Should airlines be regulated like a public utility?

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?

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Pension protection debate holds up FAA bill

The House’s version of the FAA reauthorization bill has been on the Senate floor for the past few weeks, but it’s currently stalled (although scheduled for a cloture vote today, May 6, which if passed would move it forward for consideration by the full Senate without more amendments or if lost would hold up the bill further). The major hangup in the legislation was an amendment offered by Senators Dick Durbin (D-Ill.) and Kay Bailey Hutchison (R-Tex.).

Here’s the procedural history: on April 29, Senator Jay Rockefeller (D-W.Va.) proposed a set of amendments to the House bill. Section 808, which affected required funding a new accruals under airline pension plans, was a sticking point. Current law calls for airlines to fund their defined-benefit pension plans under the assumption of 8.25 percent growth; the amendment adds to the 8.25 percent rate the requirement to fully fund their pension obligations each year.

On April 30, Durbin and Hutchison introduced an amendment to eliminate Section 808. They argued that it would have disadvantaged their home-state airlines American and Continental, which continue to offer defined-benefit plans as obligated by their contracts. (This is absolutely the right thing to do. A defined-benefit pension is nothing more than deferred compensation. To shred it in bankruptcy is like asking an employee to give back part of his paycheck.) (N.B.: All airlines offer a small defined benefit to pilots, the “b-fund,” because pilots have until now been forced to retire at sixty.) Durbin says that this new, stricter requirement in Section 808 disincentivizes airlines from offering pension benefits and that it especially rewards Delta and Northwest, who slipped out of their pension obligations in bankruptcy and handed off the liability to you and me. “It seems to me instead we encouraged companies to freeze their benefit plans,” said Durbin in remarks on the Senate floor.

Last year, Durbin said,

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And emissions trading would have helped here how?

The Internet is abuzz about the latest example of “eco- scandalous” airline behavior. An American Airlines flight from Chicago to London flew February 9 with only five passengers, using — reportedly — 22,000 gallons of Jet A. Why is this causing an uproar? The advocacy group Friends of the Earth considers it an “obscene waste of fuel” that raised each of the five travelers’ carbon footprints by “45 times.” Of course, there’s a sensible explanation for why the airline didn’t just scuttle the flight: “However, this would have left a plane load of west-bound passengers stranded in London Heathrow who were due to fly back to the US on the same aircraft. . . . We sought alternative flights for the west-bound passengers but heavy loads out of London that day meant that this was not possible.”

What is the environmentalists’ solution? “Governments must stop granting the aviation industry the unfair privileges that allow this to happen by taxing aviation fuel and including emissions from aviation in international agreements to tackle climate change.” These measures would have changed nothing about the total environmental impact of the February 9 flight. American needed the plane to be in London that day, emissions trading scheme or not, so it would just have to had bitten the bullet and to ponied up for its environmental impact. Emissions trading programs are meant to reduce the environmental impact of aviation systemically, not in one-off circumstances. It’s dishonest of Friends of the Earth not to acknowledge that their solutions would end up costing travelers more without ending these rare sorts of trips.

Plane flies five passengers from US to London [Telegraph]

Photo credit: Flickr user dyobmit. Used through a Creative Commons license.

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Is avoiding bankruptcy worth it?

The Dallas Morning News ran an in-depth report on American Airlines’ current woes, wondering “what if American hadn’t avoided bankruptcy?” The Ft. Worth-based airline was one of the only ones to avoid Chapter 11 in the early 2000s, and now it is being punished by Wall Street analysts for having (relatively) high labor costs and pension obligations, compared to its competitors, who mostly shedded pensions and gutted contracts while under bankruptcy protection. The article provides a good background of the acrimonious disputes leading up to a 2003 agreement by three AA unions to agree to big pay cuts–over $1.5 billion annually. That affair was dominated by the resignation of CEO Donald Carty, who, along with several other top executives, were to receive several million dollars in bonuses as a “reward” for winning the concessions.

Most of the other major airlines used bankruptcy as a cudgel to trim down. When they emerged, leaner and cheaper, Wall Street applauded. AA managed to return to profitability too, but it did so more gracefully, with less hurt to employees. Now that all the major airlines are out of bankruptcy and in the black, unions are calling for profits to be directed toward restoring compensation lost in the lean years. Unions at AA are calling for this too, and they have a special argument: their concessions saved the company. “‘We didn’t just bail out American Airlines and AMR Corp.,’ [pilots union spokeman Karl] Schricker said. ‘We bailed out the leaseholders. We bailed out the debt holders. We bailed out the shareholders. We bailed out everyone.'”

But why avoid bankruptcy? According to the DMN, it became “a part of business strategy” after deregulation in 1978. According to one academic they cite, bankruptcy is “a corporate restructuring device, just like a spin-off, a divestiture, an equity carve-out, a merger. . . . Really, Chapter 11 reorganizations are really no different than hostile takeovers or a leveraged recapitalization as a device for improving a company.” According to research presented last fall by Aparna Mathur, lenient bankruptcy laws stimulate entrepreneurship, and U.S. bankruptcy laws are well-suited to our business climate: “America’s bankruptcy law is rooted in the “fresh start”—the idea that honest debtors experiencing a spot of bad luck, such as temporary job loss, illness, or divorce, are capable of putting the past behind them and moving on. This concept works especially well for owners of small businesses. By wiping out debts and pardoning failure, American bankruptcy gives the entrepreneur a chance to bounce back.”

So why did AA work so hard to avoid Chapter 11? According to a former exec at US Airways (a two-time post-2001 bankruptcy vet), “The problem is that bankruptcy leaves a lot of carcasses around. You have shareholders who are wiped out. You have employees whose contracts are severely modified and end up being incredibly disgruntled and unhappy coming out of it. You have a slew of other vendors and outside people whose contracts have been abrogated or severely modified. You don’t create a situation where you’ve got a lot of constituents on your side when you go into bankruptcy.”

Furthermore, there’s a social norming stigma associated with bankruptcy that’s healthy to preserve. In Monopoly, bankruptcy=defeat. It’s not a position of strength. And bankruptcy, even if it is through no fault of the petitioner, involves “erasing” debts–a misnomer, because the creditor still eats the loss. In the case of large companies, like airlines, it also involves breaking promises to employees and perhaps fatally wounding morale. “‘It amazes me that bankruptcy has lost its stigma in business,’ said Mr. Schricker of the pilots’ union. ‘It used to be, a company went bankrupt and all these senior managers went away. Now it’s like bankruptcy is just a business strategy–and that’s not what America is about.'”

George Will once wrote two very different columns on these issues, separated by four years. In 2002, he castigated United’s employee-owners and urged the airline into Chapter 11, singing the praises of bankruptcy all the way. Then, interviewing AA clean-up CEO Gerard Arpey in January 2007, he asked:

Is it irresponsible for American not to use bankruptcy to lighten legacy costs — shredding labor contracts and reducing obligations to retired employees?

Gerard Arpey, American’s chief executive, replies with a laconic “no.” He considers it unseemly and shortsighted — and unnecessary — to seize short-term competitive advantages by reneging on labor contracts freely consented to, and to escape commitments to investors who lent you money in good faith. Furthermore, the damage to employee relations makes bankruptcy more costly than some companies realize when they use it as a routine management tool.

So, readers and commenters: should airlines try at all costs to avoid bankruptcy, or should they embrace it as a business practice?

What if American hadn’t avoided bankruptcy? [Dallas Morning News]

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