Airline Deregulation

Rajeet Guha
Airline deregulation: Success or Failure
The U.S. airline industry was an industry that emerged as a separate industry itself only in the 20th century quite naturally as airplanes itself were invented in the early decades of the 20th century by Wilbur and Orville Wright in USA. The airline industry was then dominated by five firms and was an oligopoly. The firms were United Airlines, TWA, Eastern Airlines and American Airlines. These four firms dominated and determined fares and routes within the U.S. skies. Pan American Airlines held the exclusive monopoly on international flights. In the 1930s new competitors tried to carve a niche for themselves in the marketplace. The result was inevitable price wars, which threatened the position of the major domestic airlines, and they in turn persuaded the government to enforce regulations. This is how regulation came into effect. The incentives for regulation also stemmed from the need to safeguard and promote the infant airline industry as well as preserve the national airline industry, as it was a source of national prestige. (www.columbia.edu / ~ lnp3/ mydocs/ economics/ airline_deregulation.htm)

Under Franklin D. Roosevelt’s New Deal program a Civil Aviation Authority was created to monitor and improve the performance and safety of the airline industry. At that time there were only four or five large firms namely American Airlines, Continental Airlines, Eastern Airlines and TWA. These airlines served the U.S. domestic routes. Pan American Airlines had the exclusive monopoly to serve international routes. The task of the Civil Aviation Authority was to decide whether to allow new firms to enter the airline oligopoly and if so, when could it enter and what requirements would the firm have to meet in order to be allowed entry. The Civil Aviation Authority later became known as the Civil Aviation Board. The CAB would also determine whether any of the existing firms could be allowed to exit the industry or be acquired by another rival airline.

This board would also decide whether to allow airlines to carry mail and how much quantity of it to be allowed. It would also determine if airlines were to be allowed to carry cargo and place the weight ceiling on the amount of cargo to be air delivered. The CAB would set the fares to be charged on the mail and cargo. It would allow mail and cargo to be transported only along certain routes. On some routes cargo and mail would not be allowed to carried. The government authority would grant the license to transport mail and cargo on certain routes to only a single airline while the rest were to be given the exclusive privilege to operate on other routes. This system allowed each of the airlines a virtual monopoly on some routes. No airline could infringe or challenge another airline on the same route. If the airline wanted to operate on a new route, it would have to take permission from the CAB. It would take a lot of time for the CAB to deliberate on whether to grant permission. The answer would often be no in most cases.

The CAB would also decide the fares to be charged by airlines on passenger travel. Often, price floors and price ceilings would be set to prevent oligopolistic competition or collusion. The government would set price floors on long-haul routes and price ceilings on short-haul routes. Price floors would be set on long-haul routes to prevent cut-throat competition and from preventing the price from going to low. Price ceilings would be set on short-haul routes to prevent the fares from being set exorbitantly high. Thinly traveled routes would be subsidized while the densely traveled routes would be overpriced. This would have no impact on demand for passengers as that would be relatively inelastic but would have significant impact on the relatively elastic supply of passenger curve. It would reduce the quantity of passengers commuting on long-distance and densely traveled routes while increasing the quantity of passengers on short-distance and thinly traveled routes.

The government would also decide what routes the airlines should take and should not be allowed to take. The govt. would also decide the number of flights that pilots of a particular airline could make back and forth between two cities in a month. No rival airline would be allowed to threaten the monopoly of the other airline on some specific routes. The govt. would also make certain trips compulsory to some small towns and vigorously compel the airlines to take trips to unattractive destinations. The airlines would have to take permission to buy jumbo jets or wide-body sized airlines. The government would also impose restrictions on the number of jumbo jets to be flown or the number of small aircrafts to be flown. The government would set rules on the maximum number of seats to be allowed on airlines and would also enforce minimum quality standards on amenities, comfort and food provided on airlines. There would also be uniform fares paid by different types of passengers, leisure or business, on airline travel. The govt. would also implement minimum safety standards on the maintenance standards of airlines and keep a close watch on no infringements of air space by other airlines to minimize airplane crashes.

Six decades of government regulation had stifled the growth of the airline industry. Government regulation as played out through a variety of checks and balances had given rise to many problems and inconveniences. One of these problems were the extravagant fares to be paid by travelers. The sharply rising cost of airline tickets was a worrying concern for the travelers. The inability to raise prices was a matter of concern even for the major airlines like United Airlines, TWA, American Airlines and Pan American Airlines. These airlines were making heavy losses and had been considering merging with each other. (John Barnum of McGuire Woods LLP)
One of the biggest problems of regulations which was charged with the responsibility of fixing and approving fares had insufficient information about the market as they were not operating the airlines resulting in highly distorted pricing structures. This affected the consumers and producers adversely. Consumers ended up paying more and producers did not have the flexibility to adjust fares. This resulted in losses in consumer surpluses for the consumer and losses in producer surplus for the airline industries. When TWA applied for discounted fares on trunk routes, this request was turned bown by the CAB. The second major issue, which made regulation untenable, was the difficulty of new airlines to enter the airline industry or for the existing airlines to fly on a new route. This resulted in inefficiency and the costs of such inefficiency were passed on the consumer. Further, it had become extremely difficult for airlines to withdraw from existing routes, which were unprofitable because of denial of permission from CAB. For example Continental had to wait eight years to add San Diego to Denver to its system. The rigidity of routes was also cumbersome for the passengers. (John Barnum of McGuire Woods LLP)

Another general factor why regulation had become unsustainable was the time delays taken by the CAB in processing requests from airlines for new routes and schedules. Another serious inefficiency in the market that the CAB introduced was the system of allocating seat quotas to the trunk airlines on different routes. As a result, many airlines operated with many empty seats. Insufficient load on airlines such as being only 40 % full led to greater ticket fares being extracted from the consumer’s pocket. This was further exacerbated by the oil crisis. This affected the profitability of the airlines and resulted in market inefficiency. (John Barnum of McGuire Woods LLP). Two other counts on which regulation came under severe criticism was the ease and nonchalance with which the CAB seemed to disapprove of airline mergers and reject them without considering their anticompetitive effect on the industry. The other was the obvious efficiency of some unregulated intra-state airlines like Southwest, which were selling seats for much less than the major trunk airlines whose fares were regulated by the CAB. These airlines had greater profitability than the trunk airlines. This made deregulation imperative. The stage was then set for deregulation and there were compelling grounds for the Congress to deregulate the industry. (John Barnum of McGuire Woods LLP)

Deregulation was carried out in phases from 1978 to 1984. Initially the fixing of fares on cargo was done away with. Secondly the CAB was required to abandon its right to arbitrarily set fares on travelers. CAB’s control was now given to the Department of Transportation. The CAB’s power to set routes and stopovers was confiscated. It could not stop airlines from operating on air routes originally the domain of other airlines. It could not force airlines to make stopovers at places where they didn’t want. It could not impel the airlines to travel to unattractive destinations. The airlines could charge differential fares from business and leisure travelers. The airlines could decide the number of flights it would take in a month between two points. The airlines would charge the market fares on long haul and short-haul routes as determined by the demand for and supply of travel. This would apply to passengers as well as mail and cargo. Airlines could abandon old routes if they were not generating enough profits. Airlines could raise or lower prices as they wished. Airlines could now increase their load factors and there would be less empty seats now on airlines. This would result in cost reductions to customers. Restrictions on entry of new airlines and barriers to exiting the industry for existing firms were dismantled. Bureaucratic delays in processing requests for new routes and new aircrafts was done away with. International Airlines like Pan American Airways was allowed to compete with the domestic airlines on local routes. Extra charges on interstate routes were removed. Finally the trunk airlines were allowed to compete with the unregulated airlines like SouthWest that operated chiefly as intra-state carriers. The disbanding of many of these regulations were steps in the right direction but a few deregulations like the abandonment of safety and quality of service standards made the environment right for unfettered and immoral licentious competition. We will now examine the effects of deregulation on the airline industry in an objective and unbiased manner. (Airline Deregulation Act, Wikipedia)

Deregulation unleashed the latent potential of the market forces on the airline industry. It brought about a dramatic change in various aspects of the industry and radically altered the nature of the airline industry from a protected industry to a ruthlessly competitive industry where the creed of aggressive capitalism was tinged with a bit of social Darwinism. In the following paragraphs we will see how deregulation was eventually played out in the airline industry. A lot of literature has been generated on the pros and cons of deregulation. There have been justifications on both sides of this heated debate. What is necessary is to balance the advantages and disadvantages and reach a reasonable conclusion. Finally, we will conclude as to whether deregulation has yielded benefits or spawned new problems.

One of the benefits of deregulation have been the appreciable decline in airline fares for commuters as well as mail and cargo. Lower airline fares have benefited the consumers by increasing their consumer surplus. From 1978-90 deregulated fares were 10 % to 18 % lower than in the era of regulation according to the best estimates. Travelers are reported to have saved 5 to 10 billion dollars per year. Lower price of tickets also helped the airlines garner a larger number of passengers on their flights. As load factors increased so did profits. Another benefit, which has been an outcome of deregulation is that, the productivity of airlines has gone up by leaps and bounds. Airlines have discarded long-winding and unprofitable routes and marginal destinations in favor of profitable routes and popular destinations that bring in a lot of passenger traffic. Airlines have usually concentrated their operations on hub cities and this has lowered their operating costs. Airlines now have to wait less time to be granted permission to fly on new routes. Deregulation has also given the airlines the flexibility to choose what type of aircraft to cater to long-distance and short routes. (Airline Deregulation: Concise Encyclopedia of Economics: Alfred Kahn). Another advantage of deregulation has been that passengers can now book tickets over the internet. However, deregulation has given birth to new problems as well. One of them is that airplane crashes in the deregulated age have been more frequent than in the regulated era. This is because airlines have neglected safety and maintenance standards. The quality of service, comfort levels and levels of amenities provided have gone down. Many airlines have failed and gone out of business. Many of them are in a state of bankruptcy or near bankruptcy. Many airlines have been acquired by others. Smaller communities and small towns have been bypassed. Many travelers cannot avail discount fares because they cannot meet the prerequisites for discount fares. Many airlines practice price discrimination against travelers. Hubs have been effectively monopolized by one airline or other resulting in monopoly rent being extracted. Some of the airports have become heavily congested. People from the spoke cities have been disadvantaged and have to incur more expenses. Some of the bigger airlines have weeded out the smaller competitors through collusion with travel agents and computer reservation system. The effect has been exaggerated through frequent-flyer programs. Besides, price of tickets have not fallen as much as expected. Besides, foreign airlines have not been allowed to compete with the major American companies. (Opening U.S. skies to global airline competition – Kenneth J. Button) Many people have suffered unemployment and have lost their job benefits. Many workers have suffered from horribly low wages being paid to them and billions of dollars have gone down the drain for the airline companies. (Airline Deregulation: The Unfinished Revolution) Overall, deregulation has had tragic and unforeseen consequences.





















Bibliography:
1) www.columbia.edu/ ~lnp3/ mydocs / economics / airline_deregulation.htm
2) Airline Deregulation: The Unfinished Revolution – Robert W. Poole Jr.
3) Opening U.S. skies to global airline competition: Kenneth J.Button
4) Airline Deregulation – Alfred Kahn – Concise Encyclopedia of Economics
5) Airline Deregulation Act – Wikipedia
6) McGuire Woods LLP – John W.Barnum