Very interesting program on the Diane Rehm Show on the ill health of the American airline industry. Clearly record high prices for jet fuel are a major contributor to the problem, but there are other problems with the airline industry as well, some of which I don't fully understand. Some interesting tidbits from the program:
- The airline industry was de-regulated in 1978; wikipedia suggests that prices as well as routes and schedules were regulated by the government. One claim is that the de-regulation of the industry has allowed new carriers to spring up rather quickly and drive prices down throughout the industry. These new carriers can evidently buy or lease planes with little or no money down, charge low prices until their IPO, then declare bankruptcy later. Bob Crandell, former chairman and CEO of American Airlines and one of the guests on the program, points out that over 200 new airlines have come and gone since de-regulation in 1978. On one hand, the constant pressure of new carriers charging low prices drives down prices for consumers; on the other hand it doesn't allow the major airline companies to price flights high enough to cover their costs and leads to an industry that doesn't make any money as a whole, which is disconcerting given the relative importance of air travel to the overall health of the US economy.
- For background on regulation: Timothy Taylor devotes a lecture to regulation in Economics, 3rd Edition, a series of lectures recorded for The Teaching Company
- His observations about regulation of the airline industry are not unique and he cites a number of sources in the lecture's bibliography
- By the way, the lectures from The Teaching Company are of very high quality, and once you buy something they send you enough special deals and put enough material on sale that you can pretty much guarantee the $50 sale price to download 36 30-minute lectures on a topic of interest.
- The airline industry in the late 20th century resembles the railroad industry in the late 19th century in that there are very high fixed costs to build the network (expenses to lay track VS expenses to buy places, build airports, set up a massive air-traffic control system, and establish a system of flight connections), but very low marginal to operate the network. So once the network is set up, new companies keep forming, driving down prices, and preventing everyone from making any money.
- Other industries that are chained to an expensive fixed network, such as gas, electric and water utilities, also don't lend themselves nicely to competition and are typically regulated in some way, such as a regulated monopoly
- The telephone network used to be a regulated monopoly, but was eventually broken up into several smaller companies
- Notes on government price regulation:
- Cost-Plus Regulation: The company can charge a price that's high enough to recover their costs, plus a certain amount of profit. Terrible idea because there is absolutely no incentive to cut costs!
- Price-Cap Regulation: The company is allowed to charge a certain price for a period of time, and can make more profit but cutting their costs substantially below that price. Not as good as market competition, but much, much better than cost-plus regulation.
- Note that de-regulation in this context means that the prices were de-regulated; this does not mean that the FAA got rid of safety standards for the airlines! That's a different type of regulation.
- Also note that government regulation carries the risk of regulatory capture, the term for a revolving door for personnel between the regulatory agency and the industry under regulation that weakens the impact of regulation.
- Reading between the lines, I imagine there airlines were regulated by cost-plus or price-cap prior to 1978, and the price de-regulation in 1978 opened the door to competition from new start-up airlines that has decimated the industry.
- So it looks like there are structural problems to the airline industry such that unfettered competition drives down prices for consumers, but ultimately drives all the airlines out of business. One thing I'd like to know is how to measure the impact of air travel on the US economy, and what happens when an airline goes out of business. I've heard that the government routinely bails out bankrupt airlines, but I don't know what exactly this entails and what it costs if it indeed happens.
- The US has an outdated radar-based air traffic control system from the 1950s, which means that commercial air traffics needs to fly inside special lanes so that the radar can find the planes. Needless to say, these lanes are not always the most direct way between two cities, and the lanes are fairly congested. Research done by the FAA through the MITRE corporation suggests that a new satellite/GPS-based system for tracking (for which the technology already exists, though guests on the DRS suggest would cost $20-30 billion or more) would allow airports to increase their volume of flights by 15-20%.
- Bob Crandell points out that the US Dept. of Transportation doesn't really have a cohesive national transportation plan, and that if there existed the political will to craft such a plan and then spend the necessary capital to make it happen, then it's likely that we'd connect the northeast corridor from DC to Boston with really fast trains and not clog up the skies in that part of the country.
