Regulation as a bailout

Alan Reynolds
Posted: Feb 03, 2005 12:00 AM

Federal regulation of business is often described naively, as if regulations were intended to rein in companies rather than bail them out. In reality, however, regulation has often coddled inefficient companies by keeping competition down and prices up. Protectionist regulation, like protectionist trade policy, is just a disguised subsidy from consumers to politically favored businesses.

 The New York Times provided a revealing example of who really lobbies for government regulation and why. The article "Coffee, Tea or Regulation?" was about political efforts to get the government back in the business of regulating airline fares and routes.

 "Representatives of labor unions and some consumer groups," it explained, "long for the stability of the time, before 1978, when the government decided fares and determined where airlines would fly. ... These groups say it is time to consider reregulating airlines. ... Because the Democratic Party, a traditional ally of organized labor, is out of power, Congress could easily turn a deaf ear. But that is not stopping union leaders and others from floating ideas, like asking the government to require airlines to charge a flat fee per seat mile. ... Some people have even suggested forbidding companies to start new airlines."

 Asking the government to ban discounts and new competition is blatant special interest group pleading, rebuked by all objective economists. The article quoted Clifford Winston of the Brookings Institution, who calculates that since the Civil Aeronautics Board (CAB) stopped dictating air fares and routes, "fares have dropped by more than 30 percent, on average, and as much as 70 percent."

 Replacing regulation with competition also resulted in more choices in more cities: "American ... flew to just 50 cities in 1975; it now serves more than three times that number. Southwest, which started in 1971 with a single route in Texas, now flies to 61 cities."

 Although The New York Times suggests deregulation "irritates consumers" or nameless "consumer groups," few consumers object to more carriers offering more flights at lower fares. While it existed, the CAB worked hard to battle low fares (although charter flights and intrastate airlines were outside CAB control). The CAB had nothing to do with safety, nor with any of travelers' current complaints about baggage handling, meals, overbooked flights and the like.

 Nostalgia about supposedly better service before 1978 forgets that this was because coach seats were priced as though they were first class. In 1982, the current Supreme Court Justice Stephen Breyer wrote a classic book, "Regulation."

 "Because the CAB prevented price competition," he wrote, "the airlines channeled their competitive energies into providing more and costlier service -- more planes, more flights and more frills -- too the point where travelers were offered ... in-flight gourmet meals and Polynesian pubs. Yet the planes themselves flew more than half-empty." Planes were indeed less crowded when regulation banned competitive pricing, but that meant the costs of travel were spread among fewer passengers.

 Today's talk of reregulating airline fares and banning new competitors is not coming from genuine "consumer groups," but from executives of the old hub-and-spoke unionized airlines and their union bosses.

 "Airline executives," the article notes, "say they never anticipated that deregulation would precipitate a crisis as deep or as long as the present one, in which the industry has lost $30 billion over the last five years, compounded by high jet fuel prices that have removed the airlines' breathing space." The implication that big airlines recently began losing money because of deregulation in 1978 is as illogical as blaming deregulation for high oil prices. Still, it should not be surprising that executives of older airlines believe their jobs would be much easier under a regulated cartel than battling competition from upstarts like Southwest and Jet Blue.

 Under pre-1978 regulations, the CAB set airfares high to guarantee profitability (a 12 percent return) even if planes flew 45 percent empty. There was no incentive to control costs or to try filling those empty seats by offering discounts (which were banned). From 1938 to 1978, the CAB did not allow a single new company to enter the business, although the CAB received 79 such applications after 1950. Even privileged airlines within this overprotected cartel could rarely gain authority to add a route.

 "Carriers like TWA, Pan American World Airways, Eastern and Braniff ... could not compete in a deregulated industry," The New York Times observes. So what? Delta acquired Pan Am, and American acquired TWA. Eastern Airlines' planes and routes were taken over by American, Continental and the Trump Shuttle. "Previous airline crises," the article points out, "prompted competitive solutions, including mergers, the development of frequent-flier programs to help retain customers and computerized reservation systems, which helped airlines manage their inventories of unsold tickets and decide when to cut fares."

 If airlines that can't compete today were instead bailed-out by protectionist regulation, they might still go under (as six did under the CAB) because artificially high fares would discourage travel, encourage costly non-price competition in frills and make it easier for airline unions to hold the traveling public up for ransom.

 Union leaders obviously believe they could siphon-off any monopoly profits resulting from reregulation, leaving the airlines no more profitable than before. The head of one union "wants the Transportation Department to require airlines to charge at least what it costs them to transport passengers." A rival union "has floated a proposal to charge a set fee per mile for plane tickets."

 Both excuses for banning discounts confuse average cost per passenger on board (which is about a third higher among that Big Six than among their scrappy rivals) with the low marginal cost of adding another passenger to a flight that is not full. If airlines were forced to charge the same price for every seat, you can be sure that price would be high and the planes would once again fly 50 percent to 60 percent empty.

 A Washington Post article about airline fares claimed "business travelers have felt like captives, singled out by the cost of walk-up fares that, until last week, had outpaced the consumer price index since airline deregulation." The source was some figures from USA Today travel columnist Joe Brancatelli. Yet Brancatelli's usual advice to travelers is to skip the Big Six and instead fly Southwest, Jet Blue, ATA, America West, Frontier, Spirit, Air Tran, Midwest Express, Aloha or Independence Air.

 Those who plead for greater government involvement in business, whether that means complaining that Chinese clothing is too cheap or that Wal-Mart's prices are too low, are really just hoping to enlist the government's help in profiting from higher prices.

 Government regulation of airline fares, like government regulation of everything from milk to peanuts, was simply a political-industrial conspiracy to gouge consumers. The expression "let the buyer beware" is particularly appropriate when it comes to listening to interest group excuses for special protection against competition and low prices.