September 09, 2003

Did Airline Deregulation Fail?

Morgan Stanley in its August 15, 2003, report on the airline industry in the U.S. tersely notes: “If an industry produces negative total returns on capital over its entire history, consolidation is inevitable.”

Atlanta attorney Dean Booth believes that consolidation is taking us to two mega-airlines, which means a return to regulation.

Morgan Stanley’s report certainly points that way. The major airlines are burning cash at unsustainable rates. Despite draconian cost-cutting and reneging on pension promises to employees, revenues cannot be made to cover costs. American Airlines is burning cash at the rate of $1.1 million per day. Continental Airlines’ burn rate is $1.2 million per day, as is Delta’s. Northwest’s burn rate is $2.3 million per day.

It is popular fantasy that these amazing losses are due to a brake put on air travel by the September 11 terrorist acts. But Morgan Stanley shows that airline revenue per mile per seat (passenger yield) has fallen 4.5% annually since deregulation in 1978, whereas airline unit costs have only dropped by 0.7% annually.

Which airlines will survive? As a percentage of its cash on hand, Delta’s burn rate is the lowest. But Congress in its unwisdom has loaded the game in favor of the weakest airlines with a $10 billion pot of taxpayers’ money to lend to the airlines that fail the fastest. Under this scheme, the first to fail will last the longest.

The new monopoly regulation toward which we are rapidly approaching will be worse than the pre-1978 regulatory regime. Under the old regime, there were two or more carriers serving most routes. Under the coming regime, there will be one carrier—unless we re-regulate before consolidation does its work.

When deregulation began, United, TWA, Eastern and American were the largest carriers. Three of them have gone bankrupt, along with Pan American, Allegheny, Braniff, Southern, Ozark, Piedmont, National, Frontier, TransTexas, Continental (twice)—who can remember them all?

Dean Booth predicted this outcome in the July, 1971, issue of the Transportation Law Journal. He pointed out that the case for deregulation was based on a comparison of fares between one unregulated intrastate airline serving the San Francisco-Los Angeles market—the largest air travel market in the U.S.—and the average fare of regulated carriers serving interstate travel.

One intrastate airline skimming the cream hardly makes a case for deregulation. Moreover, Mr. Booth noted, the one airline skimming three California markets was all that remained out of 16 intrastate California carriers serving 32 markets.

What about lower fares? Didn’t deregulation pay for itself with lower fares? Apparently not. Morgan Stanley shows that airline pricing has been falling for 40 years. Eyeballing the chart, the fall in prices was steeper between 1962 and 1978 than after deregulation.

For the sake of argument, Mr. Booth says, let’s accept the claim that deregulation has brought a 25% decline in ticket prices. We are not comparing the same product. In the bad old days of regulated airlines, service was superior. Even coach passengers were served hot meals. Since deregulation, block-to-block time (from departure to arrival) has extended dramatically on flights of less than 700 miles. All but full fare tickets are full of restrictions. Free stopovers no longer exist.

Overlooked, too, is the fact that ticket prices are subsidized by taxpayers through government bailouts and by the shareholders and creditors of failing airlines.

Worst of all, perhaps, ticket prices are all over the map. Pre-1978, the maximum difference between coach and first class was 130%. Today ticket prices for the same flight can vary 2000%.

The price competition generated by deregulation created a pricing model that assumes that information is market-segmented. The model, which sells seats at different prices at different times, assumes that business and emergency travelers will continue to pay full fare, while otherwise empty seats can be sold for a discount.

The pricing information, however, could not be kept segmented, and airlines are not the only businesses with profit problems.

Under the present deregulation regime, airline failure is a sign of success. It is taken to mean that “creative destruction” is working by forcing out high-cost providers. Once competition eliminates itself, we will have monopoly and re-regulation, but not enough carriers to provide competition in service.

You think you hate air travel now? Just wait.

Paul Craig Roberts is the author with Lawrence M. Stratton of The Tyranny of Good Intentions : How Prosecutors and Bureaucrats Are Trampling the Constitution in the Name of Justice. Click here for Peter Brimelow’s Forbes Magazine interview with Roberts about the recent epidemic of prosecutorial misconduct.