A delusional view of the aviation market


I often enjoy reading economic analysis of the aviation industry. I usually feel like I’m learning something new and the nuance is generally interesting. I was quite surprised when reading an OpEd piece in the New York Times last week to uncover what would appear to be a rather ridiculous suggestion: Small and mid-size markets in the USA would benefit from foreign carriers being given permission to operate on wholly domestic routes. The basic claim is that there is insufficient competition in the market today, allowing fares to creep higher and planes to be more full. And service to small and mid-size markets is enduring the brunt of the pain; most of the "heartland hubs" (CLE, CVG, PIT, MEM, STL) have seen major capacity cuts in recent years, with their status as a hub in question. And the solution, according to Mr. Winston, is opening the skies over the USA to anyone who wants to operate here.

That is, unless policy makers do what they should have done a long time ago and allow foreign airlines, including discount carriers like Ryanair and global players like Qantas and British Airways, to serve domestic routes in the United States. Why, after all, should an industry that has ingeniously used free-market principles to squeeze the most revenue out of each middle seat be protected from competing in a real free market?

Well, we can start with the part about how that isn’t actually a "real free market" based on a lack of reciprocity in the other countries. And even if that were made available it still is an unlikely solution. Or at least not likely a good one. After all, what’s the value proposition being suggested? Apparently the key to improving the UA aviation market is to flood it with more capacity, driving down fares. But that increased supply will somehow also drive demand. Last I checked that’s not how the basic supply/demand curve works, though I will admit I dropped my Econ class after the first exam because I didn’t really like it.

There is a certain amount of discretionary travel demand which increases as fares drop below a certain threshold. I believe that number is roughly $100 each way these days. But just flooding the market with inventory to drive the fares down that low doesn’t mean that enough people will necessarily buy the seats in a volume which pays for the service. In fact, it is rare that flights operated at that discretionary demand point are profitable to the airlines at all.

Mr. Winston notes that passengers have likely saved $5bn annually thanks to Open Skies agreements between the US and Europe. Not surprisingly the airlines are trying to claw some of that revenue back, cutting service and striking joint ventures which allow them to cut costs and pool revenue and collude on prices. Are these agreements good or bad for passengers? If only measured by average fare paid then they are probably bad. But that’s not really the only metric. Look at the carriers who have gone bankrupt in the interim. For those customers  – and those employees and creditors – the $5bn in annual savings means a lot of losses, not gains.

Mr. Winston also suggests that one upside of the competition is that it will help reduce unemployment:

Competition from foreign airlines would put downward pressure on wages, something that union workers may object to. But by reducing fares and expanding service, it would also increase the demand for air travel and related services — thus, presumably, creating additional jobs during a time of persistently high unemployment.

Can someone explain to me how cutting the salaries of US-based employees and creating an environment where the domestic airlines will struggle more to maintain their margins is actually going to increase the employment rates?

So if the fares are driven sufficiently low, to the point that they cannot cover the costs of operating the flights, then other airlines will want to jump in to the market, right? Certainly then Singapore Airlines will show up to operate on Sarasota – Cincinnati, making the service better and the price lower, right? That’s what is being claimed in the piece.

The reality is that opening up the US skies to foreign carriers would see those carriers do the same thing that pretty much every other start-up airline has done in recent years: cherry pick. JetBlue started by cherry picking routes between JFK and upstate New York or Florida. Virgin America has picked heavy business routes and seems to be losing a ton of capital doing so. Oh, and that’s with the fares higher now; things would be much, much worse for them were the fares depressed further.

So where can these foreign carriers make money operating in the USA? Certainly the grandmother trying to get from Sarasota to Cincinnati (his example, not mine) worried about fewer flights and higher fares won’t benefit from Qantas getting local traffic rights on their LAX-JFK flight. And even if Singapore Air could operate to Sarasota, why would they? The market demand there isn’t very high. So instead of the smaller markets getting more service the carriers who serve them today suffer from lower yields on their more profitable routes. That means they scale back the less profitable routes. So grandma gets even fewer options, not more.

Maybe easyJet or RyanAir could set up shop in the USA and make it work. But SkyBus certainly couldn’t. Maybe the others would actually serve the airports in the cities they advertise, but they often don’t in Europe. RyanAir’s idea of service Paris is an airport 60+ miles away. That’s like flying in to Trenton for service to New York City.

Competition is good. Monopolized markets are not very consumer friendly. But neither are unstable markets. A few people might win, playing in the margins, but the big picture effects of pursuing open skies on all domestic markets would be a disaster for the US economy. And for the passengers such a change supposes to help.

Never miss another post: Sign up for email alerts and get only the content you want direct to your inbox.


Seth Miller

I'm Seth, also known as the Wandering Aramean. I was bit by the travel bug 30 years ago and there's no sign of a cure. I fly ~200,000 miles annually; these are my stories. You can connect with me on Twitter, Facebook, LinkedIn and .

10 Comments

  1. FWIW, it’s Dr. Winston, and he’s a very well known transport economist. But, in any case, he is totally off base with this idea.

  2. “Well, we can start with the part about how that isn’t actually a “real free market” based on a lack of reciprocity in the other countries.”

    Actually, the Open Skies agreement with Europe allows cabotage in both markets, and it’s only waiting for the USA to decide to implement it (they’ve been trying to get europeans to allow it first, but they are not so stupid), and then all american airlines could fly anywhere between 2 points inside the EU (plus Norway and Iceland, I believe).
    As for the rest, it’s exactly what was said before the deregulation here in the US (as well in Europe). No need to say what happened to that doomsday view (and Ryanair might be awful – it certainly is in many regards – and flying to place in the middle of nowhere, but the customers (those damn fools that do not know what’s best for them!) apparently keep giving them their business and making it one of the biggest – and more profitable – airlines in the world).

  3. Additionally, the aviation market is not free at all in the US because it does not allow more than 25% of foreign capital in each airlines. A country that puts limit on foreign investments (de facto exports) is not very smart (if people want to leave their money here with us the only thing we should say is “well sir, go ahead and bring your friends with you”).

    1. Foreign investment doesn’t mean that the money stays in the USA. That’s why it isn’t permitted. A foreign company investing in the USA will take the profits out from the USA back home. That’s not so useful to the US economy.

      I also find it interesting that you suggest the Europeans are not so stupid to open up cabotage/local traffic rights first but that the US should. How does that work?? I also disagree that the economic impact of allowing open skies access is the same as deregulation from the 70s.

  4. Amusing. The article’s comment about lower wages and higher employment seems to miss a larger point. If we wanted full employment, we could cut everyone’s wage to a dollar and hour and guarantee a position doing something–anything. But underemployment is not much better than unemployment. Better to pay people more to do a better job with fewer employees and redistribute labor elsewhere.

  5. I for one have no problem with SQ or AZ for example serving domestic US routes. A free market society should allow them to do so. They will cherry pick and maybe be profitable or maybe not. But, the role of US government should not be protectionism. There is no national security threat if CA flies from LAX to NYC. Let the market decide

  6. Hahaha! The European airlines wouldn’t touch the US domestic market with a 747ft pole if they were even allowed to. Virgin supports VX but that is badly flopping as no one wants to pay for decent service. People may rack up debts to get an iphone, but run when air prices go up by 10 LH supports B6, but mainly due to the cherry picking and the top operation they run. EU & Asian legacy carriers will perhaps add transcon tag on flights if at all. A company investing billions in hundreds of plans to start another southwest/ryanair is highly unlikely. The money is much better invested in some emerging market :p

  7. It’s an academic argument as it’s never going to happen, whatever treaties the US signs. The USA is one of the most protectionist countries in the western world, tending only to sign trade agreements to bolster its exports, and then doing its best to obstruct imports.

    Open skies could be a huge step forward, and the signs are that the EU is keen to implement it when the US does (simultaneously, so that works just fine) but the US seems to have no intention of living up to the treaty.

    If you look at what open skies did in Europe, you will see that, whilst it has not revolutionised the aviation market, it is having a significant effect as airlines are beginning to see where it will work for them. The AF/KLM and BA/Iberia mergers are two examples of its effect, and an AA/IAG merger would be an outcome that would please many. Of course SQ is not going to fly from Syracuse to Miami but it might want to provide some form of feed for its premium passengers to important destinations which does not mean they have to suffer a domestic US airline.

  8. This will NEVER happen. Irrespective of whether or not it’s a good idea, politicians and unions will scream bloody murder about American jobs and money going overseas. That would not necessarily be the reality, but that’s what would dominate the headlines and the talk shows. In the current economic state, it would be political suicide for any political figure to try to advance it. Even if the economy were thriving, it would be the hottest of political hot potatoes.

Comments are closed.

BoardingArea