...Archive for April 2017

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”