Transcript Export Subsidies in Agriculture and High

10
EXPORT SUBSIDIES IN
AGRICULTURE AND
HIGH-TECHNOLOGY
INDUSTRIES
1
WTO Goals
2
Agricultural Export
Subsidies in Small Country
3
Agricultural Export
Subsidies
in Large Country
4
Agricultural Production
Subsidies
5
High-Tech Export
Subsidies
6
Conclusions
Introduction
• In December 2005, representatives of the 149
countries belonging to the WTO met in Hong
Kong to discuss reforms of the world trading
system.
• The main focus of these meetings was the trade
policy (tariffs and subsidies) on agricultural
products.
 Lower world prices hurt farmers in land-rich developing
countries like Brazil, India, and China.
 But lower world prices benefit land-poor developing
countries that import agricultural products.
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Introduction
• The first goal of this chapter is to explain agricultural
subsidy policies.
• The primary reason for agricultural export subsidies is
political.
• Examine how export subsidies can be used strategically
by governments to bolster domestic companies and
industries
 E.g. high-tech industries
• Legislators often believe that subsidies to high-tech
industries might raise their profits and benefit the exporting
countries.
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WTO Goals on Agricultural Export Subsidies
• Agricultural Export Subsidies
 An export subsidy is a payment to a firm for every unit
exported.
 A fixed amount or a fraction of the sales price.
 Governments give subsidies to encourage domestic
firms to increase production in particular industries.
 Europe maintains a system of agricultural subsides
known as the Common Agricultural Policy (CAP).
 As a result, the sugar beet subsidy makes Europe a leading
supplier of sugar, even though other countries have a natural
comparative advantage over Europe.
 Other countries maintain similarly generous subsidies.
 U.S. pays cotton farmers to grow more cotton and subsidizes
agribusiness and manufacturers to buy the American cotton.
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WTO Goals on Agricultural Export Subsidies
• Domestic Farm Supports
 These include any assistance given to farmers, even if it is not
directly tied to exports.
 These programs can still have an indirect effect on exports by
lowering production costs, and therefore the competitiveness, of
domestic products.
• Cotton Subsidies
 Export subsidies in cotton received special attention because that
crop is exported by many low-income African countries and is
highly subsidized in the U.S.
 Although the U.S. agreed to eliminate them, it still leaves open
other domestic supports to cotton not directly tied to exports.
• Let’s look at the effects of export subsidies on a “small”
country.
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Agricultural Export Subsidies
in a Small Home Country
Figure 10.1
The free trade equilibrium at world price PW, gives
(without subsidy)
exports of X1 and a horizontal Foreign import
demand. Equilibrium is at B.
Home
Price
World
Price
S
D
Home export
supply
X
B
PW
Foreign import
demand
A
D1
X1
S1
Quantity
X1
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Exports
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Agricultural Export Subsidies
in a Small Home Country
• Impact of an Export Subsidy
 Suppose the government wants to boost domestic
exports of sugar.
 Each ton of sugar exported receives a subsidy, s.
 Exporters will receive PW+s for each ton exported.
 Domestic price must rise to PW+s, otherwise firms will
not sell any output domestically.
 Home consumers could just import sugar at the world
price, PW.
 Therefore, Home will impose a tariff equal to or higher
than the amount of the export subsidy.
 This typically happens and, is therefore, realistic.
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Agricultural Export Subsidies
in a Small Home Country
• Impact of an Export Subsidy
 The combined effect of the subsidy and the tariff is to
raise the price at Home.
 Exports increase due to two factors:
 Higher domestic price (movement along supply curve).
 Subsidy (shifts the export supply curve).
 Production and Consumption effects.
 As with a tariff, the subsidy has driven a wedge
between what domestic exporters receive (PW+s), and
what importers abroad pay (PW).
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Agricultural Export Subsidies
in a Small Home Country
Figure 10.1
(with subsidy)
ThisHome
decreases
to D2, shifts
increases
to S2the
, and
The
exportdemand
supply curve
downsupply
by exactly
increases
exports
to Xthe
. Equilibrium
atfalls
C.to by
amount
ofthe
the
subsidy.
of production
s.
With
subsidy,
Home
priceisrises
PWexactly
+s
2MC
Home
Price
World
Price
X
S
D
X–s
C
PW+s
B
s
PW
C'
s
A
D2 D1
X1
X2
S1 S2 Quantity
X1
X2
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Exports
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Agricultural Export Subsidies
in a Small Home Country
• Impact of the Subsidy on Home Welfare
 The rise in price lowers consumer surplus by (a+b).
 The rise in price raises producer surplus by (a+b+c).
 The export subsidy costs the government the amount of
the subsidy, s, times the amount of exports, X2 shown
by (b+c+d).
 Adding up this impact, we are left with a net effect on
Home welfare of –(b+d).
 b is the production loss or efficiency loss for the economy.
 d is the consumer loss for the economy.
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Agricultural Export Subsidies
in a Small Home Country
Figure 10.1
The increased price decreases consumer surplus by (a+b)
(with welfare effects) Producer surplus increases by (a+b+c)
The subsidy costs the government the amount –(b+c+d)
This leaves us with a deadweight loss of (b+d) as before.
Home
Price
World
Price
S
D
b
Total deadweight
loss, b+d
d
a
X–s
C
PW+s
s
X
B
c
PW
C'
s
A
D2 D1
X2
S1 S2
Quantity
X1
X2
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Exports
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Agricultural Export Subsidies
in a Large Home Country
• Now suppose Home is large enough that its
subsidy affects the world price of sugar.
 Foreign export demand curve, M*, is downward sloping.
• Note that the new world price, P*, is less than PW
although the new Home price is PW+s.
 Home terms of trade fall but foreign terms of trade rise.
• Since Home terms of trade fall, the Home country
will suffer overall losses.
• Foreign consumers will gain.
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Agricultural Export Subsidies
in a Large Home Country
Figure 10.2
We begin in free trade equilibrium
(with subsidy)
Home demand
applies adecreases
subsidy, shifting
and home
the export
supplysupply
increases
curve
leading
right by
to
the amountexports,
increased
of the subsidy,
X2
s
The new world price is at new equilibrium, P*. New Home price is P*+s
(a) Home Market
(b) World Market
Home
Price
World
Price
D
Home exports
supply, X
S
X2
P*+s
s
X1
s
X–s
PW
P*
Foreign
import
demand, M*
D2 D1
S1 S2
Quantity
X1
X2
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Exports
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Agricultural Export Subsidies
in a Large Home Country
• Home Welfare
 The higher Home price reduces consumer surplus by
(a+b).
 Additionally, the higher price increases producer
surplus by (a+b+c).
 We also need to consider the cost of the subsidy—the
amount of the subsidy times the exports after the
subsidy, area (b+c+d+e).
 This gives a net welfare loss of (b+d+e).
 Area e represents the terms of trade loss.
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Agricultural Export Subsidies
in a Large Home Country
Figure 10.2
Consumer surplus falls by -(a+b).
(with subsidy)
Producer surplus increases by +(a+b+c).
Home Welfare
The subsidy costs the government (b+c+d+e): subsidy times exports.
Home
Price
D
b
d
S
This leaves a net deadweight loss
of (b+d+e), greater than in a small
country.
P*+s
c
a
s
PW
e
P*
D2 D1
S1 S2
Quantity
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Agricultural Export Subsidies
in a Large Home Country
• Foreign and World Welfare
 From Home’s perspective, the terms of trade loss is just
(e), but when we move to foreign welfare next, it will be
useful to break up (e) into the two parts e’ and f.
 The price of Foreign imports decreases leading to an
increase in Foreign consumer surplus by (e′).
 Combining Home welfare loss of (b+d+e) and
subtracting Foreign terms-of-trade gain (e′), there is an
overall deadweight loss for the world, (b+d+f) in panel b.
 The area (f) is the additional world deadweight loss due
to the subsidy.
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Agricultural Export Subsidies
in a Large Home Country
Figure 10.2
World Consumer surplus rises by -(e’)
which
is a terms
of trade
gain
With Home
welfare
loss of
(b+d+e) and Foreign terms-of-trade
gain
(e’),
there is World
an overall
loss for
the world
of of
f is an
additional
lossdeadweight
due to decrease
in Home’s
terms
(b+d+f)
in completely
panel b
trade not
offset by increases in World’s terms of trade
(without subsidy)
(a) Home Market
(b) World Market
Home
Price
World
Price
D
b
d
S
Home exports
supply, X
b+d
P*+s
c
a
s
s
PW
e
X–s
f
e'
P*
Foreign
import
demand, M*
D2 D1
S1 S2
Quantity
X1
X2
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Exports
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Agricultural Export Subsidies
in a Large Home Country
• Foreign and World Welfare
 This transfer of terms of trade is what countries
sometimes use to make subsides sound like good
ideas to “aid” poorer countries.
 However, the deadweight loss (f) means using the
export subsidy to increase exports is an inefficient way
to transfer gains from trade among countries.
 It would be more efficient to just give cash aid to the
poorer countries.
 Cash does not change trade levels so would not have
deadweight loss of (b+d+f).
 This is why the European countries eliminated transfers of food
as a form of aid several years ago.
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Who Gains and Who Loses?
APPLICATION
• Let’s return to the Hong Kong meeting of the WTO
in December 2005 to see which countries will gain
and which will lose when the export subsidies are
eliminated by 2013.
• Gains
 Obvious winners will be current agricultural exporters in
developing countries such as Brazil, Argentina,
Indonesia, and Thailand, along with potential exporters
such as India and China.
 These countries will gain even more when and if an
agreement is reached on eliminating agricultural tariffs
in the industrial countries.
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Who Gains and Who Loses?
APPLICATION
• Gains
 These actions will also benefit industrial countries,
suffering from deadweight losses and terms-of-trade
losses from the combination of subsidies and tariffs.
 Clearly the farmers in industrial countries who lose the
subsidies will be worse off.
 Given that it is usually the largest farmers who gain the most
from subsidy programs, they may be better able to adjust to the
elimination of subsidies than smaller farmers.
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Who Gains and Who Loses?
APPLICATION
• Losses
 Given that eliminating subsidies will typically lead to
increased world prices, food-importing countries,
typically the poorer non-food producing countries, will
lose.
 One study finds that the existing pattern of agricultural
supports raises the per-capita income of two-thirds of
77 developing nations, including most of the poorest
countries such as Burundi and Zambia.
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Who Gains and Who Loses?
APPLICATION
• Losses
 Figure 10.3 shows some of these results.
 Poor countries are net importers of essential food items
such as corn, rise, and wheat, and would be harmed by
an increase in their world price.
 Many of the world’s poorest individuals depend on
cereal crops for much of their diet and would be
especially hard hit by any increase in those prices.
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Who Gains and Who Loses?
APPLICATION
Figure 10.3
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Who Gains and Who Loses?
APPLICATION
Figure 10.3
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Agricultural Production Subsidies
• The agreements reached in Hong Kong
distinguish between export subsidies in
agriculture and all other forms of domestic support
that increase production.
 Tax incentives and other types of subsidies
• This is because it is expected that these other
forms have less impact on exports than do direct
subsidies.
• In this section, therefore, we will examine the
impact of a production subsidy in agriculture for
both a small and a large country.
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Agricultural Production Subsidies
• A production subsidy is when the government
provides a subsidy of s dollars for every unit that a
Home firm produces.
 It is a subsidy to every unit produced, not just to units
exported.
• The subsidy can be implemented by the
government:
 guaranteeing a minimum price to the farmer.
 providing subsidies to the users of the crop to purchase
it, thereby increasing demand for the crop and the
price.
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Agricultural Production Subsidies
• These policies all fall under Article XVI of the
GATT.
• This states that partner countries should be
notified of the extent of such subsidies, and where
possible, these subsidies should be limited.
• In Hong Kong, the WTO members further agreed
to classify countries according to the extent of
such subsidies.
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Agricultural Production Subsidies
• Effect of a Production Subsidy in a Small Home
Country
 We have a small country with a fixed world price of PW.
 There is a subsidy of s increasing Home price to
producers to PW+s.
 Quantity demanded at home does not change since
producers still charge the world price at Home.
 This happens because Home producers receive the
subsidy no matter who they sell to.
 The production subsidy increases exports by less than
an export subsidy.
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Agricultural Production Subsidies
Figure 10.4
(with production
subsidy)
Subsidy
to producers
increasing
supply to
We can increases
see in (b) price
that Home
export supply
increases,
S-s
producing
S2. Home
quantity
demanded
showing
that exports
increase
from
X1 to X2. does
This not
is a
change.
smaller increase than with an export subsidy since Home
demand does not change.
(a) Home Market
(b) World Market
Home
Price
World
Price
X
D
S
S-s
X’
C
PW+s
s
B
PW
C'
D1
S1 S2
Quantity
X1 X2
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Exports
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Agricultural Production Subsidies
• Home Welfare
 Producer surplus rises by (a+b) in panel a.
 Government cost of the subsidy is (a+b+c) – the
amount of subsidy s times total production S2.
 Consumer surplus is unaffected since quantity
demanded is unaffected.
 This leaves a new effect on Home welfare of (–c).
 The deadweight loss caused by the production subsidy,
(c), is less than that caused by the export subsidy,
(b+d).
 The only deadweight loss is in production inefficiency—
producers produce at higher than marginal cost.
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Agricultural Production Subsidies
Figure 10.4
(with welfare effects)
Home producer surplus rises by (a+b)
Subsidy costs government (a+b+c)
Deadweight loss from production subsidy is c, which is less
than with export subsidy of (b+d) in figure 10.1.
(a) Home Market
(b) World Market
Home
Price
World
Price
X
D
S
S-s
C
PW+s
a
s
X’
b
PW
B
c
C'
D1
S1 S2
Quantity
X1 X2
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Exports
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Agricultural Production Subsidies
• Targeting Principle
 Since the deadweight loss is lower for this subsidy than
for the export subsidy, it makes a better policy
instrument for the purpose of increasing Home supply.
 This is an example of the targeting principle.
 To achieve some objective, it is best to use the policy
instrument that achieves the objective most directly.
 To use an example from this book, it is better to provide
trade adjustment assistance directly to those affected,
than to impost a tariff or quota.
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Agricultural Production Subsidies
• Effect of Production Subsidy in a Large Home
Country
 We will not draw this case in detail but will use figure
10.4 to briefly explain.
 Price rises from PW to PW+s, and Home production
increases to S2.
 Since demand has not changed, exports increase by
the same amount as the change in Home supply.
 The rise in exports from B to C′ is less than the
increase in exports with an export subsidy, from B to C.
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Agricultural Production Subsidies
Production Subsidy for a Large Home Country
W +san export
This
increase
exports
(B
to
less than
we curve
saw
with
Thesee
production
subsidy
leads
to is
increase
in price
to P
We
this asinan
increase
inC′)
the
export
supply
from
X to X’
subsidy
(B
to
C).
and increased
productionfrom
to SB2 increasing
exports by S1-S2
changing
the equilibrium
to C’
(a) Home Market
(b) World Market
Home
Price
World
Price
X
D
S
S-s
X’
C
PW+s
s
B
PW
C'
ΔX
D1
S1 S2
Quantity
X1 X2
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Exports
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Agricultural Production Subsidies
• Effect of Production Subsidy in a Large Home
Country
 In the export supply subsidy, the increase in exports
occurred due to the increase in supply and the
decrease in demand.
 The export supply curve shifted down by the exact amount of
the subsidy, s, (as in figure 10.1).
 With a production subsidy, the exports increased only due to
the increase in Home production.
 The export supply curve then shifted down by an amount less
than s, (as in figure 10.4).
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Agricultural Production Subsidies
• Effect of Production Subsidy in a Large Home Country
 If we draw a downward-sloping foreign import demand curve
in panel b, then the increase in supply due to the production
subsidy would lower the world price.
 But the drop in world price would be less than the drop that
occurred with the export subsidy, since the increase in
exports is less.
• Production subsidies in agriculture still lower world prices,
but by less than export subsidies.
• Therefore, the WTO is less concerned about eliminating
production subsidies and other forms of domestic support
for agriculture.
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High-Technology Export Subsidies
• We now change focus from agriculture to high-technology
products.
• The high-tech sector also receives substantial subsides
from the government.
 An example being subsidies to the aircraft industries in both the
U.S. and Europe.
• In the U.S., subsidies take the form of low-interest loans
provided by the Export-Import Bank.
 The Export-Import Bank is a U.S. government agency that finances
export related projects.
• Japan and South Korea give direct subsidies to high-tech
manufacturing firms and reach certain targets for export
sales.
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High-Technology Export Subsidies
• One reason that some governments support hightech industries is because of the possible spillover
benefits to other areas of the economy.
• Governments believe there is a positive
externality that exists from the production of hightech products, so subsidizing them increases
production and minimizes the externality.
• This is similar to the infant industry argument for
tariffs, but is applied to an export instead of an
import.
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High-Technology Export Subsidies
• “Strategic” Use of High-Tech Export Subsidies
 Governments argue subsidies might give a strategic
advantage to export firms competing with a small
number of rivals in international markets.
 If extra profits are greater than the subsidy, then the exporting
country has an overall gain.
 We will use an assumption of imperfect competition to
examine this issue. duopoly
 Each firm can set the price and quantity of its output
based on the price and quantity decisions of the other
firm.
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High-Technology Export Subsidies
• “Strategic” Use of High-Tech Export Subsidies
 We then examine the effects of strategic export
subsidies in determining whether the profits of the
exporting firm will rise enough to offset the cost of
the subsidy to the government.
 To capture strategic decision making of two firms, we
will use game theory.
 The modeling of strategic interactions (games) between
firms as they choose actions that will maximize their returns.
 The goal is to model the strategic interactions of
high-tech firms in Home and Foreign, and then see
the impact of export subsidies on their respective
decisions and payoffs.
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High-Technology Export Subsidies
• “Strategic” Use of High-Tech Export Subsidies
 We begin with free trade.
 Two firms are competing for sales of a new type of
aircraft.
 We will focus on the decision of each firm to develop
the new aircraft, that competes with the aircraft of the
other firm for sales to the rest of the world.
 We will ignore sales in their own countries, so we do
not have to keep track of consumer surplus.
 Welfare is only dependent on the profits earned by
Boeing or Airbus from sales to the rest of the world.
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“Strategic” Use of High-Tech
Export Subsidies
• Payoff Matrix
 Figure 10.5 shows a payoff matrix for Boeing and
Airbus.
 Each producer must decide whether or not to produce
the new aircraft.
 Each quadrant of the matrix shows the profit earned by
Boeing in the lower-left corner.
 The profits of Airbus are in the upper-right corner.
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“Strategic” Use of High-Tech
Export Subsidies
Figure 10.5
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“Strategic” Use of High-Tech
Export Subsidies
• Nash Equilibrium
 We want to determine the outcome of this game
between the two firms.
 We use the concept of the Nash Equilibrium.
 The action of each player is the best possible response to the
action of the other player.
• Best Strategy for Boeing
 What are Boeing’s possible strategies if Airbus chooses
to produce?
 Systematically work through the matrix.
 The bottom left square is a Nash Equilibrium.
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“Strategic” Use of High-Tech
Export Subsidies
• Multiple Equilibria
 Is it possible to have more than one Nash Equilibrium?
 What if Boeing decides to produce first.
 We can then look at the top row and see that Airbus’
best strategy is to not produce.
 If Airbus does not produce, looking at the last column of
the matrix, Boeing’s best strategy is to produce.
 Therefore, the top right-hand box, with Boeing
producing and Airbus not producing, is also a Nash
Equilibrium.
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“Strategic” Use of High-Tech
Export Subsidies
• Multiple Equilibria
 When there are two Nash equilibria, then there must be
some force that determines which one we are in.
 One of these is the first mover advantage.
 One firm is able to decide whether or not to produce before the
other firm.
 Suppose we start at the Nash equilibrium in the upperright quadrant.
 Because Airbus is not producing and making $0 profits, the
government in Europe might want to try to change the
equilibrium so that Airbus would earn positive profits.
 The government might want Airbus to produce.
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“Strategic” Use of High-Tech
Export Subsidies
• Multiple Equilibria
 The European government might decide to provide
subsidies to Airbus to achieve this.
 What happens to the payoff matrix, if anything, in such
a case?
 The type of subsidy we will consider is a cash payment
to Airbus.
 But in practice we know that subsidies can take on many forms.
 We will present a subsidy example in the “Headlines”
section next.
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Airbus, China and Quid Pro Quo
HEADLINES
• Airbus was negotiating to build an assembly line
for a new passenger plane in China.
• The deal would have a significant effect on its
business dealings there.
• Producing European planes in China would give
Airbus an advantage in the battle with Boeing for
the world’s next great aviation market.
• Airbus has 344 planes in service in China, Hong
Kong, and Macao, but Boeing still dominates with
nearly 2/3 of the market.
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Airbus, China and Quid Pro Quo
HEADLINES
• Airbus’ move shows the lengths it is willing to go
to break into China’s market, despite being active
there since 1985 without success.
• Boeing has no plans to build a production line in
China, but has still won orders to supply many of
its 737s to Chinese carriers.
• Airbus could greatly aid Europe in cultivating
commercial ties with China.
• Chinese and French leaders celebrate visits to
each other with the signing of aircraft deals.
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“Strategic” Use of High-Tech
Export Subsidies
• Effect of a Subsidy to Airbus
 Suppose the European governments provide a subsidy
of $25 million to Airbus to produce.
 This increases Airbus’ profits by $25 million when it
produces.
• Best Strategy for Airbus and Boeing
 In fact, Airbus is better off producing, now matter what
Boeing does.
 Boeing recognizes this and stays out of the market.
 The bottom left corner is the only Nash equilibrium.
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“Strategic” Use of High-Tech
Export Subsidies
Figure 10.6
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“Strategic” Use of High-Tech
Export Subsidies
• European Welfare
 The subsidy has a big impact on the equilibrium of the
game, but is Europe better off?
 Since Europe is producing for the rest of the world,
there is no consumer surplus in Europe.
 Airbus’ profits have increased from $0 to $125 million.
 The revenue cost of the subsidy is $25 million.
 The net gain in European welfare is +$100 million.
 The increase in profits are greater than the cost of the subsidy.
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Subsidy with Cost Advantage for Boeing
• What about cost differences?
 Let us now consider another case in which Boeing has
a cost advantage over Airbus.
 Assume the advantage is not from a subsidy, but due to
U.S. comparative advantage in aircraft production.
 This gives another payoff matrix in figure 10.7.
 Boeing earns profits of $5 million when both firms
produce, and profits of $125 million when Airbus does
not produce.
 The only Nash equilibrium—the upper right quadrant—
is where Boeing produces and Airbus does not.
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Subsidy with Cost Advantage for Boeing
Figure 10.7
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Subsidy with Cost Advantage for Boeing
• Can we have both?
 Now suppose the European government provides the
$25 million subsidy to Airbus but Boeing still has the
cost advantage.
 Best Strategy for Airbus
 With the subsidy in place, and Boeing producing, the best
decision for Airbus is to produce and earn profits of $20 million.
 Best Strategy for Boeing
 Given that Airbus produces, Boeing earns profits of $5 million
when it produces and $0 when it does not.
 Therefore, Boeing will stay in the market. Both firms
producing is now the new Nash equilibrium.
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Subsidy with Cost Advantage for Boeing
Figure 10.8
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Subsidy with Cost Advantage for Boeing
• European Welfare Once Again
 When Boeing has the cost advantage, the European
subsidy allows Airbus to enter the market.
 This has not resulted in the exit of Boeing as it did in
the earlier no-cost-advantage scenario.
 Airbus’ profits have increased from $0 to $20 million.
 The revenue cost of the subsidy to Europe is still $25
million.
 The net gain in European welfare is now -$5 million.
 When Boeing has the cost advantage, the subsidy
leads to a net loss in European welfare.
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Subsidy with Cost Advantage for Boeing
• Summary
 Under conditions of imperfect competition, a subsidy by
one government to its exporting firm might increase
welfare for its nation or it might not.
 There is an increase in welfare only if profits rise by
more than the cost of the subsidy.
 This is more likely satisfied if the subsidy leads to the
exit of the other firm.
 However, if both firms remain in the market, it is unlikely
that the increase in profits for the subsidized firm will
exceed the subsidy cost.
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Subsidies to Commercial Aircraft
APPLICATION
•
The U.S. and Europe have used various types of
subsidies to support their respective firms:
1. Indirect subsidies that arise because the R&D for
military versions effectively subsidize R&D for civilian
aircraft.
2. The government might directly subsidize the R&D
costs of a new aircraft, as Europe subsidizes R&D at
Airbus.
3. The government can subsidize the interest rates that
aircraft buyers pay when they borrow money to
purchase aircrafts.

Europe and the U.S. both provide low interest loans to aircraft
purchasers.
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Subsidies to Commercial Aircraft
APPLICATION
• 1992 Agreement
 Development subsidies are now limited to 33% of the total
development costs of a new aircraft.
 Limits indirect (military) subsidies to not more than 4% of any firm’s
annual sales.
 Prohibits production subsidies.
 Limits the ability of government agencies to subsidize the interest
rate on purchases of aircrafts.
• Reducing subsidies led to a rise in prices for aircraft by
3.1% and 8.8%.
 Governments benefit from not having to pay the subsidies.
 Higher prices help firms but hurt importing countries.
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Subsidies to Commercial Aircraft
APPLICATION
• The Super Jumbo
 There are claims that the terms of the agreement are
being violated by Airbus.
 It is selling a new aircraft, the double-decker A380,
which is larger than the Boeing 747 and competes
directly with it.
 The expenditures to develop the A380 are estimated at
$12 billion.
 The European governments provided about $3.5 billion
in low-interest loans to cover development costs.
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Subsidies to Commercial Aircraft
APPLICATION
• The Super Jumbo
 In 2005, both the U.S. and the EU filed countercomplaints at the WTO regarding illegal subsidies by
the other party to their respective aircraft producers.
 Europe was accused of “illegally” subsidizing the A380,
while the U.S. was accused of subsidizing the
development of Boeing’s 787 commercial jet.
 The complaints charged that these subsidies violate the
1992 agreement.
 The U.S. is calling for termination of the agreement.
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Subsidies to Commercial Aircraft
APPLICATION
• National Welfare
 Will the subsidies to Airbus increase national welfare?
 From the previous information, it is more likely to
happen if Airbus is the only firm producing in that
market.
 Boeing has announced it will not produce a doubledecker like the A380.
 It will instead modify its current 747 and focus R&D on
its new 787 “Dreamliner” aircraft.
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Subsidies to Commercial Aircraft
APPLICATION
• National Welfare
 Since Boeing will not enter the double-decker market, it
is possible the profits earned by Airbus will cover the
subsidy.
 Of course that assumes the Boeing plane is not more of a direct
competitor to the Airbus.
 The profits earned will depend on how many are sold
and at what price.
 Airbus says it needs to produce at least 250 planes to
cover development costs, but expects to sell 1,500 over
the next 20 years.
 As of April 2006, it has orders for only 159 and many of
those has been discounted at least 10%.
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Subsidies to Commercial Aircraft
APPLICATION
• National Welfare
 In mid-June 2006, Airbus told its buyers it could not
deliver as promised—delays of 6 months or more.
 Several of the largest customers entered into
discussions to seek compensations for the delay.
 Singapore Airlines announced it would order the Boeing
787 “Dreamliner” instead.
 The stock price of Airbus’ parent company, EADS, fell
by more than one-quarter of its value in a single day.
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Subsidies to Commercial Aircraft
APPLICATION
• These events do not mean the Airbus A380 will
fail; delays happen often in this industry.
• These events do, however, illustrate the intensity
of the competition in the airline industry.
• This competition benefits consumers who will be
traveling on the new aircraft.
• However, competition makes it more difficult for
government subsidies to be recovered in profits
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