Rough Landing

Don’t book your flight tickets too far in advance. Doesn’t it seem that every other day there is news that another airline company is on the brink of extinction? Ever since 9/11 it seems nearly impossible for any major airline to be profitable but the reason doesn’t lie solely on the WTC attacks. Should government continue to bail out airline companies on the brink of bankruptcy? What would happen to the industry if several large companies went out of business? Would this even happen?

Before 1979 the airline industry was highly regulated by the Civil Aeronautics Board with the goal of keeping the passenger's interests in mind. The Board was responsible for setting prices and safety standards, among other things. Studies have shown that since deregulation, the number of air passengers has increased while the price of airfares has decreased, both indicating that deregulation has benefited customers. Some would argue that price decreases and increased traffic could be at least partially the result of factors not in relation to deregulation. While this is probably true to some extent, I would say that artificial price mechanisms never achieve higher efficiency than perfect competition.

Although the prices and profits of the actual airlines are largely deregulated, some of the major inputs, namely fuel and labor, have remained at least somewhat regulated. While the price of oil has gone down (in relative terms), the price of jet fuel has risen and therefore constitutes a rise in airlines’ costs. One explanation for this increase in price could be the factor-price effect, which occurs when one industry’s supply (in this case the jet fuel refiner industry) constitutes a large portion of another industry’s demand (commercial airlines). Labor continues to be unionized for most airline companies. This can be an artificial price mechanism in the labor market which then drives up labor costs or at least allocates workers inefficiently. Another aspect of the industry that remains regulated is the use of local airports. Local governments regulate the use of airport space, ultimately opening the door for abuses of competition by larger companies. This is especially true at hub airports where one company may control seventy-five percent or more of the airport.

The answer most likely lies not in whether the price of an airline ticket is regulated but rather the effectiveness of public policy in encouraging competition and limiting abusive market power. We have seen airlines like Northwest and Jet Blue become successful as efficient, low cost airline providers and we wonder what keeps the rest from achieving similar results. If several large companies are left out to dry then one of two things will happen. If the company is beyond reengineering or refuses to change, then the company will disappear, but the other option they have is to become efficient, even if it means taking some lessons from the little guys. I believe that in the long run (its very important we look ahead), the consumer will pay lower prices and enjoy better service if and only if policy makers take a hands-off approach to airline prices and spend more time making sure large companies aren’t abusing their market power.