Joe Anselmo:

Welcome to this week's Check 6 podcast. I'm Joe Anselmo, Aviation Week's editorial director. Rising geopolitical and trade tensions between China and the United States are sometimes referred to as the “New Cold War,” but there's a big difference. In the original Cold War, the U.S. And the Soviet Union had minimal trade. The U.S. And China are the world's two largest economies, and those economies are intertwined.

In the 2010s, China was the engine that propelled the growth of commercial aviation, creating a wave of prosperity for Western airplane builders and suppliers. It's not just Airbus and Boeing. U.S. companies account for nearly 60% of the suppliers on Comac’s new C919 narrowbody jet.

So how are aerospace suppliers navigating tensions between Washington and Beijing? That question was the focus of two recent Aviation Week stories written by business editors Michael Bruno and Matthew Fulco. And joining them is Kevin Michaels, managing director at Aerodynamic Advisory, a specialty consulting firm focused on aerospace and aviation around the world.

Michael, let's kick off with you. Tell us about your recent reporting and what's behind it.

Michael Bruno:

This was a fascinating and fun package of stories. This is actually part of a series that we're doing in Aviation Week & Space Technology about China trying to look at the issue of China and the U.S. from every angle, whether it's commercial aviation or defense. And the reason behind that is it's very clear that there's a paradigm shift going on in that relationship, but it's also very clear that it's still central to the growth prospects for good and for ill in the Western aerospace and defense sector.

So, in particular for the commercial aviation side of things, Aviation Week partnered with Bank of America's very esteemed analyst, Dr. "Rocket" Ron Epstein, who's a good friend of all of ours here on the podcast. And we did a survey between Bank of America and Aviation Week of the commercial aerospace suppliers who are active, or at least been involved in the Chinese aerospace industry to date. And we found some really interesting results, one of which was the majority of respondents, about 58% in this survey said that they were beginning to diversify away from China. And 51% of them, so a slim majority, but a majority nonetheless, 51% of them said that they anticipate even reshoring or nearshoring away from China and more toward the West, most likely the U.S. and North America as they move to diversify to get out of China. And maybe most striking was that 79% of those surveyed in this AV Week/Bank of America survey said that they just don't see growth in the Chinese aerospace marketplace for them anymore. And that caught Ron Epstein and me kind of off guard that so many people had become relatively negative on growth prospects in the marketplace.

And when you dig down and you ask them a little deeper, the survey respondents said they were not getting out of China, they were not jettisoning their operations there. They were not writing off all of their investments made there. They just didn't see the growth that they saw there maybe 10 years ago. And that was a bit surprising.

So happy to talk more about that survey and some of the results that we found, but I think it's worth going to Matt next and basically attacking the elephant in the room topic here, which is all of this comes from the trade tensions that have emerged between China and the U.S., going back to the Trump administration, but which have been continued by the Biden administration along with all kinds of other things that are happening around the countries and around the world. And Matt really tackled that. So, Matt, I want to ask you essentially, where are we in this new Cold War, especially when it comes to the trade relations in aerospace between the two countries?

Matt Fulco:

That's a great question, Michael. I think that RTX CEO Greg Hayes made an interesting comment back in June when he said that decoupling from China is impossible. And I think what he meant by that was there's just such a high level of interdependency in the aerospace sector between U.S. and Chinese supply chains that just tearing that all up is not realistic.

That being said, if we look at some of the recent developments, whether that's China placing export restrictions on gallium and germanium, or whether it's the fact that China has actually sanctioned Hayes himself, symbolically it seems, as well as Boeing's defense arm. What we see though is that the Chinese have not to date done anything overt with respect to the commercial arms of RTX and Boeing because they are important suppliers to China's aerospace sector. Although we do see that it's been quite some time, I think it was 2017 was the last time that China placed a large order for Boeing aircraft, and that happens to be the last year before the trade war. So I don't know if that's a coincidence or not, perhaps not.

But it's very interesting to see that while Boeing is having difficulties in China that Airbus seems to be doubling down. If we look at the fact that they are redoubling their efforts in the Tianjin facility. In April, Airbus's CEO visited China alongside a delegation led by French President Emmanuel Macron, and we see that Airbus seems more committed to the China market than ever. I don't think it's that they're unaware of these geopolitical tensions. I think it's more that from the French standpoint, they're not the same kind of security player that the U.S. is in the Indo-Pacific. They obviously are part of NATO and are U.S. ally but they're not looking at those tensions from the same standpoint.

And to some degree, it could be opportunistic. There's a duopoly that exists in this industry, and Airbus sees an opportunity in a market that remains big where Boeing is struggling. So, I think that's one of the most interesting trends we have discovered that there's sort of a split between the U.S. and European companies in this industry and to some extent Asian companies as well in the aerospace sector that are not directly entangled so much in this trade war or U.S.-China tensions.

Joe Anselmo:

I wanted to ask Kevin about that, but Kevin first, you make your way into a good number of boardrooms in this industry, companies small and large. Michael referred to the results of our Bank of America survey. Are you hearing the same thing about reshoring to the United States or nearshoring to places like Mexico and out of China?

Kevin Michaels:

The foreign direct investment in China for aerospace by our own research really peaks, the apex of it was back in 2009, 2010, 2011 when Comac was setting up and mandating joint ventures and the like. The big wave of investment for manufacturing actually took place then. And back then, companies were also looking to set up engineering centers in China as well. And boy, things have changed since then. And so now you're not seeing any public announcement of an OEM, or supplier closing down a factory and moving it back to America or Mexico, but rather they're not adding to their investment. What they have there is what they have. They're not adding to it right now. In time, we may well see those public announcements take place, but they're just not adding additional capacity, which means in essence, they're really sort of losing out. That's for U.S. manufacturers.

And as was pointed out, European, it's a completely different matter, and it's not just Airbus, but it's the Airbus suppliers that maybe see an opportunity here where they're not in the same geopolitical situation [of] American suppliers. Not only do we have a course where Airbus has done in Tianjin with their final assembly facility, but you have investments going on like GKN setting up joint ventures to make aerostructures and transparencies. Safran doubling its LEAP engine blade production at Guiyang. And Safran themselves delivering their first LEAP-1A engine nacelle for the A320neo. It's those parts. So, it's quite a dichotomy between the U.S. suppliers and OEMs and European.

Joe Anselmo:

And you were saying earlier on that MRO is also sort of not considered strategic, so it's not being affected by this.

Kevin Michaels:

Right. MRO is not in the same category, and yes, there's still investment going into China and the MRO market will still grow in China at a fairly robust rate. So, you are still seeing -- most OEMs and most of our clients when they look at Asia, what they conclude is they really need an ecosystem to serve the Chinese market because of the customs, the difficulty of getting in and out of China, and the need to be in country and then serving the rest of Asia. And many of them have set up in China, typically through a joint venture, but sometimes on their own. And then they set up in places like Singapore, Malaysia, and other MRO hubs, which is where they serve the rest of Asia. That's kind of a generic playbook, but no, MRO seems to be treated quite differently.

Michael Bruno:

It's really interesting then, and Kevin and Matt, I want to bounce this question off you in a moment, but it feels like we're in a moment of stagnation, sort of a very long moment of stagnation between China and the U.S. And you can see it in everything from large commercial aircraft orders and deliveries, okay, so the orders haven't been canceled, but the deliveries are not happening, particularly from the Boeing side. On the manufacturing side, Kevin, you just pointed out, they're no longer throwing money into China to stand up new factories and get supply chains set up. At the same time though, we don't really see a stepping away when it comes to offshoring out of China. You just see companies starting to set up operations elsewhere, maybe Vietnam, Indonesia certainly maybe looking more into Mexico, so the nearshoring back to the U.S. So it's this weird stagnating scenario where neither side seems to really want to pull back from each other and they may threaten, they may hint that they're going to do that, but we're not seeing that. Would you agree with that assessment?

Kevin Michaels:

I would agree. I would agree that you're not seeing it publicly, but where it is happening for sure is in engineering and R&D, and this is very quiet. You're seeing a lot of the companies that rushed into China, and even universities as well, rushing, but they have quietly moved a lot of their best technology, or some of the real juicy R&D aspects of that out of China back to mothership, and it's being done very quietly. But that has certainly been a shift the same place, but that isn't closing factories to your point. It's not that public announcement of something changing.

Michael Bruno:

Right. A not So in your face kind of a change.

Kevin Michaels:

Not so in your face. And if you go back in time too, 10 years ago back when C919 was announced, and we were in a very different era. Back then we thought that China would be the next big business jet market. There's great optimism about that and setting and then what C919 could become as well. So, we were in a very different place back then and fast-forward now.

And you can't have this discussion without talking about President Xi and the new policies that have come down and what it has meant for entrepreneurs and ultra-high net wealth individuals in China, many of them lining up to get out of the country. The business jets being sent off to places like Macau, you've got to stay under the radar screen and suddenly what was going to be the next big business jet market has screeched to a halt.

And then layered on top of that's just what we've all seen in air travel growth, which Aviation Week has documented very thoroughly in terms of the slowdown in air travel, which by the way was slowing down before COVID, I think it was 5% in 2019. So the demographic shifts which suddenly have just emerged, and now I think we're all familiar with it, coupled with the real estate bubble that's slowly unfolding and the financial crisis and the high unemployment rate amongst youth.

All these things have really slowed down the long-term growth. And even in our own forecast now, I think we have China growing at more like a mature economy, going forward it's no longer this 10, 12, 14%, it's more in line with, I think we have China growing at 4.8% over the next 20 years. So, it's more in line with a mature economy.

Joe Anselmo:

So, Kevin, this brings to mind something that your partner Richard Aboulafia brings up a lot. Embraer is based in Brazil, but they go out and source the best suppliers and provide ironclad IP protection, so they get the best. China has a stated goal of making its own aircraft engines and components. So, there's a limited timeframe in here, isn't there? And companies aren't going to put their best IP into China anyway now because they're worried it will be stolen.

Kevin Michaels:

That's right. And the C919 reflects that. It does not have the leading edge technology. And there have been a number of actions recently too. We mentioned Greg Hayes at the outset of this podcast, but even the government, they're rating the offices of prominent management consulting firms. That's the business I'm in. There's just a real fear of doing anything that smacks of technology sophistication in China. So, the record of countries having autarky and having self-created systems and not getting the best of the best is not good. And it doesn't bode well for China's future.

In the last year, of course, the C929, we've now seen what I think what a lot of us long suspected is that the China-Russia partnership was very fragile below the surface. And now that's officially ended formally, and it was never built on solid ground to begin with. So yeah, it's going to be a real challenge. And China's Achilles heels continue to be in areas like gas turbine engines and they're putting a lot of capital into that and trying to make up ground and to become self-sufficient as soon as they can. And Western engine OEMs are in no mood to help them accelerate with that progress.

Michael Bruno:

And Matt, I wanted to come back to you to go kind of full circle. We talked at the start about this being sort of a new Cold War, and in your article you talked a lot about the sanctions that the two countries have put on each other. We certainly had the blacklist that the Trump administration started and the Biden administration did not take away, which I think was surprising at the beginning of the Biden administration to many. And of course, China continues to put sanctions on people like Greg Hayes and Ted Colbert and just trying to say that these companies in the West, the big primes, could be at risk, but yet they're not. It's kind of a weird scenario. It's stagnation, it's a whole lot of politicking and posturing and edging toward the cliff, but yet nobody seems to actually be doing anything that is truly changing the game yet. Do you agree?

Matt Fulco:

I do. I think that there's a duality that's very interesting in China with its state-controlled economy and the heavy politicization of strategic industries. If we look at the fact that the U.S. has been trying to change the name of decoupling to de-risking, to try to play that down and emphasize that as you said, there isn't going to be a ripping apart of supply chains, or a real separation of these supply chains into a U.S. one and a Chinese one.

But the Chinese are not happy with that, their state media has come out pretty heavily against this concept of de-risking. They've even said there isn't a whole lot of difference to try to disrupt as a word they use a lot, disrupt these supply chains in the name of political reasons or because the U.S. has trade tensions with China is unreasonable and not good for the aerospace and defense industry.

So, I think that it's ironic that the U.S. has tried to kind of take decoupling down a notch and on the Chinese side, they're still not happy with that at all. What they want is continued interdependency and heavy dependency on China in this industry because it's good for their economy, it's good for political goals, it's good for a lot of things from their perspective.

So, the fact that there is even some limited de-risking, decoupling, or breaking up of supply chains is not something the Chinese are happy about. Yet, they also recognize that because of these tensions that exist geopolitically and just an emerging great power competition between China on one side and the U.S. on the other, and I think that's what these moves around rare earths are about, reminding the U.S. that two can play at this game. And that China, where does it really have control in the supply chain, it's not at the really high end the way the U.S. does.

They can control commodities, but we've written about it in Aviation Week how trying to control rare earths in that way and put export bans on them may backfire because U.S. and its partners are already working to build up resiliency in that respect. So, I don't think that China putting an export ban on rare earths is going to disrupt the aerospace industry too much, but I think it may push some limited decoupling, which we are seeing.

But ultimately, I think there's too much interdependency for the two sides to fully, not fully, or even comprehensively decouple, and it wouldn't be in the economic interest of China to do so. And I think that for the legitimacy of their political system and for just the well being of the people, they definitely want there still to be a high degree of interdependency.

Joe Anselmo:

Kevin, did you want to have the final word, you look like you do?

Kevin Michaels:

Sure, of course. I think putting this in context too, according to government data in the U.S., I mean, let's put it into context. Chinese imports into the U.S. aerospace imports are less than $2 billion a year. This is not an electric vehicle story or other industries [like] consumer electronics that we're familiar with. I mean, China has a role in the ecosystem, but China's definitely expendable on the ecosystem side of this too. We don't need China. China needs us.

The aircraft manufacturers need the Chinese market of course, and the engine manufacturers and everyone else. But on the ecosystem standpoint, we don't necessarily need China with the exception of maybe some of these rare earths where they can have an outsize impact on market prices.

And the big winners in all this, Mexico clearly. Again, Aviation Week has written about that. The last time I checked, there is no Mexican Regional Jet. They take good care of our intellectual property. They haven't had the labor wage inflation that we've seen in other countries, but then in Asia, India's time is coming. And so Vietnam, India with the geopolitical shifts are going to be best cost sourcing will still go on for certain components and items and places like Vietnam and India really stand to benefit from what's happening.

Joe Anselmo:

Well unfortunately we're going to have to wrap it up on that thought because we are just about out of time. Kevin, you haven't been on for a while, so welcome back to the Check 6 podcast. Matt Fulco, congratulations on your first Check 6 podcast. It's great to have you on board. And Michael, thanks to you as always. That is a wrap for this week's Check 6. A special thanks to our podcast producer in London, Guy Ferneyhough.

Join us again next week for another Check 6, where Aviation Week's, Graham Warwick and I will be talking with the founders of a venture that has raised more than $40 million to develop a new engine that could transport flyers from San Francisco to Tokyo in one hour. You heard me right, one hour. Until then, thanks for your time, and have a safe week.