Trillion Dollar Economists: How Economists and Their Ideas have Transformed Business by Litan Robert

Author:Litan, Robert [Litan, Robert]
Language: eng
Format: epub, azw3
Tags: Itzy, Kickass.so
ISBN: 9781118781838
Amazon: B00LMB5P10
Publisher: Wiley
Published: 2014-08-29T00:00:00+00:00

Airline Deregulation

Once established, the regulation of prices and entry into the major modes of mass transportation became something like the woodwork or plumbing in a house: just taken for granted. Incumbents that had their routes were happy with them, even though price controls limited their profits. In return, the authorized carriers were protected from competition with new firms in all of the different transportation modes.

There was one major loophole in this cozy system: Under the Constitution, which authorizes Congress to regulate interstate commerce, the CAB could only oversee travel between states. What the states did within their own borders was their own business.

For most states, this didn’t really matter, because they were either too small or too sparsely populated to support multiple carriers within any transportation segment. This was not true in airline or truck traffic, however, especially in the two largest states (by land area): California and Texas. Both served their roles as laboratories well, especially regarding airlines.

Michael Levine, one of the pioneers of what would eventually turn into full-scale airline deregulation, and later William Jordan, published studies of intrastate air traffic in California in 1965 and 1970, respectively, and compared its cost to interstate travel over comparable distances. Their startling conclusion: Intrastate fares were roughly half the comparable interstate fares.5 This finding reinforced the conclusion reached in an earlier, more academic study by one of America’s then-leading industrial organization and trade economists, Richard Caves, of Harvard University, that the airline industry displayed no evidence of economies of scale and therefore was not suited for price and entry regulation.6 A subsequent study in the 1970s by economists George Douglas and James Miller (who later went on to head the Federal Trade Commission and the Office of Management and Budget) found that regulation led airlines to schedule too many flights, explaining their low load factors, while denying consumers the ability to choose cheaper, unregulated flights.7

It is difficult to understate how remarkable these economic studies were. Airlines were regulated, so it was thought, in order to reduce airline prices, ostensibly on the theory that air flight exhibited economies of scale and would enable airlines to exercise market power, or charge prices well above marginal cost. In fact, regulation shielded the major airlines from competition, and by encouraging them to compete on the basis of flight frequency rather than cost, the airlines responded by flying their planes roughly half-full. This had the effect of keeping average costs high, and likewise for passenger fares, which were regulated to ensure the airlines could recover their average costs with a profit on top.

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