34:1 - Hardaway, Of Cabbages and Cabotage: The Case for Opening up the U.S. Airlines Industry to International Competition
Introduction: The U.S. domestic airline market is one of the very few 
American industries which, since its inception, has remained tightly closed to any and all foreign competition. Although the reasons for this closed-door policy are mostly geopolitical, the role of economic protectionism as the prime determinant has not heretofore been comprehensively examined.
Often cited as a reason for excluding all foreign competition is the refusal of foreign countries to allow American carriers to compete with the domestic carriers of those foreign countries. The U.S. Policy of excluding all foreign competition from domestic air markets is a legacy of the protectionist policies of U.S. Government Depression era policies. Those policies in turn found their roots in the successful attempts by the large railroad cartels during the late 1800’s to enlist the aid of the U.S. Government to fix prices and exclude competition.
Fierce competition in the railroad industry in the late 1800’s prompted the most powerful railroads to form cartels in order to fix prices and exclude competition, thereby insuring high oligopoly profits. Particularly irksome to the most powerful railroads were the new industry entrants who offered lower prices to consumers, thereby taking business from the entrenched railroads. Even more alarming was the practice of some members of the railroad cartels to “cheat” by offering lower prices in order to win customers.
When the Sherman Antitrust Act threatened to made oligopoly and monopoly price fixing and collusion illegal, the railroad cartel finally concluded that the only way to insure discipline from within and to immunize themselves from criminal charges of price fixing, was to get the government to pass a law which not only condoned price-fixing by enshrining the practice into law, but which actually obligated the government to do the dirty work of fixing prices for them. The result was the Interstate Commerce Act (ICC Act), and the founding of the Interstate Commerce Commission (ICC), under which the government itself set prices on behalf of the railroad cartels. By making it illegal for competitors to offer lower prices to customers, the ICC Act effectively broke the backs of any competitor who tried to enter the industry by offering more efficient or economical service.
The ICC Act more than others epitomized Stigler’s first law of economics: “(E)very industry or occupation that has enough political power to utilize the state will seek to control entry.” The final victory of the railroad cartel was marked by the passage of the Hepburn Act of 1906 which further tightened the power of government to fix prices on behalf of the cartels. This prompted George Perkins to write to his boss, J.P.Morgan, “the Hepburn bill is going to work out for the ultimate and great good of the railroads. There is no question but that rebating (offering lower prices) has been dealt a death blow.” The New York press noted that the railroads themselves had written the law and “that explains why the railroad lobbies did not raise a note of protest against the Hepburn bill in the house.” The Hepburn act set the stage for similar law fixing not only prices, but routes and rights of entry in the motor carrier and airline industries.
The Civil Aeronautics Act of 1938 went further than any of the previous transportation regulatory laws by not only fixing prices, but also by establishing virtually absolute barriers to entry by competitors. Although new entrants could, in theory, receive permission to compete with established carriers by persuading the civil aeronautics board to issue a certificate of “public convenience and necessity,” in practice the Civil Aeronautics Board (CAB) succeeded in preventing a single competitor from entering the airline industry during its heavy-handed reign (1938-1975). Professor Paul Dempsey has observed that ‘this excessively rigid regulatory scheme established by the CAB…between 1938 and 1975, allowed the creation of an effective oligopoly composed the five largest trunk line carriers” - this despite the fact that the airline industry itself expanded by 23,800 percentage points during this same period.
Building on the success of the railroad cartel in enlisting the power of government to fix prices and exclude competition, the airline industry succeeded in establishing itself as a price-fixing cartel thriving on high fares and immunity from competition of any kind. In 1962, President John F. Kennedy demanded in his transportation message “greater reliance on the forces of competition and less reliance on the restraints of regulation.” It was clear that the price-fixing and competition-excluding laws harmed consumers and workers alike.
The final straw was the revelation by the 1975 Kennedy hearings in Congress that regulated air fares were 40% to 100% higher than they would be without government price-fixing on behalf of entrenched carriers, thereby costing consumers up to $3.5 billion in excess fares. The final to government sponsored price fixing and exclusion of competition was the Airline Deregulation Act of 1978 (ADA) which “placed maximum reliance on competitive market forces.” Everyone enjoyed the benefits of competition. Consumers enjoyed reduced fares, while workers received an expanded industry with many more jobs. Only three years after deregulation eleven newly formed airlines providing jet service had entered the U.S. Airline market.
By 2000, however, disturbing trends toward renewed concentration in the industry were evident. This trend was exacerbated in part by lax antitrust policies of the U.S. Government which permitted anti-competitive mergers and consolidations, and partly by political forces placed on the government to protect airlines, particularly large ones, from failure and the consequences of their inefficiency. Lax bankruptcy laws allowed failing, inefficient, and bloated carriers to continue operating, often with little prospect of ultimate success or economic viability, instead of allowing those firms to simply dissolve and allow the process of bankruptcy to redistribute its assets to more efficient and cost productive firms.
The most important cause of the reconsolidation of the airline industry has been the continued oligopolization of airport resources. Deregulation in the “air,” in the form of freedom to charge market fares and choose the most efficient routes and schedules, was never followed up with deregulation on the “ground” - that is with access to airport gates and slots. Long term leases with airport authorities assured entrenched trunk lines of access to scarce gates, while landing rights and “slots” awarded without cost to favored carriers during the regulatory years (1938-1975) provided ground right monopolies and a barrier to new entry.
Since I testified before Congress to urge that the government condemn airport gates and slots and open them up to fair and open bidding by all carriers, including new entrants, little has been done to open up access to airport resources. Without such access, new entrants are denied entry to the market no less than by the arbitrary exclusion policies of the CAB during its regulatory reign.
While opening up airport resources to competitors and new entrants would go far in achieving the ultimate goals of the ADA, true economic deregulation requires that such a policy be combined with opening up the domestic market to foreign competition. With a stroke of the pen, the trend toward reconsolidation and oligopolization of the domestic airline market could be reversed and the benefits of free trade and competition once again enjoyed by the traveling public.
This article attempts to show that the economic advantages of free trade in the airline industry is no less than other industries, but also that the reasons posited for the rejection of free trade do not stand up to comprehensive analysis. Proposed herein is the adoption of “cabotage,” defined by the Standard Dictionary of the English language as "air transport of passengers and goods within the same national territory." The definition adopted by International Civil Aviation Organization (ICAO) at the Chicago Convention is, "Each state shall have the right to refuse permission to the aircraft of other contracting states to take on its territory passengers, mail, and cargo destined for another point within its territory.” Current international agreements, often misleadingly described as “open skies” agreements,” provide only for reciprocal rights of U.S. and foreign governments to share international routes. Under such an agreement a carrier is permitted to carry passengers from country X to city A in country Y, and to carry some of those same passengers from city A to city B in country Y. These agreements do not permit a foreign carrier to pick up passengers in city A and carry them to city B.
Part II briefly reviews the regulatory history of the U.S. domestic airline industry. Part III reviews the causes of the current trend to reconsolidation of the domestic airline industry, including the contribution of antitrust and bankruptcy policies. Part IV describes the current state of cabotage and examines the political and geopolitical reasons most often posited for resisting its adoption, including the resistance of labor—paradoxically the resistance of both domestic as well as foreign labor. Finally, part V applies basic economic principles to show that that adoption of cabotage would lower fares, increase productivity as well as the GNP of countries participating in cabotage agreements, foster competition, and achieve the goals set forth in the ADA.
Access this article in full length on LexisNexis or Westlaw or order a reprint. For reprint and subscription information, visit the Transportation Law Journal subscription Web site.
American industries which, since its inception, has remained tightly closed to any and all foreign competition. Although the reasons for this closed-door policy are mostly geopolitical, the role of economic protectionism as the prime determinant has not heretofore been comprehensively examined.Often cited as a reason for excluding all foreign competition is the refusal of foreign countries to allow American carriers to compete with the domestic carriers of those foreign countries. The U.S. Policy of excluding all foreign competition from domestic air markets is a legacy of the protectionist policies of U.S. Government Depression era policies. Those policies in turn found their roots in the successful attempts by the large railroad cartels during the late 1800’s to enlist the aid of the U.S. Government to fix prices and exclude competition.
Fierce competition in the railroad industry in the late 1800’s prompted the most powerful railroads to form cartels in order to fix prices and exclude competition, thereby insuring high oligopoly profits. Particularly irksome to the most powerful railroads were the new industry entrants who offered lower prices to consumers, thereby taking business from the entrenched railroads. Even more alarming was the practice of some members of the railroad cartels to “cheat” by offering lower prices in order to win customers.
When the Sherman Antitrust Act threatened to made oligopoly and monopoly price fixing and collusion illegal, the railroad cartel finally concluded that the only way to insure discipline from within and to immunize themselves from criminal charges of price fixing, was to get the government to pass a law which not only condoned price-fixing by enshrining the practice into law, but which actually obligated the government to do the dirty work of fixing prices for them. The result was the Interstate Commerce Act (ICC Act), and the founding of the Interstate Commerce Commission (ICC), under which the government itself set prices on behalf of the railroad cartels. By making it illegal for competitors to offer lower prices to customers, the ICC Act effectively broke the backs of any competitor who tried to enter the industry by offering more efficient or economical service.
The ICC Act more than others epitomized Stigler’s first law of economics: “(E)very industry or occupation that has enough political power to utilize the state will seek to control entry.” The final victory of the railroad cartel was marked by the passage of the Hepburn Act of 1906 which further tightened the power of government to fix prices on behalf of the cartels. This prompted George Perkins to write to his boss, J.P.Morgan, “the Hepburn bill is going to work out for the ultimate and great good of the railroads. There is no question but that rebating (offering lower prices) has been dealt a death blow.” The New York press noted that the railroads themselves had written the law and “that explains why the railroad lobbies did not raise a note of protest against the Hepburn bill in the house.” The Hepburn act set the stage for similar law fixing not only prices, but routes and rights of entry in the motor carrier and airline industries.
The Civil Aeronautics Act of 1938 went further than any of the previous transportation regulatory laws by not only fixing prices, but also by establishing virtually absolute barriers to entry by competitors. Although new entrants could, in theory, receive permission to compete with established carriers by persuading the civil aeronautics board to issue a certificate of “public convenience and necessity,” in practice the Civil Aeronautics Board (CAB) succeeded in preventing a single competitor from entering the airline industry during its heavy-handed reign (1938-1975). Professor Paul Dempsey has observed that ‘this excessively rigid regulatory scheme established by the CAB…between 1938 and 1975, allowed the creation of an effective oligopoly composed the five largest trunk line carriers” - this despite the fact that the airline industry itself expanded by 23,800 percentage points during this same period.
Building on the success of the railroad cartel in enlisting the power of government to fix prices and exclude competition, the airline industry succeeded in establishing itself as a price-fixing cartel thriving on high fares and immunity from competition of any kind. In 1962, President John F. Kennedy demanded in his transportation message “greater reliance on the forces of competition and less reliance on the restraints of regulation.” It was clear that the price-fixing and competition-excluding laws harmed consumers and workers alike.
The final straw was the revelation by the 1975 Kennedy hearings in Congress that regulated air fares were 40% to 100% higher than they would be without government price-fixing on behalf of entrenched carriers, thereby costing consumers up to $3.5 billion in excess fares. The final to government sponsored price fixing and exclusion of competition was the Airline Deregulation Act of 1978 (ADA) which “placed maximum reliance on competitive market forces.” Everyone enjoyed the benefits of competition. Consumers enjoyed reduced fares, while workers received an expanded industry with many more jobs. Only three years after deregulation eleven newly formed airlines providing jet service had entered the U.S. Airline market.
By 2000, however, disturbing trends toward renewed concentration in the industry were evident. This trend was exacerbated in part by lax antitrust policies of the U.S. Government which permitted anti-competitive mergers and consolidations, and partly by political forces placed on the government to protect airlines, particularly large ones, from failure and the consequences of their inefficiency. Lax bankruptcy laws allowed failing, inefficient, and bloated carriers to continue operating, often with little prospect of ultimate success or economic viability, instead of allowing those firms to simply dissolve and allow the process of bankruptcy to redistribute its assets to more efficient and cost productive firms.
The most important cause of the reconsolidation of the airline industry has been the continued oligopolization of airport resources. Deregulation in the “air,” in the form of freedom to charge market fares and choose the most efficient routes and schedules, was never followed up with deregulation on the “ground” - that is with access to airport gates and slots. Long term leases with airport authorities assured entrenched trunk lines of access to scarce gates, while landing rights and “slots” awarded without cost to favored carriers during the regulatory years (1938-1975) provided ground right monopolies and a barrier to new entry.
Since I testified before Congress to urge that the government condemn airport gates and slots and open them up to fair and open bidding by all carriers, including new entrants, little has been done to open up access to airport resources. Without such access, new entrants are denied entry to the market no less than by the arbitrary exclusion policies of the CAB during its regulatory reign.
While opening up airport resources to competitors and new entrants would go far in achieving the ultimate goals of the ADA, true economic deregulation requires that such a policy be combined with opening up the domestic market to foreign competition. With a stroke of the pen, the trend toward reconsolidation and oligopolization of the domestic airline market could be reversed and the benefits of free trade and competition once again enjoyed by the traveling public.
This article attempts to show that the economic advantages of free trade in the airline industry is no less than other industries, but also that the reasons posited for the rejection of free trade do not stand up to comprehensive analysis. Proposed herein is the adoption of “cabotage,” defined by the Standard Dictionary of the English language as "air transport of passengers and goods within the same national territory." The definition adopted by International Civil Aviation Organization (ICAO) at the Chicago Convention is, "Each state shall have the right to refuse permission to the aircraft of other contracting states to take on its territory passengers, mail, and cargo destined for another point within its territory.” Current international agreements, often misleadingly described as “open skies” agreements,” provide only for reciprocal rights of U.S. and foreign governments to share international routes. Under such an agreement a carrier is permitted to carry passengers from country X to city A in country Y, and to carry some of those same passengers from city A to city B in country Y. These agreements do not permit a foreign carrier to pick up passengers in city A and carry them to city B.
Part II briefly reviews the regulatory history of the U.S. domestic airline industry. Part III reviews the causes of the current trend to reconsolidation of the domestic airline industry, including the contribution of antitrust and bankruptcy policies. Part IV describes the current state of cabotage and examines the political and geopolitical reasons most often posited for resisting its adoption, including the resistance of labor—paradoxically the resistance of both domestic as well as foreign labor. Finally, part V applies basic economic principles to show that that adoption of cabotage would lower fares, increase productivity as well as the GNP of countries participating in cabotage agreements, foster competition, and achieve the goals set forth in the ADA.
Access this article in full length on LexisNexis or Westlaw or order a reprint. For reprint and subscription information, visit the Transportation Law Journal subscription Web site.
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