Deregulation Term Paper

1Running Head: AIRLINE INDUSTRY: POSITIVES & NEGATIVES OF DEREGULATION

AIRLINE INDUSTRY: POSITIVES & NEGATIVES OF DEREGULATION

Tenzing C. Sherpa

York College

2AIRLINE INDUSTRY: POSITIVES & NEGATIVES OF DEREGULATION

Abstract

The Airline Deregulation Act signed into effect in 1978, brought about much change

in the aviation industry nationwide and to some extent, globally. Before the Airline Deregulation

Act, the government through the Civil Aeronautics Board (CAB) vigorously regulated every

aspect of the airlines. With much study and research, framers felt the need to deregulate this

industry in order for the airlines to fulfill the economic potential that is available. Since the

ADA, there has been much success for the travelers and the carriers. Lowered airfares, more

destinations, lowered costs, and increasing demand has led to the airline industry now becoming

a major economic booster. While this is true, success has come at a cost. The airline industry

since deregulation has seen major air carriers file for bankruptcy, merge or liquidate completely.

The failure of these airlines has resulted in a number of carriers dominating most hubs, which

concerns the travelers in particular. Since deregulation, many smaller communities have seen a

decrease in air service and an increase in airfares to and from those communities. The airline

industry has therefore seen great success at a certain cost. Many claim that the good far outweigh

the bad and reregulation is not an option. According to Government Accountability Office

(GAO), “The evidence suggests that reregulation of airline entry and fares would likely reverse

much of the benefits that consumers have gained and would not save airline pensions.” This

paper will discuss and cover the positives of regulation and deregulation era and make

differences based on the past results, success and failures.


Leonardo Da Vinci once said, “Once you have tasted flight, you will forever

walk the earth with your eyes turned skyward, for there you have been, and there you will always

long to return.” The year 1903 proved to be the benchmark for the Aviation industry. In a small

field in North Carolina, the Wright brothers accomplished the invention of a heavier-than-air

flying machine that gave humanity the gift of flight (Crouch, 2003). In 1914, America’s first

commercial flight led the way into becoming what is now, probably one of the largest industries

worldwide (Morrison & Winston, 1995).

In the following years after 1914, airlines started to emerge into the market to serve

the increasing demand for air travel. As always, the government had to intervene and create

regulations and took over the entire aviation industry in the United States. The Civil Aeronautics

Board created in 1938 overlooked and ran the industry. They controlled every aspect of each

airline, from ticket prices, routes, destinations, number of flights to number of airline companies,

etc. While this proved to be of much benefit to the public, airline companies and economists

believed that this was limiting the growth of this industry (Bailey, Graham & Kaplan, 1991).

New Deal programs started by Franklin D Roosevelt further expanded the government

regulations and this carried on through the 1960’s. The U.S soon suffered high inflation, high

unemployment and underemployment in the 1970s, the period also known as stagflation. Many

blamed and accused the government’s excessive regulation as the cause behind stagflation.

Therefore, deregulators stood in support of reduction of government rules – the idea being to turn

businesses free to operate, letting the market do the regulating. The framers made efforts to

reduce the day-to-day government involvement in private business activities and this was termed

as ‘deregulation’ (Gress, 2003).


According to Morrison & Winston (1995), “Believing that such strict regulation

made the industry inefficient and inhibited its growth; Congress in 1978 adopted

the Airline Deregulation Act. Championed by Congressional Democrats and signed into law by

President Jimmy Carter, the Act represented a fundamental shift away from regulation and

toward an air transportation system that relied on competitive market forces to determine the

quality, variety, and price of air services”. The Airline Deregulation Act of 1978 put an end to

the strict government control and gave airlines much needed freedom with their operations,

increasing the competition, which in turn benefitted customers (Bailey, Graham & Kaplan,

1991). Since then, the aviation industry has flourished globally but with the growing domination

of the remaining major carriers, suggestions for re-regulating the airline industry has often come

up. This paper will give you an insight on the positive effects as well as the negative effects of

Deregulation on the economy and the public.

Since the invention of airplanes, the airline industry has grown rapidly and in such

short period has become a dominant economic booster worldwide. During the years from 1938 to

1978, the demand for air transportation far exceeded the expectancy. According to Wensveen

(2007), “The number of passengers (domestic and international) carried by U.S. airlines

increased from a little over 1 million in 1938 to almost 267 million in 1978. With increases in

average length of journey, there was an even greater growth in U.S. airline passenger miles, from

533million in 1938 to 219 billion in 1978. Thus, over the four decade period, revenues increased

from $58 million to $22.8 billion, and total airline assets increased from under $100 million to

over $17 billion”

In the coming years, with technological advancements, U.S. aviation was the

dominating super power in the aviation industry worldwide. The U.S exported thousands of


aircrafts to foreign countries through private sectors. Wensveen (2007) also stated, “The exact

figures have not been available, as the Civil Aeronautics Board did not identify the

compensatory element in total mail pay until 1951. For the fiscal year of 1951, slightly over $75

million was paid in subsidies equal to slightly over 7 percent of total industry revenues”.

Over the forty-year period, the airline industry did relatively well and was

extremely successful and popular. The regulation brought about an increase in the number of

destinations to small cities and gradually increased the number of international flights. The

number of U.S carriers increased and frequent mergers took place (although no airline filed for

bankruptcies among them). During this period, eight new local service providers, three cargo

companies and ten charter airlines began operation in the American aviation industry. This

definitely proved much success and some of the charter airlines played a significant role in

providing lower price transportation services and came to be a dominant force in the market. All

these improvements made air transportation very popular among the public. In a survey, out of

twenty-one U.S industries, the airlines were rated number one for customer satisfaction and

proved to be the industry that gave the customers services worth their money (Wensveen, 2007).

Washington Monthly posted an article, ‘Terminal Sickness’, written by Phillip

Longman and Lina Khan (March/April, 2012) that discusses the effects of deregulation on the

aviation industry over the last three decades or so. The article focuses on small cities in the U.S

such as Memphis, Cincinnati that have suffered a great deal due to deregulation. Longman and

Khan give an example of Fernando Aguirre, CEO and chairperson of Chiquita Brands

International and a part owner of the Cincinnati Reds baseball team. Fernando had raised his

family and built his career in Cincinnati, Ohio. He gained much success and naturally was in

love with the city. While everything seemed perfect, he had to drastically alter and change his


and his family’s lifestyle completely by moving away from Cincinnati to uptown in Charlotte.

The question arises why. The only reason behind his dramatic decision to move his company

headquarters and his family to NASCAR plaza, in uptown Charlotte was the fact that traveling

had become very expensive from Cincinnati due to decrease in the number of carriers providing

flight services to and from Cincinnati/North Kentucky Airport (CVG). While this does not seem

all too concerning, Cincinnati happens to also be a city that is home to six fortune 500 companies

and fifteen fortune 1000 companies. This comes as a major reason for concern to the city of

Cincinnati as these companies provide the city with thousands of jobs that could disappear if

these companies decide to move elsewhere as in the case of Chiquita Brands International.

Former Minnesota Congressman Jim Oberstar (2012) stated in a New America Foundation’s

conference:

“In 1978, I sat on the full committee markup for the Aviation Deregulation Act and the

question that really bothered me was, ‘how are towns going to be served in an era where

we don’t have anyone standing in between the airline and the airline traveler?’ No one

was looking out for the interest of the cities. Airlines were simply looking out for their

own interests. I offered an amendment to hold in service where that existed at the time

and to provide a mechanism for funding service to small communities known as central

air service. To wrap up my statement, I said, ‘Mr. Chairman, if this amendment isn’t

passed in the era of deregulation, there will be towns like some of them in my district that

are so remote that without air service the only way to get there would be to be born

there’. That passed.”

Tom Jones (2012), a columnist for Memphis Magazine said:


“The impact from the high fares comes slowly and as a result, we accept a decrease in

service and adapt. We come to grips with increase in fares and we adjust. Then this way,

the impacts are more personal than economic. Every person in our region has a horror

story about airfares. Delta’s 25% cut in flights, discontinuing of year round direct flight

to Amsterdam took place while the Federal Government was building a $72 million air

traffic tower and while our airport authority was building a parking garage and passenger

facilities that cost even more. Except for the few hours when Delta flights are landing and

departing, the airport in Memphis is eerily quiet. Despite more than a decade of talks of

North West was imminent to move into Memphis, the old axiom remains true, ‘If you die

in Memphis and go to heaven, you have to go through Atlanta.’ Also worth remembering

is that some of the highest fares for a hub in the United States are taking place in a region

with some of the lowest median household incomes in the country. Our economy remains

fragile in Memphis and many things have to be done right for us to improve our

trajectory. High airfares are ice on our wings, at the exact time that we need our economy

to take off, the ice unlevel the playing field at the exact time that we need all of our

opportunities to align for new jobs and economic growth.”

Deregulation has proven to be negative in so many ways. While deregulation was

considered as a good thing, many communities lost air service immediately and the industry

adopted the new hub and spoke system that exists to this day eliminating many direct routes.

While there were some positives from the deregulation, many failed to see that all the positives

were simply temporary and could have happened with or without deregulation. Longman and

Khan (2012) also stated that a study in 1990 by the Economic Policy Institute concluded that the

airline fares fell more rapidly in the ten years before 1978 as opposed to after. A study in the


Journal of the Transportation Research Forum in 2007 confirmed that the pattern continued up

until the events of 9/11 after which the airfares dropped drastically as airline companies tried to

attract the frightened customers. The slow decline in prices adds concern in today’s world where

the quality of service has declined a great deal, from delays and long connecting flights to

charges on checked baggage and onboard amenities. Records also indicate that the declines in

the prices since deregulation have occurred due to factors that cannot be repeated such as

delayed replacement of aging aircrafts, elimination of complimentary meals and checked

baggage and the decrease in seat sizes and legroom.

Airline Industry has suffered failures due to the deregulation. Since 1978 after the

deregulation act, there have been a large number of airlines filing for bankruptcy, merging or has

resulted in complete liquidation naturally leading to instability in employment and periods of

labor strife (Goetz and Vowles, 2009). According to Evans and Kessides (1993), “As quickly as

new carriers were created, both old and new carriers began to exit the industry through merger,

acquisition, or failure. Of the 29 airlines operating in 1978, only 12 are still in existence, while

only three of the larger new entrants (America West, Midwest Express, and South-west) have

survived. The turbulence of the 1980s is in stark contrast to the period between 1970 and 1978

when only four firms entered and two firms exited the domestic airline industry.”

Severin Borenstein (1990) presented the table below stating:

“The data are from the third quarters of 1985, 1986, and 1987. The first of these periods

is probably before or during the preliminary merger negotiations. The second is after

agreement on the mergers and just before, they consummated. The third is nearly a year

after the mergers took place. The table shows that the two mergers examined here


accounted for the largest hub airport price increases during this time. Minneapolis and St.

Louis were two of the least expensive hubs to travel to and from in 1985 (with prices of

the dominant airlines at these airports just 11-12 percent above the national average

prices), but by 1987 were about as expensive as the other major dominated hubs.”

Airline Airport 1985 1986 1987 85-87

NW/RC Minneapolis 12.4 10.0 25.2 11.4

TWA/OZ St. Louis 11.0 7.1 20.5 8.6

American Dallas (DFW) 20.0 22.5 26.9 5.8

Delta Atlanta 26.2 37.8 24.4 -1.4

United Chicago (ORD) 15.8 19.1 1.9 -12.0

According to Cohen and Dolan (2001), “Until the 1970s, life for the airlines under

regulation was stable and marginally profitable. Some analysts have gone so far as to call this

regulatory scheme a ‘brilliant success.’ While others have not been so bold, but argue that the

regulated airline industry was stable and grew rapidly during this period. Despite the fact that

profits were small, the airlines were content under regulation as they were protected from

potential new airlines that were denied access into the system. The executive and legislative

branches were also happy with a system that was relatively safe and problem-free.”

In 1978, Congress passed the Airline Deregulation Act that phased out

government control over fares and services and allowed the market forces to control and

determine the price and level of domestic airline service in the United States. According to

Edelman and Baker (1996), “The main provisions of this act were as follows:


1. The airlines assumed responsibility for determining their domestic routes and schedules

effective December 31, 1981;

2. The airlines became free to set domestic fares and engage in price competition on

January 1, 1983;

3. The CAB ceased operations on January 1, 1985; and

4. Responsibility for overseeing relationships among domestic and foreign airlines was to

transfer to the Department of Justice on January 1, 1985.”

Some of the framers of the airline deregulation act had foreseen certain airlines failure and

thereby created the Essential Air Service (EAS) program, which subsidizes air service to smaller

communities. As predicted by the framers of the deregulation, the airfares have gradually

decreased since deregulation and the services have improved to some extent (GAO, 2006).

According to the Government Accountability Office (GAO), “Overall, median fares have

declined in real terms by nearly forty percent since 1980.”

Critics of deregulation have often pointed to the industry’s instability because

of industry layoffs and pension terminations along with declining service and high fares for some

communities as evidence of negative effects of deregulation. While that is true to some extent

and regrettable, many claim that the benefits of deregulation far outweigh the negative effects

and have provided an alternative option in EAS program. These effects on smaller communities

and the struggles of legacy airlines are all due to the competitive market forces. The legacy

airlines failure also goes on to prove that the market is extremely competitive and is working

thereby giving new lower-cost airlines to emerge into the market, increasing the competition and

driving the airfares down (GAO, 2006).


The chart above taken from the Government Accountability Office’s Report to

Congressional Committees in 2006 gives a fair view of the industry’s expansion thus far. “The

figure shows the consumption of airline travel as measured by revenue passenger miles (RPM)

grew from 188 billion RPMs in 1978 to 584 billion RPMs in 2005, while airline capacity grew at

a similar pace – from 306 billion available seat miles (ASM) in 1978 to 758 billion ASMs in

2005. Over the same period, revenue passenger enplanements increased from 254 million in

1978 to 670 million in 2005.” All positive attributes of the Airline Deregulation Act.

The Airline Deregulation Act benefitted not just customers but also the companies in

so many different levels. The Deregulation meant that predated legacy airlines had to adapt to the

new changes, and the competitive market gave them opportunities to redeploy their resources

and acquire new routes and implemented more profitable, innovative and efficient operational


practices (Kole, 1992). With the gradual decrease in regulatory restrictions, major carriers took

steps into reducing costs from all across the field, from fuel, labor, fleet, maintenance, route

structures and even operations. The most important of these changes being the route structure as

we moved from the linear systems to the current hub-and-spoke system (Vietor, 1990).

Hub-and-spoke system was a major change that none had predicted or foreseen.

This system came about to replace the mandatory direct point-to point nonstop flights that had

become mandatory for the airlines to carry through by the CAB before the deregulation. One of

the main advantages of these hub-and-spoke system operations is that, this system provides air

carriers with an enormous ‘multiplier’ effect in terms of the number of city-pairs that they can

serve. Hub-and-spoke system also offers advantages to travelers. Often connecting at hubs gives

customers the convenience of frequent flights to and from that particular hub. This therefore

reduces schedule delays and increases the passengers’ chances of finding a seat of their desired

flight as this system encourages the use of larger jets (Wensveen, 2007). This system also

provided airline companies the ability to offer more frequent flights and to larger number of

destinations with the near simultaneous arrivals and departures that we see in today’s world

(Vietor, 1990). The benefits of this system were substantial on both the revenue side and the cost

(Berry, 1990).

The Airline Deregulation Act brought about a major improvement into the

industry where prices were concerned. The introduction of brand loyalty programs such as

frequent flyer programs gave travelers discounted tickets and other amenities that before

deregulation, the CAB forbid discounted prices claiming that these were ‘discriminatory prices’.

Alfred E. Kahn (2001) claims, “According to Air Transport Association, 90 percent of all

passengers in 1986 traveled on discount tickets, at an average 61 percent below coach fare. The


Deregulation Act also introduced Computerized Reservation Systems (CRS) that have made a

huge impact on the airline industry. Rakowski and Bejou (1992) stated, “Those who supported

deregulation had no idea of the power of CRS’s. Brenner states that ‘no other industry has ever

confronted their consuming public with the turbulence of pricing paradoxes we see in today’s

airline fare structure.’” The Airline Deregulation Act made more intensive and high productivity

use of travel agents. Since deregulation, airlines have focused largely on marketing and have

created smart and innovative methods of doing so. Travel Agents have played a very important

role during the evolution of the airline industry after deregulation. According to Robert W.

Coggin (1986), Delta Airlines’ assistant vice-president, “Travel agencies account for about 70

percent of airline revenues. Nearly 90 percent of the agencies’ share comes from their access to

one of the five airlines’ CRS system.” Melinda Bush (1985), vice-president and publisher of

Hotel &Travel Index stated, “The result of deregulation is that 70 percent of domestic air sales

and 90 percent of international sales are made through travel agencies.”

The Deregulation of Airlines has also proven a great success while comparing

worker salaries and in turn has benefitted the company largely by getting rid of those huge

pension plans and unionized labor. According to Government Accountability Office (2006),

“Since 1978, airline industry salaries and total compensation experienced real increases, though

with some decline in 2002. Inflation-adjusted benefits per employee grew on average from

$14,703 in 1979 to $24,852 in 2004, a real increase of almost 70 percent. Meanwhile, inflation-

adjusted salaries per employee grew from $52,295 in 1979 to $54,848 in 2004 on average, a real

increase of less than 5 percent.” The average annual compensation per employee was

approximately $77,500 by 2005 (Wensveen, 2007).


The impact of the airline industry on the U.S. economy has been massive and

undisputable. Pulitzer Prize winner Daniel Yergin (2005) said, “Every day, the airline industry

propels the economic takeoff of our nation. The airline industry is the great enabler, knitting

together all corners of the country, facilitating the movement of people and goods, which is the

backbone of economic growth. The airlines also firmly embed us in that awesome process of

globalization that is defining the 21st century.” An article from the Journal of Accountancy

(2006) claims that the airlines have had a huge and positive effect on the economy stating the

airlines have contributed to about $65.5 billion dollars towards the GDP and drove economic

activity worth $298.3 billion as well as 2.1 million in jobs. In 2011, the Federal Aviation

Administration (FAA) and Air Traffic Organization (ATO) found, “ the commercial aviation to

be responsible for 4.9 to 5.2 percent of the U.S. gross domestic product (GDP), helping generate

$1.2-$1.3 trillion in annual economic activity, $370-$405 billion in personal earnings and 9.7 to

10.5 million jobs.”

Airline Industry at large is a growing industry with immense potential for both

carriers and travelers. The Airline Deregulation Act as discussed in this paper has both positive

and negative effects on the economy and the passengers. As mentioned, the impact of

deregulation has largely been positive. Critics have always pointed out to the failures and feel the

need for the industry to go through reregulation again but as the GOA stated, reregulation is not

an option if we are to protect the consumers and the industry at large. The failure of many

carriers since deregulation is the result of intense competition and market forces. These are signs

of success and while the losses of these companies are regrettable, the old simply gives way to

the new carriers. On another note, since deregulation, the government has had some control over

the airlines to this day on issues pertaining to security and safety. The airline industry has had a


huge impact on the economy since 1978 but the question will always arise, “what if the airline

industry was regulated to this day?” Many have also claimed that majority of the success that

deregulation has claimed could or would have happened even with a regulated industry. Certain

studies have proven this true as the airline industry faired pretty well even before the

deregulation. To sum up, Airline Deregulation Act has been a benchmark in the history of

Aviation Industry and the U.S. Economy and has to this day played an important role in world

economy. As Allen Howell (2010) stated, “Regulation of air travel from the federal government

should be limited to matters of safety. Congress should not venture anymore than they already

have into the regulation of customer service, pricing and competition. Government intervention

has not brought much value to anything lately and I can’t imagine a scenario where reregulation

of the airline industry will ultimately benefit the US economy and the consumer of air travel.”


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