David R. Henderson  

Let Them In

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first class.jpgYesterday, over at our sister site, "Library of Law and Liberty," Northwestern University law professor John O. McGinnis had an interesting post. It's titled "The Obama Administration is Helping Raise Your Airfares." In it, Professor McGinnis makes the case that the U.S. airline industry "has become an entrenched oligopoly." He writes:

It is the Obama administration that is accountable. Two years ago, they permitted the merger of American Airlines and US Airways, two of the biggest airlines. I generally favor a relatively relaxed merger policy, because new entry can keep even large companies from restricting output and raising prices. But it is very difficult to enter the airline industry, because the take off and landing slots are limited at airports. And zoning and environmental regulations make expanding existing airports or building new ones almost impossible If you see persistent prices above the competitive level, search for the government regulation that causes them.

But antitrust authorities need to recognize when regulation impedes new entry and count such a regulatory structure against permitting such mergers. My suspicion is that the Obama administration did not do this sufficiently, because the powerful unions in the industry stood to benefit from a more oligopolistic structure. If airlines become few enough to coordinate on price, individual airlines would face less pressure to cut labor costs. If a merger is permitted when the economics suggests it should not, search for the powerful interest groups.


Fortunately, there's a solution other than his solution of forcibly preventing mergers--and it involves less regulation, not more.

But wait. Didn't I just quote him saying that it's hard to expand existing airports or build new ones? Yes. So I'm advocating letting existing airports expand and allowing new ones, instead of adding regulation to make up for existing bad regulation.

But there's another solution that doesn't require any of this: allow foreign airlines to fly from one U.S. point to another. In other words, imitate Europe and get rid of the restrictions on cabotage that European governments abolished in 1997. Their results were great. Competition increased and airfares fell. Think Ryanair and easyJet.

You might argue that that competition wouldn't matter because the bottleneck constraints that Professor McGinnis identified are binding. In other words, goes the argument, another airline entering wouldn't matter because there wouldn't be access to gates.

But there are two problems with that argument in this context. First, if it's true, then preventing mergers wouldn't matter either because the constraint is not the number of airlines but the number of gates. We know from his post that Professor McGinnis doesn't buy that argument. Neither do I.

Second, we can't know whether it's true without allowing the new airlines in. If allowing foreign airlines into U.S. domestic markets wouldn't reduce fares, we're no worse off. But if allowing foreign airlines in would reduce fares, then we're better off. And it's easy to show that in that case, the gains to U.S. consumers would exceed the loss to U.S. airlines.

And I'm pretty sure that allowing more competitors would increase competition.

For more on this, see Fred L. Smith, Jr. and Braden Cox, "Airline Deregulation," in David R. Henderson, ed., The Concise Encyclopedia of Economics.

HT to Francois Melese.


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COMMENTS (5 to date)
J Scheppers writes:

There are no solutions just trade-offs.

What if you could reduce the time between plane take-offs by 10% at the 20 most congested airports only during times when planes were queuing.

What if you could reduce the gate time by 10% at the 20 most congested airports during times when planes are queuing.

Airline delay nation wide may be cut by 20% of the annual $31 billion delay cost. Approximately $6 billion. Everyone knows the congestion is generated from a few airports and that congestion marginal cost applies to all the planes in the queue, thereby justifying the 20% estimate.

Compared to a wild guess on the very extreme side of doubling the risk of fatality for US fliers. Let's pick a huge number like 10 as the increased rate.

Assuming those figures are true we spend(waste)$6 billion in delay to save 10 people per year. When the generous US Gov. valuation metrics show the marginal cost to save a life is $10 million. The airline industry spends 60 times the US Government estimated marginal rate per life saved. Shouldn't we investigate more take-offs?

What if closer take-off improved safety because airlines took more care. What if engineers found better ways to track the wind vertices trailing the planes to make it more safe. What if it was found to be materially more dangerous overall and we went back to the status quo. How many more people could fly reducing highway deaths? What if it was found to be materially safer and we reduced the take-off interval by 20% instead of 10%. What if we did it in 1% reduction per year, until we saw the benefits did not exceed the costs?

The upside seems to be much higher than the downside. So this is the regulation that I wish to see improve to increase the market competition. I place the odds against my wish.

[broken html fixed--Econlib Ed.]

BillD writes:

A few thoughts, in somewhat random order

It used to be an easy to start an airline business, just get someone to loan money, start flying, underprice incumbents because maintenance costs are low in the short run. Business goes bust, but planes easily re-depolyed.

At some point, airline managment developed an understanding of network economics - customers percieve value from networks. Rule of thumb: only the top 2 airlines at an airport make money. And the hubs rule. See: Philidelphia, Nashville, St. Louis, etc. for what happens when an airport loses its connections. All 3 have a lot excess capacity and not even close to zero rents would likely compel new entrants.

In spite of deregulation at the national level, local airport authorities have a lot of power. So do the larger airlines. The goals are frequently, but not always aligned.

Major airline tenants work to restrict supply at airports, particularly hubs. They are all against any kind of congestion pricing. All hubs have major peaks to maximize connection opportunities. They don't want to have to pay higher rates for peak usage. Same for gates, most US airports are exclusive use. Common use gates are more complex to manage, but probably much less today than even a decade ago.

Airline unions used to be vehemntly against mergers. The emotions of merging seniority lists exceeded the economics of consolidation. Then the major airlines went BK. At some point the unions woke up and now accept the mergers, knowing that consolidation is good for them on net.

Cabotage used to be a big issue particularly for unions. My guess is it is less so. The airlines got around nationality issues via alliances. Some airlines have revenue sharing agreements with their partners that make price competition mute. Lufthansa isn't going to come into Chicago to compete against United. Garuda Indonesia isn't a likely viable competitor.

Competition is certainly the best way of constraining airfares. And less regulation is probably better. Not sure of the sufficiency.

ChrisA writes:

On the competition from Ryanair/EasyJet, what really allowed these guys to take off was that they didn't fly to the big established airports, but smaller regional ones, or small airports located usually well outside of a big city one. It turns out that people are actually OK to rent a car at these airports and then drive to where they want to go. I think the same could be even more true in the US where there are a large amount of small under-utilised airports near any major city. The large airport with many connections is great for business travellers, but not everyone is in the category.

Krist writes:

Afaik the US airline industry as a whole runs at a loss. That seems to me to indicate that there are no monopoly rents being taken here. So how will more competition drive prices down?

David R. Henderson writes:

@ChrisA,
Really good point. This, to some extent, was the Southwest strategy. Think Midway in Chicago, Love Field in Dallas, Houston Hobby, Manchester, NH, and Islip in New York.
@Krist,
Afaik the US airline industry as a whole runs at a loss. That seems to me to indicate that there are no monopoly rents being taken here. So how will more competition drive prices down?
I don’t think that’s true any more. In any case, my argument doesn’t depend on it. I expect that some foreign airlines have lower costs and so competition from them would drive prices down. And, of course, if you’re right about no monopoly rents and if foreign airlines don’t have lower costs, then none would enter. I’m quite confident that some would. But if I’m wrong, no harm done.

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