Airbus versus Boeing revisited: international competition in the aircraft market

Douglas A. Irwin and Nina Pavcnik

One of the recurring trade disputes between the nited !tates and "urope concerns the rivalr# between Airbus and Boeing in the market for wide$bod# aircraft. Airbus first began production of aircraft in the earl# %&'(s with substantial financial assistance from "uropean governments. As Airbus succeeded in making inroads into man# of Boeing)s markets* Boeing alleged that Airbus benefited from unfair subsidies and has pressured ! trade authorities to counteract "urope)s financial support. As a result* the nited !tates and "uropean +ommunit# signed an agreement on trade in civil aircraft in %&&, that limited government subsides for aircraft production. -his agreement* however* has come under new strain as Airbus introduces the A$./( super$0umbo aircraft designed to compete directl# against the Boeing '1'. -his paper has taken an empirical look at international competition and trade

disputes in the wide$bod# aircraft market. 2e began b# estimating the demand for wide$bod# aircraft and firm markups under various assumptions on the mode of competition. -his e3ercise #ields several insights into the wide$bod# aircraft market. 4irst* we find evidence of significant market segmentation between the medium$ and long$range wide$bod# planes* consistent with the anecdotal evidence on the near monopol# position en0o#ed b# the Boeing '1' in the long$range market until the earl# %&&(s. !econd* despite the small number of firms in the industr#* market competition has intensified 5we estimate higher demand elasticities and lower markups over time6* especiall# with the entr# of new aircraft varieties. -hird* the markup estimates implied b# the Bertrand and +ournot competition are relativel# similar. -his might be e3plained b# the growing presence of multi$product firms in the industr#. As producers e3pand the range of products* their incentive to aggressivel# underbid their rivals is diminished* since price cuts might also hurt their own sales of other products. 4ourth* the presence of multi$

product firms makes it more challenging for the aircraft companies to successfull# introduce new aircraft without hurting their e3isting product line. 7iven that the aircraft industr# continues to be the source of trade friction between the nited !tates and the "uropean nion* we evaluated two ke# trade issues. 2e find evidence that the %&&, !8" agreement to limit subsidies resulted in higher aircraft prices. Although we cannot sa# an#thing about the magnitude of the government development subsidies that have helped aircraft producers to launch their products* our evaluation of the %&&, agreement suggests the observed price increases after the agreement are consistent with increases in firms) marginal costs b# about 9:. 2e also predict that the introduction of the Airbus A$./( will substitute most strongl# for e3isting Airbus aircraft rather than the Boeing '1'* although the negative impact on demand for the '1' is not negligible. -he e3tent of this substitution depends criticall# on the price discounts that Airbus offers on the A$./(.

Nevertheless* man# ;uestions remain unanswered. <ost importantl#* without more detailed information on production cost* we also cannot address the issues of strategic trade polic# that are more d#namic in nature such as the role of government subsidies to promote the aircraft market entr#. +ompetition in the wide$bodied aircraft industr# has attracted attention not 0ust because of the controvers# surrounding the Airbus subsidies* but because of the industr#)s unusual market structure* in which economies of scale are enormous relative to market demand. -he aircraft sector provides a te3tbook e3ample of an industr# in which trade polic# 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 !pencer)s 5%&/96 canonical model of strategic trade polic#. Previous studies of the commercial aircraft market* notabl# Baldwin and =rugman 5%&//6> =lepper* %&&( and =lepper* %&&1> Neven

and !eabright 5%&&96* used calibrated simulations to anal#?e the competitive interaction of Airbus and Boeing. -hese simulations focused on Airbus)s impact on the costs and profits of its competitors and on consumer surplus as a wa# of evaluating the welfare effects of Airbus)s market presence. -his paper takes an empirical approach to e3amining international competition and trade disputes in the wide$bod# aircraft market. 2e emplo# Berr#)s 5%&&16 method of estimating demand in an oligopol# market with differentiated products using data on commercial aircraft prices* sales* and characteristics from %&@& to %&&/. % -his approach provides us with estimates of price and cross$price elasticities of demand* which allow us to assess how closel# related in demand various aircraft are. -he demand s#stem* combined with an assumptions on firms) market conduct and learning parameter in production* also #ields estimates of price8cost markups* allowing us to determine whether competitive pressures have increased in this segment of the market as a result of

Airbus)s entr# and Aockheed and <cDonnell Douglas)s e3it.* , 2e then focus on two aspects of the international rivalr# between Airbus and Boeing. 4irst* we e3amine whether the %&&, !8" agreement on trade in civil aircraft limiting aircraft subsidies had a significant impact on pricing in the aircraft market. 2e find that the agreement appears to have raised the prices of both Airbus and Boeing aircraft b# about ..': in the narrow$ and wide$bod# market. Our structural model and estimates of the wide$bod# market suggest that these price increases are consistent with about 9: rise in the marginal cost of production after the subsid# cuts. !econd* we use our demand estimates to estimate the impact of the introduction of the A$./( on the prices and market shares of other wide$bod# aircraft* notabl# the Boeing '1'. 2e find that the A$ ./( can be e3pected to have a significant negative effect on the prices and sales of the '1' within the wide$bod# market* but an even greater adverse effect on demand for Airbus)s e3isting wide$bod# aircraft 5the A$ ..( and A$.1(6. -his result highlights the

fact that as Airbus and Boeing e3pand their product line over time* profit ma3imi?ation b# multi$product firms becomes more complicated as demand for a firm)s e3isting models is sensitive to the price and characteristics of its new models. ,. !tructural estimates of aircraft demand and markups -he market for aircraft is t#picall# divided into two product categories: narrow$bod# and wide$bod# aircraft. Narrow$bod# aircraft are single aisle* short$range aircraft 5up to @((( km6 that t#picall# carr# between %(( and ,(( passengers. -he leading aircraft in this categor# are the Boeing '.'* the Boeing '9'* and the Airbus A$.,(. 2ide$bod# aircraft are double aisle* medium$ to long$range aircraft 5up to %1*((( km6 that can carr# between ,(( and 19( passengers. -he leading aircraft in this categor# are the Boeing '1'* the Boeing '''* and the Airbus A$.((. 2ithin the wide$ bod# market* planes also differ significantl# in terms of their characteristics depending on whether the# are aimed at serving the medium$range 5i.e. Boeing '@'* the Airbus

A$.(( and A$.%(* D+$%(* and A$%(%%6 or long$range market 5i.e. Boeing '1' and '''* the Airbus A$..( and A$.1(* and the <D$ %%6. As a result* we can view narrow$bod#* medium$range wide$bod#* and long$range wide$bod# aircraft as imperfect substitutes for one another because the planes are designed to serve different markets. 2e focus mainl# on the wide$bod# segment of the industr# in part because most of the international trade disputes have centered on competition in this product range. -he increase in international travel since the %&'(s has made this a rapidl# growing segment of aircraft demand. -he wide$bod# market has also been ver# profitable: the Boeing '1'* for e3ample* is said to account for as much as a third of Boeing)s entire profits in certain #ears. As a result* Airbus* for e3ample* entered the aircraft market in this segment with the A$.(( in %&'1* and onl# later began competing in the narrow$ bod# market with the launch of the A$.,( in %&//. -here are fewer product lines in wide$bod# segment of the market* and the

number of aircraft sold is much smaller than in narrow$bod# segment. -he cumulative output of the best selling wide$ bod# Boeing '1' has onl# reached about %%/9 units in %&&/ 5it was introduced in %&@&6* and the best selling Airbus aircraft A$.(( sold onl# 1/% units between %&'1 and %&&/. As a result* competition tends to be more intense in the wide$bod# market* since from the firm)s perspective* each additional sale generates valuable revenue. In contrast* narrow$bod# planes often sell well above %((( units over their lifespan* with Boeing '.' selling over .,(( units until %&&/. Aspects of Airbus8Boeing competition -he structural estimates from the previous section can be used to e3plore the impact of two important events: 5%6 the %&&, agreement between the nited !tates and "uropean +ommunit# regarding subsidies and competition in the aircraft production* and 5,6 the entr# of the A$./(* Airbus)s new wide$bod# that aims to compete directl# with the Boeing '1'. ..%. Impact of the %&&, agreement

4ollowing the trade tensions between the nited !tates and the "uropean nion surrounding the subsidi?ed entr# of the A$ .(( in the earl# %&'(s* the rivalr# between Boeing and Airbus intensified considerabl# after Airbus introduced the narrow$bod# A$.,( in the mid$%&/(s. After Air India cancelled an order for Boeing '9's when Airbus offered steep discounts on the A$.,(* the ! government intervened on Boeing)s behalf. -he nited !tates threatened using the countervailing dut# laws or opening a !ection .(% case against Airbus unless an agreement on subsidies was reached. In %&&,* the nited !tates and "uropean +ommunit# reached a bilateral agreement on trade in civil aircraft 5see Pavcnik* ,((, and -#son* %&&,6. -he agreement establishes limits on the direct and indirect 5militar#6 subsidies used to finance the development of new aircraft. -he ma3imum allowed direct subsid# is ..: 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. 4or e3ample* the agreement prohibits production subsidies and restricts the government)s abilit# to help the domestic aircraft producer offer financing to airlines. -he agreement also re;uires detailed reporting on subsidies* interest rates* and repa#ment conditions* and establishes procedures to monitor the agreement. 4inall#* the agreements repa#ment provision re;uires that Airbus make repa#ments on a per$plane basis rather than dela# repa#ment until the end of the loan* reducing the incentive for Airbus to cut price significantl# to capture certain sales. -he unanswered ;uestion is whether the %&&, bilateral agreement had an# impact on pricing in the aircraft market. In particular* one would a priori e3pect the agreement to increase prices because the agreements provision on financing* production subsidies* and repa#ments of the loan implicitl# increase the marginal cost of an aircraft. Although we can never trul#

identif# the effect of the %&&, !8" agreement on aircraft prices* our data enable us to compare the aircraft prices before and after the agreement. 2e thus regress aircraft prices 5in logs6 on a dumm# variable set at unit# from %&&, and other potential determinants of price. 2e control for other time$var#ing factors that could affect the pricing of aircraft through the inclusion of 7DP growth* price of petroleum* market segment Berfindahl inde3* and a time trend. Product fi3ed effects control for the differences in characteristics across aircraft that affect pricing.* %/ !ince the estimated coefficients are not statisticall# different from each other when we estimate the separate narrow$ and wide$bod# market segment separatel#* we pool the data from both market segments to gain efficienc#. 2e restrict our anal#sis to data from %&/9 onwards so that we have e;ual number of time periods before and after the treat#. -he results: -he coefficients on the treat# indicator suggest that prices of aircraft have on

average increased after the %&&, !8" trade agreement. -he estimates range from &.1: to ..': as we add controls for other time$var#ing factors that could independentl# affect prices such as market concentration captured b# Berfindahl inde3 7DP growth and price of petroleum * a time trend* and all of the above controls . 2e allow the treat# to have a differential impact on Airbus)s pricing b# interacting the treat# indicator with the Airbus indicator. Our results suggest that the agreement did not have a statisticall# differential impact on the pricing of Airbus.