Open Skies Agreements and aviation industry deregulation policies

¶ … Open Skies Agreements on Domestic and International

Carriers

Current Status of International Open Skies Agreements

The Economic Impact of Open Skies Agreements

Open Skies Agreements: A Dual-Edged Sword

The aviation industry has suffered from a triple whammy during the past decade. Following the horsewhipping the industry received as a result of the terrorist attacks of September 11, 2001, a more recent global recession and skyrocketing energy costs have caused a number of legacy carriers to seek protection using Chapter 11 bankruptcy proceedings while others have simply folded. The current state of affairs, though, did not develop during the past decade alone, but is rather the results of almost a century's worth of increasing deregulation of the aviation industry in the United States. For instance, during the 30-year period from 1919 to 1949, a framework of international regulation emerged in response to the economic, technological and political developments that were taking place in air transport (Doganis, 2002). This framework was consistent and, generally speaking, global in its applicability to the aviation industry (Doganis, 2002). Moreover, during the post-World War II period from 1950 to the 1970s, this international regulatory framework was followed without significant changes; the framework was triangulated, being based on (a) bilateral air service agreements, (b) on inter-airline pooling agreements and (c) on the tariffs and pricing agreements that were agreed upon under the auspices of the International Air Transport Association (IATA) (Doganis, 2002). In sum, these three components served to define a highly regulated operating environment that was different from any other international industry and discouraged innovation and change; however, an analysis of U.S. international aviation policy in 1979 resulted in a number of liberalization policies that affected the economic regulation of international air services over the next 2 decades. According to Doganis, "This process of liberalization became more rapid after the mid-1980s when it was adopted by key European countries and eventually by the European Union" (2002, p. 26).

According to Juan (1997), an air transport specialist at the World Bank, in the era before the 1980s, air traffic between nations was controlled by narrowly defined bilateral agreements that stipulated the permissible capacities of passenger aircraft, the frequency of flights, and the type of passenger and cargo services that airlines could provide. One of the fundamental features of these bilateral agreements was the notion of a so-called "flag carrier," which could be an airline, either private or public, provided that its ownership was mostly domestic by which the respective nations would exercise the same rights that were received pursuant to the bilateral agreements (Juan, 1997). Indeed, Juan emphasizes that, "For almost four decades, for example, Pan Am was the world's most formidable flag carrier, enjoying a near monopoly on some foreign routes and sitting in on diplomatic negotiations between the United States and other countries" (1997, p. 141). This situation began to change during the last two decades of the 20th century, though, following the deregulation of the worst most lucrative air transport market in the domestic U.S. airline industry. During the heyday that followed deregulation, a number of new carriers entered the market, thereby increasing both competition and efficiency of the airlines (Juan, 1997). According to Juan, "Lower fares helped to lure more passengers, expanding the market. Deregulation in the United States proved a catalyst, in turn, for deregulation overseas. Although foreign governments feared the commercial ambitions of U.S. carriers, they feared the American competitive advantage even more and soon began looking at how to open up their own internal markets, especially in Europe and Latin America" (1997, p. 141).

Consequently, by the turn of the 21st century, there were, generally speaking, two different regulatory regimes in place that had global implications. In this regard, Doganis (2002) notes that a number of major routes to and from the United States, routes between the member states of the European Union, as well as routes between some European states or the United States and some Asian countries began to operate pursuant to so-called "open skies" agreements. Concomitantly, in other parts of the world, international air services were and continue to function pursuant to the traditional regulatory structure that emerged during the 20th century (Doganis, 2002). It must be pointed out, though, it is not a matter of a straightforward dichotomy of regulation. According to Doganis, "There are gradations in each of the regulatory regimes. Some traditional bilateral agreements are very restrictive while others are much more open and allow more effective competition" (p. 27). Likewise, in some deregulated markets (i.e., the European Union), the majority of restrictions on inter-airline competition have been removed as a result while in other there are some portions of the traditional regulatory system still in place (Doganis, 2002).

The so-called "open skies regimes" that have emerged progressively in some key markets since the early 1980s are described by Bilotkach (2007) as being one of the most important recent developments in international business. In this regard, Bilotkach emphasizes that, "The potential benefits of allowing the market forces to govern international aviation are enormous" (p. 505). For example, the European Union (EU) has projected that air traveling consumers will enjoy benefits as large as $5.8 billion annually from the creation of the currently negotiated "open aviation area" that includes North America, the EU, and the North Atlantic Ocean (Open skies and flights of fancy, 2003, p. 37). In this regard, the "open skies" agreement will make it possible for American and European airlines to fly from any airport in Europe to any in the United States and for American carriers to do the same in the EU; it is this aspect of the open skies agreements that are particularly troubling for pilots flying for American carriers since this trend holds the potential for making the low-cost European airlines more competitive against the American legacy carriers (Stephen, 2007). According to the U.S. Department of State (2009), though, the up-side to this trend towards open skies agreements is also worth noting: "Open Skies agreements have vastly expanded international passenger and cargo flights to and from the United States, promoting increased travel and trade, enhancing productivity, and spurring high-quality job opportunities and economic growth" (Open skies agreements, p. 2).

This laissez-faire approach to airline regulation, the State Department maintains, allows the invisible hand to regulate prices, and encourages innovation and competition in ways that are good for the economy as well as for consumers and businesses. By promoting competition, it is felt that innovation and efficiency will improve. In this regard, the State Department notes the manner in which these laudable goals are achieved: "Open Skies agreements do this by eliminating government interference in the commercial decisions of air carriers about routes, capacity, and pricing, freeing carriers to provide more affordable, convenient, and efficient air service for consumers" (Open skies agreements, 2009, p. 3).

The open skies regimes that have emerged in recent years have taken place during a period in which the airline industry has experienced the same effects of globalization as other industries. In this environment, the need for improved flexibility over the traditional regulatory approach has been cited by the State Department and numerous air transport analysts as being a positive trend. For instance, the State Department enthuses, "By allowing air carriers unlimited market access to our partners' markets and the right to fly to all intermediate and beyond points, Open Skies agreements provide maximum operational flexibility for airline alliances" (Open skies agreements, 2009, p. 3).

To date, the U.S. has entered into open skies agreements with more than 90 countries representing all regions of the world as well as all levels of economic development; besides bilateral open skies agreements, the U.S. has also entered into two multilateral open skies arrangement:

1. The 2001 Multilateral Agreement on the Liberalization of International Air Transportation (MALIAT) with New Zealand, Singapore, Brunei, and Chile, later joined by Samoa, Tonga, and Mongolia; and.

2. The 2007 Air Transport Agreement with the European Community and its 27 Member States (Open Skies Agreements, 2009).

Pilots currently employed by domestic airlines in the United States, though, provide another side to these trends. The history of open skies agreements in the U.S. may be a positive trend for some, but lately there have been talks to make unrestricted open skies or more agreements that could potentially benefit the consumer but as a pilot's perspective, this could hurt pay, quality of life and overall job security if other airlines from different countries are able to come to the states (and usually these other airlines are government supported) and fly routes our legacy carriers have done for years at cut-throat prices. As Smith (1999) emphasizes, "Such bilateral agreements often have the effect of propping up inefficient national carriers, shielding them from competition, while guaranteeing a certain proportion of landing and take-off slots" (p. 19). Taken together, the move towards less regulation can be viewed as a positive trend in some respects but policymakers are failing to take into account other issues that form the "big picture" involved in ways that will adversely affect airline staff morale and operational efficiency among U.S. domestic carriers are at period in the industry's history when these factors are already beleaguered by downturns in the global economy, increasing competition from international carriers, and the aforementioned high costs of energy.

Chapter 2: The Impact of Open Skies Agreements on Domestic and International Carriers

Under an open skies agreement, both signatories to the agreement enjoy open access to international airline routes between the two countries as well as eliminating virtually all domestic restrictions on international carriers (Lick, 1998). In an effort to develop more closely integrated pricing and route schedules, signatories to these agreements typically also seek to gain immunity from national antitrust laws (Commercial aviation: Legacy airlines must further reduce costs to restore profitability, 2004). The U.S. Department of Transportation reviews these types of airline alliances from an antitrust perspective and refuses to approval an alliance without a reciprocal open skies agreement with the foreign airline's home nation (Schlangen, 2000). These are important considerations for domestic carriers because the international market is currently more lucrative than domestic air routes (Moylan, 2005). In this regard, Moylan advises, "This is partly due to increasing globalization of business, the rise of the middle class in other nations like India, strong leisure travel, and a lack of low-fare carriers who have transatlantic routes. Therefore, the United States is desperate to negotiate open skies pacts with other nations" (2005, p. 37).

By eliminating restrictions on the prices airlines are allowed to charge, the frequency wit which airlines are permitted to fly to the alliance country, and the type of aircraft airlines are allowed to use, open skies agreements are regarded as the framework that is required to help provide the flexibility needed for these carriers to remain competitive (Moylan, 2005). According to Moylan, pursuant to an open skies agreement, air carriers from either country are allowed to fly from any city in one country to any city in the other country. Currently, the United States has open skies agreements with almost one hundred other countries and continues to hammer out agreements with the remaining European Union states (Moylan, 2005).

According to McQuaid (2007), the United States has entered into agreements with some other countries that are not regarded as being open skies agreements per se. "For example," McQuaid notes, "the United States signed an aviation pact in July 2004, with China that increased flights between the two countries from 54 to 249 over 6 years" (p. 664). In addition, the agreement between the United States and the United Kingdom is not an open skies agreement strictly speaking; however, travel between the two nations is controlled by a similar bilateral air services agreement that is known as Bermuda II (McQuaid, 2007). The provisions of Bermuda II allow nonstop service to London from 26 gateway cities in the United States; however the agreement stipulates that just American Airlines and United are allowed to provide service to Heathrow Airport but this agreement does not restrict U.S. airlines from flying to London's Gatwick Airport (McQuaid, 2007).

The provisions the fairly restrictive Bermuda II agreement experienced a partial easing in 1995; at that time, airlines of both the United States and the United Kingdom were granted unlimited access between any set of airports, with the notable exceptions of London Heathrow and Gatwick; at that time, United Airlines also received Chicago-London rights (the Economic Impact of Air Service Liberalization, 2007). Not surprisingly, these changes results in a continuous increase in air services and traffic. According to the study, "The Economic Impact of Air Service Liberalization" (2007), "Since 1995, traffic between Chicago and London has more than doubled. Services have expanded at Manchester, Birmingham and Glasgow, while Bristol and Edinburgh have emerged as trans-Atlantic gateways. The economic benefits have been significant. By 2004, the additional traffic and services generated 9,197 full-time jobs in the United States and over 16,700 in the United Kingdom" (p. 18). During the 12-year period from 1995 to 2007, the gross domestic product of the United States also increased by $747 million and the United Kingdom experienced an almost one billion dollar ($970 million) increase (the Economic Impact of Air Service Liberalization, 2007, p. 18).

The changes implemented in U.S.-U.K. routes as a result of policy revisions in Bermuda II can be easily discerned from Figures 1 and 2 below.

Figure 1. Nonstop U.S.-UK Routes (Excluding Heathrow and Gatwick) as of May 1994.

Figure 2. Nonstop U.S.-UK Routes (Excluding Heathrow and Gatwick) as of May 2006

Source: The Economic Impact of Air Service Liberalization (2007)

Based on the foregoing trends, it is reasonable to posit that further relaxations in the regulatory framework governing U.S.-U.K. air travel will have further positive impacts on the economies of both countries during a period when such improvements are desperately needed. Based on a simulation of a complete liberalization of the U.S. And the European Union, the analysts at InterVISTAS-ga2 emphasize that air traffic between the two continents would increase a whopping 29%. According to this study, "The increase would derive in part from lower fares, and in part from allowing any U.S. city to obtain nonstop service to London's Heathrow or Gatwick airports. The economic benefits of this liberalization would be substantial. Over 117,000 new jobs would be created, and incremental GDP would approximate $7.8 billion" (the Economic Impact of Air Service Liberalization, 2007, p. 18). Since the United States currently has open skies agreements in place with the countries that Delta and Northwest service pursuant to the SkyTeam alliance, it is improbable that any merger attempts between the two carriers would result in antitrust concerns in the serviced countries; even in the event three were some antitrust issues raised, though, foreign governments will probably just require any new merged entity to forfeit some routes or airport slots, comparable to the requirements needed for approval of the Air France-KLM merger (Baker, 2004).

As noted above, open Skies agreements provide a flexible framework for international aviation markets and restrict governmental oversight to a bare minimum; the provisions of open skies agreements, though, are applicable to passenger and cargo air transportation and include both scheduled and charter services. Some of the key provisions of open skies agreements to which the United States is currently party to include those described in Table 1 below.

Table 1

Key Provisions of Open Skies Agreements

Provision

Description

Free Market Competition

No restrictions on international route rights; number of designated airlines; capacity; frequencies; or types of aircraft.

Pricing Determined by Market Forces

A fare can be disallowed only if both governments concur -- "double-disapproval pricing" -- and only for certain, specified reasons intended to ensure competition.

Doing Business Protections

Examples of these include:

1. All carriers of both countries may establish sales offices in the other country, and convert earnings and remit them in hard currency promptly and without restrictions.

2. Carriers are free to provide their own ground-handling services -- "self handling" -- or choose among competing providers. Airlines and cargo consolidators may arrange ground transport of air cargo and are guaranteed access to customs services.

3. User charges are non-discriminatory and based on costs.

Cooperative Marketing Arrangements

Airlines may enter into code-sharing or leasing arrangements with airlines of either country, or with those of third countries. An optional provision authorizes code-sharing between airlines and surface transportation companies

Provisions for Consultation and Arbitration

Model text includes procedures for resolving differences that arise under the agreement.

Liberal Charter Arrangements

Carriers may choose to operate under the charter regulations of either country.

Safety and Security

Each government agrees to observe high standards of aviation safety and security, and to render assistance to the other in certain circumstances

Optional 7th Freedom All-Cargo Rights

Provides authority for an airline of one country to operate all-cargo services between the other country and a third country, via flights that are not linked to its homeland. Seventh freedom operations often take place among global all-cargo air carriers and are very infrequent in passenger operations.

Source: Open Skies Agreement Highlights Fact Sheet, Office of Aviation Negotiations, Bureau of Economic, Energy and Business Affairs, Washington, DC (2009, January 30) at http://www. state.gov/e/eeb/rls/fs/2009/119760.htm; the Economic Impact of Air Service Liberalization (2007), p. 134.

Chapter 4: The Economic Impact of Open Skies Agreements

Domestic deregulation has made the traditional restrictive bilateral agreements that control air travel between nations obsolete. In the place of these traditional regulatory frameworks, the open skies agreements have removed restrictions of flights as well as expanded the rights that participating countries' air carriers enjoy under the so-called "six freedoms" (Juan, 1998). The fundamental changes that have taken place in the air transport industry that resulted from deregulation of the industry and the introduction of open skies agreements has been an important component in contributing to the healthy growth that has been experienced in international trade, tourism, and cross-border investment in recent years (Juan). During the period from 1980 to 1995, for example, tourism air travel increased by 200%, an increase that had enormous economic implications worldwide (Juan). According to this World Bank analyst, "As of 1994, the tourism industry employed 10.6% of the world's workforce, generated 10.2% of the world's gross national product, and accounted for 10.9% of total consumer spending" (Juan, p. 143).

Likewise, during the period 1998 through 2005, global tourism has been estimated to have increased by a respectable 6.5% each year, a full 1.5 percentage points higher than the period from 1988 to 1998 (Juan). Moreover, these projections do not include the inevitable participation by China and Eastern Europe in the air travel market which will undoubtedly take place once their populations achieve higher levels of personal income that permits them to travel to other countries (Juan). In this regard, Juan emphasizes that, "By 2005, some 20 million Chinese travelers (up from the current 3 million) will swell the international tourist market. At current forecast rates, the air transport sector will double its share of all means of transport (from bicycles to railways and ships) in the next decade" (Juan, p. 142).

On the one hand, a study conducted by InterVISTAS-ga2 identified a substantial amount of evidence that supports the generally accepted "conventional wisdom" that further relaxation of regulatory oversight of air services between countries contributes to a substantial increase in new opportunities for consumers and businesses alike, particularly in an increasingly globalized marketplace. There is also a multiplier effect from such increased international trade that will directly and indirectly affects a number of organizations that will likely result from this type of air travel liberalization (the Economic Impact of Air Service Liberalization, 2007). On the other hand, though, it has also become apparent that restrictive bilateral air services agreements between countries restrict air travel, tourism and business, and, as a result, have an adverse effect on economic growth and the creation of new jobs during a period in history when unemployment is reaching alarming levels and economic growth has stagnated (the Economic Impact of air Service Liberalization, 2007).

Some of the key findings to emerge from the report entitled, "The Economic Impact of Air Service Liberalization" (2007) included the following:

1. Traffic growth subsequent to liberalization of air services agreements between countries typically averaged between 12% and 35%, significantly greater than during years preceding liberalization. In a number of situations, growth exceeded 50%, and in some cases reached almost 100% of the pre-liberalization rates.

2. A simulation of the likely results of liberalizing 320 country pair markets that are not today in an Open Skies (deregulated) mode indicate traffic growth, on average, of almost 63%. This is substantially higher than typical world traffic growth of around 6%-8%. Liberalizing only these 320 bilateral agreements of the 2,000 in the study's database would create 24.1 million full-time jobs and generate an additional $490 billion in Gross Domestic Product. This corresponds to an economy almost the size of Brazil.

3. The creation of the Single European Aviation Market in 1993 led to an average annual growth rate in traffic between 1995 and 2004 that was almost double the rate of growth in the years 1990 to 1994. This produced about 1.4 million new jobs.

4. A simulation of full liberalization of the United States-United Kingdom market under a Comprehensive First Step Air Service Agreement (ASA) between the United States and the European Union would produce an almost 29% increase in traffic. Some of the increase results from the impact of lower fares, while the remainder would result from allowing any U.S. city to obtain nonstop service to London's Heathrow or Gatwick airports. The economic benefits of this liberalization would be substantial. There would be an additional 117,000 new jobs generated, and the incremental GDP impact to both the U.S. And to the U.K. would be roughly $7.8 billion.

5. An examination of 190 countries and 2,000 bilateral air service agreements suggests that there are still a number of countries that place a priority on protecting their flag carrier(s), rather than enhancing the overall welfare of the broader public interest (the Economic Impact of Air Service Liberalization, 2007, p. 5).

Taken together, open skies agreements can help create jobs, fuel economic growth and provide improved service for consumers and businesses alike; however, on the downside, the research also showed that liberalized air service can spell trouble for airline pilots who will be competing with international carriers whose governments may be subsidizing their service in ways that create an unleveled playing field for U.S. legacy carriers. In the final analysis, competition in the aviation industry must be viewed as a healthy trend, but all of the players involved should play by the same rules.