Deregulation and Privatization of the Air Transport Industry

1. Deregulation and Privatization of the Air Transport Industry Kenneth Button University Professor George Mason University June 2008

2. “Only the psychologically disturbed or inadequate want transport for its own sake.” Denys Munby, 1968

3. Some quotes “These days no one can make money on the goddam airline business.The economics represent sheer hell” C.R.Smith American Airlines “People who invest in aviation are the biggest suckers in the world” David Neeleman, jetBlu Airways, 1999 “If the Wright brothers were alive today Wilbur would have to fire Orville to reduce costs” Herb Kelleher, Southwest Airlines, 1994 “They don't realize that while you're sitting here talking, someone is f**king you. Changing a fare, changing a flight, moving something. There's no autopilot, and that's why I've seen a lot of guys come and go” Gordon Bethune, Continental Airlines, 2004 “There are always going to be some stupid people who will invest in airlines” Kenneth Button, Washington Post, 2005

4. Institutions • Formal: laws, regulations, contracts • Informal: “ways of doing business, interpretation of laws • Personal: habit

5. Do institutions matter? • Coase said in Nobel speech: “These ex-communist countries are advised to move to a market economy, and their leaders wish to do so, but without the appropriate institutions no market economy of any significance is possible.” • Matthews in his Royal Economic Society address said: “.. Economics of institutions has become one of the liveliest areas of our discipline. …institutions do matter…the determinants of institutions are susceptible to analysis by tools of economic theory”

6. Do institutions matter? However, Williamson points out: “we are still very ignorant about institutions” “Chief among the causes of ignorance is that institutions are very complex. That neo-classical economics was dismissive of institutions and much of organization theory lacked scientific ambitions have been contributing factors.”

7. “New” institutional economics • Old institutional economics • Descriptive • Legalisic • Historic • Often negative (attacking neo-classical economics) • “New” institutional economics • Holistic approach to economics • Analytical in nature

8. Linkages between economic institutions

9. Characteristics of air transport • Long/medium distance • Fast and reliable (important for some types of freight) • Highly flexible (spatially and temporally) • Quick to put in place (relatively low fixed costs) • Significant development about terminals • Relatively secure (no track) • Relatively safe • Relatively easy to develop private/public structures

10. Airlines part of an air transport system

11. Air transport is a major industry • 1,600 million passengers a year • 3.9 million jobs • $260 billion turnover • 18,000 aircraft • 15 million kilometer network • 10,000 airports • 130 billion revenue ton kilometers • 30 million tons of freight

12. Further features of the global market • Large industry in its own right (1% of Western European GDP, more than 1% of US GDP) • Important for key modern industries (high-tech management flies 60% more than traditional industries) • Important for long term economic/political integration • Lubricant for the economic system • Half of tourists outside of Europe travel by air

13. Dimensions of economic benefits of air transport • Simulates macro economic growth • Regional effects • Access to remote regions • Sector effects (e.g.tourism) • Air cargo (high value goods) • International markets • Foreign exchange earnings • Social cohesion • Retaining family/social ties • Cultural understanding

14. Air transport can benefit economic development • Primary effects. (e.g., building an airport) • Secondary effects. (e.g., running an airport) • Tertiary effects. (e.g., using an airport) • Perpetuity effects. (e.g., changing the economy)

15. Some studies of airport impacts • US MSAs - hub airport increases region’s employment by 12000 • Chicago O’Hare – 50% increase in traffic will increase employment in the region by 185,000. • Atlanta - 264 foreign-based firms, direct international services was 3rd most important thing in location • 57 companies in Europe – air transport network the 3rd most important factor in location. • Zurich – 34% of firms considered the airport as ‘very important’ and 38% as ‘important’ as location factor. • Schiphol Airport (Netherlands) – 85,000 jobs for the country.

16. Jobs and income from having a local airport (per million passengers) Jobs Economic Impact ($millions) Direct Total Direct Total High 2000 8000 225 1600 Medium 1500 6000 75 650 Low 750 2500 35 130

17. Tourist growth ($millions) by destination 1995 2020 % Annual Change Europe 338.4 717 3.0 Americas 108.9 282 3.9 East Asia/Pacific 81.4 397 6.5 Africa 20.2 77 5.5 Middle East 12.4 69 7.1 South Asia 4.2 19 6.2 Intra regional 464.1 1,183 3.8 Intercontinental 101.3 378 5.4 Total Trips 565.4 1,561 4.1

18. Trend in air transportation • Growth in both passenger and freight forecast • Lower fares • Deregulation; Technology; Improved management (low cost carriers) • Lower cargo rates • Improved management (supply chain logistics) • Integrated networks • Mergers; Alliances • Internationalization • Open Skies; European Union; Role of ICAO, etc

19. Traditional regulation • Economic efficiency • Largely static • Major concern with monopoly practices • Monopolies • Predatory pricing • Mergers • Barriers to market entry

20. Regulation of air transport • Airlines • Fares • Market entry • Revenue allocation • Ownership • Information/booking systems • Displays • Airports • Ownership • Rates • Air navigation systems • Ownership • Rates • Profits

21. Social regulation • Covers environment, labor protection, consumer protection, etc. • Growing in importance • Often uses command-and-control regulation rather than fiscal instruments (such as prices) • Can interact with economic regulation (e.g., change relative prices and affect market structure) • Sometimes captured to achieve economic objectives (e.g., redistribute income)

22. Problems with traditional regulation/public ownership • Regulatory capture • By industry • By regulators • Political manipulation • Lack of efficiency • High transactions costs (policing, administrating) • Lack of dynamism in adjusting parameters • Impedance to innovation

23. Vertical or horizontal regulation • Problems of impact on value chain of regulating one element • Problem across sectors if one value chain is regulated because of linkages

24. Porter’s value chain

25. Phases of Regulatory Reform in Aviation • THE LEGACY • To 1910 -> gentle assistance for innovation • 1910-1918 -> military importance • 1920s -> national integration (mail services) • 1930s -> internationalism (esp. Empires) • 1940s+ ->military development • Late 1940s-1970s -> economic regulation • Chicago convention • domestic price/ market access controls • MODERN AGE • 1970s+ -> “deregulation of operations” • domestic from late 1970s in US • international (Open Skies, EU packages, etc) • 1980s+ -> “deregulation of infrastructure” • 2000s+ -> environmental regulations

26. Forces for regulatory reform • Academic work (Levine, Jordon) • Issue of capture (Stigler, Peltzman) • Ideas of contestability (Baumol) • Concepts of “competition for the market” (Demsetz) • Role of countervailing power • Better understanding of cost structures • New forms of regulation (price-capping)

27. Winners and losers • Regulation always has winners and losers - i.e., not usually a Pareto benefit • Net benefits should be positive! • Effects may be long term so winners and losers may involve future generations • Often adverse effects of regulations are widespread while benefits are more focused

28. Normative income considerations • Policy makers more concerned with equity than efficiency - Frey • Interpersonal comparisons of welfare • Equity (Bentham, Rawls) • Income • Wealth • Spatial • Inter-generational (sustainable development)

29. Privatization • Objectives • Raise revenue for government • Make industry more efficient • ‘Share owning democracy’ (Thatcher) • Methods • Sell shares • Sell to managers/employees • Outsource • Allow private companies to compete with state owned ones • Sell to a single company • There are financial costs in privatization

30. Privatization and regulation • State ownership • Extreme form of economic regulation • Privatization equals more regulation • Social regulation • Mergers policies • Anti-trust/competition policy • Public corporations • State involvement • Non-profit

31. Features of contestable market • No sunk costs - ultra free entry and exit • There may just be one supplier • No excess profits are earned because of fear of hit-and-run entry when there is perfect contestability • Perfect competition is a special case of perfect contestability

32. Competitive, contestable and monopoly markets

33. Structure of regulatory change • Big-bang • Sudden reform • Stranded costs • Quick payback • Little scope for capture • Gradualism • Phased reform • More time to adjust resource use • Longer time before benefits emerge • Scope for industry to capture the system

34. Big bang or gradualism?

35. Nature of liberalization • US : ‘Big Bang’ • Airline Deregulation Act 1978 • Open Skies Policy from 1979 • EU: Phased liberalization • Add hoc reforms (from early 1980) • Package 1 (1988) • Opening up the existing structure • Package 2 (1990) • Liberalizing the EU international market • Package 3 (1993) • An open European air transport market • Extra-territorial authority (2003)

36. Measuring efficiency of deregulation/privatization • Benchmarks (Quality constancy) • International (comparable data) • Public/private or regulated/deregulated (counterfactual) • Time trends (trend shifts) • Simulations • Expert opinion

37. Internal African liberalization • 1988 Yamoussoukro Declaration • 1984 Mauritius guidelines • 1997 Banjul Accord • 1998 ACAC Agreement • 1999 CEMAC Agreement • 1999 COMESA Agreement • 1999 Yamoussoukro II Decision • 2000 Abuja Treaty

38. Factors influencing EU air transport

39. Relative efficiency of European airlines • UK Civil Aviation Authority (1983) EU airlines costs were double US trunk carriers. • Starkie/Starrs (1984) Comparing 5 years to 1975 with the subsequent 5 years found productivity growth of US carriers continued at pre-US deregulation levels but declined 40% for non-US airlines. • Barrett (1987) In 1984, the productivity of US airlines was 36% greater than their European counterparts in terms of traffic units per staff member. • Caves et al (1987) for the period 1970 to 1983 found EU carriers to be less efficient than their US counterparts. • McGowan/Seabright (1989) In the late 1980s US majors enjoying 1.6 million revenue passenger kilometers per employee compared to 1.1 for the best European carrier. • Encaoua (1991) Convergence of European airline costs between 1981 and 1986. • Good, et al (1995) European airlines from 1976 to 1986 would have saved about $4billion a year (1986 dollars) if they became as efficient as US airlines. • Distexhe/Perelman (1994) Reduced X-inefficiency amongst EU airlines 1973 to 1983. • Oum/Yu (1995) 1986 to 1993 saw productivity improvements in the European carriers compared to US counterparts.

40. Passenger numbers by distance of service

41. Travel mix in the US and Europe

42. Airline labor physical productivity in Europe (ATK per employee)

43. Passenger and cargo yield for European Union scheduled airlines

44. The proportion of UK business passengers traveling business class

45. Weighted average fares within the EEA

46. Growth of no-frill carriers

47. Cost differences between a no-frill carrier and a legacy carrier

48. Simplified theories of migration

49. The notion of gateways

50. Impact of opening more gateways