Cablegate: Bombardier and the World Aircraft Subsidies Game

This record is a partial extract of the original cable. The full text of the original cable is not available.

041818Z Aug 05

UNCLAS SECTION 01 OF 03 OTTAWA 002352

SIPDIS

STATE FOR WHA/CAN - BREESE AND HOLST STATE

PASS USTR FOR CHANDLER

USDOC FOR 4320/OFFICE OF NAFTA/GWORD/TFOX;
3134/OIO/WESTERN HEMISPHERE

E.O. 12958: N/A
TAGS: ETRD EIND EINV CA
SUBJECT: BOMBARDIER AND THE WORLD AIRCRAFT SUBSIDIES GAME

REF: OTTAWA 822

SUMMARY/INTRODUCTION
--------------------
1. This report outlines a significant part of the backdrop to
the WTO's current aircraft subsidies case: Canadian-
based Bombardier Aerospace and the market for 100-seat-
and-up "regional jets" - airliners at the small end of
the product ranges offered by Boeing and Airbus.

2. Bombardier announced in May 2005 that final assembly
of its proposed "C series" aircraft would occur in the
Montreal area, after it played the Canadian federal and
Quebec provincial governments off against other
jurisdictions for subsidy commitments. This represents
a solid renewal of Canadian governments' commitment to
subsidies in manufacturing industry (reftel). If the C
series goes ahead, it also represents a step by
Bombardier into the 100-seat-and-up product range,
which is dominated by Boeing and Airbus and their major
(as opposed to regional) airline customers.

3. Bombardier's political connections in Canada are
legendary. In a bitter dispute (1996-2001) with
Brazil's Embraer, the GOC proved willing to play
hardball to support the company in trade litigation and
in the market. Bombardier and its suppliers account
for some 30,000 jobs, many of them in politically
crucial constituencies around Montreal. Moreover,
Canada can afford (probably better than Brazil) to
continue this support. END SUMMARY/INTRODUCTION.

THE COMPANY
-----------

4. Canada's aerospace industry, with more than 400
firms employing over 80,000 people (see industry
website www.aiac.ca ), claims to be the largest in the
world after those of the United States and the combined
European Union. As in other Canadian manufacturing
industries, integration with the U.S. market (including
access to defense contracts) has facilitated growth
particularly among parts manufacturers and service
providers since the 1940's. Canada's own very small
military budget has been a disadvantage for this
sector, providing few opportunities to produce entire
aircraft, and (as in shipbuilding) this has been used
to help make the case for direct government support.

5. Bombardier - which pioneered the snowmobile in the
early twentieth century and later expanded to
motorcycles, boats and rail/subway systems - grew into
aerospace in the 1990's through acquisition of Canadair
(Quebec), de Havilland (Ontario), Shorts (U.K.) and
Learjet (U.S.). Combining existing strengths in
turboprops and business jets, Bombardier caught a
strong trend in the 1990's toward the use of 50-to-70-
seat regional jets on inter-city routes in North
America.

6. Bombardier's current commercial offerings (based on
designs more than a decade old) are turboprops carrying
from 37 to 56 passengers and jets ranging up to 90
seats (see website www.bombardier.com). In the late
1990's, Bombardier considered developing a 115-seat
model, but held back - a decision that may have been
fortunate given the post-2001 sales slump. With
airline profits reviving, Bombardier is discussing the
110-to-130-seat "C Series" with prospective customers
and has selected Montreal as the assembly site but has
not made a final launch decision.

SUBSIDY PROGRAMS
----------------

7. Taxpayer funding to Bombardier is channeled through
the following major routes:

TECHNOLOGY PARTNERSHIPS CANADA (TPC): This is a GOC
program of loans to finance research and development
(see website www.tpc-ptc.ic.gc.ca ). While the loans
are nominally repayable, less than five percent of the
value of all TPC loans has been repaid so far (data for
individual firms are not released). And while TPC
loans are nominally available to industries other than
aerospace, the bulk of funding is awarded to Bombardier
and a few other aerospace players, including Canadian
branches of some U.S.-based firms. GOC officials argue
that the time frames for repayment are necessarily
long, and in recent weeks Industry Minister David
Emerson commented that expecting full repayment would
not be realistic. Critics of Bombardier's influence in
the GOC say that TPC's repayment conditions are
deliberately pitched so high that they will never be
triggered. The Canadian Taxpayers Federation (see
website www.taxpayer.com ) estimates that including its
commitment to the C Series, the GOC's cumulative direct
contributions to Bombardier total C$1.12 billion (about
US$900 million). As a result of adverse panel findings
in the dispute with Embraer (see below), TPC has been
crafted to withstand WTO challenge.

EXPORT DEVELOPMENT CANADA (EDC): This is the GOC's
official export credit agency (counterpart to
Eximbank). While details of loans made on EDC's own
account are not publicly available, EDC claims
compliance with the OECD's "consensus arrangement" for
official export finance. In addition to lending its
own funds, EDC sometimes supports Bombardier sales (and
those of a very few other exporters) with funds drawn
directly from the GOC treasury (the "Canada account"),
with case-by-case approval from the GOC. This
mechanism has even been used to support Bombardier
sales to Air Canada. See website www.edc.ca . At the
end of 2004, EDC had C$6.8 billion in exposure to
aerospace customers (about one-third of EDC's total
exposure) and C$7.3 billion in exposure to surface
transportation customers, another major business
segment for Bombardier.

DIRECT RESEARCH: Over the past year the GOC has
constructed and staffed an Aerospace Manufacturing
Technology Centre, located in Bombardier's hometown of
Montreal, whose mission is to help this industry reduce
manufacturing costs. See website www.iar-ira.nrc-
cnrc.gc.ca .

SUB-FEDERAL SUPPORT: Like the GOC, the provincial
Government of Quebec supports Bombardier with
"repayable" loans (including C$118 million for the C
Series), equity guarantees to aircraft buyers, and
other measures such as infrastructure investment,
worker training and tax holidays.

THE BATTLE WITH BRAZIL
----------------------

8. Bombardier's most direct competitor is Brazil's
Embraer, a larger firm with a wider range of planes
offered (a 118-seat commercial jet is expected to be
certified for service in 2006) and a stronger defense
products business. Unlike Bombardier, Embraer started
as a state-owned firm, but during the 1990's it was
privatized and, like Bombardier, prospered by catching
the trend toward "regional jets." The main subsidy
mechanism for Embraer is an export financing program
called Proex, which purports to compensate for Brazil's
high interest rates.

9. Bombardier first enlisted the GOC to complain to
Brazil about Proex in the mid-1990's, eventually
impeding (some say killing) Canada's plans to conclude
an FTA with the Mercosur trade bloc. Special envoys
appointed to resolve the dispute proposed a bilateral
pact based on OECD subsidy rules, but (by Canadian
accounts) Brazil refused this solution. The countries
traded WTO complaints in 1998, and the resulting panel
found Proex and TPC, as well as the use of the Canada
Account mechanism for aircraft sales, all to be
illegal.

10. Both countries adjusted their programs but Brazil's
revised "Proex 2" was also successfully challenged by
Canada at the WTO. Meanwhile, however, Embraer
continued to win sales orders for regional aircraft.
In 2001, faced with a situation where it felt that it
was winning at the WTO but losing in the marketplace,
Canada decided to match the Proex advantage by offering
Bombardier's customers expanded below-market financing
through EDC and the "Canada Account." As a result,
Bombardier won two critical orders from U.S. airlines
(for a total of 225 planes).

11. While Bombardier regained its competitive position,
trade policy watchers believed that Canada lost moral
credibility at the WTO by resorting to unauthorized
retaliation. Moreover, the escalation in the
diplomatic dispute with Brazil (which also involved a
spat over beef trade) scuttled any prospect of Canada-
Brazil collaboration at the time on wider trade policy
goals such as hemispheric free trade.

12. The dispute wound down in 2002-03 with a negotiated
peace. Bombardier and Embraer split major orders from
US Airways and Air Canada. In the Air Canada deal in
September 2003, while the two suppliers divided the
units evenly between them, Embraer obtained all the
orders for larger planes - underscoring the need for
Bombardier to bring forward a new design in the 100-
seat-plus market.

COMMENT - KEY QUESTIONS
-----------------------

13. In our view, two key sets of questions hang over the
market for aircraft seating 100 to 150 passengers:

-- How will Boeing and Airbus respond to encroachment
from Bombardier and Embraer? Boeing is discontinuing
its 106-passenger 717 model, but still offers versions
of the 737 with from 110 to 189 seats. The Airbus A320
"family" covers a similar range.

-- Even if Boeing and Airbus were to effectively cede
the smaller end of this market, how would Bombardier
and Embraer manage the resulting duopoly? Will they
continue to induce customers to split major orders
between them? And if so, might their sponsor
governments have an incentive to reduce subsidy levels
in this industry?

14. We see little prospect that subsidy levels to
Bombardier in Canada will decline. The firm and its
suppliers are the flagship industry in Quebec
constituencies which are intensely contested by
federalist and separatist parties at both the federal
and provincial levels. Bombardier watchers say the
firm's political connections will survive any
foreseeable change in government and will keep the
dollars flowing.

WILKINS

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