Destroying Competition in Order to Save It: Predation Rules and the Airline Industry

“We had to destroy the village in order to save it.” According to legend, this rationale was once given by the U.S. army to justify burning a village during the Vietnam War. While perhaps apocryphal, the statement has become a universally known example of dubious logic.

Today, federal policymakers are pursuing that same logic in a misdirected effort to remedy perceived problems in airline competition. Within the next few weeks, the Department of Transportation is expected to release new guidelines concerning below-cost pricing and other “predatory” conduct by airlines. Similarly, the Department of Justice is investigating claims of such predation. In addition, Congress in considering several bills on the subject, including S. 1331, by Senator John McCain (R-AZ), which contains a provision requiring DOT to move more quickly on predation claims.

Competing too hard? While the intent of these efforts is to protect competition, the result will more likely be a chilling of aviation rivalry, with airlines punished for competing too hard. Competition could be destroyed in an attempt to save it.

The theory of predatory pricing is simple: when competition arises on a particular route (or at a particular hub airport), the incumbent airline can lower its prices below cost, causing the new competitor to lose money and leave the market. The incumbent, with the market all to itself, then raises its prices, getting monopoly profits.

Loch Ness Monster. It’s a nice-sounding theory, but in practice such predatory behavior rarely (if ever) works. To make the gambit worthwhile, the predator must not only make monopoly profits at the end, but make enough to compensate for the revenue it loses in the process – plus interest. That’s hard to do, especially when another firm could at any time enter the market and ruin the whole thing. That’s why, decades of research have revealed virtually no cases of successful predation. To paraphrase economists Donald Boudreaux and Andrew Kleit, predatory pricing is the Loch Ness Monster of public policy.

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, or even meet, the competition. The Supreme Court itself said in a 1986 case on predatory pricing that such claims can “chill the very conduct the antitrust laws are designed to protect.” This might be great for some airlines, but not so good for the consumer.

This is not to say that there are no airlines in real trouble. Many small upstart airlines have fallen on hard times in recent years. Until a couple of years ago, smaller carriers were flying high, representing the biggest growth sector of the industry. Then the pendulum began to swing – pushed in no small part by ValueJet’s Florida crash, and it’s subsequent shutdown by regulators. Another factor, no doubt, has been hard competition from the major airlines, responding to the challenge posed by their smaller rivals. But should these big airlines compete less vigorously when their rivals are small? Doing so might help a few competitors, but would leave consumers holding the bag.

Better ways. Better ways exist to ensure that vigorous competition in the airline business continues. Rather than worry about whether prices are too low, policymakers should instead try to make more room for competitors in the airport and airway system. For starters, they could review regulations that limit the number of take-off and landing slots at several major U.S. airports. Recently, DOT has reassigned certain slots to selected new entrants. A better approach would be – to the extent consistent with safety needs — to increase available slots, or even abolish slot controls entirely.

More broadly, policymakers could take steps to move the air travel infrastructure out of the government bureaucracy, thereby encouraging more consumer-friendly policies. Specifically, the air traffic control system should be removed from the FAA and reestablished as an independent corporation. The resulting increases in investment and efficiency could significantly increase capacity at these infrastructure bottlenecks. Such reforms aren’t as radical as once seemed – more than a dozen other nations, including Canada, have already moved air traffic control out of direct government control.

Only through steps like these — which foster marketplace opportunities and dynamism, rather destroy them – can policymakers ensure that competition in air travel will continue to thrive.

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1 Matsushita Electric Industrial Co. v. Zenith Radio Corp., 475 U.S. 590 (1986).James L. Gattuso ([email protected]) is Vice President for Policy and Management at the Competitive Enterprise Institute.