PERSPECTIVE ON AEROSPACE : Let McDonnell’s Deal Go Through : It has separated its military business from the commercial, ensuring protection of sensitive technologies.

The American commercial and military aerospace industry has been an industrial success story since World War II, generating “good jobs at good wages” and high levels of exports, while the rest of our high-technology industry has been losing world market share. Therefore, the recent announcement that the commercial division of McDonnell Douglas plans to sell up to 40% of its equity to the Taiwan Aerospace Corp. for $2 billion has generated a spirited debate.

McDonnell needs venture capital to develop its new MD-12 wide-body airplane to compete with Boeing and the European Airbus. McDonnell said that it cannot find the required capital in America.

In a letter to President Bush, 30 senators expressed concern that this transaction would be detrimental to U.S. strategic interests, a cheap giveaway of American technology and market position after a significant government investment. The lawmakers have urged the government to block the deal.

This proposed deal is not a new phenomenon but part of a growing trend toward international cooperative ventures in the high-technology area.

There are five primary reasons why this internationalization is occurring:

-- The world capital market is in general becoming more integrated as American firms buy and operate factories and offices overseas and foreign concerns do the same here. It is therefore becoming more likely that a match between firms of different nationalities will be made for any given project.

-- Aerospace projects, and high-technology projects in general, tend to have very high costs as the advanced technologies they embody become more complex. Foreign countries, with their higher rates of savings and lower cost of capital, are likely to be able to bring more attractive terms to American partners in such financially large, and therefore risky, ventures.

-- Foreign countries are rapidly increasing their indigenous capacity to develop and produce high-technology products that America once had a monopoly on. One reason is the relatively higher emphasis put on engineering education among foreign students compared to American students.

-- Joint foreign ventures lead to access to foreign markets and foreign technology.

Critics of such international joint ventures put a different spin on these factors. They argue that the foreign capital funds (that is, investment dollars) that are available to buy into the American high-technology industry are largely available because of subsidies or direction by foreign governments, and are available, on a very selective basis, only to firms that control specific advanced technologies that foreign governments want their industries to acquire for future marketing advantage. They argue that such deals are counterproductive for the United States because the long-run costs of losing exclusive control of the technologies or markets outweigh the short-run benefits of lower-cost investment resources. Finally, They argue that foreign partnerships lead to a higher share of components being acquired abroad, resulting in further erosion of the American job market.

With these perspectives on the costs and benefits of foreign joint ventures, let us evaluate the consequences of the three broad policy options facing the U.S. government in this situation.

First, it could insist that McDonnell find the $2 billion needed to develop the new aircraft in the United States. One possible consequence might be that no American partner could be found, where “partner” broadly includes equity participants, lending institutions and McDonnell shareholders themselves. Then the company would find itself out of the future commercial airline business, and the world would have only two suppliers: Boeing and Airbus.

This could lead to inadequate competition in a vital international industry and, depending on how the sales that would have gone to McDonnell were distributed between Boeing and Airbus, could also lead to a loss of jobs and exports for the United States.

Another possible consequence is that an American partner might be found that would bring less attractive financial terms, or poorer technology or market benefits to the deal. This would hurt McDonnell competitively, and lower the chance that the new airplane will succeed in the market. If the new airplane fails in the market, the negative consequences associated with McDonnell dropping out will still occur, with large losses for American investors offsetting the development jobs that would have existed for several years.

A second possible U.S. government policy is to itself become the partner in this aircraft development by providing guarantees for $2 billion in lending to McDonnell Douglas. Such a dramatic reversal in the current hands-off industrial policy would raise troubling issues. Would the U.S. government stand ready to provide credit to any aircraft manufacturer (or any high-technology firm) that receives a foreign partial purchase offer? Such a decision in the case of McDonnell Douglas would put the U.S. government on a slippery slope toward national credit allocation and management; it would be unfair to extend it to only one company, and unwise to extend it to all. How would foreign offers be judged as beneficial or not, let alone bona fide or not?

A second problem is whether the U.S. government would require management oversight on the program, comparable to that exercised on military aircraft such as the C-17 or the B-2. Historical problems associated with those programs suggest the wisdom of the hands-off policy, yet concerns of public stewardship of a subsidy program would lead to calls for oversight. We note that McDonnell Douglas, which does the majority of its business for the U.S. government under current acquisition regulations, is in financial straits, while Boeing, which largely operates in the open market, is financially healthy.

We now ask: Would either of the above two policies keep Taiwan out of the commercial aerospace market, or reduce use of foreign components in the MD-12, if built? Taiwan’s indigenous military fighter plane was developed just that way, indigenously, with substantial U.S. commercial assistance. Unless truly Draconian laws forbidding American citizens with technical expertise from working for foreign companies are passed, there is nothing to prevent Taiwan from trying to enter the commercial airplane market this way. Of course, it would cost much more, and have a lower probability of success, but we can’t stop it. However, a Taiwanese alliance with a European or Japanese entity to develop a new airliner would be more likely.

On the issue of foreign components, critics say that a higher proportion will be bought overseas if the aircraft is jointly developed with Taiwan Aerospace than if an American partner is recruited. This flies in the face of the common-sense argument that the lowest-cost supplier will be found for all components, regardless of the name on the final assembly plant. Boeing aircraft, for example, use many foreign parts to lower their costs and stay competitive.

This leads to the third, and in our view the best, U.S. policy: Let the deal go through. McDonnell Douglas has already separated its military business from the commercial to ensure protection of militarily sensitive technologies. Given all the potential problems with interfering in this venture, and the dubious benefits of stopping it, we believe that this is a good time to let the market work, and for Congress to let this opportunity to intervene pass.