Matthew Kudija

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Why Flying Is Miserable: And How to Fix It by Ganesh Sitaraman

(New York: Columbia Global Reports, 2023), 145

Introduction

• Many of the challenges we have with flying are a product of public policy. We have had three systems in US aviation history:
  • Cultivate early airlines with subsidies
  • Airlines regulated as public utilities, or regulated oligopoly (1938 to 1978)
  • Deregulation, or unregulated oligopoly (since 1978)
• Air travel is getting worse: fewer flights to fewer places, less competition and higher prices, understaffed airlines
• Given current challenges, and given the distance we have from both the regulated and unregulated periods in our history, we should step back to reflect on the benefits of each and design a better system going forward. We should "remember and revive the American tradition of regulated capitalism." (19)
• Three principles for reform (20)
  • No flyover country (geographic connectivity)
  • No bailouts or bankruptcies
  • Fair and transparent prices

Chapter 1: The Rise of Airline Regulation

• Airmail Act of 1925 provided subsidies to airlines that would carry mail (23)
• Air Commerce Act of 1926 brought aircraft registration, pilot certification, etc.
• The 1920s were a period of irrational exuberances in the airlines, followed by crisis during the Great Depression
• Walter Brown organized the "spoils conference" to merge firms and consolidate routes (25)
  • McNary-Watres Act of 1930 allowed postmaster general to award airmail contracts to the lowest bidder
  • FDR moved all airmail to the USAAC, but it failed miserably and the Airmail Act of 1934 reopened competitive bidding
• American Tradition of Regulated Capitalism (28+)
  • Advocated by Edgar Gorrell, who thought airlines should be regulated as public utilities (now called "networks, platforms, and utilities" or NPUs)
  • NPUs are different from other industries in that they facilitate a wide range of other commercial and social activities, and they have a tendency toward monopoly or oligopoly
  • Post Office Principle: set prices using cross-subsidies, where pricing is uniform and profits from high-volume, high-margin routes offset losses from low-volume, low-margin routes but ensure nationwide connectivity (31)
    • Without the post office principle, natural competition leads to Cream-Skimming where carriers serve only high-margin routes and low-margin routes are left without service (32)
  • NPUs grow out of the tradition of the postal service, banking, and English common law
  • NPUs are regulated via:
    • Specially chartered by the government to preclude competitors from entering
    • Must accept all comers
    • Must charge just and reasonable rates
    • Cannot operate downstream or adjacent businesses
  • This tradition is distinctively American: neither exclusively public ownership or laissez-faire
  • "Too much competition can be just as bad as too little competition" (37-39)
    • Too much competition → speculation → collapse → lack of investment
• Civil Aeronautics Act of 1938 created a system that followed the American tradition of regulated capitalism, and the Civil Aeronautics Authority (CAB)
  • Routes assigned by CAB to prevent destructive competition and wasted capital, and to guarantee service to smaller airports
  • Regulated rates on a cost plus model
  • Structural separation rules
• Threefold Crisis of the 1970s:
  • Less demand from slowing passenger travel
  • Over supply from new wide-body aircraft
  • Cost inflation from fuel prices

Chapter 2: The Decline and Fall of Airline Regulation

• Chicago School economists argued that most industries were really the same and that fares would be lower without regulation, with aligned with Ralph Nader's views on Regulatory Capture (48-49)
• Stephen Breyer worked with Ted Kennedy on a committee report proposing deregulation
• Alfred Kahn then appointed to run the CAB and started shaking things up (or allowing them to be shaken up): Bob Crandall's "super saver" fares on AA, Frank Lorenzo's "peanuts fares" in TX
• Congress then passed the Airline Deregulation Act of 1978
  • Bob Crandall: "You fucking academic pinhead! You don't know shit. You can't deregulate this industry, you're going to wreck it." (59)
• "Ultimately, the internal contradictions of the deregulatory approach reflected a misguided view of the economic dynamics of the airline industry." (68)

Chapter 3: The Great Debate: Did Deregulation Work?

• Crandall: "deregulation is profoundly anti-labor and is a massive transfer of wealth from airline employees to airline passengers" (73)
• Delays in 1986 led to anti-trust immunity for airlines to coordinate their schedules (76)
• Even deregulation advocate Alfred Kahn acknowledged shortcomings of (77)
  • painfulness of the process
  • reconcentration in the industry
  • monopolistic exploitation
  • declining quality of service
• Deregulation led to an initial burst of new entrants, followed by waves of consolidation (78)
  • Consolidation encouraged by economies of scale realized from hub and spoke concentration, reservation systems and frequent flier programs, and the ability to discount fares

Chapter 4: Airlines Unleashed

• Airlines have consolidated to become "too big to fail" like banks, leaving the upside of huge profits for private shareholders in good years and the downside paid by taxpayer bailouts in times of crisis (105)
  • Major crisis years were 1990 (fuel spikes and fears of terrorism after Gulf War, a year in which the airlines lost $6B, more than cumulative profits since 1920), 2001 after 9/11 (leading to a taxpayer bailout), and 2020 from COVID (with another bailout)
  • The industry had consistent profitability before deregulation, but high volatility since deregulation
• With frequent flyer programs and credit card points, airlines have become like banks that incidentally provide air service
  • Airline points are a currency, and the airline is the monetary authority (with little transparency and arbitrary exchange rates)
• Geographic inequality has increased since deregulation, and geographic concentration has increased with "fortress hubs"
• Deregulation flipped incentives for airlines, leading to a decline in service quality
• All of these undesirable consequences (consolidation, financialization, higher prices, worse service, geographic inequality, bailouts and bankruptcies) are the result of a public policy choice (117)

Chapter 5: How to Fix Flying

• We will have to change public policy to fix flying. This requires a clear understanding of the dynamics of the industry, and clear articulation of our goals (118)
• Key features of the airline industry that must be contemplated by new policy proposals (119):
  • Network Effects: geographic reach and flight frequency increase the value of flying on a given airline
  • Economies of Scale: found in efficiency of hub-and-spoke networks (offset by fewer direct flights and the increased fragility of hub-and-spoke model)
  • Barriers to Entry: found in the physical infrastructure limitations at airports
• Proposed goals for a new airline policy to improve reliability, stability, and access (125):
  • No flyover country (geographic connectivity)
  • No bailouts or bankruptcies
  • Fair and transparent prices
• Possible policy solutions (126+):
• National Airline
  • Benefits:
    • If airlines need public support in downturns, the public should benefit from profitable years as well (or price at system cost if not chartered to make a profit)
    • Creates a single, unified system to benefit from network effects and economies of scale
    • Cross-subsidize routes to small and rural airports
  • Drawbacks:
    • Declining service quality from lack of competition
• Regulated Monopoly (single privately-capitalized public utility with contract structure)
  • Benefits:
    • Creates a single, unified system to benefit from network effects and economies of scale
    • Cross-subsidize routes to small and rural airports (government contract specifies pricing)
    • Would not need to compete on service quality (like piano bars under CAB)
  • Drawbacks:
    • Government would need to the administrative apparatus to monitor the airline
    • Declining service quality from lack of competition
    • Public Option (national carrier operates alongside private carrier with identical terms of service)
  • Benefits:
    • Maximize benefits from network effects and economies of scale while preserving competition
    • Superior to private duopoly because public carrier is not incentivized to collude with the private carrier on price or service
  • Drawbacks:
    • Unlikely to succeed unless both were required to serve all locations (otherwise private option would be incentivized to cream-skim)
• Regulated Competition
  • Benefits:
    • Less of a structural shift than the options presented above
  • Drawbacks:
    • Does not solve structural problems; opportunities for whack-a-mole; difficult to implement rules effectively
• Regulated Competition Ideas
  • Ensure geographic access with a "Regional Conference System" where major carriers serve long routes, and monopoly regional carriers connect smaller cities within their regions with cost plus pricing; or a "Draft-Pick System" where monopoly license to smaller routes are awarded periodically via a draft
  • Increase stability with requirements to Mandate Rainy Day Funds, Deconcentrate Fortress Hubs, or Unifying Labor Negotiations across the industry
  • Support fair and transparent pricing with regulation based on equal fares for equal miles, anti-trust litigation, or required uniform seat pricing

Conclusion: Reviving the American Tradition of Regulated Capitalism

• "That a huge and essential part of the economy was radically transformed in a matter of just a few years based on such an inaccurate understanding of the industry is shocking." (141)
• We have seen similar failures of regulation in railroads, telecommunications, energy, and banking; but antitrust law is having a revival (neo-Brandeisian movement).
• "The American tradition has recognized that regulation is often the only way to avoid capitalism's abusive tendencies while harnessing its benefits." (144)

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Topic: Aviation, Economics

Source

• 2023-09-27 Airlines Are Just Banks Now

Further Reading

• Hard Landing
• Rapid Descent

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Created: 2023-09-27-Wed
Updated: 2023-12-26-Tue