Quick thoughts about airline economics

  • If you’ve not already read this piece by Matt Stoller challenging the conventional wisdom that airline deregulation in the 1970s has been a great success, you should. See also this 2012 piece by Phillip Longman and Lina Khan, and this 2015 piece by Longman. Thanks to Matt Ygesias and Marshall Steinbaum for pointers.

  • You should also read Yglesias’ not-so-much-challenging-the-conventional-wisdom piece on why air travel sucks so much these days. Pieces like this have a long pedigree. Here is Megan McArdle in 2015, for example.

  • Conversations about airline regulation are often framed in terms of neoliberalism and its discontents. That’s dumb. On purely neoliberal terms, airlines were never a good candidate for “the magic of competition” to do its work. Neoliberals should support some form of regulation of air travel for precisely the same reason they support the limited, regulated monopolies provided by patent and copyright protection. Just like inventing stuff or writing novels, air travel is a high fixed cost, low marginal cost business. The prediction of the Economics 101 reasoning that animates neoliberal thinking is that, if competition is let to do its work, price will fall to marginal cost, and all the airlines will go out of business. And that’s right. That basically was the result of airline deregulation. It was, of course, nice for consumers during the period when competition drove price towards marginal cost. But that was a classic Stein’s Law moment, and it is silly to imagine it can be indefinitely repeated. Airline investors may be dumb, but even they eventually learn. Plus, the subsidy provided to airline consumers by loss-making airlines was not provided only by foolish investors. Ex post, airline creditors, employees, retirees contributed to the subsidy by having their debts, pensions, and benefits written down. Taxpayers contributed to the subsidy by bailing out the airlines. If we mean to keep air travel cheap via some form of socialized subsidy, we can do a better job of designing it.

  • Unsurprisingly, absent state protection from forms of price competition incompatible with their continued operation, the airlines tried and eventually succeeded to gain some protection via consolidation and monopolization of scarce slotting at airports. So, instead of state-managed pricing power, we have industry-managed pricing power. (This is one of Stoller’s main points.) By its nature, a sustainable air travel business is going to be regulated by something other than straightforward price competition. The question isn’t whether the industry will be regulated, but how and by whom, whether the state or a tacit cartel is more likely to do a better job.

  • None of this is to hold up the 1970s Civil Aviation Board as a model of virtue. I don’t know the history or the industry well enough to make claims about the details of that regulatory regime. I suspect it had flaws. But so long as the issue is framed as a debate about “deregulation”, we will make no progress. Whether we craft it legislatively or let it evolve from strategic behavior within the industry, some regime will emerge that prevents competition from driving price to marginal cost.

  • One aspect of the ancien régime that I think we do want to resuscitate is frequent and inexpensive service to smaller and mid-tier markets. Yglesias writes, in a tweetstorm, which I have edited into text:

    [Phil Longman and Lina Khan] note that deregulation robbed many smaller cities of the covert subsidies that were funneled there way by the Civil Aeronautics Board. This was a downside of deregulation and the goal is to conclude that deregulation is bad, one concludes that the loss of subsidy was bad. But separate from the question of deregulation, it’s worth actually asking the question of whether or not this is a worthy policy goal. If subsidized airfare generates large community benefits, presumably communities themselves could provide the subsidy. And if the overall policy objective is to ensure that poor places receive economic resources, you could do that by giving them money. So that the people of St. Louis or Cleveland or wherever could decide if subsidizing airline service is what their community best needs. But it seems to me that air travel is associated with lots of negative pollution externalities and we should tax it, not subsidize it.

    I think that this view is mistaken. If there is one reason why “neoliberalism” most deserves the pejorative connotation it has taken, I’d argue it is the tendency to look through the forest ecosystem of human communities and see only a bunch of individual trees. Yglesias makes this error here with a twist, he looks through the national community to metropolitan communities, and treats these as independent actors whose choices or wealth are all that matter. The case for supporting a rich transportation infrastructure to and from St. Louis or Cleveland isn’t (just) that we wish those communities well like some distant acquaintance. It is because we wish to build and support a vibrant and cohesive nation. The fate of American places is not a private concern of other people. Their struggles are our struggles. Their catastrophes are a cancer on our body politic. It is desperately urgent, the most urgent problem we face in my view, to mend some of the many ways that we find ourselves fraying as a nation. Yglesias appreciates this in other contexts. For example, he has proposed spreading the Federal government around, which would among other things help blur and heal the divide between “Washington” (an idea more than a place) and the increasing fraction of the country which feels alienated from it. There is a burgeoning industry among pundits for proposals like this, break up the liberal city, spread out the universities, pay a UBI, etc. And that is unironically great. Hopefully we will do some of these things.

    But the case for transportation infrastructure, meaning not just the physical facilities, but the institutions required to ensure rapid, convenient movement between places, is doubly strong. Like those other ideas, building transportation infrastructure provides and encourages economic development within far-flung communities, reducing the geographic disparities that now threaten the viability of the United States as an integrated polity. But transportation infrastructure also very directly binds distant parts of the polity together, and reduces the likelihood that dangerous disparity will develop or endure. If Cincinnati has abundant and cheap air transportation capacity that will remain whether it is fully utilized or not, firms in New York and DC and San Francisco will start thinking about how they can take advantage of the lower costs of those regions in a context of virtual geographic proximity. When decisions about transportation capacity are left to private markets, a winner-take-all dynamic takes hold that is understandable and reasonable from a business perspective, but is contrary to the national interest. Private entrepreneurs cannot overcome this. Even if an airline were to “adopt” an underserved city, providing transportation at a loss in hopes that a business renaissance later justifies it, firms will be discouraged from moving in by the ever present risk that the service will disappear or the terms will worsen. Only a commitment at a policy level to abundant and inexpensive transportation can eliminate this risk.

    It’s a cliché that the government builds “bridges to nowhere” that the private sector never would build. That’s true. And it’s a credit to the public sector. Bridges to nowhere are what turn nowheres into somewheres. We need many, many more bridges to nowhere.

  • Finally, I want to express my annoyance at a trope in punditry about air travel that is as common as it is mistaken. Here is Kevin Drum:

    So flying sucks because we, the customers, have made it clear that we don’t care. We love to gripe, but we just flatly aren’t willing to pay more for a better experience. Certain individuals (i.e., the 10 percent of the population over six feet tall) are willing to pay for legroom. Some are willing to pay more for extra baggage. Some are willing to pay more for a window seat. But most of us aren’t. If the ticket price on We Care Airlines is $10 more, we click the link for Suck It Up Airlines. We did the same thing before the web too. As usual, the fault lies not in the stars, but in ourselves.

    Here is Megan McArdle, in a piece titled (by somebody) “Hate Flying? It’s Your Fault”:

    Ultimately, the reason airlines cram us into tiny seats and upcharge for everything is that we’re out there on Expedia and Kayak, shopping on exactly one dimension: the price of the flight. To win business, airlines have to deliver the absolute lowest fare. And the way to do that is . . . to cram us into tiny seats and upcharge for everything. If American consumers were willing to pay more for a better experience, they’d deliver it. We’re not, and they don’t.

    There are two things wrong with this line that air travel is awful because consumers’ true revealed preference is that it should be awful and cheap. First, there is the fact that air travel managed by the main domestic carriers in the United States is uniquely awful, and there is no evidence that US travelers are any more price conscious than consumers in other countries. No frills, discount air travel is popular in Europe as well, and it is sometimes awful, but it is on the whole much cheaper than “discount” air travel within the US. Mainstream carriers almost everywhere else in the developed world are notably less awful than the big American carriers, and often just as cheap.

    Second, this line of reasoning reflects a very basic misinterpretation of economics. Aggregate outcomes are not in general or even usually interpretable as an aggregation of individual preferences. When we learn about the Prisoners’ Dilemma, we don’t interpret the fact that both players rat as evidence that, really, they both just wanted to go to jail for a long time. After all, that is their revealed preference, right? No. We understand that the arrangement that would obtain if they could cooperatively regulate one another’s behavior is in fact the outcome that they would prefer. As isolated individuals, they simply have no capacity to express this preference.

    The same may well be true of air travel. As individuals, we face some degree of choice between price and quality when we purchase plane tickets, and maybe it’s true that under present circumstances, most of us don’t reveal a preference for paying much for quality. [1] But as individuals we face a very different trade-off than we do collectively, in aggregate. In particular, as individuals the amenity value of a flight is highly uncertain, whether we mean to pay up for quality or not. No matter how much we pay for extra leg room, we may end up next to the screaming kid. Our “media center” may be malfuctioning even while our neighbors watch an endless series of bad action films, and ultimately there is nothing we can do but nag the flight attendant about it. The wifi may be decent, or it may be crap, however much we pay for it.

    On an individual level, it is perfectly rational to discount a highly uncertain return in amenity value relative to what one would pay for a reliably enjoyable flight. [2] But because customers choose what to pay as individuals, airlines’ incentive to invest in quality reflects the tiny uncertainty-discounted value of amenities, not the value that travelers would place on those amenities if they were far more reliably provided. Reflecting this, airlines don’t invest much in quality, so quality differential between US airlines tends to be small relative to the uncertainty surrounding the experience. And so customers shop based almost exclusively on price, because they rationally discount small, extremely uncertain quality differentials to near zero. But that creates incentives for airlines to compete by continually downgrading quality to optimize on price. When you or I buy a plane ticket, we are not expressing a preference between the standards of service that obtained in 1976 and the price that would be required to support that vs the indignities and somewhat lower prices of today. With each budget airline ticket purchase, we are expressing a preference only over a very tiny and uncertain quality differential. It is quite possible (I would say quite probable) that the behavior in aggregate that results from those individual choices reflects quite the opposite of our true preferences. If that is the case, as in the Prisoners’ Dilemma, the solution to the problem would be to cooperate to regulate the circumstance in which our isolated, individual choices yield bad outcomes.

    Competitive races to places you don’t want to go are in fact a very common phenomenon. Most of us don’t, for example, claim that if workers who compete for jobs find they must accept unsafe workplaces, that merely reflects individuals’ preferences about trade-offs between pay and safety. We understand that there is a competitive dynamic that can leave workers with little choice but to accept crappy jobs, and employers with little choice but to scrimp on safety (however personally virtuous an individual business owner may mean to be). The solution to this problem isn’t to talk about how we are all terrible people and we bring this on ourselves. Instead, we invent OSHA, which is a means by which business owners coordinate to ensure that behaving decently is consistent with business survival in the context of continuing competitive dynamics.


[1] That is contestable, given how much the airlines now make in fees for things one might describe as disaggregated dimensions of quality — extra leg room, priority boarding, food, any baggage at all.

[2] It makes sense that people who purchase “diversified portfolios of air travel amenities” — very frequent fliers — would more rather than less likely to pay up for amenities than infrequent travelers, despite the multiplication of costs. And I think that is the case. Am I right?

Update History:

  • 14-Apr-2017, 10:50 a.m. PDT: “…makes this error here with a twist, he looks through the natural national community to metropolitan…”
  • 16-Apr-2017, 10:35 p.m. PDT: “…days. Piece Pieces like this have a long pedigree. Here…”; “building transportation infrastructure provides and encourage encourages economic development”
 
 

18 Responses to “Quick thoughts about airline economics”

  1. Market Fiscalist writes:

    ‘air travel is a high fixed cost, low marginal cost business. The prediction of the Economics 101 reasoning that animates neoliberal thinking is that, if competition is let to do its work, price will fall to marginal cost, and all the airlines will go out of business.’

    I do not think that econ 101 says this. In the long run fixed costs are also variable costs and the long-run equilibrium will be at the output where Price = MC = AC, and airlines will have a sustainable business.

  2. Steve Roth writes:

    Great as usual. Generalizing from your last couple of paragraphs:

    “the solution to the problem would be to cooperate to regulate the circumstance in which our isolated, individual choices yield bad outcomes.”

    When we “vote with our wallets,” we’re not voting on which set of choices we’d like to have available. That vote is not available to us in “the market.” We’re simply choosing within the available choice set.

    Available choices set are determined at a higher level and via different institutions. We’ve collectively chosen to provide a very particular and arguably deeply inferior set of choices to airline customers.

  3. Detroit Dan writes:

    With regard to Market Fiscalist’s reply #1, I’m leaning towards Waldman’s economic law. Without getting into the theory, it seems to be borne out in practice. Thus, in Railroading Economics, by Michael Perelman, we see the history of the railroad industry in the U.S.

    Perelman thinks that in pursuing competition, prices were forced so low that many railroads were forced into bankruptcy, much as is happening in airlines today. This opens the door for the “financial capitalists” who make money reducing competition (via mergers) and reorganizing bankrupt companies, getting rich in the process and hurting workers of the involved companies. The Enron/WorldCom problems of the early twenty-first century are not that different from those created by J.P. Morgan organized mergers of a century earlier, best symbolized by the formation of U.S. Steel.

    In Perelman’s eyes, the instability arising from the lack of realization of the importance of fixed costs, the machinations of financial interests, and so forth, have caused internal contradictions in capitalism.

  4. bruce wilder writes:

    “high fixed cost, low marginal cost” does not quite narrow the economics to the case, as this is generally true of a vast number of industries. Airlines are one example of a scheduled common carrier transportation with economies of scale in the vehicle. “Common carrier” is the part that introduces the public policy regime, and, of course, as you say, that relates to the public interest in a transportation system.

    The airlines are producing (presumably round-trip or networked) plane-movements and doing so according to a fixed schedule and then selling (one-way) passenger-trips. The unit of production and unit of sale are quite different. And, as is typical of transportation, there are economies of scale in the vehicle: a bigger plane is always cheaper per seat-trip. It is counter to common intuitions, but economies of scale imply that the cheapest plane to use on any route with any given number of passengers is always one which has some empty seats. It sounds crazy, but it is true: the airline is always on the downslope of the long-run cost curve: there is no long-run equilibrium available.

    The bottom line is that the airline has to find some strategic capacity to price discriminate, in order to efficiently cover its fixed costs while while still offering at least some seats at near the marginal cost, in order to fly an efficient (low-cost) choice of plane. This was one of the key problems that led railroads in the 1880s to accept the Interstate Commerce Commission and the scheme of ad valorem rates that institution enabled.

  5. Brett writes:

    The Europe example is rather interesting. If your view is that airlines are inherently prone to oligopoly (either state-managed or privately-managed), then what is Europe doing right in terms of discount airlines that the US is doing wrong? It sounds like they have a very competitive air market as well, a mixture of discount airlines and legacy former national carriers.

    In any case, going back to something like the previous Regulation Era regime would be very difficult politically. To cover the costs of unprofitable links in the network, you’d need to either directly subsidize airlines, run a public airline directly, or drastically raise ticket prices so that the more profitable routes could cover the unprofitable ones. Imagine trying to sell the jacking-up of ticket prices in Congress, the creation of a public airline that would immediate be castigated as “Amtrak for Planes”, or a heavy subsidy to airlines that nobody likes.

  6. Steve Roth writes:

    Wondering: what would be the $-denominated “economic profit,” compared to the current system, of a system of densely networked interconnections, including direct flights among smaller cities (vs big-city-centered hub and spoke).

    Bloody hard to calculate, I’m thinking. But clearly, the current system can’t/won’t offer us that option.

  7. traducteur writes:

    I think I’ll just go on taking the train.

  8. Dilan Esper writes:

    Well, they have Ryanair in Europe, and it’s cheap, no frills (on the level of Spirit Airlines here), and extremely popular.

    And speaking of Spirit, how is that airline so profitable if the Kevin Drum/Megan McArdle narrative about air travel is wrong? Everyone knows how bad the service on Spirit is, and yet they get lots of business anyway.

    Look, it isn’t as though better service isn’t available. You just have to pay for it. On United, you can buy a higher fare basis (which will protect you from bumping), an economy plus seat or first or business class, an onboard meal and snack, and wi-fi, and you can pay to wait in a nice well appointed lounge at most major airports. I fly United all the time and get good service. And if the majority of United’s customers paid for this stuff, they would probably go ahead and build it into the ticket price. But they don’t.

  9. Hubert Horan writes:

    Sorry but what you’ve written here is largely misleading and partially garbage and isn’t based on actual airline economics. The articles you’ve cited are even worse. Stoller makes some valid points but has no understanding of history, the Longman pieces are total garbage. Yglesias is in between. A quick statement of qualifications: I was in the industry for over 30 years, I was involved in many of the post deregulation mergers, helped invent the international airline alliance, and was involved in many of the recent airline bankruptcy cases. I not only agree that competition is a serious issue, but I was the only industry insider actively opposed to the Bush-Obama era consolidation; I testified against all of the recent international antitrust immunity grants and testified before Congress against both the Northwest-Delta and United-Continental mergers.
    The garbage here is taking the leap from 1970s deregulation to what the cops did on that Republic Airways flight last week, while totally ignoring industry economics in order to make some broad point about “neoliberalism.” Stoller understands that “neoliberalism” is problematic but his airline evidence is inappropriate to that issue and largely wrong. Yglesias wants to defend “neoliberalism” and errs in the opposite direction. He presents industry data that don’t support his points because they conflate domestic and international markets.
    The arguments here are analogous to pointing out that in the 1960s banks had to get regulatory permission in order to give away toasters to people opening accounts at new branches. It is garbage to claim that eliminating regulations about toaster giveaways led directly to the systemic risk that crashed the world economy. It is garbage to claim that the current state of the industry is because the industry is too efficient and too attentive to consumer preferences. It is absolute complete garbage to claim consumers would be better off if airlines had been required to maintain the St. Louis and Cleveland hubs at their (unprofitable) 1990 operating level.
    Cannot do full justice to the broader story, but a couple key points. 1960’s CAB regulatory practices forbade new market entry and froze industry competition at the level in place in the 1930s. The Kennedy/Breyer/Kahn “deregulation” efforts focused on three objectives (1) eliminating the hard barrier to new market entry (2) shifting day-to-day tactical marketing decisions from CAB staff to the airlines (3) maintaining and strengthening all other forms of deregulation including consumer protection, labor rights, antitrust and safety. Yes fares had fallen in CAB days, but despite regulation, not because of it. Airlines benefitted from massive technology changes (jet engines) and the massive growth of the US economy. The increased post deregulation competition made prices fall even faster, as airlines were forced to find more and more sources of innovation (much larger hubs, advanced revenue management systems, frequent flyer programs, much smarter fleet planning) that would have been actively discouraged by CAB practices that would have blocked new innovations unless everyone else in the industry could review the plans in advance, and demand special protections from lost business. Airline profits in the mid 90s were much higher than they had ever been, prices were much lower, service had been vastly expanded, and there was still vibrant competition.
    Where did things go wrong? As you many have noticed in other sectors, “deregulation” was transformed from “don’t let regulatory staff and competitor lawyers have veto power over tactical market decisions” to “eliminate all rules protecting competition, consumers, workers and safety.” The idea that Eastern and Braniff didn’t need to exist forever just because they existed in 1965 became “mergers always improve efficiency” Claims about competition that might be justified in the US domestic market (where there are almost no entry barriers) were copy/pasted to international markets where entry bariers were huge. All of the competitive problems you see today resulted from the totally artificial consolidation of transatlantic markets, which has over 20 competitor in the late 90s but was systematically reduced to a permanent 3-player oligopoly by back room deals between United, Delta, American and the DOT, and everything was based on totally fraudulent regulatory claims. For the long story of industry consolidation see a piece I wrote seven years ago (1). In every case, consolidation was structured to eliminate a more efficient carrier (Northwest, Continental, USAirways) in order to protect a less efficient carrier (Delta, United, American).
    So Stoller is right that we ended up with a uncompetitive system serving powerful incumbents, but he’s totally wrong to blame this on Kennedy, Breyer, Kahn and decisions taken in the 1970s. Yglesias is right that deregulation initially created significant, but he’s clueless about what drove subsequent changes. Longman is simply clueless. You are wrong to look at the airline industry as “infrastructure” similar to a local water system. Airlines are network businesses and basic efficiency demands that they be structured certain ways and are incredibly sensitive to the balance between supply/demand. Market demand limits the number of hubs that can work. Prices can’t fall without steady productivity improvements; replace competition with permanent oligopoly and you lose the incentive to innovate, and gains don’t get passed on to consumers.

  10. Chris Mealy writes:

    Aggregate outcomes are not in general or even usually interpretable as an aggregation of individual preferences

    Economics students should have to write that 400 times or however many times it takes for them to remember it (I wish somebody had made me do that).

  11. Hubert Horan writes:

    Sorry, footnote to the article about how airlineindustry competition was eliminated accidently omitted from previous comment

    (1) Double Marginalization and the Counter-Revolution Against Liberal Airline Competition, 37 Transportation Law Journal 251-291 (2010) downloadable from SSRN at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1743685

  12. Kaleberg writes:

    This is an excellent analysis of the situation. You make two good points. One is that transportation is about networks that lie at the heart of civilization, so it makes sense to build interstate highways even out in the middle of nowhere. The other is that airline passengers, unlike airlines, cannot operate collectively except through government regulation which has become unfashionable.

    I was recently reading an article on the US merchant marine in the 1930s. The government paid huge subsidies in the form of overpriced mail contracts guaranteeing regular deliveries of mail. That often meant that ships would depart barely loaded. However, it was vital for exports since manufacturers would schedule their operations around a ship departing on a particular schedule. The days of the tramp steamer were long over. An industrial civilization needed a transportation network, not a bunch of haulers. (Of course, that subsidized merchant marine paid off big time in the 1940s.)

    Every civilization has subsidized transportation. The Roman government paid for roads, justifying the cost as the cost of moving legions, but they opened trade networks. Henry VI regulated the post chaise market in England setting prices and standards. Governments have subsidized ocean shipping, river boats, cart traffic, canals, railroads and highways. They are what make a civilization work. Just about every mode in that list and the airlines have gone broke regularly. We may groan about the archaic taxi regulations, but they were imposed so that cab drivers could make a living. You’d think that the market could do better, but it’s not as if Uber or Lyft is making a profit.

  13. ChrisA writes:

    And yet, the number of passengers continued to climb every year;http://data.worldbank.org/indicator/IS.AIR.PSGR?locations=US
    Doesn’t look to me like a system which is not providing it’s customers with what they want. Of course if you hate the idea of the lower classes enjoying the same kind of benefits that only very rich people enjoyed a few decades ago, then this is bad news. But for middle class and working class people deregulation was an unmitigated boon opening up new horizons and enabling families to re-unite on a regular basis. My mom can now see her grandchildren several times a year for instance, when her sole income is social security. How incredible is that!
    In addition, if you want the frills of yesteryear, its all still available, at a price probably lower than the regular economy fares of the past.

  14. Mercury writes:

    “There are two things wrong with this line that air travel is awful because consumers’ true revealed preference is that it should be awful and cheap….”
    —————————————————————————

    No, awful and cheap really is preferred over great and expensive, at least by a critical mass of customers. Yes, most of us prefer to have the convertible AND the blonde without any of the inherent trade-offs or downsides but once reality is actually confronted on reality’s terms, most of us end up driving Honda Civics with good gas mileage.

    I suspect that many European airlines are more heavily subsidized than US airlines and I know that they have been complaining about competition from the VERY heavily subsidized Middle-Eastern and Asian airlines (the ones with the hot stewardesses and electric everything).

    I believe various “business class only” type airlines have launched and flopped in the US over the years – and problems stemming from their smaller scale models are probably at least as big an issue than lack of consistent demand. So, it’s not like no one has thought of this before.

    Finally, yes the US airline oligopoly situation is starting to bite customers in the ass but it’s being made worse by post-9/11 security related issues (which now includes everything). Because we have all apparently accepted that every single person on the planet is equally likely to hijack an airplane, we are willing enough to all be treated like animals (yes, that is a revealed preference too). The airlines and new government agencies that surround their infrastructure act accordingly and flying now sucks that much more than it otherwise would. Notice how United has still not been charged with anything stemming from their recent passenger ejection incident.

  15. Good job writes:

    Good post, keep

  16. Nick Bradley writes:

    I want to point out that this notion of a choice between cheap/awful and great/expensive is patently absurd. If you apply the Standard Industry Fare Level (SIFL) regulated fare structure to today’s cost inputs, its actually more expensive than it would be under regulation. And if you adjust for the much higher average load — its 85% now vs 55% in the early 1980s — it would be much cheaper!

    Are we really to believe that in the absence of deregulation, computer networks would not have invented, oil would still cost $120 a barrel (inflation adjusted), travel agents would still book 90% of flights, and blue collar labor prices wouldn’t have collapsed?

  17. Hubert Horan writes:

    Have now had the time to lay out explanations of the errors in the original post a little more carefully.
    1. “On purely neoliberal terms, airlines were never a good candidate for “the magic of competition” to do its work… air travel is a high fixed cost, low marginal cost business.” On a pure factual basis, this is completely wrong. Airline cost structures are 80-90% variable, depending on the time frame you use to define “fixed” costs. I’ve designed route profitability systems for multiple airlines; your claim was pulled out of thin air. Other industries have cost structures that make classic market competition difficult or impossible—for example urban transport systems and passenger railroads. To assert “competition can’t work” you need to lay out the structural problems supporting that claim. You can’t do that. Since commercial aviation has functioned reasonably well on a purely private sector basis for decades why should anyone take an unsubstantiated claim of extreme market failure seriously?
    2. “if competition is let to do its work, price will fall to marginal cost, and all the airlines will go out of business.” Again, fundamentally wrong. This is the classic misuse of simplistic Econ 101—no real world businesses equate price and marginal cost in the textbook sense, and no real world business defines MC in the extremely short term sense you’ve used it here. Peter Thiel makes the same BS argument to attack competition and justify his pursuit of rent-seeking market power (competition can’t work because all investor returns get competed away as price falls to short-run MC). Airlines have always understood the difference between very short run pricing decisions (“hey the plane is leaving in 30 minutes, so we are better off accepting any fare that covers the cost of the added fuel burn due to the added passenger) and the medium term pricing needed to cover true variable costs (“but if we sell any tickets at short-run MC cost level, we’ll never be able to sell any at prices that cover the actual cost of crew, aircraft, airport, systems, capital, etc).
    3. “[all the airlines will go out of business.] That basically was the result of airline deregulation”. Again totally false. Absolutely true that numerous individual airlines at various points in time made stupid investment and pricing decisions, but absolutely false that they were “caused” by deregulation, or that normal competitive forces couldn’t sort out the mess. Classic example was the dot com era. In the early 90s airlines were earning record profits, productivity was up, prices had fallen, and supply and demand were roughly in balance. This was 15-20 years after deregulation. When the late 90s boom hit, certain airlines (Continental primarily, also United and Delta) went hog wild buying new airplanes, even though the artificial/cyclical demand boom couldn’t possibly be sustained over the 25 year life of the new aircraft. Despite the biggest economic boom in history, airline yields fell. The new added new capacity had very high marginal costs; the fares to fill the added seats were at very low marginal yields. Industry profits collapsed, even for the carriers (Northwest, American, Southwest, USAir) who hadn’t added uneconomic capacity. Of course the industry blamed the profit collapse entirely on Osama bin Laden, even though the yield collapse and the economic downturn clearly predated 9/11.
    4. “absent state protection from forms of price competition incompatible with their continued operation, the airlines tried and eventually succeeded to gain some protection via consolidation and monopolization of scarce slotting at airports. So, instead of state-managed pricing power, we have industry-managed pricing power. (This is one of Stoller’s main points.).” Second part here is actually (at least directionally) correct. The industry responded to (what they called) the post 9/11 profit collapse by working aggressively to consolidate the industry. Started in earnest with the KLM-Air France merger in 2004, which led to the carve up of the highly profitable North Atlantic which led to all the recent mergers (the full history is in the law journal article I referenced at comment 11). But your central point (and Stoller’s main point) that this should be blamed on the Airline Deregulation Act of 1976 and the “market competition could never work with airlines” assertion is complete garbage. Liberal competition was working fine through the mid 90s. Badly run airlines (Eastern, Braniff, Pan Am) had gone away, better run airlines had grown rapidly. Productivity was growing, and benefits were being passed to consumers in terms of lower fares and increased service. Not perfectly, but competition was fundamentally working the way it is supposed to. After 2004, the airlines that had screwed up the worse to shift the cost of their failures to workers and pensioners (via abusive chapter 11 cram downs—I worked on 4 of the major airline bankruptcy cases) and consumers (prices on the highly profitable North Atlantic shot up rapidly as a market with 20+ competitors became a permanent 3 play oligopoly). The problems you see today are because the liberal competition created by 1970s deregulation was systematically destroyed after 2004. Your historical facts are off by 25-30 years.
    5. “Plus, the subsidy provided to airline consumers by loss-making airlines was not provided only by foolish investors. Ex post, airline creditors, employees, retirees contributed to the subsidy by having their debts, pensions, and benefits written down. Taxpayers contributed to the subsidy by bailing out the airlines. If we mean to keep air travel cheap via some form of socialized subsidy, we can do a better job of designing it.” Yes, as noted above workers, pensioners and consumers paid so that the managers at United, Continental and Delta would not only not have to suffer the discipline of market competition, but could become fabulously wealthy by exploiting the chapter 11 process (United CEO Glenn Tilton personally made over $40 million). The Congressional 9/11 airline bailout money was actually pretty trivial. The real socialized subsidies came from the banks, whose airline frequent flyer credit cards were so phenomenally profitable that they subsidized these carriers through the chapter 11 process (and protected the incumbent mangers) in order to protect their rent-extraction franchises. United Airlines spent 4 years in bankruptcy, with no legitimate hope of reorganization (management’s plan assumed fuel would never go above $65/bbl and there would be no economic downturn in ten years) but was subsidized by JPMorgan Chase. Again your (and Stoller’s) attempt to explain everything as the result of “deregulation” is absurd.
    6. “None of this is to hold up the 1970s Civil Aviation Board as a model of virtue. I don’t know the history or the industry well enough to make claims about the details of that regulatory regime. I suspect it had flaws. But so long as the issue is framed as a debate about “deregulation”, we will make no progress.” Agree that simplistically framing this as a debate about deregulation is stupid, but that’s what you’ve done, and the Stoller piece you’ve relied on does it even more explicitly. I do know this history in great detail, and could document the problems with CAB regulations at length, and document how many of the post-deregulation productivity gains came from changes the CAB had fought tooth and nail. The real problem is your (and Stoller’s) false conflation of 1970s airline “deregulation” with the type of Koch brothers Gilded Age ultra-laissez faire concept of “deregulation”. Night and day differences. This was explained in my initial comment. Getting CAB staff out of the business of micro-managing short-term tactical pricing and scheduling decisions is not the same thing as eliminating all antitrust protections for competition, or DOT oversight over safety and consumer rights. In the first decade of this century the former morphed into the latter. Blaming everything on “deregulation” is wrong on the history, wrong on the economics and wrong on the politics.
    7. “One aspect of the ancien régime that I think we do want to resuscitate is frequent and inexpensive service to smaller and mid-tier markets.” Secondary point, but you are totally wrong here, and the Longman piece is profoundly ignorant. First, the Essential Cities Subsidy program was the one major cross-subsidy explicitly protected and preserved after deregulation. It still exists. Second, the actual costs of serving small markets is substantially higher than cities that can support lots of mainline jet flights. That’s why Southwest (historically the most efficient domestic airline) never served any of these markets. Most people hate hubs, but their main purpose was to allow much more service to smaller markets, and when CAB rules that sharply limited hub growth went away, service to these markets grew enormously. Longman’s attempt to blame the decline of service at Cleveland and St.Louis on deregulation is pure bullshit. Hubs did not develop at Cleveland or St.Louis until after deregulation (I worked on the original plan to merge TWA and Ozark and create a true hub in St. Louis decades ago). But the market can only support so many hubs, and megahubs (ATL, DFW) have enormous efficiency advantages over smaller ones. Perhaps the hubs in Cleveland and St. Louis would have survived longer if pre-2004 levels of industry competition had been preserved, but perhaps not.

  18. Longtooth writes:

    There’s no doubt that public demand for common carrier air transportation services exists. The only issue then is to what degree a common carrier is regulated. As such, then private enterprises will always compete to provide a common carrier service if there is a profit to be had under what-ever regulations exist. There is an absolute conflict of interest between private enterprise and regulations and thus a conflict of interest in common carrier’s interests as private enterprises profit making capability and the public’s interest in regulating common carriers.

    This was true in the 17th and 18th centuries with shipping, 19th century with railroads, and 20th century with air transport and communications. Nothing has really changed at all.

    What seems to be the issue is that air-transport capital costs are high, and in-as-much as capital has to return an roi, then air transport capital competes with other capital enterprises for roi, which thus requires air transport roi levels to maintain competitive capital availability. However, very little capital is subject to common carrier regulations. Those regulations, no matter what they are, reduce the capacity of common carriers to return the same level of capital roi as enterprises which are not regulated to the same degree.

    It is therefore in the interests of capital owners invested in common carrier private enterprises to be as free of regulation as possible while it is in the public’s interest to have as much regulation as the public desires for the availability of the service, its convenience, safety, security, and price.

    Next comes profitability or better stated capital roi. Profit increases with scale… volume of business clients so common carriers in competition seek to maximize their volume by increasing the number of routes their transport service provides from locations which have maximum air transport demand. This enables them to offer more competitive prices and thus increase or maintain volumes and thus profits hence roi on capital.

    If unregulated or if regulation is minimal, then the services will be provided in proportion to population size locations… that is, more services to and from metro regions and less to regions with lower population (or demand for services to / from a region with lower population sizes. Any additional service locations will be at lower profits or losses, thus reducing capital roi below the levels necessary to sustain capital investment in air transport.

    I’m not sure at all if this is possible (serving low population transport demand locations)while maintaining capital roi sufficient to compete for it to sustain air transport… that depends on capital roi competition for capital, which varies over the short term (5 years), but has a relatively narrow average rate over the long term (>15 years) The only way to serve low population demand locations profitably is to increase prices at those locations or to offer lower cost service.. both frequency of service and smaller lower capital cost transport (also referred to as “feeder” transport).

    The alternative is to consolidate competitors to increase volumes per remaining compeitors, thus reduce costs and increase or maintain profits, hence roi.

    If the public’s demand for air transport is a function of prices relative to alternatives to reach the same destination by other means, albeit at longer elapsed times, then in essence the airlines compete on time to destination plus price. Reducing time to destination is primarily a function of technology (at a given price level). I just reviewed a film my father took of our first transatlantic flight (1961 or ’62) from Frankfurt to Newfoundland, to NYC by 4 engine prop airliner (TWA) and our first trans national flight from NYC to Chicago to SFO on a new jet airliner (also TWA). There’s very little real difference in the interiors or customer convenience… except for so much less leg room, seat widths, & isle widths of course now than then (and in-flight movies, audio, etc). The alternative crossing the Atlantic was by ship (7 – 8 days) and cross country by train (2.5 – 3 days). the other difference: Lines are far longer at airports now; boarding was by walking on the tarmac to the mobile stair unit then; friends could greet you on arrival on the tarmac at the bottom of the mobile stair case; and oh, I almost forgot, the flight attendants were all gorgeous, young females (I was a teen-ager who noticed such things), who brought you your meals, and drinks … no carts down the middle of the isles to block going to the bathroom, and smoking of course was allowed in all seats (one thing at least that’s changed now for the better, though I’m a smoker).

    Of course on a relative price basis (income levels to prices for air travel) the prices now are within reach of most people if not all, while then they were not even close.. air travel in the early 1960’s was for the upper income 10%, and predominantly the upper 5%. Only some of the price reduction is due to deregulation.. but most is due to the relatively much lower prices of airliners now than then… competition, technology advances (fuel efficiencies, materials development, etc)a, and increasing volumes and consolidations by aircraft manufacturers… despite unions I might add. In short, long term capital costs dropped which reduced prices and increased demand.

    So regulation isn’t the problem… as long as capital roi investment in air travel common carriers remains competitive over the long term, airlines will compete for traffic and in doing so will seek to obtain that traffic from existing population demand center — metro area’s. The. Feeders from lower traffic demand locations will always be priced higher (or there will be more passenger’s per flight per aircraft size (e.g less room per passenger) simply because capital roi has to be maintained.

    Regulation (or deregulation) isn’t the problem…. airlines capital owners desire to increase their returns on capital is the issue. The more consolidations the less competitive forces can drive the price down or maintain them even… so we see baggage charges now, pay for meals, slightly more legroom seats, etc. etc. as price adders without including those costs in the “flight price”….. so a $400 flight price turns into a $450+ real price by the time you check baggage and exit the flight at your destination. .. and for that you sit cramped and uncomfortable for the duration to boot.

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