Airline Transportations on Economy Impacts of Airline

¶ … Airline

Transportations on Economy

Impacts of Airline Transportations on Economy

INTRIDUCTION

The rapid rise in the use of air transportation since deregulation in 1978, coupled with the unprecedented financial crisis in the airline industry after the September 11 terrorist attacks raises questions on how vulnerable the nation is to significant interruptions to its air transportation system[footnoteRef:1]. In an attempt to better understand its national importance; this paper examines some aspects of how the air transportation system has had an impact on the economic structure and social behavior in the United States. To help identify these economic and social impacts, a conceptual model of these interdependencies was developed to structure the analysis of this paper. In light of this framework, two major changes in the air transportation system are evaluated. The first change was the deregulation of the airline industry in 1978. Fundamental changes in airline services occurred after the Civil Aeronautics Board eliminated restrictions on routes and fares[footnoteRef:2]. The second major change was the dramatic downturn in the U.S. airline industry following the attacks of September 11, 2001. Although revenues had been declining at the major airlines well before the 9/11 attacks, the subsequent changes in travel behavior led to a reduction in national air transportation capacity by 10 to 20% in just a matter of weeks. This dramatic change has highlighted the key interdependencies between the economy and the airline industry. [1: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.] [2: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

LITERATURE REVIEW

Most analyses on the economic impact of air transportation typically only address the direct financial effects from aviation employment and spending. The FAA has estimated that the U.S. aviation industry accounts for some 11.6 million direct, indirect, and induced jobs and over $316 billion dollars in earnings[footnoteRef:3]. These methods, however, may underestimate the true impact of air transportation by failing to take into account the Enabling Effects of air transportation and how high quality air connectivity affects access to markets, capital, ideas, and people. To examine the relationship between the economy and the air transportation system, a review of economic and social trends in the U.S. since deregulation was conducted. Increases in air travel, GDP growth, population geography, and travel behavior were analyzed[footnoteRef:4]. [3: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.] [4: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

Growth in air travel: In order to fully document the changes in the supply of air transportation, the growth in passenger traffic data, airline capacity and airline fleets were analyzed. The growth in domestic capacity was measured in terms of Available Seat Miles (ASMs), while Revenue Passenger Miles (RPMs) were used to measure traffic. RPMs grew considerably faster after deregulation than in the period between 1954 and 1978. Between 1954 and 1978 U.S. domestic RPMs grew at an average rate of 750 million RPMs per year.

Between 1978 and 2000, RPMs grew at average rate of 1.8 billion RPMs per year. Reflecting this increase in demand, Figure 3 shows that the domestic scheduled ASMs increased from 300 billion in 1978 to over 700 billion by 2000. Figure 4 shows that the growth in capacity and traffic was achieved by a major increase in the size of airline fleets. The number of aircraft used in commercial airline service increased from 2,000 aircraft to over 7,000 aircraft between 1978 and 1995[footnoteRef:5]. [5: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

At a more local scale, found that in a survey of 32 Japanese companies with branches in the Chicago metropolitan area, 23 considered accessibility to O'Hare the most important factor in their locational decision, followed by highway access at ten companies, and the existence of customer companies at eight. While this finding might not explain why international firms are drawn to a particular metropolitan area, it does explain why they locate where they do within that region[footnoteRef:6]. [6: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

Additionally, Kasarda's exploration of "Global Air Cargo-Industrial Complexes as Development Tools" goes so far as to say, "The combined thrust of [globalization and just-in-time manufacturing] is creating an entirely new economy where aviation and airports will ultimately supplant seaports, rail, and highway systems as the primary job and wealth generators for states and localities."

The 1987 report by Coley/Forrest, Inc., "Ready for Takeoff," comes closest to the aim of this study. It reviews "the timing, scale and type of business development that did occur in the airport environs" of what were the three most recent large-scale airport projects in the United States: Atlanta, Dallas-Ft. Worth, and Kansas City. The report listed nine major findings and described their applicability to Denver. First, a new airport will inevitably draw certain kinds of businesses, but it takes strong marketing to draw businesses that are not directly airport-related.

Second, international businesses follow international flights, something Denver is counting on. An upscale image and strong public sector economic development activity can draw businesses to the airport area even if it is in a traditionally underdeveloped sector of the city. Next, a definite order of development was observed: lodging, industrial/office/warehouse (first single-user, then small multiple-user, then large), multistory office buildings, and restaurants. Large-scale developments of over 1,000 acres can make a significant difference in attracting additional development due to their marketing efforts. Finally, air cargo can attract even more development than passenger flights and should not be overlooked as an economic development tool.

These are the types of studies that airport operators and cities often use to justify their need for increasing the size of an airport or relocating the facility altogether. It is undeniable that airports can have a powerful impact on metropolitan economies, both in and of themselves, and as catalysts for other kinds of economic growth. But only the Coley/Forrest study takes those economic impacts down to the local level, showing what types of land uses are and are not attracted to the airport environs, along with the potential influence that cities can exert over the development process. It is unfortunate that this study looked at only three airports[footnoteRef:7]. [7: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

Direct impacts of liberalization (D) "arise immediately from the conduct of those entities performing the activity in question." In case of air transportation this means direct impacts include all the changes in employment, value added or total product that can be immediately attributed to changes in air traffic level. These changes affect airlines, airports, ground handling agents, aircraft producers, maintenance providers, ATC providers and other companies whose principal business involves commercial aviation[footnoteRef:8]. [8: Air Transport Association, Annual Passenger Prices (Yield), U.S. Scheduled Airlines. Washington: ATA, September 4, 2002. Available online from: http://www.airlines.org/Air Transport Association, Annual Traffic and Capacity: U.S. Scheduled Airlines. Washington: ATA, 2003.]

Indirect impacts (I) are defined as impacts "involving the supply chain of businesses or entities conducting the primary activity." Higher number of flights requires increased orders of fuel and in-flight services. Higher number of passengers boosts turnover of airport retail outlets. Higher demand for aircrafts supports the extensive network of sub-contractors. All in all, indirect impacts involve growth of purchases by airlines, airports, aircraft producers, airport retail outlets and hotels. They also include construction activity at the airports and services provided by call centers. It is obvious that the magnitude of indirect impacts is primarily influenced by the extent of direct impacts. Therefore indirect impacts are computed as I = a.D, where A is a market-specific coefficient. Induced impacts (N) emerge when "those employed directly and indirectly in air transport services use their earnings to buy other goods and services."

A pilot might use a part of his salary to buy computer. This represents income for the computer seller, who might subsequently spend it at a bookstore; the bookseller might spend it at a grocery store etc. The process will continue indefinitely in decreasing cycles. Thus, the initial increase in salary of one person is transformed into increase in salaries of many households. This process is known as the multiplier effect. If air transport liberalization directly or indirectly creates n new jobs, the national income will increase by ?Y = ?ni=1 wi, where wi is the wage of employee i. A part of this income will be saved and the rest will be spent, depending on propensity to consume (c) and propensity to save (s). The change in consumption ?C=c. Y creates new income for other market entities who consume a part of it and save the rest. The total multiplier effect in its simple version can be computed as ?. Y = ?Y / s, where ? is a multiplier. As a result of this induced impacts equal the sum of direct and indirect impacts multiplied by the multiplier: N = ?. (D + I), that is N = ?. (D + a.D).

Catalytic impacts (C) are a very wide and diverse group. They are defined as "net economic effects (e.g. On employment, incomes, government finances etc.) resulting from the contribution of air transport to tourism and trade (demand-side effects) and the long-run contribution to productivity and GDP of growth in air transport usage (the supply-side performance of the economy)."

They include all the impacts of air transport liberalization on national economies that cannot be described as direct, indirect or induced. As a result of market changes brought about by liberalization, people alter their consumption patterns -- they travel to destinations they normally wouldn't, businesses focus on new markets, alter their production methods etc. Most of the catalytic impacts are utterly difficult to measure. They should be perceived as indicators of quality rather than quantifiable indicators.

FINANCIAL ANALYSIS

Figure 1: RPMs before and after deregulation

Prior to 1978, the Civil Aeronautics Board (CAB) regulated entry, routes, and fares in order to promote stability in the air transportation system. Amidst a wave of political support and a growing body of academic research that disputed long-held concerns about economies of scales, monopolies, and degraded service, the Airline Deregulation Act of 1978 eliminated CAB authority over routes and domestic fares. This triggered a set of dynamics that would reshape the air transportation system and would set the stage for dramatic growth in the supply and demand of domestic air travel.

The rapid growth of air transportation after deregulation can be seen through increases in capacity as measured in terms of Available Seat Miles (ASMs) and traffic measured through Revenue Passenger Miles (RPMs). The figure above shows that scheduled RPMs grew considerably faster after deregulation than in the period between 1954 and 1978. Between 1954 and 1978, RPMs grew at an average annual rate of 5.8 million RPMs per year, but this more than doubled during the period between 1978 and 2002 to an average rate over 11.7 million RPMs per year. Airline capacity grew accordingly with this increased demand. Figure 3 shows the growth of scheduled ASMs together with the growth in RPMs. Scheduled annual ASMs increased from 300 billion in 1978 to over 700 billion by 2000.

Figure 2: RPM and ASM growth, 1954-2002

More recently, the close relationship between economic growth and the demand for air travel also translated into record traffic loads and profits for the airline industry during the economic growth cycle of the late 1990's. Fueled by the development of the internet and the investment boom in startup dot-com companies, this bubble economy was responsible for increasing the real U.S. gross domestic product by $2.3 trillion in 1996 dollars between 1992 and 2000. This affected the dynamics of supply and demand as airlines adjusted their operating strategies and passengers modified their travel behavior. Between 1990 and 2000, the domestic revenue passenger miles at the major U.S. carriers increased by 40% from 338 to 474 billion RPMs. Total capacity increased by only 23%, however, and thus load factors climbed to record levels. The average load factor in 1990 was 60.5%, but that had increased to 71.7% by 2000.

RESULTS AND ANALYSIS

After deregulation, the airline networks evolved to provide greatly enhanced connectivity while yield management brought down prices. Horizontal consolidation occurred through mergers and acquisitions -- creating instant nationwide or regional airline networks. Vertical integration occurred as airlines developed regional feeder services and acquired international route authorities. Airlines moved to develop hub-and-spoke networks which captured as much connecting traffic as possible. By funneling passenger connections from multiple cities through a central hub, the consolidation of demand offered fundamental economies of scale -- enabling more frequent service to smaller cities or other weak markets that wouldn't otherwise be covered in a point-to-point network[footnoteRef:9]. [9: Air Transport Association. Monthly Passenger Traffic Report -- Scheduled Service Only. Washington: ATA, 2003.National Research Council, Transportation Research Board. Winds of Change: Domestic Air Transport since Deregulation. Special Report 230. Washington DC: Transportation Research Board, 1991.]

Advances in seat inventory control and automated pricing systems in the years after deregulation also enabled the major carriers to effectively compete with low-fare airlines without diluting their entire inventory and revenues. By offering different prices for virtual groupings of seats, yield management systems enabled airlines to offer a range of low fares to stimulate demand and sell-off excess seat inventory while preserving the revenue from passengers willing to pay higher fares. Evidence of how yield man gement has affected the industry can be seen through data on airline revenue and traffic. Airline yields (the average price paid per passenger-mile) were examined using constant 1978 dollars in order to account for inflation.

Figure 1 shows that the average yield has been continually declining since the 1960s, although this decline slowed in the 1990s. At the same time, Figure 2 shows that the average industry domestic load factors increased from about 60% in 1978 up to 72% in 2000. This indicates that even though prices on average were going down, airplanes had more seats filled and were thus generating more revenue per flight. To illustrate the changes in network pricing strategies, the evolution of fares in one specific city pair market at one major airline was analyzed using the U.S. DOT DB-1A ten-percent sample of all domestic tickets. Figure 6 shows the distribution of the fares purchased between New York Kennedy and Los Angeles using a histogram set at $100 dollar intervals.

The data shows several key changes. The average current-dollar fare actually dropped between 1985 and 1990, but had increased significantly by 1998[footnoteRef:10]. This is important because at the same time, there was a distinct increase in the gap between the highest and lowest fares. The ratio between the highest and lowest fares increased from 10.3 in 1985 up to 16.3 in 1998. In addition, the number of passengers in the lowest fare segments had increased dramatically by 1998, creating a much more skewed distribution of passengers at the lower end. [10: Air Transport Association. Monthly Passenger Traffic Report -- Scheduled Service Only. Washington: ATA, 2003.National Research Council, Transportation Research Board. Winds of Change: Domestic Air Transport since Deregulation. Special Report 230. Washington DC: Transportation Research Board, 1991.]

CURRENT UPDATES

Despite ongoing restructuring efforts at several of the major carriers, the U.S. airline industry continues to lose vast amounts of money projected to be almost $10 billion dollars in 2003. The more recent and ongoing impacts of the Iraq war and the outbreak of Severe Acute Respiratory Syndrome are having serious impacts on international traffic and airlines in Europe and Asia. With profitability not expected to recover until 2005, many of the traditional major network carriers are restructuring to minimize losses and cope with the changes in industry dynamics. Labor negotiations and attempts to reduce operating costs also achieved a new sense of urgency during 2002 and 2003 as major carriers such as United, U.S. Airways, and American dipped into or loomed under the threat of bankruptcy.