A 2001 order for 75 Bombardier Inc. regional jets from tiny Air Wisconsin doesn’t exactly seem like an industry-shaking coup, but it was at the time.
Air Wisconsin had chosen Bombardier over Brazil’s Embraer SA, a victory that occurred in the midst of a seven-year battle between the two over government subsidies. Tensions were running high and the dispute escalated well beyond the aerospace sector, with Canada and Brazil engaging in a volley of complaints and counter-complaints at the World Trade Organization (WTO).
Canada banned imports of Brazilian beef, ostensibly over mad-cow disease fears. That sparked boycotts of Canadian goods in Brazil and President Fernando Cardoso threatened a trade “war,” forcing Canada to backtrack on the beef ban.
The two countries reached an uneasy truce in 2003, but the issue of subsidies never really went away. Now a senior Embraer executive is alleging that Bombardier was only able to win a major CSeries order from Delta Air Lines Inc. in April because of potentially illegal government subsidies, and is threatening to get Brazil to take the issue to the WTO.
It appears that Bombardier, after securing orders for its oft-troubled CSeries jet from Delta and Air Canada, is suddenly looking a lot more threatening to its competitors. And with the federal government continuing to weigh Bombardier’s request for US$1 billion in funding, matching an investment promised by Quebec, the question of government support is raising its ugly head again — just as it did in 2001 when Bombardier beat Embraer on the Air Wisconsin deal.
Government support, of course, is nothing new in the aerospace industry. All aircraft manufacturers receive taxpayer aid in one form or another. Even the mighty Boeing Co. and Airbus Group SE have a lengthy history of trade disputes over various subsidies.
Canada is no different: Export Development Canada (EDC) has long supported Bombardier’s exports by offering financing to its airline customers, and the company has received plenty of government assistance through programs such as Technology Partnerships Canada (TPC) and its successor, the Strategic Aerospace and Defence Initiative (SADI), not to mention a variety of aid at the provincial level from Quebec.
Embraer, meanwhile, has won orders by using a Brazilian subsidy program called ProEx, which offered Embraer customers low-cost financing through significant interest-rate discounts.
Bombardier and Embraer were mad enough at each other in early 1997 that they threatened to take each other to the WTO over government subsidies. Things escalated later that year when Bombardier was awarded a $2.85-billion North Atlantic Treaty Organization (NATO) training contract that required aircraft the company couldn’t supply itself.
You want to go into this battle armed; you don’t just want to be on the defence
Bombardier strongly hinted that it would choose Embraer’s Super Tucano, but eventually went with U.S.-based Raytheon Co.’s Texan II instead, citing “technical reasons.”
Brazil was outraged and said it would “review all Canadian aeronautics industry projects” in the country and ask for the suspension of free-trade negotiations between Canada and Mercosur, a Latin American bloc.
In the meantime, Embraer with ProEx financing continued to siphon market share from Bombardier with its new ERJ family of regional jets that competed directly with the Canadian company’s CRJ.
To de-escalate the situation, Canada and Brazil agreed to appoint two envoys — former Canadian cabinet minister Marc Lalonde and Brazil’s Luis Olavio Baptista — to put together a series of recommendations.
Lalonde and Baptista called on the two countries to negotiate a bilateral agreement that would set a benchmark for government support of the aerospace industry, but that was flatly rejected.
Lalonde blames this on Brazil’s government at the time.
“My Brazilian colleague and I thought … that we had put forward what was a reasonable proposition, but, as you may know, sometimes in politics reason does not prevail,” Lalonde, 86, said in an interview from his home in Montreal.
“The signals I had from the Canadian government were that they were satisfied with the report and they were willing to proceed with it,” but Brazil rejected the suggestion.
Instead, both countries by 1998 had filed official complaints at the WTO: Canada accused Brazil of offering illegal subsidies on aircraft sales through ProEx, and Brazil charged that EDC and TPC were unfair forms of government support.
Although ProEx and its successor, ProEx 2, were both found by the WTO to be illegal, Brazil kept tweaking the program rather than eliminating it.
By the time the Air Wisconsin deal was up for grabs in 2001, ProEx 3 was in place and Bombardier was fed up. It convinced Canada to match the interest-rate discount offered by Brazil, even though it knew it might violate WTO trade rules by doing so.
“The problem was that we knew we were going to lose the deal, so what Ottawa decided to do was to match Brazil,” said a former Bombardier executive who was involved in the lengthy dispute.
After Bombardier won the Air Wisconsin deal, Brazil immediately took Canada to the WTO to challenge the interest-rate discount that was offered.
“It was the same rate (Embraer) offered. It was identical,” said the former executive, who asked not to be named. “In fact, the Canadian government sent two diplomats to Appleton, Wisconsin, and made Air Wisconsin sign a letter saying the terms and conditions offered by Canada are no more favourable than those of Brazil, but then Brazil goes to the WTO and cries bloody murder.”
The stakes are exceptionally high
Another order from Northwest Airlines (since merged with Delta) followed, and Bombardier won that one too by again matching Brazil’s interest-rate discount.
The WTO eventually ruled in 2002 that both countries had broken trade rules. It awarded Brazil the right to retaliate against Canada with US$248 million of countermeasures — a significant amount, but one that paled in comparison to the US$1.4 billion in retaliatory rights it had granted to Canada.
“We felt pretty good about those results, but we knew that from a public relations point of view we could never get that story out there because it was all about, ‘Aha, you see, you were subsidizing too,’” the former Bombardier executive said. “But we frankly didn’t care because we got the order.”
Today, as Embraer raises the spectre of another WTO challenge, both countries might want to ask themselves whether another battle is worth the effort.
“The stakes are exceptionally high,” said Matthew Kronby, the Government of Canada’s lead counsel during the last Brazilian trade battle and now a partner at Bennett Jones. “These (aerospace) cases really do take an enormous amount of time to resolve, far longer than the average WTO dispute.”
Generally speaking, a country that wins a trade dispute in the WTO is granted the right to retaliate with countermeasures, but these often hurt consumers in the winning company’s homeland as much as they hurt the losing side, according to the former Bombardier executive.
“The problem with countermeasures is what do you want to look at? Do you want to tax Brazilian imported fruit juice? Do you want to tax imported leather goods?” he asked. “There was no way to apply the countermeasures without contaminating other sectors of the economy.”
That’s a big reason why back in 2002, neither country applied its retaliation rights and instead went back to the negotiating table to work out a bilateral agreement on government support for aircraft sales — just like Lalonde and Baptista had urged.
The first test of this was a regional jet order from Air Canada in 2003 that was split evenly between Bombardier and Embraer, with the airline ordering 45 planes from each manufacturer.
With this outcome, one can’t help but feel that all the WTO wrangling was pointless.
“The WTO has not succeeded and obviously has not been the instrument chosen by any of the concerned countries to really deal with this matter,” Lalonde said.
In the long run, the best outcome that can be hoped for is pressure to settle the dispute at the negotiating table, Kronby said.
But that’s a long-term game, and doesn’t reverse the orders that are won in the meantime.
“The whole experience led to a more market-oriented and collaborative behaviour on the part of Brazil, but remember, that’s only after they got 1,100 aircraft into the market with below-market financing,” said the Bombardier executive.
Now it seems Embraer is worried Bombardier could turn the tables again with its CSeries.
At issue is Delta’s recent order for 75 CS100 aircraft with options for 50 more, planes that Embraer’s president of commercial aviation believes were sold below cost. Embraer said it competed “very aggressively” for the Delta order with its E190 jet.
“According to our experience in this campaign with Delta, clearly what was offered there was only possible because of the huge support coming from the government,” Paulo Cesar de Souza e Silva told trade publication Air Transport World last month.
Embraer did not respond to requests for further comment.
Bombardier spokeswoman Marianella de la Barrera pointed out that the company has yet to actually receive any investments from Quebec City or Ottawa.
The Quebec government is still negotiating the terms of its contribution, with a deal expected by the end of June, while the federal government has not yet agreed to provide any support.
“All our commercial aircraft transactions are 100-per-cent compliant with WTO rules,” she said.
A spokesman for Innovation, Science and Economic Development Canada said the government “will ensure that any assistance will comply with international obligations.”
Delta chief executive Ed Bastian said at the time the order was announced that the promised funding from Quebec “gave us a lot of confidence to be able to step forward and make the decision.”
However, trade lawyers say it’s unlikely that Brazil would be able to mount a successful WTO challenge of the proposed aid, for which Quebec will get a 49.5-per-cent stake in the CSeries program.
“What Embraer is trying to do is … create uncertainty around the Bombardier product. That’s what this is all about,” said Lawrence Herman, an international trade lawyer with a practice in Toronto.
“It’s a shot across the bow and whether it has any merit at this stage, other than just sabre-rattling, is far from certain.”
The former Bombardier executive agreed Embraer is likely trying to raise further questions about the viability of the CSeries program, which has already been beset by delays, cost overruns and a lengthy order drought.
“Talk is cheap,” he said. “It’s the least expensive way you have to try to cast some level of doubt on the competitor’s program.”
In order to successfully challenge Bombardier’s government support this time around, Embraer would have to prove that it was the main reason why it lost the Delta order to Bombardier, Kronby said. It would also have to show that the funding meets the definition of an illegal subsidy, which it probably wouldn’t because the Quebec government plans to take an equity stake in return.
If Embraer persuades the Brazilian government to mount a WTO challenge, it can also expect a quick Canadian counter-attack.
“I would expect that Canada is examining very carefully what sort of support Embraer is continuing to receive,” Kronby said. “You want to go into this battle armed; you don’t just want to be on the defence.”