breakfastburrito
19th Apr 2008, 07:31
Don't worry. Avert your eyes from the continuing disaster of the airline industry. Mergers will fix everything!
Delta and Northwest are in full throes of the wedding dance, because businesses in a bad way must do something, and merging is something. But
Monday's deal probably won't avail either companies' shareholders much, and may prove a folly if pilots are in an extortionate mood. Nor will a spate of mergers, however useful it would be to shrink the number of large network carriers, fix the industry's structural profit shortage, which has meant the entire industry flirts with bankruptcy at least once a decade.
To be sure, one of the industry's migraines comes unexpectedly from a Federal Aviation Administration that has suddenly decided to take oh-so-seriously its mythical role in airline safety. Airlines on a daily basis make the decisions that lead to safety, and incidentally also meet the FAA's myriad of paper requirements – and any relation between the two is an optical illusion.
Meanwhile, the one inescapable function of the FAA, its control of the air traffic control system, continues with bureaucratic ineptitude. Let two words suffice: vacuum tubes.
But even here lies no solution for the industry's chronic misery. Airlines would likely just compete away the benefits of a cheaper, more efficient ATC system. Reliable profits would continue to elude them, and airline investment would continue to fall short of providing all the flights and destinations consumers would willingly pay for.
We hesitate to tax a newspaper reader with theory, but a theory that fits is University of Chicago economist Lester Telser's "empty core" – which describes certain peculiar industry structures that are incapable of equilibrium.
Let's take it slowly: Businesses don't exist unless they can cover their costs, and yet airlines exist. Indeed, until Scotty gets the transporter beam working, commercial aviation is a hugely valuable product without a close substitute. But profits are chronically elusive. Why? To oversimplify, because the seats must fly whether they are empty or full, so competitive pressure drives carriers to provide more seats than they can fill and then to fill the seats by cutting fares close to marginal costs – i.e. the cost of a bag of peanuts and the wear a passenger's posterior inflicts on the upholstery.
Now before there was a University of Chicago, another industry faced a similar set of dynamics – scheduled ocean shipping. Steamship operators who were unfettered by certain modern regulatory notions devised a solution to the circumstances they encountered: They engaged in price fixing.
Such price fixing did not make scheduled shipping excessively profitable, but it did discourage shipowners from cutting rates below cost to fill up their ships before their scheduled departures. And their customers actually benefited, because it made the reliable service they sought economically viable.
William Sjostrom, of National University of Ireland, Cork, is your economist of authority here. Such price fixing continues today, and has for 150 years, under legally protected "shipping conferences." For that matter, railroad regulation, and indeed airline regulation, in their day were also attempts to solve the same problem through government allocation of markets and setting of prices, with perverse consequences as it turned out.
Airlines live in a different regulatory world today, but airline executives are straining after similar solutions when they propose mergers or "code-sharing" agreements. Mergers, alas, won't deliver an oligopoly capable of filling the empty core – more likely they will just create new layers of overhead on which airlines can lose money. Intellectual revolution though it would require, the real fix would be some kind of code-sharing "safe harbor" to which airlines could repair in times of financial stress. Crudely, when profits are scarce, carriers would be free to collude over fares and routes in order to maintain service levels without bleeding each other to death.
Delta's then-President Fred Reid dared to broach just such a proposal at an industry conference several years ago. The same crazy idea also appears in a growing body of academic work by people like Kenneth Button at George Mason University and Embry-Riddle's Jayathi Raghavan and Vedapuri Raghavan. To most Congressmen, it's safe to say, the concept is sadly unthinkable – most Congressmen being unaware that Congress has permitted such behavior on the high seas for nearly 100 years.
Antitrust, of course, prizes competition to the exclusion of cooperation, but society needs both. Washington may wish it had this larger principle handy if it now faces a flurry of mergers confronting regulators with a choice between airline oligopoly and industry bankruptcy.
A final note to those still upping their Lipitor dose after our dismissiveness of the FAA's safety efforts. Here's a historical fact: The FAA's safety function was originally and explicitly created to compensate for the effects of economic regulation, which protected carriers from the competitive consequences of accidents. Then came deregulation. There have been 15 years since the late 1920s in which passenger deaths fell to single digits or zero, 14 of them since deregulation in 1978.
That speaks impressively to the power of economic incentive to provide safety even when it can't provide profits.
Source Wall Street Journal (http://online.wsj.com/public/article_print/SB120830610198917981.html)
Delta and Northwest are in full throes of the wedding dance, because businesses in a bad way must do something, and merging is something. But
Monday's deal probably won't avail either companies' shareholders much, and may prove a folly if pilots are in an extortionate mood. Nor will a spate of mergers, however useful it would be to shrink the number of large network carriers, fix the industry's structural profit shortage, which has meant the entire industry flirts with bankruptcy at least once a decade.
To be sure, one of the industry's migraines comes unexpectedly from a Federal Aviation Administration that has suddenly decided to take oh-so-seriously its mythical role in airline safety. Airlines on a daily basis make the decisions that lead to safety, and incidentally also meet the FAA's myriad of paper requirements – and any relation between the two is an optical illusion.
Meanwhile, the one inescapable function of the FAA, its control of the air traffic control system, continues with bureaucratic ineptitude. Let two words suffice: vacuum tubes.
But even here lies no solution for the industry's chronic misery. Airlines would likely just compete away the benefits of a cheaper, more efficient ATC system. Reliable profits would continue to elude them, and airline investment would continue to fall short of providing all the flights and destinations consumers would willingly pay for.
We hesitate to tax a newspaper reader with theory, but a theory that fits is University of Chicago economist Lester Telser's "empty core" – which describes certain peculiar industry structures that are incapable of equilibrium.
Let's take it slowly: Businesses don't exist unless they can cover their costs, and yet airlines exist. Indeed, until Scotty gets the transporter beam working, commercial aviation is a hugely valuable product without a close substitute. But profits are chronically elusive. Why? To oversimplify, because the seats must fly whether they are empty or full, so competitive pressure drives carriers to provide more seats than they can fill and then to fill the seats by cutting fares close to marginal costs – i.e. the cost of a bag of peanuts and the wear a passenger's posterior inflicts on the upholstery.
Now before there was a University of Chicago, another industry faced a similar set of dynamics – scheduled ocean shipping. Steamship operators who were unfettered by certain modern regulatory notions devised a solution to the circumstances they encountered: They engaged in price fixing.
Such price fixing did not make scheduled shipping excessively profitable, but it did discourage shipowners from cutting rates below cost to fill up their ships before their scheduled departures. And their customers actually benefited, because it made the reliable service they sought economically viable.
William Sjostrom, of National University of Ireland, Cork, is your economist of authority here. Such price fixing continues today, and has for 150 years, under legally protected "shipping conferences." For that matter, railroad regulation, and indeed airline regulation, in their day were also attempts to solve the same problem through government allocation of markets and setting of prices, with perverse consequences as it turned out.
Airlines live in a different regulatory world today, but airline executives are straining after similar solutions when they propose mergers or "code-sharing" agreements. Mergers, alas, won't deliver an oligopoly capable of filling the empty core – more likely they will just create new layers of overhead on which airlines can lose money. Intellectual revolution though it would require, the real fix would be some kind of code-sharing "safe harbor" to which airlines could repair in times of financial stress. Crudely, when profits are scarce, carriers would be free to collude over fares and routes in order to maintain service levels without bleeding each other to death.
Delta's then-President Fred Reid dared to broach just such a proposal at an industry conference several years ago. The same crazy idea also appears in a growing body of academic work by people like Kenneth Button at George Mason University and Embry-Riddle's Jayathi Raghavan and Vedapuri Raghavan. To most Congressmen, it's safe to say, the concept is sadly unthinkable – most Congressmen being unaware that Congress has permitted such behavior on the high seas for nearly 100 years.
Antitrust, of course, prizes competition to the exclusion of cooperation, but society needs both. Washington may wish it had this larger principle handy if it now faces a flurry of mergers confronting regulators with a choice between airline oligopoly and industry bankruptcy.
A final note to those still upping their Lipitor dose after our dismissiveness of the FAA's safety efforts. Here's a historical fact: The FAA's safety function was originally and explicitly created to compensate for the effects of economic regulation, which protected carriers from the competitive consequences of accidents. Then came deregulation. There have been 15 years since the late 1920s in which passenger deaths fell to single digits or zero, 14 of them since deregulation in 1978.
That speaks impressively to the power of economic incentive to provide safety even when it can't provide profits.
Source Wall Street Journal (http://online.wsj.com/public/article_print/SB120830610198917981.html)