Freedom in the Skies 1979–1989
Over and Out
The drama behind regulation
The airline revolution is often portrayed as the handiwork of that unlikely Democratic Party duo—the left-liberal Senator Ted Kennedy and the market-oriented academic economist Alfred Kahn. Kennedy, more usually associated with schemes to expand the power of government, sponsored the legislation that finalized deregulation of the airlines and abolished the regulating agency, the Civil Aeronautics Board (CAB). Kahn, flamboyant, candid, and very persuasive as chairman of the CAB, was an enthusiastic and forceful deregulating agency chief.
But deregulation was far from simply a Democratic scheme, as suggested by the focus on Kennedy as reformist legislator and Kahn as the boss-cum-gravedigger of the CAB. Some infrequently lauded Republicans—notably Kahn's predecessor as CAB chairman, John E. Robson, President Ford's Secretary of Transportation William T. Coleman, and Ford himself—deserve perhaps half the credit for deregulation. Perversely, some credit must also go to a bunch of proregulation GOP administrators at the CAB who inadvertently managed to discredit the regulatory system in the early '70s with the zeal of their industry-protectionist policies.
A great deal of the impetus for deregulation came from the gradual professional ascendancy of economists over lawyers in the policy branches of government agencies—particularly the Department of Transportation. Lawyers, with their predisposition toward an arbitrated solution, are still the dominant professional species in Washington, but the 1960s and '70s saw large numbers of economists recruited to many different agencies. Many of these people delighted in demonstrating the irrationality and heavy costs of regulation and in outlining the advantages of harnessing the free market.
In doing so, they could tap a well-developed body of research demonstrating the inefficiency of airline regulation. The CAB system, economists noted, propped up financially weak carriers by giving them preference in route awards and fare approvals. It rarely permitted new routes and wouldn't allow airlines to transfer the routes it did grant. The system bred a cost-plus pricing mentality and invited management indulgence of labor unions. It stifled innovation, prevented new route offerings, and forbade discount fares.
Until the early '70s, however, economists were usually dismissed as "ivory tower theorists" who knew nothing about the realities of running an airline. But then theory met reality—and deregulation became a political possibility.
For the first 30 years of its life, the CAB stayed uncontroversial by letting in just enough new service to deter complaints from thwarted entrepreneurs and consumers, while quietly and discreetly looking after the entrenched airlines. The CAB saw itself as an industry stabilizer, keeping tight control on the number of flights and boosting fares in economic hard times but loosening its regulatory grip in times of prosperity to prevent super-profits.
But around the end of the 1960s, an unusual conjuncture of events put financial pressure on the industry. The airlines found they had over-ordered the new generation of wide-body planes—747s and DC-10s—that Boeing and Douglas were rolling out of their plants for the first time. And there was a recession. Instead of letting the airlines live with the consequences of their overinvestment in the fancy new jumbos and the economic downturn, Nanny CAB fussed over the airlines as if they were all in mortal danger.
Chairman Secor Brown in effect implemented a "route moratorium" by refusing even to hold hearings on applications for permits for new flight routes. Beginning in 1969, the CAB openly urged competing airlines to form cartels in order to reduce capacity further. It cut the number of flights allowed on four major transcontinental routes.
Fares soared. And once the economy revived and the airlines filled their overcapacity, the CAB still failed to relax its regulatory grip. A new CAB chairman, Robert Timm, tried to make the route moratorium permanent. By 1973, petroleum prices were rising rapidly because of the Arab oil embargo. The Timm board used fuel conservation as justification for even further reductions in capacity and approved major increases in fares. In an apparent attempt to bolster the finances of troubled TWA and Pan Am, the CAB also proposed tougher restrictions on charter flights. Timm so openly espoused the industry line that airline executives regarded him as the "best thing that happened since the invention of the jet engine," according to a 1973 New York Times article.
But Timm set himself up to be discredited. In August 1974 the Washington Star reported that he had engaged in an expenses-paid frolic in the Bahamas with executives of several airlines and an aircraft manufacturer. Congress and the media bitterly denounced Timm and his CAB as corrupt. His Bahamas scandal became a symbol of the agency's capture by the industry and its betrayal of the public trust. When Timm's term expired in 1975, President Ford appointed the deregulation-minded lawyer John Robson to replace him.
Before that transition, however, Ford had encouraged staff at the White House and the Department of Transportation to move toward deregulation. Ford always had a bit of the populist in his political makeup, being quite cynical about organized lobby groups. He also was something of a Reaganite about the evils of overlarge and overintrusive government, and he found that this theme went over well in his speeches.
Encouraged by the positive political feedback, he told his staff to put some content into his smaller-government policy. To come up with specific proposals, he appointed a deregulatory staff group of senior people from the Office of Management and Budget and various cabinet departments. Cumbrously titled the Domestic Council Review Group on Regulatory Reform (DCRG), the group met at the White House twice a week from the summer of 1974 into 1976. Economists—antiregulators—dominated it.
Its leading lights, economists Paul MacAvoy and Edward Schmults, pushed a broad deregulatory agenda, encompassing everything from cost impact statements on all new laws and regulations to an end to the postal monopoly and minimum-wage laws. Transportation Secretary Coleman cooperated more closely with the DCRG than other agency heads did, and he and his staff produced bills proposing major cutbacks in the regulatory powers of both the CAB and the Interstate Commerce Commission.
So the stage was set for major changes when Robson took over as CAB chairman in April 1975. After only a couple of months, he developed into a strong believer in deregulation. "The Board's judicial process and trappings [were] a Hollywood set for the preservation of the belief that the regulatory process was scientific, fair and equitable and done according to law," he later wrote. "But the decisions were in fact arbitrary.…It was just nutty. "
Robson was determined to subvert the CAB but to do it in a quiet, methodical way—to avoid polarization and an overt push for deregulation before it could succeed. "My plan," he explained after his retirement, "was to use staff resources…to create momentum for deregulation within the agency, to attack the other board members from within."
Robson's predecesssor Timm had already started to create that momentum. As one of his last acts, Timm had established a task force of CAB staff members to "explore afresh all the areas into which our regulation reaches and determine without preconception or prejudice whether deregulation, or the regulatory status quo, would be in the best interests of the consumer and the industry."
Roy Pulsifer, a leading internal maverick, led the group. A lawyer by training, Pulsifer had "found" economics and had become an acerbic critic of CAB procedures. Pulsifer was an avid reader, knew the economics literature on airline regulation backwards, and had become a zealous economic libertarian. He had a picture of Milton Friedman on his desk at the CAB.
To underline its desire for thoroughgoing self-criticism, the CAB let Pulsifer select the other four members of his task force. For his deputy, Pulsifer picked Lucile Keyes, who in a 1951 book had launched one of the earliest economic attacks on airline regulation. Pulsifer's group worked for six months—Timm's last four months and Robson's first two.
The Pulsifer group's report drove a spear into the heart of the CAB. It bluntly declared that "protective entry control, exit control and public utility type price regulation…are not justified by the underlying cost and demand characteristics of commercial air transportation.…The present system of regulation causes higher than necessary costs and prices (which in turn suppress demand), weakens the ability of carriers to respond to market demand and other constantly changing conditions, narrows the range of price/quality choice to the user, and thus produces a misallocation of the nation's economic resources." It proposed a three- to five-year phaseout of CAB activities by legislation.
Robson took his time to make public his own position. He first assembled a broader CAB staff task force to review the Pulsifer report and assigned a committee of CAB bureau directors to assess regulation. Both substantially endorsed the deregulation approach.
Eventually, Robson's slow campaign brought around longtime supporters of regulation on the five-member board. They unanimously endorsed deregulation as CAB policy. That endorsement, the chairman later said, "resulted from an amalgam of persuasion, loyalty to the chairman, fear of political retribution, institutional pride that sought to restore the CAB to a leadership role, the tactic of ensuring that pressure came from the indigenous professional staff, and a belief by some members that even if the CAB recommended deregulation, Congress and the airlines would never let it happen."
When Robson announced the unanimous deregulation recommendation to Congress, reporters described it as a bombshell. The CAB's decision proved decisive in removing the last major roadblock to deregulation—opposition by Sen. Howard Cannon, chairman of the subcommittee on aviation and hitherto a regulationist and rival of Kennedy's.
Cannon had long indulged in anti-intellectual name calling to the effect that deregulation was "impractical" and "ivory tower theorizing." But he had relied on the CAB as the source of common sense. Witnesses at the hearings said that Cannon's jaw dropped when Robson announced that the CAB was unanimous in favor of deregulation of the airline industry. From then on, he supported Senator Kennedy and by 1976 they cosponsored a deregulation bill.
Robson says of his term as chairman: "We had taken a government agency that had regulated airlines for 40 years and turned it 180 degrees to a policy of deregulation." Under Robson, the agency liberalized charter operations and authorized SuperSaver fares and other discounts, giving deregulation something of a trial run. So when Alfred Kahn became chairman under Jimmy Carter, he inherited a basically deregulationist CAB.
For his part, Kennedy first moved toward deregulation on the advice of Stephen Breyer, a Harvard lawyer who had collaborated with economist Paul MacAvoy on a book supporting reduced controls over natural gas. Joining the staff of the subcommittee on administrative practice and procedure early in 1974, Breyer urged Kennedy to conduct hearings on airline regulation as the first of what he hoped would be a whole series of inquiries into controls over industry. He chose airlines because he felt the case for reform was most heavily developed.
Kennedy wasn't enthusiastic at first, but he soon realized that deregulation could prove a good pro-consumer issue in his 1976 campaign for president. Breyer swung into a major program to produce telling and newsworthy witnesses for hearings that opened in February 1975. Kennedy prepared himself well, making strong, clear statements and subjecting witnesses to effective cross-examination. The hearings attracted enormous attention, making airline deregulation a national issue. Kennedy came out of the hearings a Senate leader and was able to claim in his campaign for the 1976 nomination that he was the "father of deregulation."
The Kennedy hearings highlighted a real-world example of competition: the purely intrastate airlines of California and Texas, which had developed free of federal regulation. In 1974, Pacific Southwest Airlines offered Los Angeles–San Francisco fares of $19—compared to the $41 charged on the regulated, but otherwise comparable, Baltimore-Washington run. Similarly, intrastate and unregulated Southwest offered $15 off-peak and $25 peak fares between Dallas and Houston; CAB-regulated interstate airlines charged 28 percent more on the same route. Advocates of deregulation could argue an impeccable logical case against regulation, but for noneconomists those Texas and California fares were often far more eloquent persuasion.
Also, in the middle of the four-year struggle for deregulation, airline industry resistance began to break up. Late in 1974, United, the largest carrier, said it "would welcome total deregulation." This announcement immobilized the industry lobby, the Air Transport Association. United's move was influenced partly by its long-simmering resentment at the CAB's never ever giving it the new route authority it asked for. In addition, some of United's senior executives came from the intensely competitive and unregulated hotel business and may have felt confined by the sheltered workshop environment they found in aviation.
The Carter White House, too, played some hardball politics with the airlines. United suddenly seemed to get better treatment in overseas route allocations after it had made its dramatic announcement. A Western Airlines spokesman said bluntly that his airline followed United in endorsing deregulation because President Carter was treating United better: "During the legislative process, we realized we were paying too heavy a price in being opposed to it. Our route awards dried up, so we changed sides."
The funniest aspect of airline deregulation was the way the law came to include a "sunset" clause mandating elimination of the CAB after seven years. It was inserted by pro-regulation Rep. Elliott Levitas (D–Ga.), who hoped to build opposition by making the deregulation bill more extreme. He figured Congress would never vote for abolition of the agency and that this would be a "killer amendment." Kahn opposed the sunset clause at the time on just these grounds. But it was never thoroughly debated, since most lawmakers believed that such an extreme clause would be dropped in conference. Somehow, apparently by accident, the sunset provision never got axed, and so for the first time in the history of federal regulation a major agency was simply abolished by law.
To be sure, no such victory is ever complete and final, for as George Shultz said in another context about Washington politics, nothing is ever settled in this city. Every issue gets fought over and over. In air transport there are still battles to be fought (perhaps at the state and municipal level principally) to get the supply of airport capacity freed up so the airports can respond to the greater flow of aircraft and passengers that deregulation has brought. And there are issues of air traffic control still unaddressed by the feds.
But having seen how a small bunch of persistent economists, some honorable public servants, and several otherwise rather ordinary politicians were able to transform an industry—against the opposition of all the established airline companies—in just four short years, it seems a little less hopeless to think that we might one day be able to privatize and deregulate the mails, abolish farm subsidies, and have competitive unsubsidized transit.
Above all, airline deregulation is a good-news story for idea-mongers and idealists, the people who devote themselves to the good old "public weal" and who really get steamed up about the unnecessary bureaucracy, inefficiency, and downright stupidity of a regulatory regime. For, here, they won one.
Contributing Editor Peter Samuel is a Washington journalist. He has written for REASON on deregulation of transit and telecommunications in the United States and, most recently, on the New Zealand Labour experiment in economic reform (March 1987).
$100 billion and a whole lot of time
Back in the late '60s and early '70s, Fred Ebner traveled to Europe in his job as a textbook publisher's representative. But after retiring for health reasons, he couldn't afford to vacation in Europe on his own. Airline tickets were just too expensive.
"Being a retiree on a limited income, it was just not possible for me to travel the way I wanted to," he recalls. "But when they deregulated the airlines it made it possible for me to travel again by bringing about a drop of several hundred dollars in the trans-Atlantic fare." Ten years after deregulation, Ebner still finds rates on the North Atlantic route some 30–60 percent less than they were in the early '70s—even without accounting for inflation.
Ebner is only one of millions of consumers for whom deregulation has opened up new opportunities for air travel. U.S. airlines carried 447 million passengers in 1987, up from 240 million a decade earlier—an increase almost the size of the entire population of the United States. In a February 1988 report, the Federal Trade Commission estimated that airline deregulation has saved consumers more than $100 billion in lower fares since its inception. The annual savings totals $10–12 billion.
But deregulation has done more than simply save money. It has changed the way Americans think about flying. No longer are airplanes off-limits to all but the business traveler and the wealthy tourist. Like long-distance phone calls or VCRs, flying is a former luxury most consumers take for granted. "It's affordable now for students, for families, retired people—different groups are able to travel now by air, where before it was the bus or the train," notes Liz Venable, a travel agent at Bon Voyage Travel in Austin, Texas.
Airline deregulation has knit families together, encouraged long-distance romances, and popularized the four-day Hawaiian vacation. When airlines hike their prices before Thanksgiving, it makes the evening news—precisely because nearly everyone nowadays can at least contemplate buying an airline ticket. And if airline jokes have become fodder for most comic routines, that, too, is because the audience is flying.
Matt Pinsonneault doesn't remember the days when the only way a college student could afford to fly was to spend hours hanging around airports in hopes of getting a standby seat. A computer science major at the University of Texas in Austin, he worked at a programming job in St. Louis last summer and flew back home to Houston frequently. Although the company he was working for paid for the flights, he found the round-trip prices—sometimes as low as $120—very reasonable, thanks to fierce competition. (And it's hard to imagine a company footing the bill for such a fringe benefit back in 1978, when a round-trip ticket—on a 45-day advance purchase—would have cost $292 in today's dollars.)
"The rates weren't bad, and flying is a hell of a lot faster" than other forms of transportation, notes Pinsonneault. "Getting to and from places [on the airlines] is pretty easy. Getting in and out of the airport is not so pleasant."
Indeed, airports seem to be the number-one complaint, especially among business travelers. "Airports haven't kept pace with flyers," notes Gary Battson, director of the import-export division of Hoechst-Celanese, a polyester film manufacturer in South Carolina. A frequent flyer, he says the huge increase in the number of travelers has degraded service: "Airlines today treat you as one of the herd."
While deregulation has undoubtedly overstressed airports, other travelers believe competition has made at least some airlines more likely to give good service. "Today, in some airports the people are friendly, some discourteous. In the old days, they were all somewhat indifferent," says Marlin Miller, a branch manager at Kranco Inc., a Houston heavy-equipment company. His colleague Ray Bauer, vice president of service, thinks competition has even improved airline food, which once resembled military grub.
By bringing air travel to the masses, airline deregulation has brought the masses to air travel. That means more crying babies and fewer empty center seats. But it also means more choice—and greater competitiveness for American business. Says Miller: "We do a lot of flying from Houston to Los Angeles, and the fares are nothing at all because of the competition. It used to be, whatever airline you took, you paid one price and it was high." The days of take it or leave it are gone.
Lawrence Person is a contributing editor for Nova Express magazine and was a runner-up in the Institute for Humane Studies' Felix Morley Memorial writing competition in 1987.
Clear the Runways
Ending congestion and delays
James L. Gattuso
"Sure, air fares are lower. Sure, flights are more frequent. Sure, vast numbers of people now routinely hop on a plane to get where they're going. But what about the delays?"
Airline deregulation has become a victim of its own success. By opening up air travel to millions of Americans, it has strained the capacity of U.S. airports and airways. The results: delayed and cancelled flights, missed connections, overworked air traffic controllers, overcrowded airports, and angry travelers—some of whom blame deregulation for their troubles.
To resolve these problems, the United States could return to its old system of regulation. This would jack up prices and put an end to travel for the masses. While reregulation would reduce congestion, it would hardly improve the lot of consumers.
The alternative is to look at what airline deregulation didn't touch. The 1978 act did nothing to address other crucial components of the aviation system—including the airports and airways. These vital parts of the aviation infrastructure are owned and operated by government agencies, insulated from most market forces and private-sector incentives.
Airway and airport systems can be designed to better meet the needs of air travelers. As with the pre-1979 airline cartel, the trick is to increase market incentives and the role of the private sector so that operators will respond quickly to the needs of consumers.
A prime target for policymakers who want to help travelers is the air traffic control system. Currently, the system in the United States is almost completely owned and operated by the federal government, through the Federal Aviation Administration. Except for a handful of people at some very small airfields, controllers are FAA employees. The FAA also operates all "en route" control centers and virtually all airport towers. Federal taxes on passenger tickets and on aviation fuel provide most of the funding. Accordingly, all spending on air traffic control must be authorized and appropriated by Congress.
This structure has caused enormous problems, with difficulties most apparent in three main areas:
Personnel: Controllers are federal employees, and civil service rules limit the ability of managers to reassign them or alter their duties as needs arise. Moreover, civil service employees across the country have to be paid on a uniform nationwide scale, making it difficult to attract enough controllers in areas with a high cost of living, such as Chicago. The result: overworked controllers and increased friction between management and labor.
Procurement: The air traffic control system suffers from similar inflexibility in obtaining equipment, because of the federal government's elaborate procurement rules. It often takes the FAA years longer than the private sector to put new technology in place. For instance, parts of the FAA's "National Airspace System Plan," a 10-year project begun in 1983 to modernize the traffic control system, were already 4 years behind schedule by 1987. Secretary of Transportation James Burnley recently admitted that new computers and other systems are often "technological relics" by the time they are actually put in place.
Budget: Because Congress must approve all expenditures for air traffic control, political pressures often override the needs of users. Spending, for instance, can be directed to particular congressional districts or to areas of media attention, regardless of real need. Worse, managers of the system find it difficult to plan for the long term since they cannot predict when—or whether—Congress will appropriate funds.
As part of the federal bureaucracy, the air traffic control system will always be hampered by administrative and bureaucratic restrictions that hinder its ability to serve travelers. Recognizing this, some policymakers, including the President's Aviation Safety Commission, recommend reorganizing the U.S. air traffic control system as an independent agency, free of federal personnel and procurement rules and funded directly by users.
Such a reorganization would improve the situation by taking the system out of the federal bureaucracy. Yet it would fall far short of what is needed. While an independent agency would have the ability to respond to the needs of air travelers, it would still lack the incentive to do so. Its managers would still be ultimately responsive to political authorities—the president and Congress—rather than to its users.
Anyone who doubts this should consider the record of the Postal Service since it was reorganized in the 1970s. As a government corporation, it was given even more independence from the federal bureaucracy than envisioned for the air traffic control system under this plan. Whether or not this improved the Postal Service, there is near-universal agreement that the system's quality and efficiency still fall short—so much so that privatization of mail delivery has become a very live option.
If we really want to improve the ability of the air traffic control system to meet rising demand without sacrificing safety, the best alternative is to move directly to privatization. As envisioned by the Reason Foundation's Robert W. Poole, Jr., a long-time observer of the air traffic control system, the government could divest itself of these operations in two parts. The "en route" system could be operated by a user-owned cooperative made up of the airlines, private pilots, the military, and even air traffic controllers. It would be subject to safety regulation by the FAA but would otherwise be free to operate the system as it saw best. As system users, the coop's owners would have strong incentives to adopt improved technology, adjust employee pay and assignments to meet local conditions, and put money into the operations that need it most.
The Poole plan would also put the operation of local airport control towers—from which take-offs and landings are directed—in the hands of the airports. Because local tower operations represent a discrete and separate function from other aspects of traffic control, there is no reason for tower controllers to be employed by the same organization. Under this arrangement, airports could determine for themselves how best to operate their towers. In Great Britain, such a system has been in place since 1972, allowing individual airports to operate their own towers, hire private companies to do so, or contract with the national government for the service. Airports can choose operators who best meet their needs, while each operator—whether public or private—has a strong incentive to provide the best service possible.
As a second-best solution, if full privatization proves politically impossible, the national air traffic system could be kept under nominal federal ownership but controlled by a board substantially selected by the users. Local operations could still be devolved to the airports, as in Britain. Unlike the current system or a government corporation, this plan would offer managers a direct incentive to please users rather than politicians, although the federal government would still have a connection to the system.
Getting government out of the air traffic control business would not, however, end airport congestion. As deregulation has increased demand for flights, the old first-come, first-served way of doling out take-off and landing slots has completely broken down. But the "scheduling committees" that have taken its place divvy up slots based more on clout than on who actually values the slots the most. And airports still charge for runway use based on aircraft weight rather than supply and demand.
As a result, take-off and landing rights are misallocated. For instance, although airports, like phone companies and electric utilities, have certain "peak hours" when traffic is busiest, airlines and private pilots have few incentives to reduce congestion by flying at another time. A jet landing at an airport at 4:00 P.M. often pays the same fee as one landing at midnight. Moreover, weight-based fees have nothing to do with the economic value of the slot itself. Lightweight private planes may pay only $25 for landing at a busy airport, even when a jumbo jet carrying hundreds of passengers is thereby kept waiting.
Market principles can be used in several ways to allocate these rights more sensibly. Most simply, airports could charge fees that vary according to the demand for taking off and landing at particular times. To better manage the flow of traffic, an airport could charge more to depart at 5:00 P.M. than at 11:00 P.M. Since such charges would be reflected in ticket prices, travelers would then have an incentive not to fly at peak times unless the value of doing so matched the higher price.
Alternatively, airports could auction specific take-off and landing slots, allowing users to bid for rights at a particular time. In this way, the slots available at each airport would be distributed according to how highly users valued them. If United expects its 5:00 flights into O'Hare to be full, and Continental can sell only half its seats, it's not hard to guess which would bid more for a 5:00 slot.
One last reform that policymakers need to explore is moving airports into the private sector. Currently, all the major airports in this country are owned by one or another unit of government—typically by local airport authorities. While most of these airports are self-financing and fairly well run, like other governmental entities they may have less incentive than private firms to serve their users and may be more lethargic about adjusting to changing conditions. As the need for new and expanded airport capacity grows, this will become more of a problem.
In Great Britain, most major airports are already privately owned, including London's Heathrow and Gatwick airports. Privatization, of course, cannot solve all of airports' problems. Regardless of who owns an airport, it may face such obstacles to airport expansion as noise and zoning regulations. But even here the profit motive can serve well, by inducing airport operators to find ways to overcome these problems by boosting efficiency.
All of these changes would help extend the successes of airline deregulation. Everyone agrees that it has chalked up successes; few deny that it has also brought problems in its wake. But the answer is to go all the way with air travel deregulation, not to pull back. Today's problems can be traced to continuing government involvement in air travel in the United States. The process begun by airline deregulation needs to be completed.
James L. Gattuso is McKenna Senior Policy Analyst in Regulatory Affairs at the Heritage Foundation
Onward and Upward
Free the airports
Robert W. Poole, Jr.
"Exactly 10 years after it began with much ballyhoo, the great American air deregulation 'competition' is over," wrote syndicated columnist Bob Maynard in September. And a June 1988 Consumer Reports cover story explained "The Big Trouble with Air Travel." The villain in both pieces—and many others—is the relatively new phenomenon of "fortress hubs." Airline deregulation, many people seem to think, has ended up replacing national monopolies with local monopolies.
On a national level, eight major airlines compete vigorously, and the largest (Texas Air's combined total of Continental and Eastern) holds only 20 percent of the market. But at a number of big-city hubs, a single airline has come to predominate: USAir at Pittsburgh (84 percent of all flights), TWA at St. Louis (82 percent), and Northwest at Minneapolis (80 percent). Salomon Brothers airline analyst Julius Maldutis found in a 1987 study that 40 of the 50 largest airports in the country are "highly concentrated"—meaning that only one or two airlines provide the majority of service.
Concern that dominant airlines may overcharge passengers has led to calls for the federal government to step in with some form of regulation. Even Alfred Kahn, the father of airline deregulation, has advocated reregulating the fares of single carrier routes from concentrated hubs. Others want to use the antitrust laws to break up the airline mergers that have led to some of the more extreme concentrations.
How much of a problem are fortress hubs, in fact? And if they are a problem, what should be done about them?
The development of hub-and-spoke route structures is one of the greatest productivity-increasers in airline history. Trying to serve more than a handful of city-pairs with a modest number of airplanes is very difficult if you try to link them all on a point-to-point basis. But by feeding flights into a central hub where people can change planes, the number of possible city-pair combinations escalates dramatically. For example, an airline that serves 30 cities can provide flights from any one of them to any other one—900 possible pairs—with only 30 planes, using a central hub.
It's been estimated that to provide just a single nonstop flight per day between every city-pair currently receiving airline service would take 162,000 flights—nine times—the present level.
Deregulation did not create the hub-and-spoke system. Delta has been using it at Atlanta for as long as anyone can remember. But by getting the government out of the business of deciding which airlines could serve which routes at which prices, deregulation allowed airlines to opt for greater efficiency by switching massively to hub-and-spoke systems.
Passengers and airlines alike have benefited from the change. Hubbing permits more-frequent service, though it increases the possibility of having to change planes. Still, most passengers today fly either nonstop or make a single plane-change at a hub; the old two-stop, three-stop, and four-stop flights from the CAB era are long gone. Average travel time has decreased. And because hubbing allows airlines to fill more seats on each flight, they can be more competitive in pricing—which helps explain why air travelers are saving some $10 billion a year on fares.
And, while the charge that localized airline monopolies are ripping off consumers has some validity, there's less to it than you might think. Economist Paul Bauer points out that if an airline starts a hub, as American did at Nashville, and ends up with 60 percent of the traffic, as much as half that market share may simply represent brand-new through traffic—people changing planes at the hub. So the 60 percent figure exaggerates the extent of the problem.
In fact, a study by Boeing Co. found that fares for such through services via fortress hubs are highly competitive. For instance, passengers flying from Cleveland to New Orleans, a route that has no nonstop service, can choose among four airlines connecting through four different hubs: TWA (St. Louis), United (Chicago), Delta (Atlanta), or Northwest (Memphis).
But that same Boeing study found that the opposite is true of local service from fortress hubs. Local flights originating at USAir's Pittsburgh hub, for instance, cost nearly 50 percent more than the "Standard Industry Fare Level," TWA's from St. Louis about 42 percent higher, and so on, for 14 fortress hubs. No wonder many people are worrying about captive consumers.
How can airlines acquire such huge market share at hub airports? Wasn't freedom of entry the hallmark of deregulation? To be sure, the federal government no longer prevents any airline from seeking to serve any route it wishes. But to serve a city, the airline must be able to land and take off. And here it runs right up against the local, regional, or state government that operates the airport.
Airports are inherently commercial enterprises; they can and do make money for their municipal owners. But that does not mean they are run like for-profit businesses. Federal policies, bureaucratic tradition, and nonmarket thinking have combined to make airport operations a kind of bureaucratic-socialist enterprise—which the airlines have long since learned how to manipulate for their own benefit. As a result, incumbent airlines can insulate themselves from new competitors.
The name of the game is to limit access to terminal gates and to landing slots. Incumbent airlines often have a lock on both.
Before deregulation, airport operators who needed to sell bonds to finance their terminals were glad to sign long-term leases—for as long as 50 years—with their existing airline tenants. In exchange for agreeing to sign, the airlines insisted on "majority in interest" clauses in the leases. An MII clause requires the airport operator to get permission from a majority of the existing airline tenants before embarking on any additional bond-funded expansion.
As long as CAB regulation severely limited entry, those clauses were of little consequence. But today, airlines use them to maintain their virtual monopolies. USAir, for example, okayed a new Pittsburgh terminal only on condition that the old terminal could not be used by other airlines and USAir would get an increase in gates from 33 to 42, while all other carriers would still have just 20. Similar provisions required the demolition of the old Atlanta terminal when the new one was built—to protect the dominant positions of Delta and Eastern. Today, Continental and United are in court trying to prevent Denver from building a new airport that would be large enough to accommodate a third large hub operation.
To make matters worse, landing and take-off slots—the right to use the runway at a specific time—are generally parceled out not by supply and demand but by haggling between interest groups in appointed "scheduling committees." Here again, the incumbent airlines tend to predominate.
Something of a market in slots does exist at four of the country's largest airports, but with a fatal flaw. The federal government has imposed a ceiling on the number of slots per hour at O'Hare, Washington National, LaGuardia, and Atlanta's Hartsfield airport. Within the ceiling, the Federal Aviation Administration does allow airlines to buy and sell these airports' slots among themselves. Advocates said that this process would let the market allocate slots, much as it allocates 737s. But Boeing sells 737s to anyone who has the asking price, and it keeps producing them until the demand is filled. Nobody is producing any more slots these days. And, predictably, there have been very few sales by fortress hub incumbents to would-be entrants.
What we have, then, is an artificial scarcity of airport capacity at our government-owned airports. Breaching these fortress hubs will not be easy, but a thought experiment can show how to do it. Suppose airports were run as for-profit enterprises. When a demand existed for more service at a hub (local passengers wanting more choice, airlines wanting to provide it), it would be in the interest of the airport company to meet this demand. Presumably, it would do this by adding capacity: building more terminal space and adding runways or electronics to create more landing slots. It would be able to finance these additions by charging its users: passengers, airlines, concessionaires, and so on.
It would not be in the interest of a for-profit airport company to link its future to one or two airlines. And under today's competitive airline conditions, an airport company would not need to rely on long-term leases to obtain financing. Given the serious constraints on building new airports in urban areas, increasing the capacity of existing airports is a guaranteed money machine—what one airline doesn't need, another will be glad to use.
In short, since airport capacity is scarce, we need to make it profitable to be in the business of providing airport capacity. Airport privatization—ideally—would do the trick.
Five years ago the very phrase "airport privatization" would have sounded fanciful. But today airports are one of the new frontiers of privatization. In 1987 the British government privatized the British Airports Authority; it is now a for-profit, shareholder-owned enterprise that owns and operates Heathrow, Gatwick, and a number of other airports. Less flamboyantly, the Canadian government is in the process of selling off that country's major airports to enterprises owned jointly by investors and local governments. New Zealand, Malaysia, and Thailand are all considering selling government-owned airports. And both the Japanese and Chinese governments are using private capital and management to develop all-new airports.
Here at home, the management of parts of major airports by private contractors has been quietly growing over the past decade. Only one airport serving major carriers—Burbank—is operated entirely by a private firm, Lockheed. But Merrill Lynch has been holding discussions with Atlanta officials about a possible purchase of Hartsfield International by an unnamed (but rumored to be Japanese) group of investors. And Denver officials are discussing a major role for the private sector in financing and building their new airport—precisely to get around resistance from Continental and United.
Even though most airports are not going to go private, at least in the near term, there are ways to get them to operate more like for-profit enterprises. Federal policy imposes many barriers, which should be speedily removed in order to open up entry at fortress hubs. Airports need to be given the freedom to create new capacity, in both gates and slots, to facilitate service by additional airlines. Since capacity depends critically on the adequacy of runways and landing aids, the control tower and the equipment that guides planes in for landing should be transferred from the FAA to the airport operator.
Last October's drastic cutback of flights at O'Hare, for example, stemmed directly from the shortage of controllers and obsolescence of the tower and equipment. But the FAA can't allocate the necessary money for upgrades because O'Hare competes with the "needs" of airports in 434 other congressional districts. Were O'Hare the owner of the tower and equipment, and the employer of the controllers, it could generate the funds to remedy these deficiencies in short order.
And that leads to the second requirement. Airports must be given the authority to charge market prices for their services—which they cannot now do, under the regulations imposed by the federal airport grants program. Any airport that elected to opt out of the grant program should be free to do so. In exchange, it would gain the authority to levy both passenger facility charges (probably $3–5 per passenger) and landing fees based on supply and demand.
With hefty new sources of revenue, commercial airports would not need federal grants, nor would they be dependent on municipal bond revenues linked to majority in interest (MII) clauses. But to hasten the demise of fortress hubs, it would also be interesting to explore the applicability of the antitrust laws to the MII clauses. A plausible case can be made that by making such agreements, airport authorities are "restraining trade" as that term is used in the Sherman Act.
Finally, the above changes would make explicit what is only implicit today: that a "slot" is physically the creation of the airport authority, not the airlines. The addition of a microwave landing system or a separate runway for commuter planes can substantially increase the number of slots. Hence, slots should be legally recognized as the property of the airport, not the airlines. It is highly likely that airport operators—even government ones—would not sell their slots but would auction off the right to use them for relatively short periods, probably a few years at a time. This, too, would facilitate entry by newcomer airlines.
In short, airline deregulation has not failed, even though fortress hubs have popped up in some locales. Rather, Congress has failed to complete the job of opening up markets for air service. Rather than reimposing regulation, the urgent task today is to breach the fortresses, letting in the winds of competition.
Robert W. Poole, Jr. is president of the Reason Foundation and publisher of REASON. A former aerospace engineer, he has written widely on aviation issues.
Surprises, But Few Regrets
A conversation with Alfred E. Kahn
Interviewed by Robert W. Poole, Jr.
Alfred E. Kahn is, officially, Robert Julius Thorne Professor of Political Economy at Cornell University. But most people just call him "the father of airline deregulation," a title he garnered as head of the Civil Aeronautics Board from 1977 to '78. Accessible and opinionated, he is still sought-after by reporters looking for good quotes and for signs that he might disown his controversial offspring. But while he does offer the occasional criticism, particularly of airline monopoly power, Kahn's disenchantment with deregulation has been greatly exaggerated. He is, was, and will be a proud papa.
"Now," he wrote recently in Regulation magazine, "when a plane crashes or nearly does, or when congestion, delays, labor unrest, a bankruptcy, accident, price war—or a price increase!—or a rash of lost baggage puts the airline industry in the news, one reporter or another will look up my number and call me to ask if I am sorry for what I did. My invariable answer is no. I would do it again." Kahn was interview by REASON publisher and long-time airline watcher Robert W. Poole, Jr.
REASON: When you assumed the CAB chairmanship, did you think deregulation would go as far as it ended up going, actually eliminating the CAB?
KAHN: No, I did not. Very few people foresaw that end result, and surely not that it would come so quickly. I do remember specifically saying that I really preferred to be on the Federal Communications Commission. That was the future. I didn't regard it as my highest aspiration to make it possible for people to jet all over the world. And I thought what I was doing in New York, where I was chairman of the Public Service Commission, regulating gas, electric—the whole energy and telecommunications field—was more important. But then finally I became persuaded that, by an interesting conjuncture of political and economic developments, airlines was where it was going to happen first.
REASON: What created the critical mass of support to make airline deregulation happen?
KAHN: I think a whole series of circumstances. The industry had engaged in a total substitution of jet for piston craft, partly because the regulations forbade them to price their flights on piston craft intelligently. They should have been free to reduce those prices to whatever point necessary as long as they could cover their incremental cost—so as to continue to use what were not obsolete planes. This was equipment that still had good economic life.
REASON: But because the planes had been depreciated—is that it?
KAHN: Because the airlines were not permitted to have price differentials. Since you had to set the same prices, obviously no passenger was going to travel on a piston aircraft if they could travel on a jet. So the airlines had gone not only the entire jet route but then the wide-bodied jet revolution. The industry found itself with an enormous excess capacity—all those beautiful, empty seats waiting to be filled.
REASON: But didn't that lead the industry to fight more doggedly to preserve regulation?
KAHN: It had two effects. On the one side, yes. It led the CAB for five years, about '70 to '75, to refuse as a matter of policy to entertain one single request for new route authority.
At the same time, the industry was not making any money. For five years the trunk carriers averaged 3 percent on equity. So it began to look attractive to some firms to say, Look we've got all these empty seats. It was American that came up with the idea of the SuperSaver: capacity restricted, low fares, well above incremental costs, clearly compensatory. Then some of the carriers, particularly United, which never was permitted to get a new route because it was so big, began to say, Well, maybe we can do better in a free market.
REASON: Do you think the fact that it was a Democratic administration helped? And that people like Ted Kennedy supported it, when deregulation had more traditionally been associated with Republicans?
KAHN: I think it probably helped. But of course, the initial proposals came in the Ford administration. As a matter of fact, it was Kennedy—that is to say John Kennedy's Council of Economic Advisers, back in the early '60s—that began to propose some deregulation of transportation.
REASON: That I didn't realize.
KAHN: Remember, also, that anybody who is a strong anti-truster ought to be opposed to regulation. So it was the convergence of the free-market people and the antitrust tradition, in which Kennedy is very strong. We had a most interesting political alliance of the National Association of Manufacturers and Ralph Nader. We had Common Cause and we had the National Federation of Independent Businesses. We had the Ford Motor Co. and we had the Consumer Federation of America.
REASON: Which is really quite an unusual coalition. Looking back now from 10 years, has deregulation worked about as you expected?
KAHN: Yes, it has for the most part. I would, of course, not claim there were no surprises. If the regulators could be omniscient, then regulation could work perfectly well, but the essence of the case for the free market is unknowability. That's one answer.
I was amazed at how rapidly people came into the industry and how much they succeeded for a while. The extent of price competition exceeded my wildest expectations. On the other side, the rapidity of the disappearance of all those competitors—I knew there would be turmoil, I knew there would be entries and exits and reorganizations. An industry that had been in a hothouse of protectionism for 40 years, you would expect a great shakeout. But both the turmoil on one side and the shakeout on the other were far more extreme than I would have expected.
One of the ways in which we were clearly mistaken was in expecting that the more you got really intense competition, the more you would get uniform prices. Because we all know as economists that price discrimination is a phenomenon of monopoly. But I remember also saying, This is an industry in which you're always going to have marginal costs way below average total costs if you have scheduled flights, and therefore we are probably never going to lose patterns of price discrimination.
And it turns out that the advantages have been enormous for the hub-centered, big, brand-name carriers, who have also with extraordinary rapidity: One, got their costs under control, which we hoped and expected. Two, developed computerized reservation systems, which have given really overwhelming competitive advantages. Number three, developed a brilliant marketing technique, the frequent flyer program. And the override commissions—if you are big at the hub you can offer commissions giving major incentives to travel agents.
We emphasized the contestability of airline markets and thought people would be well protected by the possibility of entry, because airplanes can move. Well, I think we exaggerated that and failed to realize how the combination of circumstances that I just described has made new entry highly unlikely—except by existing carriers.
REASON: It's charged that deregulation has led to reductions in safety. True or false?
KAHN: I don't know of any evidence of that. The principal evidence—objective evidence—would be accident rates, which, as you know, are down 35 percent to 40 percent with no trend observable within 10 years of deregulation.
REASON: Are you worried at all that there might still be some trend that has not shown up in actual crashes?
KAHN: I think we have to be alert to it. We must recognize, of course, the principal protection is never government regulation but the incentive of the people in the front of the plane. We've got two hostages. And the fact that the airline company which has a series of crashes is finished.
REASON: And there's actually evidence that they get punished immediately in the stock market for crashes.
KAHN: Absolutely. The fact remains, that there may be, under pressure of competition, some temptation to cut corners—even if you discount, as you must, the complaints of the disgruntled pilots and machinists, who are obviously not happy about deregulation. I can't deny when companies are losing hundreds of millions of dollars a year, there may be some strong temptation to say, Take off, we'll look at you later. And that's why I'm not a total free-marketeer and believe that you do have to engage in safety scrutiny.
REASON: Was there any thought given in the process of crafting deregulation to making sure that the FAA, which after all has the responsibility for safety regulations, would keep pace?
KAHN: I wrote formally to the head of the FAA to say, You have an increasing responsibility for safety. There are going to be new carriers, probably more of the business will be taken over by commuter carriers, who on average have a poorer safety record. And more people are going to be flying, and therefore, FAA, we want to alert you to the fact that we are deregulating and you've got to increase appropriations.
REASON: And yet that didn't happen. Congress failed to act.
KAHN: Absolutely failed. That relates to some of the things you have been saying about the absurdity of having the FAA's budget incorporated with the federal budget.
REASON: It relates also not only to the safety, but to the problem of delays and congestion.
KAHN: I made a speech on airport congestion at the FAA conference in 1978, in which I said, You have got to start pricing airport landings intelligently. Don't expect us to do irrational things in order to protect you. Don't expect us to ration flying. We are going to move in the direction of liberalizing, and you have got to mend your ways. Now of course the FAA is just—and DOT—it's just incredible their stupidity. Particularly in an administration that is supposed to understand how the free market works.
REASON: What would you change about the way air traffic control is provided to keep pace properly with the needs that are out there?
KAHN: I've not gotten as far as you in having great certainty about what is the ideal method of organization. I certainly agree that this is a perfect case in which services are being supplied to particular people who should pay for them.
REASON: You're saying it should be directly user-funded.
KAHN: Precisely. I believe in user fees. But I think the other side of the coin is that when you pay the fees you should get the services. So I feel strongly, second, that being subject to civil service procurement, civil service personnel compensation, and the like does not make sense when you're talking about the supply of essentially commercial service. So I'm attracted to the idea of air traffic control being supplied by some relatively autonomous self-financing agency. I'm similarly attracted to the idea of the airports having incentives to price intelligently.
REASON: Every time market pricing is suggested, the small-plane owners say, Wait a minute, this is all wrong, we pay through user taxes for access and it's unfair, discriminatory, to keep us out.
KAHN: That's ridiculous. The fact that a service is supplied by government authority does not mean that one has a right to it regardless of cost or price. I'm probably much more prepared than you to make some services available to people regardless of their ability to pay. But I would subject those to a means test—and as I said to these people when they raised this question to me, If you're prepared to make a good case for airline travel stamps, like food stamps, for people who can't afford it, I'm prepared to say okay.
REASON: Or Learjet stamps.
KAHN: Yes. But as long as we are dealing with a scarce resource in which there are genuine economic costs imposed by landings, costs in terms of congestion and delay and exclusion of other people, then we have no choice but to use those limited resources, intelligently, to price them. When a Learjet with 1 or 2 or 3 passengers uses up space that would otherwise be used by 200 or 300 people congregated in a larger plane, I do not believe in excluding them arbitrarily, but I believe in making them pay the price.
REASON: If it's really worth it to them, let them pay it, sure.
KAHN: By the way, I think that is in large measure the answer to the commuters who claim that they will be excluded from the market because a plane with 20 people can't pay as much as a plane with 200. The question is not whether one plane with 20 can pay as much as one with 200, but what will people pay for the first commuter trip out of a relatively small community in order to be able to travel at a congested time as compared with the fifth trip out of a big community.
REASON: One of the biggest problems with deregulation in the last few years seems to be the phenomenon of "fortress hubs," where there does seem to be some kind of limitation of competition imposed by one or two carriers gaining a very predominant position. What is your solution to that problem?
KAHN: Oh dear. Well, I don't have a solution to all the problems of the world.
REASON: But as the father of airline deregulation you are expected to.
KAHN: Well, my first answer is that the industry as a whole is far more competitive and customers are clearly saving $10–15 billion dollars a year. Number two, the benefits are clearly being unequally distributed. I don't have any doubt that there are people who begin or end trips at fortress hubs—particularly nondiscretionary travelers who can't stay over a weekend—who are indeed paying monopolistically high prices. Some of the fares that I hear of, even after I adjust for the inflation of airline costs that have occurred over the last 10 years, do strike me as outrageous.
REASON: In other words, fares in those kind of situations.…
KAHN: I think do have a monopoly element. We must recognize two offsets immediately. One is that those high fares play an important role in determining and justifying the scheduling decisions by the airlines. And studies about the convenience of scheduling for business travelers, particularly, all demonstrate that there has been a very substantial improvement in convenience. Therefore, the people to whom that convenience is important are the very ones who are for the most part paying these higher full-coach fares.
REASON: So they may not be exploited to the degree that it seems.
KAHN: Number one. Number two they get frequent-flyer benefits. And that tends to be the same people. The fact remains that there is a residual here of monopoly that troubles me. And while I know that you're never going to solve totally the presence of monopoly power in any industry—competition is necessarily imperfect—I certainly would have wanted to see a more aggressive enforcement of the antitrust laws.
REASON: Relating to which mergers have been allowed?
KAHN: Which mergers, for example. But I hasten to say that the popular impression that this is principally the result of mergers I think is wrong. The mergers have been far more a reflection of the non-viability of competition by the smaller carriers than they are the cause of the monopoly. I am prepared to call—as I have for three years—for the divestiture of the computerized reservation systems.
REASON: But the airlines such as American and United have invested huge resources in developing those as marketing tools. Do you really think that it's justified to take them away?
KAHN: No, I don't think you should take them away in the sense that you simply deprive them of the value of their innovations. But it isn't simply that they've developed these, marvelous as they are, innovations. That would not alone explain why it is that over 90 percent of travel agents in Dallas–Fort Worth use the American system, whereas 75 percent of the travel agents in Denver use the United system. That is clearly closely related to their dominance as carriers in those particular hubs.
Also, we need to consider the preferential relationships between the hub-dominating carriers and the airport facilities. We've got to divorce the financing of airports from the long-term leases entered into by the dominating carriers, because those preferential arrangements are an impediment to free entry.
Another thing we surely should try to do—the obstacles would be enormous—is to expand airport capacity. Observe particularly the way Midway has created a niche for a new competitor, Midway Airlines, who has miraculously survived. And Love Field at Dallas–Fort Worth in the same way. Hobby at Houston in the same way. I just got a long letter from the people who are in Newburgh—you have probably not heard of Newburgh. It's about 60 miles north of New York City. There's an old military field there. You could build a limited-access road so that it would be an hour from New York City itself and therefore much less than an hour for a lot of people who now have to go to Kennedy, LaGuardia, and even Newark. And apparently it is a relatively depressed area. They might be happy to expand airport capacity. And that would also create the opportunity for new competitive entry.
I went down to testify before the Fulton County Board of Commissioners—that's out in Atlanta—on behalf of a group that was trying to set up a new airline that would just give commuter service beginning in Atlanta, going someplace and coming back—Detroit, New Orleans, a few other cities. Recognizing that those people don't need the big Hartsfield airport, over 75 percent of whose traffic is really connecting traffic. It's the commuters who are the ones who are paying the very high prices. So we were pleading with the commissioners to permit this—there was a perfect airport for turnaround service. The county commissioners wouldn't do it. It's partly the influence of Delta. Partly Coca-Cola, which uses that airport for flying crates of Coca-Cola around the world. But that would have been an entree for a competitor who might have survived because of the niche. Whereas the competitor did not survive, could not survive, in direct confrontation with the majors.
REASON: Do you see any role in expanding our nation's airport capacity for private capital and the private sector—perhaps, the airports being developed as for-profit enterprises?
KAHN: I would be all for it, simply because of my desire to open markets for anyone who wants to invest his or her capital. The problem is, however, that as long as they are competing with airports that price subject to stupid constraints, it diminishes the possibility of their coming in.
REASON: If you want to foster that kind of thing you'd have to look at some of the existing policies…
KAHN: Which hold prices to noncompetitive historic costs. And don't leave out—high on the list of possible solutions—foreign entry.
REASON: You mentioned that in a New York Times piece. Could you explain what's not permitted today?
KAHN: In the strange world of transportation, particularly airlines, things are taken as gospel that are totally unknown outside the airline field. We permit foreign companies, foreign entrepreneurs, to own hotels, to supply banking services, to own land, to own industrial establishments—to serve the American market without limitation. We do not permit foreign airlines to carry American domestic traffic. That's not just us. That's universal law. There's an eighth deadly sin, apparently, and that's called cabotage.That's the sin of a foreign-owned transportation enterprise carrying domestic traffic in any country.
REASON: If British Airways is serving London from New York and Chicago, it cannot carry any domestic passengers between those two points.
KAHN: Before I came to the CAB, even Pan Am, which might fly from San Francisco to New York to London, could not fill any empty seats on the San Francisco to New York part of the journey with local passengers. Absolutely absurd. That we eliminated with deregulation, but it remains true of foreign carriers; they cannot carry domestic traffic, nor can a foreign airline own more than 25 percent of an American airline.
It's perfectly clear that foreign carriers are more and more looking for ways to compete effectively with American carriers. They have a very severe handicap. The KLM people have said to me that they fly out of Atlanta. They have great difficulty competing with Delta, because they don't have all the domestic flights feeding into it.
REASON: That explains why SAS just made a deal with Texas Air?
KAHN: Yes. I don't expect miracles to come, but I think it's a desirable thing.
REASON: So this allows all of Continental and Eastern flights to feed traffic into SAS.
KAHN: And the reverse. Not a tremendous amount of traffic, I'm sure. A more important consideration is SAS's reputation for quality, service—and Continental and Eastern do have a very severe problem, perhaps more in perception than in reality.
I have much more mixed feelings about the British Airways–United arrangement, because that under previous antitrust administrations might well have been attacked as eliminating really strong potential competition. United, with its enormous U.S. domestic route system, is a logical carrier to go on to the international route, and British Airways, but for our prohibition of cabotage, might have been delighted to build its own domestic route system.
REASON: Could you reflect on the degree to which what we've learned from airline deregulation has some applications for other industries today? Are there other areas where we should go further with deregulation and build on what's been done with airlines?
KAHN: Of course I think that's true—although the main industries that I'll identify are ones that we have already in some measure done that to, like trucking.
REASON: But should we go further in those areas?
KAHN: We are, I think, embarked almost irrevocably on the same path—although we are only a tiny distance along the way—in electricity, in natural gas transmission and distribution, in telecommunications, and in financial markets. Now in all of these cases, there are unique aspects, the most important common one of which is that there remain large areas that may be natural monopolies. And in which we are therefore not willing, and probably should not be willing, to go all the way to total deregulation. And that creates mammoth problems of possible distortions in an industry that is part regulated and part competitive. But I think even in telecommunications, where there's been a lot of turmoil, that we are seeing the benefits of decentralized innovations and competitive entry—most obviously in the customer terminal equipment field but also in telephonic equipment generally, where Western Electric used to dominate. And in the fashioning of packages of services tailor-made, mixing telecommunications and computer technology.
I think the same thing is likely to continue in the electric field and the gas field. And again, it's likely to happen in banking as well. Though we've got to recognize that you may get into terrible distortions if you don't deregulate entirely. And nobody's prepared to eliminate deposit insurance, and we've just seen that the combination of deposit insurance and competition produces an incredible mess.
REASON: It certainly is an incredible mess, and we still don't know how large its cost is going to be.
KAHN: It's going to cost in excess of $100 billion. And that's because we have not thought through clearly the implications for other government policies of introducing competition. Just as we had not in airlines.
REASON: We failed to keep the infrastructure in mind.
KAHN: By deregulation, we've increased the demand for infrastructure, but we haven't done anything about the supply, or the effective rationing of supply.
REASON: Thank you so much. This has been terrific.