BOMBARDIER AND THE WORLD AIRCRAFT SUBSIDIES GAME

UNCLAS SECTION 01 OF 04 OTTAWA 003095

SIPDIS

SENSITIVE

STATE FOR WHA/CAN - BREESE AND HOLST

STATE PASS USTR FOR CHANDLER

USDOC FOR 4320/OFFICE OF NAFTA/GWORD/TFOX;
3134/OIO/WESTERN HEMISPHERE

PARIS FOR USOECD

E.O. 12958: N/A
TAGS: ETRD EIND EINV EAIR CA
SUBJECT: BOMBARDIER AND THE WORLD AIRCRAFT SUBSIDIES GAME

REF: OTTAWA 822

SUMMARY/INTRODUCTION
--------------


1. (U) SENSITIVE, BUT UNCLASSIFIED. NOT FOR
DISTRIBUTION OUTSIDE USG CHANNELS.


2. (U) This report outlines an increasingly
significant part of the backdrop to large aircraft
subsidies issues: Canada-based Bombardier Aerospace
and the future of the market for commercial jets
carrying 100 to 130 passengers. While these
airliners are at the smallest end of the product
ranges offered by Boeing and Airbus, they are
sufficiently large to be covered by the OECD Large
Aircraft Sector Understanding - LASU. Brazil's
Embraer is already in this market with models of
around 108 seats. Bombardier's proposed "C series"
aircraft, if it proceeds, would offer 110 to 130
seats.


3. (U) Bombardier announced in May 2005 that final
assembly of its proposed "C series" aircraft (if
built) 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 major
venture by Bombardier into the 100-seat-and-up
product range, and a further escalation of its
decade-long competition with Embraer in regional
jets.


4. (SBU) Bombardier's political connections in
Canada are legendary. In a bitter dispute (1996-
2001) with Embraer, the GOC proved willing to play
hardball to support the company in WTO trade
litigation and in the market. Bombardier's domestic
critics are unable to calculate the economic value
of this support, particularly on the export
financing side, due to lack of data. Bombardier and
its suppliers account for some 30,000 jobs, many of
them in politically crucial constituencies around
Montreal. Moreover, Canada can afford to continue
this support. END SUMMARY/INTRODUCTION.

THE COMPANY
--------------


5. (U) 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
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 1940s.
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 as a rationale for
direct government support.


6. (U) Bombardier - which pioneered the snowmobile
in the early twentieth century and later expanded to
motorcycles, boats and rail/subway systems - claims
to be the world's largest manufacturer of railway
rolling stock (which it admits is a risky and not
very profitable business, with margins only around
2.6 percent). Since July, its rail division has
announced over US$800 million worth of contracts in
Europe, the United States and Mexico. Bombardier
entered aerospace in the 1990s 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 1990s toward
the use of 50-to-70-seat regional jets on inter-city
routes in North America. While profits in this
business have slumped along with that in airlines
since 2001, Bombardier's private and business jet
products/services (which include Flexjet and
Learjet) have prospered.

7. (U) Bombardier's current commercial offerings,
all 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
--------------


8. (SBU) 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 loan repayment are necessarily
long, and Industry Minister David Emerson has
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. There is little publicly available
information on the terms of these loans, as the GOC
considers this commercially sensitive information.
An ongoing lobbying scandal pushed Emerson to
announce on September 20 that TPC will be
restructured into the "Transformative Technologies
Program" (TTP). The Canadian Taxpayers Federation
(a vocal critic of TPC and Bombardier -- 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 had already 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 a promise of C$118
million for the C Series),equity guarantees to
aircraft buyers, and other measures such as
infrastructure investment (constructing buildings,
usually in or around Montreal's two airports, and
leasing them to the company),worker training and
tax holidays.

THE BATTLE WITH BRAZIL
--------------


9. (U) 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 1990s 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.


10. (U) Bombardier first enlisted the GOC to
complain to Brazil about Proex in the mid-1990s,
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, to be illegal.


11. (U) 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).


12. (SBU) 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, provoking
widespread bitterness in Brazil) scuttled any
prospect of Canada-Brazil collaboration on wider
trade policy goals such as hemispheric free trade.


13. (U) 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
--------------


14. (SBU) In our view, two key sets of questions hang
over the market for commercial aircraft seating 100 to
130 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?


15. (SBU) 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