Keeping Economics Simple

Emile Woolf, Going Postal
The first Airbus A380 sold by Airbus to Singapore Airlines 15 oct 2007, Falcon® Photography CC BY-SA 2.0

The US Department of Defence is a major customer of many private sector suppliers, including the Boeing Company. Although relationships between customer and supplier are mutually beneficial, that is by no means the only reason why Boeing has proved to be such an enduring commercial success.

When Boeing offered a 100-year bond last year, some commentators queried whether the company would still be around to pay it off. But, as noted by Holman Jenkins in the Wall Street Journal, 100 years is merely two product cycles for the company!

Boeing’s iconic 747 was launched in 1969, and its air-cargo version will continue to be built near Seattle for at least another four years; and the 737, which first flew in 1967, has a backlog of existing orders that will take it beyond 2027 to fulfil. By any reckoning that’s an enviable achievement.

Prerequisites for commercial success

When assessing what makes for such success, two key components stand out: ownership and funding. Whether owners of an enterprise choose to develop a project by using their own capital (invested funds + accumulated savings), or by borrowing, that decision cannot sensibly be reached without clear-eyed economic analysis.

For example, if the borrowing route is selected, issues such as creditworthiness and ability to meet contractual repayment terms come into play, as well as the size of the required loan in relation to its projected return – and whether alternative funding arrangement are more likely to satisfy the company’s optimal time preferences for the use of its resources.

Simply put, investors expect a return on the money they have invested, and every decision by management is therefore subject to a high level of accountability.

What happened at Airbus?

After viewing Boeing’s successes, it is difficult to understand why, in January of this year, Airbus decided to announce the termination of its A380 production programme. In terms of design and engineering this double-decker, four-engine, 535-seat, superjumbo is a sensational creation – but the trouble was that age-old equaliser – money!

It’s development was underwritten by massive EU government subsidies, since ruled illegal under World Trade Organisation regulations. French and German politicians, for whom it represented an irresistible glamour project rather than a hard-headed commercial proposition, spearheaded a funding largesse untroubled by any budgeted spending plans or a projected return on investment.

“Public/Private”? Like being only slightly pregnant

Despite its “public/private partnership” veneer its roots were socialist. Tax revenues taken from the earnings of employed masses, and applied by an unaccountable state bureaucracy to purchase technology created by free enterprise, with commercial rationale based on unmeasured public demand, you have the very definition of contemporary state-applied socialism. It wasn’t the politicians’ own money at stake; they just wrote the cheques.

The venture may have appeared functional at first but its hybrid structure, under which design, marketing and construction issues took precedence over cost control, created irreconcilable tensions that rendered the venture irreversibly dysfunctional.

To ascertain what went wrong, we should ask:

What were the technical and commercial realities that EU finance providers and Airbus managers chose to disregard before giving the fateful production “go-ahead’ that sank the A380?

1 – Direct flights. They would have had to ignore the advice of market analysts, had they asked: the majority of passengers prefer direct flights to their destinations, rather than via the crowded hubs for which the A380 was designed. Flying a 500-people plane-load to a small Greek island without stopping in Athens looks like quite a marketing challenge!

2 – Frequent departures. The same analysts would have advised that business travellers require a choice of frequent departure times. The A380 has 535 seats to fill and is therefore hopelessly matched against companies offering more convenient schedules, again by using smaller planes. 

3 – Cost. Fuel-efficient smaller planes, such as the Boeing 787 or any in Airbus’s own A320 series, are cheaper to operate on a per-seat basis, despite the ability of the four-engined A380 to accommodate double the number of passengers.

4 – Supplier-confidence in the model. The aerospace industry’s global supplier base showed some understandable hesitation before committing to devise, develop and improve special technology for a new fuel-efficient engine in an aircraft whose future, for the above reasons, is commercially doubtful.

5 – Too much has already been spent. It’s the old story: “We have blown so much money already that we shall appear as complete arseholes if we abandon it now!” Think HS2; think Hinckley Point; think Heathrow expansion. Think “smart” meters, “smart” motorways. Think anything labelled “smart” by the government, and you’ll know for certain that it’s as dumb as hell. This snivelling mindset is a giveaway. It means that the go-ahead was given blindly and thoughtlessly, without appropriate cost-benefit analysis.

The final act in the saga

The A380’s initial development cost projection of 10 billion euros rapidly escalated to 18 billion and finally, when the immense weight of 330 miles of cabling, per plane, was factored in, the cost projection shot up to over 25 billion euros: an overrun of a mere 150 per cent! Imagine how many planes you would need to sell just to recoup the development cost!

Boeing’s board was harangued at the time for declining to compete with Airbus and replace its 50-year old 747. But unlike their counterparts in the EU, Boeing did its own commercial due-diligence on solid “validation-versus-vanity” principles, and concluded that the market was unlikely to favour the advent of a new jumbo-sized craft.

We can draw some economic truths from this tragic waste

Patrick Barron, in his latest essay, reminds us of the underlying principle that government may alleviate, but not cure. It might gain partisan support by steering economic resources (our taxes) in a way that helps sectoral pressure groups, like steelworkers or chicken farmers, but can do little that benefits society as a whole. EU money can be applied to construct a “dreamliner”, but cannot make it fly – not commercially, anyway!

Patrick refers to the French economist Frederic Bastiat (1801 – 1850) whose insight was to recognise that the consequences of all these manipulations, for better or worse, are visible – you can see their effects – but what are always hidden are the innumerable, unseen, alternative uses to which those resources might have been applied to achieve a more desirable end for society as a whole. But once applied, no matter how wastefully, those resources are gone forever.

The word “devastation”, is derived from the Latin verb meaning “to lay waste” – a perfect epithet for the A380’s demise, vividly portrayed by planes in pristine condition wasting away, unsold, in used-plane hangars. Holman Jenkins, to whom I am indebted for much factual background, tells us that one such aircraft, retired by Singapore Airlines, is now “being broken up for scrap, proving once again socialism’s knack for making grown men cry.”    

The principle in all of this cannot logically be ignored. Capitalism’s ubiquitous success is based on the innate human desire for self-improvement, and the intelligence to achieve it. Industry is the result. The perennially-cited blots – exploitation and greed – although equally human, are aberrations; they represent traps for indiscriminate and unwary minds – but they cannot gainsay the successes.

© Emile Woolf September 2019 (website)