How a thirty-year-old policy of deregulation is slowly killing America’s airline system—and taking down Cincinnati, Memphis, and St. Louis with it.
High fuel prices, to be sure, are a factor in this tale of woe. In 1999, fuel comprised 10 percent of an airline’s budget; now it ranges from 30 to 40 percent. But while high fuel costs make the price of providing short-haul service to sparsely populated areas higher than it has been in the past, they are not sufficient to explain the continuing deterioration of the airline industry. Nor can we blame the problem on the effects of the Great Recession. After decades in which the price of energy has risen and fallen and the economy has boomed and busted, the long-term trend is clear. The industry has been in turmoil and decline for more than thirty years, barely able to earn its cost of capital in the best of times and only then by cutting service and quality. It’s now evident that the industry’s problems are structural and deepening, as is the crisis faced by cities and industries that depend now more than ever on frequent, affordable air service to remain competitive in the global economy.
No doubt a few Wall Street tycoons and consulting firms have made billions merging and stripping down the airline industry over the last generation. But the fundamental problem is that the business model that airlines are left with doesn’t work for common shareholders, airline employees, or the American business community, much less the public.
One reason this business model doesn’t work is that it’s at odds with the basic physics of flying. It requires a tremendous amount of energy just to get a plane in the air. If the plane lands just a short time later, it’s hard to earn the fares necessary to cover the cost. This means the per-mile cost to the airlines of short-haul service is always going to be much higher than that of long-haul service, regardless of how the industry is organized. Yet the value of airline service to the public and the economy depends on providing connectivity to as many places as possible. Thus, without some form of cross-subsidization between short hauls and long hauls, the economic benefits of the network will be compromised. Fewer people will be flying to fewer places, which by itself hinders economic activity, while the high fixed cost of the remaining service has to be spread among a diminished number of passengers.
This highlights another problem that inevitably leads to declining service. It costs virtually the same to maintain an air traffic control tower, a runway, and ticketing and baggage-handling facilities whether an airport serves five or fifty flights a day, or whether each plane carries five or fifty passengers. So the per-passenger cost on low-volume routes is necessarily more than on high-volume routes, which again requires some form of cross-subsidization if robust connectivity is to be maintained.
Dealing with high fixed costs is a challenge common to virtually all networked industries, and in one way or another, America has grappled with the problem throughout the country’s history. The Founders understood that private enterprise could not by itself provide broadly distributed postal service because of the high cost of delivering mail to smaller towns and far-flung cities, and so they wrote into the Constitution that a government monopoly would take on the challenge, providing the necessary cross-subsidization.
Throughout most of the nineteenth century and much of the twentieth, generations of Americans similarly struggled with how to maintain an equitable and efficient railroad network, and for much the same reason. During various railroad bubbles, exuberant investors would build lines to the farthest corners of continent, much like start-up airlines in the 1980s. But over time, the high fixed cost of railroading and the basic economics of any networked industry left all but the core of the emerging system unprofitable before it received the benefits of government regulation. In the 1870s, railroads accounting for more than 30 percent of domestic mileage failed or fell into court-ordered receivership.
This was true even though most railroads maintained a near or total monopoly in most of the intermediate towns through which they ran. As Charles Francis Adams wrote in his 1878 book, Railroads: Their Origin and Problems:
Every local settlement and every secluded farmer saw other settlements and other farmers more fortunately placed, whose consequent prosperity seemed to make their own ruin a question of time. Place to place, or man to man, they might compete; but where the weight of the railroad was flung into one scale, it was strange indeed if the other did not kick the beam.
This was bad enough, but matters soon got worse. High fixed costs combined with ruinous competition in the early railroad industry created an overwhelming business incentive to consolidate and downsize, again much like what’s happening in the airline industry today. And consolidation in turn led to even more monopoly power—not just over small and midsize communities but over large cities as well. By the 1880s, the fortunes of such major cities as Philadelphia, Baltimore, St. Louis, and Cincinnati rose and fell according to how various railroad financiers or “robber barons” combined and conspired to fix rates. Just as Americans scream today about the high cost of flying to a city like Cincinnati, where service is dominated by a single carrier, Americans of yesteryear faced impossible price discrimination when traveling or shipping to places dominated by a single railroad “trust” or “pool.”
This, more than any other factor, is what led previous generations of Americans to let go of the idea that government should have no role in regulating railroads and other emerging networked industries that were essential to the working of the economy as whole. “While the result of other ordinary competition was to reduce and equalize prices,” Adams noted, “that of railroad competition was to produce local inequalities and to arbitrarily raise and depress prices. The teachings of political economy were at fault.”
And indeed they were. The response was the creation of the Interstate Commerce Commission in 1887—a move that most Americans viewed as essential to preserving free enterprise and their way of life. The ICC took on the task of moderating the price discrimination that railroads practiced, evening out the burden among different regions and classes of passengers and shippers in a way that allowed railroads to earn enough money to cover their fixed costs, improve their infrastructure, and give their investors a fair reward. In effect, the profits railroads earned on some highly trafficked long-haul routes came to be rechanneled by government policy to cover the cost of providing balanced and affordable service throughout the country. Railroads were regulated much as telephones and power companies came to be—as natural monopolies that would be allowed to remain in private hands and earn a profit, but not at the cost of skewing the overall efficiency, balance, and fairness of American economy.
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