airline deregulation
TRANSCRIPT
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Airline Deregulation: The Benefits Versus the Detriments
Nathan DeRosa
Economics 470
Dr. Jason Dunick
April 13, 2012
Airline Deregulation 2
Introduction
The U.S. airline industry has faced substantial changes in the way it operates
since they were deregulated just over thirty years ago. Prior to deregulation, the airlines
were tightly controlled by the Civil Aeronautics Board (CAB), which controlled prices
and limited the airlines to where they could provide service. Barriers to entry for new
airlines were formidable, and the existing major carriers had oligopolistic control over the
market. In fact, the ten largest airlines controlled 90% of the market with the remaining
portion controlled primarily by small regional airlines (Maynard, 2008). Proponents of
deregulation sought to increase competition among the airlines as well as lower fares—
two factors that had been largely absent from airline market.
Lowered Fares and Lowered Barriers
By eliminating price controls on airfares and lowering the barriers to entry for
new airlines, deregulation supporters predicted that it not only lead to increased
competition, but ultimately lead to lower fares in general and better quality service.
Since the Airline Deregulation Act passed in 1978, the rise of low-cost carriers (LCC’s)
as well as regional carriers had developed resulting in part to less expensive fares. With
lower fares and lower barriers to entry, it also meant more people would be able to afford
flying and more competitors could be introduced into the market, which has all lead to a
considerable increase in traffic volume since deregulation. The gradual elimination of
the CAB by the Airline Deregulation Act is also attributed to lower airfares. By measure
of competition and airfares, supporters have predicted that deregulation has accomplished
the task of lowering airfares as well as the barriers to entry and exit.
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Negative Effects: Job Losses and Service Cuts
On the other hand though, other measures have been used to argue that
deregulation has yielded unintended consequences that challenge the benefits of
deregulation. While deregulation has benefited passengers in the form of consumer
savings, it has taken a toll on airline workers. As supporters were pushing for the Airline
Deregulation Act, opponents cited that he legislation would result in job losses, a loss of
service in many cities, and higher fares (Maynard, 2008). While fares are generally less
expensive than they were before deregulation, opponents were partly right in that it
would result in a loss of service and jobs. Since the beginning of the 2000s, the airlines
collectively shed approximately 100,000 jobs.
With the Deregulation Act passed in 1978, many rural communities were fearful
of airlines pulling out, resulting in a loss of service as well as jobs. To remedy this fear,
the Essential Air Service Program, or EAS, was established. The goal of the program is
to keep airline service in rural communities deemed unprofitable by the airlines trough
direct government subsidies to the airlines serving that community. Small cities were not
the only places to have lost service as some larger cities have as well. Maynard points
out that cities such as St. Louis and Pittsburgh, which were once large hubs for American
and US Airways respectively, have far less service as a result of airlines trying to control
costs and fares generally go up in these instances as a result.
Unforeseen Consequences: Fuel Costs, Alliances, and the Hub-and Spoke System
Another negative factor that also comes into play are persistently high fuel costs,
which airlines attribute to their financial troubles and even bankruptcy. Between 2001
and 2006, the airlines collectively lost about $30 billion and any profits that were made
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were dwarfed by the losses. This is something that Alfred Kahn, the chief architect of
airline deregulation, has said that proponents did not foresee (Maynard, 2008).
Deregulation proponents also failed to foresee the rise of the hub-and-spoke system, in
which airlines maintain a large base from which flights either originate or serve as a
conduit between two non-hub cities. With the goal of deregulation to spur competition,
the hub-and-spoke model creates incentives for customers to stay with one airline rather
than shop by price since the hub airline has dominating control on pricing.
In addition to the rise of the hub-and-spoke model, deregulation supporters also
did not foresee the rise of airline alliances, which offered larger route networks but also
provided another incentive for travelers to stay with one airline and further inhibiting
competition rather than facilitating it (Maynard, 2008). While there have been many
changes since the Airline Deregulation Act was implemented, deregulation itself did not
take effect immediately and as a result, neither did the outcomes. Even thirty years after
deregulation became law, the airlines continue to discard inefficiencies. The process of
deregulation did not officially end until the mid-1980s with the dissolution of the CAB,
and innovations such as the selling of fares on the Internet in the mid to late 1990s would
not have been developed as it would have been illegal under CAB authority.
When examining the airline industry’s nearly nine-decade existence, it had been
regulated for nearly half of its lifetime, and it has nearly taken that amount of time for the
industry to transition from a regulated market to a deregulated one. Essentially,
deregulation has had positive effects on the industry through more affordable fares for
customers as well as enabling the entrance of new competitors. However, airlines have
endured billions of dollars in losses and have significantly cut their workforce in an effort
Airline Deregulation 5
to curb rising costs such as fuel, and airline workers have seen a general decline in
earnings and continue to see a downward pressure on wages. Overall, this paper studies
airline deregulation and the economic outcomes it has yielded, and my focus is on the
deregulation of passenger fares and flight routes as well as the fare savings, traffic flow,
financial performance, and labor issues.
Research Method
Most of the research I collected on this matter thus far has been mostly in the form of
literature reviews, and I plan on conducting my research in kind. That is, the method I
plan on using is a literature review. The sources I have obtained are diverse and vary
from sources in transportation, law, economics, business, and public policy. Some of the
more prominent sources in economics have come from the Journal of Economic
Perspectives and the National Bureau of Economic Research. I have also obtained
additional sources in economics coming from the Industrial and Labor Relations Review,
International Journal of Industrial Organization, and the Economics Bulletin. Other
prominent sources have also come from the public policy think-tank Brookings
Institution as well as sources in law such as the Yale Journal on Regulation and Houston
Law Review. I have also obtained sources from aerospace such as Taking Stock of Air
Liberalization, American Institute of Aeronautics and Astronautics, and the
Transportation Research Forum. Notable business sources have been published in the
Journal of Applied Business Research, and the Journal of Financial Economics. In
addition to the more academically based sources I have obtained, I also have incorporated
a source from the well-known newspaper The New York Times analyzing the airlines
under the past three decades of deregulation. Overall, my sources represent different
Airline Deregulation 6
disciplines encompassing economics, politics, business, finance, law, and aerospace. As
a result, these sources also represent unique perspectives from academia, business
professionals, and other researchers.
Main Findings
Although the airline industry has been deregulated for the last thirty years, it has
spent a longer time, though not significantly longer, regulated by the government. In
order to have an understanding of airline deregulation, it is important to examine
regulation, the rationales for it, as well as the events that led to deregulation in 1978. The
rationale for regulation can be traced back as early as the American Industrial Revolution
in the late 1800s, before the dawn of aviation as we know it today. The case for
regulation was made under two claims. With the rise major industries, concentrations of
market power could ensue leading to monopoly prices being forced on consumers and
potential competitors. As a result, governments deemed it necessary to hold corporations
accountable and preserve competitive markets if not to produce outcomes that were
sufficiently market-like (Eisner, 2008). The second claim, which was more prominent in
the 1930s during the Great Depression, was that “ruinous” competition would result in
market instability through price wars, destabilizing price fluctuations, and bankruptcies if
major companies were left to their own devices (Eisner, 2008).
Birth of the Airline Industry
Even though the case for regulation of industry was made before the development
of commercial aviation, it nevertheless coincided with the development of commercial
aviation in the early twentieth century. While in the 1920s the government did not
officially regulate the emerging airlines, they were greatly influenced by public policy.
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Starting in 1918, the federal government used private air carriers to supplement military
airmail carriage, with early payloads devoted to mail, not passengers. In 1925, while the
airlines continued to develop, the Kelly Airmail Act was passed which set up a
competitive bidding system for private airmail carriage. Following this legislation,
amendments were passed that allowed the Post Office to award contracts with payments.
This, along with the Ford Motor Company’s introduction of a 12-seat aircraft, facilitated
the expansion of air service in the young, struggling airline industry (Borenstein and
Rose, 2007). By the 1930s, in the onslaught of the Great Depression, regulation became
an even more serious issue, and the airlines were not excluded from this. As a result of
bid rigging and market dividing efforts over airmail contracts by the Postmaster General,
Congress passed legislation that enabled the Interstate Commerce Commission (ICC) to
regulate the airlines (Levine, 1987). However, economic regulatory responsibility would
be shifted to the Civil Aeronautics Board with the passing of the Civil Aeronautics Act
(CAA) in 1938 (Borenstein and Rose, 2007). The objective of the regulation created by
the CAA was “‘to…foster sound economic conditions in the industry (U.S. Statutes at
Large 52 : 973 (1938), 101(b)). Price and entry regulation in the airline industry was
deliberately designed to promote the financial stability of airlines” (Kohl and Lehn,
1998). This was something that both politicians and airline managers greatly desired. As
a result, policymakers and industry executives alike willingly accepted the coordination
efforts by the government over the perceived volatilities of the market. In addition,
“perceived national defense interests in a robust domestic airline industry added to the
appeal” with World War II looming in the near future (Borenstein and Rose, 2007). The
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establishment of the Civil Aeronautics Board essentially marked the official beginning of
regulation in the airline industry.
The Regulation Era
However, since regulation began in 1938 and carriers such as American Airlines,
Delta Air Lines, and United Airlines had commenced operations before the CAB’s
establishment, existing carriers such as these had their operating authority in their
respective markets grandfathered in. Any airline that commenced operations after the
CAB’s establishment found it extraordinarily difficult to enter the market while
facilitating the operations of the major carriers. However, “the CAB bowed to pressure
to authorize entry by carriers providing service to and from smaller communities” during
and after the Second World War (Borenstein and Rose, 2007). While it was difficult for
new airlines to enter the market, it was also difficult for already existing major carriers to
expand. Any carrier that was wishing to expand had to show the Board that their
expansion would not hurt the incumbent carrier as there was already very little route
overlap between the carriers (Borenstein and Rose, 2007). It was in this way the Board
regulated entry of air carriers and route structure of the already existing airlines. In
addition to regulating entry and route structure, the CAB regulated fares as well. The
goal of regulating fares was to essentially ensure profit adequacy. As a result of the
Board’s focus on profits and subsequently continued development of air transportation,
they generally approved of most fare increases initiated by air carriers (Borenstein and
Rose, 2007).
However, higher passenger fares regulated by the CAB did not translate into
higher profits for the airlines. Borenstein and Rose refer to a study conducted by
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Theodore Keeler, in which “he argued that high fares in conjunction with apparent
normal rates of return to capital for airlines suggested that ‘airline regulation extracts
high costs in inefficiency on high-density routes.’ Carriers responded to high margins
with behavior that increased costs, reduced realized returns, and raised the cost of
meeting a given level of demand for air service.” As a result of the higher prices and
subsequent behavior of the airlines, the carriers focused on competing for passengers
based less on fares and more on other aspects of service, such as seat spacing and quality,
food and beverage service, and entertainment, which raised costs for the airlines and in
turn produced lackluster profits.
While the major carriers under CAB regulation did not fare well in terms of
profitability, the smaller, local carriers that the Board allowed to begin operations in the
1940s turned higher profits while charging lower fares than their major counterparts.
Since these carriers served smaller communities and did not fly across state lines, they
were not subject to CAB regulation as the CAB only had jurisdiction over interstate
markets dominated by the major airlines. Unlike the major airlines that were competing
in non-price ways, the small intrastate carriers competed with each other based on price.
As a result, the smaller local carriers charged fares based on the market, which were
lower, and as a result, the frequency of flights and passenger load factors were relatively
higher than the major carriers (Borenstein and Rose, 2007). Of course, it was difficult for
the intrastate carriers to expand because by their very nature they provided service within
one state, but also if they wanted to expand, it would mean that they would be subject to
federal regulation. Ultimately, the structure of the intrastate market provided a glimpse
of what a deregulated airline market on a large scale might look like given that the
Airline Deregulation 10
biggest local markets were California and Texas, which were comparable to the interstate
markets of the east coast (Borenstein and Rose, 2007). Given the generally higher rates
of profitability among the smaller, local airlines like Pacific Southwest compared to the
major carriers such as United Airlines throughout the 1960s and 1970s, critics began to
question the Board’s effectiveness in regulating the airlines (Chung and Szenberg, 1996).
The Push for Deregulation
In the 1970s, the push for deregulation of the airline industry gained more
momentum with stagflation and surging oil prices plaguing the economy. The time
became politically ripe to push for deregulation of not only the airline industry, but the
communications, financial, and utilities industries as well (Eisner, 2008). While it would
not be until the late 1970s that the Airline Deregulation Act would become law and
deregulation would officially begin, economic deregulation started four years prior with
experimentation with discount fares by the Board (Winston, 1998). While the CAB
traditionally was skeptical of discount fares, pro-reform appointments to the CAB such as
John Robson and Alfred Kahn changed the agency’s attitude toward regulation
(Borenstein and Rose, 2007). Finally in 1978, Congress passed the Airline Deregulation
Act that would change the way the airline industry operates. It should be noted, however,
that regulatory regimes are not dismantled overnight, and it took five years for the
airlines to be fully deregulated economically with the elimination of regulations on fares,
entry, and exit (Winston, 1998). It would not be until 1985 when the Civil Aeronautics
Board would be disbanded (Borenstein and Rose, 2007). The Federal Aviation
Administration, which was established in 1958 to regulate the safety of civil air travel,
would remain in its role .
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The Deregulation Era: Lowered Prices and Barriers
While deregulation would eventually change the airline industry, a legacy from
the regulatory era would remain, known as the Essential Air Service Program (EAS),
which has the goal of incentivizing airlines with subsidies to fly to smaller communities
that would otherwise be unprofitable for the airlines. Aside from the program, which was
kept out of political pressure, the airlines were largely exposed to market forces in an
unprecedented manner. Advocates of deregulation claimed that exposing the airlines to
the marketplace would lower airfares and make flying more accessible to the public as
well as increase competition by an influx of new competitors, as well as elimination of
other competitors. It was in these predictions that deregulation supporters were generally
correct. Between 1980 and 2005, passengers saw a general decrease in airfares by
approximately 40%, adjusted for inflation. The decrease in airfares was also met with
increased load factors as more people could afford air travel, and passenger miles more
than tripled from 188 billion to 584 billion between 1978 and 2005 (Eisner, 2008). In
addition to lower fares, competition among the airlines also surged. In February 1984,
six years after the Airline Deregulation Act became law, the total number of carriers rose
to 123, with more than half of them no longer in existence a decade later (Chung and
Szenberg, 1996). While many airlines liquidated, many filed for bankruptcy protection,
were absorbed into other airlines, made subsidiaries of larger airlines, or made into
regional carriers serving larger airlines. In 1979, Southern and North Central Airlines
consolidated and became Republic Airlines, until it was acquired by Northwest Airlines
in 1986, and Northwest would eventually merge with Delta in 2008. In 1985, United
Airlines acquired Pan Am Airlines’ Pacific routes, a move that signaled the beginning of
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globalization in the airline industry and continued throughout the 1990s and 2000s as the
major airlines looked to expand substantially internationally (Chung and Szenberg,
1996). Globalization gained momentum in the airline industry in the 1990s with the
pursuit of open skies policies, liberalization of international aviation regulations, between
the U.S. and Europe (Chung and Szenberg, 1996).
Unforeseen Outcomes: Alliances and the Hub-and-Spoke Model
What economists and policymakers pushing for deregulation did not predict was
the rise of loyalty programs. First started in 1980 by American Airlines with others
following suit, these programs offer mileage points to individual customers in exchange
for ticket purchases as well as catering to travel agents who steer clients their way and to
corporations in the form of quantity-based discounts (Borenstein and Rose, 2007). Also,
deregulation proponents did not foresee the rise of airline alliances, both domestic and
international. In terms of domestic alliances, many major airlines in the 1980s like Delta
looked to joining forces with smaller, regional airlines such as Atlantic Southeast Airlines
(ASA) that could provide access to smaller cities that would be otherwise unprofitable for
the major carrier. This kind of alliance enabled the major and commuter carriers to
coordinate their schedules and code-share, which presented the product as a single airline
ticket. This was used as an alternative to mergers, especially when antitrust laws became
more stringent after a slew of acquisitions under the first decade of deregulation
(Borenstein and Rose, 2007). In addition to code-sharing between domestic airlines,
international code-sharing partnerships were also made between U.S. carriers and foreign
ones. Essentially, the practice and end result are the same as domestic code-sharing with
the only difference being it provided access to international destinations where an airline
Airline Deregulation 13
could not serve due to regulatory constraints on entry into an international market
(Borenstein and Rose, 2007).
Perhaps the most unanticipated outcome in response to deregulation was the
complete transformation of airline networks from a point-to-point system to a hub-and-
spoke system. Under regulation by the CAB, most airline route networks operated under
the point-to-point model, in which flights flew from one city to another directly. That
was one of the few changes that occurred rather quickly with deregulation in 1978 when
most carriers under CAB authority switched to a hub-and-spoke system where flights
between two smaller cities had to go through the larger hub airport if the hub was not the
destination. The reason for this change in operations by the airlines is that the hub-and-
spoke paradigm provides advantages in terms of cost, demand, and competition. The
way it provides these advantages is that hubs provide travelers more flight options and
facilitate more convenient service on routes where demand is not high enough to support
non-stop flights at relatively low prices (Borenstein and Rose, 2007). Hub airports also
enable the hub airline to offer frequent service while maintaining high load factors due to
hubs having dense operations. Because hub operations at an airport are so dense, very
few airports have the economic and logistic capacity to service more than one airline.
This results in another advantage for the hub airline by yielding considerable market
power at the hub airport (Borenstein and Rose, 2007). Coupled with majority market
power and flight frequencies, the airlines are able to exude a demand advantage on routes
out of the hub compared to its competitors. As a result, the hub-and-spoke configuration
grants the hub airline the ability to effectively influence consumer preferences by
garnering a certain degree of brand loyalty (Borenstein and Rose, 2007).
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Other Sweeping Changes
Another change that came about since deregulation of the airlines has been the
change in quality of the service provided by airlines. Certain aspects of service such as
flight options and frequency have changed in very specific ways. With the reorganization
of airline networks to the hub-and-spoke model, it led to a reduction in non-stop flights
between two smaller cities since the new model required the flight to stop at the hub
airport. Simultaneously, this also led to an increase in the number of connecting flights
for passengers, however the change was relatively small. According to Borenstein and
Rose, the share of passengers having to change planes was slightly 30% in 1979, and
increased to just over 30% in 2005. Instead, the data pointed to a more significant change
happening at the same time: distance travelled by passengers was increasing. Borenstein
and Rose found that the average trip distance had increased from 873 miles in 1979 to
1,058 miles in 2005; so “more people were flying longer distance trips on which
changing planes is more common.” While connecting flights increased rather modestly,
interline flights, connecting flights between airlines, declined drastically and then steadily
increased. In 1979, interline flights were at 45% and fell to 8% by the early-1990s
(Borenstein and Rose, 2007). This is attributed to the fact that connecting flights within
an airline was associated with improved connections and better baggage handling service.
The increase began in the mid-1990s with the further spreading of code-sharing. As a
result, interline flights were reported at approximately 42% in 2005, back to levels seen
just after deregulation (Borenstein and Rose, 2007). While the hub-and-spoke system is
the prevailing model of many airlines, the number of non-stop flights increased
dramatically to almost 70% by the late 1990s. This trend corresponds with the increased
Airline Deregulation 15
use of regional jets (RJ’s) by regional airlines like ASA (Borenstein and Rose, 2007).
RJ’s are aircraft with less than 100 seats and were used to replace many turboprop
aircraft that the regional airlines initially used. Lastly, load factors also changed
significantly from deregulation’s inception onward. Borenstein and Rose document that
load factors were below 50% prior to deregulation and rose over 20% in the 1980s. Load
factors rose above 70% in the 1990s hitting 77% in 2005 and remaining over 80% in the
first half of 2007 (Borenstein and Rose, 2007). Indeed, deregulation marked a significant
change in the airline industry, and it generated positive outcomes, especially for
consumers and new entrants. However, the outcomes of deregulation have been rather
mixed on other fronts such as labor, other aspects of customer service, traffic flow, and
financial performance.
Counter Arguments
While the benefits of airline deregulation have been widely noted, so too have the
negative effects. It is clear that deregulation has significantly helped in the development
of the air transportation system. Growth is most visible in terms of traffic and operating
capacity, which are measured as Available Seat Miles (ASM’s) and Revenue Passenger
Miles (RPM’s), respectively. Between 1954 and 1978, RPM’s averaged at 5.8 million
per year, and between 1978 and 2002, RPM’s averages more than doubled to 11.7 million
(Jiang and Hansman, 2006). With this rapid period of growth following deregulation,
there was the assumption among proponents that this would translate into a more
profitable industry, but the data strongly suggests otherwise. While revenues and costs
for the major, regional, and cargo airlines have grown with the rise in traffic, industry
profits have fluctuated around zero. Between 2001 and 2003, the airlines cumulatively
Airline Deregulation 16
lost over 23 billion dollars, outpacing the total earnings of the past. (Jiang and Hansman,
2006). In addition to the severe financial losses incurred by the airlines, many of those
same airlines were forced to file for bankruptcy protection. Between 2001 and 2006,
United Airlines, US Airways, ATA Airlines, Northwest Airlines, and Delta Air Lines all
filed for Chapter 11 Bankruptcy (Jiang and Hansman). Most recently, American
Airlines’ holding company, AMR Corporation, filed for bankruptcy protection after
nearly avoiding bankruptcy in the early to mid-2000s. While the airlines suffered from
poor financial results in the 2000s, they have collectively lost approximately 60 billion
dollars in the thirty years after deregulation. These losses have been exclusively in the
domestic market. Broken down, the airlines lost approximately 10 billion dollars
between 1979 and 1989, which was then followed by 5 billion dollars in profits in the
1990s, but the airlines once again suffered losses at an astounding 54 billion dollars
between 2000 and 2009 (Borenstein, 2011). Since deregulation, specifically since the
2000s, the major carriers’ most profitable routes were coming from international
operations, as most international routes remain heavily regulated unlike domestic routes.
Generally, international routes are more lucrative to the airlines that are allowed to serve
them (Borenstein, 2011). Many industry leaders attribute the significant losses of the
airline industry to several factors.
Negative Effects: Service and Job Cuts
One factor that has had an effect on many airlines is exogenous demand shocks.
Perhaps the most well known factor that has negatively impacted the airline industry
financially is 9/11. After the terrorist attacks on September 11, 2001, air travel demand
fell sharply by approximately 20% (Borenstein, 2011). As a result of this rapid decline in
Airline Deregulation 17
demand for air travel, the airlines cut capacity, or scaled back operations significantly, in
order to cut costs. In addition to capacity cuts, the airlines also reduced the size of their
fleets, which contributed to a higher load factor that rose to approximately 81%, up 10
percentage points from 2000 (Borenstein, 2011). In order to spur demand in light of the
recent attacks, the airlines also cut their fares significantly, which contributed to the
airlines’ dismal financial performance, as cost would continue to outpace revenue. Even
by 2008, air travel demand remained 3% lower than it was in 2000, and in 2009 demand
fell by another 11%, suggesting that the airlines continue to suffer from a lag in demand
(Borenstein, 2011).
While external demand shocks have taken a toll on many airlines, industry
observers and participants have pointed to the rise of low-cost carriers (LCC’s) as part of
the reason for low profits. Since LCC’s are smaller and compete almost exclusively on
price, they forego many amenities and services the major carriers provide enabling them
to offer flights at lower fares, which puts pressure on the high cost major carriers to lower
prices However, there is little agreement on what the connection is between low profits
and the LCC’s (Borenstein, 2011). Some labor and industry leaders claim that LCC’s
have made excessive capacity investments during growth periods and even during some
downturns leading to depressed prices overall (Borenstein, 2011). However, the evidence
does not seem to support the notion that LCC’s have a tendency to overinvest. In terms if
fleet size, LCC fleets are generally much smaller than the legacy carriers, but fleet size
adjustments in the last thirty years have been more significant for the legacy carriers
suggesting that the major carriers have overinvested relative to their traffic growth and
Airline Deregulation 18
that investment decisions have not been the primary factor for industry capacity changes
(Borenstein, 2011).
In addition to pointing to overinvestment by LCC’s as a factor for poor financial
performance, an alternative explanation is that low-cost carriers have been chipping away
at the entrenched positions of the legacy carriers. It should be emphasized, however, that
the process has been slow because the legacy carriers are protected by network marketing
programs and the major carriers’ ability to control availability of gates and landing slots,
which raise barriers to entry by more efficient airlines (Borenstein, 2011).
Nevertheless, LCC’s have been growing steadily since deregulation. Despite a
loss in market share in the mid to late 1980s as a result of larger airlines acquiring many
LCC’s, the market share of low-cost carriers had increased from under 5% in 1979 to
over 60% market share thirty years later (Borenstein, 2011). Also, LCC’s have much
lower operating costs compared to the major airlines. On average, the major airlines have
maintained 30% to 60% higher operating costs per available seat-mile relative to the low-
cost carriers (Borenstein, 2011). While the cost differential is large, the average price
disparity has been shrinking. This attributable to the major carriers significantly lowering
their fares in the 2000s, and the LCC’s fares declined rather slightly, reflecting in part the
lower burden excess aircraft capacity and a large part of the reason why the LCC’s
incurred smaller financial losses in the 2000s (Borenstein, 2011).
While the growth of low-cost carriers has been deemed a factor on persistent
industry losses, taxation and high fuel prices have also been blamed for the airlines’ poor
financial record. Many industry leaders argue that current taxes and fees on tickets are
excessive, and the tax currently stands at 7.5% and fees up to $6.20 per flight flown.
Airline Deregulation 19
Additionally, many airports impose passenger facilities charges (PFC’s) of up to $4.50 on
each passenger boarding a flight at an airport (Borenstein, 2011). Indeed, fees have been
added and taxes have risen over time. In the 1980s, the entire ticket tax was a percentage
of the ticket value, and that was all that existed in terms of taxation and there were no
fees (Borenstein, 2011). However, PFC’s were introduced in the 1990s along with the
segment taxes, and in early 2002, the security fee was added in response to the 9/11
terrorist attacks (Borenstein, 2011). The tax rates have increased significantly since
deregulation, but the value of the taxes themselves has not changed as much. A large
increase in the tax percentage is not a result of tax increases, but rather reductions in base
fares, mainly after 9/11, which resulted in an increase on the tax burden as a percentage
of the base fare (Borenstein, 2011). Although many industry leaders point to taxes as
inhibiting financial performance, the data suggests that taxes have not had a significant
impact on the airlines financially, but rather the problem is that fares have fallen and
continue to stay low (Borenstein, 2011).
More Cost Cutting
Another factor that has contributed to airline losses during some years has been
the cost of fuel. Borenstein notes that oil prices were the highest in the first seven years
of deregulation as well as the last five years of deregulation. However, for the better part
of deregulation, oil prices have been relatively stable. From 1986 to 2004, the average jet
fuel price expressed in dollars per gallon was $1.40, and even with these rather low and
stable fuel prices the airlines still lost 31 billion dollars (in 2009 dollars) during 13 of the
19 years (Borenstein, 2011). While dramatic fluctuations in the price of fuel has
contributed to industry losses in the short term, there does not seem to be a barrier to
Airline Deregulation 20
capacity adjustment over three to six months in response to changes in oil prices. The
surge in oil prices in late 2008 make that clear as the airlines cut back their schedules and
work force to counter rising fuel costs. However, it should be noted that simply reducing
flight schedules does not mitigate or eliminate costs if those costs are fixed. Rather, air
carriers can adjust to unanticipated costs, such as fuel, by growing more slowly in times
of growing demand so as to avoid larger fluctuations in scheduling, fleet size, and in the
work force. On the other hand, making changes in the areas are more costly and difficult
in times of stagnant or declining demand (Borenstein, 2011). While external cost shocks
such as rapid fluctuations in oil prices and demand shocks such as 9/11 have had
significant effects on the industry’s financial performance, it nevertheless remains
unlikely that losses are due entirely to exogenous circumstances relative to management
and investor expectations and decisions given the last thirty years of deregulation.
While financially the airlines have suffered billions of dollars in losses despite
traffic growth, labor has also seen losses of its own and in some cases translating into
poorer customer service. Over the course of the first decade under deregulation, airline
workers saw a 10% decline in earnings in industry specific jobs such as pilots, flight
attendants, and aircraft mechanics s well as more general jobs such as mid-level
management and supervisory positions (Card, 1996). The decline in earnings from this
period is a result of few factors that had a rather immediate effect on labor. Soon after
deregulation was passed, many weaker airlines successfully negotiated wage cuts for
their unionized workers, and new entrants into the market began hiring non-union
workers in an industry that had been traditionally unionized (Card, 1996). In addition,
some airlines resorted to bankruptcy protection in order to force wage cuts and other
Airline Deregulation 21
concessions on their employees. One notable example in the 1980s was when local
service carrier Texas International bought Continental Airlines, and then filed for Chapter
11 bankruptcy in order to abrogate Continental’s union contracts with its employees
(Card, 1996). Moreover, several other air carriers including United, US Airways, Delta,
Northwest, and American have filed for Chapter 11 bankruptcy at least once, and it has
been hailed in the business press as a way to gain more bargaining power in negotiations
with the unions on wage concessions (Gittell et al., 2004). Ultimately, the continued
downward pressure on wages and alleged anti-union efforts have led relations between
labor and management at most airlines to become embittered and plagued with mistrust.
In some cases, management’s persistent attempts to cut wages and the workforce have
had a negative impact on customer service rather than a return to financial solvency.
Unlike the other legacy carriers, Delta Air Lines remains mostly non-union with
the exception of its pilots and dispatchers and was able to do so through the union-
substitution approach (Gittell et al., 2004). In this approach, Delta committed itself to
providing high wages, lifetime employment, and a “family” culture, and this approach
helped Delta maintain a reputation as a high quality carrier and ranked high in customer
service (Gittell et al., 2004). However, in 1994 amid its first significant financial losses,
Delta laid off approximately 15,000 employees and unilaterally cut wages. Subsequently,
Delta’s position as a high-ranking, quality carrier deteriorated and passenger complaints
rose from below the industry average to above the industry average (Gittell et al., 2004).
While Delta is one specific example of cutting costs, a trend among many airlines has
been the aggressive pursuit of cutting costs, and even after 9/11 the focus has continued
on cutting costs with the major carriers laying off 15-20% of their workforce immediately
Airline Deregulation 22
after the attacks (Gittell et al., 2004). As a result of a focus on cost-cutting initiatives,
there has been little focus on improving labor-management relationships. However,
notable exceptions in include Alaska Airlines and Southwest, who avoided layoffs in the
aftermath of 9/11 and have focused their efforts on engaging the unions in trying to build
a better labor-management relationship through shared governance rather than through an
adversarial relationship or union suppression (Gittell et al., 2004). While Southwest and
Alaska are smaller airlines and were able to avoid the massive layoffs the legacy carriers
could not, they nonetheless paid more attention to building labor-management relations
than the legacy carriers and have managed to avoid capacity cuts, make profits, and have
modest growth (Gittell et al., 2004). While costs are indeed a significant component of
the airline business and cutting costs proves necessary at times, the data ultimately
suggests that reduction in wages and union power will at best only bring short-term relief
from financial pressures, and that conflict and workplace culture are better determinants
of performance. Essentially, sustained improvement financially as well as in customer
service will require sustained focus on the quality of labor-management relations (Gittell
et al., 2004).
While labor has incurred losses, safety is another factor that has become a cause
for concern following deregulation. Many new entrants in to the marketplace followed
the passing of the Airline Deregulation Act in 1978, which translated into more air traffic
making the skies more congested. More congested skies have also translated into more
delays, and that trend is expected to go up if funding for better air traffic control
technologies is threatened. Although advancements such as Doppler equipment and
traffic monitoring systems like Mode C transponders and traffic collision avoidance
Airline Deregulation 23
systems (TCAS) have been developed, the FAA, which has a duel, conflicting role of
overseeing infrastructure development as well as safety, is running years behind air
traffic growth posing a great safety risk on the future (Savage, 1996). These conflicting
roles are attributable not only to a lack of infrastructure development to the National
Airspace System (NAS), but also to lack of safety oversight of carriers. With financial
instability and new carriers entering the market following deregulation, many carriers
have skimped over safety expenditures in maintenance and pilot training, which has
arguably contributed to some notable accidents. The 1996 in-flight fire and subsequent
crash of ValuJet Flight 592 in the Florida Everglades raised serious concerns over safety
when it was found that there were maintenance irregularities and in-flight problems with
the airline. Although ValuJet would eventually cease operations soon after, the FAA was
also faulted for a lack of oversight given the airline’s already poor safety record, and the
agency has been at times accused of regulatory capture (Savage, 1996). The crash of
regional airline Colgan Air Flight 3407 in 2009 once again brought attention to a lack of
oversight and poor personnel practices when it was found that the flight crew suffered
from fatigue and furthermore had a lack of experience despite certification. Even with
these concerns, air travel remains one of the safest modes of travel, but a failure to
enforce safety standards and commit funding to upgrade aviation infrastructure to meet
growing air travel demand could compromise that in the future.
Conclusion
Before 1978, regulators attempted to ensure a stable, yet growing airline industry
to benefit consumers and the economy, but it resulted in high fares, inefficient operations,
and volatility in earnings. The goal of the Airline Deregulation Act was to lower
Airline Deregulation 24
passenger fares as well as to lower the barriers to entry for new airlines in the hopes that
it would lead to a more profitable industry. Deregulation succeeded in lowering fares for
passengers, which amounted to nearly 6 billion dollars in consumer savings and overall
lower fares adjusted for inflation. Since 1978, a slew of airlines commenced operations
and gained a share in the market. Deregulation also helped to facilitate the introduction
of new technologies and innovations such as computerized reservation systems, the
selling of fares via the Internet, yield management, and frequent flyer programs.
Although deregulation undoubtedly has produced benefits to the traveling public, it has
come at a cost to the airlines financially, to labor, and necessary infrastructure
advancements have been slow to develop. Since deregulation, the airlines have lost a
combined 60 billion dollars despite increased growth in traffic, and the airlines continue
to lose billions of dollars from delays and airport congestion from a lack of upgrades to
the air transportation system. Many airlines have filed bankruptcy, failed, or merged with
other carriers, and airline workers have suffered layoffs and declining earnings in part
due to the financial instability as well as to overinvestment that led to cutbacks in
operations. Ultimately, these are issues that must be addressed and taken seriously if the
airlines want to return to profitability in this manner. If the airlines are intent on
returning to consistent profitability, they must narrow the gap between their costs or raise
the price premium they maintain, and they must pay more attention to improving the
quality of their labor-management relationships as that is tied more to productivity and
quality service more than simple, aggressive cost-cutting measures. While it is necessary
for the airlines themselves to manage their way back to financial stability, it is equally
important that funding for infrastructure improvements not be hampered, and that the
Airline Deregulation 25
FAA properly enforces safety standards to ensure public safety and trust. Ultimately, the
problems of deregulation are ones that must be tackled by several different actors in order
to ensure the sustainability of the airline industry.
Airline Deregulation 26
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