air transport liberalization and its impacts on airline competition and air passenger traffic

XIAOWEN FUTAE HOON OUMANMING ZHANG

Air Transport Liberalization and ItsImpacts on Airline Competition and

Air Passenger Traffic

AbstractThis study examines the impacts of air transport liberalization policies on economic growth,

traffic volume, and traffic flow patterns, and investigates the mechanisms leading to those changes.Our investigation concludes that (1) liberalization has led to substantial economic and trafficgrowth. Such positive effects are mainly due to increased competition and efficiency gains in theairline industry, as well as positive externalities to the overall economy; (2) liberalization allowsairlines to optimize their networks within and across continental markets. As a result, trafficflow patterns will change accordingly. Strategic alliance is a second-best solution and will havea reduced role when foreign ownership restrictions are relaxed; (3) there is a two-way relationshipbetween the expansion of low-cost carriers (LCCs) and liberalization. The rapid growth of LCCsleads to increased competition and stimulated traffic, calling for the removal of restrictions oncapacity, frequency, pricing and entry. In addition, development of LCCs in domestic marketscan promote liberalization policy for international aviation by increasing the competitiveness ofthe national aviation industry. On the other hand, the existing regulations hindered the growthof LCCs. Further liberalization is needed for the full realization of associated benefits.

International air transport operates withinthe framework of the 1944 Chicago Conven-tion on international air transportation, underwhich airlines’ commercial rights on interna-tional routes are governed by a complex webof more than 10,000 bilateral air servicesagreements (ASAs) between each country-pair.These ASAs regulate a wide range of condi-tions related to the provision of international

Mr. Fu is assistant professor, faculty of business, TheHong Kong Polytechnic University, Kowloon, HongKong, China; email [email protected]. Mr. Oum isUPS Foundation Chair in Transportation, Sauder Schoolof Business, University of British Columbia, Vancouver,British Columbia, Canada; email [email protected]. Zhang is Vancouver International Airport AuthorityProfessor in Air Transportation, Sauder School ofBusiness, University of British Columbia; [email protected]. The authors would like tothank the participants in the 2009 Sydney OECD- ITF(International Transport Forum) Conference and IFSPA2009 Hong Kong Conference for helpful comments.Financial support from the OECD-ITF, Social Scienceand Humanities Research Council of Canada (SSHRC),and Hong Kong RGC Public Policy Research Grant(PolyU5002-PPR-5) are gratefully acknowledged. Specialthanks to Zhuo Lin for his assistance in this study.

air services. The World Trade Organization(WTO) Secretariat (WTO 2006) identifiedseven features of ASAs as relevant indicatorsof openness for scheduled air passenger ser-vices: (1) Grant of rights (air freedomsallowing airlines to provide services over des-ignated markets)1; (2) Capacity clause (regula-tion on volume of traffic, frequency of service,and/or aircraft types); (3) Tariff approval(whether fares need to be approved before ap-plied); (4) Withholding (which defines the con-ditions for a foreign carrier to operate, such asownership and effective citizen control require-ments); (5) Designation (which governs thenumber of airlines allowed to serve the marketbetween two countries and on specific routes);(6) Statistics (which requires the exchange ofoperational statistics between countries or theirairlines); and (7) Cooperative arrangements(which regulate the cooperative marketingagreements between airlines). After reviewing2,299 ASAs in International Civil AeronauticsOrganization (ICAO) and WTO databases,Piermartini and Rousova (2008) indicated that

2010 AIR TRANSPORT LIBERALIZATION 25

the regulations used most frequently are onpricing, capacity, and cooperative arrange-ments. In addition, while 60 percent of theASAs allow multiple designations, the re-maining 40 percent permit only single desig-nation.

Since the deregulation of its domestic airlineindustry, the U.S. government has also pushedfor the liberalization of international air mar-kets. In 1979, the United States enacted theInternational Air Transportation CompetitionAct, which formally laid down the principleof promoting liberalized bilateral ASAs withforeign countries. A major breakthrough wasachieved when the first open-skies agreementwas reached between the United States and theNetherlands in 1992, removing capacity andfrequency constraints for aviation services be-tween the two nations. As of November 25,2008, the United States has open skiesagreements2 with 94 countries in six continents,making it the open-skies hub nation of theworld (U.S. Department of State 2009).

During the time period of 1988 to 1997,three air transport liberalization packages wereimplemented by European Union (EU) coun-tries, which eventually created a single aviationmarket for the EU community carriers by add-ing cabotage rights in 1997. As of January 11,2007, a total of 66 countries in all continentsrecognized EU common market in their ASAs,allowing European air carriers to operateflights between any EU member states andthese countries. In April 2007, the EU-U.S.Open Aviation Agreement (OAA) was signedand went into effect on March 30, 2008. Whilesimilar agreements are being negotiated withother nations, efforts are being made to furtherliberalize the international aviation market,which would remove remaining constraintssuch as ownership restriction.

Bilateral air services agreements remain theprimary vehicles for liberalization of interna-tional air transport services for most countries.During the past decade, about one thousandbilateral air services agreements (includingamendments and/or memoranda of understand-ing) were reportedly concluded. Over 70 per-cent of these agreements and amendments con-tained some forms of liberalized arrangements,such as expanded traffic rights (covering Third,Fourth and in some cases Fifth Freedom traffic

rights), multiple designations with or withoutroute limitations, free determination of capac-ity, a double disapproval or free pricing regime,and broadened criteria of airline ownership andcontrol. As the airline business evolves, someof the recent bilateral air services agreementshave included provisions dealing with com-puter reservation systems (CRSs), airline codesharing, and leasing of aircraft and intermodaltransport. One notable development is the con-siderable increase in the number of bilateral‘‘open skies’’ air services agreements, whichprovide for full market access without restric-tions on Third, Fourth, and Fifth Freedom traf-fic rights, designation, capacity, frequencies,code sharing, and tariffs. As of February 2008,142 bilateral ‘‘open skies’’ agreements havebeen reportedly concluded worldwide.

Despite the fact that many liberalizationagreements have been reached over the years,liberalization of the international aviation mar-ket remains a formidable challenge. Even withstrong political will, the negotiation of liberal-izing ASAs remains a lengthy process full ofdisagreements and bargaining. Many of the dif-ficulties in liberalization efforts can be ascribedto stakeholders’ different expectations on theeffects of alternative policy or agreement sce-narios. The resulting uncertainty of liberaliza-tion has prevented many governments fromadopting substantial regulatory changes, andhas given certain interest groups, including na-tional flag carriers, strong influence over thenegotiation process. Therefore, there is a needto review the actual effects brought on by theliberalization process worldwide, and investi-gate the mechanisms leading to those changes.These efforts would, of course, facilitate policymakers in their efforts to address future liberal-ization initiatives.

This study aims to achieve the above objec-tives by investigating three important areas.In the next section, the economic effects ofliberalization on the air transport industry andeconomy are reviewed. Then, the airline net-work competition and restructuring processwith deregulation and liberalization is exam-ined. The third area focuses on the impactsof low-cost carriers on airline networks andaviation policy. The last section summarizesand concludes the study.

26 TRANSPORTATION JOURNAL™ Fall

ECONOMIC EFFECTS OF AIR TRANSPORT

LIBERALIZATION

The evolving liberalization of internationalair transport regulation since the mid-1990shas played an important role in the growthof the air transport industry by providing afavorable regulatory environment. Worldwide,the total number of annual passengers hasgrown by 46 percent in the past 10 years, in-creasing from 1.457 billion passengers to 2.128billion per year (ICAO 2007). The ICAO Sec-retariat (2007) estimated that, in 2006, about31 percent of the country-pairs with non-stoppassenger air services and about 49 percent ofthe seat capacity were offered between coun-tries that have embraced liberalization eitherby bilateral ‘‘open skies’’ ASAs, or by regionalor plurilateral liberalized agreements and ar-rangements. To put these figures in perspec-tive, it is estimated that there were less than 4percent and about 16 percent of the country-pairs with non-stop passenger air services in1995 and 2000, respectively. About 20 percentand 42 percent of the seat capacity were offeredin 1995 and 2000, respectively, between coun-tries that have embraced liberalization. Numer-ous reports and papers from academia, govern-ments, and industries confirmed that theliberalization efforts had brought significantwelfare gains and economic growth worldwide.

This section provides an overview of theeconomic effects of regulation and liberaliza-tion. A short summary of the origin and resultsof regulation is given first. We then review theeconomic impacts of air transport liberalizationon the aviation industry. Finally, a discussionon the relationships between air transport liber-alization and overall economy is provided.While this article focuses on the liberalizationof the international market, the U.S. regulationand deregulation process is also discussedwhere appropriate. This is because the regula-tion and deregulation practice in this markethas served much as a prototype in the industry.In addition, the U.S. market has been exten-sively studied and rich results and findingshave been obtained.

Rationale and Economic Effects of AirTransport Regulation

After World War I, some state-owned enter-prises and private airlines began to offer com-mercial air transport services to the public.

However, with low demand and high risk ofoperation, commercial air transport would nothave been sustainable without government sup-port. As a result, the Kelly Air Mail Act of1925 was passed in the United States, allowingthe U.S. Post Office to subsidize private airmail carriage by awarding contracts with pay-ment exceeding air mail revenue on the routes.To oversee such a system, the Civil Aeronau-tics Board (CAB) was created as a regulatorby the Civil Aeronautical Act of 1938. Chargedwith ‘‘the promotion, encouragement and de-velopment of civil aeronautics,’’ CAB aims toeliminate ‘‘unfair or destructive competitivepractice’’ by regulating entry, rate levels andstructures, subsidies, and merger decisions(Caves 1962; Levine 1965; Borestein and Rose2007).

Quite a few studies (Levine 1965; Jordan1970; Keeler 1972) found that the regulationsimposed by CAB resulted in limited competi-tion and high fares. Levine (1987) pointed outthat fares in unregulated intra-state routes tendto have relatively high service levels and loadfactors with remarkably lower fares. High faresmaintained by regulation did not, however,lead to high industry profits. Airlines engagedin non-price competition with inefficientlyhigh service quality (e.g., flight frequency, in-flight amenities) and newer, larger aircraft.This practice reduced airlines’ load factors andincreased average costs. In the years just priorto deregulation, the industry average load fac-tors fell below 50 percent (Borestein and Rose2007).

Similar patterns have been observed in theinternational market. The regulatory system oninternational air transport was formalized in the1944 Chicago Convention. The United States,which was effectively the only country withsufficient financial resources, a large aircraftfleet, and expertise after the World War II,attempted to promote competition on a multi-lateral basis. However, such an effort was notsuccessful. Following the precedent of the firstU.S.-UK bilateral agreement in 1946 (‘‘Ber-muda I’’), ASAs generally regulate services(passenger and cargo) and routes to be oper-ated, and stipulate fare-setting mechanisms andcapacity limits. In one sense, this bilateral sys-tem was an interesting solution to a competition


issue; that is, countries at the time feared unilat-eral application of monopoly power by a trad-ing partner. However, it introduced another setof competition problems by constraining entry,especially to routes between countries (Warrenand Findlay 1998). All these regulations havegreatly hindered the growth of internationaltravel. Such a situation only began to changegradually with the passage of the 1979 U.S.International Air Transportation CompetitionPromotion Act (IATCPA), after which theUnited States began to explicitly promote liber-alized bilateral ASAs with foreign countries.

As evidenced by the outcomes in both do-mestic and international markets, regulationswere introduced with good intentions and ob-jectives. Over time, however, policy makersfound themselves drifting away from theseoriginal targets, with more and more regula-tions imposed to correct the undesirable effectsof the predecessors. Many governments haverealized that a better solution is to deregulate/liberalize the market, which has brought verypositive economic effects to the air transportindustry as well as the overall economy.

Economic Effects of Liberalization on theAir Transport Industry

While the net effects of previous liberaliza-tion events vary across the markets, there aresome common changes brought to the air trans-port industry, as follows.

Increased Competition, Reduced Price, andTraffic Stimulation Effects

Most liberalization efforts have brought sig-nificant traffic growth. Such traffic growth wasmainly driven by two factors. First, liberaliza-tion removes constraints on pricing, route en-try, service capacity, and cooperative arrange-ments among alliance members. Removal ofthese constraints allows airlines to competemore effectively and operate more efficiently,which reduces price and increases service qual-ity in terms of flight frequency, frequent flierprograms, etc. As a result, passenger trafficcan be stimulated substantially. Secondly, lib-eralization allows airlines to optimize their net-work configuration. The implementation ofhub-and-spoke networks enabled carriers tolink small markets with their hub airports, thusexpanding air services to new destinations.Maillebiau et al. (1995) developed a translog

air travel demand function in a single aviationmarket in order to forecast the passenger in-crease between the United States and five Euro-pean countries: UK, France, West Germany,Netherlands, and Italy. They estimated thattraffic growth from liberalization is 56 percentwith an average benefit of $585 per passenger.Their results also found a decrease in airlineyield of 35 percent and an increase in accessi-bility of 44 percent.

This is not a surprising result. Button (1998)found that following the U.S. deregulation, dur-ing 1978-1988, passenger traffic increased by55 percent while scheduled revenue passenger-miles grew by over 60 percent. The real costsof travel fell by about 17 percent on majorroutes.3 Morrison and Winston (1986) esti-mated that the U.S. deregulation yielded wel-fare gains of $6 billion to passengers and profitgains of about $2.5 billion to stakeholders ofcarriers (including various labor unions). Table1 compares the changes in prices of air travelversus other goods and services in the UnitedStates during the 1978-2006 time period. Itshows that both domestic and international airservices are two of the four items with thelowest nominal price increases during the 28-year period: 1.5-1.6 times the price of 1978for air travel while CPI index more than tripledduring the same period.

The U.S. Government Accountability Office(GAO) (2006) studied the effects of deregula-tion on airline competition and air fare in theU.S. domestic market. The study found that in1980, the average number of competitors was2.2 per market, which increased to 3.5 in 2005.During the same period, median fare declinedalmost 40 percent, as shown in Figure 1.

Productive Efficiency ImprovementLiberalization has improved productive effi-

ciency of the airline industry in several ways.First, liberalization allows airlines to optimizetheir network and pricing strategy. This im-proves airlines’ operation efficiency and aver-age load factor. As a result, average costs havebeen reduced steadily. Secondly, the increasedcompetition following liberalization forces air-lines to relentlessly improve their efficiency.Less efficient airlines are either merged orbankrupted, while new business models andinnovations (e.g., low-cost carriers, e-tickets,and self service check-in) are nurtured when


Table 1. Price Changes of Air Travel versus Other Goods and Services

Item-U.S. Good or Service Unit 1978 1990 2006 Growth

College tuition: public Year $688 $1,908 $5,836 8.5xCollege tuition: private Year $2,958 $9,340 $22,218 7.5xPrescription drugs Index 61.6 181.7 363.9 5.9xNew single-family home Home $55,700 $122,900 $246,500 4.4xNew vehicle Vehicle $6,470 $15,900 $28,450 4.4xUnleaded gasoline Gallon $0.67 $1.16 $2.59 3.9xCPI (Urban-all items) CPI-U 65.2 130.6 201.6 3.1xMovie ticket Ticket $2.34 $4.22 $6.55 2.8xFirst-class postage Stamp $0.15 $0.25 $0.39 2.6xWhole milk Index 81.0 124.4 181.6 2.2xGrade-A large eggs Dozen $0.82 $1.01 $1.31 1.6xAir travel: international Mile 7.49¢ 10.83¢ 11.85¢ 1.6xAir travel: domestic Mile 8.49¢ 13.43¢ 13.00¢ 1.5xTelevision Index 101.8 74.6 22.3 0.2x

Sources: General Accountability Office (2008), ‘‘Airline Industry: Potential Mergers and AcquisitionsDriven by Financial and Competitive Pressures,’’ GAO-08-845, July 31.

Figure 1. Median Fare in U.S. Market, 1985-2005 (Fares in 2005 Dollars)

Source: GAO (2006)

firms drive to achieve competitive edge. Oumand Yu (1998) and Oum, Fu, and Yu (2005)found that after deregulation, many remainingU.S. carriers have achieved global leadershipin cost competitiveness. Similarly, Fethi, Jack-son, and Weyman-Jones (2000) found that theEU liberalization has improved airlines’ effi-ciency significantly.

Effects on Employment in the Aviation IndustryAs one would expect, the rapid growth

brought by liberalization must lead to addi-

tional jobs in the aviation sector. Button (1998)estimated that with the substantial growth fol-lowing U.S. deregulation, the employment inthe air transport industry increased by 32 per-cent during the 1978-1988 period. InterVIS-TAS (2006) estimated that the creation of theSingle European Aviation Market in 1993 pro-duced about 1.4 million new jobs in aviationand related industries; the 1998 UK-UAE(United Arab Emirates) liberalization createdover 18,700 full-time-equivalent positions in


the UK side; and the 1986 Germany-UAE lib-eralization created 745 new full-time positionsin UAE and 2,600 new jobs in Germany.

It should be noted that the job creation pro-cess sometimes is accompanied by job reloca-tion when firms outsource certain functions tomore cost-effective regions. For example, withthe liberalization/formation of the Europeansingle aviation market, Lufthansa (LH) beganto outsource certain functions to Eastern Euro-pean countries. In 2005, LH built a new sharedcustomer services center in the Czech Repub-lic, and set up maintenance facilities for heavychecks in Hungary. The airline also plans tomove most of its accounting and purchasingoperations to Poland. In addition to cost cut-ting, outsourcing strategies are likely drivenby the company’s desire to explore overseasopportunities. While outsourcing operationsabroad will reduce domestic production, a morecompetitive airline in the global market willachieve more service export for the country(e.g., Clougherty and Zhang 2008).

Air Transport Liberalization and OverallEconomy

There is a two-way relationship between airtransportation and the overall economy. It hasbeen well recognized that air transport and lo-gistics, like other transport services, are so-called ‘‘derived’’ demands. They are usuallypurchased as inputs or intermediate productsfor the consumption and production of someother services. Passengers purchase air servicebecause they need to go to the destination forbusiness or leisure, whereas cargos are shippedsuch that they can be consumed or processedat the destination. Therefore, the demand fortransport services is largely driven by the over-all economy. Boeing (2008) attributes abouttwo-thirds of traffic growth to the GDP growth,and the rest to other factors such as increasingtrade, lower costs, and improved services.ICAO estimated the income elasticity for airtravel to be 1.27. That is, ceteris paribus, a 1percent increase in GDP will lead to a 1.27percent increase in air travel.

While air transport is driven by the globaleconomy, it is in itself an important driverfor the global economy. The International AirTransport Association (IATA) 2005 annual re-port noted that air transport directly employsfour million people worldwide and generates

$400 billion in output. In addition, the effi-ciency and quality improvements in air passen-ger services contribute to the growth in sectorssuch as hotel and tourism. The free flow ofpeople and information, together with im-proved air cargo operations, promote trade andimprove the efficiency of the overall economy.That is, the aviation sector imposes significantpositive externalities to other industries, con-tributing to economic and employment growth.Button et al. (1999) examined the link betweenhigh-tech employment in a region and whetherthe region is served by a hub airport. Usingdata from 321 U.S. metropolitan areas in 1994,the analysis found that the presence of a hubairport increased high-tech employment by anaverage of 12,000 jobs in a region. Irwin andKasarda (1991) examined the relationship be-tween the structure of airline networks andemployment growth in 104 metropolitan areasin the United States. They found that expansionof the airline network serving a region had asignificant positive impact on local employ-ment. The effect was particularly significant inthe service sector. Furthermore, analysis usingnonrecursive models confirmed that increasesin the airline network were a cause rather thana consequence of this employment growth. Inaddition to job creation, air transport facilitatescommerce communication and labor mobility.Button (2006) pointed out that in the UnitedStates and Europe, more than 40 percent of airtravel is for business purposes. The remainingtrips are either for leisure or for visiting friendsand relatives. Leisure travel promotes the hoteland tourism sectors, while visiting trips providethe basis upon which social ties are retainedand, as such, allow for an efficient and inte-grated labor market.

Air transport is ideal for the coordination ofglobal supply chains, and thereby improves theoverall efficiency of the economy. As firmssource around the world for most favorableinputs such as labor, land, technology, and cap-ital, manufacturing and factory locations canbe sparsely distributed. Hummels (2006) foundthat the elasticity of air shipping costs withrespect to distance declined dramatically, de-creasing from 0.43 in 1974 to 0.045 in 2004.That is, doubling distance shipped caused a 43percent increase in air shipping costs in 1974,but only a 4.5 percent increase in air shipping


costs in 2004. As a result, the average air ship-ment is getting longer and the average oceanshipment is getting shorter.4 Recent papers byAizenman (2004) and Schaur (2006) arguedthat air shipping may be an effective way tohandle international demand volatility. Be-cause air shipments take hours rather thanweeks, firms can wait until the realization ofdemand shocks before deciding on quantitiesto be sold. That is, air shipping provides thesefirms with a real option to smooth demandshocks.

Like improvements of other shipping modes,the efficiency and quality improvements of airtransportation promote trade and economicgrowth. Two major barriers for trade are costand time related to transportation. Limao andVenables (2001) found that a 10 percent in-crease in transport costs reduces trade volumeby 20 percent. Recent studies found that a 10percent increase in time reduces bilateral tradevolumes by between 5 percent and 8 percent(Hausman et al. 2005; Djankov et al. 2005).While air transport is clearly superior to othershipping modes in terms of speed, its perceivedcost disadvantage has been reduced over theyears. Swan (2007) found that since 1970, bothprice and production cost for air travel havebeen declining at about 1 percent annually.As shipments are of higher value and lighterweight, the ad valorem cost of air freight, i.e.,the transport cost needed to move a dollar ofgoods, is also decreasing. Harrigan (2005) esti-mated that the relative cost of air transport hasdeclined by 40 percent between 1990 and 2004.As a result, air cargo is of growing importancein cargo logistics, accounting for about 40 per-cent of international trade by value. Manycountries have chosen to locate special eco-nomic zones and high-tech parks near airports.

Some nations, such as the Netherlands andSingapore, achieved rapid economic develop-ments by leveraging their liberalized transportsystems. Compared to its European neighborssuch as France and Germany, the Netherlandshas a relatively small domestic market. Never-theless, the country has been aggressive in lib-eralizing its transport sectors. In 1992 it signedthe first open skies agreement in the world withthe United States, promoting Schiphol airportas a major gateway for cross-Atlantic traffic,while facilitating its flag carrier at the time,

KLM, to further expand its network coveragein Europe and North America. These efforts,together with its superior transport infrastruc-ture of marine ports, rail, and road,5 have madethe Netherlands not only a major Europeanaviation hub nation, but also an ideal place toestablish European Distribution Centers (Oumand Park 2004). In terms of value, only 5 per-cent of the express cargo and retail logisticshandled in the Netherlands is for local con-sumption (Datamonitor 2005). With the estab-lishment of their European Distribution Cen-ters, many companies have chosen to alsolocate their billing centers, service depots, re-search centers, or even European headquartersin the country. The well developed transportand logistics sector in the Netherlands hasclearly enhanced the overall competitivenessof its economy.

AIRLINE NETWORK COMPETITION AND

LIBERALIZATION

In markets not yet liberalized, there can bemany constraints on airlines’ network configu-ration. Bilateral ASAs between two countrieslimit airports and route access, flight fre-quency, and seat capacity. These regulationsprevent carriers from optimizing their overallnetworks. The limitations imposed with a thirdcountry (i.e., limitations on beyond rights suchas Fifth Freedom) will further constrain a carri-er’s network structure in a region. As manytheoretical and empirical studies found, whenthese constraints are removed, airlines oftenchoose to reconfigure their networks to achievevarious objectives, among which are to im-prove cost efficiency by exploiting ‘‘econo-mies of traffic density,’’6 to enhance servicequality by initiating direct flights and/or byincreasing flight frequency,7 and to price moreaggressively or to compete more strategically.8

Many of these objectives are achieved bystreamlining a carrier’s multi-hub network.

Effects of Hub-and-Spoke Networks andAirline Network Competition

The emergence and prevalence of hub-and-spoke (HS) network is one of the most commondevelopments in deregulated markets, espe-cially for airlines endowed with access rightsto a single large market such as the UnitedStates and European Single Aviation Market.


The formation of a hub-and-spoke network canaffect both demand and cost.

The effect of hubbing on costs has beenextensively studied in the literature (e.g., Caveset al. 1984; Brueckner and Spiller 1994; Hen-dricks et al. 1995, 1999). Costs can go downdue to higher traffic densities in HS operationsthan in fully connected (FC, or point-to-point)operations, although these cost savings mightbe offset by the travelers’ circuitous routingsvia hubs.

Hubbing can also affect demand (which, inturn, affects revenues and profits) with its effecton passenger travel time and schedule delaytime. Compared to non-stop services, an HSnetwork increases the average passenger’stravel time due to the extra connecting time athubs and the circuitous routing of passengertrips. On the other hand, HS reduces a passen-ger’s schedule delay time–i.e., the time be-tween his desired departure and the actual de-parture time (Douglas and Miller 1974)–byoffering increased flight frequency. In addition,an HS network allows an airline to serve manyadditional city-pairs when a new spoke routeis added to the network (Oum and Tretheway1990).

The HS network is an efficient way to servedestinations over large spatial distances. Airbus(2007) pointed out that one source of connect-ing traffic is passengers who could in fact flydirectly if they wanted to. For example, in2006, 20 percent of those flying between Eu-rope and Asia selected a connecting route, eventhough they could have taken a direct service.There are several reasons for this behavior.Many passengers prefer connecting servicesto direct service due to the wider variety ofschedules offered at major hubs, either in termsof flight frequency or number of destinationcities. Airlines often offer lower prices for con-necting services, which is a by-product benefitfrom global airline alliances (e.g., Oum et al.2000). Passengers may also choose to fly viaa hub to take advantage of a stay-over at anintermediate stop.

Airlines may form HS networks as a strate-gic response to competitors rather than to sim-ply save costs. Oum, Zhang, and Zhang (1995)show that hubbing can be used as both anoffensive and a defensive strategy in airlinenetwork rivalry. Another major benefit of HS

networks is associated with a carrier’s domi-nance at its hub airports, which allows it toachieve substantially higher mark-up abovecosts. Such a benefit to the dominant carrieris referred to as the ‘‘hub premium’’ in theliterature, as has been confirmed in numerousstudies including Borenstein (1989), Dresnerand Windle (1992), Morrison and Winston(1995), Lee and Prado (2005), GAO (1989,1990), Lijesen, Rietveld, and Nijkamp (2004),and DOT (2001). Such a benefit gives airlinesa strong incentive to dominate an airport. Table2 shows that during the fifteen years after U.S.domestic airline deregulation in 1978, all majornetwork carriers have strengthened their mar-ket shares at their respective hubs.

In conclusion, the prevalence of HS net-works after airline deregulation can be ex-plained by cost advantages in production(economies of density) and/or revenue advan-tages achieved via demand stimulation (net-work complementarity). Even when there isneither cost nor revenue advantage, the threatof potential entry alone can give rise to an HSnetwork as opposed to an FC network. Zhang(1996) further argues that, for strategic reasons,competing airlines would choose to developHS networks using different hub airports.

Upon deregulation in 1978, major U.S. carri-ers began to strategically plan their networksto strengthen their dominance in existing hubsand to expand continental market coverage.Such a process was accompanied by massivemergers, acquisitions, and liquidations. For ex-ample, many airlines based in Central and East-ern United States acquired carriers based inWestern United States.9 This trend resulted ina massive consolidation of the industry, whichreduced the number of trunk airlines from over25 before the 1978 deregulation to six majornational network carriers. As a result, all ofthe national network carriers have built upmultiple hub networks in the United States.

While network carriers often use multiplehubs, they cannot afford to have more than onehub in a region. Airneth (2005) observed thatthe closest distance between two major hubsin a successful dual-hub system in the UnitedStates is 900 kilometers (km), the case ofNorthwest’s Minneapolis-St. Paul and Detroit.In 2008, Delta Airlines acquired Northwest,with a plan to reduce or close the hub functions


Table 2. Increased Share of the Dominant Carriers at Concentrated Hub Airports,1978–1993

1978 1993

Airport Share Carrier Share Carrier

Atlanta 49.7 Delta 83.5 DeltaCharlotte 74.8 Eastern 94.6 USAirCincinnati 35.1 Delta 89.8 Delta

Dayton 35.3 TWA 40.5 USAirDenver 32.0 United 51.8 UnitedDetroit 21.7 American 74.8 Northwest

Greensboro 64.5 Eastern 44.9 USAirMemphis 42.2 Delta 76.3 Northwest

Minneapolis-St.Paul 31.7 Northwest 80.6 Northwest

Nashville 28.5 American 69.8 AmericanPittsburgh 46.7 Allegheny 88.9 USAir

Raleigh-Durham 74.2 Eastern 80.4 AmericanSt. Louis 39.4 TAW 60.4 TWA

Salt Lake City 39.6 Western 71.4 DeltaSyracuse 40.5 Allegheny 49.5 USAir

Source: Morrison and Winston (1995)

of Memphis (NW’s hub) and Cincinnati (Deltahub), since they are too close to the Atlantaand Detroit hubs of the combined carrier. Thisrestructuring would result in a network of fourhubs in North America: Atlanta, Detroit, Min-neapolis-St. Paul, and Salt Lake City. U.S Air-ways has also drastically reduced the hub func-tions of Pittsburgh in the last five years sinceit is close to its own hub in Washington ReaganInternational Airport.

Airline Network Development and PolicyImplication

If domestic and international markets areboth fully deregulated, network carriers wouldbe able to expand their multi-hub networks toglobal markets. Intercontinental mergers andacquisitions are likely to occur since they areusually cheaper and less time-consuming thandeveloping a carrier’s own network in othercontinents (Oum, Taylor, and Zhang 1993).The current discussions between the EuropeanCommission and the United States on deregu-lating foreign ownership of airlines would havesimilar effects as a complete deregulation. Infact, such an agreement that aims to dismantlethe limitations on foreign ownership may even-tually lead to a complete dismantling of thebilateral ASA system.

Under the gradual liberalization scenario,there will be several driving forces for airlinesto restructure their networks. First, full-serviceairlines (FSAs) will consolidate via merger andacquisitions in domestic and intra-continentalmarkets, in order to strengthen their networksand market positions in a continent. Second,network and market linkages across differentcontinents will be strengthened via global stra-tegic alliances (Oum, Park, and Zhang 2000),as evidenced by the formation and growth ofmajor airlines alliances such as STAR, Sky-Team, and OneWorld. Since the airlines withineach Strategic Alliance Group will retain theirown identity, they will structure their networksin such a way that their own profits are max-imized. As a result, these airlines’ internationaland intercontinental networks will be influ-enced heavily by the structure of their domesticand continental networks.

Previous alliance studies suggest that inter-national alliances lowered fares, grew the mar-ket, and improved partners’ operations and ser-vice quality.10 However, the future of theseglobal alliances is not crystal clear. Since theexisting alliances grew under a web of restric-tive bilateral ASAs which barred cabotage andforeign ownership, they represented a ‘‘second


best’’ approach to the realization of inter-firmsynergies on both the cost and demand sides.(In effect, such realization is constrained bythe existing restrictive international regimes;as a consequence, the observed benefits fromalliances are lower than their full potential.)Therefore, the future growth of global airlinealliances would be limited, if not approachingzero, under a fully liberalized (both domesti-cally and internationally) air transport market.

When restrictions on route entry, capacity,and frequency are dropped in domestic andintra-continental markets, network reconfigu-rations are likely to be different among carriersoperating in United States, Europe, and Asia.The U.S. carriers have had complete freedomto restructure their domestic networks since1978. Transborder open skies in Europe beganin 1993, and the complete single market (in-cluding cabotage rights for all EU carriers)began in 1997. As a result, European airlineshad less time to adjust their networks comparedto their peers in the United States. Most cross-border markets in Asia are still heavily regu-lated. As a result, most of the Asian carriersserve their principal city markets, rather thanusing their super airports as hubs. Such networkpatterns can be seen in Table 3. Many U.S.airports serve as real hubs, with over 50 percentconnecting ratios. In Europe, only the Frankfurtairport has more than a 50 percent connectingratio. All other airports, including London,Amsterdam, and Paris, have less than 50 per-cent connecting ratios. The Asian airports per-form even fewer hub functions. Even the mostactive hub airport in East Asia, Hong Kong,has only slightly higher than a 30 percent con-necting ratio.11 Many Asian carriers are takingadvantage of the restrictive international regu-latory regime since, with capacity restricted,airlines are able to charge higher prices to localtraffic. Therefore, they have less incentive touse the scarce intra-Asia capacity to attractconnecting passengers. In 2007, Narita and In-cheon airports have only 17 percent and 12percent connecting ratios respectively. As theinternational liberalization advances furtherand perhaps more rapidly in the future, Asiannetwork carriers are likely to restructure theirnetwork and traffic routing patterns in such away that functions of their major airports areincreased.

The varying stages of openness in globalaviation markets imply that airline networks,and accompanying traffic flows, will experi-ence a shift in spatial pattern and market power.For example, Hong Kong had been much moreliberalized than the neighboring economies, in-cluding mainland China, Taiwan, Thailand,and Vietnam. Together with its fast-growingeconomy, Hong Kong had secured leadershipfor its airports and marine ports in the region.However, with the gradual liberalization inmainland China, Hong Kong airport’s hub sta-tus is facing serious challenges from nearbyairports such as Guangzhou and Shenzhen.Since South Korean air carriers lost most oftheir domestic markets to high-speed rail,KTX, the country has no choice but to adopta Singapore-style policy to promote open skiesregimes internationally, especially with China,Japan, and Southeast Asian countries. It isworth noting that South Korea has had openskies ASA with the United States since 1998.

Due to historical reasons, Japan gave majorbases of operations at Narita and other majorJapanese airports to United Airlines, NorthwestAirlines, and Federal Express, and opened itsmarkets to other U.S. carriers substantially.However, the Japanese government now real-izes that the importance of economic integra-tion with China and South Korea, and thus, theopen skies regime in Northeast Asia, is a moreurgent task than signing open skies with theUnited States or Canada. Since both Tokyo-Narita and Tokyo-Haneda airports are expectedto have substantially more slots in 2010, Japanexpects to allocate a lion’s share of these in-creases to Asian carriers, especially carriers ofthe Northeast Asian subcontinent. An issue thatworries Japanese government is that there hasbeen an increasing trend that Northeast Asia-North America air traffic is bypassing Tokyo-Narita (NRT), as shown in Figure 2.

Even for countries with deregulated airtransport markets, it is important to maintaintheir leadership in liberalization to keep theiraviation sector competitive in the global mar-ket. Singapore, for example, has been workinghard to maintain its leadership in the region interms of air transport liberalization. As of 2006,Singapore has signed over 90 ASAs with othercountries, compared to the 57 ASAs signed by


Table 3. Percentage of Connecting Passengers at Major Airports, 2007

Airport % Connecting Passenger Airport % Connecting Passenger

North America Europe

ATL 64.0% AMS 41.3%CLT 30.0%* ARN 22.0%DEN 43.0% ATH 21.0%*DFW 60.0% CDG 32.0%**DTW 48.4% CPH 27.8%EWR 30.6% FRA 53.0%IAD 20.7%* LHR 36.0%**IAH 51.2% PRG 20.3%*JFK 30.8% VIE 31.9%LAS 12.9%** ZRH 33.8%*LAX 3.9%MDW 25.0%** AsiaMEM 63.3% CAN 20.1%MIA 39.0% HKG 33.3%MSP 47.3% ICN 12.1%ORD 68.0%** NRT 17.2%PHL 37.0%* PEK n.a.PIT 14.0% PVG 16.3%SEA 28.0% TPE 11.0%SFO 24.9%SLC 50.4%STL 23.9%

Source: The ATRS Airport Benchmarking Report, 2005-2007* 2006 data ** 2005 data

Hong Kong.12 Singapore also reached open-skies agreements with the United States, NewZealand, and the United Arab Emirates. In June2006, the country became the first Asian nationto sign an open skies agreement with the EU,which allows Singapore Airlines to fly any-where within the 27 EU-nation bloc. Such anaggressive and determined liberalization policyhad helped the nation to maintain the competi-tiveness of its airports and airlines.

IMPACTS OF LOW-COST CARRIERS AND

IMPLICATIONS ON AVIATION POLICY

A strong trend that emerged with deregula-tion and liberalization in the United States,Canada, and Europe was the simultaneous oc-currence of the birth of upstart competitors andthe disappearance of weaker airlines throughbankruptcies or mergers. Well establishedbrands like Pan American World Airways (Pa-nAm), Eastern Airlines, Trans World Airlines(TWA), and Canadian Airlines Internationaldisappeared, while LCCs such as Southwest

and several new brands (e.g., JetBlue, Westjet,Ryanair, EasyJet) emerged and prospered. Aspointed out by the Transportation ResearchBoard (1999), ‘‘Probably the most significantdevelopment in the U.S. airline industry duringthe past decade has been the continued expan-sion of Southwest Airlines and the resurgenceof low-fare entry generally.’’13 The ‘‘South-west effect –i.e., a rapid increase in traffic vol-ume and a simultaneous fall in fares on routeswhere, or close to where, Southwest Airlinesoperates–has become widely known (U.S.DOT 1993; Richards 1996). The price effectsof LCCs were empirically estimated by, amongothers, U.S. DOT (1993), Windle and Dresner(1995), Dresner et al. (1996), and Morrison(2001).14 Franke (2004) suggested that Europehas a similar ‘‘Ryanair effect,’’ whereas Zhanget al. (2009) suggested that the ‘‘Southwesteffect’’ might also exist in Asia.

LCCs such as Southwest Airlines andRyanair grew under a deregulatory domestic


Figure 2. North American – East Asian Traffic Diversion

Source: Swan (2007)

environment. In Europe, after the EU integra-tion in the mid-1990s, the EU internal markethas become a ‘‘domestic’’ market. In Asia,entry of LCCs was facilitated by domestic de-regulations as well. While deregulation andliberalization have facilitated the growth ofLCCs, the LCC experience has also promotedpolicy reform and liberalization. Until 1978,the U.S. airline industry was regulated by theCivil Aeronautics Board. It was mainly throughthe experience of unregulated Southwest Air-lines–which offered lower fares for intra-state(Texas) services than comparable regulatedservices between states–that the deregulationof market entry commenced in 1978 with thepassage of the Airline Deregulation Act (Lev-ine 1987; Morrison 2001). This has, in turn,stimulated Southwest’s domestic expansion asthe state borders no longer mattered.

Another case in which the LCC experiencestimulates policy liberalization is the Associa-tion of Southeast Asian Nations (ASEAN) re-gion, where significant progress has been madelately. In July 2007, ASEAN countries reachedan agreement under which unlimited flightsbetween capital cities in ASEAN would startat the end of 2008. Furthermore, it was ex-pected that ASEAN nations would sign an open

skies agreement as early as December 2008(Asia Times 2008). These positive policy de-velopments are due mainly to the positive ef-fects of liberalization, both domestically andregionally, and of emerging LCCs. Considerthe case of Malaysia. After maintaining a strictclosed skies aviation policy for many decades,Malaysia has recently seen a boom in air trafficgrowth due to greater domestic competition ledby AirAsia. This air traffic growth, togetherwith the success of other regional LCCs, hasprompted the Malaysian and other ASEANgovernments to push for a more liberalizedregulatory regime (Asia Times 2008). Anothermajor motivation for liberalization in theseSoutheast Asian countries is to boost tourismand business travel after the devastating Asianfinancial crisis in the late 1990s.15 *FN0* Asa case of regional liberalization, consider thelucrative Singapore-Kuala Lumpur route. Thisroute had for years been restricted by Malaysiato protect Malaysian Airlines, and was domi-nated by Malaysian Airlines and SingaporeAirlines as a duopoly. In late 2007, the Malay-sian government decided to allow AirAsia tooperate on the route, paving the way for TigerAirways (from the Singaporean side) to enterthe route as well. The liberalization policy


Table 4. Contribution of LCCs to the Useof 5th-9th Freedoms(Europe 2005, excluding SAS from the total)

Air Freedoms Flights Seats

5th 0% 0%6th 0% 0%7th 63% 77%8th 0% 0%9th 24% 47%

Total 53% 71%

Source: Dobruszkes (2009)

started with allowing two flights daily fromeach LCC, and then was extended to six dailyflights in September 2008. As illustrated inZhang et al. (2009), the entry by AirAsia andTiger Airways forced the two incumbent FSAsto significantly lower their fares, to the clearbenefit of passengers.

Dobruszkes (2009) investigated airline com-petition in Europe following the liberalizationin 1997. He found that traditional Europeanairlines, especially the majors (Air France,British Airways, Lufthansa, and KLM) havenot benefited directly from the liberalizationof European airspace in order to operate flightsnot centered on their country of origin. Theircontribution to the usage of the 5th-9th Air Free-doms in Europe is less than 1 percent each.These carriers make greater use of the 5th-9th

Freedoms outside Europe, in particular onlong-haul flights to the Far East that involvea stopover. In Europe, these carriers remainstrongly rooted in their national centers. It isLCCs that have benefited most from the newair freedoms made available by the liberaliza-tion, as shown in Table 4. Dobruszkes (2009)suggests that this benefit may be due to thenew mode of operation by LCCs, which facili-tates the development of extra-national bases.

Another important channel via which LCCspromote further policy liberalization is throughthe enhancement of the competitiveness of na-tional carriers. Clougherty and Zhang (2008)identify three paths via which domestic rivalry(domestic competition) might influence inter-national performance on the part of airlines.First, when there is an equivalence betweenthe number of domestic and international com-petitors (that is, every domestic airline also

serves international markets), then increasingthe number of domestic competitors also in-creases the number of international competitorsrepresenting the nation. Accordingly, a strate-gic effect of having multiple national competi-tors in world markets is enhanced exports. Sec-ond, a ‘‘joint economies of production’’ effectderives from the impact of domestic rivalryon the size of an incumbent firm’s domesticoperation, since size of domestic operation af-fects international performance in the airlineindustry (Clougherty 2002, 2006). Third, do-mestic rivalry may also pressure firms to im-prove product quality and/or productivity, thusenhancing the competitiveness of home-nationairlines in international markets. In short, anadditional rationale behind domestic deregula-tion and competition could well be the promo-tion of domestic carriers’ competitiveness ininternational markets. Accordingly, the dra-matic growth in domestic competition due toLCCs may significantly impact internationalcompetitive outcomes.

The large economic benefits of LCCs are sovisible that their further developments tend tospeed up the deregulation/liberalization pro-cess of domestic and international airline mar-kets. On the other hand, as discussed in Zhanget al. (2009), there are still a large numberof visible and invisible barriers acting againstgrowth of LCC activities in markets whereLCCs are most needed.16 The organizationalstructure of AirAsia, arguably the most suc-cessful LCC in Asia, shown in Figure 3, servesas telling evidence of restrictions for an AsianLCC to grow its services across nationalboundaries. In particular, given the restrictedaviation regime in the region, AirAsia couldextend its network and enter a new regionalmarket only through joint venture (JV) arrange-ments or alliances: Thai AirAsia in Thailandand Indonesia AirAsia in Indonesia are two JVexamples in which AirAsia holds a 49 percentshare, so as to abide by the national ownershiprestrictions of Thailand and Indonesia respec-tively.

More recently, Tiger Airways (of Singapore)tried to establish JVs, namely, Tiger AirwaysAustralia and Incheon Tiger Airways, in anattempt to expand its services to Australia andSouth Korea, respectively. While the Austra-lian JV is in operation, the Korean project was


Figure 3. Operating Companies for Air Asia Group

called off in late December 2008 after morethan one year of planning, citing the ‘‘regula-tory uncertainty’’ in Korea and a weak globaleconomy as reasons for the cancellation. Theproject would have been a tie-up with IncheonMetropolitan City, with the Singapore com-pany taking a 49 percent stake. But from dayone, the project faced local opposition. In Au-gust 2008, Korean LCCs (namely, Air Busan,Yeongnam Air, Jeju Air, and Jin Air), jitteryabout the impending competition, filed a com-plaint with their country’s Ministry of Land,Transport and Maritime Affairs. They urgedthe government to put the brakes on the launchof the new carrier, claiming that it would ineffect be controlled and run by Tiger since theother shareholders had no airline experience.The airlines went so far as to say that thenew airline would ‘‘attack Korea’s aviationsovereignty’’ (The Straits Times 2008).

The experiences from North America andEurope suggest that the benefits brought byLCCs are concrete, dramatic, and lasting, andthat they form a significant part of the gainsfrom air transport liberalization. However, tofully gain such benefits, liberalization and de-regulation need to be carried out.

SUMMARY AND CONCLUSION

As early as the system of bilateral ASA wasadopted as the primary regulatory system forinternational air transport at the Chicago Con-vention in 1944, there have been proposals to

liberalize the international aviation market. Ittook the world nearly one half of a centurybefore the first open skies bilateral ASA wassigned by the United States and the Netherlandsin 1992. Although many open skies agreementshave been reached in the following years, liber-alization of international air transport remainsa formidable challenge. In addition, many ofthese liberalizations have been partial and in-complete, mostly requiring further deregula-tion of foreign ownership, beyond rights, entry,and other factors. Many of the difficulties fac-ing liberalization issue can be attributed to thestakeholders’ different expectations about theeffects of alternative policies and agreements.The resulting uncertainty has prevented manygovernments from adopting substantial regula-tory changes. This study examined the effectsof past liberalization policies on economicgrowth, passenger traffic, and low-cost carri-ers. While the actual effects of liberalizationare subject to the influences of many factors,including the country’s domestic market size,competitiveness of home carriers, and evengeographic location of major hub airports,some general conclusions obtained from ourinvestigation can be summarized as follows:

Liberalization has led to substantial eco-nomic and traffic growth. Such positive ef-fects are mainly due to (1) increased competi-tion in the aviation market, which reduces priceand stimulates traffic growth; (2) productive


efficiency gains as a result of carriers’ optimi-zation of their route network and pricing strat-egy as well as due to the increased competitivepressure to improve productivity to survive;and (3) positive externalities generated to theoverall economy, including promotion of em-ployment opportunities, trade, and tourism, andbetter transport and logistics services. Theseimpacts are not uniform across countries. How-ever, an increasing number of countries haveadopted progressive liberalization, suggestingthat the countries involved have benefited fromliberalization in general.

Liberalization allowed carriers to opti-mize their networks to cover intra- and in-ter-continental markets. Hub-and-spoke net-works have been used extensively by airlinesto achieve revenue advantage and/or cost ad-vantages in production through economies ofdensity. If foreign ownership and control re-strictions are relaxed, market consolidation viamerger and acquisition would allow airlines tostrengthen their networks and market position.Strategic alliances allowed airlines to achieve‘‘second best’’ network connection in marketswhere bilateral ASAs are still restrictive. Uponliberalization, the future growth of global air-line alliances would be limited. Liberalizationand network competition in international mar-kets lead to shifts in the spatial pattern of trafficflow as well as reducing market power of domi-nant carriers. Therefore, it is important for for-ward-looking countries to maintain their lead-ership in liberalization so that they may be ableto induce traffic flow patterns to shift in theirfavor.

The rapid growth of LCCs has broughtsignificant impacts to the airline industry.There is a two-way relationship between LCC

ENDNOTES1 For the official definition of the freedoms of the air,

the reader is referred to the Manual on the Regulationof International Air Transport, or the International CivilAviation Organization (ICAO) Web site at http://www.icao.int/icao/en/trivia/freedoms_air.htm.

2 The precise definition of ‘‘open skies agreement’’differs across countries. In general, it broadly refers toASAs that remove most of the constraints discussed atthe beginning of this article, particularly constraints onpricing, capacity, designation of airlines, and entry on the3rd/4th Freedom markets. The U.S.-style open skies alsoinclude exchange of unlimited 5th Freedom rights. The

expansion and liberalization (and deregula-tion). Liberalization has increased competitionand reduced air fares, which in turn has stimu-lated traffic substantially. These changes callfor removal of restrictions on capacity, fre-quency, pricing, and entry. In liberalized mar-kets such as the EU single aviation market,LCCs have benefited most from the deregula-tion of beyond traffic rights, which give themfreedom to establish airport bases in foreigncountries. In addition, development of LCCsin domestic markets can promote liberalizationpolicy by increasing the competitiveness of anation’s airline industry as a whole. On theother hand, existing regulations on route entry,foreign ownership, and effective citizen controlhave constrained expansion of LCCs. Theseexisting regulations thus prevented the associ-ated benefits of liberalization policy to its citi-zens and economies from being fully realized.

The possibility of creating ‘‘destructive’’ or‘‘excessive’’ competition has often been usedas an excuse for maintaining regulation and/orfor slowing the inevitable course of deregula-tion. Our investigation revealed that such regu-latory protection of flag carriers did not leadtheir airline industry to efficiency and profit-ability, as policy makers had hoped. Instead,countries spearheading deregulation and liber-alization scored various long-term benefits totheir aviation industry as well as gained bene-fits for their consumers and overall economyin a major way. Therefore, we suggest that itis important for the first-mover countries tomaintain their leadership in liberalization. Inaddition, it is urgent for countries still practic-ing regulatory protection of their flag airlinesto abandon these practices and change theirpolicy to use airlines to the benefit of theirconsumers and economy.

Current Model Open Skies Agreement used by the UnitedStates is available at http://www.state.gov/e/eeb/tra/ata/.

3 Borenstein and Rose (2007) found that between 1976and 1986, the U.S. average domestic passenger yielddeclined in real terms at a rate of 3.4 percent per year,while revenue passenger miles increased at a rate of 8.2percent per year. However, they pointed out that the priceeffects of U.S. deregulation may have been overestimated.Instead, a major change was an increase in pricedispersion. Price dispersion within carrier-routes morethan doubled between 1979 and 2001.

4 Hummels (2006) pointed out that ocean-shipped cargotraveled an average of 2,919 miles in 2004, down from


3,543 miles in 1975. In contrast, air-shipped cargo traveledan average of 3,383 miles in 2004, up from 2,600 in 1975.

5 The Netherlands has the largest marine port in Europe(Rotterdam), superior inland river shipping to Germanyand France, and extensive high-speed rail and roadconnections to Western Europe.

6 See, e.g., Caves et al. (1984) and Brueckner and Spiller(1994). Traffic density is calculated by dividing the totaltraffic volume by the carrier’s network size. Network sizeis usually defined as the number of origin-destination pairsserved by the carrier, or the number of nodes connectedin its network.

7 See, e.g., Morrison and Winston (1987), Berechmanand Shy (1998), Brueckner and Zhang (2001), andBrueckner (2004).

8 Borenstein (1989), Spiller (1989), Berry (1990),Bittlingmayer (1990), Brueckner and Spiller (1991),Brueckner et al. (1992), Zhang and Wei (1993), Oum et al.(1995), Zhang (1996), and Hendricks et al. (1997, 1999).

9 For example, Delta acquired Western Airlines in orderto expand its market coverage in the western United Statesand to secure Salt Lake City as its western hub. AmericanAirlines strengthened its Dallas-Ft. Worth hub andacquired Air California. U.S. Air acquired Piedmont andPacific Southwest. On the other hand, Northwest acquiredRepublic in order to increase dominance of itsMinneapolis-St. Paul hub and surrounding markets.

10 For instance, the global alliances have facilitatedcompetition among alliance networks, which significantlyimproved the efficiency of the international interliningmarket. Brueckner and Whelen (2000) found that faresare about 18-20 percent lower on international allianceand interlining routes.

11 Hong Kong International Airport provides extensiveconnection services via ferry, rail, and shuttle buses tocities in the nearby Pearl River Delta region of mainlandChina. Although such connections expand the catchmentsarea of the airport, they enhance the status of Hong Kongas an aviation hub very little. The major benefits broughtby aviation hubs, such as cost savings or competitiveadvantages, are not fully realized.

12 It should be noted that the number of ASAs signedis not the sole indicator of market openness, since someASAs signed may not be active. In addition, compared toother Asian economies, Hong Kong has much better accessto mainland China, a large and fast-growing market.

13 This statement was also quoted at the beginning ofMorrison (2001).

14 See Tretheway and Kincaid (2005) for a literaturereview on the effect of LCCs on air fares in the UnitedStates.

15 It is also interesting to note that statistics from theTourism Office of Macau Government shows that afterViva Macau, a LCC, flied to Indonesia, Australia andJapan, visitor arrivals by air from these three countrieshave grown by 71 percent, 290 percent, and 300 percent,respectively.

16 In addition to the policy issues discussed in thissection, availability of suitable secondary airports alsoplay important roles in the success of LCCs. Murakami(2007) pointed out that Japanese LCCs, which achievedslow growth in recent years, had limited access tosecondary airports. The usage of expensive and congestedHong Kong International Airport may also have

contributed to the failure of Oasis Airlines, a short-livedLCC based in Hong Kong.

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air transport liberalization and its impacts on airline competition and air passenger traffic

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international aviation

liberalization policy

international routes

grant of rights air

traffic growth

aviation services

traffic volume

volume of traffic