Monopoly Basics

Airlines & Monopoly

Complaints about the decline of airline service have now become a commonplace of American life. Viral videos showing passengers being manhandled or pushed to the ground and left unconscious by airline employees become the talk of the nation. These amplify long simmering resentments over such routine indignities as “involuntary denied boardings,” late and canceled flight, mishandled baggage, bruised knees, and ever more add-on charges.

Meanwhile, more and more cities and even whole regions of “fly over America” are finding they are served by fewer and fewer flights costing more and more. While the number of departures at large hub airports declined 6.2 percent between 2007 and 2016, the decline at small and non-hub airports was 31.5 percent, or five times as great. An analysis of government data by the Wall Street Journal shows that not only has service to all but the largest airports fallen dramatically over the last decade, the already high cost of flying to most mid-size and smaller locations has increased faster than inflation. Adding insult to injury, the industry’s profitability recently hit an all-time high, reaching $20 billion in 2016.

No wonder that in surveys of consumer satisfaction, the dominant airlines in the United States score abysmally. They are now exceeded their unpopularity only by health insurance companies and Internet service providers.

What explains the sorry state of airline travel in the United States? Largely, it is story of government retreating from its historical role in structuring competition in airline markets, combined with a near wholesale abandonment of anti-trust enforcement.

Today, a series of mega-mergers have left the four largest U.S. airlines—American, Delta, United, and Southwest—controlling about 80 percent of total domestic passenger traffic. In many cities and regions, the degree of monopoly is much more extreme. As of 2015, a single airline controlled a majority of the market at 40 of the 100 largest U.S. airports, up from 34 airports a decade earlier. At all but 7 of the top 100, one or two airlines control a majority of the seats for sale.

In other industries where a few large firms dominate (think Coke and Pepsi) they may still compete fiercely with each other in every city and town, but when consolidation occurs among airlines it often leaves local communities completely dominated by single carrier or cartel of common owners. Underscoring the degree of cartelization in the today’s U.S. airline industry is the fact that the biggest four airlines each count among its largest shareholders the same four large institutional investors: BlackRock, Vanguard, State Street, and PRIMECAP. This interlocking, common ownership structure of airlines, which is akin to the giant investment banking trusts that gained control of the railroadsand other key industries in the late 19th century, means that even nominally independent airlines have strong incentives to avoid competing for market share. One study comparing fares on routes served by airlines with and without common owners finds that the horizontal ownership structure that pervades the U.S airline industry raises the cost of flying by 10-12 percent.

Concentrated ownership of airlines also leads to lower service levels. The Federal Aviation Administration has estimated that when a market’s service options shrink from three airlines to two, the length of delays in the market increases by 25 percent.

These problems trace back to policy changes begun during the late 1970s. Until 1978, the United States viewed airline service as a “public convenience and necessity” and used a government agency – the Civil Aeronautics Board, or CAB – to assign routes and set fares. The airline industry was highly concentrated, to be sure. In 1956, the so-called “big four” carriers—American, United, Trans World, and Eastern—accounted for nearly 80 percent of premium market passenger miles. But regulation by the CAB prevented airlines from abusing their market power while also ensuring that citizens in cities of comparable size received roughly equal service, in terms of both quality and price.

This regulatory regime had problems, but on balance, the system worked well. Protected by government regulation from ruinous price wars, the industry remained profitable enough to finance continuous improvements in new and dramatically faster, safer, more efficient aircraft. These efficiency gains in turn allowed for a steady decline in fares that vastly expanded access to air travel. By 1977, 63 percent of Americans over 18 had taken a trip on an airplane, up from 33 percent in 1962. At the same time, the industry provided secure middle-class jobs for pilots, mechanics and other personnel.

In the late 1970s, however, powerful voices, including those of many liberal Democrats, began calling to dismantle the very regulatory regime that had widely democratized airline travel. In 1978 president Jimmy Carter signed the Airline Deregulation Act, thereby ending government regulation of airline routes and pricing. A first-order effect was a wave of startup airlines that brought fare discounting on many routes. But over time, most new start airlines failed and fare competition waned.

Indeed, after adjusting for changes in energy prices, a 1990 study by the Economic Policy Institute concluded that airline fares fell more rapidly in the 10 years before 1978 than during the subsequent decade. Another study finds airfares would have fallen still faster after 1978 if, instead of letting carriers charge whatever the market would bear, the CAB had been allowed to continue enforcing its long-standing formulas for setting maximum fares. The disparity be would be even greater if today’s ticket prices could be adjusted for the loss of convenience and productivity caused by the Airline Regulation Act, which allowed airlines to cut service to many cities altogether,  to drop many direct flights in favor of a hub and spoke system, and to put severe restrictions on passengers’ ability to change tickets or get refunds.

Proponents of Airline Regulation Act imaged that freeing airlines from regulation by the CAB would result in greater market competition and thereby secure greater value for the travelling public. But as it happened, a simultaneous retreat from anti-trust enforcement would lead to less, not more competition, while regulation of industry simply shifted from control by public institutions to control by ceos and private financiers. As Paul Stephen Dempsey and Andrew Goetz have noted: “we should have learned that the transportation industry has too many social and economic externalities to allow it to be manipulated by a handful of unconstrained monopolists. The quasi-public utility nature of the transportation industry suggests the need for enlightened regulation in the public interest.”

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