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Around the World in 80 Ideas |
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TRANSPORT 52: Freedom of the skies The benefits of airline deregulation The problem: the cost of regulation Airline services used to be strictly regulated in the United States as well as in the United Kingdom and other countries in Europe. They are still heavily regulated in many parts of the world, notably the Middle East. International regulation fixed prices, controlled mergers, determined the number of carriers and even the number of airline seats being offered. The result was high prices, limited consumer choice and an inefficient airline industry. The idea: fly free Exasperated by poor service and high prices, in a bold and unexpected move the US goverrnment deregulated the domestic airline market in 1978. The driving force behind these reforms was Alfred Kahn, a professor of economics at Cornell University who became chairman of the Civil Aeronautics Board. De-regulation allowed any airline to operate on any route, setting its fares as it liked. Carriers that were previously barred from operating out of state were free to fly anywhere in the country. Liberalization led to the creation of a host of new airlines including People Express, Southwest Airlines and New York Air. These carriers offered innovative services at very low prices. Example: new organizational patterns De-regulation had a catalytic effect on the US airline market. Carriers were obliged to respond to a new competitive dynamic. De-regulation encouraged a more efficient way of flying people around the country. Instead of flying out of many different centres, and bearing the administrative cost of having a presence in each one, many airlines moved to a hub and spoke model. In this system, an airline would operate from a smaller number of centres, or perhaps just one centre, concentrating its operations at the hub. Passengers might no longer be able to find a direct flights between different points on the map: they might have to fly along one of the spokes to the central hub such as Chicago O'Hare or Miami, change planes, and then fly along another spoke to their destination. But in exchange for this inconvenience, the airlines could cut costs and deliver much higher frequencies on the flying timetable. The impact of deregulation can be divided into a number of distinct phases. In the first phase, dominant airlines faced a far more contestable market. Whereas in 1978 the top five carriers accounted for 69 per cent of the industry's output, in 1985 this share was down to 57 per cent. Fares tended to move towards the costs of the more efficient producers rather than reflect the industry's average costs, as they had done previously. High-cost carriers were forced to cut costs, particularly labour costs, to remain competitive. The second phase of deregulation was characterized by a period of consolidation as the major airlines fought back to regain market share and new groupings emerged. By 1993, the top five carriers accounted for 70 per cent of the industry output. Many of the new entrants that had been attracted into the market after deregulation were acquired by other carriers or had by that time been forced out of business or had merged with others. The third phase has seen the failure of a number of airlines. Many lost money in the early 1990s due to the economic recession. Since then, until the 2001 recession and terrorist strikes, the airline industry boomed alongside the rapid rate of growth in the US economy. Airlines such as American, Delta and United expanded their international services where bilateral agreements have permitted. Since the terrorist events of 11 September 2001, all airlines have faced problems; but with the greater efficiencies that the new system has encouraged, they are arguably much better placed now to survive them. Southwest actually boosted its profitability with deeper fare cuts, and plans to expand. Assessment: flying high Passengers have benefitted from greater choice. Travellers flying from larger airports in the major cities have benefitted the most: price competition is particularly fierce where rival hub and spoke systems overlap, or where innovative carriers have entered the market. And carriers have developed new-technology planes to serve the 'long thin' routes that have emerged elsewhere. The impact on costs and prices has been substantial too. The US Department of Transportation estimates that passengers save $19.4 billion dollars per year, thanks to lower fares due to deregulation. Airline ticket prices are almost 40% lower today than in 1978. There are now more competitors on different routes. Previously, some routes were too thinly patronized to support a direct service at all, while others were too thin to support more than operator. This lack of competition left passengers facing high prices and low standards of service. Now, by changing planes at the large hubs, passengers often have a greater choice of services (albeit indirect) and operators, which forces prices down and quality up. Over time, the major airlines have created their own subsidiaries to target specific segments of the air travel market, notably the no-frills cheap fares sector. Thus Delta created Delta Express and United its Shuttle. The no-frills Southwest Airlines, run by Colleen Barrett is now the seventh largest major airline in the United States, flying 57 million passengers a year. It has been the model for new carriers in the United Kingdom such as Go (a low-fares subsidiary set up by British Airways), Easyjet (the first 'internet only' airline, which flies from London's Luton airport to many UK and European destinations), Buzz (a KLM subsidiary) and Ryanair (the market capitalization of which is now larger than that of British Airways). However, deregulation has not solved all problems. New entrants have sometimes found it difficult to obtain slots at the most congested airports; and major airlines have been accused of using predatory pricing to stifle low-cost competition. For each complaint like this, however, there are many passengers who are reaping the benefits of deregulation in terms of lower cost and better service. For further information:
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Copyright 2002: Adam Smith Institute
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