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. 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. 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. 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. 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).