The Benefits Versus the Detriments

Nathan DeRosa

Have the positive effects of airline deregulation outweighed the negative effects?

The role of government in economic affairs is continuously debated◦ Trade-offs between freer markets and

government intervention

The federal government contracted with private carriers to supplement military airmail carriage starting in 1918 (Borenstein and Rose, 2007)

Airlines started emerging in the 1920s Airlines became increasingly regulated

during the Great Depression◦ 1938: Civil Aeronautics Board (CAB) was

established marking the official beginning of airline regulation (Borenstein and Rose, 2007)

High Barriers to entry into the marketplace◦ Carriers established after the CAB had the most

difficulty entering the market Competition was largely absent

◦ Competition was based less on price and more on non-price determinants (e.g. legroom, seat quality, in-flight amenities, flight frequencies)

◦ Carriers needed approval from the CAB to expand Price controls were put into place to ensure

profitability and kept prices high (Borenstein and Rose, 2011)

Major carriers like American, Delta, and United competed in the interstate market

Smaller, local carriers like Pacific Southwest and Texas International flew in the intrastate market (Borenstein and Rose, 2007)◦ Competed based on price, charged lower fares,

and turned higher profits than the major carriers◦ Not subject to federal regulation◦ Provided a glimpse of a deregulated airline

market

Regulated airlines turned lackluster profits (Borenstein and Rose, 2011)

High prices prompted consumer groups to support deregulation

High oil prices and stagflation in the 1970s further pushed opinion towards deregulation (Eisner, 2008)

The appointment of pro-deregulation officials such as Alfred Kahn paved the way starting with discount price experimentation (Winston, 1998)

In 1978, the Airline Deregulation Act was signed into law

Gradually lifted CAB price, route, entry, and exit controls

The CAB disbanded in 1985 marking the official end of deregulation (Borenstein and Rose, 2007)

The Federal Aviation Administration (FAA) would continue to regulate safety as it had done since 1958

Overall lowered prices◦ Fares are approximately 40% lower than prior to

deregulation even when adjusted for inflation (Borenstein, 2011)

Barriers to entry and exit were lowered◦ Many existing airlines either have went bankrupt,

liquidated, or merged with other airlines while many new airlines entered the market

Labor saw a 10% decline in earnings following deregulation (Card, 1996)

Aggressive cost-cutting measures amid financial losses and bankruptcies have had a toll on labor-management relations and customer service (Gittell et al., 2004)

Lowered prices and barriers to entry were expected to lead to traffic growth and higher load factors

Airport congestion was not seen as a predictable outcome◦ Traffic growth outpaces

infrastructure development (Savage, 1996)

Since deregulation, the airlines collectively lost $60 billion (Borenstein, 2011)

Financial performance is tied to the performance of the national economy

Propensity to over invest during economic booms which then lead to drastic cuts in capacity, scheduling, and the workforce during economic downturns

Reluctance to raise fares Exogenous demand shocks

such as 9/11 (Borenstein, 2011)

Exogenous cost drivers like jet fuel (Borenstein, 2011)

Rise of the hub-and-spoke system (Borenstein and Rose, 2011)◦ Centralizing operations in

one or more select cities Establishment of airline

alliances (Borenstein and Rose, 2011)◦ Brought about codesharing

—an agreement where two or more airlines share the same flight

Resulted in concentrations of market power in select cities (Borenstein and Rose, 2011)

Deregulation was successful in lowering prices and barriers to entry and exit

The Airline Industry has nonetheless suffered financially. To ensure financial sustainability, airlines must:◦ Invest more moderately◦ Work on improving relationships with labor

Labor productivity is tied to customer service quality more than cost-cutting measures (Gittell et al., 2004)

◦ Raise their price premiums (Borenstein and Rose, 2007) Raising quality and fares to cover operational costs

Borenstein, Severin (2011). On the Persistent Financial Losses of U.S. Airlines: A Preliminary Explanation. National Bureau of Economic Research, 1-17.

Borenstein, Severin and Nancy L. Rose. How Airline Markets Work…Or Do They? Regulatory Reform in the Airline Industry. National Bureau of Economic Research. 1-82.

Card, David (1996). Deregulation and Labor Earnings in the Airline Industry. National Bureau of Economic Research. 1-58.

Eisner, Marc Allen (2008). Markets in the Shadow of the State: An Appraisal of Deregulation and Implications for Future Research. Tobin Project

Conference. 1-28. Gittell, Jody Hoffer et al. (2004). Mutual Gains or Zero Sum? Labor Relations and

Firm Performance in the Airline Industry. Industrial and Labor Relations Review. Vol. 57, No. 2. 163-80.

Savage, Ian (1999). Aviation Deregulation and Safety in the United States: The Evidence After Twenty Years. Taking Stock of Air Liberalization. 93-114.

Winston, Clifford (1998). U.S. Industry Adjustment to Economic Deregulation. Journal of Economic Perspectives. Vol. 12, No. 3. 89-110.