EU ETS and WTO confrontation raise the spectre of aviation protectionism at the worst possible time

With economies in the US and Western Europe exhibiting either painfully slow growth or no growth at all, both the World Bank and the WTO have cautioned recently that protectionist sentiment is creeping into economic policies. Political representatives on all sides have voiced concern over the possibility of trade sanctions and retaliation.

ECJ has rejected the US argument against the ETS: 'appropriate action' to provoke 'countermeasures'

The European Court of Justice of the European Union (ECJ) this week rejected a legal challenge by Airlines for America (A4A), the US airline industry trade body (formerly the Air Transport Association of America), three US airlines, IATA and the National Airlines Council for Canada against the inclusion of aviation in the EU ETS. An initial opinion delivered by the ECJ advocate general in Oct-2011 found the EU legislation valid. The ECJ's final 13-judge ruling on 21-Dec-2011 endorsed that legal opinion. The ruling comes just 10 days before the EU ETS legislation is due to come into effect, on 01-Jan-2012.

The US team has labelled the EU ETS as "unlawful and unjust", claiming that it violates US sovereignty and international law and undermines efforts to find a global solution to aircraft emissions through ICAO.

Earlier this month, the US Secretary of State Hillary Clinton wrote to EU officials, urging them to reconsider the scheme and halt or delay the introduction of the legislation. If not, she said, the US would be "compelled to take appropriate action", according to a report in the Wall Street Journal. Mrs Clinton urged Europe to "re-engage with the world".

Threats are emerging from the other side of the Atlantic as well. In Oct-2011, the European Parliament environmental committee chair, labelled the US legislation as "arrogant and ignorant" and suggested the EU should "refuse to be blackmailed and resort to countermeasures, if necessary" if it passed Congress.

The Association of European Airlines (AEA) secretary general Ulrich Schulte-Strathaus has warned that even if the ECJ ruled in favour of the US case, it would not diffuse international tension over the scheme. AEA maintains the real issue is political, not legal.

According to the AEA, even though the ECJ decided the EU ETS conforms with EU law, the ruling would not resolve non-European countries' "vehement hostility towards the way EU ETS was introduced globally". AEA believes the political face-off will not be solved in European courts, but rather should be through ICAO - a position that most nations outside the EU have been advocating for some time.

In the wake of the (already expected) rejection of the US' position by the ECJ, A4A announced it would explore mounting a further challenge in the UK High Court - probably more sabre-rattling than real. But there is a greater prospect that the US Department of Transportation (DoT) will move to examine whether the ETS will have the effect of discriminating against US airlines, in which case retaliation becomes possible. Then again, in the growing noise building around next year's Presidential election, the political attraction of appearing tough on the international stage will encourage some candidates and Congressional figures to call for stern measures.

Meanwhile, US airlines are placed in the invidious position of being damned if they do and damned if they don't. A Republican-sponsored Bill has passed the House of Representatives which would prevent US airlines either reporting on their level of emissions or of paying any assessments, although the Senate has not yet followed suit. If that happens US airlines would be exposed to fines from the EU, possibly even suspension of operating rights - with the inevitable retaliation and escalation.

China and many others are staunchly opposed, with legal action threatening

The EU ETS legislation has put Europe in conflict with not only the US but also a broad swathe of the developed and developing world. China, India, Russia and others have all threatened to follow the US in taking legal action against the inclusion of international aviation under the EU scheme.

IATA, along with other airline and industry bodies, has warned the EU ETS dispute could trigger a trade war. However, although the scheme is due to commence on 01-Jan-2012, it will be some time until any money is due to change hands. That would suggest there is still time for a compromise, provided enough political room remains to accommodate one.

It may also spur ICAO into adopting a more active role, effectively now as a mediator, by accelerating moves to achieve a worldwide compromise that will satisfy the EU as well.

Although that may be an eventual outcome, it will not be achieved without blood being spilled in the meantime.

The UK's British Air Transport Association (BATA), which represents UK airlines, yesterday raised this spectre in the wake of the ECJ decision. BATA remained "concerned at the growing signs that including aviation in the EU ETS could lead to a damaging trade war that is in no one's interests. We look to the UK Government to ensure that UK airlines are not subject to retaliatory actions from States that are opposed to the inclusion of aviation within the EU ETS."

The European Regions Airline Association (ERA), whose members are mainly regional carriers, shared similar concerns: "European airlines and the European economy must not get caught in the political cross fire, or be put at a competitive disadvantage. If these tensions erupt into full-scale trade conflict, there will be no winners - least of all the environment. Political conflict does not cut emissions. However, global political will can."

And the US carriers' association was even less impressed at the court's assertion that the EU as an entity was not bound by the Chicago Convention. A4A said, "today's court decision further isolates the EU from the rest of the world and will keep in place a unilateral scheme that is counterproductive to concerted global action on aviation and climate change. The court did not fully address legal issues raised and has established a damaging and questionable precedent by ruling that the European Union can ignore the Chicago Convention and other longstanding international provisions that have enabled governments around the world to work cooperatively to make flying safer and more secure, and to reduce aviation's environmental footprint."

Aircraft funding subsidy disputes also threaten tit-for-tat trade war

Also making waves across the Atlantic is the commercial aircraft subsidy dispute. At the beginning of Dec-2011, the EU announced it had completely met its obligations to eliminate subsidies to EADS and its commercial aircraft unit Airbus, acting on a WTO appellate body ruling made in 2010. The European Commission noted that only "limited changes" were necessary to end the subsidies and its package of measures had addressed "all categories of subsidies, all forms of adverse effects, and all models of Airbus aircraft covered by the WTO rulings."

In addition to its compliance announcement, the EU also announced that it expected the US would take "an equally solid set of compliance actions" to ensure that all illegal subsidies to Boeing had been removed.

The two sides - as they have been wont to do since the dispute began - however see things very differently. The US Trade Representative, Ron Kirk, announced that after reviewing the European actions, the EU had "not withdrawn the subsidies in question and has, in fact, granted new subsidies to Airbus' development and production of large civil aircraft".

In the same announcement, Mr Kirk noted the US would also request authorisation from the WTO Dispute Settlement Body to impose "countermeasures" in response to the EU's claim that it had fully complied with the WTO ruling. The countermeasures would vary from year to year, but could be in the range of USD7-10 billion annually, given current aircraft sales.

The same refrain repeats, with increasingly divergent positions emerging

The EU and the US have been increasingly ideologically divergent on the aircraft manufacturer subsidy issue. Neither side really wants to change the way it does business - a fact aptly illustrated by the claims of victory or vindication from both sides whenever the WTO issues a decision on either case. This is followed almost immediately by an appeal of various elements of the decision from both sides.

Each party has tossed around seriously questionable estimations of the damage that subsidies have caused. When the WTO ruled in 2009 on EU subsidies, Boeing claimed that as much as USD205 billion in aid had been provided to EADS and Airbus since the company's formation. In early 2011, Airbus counterd by estimating that Boeing had received USD45 billion in direct and indirect subsidies, and labelled the 787 the "most subsidised aircraft in history".

Given the complexity of the decisions and the ambiguity created by the length of the rulings - some exceeded 1000 pages - and the subsequent reversals of some rulings by the WTO Appellate Body - it is understandable that both the EU and the US, not to mention Airbus and Boeing, can continue to claim victory in the various cases.

The stakes involved in the commercial aircraft manufacturing business are considerable. The industry is valued at USD170-200 billion p/a over the next 20 years and directly employs more than a million people in the US and Europe, supporting another 2.5 million jobs. In 2010, the US aerospace industry was the country's strongest export segment - and Boeing the country's largest single exporter - generating a USD57.4 billion trade surplus.

A negotiated solution may be in the wind

There is, however, some cause for optimism among this war of words. The EU has been advocating a negotiated solution, something the US previously steadfastly refused to countenance. Following Dec-2011's EU compliance notice, the US Trade Representative announced the US was willing to negotiate with the EU with the "goal of ending subsidised financing at the earliest possible date". With the final ruling by the WTO Appellate Body on the EU case against US subsidies for Boeing not due until the second quarter of 2012, it remains unlikely though that the EU will be willing to sit down prior to that.

But a spark is all that's needed to ignite the rising pressures for protectionism

This apparent withdrawal from the brink of what promised to be a defining battle over aircraft subsidies is potentially good news. But the storm of protest over the EU ETS and threatened retaliation by other states has all the ingredients of a drawn out and bloody struggle, with governments digging in to entrench their opposing positions.

The particularly bad news is that this comes at a time when European and US airline growth is constrained - with little positive economic news on the horizon. Hence the temptation to extrapolate these conflicts into something bigger becomes a real threat. Such a conflict would not be contained between the US and the EU. Rising protectionist and nationalist attitudes is not where an evolving airline industry needs to be right now.