Boeing and Airbus have called a truce in their 17-year battle over subsidies. During this period, both have accused each other of unfair government subsidies to their respective plane makers.

The long-running trade dispute

In October 2004, the USA requested the establishment of a WTO panel to consider whether Airbus was providing unfair subsidies to develop its new super-jumbo – the A380. This provoked a counter-request by Airbus, claiming unfair subsidies of $27.3 billion for Boeing by the US government since 1992. In July 2005, two panels were set up to deal with the two sets of allegations.

In June 2010, the WTO panel circulated its findings on Boeing’s case against Airbus. It found Airbus guilty of using some illegal subsidies to win contracts through predatory pricing, but dismissed several of Boeing’s claims because many of the subsidies were reimbursable at commercial rates of interest. However, some of the ‘launch aid’ for research and development was given at below market rates and so violated WTO rules. The report evoked appeal and counter-appeal from both sides, but the WTO’s Appellate Body reported in May 2011 upholding the case that ‘certain subsidies’ provided by the EU and member states were incompatible with WTO rules. In June 2011, the EU accepted the findings.

In March 2011, the WTO panel circulated its findings on Airbus’s case against Boeing. The EU claimed that ten specific measures amounted to subsidies to Boeing, which were inconsistent with the WTO’s rules on subsidies (the SCM agreement). It upheld three of ten alleged breaches, including subsidies between 1989 and 2006 of at least $5.3 billion. These subsidies were adjudged to have resulted in adverse effects to the EU’s interests, specifically in lost sales, especially to third-country markets, and in significantly suppressing the price at which Airbus was able to sell its aircraft.

But these rulings were not the end of the matter. Various appeals and counter-appeals were lodged by both sides with varying degrees of success. Also the disputes extended to other wide-bodied jets and to narrow-bodied ones too with claims by both sides of unfair subsidies and tax breaks.

On 9 June 2017 the WTO’s compliance panel rejected several EU claims that the USA had failed to withdraw all illegal subsidies to Boeing. However, it also found that the USA had not complied with an earlier ruling to abolish illegal tax breaks. Both sides claimed victory. Airbus claimed that the ruling had seen the WTO condemn non-compliance and new subsidies. In particular, it focused on the WTO ruling that Washington State subsidies had resulted in a significant loss of sales for Airbus. On the other hand, a Boeing press release spoke of a US win in a major WTO compliance ruling. Boeing claimed that that ruling meant that the United States had complied with ‘virtually all’ of the WTO’s decisions in the counter-case that the EU had filed against the USA in 2006.

On 27 June 2017, as expected, the EU challenged the WTO decision. This meant that the EU’s case would go back to the WTO’s appellate body, which was still considering a separate US case over state aid to Airbus.

On 15 May 2018, the WTO ruled that Airbus did not use unfair subsidies for narrow-bodied jets, such as the A320, which competes with the 737, but did for wide-bodied jets. The EU said that it would comply with the WTO ruling over the support for wide-bodied jets.

In 2019, the WTO ruled that the EU had illegally provided support to Airbus. The USA responded with tariffs of up to $7.5bn on a range of goods imported from the EU. In a parallel case, the WTO ruled that the US benefits to Boeing also violated trade rules, authorising the EU to impose tariffs on US imports worth roughly $4bn. Then in March 2020, the USA imposed a 15% tariff on Airbus aircraft.

The truce

Agreement was reached on 15 June 2021 in trade talks between the USA and the EU in Brussels. Both sides recognised that the dispute had been a negative-sum game, with both sides losing. It was thus agreed to suspend for five years all tariffs on aircraft and on a range of other goods, such as EU cheese and wine and US tobacco and spirits. The agreement did not include ending EU tariffs on US steel, however.

It was also agreed to work on an overarching agreement on subsidies, which would allow fair support by governments on both sides, and to co-operate in finding ways to counter unfair state investment in aircraft by China. US Trade Representative Katherine Tai said that the agreement ‘includes a commitment for concrete joint collaboration to confront the threat from China’s ambitions to build an aircraft sector on non-market practices’. China’s state-sponsored aerospace manufacturer, the Commercial Aircraft Corporation of China, or Comac, sees its C919, now in late stages of development, as a direct rival to the Airbus A320neo and the Boeing 737 Max.

To work out the details of US-EU collaboration, a working group will be set up. It will consider ways of ensuring that finance is provided on market terms, that R&D funding is transparent and that support given to aircraft manufactures will be equivalent by each side and will avoid harming the other side. It will consider just how the two sides can co-operate to address unfair competition from elsewhere.

Two days later, an almost identically worded deal was reached between the USA and the UK to end tariffs on a range of goods and join the EU-USA co-operation on aircraft manufacture.

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Questions

  1. Choose any one particular complaint to the WTO by either Boeing or Airbus and assess the arguments used by the WTO in its ruling.
  2. Are subsidies by aircraft manufacturers in the interests of (a) passengers; (b) society in general?
  3. Is collaboration between Boeing and Airbus in the interests of (a) passengers; (b) society in general?
  4. How is game theory relevant to the long-running disputes between Boeing and Airbus and to their relationships in the coming years?
  5. Would cheaper aircraft from China be in the interests of (a) passengers; (b) society in general?
  6. Explain what is meant by ‘strategic trade theory’. How is it relevant to aircraft manufacture?

The effects of the Brexit trade deal are becoming clearer as new data are released. Figures for UK food imports and exports from and to the EU for the first quarter of 2021 have been published by the Food and Drink Federation. These show a 46.6% fall in UK food and drink exports to the EU in Q1 2021 when compared with Q1 2020, and a 55.1% fall when compared with Q1 2019 (before COVID).

The dairy sector has been the hardest hit, with exports of milk and cream to the EU down by more than 90% and exports of cheese down by 67% compared with Q1 2020. Other hard-hit sectors have been soft drinks, fish, potatoes and chicken. (Click here for a PowerPoint of the following chart.)

The Brexit trade deal did not involve the imposition of tariffs on exports and imports. However, with the UK having left the EU single market, there are now many regulatory checks and a considerable amount of paperwork to be completed for each consignment of exports. These frictions are slowing down trade and adding to costs. Although food and drink exports are beginning to recover somewhat, the delays while formalities are completed will have a lasting dampening effect on exports to the EU, especially in the case of perishable goods, such as meat and fish.

Also, farming has been badly affected by labour shortages, with many EU citizens returning to the EU. For example, according to the British Poultry Council (BPC), 10 per cent fewer chickens had been produced since Easter because of worker shortages. Across meat processing generally, similar shortfalls are being recorded because of a lack of labour.

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Questions

  1. Find out how exports to the EU from sectors other than food and drink have fared since January this year.
  2. What are rules of origin? Why are they less likely to apply to food exports to the EU than to manufactured exports?
  3. Would you describe the Brexit trade deal (the EU-UK Trade and Cooperation Agreement) as a ‘free-trade’ deal? Explain.
  4. What are the particular difficulties for the food and drink sector in the Trade and Cooperation Agreement?
  5. Find out which parts of the food and drink sector have been particularly affected by labour shortages.

One of the major economic concerns about the COVID-19 pandemic has been the likely long-term scarring effects on economies from bankruptcies, a decline in investment, lower spending on research and development, a loss of skills, discouragement of workers, disruption to education, etc. The result would be a decline in potential output or, at best, a slower growth. These persistent effects are known as ‘hysteresis’ – an effect that persists after the original cause has disappeared.

In a speech by Dave Ramsden, the Bank of England’s Deputy Governor for Markets & Banking, he argued that, according to MPC estimates, the pandemic will have caused a loss of potential output of 1.75%. This shortfall may seem small at first sight, so does it matter? According to Ramsden:

The answer is definitely yes for two reasons. First, a 1¾% shortfall as a share of annual GDP for the UK … represents roughly £39 billion – for context, that’s about half of the education budget. And second, that 1¾% represents a permanent shortfall, or at least a very persistent one, on top of the impact of the immediate downturn. If you lose 1¾% of GDP every year for ten years, then in total you have lost 17.5% of one year’s GDP, or around £390bn in 2019 terms

However, as the IMF blog linked below argues, there may be positive supply-side effects which outweigh these scarring effects, causing a net rise in potential GDP growth. There are two possible reasons for this.

The first is that the pandemic may have hastened the process of digitalisation and automation. Examples include ‘video conferencing and file sharing applications to drones and data-mining technologies’. According to evidence from a sample of 15 countries cited in the blog, a 10% rise in such intangible capital investment is associated with about a 4½% rise in labour productivity. ‘As COVID-19 recedes, the firms which invested in intangible assets, such as digital technologies and patents may see higher productivity as a result.’

The second is a reallocation of workers and capital to more productive sectors. Firms in some sectors, such as leisure, hospitality and retail, have relatively low labour productivity. Many parts of these industries have declined during the pandemic, especially those with high labour intensity. At the same time, there has been a rise in employment in firms where output per worker is higher. Such sectors include e-commerce and those where remote working is possible. The greater the reallocation from low labour-productivity to high labour-productivity sectors, the more will overall labour productivity rise and hence the more will potential output increase.

The size of these two effects will depend to a large extent on expectations, incentives and government policy. The blog cites four types of policy that can help investment and reallocation.

  • Improved insolvency and restructuring procedures to enable capital in failed firms to be reallocated to sectors with potential for growth.
  • Promoting competition to enable the exit and entry of firms into expanding sectors and to prevent powerful firms from blocking the process.
  • Refocusing policy from retaining labour in existing jobs to reskilling workers for new jobs, thereby improving labour mobility from declining to expanding sectors.
  • Addressing financial bottlenecks, so as to ensure adequate access to financing for viable firms.

Whether there will be a net increase or decrease in productivity from the pandemic very much depends on the extent to which firms and workers are able and willing to take advantage of new opportunities and the extent to which government supports investment in and reallocation to high-productivity sectors.

Blogs, articles and speeches

Questions

  1. Can actual economic growth be greater than potential economic growth (a) in the short run; (b) in the long run?
  2. Give some example of scarring effects from the COVID-19 pandemic.
  3. What effects might short-term policies to tackle the recession caused by the pandemic have on longer-term potential economic growth?
  4. What practical policies could governments adopt to encourage the positive supply-side effects of the pandemic? To what extent would these policies have negative short-term effects?
  5. Why might (endogenous) financial crises result in larger and more persistent reductions in potential output than exogenous crises, such as a pandemic or a war?
  6. Distinguish between interventionist and market-orientated supply-side policies to encourage the reallocation of labour and capital to higher-productivity sectors.

At a meeting of the G7 finance ministers in London from 4–5 June, it was agreed to adopt a minimum corporate tax rate of 15% and to take measures to prevent multinational companies using tax havens to avoid paying taxes. It was also agreed that part of the taxes paid should go to the countries where sales are made and not just to those where the companies are based.

This agreement is the first step on the road to a comprehensive global agreement. The next step is a meeting of the finance ministers and central bank governors of the G20 countries in Venice from 9 to 10 July. The G7 ministers hope that their agreement will be adopted by this larger group, which includes other major economies such as Russia, China, India, Brazil, Australia, South Korea and South Africa.

Later in July, the proposals will be put to a group of 139 countries and jurisdictions at a meeting co-ordinated by the OECD. It is hoped that this meeting will finalise an international agreement with precise details on corporate tax rules. It follows work by the OECD on reforming international taxation under its Framework on Base Erosion and Profit Shifting (BEPS).

These meetings follow growing concerns about the ability of multinational companies to avoid taxes by basing regional headquarters in low-tax countries, such as Luxembourg or Singapore, and declaring their profits there, despite having only a tiny proportion of their sales in these countries.

The desire to attract multinational profits has led to a prisoners’ dilemma situation, whereby countries have been competing against each other to offer lower taxes, even though it reduces global corporate tax revenues.

With many countries having seen a significant rise in government deficits as result of the COVID-19 pandemic and the support measures put in place, there has been a greater urgency to reach international agreement on corporate taxes. The G7 agreement, if implemented, will provide a significant increase in tax revenue.

Details of the G7 agreement

The agreement has two parts or ‘pillars’.

Pillar 1 allows countries to tax large multinationals earning global profits of more than 10% if these companies are not based there but earn revenues there. Countries will be given tax rights over at least 20% of the profits earned there which exceed the 10% margin. The level of profits determined for each country will be based on the proportion of revenues earned there.

Pillar 2 sets a minimum corporate tax rate of 15% for each of the seven countries, which call on other countries to adopt the same minimum. The hope is that the G20 countries will agree to this and then at the OECD meeting in July a global agreement will be reached. If a country chooses to charge a rate below 15%, then a top-up tax can be applied by the home country to bring the total rate up to the 15%.

It is possible that these proposals will be strengthened/amended at the G20 and OECD meetings. For example, the 15% minimum rate may be raised. Indeed, the USA had initially proposed a 25% rate and then 21%, and several EU countries such as France, have been pushing for a substantially higher rate.

Analysis

The agreement was hailed as ‘historic’ by Rishi Sunak, the UK Chancellor of the Exchequer. This is true in that it is the first time there has been an international agreement on minimum corporate tax rates and locating part of tax liability according to sales. What is more, the rules may be strengthened at the G20 and/or OECD meetings.

There have been various criticisms of the agreement, however. The first is that 15% is too low and is well below the rates charged in many countries. As far as the UK is concerned, the IPPR think tank estimates that the deal will raise £7.9bn whereas a 25% rate would raise £14.7bn.

Another criticism is that the reallocation of some tax liabilities to countries where sales are made rather than where profits are booked applies only to profits in excess of 10%. This would therefore not affect companies, such as Amazon, with a model of large-scale low-margin sales and hence profits of less than 10%.

Also there is the criticism that a 20% reallocation is too low and would thus provide too little tax revenue to poor countries which may record large sales but where little or no profits are booked.

The UK was one of the more reluctant countries to sign up to a deal that would have a significant impact on tax havens in various British overseas territories and crown dependencies, such as the British Virgin islands, Bermuda, the Cayman Islands, the Channel Islands and Isle of Man. The agreement also calls into question whether the announced UK freeports can go ahead. Although these are largely concerned with waiving tariffs and other taxes on raw materials and parts imported into the freeport, which are then made into finished or semi-finished products within the freeport for export, they are still seen by many as not in the spirit of the G7 agreement.

What is more, the UK has been pushing for financial services to be exempted from Pillar 1 of the deal, which would otherwise see taxes partly diverted from the UK to other countries where such firms do business. For example, HSBC generates more than half its income from China and Standard Chartered operates mostly in Asia and Africa.

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Questions

  1. How are multinationals currently able to avoid paying corporate taxes in many countries, even though their sales may be high there?
  2. If the deal is accepted at the OECD meeting in July, would it still be in the interests of low-tax countries to charge tax rates below the agreed minimum rate?
  3. Why was the UK reluctant to accept the 21% rate proposed by the Biden administration?
  4. Find out about the digital services tax that has been adopted by many countries, including EU countries and the UK, and why it will be abolished once a minimum corporate tax comes into force.
  5. Argue the case for and against taxing the whole of multinational profits in countries where they earn revenue in proportion to the company’s total global revenue. Would such a system benefit developing countries?
  6. Should financial services, such as those provided by City of London firms, be exempted from the deal?

The OECD has recently published its six-monthly Economic Outlook. This assesses the global economic situation and the prospects for the 38 members of the OECD.

It forecasts that the UK economy will bounce back strongly from the deep recession of 2020, when the economy contracted by 9.8 per cent. This contraction was deeper than in most countries, with the USA contracting by 3.5 per cent, Germany by 5.1 per cent, France by 8.2 per cent, Japan by 4.7 per cent and the OECD as a whole by 4.8 per cent. But, with the success of the vaccine roll-out, UK growth in 2021 is forecast by the OECD to be 7.2 per cent, which is higher than in most other countries. The USA is forecast to grow by 6.8 per cent, Germany by 3.3 per cent, France by 5.8 per cent, Japan by 2.6 per cent and the OECD as a whole by 5.3 per cent. Table 1 in the Statistical Annex gives the figures.

This good news for the UK, however, is tempered by some worrying features.

The OECD forecasts that potential economic growth will be negative in 2021, with capacity declining by 0.4 per cent. Only two other OECD countries, Italy and Greece, are forecast to have negative potential economic growth (see Table 24 in the Statistical Annex). A rapid increase in aggregate demand, accompanied by a decline in aggregate supply, could result in inflationary pressures, even if initially there is considerable slack in some parts of the economy.

Part of the reason for the supply constraints are the additional barriers to trade with the EU resulting from Brexit. The extra paperwork for exporters has added to export costs, and rules-of-origin regulations add tariffs to many exports to the EU (see the blog A free-trade deal? Not really). Another supply constraint linked to Brexit is the shortage of labour in certain sectors, such as hospitality, construction and transport. With many EU citizens having left the UK and not being replaced by equivalent numbers of new immigrants, the problem is likely to persist.

The scarring effects of the pandemic present another problem. There has been a decline in investment. Even if this is only temporary, it will have a long-term impact on capacity, unless there is a compensating rise in investment in the future. Many businesses have closed and will not re-open, including many High Street stores. Moves to working from home, even if partially reversed as the economy unlocks, will have effects on the public transport industry. Also, people may have found new patterns of consumption, such as making more things for themselves rather than buying them, which could affect many industries. It is too early to predict the extent of these scarring effects and how permanent they will be, but they could have a dampening effect on certain sectors.

Inflation

So will inflation take off, or will it remain subdued? At first sight it would seem that inflation is set to rise significantly. Annual CPI inflation rose from 0.7 per cent in March 2021 to 1.5 per cent in April, with the CPI rising by 0.6 per cent in April alone. What is more, the housing market has seen a large rise in demand, with annual house price inflation reaching 10.2 per cent in March.

But these rises have been driven by some one-off events. As the economy began unlocking, so spending rose dramatically. While this may continue for a few months, it may not persist, as an initial rise in household spending may reflect pent-up demand and as the furlough scheme comes to an end in September.

As far as as the housing market is concerned, the rise in demand has been fuelled by the stamp duty ‘holiday’ which exempts residential property purchase from Stamp Duty Land Tax for properties under £500 000 in England and Northern Ireland and £250 000 in Scotland and Wales (rather than the original £125 000 in England and Northern Ireland, £145 000 in Scotland and £180 000 in Wales). In England and Northern Ireland, this limit is due to reduce to £250 000 on 30 June and back to £125 000 on 30 September. In Scotland the holiday ended on 31 March and in Wales is due to end on 30 June. As these deadlines are passed, this should see a significant cooling of demand.

Finally, although the gap between potential and actual output is narrowing, there is still a gap. According to the OECD (Table 12) the output gap in 2021 is forecast to be −4.6 per cent. Although it was −11.4 per cent in 2020, a gap of −4.6 per cent still represents a significant degree of slack in the economy.

At the current point in time, therefore, the Bank of England does not expect to have to raise interest rates in the immediate future. But it stands ready to do so if inflation does show signs of taking off.

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Data, Forecasts and Analysis

Questions

  1. What determines the rate of (a) actual economic growth; (b) potential economic growth?
  2. What is meant by an output gap? What would be the implications of a positive output gap?
  3. Why are scarring effects of the pandemic likely to be greater in the UK than in most other countries?
  4. If people believed that inflation was likely to continue rising, how would this affect their behaviour and how would it affect the economy?
  5. What are the arguments for and against having a stamp duty holiday when the economy is in recession?