Beruflich Dokumente
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To update and complement the Brevis report in such a way as to provide the executive committee
with the necessary information to analyze both the general and specific opportunities and threats
that are present in the aerospace sector.
2. What was the unit labour cost advantage of producing in China relative to Mexico in 2006?
Does China’s unit labour cost now exceed that of Mexico?
3. If China is more expensive now, what may explain this sudden reversal? And will this
trend continue in the long term? Don’t hesitate to draw on the role that macroeconomic
factors may be playing in driving wages in China today and in the future (hint: make use of
the labour market model that you discussed in macro).
High GDP growth rate
Increase inflation
4. Are there any other key advantages in Mexico’s business regulations and enforcement
compared to China that may make it an attractive location for Bombardier to conduct
manufacturing?
Free trade agreements with many countries
5. What other factors should play a role in Bombardier Aerospace’s decision whether to
manufacture plane components such as fuselages in China or Mexico?
Labour Cost
Political Stability
Distance
Intellectual Property protection
Currency rate fluctuation
Finance
Potential orders in exchange of setting up plant in location
GDP growth rate
Demand of planes
Technical Expertise / Specialization
2 Pisano, G.; Shih, W. 2009. Restoring America’s Competitiveness. Harvard Business Review.
3 http://www.bloomberg.com/news/2012-11-07/bombardier-delays-first-flight-of-cseries-until-end-of-
june-1-.html
We are interested in getting a better sense of how the demand for air travel, throughout the world,
but in North America in particular, is impacted by changes in prices.
The Brevis report contains only minimal information on this. Specifically, it states that estimates
suggest that demand for air travel is quite elastic (own-price elasticity estimates in the range of -
1.5 to -2) and that consumers view different airlines as close substitutes (cross-price elasticity
estimates of approximately 1). The report also hints that for many international markets, elasticities
have already been calculated.
Since the report fails to provide information for the international markets, we would like you to
research elasticities in this market. We are also somewhat sceptical of the North American numbers
they have calculated, since they do not coincide with our intuition. From past research we have
compiled a small database containing prices and sales information for certain North American
routes between 2009 and 2012. We would like you to examine these data to determine whether the
numbers in the Brevis report make sense.
The Brevis report contains certain information about the structure of the aircraft (production)
industry. However, this information is far from complete. In fact for some reason it focuses mostly
on the wide-body segment of the industry. We would like you to fill in the blanks and provide
more information about the structure of the market, especially the regional- and business-jet
markets where Bombardier is more active.
a. Before focusing our attention to China, we would first like to determine how different the recent
growth experiences of China and India have been over the recent past. In the companion dataset
named “china_india_data_2017.xlsx”, you will find data on real GDP, the capital stock and
employment for both countries between 1960 and 2014. We would like you to perform a growth
accounting exercise for both countries to get a sense of how their growth engines compare.
i. For each of the sub-periods 1970-1990, 1990-2000 and 2000-2014, please give us an idea of the
relative contribution of the capital stock, labour force and total factor productivity to the average
annual growth rate of real GDP of each country. Use the assumption that the share of labour income
in total national income is 50% for both countries. You should be providing us with two tables,
one for each country, with results for the respective sub-periods in separate rows.4
ii. How would you characterize the respective recent growth experiences of China and India (2000
to 2014)? In particular, would you say that the sources of growth were similar across the two
countries? Explain briefly.
iii. Focusing on China, do you notice any changes in the relative importance of the factors of
growth over time? Regarding the contribution of the labour force more specifically, what do you
think is the structural reason behind the trend you observe since the 1970s?
4 Hints: (1) by definition, the sum of the contributions of the three factors has to be equal to the real GDP
growth; (2) to compute the average annual growth rate of Y between, say, 1975 and 1980, use the formula
DY75-80 = (Y1980/Y1975)^(1/5)-1
During a recent visit to China, many of us on the executive committee were left with the impression
from talking to local officials and analysts that a major challenge remains the quality of
macroeconomic data. Computing the labour share of income is particularly problematic. Do your
conclusions change radically if you instead assume that the labour share of income is 60% instead
of 50%?
Enough with the past, let’s now look towards the future. Given its sheer size and the fact that plane
makers often tout it as a promising market, it seems only logical that your initial analysis should
focus on China. As we mentioned earlier, multiple executive committee members would like to
get a sense of how sensitive the future growth pattern of China is to various potential economic
and social changes. We suggest that you use as a starting point the accompanying Excel
spreadsheet “China_Solow_growth_2017.xls”. An ex-associate who had a passion for
macroeconomics and went on to take a policy job in Washington left them behind. From what we
can understand it basically is a simulation of the Solow model, the framework at the center of
modern growth theory. The notes in the last tab of the file could be helpful. As far as we know,
the benchmark parameters and assumptions it contains are all reasonable. Notice that while
standards of living are more directly related to GDP per capita, our interest is in the size of the
entire market, which means that your analysis should be about total GDP.
b. Glancing at the Excel spreadsheet, it seemed to us that it was incomplete, in the sense that our
associate was not done filling in all the formulas necessary to analyze the future growth profile of
the country before leaving the company. Please start by doing so for the years 2015 to 2080,
drawing on what you know from the Solow model.5
Now, moving on to the risk analysis, we identified two main areas of concern that have come up
often in our committee discussions and that we would like you to investigate more thoroughly.
Population dynamics
Economists have long warned that the one-child policy of 1979 would, eventually, imply that the
employment-to-population ratio of China could decrease significantly as older generations started
to retire and would not be replaced by a large enough wave of young workers. In fact, the working
age population (ages 15 to 64) has already started declining, falling by half a percentage point in
2015. The chart below, from the Wall Street Journal (China Eases One-Child Policy, Nov 15
2013), very clearly expresses this point: without any change to its birth policies, China would be
expected to see a drop of more than 10% of its working-age population by 2040.
5 You can use the partial template he left behind to compare your answers.
c. We would like you to entertain for a moment the scenario presented by the WSJ. Under current
policies, they expect the population growth rate in China to be about 0% between now and 2050.
The employment rate among people aged between 15 and 64 was about 75% in 2015. In addition,
that age group represented about 72% of the total population in 2015 according to the World Bank.
i. According to the WSJ, the total population of China will be roughly the same in 2050 than in
2015, while the working-age population (number of people aged between 15 and 64) will shrink
by a total of about 10%. What does that imply for the fraction of the 15-64 group in the total
population in 2050? According to the WSJ, what will be its value in 2050 (from a base level of
72% in 2015)?
ii. Now assuming that all workers in China are aged between 15 and 64 and that the employment
rate in that age group remains unchanged at 75%, what should happen to the employment-to-total-
population ratio (N/Pop) between 2015 and 2050? What is the implied average change (in
percentage points per year, i.e. linearly over time) of the N/Pop ratio over this period?
iii. With the help of the Excel spreadsheet, can you give us an idea of how this change in the
employment-to-population ratio you just identified would affect Chinese real GDP? In particular,
by how much would the size of the Chinese market (i.e. GDP) be expected to grow from 2015 to
2050 under this scenario vs. the initial assumption that the N/Pop ratio does not change? Please
also provide us with a plot of the evolution of China’s GDP over that period.
In October 2015, the Chinese government officially ended its iconic policy, allowing each family
to have a maximum of two children. The impact of such a change is still unclear, as multiple forces
are at work. However, it seems safe to say that the growth rate of the population, as well as the
labour force, is expected to rise with higher fertility rates.
d. What can you tell us about the impact of an increase in 1 percentage point (e.g. from 0% to 1%)
in the growth rate of the population (as well as the labour force) on the level of GDP in the very
long run, say by 2075? Assume this time that the employment-to-population ratio remains constant
over this horizon, thanks to the change in policy. Also, implement the change starting right away
in 2016, for simplicity. 10
Overinvestment and its consequences
There are ongoing talks of overinvestment in capital in China, of empty cities and credit-fuelled
projects of dubious economic value. Opinions vary about the extent of the problem and its potential
impact on future growth, but we would like to get a sense of the risks involved. One related concern
that is sometimes raised is that some of this new capital being built up, particularly commercial,
residential and industrial structures, are of low quality. One interpretation would be that the life
expectancy of this capital stock might be lower than expected; in other words, its depreciation rate
is higher.
e. Starting from the initial scenario envisioned by our ex-associate, consider the possibility that the
depreciation rate of the capital stock is 10% instead of the currently estimated 8% starting in 2016.
What would be the predicted impact of such a reassessment on the level of GDP in 2040? In other
words, what would be the difference, in percentage, between the levels of GDP under the original
and alternative scenarios in 2040? Please also provide us with a plot of the evolution of China’s
GDP between 2015 and 2040 for both the initial and new scenarios.
f. How does the average annual growth rate of China over the 2015-2040 period in this scenario
compare to that under the original one?
Another consequence of such overinvestment is that some of the capital stock built may just end
up not being used at all, as for example commercial and residential buildings stay empty and
become decrepit.
“Has China really blown $6.8 trillion on worthless investments over the past five years? This is
the startling claim made by two Chinese government researchers that has, understandably, caused
quite a stir. If true, it would mean that fully 37% of Chinese investment since 2009 was wasted on
building bridges to nowhere and homes with no one in them.”, The Economist, November 28th,
2014.
From the point of view of the Solow model, this unused capital stock can be simply viewed as
having no marginal value, and therefore can be considered as destroyed. Imagine a scenario in
which at the beginning of 2016, it becomes obvious that 10% of the Chinese capital stock at that
point in time can simply be written off, i.e. considered as destroyed. Assume that the depreciation
rate is unchanged at 8%.
g. How does the average annual growth rate of China over the 2015-2040 period in this scenario
compare to that under the original one?
h. How does it compare to your answer in f.? Does your interpretation of the consequences of
overinvestment (higher depreciation rate vs. capital stock write-off) affect your view regarding the
future growth and level of GDP in China? Explain briefly and back your explanation with plot(s).
11
j. There is generally a very strong link between the investment and saving rates in a country.
Assuming that the fall of the investment rate is accompanied by a decline in the saving rate of
households, what do you think could be the consequences overall for the aerospace industry in that
market?
k. One of our analysts argues that our current assumption for the growth rate of TFP is conservative
when compared to the experience of the Chinese economy since 2000. Do you agree?
He also said the following: “When you focus on China’s real GDP by 2045, I bet that you can
compensate the negative effect of the fall in the investment rate by simply assuming a slightly
higher growth rate of TFP.” Do you agree? Provide a precise number. 12
The Brevis report seemed to hint at the fact that the aeronautics sector is very cyclical. It would be
good to get a better idea of what this means, quantitatively. As a starting point, we suggest that
you focus on the U.S. market, as historical data are more readily available. Not only does it remain
a major market for aircrafts, but also extrapolation to other markets should not be too problematic
given the type of questions we are interested in.
There are many types of data that you could use, but a good start would be to look at real private
fixed investment in aircraft, an annual data series compiled from the U.S. Department of
Commerce. This data series can be found on the FRED database of the Federal Reserve Bank of
St. Louis, among other sources (it will be provided as a quantity index starting in 1929, which is
not a problem since you will care only about growth rates). On this website you will also find
yearly data for annual real GDP. In general, be careful not to use price indices instead of measures
of quantities.
a. Using Excel or any other software, run a linear regression of the yearly growth rate of real private
fixed investment in aircraft on a constant and the growth rate of real GDP, starting in 1960, and
report the results. Based on the findings from your regression, would you conclude that the
aeronautics sector is procyclical, acyclical or countercyclical? Is this result significant statistically?
b. Based on your regression results, can you give us a sense of how much a rise of 1 percentage
point (e.g. from 2% to 3%) in real GDP growth would be expected to impact, on average, the
growth rate of investment in aircraft in the U.S.?
c. Run the regressions for two sample periods: 1960-1985 and 1985 to now. For which sample
period are growth in real GDP and aircraft investment most correlated (best fit of the regression)?
For which period is the impact of real GDP growth on growth in aircraft investment the largest?
d. Now do the same exercise but using total real private non residential fixed investment (use the
series that is available starting from 1929) instead of aircraft investment. Would you say that
aircraft investment is more or less cyclical than nonresidential investment in general? Is the
coefficient on real GDP growth significant statistically?
Using your results, we would like you to give us a sense of the outlook for aircraft investment in
the U.S. A good starting point would be the most recent IMF World Economic Outlook Report
and its growth projections for the United States (see the appendix of the document for the detailed
real GDP projections).13
e. Based on your regression results, what would be the predicted growth rate of aircraft investment
for this year and the next? Please make sure to indicate your methodology.
f. Forecasting the macroeconomy is notoriously difficult given the number of moving parts and
the shocks hitting continuously the global economy. For this reason, we want to get an idea of
what a “worst-case scenario” would imply for the aircraft sector. In other words, we would like
you to conduct a simple sensitivity analysis. To do this, consider scenarios where the growth rate
of output is 1, 2 and 3 percentage points lower than the scenario you considered in part (d). Indicate
the growth rate of aircraft investment under each of these situations for this year and the next.
All of us are assiduous readers of business newspapers and we are constantly exposed to various
points of views about the economy. It is sometimes quite hard to make sense of all this. We would
like you to provide us with a brief analysis of some of the topics that are discussed these days so
that we can get a better idea of their potential impact on the economic outlook. Please do not
hesitate to impress us by using the frameworks you have learned during your MBA degree.
Bombardier is hoping that the next few months will help it secure a significant number of orders
for its aircraft division. Despite a very competitive environment, it has reason to believe that its
local credentials may help it win contracts from Canadian airlines, for example from a fast growing
company such as Porter Airlines, hence giving the necessary impetus to its CSeries venture and
paving the way for larger international orders. Ultimately, however, aircraft demand can only be
sustained if airlines are booming; one only has to remember the difficulties faced by aircraft
manufacturers in the wake of the drop in air travel in the aftermath of 9/11.
g. Two topics that have garnered a lot of interest lately in Canada are the high household debt
levels and the recent boom in house prices. Some executive committee members are concerned
that these two elements represent some significant downside risk for the demand faced by
Canadian airlines, and as a result the outlook for Bombardier’s sales in the country. This is
particularly concerning given the fact that Air Canada is expected to be a large customer of the
CSeries (or at least that’s the hope!).
Using external sources as well as the AD-AS model, can you enlighten us briefly on:
i. …the reasons why the Canadian situation is a particular source of concern relative to, say, the
U.S. or U.K.;
ii. …the impact a sharp correction in house prices would have on the aggregate Canadian economy,
household income and airline demand;
iii. …the challenges faced by the Bank of Canada in trying to deal with the scenario you described
in (ii)?
h. More generally, what do you see as the main factors that could disrupt the current consensus
regarding growth prospects in the short run? In your answer, focus on the mature aircraft markets
(i.e. the main advanced economies of U.S., Europe, Japan, etc.) and make sure to be brief, clear
and concise, limiting yourself to the two or three main upside or downside risks to the
macroeconomic outlook in your opinion (your answer should not exceed 400 words).