Back to the Future

Back to the Future

January 31, 1998

Over the past several years, America has faced a disturbing trend. It started with the disco revival and John Travolta’s return to the silver screen. More recently, we have seen the return of lava lamps, and even an AFC victory in the Super Bowl. The 70’s are coming back.

All this was bad enough. But things might soon get worse: Regulators are getting ready to join the Mellow Decade bandwagon by reintroducing price regulation of airlines, a practice thought to have gone out with shag carpeting.

For those who don’t remember, from 1938 to 1978 the airline industry was restricted by a comprehensive system of federal regulation. Every route flown and fare charged needed approval from the Civil Aeronautics Board in Washington. Competition was kept at bay and price wars were unheard of.

The changes after deregulation were remarkable. Overall, fares dropped by almost a third. Perhaps more important, the number of passengers ballooned, democratizing a mode of travel which previously had been widely inaccessible.

Given this clear success, most of today’s reregulators say they don’t want to roll back the clock. They just want to "fine-tune" competition. Watch out. Whenever you hear a regulator say they want to fine tune anything, you should grab your wallet and hold on tight.

One of the most worrisome fine-tuning plans comes from the Department of Transportation, which is expected to soon release competition guidelines to prevent "predatory" behavior by airlines. Remarkably, the concern isn’t that prices are too high – these guidelines will be aimed at ensuring that prices don’t get too low. As Dave Barry would say, I’m not making this up.

Here’s the theory: To fight off competition a particular route or airport, an airline might lower its prices below cost, causing its competitor to lose money and leave the market. The airline, with the market all to itself, then can raise its prices to monopoly levels.

It’s a nice theory, but in practice, such predatory behavior rarely if ever works. To make the gambit worthwhile, the predator must make not only make monopoly profits at the end, but make enough to make up for its lost revenue — plus interest. That’s hard to do, especially when another airline can always enter the market and ruin the whole thing. That is why, after decades of research, there have been no clear cases of successful predatory pricing. As economists Donald Boudreaux and Andrew Kleit have put it, it’s the Loch Ness monster of antitrust.

Moreover, even if predation did occur in some cases, rules against it are likely to cause more harm than good. It’s every weak competitor’s dream. If your rival is underpricing you, drag him into court. The prospect of years of litigation would certainly make anyone think twice about lowering their prices to beat the competition. This might be great for some airlines, but not so good for the consumer.

Rather than worry about whether prices are too low, policymakers should instead try to make more room for new competitors in the (governmentally-controlled) air traffic control system. For starters, they could review regulations that limit the number of landing slots at several major U.S. airports. More broadly, they could also move the air traffic control system out of the FAA and into the private sector. Only through such steps can we start to move air travel into the 21st century, rather than back to the 1970s.