US embassy cable - 05OTTAWA2352

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