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May 1,1989 • References ___ Bailey, Elizabeth E., Graham, David R., and Kaplan, Daniel P., Deregulating the Air. . lines, Cambridge,I MA: Th e MIT Press, 1985. Bauer, Paul w., '''Don't Panic': A Primer on Airline Deregulation." Economic Review, Federal Reserve Bank of Cleveland, IVQ:86. _. __ , "Competition, Concentration, and Fares in the U.S. Airline Industry," Economic Commentary, Federal Reserve Bank of Cleveland, September 15, 1987. ___ , and Zlatoper, Thomas 1., Deter- minants of Direct Air Fares to Cleveland: How Competitive"," Economic Review, Federal Reserve Bank of Cleveland, IQ:89. Baumol, William J., Panzar, John c., and Willig, Robert D., Contestable Markets and , and Huston, John H., "Deregula- • eCONOMIC COMMeNTORY Footnotes tion and Mergers: How Have They Affected 1. For a short description of the airline in- Airline Service to Small Communities?," dustry under CAB regulation and the early paper presented at the Southern Economic Association Meetings, San Antonio, Texas, years of deregulation see Bauer (1986). November 1988. 2. See Douglas and Miller (1974). 3. See Kahn (1988). Call, Gregory D. and Keeler, Theodore E., "Airline Deregulation, Federal Reserve Bank of Cleveland Fares, and Market Behavior: Some Empirical Evidence," in Andrew F. Daughety, ed., Analytical Studies in Transport Economics, New York: 4. See Butler and Huston (1988). S. See Call and Keeler (1985), Bailey Airline Deregulation: Boon or Bust? Graham, and Kaplan (1985), and Butler and Huston (1987) for some of the tests for con- Cambridge University Press, 1985. testability. See in particular Butler and Hus- Congressional contestability. ton (1987) for a test of imperfect Budget Office, "Policies for the Deregulated Airline Industry," July 1988. Douglas, George W. and Miller, James c., Economic Regulation of Domestic Air Transport: Theory and Policy, Washington, D.C., Brookings Institution, 1974. the Theory of Industry Structure, New York: Regulation, Borenstein, Severin, "Hubs and High Fares: by Paul W. Bauer 8. See Rose (1988). T Kahn, Alfred E., "I Would Do It Again," Harcourt Brace Jovanovich, Inc., 1982. 6. See Bauer (1987). 7. See Meyer and Oster (1987) p. 15. 1988,2. Meyer, John R. and Oster, Jr., Clinton Y., Paul W. Bauer is an economist at the Federal Airport Dominance and Market Power in Deregulation and the Future of Intercity Reserve Bank of Cleveland. The author the U.S. Airline Industry," Institute of Passenger Travel, MIT Press, 1987. would like to thank Randall W. Ebertsfor his helpful comments. Public Policy Studies Discussion Paper No. 278, University of Michigan, March 1988. Morrison, Steven, and Winston, Clifford, "Empirical Implications and Tests of the Butler, Richard Y., and Huston, John H., Contestability "Actual Competition, Law and Economics, April 1987,30,53-66. Potential Competi- tion, and the Impact of Airline Mergers on Fares," paper presented at the Western Economic Association Meetings, Vancouver, British Columbia, July, 1987. Federal Reserve Bank of Cleveland Research Department PO. Box 6387 Hypothesis," Rose, Nancy L., "Profitability The Journal of and Product he Airline Deregulation Act of 1978 took the operational decisions of running an airline (what routes to fly and what fares to charge) away from government regulators and returned them to the airlines. 1 The views stated herein are those of the author and not necessarily those of the Over the last decade, the airlines have used this new freedom to institute a number of fundamental changes in the structure of the industry. Since 1978, Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Quality: Economic Determinants of Airline Safety Performance," MIT, Sloan Working discount fares have been more widely used and the variety of restrictions on these fares has increased, frequent flier plans have proliferated, carriers have come and gone, and hub-and-spoke operations have emerged. Paper #2032-88, June 1988. This Economic Commentary examines the benefits and problems that have BULK RATE U.S. Postage Paid Cleveland, OH Permit No. 385 resulted from the deregulation of the airline industry and makes some recommendations for changes in public policy to preserve the benefits and to mitigate the problems. Cleveland, OH 44101 Address Correction Requested: Please send corrected mailing label to The Federal Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, Ohio 44101 • Benefits of Deregulation Deregulation increased both the degree and scope of competition in the airline industry. From 1938 to 1978, the Civil Aeronautics Board (CAB) essentially controlled the routes airlines could fly and the fares they could charge. Airlines could only compete with one Material may be reprinted provided that the source is credited. Please send copies of reprinted materials to the editor. another by offering higher quality service than their rivals. Since the CABalso charged with promoting the industry-would raise fares to cover higher ISSN 0428-1276 operating costs to ensure the financial health of the industry, there was little incentive for the airlines to work to hold costs down. The result was higher fares and higher quality of service than the average traveler preferred. 2 In a deregulated market, airlines have had to adopt productivity-enhancing techniques, such as the hub-and-spoke route networks, to stay competitive. As a result, labor productivity has increased greatly. Since deregulation, the number of workers in the industry has increased only 48 percent, while the number of passengers flown has increased 86 percent and the number of miles flown has increased 109 percent. The gains in operating efficiency brought about by competition were largely passed on to travelers in the form of lower fares and more frequent flights. Although fares have risen some in the past year, average revenue per passenger declined 30 percent in real terms between 1976 and 1987.3 Some of the price reduction came at the expense of more restrictions on tickets (not fully refundable, for example, requiring advance purchase, or requiring a stay over a Saturday night). About 90 percent of passengers now fly on discounted tickets at an average discount of 60 percent off the "regular" coach fare according to the Air Transport Association. - Deregulation of the airline industry has produced wide-ranging changes that have created benefits and some problems for the public. The promotion of safety, high-quality performance, and beneficial competition within the industry should be a goal of public policy. These policy goals, however, must be based on a sound understanding of the market forces behind the post-deregulation changes in the airline industry. The hub-and-spoke route systems now the route.5 In recent research looking In part, the higher fare for flights into fie controllers continue to use vacuum- commercial flying is still a much safer In the meantime, scarce airport re- used by the airlines have resulted in more frequent flights. Most destinations can now be reached with, at most, a one-stop flight; densely traveled at the determinants of direct fares to Cleveland, Bauer and Ziatoper (1989) found that for each additional carrier serving a route, fares were lower, but by less and less as the number of car- and out of the hub reflects the higher quality of service offered to these passengers (more nonstop flights and more frequent flights), but it also reflects the market power of the hub airline, which is further entrenched by its computer reservation system, its frequent-flier plan, and its target commission rates- tube technology. mode of travel than the private auto or private plane.7 Yet there is no reason to be complacent given the current strains on the air traffic control system. Cur- sources would be more efficiently utilized if they were priced correctly. If takeoff and landing fees varied by time of day, then price-sensitive passengers rently there are fewer FAA inspectors than there were eight years ago, while there are many more planes in commercial service. would fly off-peak, thus reducing the peak demands on the system and freeing up resources for users who value them more highly. This would reduce congestion and increase the margin of safety in the system. routes still receive nonstop service. Morrison and Winston (1987) studied the effect of hub-and-spoke networks and found the total benefits to passengers were on the order of $5.7 billion dollars a year in 1985. While the majority of travelers have benefited from deregulation, gains riers in a market increases. Fares decline as additional carriers are added to the route, but only until about four carriers are serving the route. The increase in the national market shares of the largest airlines, resulting from the merger wave of the mid- all of which serve to deter entry by other carriers. The trade-off between fares and quality of service benefits business travelers, who tend to be timesensitive and price-insensitive, much more than tourist travelers, who tend to be price-sensitive and time-insensitive. have not been distributed evenly. While very few cities have lost air service, some did lose service by major carriers. These cities may be better off with more frequent commuter airline service than they were under relatively infrequent major carrier service.4 1980s and the operating agreements of the major carriers with local service airlines, has worried some analysts. Both of these developments have trade-offs between higher operating efficiency and quality of service on one hand and potential anti-competitive effects on the other. Since fares are determined by dividual route level, concentration has actually fallen slightly since deregulation. A recent Congressional Budget Office study found that the number of car- The benefits of lower fares are also not individual route and airport factors, it is not clear how concerned policymakers should be by the increase in concentration at the national level. riers per route has actually increased for most types of routes. Currently, an average of 2.5 carriers serve the typical route. Easing the entry of additional evenly distributed among classes of passengers. Fares tend to be higher on routes served by fewer carriers. In addition, business travelers often cannot meet the requirement for discount fares. Passengers who could afford to fly before the discount fares of deregulation must endure more closely packed seats, a higher percentage of seats being filled, and the general in- A second source of concern is the increase in concentration at airports with only one carrier offering hub service, creating what are known as "fortress crease in c.ongestion at the airport. All in all though, there is little doubt that hubs." Market shares at such airports tend to overstate the market power that the hub airline has since most of the passengers of the hub airline are only passengers are on average better off. making connections at the airport." • However, these hub airlines usually have sufficient market power so that they can price discriminate between passengers traveling to or from the airport and passengers only making connections at the airport. Borenstein (1988) and Butler and Huston (1987) Industry Competitiveness Unfortunately, competition does not work as well at "regulating" the airline industry as some proponents of deregulation had predicted. Some felt the airline industry was an example of a perfectly contestable market. Fares would be set just high enough to cover costs because, if they were set any higher, other carriers would enter the market and undercut the incumbent carrier. Every study that has examined this issue has failed to find evidence that the airline industry is perfectly contestable. However, there is evidence that the industry is imperfectly contestable: the number of carriers that could quickly enter a route does limit how high incumbent firms can raise their fares on find that the fare from a rim city to a hub city, plus the fare from that hub city to another rim city, is usually much higher than the connecting farethrough the same hub city-for the flight between the two rim cities. The reason is that there are usually other hub cities where passengers could make connections to go between the two rim cities, but passengers flying to the hub city will most likely have to fly on the airline that has a hub there. It must be remembered that at the in- At some point, the air traffic control system will have to be modernized and expanded, but until then, existing facilities could be utilized much more efficiently by using prices to allocate scarce gate space and takeoff and landing slots. If takeoff and landing fees varied by time of day, with higher fees during the peak times, airlines would have an incentive to use these facilities more uniformly throughout the day. High fees at the most congested airports might induce some airlines to shift some flights to less congested airports, particularly those flights involving a high percentage of connecting passengers. • Service Quality Under deregulation, airlines can compete with fares in addition to quality of service. This has resulted in meal service and other amenities being cut back, since most passengers have carriers onto routes should continue to be a policy objective, since the industry is not perfectly competitive. revealed a preference for lower fares even at the expense of lower quality. • Congestion Requiring airlines to publish their ontime performance records provides pas- The congestion of the air traffic control system should be viewed as evidence of the success of deregulation. Put another way, if fares were set higher, fewer travelers would fly and there would be less congestion. This would hardly be a welfare-enhancing public policy either from the standpoint of equity or economic efficiency. The congestion stems primarily from the air traffic control system failing to expand rapidly enough and from the inefficient way scarce gate space and takeoff and landing slots are allocated. Little has been done over the last eight years to expand the air traffic control system despite the large growth in its use. This has occurred despite the $3.5 billion surplus in the Airport and Airway Trust Fund-a fund financed by users' fees that can only be spent on maintaining and improving the air traffic control system. Two decades into the age of semiconductors, the air traf- sengers with better information with which to plan their trips. On balance, it was a positive development; however, it has led the airlines to change their be- Proponents of deregulation never intended for the government to slacken its efforts in regulating the safety of the industry. In fact, government regulation of safety is more important in a deregulated environment than it was in a regulated environment, since the financial condition of an airline may influence its safety choices (such as spending on maintenance and pilot training).8 Under deregulation, the FAA should be even more vigilant. expanding the benefits brought about by airline deregulation, but government regulation of the routes airlines can fly and the fares they can charge is not good policy. Government enforcement of existing safety, antitrust, and consumer protection laws is beneficial. Government investment in improving • the air traffic system (airports and air traffic control) is essential. Conclusion Effective public policy must be based on a sound understanding of the forces driving the changes in the airl ine industry after deregulation. The benefits of airline deregulation have been substantial, but they have not been uniformly distributed among passengers and between cities. Care must be taken to preserve the benefits to travelers. Informed enforcement of the antitrust havior in ways that are not necessarily optimal. First, since the on-time arrival laws should be sufficient to preserve competition at the route level. So far, rate refers to the plane, not to the passengers, airlines may not wait as long for connecting passengers on delayed incoming flights as they used to in order to preserve their "on-time" performance. Another problem is that the on- even with the wave of mergers in the mid 1980s, there are still more carriers per route on average than in 1983 and certainly more than there were under CAB regulation. Steps to make acquisition of gate space and takeoff and land- time arrival rate masks the true extent of the congestion problem. One way airlines increased their on-time arrival rate was by adding time to their flight schedules into congested airports. These scheduled congestion delays result in millions of lost man-hours in the course of a year. ing slots easier would also help reduce the market power an airline has at its hubs. The safety dimension of service quality is a more serious issue. To date, there have been fewer accidents per passenger mile flown than was the case under regulation. By most measures, In short, there is a useful role for government to play in preserving and Though safety will always be a concern, there have been fewer accidents per passenger-mile since deregulation. With rigorous enforcement of the existing FAA safety regulations and with a modernization of the air traffic control system, there is every reason to expect this trend to continue. The hub-and-spoke route systems now the route.5 In recent research looking In part, the higher fare for flights into fie controllers continue to use vacuum- commercial flying is still a much safer In the meantime, scarce airport re- used by the airlines have resulted in more frequent flights. Most destinations can now be reached with, at most, a one-stop flight; densely traveled at the determinants of direct fares to Cleveland, Bauer and Ziatoper (1989) found that for each additional carrier serving a route, fares were lower, but by less and less as the number of car- and out of the hub reflects the higher quality of service offered to these passengers (more nonstop flights and more frequent flights), but it also reflects the market power of the hub airline, which is further entrenched by its computer reservation system, its frequent-flier plan, and its target commission rates- tube technology. mode of travel than the private auto or private plane.7 Yet there is no reason to be complacent given the current strains on the air traffic control system. Cur- sources would be more efficiently utilized if they were priced correctly. If takeoff and landing fees varied by time of day, then price-sensitive passengers rently there are fewer FAA inspectors than there were eight years ago, while there are many more planes in commercial service. would fly off-peak, thus reducing the peak demands on the system and freeing up resources for users who value them more highly. This would reduce congestion and increase the margin of safety in the system. routes still receive nonstop service. Morrison and Winston (1987) studied the effect of hub-and-spoke networks and found the total benefits to passengers were on the order of $5.7 billion dollars a year in 1985. While the majority of travelers have benefited from deregulation, gains riers in a market increases. Fares decline as additional carriers are added to the route, but only until about four carriers are serving the route. The increase in the national market shares of the largest airlines, resulting from the merger wave of the mid- all of which serve to deter entry by other carriers. The trade-off between fares and quality of service benefits business travelers, who tend to be timesensitive and price-insensitive, much more than tourist travelers, who tend to be price-sensitive and time-insensitive. have not been distributed evenly. While very few cities have lost air service, some did lose service by major carriers. These cities may be better off with more frequent commuter airline service than they were under relatively infrequent major carrier service.4 1980s and the operating agreements of the major carriers with local service airlines, has worried some analysts. Both of these developments have trade-offs between higher operating efficiency and quality of service on one hand and potential anti-competitive effects on the other. Since fares are determined by dividual route level, concentration has actually fallen slightly since deregulation. A recent Congressional Budget Office study found that the number of car- The benefits of lower fares are also not individual route and airport factors, it is not clear how concerned policymakers should be by the increase in concentration at the national level. riers per route has actually increased for most types of routes. Currently, an average of 2.5 carriers serve the typical route. Easing the entry of additional evenly distributed among classes of passengers. Fares tend to be higher on routes served by fewer carriers. In addition, business travelers often cannot meet the requirement for discount fares. Passengers who could afford to fly before the discount fares of deregulation must endure more closely packed seats, a higher percentage of seats being filled, and the general in- A second source of concern is the increase in concentration at airports with only one carrier offering hub service, creating what are known as "fortress crease in c.ongestion at the airport. All in all though, there is little doubt that hubs." Market shares at such airports tend to overstate the market power that the hub airline has since most of the passengers of the hub airline are only passengers are on average better off. making connections at the airport." • However, these hub airlines usually have sufficient market power so that they can price discriminate between passengers traveling to or from the airport and passengers only making connections at the airport. Borenstein (1988) and Butler and Huston (1987) Industry Competitiveness Unfortunately, competition does not work as well at "regulating" the airline industry as some proponents of deregulation had predicted. Some felt the airline industry was an example of a perfectly contestable market. Fares would be set just high enough to cover costs because, if they were set any higher, other carriers would enter the market and undercut the incumbent carrier. Every study that has examined this issue has failed to find evidence that the airline industry is perfectly contestable. However, there is evidence that the industry is imperfectly contestable: the number of carriers that could quickly enter a route does limit how high incumbent firms can raise their fares on find that the fare from a rim city to a hub city, plus the fare from that hub city to another rim city, is usually much higher than the connecting farethrough the same hub city-for the flight between the two rim cities. The reason is that there are usually other hub cities where passengers could make connections to go between the two rim cities, but passengers flying to the hub city will most likely have to fly on the airline that has a hub there. It must be remembered that at the in- At some point, the air traffic control system will have to be modernized and expanded, but until then, existing facilities could be utilized much more efficiently by using prices to allocate scarce gate space and takeoff and landing slots. If takeoff and landing fees varied by time of day, with higher fees during the peak times, airlines would have an incentive to use these facilities more uniformly throughout the day. High fees at the most congested airports might induce some airlines to shift some flights to less congested airports, particularly those flights involving a high percentage of connecting passengers. • Service Quality Under deregulation, airlines can compete with fares in addition to quality of service. This has resulted in meal service and other amenities being cut back, since most passengers have carriers onto routes should continue to be a policy objective, since the industry is not perfectly competitive. revealed a preference for lower fares even at the expense of lower quality. • Congestion Requiring airlines to publish their ontime performance records provides pas- The congestion of the air traffic control system should be viewed as evidence of the success of deregulation. Put another way, if fares were set higher, fewer travelers would fly and there would be less congestion. This would hardly be a welfare-enhancing public policy either from the standpoint of equity or economic efficiency. The congestion stems primarily from the air traffic control system failing to expand rapidly enough and from the inefficient way scarce gate space and takeoff and landing slots are allocated. Little has been done over the last eight years to expand the air traffic control system despite the large growth in its use. This has occurred despite the $3.5 billion surplus in the Airport and Airway Trust Fund-a fund financed by users' fees that can only be spent on maintaining and improving the air traffic control system. Two decades into the age of semiconductors, the air traf- sengers with better information with which to plan their trips. On balance, it was a positive development; however, it has led the airlines to change their be- Proponents of deregulation never intended for the government to slacken its efforts in regulating the safety of the industry. In fact, government regulation of safety is more important in a deregulated environment than it was in a regulated environment, since the financial condition of an airline may influence its safety choices (such as spending on maintenance and pilot training).8 Under deregulation, the FAA should be even more vigilant. expanding the benefits brought about by airline deregulation, but government regulation of the routes airlines can fly and the fares they can charge is not good policy. Government enforcement of existing safety, antitrust, and consumer protection laws is beneficial. Government investment in improving • the air traffic system (airports and air traffic control) is essential. Conclusion Effective public policy must be based on a sound understanding of the forces driving the changes in the airl ine industry after deregulation. The benefits of airline deregulation have been substantial, but they have not been uniformly distributed among passengers and between cities. Care must be taken to preserve the benefits to travelers. Informed enforcement of the antitrust havior in ways that are not necessarily optimal. First, since the on-time arrival laws should be sufficient to preserve competition at the route level. So far, rate refers to the plane, not to the passengers, airlines may not wait as long for connecting passengers on delayed incoming flights as they used to in order to preserve their "on-time" performance. Another problem is that the on- even with the wave of mergers in the mid 1980s, there are still more carriers per route on average than in 1983 and certainly more than there were under CAB regulation. Steps to make acquisition of gate space and takeoff and land- time arrival rate masks the true extent of the congestion problem. One way airlines increased their on-time arrival rate was by adding time to their flight schedules into congested airports. These scheduled congestion delays result in millions of lost man-hours in the course of a year. ing slots easier would also help reduce the market power an airline has at its hubs. The safety dimension of service quality is a more serious issue. To date, there have been fewer accidents per passenger mile flown than was the case under regulation. By most measures, In short, there is a useful role for government to play in preserving and Though safety will always be a concern, there have been fewer accidents per passenger-mile since deregulation. With rigorous enforcement of the existing FAA safety regulations and with a modernization of the air traffic control system, there is every reason to expect this trend to continue. May 1,1989 • References ___ Bailey, Elizabeth E., Graham, David R., and Kaplan, Daniel P., Deregulating the Air. . lines, Cambridge,I MA: Th e MIT Press, 1985. Bauer, Paul w., '''Don't Panic': A Primer on Airline Deregulation." Economic Review, Federal Reserve Bank of Cleveland, IVQ:86. _. __ , "Competition, Concentration, and Fares in the U.S. Airline Industry," Economic Commentary, Federal Reserve Bank of Cleveland, September 15, 1987. ___ , and Zlatoper, Thomas 1., Deter- minants of Direct Air Fares to Cleveland: How Competitive"," Economic Review, Federal Reserve Bank of Cleveland, IQ:89. Baumol, William J., Panzar, John c., and Willig, Robert D., Contestable Markets and , and Huston, John H., "Deregula- • eCONOMIC COMMeNTORY Footnotes tion and Mergers: How Have They Affected 1. For a short description of the airline in- Airline Service to Small Communities?," dustry under CAB regulation and the early paper presented at the Southern Economic Association Meetings, San Antonio, Texas, years of deregulation see Bauer (1986). November 1988. 2. See Douglas and Miller (1974). 3. See Kahn (1988). Call, Gregory D. and Keeler, Theodore E., "Airline Deregulation, Federal Reserve Bank of Cleveland Fares, and Market Behavior: Some Empirical Evidence," in Andrew F. Daughety, ed., Analytical Studies in Transport Economics, New York: 4. See Butler and Huston (1988). S. See Call and Keeler (1985), Bailey Airline Deregulation: Boon or Bust? Graham, and Kaplan (1985), and Butler and Huston (1987) for some of the tests for con- Cambridge University Press, 1985. testability. See in particular Butler and Hus- Congressional contestability. ton (1987) for a test of imperfect Budget Office, "Policies for the Deregulated Airline Industry," July 1988. Douglas, George W. and Miller, James c., Economic Regulation of Domestic Air Transport: Theory and Policy, Washington, D.C., Brookings Institution, 1974. the Theory of Industry Structure, New York: Regulation, Borenstein, Severin, "Hubs and High Fares: by Paul W. Bauer 8. See Rose (1988). T Kahn, Alfred E., "I Would Do It Again," Harcourt Brace Jovanovich, Inc., 1982. 6. See Bauer (1987). 7. See Meyer and Oster (1987) p. 15. 1988,2. Meyer, John R. and Oster, Jr., Clinton Y., Paul W. Bauer is an economist at the Federal Airport Dominance and Market Power in Deregulation and the Future of Intercity Reserve Bank of Cleveland. The author the U.S. Airline Industry," Institute of Passenger Travel, MIT Press, 1987. would like to thank Randall W. Ebertsfor his helpful comments. Public Policy Studies Discussion Paper No. 278, University of Michigan, March 1988. Morrison, Steven, and Winston, Clifford, "Empirical Implications and Tests of the Butler, Richard Y., and Huston, John H., Contestability "Actual Competition, Law and Economics, April 1987,30,53-66. Potential Competi- tion, and the Impact of Airline Mergers on Fares," paper presented at the Western Economic Association Meetings, Vancouver, British Columbia, July, 1987. Federal Reserve Bank of Cleveland Research Department PO. Box 6387 Hypothesis," Rose, Nancy L., "Profitability The Journal of and Product he Airline Deregulation Act of 1978 took the operational decisions of running an airline (what routes to fly and what fares to charge) away from government regulators and returned them to the airlines. 1 The views stated herein are those of the author and not necessarily those of the Over the last decade, the airlines have used this new freedom to institute a number of fundamental changes in the structure of the industry. Since 1978, Federal Reserve Bank of Cleveland or of the Board of Governors of the Federal Reserve System. Quality: Economic Determinants of Airline Safety Performance," MIT, Sloan Working discount fares have been more widely used and the variety of restrictions on these fares has increased, frequent flier plans have proliferated, carriers have come and gone, and hub-and-spoke operations have emerged. Paper #2032-88, June 1988. This Economic Commentary examines the benefits and problems that have BULK RATE U.S. Postage Paid Cleveland, OH Permit No. 385 resulted from the deregulation of the airline industry and makes some recommendations for changes in public policy to preserve the benefits and to mitigate the problems. Cleveland, OH 44101 Address Correction Requested: Please send corrected mailing label to The Federal Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, Ohio 44101 • Benefits of Deregulation Deregulation increased both the degree and scope of competition in the airline industry. From 1938 to 1978, the Civil Aeronautics Board (CAB) essentially controlled the routes airlines could fly and the fares they could charge. Airlines could only compete with one Material may be reprinted provided that the source is credited. Please send copies of reprinted materials to the editor. another by offering higher quality service than their rivals. Since the CABalso charged with promoting the industry-would raise fares to cover higher ISSN 0428-1276 operating costs to ensure the financial health of the industry, there was little incentive for the airlines to work to hold costs down. The result was higher fares and higher quality of service than the average traveler preferred. 2 In a deregulated market, airlines have had to adopt productivity-enhancing techniques, such as the hub-and-spoke route networks, to stay competitive. As a result, labor productivity has increased greatly. Since deregulation, the number of workers in the industry has increased only 48 percent, while the number of passengers flown has increased 86 percent and the number of miles flown has increased 109 percent. The gains in operating efficiency brought about by competition were largely passed on to travelers in the form of lower fares and more frequent flights. Although fares have risen some in the past year, average revenue per passenger declined 30 percent in real terms between 1976 and 1987.3 Some of the price reduction came at the expense of more restrictions on tickets (not fully refundable, for example, requiring advance purchase, or requiring a stay over a Saturday night). About 90 percent of passengers now fly on discounted tickets at an average discount of 60 percent off the "regular" coach fare according to the Air Transport Association. - Deregulation of the airline industry has produced wide-ranging changes that have created benefits and some problems for the public. The promotion of safety, high-quality performance, and beneficial competition within the industry should be a goal of public policy. These policy goals, however, must be based on a sound understanding of the market forces behind the post-deregulation changes in the airline industry.
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