Senate should oppose any antitrust exemption for airlines to jointly downsize, AAI says in letter to Senator Leahy

Oct 11 2001
Testimony and Interventions

The Honorable Patrick J. Leahy, ChairmanCommittee on the JudiciaryUnited States SenateWashington, DC 20510

Dear Senator Leahy:

The American Antitrust Institute is an independent non-profit education, research, and advocacy organization dedicated to a vigorous role for the principles of antitrust in our national economy. We take this opportunity to comment on efforts being made by some of the airlines to gain an antitrust exemption for the purpose of planning an orderly downsizing in light of the recent precipitous drop in demand for airline services.

Competition has proven its ability to provide the public with benefits of price, choice, and quality in almost every circumstance, whereas the public is usually the loser when competitors are allowed to jointly divide up markets, set prices and terms of trade, and otherwise overcome the strictures of competition. Every industry has its reasons for urging a more orderly marketplace. When one industry is allowed to become an exception, other industries are inevitably affected and they, too, will feel justified in seeking similar legislation. Legislators will be hard pressed to say "No" once they have said "Yes." This is why supporters of antitrust almost always oppose efforts to legislate exemptions.

Today we recognize that the airline industry has been badly damaged by a dramatic drop in consumer demand. Obviously, the industry must react, and (in addition to obtaining very generous financial support from taxpayers) it has already reacted by canceling many flights and laying off a hundred thousand employees. It is clear that the industry knows how to downsize in a hurry.

We note that prior to September 11, the airline industry was seeking an antitrust exemption so that its members could jointly deal with congestion. Now it seeks the same remedy for the opposite problem. The question is whether the airlines should be permitted to get together in order to jointly plan a downsizing. We do not believe this is necessary. Indeed, since no one knows how long demand will be reduced or at what level a recovery will stabilize, it would be a mistake to foster decisions or habits that could either slow a recovery or reinforce a habit of peaceful coexistence that already characterizes many aspects of air transportation.

Capacity reductions involve reducing the number of daily flights on individual routes or, in some cases, dropping nonstop service on certain routes entirely. (Capacity reductions might also involve substituting smaller aircraft for larger ones, but that is not the main issue here.) A long-term reduction in airline demand, whether resulting from a recession or passenger concerns about air safety, will lead firms to reduce capacity if they are competing rather than coordinating. If the airlines are permitted to agree on capacity reductions, the principal competitive danger is that they would reduce capacity beyond what would happen in a competitive market, harming airline passengers.

The harm comes in two ways. First, capacity reductions lessen the quality of service, as by reducing service convenience and connecting opportunities. Second, they will raise the utilization rates (load factors) of the aircraft still in service above what those load factors would be in a competitive market, and so lead the carriers to reduce the allocation of seats to low fare tickets. This will cause some buyers of restricted tickets not to fly, and other buyers of restricted seats to switch to higher-fare unrestricted tickets they would not have otherwise purchased in order to obtain a seat. The leisure passengers that are displaced or squeezed into higher-fare business seats are not limited to local passengers flying nonstop on a route; passengers flying the same route as part of a connecting itinerary will also be harmed. In other words, reduction in capacity ultimately means increases in price for the consumer.

The question to focus on is how the amount, pace, and choice of capacity reductions differ if undertaken in a coordinated fashion relative to an uncoordinated contraction process. The latter has been looked at in the economics literature in the context of declining industries, and we have learned much about the inefficient choices that coordination generally produces. Those inefficiencies take three forms: too much capacity reduction (leading to output reductions--the usual effect), generally at too quick a pace (i.e., premature withdrawal of capacity), and sometimes the retirement of the wrong capacity. All of these will adversely affect consumers in various ways at various points in time. A centralized decision on capacity reduction, whether by a government agency or a jointly made decision by the competing parties, has the potential, particularly when the future of demand is so difficult to predict, of making a catastrophic mistake.

What, if anything, is wrong, with the contraction process without coordination? The economics of uncoordinated reduction runs roughly as follows: Less efficient elements will be shed first, whether planes, routes, or hubs. Each airline has its own characteristics, its own strengths and weaknesses and needs. By making individualized decisions on an incremental basis, they will systematically pull back. Airlines will reorganize the remainder of their system to maximize efficiency. Some may ask for wage concessions. Some will surely lay off workers. Among the equally efficient, larger carriers will contract more, since they stand to benefit more from the resulting better industry price. Different airlines may choose different strategies (e.g., Southwest has continued to fly a full schedule), hedging society's bets about the best approach. Some companies may fail. But there is nothing inherently "wrong" with the market process for contraction, which, after all, lots of industries have experienced.

No doubt coordination of contraction is more appealing to the carriers. It promises quicker adjustment, but that is not necessarily economically optimal. It will blunt any single carrier's incentive to work out a distinctive plan that it may benefit from. And it is likely to favor certain types of carriers over others. The public will benefit more from incremental decision-making by airlines that can operate in what they perceive as their individual best interest. We strongly urge that an exemption be avoided.

As the nation reacts to the massive disruptions of September 11, it is all the more important that we hold on to our principles and not be rushed into abandoning institutions that are tried and true. Antitrust is one of those institutions.

Sincerely,

Albert A. FoerPresident