Reuters (3rd October 2019)

U.S. widens trade war with tariffs on European planes, cheese, whisky to punish subsidies

Syllabus Links

Subsidies (Edexcel 1.2.9, AQA 4.1.8.9, OCR 1.2.11)

Check out the “Economics in Action” YouTube video here.

Check out the “Technical Stuff” YouTube video on Subsidies here.

Potential questions

Using a suitable diagram, show the impact of the subsidy given to the producers of Airbus airplanes.

Export subsidies are very controversial, assess the impact of an export subsidy for both domestic and foreign producers of a product of your choice.

Some ideas to consider:

Donald Trump is set to announce a first round of tariffs on European Union exports to the USA. The USA is already in an ongoing trade dispute with China that has brought down the levels of predicted global economic growth. He has now turned his attention to Europe. What are the potential implications of this move?

A tariff is a tax on imports, and has been covered in this blog recently, this story being a good example. I am going to focus on why this new round of tariffs is being imposed, by looking at the export subsidies that has caused the argument. An export subsidy is when a country, or in this case, an economic union, protects its domestic industry by giving it subsidies.

A subsidy is money given by the government to a company to reduce the costs of production, increase supply, and to reduce the price. In this case, Airbus was given money by the EU, making Airbus prices cheaper. This negatively impacted the demand for US made Boeing aircraft, estimated at $7.5bn, and the World Trade Organisation has therefore allowed the USA to implement tariffs worth $7.5bn on EU imports into the USA. The likelihood is that the EU will now retaliate with tariffs added to US products, especially given the subsidies that Washington apparently gives to Boeing. We look set for another round of increasingly aggressive Donald Trump led trade bickering, this time with the EU, not with China.

The World Trade Organisation (WTO), according to its own website, is the “only global international organisation dealing with the rules of trade between nations… The goal is to ensure that trade flows as smoothly, predictably and freely as possible”. If a country believes that another country is not playing fair in international trade, they have the right to take the case to the WTO and have it heard. This particular case between the USA and the EU has apparently taken many years to come to a decision, this is one problem the organisation has, given the time it can take for a dispute to be concluded.

The subsidy diagram is as follows. By reducing the costs of production, it allows companies, in this case, Airbus, to supply more aircraft. The export subsidies shift the supply curve to the right from S1 to S2, reducing the price of the product on the market from P1 to P2.

The subsidy is represented by the vertical distance (bc) between the two supply curves. We can see the benefit to the consumer, represented by the lower prices and highlighted by the yellow shaded area. The producer would benefit from the green shaded area. If we combine both the yellow and the green areas (abcP2), this represents to the total cost to the EU government of implementing the subsidy. This therefore represents the cost to the tax payer of supporting Airbus.

Could these export subsidies have been better spent elsewhere? This is the idea of opportunity Cost, the value of the next best alternative foregone when an economic decision is made. This is a considerable sum of taxpayers’ money that could have been used elsewhere. Is the benefit of supporting Airbus greater than the cost? And is the potential impending trade dispute likely to negate these benefits? These are questions that we eagerly await an answer for.

This means that Airbus products are more price competitive, and Boeing would lose out as a result. This would ensure jobs are protected in the EU airplane industry, but potentially at the cost of jobs at Boeing. The US government believes this subsidy to be illegal, and has now been supported by the WTO. Has the EU been giving its aircraft producers an unfair advantage over these years? The WTO has suggested that this is the case.

How else could the EU protect its aircraft industry? Other options are available, for example putting tariffs on imported airplanes from outside the EU. This is a big issue in global trade currently, with the ongoing issues regarding China. Tariffs do have one big advantage though, instead of it increasing government spending, it potentially increases government revenue from the tax imposed.

We could also impose a quota, a physical limit on the number of non-EU planes brought into the area. This would reduce the quantity of imported products available, and hopefully ensure local companies would buy from the EU instead.

We could also promote the purchase of EU products, in much the same way as “buy British” campaigns aim to switch people’s preferences away from imported products towards domestic products. Airplanes are not on the same scale as beef though! This may also backfire at a time when the UK in particular is going through a messy divorce from the EU. I think products with a blue and yellow starred flag in the UK and the message “Buy European” would not be welcomed at the moment by certain groups.

Each of these issues have potential problems associated with them. It is up to you to decide which policy you think will be the best and to justify your decision. You also need to follow this story as it potentially mushrooms into something much larger. It only takes a few rounds of tit for tat retaliation and the impact globally could be quite dramatic.

Additional activities

“The best way forward is to ensure self-sufficiency in a country, this way we are not at the whims of political leaders with their own agenda.” Critically evaluate this statement

Discuss the reasons for a country wanting to protect its domestic economy. Which do you consider to be the most important and why?

Additional information

The World Trade Organisation

WTO Website (date accessed 3rd October 2019)

How the WTO resolves trade disputes

Kimberly Amadeo writing for The Balance (25th June 2019)