Aviation policy: past and present.

• Author: Bailey, Elizabeth E.
• Position: Association Lecture

1. Introduction

   Airline deregulation has been a symbol of the trend toward less expansive government over the past quarter century. The move from economic regulation to deregulation has delivered on its efficiency promises. Although there are only a handful of large carriers remaining after the consolidations of the 1980s and 1990s, there have been enormous benefits to consumers in terms of lower prices and more convenient schedules. However, airline competition remains imperfect, particularly at hub airports. The nature of these imperfections is explained better by models of oligopolistic behavior than by the contestability theory.

   Paradoxically for this industry, 19 men and four airplanes brought the drive to shrink government to an abrupt end on September 11, 2001. The resulting tragedy has dramatized the public-good aspects of protection from terrorist attack and the need for information sharing by law enforcement authorities. Emergency legislation sought to provide financial stabilization for the airline industry in the short run. Subsequent legislation addresses the need for stronger aviation security in the long run.

   This paper begins with a look at past policy. It describes the nature of aviation regulation and the causes and beneficial consequences of economic deregulation. It then evaluates the nature and extent of competition in the deregulated marketplace. Finally, it examines continued areas of governmental intervention in aviation, including new security and bailout policies.

2. The Regulatory Era: 1938-1978

   The Civil Aeronautics Board (CAB) was formed in 1938. Most infrastructure industries (transportation, communications, energy, financial services) had major regulatory initiatives during this period. There was a downturn of faith in a laissez-faire economy emanating from the Great Depression (Vietor 1990).

   The Civil Aeronautics Act of 1938 created a five-member independent regulatory agency and gave it authority to (i) control entry into the industry (both interstate and foreign commerce) and control entry of existing carriers into new or existing routes; (ii) control exit by requiring approval before cessation of service to a point or on a route; (iii) regulate fares on the basis of rate-making provisions adopted from the Interstate Commerce Act (which regulated railroads); and (iv) approve mergers, grant antitrust immunity to international rate-making agreements, and engage in other antitrust functions. The original act gave the CAB authority over safety issues as well. Congress separated safety regulation from economic regulation in the Federal Aviation Act of 1958 (Bailey, Graham, and Kaplan 1985).

   The CAB designed route authority to ensure that an integrated service network would develop. Route rights were granted to trunk carriers on long-haul parallel routes and to local service carriers within geographic regions. For example, United Airlines was granted the east-west route through Chicago, and TWA was granted the east-west route through St. Louis. Originally, planes flying coast-to-coast had to stop at these interior cities because of the limitations of airplane technology. Competition was not direct, but instead occurred over parallel routes (New York to San Francisco via Chicago or St. Louis). In this way, air travel was similar to rail transport. However, the introduction of jet aircraft in the late 1950s and early 1960s enabled overflights of cities (nonstop service). Competition then became direct.

   The local service carriers were granted service in largely nonoverlapping regions, for example, North Central around Minneapolis, Allegheny around Pittsburgh, and Ozark around St. Louis. Because these carriers were intended to serve as gatherers of traffic from small communities, the CAB severely restricted their ability to compete against the long-haul trunk carriers. Throughout the regulatory period, the focus of the CAB was on strengthening existing carriers, not authorizing new carriers. If a carrier was nearing bankruptcy, it would be merged into a financially healthy carrier (Transportation Research Board 1991).

   Because of the monopoly, or near monopoly, conferred by CAB route authority, it was necessary to regulate rates so that consumers were protected from prices that were too high. Prior to World War II, airfares were conventionally set at the prevailing first-class rail fare. Gradually, a more formal review process set fares on an industry-wide basis. Fare competition was not precluded by statute, but the CAB's procedures and policies strongly discouraged it. Discount fares were permitted for charter carriers, which were also called "irregular," or unscheduled, carriers. There were no low-fare scheduled carriers. Proposals to change fares substantially were the subject of hearings. Thus, fares could not be changed quickly. There were also provisions to subsidize jet service to small communities (Meyer and Oster 1982).

   This type of price and entry regulation contrasts sharply with market competition, in which the status quo is regularly overthrown and in which there is no legal recourse to entry and price changes as long as no antitrust laws are violated. Regulation entailed delays of two to four years for most route entry and industry-wide fare cases.

3. The Deregulatory Era: 1978-Present

   By the early 1970s, evidence had begun to accumulate from a number of infrastructure industries that regulation was having unintended consequences, such as harm to efficiency and innovation. Government was viewed as being captured by the industries they were supposed to control and was believed to have become heavy-handed, doing more harm than good. In aviation, three carriers (Eastern, TWA, and Pan American) were near bankruptcy in the early 1970s. Political forces began to marshal, and these forces reached full flower in the aviation hearings held by Senator Edward Kennedy in 1975. Steven Breyer, now a Supreme Court Justice, provided Kennedy staff support for these hearings (Breyer 1982).

   There was a lot of drama generated by the way the hearings were staged: Each day produced a dramatic point; for example, on one day, East Coast Boston fares were shown to be twice as high as West Coast San Francisco fares for routes of similar distances and densities. On another day, it was made clear that no new carrier entry had been permitted into the industry in 40 years. The hearings were fact-based. Evidence was...