Silviase/jgov_v1.4_full_ann huggingface dataset:
Aeronautics Board (CAB). This legislation, enacted during the Great Depression, reflected the widespread distrust of market forces that prevailed then and the belief that government regulation could improve the market outcome.

The Civil Aeronautics Act required carriers to have a certificate of public convenience and necessity issued by the Board. The sixteen carriers operating when the Act was passed received “grandfather” rights and were granted certificates for the routes they served. Other applicants had to show that they were “fit, willing, and able” to perform the proposed service and that the service was “required by the public convenience and necessity.”

The Act allowed the entry of new carriers, but the CAB never granted a major (trunk) route award to a new entrant. However, the Board did allow entry into other categories: “local service” carriers providing feeder service for the trunks (1943); air taxi and commuter airlines operating small aircraft (usually less than 20 seats) (1952); and supplemental (charter) carriers (1962). Nonetheless, from the beginning of CAB regulation in 1938 until one year before deregulation in 1978, the Board did not permit entry on any route that already had two or more carriers. $ ^{1} $

Initially the CAB set air fares equal to prevailing first-class rail fares. Ultimately the Board set fares as a function of distance so the industry would earn a 12 percent return on its rate base, assuming a 55 percent load factor (percentage of seats filled). Because the Board felt that cross-subsidization of short-haul routes by long-haul routes would foster the development of aviation, a fare formula was designed so fares for long routes were greater than costs and fares for short routes were less than cost.

Although airlines effectively were prohibited from engaging in price competition, they were allowed to compete with service quality, especially equipment and flight frequency, which were explicitly not under the Board's control. Carriers added equipment and flights in the lucrative long-haul markets and reduced flights (to the extent allowed) in unprofitable short-haul markets.

Besides regulating entry, the Board also regulated exit. To exit a route, a carrier had to obtain CAB approval. Because the Board’s restrictive entry policy gave value to a carrier’s right to serve a route, firms did not exit the industry through bankruptcy. Instead, they “exited” through mergers, which provided a convenient way for a healthy carrier to acquire route authority.

#### 2.1. The Deregulation Movement

Economists began criticizing CAB regulation as early as the 1950s. Gradually, more and more analysts accepted the position that the airline industry did not have characteristics that made economic regulation necessary. The critics argued that airline regulation had led to higher fares than would prevail in an unregulated market, yet the industry was not earning excess profits.

Since the Civil Aeronautics Act regulated “interstate air transportation,” airlines operating
only within one state were not subject to federal regulation. This aspect of the law set up an interesting “controlled” experiment of sorts: by comparing unregulated intrastate fares with fares on similar interstate routes, a measure of the effects of regulation could be obtained. One particularly influential study pointed out that in 1965 the fare charged by the intrastate carrier Pacific Southwest Airlines (PSA) between San Francisco and Los Angeles (338 miles) was 11.43, while the fare charged by CAB certificated carriers between Boston and Washington, D.C. (400 miles) was 24.65. $ ^{2} $

In 1975 the Ford administration sought deregulation of the airlines. Shortly thereafter, during 1976-1977, the CAB began to loosen regulatory control by interpreting the existing statute more liberally, a trend that increased dramatically when economist Alfred Kahn was appointed Chairman of the CAB in 1977. The resulting liberalizations, such as the Board approval of American Airlines' proposed "Supersaver" fares in 1977, gave legislators a inkling of how a deregulated marketplace would function. Although the Congress was won over, airlines themselves (and airline labor groups) remained largely unconvinced of the wisdom of deregulation: most airlines and unions opposed deregulation.

Finally, in 1978, Congress passed and President Carter signed the Airline Deregulation Act. The overriding objective of the Act was reliance on competition. Entry regulations were phased out; since 1982 carriers have been free to enter any route they desire, as long as they are fit, willing, and able. Exit regulations were eliminated; carriers can now exit at will. Fare regulation was also phased out. In 1983, the CAB's authority over fares was eliminated. Carriers can charge whatever fares they desire. Finally, in 1985 the CAB ceased to exist; its remaining functions (e.g., review of mergers, international aviation, consumer protection) were transferred to the Department of Transportation.

### 3. The Effects of Airline Deregulation

Before describing the changes deregulation has brought to the airline industry, we must address two methodological points. First, when did airline deregulation begin? The simple answer---although too simple---is October 28, 1978 when President Carter signed the Airline Deregulation Act. But, as mentioned above, the CAB began loosening the constraints of regulation as early as 1976. So comparisons that use 1978 as the starting point probably understate the effect of airline deregulation.

The second point is more subtle. Most evaluations of airline deregulation simply compare the industry's performance “before” with its performance “after” and ascribe the difference to deregulation. In other words, such “factual” comparisons simply compare what was to what is. But, a hidden assumption is the only changes in the industry were those induced by deregulation. There is no question that factual comparisons can be illuminating; most of the comparisons in this
paper are factual. But one must always ask if something other than deregulation could have contributed to the observed changes.

The way around this problem is a counterfactual analysis, in which what is compared with what might have been. For example, to see what effect deregulation had on fares, we will compare actual deregulated fares with (an estimate of) what regulated air fares would have been if regulation continued. Since regulated fares never existed in the deregulated era this is counterfactual.

#### 3.1. Market Structure

Contrary to what many people may think, there are more airlines in the industry today than in 1978 when airlines were deregulated. From 1979 to 1991 153 carriers entered the industry and started service. The largest number of new carriers entered in 1979, immediately after the passage of the Airline Deregulation Act in October 1978. However, during the same time, 136 carriers ceased service, either by going out of business or by merging with another carrier. The net effect of entry and exit was that the number of airlines increased from 43 at the end of 1978 to 60 at the end of 1991, with a peak of 87 during 1984. So, a simple count of airlines shows that the deregulated industry has more players than under regulation.

Although a simple count of airlines provides interesting information, counting a large airline as equivalent to a small airline masks the changes that have occurred in the size distribution of firms. This is rectified in Figure 1, which plots the domestic airline industry's four- and eight-firm concentration ratios, frequently used measures of industry concentration. $ ^{3} $ At the time of deregulation, the four largest airlines controlled about 60 percent of total domestic revenue passenger miles with eight largest airlines accounting for about 82 percent. By 1994 this had risen to about 62 percent and 90 percent, respectively. In the intervening years, until early 1985, the industry became less concentrated. But during the second half of 1986 the industry became much more concentrated because of the mergers that took place during that period. $ ^{4} $ There has been a slight downward trend in concentration since mid-1992.

The use of concentration ratios, however, gives a distorted impression of the degree of competition in the airline industry. The output of airlines isn't really revenue passenger miles, that is merely a simple way of aggregating the output of the industry into a single number. Instead of looking at what has happened to competition in the “national market” for revenue passenger miles, we should look at what has happened to competition at the route level. It is at the route level, after all, that airlines actually compete with one another. Measures of the extent of competition at
the route level tell a strikingly different story than the other more aggregate measures. In Figure 2 we see that at the time of deregulation in the fourth quarter of 1978 the average domestic airline route had about 1.7-1.8 effective competitors, depending on whether passengers or passenger miles is used to aggregate across routes. $ ^{5} $ These measures of competition rose steadily until mid-1986 when, due to mergers, the number of effective competitors per route declined. Competition at the route level has remained more-or-less steady since about 1991. Using these route level measures, airline competition is now nearly as strong as it has ever been. The divergence of the two measures over time reflects the greater entry that has occurred on long-haul routes relative to short-haul routes.

Another, perhaps more intuitive, way to look at the extent of route-level competition is to see what has happened to the percentage of passengers who travel on “monopoly” carriers (i.e., those with a route market share greater than 90 percent) and those who fly on “competitive” carriers (i.e., those with a route market share less than 20 percent). These measures are reported in Figures 3 and 4. The percentage of passengers captive to monopoly carriers has fallen sharply---from about 28 percent in late 1978 to about 18 percent in early 1994. During that time the percentage of passengers flying on competitive carriers more than doubled, from 7 percent to 15 percent. $ ^{6} $

Thus, under deregulation there are more airlines, the larger ones control more of the “national” market than before, but they airlines compete against each other at the city pair level more often than nearly ever before.

#### 3.2. Fares

Although it should be noted that there are other aspects of the industry that are also important---service quality, for example---fares occupy center stage in any discussion of the airline industry and deregulation's effect on it.
A simple way to look at the effect of deregulation on air fares is to see how air fares have changed relative to the overall price level. This is shown in Figure 5, which plots real airline yield from 1970 through 1993. $ ^{7} $ Real air fares have fallen under deregulation, regardless of when you consider deregulation to have started. As of 1993, air fares were about two-thirds of their level in 1976. Figure 6 takes a disaggregate look at real yields and shows how they have changed by distance from 1978:4 to 1993:4. Fares on routes less than about 800 miles have risen, in a few cases by 30 percent. However, long-haul routes have had decreases of up to 40 percent. These changes in fares were to be expected given the CAB's attempt to cross-subsidize short-haul fares with long-haul fares.

But can the overall decline in yields shown in Figure 5 be attributed to deregulation? As the figure shows, yields had a downward trend even before the beginning of the deregulation movement. Here a counterfactual comparison would help. The results of such an analysis are shown in Figure 7, which compares the actual (nominal) yield from 1978:4 until 1993:4 with what yield would have been if fares continued to be regulated by the CAB. $ ^{8} $ This curve shows that actual yields have consistently been lower than regulated yields, although the amount has varied greatly over the course of deregulation. The biggest percentage gap occurred during the 1981-82 and 1990-91 recessions. Because airline costs were increasing (due to rising fuel costs), regulated fares (would have) increased. Faced with recession, however, carriers actually lowered fares to attract what business was available. Averaged over the fifteen years in the figure, deregulation has led to fares about 22 percent lower than they would have been if regulation continued. This amounts to annual savings averaging about 12.4 billion (1993 dollars). $ ^{9} $ During 1993 fares were 19 percent lower than they would have been under regulation. Real fares (Figure 5) have declined by about 33 percent since 1976. Thus deregulation has accounted for about 58 percent (19/33) of the observed decline in fares.

Another feature of fares under deregulation that is lost when looking at yields is the change in the distribution of fares charged on any given route. Even occasional air travelers are aware of the array of fares available, ranging from expensive unrestricted coach fares to deeply discounted fares with a host of restrictions. The effect of this variation in pricing is shown in
Figure 8, which plots the percentage of air travelers as a function of how the fare they paid compares with the average fare on the route they traveled. As is readily apparent in the figure, fares have become more dispersed since deregulation. In 1978:4 fares on each route were relatively tightly distributed. Fare dispersion increased in both 1985 and 1993. $ ^{10} $

In any discussion of post-deregulation air fares, the subject of fares at hub airports always comes up. The nature of a hub necessitates that the hubbing carrier has a large share of airport operations. But will the hubbing carrier also be able to charge higher fares? The answer appears to be yes, although recent research suggests that the hub premium is not as large as previous research indicated.

The U.S. General Accounting Office examined yields at 15 airports where one or two carriers had a large share of total enplaned passengers. They compared the average yield at the 15 concentrated airports in 1988 with the average yield at 38 unconcentrated airports and found concentrated airports had yields 27 percent higher. $ ^{[1]} $ This figure has been widely cited and was partly the basis for legislation to increase competition at concentrated hub airports. However, such a comparison assumes that concentration caused the higher yields and not some other factors. In particular, to zero in on the effect of concentration on price, we must make sure that differences in flight distances, number of connections, and use of frequent flier tickets are taken into account. Further, we must make sure that the comparison airports have the same mix of business and pleasure traffic as the concentrated airports. Finally, we must make sure that any hub premium is, in fact, that: an additional amount a carrier is able to charge at hubs it dominates. Alternatively, the hub premium could be a carrier premium that the carrier is able to charge at all the airports it serves.

Figure 9 shows the results of a study that measured the hub “premium” when these factors were and were not accounted for. After adjustment, the hub premium has been in the 5-10 percent range for several years, much lower than the 27 percent found by the GAO. $ ^{12} $
disappeared and have been replaced by online connections, which passengers prefer, where passengers change planes but not airlines. Only about two percent of travelers now make interline connections. But most important of all, the hub-and-spoke route structure gives passengers---from spokes and from the hub---more frequent service than would be possible with single plane service. Because passengers bound for many destinations are flown in the same plane, more frequent service is possible than with single plane service. In fact, one study of deregulation found that about two-thirds of the benefits to passengers from deregulation were from increased frequency of service made possible by the hub-and-spoke route structure. $ ^{13} $

Figure 14 shows the change in average aircraft size that has accompanied the evolution of the hub-and-spoke system. On average, smaller aircraft were used on short routes (less than 300 miles) in 1993 than in 1978. With one exception, larger aircraft were used on routes from 300 miles to 2200 miles. Again, with one exception, smaller aircraft were used on long routes (more than 2200 miles). Finally Figure 15 shows how actual flight time (for non-stop flights) has changed since 1978. Both ground and air time have increased so that in 1993 the average flight segment took nine minutes longer than in 1978. This is presumably due to airport and airway congestion, although slower cruising speeds might also contribute to the greater air time.

#### 3.4. Employment

Figure 16 shows the trend in airline industry employment from 1970 to 1993. Employment was steady from 1970 to 1976 when it began to increase. After a dip caused by the recession in the early 1980s employment increased dramatically and has leveled off since 1990. Employment in 1993 was about 80 percent larger than in 1976. However, these changes at the aggregate level mask what happened at the individual carrier level as employees were hired during expansions and laid off during downturns. For example, Continental Airlines' employment fell by more than 5 thousand workers during its first bankruptcy (although employment was greater when it emerged from bankruptcy in 1986 than when it entered in 1983). Trans World Airlines shed about 6 thousand workers during its time in bankruptcy. Of course, when an airline goes out of business, all employees lose their jobs. The most significant cases of this type are Eastern and Pan American Airlines. At their peak, Eastern had about 44 thousand employees (1987) and Pan American had about 32 thousand workers (1981). They now have none. Of course, it is difficult to say if deregulation caused this. Both these airlines had financial problems before deregulation in 1978.

Airline workers are well paid relative to U.S. workers in general earning an average (total compensation) of $52,188 in 1992 compared with $34,536 for all workers. However, the earnings gap has been closing. Since 1980 (nominal) total compensation of airline workers has increased at 3.9% per year while total compensation for workers in general has risen 5.2% per year.
#### 3.5. Investment

Airline investment in physical assets (largely flight equipment) has expanded rapidly since deregulation. From 1977 to 1994 airline physical assets (in constant 1994 dollars) more than doubled from $24.5 billion in 1977 to $55.8 billion in 1994.

#### 3.6. Profitability

Figure 17 shows the operating profit margin for U.S. scheduled airlines. Operating profit margin expresses operating profits (operating revenue minus operating cost, which excludes interest and taxes) as a percentage of operating revenue. As the figure makes clear, the industry is a cyclical one. During the recession of the early 1980s industry operating profits were negative. They recovered in 1983 and 1984 and then hovered in the 3-5 percent range. The years 1990-92 saw negative operating margins. Improved, but poor, performance occurred in 1993. However, these industry averages hide wide variations in profitability among firms. In 1989 operating profit margins ranged from -56 percent at Eastern Airlines (which went out of business in early 1991) to 10 percent for Southwest Airlines.

#### 3.7. Safety

The subject of airline safety invariably comes up in any discussion of airline deregulation. But safety was not deregulated. Safety standards continue to be enforced by the Federal Aviation Administration. However, some people believe that increased competition in a deregulated marketplace will cause airlines to be less safe by skimping on maintenance or by hiring less experienced pilots. Others counter that without the protection from competition afforded by regulation, a carrier that was unsafe (or even perceived to be unsafe) would not survive in a regime of free entry by other carriers. Both views make sense. Ultimately, it is an empirical question. What has happened to the safety record of airlines since deregulation? Figure 18 shows the probability of an airline passenger dying in an airline accident from 1975 to 1993. The safety record of airlines continues to improve in the deregulated era. $ ^{14} $

### 4. Possible Trouble Spots

This section examines several areas that have been identified by some observers as possible areas where deregulated competition has led to (potential) problems that might warrant increased scrutiny by the government.
#### 4.1. Frequent Flier Programs

Frequent flier programs began in May 1981 when American Airlines began its Advantage program. It was 1986, however, before all major airlines had one. In such programs, airlines award points for each mile a person travels. Once a specified number of miles have been accumulated, a member of a frequent flier program can redeem his miles for free travel or an upgrade to another class of service. $ ^{15} $ According to Stephenson and Fox (1987) in 1985 approximately 10 million people---accounting for 70-75 percent of business travelers---belonged to at least one frequent flier program. Bryant (1994) reports data from Inside Flyer magazine that by 1993 membership in frequent flier programs totaled 30 million people with 1.7 trillion accumulated miles in their accounts. Figure 19 shows how the use of frequent flier tickets has grown over the years. The figure shows the percentage of U.S. domestic air travelers flying on zero fare tickets. $ ^{16} $ If we consider the level of zero tickets during 1978-86 to reflect free travel by airline employees and coding errors and not frequent flier travel, since 1989 about 4 percent of travelers and 6 percent of passenger miles were free frequent flier trips. This understates the importance of frequent flier programs because it excludes those travelers who use their miles for free upgrades rather than for free travel.

It appears that by any number of measures frequent flier programs have assumed a large importance in deregulated airline competition in the United States. The policy question, however, is whether these programs are a benign marketing device or whether they distort competition. At first blush, frequent flier programs may appear to be a form of quantity discount---airlines reward their good customers with free travel. However, as Levine (1987, p. 452) points out, although this characterization may be accurate for pleasure travelers it is not for business travelers because pleasure travelers pay for their own tickets but business travelers do not. Frequent flier programs for business travelers are an attempt to exploit the “principal-agent” problem: the agent (the business traveler) makes travel decisions that are not in the best interest of the principal (his or her employer). Even so, does this distort competition? The answer appears to be yes for two reasons. First, large airlines, with their large route systems, give travelers a greater opportunity to earn miles and also have a more diverse set of destinations to offer when the traveler accumulates enough miles to earn an award. Consider, at one extreme, the disadvantage faced by an airline that serves only one destination. Having accumulated enough miles for a free trip the traveler is rewarded with another trip to the same place! Small carriers could join forces with other small carriers or