The Effects of Airline Deregulation: What’s The Counterfactual?
by Tom Bozzo
Crossposted with Marginal Utility.
Matt Welch at the Reason blog takes credit for airline deregulation on behalf of libertarianism:
The “worldview” of libertarianism suggested, back in the early 1970s, that if you got the government out of the business of setting all airline ticket prices and composing all in-flight menus, then just maybe Americans who were not rich could soon enjoy air travel. At the time, people with much more imagination and pull than Gabriel Winant has now dismissed the idea as unrealistic, out-of-touch fantasia. They were wrong then, they continue to be wrong now about a thousand similar things, and history does not judge them harsh enough.
Mark Kleiman observes that transportation deregulation was more directly the progeny of 1970s Brookings-esque neoliberalism (though I’d grant Welch that libertarians got there first), though Kleiman doesn’t take issue with the basic claim that deregulating prices and service offerings “was, on balance, a good thing.” This argument ultimately rests on the declines in airfares and resulting democratization of air travel that Welch cites; indeed that’s what the Brookings-esque neoliberals I know cite when they’re defending the deregulatory record.
The catch is that all such economic comparisons must be counterfactual: they must show an improvement not with respect to CAB-set fares of the late-1970s, but rather with respect to what reasonably competent regulation could have produced under the other circumstances of the deregulated era. (This, FWIW, is one of Robert W. Fogel’s central insights into what makes economic history economic history.) If the comparison exercise is tough by the (inappropriate) historical yardstick thanks to declines in (average) service quality and the airline industry’s trail of fleeced stakeholders, then the counterfactual comparison is going to be tougher still thanks to a couple of factors that should have produced large declines in airline costs and hence fares even in the absence of deregulation.
The factors of note are a pair of technological advancements — the development of high bypass ratio turbofans suitable for shorter-haul airliners and the demise of the flight engineer’s job thanks to cockpit automation, both of which have origins predating deregulation — and the long secular decline in oil prices through the deregulated era’s zenith prior the crash of the 1990s stock market bubble. Since a regulator could have promoted adoption of the cost-saving technologies and passed the resulting productivity improvements and input cost decreases through to fare-payers using elementary regulatory technologies, deregulation must have produced substantial fare reductions relative to the late CAB era to have a claim to constituting a true improvement.
One of the airline industry’s problems is that it isn’t “revenue adequate” or able to recover its total costs including a normal return to investors. If you thought airlines were incurring costs efficiently, then moving towards revenue adequacy would require more revenues and hence higher average fares. On the face of things, that wouldn’t look good for a regulated alternative providing more secure revenues to the industry. However, there are dynamic efficiency counterbalances to the apparent static inefficiency under regulation: revenue adequacy implies having money for efficiency-improving investments. For instance, U.S. legacy airlines have somewhat notoriously kept relatively aged fleets in the air. Partly, that was a deliberate strategy that blew up when the Goldilocks conditions of the late-90s ended, and partly they don’t have the money to turn over their fleets as fast as they arguably should.
The formerly regulated transportation industries shared, to one extent or another, cost structures under which an efficient carrier would go broke under econ 101 perfect competition with prices driven down to marginal costs. So the question isn’t so much whether carriers will exercise such market power as they have in order to survive, but how. Real firms might or might not do that better than a real regulator. I do think there’s a good case to be made for some degree of pricing and service liberalization with regulatory policing of “excessive” use of market power; that’s a one-sentence version of the Staggers Act’s approach to the (very successful) freight rail industry.
Added: Good comments at Economist’s View, too, particularly a long one from Bruce Wilder expanding on the cost structure issue, discussing pricing strategies, and opining on the sources of apparent gains from deregulation.
“The catch is that all such economic comparisons must be counterfactual: they must show an improvement not with respect to CAB-set fares of the late-1970s, but rather with respect to what reasonably competent regulation could have produced under the other circumstances of the deregulated era.”
Take a socio political theory (libertarianism, neo-liberalism, call it what you will) which insists that “reasonably competent regulation” does not exist, indeed, cannot exist (while still accepting that at times the inevitable not competent regulation is better than an anarchic free for all) given the incentives faced by, the capture of, those regulators, then disprove the socio political theory by assuming the existence of what the theory denies the possible existence of.
That’s a good trick really, must work it into my repertoire…..I shall now demonstrate the error of Marx’s views on capitalists by denying the existence of capitalists perhaps?
In point of fact we knew perfectly well in the 1970s what the approximate cost of regulation was. California had a number of instate(non CAB regulated), high volume, short and medium haul routes that were flown by several local airlines — primarily Pacific Southwest Airlines — using Boeing 727s and simiilar aircraft. Their walk up to the counter and buy a ticket fares were about half of the CAB controlled fares on United, American etc. PSA et al provided reasonable service, paid their employees decently, and had OK safety records.
Much of the cost of regulation was thought to be (and possibly was) the cost of providing service on thinly travelled routes in rural areas. Under the CAB, if you wanted an 8am Chicago to NYC flight in your repetoire, you better be prepared to fly a daily puddle jumper mostly empty from Cleveland to Madison to Omaha to Casper to Twin Falls to
For many decades, I thought airline deregulatrion was a success story. And it might have been if it had stabilised at 1990 levels of cost and service. The current horror show with wings is like travelling on a thrid world bus — without the idosyncartic charm of the latter. And it isn’t even all that cheap unless you buy a non-refundable ticket six months in advance. For the most part, I’d rather hitchhike than fly nowadays.
BTW, Frontline had a program on commuter airlines last night. I watched parts of it during commercial breaks on ABC. It was … disturbing. Here’s a web link. I haven’t reviewed the material there http://www.pbs.org/wgbh/pages/frontline/flyingcheap/
I fly pretty heavily, since 1993 I have vacillated between 50-100K miles a year. Overall I’d say it is a pretty good experience, and fares are reasonable. Much of the better experience is the result of two things. One, is the emergence of of Soutwest (and other airlines that emerged after deregulation), whose emergence resulted from deregualtion (the last of which was repealed – Wright amendment). The second was 9/11, whcih forced airports to operate more effciciently from a security perspective. For example, I remeber the old days when ANYONE could go through security, so it took 3 hours at times because of all the non-travelers.
I would also add that air travel is still very heavily regulated, and efficient, cheap air travel is dependent on the governmnet executing on its part of the deal.
Lastly airfares have gone up, becuase fuel prices are up. We cannot judge success by the fare alone.
Why is anyone surprised that airlines aren’t revenue adequate? No transportation system is revenue adequate. That goes for pack camels, horse and carriage routes, steamships, turnpikes, railroads and will probably appy to future rocket lines and teleportation systems. Traditionally, the government has stepped in, usually claiming the military importance of transportation. In the U.S. it was often the Post Office that did the actual check writing. It subsidized air mail with inflated cargo rates into the late 80s.
The air fares before deregulation were high, but the airlines actually made money. If nothing else, the well connected sorts running them saw to it. (Trippe of Pan Am, anyone? He was notorious for cushy government dealing.) There were discount fares available if you were willing to buy 21 days in advance, though if you knew what you were doing, you could save 50% or even 75%, by asking for an Apex fare, even on a tighter deadline. (I remember paying about $280 to fly cross country back in ’77. That’s about $1000 now. )There were also experiments with youth fares and youth standby that turned the baby boomers into a flying generation. My guess is that fares would have continued falling into the 1980s with or without regulation.
Does anyone else here remember Sir Freddy Laker or Icelandic Air?
Of course there were only three states big, and populus enough to support successful intrastate carriers: CA, TX and FL. Certainly, technological progress is one cause of cheaper air travel. But there were plenty of empty seats in the CAB days, something that the Byzantine pricing of modern carriers has done much to reduce. There’s little doubt in my mind that de-regulation was bad for the stakeholders, but good for passengers.
The counterfactuals regarding the effect on safety is harder. I generally suspect that while air travel is safer because of technological and regulatory changes, increased economic pressure on carriers has led to a decrease in safety compared to what we’d have seen if the old system where profits were assured so long as carriers kept in good with the regulators. But air travel is, by most statistical measures, much safer than the alternatives so whether any additional safety would have made sense from a dollars per life saved point of view is questionable.
I’m somewhat surprised a discussion of airlines ability to be revenue adequate ignores one of the biggest prizes captured by managers of United – their ability to convince a bankruptcy judge to let them default on $3.2B in pension obligations in 2005.
Yet another quiet subsidy by the US taxpayer who of course ends up adding this corporate bailout to the liabilities of the PBGC.