Airbus, Alabama, Boeing, and McCain

Press reports on the tanker saga have left two points unappreciated. The first is the hidden cost of creating a new aircraft assembly facility in Alabama. The second is how John McCain’s demands for competition in this deal helped Airbus and Northrop – not because McCain is crooked but because competition in defense contracting is phony.

To review: The Air Force needs refueling tankers because we fight far-off wars and don’t want to ask permission for overseas basing rights. B-52 bombers couldn’t fly from Missouri to Afghanistan to bomb the Taliban without tankers. Fighters and cargo aircraft need them too. The Air Force’s tanker fleet of 520 KC-135s and 59 larger KC-10s is old. In 2004, the Air Force tried to begin replacing them by leasing tankers from Boeing, as private airlines do. The deal unraveled when it emerged that leasing the tankers would add $6 billion to the taxpayers’ bill, that the deal was partially intended to prop up Boeing, and that Boeing had bought influence with Pentagon officials. McCain led the opposition. Two Boeing executives and one Air Force official went to prison. The Secretary of the Air Force and the head of Boeing lost their jobs.

Still looking for new tankers, the Air Force solicited another set of proposals for the new tanker, now dubbed the KC-45A. A few weeks ago, Airbus, a subsidiary of EADS, the European Aeronautic Defence and Space Company, won, along with its partner, American defense contractor Northrop-Grumman. The deal would eliminate jobs in Kansas and Washington where Boeing has production facilities. Congressmen and Senators from those states erupted into patriotic indignation and vowed hearings. Politicians from Alabama, where Airbus will place a new production facility, vowed to fight for the deal. Boeing protested, which forces a GAO review – delaying the start of production by at least 100 days. Now allegations have emerged that McCain aided the victors while taking their money and their lobbyists for his Presidential campaign. Got it?

The Air Force says EADS’s tanker is better than Boeing’s. I believe them. It would be reckless to choose an inferior product given the likely protest from the loser and what happened in 2004. But while getting the best plane for the least money is essential, when it awards contracts, the Pentagon should be able to consider their effect on the political landscape, because that landscape drives future contracts. You can’t get the politics out of defense contracting, so you need to get the politics right.

The political problem with the Airbus deal is that it opens a production facility in Alabama to make conventional aircraft assembled elsewhere into tankers, but will not close Boeing’s similar plant in Wichita, Kansas. This means taxpayers have a new mouth to feed. Because they create concentrated interests, US military production facilities are nearly impossible to close. In the private sector, sellers make money by cutting costs and delivering products more efficiently. In defense contracting, companies succeed by keeping production lines open and relying on local Congressman, workers and lobbyists to get them work. That’s why the US has twice the number of shipyards it needs despite consolidation in the shipbuilding industry. It would have been better to keep all the production in Europe, preventing new domestic lobbies from forming, or more realistically, accomplish the same thing by making Airbus lease Boeing’s plant.

Senator McCain has mud on his face because after he blocked the Boeing lease deal and pushed to reopen the bidding, he got around $14,000 in contributions from EADS employees, more than any other politician. Then he hired some of their lobbyists for his presidential campaign. Did that affect his behavior on the current round of proposals? McCain says no. “All I asked for in this situation was a fair competition,” he says.

But keep in mind what fair competition here means. As my friend Owen Cote, a researcher at MIT, points out, with only two viable competitors, this is a not a real market. Ensuring competition among two sellers means giving both leverage over the buyer, because if one exits the process, competition is lost. What the press has not pointed out is that McCain’s insistence on competition gave Airbus the power to force changes in the Air Force’s criteria.

There were two disputes about the Pentagon’s request for proposals that McCain got involved in to the benefit of Northrop-Airbus. First, in September and December 2006, just before the Pentagon was to release its RFP, McCain wrote to top Pentagon officials, asking them to eliminate language in the RFP forcing consideration of how penalties due to a WTO dispute over subsidies might affect the tanker’s production cost. That provision, championed by Boeing booster Norman Dicks (D-WA), would have hurt Northrop-Airbus more than Boeing. McCain got his wish.

Second, in the December letter, McCain asked the Pentagon to give the proposals credit for having more cargo space, instead of equal points for having in excess of a certain amount of space. Meanwhile, the Northrop-Airbus team, which was proposing a bigger aircraft, threatened to withdraw their bid if the Air Force did not change its criteria on this issue. This double whammy put the Air Force up a creek. If Northrop and Airbus weren’t bluffing, leaving the criteria be would hand the deal to Boeing, and enrage McCain, who could then accuse the Air Force in public hearings of giving Boeing another sweetheart deal. The Air Force complied, giving another advantage to Northrop-Airbus.

It therefore appears that John McCain was necessary to EADS getting this deal, even as he was taking in their campaign contributions and lobbyists. That doesn’t mean there’s anything nefarious here. McCain had good reason to help block the deal in the first round. The changes he asked for in the second round were arguably wise. The subsidy issue could actually be seen as an ace in the hole for Boeing that should not have been there in the first place. Plus $14,000 is cheap if he were going to sell out.

But it sure doesn’t look good. Who was it that said that “questions of honor are raised as much by appearances as by reality in politics”?