Strategic Trade Theory

An argument for protection?

Lester Thurow is Dean of the Sloan School of Business at the Massachusetts Institute of Technology (MIT). He is also one of the USA's best-known and most articulate advocates of ‘managed trade'.

Thurow (and others) have been worried by the growing penetration of US markets by imports from Japan, Europe and many developing countries. Their response is to call for a carefully worked-out strategy of protection for US industries.

The strategic trade theory that they support argues that the real world is complex. It is wrong, they claim, to rely on free trade and existing comparative advantage. Particular industries will require particular policies of protection or promotion tailored to their particular needs:

Some industries will require protection against unfair competition from abroad – not just to protect the industries themselves, but also to protect the consumer from the oligopolistic power that the foreign companies will gain if they succeed in driving the domestic producers out of business.
Other industries will need special support in the form of subsidies to enable them to modernise and compete effectively with imports.
New industries may require protection to enable them to get established – to achieve economies of scale and build a comparative advantage.
If a particular foreign country protects or promotes its own industries, it may be desirable to retaliate in order to persuade the country to change its mind.

But, despite the enthusiasm of the strategic trade theorists, their views have come in for concerted criticism from economic liberals. If the USAis protected from lower cost imports, for example from China, they claim, all that will be achieved is a huge increase in consumer prices. The car, steel, telecommunications and electrical goods industries might find their profits bolstered, but this is hardly likely to encourage them to be more efficient.

Another criticism of managed trade is the difficulty of identifying just which industries need protection, and how much and for how long. Governments do not have perfect knowledge. What is more, the political lobbyists from various interested groups are likely to use all sorts of tactics – legal or illegal – to persuade the government to look favourably on them. In the face of such pressure, will the government remain ‘objective'? No, say the liberals.

So how do the strategic trade theorists reply? What is needed is a change in attitudes. Rather than industry looking on the government as either an enemy to be outwitted or a potential benefactor to be wooed, and government looking on industry as a source of votes or tax revenues, both sides should try to develop a partnership – a partnership from which the whole country can gain.

But whether sensible, constructive managed trade is possible in the US democratic system, or Australia for that matter, is a highly debatable point. ‘Sensible' managed trade, say the liberals, is just pie in the sky.

The case of Airbus

Supporters of strategic trade theory hold that comparative advantage need not be the result of luck or circumstance, but may in fact be created by government. By diverting resources into selective industries, usually high tech and high skilled, a comparative advantage can be created through intervention.

An example of such intervention was the European aircraft industry, and in particular the creation of the European Airbus Consortium.

The European Airbus Consortium was established in the late 1960s. Its four members were Aérospatiale (France), British Aerospace (now BAE Systems) (UK), CASA (Spain), and DASA (Germany). The setting up of this consortium was seen as essential for the future of the European aircraft industry for three reasons:

to share high R&D costs;
to generate economies of scale;
to compete successfully with the market's major players in the USA, Boeing and McDonnell Douglas (which have since merged).

The consortium, although privately owned, was sponsored by government and received state aid, especially in its early years when the company failed to make a profit. In more recent times Airbus has become very successful, capturing a larger and larger share of the world commercial aircraft market. By 2001, its share of the large civil aircraft market had risen to 55 per cent. As a consequence, it should come as no surprise to find that the Americans, and Boeing in particular, have brought accusations that Airbus is founded upon unfair trading practices, and ought not to receive the level of governmental support that it does.

In 1999/2000, there were three major developments. The first was the merger of Aerospatiale-Matra, Dasa (DaimlerChrysler Aerospace) and Casa to form the giant European Aeronautic Defence and Space Company (EADS). The second was the creation of an Airbus Integrated Company (from EADS and BAE Systems) as a single entity to replace the looser Airbus Consortium. Then towards the end of 2000, it was announced that enough orders had been secured for the planned new 550+ seater A3XX for production to go ahead. This new jumbo will be a serious competitor to the long-established Boeing 747.

So does the experience of Airbus support the arguments of the strategic trade theorists? Essentially three kinds of benefits were expected to flow from Airbus and its presence in the aircraft market; lower prices; economic spillovers; and profits.

Without Airbus the civil aircraft market would have been monopolised by two American firms, Boeing and McDonnell Douglas (and possibly one if the 1997 merger had still gone ahead). Therefore the presence of Airbus would be expected to promote competition and thereby keep prices down. Studies in the 1980s and 1990s have tended to support this view, suggesting that consumers have made significant gains from lower prices. One survey estimated that without Airbus commercial aircraft prices would have been 3.5 per cent higher than they currently are, and without both Airbus and McDonnell Douglas they would have been 15 per cent higher.
Economic spillovers from the Airbus Consortium, such as skills and technology developments, might be expected to benefit other industries. Findings are inconclusive on this point. It is clear however, that although aggregate R&D in the whole aircraft industry has risen, so has the level of R&D duplication.
Airbus's presence in the market is estimated to have reduced Boeing's profits by as much as $100 billion, and McDonnell Douglas's by two thirds. Airbus's profits in 1999 were approximately $1 billion.

On balance it appears that Airbus has had many positive effects and that the strategic trade theory that has underpinned state aid, in this instance, has led to a successful outcome. A competitive advantage has been created, and it looks as though it will be maintained into the future, quite possibly without state aid!

Questions

1. In what other industries could the setting up of a consortium, backed by government aid, be justified as a means of exploiting a potential comparative advantage?

2. Is it only in industries that could be characterised as world oligopolies that strategic trade theory is relevant?