## 1 Introduction

There are presently eight scheduled airline companies in Japan. With respect to passenger transport, the big three - Japan Airlines (JAL), All Nippon Airways (ANA) and Japan Air System (JAS) - account for nearly all of the major markets; together they serve roughly 91% of the passengers on both domestic and international routes. ANA claims about 45% of the domestic market, while JAL about 76% of the international market. The other airlines are for the most part subsidiaries of the big three. The domestic air transport market, with about 70 million passengers annually (55 billion revenue-passenger kilometers), is one-sixth (one-tenth) the size of the United States' markets. Japan's airlines carry about 11 million international passengers a year, about one-quarter of that of the United States' carriers.

Japanese airlines experienced a boom during the second half of the 1980s. From 1985 to 1991, revenue passenger kilometers in the domestic market grew at the rate of 9.3% annually, and in international markets 8.0%. As a result, their operating profits also soared, and they recorded the highest profits in their company histories. These trends reversed from the beginning of 1990. The average growth rate from 1991 to 1993 fell to 3.4% and 4.8% respectively. The declining growth rate influenced the companies' operating performance. JAL, especially, operations in international markets constitute more than half of their business, has suffered huge losses since 1991. It is true that the losses of JAL were caused mainly by changing market conditions, but it should be noticed that the rapid appreciation of yen also made the situation worse.

Air transport markets in Japan have developed in a strictly regulated environment. The Civil Aeronautics Law, which governs the industry, requires that airline companies obtain government licenses to enter the market. Airlines also need government approval for setting and charging their fares, and even for their annual business plans. Naturally, international routes also require government-negotiated bilateral agreements with other countries. In this respect, Japan has been a traditionalist. Its agreements are generally modeled after the old Bermuda Agreement, concluded between the United States and the United Kingdom in 1946.

However, the world-wide policy trend to deregulate the industry reached Japan in the mid-1980s. In 1985, the United States and Japan concluded a provisional agreement on international air transport. This agreement allowed new entry into the market, but required the Japanese government to change their air transport policy, because the government had restricted its carrier in the international market to just one. The government then changed its policy not only in the international market but also in the domestic, intending to promote competition in both markets. But this policy change was not as complete as that of the U.S. government. Since the institutional framework (such as entry licensing and fare approval system) remained unchanged, whether the competition would work effectively depends on how the regulators control markets.

The purpose of this paper is to evaluate the policy changes in the Japanese air transport industry. In sections 2 and 3, we describe the evolution of the policies, and in section 4 we sketch the domestic market structure and performance of the industry. Then, from section 5 to 7, we