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Should airlines be regulated like a public utility?

June 12, 2008 by Evan Sparks

Yesterday, several outlets reported on former American Airlines CEO Robert Crandall’s speech at the Wings Club (full text here). Crandall, who ran AA during the process of deregulation and made it an industry leader in the post-deregulation era, opposed deregulation in the late 1970s, and his opinions haven’t changed: “We have failed to confront the reality that unfettered competition just doesn’t work very well in certain industries, as aptly demonstrated by our airline experience and by the adverse outcomes associated with various state efforts to deregulate electricity rates. It’s time to acknowledge that airlines look and are more like utilities than ordinary businesses.”

Because Crandall is such a legend in the airline world, I’d like to go through his remarks seriously and respectfully. The key question: should airlines be operated like public utilities? Public utilities arise from natural monopolies, in which it is most efficient for a single firm than multiple, competitive firms to provide a service. Natural monopolies usually result in infrastructure- and capital-intensive industries. Classic examples include electricity transmission or public transportation: it’s too costly for competing firms to maintain multiple networks of power lines or subway tunnels. A utility is often created because it is the only way to ensure crucial infrastructure investments are made; if multiple firms are competing, they may not be able to afford to upgrade their systems over time. Economists have been doing important work exploring whether such utilities are really natural monopolies. Back in the 1970s, a consensus was reached that airlines did not constitute such a monopoly.

Indeed, certain elements of the infrastructure of the airline industry may be natural monopolies. Would it be more efficient to have multiple air traffic control firms competing? Not likely. And communities in which there is one major airport may find that a natural monopoly. (But regions with multiple, competitive airports, like London or New York, have great potential for airline competition. BAA, the owner/operator of London’s three largest airports, was set up as a sort of private utility with so much market power because only such a structure was thought to allow sufficient investment in infrastructure. As it turns out, BAA’s common ownership in a competitive environment has retarded investment.)

But airlines themselves are no longer thought of as a utility. Why were they ever? They were regulated as one, with strict limitations on fares and routes. Deviations from scheduled fares and routes were rarely if ever granted. Competition was thus limited, and slim profit margins for conservatively managed airlines were ensured. But what investment were the airlines supposed to be making? The largest capital investment airlines make is in aircraft, and the track record of investment in the regulation era is not great. Today, U.S. airlines may have relatively old fleets, but managements under regulation often made foolish or risky decisions about capital investment. Howard Hughes of TWA refused to buy jets, setting his airline back several years technologically and perhaps dooming it when deregulation occurred. On the other hand, Pan Am’s Juan Trippe and his successor, Najeeb Halaby, aggressively pursued the Boeing 747, an investment that paid off but nearly bankrupted the airline — not an example of the prudent investment meant to characterize a utility.

In addition to making investments, airlines instead used their protected positions to offer exceptional benefits to their employees — contractual obligations that put them at a disadvantage to new competitors in a deregulated market. That’s the key reason so many airlines suffered financially in the 1980s and ’90s, but it’s not a reason to treat airlines as utilities. Monopoly protection is not afforded to protect wages but to promote investment and efficiency.

Robert CrandallSo then, let’s look at Crandall’s argument. (Forgive the all caps; that’s the way it’s published on the Wings Club website and I don’t have the time to retype it all.)

CONSUMERS CLEARLY BENEFIT FROM THE EXISTENCE OF MULTIPLE AIRLINES; THE ABSENCE OF ALTERNATIVES DOES NOT ENCOURAGE GOOD CUSTOMER SERVICE. THUS, OUR GOAL SHOULD BE TO HARNESS COMPETITION AND REGULATION TO CREATE A SYSTEM RESPONSIVE TO BOTH THE IMPERATIVE OF EFFICIENCY AND THE DESIRABILITY OF DECENT SERVICE.

One reason for deregulation was to improve efficiency, and economic research shows it has. Indeed, regulation promotes “fairness,” not market efficiency. “Deregulation has shown that the well-intentioned and orderly views of the regulators caused enormous distortions in productivity and service,” write Elizabeth E. Bailey (a former Civil Aeronautics Board member), David R. Graham, and Daniel P. Kaplan. The results of deregulation — rationalization of routes, drops in fares, variable pricing based on loads and demand — have produced a different, more efficient equilibrium between fares and service.

THE INDUSTRY’S PROBLEMS REFLECT SEVERAL SHORTCOMINGS:
• FIRST AND FOREMOST, WE HAVE FAILED TO CONFRONT THE REALITY THAT UNFETTERED COMPETITION JUST DOESN’T WORK VERY WELL IN CERTAIN INDUSTRIES, AS AMPLY DEMONSTRATED BY OUR AIRLINE EXPERIENCE AND BY THE ADVERSE OUTCOMES ASSOCIATED WITH VARIOUS STATE EFFORTS TO DEREGULATE ELECTRICITY RATES. IN MY VIEW, IT IS TIME TO ACKNOWLEDGE THAT AIRLINES LOOK AND ARE MORE LIKE UTILITIES THAN ORDINARY BUSINESSES.
• SECOND, OUR GOVERNMENT HAS FAILED TO DEVELOP A NATIONAL TRANSPORTATION PLAN OF ANY KIND AND HAS THUS BEEN INDIFFERENT TO THE CONTINUING DECLINE OF OUR HIGHWAYS, OUR RAILROADS AND OUR AIRLINES.
• AND THIRD, THE GOVERNMENT HAS FAILED TO INVEST IN THE CAPABILITIES AND RESOURCES WHICH ONLY IT CAN PROVIDE, MOST NOTABLY BY FAILING TO IMPLEMENT THE NEW AIR TRAFFIC CONTROL SYSTEM THAT EVERYONE AGREES WE DESPERATELY NEED.

As I’ve discussed above, airlines do not resemble traditional utilities. But Crandall is right: our public-sector infrastructure agencies have not made investments to keep up with the growth unleashed by deregulation. Economist and deregulator Alfred Kahn warned about this in 1978:

There is no guarantee that freer competition on the airline side of the equation—that is the part that creates the demand for airports [and air traffic control]—alone will solve these problems. On the contrary, it will stimulate more air travel. . . . [M]y moral is simply this to the FAA: If you are going to follow economically irrational policies, don’t ask the CAB to bail you out by doing the same thing.

The business side of the airline industry was reformed to promote efficiency, but the government side wasn’t, and although it has expanded and developed, it has not kept pace — a key factor in today’s congestion and delays that Crandall rightly complains about.

I FEEL LITTLE NEED TO ARGUE THAT DEREGULATION HAS WORKED POORLY IN THE AIRLINE INDUSTRY. THREE DECADES OF DEREGULATION HAVE DEMONSTRATED THAT AIRLINES HAVE SPECIAL CHARACTERISTICS INCOMPATIBLE WITH A COMPLETELY UNREGULATED ENVIRONMENT. TO PUT THINGS BLUNTLY, EXPERIENCE HAS ESTABLISHED THAT MARKET FORCES ALONE CANNOT AND WILL NOT PRODUCE A SATISFACTORY AIRLINE INDUSTRY, WHICH CLEARLY NEEDS SOME HELP TO SOLVE ITS PRICING, COST AND OPERATING PROBLEMS.

Crandall himself pioneered yield management software that enabled airlines to sell some seats cheaply and some for higher prices. As for costs, airlines accumulated those costs up in a regulated, protected environment because they were sheltered from competition — not because airlines “can’t” make it. Earlier in his speech, Crandall says that high oil prices are just one of the airlines’ problems. But airlines have already become so lean that many of them would be profitable today had oil not gone up nearly 200 percent over a few years.

THE MOST AGGRESSIVE FAVOR GOVERNMENT SUPERVISED PRICING DISCUSSIONS WHOSE GOAL WOULD BE TO ESTABLISH MINIMUM FARES SUFFICIENT TO COVER FULL COSTS AND PRODUCE A REASONABLE RETURN. WHILE I WOULD FULLY SUPPORT SUCH AN APPROACH, THE IDEA IS DEEPLY OFFENSIVE TO THOSE WHO CLING TO THE BELIEF THAT THE MARKETS CAN SOLVE EVERYTHING.

Markets can’t solve everything, but they can price airfares efficiently.

SUPPOSE FOR A MOMENT THAT IN A WORLD WHERE EVERY AIRLINE SET ITS OWN PRICES, A REGULATORY AGENCY REQUIRED THAT ANY PASSENGER TRAVELING BETWEEN TWO POINTS VIA A CONNECTING POINT PAY THE SUM OF THE LOCAL FARES ON HIS OR HER ITINERARY. AS WE HAVE ALL KNOWN FOR MANY YEARS, THE CHEAPEST WAY TO CARRY A PASSENGER FROM POINT A TO POINT B IS NON STOP, AND THE MOST EFFICIENT WAY TO DO IT IS BY USING THE LARGEST AIRPLANE COMPATIBLE WITH DEMAND.

I addressed this issue in a recent post, but I think airlines ought to be free to set fares that fit the market. Crandall seems to want to break down the hub-and-spoke system (again, something he developed for American during his time there). But the system produces efficiencies that allow relatively lower fares. There’s no reason to impose a Ryanair-style pay-by-the-leg fare system if most airlines prefer not to operate that way.

But perhaps there’s a reason to begin undoing the efficiencies of the hub-and-spoke system:

TIMES ARE VERY DIFFERENT NOW THAN THEY WERE WHEN THE HUB AND SPOKE SYSTEM WAS GROWING RAPIDLY. IN THOSE DAYS, THE UNITED STATES GAVE LITTLE THOUGHT TO EITHER GLOBAL WARMING OR ENERGY INDEPENDENCE; TODAY, THE U. S. SPENDS $600 BILLION PER YEAR ON PETROLEUM , PINES FOR ENERGY INDEPENDENCE AND WATCHES THE ICE CAPS WITH INCREASING TREPIDATION.

But to incentivize reduced emissions and fuel use, carbon taxes or other market-based mechanisms like cap-and-trade are more likely to set the most efficient prices with the stipulated environmental conditions than regulatory fiat.

THE CARRIERS ALSO NEED HELP IN CURBING LABOR COSTS. AS EVERYONE HERE KNOWS, AIRLINE EFFORTS TO CONTROL LABOR COSTS HAVE BEEN BLUNTED – SINCE THE DEMISE OF THE MUTUAL AID PACT IN 1978 — BY THE DRAMATIC IMBALANCE BETWEEN THE NEGOTIATING STRENGTH OF ORGANIZED LABOR AND THAT OF THE AIRLINES. . . . AS A PRACTICAL MATTER, NO AIRLINE CAN ENDURE A STRIKE AND WILL INVARIABLY YIELD TO LABOR’S DEMANDS BEFORE A STRIKE IS ACTUALLY CALLED. . . . SINCE STRIKES AGAINST TRANSPORTATION UTILITIES ARE ILLEGAL IN MANY JURISDICTIONS AROUND THE WORLD AND ARE CLEARLY CONTRARY TO THE PUBLIC INTEREST, I DO NOT SEE WHY THE RAILWAY LABOR ACT SHOULD NOT BE AMENDED TO REQUIRE BINDING ARBITRATION.

But these labor costs have only to do with legacy airlines’ ability to make a profit, not with whether they’re utilities. The Big Three U.S. automakers are also having trouble meeting their pension obligations and face hostile unions. Can they be regulated as utilities? Clearly not — and the same holds for airlines.

WE WOULD ALSO BE WELL ADVISED TO REVISE OUR BANKRUPTCY LAWS TO DEPRIVE FAILED CARRIERS OF THE RIGHT TO USE LOWER COSTS TO UNDERCUT THE FARES OFFERED BY THEIR MORE PRUDENT RIVALS. FORCING BOTH MANAGEMENT AND LABOR TO FACE THE TWIN SPECTRES OF LIQUIDATION AND UNEMPLOYMENT WOULD LIKELY BE ANOTHER STEP TOWARDS LESS CONFRONTATION AND MORE COOPERATION.

Agreed.

IT IS ALSO CLEAR THAT DECISIVE GOVERNMENT ACTION IS NEEDED TO RELIEVE THE EXTREME CONGESTION NOW BEING EXPERIENCED AT OUR BUSIEST AIRPORTS. . . . THE ONLY SOLUTION IS A REGULATORY MANDATE THAT LIMITS THE NUMBER OF FLIGHTS SCHEDULED TO WHAT THE RUNWAYS, TERMINALS AND AIR TRAFFIC CONTROL FACILITIES AT A GIVEN AIRPORT CAN HANDLE. TO GET THERE, PRESENT SCHEDULES SHOULD BE REDUCED PROPORTIONALLY TO EACH CARRIER’S PRESENT FREQUENCY SHARE. DOING SO WOULD CREATE PRESSURE TO USE THE LARGEST FEASIBLE AIRCRAFT IN EACH SLOT.

This is nothing more than incumbent protection. Congestion pricing is a rational, efficient way to allocate space for its most productive uses. The final claim is unsubstantiated; instead, congestion pricing would give airlines financial incentives to use their spaces as efficiently as possible.

WE SHOULD ASK OURSELVES WHETHER USING OUR ANTI-TRUST LAWS TO PREVENT AIRLINES FROM COLLABORATING TO ACHIEVE MORE INTENSIVE ASSET UTILIZATION AND MORE EFFICIENT OPERATIONS REALLY MAKES SENSE.

This is what Holman Jenkins has suggested.

BUT REGULATION ALONE IS NOT ENOUGH. WE ALSO NEED A NATIONAL TRANSPORTATION PLAN, INCLUDING A CLEARLY ARTICULATED, WIDELY UNDERSTOOD STATEMENT OF OUR AVIATION GOALS. IN MY VIEW, OUR OBJECTIVES SHOULD BE:
• FIRST, TO STRENGTHEN OUR NATIONAL ECONOMY BY ENCOURAGING THE CREATION OF A COST EFFECTIVE, ENERGY SENSITIVE TRANSPORTATION NETWORK WHICH WILL PERMIT PEOPLE TO MOVE EASILY FROM ONE PLACE TO ANOTHER
• SECOND, TO ASSURE SAFE, COURTEOUS AND ON TIME SERVICE FOR CONSUMERS
• AND FINALLY, TO IMPROVE THE FINANCIAL PERFORMANCE AND INTERNATIONAL COMPETETIVENESS OF AMERICA’S AIRLINES.

The second would be a fantastic expectation for airlines, but government regulation of courtesy strikes me as a bit of an overreach. Furthermore, what if I wanted to fly a rude airline that charged lower fares (i.e, Ryanair)? Would Crandall give me that option? Apparently, no:

UNHAPPILY, SUCH A PLAN DOES NOT EXIST. FOR MANY YEARS, THE ONLY APPARENT GOAL OF U. S. AVIATION POLICY HAS BEEN TO SECURE LOWER FARES FOR CONSUMERS BY ENCOURAGING COMPETITION OF ANY STRIPE IN EVERY MARKET, WITHOUT REGARD TO ANY OTHER CONSEQUENCES, INCLUDING THE INDUSTRY’S VIABILITY.

Crandall claims that his proposals would not constitute full-scale reregulation. But it would reduce efficiency in the financial interests of airlines. He is clearly looking out for airlines’ bottom lines. But if airlines aren’t profitable, that doesn’t mean they have natural monopolies and should be regulated that way. It’s clear that they don’t have these monopolies. I don’t dispute Crandall’s knowledge of the industry, but I do dispute his disdain for rational economic analysis of aviation. As he said to a congressional staffer during the deregulation debates of the 1970s, “You f***ing academic eggheads! You don’t know s***. You can’t deregulate this industry. You’re going to wreck it. You don’t know a g****m thing!”

A little economic analysis never hurt anyone.

Photo credits: Flickr user OiMax through a Creative Commons license; Washington Speakers Bureau.

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Posted in Evan's Commentary | Tagged american, business, history, labor, regulation, travel | 8 Comments

8 Responses

  1. on June 12, 2008 at 8:12 pm R. May

    Evan;

    You drone on like an old airplane. Here is the reality. People want to go to big cities. The airports at big cities are crowded. They always have been. They always will be. No matter how many bridges and tunnels into Manhattan there will always be a log jam. Same with airports, airspace, ramps and gates. Mincing and parsing Crandel’s lecture won’t change that. Economics lesson over.

    Oh, don’t forget to blame labor, a union has no leverage since deregulation. (exceptional benefits) By the way how much do you make? I know there is a lot of risk involved in blogged in front of a computer. Skilled labor isn’t going to fly you safely for nothing just because you think you are royalty.


  2. on June 12, 2008 at 8:39 pm Bea Scott

    Thanks for this very thorough dissection — I would have to say “no.” With my concerns being this: “UNHAPPILY, SUCH A PLAN DOES NOT EXIST. FOR MANY YEARS, THE ONLY APPARENT GOAL OF U. S. AVIATION POLICY HAS BEEN TO SECURE LOWER FARES FOR CONSUMERS BY ENCOURAGING COMPETITION OF ANY STRIPE IN EVERY MARKET, WITHOUT REGARD TO ANY OTHER CONSEQUENCES, INCLUDING THE INDUSTRY’S VIABILITY.” Blergh.


  3. on June 12, 2008 at 10:34 pm Evan Sparks

    Mr. May —

    If there’s always going to be a “log jam,” we have tools proven to allocate that limited space efficiently: congestion pricing. Crandall seems immune to this helpful mechanism, and that’s why it’s important to “parse” Crandall’s lecture.

    Re: airline labor, I didn’t say airline pilots should be paid “nothing” and I never claimed to be royalty. Crandall is the anti-labor one. All I said is that airlines negotiated generous pay scales and defined-benefit pension plans with labor, and they should honor those contracts. They should not use deregulation as a shield to gut them or make unwarranted claims about being a public utility in order to be protected competing airlines with lower labor costs.

    Indeed, economics is going to work out the pilot pay situation on its own. When pay and benefits were better, pilots lined up out the door for a job at a big airline. In today’s market (at least until this spring of capacity cuts and furloughs), pilots are leaving the industry or going to work overseas and in other aviation sectors, meaning that airlines will have to readjust their compensation eventually to become attractive employers again. As you might say, “economics lesson over.”


  4. on June 13, 2008 at 4:20 am realylife

    I don`t think so
    But in Indonesian we use another way


  5. on June 13, 2008 at 12:56 pm Occam's Razor

    The focus of your analysis is centered on monopoly and utility, when Crandall’s use of the term “utility” was meant to provoke the listener to view the our national aviation system as an infrastructure that requires considerable investment….much like a utility.

    Hopefully, you haven’t missed the fact that the airline industry’s market structure is one of oligopoly, not monopoly. There are many models which claim to predict the end game in an oligopoly market structure….ie Kinked Demand Curve, Uncertain Demand Curves et al.

    In all of these economic models, there exists a market clearing price or equilibrium, that ultimately benefits producers and consumers a like. This “mutual” benefit is key to a healthy industry. This ability to establish a mutually beneficial equilibrium is true whether you’re talking about perfect competition models, imperfect/oligopoly competition models or monopoly models.

    Because of the widespread belief that there “always” exists a “market solution” to any economic allocation problem….many industries are best left to “the market” as a matter of public policy. Thus there is considerable resistance to Crandall’s view that the “the market” can not solve the airline industry’s problems. Fortunately, for Crandall his view has both theory and practice to underpin his belief that public policy needs to play a role in the airline industry.

    All of the above mentioned economic models have one thing in common…the ability to establish an equilibrium or market clearing price. And yet, after 3 decades of experience with a deregulated airline industry….Crandall and others rightfully ask….”Where is the equilibrium?” “Where is the market clearing price?” “Where is the mutual benefits of a healthy industry?”

    The answer it seems lies in a little known economic theroy that was emerging around the time deregulation. At the University of Chicago, Professor Lester G. Telser was putting his finishing touches on his “Theory of the Core” to offer an explanation was to why some markets do not seem to establish a “mutually beneficial equilibrium” as predicted by the many of our dearly beloved “free market” models.

    Telser showed that some markets are likely to exhibit empty core behaviors, inability to achieve equilibrium, if they possess certain unique characteristics. Sadly, the airline industry has many of the characteristics that fit Telser’s description of a market without a core. According to Telser, such industries….if they are important enough to the national good….deserve certain protections from the destructive forces unfettered” competition as a matter or national public policy. Unfettered competition, in markets with an empty core, can actually do more public harm than good. Particularly if the industry needing protection is part of a nation’s infrastructure, with multiplier benefits.

    Telser offers two solutions to the empty core problem…
    1.Regulate the destructive behaviors of the competitors.
    2. Allow the competitors to “collude” to establish an equilibrium that the free market alone CAN NOT do its own.

    What Crandall is attempting to do, is to call attention to the fact…..born out by 3 decades of actual results…..that there exists no equilibrium or market clearing price in the airline industry. That if our nation is to have a “mutually beneficial equilibrium” in the airline industry…the industry needs some government help to establish one.

    Really, that’s all I see him saying.

    Crandall offers a possible solution for government help on a limited basis. Establish an enforced requirement to price at the “sum of the locals” . Whether this can achieve equilibrium, I don’t know.

    Crandall simply asks the listener to consider the significant investments made in our nation’s aviation infrastructure as something that exists for “everyones” benefit. Something much “like” a utility.

    He’s not asking to treat the industry as a regulated monopoly….he’s simply stating the because of the unique characteristics of the airline industry, there exists no free market solution. To some this may be heresy. To me he’s hit the mark!

    So if we are to “protect” what already is a pretty efficient allocation of resources in the airline industry, and call it our “nation’s aviation infrastructure”, then the airline industry needs some “help” in overcoming its pricing problems. These pricing problems are due to the existence of an empty core.

    There is clearly a need for a national system of air transportation. If the “core” of the airline industry is indeed an empty one……..then Core Theory says that, left to the free markets, you will ultimately end up with an “inefficient” allocation or resources. A situation where, over time, everyone loses….from the investor, employee, customer, port authorities and the government.

    On second thought…….there may be one winner in the end result after all.

    As Crandall notes……..The Europeans have no intention of participating in the destructive orgy of domestic markets. They will stand back, watch it all collapse, and then step in and only “use” our large population centers as “connecting feed” for THEIR global networks.

    The Europeans have no interest in preserving or building an aviation infrastructure for the United States. You see……..that is a public policy problem…..it’s not a British Airways problem.

    You can not expect the Europeans to solve OUR public policy problems.

    Crandall…..”We used to pretty good at solving problems in this country. What happened?”


  6. on June 13, 2008 at 12:58 pm R. May

    Evan;

    You are correct that Crandell is no friend of labor and that supply and demand MAY cure the compensation breach but I just have no faith in congestion pricing as a minor band-aid to the lifelong woes of a truly pathetic industry. This is just a small part of it. How about the airspace? How do you congestion price it? Face it, there is no end. Is regulation ideal, hell no, but this industry just doesn’t work. Creditors don’t get paid, investors are ripped off, employees screwed, government loans to thieving management who spend their time in France overseeing their $140 million dollar portfolios (Steven Wolf).

    You are welcome again for reality economics 202.

    Sincerely,


  7. on June 13, 2008 at 10:35 pm Evan Sparks

    Occam —

    Thanks for your thoughtful response. I don’t think I was confusing the airline industry with a monopoly; in fact, I was arguing that it is precisely because they do not enjoy a natural monopoly that they should not be regulated that way.

    Thanks also for bringing up Telser’s theory of the core. If Crandall wasn’t so impervious to economic theory, it might have served his argument better.

    Even so, I think the bigger problem is that the legacy airlines inherited regulation-era cost structures that too many of them were unable to pare down. That persistent problem, combined with the twin 2000s shocks of 9/11 and the 2007-2008 runup in fuel costs, has affected many carriers’ profitability, not the general inability of airlines to make money. And look at United today or Eastern in the late ’80s — poor management, a curse not limited to airlines, can doom a carrier just fine on its own.

    /E


  8. on June 14, 2008 at 8:08 pm Occam's Razor

    Evan Sparks says…
    “Even so, I think the bigger problem is that the legacy airlines inherited regulation-era cost structures that too many of them were unable to pare down. That persistent problem, combined with the twin 2000s shocks of 9/11 and the 2007-2008 runup in fuel costs, has affected many carriers’ profitability, not the general inability of airlines to make money.”

    Occam’s Razor says…..

    If we go back to a point in time when oil was selling for $12 a barrel, you will find airlines were still losing money. Fuel prices were not the problem then….it’s not the problem now. The empty core is the problem. And it would probably be worthwhile for government policy makers to seek out Telser’s input at some point…to see if what Crandall is recommending is “rent seeking” behavior or simply a resolution to the “empty core” of destructive airline competition.

    With respect to paring down “legacy” related costs….this industry is operated in an entirely different manner than during the regulated era. As such, the cost structures will, in many ways, be different and irrelevant.

    The term “legacy costs” is often misused, misunderstood and abused. Generally, it is meant to describe a cost structure that existed before deregulation and is still at work, even today. After 30 years of deregulation, there is very little left of modern “network” carrier cost structures that can be considered “legacy cost” related. Legacy cost is term, coined by outside consultants to keep the momentum of concession bargaining intact.

    After deregulation, the airline industry eagerly undertook the task of re-engineering their businesses. The opportunity for “scale production” now became competitively important…enter the Hub and Spoke Network. Deregulation gave birth to “Hubbing”. It is a creature of deregulation. The “new” Hub and Spoke concept brought with it, entirely “NEW “COSTS” that NEVER existed before deregulation. Modern network carrier’s cost structures look nothing like their “legacy” counterpart’s cost structures of yesteryear. You can not call these newly emerged Hubbing costs …..”legacy costs”….they were eagerly undertaken by all network carriers for very good and different reasons. And it is these costs that are the focus of Crandall’s speech. These are costs that “network” carriers have, and that point-to-point operators do not have. Crandall’s “sum of the locals” is an attempt to differentiate this fact via the “government intervention mechanism”….since the “market mechanism” has failed to do this over a 30 year period. All in keeping with predictions made by Telser’s empty core

    As Crandall notes, viewed on an individual flight basis …..the costs of operating a Hub and Spoke Network are much higher than direct flights. But viewed on a “Network” basis, total costs are lower. Because serving the same number of city-pairs, on a direct basis, would require even more labor and capital.

    Today, despite their higher operational costs, Hubbing still remains the most efficient allocation of resources to serve the most number of city-pairs. It is an innovation that’s been successfully applied to other industries as well…..called “Network Effects”. In short, “Hubbing” quickly became our defacto national aviation system, offering lower prices and better, more frequent service. It allowed for scale efficiencies never before possible. But again, it also brought with it entirely “new” costs that can hardly be considered “legacy costs”. They are more accurately called ….. “Network Costs”.

    So these newly emerged “Networks” and their “COSTS” did not exist before deregulaton….”THESE NETWORK COSTS” are “deregulation’s costs” NOT “legacy costs”.

    Additionally, with respect to labor costs, pilot cost in particular, it’s difficult to see any thing “legacy” related. Shortly after deregulation the two-tier wage system was established. By all accounts, managements everywhere enjoyed the upper-hand in negotiations over these past 30 years….as “pattern bargaining” quickly gave way to “concesson bargaining”. Hardly the type of “rent-seeking” behavior one would expect as a holdover from the legacy era.

    One can lament the loss of the “two tier” wage system if you like…..I prefer to think of it as an “unsustainable, contrived and artificial” market place distortion. A distortion of the “free market” forces for pilot labor, where the monopsony power of the employer created an unsustainable disequilibrium for these highly skilled pilots. It was only a matter of time before this fell. Monopsony distortions eventually get corrected. Our labor laws are written to specifically overcome such marketplace distortions. Economic models of collective bargaining show that, left to its own, one can expect a rough approximation of the “free market” for union wages. Where the monopsony power of a few employers is “checked” by the collective bargaining power of unions. The result is an equilibrium price for pilot labor. There is no way that a ‘two-tier” structure could have existed for long. And such discussions to reinstate them are similarly a waste of time.

    In the wake of deregulation and the concessionary deals of 2003, it’s hard to see anything that resembles “legacy” costs for pilot labor from a by-gone era. Similarly skilled pilots now make vastly more money carring packages than people. It’s difficult to see this as a “legacy” outcome. If pilots are a “rent-seeking” lot…..then they fail miserably at the task.

    PS…………..
    I certainly wish Crandall would’ve leaned more heavily on Core Theory to make his point. Many of his points seem to be taken from Core Theory. Perhaps he doesn’t want to be associated with “egghead” theories, he’s shown contempt for in the past. And yet…”new ideas” are generally not well recieved by public policy makers unless you can underpin your “new idea” with solid theoretical support. Crandall’s “new idea” does have such support, yet he’s not calling attention to it. Why? I don’t know.



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