Risk Shifting, Technology Policy and Sales Contingent Claims: When is Launch Aid to the Aerospace Industry a Subsidy?

Abstract

This Paper studies the criteria with which the presence or absence of 'subsidy' in sales contingent Launch Aid R&D support may be determined when payoff-relevant market incompleteness limits the precision of market-based pricing to non-trivial intervals. The criteria currently employed in WTO and EU proceedings are consistent with correct accounting for the opportunity cost of capital when markets are complete and frictionless, but fail in the presence of payoff-relevant market incompleteness where the interval between bid and ask prices may not be finessed away. An economic definition of subsidy must necessarily capture opportunity cost, and we develop a definition that fully incorporates government's opportunity cost in both complete and incomplete market settings. With this in hand we then revisit some commonly posed questions concerning the subsidy status of Launch Aid, giving indication of how they may be best resolved by those in possession of the relevant details.

Keywords: Incomplete markets, R&D, subsidies, civil aerospace, sales contingent claims

JEL Classification: D52, F13, H25, L62, O38