Note To China: Get Out of the Airplane Business -- Leave It to Boeing and Airbus

Santa Monica, Calif. (TheStreet) -- A new report by the Rand Corporation said China should get out of the aircraft manufacturing business, where it is hopelessly behind Airbus and Boeing (BA) and losing ground.

Commercial aviation manufacturing "is a huge waste of money for China," said Keith Crane, director of the Rand Environment, Energy and Economic Development program and co-author of the report "The Effectiveness of China's Industrial Policies in Commercial Aviation Manufacturing."

China has already spent more than $7 billion to develop the C919, a narrowbody aircraft. The problem is that "by the time it gets out there in the market, it will be a full generation behind the Boeing 737MAX and the Airbus A320neo," Crane said in an interview.

Being so far behind means that the C919 "will be competing against used aircraft, where you are really in a very tough position," he said. "The bottom of the used aircraft market is scrap value, (where) you just look at how much you can get out of it."

Asked whether Chinese could overcome buyer resistance by cutting the price of its aircraft, Crane responded: "If it's a generation behind and lacks improvement, that could not be overcome by cutting the price. For an airline, it's not the price that drives a purchase. It's down-time and fuel efficiency."

China is also developing a regional jet, the ARJ-21, which "has also been expensive," according to the Rand Corporation report, which noted that "most of our interlocuters were skeptical that either the C919 or the ARJ-21 will ever be commercial successes.

The principal problem, the report said, is that "foreign companies are not given the same treatment as their Chinese counterparts (or) are afraid that their intellectual property rights will not be safe (and) they will remain cautious about what technologies they bring to China.

"If China wishes to become fully integrated into the global commercial aviation manufacturing industry, China's government would be well advised to change its current policies to create a more equitable business environment for both foreign and Chinese commercial aviation manufacturers."

Aviation consultant Richard Aboulafia of Virginia-based Teal Group, who has read the report, said Rand did "a good job of documenting (what) has been an open secret in the airplane business," which is that flawed government policies have led to the failure of Chinese aircraft manufacturing.

"The Chinese have great talent, a great market, and great resources," Aboulafia said. "You have to work awfully hard to destroy its prospects of getting into commercial aviation."

The government-owned Commercial Aviation Corporation of China, established in 2008, presides over Chinese efforts to compete with Boeing and Airbus.

"In light of the many hurdles facing COMAC, in our view this is an opportune time for the Chinese government to rethink its investments and policies targeting specific industries," the Rand report said. "Focusing its energies on creating a business environment friendly to all firms -- private, foreign and state-owned alike -- will be much more likely to result in a higher payoff."

Government pressure means that Chinese airlines are customers -- practically the only customers -- for Chinese-built aircraft. Rand said 251 of the 267 orders for the ARJ-21 are from Chinese airlines, and that 370 of 380 orders for the C919 are from Chinese airlines, according to COMAC. The other 10 orders are from GE Capital Aviation Services, which would lease the aircraft to Chinese carriers.
"If you want to make money as an airline, you don't want some government telling you want kind of jet you will buy," Aboulafia said.

The Chinese "should do the smart thing and drop their technology transfer nonsense," he said. "They could be like the Japanese and become experts at some aspects of technology, or be like Brazil and build a plane and source it, however. Just don't be a government-run shop."

Both Boeing and Airbus are selling thousands of planes in China as well as using Chinese components in their aircraft. "China should manufacture (aircraft) components," Crane said. "They do OK there." Rand said such companies are willing to invest in China to cultivate a competitive source for parts and to generate sales, but they don't want to lose their intellectual property and technology to the Chinese government.

In 2008 Airbus established an A320 final assembly line in Tianjin, its first assembly line outside Europe. The Tianjin line is a joint venture between Airbus and a Chinese consortium. Last month, the partners announced an extension of the joint venture into 2025.

As of late 2013, Chinese deliveries represented 20% of Airbus global production. Airbus delivered its 1,000th aircraft to a Chinese operator in December, when Air China took delivery of an A320.

Meanwhile, Boeing said that some 7,000 Boeing aircraft currently in operation have Chinese parts, and that Chinese firms have built components for every current Boeing commercial aircraft including the 787.

Boeing, which has more than 50% of the Chinese passenger jet market, projects Chinese demand for 5,580 new airplanes, valued at $780 billion, over the next 20 years. Boeing's China Current Market Outlook, released in September, said the country's fleet would triple in size in that time.

"Thanks to strong economic growth and increased access to air travel, we project China traffic to grow at nearly 7% each year," said Randy Tinseth, vice president of marketing, Boeing Commercial Airplanes, in a prepared statement. "China is a key market for Boeing."

Written by Ted Reed in Charlotte, N.C.

To contact this writer, click here.

Follow @tedreednc

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