Airline Deregulation: Reregulating the Airline Industry Would Likely Reverse Consumer Benefits and Not Save Airline Pensions
Published: 2006-06-09T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Airline Deregulation Act of 1978 phased out the government's control over fares and service and allowed market forces to determine the price and level of domestic airline service in the United States. The intent was to increase competition and thereby lead to lower fares and improved service. In 2005, GAO reported on the tenuous finances of some airlines that have led to bankruptcy and pension terminations, in particular among those airlines that predated deregulation (referred to as legacy airlines). The House Report accompanying the 2006 Department of Transportation (DOT) Appropriation Act expressed concern about airline pension defaults and charged GAO with analyzing the impact of reregulating the airline industry on reducing potential pension defaults by airlines. GAO subsequently agreed to address the pension issue within a broad assessment of the airline industry since deregulation. Specifically, GAO is reporting on, among other things, (1) broad airline industry changes since deregulation, (2) fare and service changes since deregulation, and (3) whether there is evidence that reregulation of entry and fares would benefit consumers or the airline industry, or save airline pensions. DOT agreed with the conclusions in this report. GAO is making no recommendations in this report.
section_title: What GAO Found
paragraphs: The airline industry has undergone significant change since the late 1970s. Industry capacity and passenger traffic have tripled. At the same time, the industry's profitability has become more cyclical, and the financial health of large legacy airlines has become more precarious. Legacy airlines emerged from a regulated environment with relatively high structural costs, driven in part by labor costs, including defined benefit pension plan costs. Over the last few years, facing intense cost pressures from growing low-cost airlines like Southwest, both United and US Airways entered bankruptcy, voided labor contracts, and terminated their pension plans costing the Pension Benefit Guaranty Corporation, the federal government insurer of defined benefit plans, $10 billion and beneficiaries more than $5 billion. In 2005, two other legacy airlines entered bankruptcy leaving their pension plans in doubt. Only two airlines still have active defined benefit pension plans. Airfares have fallen in real terms over time while service--as measured by industry connectivity and competitiveness--has improved slightly. Overall, the median fare has declined almost 40 percent since 1980 as measured in 2005 dollars. However, fares in shorter-distance and less-traveled markets have not fallen as much as fares in long-distance and heavily trafficked markets. Since 1980, markets have generally become more competitive; with the average number of competitors increasing from 2.2 per market in 1980 to 3.5 in 2005. The evidence suggests that reregulation of airline entry and fares would likely reverse much of the benefits that consumers have gained and would not save airline pensions. The change in fares and service since deregulation provides evidence that the vast majority of consumers have benefited, though not all to the same degree. Although a number of airlines have failed and some have terminated their pension plans, those changes resulted from the entry of more efficient competitors, poor business decisions, and inadequate pension funding rules. GAO has previously recommended that broad pension reform is needed.

section_title: Letter
paragraphs: In 1978, Congress deregulated the airline industry. The Airline  Deregulation Act of 1978 phased out the government’s control over fares  and service and allowed market forces to determine the price and level of  domestic airline service in the United States. We have previously reported  that overall fares have declined and service has increased since  deregulation, but that these benefits have not been evenly distributed  throughout all markets. More recently, we reported on the tenuous  finances of some airlines that have led to bankruptcy and pension  terminations, in particular among those airlines whose operations  predated deregulation, referred to as legacy airlines. Critics of  deregulation, including some academics and some in Congress, have  pointed to industry instability that has resulted in industry layoffs and  pension terminations along with declining service and high fares for some  communities as evidence of negative effects of deregulation.
The House report accompanying the 2006 Department of Transportation  (DOT) appropriations legislation expressed concern about airline pension  defaults and charged us with analyzing the impact of reregulating the  airline industry on reducing potential pension defaults by airlines. In  subsequent discussion with House appropriations offices, following our in- depth report on airline pensions and bankruptcy, we agreed to more  broadly assess the airline industry since deregulation. Specifically, we  agreed to report on (1) the original rationale for deregulating the airline  industry in 1978, (2) broad airline industry changes since deregulation, (3)  fare and service changes since deregulation, and (4) whether there is  evidence that reregulation of airline entry and rates would benefit  consumers and the airline industry, or save airline pensions.
To address these objectives, we relied on historical documents, our past  studies, and our analysis of DOT passenger ticket data. To assess the  original intent of Congress in passing the Airline Deregulation Act, we  reviewed the act and accompanying legislative materials and various other  documents and studies. To evaluate past changes in the airline industry,  we reviewed our past studies, reviewed DOT studies, analyzed financial  and operational data, and interviewed industry experts. To analyze fare  and service changes since deregulation, we used the DOT’s Origin and  Destination Survey, a database containing information on every tenth  airline ticket sold. The survey includes the fare paid (including taxes) and  itinerary, including flight segments. The survey does not provide  information on frequency, type of aircraft, or operational performance. We  excluded tickets with international, Hawaiian, or Alaskan destinations or  origins so that we could examine changes within continental U.S.  domestic markets. To simplify the analysis, we examined only tickets for  flights during the second quarter of each year—generally considered  neither the busiest nor the slowest quarter of the year. We limited our  analysis of service measures to only those city-pairs with at least thirteen  passengers in our sample (or about 130 actual flying passengers) in every  quarter in order to ensure that the changes in service we observed in our  sample reflected actual flow routes and were not due to sampling or data  error. Even so, the vast majority of passengers were included in our  analysis—for example, in 2005, excluding city-pair markets with less than  13 passengers per quarter excluded only one percent of passengers. In  addition, for our analysis of competition in city pairs, to ensure the  sampling confidence in each competitor airline, we limited our analysis to  city pairs with at least 118 passengers in the sample (or about 1180 actual  flying passengers) per quarter. No minimum passenger levels were  imposed for our analysis of fares. Because the survey does not identify the  destination airport, to ensure city-pair accuracy, we eliminated  nonsymmetrical roundtrip tickets. We reviewed our methods and results  with DOT and academic experts from the Massachusetts Institute of  Technology’s Global Airline Industry Program. To determine whether  there is sufficient evidence to reregulate the airline industry, we  considered our findings under the prior questions of this report, especially  the changes in fares and service since deregulation. We also considered  the findings of our earlier reports, especially those relating to small  community air service and defined benefit pension terminations and  regulation. We performed our work between September 2005 and May  2006 in accordance with generally accepted government auditing  standards.
subsections: section_title: Background
paragraphs: Industrywide regulation of the U.S. airline industry began in 1938 in  response to congressional concern over safety, airlines’ financial health,  and perceived inequities between airlines and other regulated forms of  transportation. The Civil Aeronautics Act of 1938 (P.L. 706) applied to  interstate operations of U.S. airlines and gave the Civil Aeronautics  Authority, redesignated as the Civil Aeronautics Board (CAB) in 1940,  authority to regulate which airlines operated on each route and what fares  they could charge. Airlines could not add or abandon routes or change  fares without CAB approval.
CAB also limited the number of airlines in the industry. In 1938, the  interstate U.S. airline industry consisted of 16 “trunk” airlines, but this  number contracted to 10 by 1974, despite 79 applications from new  airlines to initiate service. Competition was limited on a route to one  airline unless the CAB determined that demand was sufficient to support  an additional airline. Airfares were based on a complex cost-based formula  used by the CAB, though the exact formulas and process varied over the  life of the CAB. Generally, though, airlines during this time had little  incentive to reduce costs, since each was assured a fixed rate of return. As  a result, the competition that existed among airlines was largely based on  the quality of service. Airlines operated largely a point-to-point system,  more similar to railroads than the airline networks that we know today.  For example, as shown in figure 1, the route-maps of Eastern Airlines  (1948) and Western Airlines (1962) show a system vastly different from  today’s hub-and-spoke networks.
Airlines have traditionally relied on union labor, and labor relations have  been covered by the Railway Labor Act since 1936. The union bargaining  structure that developed within the airline industry has been highly  decentralized and separated by craft (e.g., pilots, mechanics, etc.). Before  deregulation, unions and airline management engaged in carrier-by-carrier  bargaining whereby the last contract signed by one carrier generally  served as the starting point for the next airline (known as “pattern  bargaining”). During regulation, labor relations were generally good  because CAB’s fare-setting allowed airlines to pass increased labor costs  on to passengers. Airlines’ bargaining power was enhanced by the Mutual  Aid Pact, a strike insurance plan created in 1958, through which a struck  airline was compensated by nonstruck airlines based on increases in  traffic the latter received during a strike. The Mutual Aid Pact was  eliminated with deregulation, thereby enhancing airline labor’s power in  contract negotiations.
section_title: Airline Deregulation Was Originally Intended to Encourage Competition, Thereby Lowering Fares and Improving Service
paragraphs: The Airline Deregulation Act phased out federal control over airline  pricing and routes. Airline deregulation was premised on an expectation  that an unregulated industry would attract entry and increase competition  among airlines, thereby benefiting consumers with lower fares and  improved service. The experience of unregulated (i.e., state-regulated)  intrastate service in Texas and California provided support for this  expectation. Moreover, prior to deregulation, industry analysts—on the  basis of conventional economic reasoning—expected that opportunities  for increased competition would increase the number of airlines operating  in many markets, thereby lowering fares and expanding service.
The Airline Deregulation Act established specific goals of encouraging  competition by attracting new entrant airlines and allowing existing  airlines to expand. According to the act, competition was expected to  lower fares and expand service, the chief aims of deregulation. At the  same time, Congress recognized that deregulation could lead to economic  dislocations for some communities and workers as service patterns  adjusted and airlines entered and exited markets and the industry overall.  As a result, the EAS program and the EPP were established.
The EAS program was put into place to guarantee that small communities  served by commercial airlines before deregulation would maintain a  minimal level of scheduled air service. DOT currently subsidizes  commuter airlines to serve approximately 150 rural communities across  the country that otherwise would not receive any scheduled air service.  According to DOT, EAS subsidizes 39 communities in Alaska and 115 more  in the rest of the United States. The EAS budget ranged from about $100  million early in the program down to about $25 million, before rising in  recent years to $100 million. In Fiscal Year 2006, EAS was funded at $109  million.
EPP was created, first, to compensate airline workers who lost their jobs  or received lower pay as a result of bankruptcies or major contractions  whose major cause was airline deregulation and, second, to grant such  workers first-hire rights. However, the Department of Labor delayed the  establishment of regulations to administer these rights, Congress did not  appropriate funds to compensate displaced employees, and airlines fought  the requirements in court. On August 7, 1998, the statute authorizing the  EPP was repealed. No compensation was ever provided to displaced  employees, and the first-hire right was never enforced.
While the practice of setting of airline entry and rates was deregulated, the  federal government is still involved in many facets of the airline industry,  including many aspects that affect the economics of the industry. For  example, the federal government still influences financing and investment  decisions affecting the nation’s aviation infrastructure, including airports  and air navigation systems. In addition to the various taxes and user fees  on commercial airline tickets, which averaged 15.5 percent of the base fare  in 2002, the federal government also provides support from its general  fund for FAA operations. In 2007, the Airport and Airways Trust Fund,  which finances the nation’s aviation infrastructure, will be up for renewal.  The federal government also provided commercial airlines with $7.4  billion in financial assistance and $1.6 billion in loan guarantees for six  airlines as a result of the September 11, 2001, terrorist attacks. Finally,  PBGC has assumed almost $12 billion in net airline pension obligations  since 1991.
section_title: The Airline Industry Has Undergone Significant Change since Deregulation
paragraphs: The airline industry has undergone significant change since the late 1970s.  Air travel, and along with it industry revenues and expenses, have tripled  since 1978. However, industry profits have become increasingly cyclic,  with the most recent downturn leading to almost $28 billion in operating  losses since 2001. Airline employee compensation grew following  deregulation, even though many studies have found that employees earned  a premium under regulation. Nevertheless, employee compensation as a  share of total expenses has declined, especially in recent years. During  regulation, airlines operated almost as regulated monopolies, encountering  little competition and facing little pressure to restrain costs because fares  were based on the airlines’ costs plus a fixed rate of return. Following  deregulation, legacy airlines were able to stave off new entrant  competition through various operating barriers, such as FAA-imposed  take-off and landing times at congested airports (slot controls), perimeter  rules at Washington Reagan National Airport, and airlines’ exclusive-use  control of gate leases; and business practices, such as frequent flyer  programs and ticket distribution systems. The market downturn that  began in 2000 exposed legacy airlines’ precarious financial condition,  allowing low-cost airlines the opportunity to compete more aggressively.  Owing to financial instability since deregulation, airlines operating in  bankruptcy have become more common, but we found that bankruptcy  protection has not adversely affected nonbankrupt airlines. More troubling  has been the use of bankruptcy to terminate defined-benefit pension plans,  costing the PBGC and airline employees billions of dollars. Only two  airlines still offer defined benefit pension plans.
subsections: section_title: The U.S. Airline Industry Has Expanded since Deregulation
paragraphs: The U.S. airline industry has expanded threefold since deregulation.  Figure 2 shows that the consumption of airline travel as measured by  revenue passenger miles (RPM) grew from 188 billion RPMs in 1978 to 584  billion RPMs in 2005, while airline capacity grew at a similar pace—from  306 billion available seat miles (ASM) in 1978 to 758 billion ASMs in 2005.  Over the same period, revenue passenger enplanements increased from  254 million in 1978 to 670 million in 2005.
Owing to the growth of air travel, U.S. airlines’ revenues grew almost  fourfold in real terms (see fig. 3). However, expenses also grew at a similar  pace, sometimes outpacing industry revenues. While profits were  relatively stable under regulation, earnings have been increasingly cyclical  since deregulation. One explanation for this cyclicality is that, with  revenues closely tied to the business cycle, high fixed costs for aircraft,  and a rigid and costly labor structure, outside shocks—such as the  September 11, 2001, attacks or high fuel prices—make it difficult for the  industry to adjust its capacity. The industry has incurred operating losses  of nearly $28 billion since 2001, most of this by legacy airlines. These  airlines have compensated by taking on additional debt, using all (or  nearly all) of their assets as collateral and limiting future access to capital.
section_title: Airline Salaries, Compensation, and Efficiency Have Grown since Deregulation
paragraphs: There have been significant changes to airline employee compensation,  employment, and productivity since deregulation. Prior to deregulation,  labor was highly unionized and wage demands were typically met.  Regulation allowed for increases in labor costs to be passed on to  consumers through the regulated fare system. Several studies have  estimated that airline wages were greater under regulation than they  would have been in a competitive deregulated market. Even so, industry  growth, barriers to entry, and union bargaining strength allowed labor to  protect its compensation following deregulation. Since 1978, airline  industry salaries and total compensation experienced real increases,  though with some decline since 2002 (see fig. 4). Inflation-adjusted  benefits per employee grew on average from $14,703 in 1979 to $24,852 in  2004, a real increase of almost 70 percent. Meanwhile, inflation-adjusted  salaries per employee grew from $52,295 in 1979 to $54,848 in 2004 on  average, a real increase of less than 5 percent. Despite this increase in  compensation costs, employee compensation as a share of total operating  costs has declined since deregulation, especially since 2002 (see fig. 5).  This decline in compensation costs as a share of total operating expense is  attributable to falling employment levels, to large increases in capacity,  and increases in other costs (especially for fuel). Employment began to  decline with the industry downturn that began in 2000. As a result,  measures of overall industry efficiency (as illustrated by available seat  miles per employee in fig. 6) increased significantly. This is attributable to  efficiency gains by legacy airlines during and under the threat of  bankruptcy, and to more efficient low-cost carriers providing more  capacity than previously.
section_title: Legacy Airlines Remained Dominant until 2000, When Low-Cost Airlines Increased Market Share
paragraphs: Following deregulation, legacy airlines were considerably larger and better  financed than the host of small new airlines that entered the market place.  Most of the new entrant airlines during the 1980s and 1990s failed. Large  legacy airlines were generally able to retain market share despite new  entrant airlines because of operating barriers—such as slot controls—and  business practices—such as frequent flyer programs—that gave them  competitive advantages. Larger and better-capitalized legacy airlines  seeking to increase market share acquired weaker airlines—for example,  American Airlines’ acquisition of Reno Air. Legacy airlines built up their  hub-and-spoke networks, which allowed them to build their traffic flows  and fend off potential competitors. We and others reported on the higher  fares experienced by passengers that had to use these “fortress hubs.”  Legacy airlines also developed regional, national, and international code- sharing arrangements to extend their networks and compete for domestic  and international passenger traffic. During the 1990s, we repeatedly  reported on these and other barriers to entry that limited competition in  the U.S. airline industry.
Since the industry downturn that began in 2000, there has been a shift in  the airline industry: a weakening of the financial condition of legacy  airlines and an increasing market share for low-cost carriers. The  consequences of an overburdened cost structure for legacy airlines  became apparent after 2000 when demand fell, especially demand from  premium-fare business travelers. Low-cost airlines, which generally did  not have these cost structures, have been able to increase their market  share, while legacy airlines have struggled to bring their costs down. As  we reported in 2004, low-cost airlines increased their presence in the top  5,000 domestic city-pair markets by 44.5 percent; from 1,594 markets in  1998 to 2,304 markets in 2003. In 1998, low-cost airlines operated in 31.5  percent of markets served by legacy airlines, providing a low-cost airline  alternative to 72.5 percent of passengers. By 2003, low-cost airlines  competed directly with legacy airlines in 45.5 percent of markets served by  legacy airlines, serving 84.6 percent of passengers in the top 5,000 markets.  While legacy airlines began to reduce their operating costs starting in 2001,  they did so through capacity reductions and were not able to reduce their  unit costs vis-à-vis low-cost airlines that were adding capacity. We  warned that legacy airlines could not survive with continued losses. In  2005, two legacy airlines (Delta and Northwest) entered bankruptcy and  are currently attempting to reorganize.
section_title: Bankruptcy Has Been Used to Terminate Defined Benefit Pension Plans
paragraphs: In 2005, we examined the issue of airline bankruptcy and, in particular,  how some airlines were using bankruptcy to terminate their defined  benefit pension plans. We found that bankruptcy has been endemic to the  airline industry since deregulation, with 162 bankruptcy filings since 1978,  owing to the fundamental financial weaknesses of the airline industry.
Despite the prevalence of bankruptcy, however, we found no evidence  that bankruptcy harmed the airline industry by contributing to  overcapacity or by underpricing. Nevertheless, we expressed concern  about the use of bankruptcy to terminate defined benefit pension plans  because of the costs to the federal government as well as to employees  and beneficiaries. USAirways and United, subjected to intense cost  pressures from growing low-cost airlines like Southwest, entered  bankruptcy and terminated their labor contracts and pension plans.  The  pension plan terminations cost PBGC nearly $10 billion and plan  participants lost more than $5 billion in promised benefits that are not  covered by PBGC. If Delta and Northwest, which entered bankruptcy in  2005, similarly terminate their pension plans, the costs to PBGC and plan  participants will be even greater. At present, only American Airlines and  Continental have active defined benefit pension plans, while the remaining  airline plans are either terminated or frozen. In total, active and frozen  airline plans were underfunded by almost $15 billion at the end of 2005,  according to Securities and Exchange Commission filings.
section_title: Real Fares Have Declined and Service Has Expanded since 1980
paragraphs: Airfares have fallen in real terms over time, with round-trip median fares  almost 40 percent lower since 1980. However, fares in short-distance  markets (less than 250 miles) and “thin” markets (the bottom 20 percent of  passenger traffic) have not fallen as much as those for longer distances or  in heavily traveled markets. Price dispersion—that is, the extent to which  passengers in the same city-pair market pay different fares—has also  declined since 2003, likely indicating consumers’ unwillingness to pay the  very high fares airlines were able to charge in the late 1990s. The extent to  which these benefits are attributable to deregulation as opposed to other  factors, such as advances in technology, is uncertain. Various studies have  attributed significant consumer benefit to deregulation, but estimating this  benefit depends on several major assumptions and is not free of  controversy. The decline in fares coincided with a growth in passenger  traffic and increased competition over the period. While large  communities and markets have experienced large gains in the number of  passengers and service, as well as increased competition, small  communities and markets have experienced much smaller gains. On  average, however, the number of competitors in city-pair markets grew  from 2.2 in 1980 to 3.5 in 2005.
subsections: section_title: Real Fares Have Declined, but Declines Have Varied by Market
paragraphs: Our analysis of DOT’s ticketing data from 1980 to 2005 shows substantial  decreases in median fares since 1980, with an overall decrease of nearly 40  percent for median round-trip fares since that time. In addition, our  analysis shows a convergence of fares across trip distances, although  substantial differences in fares by trip length and by market size remain. In  recent years, passengers flying long distances or in medium to large  markets have paid much lower fares as compared with 1980 fares, while  those flying in smaller markets or over shorter distances today have seen a  smaller reduction in fares as compared with 1980 fares. Finally, the  difference between the fares paid by customers flying within the same  routes began to decline in 2003, after increasing in the years following  deregulation.
Overall, median round-trip fares have declined 38 percent since 1980,  falling from $414 to $256. The largest decreases occurred in the late  1980s, but the overall trends have continued down in subsequent years.  Figure 7 provides information about median round-trip fares.
Median fares have converged when compared by the distance traveled  since deregulation. In 1980, median fares ranged from $680 for trips longer  than 1,500 miles to $230 for trips of 250 miles or less— reflecting the  pricing structure in place under regulation, which linked fares to costs  while subsidizing shorter routes. Since that time, however, fares have  converged toward the low end of this range, with the longest trips now  averaging just $326, a drop of 52 percent. Median fares for the shortest  trips, in contrast, have not fallen as much. For trips of 250 miles or less,  median fares have fallen 13 percent to $201. Figure 8 provides information  about median fares by distance categories.
The size of the market has also affected how fares have changed since  deregulation. The smallest markets continue to have the highest average  fares, and have seen the smallest reduction in these fares (see fig. 9). In  1980, passengers flying in the smallest markets paid $412 on average for  their tickets, while those flying in the largest markets paid $329. By 2005  average fares in the smallest markets had fallen 16 percent to $348, while  passengers in the other markets we analyzed saw their fares fall 26 percent  or more on average. Examples of city pairs in the smallest-market category  in both 1980 and 2005 include the Atlanta, Georgia–Joplin, Missouri route;  and the Great Falls, Montana–Sacramento, California route. In contrast,  the Boston, Massachusetts–New York, New York route; and the Chicago,  Illinois–Los Angeles, California route, were in the largest-market category  in both 1980 and 2005.
While median fares trended down steadily after deregulation, the  differences in the prices paid by individual customers in the same city-pair  market grew, most notably in the 1990s with the increased use of yield- management systems by airlines. The dispersion of fares began to decline  in 2003, however, when changes in the overall economy and a decline in  the willingness of some passengers to pay higher fares for premium  service—notably business passengers—likely combined with the  increased use of the Internet for ticket purchases to reverse some of the  prior increases in ticketing variation. Since then, the variability of fares  has decreased, meaning that fares for most tickets sold are now generally  more similar to average fares. Figure 10 illustrates the coefficient of  variation, or dispersion, of round-trip yields.
section_title: Studies Have Found Fare Reductions but Vary in the Degree to Which They Credit Deregulation
paragraphs: Many studies have estimated that consumers have benefited from  deregulation. Assessments of these benefits, however, vary substantially  as have the methodologies used. One approach is to calculate the  difference between actual fares and a benchmark proxy measure of what  fares might have been had the industry remained regulated. Any  differences are then attributed to the effects of deregulation. Some studies  using this approach have used the Standard Industry Fare Level (SIFL) to  approximate the regulated fare and concluded that consumers as a whole  have benefited from lower fares resulting from deregulation. For  example, in 2005 Rose and Borenstein compared postderegulation fares to  the SIFL and estimated that 2004 fares were about 30 percent lower than  what the comparative regulated fares would have been, resulting in a $5  billion savings to passengers that year. Likewise, Winston and Morrison  used the same proxy in 1995 and estimated that real fares declined about  33 percent from 1976 to 1993. After adjusting the SIFL data to account for  presumed productivity gains and increased load factors, they estimated  that, on average, deregulation led to fares 22 percent lower than they  would have been in a regulated environment, resulting in an annual  savings of about $12.4 billion in 1993 dollars over the same period. While  pointing to declines in overall fares, these studies also indicated that  benefits have been unevenly distributed by market size and route length.  In fact, those traveling on heavily traveled routes are likely to be paying  less than they would have paid under a regulated system, and those flying  on shorter-distance routes are likely to be paying more.
Some experts have questioned the extent to which deregulation can be  credited for decreases in airfares since 1978, and draw attention to the  difficulty in measuring impact. First, a former CAB and DOT official, who  participated in CAB route awards and fare determinations and later  calculated the SIFL for DOT, points out that the fare ceilings used by CAB  under regulation—calculated as the Domestic Passenger Fare  Investigation (DPFI)—were more complicated than their proxies. Rose  and Borenstein also acknowledged that using the SIFL as a proxy for the  CAB regulated fare may be increasingly implausible, given that it is  unlikely that the same cost assumptions would have been used for the 27  years following deregulation. As a result, using the SIFL to approximate  airline fares under regulation may overestimate the savings resulting from  deregulation. For example, while the DPFI fare calculations took several  factors into account, including depreciation and capacity, the SIFL  calculations primarily consider airline costs. The former DOT official  further noted that the DPFI calculations allowed for discounted fares if  load factors were increased to offset the fare reduction, something not  reflected by the SIFL fare. Second, some experts have pointed out that  fares were already declining before deregulation, thus making it difficult to  attribute changes in the industry to deregulation rather than improvements  in productivity and other factors. In fact, real average fares paid per mile  (yields) since 1962 do show a steady decline, reflecting both CAB fare  setting flexibility and cost-savings following the introduction of jet service  in the early 1960s, but without a sharp break in 1978 following the  deregulation of the industry (see fig. 11).
section_title: Airline Traffic Has Grown and Markets Are More Competitive, Though to a Lesser Degree in Small Markets
paragraphs: As predicted by deregulation, airline city-pair markets have become more  competitive since deregulation. As shown in figure 12, the average number  of effective competitors (any airline that carries at least 5 percent of the  traffic in that market) in any city pair increased from 2.2 in 1980 to 3.5 in  2005. By 2005, 76 percent of the city-pair markets we analyzed had three  or more carriers compared with 34 percent of all city-pair markets in 1980  (see fig. 13). By contrast, the percentage of city-pair markets with only one  carrier decreased from 20 percent in 1980 to 5 percent in 2005. As these  two figures show, most of the increase in competition occurred during the  1980s, just after deregulation.
Longer-distance markets are more competitive than shorter-distance  markets, some of which have lost competitors since 1980. While city pairs  with a distance of over 1,500 miles have seen an increase in the average  number of carriers from 2.3 in 1980 to 4.2 in 2005, markets shorter than  250 miles have seen a decrease from 1.6 in 1980 to 1.4 in 2005 (see fig. 14).  This difference exists in large part because longer-distance markets have  more viable options for connecting over more hubs. For example, a  passenger on a long-haul flight from Harrisburg, Pennsylvania, to Seattle,  Washington (a distance of over 2,000 miles), would have options of  connecting through six different hubs, including Cincinnati, Chicago, and  Detroit. By comparison, a passenger from Harrisburg to Rochester, New  York (a distance of just over 200 miles), has three viable connecting  options.
section_title: Passenger Traffic Is More Concentrated despite Growth in the Number of City Pairs since 1980
paragraphs: Passenger traffic, already concentrated in relatively few city-pair markets  in 1980, has become more concentrated. In 1980, 80 percent of passenger  traffic occurred in the largest 14.1 percent of all city-pair markets, but by  2005, that same percentage of traffic occurred in the largest 10.7 percent of  all city-pair markets (see fig. 15). While large markets have seen  substantial gains in traffic, smaller markets have not, and in many cases  have actually seen declines in traffic since deregulation. For example,  while the number of passengers flying between Washington, D.C., and Los  Angeles grew 327 percent between 1980 and 2005 in our sample, the  number traveling between Boston and Cedar Rapids, Iowa, decreased 49  percent.
The number of city-pair markets has increased modestly since 1980.  Largely owing to an overall growth in traffic, the number of city pairs with  at least 13 passengers in the sample per quarter (which equates to about  130 actual passengers per quarter) increased by over 3,800 city-pair  markets between 1980 and 2005, from about 8,500 to over 12,300 (see fig.  16). However, few cities have gained air service since deregulation  because the airport system was already largely developed at the time of  deregulation, so the number of cities that could be connected would not  be expected to have changed much since deregulation. Instead, many city- pair markets that could be connected did not have enough actual  passengers reflected in the sample data to be counted.
section_title: Smaller Communities Have Not Experienced Comparable Benefits since Deregulation
paragraphs: Smaller communities, in general, have not experienced the same increases  in traffic and air service as larger cities since deregulation—particularly in  recent years, when many small cities lost service or experienced a decline  in the number of departures. For example, we reported in 2005 that while  large, medium, and small-hub airports have seen traffic rebound since  September 11, 2001, nonhub airports had 17 percent fewer flights in July  2005 than in July 2000. Additionally, we reported in 2002 that traffic at  EAS communities decreased 20 percent from 1995 to 2002. However, lack  of service for small communities is not solely a problem of the deregulated  era. We reported in 1985 that in the 10 years leading up to deregulation,  137 small communities lost all commercial air service.
The primary reason for diminished service to smaller communities is the  lack of a population base to support that service. Local air traffic is  directly related to both local population and employment. For small  communities located close to larger cities, these demand reductions are  exacerbated because local passengers drive to airports in larger cities to  access better service and lower fares. We reported in 2002 that some EAS  airports serve only about 10 percent of the intercity traffic to and from  their city because many travelers instead drive to alternative airports or to  their destination. Small communities have not benefited from the service  of low-cost carriers; as we reported in 2005 only 5 of over 500 nonhub  airports received low-cost carrier service. Lack of service from low-cost  airlines can partially explain why small cities also face relatively higher  fares than larger cities do.
Similarly, longer-distance markets have seen greater gains in traffic than  shorter-distance markets. Passengers on routes of 1,500 (or more) miles  increased 312 percent between 1980 and 2005, while passengers on routes  between 250 and 499 miles grew 68 percent in our sample. For example,  while traffic between Dallas-Fort Worth, Texas, and Hartford,  Connecticut—a distance of 1,470 miles—grew 477 percent between 1980  and 2005, traffic between New York and Raleigh-Durham, North  Carolina—a distance of 427 miles—fell 19 percent in our sample. Short- distance markets lost a large share of their passengers after September 11,  2001, in part because the increased time required for security measures  makes driving a more viable alternative. The frequency of short-haul  flights has also decreased. DOT found that the number of scheduled flights  under 250 miles decreased 26 percent between July 2000 and July 2005,  while the number of flights of over 1,000 miles increased by 15 percent  during that time.
section_title: The Average Number of Connections per City-Pair Market Has Increased Since Deregulation
paragraphs: Our analysis indicates that the average number of connections needed, at a  minimum, to connect any two cities has increased since 1980. Figure 17  shows the percentage of all city-pair markets in our sample with at least 13  passengers per quarter (or 130 actual passengers) that can be connected  nonstop, with one connection, or with two connections. Very few city- pair markets currently require two connections. The average number of  connections needed to connect any two city-pair markets increased from  1.6 in 1980 to 1.7 in 2005, which is likely attributable to the development of  hub-and-spoke networks to connect airline traffic. For some passengers  this development has increased the number of connections needed. For  example, in 1980, passengers traveling between Philadelphia,  Pennsylvania, and Tulsa, Oklahoma, could fly nonstop, but by 2005 one  connection was required. While there may have been declines in nonstop  connectivity for many small city-pair markets, the overall ability of  passengers to connect to wider markets through hubs has likely improved.  The shift from shorter-range turboprop planes to longer-range regional jets  has allowed cities that are too small to support mainline jet service, but  too far from hubs for turboprop service, to be connected to hubs,  increasing the number of one-connection city-pair opportunities.
The largest markets are generally served by nonstop service. In 2005, 88  percent of passengers traveled in city-pair markets that included nonstop  service and less than 1 percent of passengers traveled in city-pair markets  that required two connections. However, because many passengers in  directly connected markets may choose to fly with a connection (e.g., in  exchange for a lower fare), the actual number of passengers flying without  a connection is lower. For example, while passengers flying between  Seattle and Tampa, Florida, could fly nonstop in 2005 (and were able to in  1980), they could also choose to connect through a number of hubs,  including Chicago, Atlanta, and Denver, Colorado, for a number of  reasons. Our data do not distinguish between passengers who flew with  one or two connections out of necessity (e.g., because of no better option  in their market) or voluntarily when a direct flight was available.  Additionally, the development of hubs has helped bring about increases in  flight frequencies, allowing some passengers taking connecting flights to  benefit from better flight times and reduced connection times.
As another means of measuring changes to connectivity over time, we  calculated a flight distance ratio. This ratio, also known as “circuity,”  measures the total miles flown on a trip (adding up the distance of all  segments of a flight) divided by the distance between origin and  destination. A nonstop flight would have a ratio of 1, and a ticket with at  least one stop would have a higher ratio the farther out of the way the  connections were between origin and destination. Figure 18 shows that,  since 1980, the flight distance ratio has slowly risen. Much of this increase  is likely due to the increased use of connecting flights.
By other measures of airline service---not covered by DOT’s Origin and  Destination Survey data such as flight frequencies, flight delays, and  amenities---service has been mixed. For example, in 1999 we reported that  medium and large communities had significant improvements in their  number of departures, nonstop destinations served, and use of jet service  since deregulation. However, by other measures, service has  deteriorated, especially in recent years as traffic has rebounded. For  example, DOT has reported that 77.4 percent of flights arrived ontime in  2005, compared with 82.1 percent in 2002 and 79.4 percent in 1990.  Additionally, DOT reported that the agency received almost 7,000  consumer complaints in 2005, an increase of over 50 percent from 2003.
section_title: Evidence Suggests That Reregulation of Airline Entry and Rates Would Reverse Consumer Benefits and Not Save Airline Pensions
paragraphs: According to our analysis of the evidence, reregulation of airline entry and  rates would not benefit consumers and the airline industry. Although some  aspects of customer service might improve, reregulation would likely  reverse many of the gains made by consumers, especially lower fares.  While numerous industries have been deregulated over the last 30 years,  very few have been reregulated. We found that the few instances in which  an industry was reregulated stemmed from inadequate competition, such  as occurred in the cable television industry after it was deregulated. Lack  of competition has not been the case in the airline industry, where  competition has been keen. Our analysis of fares and service since  deregulation provides evidence that consumers have benefited over the  intervening years. While it is impossible to accurately calculate these gains  because no regulated system exists against which to compare deregulated  fares, deregulation has corresponded with increased competition in the  airline industry, which has likely contributed to lower fares and a larger  airline market than might have prevailed without it. Reregulating the  airline industry would have ramifications reaching far beyond the fare and  service effects on airline passengers and communities. For example, the  higher fares for airline travel that would likely result from reregulating the  industry could shift some of the nation’s 670 million domestic airline  passengers to other modes of transportation that are neither as safe nor  efficient as air travel, and considerable infrastructure investment would be  required to handle the increased demand.
Restoring service to some small communities is an insufficient reason to  reregulate airline entry and rates. We previously reported that small  communities face a range of fundamental economic challenges in  attracting and retaining commercial air service. Among these challenges is  the lack of a population base or economic activity that could generate  sufficient passenger demand to make service profitable to airlines. Smaller  communities located near larger airports may also face reduced demand  because they do not have low-cost airlines or frequent service. Despite  these challenges, smaller city-pair markets have generally experienced  lower fares since deregulation—just not to the degree that the largest city- pair markets have. The smallest city-pair markets in our analysis have also  experienced a net gain in the number of connections and in overall traffic  since deregulation. If Congress determines that these markets are  underserved, it might more directly address service to small communities  through targeted legislation—such as increasing subsidies for EAS—than  through wholesale reregulation.
Finally, reregulating the airline industry would not salvage airline  pensions. Legacy airlines’ financial problems are the result of the same  competitive forces that contributed to lower fares for consumers. The  demise of airlines since deregulation has been endemic to the airline  industry, as more efficient airlines have taken market share from less  efficient airlines. As we found in our 2005 report on airline bankruptcies  and pension problems, pension losses were attributable to market forces,  poor airline management and union decisions, and inadequate pension  funding rules—including insufficient funding requirements and the  inadequate relationship between premiums paid by plan sponsors and  PBGC’s exposure to financial risk. These factors also led to the  termination of pensions in other industries with large legacy pension  costs, such as steel. Increasing fares via government-imposed price floors  similar to those that existed prior to 1978 would be an inefficient means of  ensuring that airlines would generate sufficient revenues to adequately  fund their pension plans, especially when most airlines no longer offer  defined benefit plans. Congress is currently considering changes to  defined benefit pension regulation, including specific provisions that  would grant airlines additional time to fund frozen defined benefit plans  and thereby avoid plan terminations. We have previously recommended  that Congress consider broad pension reform that is comprehensive in  scope and balanced in effect.
section_title: Agency Comments
paragraphs: We provided a draft of this report to DOT for its review and comment.  DOT officials provided some clarifying and technical comments that we  incorporated where appropriate.
We provided copies of this report to the Secretary of Transportation and  other interested parties and will make copies available to others upon  request. In addition, this report will be available at no charge on our Web  site at http://www.gao.gov.
If you or your staff have any questions on matters discussed in this report,  please contact me on (202) 512-2834 or at heckerj@gao.gov. Contact points  for our Offices of Congressional Relations and Public Affairs may be found  on the last page of this report. Key contributors to this report can be found  in appendix II.
section_title: Appendix I: Scope and Methodology
paragraphs: To assess the original intent of Congress in passing the Airline  Deregulation Act, we reviewed the act and accompanying legislative  materials, and various other documents and studies. To ascertain the  legislative intent of Congress in deregulating the airline industry, we  reviewed the act, legislative reports, and floor debates. We also reviewed  related court cases and studies and historical accounts of airline  deregulation.
To evaluate past changes in the airline industry, we reviewed Department  of Transportation (DOT) studies, our own studies, analyzed financial and  operational data, and interviewed industry experts. We analyzed airline  financial and operational data from DOT’s Form 41 data set. We obtained  these data from BACK Aviation Solutions, a private contractor that  provides online access to U.S. airline financial, operational, and passenger  data that are reported by airlines to DOT. To assess the reliability of these  data, we reviewed the quality control procedures applied to the data by  DOT and BACK Aviation Solutions and subsequently determined that the  data were sufficiently reliable for our purposes.
To analyze changes to airline fares and service since deregulation, we used  data from DOT’s Origin and Destination Survey. Begun in 1979, the Survey  captures airline-reported information about the full itinerary and fare paid  from every tenth ticket to DOT. The survey does not include data on flight  frequency, aircraft type, flight amenities, or other data that could be used  to measure airline service. In the fourth quarter of 1998 DOT changed the  name of the database from DB1A to DB1B and began collecting an  additional data field to distinguish between the carrier that issued the  ticket from the carrier that operated the flight (e.g., a flight operated by Air  Wisconsin as a US Airways Express flight, connecting to a US Airways  Express flight, connecting to a US Airways mainline flight—all issued by  US Airways under the “US” code). To assess the reliability of these data,  we reviewed the quality control procedures applied to the data by DOT  and subsequently determined that the data were sufficiently reliable for  our purposes.
We analyzed these data for the period from 1980 through the second  quarter of 2005. We did not include 1979 data in our analysis because DOT  staff reported that these data were not reliable, since many airlines had  difficulties reporting data in the first full year of deregulation. We limited  our analysis to data reported for the second quarter of every calendar year  in order to avoid data reflecting increased summer travel or reduced  winter travel. Furthermore, we limited our analysis to passenger  itineraries wholly within the continental 48 states; thereby excluding  international itineraries and any travel to airports in Alaska, Hawaii, and  U.S. dependencies. We excluded international fares and foreign carriers  because international markets were not deregulated when domestic  markets were. We excluded flights to or from Alaska, Hawaii and U.S.  territories because of the long distances involved.
In general, we limited our analysis to a subset of round-trips and certain  one-way trips between city pairs. We defined markets by city pairs rather  than airport pairs. For cities served by multiple airports (e.g., the Dallas  area includes both Dallas-Forth Worth International Airport and Dallas  Love Field), we recoded all airports in the city to the one with the most  enplanements. Thus, we identified round trips as those for which the final  city on the ticket was the same as the originating city (even if the  passenger record indicated, for example, that the trip originated at Dallas- Fort Worth and returned to Dallas Love Field). One-way trips were those  in which no two cities in the ticket matched one another.
We included only round trips involving two, four, or six flight segments  (coupons). These represent round trip itineraries that have no stops, one  stop, or two stops in both directions. In counting the number of coupons  used in each direction of a flight (i.e., outbound or return), we relied on  the “trip break” codes that DOT assigns. These codes indicate the point in  a passenger’s itinerary at which the passenger begins the return trip.  Because the data originally reported by the airlines do not unambiguously  identify the point on a round trip at which the passenger begins the  journey home, DOT applies an arithmetic algorithm that identifies the  point in the itinerary farthest from the point of origination. However,  because DOT’s trip break codes may incorrectly identify the destination  airport, we eliminated any tickets that had an unequal number of coupons  before and after the DOT-assigned trip break. Thus, we eliminated all 3-  and 5-coupon round trip tickets (e.g., one in which a passenger flies  nonstop from Boston to Phoenix, Arizona, then to Denver, and back to  Boston). On the other hand, we included records for roundtrips that had  equal numbers of outbound and return coupons, but connected over  different airports on the outbound and return segments (for example, New  York to Los Angeles connecting in Chicago westbound and in Dallas-Fort  Worth eastbound).
We analyzed changes in fares and yields in inflation-adjusted 2005 dollars,  using the chain-weighted price index for gross domestic product. To  compute the yield for every ticket, we divided the inflation-adjusted fare  paid by the total distance between origin and destination for a one-way  ticket or by double the distance between origin and destination for a  round-trip ticket. We excluded tickets with unusually high fares (i.e., those  with yields in excess of $3 per mile in 2005 dollars), because according to  industry researchers, these fares are likely to indicate data errors. We  retained tickets in the analysis when the fare paid was $0, indicating trips  “purchased” with frequent flyer rewards.
For our analyses of changes in fares and service, we divided city pairs into  categories based on distance or passenger density. To determine the  distance between city pairs, we calculated the distance between airports  using the latitude and longitude of their locations. We then grouped all city  pairs into 250-mile or 500-mile increments. We also determined the total  number of sample passengers in each market. We then ranked, for each  year, all markets by the number of passengers and grouped the markets  into quintiles, in which each quintile had an even number of passengers.  Because the number of passengers in each market changed from year to  year, the specific markets in each quintile also changed from year to year.  Our analysis of service measures was conducted by only counting city-pair  markets with at least 13 passengers per quarter in our sample, which  equates to about 130 actual flying passengers. This was to increase the  probability that changes in service we observed in our sample reflected  actual flow routes and was not due to sampling or data error.
We defined “service” in terms of connectivity and the number of  competitors in a market. We measured connectivity in two ways: the  minimum number of flight segments available to connect two cities and  the extent to which passengers needed to connect over distant hubs to  reach their destination. We identified the minimum number of connections  needed to connect any two cities and also determined whether that  number changed over time. Additionally, because some passengers will  choose to connect between two cities rather than take nonstop flights  (e.g., because fares may be cheaper or the schedules may be more  convenient), we weighted the coupons by passenger traffic to establish  how most passengers traveled in the city pair. To determine whether  passengers could fly more or less directly to their destinations, we  calculated the distance between origin and destination along with the  distance of every segment on the ticket. We then divided the sum of the  segment distances by the distance between origin and destination (or  twice that distance if the flight was a round trip) to estimate how far out of  the way the travelers went.
To analyze competition within markets and over time, for every city pair,  we determined the market share for each reporting carrier, based on  ticketed passengers, and counted only those carriers with at least 5  percent of the market as effective competitors. We excluded tickets with  interlined flights in our analysis of city-pair competition. An “interlined  flight” is one in which a passenger transfers from one to another  unaffiliated carrier. That is, the passenger travels on at least two different  reporting carriers. When analyzing city pairs for competition, we only  analyzed those city pairs that, in any given quarter, had a minimum of 118  passengers in our sample (equaling a minimum of 1,180 real passengers in  the market). This passenger minimum was derived to provide us an  acceptably low probability of misclassifying carriers as effective  competitors, that is, as having a 5 percent market share. For various  scenarios, with this market size threshold, the probability of correctly  classifying carriers was at least 95 percent.
We recognize that many other dimensions of service quality exist. In the  past, we have reported changes in service quality in terms of available  capacity out of particular cities, whether service was provided with jets or  turboprop aircraft, and how many locations a passenger from a given city  could reach on a nonstop basis. In addition, DOT collects other  information on service quality, such as the percentage of on-time arrivals  and departures and the number of consumer complaints about airlines.  Because of time constraints on this engagement, we were unable to  incorporate more of these dimensions in our analysis.
When DOT began requiring the survey data by airlines, Southwest Airlines  received a waiver that allowed it to report data differently, because of its  unique ticketing procedures, whereby it issued only one-way tickets.  Under the waiver, Southwest reported its round trips to DOT as two  separate trips, which were included in DOT’s DB1A or DB1B databases.  Southwest maintained this waiver until the third quarter of 1998, when it  was required to report ticket data more accurately, including both  directions of a ticket. During the period covered by the waiver, the number  of one-way tickets in the sample was unnaturally high. Recognizing that  the data could be biased as a result, we reanalyzed our sample data  without the Southwest data and found that the results were only  marginally different. Median round-trip fares since 1999 have been  between $17 and $25 lower with the inclusion of the Southwest Airlines  fares than they would have been without the Southwest fares. Therefore,  we did not exclude Southwest tickets after 1999 from our analysis of  fares.
To determine whether there is sufficient evidence to support reregulating  the airline industry, we considered our findings under the prior questions  and our earlier reports, especially those relating to pension regulation. We  reviewed and updated the status of airline pension plans and assessed  examples of deregulation and reregulation in other countries and in other  industries. In addition, we reviewed our prior reports that have evaluated  past problems in the airline industry, including small community service,  barriers to entry, fare and service problems, and financial problems,  including bankruptcy and pension issues. For this and the prior report  questions, we reviewed our methods and results with DOT and academic  experts from the Massachusetts Institute of Technology’s Global Airline  Industry Program.
We performed our work between September 2005 and May 2006 in  accordance with generally accepted government auditing standards.
section_title: Appendix II: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Steven C. Martin, Assistant  Director; Paul Aussendorf; Jay Cherlow; David Hooper; Colin Fallon;  Mitch Karpman; Molly Laster; Sara Ann Moessbauer; and Mathew  Rosenberg made key contributions to this report.