Regulatory Flights of Fancy


In Washington, D.C., everything old is new again. Keynes is back as the defunct economist our politicians are in thrall to, wind and solar are the power sources of the future, just as they were in the seventies, and, after two decades in which entrepreneurs and industry were freed from the crippling hand of regulation, re-regulation is now the order of the day. The latest target is the domestic airline industry, and if Congress wanted to kill it off, they couldn’t be picking a better way.

In 2008 market imperatives in the shape of competition and economies of scale drove Delta and Northwest Airlines to unite. Those same forces are now prompting United and Continental airlines to merge together. This trend toward market consolidation has sparked concerns in Congress over consumer welfare. A number of Congressmen, led by Rep. James Oberstar (Chairman of the House Transportation and Infrastructure Committee), have gone so far as to call for the re-regulation of the industry. History and economics, however, both suggest that such a move would be disastrous for the industry and for consumers. The result would actually be less competition, higher prices, poorer safety, and fewer choices.

Until the passage of the Airline Deregulation Act of 1978, the airline industry was heavily regulated by the Civil Aeronautics Board (CAB), which restricted competition by fixing prices, determining and rationing routes among favored firms. As the economists Paul Cleveland and Jared Price have demonstrated, these restrictive policies simply prevented new companies from entering the market and kept prices high. Airlines did compete in a form — on the basis of amenities rather than price, but only when multiple carriers were allowed to serve a particular route.

Deregulation allowed the airlines to compete and adopt the more efficient hub-and-spoke system. By feeding local and regional flights through hubs, airlines are able to do a much better job of filling up their longer flights, resulting in cost savings for both the industry and consumers. All in all, consumers have saved about $19.4 billion per year since the deregulation of the airline industry. Beyond these financial gains, safety has improved as well. According to Cleveland and Price, in the first fifteen years following deregulation, the airline fatality rate decreased by 41%, even as passenger travel increased by 55%. This strongly suggests it would be foolish to re-regulate the airline industry in response to a minor and at this point only hypothetical threat to consumer welfare.

Of course, the airline industry has its own peculiarities that must be taken into account. Due to a shortage of airport slots, it is hypothetically possible that two airlines which cumulatively control 90% of the slots at a particular hub would be able to acquire monopoly power for certain flight routes after a merger. However, this situation is itself an artifact of regulation. The solution would be to increase the number of available slots by removing unnecessary environmental regulations that are currently impeding the expansion of existing airports and the construction of new ones.

Competition in the airline industry could be further revitalized by opening the market to foreign companies. Removing the current 25% cap on foreign ownership, justified only by an archaic argument about national security, would provide airlines with broader and deeper sources of capital. This could help prevent future bankruptcies during economic downturns (and thereby ensure there were still planes in the event of a national emergency). When Australia relaxed its national ownership requirement, it saw only an increase in consumer choice.

In short, if Rep. Oberstar were really interested in promoting competition, he would be fighting for deregulation rather than re-regulation. In reality, the evidence seems to indicate that many Congressmen are far more interested in expanding the public sector by having the government seize control of yet another industry. Re-regulated airlines would certainly fail, and the Federal Government would have to produce yet another bailout or, worse, create an Amtrak of the skies.

Either way, if we did choose to go back to the 1970s in this sector, we would see a corresponding return to the industry conditions of the 1970s — fewer flights and higher prices. Even Jimmy Carter realized that wouldn’t fly.