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Airline deregulation I
Source Louis Proyect
Date 01/05/07/14:52

Looking back in retrospect, it is easy to see how deregulation would lead
to new monopolies. Indeed, the same big business interests that took
advantage of government regulation in the first place were some of the
first to benefit when the 1978 Airline Deregulation Act was passed by
Congress. If pigs hang around the trough long enough, they can recognize
the farmer's footsteps.

Despite evoking images of the trust-busting golden age of Progressive
Politics, the New Deal legislation which created the Civil Aeronautics
Board catered to the needs of an infant industry and the rich white men who
launched it. Juan Trippe, the founder of Pan American Airlines, was fairly
typical.

He graduated from Yale in 1921 where he had forged "old school ties" with
Sonny Whitney and Bill Rockefeller. In 1925 Trippe got one of his
fraternity brothers, who had married into the Mellons, to set up a meeting
with a Congressman representing Pittsburgh's district (home base of the
millionaire family) and who served on the House Post Office Committee. In
an early experiment in "privatization", Trippe and others campaigned for
replacing Army mail delivery with paid contractors. In the sweepstakes that
followed the changeover, World War One ace Eddie Rickenbacker won the right
to transport mail through a new corporation called Eastern Airlines. A
Seattle timber magnate named William Boeing launched what would become
United Airlines, before moving on to airline manufacturing.

Although Trippe was awarded the lucrative New York-Boston route, he had his
eyes on bigger prizes. For public relations purposes, he convinced the
super-hero Charles Lindbergh to join Pan American as a "technical adviser,"
which was a coup similar to Nike signing Tiger Woods or Michael Jordan.
Trippe also chose a new bride carefully. He wed Betty Stettinus who was the
sister of Edward Stettinus, a steel executive who would become FDR's
Secretary of State. With financial allies in the Mellon, Rockefeller and
Whitney groups, a public relations coup, and government connections,
everything promised to go well for the young, aspiring corporate chieftain.

It was Trippe's original bright idea that planes carrying mail can just as
easily transport people. Putting wicker chairs in the back of each plane,
he charged $100 to fly to Havana, where booze was legal. His discovery that
unfilled space on a plane was unrealized profit became the cardinal rule of
airline economics, thus explaining not only deregulation of years hence but
the sardine conditions in which we travel nowadays.

When Roosevelt entered the White House, domestic air transport including
mail and human bodies was divided up by four big corporations (United, TWA,
Eastern and American), while Trippe's Pan Am owned the international routes.

During the depression, upstart airlines tried to horn in on the big four's
oligopoly. This led to price wars of the kind that marked the 1980s
post-deregulation period. For example, when a contract for post office
airmail was offered between Houston and San Antonio, Eastern Airlines was
rumored to offer a bid of less than one cents a mile! Braniff made a
counter-offer of $0.00001907378 per mile. Afterwards, Eastern put a final
bid of zero cents on the table.

This put the airline companies in a quandary. How could they do business in
the face of debilitating price wars? Since the state tends to act as an
executive committee of the capitalist class, the answer would be
forthcoming in the form of government regulation of fares and routes.
Needless to say, the interests of the rank-and-file flyer barely entered
the picture. With guaranteed profits, it did not matter to the airlines
whether those of modest means could afford a ticket. Juan Trippe instituted
a marketing campaign with the slogan "Fly Now, Pay Later" which provided an
installment loan through the Household Finance Corporation.

With such a cozy government-business relationship, it is perhaps difficult
to see why the need for deregulation ever arose. Essentially this came
about primarily as a result of overcapacity in the 1970s--to a large extent
a function of investment in the ubiquitous Jumbo Jet--the Boeing
747--interacting with the energy crisis. This would necessitate full-bore
competition to wring out excess investment.

In the vast literature defending the free market with its purported
self-regulating supply-and-demand mechanisms, nothing can be more remote
from the ideal found in those pages than the airline business. Unlike
consumer goods which compete with each other on the retail shelf for
customer preference, the airline industry seems to run by its own rules.
Investment decisions are not carefully calibrated to consumer signals, but
made by fiat in ways that might have made Stalin green with envy. A
"command economy" certainly describes some of the more grandiose plans of
the largest airline companies, each of which was run by hard-driving
executives who relied on nobody but themselves when it came to questions of
routes, fares, and most of all, the kind of airplane offered to a potential
ticket-buyer.

In 1982, a book titled "The Sporty Game" appeared. Written by Brookings
Institute fellow John Newhouse, it ran originally as a series of articles
in the New Yorker magazine. Although the word capitalism rarely appears,
Newhouse's study is about as graphic a demonstration as you are going to
find of the irrationality of the system. Unlike the well-ordered world of
Adam Smith where an "invisible hand" prevails, the airline industry has
more in common with Matthew Arnold's "Dover Beach" in which "ignorant
armies clash by night."

The years 1958 through 1968 were banner years for airline manufacturers and
their customers. Assuming that the profits would flow forever, they decided
to invest steeply in a new generation of airplanes, including the Concorde
and the 747 jumbo jet. Keep in mind that such decisions are always made
jointly. Boeing does not decide to build a 747 without having orders lined
up in advance.

Pan Am was the perfect customer for the jumbo jet, since it was more
profitable than any other airline. International routes were extremely
lucrative and Trippe's fiefdom enjoyed a virtual monopoly. On December 22,
1965 Boeing's chairman William Allen and Trippe signed a letter of intent
which committed Pan Am to purchasing 25 of the planes.

Key to the acceptance of the wide-body architecture of the 747 was the
belief that the plane could serve double-duty as a freight carrier. Two
standard-sized cargo containers could sit by side in the plane's
midsection. This approach seemed prudent at the time, since long distance
passenger travel was assumed to be dominated by supersonic jets in the
future rather than conventional planes like the 747. With everybody
bouncing back and forth across the Atlantic on Concordes, the 747 would be
guaranteed a second life as a freighter. As we now know, neither the
Concorde nor the 747 was economically viable.

Once Pan Am declared for the 747, other airlines like British Airways,
Japan Air Lines and TWA had to follow suit. They did not even have the
freedom to see how the market would respond to the jumbo. In the airline
business, the only corrective appears to be bankruptcy. Each of the
airlines justified the investment on the basis of an expected 15 percent
annual growth in passenger traffic. They might as well have thrown darts at
a board to come up with a sensible figure.

Other factors arose that made the 747 jets an even riskier investment.
Thinking as always in grandiose terms, Trippe felt that eighty inches
should be added to the fuselage to allow two extra rows of seats, another
toilet compartment and other paraphernalia to accommodate passengers.
However, the original engines designed to propel the jet proved inadequate
to the task. Sometimes they shut down in mid-flight. When more powerful
engines were substituted, the plane remained airborne but with considerable
more consumption of jet fuel. Of course, as everybody knew in 1970,
petroleum was as cheap and plentiful as water and would remain so for all
eternity.

Newhouse's final chapter, written just on the cusp of deregulation, is an
attempt to anticipate the airline industry's likelihood of returning to the
kind of profitability enjoyed in the fat years. He was glum:

"Little, if anything, of significance that has occurred in the wide-body
era figured in earlier plans of Americaís commercial aircraft and airline
industries. The bright prophecy of the 1960ís was mocked by successive
reversals, a few serious shocks and generally hard going. With very few
exceptions, the major companies have had a thin time since 1970, and their
current prospects range from uncertain to very poor. The fortunes of these
companies depend partly on their own actions and partly on forces which
they cannot influence any more than the rest of us can. Curiously, they
have behaved as if capricious economic trends and the uncongenial policies
of foreign governments were problems for other industries, but not their
own. (The same could be said of the auto industry.) The boldness of the
aircraft suppliers was matched by their innocence of the world and its
uncertainties. This unworldliness harmed their interests.

"Any lingering hope for an outbreak of good times was dissolved by the
dramatic rise in fuel prices. The oil crisis shocked the airlines and their
suppliers, even though events had clearly foreshadowed it. A Boeing
executive who directs the companyís forecasting remarks that 'Nobody in the
airline industry saw it coming, and the airlines still dislike looking
ahead. They donít look beyond next monthís fuel supply.' As for his own
company, he says: 'Boeing hadnít the least idea that a fuel crisis was
coming. We had spent hundreds of man-hours studying the economics of the
SST burning fuel at ten cents a gallon and not a penny more. Boeing planned
for the SST to be operated forever at ten cents per gallon.'" (p. 227)

In the same year that Newhouse's book appeared, a report on "Competition
and the Airlines: An Evaluation of Deregulation" was submitted by staff
economists David R. Graham and Daniel P. Kaplan to their superiors at the
Civil Aeronautics Board. Given its internal character, the authors make no
effort to depict deregulation as progressive legislation motivated to make
air travel affordable. Instead it is declining profits that occupies center
stage. In fact they openly admit that air travel had become a mass consumer
phenomenon without the help of Senator Kennedy's trust-busters. They state
that between 1949 and 1969, air traffic grew by more than 14 percent a
year. During this same period, average air fares actually fell by 2 percent
while the consumer price index rose by 50 percent. In other words, air
travel was cheap relative to other consumer goods.

What concerned the economists was the fortunes of the airline companies
rather than those of the consumers. With all the money spent on 747s and
other oversized jets, empty seats became a much more serious problem given
the economies of scale. The way they describe the problem is refreshingly
frank:

"This imbalance between fares and costs encouraged the airlines to engage
in inefficient service competition, particularly by offering high quality,
high convenience service. This was especially true in long-haul markets;
because costs fell nest rapidly in these markets, the CAB did not
substantially alter the fare structure. Consequently, the percentage of
seats the airlines filled (load factor) fell through most of the 1950s and
the 1960s.

"By the end of the 1960s, the economy and air traffic growth faltered. In
addition to the cyclical downturn, the long-term growth rate of air travel
demand slowed, because the cost savings and added convenience from the
switch to jet equipment .had largely been achieved. The carriers, however,
had ordered many new aircraft in the mid-1960s. Excess capacity grew and
the industryís profitability declined. Consequently, the carriers asked the
CAB for relief." (p. 11)

This is quite a mouthful. They identify "high quality, high convenience
service" as an obstacle to realizing corporate profits. Anybody who has
flown on a plane lately can tell how that problem was resolved. By the end
of the 1960s, when the downturn began, the solution would evidently take
the form of getting rid of this kind of service and turning the airlines
into what they have become today: cattle-cars with inedible food that are
chronically late.

Besides putting more bodies in the seats, the only other way the airlines
could increase profits was through slashing wages. Graham and Kaplan try to
explain how the employees, especially the pilots, had become fat and
pampered. During the post-WWII years advances in technologies, most
especially jet engines, had made it possible to transport ever larger
numbers of passengers in shorter times. In other sectors of the labor
market, such as coal and long-shore, productivity advances had made it
possible to reduce the work force. But the pilots were tightly organized
and resisted such cuts. Not only that, they insisted on maintaining
generous work rules that were wrested from management in 1934, at the
height of labor militancy during the depression. Although the pilots never
occupied factories or fought the national guard, it was such battles that
gave them the leverage to win an 85 hour per month limit on flights.
Obviously, if jets are moving people to their destinations in half the
time, the bosses sought ways to extend the number of hours pilots were in
the air. If you could get them to work longer hours at lower pay, so much
the better.

To put the pilots in a weaker bargaining position, the first step would be
increasing the number of airline companies, an automatic outcome of
deregulation. Prior to deregulation, pilots could maximize their work
actions by facing a relatively limited number of companies. By shutting
down two airlines, you could effectively bring the industry to its knees.
By the same token, if you doubled or tripled the number of airlines, and
made them non-union shops, the bosses would have the leverage to drive down
wages. This is exactly what happened.

It is no accident that the primary business model for post-deregulation
airlines came from Texas, a notorious "right to work" state. Prior to the
passage of the 1978 legislation, Southwest Airlines had pioneered the kind
of "no frills" approach that would be adopted by major carriers. In
exchange for low-cost connections between major Texas cities, customers
would forfeit hot meals and other amenities. The whole idea behind
deregulation was to generalize this type of transportation for the entire
country.

Texas Air was another "no frills" company, but the corporate culture was
nothing like the sort of "good old boy" paternalism fostered by Southwest
chairman Charlie Kelleher who liked to drink Jack Daniels out of a bottle
at staff meetings. Texas Air was owned by Frank Lorenzo, a Queens, NY
native who grew up near the local airports. In the course of building a
holding company that eventually would include Continental and Eastern, he
became the labor movement's most hated figure since the days of Henry Ford.

In contradistinction to Ford, Lorenzo ruled through methods more
appropriate to the Reagan-Bush years than the FDR era. Rather than using
open violence, he made use of complex financial machinations that always
put the trade unions on the defensive. His main tactic was to take on
enormous debts while financing his expansion through junk bonds arranged by
Drexel-Burhnam, the investment bank Michael Milken made infamous.

Lorenzo, a graduate of the Harvard Business School, was a master of the
leveraged buyout. When he decided to challenge the big boys from his
established base at Texas Air, he knew that he was at a disadvantage. To
become a big-time player on a national scale, he would have take over on of
the existing companies like United, American or TWA, which were many times
his size. He decided to go after National Airlines, the tenth largest
carrier. Although the term "leveraged buyout" had not be coined yet, this
is exactly what Lorenzo had in mind for his take-over. Since National
Airlines had virtually no debt, Texas International (the new name of
Lorenzo's expanding empire) could borrow enough money against National's
own assets to finance the entire acquisition, essentially buying a company
for free.

Once the buyout is complete, the new bosses are able to present the ocean
of red ink as a 'fait accompli' to the workers. Unless they agreed to wage
cuts, and longer hours, bankruptcy would be the consequence. Blackmail
rather than gun thugs would be the choice of the new corporate bosses.
Using the same leveraged buy-out techniques, Lorenzo eventually became the
owner of Continental Airlines, which like National had not only been one of
the top-ten airlines but a financially stable one as well.

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