CHICAGO — Deregulation swept through the economy 24 years ago and freed many industries from government constraint, but analysts say airlines have failed to adapt to the new world of competition while a 19th Century relic, the railroads, have thrived, according to a report from the Chicago Tribune.
Recession and terrorism have caused huge losses for the airlines and propelled US Airways and United Airlines into bankruptcy. But critics say the entire airline industry is vulnerable because it has failed to cut costs, as envisioned in 1978 by federal deregulation of air travel .
“The airline industry still has not figured it out,” said Sam Peltzman, professor of economics at the University of Chicago Graduate School of Business. “The railroad industry deregulated at the same time and has gone through nothing but prosperity as a result.”
If airlines can’t thrive without regulation, why is it that railroads can?
To explain how two similar industries–they both move objects from place to place–fared differently under deregulation requires a look at the past.
Until deregulation began under President Carter, railroads and airlines could not drop or add service without government permission. Regulators set the fees they could charge customers. And they were largely free from the worries of the marketplace
For example, the Civil Aeronautics Board inhibited competition by barring new airlines. This made it easier for existing airlines to pass cost increases through to their customers and make a profit.
“There was almost explicit collusion where fares were fixed,” said Todd Pulvino, an assistant professor of finance at Northwestern University’s Kellogg School of Management. “Under regulation, there was enough money to go around.”
Airlines didn’t worry much about labor costs.
“This insulation against cost-based competition enabled the airlines to pay employees generous wages and benefits,” United said in bankruptcy documents filed last week. The airline said the pattern of high wages and substantial benefits continues today, while the protection of regulation is gone.
John R. Meyer, a professor emeritus of economics at Harvard University who studied the progress of the rail and airline industries through deregulation, said railroads approached the issue quite differently from airlines.
“Railroads lobbied for deregulation,” he said. “They had planned on deregulation for a long time. Airlines didn’t think they would ever be deregulated.”
Deregulation meant the railroads were finally free to drop unprofitable routes.
“They sold off or abandoned the light traffic lines so they could focus on major corridors where they could consolidate traffic and run 100-car trains,” said Michael Babcock, a professor of economics at Kansas State University.
At the same time, the industry consolidated through mergers. Before deregulation there were 40 major railroads. Now there are eight.
“The profitability of the railroads improved substantially after deregulation,” Babcock said.
The major airlines took a different path. With some exceptions, the airlines continued to serve unprofitable destinations in the hope of retaining customers.
Under the hub-and-spoke system, it was thought that unprofitable flights would feed passengers to profitable connecting flights, would ensure customer loyalty and would keep competitors out of major markets.
But with new carriers free to enter the fray, competition soared, and the number of unprofitable flights multiplied.
Nearly 200 new airlines began flying in the years after deregulation, many of them offering cheap flights between busy, money-making destinations. Fares plunged, and air travel became affordable for the masses, not just an affluent elite.
The effect was devastating for major air carriers.
Braniff Airways in 1982 was the first to go bankrupt. Since then dozens of other airlines–Pan Am, TWA, Eastern among them–have stopped flying or were forced to merge.
In contrast, the railroads didn’t just accept deregulation, they embraced and exploited it.
Many communities are served by a single rail line, which faces competition only from trucks.
“Rails are dealing with a semi-monopoly,” said Ray Neidl, an analyst with Blaylock & Partners LP. “They have the ability often to raise prices, and that is not the case with airlines.”
In another move, the railroads won the cooperation of their unions to increase productivity, Neidl said.
“They got rid of cabooses, they got rid of the extra crew members, the feather-bedding,” he said.
He said United and other airlines face a built-in obstacle they have yet to overcome.
“A big problem is the labor situation,” Neidl said. “The cost structure is way out of hand.”
More than in almost any other industry, unions wield power at airlines. In the summer of 2000, for example, discontented United pilots refused overtime after contract talks bogged down. The airline lost hundreds of millions of dollars and almost was forced to shut down.
Union power means high wages for some in the airline industry. Senior pilots can earn $300,000 a year, although most earn less. Some highly skilled mechanics earn $72,000 a year, although, again, most earn less.
As union officials quickly point out, airline workers repeatedly have made wage concessions worth billions of dollars to bail out carriers otherwise faced with extinction.
Duane Woerth, president of the Air Line Pilots Association, said labor sacrifices have become the norm at airlines, and workers can’t be blamed for all the industry’s woes.
“We are in recession, we lay people off, we make concessions,” Woerth said, describing the cycle as “routine.”
Airline unions are expected to give up billions of dollars in wage concessions in the next few months to rescue their employers. That follows a pattern established shortly after deregulation took place: Every decade or so, bad economic times prompt airlines to demand a cut in labor costs. When the economy improves, labor fights to make up for what it lost.
Although deregulation has been no friend of the big airlines, it is a blessing for passengers.
“Air fares are 40 percent cheaper than 25 years ago,” said Michael Whitaker, vice president of international and regulatory affairs for United. “You can fly to Europe for $250.”
And if airlines haven’t fully adjusted to the world of competition, they have seen some benefits in deregulation.
Whitaker said United used to employ a staff of 150 to deal with regulatory matters. Now a half-dozen people can handle the job.
“People have forgotten what it was like during regulation,” Whitaker said. “Everything, down to whether you put lettuce on a sandwich, was regulated.
“It was an incredibly burdensome process. We were practically an arm of the government.”