Deregulation and its Consequences

By Asif Siddiqi, U.S. Centennial of Flight Commission

Until 1978, the U.S. government, through the Civil Aeronautics Board (CAB), regulated many areas of commercial aviation such as fares, routes, and schedules. The Airline Deregulation Act of 1978, however, removed many of these controls, thus changing the face of civil aviation in the United States. After deregulation, unfettered free competition ushered in a new era in passenger air travel.

The CAB had three main functions: to award routes to airlines, to limit the entry of air carriers into new markets, and to regulate fares for passengers. Much of the established practices of commercial passenger travel within the United States, however, went back even farther, to the policies of Walter Folger Brown, the U.S. postmaster general in the 1920s and early 1930s in the administration of President Herbert Hoover. Brown had changed the mail payments system to encourage the manufacture of passenger aircraft instead of mail-carrying aircraft. His influence was crucial in awarding contracts so as to create four major domestic airlines: United, American, Eastern, and Transcontinental and Western Air (TWA). Similarly, Brown had also helped give Pan American a monopoly on international routes.

The Civil Aeronautics Act of 1938 put in place a regulatory organization, known after 1940 as the Civil Aeronautics Board, that was authorized to not only supervise the air transport industry, but also to promote and develop it. The goals of the CAB were to provide the American public with the safest, most efficient, least expensive, and widest ranging air service possible. The CAB accomplished these objectives by regulating such aspects of the commercial aviation sector as entry into and exit from individual markets (by dictating the route patterns between cities and the frequency of flights), fares for passengers and cargo, safety, financing, subsidies to carriers flying on less profitable routes, mergers and acquisitions, inter-carrier agreements, and the quality of service.

Proponents of regulation claimed that the CAB used its power appropriately to mandate carriers to fly routes of high traffic volume (and therefore high profit) as well as those with low traffic and profit. Without regulation, advocates argued, the airlines would concentrate on flying high volume and high profit routes, depriving out-of-the-way communities of air transport altogether. Moreover, concentration of airlines on lucrative routes could easily create a business climate of cutthroat competition. In the process, the carriers would undercut the economic stability of the industry and possibly cut corners on safety and maintenance of aircraft in an effort to reduce costs to compete more effectively with the other carriers. It was the fear of cutthroat competition that had motivated Depression-era members of Congress to vote for the Civil Aeronautics Act of 1938. Regulation also ensured that no one company could dominate the market in a particular region and thus be in a position to set high fares because of the lack of competition. Federal regulation was one way of assuring that the industry operated efficiently and with the greatest good for the greatest number of Americans, although perhaps at the price of subverting the free market.

The railroad industry in the latter half of the 19th century had earlier experienced each of the problems advocates of airline regulation wanted to guard against. Vertical integration by such men as Jay Gould had enabled control of markets between two points, with disastrous consequences for consumers to whom he could charge anything he wanted. Rate wars between competing railroads had also wrecked companies, with a long slow climb out of receivership following. Piecemeal attacks on these problems from various state legislatures created a patchwork quilt of regulations that varied from jurisdiction to jurisdiction, but since the problems were inherently interstate in focus, these efforts failed to bring resolution. The consequence was that by the 1880s many officials of both the railroad industry and the federal government were advocating national regulation to bring order to the chaos. It came with the creation of the Interstate Commerce Commission in 1887 and found refinement thereafter. Air transportation offered essentially the same challenges and resolutions posed by the railroads a half century earlier.

Among the CAB's functions, one of the most important was to pick airlines from the available pool for a particular route rather than let the market decide which airline should fly that route. Established carriers already serving a route would usually evaluate new applicants and often found that the applicant lacked some requirement for flying an already-covered route. Thus, new entrants into the business were at a great disadvantage and were often shut out of key routes since the established airlines did not want new competition. Fare-setting also involved a similarly long process. In the airline industry, there was a general level of discontent about the laws that regulated civil aviation. Furthermore, discussions in Congress highlighted the fact that fares for routes within states were often much lower than fares between states, even if the actual routes were the exact same distance. This was partly because national routes were regulated to a much stricter degree then flights within states.

The push to deregulate, or at least to reform the existing laws governing passenger carriers, was accelerated by President Jimmy Carter, who appointed economist and former professor Alfred Kahn, a vocal supporter of deregulation, to head the CAB. A second force to deregulate emerged from abroad. In 1977, Freddie Laker, a British entrepreneur who owned Laker Airways, created the Skytrain service, which offered extraordinarily cheap fares for transatlantic flights. Laker's offerings coincided with a boom in low-cost domestic flights as the CAB eased some limitations on charter flights, i.e., flights offered by companies that do not actually own planes but leased them from the major airlines. The big air carriers responded by proposing their own lower fares. For example, American Airlines, the country's second largest airline, obtained CAB approval for “SuperSaver” tickets.

New York Air One of the most controversial of the new airlines that took flight in the era of deregulation was Frank Lorenzo's New York Air. Here N556NY - a DC-9-32 is seen at La Guardia in April 1981. Image courtesy of AirNikon. Find more of his photos at Airliners.net

All of these events proved to be favorable for large-scale deregulation. In November 1977, Congress formally deregulated air cargo. In late 1978, Congress passed the Airline Deregulation Act of 1978, legislation that had been principally authored by Senators Edward Kennedy and Howard Cannon. There was stiff opposition to the bill—from the major airlines who feared free competition, from labor unions who feared nonunion employees, and from safety advocates who feared that safety would be sacrificed. Public support was, however, strong enough to pass the Act. The Act appeased the major airlines by offering generous subsidies and it pleased workers by offering high unemployment benefits if they lost their jobs as a result. The most important effect of the Act, whose laws were slowly phased in, was on the passenger market. For the first time in 40 years, airlines could enter the market or (from 1981) expand their routes as they saw fit. Airlines (from 1982) also had full freedom to set their fares. In 1984, the CAB was finally abolished since its primary duty, that of regulating the airline industry, was no longer necessary.

What effect did deregulation have in the short term? First, many airlines abandoned less profitable routes that took passengers to smaller cities. For example, until 1978, United Airlines had flown to Bakersfield, California, a booming oil town of 225,000 people. With deregulation, United pulled out of Bakersfield, depriving the city of any flights to bigger cities such as San Francisco or Las Vegas. A second and related effect was the growth of “hub-and-spoke” routes. The major airlines “adopted” key cities as centers for their operations; these key cities served as stops for most flights, even if they were not on a direct route between two other end points. Delta Air Lines had a major hub at Atlanta while Eastern ran its hub operations from Miami. Both airlines ran many daily roundtrip flights from their hubs, thus keeping planes in the air for more hours each day and filling more seats. For example, the number of daily nonstop flights between New York and West Palm Beach, Florida, jumped from five to 23.

Third, deregulation allowed new start-up airlines to enter the market without having to agree to the demands of the larger established airlines. One of these was People's Express, founded by Donald Burr, a shrewd entrepreneur who introduced unconventional methods of management such as low salaries, fewer managers, employees who could perform multiple jobs, and equitable stock ownership by all employees. Burr ran an extremely tight operation where passengers had to pay for meals on planes and were charged for checked-in baggage. Fares were so low that they were comparable to intercity bus lines. People's Express revenues increased dramatically through the early 1980s, reaching a billion dollars by 1985. Eventually, though, People's couldn't compete with established airlines that also cut their prices but offered significantly better service. The older airlines, being linked with travel agents, also offered the option of advance ticket purchases. Within a year of reaching its peak, in 1986, Burr had to sell People's Express in the wake of rising losses and passenger dissatisfaction.

In general, freed from the rules of the CAB, regional and major airlines inaugurated new routes in droves. Airlines competed in a no holds-barred competition for passenger business. As a result, fares dropped dramatically and total operating revenues for the major national and international airlines rose to a high in 1979. The same year was also the peak year for passengers: an unprecedented 317 million passengers flew through American skies.

Unfortunately for the airline industry, fuel costs, economic recession, and wanton overexpansion in the wake of deregulation began to have serious negative consequences. The airlines recorded a net operating loss of $421 million as early as 1981, when the number of passengers fell to 286 million. The problems were worsened by the nationwide strike of the Professional Air Traffic Controllers Organization (PATCO) in 1981. One airline, Braniff, collapsed completely in 1982 (although the airline operated from 1984 under new ownership before entering bankruptcy once again in 1989). Other airlines continued to expand in the face of economic problems, putting them at great risk.

Analysts continue to debate the long-term effects of deregulation. The climate in the post-deregulation era was extremely unstable as illustrated by the fates of both Continental and Eastern Airlines, two major domestic carriers. Both airlines suffered through severe financial crises, which were made worse by mismanagement and bad relationships with the labor unions. Both ended up bankrupt by 1989. The most important international carrier for the United States, Pan American, suffered the same fate. Without the cover of regulation on international flights, Pan Am suddenly had to compete with new entrants such as Laker and People's Express. By the end of 1991, after a dramatic downfall through the 1980s, Pan Am was history. The number of major carriers in the United States fell from six in 1978—United, American, Delta, Eastern, TWA, and Pan Am—to three by 1991—United, American, and Delta. Ultimately, most of the big airlines suffered some sort of loss in the 1980s—either facing complete bankruptcy or with less financial growth than hoped.

There were some positive consequences of deregulation. The average airfare, for example, dropped by more than one-third between 1977 and 1992 (adjusting for inflation). It is estimated that ticket buyers saved as much as $100 billion on fares alone. Deregulation also allowed the proliferation of smaller airlines that took over the shorter routes that were no longer profitable for the big carriers. In sum, the major airlines probably suffered the negative consequences of deregulation the most. New smaller airlines and the millions of passengers flying gained the most.

Note: This article was commissioned by and first appeared on NASA's U.S. Centennial of Flight web site. It appears here with permission. We gratefully acknowledge both the author and NASA.

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Additional References:
Bailey, Elizabeth E., Graham, David R., and Kaplan, Daniel P. Deregulating the Airlines. Cambridge, Mass.: The MIT Press, 1985.
Banks, Howard. The Rise and Fall of Freddie Laker. London: Faber & Faber, 1982.
Brenner, Melvin A., Leet, James O., and Schott, Elihu. Airline Deregulation. Westport, Conn.: Eno Foundation for Transportation, Inc. 1985.
Dempsey, Paul. The Social and Economic Consequences of Deregulation. Westport, Conn.: Quorum Books, 1989.
O'Connor, William E. An Introduction to Airline Economics, Fifth Edition. Westport, Conn.: Praeger, 1995.
Wyckoff, D. Daryl, and Maister, David H. The Domestic Airline Industry. Lexington, Mass.: D.C. Heath and Co., 1977.