May 17, 2012

Ongoing Government Failures in Air Transportation

  • Kenneth Button

    Professor of Public Policy, George Mason Schar School of Policy and Government
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The enactment of the 1978 Airline Deregulation Act saw the first dismantling of a comprehensive system of government control in the United States since 1935: the sun-setting of the Civil Aeronautics Board (CAB). It freed interstate passenger airlines from most economic regulation of market entry and price setting. Freight carriers had been freed in 1977. The overall results have been generally lower fares, more services, and more diverse types of service. Moves to deregulate U.S. international airlines began with the initiation of Open Skies policies in 1979, but only really gained momentum in the early 1990s, again with significant consumer benefits. The large transatlantic market was largely deregulated in 2007.

Despite these changes, and the significant economic and social benefits that have come with them, there are still pockets of powerful government intervention in the air transportation sector. Some of these relate to the nature and growth of what is often generically called social regulation and pertains to such things as the environment, safety, security, consumer protection, and the provision of social services. These are not, however, the main concern here, although some comments will be made with a particular focus on issues of consumer protection, the environment, and security in terms of their implications for the airline industry’s performance. There are also generic economic regulations governing things such as minimum wages and working age that extend across the entire American economy; these non- specific interventions are not reviewed here.

Our concern is thus with situations where the involvement of government through the use of regulation and public ownership stymies the full potential benefits air transportation can generate. We focus primarily on a number of areas where direct economic regulation still exists and is detrimental to the efficient workings of the air transportation sector. For example, competition within the U.S. airline market, so-called cabotage, is confined to that between national carriers, limiting the potentially beneficial effects of more efficient foreign carriers entering the market. Restrictions on the ownership of U.S. airlines also prevent the potential gains from free factor mobility—in this case, foreign capital being injected into U.S. carriers—from being realized.

In addition to the residual economic regulation of airlines, there are government failures in the provision of aviation infrastructure. All the major airports in the United States, save one, are municipal entities or are owned by quasi-public bodies like the New York Port Authority. They are not run on a commercial basis and are not subject to the full rigors of the market. Air navigation services that provide air traffic control come under the auspices of the state-controlled Federal Aviation Administration (FAA), financed through taxation rather than user fees. Basically, the prices charged by the infrastructure providers have little to do with market principles, and the largely political mechanisms for financing infrastucture are almost arbitrary, often depending on the outcome of pork-barrel decision-making.

The aim of this work is not to collect a vast amount of new data, but to focus on the nature of some remaining distortions in the provision of air transportation services in the United States and to offer some very general quantification for what this may mean, appreciating that, by definition, the free-market counterfactual cannot be accurately determined. Also, international experiences can be drawn upon to highlight what has happened elsewhere. We make no attempt here to place hard figures on the costs of the distortions that exist: by definition, we have no real idea of what the market outcomes would be. If we did, we could simply regulate for them. Where possible, we offer some quantification of orders of magnitude.

The reforms to the U.S. air transportation market since the late 1970s have clearly brought about economic improvements, including lower average prices for users, and greater choice among suppliers, and service attributes more in line with what customers seek. However, the market remains far from perfect, with a range of residual economic regulations stymieing the full potential of the sector. Although many of these continuing regulations relate to infrastructure, a number of serious constraints remain on the direct market for airline services. Indeed, there are some additional constraints that have been added in recent years. These are in addition to imperfections associated with policies related to the environment, security, and safety.

The deregulation of the airlines in the 1970s, though influenced by academic work showing some of the costs of the regulatory regime, was largely a reaction to the macroeconomic stagflation of the day and the belief that inflation was a cost-push phenomenon. In many ways, it was also an easy quick fix. The regulatory structure that replaced it focused, initially through social subsidies and later through supposed measures of consumer protection, on meeting the concerns of vocal but relatively small groups. The remainder of the U.S. air transportation system has not seen significant changes in its institutional structure: public ownership in one form or another is the norm, and economic pricing and commercial investing is largely absent. This is despite mounting evidence from other countries that there are more efficient options.

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