Airbus versus Boeing revisited: international competition in the aircraft market

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Airbus versus Boeing revisited: international competition in the aircraft market

Douglas A. Irwin and Nina Pavcnik

One of the recurring trade disputes between the United States and Europe concerns the rivalry between Airbus and Boeing in the market for wide-body aircraft. Airbus first began production of aircraft in the early 1970s with substantial financial assistance from European governments. As Airbus succeeded in making inroads into many of Boeing's markets, Boeing alleged that Airbus benefited from unfair subsidies and has pressured US trade authorities to counteract Europe's financial support. As a result, the United States and European Community signed an agreement on trade in civil aircraft in 1992 that limited government subsides for aircraft production. This agreement, however, has come under new strain as Airbus introduces the A-380 super-jumbo aircraft designed to compete directly against the Boeing 747.

This paper has taken an empirical look at international competition and trade disputes in the wide-body aircraft market. We began by estimating the demand for wide-body aircraft and firm markups under various assumptions on the mode of competition. This exercise yields several insights into the wide-body aircraft market. First, we find evidence of significant market segmentation between the medium- and long-range wide-body planes, consistent with the anecdotal evidence on the near monopoly position enjoyed by the Boeing 747 in the long-range market until the early 1990s. Second, despite the small number of firms in the industry, market competition has intensified (we estimate higher demand elasticities and lower markups over time), especially with the entry of new aircraft varieties. Third, the markup estimates implied by the Bertrand and Cournot competition are relatively similar. This might be explained by the growing presence of multi-product firms in the industry. As producers expand the range of products, their incentive to aggressively underbid their rivals is diminished, since price cuts might also hurt their own sales of other products. Fourth, the presence of multi-product firms makes it more challenging for the aircraft companies to successfully introduce new aircraft without hurting their existing product line.

Given that the aircraft industry continues to be the source of trade friction between the United States and the European Union, we evaluated two key trade issues. We find evidence that the 1992 US–EU agreement to limit subsidies resulted in higher aircraft prices. Although we cannot say anything about the magnitude of the government development subsidies that have helped aircraft producers to launch their products, our evaluation of the 1992 agreement suggests the observed price increases after the agreement are consistent with increases in firms' marginal costs by about 5%. We also predict that the introduction of the Airbus A-380 will substitute most strongly for existing Airbus aircraft rather than the Boeing 747, although the negative impact on demand for the 747 is not negligible. The extent of this substitution depends critically on the price discounts that Airbus offers on the A-380.

Nevertheless, many questions remain unanswered. Most importantly, without more detailed information on production cost, we also cannot address the issues of strategic trade policy that are more dynamic in nature such as the role of government subsidies to promote the aircraft market entry.

Competition in the wide-bodied aircraft industry has attracted attention not just because of the controversy surrounding the Airbus subsidies, but because of the industry's unusual market structure, in which economies of scale are enormous relative to market demand. The aircraft sector provides a textbook example of an industry in which trade policy could affect the strategic interaction between a domestic and an international rival and shift profits in favor of the domestic firm, as proposed in Brander and Spencer's (1985) canonical model of strategic trade policy. Previous studies of the commercial aircraft market, notably Baldwin and Krugman (1988); Klepper, 1990 and Klepper, 1994; Neven and Seabright (1995), used calibrated simulations to analyze the competitive interaction of Airbus and Boeing. These simulations focused on Airbus's impact on the costs and profits of its competitors and on consumer surplus as a way of evaluating the welfare effects of Airbus's market presence.

This paper takes an empirical approach to examining international competition and trade disputes in the wide-body aircraft market. We employ Berry's (1994) method of estimating demand in an oligopoly market with differentiated products using data on commercial aircraft prices, sales, and characteristics from 1969 to 1998. 1 This approach provides us with estimates of price and cross-price elasticities of demand, which allow us to assess how closely related in demand various aircraft are. The demand system, combined with an assumptions on firms' market conduct and learning parameter in production, also yields estimates of price–cost markups, allowing us to determine whether competitive pressures have increased in this segment of the market as a result of Airbus's entry and Lockheed and McDonnell Douglas's exit., 2

We then focus on two aspects of the international rivalry between Airbus and Boeing. First, we examine whether the 1992 US–EU agreement on trade in civil aircraft limiting aircraft subsidies had a significant impact on pricing in the aircraft market. We find that the agreement appears to have raised the prices of both Airbus and Boeing aircraft by about 3.7% in the narrow- and wide-body market. Our structural model and estimates of the wide-body market suggest that these price increases are consistent with about 5% rise in the marginal cost of production after the subsidy cuts. Second, we use our demand estimates to estimate the impact of the introduction of the A-380 on the prices and market shares of other wide-body aircraft, notably the Boeing 747. We find that the A-380 can be expected to have a significant negative effect on the prices and sales of the 747 within the wide-body market, but an even greater adverse effect on demand for Airbus's existing wide-body aircraft (the A-330 and A-340). This result highlights the fact that as Airbus and Boeing expand their product line over time, profit maximization by multi-product firms becomes more complicated as demand for a firm's existing models is sensitive to the price and characteristics of its new models.

2. Structural estimates of aircraft demand and markups

The market for aircraft is typically divided into two product categories: narrow-body and wide-body aircraft. Narrow-body aircraft are single aisle, short-range aircraft (up to 6000 km) that typically carry between 100 and 200 passengers. The leading aircraft in this category are the Boeing 737, the Boeing 757, and the Airbus A-320. Wide-body aircraft are double aisle, medium- to long-range aircraft (up to 14,000 km) that can carry between 200 and 450 passengers. The leading aircraft in this category are the Boeing 747, the Boeing 777, and the Airbus A-300. Within the wide-body market, planes also differ significantly in terms of their characteristics depending on whether they are aimed at serving the medium-range (i.e. Boeing 767, the Airbus A-300 and A-310, DC-10, and L-1011) or long-range market (i.e. Boeing 747 and 777, the Airbus A-330 and A-340, and the MD-11). As a result, we can view narrow-body, medium-range wide-body, and long-range wide-body aircraft as imperfect substitutes for one another because the planes are designed to serve different markets.

We focus mainly on the wide-body segment of the industry in part because most of the international trade disputes have centered on competition in this product range. The increase in international travel since the 1970s has made this a rapidly growing segment of aircraft demand. The wide-body market has also been very profitable: the Boeing 747, for example, is said to account for as much as a third of Boeing's entire profits in certain years. As a result, Airbus, for example, entered the aircraft market in this segment with the A-300 in 1974, and only later began competing in the narrow-body market with the launch of the A-320 in 1988. There are fewer product lines in wide-body segment of the market, and the number of aircraft sold is much smaller than in narrow-body segment. The cumulative output of the best selling wide-body Boeing 747 has only reached about 1185 units in 1998 (it was introduced in 1969), and the best selling Airbus aircraft A-300 sold only 481 units between 1974 and 1998. As a result, competition tends to be more intense in the wide-body market, since from the firm's perspective, each additional sale generates valuable revenue. In contrast, narrow-body planes often sell well above 1000 units over their lifespan, with Boeing 737 selling over 3200 units until 1998.

Aspects of Airbus–Boeing competition

The structural estimates from the previous section can be used to explore the impact of two important events: (1) the 1992 agreement between the United States and European Community regarding subsidies and competition in the aircraft production, and (2) the entry of the A-380, Airbus's new wide-body that aims to compete directly with the Boeing 747.

3.1. Impact of the 1992 agreement

Following the trade tensions between the United States and the European Union surrounding the subsidized entry of the A-300 in the early 1970s, the rivalry between Boeing and Airbus intensified considerably after Airbus introduced the narrow-body A-320 in the mid-1980s. After Air India cancelled an order for Boeing 757s when Airbus offered steep discounts on the A-320, the US government intervened on Boeing's behalf. The United States threatened using the countervailing duty laws or opening a Section 301 case against Airbus unless an agreement on subsidies was reached. In 1992, the United States and European Community reached a bilateral agreement on trade in civil aircraft (see Pavcnik, 2002 and Tyson, 1992). The agreement establishes limits on the direct and indirect (military) subsidies used to finance the development of new aircraft. The maximum allowed direct subsidy is 33% of development costs. In addition to development subsidies, governments also provide assistance to domestic producers through measures that might affect variable cost of production. As a result, the agreement has several provisions that affect the variable production cost of aircraft and might thus affect pricing in the aircraft market. For example, the agreement prohibits production subsidies and restricts the government's ability to help the domestic aircraft producer offer financing to airlines. The agreement also requires detailed reporting on subsidies, interest rates, and repayment conditions, and establishes procedures to monitor the agreement. Finally, the agreements repayment provision requires that Airbus make repayments on a per-plane basis rather than delay repayment until the end of the loan, reducing the incentive for Airbus to cut price significantly to capture certain sales.

The unanswered question is whether the 1992 bilateral agreement had any impact on pricing in the aircraft market. In particular, one would a priori expect the agreement to increase prices because the agreements provision on financing, production subsidies, and repayments of the loan implicitly increase the marginal cost of an aircraft. Although we can never truly identify the effect of the 1992 US–EU agreement on aircraft prices, our data enable us to compare the aircraft prices before and after the agreement. We thus regress aircraft prices (in logs) on a dummy variable set at unity from 1992 and other potential determinants of price. We control for other time-varying factors that could affect the pricing of aircraft through the inclusion of GDP growth, price of petroleum, market segment Herfindahl index, and a time trend. Product fixed effects control for the differences in characteristics across aircraft that affect pricing., 18 Since the estimated coefficients are not statistically different from each other when we estimate the separate narrow- and wide-body market segment separately, we pool the data from both market segments to gain efficiency. We restrict our analysis to data from 1985 onwards so that we have equal number of time periods before and after the treaty.

The results:

The coefficients on the treaty indicator suggest that prices of aircraft have on average increased after the 1992 US–EU trade agreement. The estimates range from 9.4% to 3.7% as we add controls for other time-varying factors that could independently affect prices such as market concentration captured by Herfindahl index GDP growth and price of petroleum , a time trend, and all of the above controls . We allow the treaty to have a differential impact on Airbus's pricing by interacting the treaty indicator with the Airbus indicator. Our results suggest that the agreement did not have a statistically differential impact on the pricing of Airbus.

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