Sixty-two years ago, the U.S. airline industry, by most definitions, was a classic public utility. The services provided by airlines were considered essential, and the necessary capital investment was high in relation to revenues. If the industry was not always a natural monopoly, then it at least appeared to be a natural oligopoly. There was a shared belief, grounded in experience, that regulation was required to protect the pubic interest. That political consensus produced the prototypical New Deal regulatory structure. From 1938 through at least 1978, the Civil Aeronautics Board (CAB) provided cradle-to-grave economic regulation of the U.S. airline industry, literally. An airline could not go into business or out of business, or do anything in between, without the permission of a majority of the five presidentially appointed CAB members.

This all changed with the Airline Deregulation Act of 1978.¹ The driving force behind deregulation was the perception that regulation by the CAB had resulted in reduced competition and higher fares. That perception was reinforced by the actions of the CAB in the first half of the 1970’s, actions that included: an unofficial moratorium on the award of additional domestic routes and the certification of new airlines; approval of agreements among the trunk airlines that limited capacity in major domestic markets; a massive investigation into the domestic fare structure that produced, among other things, a mileage-based fare formula and detailed standards for everything from seating configurations to in-flight service; and continued grants of antitrust immunity to an airline cartel that fixed prices in international markets.

The best argument against deregulation was that proper administration and/or reform of the existing law could cure the regulatory excesses of that period, the classic baby-but-not-the-bathwater formulation.² Congress, acting on a largely bipartisan basis, chose to throw out its baby. That choice cannot be second-guessed because of the inability to predict what would have happened under a regulatory reform scenario, but this much is clear. Airline deregulation largely has been a success, albeit a nervous one with many still unanswered questions.

For this reason, the airline industry frequently is viewed as the Beta test for all federal deregulation. Setting aside the fact that the airline industry remains subject to a comprehensive federally imposed safety regime that still makes it the most heavily regulated industry in the world, there are some lessons to be learned. Those lessons may be more akin to Murphy’s Law than to classic economic or political science, but they are no less useful.

The first lesson is that you can be right for the wrong reasons. Although there were nearly three years of congressional hearings preceding deregulation, most of the evidence was anecdotal. Since no one proposed reducing the level of safety regulation for airlines, it came down to guesses about how the airlines and their customers would react to the new marketplace reality. And for many, the answer to that question simply did not matter.

Some of the more educated guesses looked to "non-regulated" analogies, most notably the intrastate operations of Pacific Southwest Airlines and Southwest Airlines. While those analogies also were flawed -- those operations were under the umbrella of highly protective state regulation at the time – those airlines did offer fares that generally were lower than their CAB-mandated counterparts. CAB-approved (albeit reluctantly) charter operations also had introduced truly low cost air transportation to the public. Finally, the General Accounting Office produced a widely quoted study estimating that domestic airfares were anywhere from 22% to 52% higher because of regulation.

On the competition side, the number of trunk airlines had decreased from sixteen in 1938 to ten in 1978. More ominously, by 1978 the five largest airlines accounted for two out of every three dollars in domestic airline revenues. This was considered an unacceptable level of concentration and one driven by the anti-competitive policies of the CAB.

The unifying economic theory among the proponents of deregulation was market contestability. Airline assets may have been "fixed" from an accounting standpoint, but they were movable in every other sense. Left unrestrained in an open marketplace, those assets would be deployed and re-deployed as market conditions demanded. This would produce both actual and potential competition that would reduce concentration and lower fares.

The empirical evidence suggests that the theory was at least partially correct. The average yield (the average fare per passenger mile) for U.S. airlines in 1998 was 41% lower than its 1978 equivalent on a constant dollar basis,³ at least partially validating the "guesstimate" made by the GAO more than two decades earlier. On the other hand, the industry remains highly concentrated. The five-carrier share of domestic revenues that caused concern in 1978 at 66% is up to 72% today -- and on the cusp of dramatically increasing.

The second lesson is that you can be wrong for the right reasons, i.e., the law of unintended consequences. Average fares are lower, but they also are highly discriminatory. One of the basic purposes of economic regulation, the prevention of discrimination, has been abandoned, completely and without much forethought. Indeed, the ability of airlines to discriminate by time of purchase, conditions of travel and, significantly, the degree of competition faced in each city-pair market, has been both the major impetus for lower average fares and the major source of most complaints about deregulation.

As strange as it may seem, another unintended consequence of airline deregulation has been its popular success. In the 1970’s, the airline industry was considered mature. As a result, most economists underestimated demand elasticity and the resulting growth that would be produced by lower prices. After 1978, air transportation, at least in some form, was made available to everyone, and nearly everyone has taken advantage of that development -- U.S. airline domestic passenger enplanements more than doubled between 1978 and 1998, and air cargo experienced a similar growth rate. This has put severe pressure on an underlying airport and airspace infrastructure largely funded by the federal government. It also has affected the perceived quality of service. The following may not be a fair economic judgment, but it is a political reality: if deregulation had offered the promise of more connecting flights on crowded aircraft with less legroom at fares that were lower for some but higher for others, there might still be a CAB.

The third lesson is that the differences between the regulated and deregulated airline industries tend towards the margins. If a regulatory scheme with a pro-competitive legislative mandate is administered properly, it should produce results that mimic an ideal open market. The weakness in that theory is the distorting and unpredictable effect of political intervention, and that certainly was the problem at the CAB. However, whatever else is said about the "dead hand" of regulation, at least it is a steady hand. The deregulated regime, to the contrary, is more likely to result in the ideal competitive norm but with extremes on both ends. That is why the U.S. airline industry today is such an environment of contradictions. Concerns about consolidation co-exist with concerns about outsourcing. Prices are too high and too low. Deregulation has no impact on safety and reliability, but something must be done about safety and reliability.

In the end, it is the public’s perception of those extremes, and the accompanying political will, that decide the longevity of deregulation. It would appear that faith in the unsteady hand of competition in the airline industry has not lessened to a significant extent, but that leads to the final lesson -- you never know what tomorrow may hold. The industry is highly sensitive to external factors ranging from the weather to the price of fossil fuels, and it is driven as much by technology as by economics. The difference between the industry ten years from now and the industry we see today could be as great as the difference in the industry in 1978 versus 1938. With change as the only constant, any regulatory configuration is possible.

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  ¹Pub. L. No. 95-504, 92 Stat. 1705 (1978). The Act phased in deregulation over a five-year period, but a proactive CAB largely finished that task, then referred to as "scrambling the eggs," within two years. The domestic all-cargo industry actually had been deregulated in 1977. While this article focuses on domestic aviation, the deregulation of international markets has been slower but no less inexorable. Back to text.

  ²In 1975, the D.C. Circuit held that the existing regulatory scheme did not have a per se presumption in favor of competition, "but when sufficient traffic exists to support competition, certification of competing carriers is mandated by the Act." Continental Air Lines, Inc. v. Civil Aeronautics Board, 519 F.2d 944, 954 (D.C. Cir. 1975), cert. denied, 424 U.S. 958 (1976). Back to text.

  ³Per the Air Transport Association, the constant (1982) dollar yield in 1978 was $.1227 compared to $.0774 in 1998. Back to text.

  ⁴The Justice Department has a less generous view of airline hubs. In a speech last year, a Department official expressed the view, given in the context of the Department’s civil antitrust action against American Airlines, that the market contestability theory was a victim of major airline hub dominance and that predation in the industry was, therefore, plausible. The Importance of Entry Conditions In Analyzing Airline Antitrust Issues, John M. Nannes, Deputy Assistant Attorney General, Antitrust Division, before the International Aviation Club, Washington, D.C. (July 20, 1999).  Back to text.