is not the case.
And don’t expect our American friends to sympathise too much.
There are a few scenarios that could unfold in the UK in the months to come – some of them relatively benign; and some of them cataclysmic (including a de facto Marxist putsch). But I can’t share them with you right now. I’ve got a night train to catch to Chicago.
[i] Financial Times, 28 September 2017, page 14.
[iv] The Times, 06 October 2017, page 40.