airline deregulation in the united states deregulation in the united states russell w. damtoft u.s....
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AIRLINE DEREGULATION IN THE UNITED STATES
Russell W. DamtoftU.S. Federal Trade Commission
Bogota, Colombia
September 14, 2011
The views expressed herein are those of the speaker and do not necessarily represent the views of
the Federal Trade Commission or any individual Commissioner
Overview
• The Origins of Regulation
• The Experience under Regulation
• The Move to Deregulate
• Effects of Deregulation
The origins of regulation
• In the 1920s, passenger air transport
was inherently unprofitable
– Low aircraft capacity
– High operating costs
– Unreliable operations
• Initial routes were subsidized to carry
airmail
– Passengers were incidental
– Non-mail services allowed, but most failed
• Subsidies developed a needed service
that the market could not yet provide
– Contrast: state ownership or operating
subsidies in other countries3
Consolidation and a whiff of scandal
• 1930: to reduce airmail subsidies, postal
authorities pressured airmail operators
to:
– Increase reliance on passenger revenue
– Consolidation leads to domination by four
domestic and one international airline
• 1934: Favoritism, pressure, and
collusion alleged in award of airmail
routes
• “Scandal” leads to brief window for
new entry4
Advances in Technology
• Meanwhile, technological
improvements made it possible
to operate airline service
profitably
• New and innovative market
participants emerged
• Was there still a rationale for
government intervention?
5
“Perfect Storm” leads to Regulation
• Mid-1930’s: Pressures for Congress to regulate
airline industry:
– Incumbent airlines seek relief from competition
– Political reaction to perceived collusion and
favoritism
– Change of political control
– High profile crashes fuel public interest
• 1938: Pervasive regulation adopted along model
for railroad regulation.
• Civil Aeronautics Board regulates:
– Entry (new airlines and new routes)
– Exit (abandonment of routes)
– Mergers
– Fares
– Safety6
Competition in the Regulated Era
• 1940s-50s: technology advances reliability, capacity,
range, and speed – and profitability, further
diminishing basis for regulation
• Demand for air travel grows and replaces rail
• CAB still allows only one carrier per route except on
select routes where believes market will support
limited competition
• Profitable routes cross-subsidize less traveled routes
• Competition limited to scheduling, equipment, and
amenities
• Fares remain regulated to guarantee a rate of return
– Little incentive to cut costs
– Airlines agree to generous labor and pension costs 7
Near-Absolute Barriers to Entry
• CAB rebuffs all requests for trunk level entry
– Demand and potential supply skyrocket after World War II
– 79 applications for new service; all are denied
– Attempted entry by non-scheduled carriers ruthlessly
suppressed
– New entry allowed for local service carriers to serve small
communities under restrictions that protect incumbents
• Natural experiment with intrastate services
– Intrastate service beyond federal jurisdiction
– States allow entry in California and Texas, which have
substantial intrastate markets
– Intrastate carriers successfully challenge incumbents with
low fare, innovative service
8
International Services
• After World War II, most international services operated
by state-owned carriers
– Prominent exception: United States
• “Flag” carriers governed by foreign policy purposes rather
than market demands
• Chicago Convention of 1944 sets stage for a network of
bilateral aviation treaties that:
– Define airline “citizenship” by ownership
– Establish routes flown
– Determine capacity
– Fix fares
– Decisions typically driven by foreign policy and domestic political
goals9
1970s: Doubts about Regulation
• Future FTC Commissioners Miller and Douglas
and others use intrastate experience to question
rationale for regulation
• Academic studies show that absence of barriers to
entry and economies of scale debunk validity of
railroad model
• Alfred Kahn and others show that theory of
contestable markets applies to airlines
• Political consensus emerges for deregulation
10
1978-1983: Dawn of Deregulation• After transitional period, restrictions to domestic entry,
exit, and fares are lifted
– Safety regulation remains
– Subsidies for service to small communities
– CAB itself is abolished
• New entry from:
– Expansion by intrastate and local service airlines
– Charter airlines enter scheduled markets
– Entirely new airlines
• International service remains regulated
– Governed by existing treaties
– Foreign governments protect national carriers
– Attempted entry by Laker fails amid epic antitrust battle11
1983-1993: Established carriers respond
• “Fortress hubs” dominate major airports
– Consolidation among incumbents unchallenged
– Rise of hub-and-spoke systems
– Fares 18-27% higher at such hubs
• Barriers to entry at major airports through:
– Landing slot allocation at key airports
– Long-term gate leases
• Incumbents carriers compete more
effectively
– Frequent flyer programs discourage switching
– Code-sharing to retain passengers at local service
and international levels
– Yield management12
1993-2001: Rise of low cost carriers
• Expansion and maturity of new entrants
and low cost carrier model
• Second wave of new entry
• Legacy carriers feel pain
– Loss of market share
– Financial stress due to higher labor and
pension costs
– Exit by some established carriers
– Strong economy helps others survive
13
2001-2011: Tectonic plates shift
• Current phase began ten years ago this week
• Industry stressed by
– 9/11 and aftermath
– Economic downturn
– Increased fuel costs
• Decline of legacy carriers continue
– Many seek relief in bankruptcy
• Low cost carriers continue to gain share
14
Shifts in International Policies
• Most national carriers privatized
• Declining relevance of “flag carrier” model
• Applicability of domestic deregulation to
international markets
• Regional experiments lead to results similar to
U.S. experience
– U.S./Canada
– Trans-Tasman deregulation
– Open skies in United Arab Emirates
– Transatlantic open skies (Netherlands, U.K.)
– EU phased deregulation 15
How Deregulation Affected Competition
• More choices on most routes
• Increase is more pronounced on long-haul routes
• Hub and spoke systems make short haul less
competitive
16
1980 2005 Change
Percent of city-pairs
with 3 or more airlines
34% 76% +42%
Percent of city pairs
with only one airline
20% 5% -15%
Avg. number of airlines
per route
2.2 3.5 +1.3
Avg. number of airlines
routes over 1500 miles
2.3 4.2 +1.9
Avg. number of airlines
routes under 250 miles
1.6 1.4 -.2
How Deregulation Affected Fares
• Average fares came down 38% from 1980-2005
• Fares came down most on:
– Long haul routes
– Routes with high demand
17
1980 2005 Decrease
Median fare $414 $216 38%
Routes over 1500
miles
$680 $326 50%
Routes under 250 miles $230 $201 16%
Largest 20% markets $329 $243 26%
Smallest 20% markets $412 $348 16%
Deregulation Effects on Consumer Behavior
• Expansion of consumption: revenue
passenger miles increase from 188 billion to
584 billion
• Low fares create incentives to travel
• Marginal shift from automobile travel
• Busses lose competitive force
18
The Effect on Small Communities
• After World War II, subsidized service added for
many communities
• Many have low traffic
– Shift of economic activity to cities reflected in rural
airport traffic
– New highways allow easy access to larger airports
with better service
– In some cases, up to 90% of local traffic uses distant
airports
– Low cost carriers cannot achieve scale needed to
profitably serve small airports
• Airlines reduce or drop service to small cities as
subsidies and incentives to cross-subsidize decline
19
The Impact on Safety
• Skeptics had predicted that competitive
pressure would cause airlines to cut costs
and compromise safety
• In fact, safety continues to improve
– Fatalities decline, in some years to zero
– Accidents per mile decrease
• Deregulation creates incentives for safety
20