Subsidies in Aviation: The elusive flight towards fair competition

A380_on_ground_front_shotAlain Lumbroso, economist at the International Transport Forum

Subsidies in aviation are almost as old as air transport itself. Most if not all countries at one point or another have provided public funding to some parts of their aviation value chains, be it air carriers, airports or air navigation services such as air traffic control.

This year, much attention has been focused on three Gulf carriers. Their strong growth and increasing market share, especially between Europe and points east and south, has generated concern from competitors that they are being unjustly subsidised and thus distorting the marketplace. Is this a legitimate concern or simply old-fashioned protectionism?

Although each side makes an eloquent case in the ongoing debate, some arguments do not pass muster. For example, while operating in a labour union-free environment can certainly reduce costs, it is by no means a subsidy. Airports the world over receive generous public subsidies which are passed on to their customers, the airlines. Although airlines who hub at a subsidised airport benefit most from the subsidy, it’s tenuous to affirm that a specific airline gets a subsidy and not others. Likewise, benefits accorded under US bankruptcy laws to any company that places itself under its protection should not be considered a subsidy, nor should provisions in competition law that permit the issuance of anti-trust immunity to help companies perform better together. A key point to remember here is that sovereign jurisdictions have the right to set their own labour, fiscal, bankruptcy and competition policies and legislation and, of course, as they vary country by country, they will confer comparative advantages or disadvantages to companies operating in those countries.

As accusations fly back and forth, it’s worth considering what actually constitutes a legal subsidy in aviation. Or what constitutes a balanced and fair competitive landscape, often referred to as a “level playing field”. Or fair competition for that matter. Unfortunately, none of these terms are actually defined for aviation, and simply adopting a commonly-accepted definition from other sectors may be an effective intellectual shortcut but has no basis in law.

What constitutes an acceptable subsidy is clearly defined for other industries. For example, the General Agreement on Trade and Tariffs defines what a subsidy is for the international trade of goods, but it is mute on what constitutes a subsidy in air transport, or any other service for that matter. The General Agreement on Trade of Services has so far failed to define what constitutes a subsidy and, in any case, specifically excludes air transport services from the agreement. Thus, reasonable people can disagree on what constitutes fair competition, especially when no competition law is broken.

The Chicago Convention of 1944, the key legal foundation of international aviation, speaks of equality of opportunity but not equality of outcomes. In that respect, operating in a low cost, low-taxation, non-unionised environment is opened to all airlines operating in the Gulf, with the local carrier benefiting the most simply because it has a higher concentration of flights there. The Chicago Convention only makes a single mention of subsidies, in Article 54i, where it tasks the International Civil Aviation Organisation (ICAO) Council to collect and publish information about public subsidies in aviation but fails to put an obligation on countries to report them or to set any kind of boundaries as to which type of subsidies are permitted and which are not.

While much focus has been on monetary subsidies, one cannot discount the impact of public policies and how they can favour domestic carriers. A prime example of this is how nearly all countries in the world outlaw cabotage, meaning that the domestic market is reserved for domestic carriers only, or, in the EU, that the intra-EU market is reserved for EU carriers. This can be a significant advantage for US, EU, Chinese, Japanese and Canadian air carriers, while remaining meaningless for carriers from smaller countries. A second example is how a number of countries negotiate air services agreements in a way to try and favour their home carriers rather than simply improving connectivity for travellers and shippers. Defending the interest of national carriers can arguably be a reasonable policy goal, but such a policy does have a very positive value for home carriers which does not show up in any accounting balance sheet.

Finally, one should note that most countries inject some sort of public funding into international aviation and that there exists no law, convention or treaty that forbids it or sets boundaries for country interventions, with the exception of the EU which has a legal framework for State-Aid of the air transport sector but applies only unilaterally to EU member countries, airlines and airports. While much of the attention has been on two countries and three carriers, most if not all countries have a rich history of public financing of the air transport value chain which continues to this day. Applying the remedies suggested by the Partnership for an Open and Fair Skies to all countries who have financially supported in some way their air transport industry, including the US, would significantly dampen efforts to liberalise global aviation and curtail the benefits that come from operating in an open and free market. And even when all public funding has ceased, the stock of subsidies has enabled the creation of the same global carriers and global hubs who are today calling for an end to subsidies in order to restore fair competition to the air transport industry.

So what could be done? Three things:

  1. In the absence of a clear legal framework defining acceptable and unacceptable behaviour, the first step is somewhat obvious: defining rules of conduct of what actually constitutes fair competition. Most likely through the auspices of the ICAO, countries must first define what is an acceptable and an unacceptable subsidy, a concept that right now is left wide-open to the interpretation of parties with a vested interest.
  2. Countries should agree on a mandatory, transparent and uniform reporting system for public subsidies that would inject some much needed transparency to the issue and avoid the volleys of accusations and counter-accusations we have witness this year.
  3. A binding arbitration process, preferably through ICAO, will need to be put in place and permit one country to file a complaint against another. Arbitration could lead to a monetary penalty paid by the country who granted unfair subsidies to the country whose carriers suffered from unfair competition. This monetary penalty would avoid the present situation where perceived wrongdoing is punished through traffic rights restrictions, in effect imposing a quota on the international trade of service, the most harmful of outcomes.

Useful links

ITF work on air transport

ITF Discussion Paper: What do we mean by a level playing field in aviation?

ITF Research Report: Liberalisation of Air Transport. Summary: Policy Insights and Recommendations

ITF Country-Specific Policy Analysis: – Air Service Agreement Liberalisation and Airline Alliances

Farmers’ markets: why international trade matters to agriculture

Ag trade policyHere are some things we started doing in the year 2000 and have been doing ever since: taking photos with digital SLR cameras; saving data to USB drives; watching Big Brother; and negotiating the WTO Doha Round. In fact the Doha Round, or the Doha Development Agenda to give it its full name, only started officially at the WTO meeting in Doha, Qatar, in 2001, but negotiations on agriculture had started a year earlier. As a new OECD book, Issues in Agricultural Trade Policy, Proceedings of the 2014 OECD Global Forum on Agriculture  puts it, “agriculture has proven to be a critical element in the effort to reach agreement”. Another way you could put it would be to say, as the WTO did, that talks collapsed in July 2008, because of the failure to agree on agriculture and NAMA (non-agricultural market access).

The failure came at a particularly bad time. When the talks had started, food prices were at historically low levels, but 2007/8 saw high volatility and high prices. Issues in Agricultural Trade Policy proposes both structural and more short-term reasons for this. Demand for food for humans and feed for animals was rising steadily as the world population grew and the economy expanded. Stocks were falling and biofuels production was increasing. The short-term shocks included key grain producing regions hit by droughts and other weather effects; exchange rate movements; and hoarding.

Governments have to take their share of the blame too. For a start, many of them encouraged biofuel crops, a measure that “contributes little to reduced greenhouse-gas emissions and other policy objectives, while it adds to a range of factors that raise international prices for food commodities” according to an OECD assessment. When the food price crisis hit, the trade restrictions and import measures, coupled with panic purchases by some governments, made matters worse. In fact a report by the International Food Policy Research Institute (IFPRI) concludes that “trade events were pervasively important in all of the major grain markets and arguably provide the most tangible explanation for the […] price series data.”

The price rises provoked food riots in a number of developing and emerging countries. The reaction in many cases was to adopt “a more defensive stance towards international markets”. Countries tried to become more food self-sufficient by for example subsidising production and penalising imports. One of the biggest changes noted by the new OECD report is the evolution of “agricultural support” – the subsidies, tax breaks and other ways governments help the sector. In 1995, the seven emerging economies for which the OECD collects information on agricultural policies accounted for just under 4% of the total support for OECD and emerging economies combined. By 2012, these seven countries accounted for over 45% of the total.

Even so, most countries comply with current WTO commitments and would have little trouble complying with what is proposed. Countries where the government is becoming more active in domestic markets are usually developing countries whose agricultural sector has a large number of poor farmers, low productivity and lack of access to well-functioning markets. Their main policy options are similar to those elsewhere – interventions in markets; provision of public goods such as roads or other infrastructure; income transfers; and reform of institutions, including land reforms and property rights, financial sector reforms, and legal frameworks – but the actual mix should depend on national circumstances.

In the case of developed countries, the OECD has established a basic principle for choosing among these instruments, stemming from the notion that policy objectives can be divided into two categories. The first is a matter of efficiency and is concerned with correcting “market failures”, for instance, if the cost of water pollution from pesticides or other agricultural chemicals is not accounted for in the market price of produce. The second set of objectives is concerned with the distribution of income (an equity issue). The principle is that policy should first seek to address market failures – ideally by tackling them at source – and then address distributional concerns with targeted policies such as payments for those affected.

However, in poorer countries where market failures are more widespread, it is often difficult to tackle them directly. For example, farmers may have low incomes partly because they have no access to credit. Subsidies to buy fertiliser or other inputs have been suggested as a practical solution to the problem of developing markets for inputs and providing financial services to small farmers. Similarly, price stabilisation has been proposed as a relatively simple way of mitigating the impacts of price shocks on poor households, as opposed to market-based forms of risk management such as insurance or the provision of income safety nets. The OECD argues that while there may be plausible reasons for governments to intervene in agricultural markets in poorer economies, the short-term benefits from the money spent may be far less than benefits from investments to support long-term agricultural development. In other words, policies that have been abandoned by OECD countries because they are inefficient and inequitable are unlikely to prove successful elsewhere.

But what do you do in the meantime? For Issues in Agricultural Trade Policy, the way to help the poor cope with sudden price movements is not agricultural policy but redistributive measures. Apart from anything else, sudden price increases or collapses do not have the same consequences for poor farmers selling food and poor urban (or rural) dwellers buying it. A policy that helps them all to maintain or improve their standard of living makes sense.

More generally, the book argues that a more open trading regime can help the agricultural sector achieve its goals, including food security, in the face of demographic and economic growth and possible threats such as climate change, by providing a greater diversity of products for consumers and by allowing the benefits from changing patterns of specialisation to be realised. Or: “The key challenge for governments in the period ahead will be to maintain a clear focus on the benefits of further reform, to renew efforts to integrate agriculture into the multilateral trading system, while addressing legitimate domestic policy interests in ways that are effective and minimise distortions to production and trade.” That’s the OECD-FAO Agricultural Outlook for the year 2000.

Useful links

OECD Global Forum on Agriculture 2014

OECD work on agricultural trade

How much do farmers get from taxpayers?

Click to find out more
Click to find out more

In 2008, one farmer from Blackburn in the UK got 32 pence (around $0.45) from the EU’s Common Agriculture Policy (CAP). That’s not much, but it’s still over 30 times as much as one of his neighbours, who only got a penny. At the same time, some large landowners in the UK and other countries got hundreds of thousands of euros. The food industry didn’t do too badly either, with some food processors getting around a million pounds each. The biggest payout, over £6.7 million, went to a “professional services company in the sugar market”.

Other OECD countries could show a similar pattern for farm subsidies, with the rich getting more than their less well-off colleagues. More what, though? There are problems with vocabulary in such a sensitive area. For some people, we’re talking about handouts or the less pejorative “aid” or “assistance”; others prefer the dynamism of “incentives”, or the neutral-sounding “transfers”. The OECD term “support” describes the various ways in which governments intervene in the business of agriculture, including subsidies, grants, tax breaks and other policies that boost revenues.

So what’s it worth? Over $258.6 billion (EUR 201.2 billion) in the OECD area in 2012 according to Agricultural Policy Monitoring and Evaluation 2013: OECD Countries and Emerging Economies, published today. Support represented 19% of farm receipts in the OECD, up from 18% in 2011. Support averaged one-sixth of gross farm receipts in the 47 OECD and non-OECD countries covered in the report. The Producer Support Estimate increased to 17% of gross farm receipts in 2012, compared to 15% in 2011.

It can be hard to understand the economic justification of support to farmers. If there is a surplus in supply, why should the taxpayer subsidise producers? If there is a shortfall, you’d expect prices to rise and the need for subsidies to disappear (or at least weaken). The reason usually given by governments is that agricultural policies are designed to improve the “competitiveness” of their farmers. Yet sometimes this is meant to be achieved by reducing support in the interests of imposing stronger market discipline, while at other times improved competitiveness means granting subsidies for inputs such as fertilisers; according tax concessions, for example on diesel fuel; or providing financial incentives to meet the costs of implementing new regulations.

Do the subsidies and other forms of support really help farmers? OECD research into farm household income suggests that with the most commonly used policy, market price support, only about 25% of the cost finds its way as a net income gain to the intended recipients in farm households. “Farmer” is not the first word that springs to mind when seeking to define what service companies, food processors and other large beneficiaries of support actually do. The CAP, like many other forms of support, does not target farmers, but farms or activities related to agriculture, which is why a confectionary firm ended up receiving 332 000 euros to help buy sugar.

Subsidies don’t help the hungry either. Some of the sharpest increases in farm support have occurred in countries that are trying to promote self-sufficiency, but the OECD sees only weak links between higher self-sufficiency and improved food security, particularly in less developed economies. Access to food would be more effectively improved by reducing poverty and developing safety nets.

Agricultural support policies are evolving, but only slowly. This may seem surprising given the repeated, often violent, calls for change and the massive amounts of public money being spent. Policy makers and the public alike would agree that some programmes no longer do what they were created for and should be modified or scrapped (for instance, one catering company supplying cruise ships got 148,000 euros in subsidies for the sugar and milk powder it “exported” in passengers’ stomachs).

Why is change so slow and difficult? In agriculture as in other areas, fundamental policy thinking is often born of crises, but can persist even when the original problems have been solved. Key features of agricultural policy in the United States emerged in the 1930s in response to the Great Depression and the Dust Bowl. Today’s agriculture policy in Europe and Japan can be traced to concerns with food supply at the end of World War II.

Policy shifts can be dramatic however. Airport security is one example of how things can change practically overnight. Agriculture provides examples of this too, for instance the sudden imposition of export restrictions and traceability norms in reaction to the BSE outbreak. However, despite the volatility of commodity prices and regional difficulties related to drought, flooding or other environmental conditions, food security is not a problem in the countries giving most of the support, and the agro-food system as a whole is not faced with any major threat to its existence. The sector even fared better than others during the recent recession.

Another factor to consider is who would gain and who would lose if the current system was changed. Actual numbers of people are less important in this respect than how the costs and benefits are distributed and how well-informed and politically influential they are.

Consumers pay twice for agricultural support, first through the taxes used to finance it, second through higher prices. The cost to an average European citizen is over 100 euros a year, but few people are aware of this extra sum they’re giving to the agri-food industry. For those receiving the support, much more may be at stake. The smallest farms receive relatively little support, but the big producers and industrialists who do get public money also have the means to finance sophisticated lobbying and public relations campaigns to block change that would seriously erode their privileges.

Useful links

OECD work on agricultural policies and support

OECD work on sustainable agriculture

Would free trade harm the rich?

Click to download the reoprt

Economists love sporting terminology. There’s the elusive level playing field and, of course, firms, even whole countries, are racing to stay ahead of the competition.

So, what kind of race is it when the starter’s pistol is loaded with live ammunition and he shoots one of the runners in the back? Try the cotton trade.

According to a new report from the Fairtrade Foundation, Benin, Burkina Faso, Chad and Mali – the C4 – produce cotton more cheaply than anywhere else in the world. They also rely on it more than any other commodity for export revenues.

But they can’t trade their way out of poverty because richer countries have subsidised their producers to the tune of $47 billion since the Doha Round of trade negotiations started in November 2001.

The C4 are trapped in a vicious circle. They’re squeezed out of markets by subsidies. That means they don’t earn the revenue that would allow them to compete – physical infrastructures like roads and ports or less tangible, but equally important competencies like managerial skills or legal knowledge. (The expression often used for this is “capacity building”. )

Lack of income also means they can’t move up the value chain, for example by investing in factories to make the cotton goods so much in demand around the world.

The OECD-WTO Aid-for-Trade Initiative aims to help developing countries overcome the  limitations that undermine their ability to profit from trade opportunities.

Useful links

OECD work on development issues

OECD work on trade

OECD work on agriculture

Seed money: How much do farmers get from government?

In 2008, farmer Jeremy T. James of Blackburn got 32 pence (around $0.45) from the EU’s Common Agriculture Policy (CAP). That’s not much, but it’s still over 30 times more than his Blackburn neighbours A&KM Barnes, who only got a penny. Queen Elizabeth II on the other hand got nearly £500 000 (around $700 000), and she wasn’t the only royal to benefit. Prince Albert II of Monaco got over half a million euros, as did the Duke of Westminster.

The industrial aristocracy didn’t do too badly either, with food giants Nestlé and Tate&Lyle getting around a million pounds each. The biggest UK  payout, over £6.7 million, went to Czarnikow Group Limited of London, a “professional services company in the sugar market” according to their website. In France, the biggest sum from the CAP was the 62.8 million euros going to Groupe Doux, a multinational present in 130 countries, that presents itself as “Europe’s number one producer of poultry and poultry-based processed products”.

Other OECD countries could show a similar pattern for farm subsidies – the rich getting more than their less well-off colleagues.

More what, though? There are problems with vocabulary in such a sensitive area. For some people, we’re talking about handouts or the less pejorative “aid” or “assistance”. Others prefer the dynamism of “incentives”, or the neutral-sounding “transfers”. The OECD term “support” describes the various ways in which governments intervene in the business of agriculture, including subsidies, grants, tax breaks and other policies that boost revenues.

Whatever the terms used, agricultural support costs a lot of money – $252 billion in 2009 for OECD countries according to the newly-published Agricultural Policies in OECD Countries.

Support as % of gross farm receipts, 2007-09 average

That sum represents 22% of total farm receipts in OECD countries, the same as in 2007, but up a percentage point from 2008, when support was less after agricultural commodity prices hit record highs. As the graph shows, the level of support varies enormously, from 1% in New Zealand to 61% in Norway.  

Support to agriculture is often criticised for going to the wrong people (a catering company supplying cruise ships got 148,000 euros in subsidies in 2008 for the sugar and milk powder it “exported” in passengers’ stomachs) or for encouraging harmful practices.

The report argues that with public budgets under pressure in the wake of the economic crisis, governments need to reassess and adapt their farm support policies to meet specific economic, social and environmental objectives, rather than simply encouraging famers to produce as much as they can.

This kind of conditional support in pursuit of broader objectives, such as preservation of the environment, conservation of natural resources or animal welfare, represented only 4% of the OECD aggregate support in 1986-88, but now represents a third. The EU, US and Switzerland provided the highest shares (around 50%) of their total support with some constraints.

Useful links

OECD work on agriculture

OECD agricultural support database includes information by country provides data on who receives EU subsidies

Subsidising Pollution?

How can we reduce fossil fuel use and make the switch to clean energy?  Debates on fossil fuel dependence and its consequences for the environment have reached a crescendo as COP15 nears its deadline.  But did you know that governments still subsidize the use of fossil fuels?  Helen Mountford of the OECD Environment Directorate, Peter Wooders of the IISD and Dr. Fatih Birol of the IEA explain the importance of dealing with these contradictory policies.

Useful links:

OECD and COP15
The IISD Blog