China’s air transportation has experienced rapid growth and major reforms in the past three decades, some of which have been partially successful and are still ongoing today. The paper aims to analyze China’s air deregulation experience over the last two decades and its impact on airline competition from a geographical perspective. After the establishment of the “Big Three” in 2002, the paper reveals that there has been a trade-off between the extent of deregulation and airline competition in China because the central government has tended to strengthen the “Big Three” rather than totally open the market to private and locally owned airlines. The paper uses each airline group as the basic unit of analysis and reveals that (1) the air market has been more concentrated in the “Big Three” as a result of the process of air deregulation; (2) airline competition in over two thirds of the airports and one half of the routes has increased in the last 18 years, but the core airports and trunk routes are chiefly dominated by the “Big Three”. The peripheral airports and thin routes have been operated by private and locally owned airlines; and (3) regionally, airline competition has occurred in most airports of the eastern region, and it is more intense than in the central and western regions. But even here, competition in the eastern region has however decreased in 1994–2012. The three main contributions of the paper are: (1) the use of two measures of competition in the airline market; (2) the analysis of the historical evolution of competition; and (3) an understanding the role of the geography of competition in the Chinese airline market.
[An updated version of this article can be found at Airline Deregulation in the 2nd edition.]
The United States Airline Deregulation Act of 1978 was a dramatic event in the history of economic policy. It was the first thorough dismantling of a comprehensive system of government control since the Supreme Court declared the National Recovery Act unconstitutional in 1935. It also was part of a broader movement that, with varying degrees of thoroughness, transformed such industries as trucking, railroads, buses, cable television, stock exchange brokerage, oil and gas, telecommunications, financial markets, and even local electric and gas utilities.
Most disinterested observers agree that airline deregulation has been a success. The overwhelming majority of travelers have enjoyed the benefits that its proponents expected. Deregulation also has given rise to a number of problems, including congestion and a limited reemergence of monopoly power and, with it, the exploitation of a minority of customers. It would be a mistake, however, to regard these developments merely as failures of deregulation: in important measure they are manifestations of its success.
These problems drive home the lesson that the dismantling of comprehensive regulation should not be understood as synonymous with total government laissez-faire. The principal failures over the last fifteen years have been failures on the part of government to vigorously and imaginatively fulfill responsibilities that we, in deregulating the industry, never intended it to abdicate.
The Benefits of Deregulation
The two most important consequences of deregulation have been lower fares and higher productivity.
Fares. Between 1976 and 1990 average yields per passenger mile—the average of the fares that passengers actually paid—declined 30 percent in real, inflation-adjusted terms. Average yields were declining in the decades before deregulation as well, thanks largely to the introduction of jets and jumbo jets. The best estimates, however, are that deregulated fares have been 10 to 18 percent lower, on average, than they would have been under the previous regulatory formulas. The savings to travelers have been in the range of $5 billion to $10 billion per year.
The overwhelming majority of the traveling public has enjoyed these lower fares. In 1990, according to the Air Transport Association, 91 percent of all passenger miles traveled were on discount tickets, at an average discount of 65 percent from the posted coach fare. The benefits of the price competition unleashed by deregulation, however, have been unevenly distributed among travelers. That is because the intensity of competition varies from one market to another. Prices per mile are usually much higher on thinly traveled than on densely traveled routes. They also are higher for the minority of travelers who have to pay full coach fares because they are unwilling or unable to meet the typical conditions for discounts (advance purchase, nonrefundability, and staying over a weekend).
These differentials are not necessarily discriminatory. It genuinely costs more per passenger to provide service on thinner routes, largely because a seat-mile on small planes costs much more than on large planes. Short flights also cost more per mile than long ones. Similarly, it is costly to provide the frequent service preferred by business travelers.
Evidence accumulates, however, that full fares on routes served by only one or two airlines, particularly on flights originating or terminating at a so-called hub city dominated by a single airline, reflect some substantial amount of monopoly power. The Department of Transportation found in 1990, for example, that after adjusting for differences in the average length of trip and density of traffic, fares on routes served by the eight most concentrated hubs averaged 18.7 percent higher than for similar markets served by other airports.
Productivity. The other major accomplishment of deregulation has been the improvement in airline productivity. Deregulation fostered this improvement by removing the previous detailed restrictions on airline prices and on where they can fly. Decontrol of prices allowed airlines to fill their planes by offering large numbers of heavily discounted fares for seats that would otherwise go unused. Decontrol of routes permitted them to plan their operations as they see fit. And deregulation has compelled improvements in efficiency through the intense pressures of the price competition it unleashed. Carriers have put more seats on their planes—the average went up from 136.9 in 1977 to 153.1 in 1988—and succeeded in filling a greater percentage of those seats—from an average of 52.6 percent in the ten years before 1978 to 61.0 percent in the twelve years after.
The dramatic move to hub-and-spoke operations (in which an airline routes its flights through one or several "hub" cities) has increased efficiency in a number of ways. It has allowed better adaptation of equipment to markets: small props and jet props for short hops and few passengers; big jets for dense, long-haul routes. It has also allowed the use of larger and more efficient planes, and the offer of a wider variety of destinations—albeit at the cost of a slight increase (estimated around 5 percent on average) in the circuity of routes. The industry's failure to realize the huge potential economies of hub-and-spoke operations under regulation is compelling evidence of the inefficiency of centralized government planning and the superiority of free competitive markets.
Tendencies to Increased Concentration and Price Discrimination
The recent wave of mergers and airline failures has made the industry more concentrated at the national level than it was before deregulation. The trend continues or threatens to do so, with the failure of Eastern Airlines, Midway, and Pan American, and the bankruptcy of carriers such as Continental, America West, and TWA. Most hubs will support only a single airline, and the superior efficiency of hubbing tends to insulate an airline from direct competition on short trips originating or terminating at its hub. All of this means that pricing may well become less competitive in the future.
On average and in the aggregate, however, it has not happened yet. That is mainly because concentration at the national level is not as important as concentration on individual routes. What passengers care about are the choices available to them between two particular points. By its detailed and pervasive restrictions on the routes that carriers could serve, regulation had substantially insulated each airline from the competition of the others. By wiping out all these restrictions and freeing carriers to enter any market, deregulation produced an estimated 25 percent increase in the average number of airlines per route despite the recent mergers.
For example, between 1979 and 1988 American Airlines increased the number of domestic airports it served from 50 to 173, and United Airlines from 80 to 169, both without major benefit of mergers. As of February 1992 a traveler between Boston and Phoenix could choose among six airlines; in 1977 there were only two. Again, back in 1979 only 27 percent of all passengers traveled on routes served by three or more competitors; by 1988 more than 55 percent enjoyed that kind of choice.
In this as in all other unregulated industries, there is always the possibility of anti-competitive behavior. That is why we have antitrust laws. The reconcentration of the industry reflects, in part, the failure of the Department of Transportation to disallow even one merger of direct competitors. Also, some of the largest airlines have, at least in the past, used their computerized reservations systems to handicap their smaller competitors. Frequent-flyer programs, operating agreements and mergers with regional feeder airlines, and deeply discounted discriminatory fares have all put smaller competitors at a severe disadvantage and contributed to the demise of many of them. Like the hub-and-spoke system itself, these practices also have large efficiency advantages and so pose a familiar dilemma to scholars and practitioners of antitrust. Moreover, these potentially anti-competitive stratagems were scarcer before deregulation because they were unnecessary. Under that regime the government forced the airlines to operate as an effective cartel.
The instances of sharply increased price discrimination that deregulation has made possible are both a competitive and monopolistic phenomenon. They reflect intense competition for the travelers most likely to be attracted by price differences among competitors. They also have promoted economic efficiency in very important ways. The deeply discounted fares to discretionary air travelers have helped fill planes and, by doing so, helped make possible more frequent scheduling, which is particularly valuable to the full-fare travelers.
Still, the discrimination also reflects the exercise of monopoly power, no longer curbed by direct price regulation. The increasing sophistication with which the leading carriers practice what the industry euphemistically calls "yield management" enables them to take full advantage of that monopoly power, particularly in the unrestricted full fares paid by about 10 percent of the travelers. The continuing reconcentration of the industry threatens to extend that exploitation to an increasing proportion of the flying public in the future.
There are three possible ways in which government might respond to this dilemma. First, it could do nothing. After all, we put up with a great deal of competitive imperfection in industries that we would not think of regulating—very high profits on razor blades, discriminatory pricing by railroads and doctors, and automobile prices that go up when demand goes down. The high, unrestricted fares paid by the minority of passengers who cannot qualify for discounts may well be compensated for by frequent-flyer credits and by the improved convenience of schedules that the high fares and hubbing help make possible. The airline industry is far more competitive than it was; the benefits of that competition have been widely distributed; and industry profits have been lower, on average, since deregulation. In these circumstances it would be reasonable to conclude that no remedy was required.
Second, the government could actively attempt to make markets more competitive by assuming responsibilities that it has neglected. It could vigorously enforce the antitrust laws. It could also remove barriers to competition by expanding airport capacity enough to allow new competitors to operate on routes, by dissolving preferential arrangements between hub-dominating carriers and their hub airports, and above all, by allowing foreign airlines to compete for domestic traffic, either directly or by investing in American carriers.
Third, where restoration of more effective competition proves infeasible, price ceilings could be reimposed to protect travelers subject to monopolistic exploitation.
My own strong preference—with which most economists would probably agree—is for the second approach. Once introduced, price controls have an almost irresistible tendency to breed further controls (see Price Controls). Because airlines could adjust to price ceilings by reducing quality, price ceilings would have to be accompanied by regulations imposing minimum quality standards. It takes no imagination to see where that might lead: to prohibitions of reductions in frequent-flyer benefits, in scheduling, or in the frequency with which full-fare-paying customers are upgraded to first class, and to stipulations about the minimum quality of meals and maximum charges for headsets. These examples are not fanciful. All of them were adopted under regulation, in mirror image, to prevent competitive evasions of governmentally set price floors.
In any event it would be thoroughly irrational to restore regulation as it was practiced between 1938 and 1978. It would make no sense to respond to the limited reemergence of monopoly by reimposing a regime under which the government thoroughly and systematically suppressed all price competition.
Safety in the Skies
Air travel is unequivocally safer now than it was before deregulation. Accident rates during the twelve-year period from 1979 to 1990 were 20 to 45 percent (depending on the specific measures used) below their average levels in the six or twelve years before deregulation. Moreover, by taking intercity travelers out of cars, the low airfares made possible by deregulation have saved many more lives than the total number lost annually in air crashes.
Of course, the margin of safety may have narrowed. The skies have become more crowded and airlines may, under pressure of competition, have cut corners. If so, the proper remedy is not economic regulation, but more spending on policing safety, air traffic control, and airports.
The Quality of Service
The question of what has happened to the quality of service is more complicated.
First, service for small towns and rural communities has improved. They have, on average, experienced a 35 to 40 percent increase in the number of scheduled departures and, thanks to hub-and-spoke operations, have an increased number of destinations available to them. On the other hand, the planes serving them are, on average, smaller and less comfortable. Critics of deregulation note that 95 towns, net, lost uncertificated (that is, unregulated) service between February 1978 and February 1991. That is true. But 137 towns suffered a similar fate during the last decade of regulation.
Second, travelers have endured an undeniable increase in congestion, delays, and discomfort. But these are not, in themselves, a sign of failure. After deregulation, low-cost, aggressively competing airlines, such as People Express, offered the public low fares, with correspondingly lower-cost service—narrower seating, longer lines, and fewer amenities. The incumbents responded with very deep discounts, accompanied by similarly poorer service. The enormous response of travelers to the availability of these new options is a vindication of deregulation, not a condemnation, even though the quality of the air travel experience has deteriorated as a result.
Third, much of the congestion is the result of the failure of governments to do their job. When the demand for any service exceeds the available supply, it means two things. First, the service is probably being produced in inadequate quantity. Second, it is underpriced.
As for the supply side, the airline industry relies primarily on the federal government to provide sufficient air traffic control and on federal and local authorities for airports. The governments have not fulfilled those responsibilities. As for the demand side, the spectacle of airplanes filled with passengers, queued up on runways for an hour or more, proves that the price of access to airports and to the air traffic control system at those times and places is too low.
Most airports charge landing fees based primarily on the weight of the aircraft. The charge for landing at Washington National Airport, for example, is $1.34 per thousand pounds, with a minimum fee of $8.00. Thus, a small plane would pay only $8.00 while a Boeing 707 would pay under $300. With prices that low for access to some of the most precious real estate in the world, no wonder demand outruns supply. Highly congested airports might properly charge thousands of dollars for landings at peak hours, whether the planes are large or small. The consequence would be that travelers who place a high value on taking off and landing at peak times and on using convenient airports would pay higher fares in exchange for shorter delays. Travelers who value money more than convenience could be offered bargains to travel off-peak or to use uncrowded feeder airports.
Airline deregulation has worked. It would be ironic if, by misdiagnosing our present discontents, we were to return to policies of protectionism and centralized planning at the very time when countries as dissimilar as China, the Soviet Union, Chile, Australia, France, Spain, and Poland are all discovering the superiority of the free market.
Alfred E. Kahn is the Robert Julius Thorne Professor of Political Economy, Emeritus, at Cornell University. He was formerly an economic adviser to President Carter and chairman of the Civil Aeronautics Board. He wishes to thank Melanie Mauldin for her assistance.
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Transportation Research Board, National Research Council. Winds of Change, Domestic Air Transport Since Deregulation. Special report 230. 1991.
U.S. Department of Transportation. Report of the Secretary's Task Force on Competition in the U.S. Domestic Airline Industry. February 1990.