House of Commons - Full speed ahead: maintaining UK excellence in motorsport and aerospace - Business, Innovation and Skills Committee

Full speed ahead: maintaining UK excellence in motorsport and aerospace - Business, Innovation and Skills Committee Contents

2 The Aerospace Industry

8. The United Kingdom has the world's largest aerospace industry outside the USA,[6] with a 17% global share of the civil aerospace market and 10% of the defence market.[7] The industry has an annual turnover of around £20.5 billion,[8] and directly employs over 160,000 people with another 200,000 people indirectly relying on the sector for their employment.[9] UK aerospace companies invested £1.8 billion in R&D activities in 2008,[10] and Britain is one of the few nations involved in the design, manufacture, marketing, maintenance and support of the full range of aircraft products—from complex composite aero-structures, including wings, aero-engines, rotorcraft, aircraft systems and avionics, through to maintenance, repair and overhaul services.[11]

9. The aerospace industry did not escape the recession. In 2008 although the sector received £35 billion in new orders, this represented a decrease of 23% on the £45 billion of orders placed in 2007. Over the same period the sector's workforce had reduced by 11%, with the loss of 12,578 jobs. In its evidence A|D|S, the industry trade association, told us that the difficulties faced by the sector in 2008 continued into the first half of 2009, and that "the downturn has been felt most markedly in the business jet, general aviation, civil fixed-wing and rotary-wing sectors."[12] However, this was still better than the industry had initially predicted. Mr Godden, Chairman of A|D|S, remarked that "in the larger commercial aircraft industry, the order book has held up better than most anticipated."[13]

10. The decrease in new orders was partially due to companies cancelling or delaying orders for new planes in response to falling passenger numbers.[14] As well as causing a reduction in new orders this has also resulted in companies postponing or reducing maintenance, repairs and improvements to their existing fleet.[15] However, larger companies have been able to minimise the impact of this by reorganising their order book. Dr Williams, Head of Business Development, Research and Technology (R&T) at Airbus, highlighted the fact that:

whilst there are some cancellations, typically there will be deferrals or movements of orders and there is, through prudent management of that order book, an ability to bring some orders forward and dampen the immediate effect on short-term production.[16]

It is also possible that the longer-term nature of aerospace investments, particularly defence aerospace, has provided some parts of the industry with a degree of stability.[17] A|D|S asserted that "the long-term nature of large-scale projects means that effects can be delayed."[18]

11. There are 9,000 SMEs in the United Kingdom who supply the aerospace industry. We discussed with major manufacturers how the recession had impacted on those businesses. It was clear that there were concerns within the aerospace industry that the recession could cause SMEs in the supply chain to go out of business. During oral evidence Mr Keen, Head of Government Relations, BAE Systems, reported that BAE was monitoring closely the health of its supply chain. He told us that out of 1,200 suppliers:

we have a watch list of about 80 companies that we are keeping a special eye on, and that we are engaging with on a weekly basis. Beyond that, we have about half a dozen companies that we have more significant concerns about.[19]

Mr Godden, Chairman of A|D|S, said that while there was no evidence to suggest that a large number of suppliers were going out of business, telling us "there are a number of companies who are exiting markets […] and there are a number of companies that we think may be in trouble in the future."[20] He also reported that his organisation had "identified so far six or seven companies that we have passed on to BIS as being in real trouble."[21] We also heard that many of the SMEs who supply the aerospace industry were also involved in the automotive supply chain, and were seeing orders in that market fall as well.[22] We return to the issue of supply chains in more depth in Chapter 4.[23]

Government strategy

12. In 2003 the Aerospace Innovation and Growth Team (AeIGT) published An Independent Report on the Future of the UK Aerospace Industry, which set out the Government's long-term vision for the future of the aerospace industry in the United Kingdom. The Report concluded that by 2020: "the UK would offer a global Aerospace Industry the world's most innovative and productive location, leading to sustainable growth for all its stakeholders." The AeIGT's Report contained a series of recommendations covering areas including:

Research and Technology;
Process excellence skills and people management;
The environment;
Safety and security, and
The socio-economic environment.[24]

The Report also recommended the establishment of a National Aerospace Technology Strategy (NATS), as a partnership between government, industry and academia with the aim of improving UK competitiveness in aerospace technologies.[25] Although the AeIGT is no longer active, many of the Department's current programmes reflect the priorities set out in its Report.

13. Mr Mans, Chief Executive, Royal Aeronautical Society, was of the view that despite the fact that the AeIGT was no longer active, its Report remained "a very relevant document and I think that it really does point the way ahead".[26] Similarly Mr Keen, Head of Government Relations, BAE Systems, said that "the general comment certainly is that the AeIGT set out the right vision."[27]

14. That said our witnesses believed that some areas could benefit from being re-visited. Mr Godden argued that the Report was in need of a "refresh" noting that it was five years old and that "as we know from our own planning [...] five years is a long time."[28] BAE, A|D|S and the Royal Aeronautical Society suggested a number of areas which they believed should be included in any review of the Report including funding for research, threats to the cost base, the service sector related to aerospace, changing technologies (in particular emerging unmanned technologies), rotorcraft, the skills agenda, and space.[29] We return to a number of these issues later in our Report.[30]

15. It is clear the aerospace sector is broadly content with the Government's aerospace strategy as set out in the AeIGT Report. However, the report is now five years old and is in need of updating. We recommend that the Government undertakes a short review in order to ensure that its strategy takes account of the latest economic and technological developments.

Government support

16. The Government supports the aerospace sector through a number of programmes and initiatives. Some of those programmes are directly tailored to aerospace, while others are designed to benefit a number of higher value-added industries. In this section we examine two forms of government intervention targeted specifically at the aerospace sector, the Repayable Launch Investment and export credit support. We also consider calls for government financial support for the Airbus A400M military transport plane.

REPAYABLE LAUNCH INVESTMENT

17. Repayable Launch Investment is a government initiative to provide financial risk-sharing investment in the design and development of civil aerospace projects in the United Kingdom. It is designed to address the unwillingness of capital markets to fund projects with high product development costs, high technological and market risks and long pay back periods on investment. Government investment is repayable at a commercial rate of return, usually through levies on sales of the product. Launch Investment is only available to the civil aerospace sector.

18. Launch Investment has supported various aerospace projects over the last 60 years. Since 1997, the Government has invested nearly £1 billion in Launch Investment projects and during that period, £1.6 billion has been received as a return on its investment.[31] Recent projects which have received funding under the scheme include:

£114 million to Bombardier Aerospace (Shorts) in Belfast towards the design and development of CSeries composite wing (July 2008);
£60 million to GKN for the design and development of A350XWB trailing edge and rear spar composite wing components (September 2008), and
£340 million to Airbus towards the development of the A350XWB (August 2009).[32]

Each applicant has to demonstrate that its project is technically and commercially viable, that government investment is essential for the project to proceed on the scale and in the timeframe specified and that the Government will recoup the investment at a real rate of return.[33]

19. The United Kingdom is far from unique in providing its aerospace sector with support in this way; the French, German, Spanish, Dutch and Italian Governments all operate some form of launch investment. The US uses indirect measures to finance its industry, most notably the R&D programmes run by NASA and the Department of Defense. However, industry has argued that government support for the UK aerospace industry compares unfavourably with that provided by other nations. The Royal Aeronautical Society stated that the terms of the UK Launch Investment "tend[ed] to be more onerous than Britain's European partners and less generous generally than some of the newer entrants such as Japan and China."[34]

20. We explored with witnesses whether this scheme was addressing a real market failure, or whether it was merely done to maintain a level playing field with our competitors. Ian Lucas MP, Minister for Business and Regulatory Reform strongly argued that the scheme was there to address the specific problems of long-term investment:

The time that is spent in terms of bringing new aircraft to market is very, very long indeed and requires long-term investment, which is very strategic investment but is very important in terms of maintaining the position of the UK as a major aerospace manufacturer. […] It is because of the long-term nature of the industry that, I think, the governmental role is particularly important and why it is necessary that the Repayable Launch Investment is there.[35]

This view was not universally shared by industry representatives. Mr Godden, Chairman of A|D|S, argued that market failure was not the primary factor. He believed that "market failure is that every single government in the world has decided that this is not a free market and a commercial marketplace."[36]

21. Despite a difference of views on why the Repayable Launch Investment was necessary both Government and industry supported the existing model and believed that it should continue. In particular, Mr Godden highlighted the benefit to the Government of the return it received on its investments, noting that launch investment "returns two-and-a-half times on investment money for Government."[37] Dr Williams, Head of Business Development, Research and Technology at Airbus agreed asking "why would you not want to invest in success?"[38] The Minister was of the same view:

I think that the model that we have operated has been very successful and, on the basis of success that we have had in the past, I think that is a powerful argument for continuing to use the model, which is why we have stuck with it.

22. We welcome the Government's continued use of Repayable Launch Investment. This investment has not only been successful in supporting the thriving aerospace sector, but has also delivered a substantial return to the taxpayer. We believe that the Government should continue to offer Repayable Launch Investment to companies—where no viable commercial financing is available—to ensure that the United Kingdom's aerospace industry retains its position as a world leader in the development of new technologies. To do otherwise would put the industry at a serious competitive disadvantage given the prevalence of similar measures available to overseas competitors.

WTO dispute

23. Despite broad domestic support for the scheme, Repayable Launch Investment has been the subject of an on-going dispute at the World Trade Organisation (WTO) between the USA and the EU. On 15 November 2006, the US made a formal submission to the WTO Panel covering US complaints of unfair EU subsidies to Airbus, which included reference to Repayable Launch Investment. On 22 March 2007 the European Union submitted a parallel complaint against US subsidies for Boeing, primarily through US Government (NASA, Department of Defense) R&D programmes and tax breaks at State level. The Interim Report on the US complaint was issued to the parties by the WTO on 4 September 2009. Its findings are likely to be appealed and the whole process, including the implementation phase, could continue until 2012-14.[39]

24. Although the contents of the Interim Report are confidential, press reports have indicated that the complaint against Airbus has, in part, been upheld. A European source, speaking on condition of anonymity to EU Business News, said that "from our reading of this report 70% of the US claims have been rejected." However, the same source confirmed that government grants had been ruled illegal.[40] The Interim Report on the EU's complaint against America has been delayed and is not now expected until June 2010.

25. The Government's memorandum states that it has "consistently argued for a negotiated settlement to the protracted dispute".[41] When questioned, Ian Lucas MP asserted that "ultimately it is in the interests of all parties to achieve a negotiated settlement in this dispute".[42] However, he did not believe that this would be possible until the Interim Report on the EU complaint against Boeing had been published:

We are at a stage at the moment where, because there is only one interim report being published, what is happening is that all parties are waiting for the next stage in the formal process to take place before they can assess their full position. Therefore, it is unlikely, until that happens that people will enter into the types of discussions that we would like to see.[43]

26. We asked our witnesses for their views on the potential impact of the WTO complaint, and the Government's response. In its submission the Royal Aeronautical Society argued that if the US complaint was upheld it would result in "significant changes in the current system to bring it closer to a commercial loan […] or to shift the nature of the funding to a more indirect form."[44] Mr Mans expanded on these points in oral evidence:

I think in the long term we may well have to move away from this particular way of supporting the aerospace community as a result of the WTO decision. I am not saying completely, but I suspect that one of the issues that is going to arise is whether our support moves from a direct to a more indirect approach which is one that the Americans adopt.[45]

He remained a firm supporter of Repayable Launch Investment but believed that both Government and industry needed to prepare for an unfavourable ruling "if in fact we find ourselves in a slightly different position in a year or two's time, we need to be ready now to respond to it."[46]

27. We asked the Government whether it was considering changes to its support for the aerospace sector and if it had explored more indirect mechanisms for support. Ian Lucas MP replied that:

[The Government is] not considering that at this stage. Repayable Launch Investment is a long established model. It is not something that is new or has just been introduced. It is a model that we have used successfully in the past and we are continuing to use it at present.[47]

28. We strongly support the Government's use of Repayable Launch Investment and the Government's defence of that investment at the World Trade Organisation. However, the Government cannot rely on a favourable ruling from the WTO. It has to be prepared for all eventualities. We recommend that the Government explore alternative ways for it to channel its support in the event that the WTO rules against Repayable Launch Investment. This should not be seen as the Government abandoning its position, but a sensible and pragmatic precaution to enable it to respond to all possible outcomes. We hope, and suspect, such a plan will not need to be implemented.

TRADE SUPPORT

29. Another form of government support to the aerospace sector is through the provision of export credit to aerospace customers through the Export Credit Guarantee Department (ECGD). Support for the aerospace industry represents a significant proportion of the ECGD's work.

30. Rolls-Royce argued that this service is "vital to aerospace manufacturers and their supply chain including SMEs as jobs throughout the supply chain depend on the ability to deliver the end product."[48] Furthermore, it was highly complimentary of the organisation's aerospace team, saying:

our experience of working with the aircraft team has been excellent […] They have been proactively visiting customers on market trips enabling them to develop relationship with the airline and better understand the customer's credit.[49]

Airbus was similarly complimentary, commenting that the Export Credits Guarantee Department (ECGD) provided an important level of support to the aerospace industry.[50]

31. However, Rolls-Royce noted that unlike other Export Credit Agencies (ECAs) the UK Export Credit Guarantee Department was limited by law in the extent to which it was able to fund loans directly. Rolls-Royce believed this gave aerospace industries in other countries an advantage over the United Kingdom.[51] Airbus also expressed concerns about the "widening pricing gap between American and European aircraft export credit."[52] Furthermore, Rolls-Royce was unhappy that the ECGD enforces what they perceived as a more strict interpretation of some OECD codes and principles than its competitors which again disadvantaged British firms.[53] However, we are aware that the ECGD carried out a consultation on this issue which concluded on 3 March 2010.[54]

32. Export credit is an important mechanism through which the Government supports the aerospace sector. It is therefore vital that it operates in a way which does not disadvantage British firms. We welcome the ECGD's consultation on its interpretation of OECD codes and principles and recommend that it includes, in any subsequent review, the possibility of offering direct support to businesses when a company cannot find a commercial bank loan to finance the purchase of aircraft.

33. Airbus also suggested several possible improvements to the way in which ECGD operated, in particular how it worked with its European counterparts. It called for greater co-operation between the ECGD and its French and German counterparts to make transactions easier for its customers. It stated that while Airbus customers had to negotiate with three agencies, Boeing's customers only had to deal with one credit agency, the American EXIM Bank.[55] Airbus believed that this gave Boeing an advantage in securing sales.

34. The ECGD and its French and German counterparts have developed working arrangements to counter this and a new method of working is currently being trialled where a single ECA "fronts" a transaction and leads on negotiations, while all three credit agencies provide the necessary finance. Airbus has welcomed this change and has called for it to be made permanent. However, it noted some reluctance on the part of ECGD to participate in this new scheme. It argued that "ECGD alone appears to lack confidence in other ECAs' analysis when not fronting [itself]"[56] When we raised this concern with the Minister he responded that the argument was "noteworthy" and undertook to "look at ways of improving it."[57]

35. Airbus argued that the ultimate outcome of reform of the trade credit agencies should be the creation of a dedicated European export credit agency specifically for the aerospace industry. It argued that the establishment of a single authority dealing with trade credit transactions in the aerospace sector would put them on a level playing field with Boeing.[58] Mr Mans, Chief Executive, Royal Aeronautical Society also believed such a solution would be beneficial to the industry:

I would argue probably there is a stronger case in terms of commercial aerospace particularly when this country is so linked up with other countries in Europe.[59]

However, when we put this proposal to the Minister he was not convinced of its merits:

We cannot design an entire strategy based upon the views of one company. It is an extremely important company, and we always take into account their views, but we have to design a model that can apply to our industry generally.[60]

36. The Government needs to ensure that all three European Export Credit Agencies work together as effectively as possible and we invite the Department to update us on the progress that has been made with the "fronting" system developed by the three agencies. However, we agree with the Minister that it would not be appropriate to accept Airbus' recommendation to create a pan-European agency. It would not be right to create a new agency which in practice would deal with only one company.

A400M

37. The A400M is the latest military transport plane to be produced by Airbus. However, the project has been beset by technical difficulties, and it is now €5 billion over budget. Despite initial plans for the plane to go into production last year it is now reported that the A400M will not be ready until 2012 at the earliest. The United Kingdom is one of seven countries that has ordered the A400M aircraft,[61] the original forecast total cost of the UK order was £3,285 million.[62]

38. The increased cost of the project has led Airbus to threaten to cancel the project should European Governments purchasing the plane not agree to make additional financial contributions to meet cost of the project. Speaking to the press the Chief Executive of Airbus, Tom Enders, confirmed that the A400M project could not be delivered without a significant financial contribution from Governments.[63]

39. The Minister reassured us that he understood the importance of the project to UK manufacturing:

It is an extremely important aircraft because of the fact that it has composite wings and it is part of the process of manufacturing of composite wings getting through to the A350 which is so important to ensure that the UK is at the cutting edge of aerospace technology.[64]

40. However when we raised the issue of additional financial contributions he was understandably unwilling to show his hand:

I do not think it would be helpful to speculate on one viable solution rather than any other. At the stage that we are at, I think we need to be very frank and forceful in our commercial discussions, but, as I say, I do not think it is appropriate for me to speculate at the moment.[65]

It has since been reported that the European Governments involved have agreed to pay an additional €2 billion for their orders and provide Airbus with €1.5 billion in loans, with EADS absorbing the rest of the losses. The total cost to the UK of this new package is estimated to be €250 million.[66]

41. The current financial problems surrounding the A400M places the Government in a difficult position given its role as both a customer and an investor in Airbus. However, Airbus, and in particular the A400M, are important to both UK manufacturing and national security. The Government is right to be forceful and frank in its commercial decisions, but it also needs to set those decisions in the context of the wider national interest.

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