Aviation Regulation – History and Practice – Part 5
4 February 2016 2 Comments
Aviation Regulation – History and Practice
This part covers economic deregulation of U.S. airlines, U.S. liberalization of international air transportation and the advent of Open Skies Air Services Agreements.
DEREGULATION AND OPEN SKIES
The Road to Deregulation
In the United States, during the decades after World War II, the airline industry experienced a veritable explosion of technological advances, growth and service improvement. And in 1969, there emerged one aircraft that could be credited for setting in motion moves to dramatically change the economic structure and rock the foundation of the industry. That aircraft would be the Boeing 747. With its introduction, capacity tripled on the routes on which it operated. Originally deployed on Pan American’s principle international routes, it was soon seen on the routes of the major U.S. domestic airlines (the “trunk” carriers) and on key international routes of foreign flagged carriers. Soon thereafter, the McDonnell Douglas DC-10 and Lockheed L-1011 wide-body aircraft were pressed into service. This increase of capacity created a need to “fill the seats” both domestically and internationally. On the domestic side, it was increasingly obvious that the CAB’s regulatory functions were seriously challenged due to the expanding scale of aviation markets. Pricing policies were viewed as insufficient, resulting in high costs for the passenger. The focus began shifting toward the consumer.
However, adversity struck when this new capacity coincided with a serious economic recession in 1970. What resulted was widely criticized CAB regulatory policies, including a four-year moratorium on all new route cases and approval of a series of agreements among airlines to limit capacity over certain major routes. On top of that, the CAB pricing policies were increasingly viewed as fostering inefficiency, higher costs and higher prices. It was pointed out that the intrastate airlines in California (Pacific Southwest Airlines) and Texas (Southwest), free from CAB regulation, were charging lower per-mile fares than those CAB regulated airlines and were operating profitably.
This situation was exacerbated in 1973 with the Arab oil embargo and the ensuing massive increase in oil costs. This prompted a series of fare increases, but with cost increases exceeding increases in yields, another period of poor airline earnings followed.
In this atmosphere, two reports were released:
The first, from within the CAB, concluded that protective entry and exit control and public utility-type price regulation were not justified by the underlying costs and demand characteristics of commercial air transportation and that they should be eliminated by statutory amendment.
The second report, from the Subcommittee on Administrative Practice and Procedure of the U.S. Senate Judiciary Committee, headed by Senator Edward Kennedy, suggested that prices should and would be lower with a more competitive system and that the CAB had not been effective in maintaining low prices. The report further stated that it was economically and technically possible to provide air service at significantly lower prices, bringing air travel within reach of the average American citizen.
This sudden growth of anti-regulation sentiment resulted in the introduction of the first deregulation bills. This started the legislation that culminated in the Airline Deregulation Act of 1978.
However, even before the Act’s passage, the CAB began its own steps toward deregulation, when Chairman John Robson, who took office in 1975, began relaxing the scheduled service route moratorium. Also, the airlines were given greater flexibility to reduce fares. With the appointment of Alfred Kahn as Chairman by President Jimmy Carter in 1977, the policies of relaxation escalated. Applications for new authority were processed and approved, in particular those applications that promised lower fares. At the same time, the Carter Administration was seeking agreements with foreign governments to permit more international competition and stood ready to authorize as much international service by U.S. airlines as foreign governments would accept. There was also far greater receptivity to fare reductions.
To kick it off, American Airlines introduced the Advance Purchase Excursion fare (APEX), called the “Supersaver”, which offered deep discounts on regular coach fares with restrictions.
The move to deregulation had begun, however, with reservations. There was opposition from most airlines, as well as labor unions and financial institutions with investment in the industry. The arguments in opposition covered a broad range of concerns:
Deterioration of the industry’s excellent safety record;
Probable concentration of service in high density markets with a consequent deterioration of service in others, and in particular, those serving small communities;
Impairment of the air transportation “system”, with its conveniences of through baggage handling, interline ticketing, etc.;
Destructive and predatory price competition, resulting in earnings deterioration and, ultimately, industry concentration;
Reduced ability to re-equip and to finance other available technological advances; and
Adverse impact on airline employees.
These arguments failed to halt the move to deregulation, and in fact, in 1977, with little or no fanfare, the domestic all-cargo service was deregulated. It simply provided that any airline operating under authority or exemption that had provided any scheduled domestic all-cargo service could apply for any or all domestic all-cargo routes and the CAB would grant the application unless the applicant was found not “fit, willing and able” to provide such service.
The Airline Deregulation Act of 1978
On 6 February 1978, Senator Howard Cannon of Nevada introduced Senate Bill S. 2493. The bill passed both the Senate and the House of Representatives and was signed into law by President Jimmy Carter on 24 October 1978. It became known as the Airline Deregulation Act of 1978.
The Act dealt primarily with U.S. domestic air transportation, recognizing that no one government could by itself deregulate international service.
The theme of the Act was that maximum reliance on competition would bring about the objectives of efficiency, innovation, low prices and price/service options while still providing the needed air transportation system. At the same time, the Act recognized the needs of the small communities and isolated areas in the U.S. and provided for direct federal assistance through the “Essential Air Service” provision. Restrictions on domestic service entry were gradually lifted and the standard for granting route applications was changed from the pre-existing requirement that the proposed transportation was “required by the public convenience and necessity” to a finding that it was “consistent with public convenience and necessity”. In addition, it was the burden of opponents to prove lack of such consistency. The CAB, however, was still required to determine that the applicant was “fit, willing and able” to provide the service. By the end of 1981, for all intents and purposes, all airlines (and would-be airlines) were free to serve, or cease serving, any and all domestic routes and cities.
In the area of pricing, pending complete deregulation at the end of 1982, the “standard industry fare levels” were retained and the CAB consideration in exercising its rate regulation functions was amended to give more weight to the desirability of low fares and increased pricing and service options. In the area of antitrust, certain types of inter-airline agreements, actions and relationships were removed from CAB jurisdiction and thus left to general antitrust laws. In addition the automatic “antitrust immunity” for any CAB approved agreement or transaction was repealed. Other provisions included the ending of the Mutual Aid Pact and provisions for the protection of employees adversely affected by the Act. The Act (along with the Warsaw/Montreal Convention with regard to international flights) also had the effect of preempting state law with regard to claims against airlines for delays, discrimination, consumer protection violations and other allegations of passenger mistreatment. Safety and technical matters remained with the FAA.
The most important of the Act’s provisions, however, was the “sunset” of the CAB. On 1 January 1985, the CAB closed its doors and what remaining functions it had were transferred to the Department of Transportation. These included international routes, certification of new carriers, consumer protection and jurisdiction over airline mergers and agreements.
Below is a post-deregulation route map of United Airlines. Compare to its route map during the regulated era covered in Part 4 of this story.
The International Air Transportation Act of 1979
As previously noted, it was beyond the power of any one government to deregulate international air transportation. Therefore the policy of the U.S. government was focused on increased competition.
As background, as far back as the early 1960s, the U.S. had a decided advantage over the European (and other) airlines. Although these airlines were able to catch up at one point, it was hardly at the expense of the U.S. airlines. The lack of capacity controls, coupled with the introduction of bigger and better aircraft, forced a downward pressure on fares to fill these aircraft. However, in the spring of 1963, IATA, backed by the European governments, increased fares when the CAB thought fares should remain stable. IATA stood by its position and won the fight, but at a heavy cost. The CAB’s response was to boost the supplemental carriers, the “non-skeds”, giving them permanent certificates so that they could purchase jet aircraft. The CAB also authorized split charters and inclusive-tour charters, enabling vacation travel to the public at bargain prices. Because of this, the scheduled airlines’ traffic in international markets declined although the overall market share stayed high as the supplemental carriers were predominantly American.
The Europeans initially resisted the supplemental airlines because they were not provided for in the post-war bilateral agreements. But because the Europeans were not united, only those countries that could count on a separate and distinct market, such as Israel, were able to avoid the charter problem. Travel to Europe, at least in the tourist market, was not necessarily point-to-point. Rather it was more regional. It did not matter what the port of entry was. Depending on the fare, a tourist could arrive in Amsterdam, travel around the continent, and leave from Paris.
The response of the scheduled airlines in the late 1960s and early 1970s was to develop a schedule of fares that were so complicated, hardly anyone could keep up. Excursion fares, inclusive tour fares, advance purchase fares, off-peak fares, were all introduced. In a sense, this was the beginning of price competition in international aviation. However, under IATA rules, it was not possible for any single carrier or group of carriers to experiment with a promotional fare to see if it would create new traffic. Thus, if one carrier could offer a special fare, all could, and unless all would do it, none could. And, by the time IATA was ready to invite the supplemental carriers to join, both Pan American and TWA had started charter services in the North Atlantic.
For the scheduled airlines, load factors continued to fall with a resultant loss of profits. The introduction of the wide body aircraft increased capacity, but did not produce the traffic increases that were predicted. And in the face of this, no one airline was prepared to curtail or reduce services for fear that its competitors would capture a greater share of the traffic. The CAB did approve capacity-restraint agreements, whereby Pan American would give up its Paris authority in exchange for TWA giving up its Frankfurt authority. This approval was done with the express hope that the over-capacity would come to pass. The prevailing view in Washington was to adhere to the Bermuda Agreement with no predetermination or no interference by governments in matters of capacity.
In 1974, Pan American lost $80 million, its sixth straight year of massive financial setbacks. Meanwhile, fares that had gone down during the 1960s and 70s began to rise, and in 1974, up to 30% on some routes. The foreign flag carriers also felt the pinch and like Pan American and TWA, began a retreat from some of their hard-earned routes to the U.S., particularly to the west coast. It was during this time the non-communist world felt the effects of inflation and recession, fuel shortages, price increases and unemployment all impacting in the worst way, discretionary travel.
In this setting, in 1975, President Ford called for a study on the possibility of regulatory reform in international aviation. And while this study was being conducted, in mid-1976, the British announced their intent to terminate the Bermuda Agreement. The British were strongly committed to the protection of its own airlines (particularly government-owned British Airways) and believed the agreement was inadequate to prevent operation of excess capacity and that the agreement was also unbalanced in favor of the U.S. airlines. In particular, the British wished to reduce the authority of U.S. airlines to carry Fifth Freedom traffic. There were other issues, including the manner in which the CAB exercised authority over rates, and, although not made explicit, a high degree of British irritation at U.S. public resistance to the introduction of supersonic Concorde service.
Negotiations on a new agreement were difficult and were exacerbated by a change in presidential administrations (from Ford to Carter) halfway through the 12-month negotiating period. The British held firm and it was not until the last moment when a new, more restrictive agreement was achieved, signed on 23 July 1977 and referred to as Bermuda II. Among other things, it limited the number of scheduled carriers operating at London Heathrow Airport to two from each side, enabled greater government control over capacity, required government review of proposed fares and routes after review by IATA, required government approval on pricing, reduced Fifth Freedom rights to U.S. carriers, granted additional U.S. gateways, allowed new carriers to operate at London’s Gatwick Airport and permitted Laker Airways to enter the north Atlantic market.
In 1978, as domestic deregulation was progressing, the administration of President Jimmy Carter began examination of the Bermuda II agreement with Great Britain. The finding was that it was overly protectionist and gave an unfair advantage to the British carriers. Encouraged by the CAB’s deregulation of the domestic airline industry and the success of Laker’s “Skytrain”, the Carter administration began to push a policy of free-market competition in the international arena. In a policy statement issued in 1978, the administration pledged to “work to achieve a system of international air transportation that places its principle reliance on actual and potential competition to determine the variety, quality and price of air service. An essential means for carrying out our international air transport policy will be to allow greater competitive opportunities for U.S. and foreign airlines and to promote new low-cost transportation options for travelers and shippers.”
As a result of this, the U.S. government began considering a way to seek more liberal, pro-competitive agreements with other governments.
Unrestricted entry by an unlimited number of carriers;
Unlimited authority to carry Fifth Freedom traffic;
No government constraints on capacity;
Carrier freedom on pricing, unless both governments disapproved; and
Foreign government acceptance of U.S. charter regulations.
The U.S. government saw these agreements as a means to put pressure on “recalcitrant” governments in the same general geographic area through an “encirclement” theory. Thus, the United Kingdom would be pressured by expansion of air service to and via Belgium and The Netherlands and Japan would be pressured by a similar agreement with South Korea.
It should be noted that the ability to achieve these agreements was by giving greater access to U.S. cities and the resultant economic benefit derived therefrom.
Although there was opposition to this policy, liberal bilateral agreements were achieved with a number of countries, and in 1980, the International Air Transportation Act of 1979 was enacted by Congress. Although the Act was more or less an international counterpart to the domestic Airline Deregulation Act, it did implement U.S. policy on international aviation.
Major provisions included:
Strengthen the competitive position of U.S. carriers to at least ensure equality with foreign carriers;
Freedom to offer consumer-oriented fares and rates;
Eliminate marketing and operational restrictions, including capacity, routes and operating rights for scheduled carriers;
Eliminate discrimination and unfair marketing practices;
Provide additional U.S. gateways to foreign carriers; and
Designation of additional U.S. carriers in international markets.
In the early 1980s, a recession, rising oil prices and an air traffic controllers strike disrupted the domestic market and the airline industry fell into a period of financial losses. In addition was the first “casualty” of deregulation, the bankruptcy and shut-down of Braniff Airways. As a result, the pursuit of a pro-competitive international policy came to a temporary end, but there continued a view that this policy would prevail over time.
The mid-1980s saw an economic turnaround and the U.S. carriers began to experience a recovery, particularly in the international markets. It was also becoming evident that greater growth was being realized in the liberal markets, those with a liberal bilateral agreement, than the more restricted markets. Although the liberal markets were not large, trading open access in a foreign country for expanded access to the U.S. appeared to benefit the traveling public.
As the economy strengthened into the late 1980s, the U.S. looked to aggressively pursue liberal ASAs, and eventually implemented a policy of negotiating “Open Skies” agreements with foreign governments.
In effect, deregulation took the political sphere out of the airline industry and replaced it with a liberalized economic and market sphere. The economic liberalization of air travel was part of a series of “deregulation” moves based on the growing realization that a politically controlled economy served no continuing public interest. This also put to an end the notion that airlines were an extension of national policy.
Open Skies Agreements
By 1982 the United States had signed twenty-three liberal ASAs world-wide, mainly with smaller nations. In the 1990s, similar agreements were achieved with individual European states. A major breakthrough was achieved in 1992, however, when the Netherlands signed the first Open Skies agreement with the United States, despite objections by European Union authorities. The U.S. subsequently granted antitrust immunity to a code-share alliance between Northwest Airlines and KLM Royal Dutch Airlines, which started in 1989 (when Northwest and KLM agreed to code sharing on a large scale), the first of the large airline alliances that would form in later years.
The key provisions of Open Skies agreements include:
Free market competition;
No restrictions on international route rights, number of designated airlines, capacity, frequencies, and types of aircraft;
Pricing determined by market forces – “double disapproval” authorized:
Designated carriers are free to provide their own ground-handling services
User charges are non-discriminatory and based on costs;
Computer reservation system displays are transparent and non-discriminatory;
Cooperative marketing arrangements;
Designated airlines may enter into code-sharing or leasing arrangements, subject to usual regulations;
Code-sharing between airlines and surface transportation companies authorized;
Provisions for dispute settlement and consultation;
Liberal charter arrangements;
Each government agrees to observe high standards of aviation safety and security, and to render assistance to the other in certain circumstances; and
Seventh Freedom all-cargo rights.
No Cabotage; and
Restrictions on Ownership and Control.
The U.S. now has Open Skies agreements with 112 nations and cargo-only Open Skies agreements with Argentina and Vietnam.
Below is a map of United Airlines international routes. Compare to Pan American’s world routes on page 41. United acquired Pan American’s Pacific routes in 1985, its London Heathrow route in 1990 and the remainder of its Latin America routes when Pan American ceased operations on 4 December 1991.
END OF PART FIVE
The next installment of this story, Part 6, will cover the development of airlines in countries from the former Soviet Union, the growth of the “Sixth Freedom” airlines, particularly in the Middle East, Liberalization of Air Transportation in Europe and Multilateral Liberalization of Air Transportation.