|Regulation Outlook 130||
No. 3, May 2010
As Americans head into the summer travel season, there is a lesson they could learn from the European Union (EU): how to make airfare cheaper. The EU instituted an "open-skies" policy in 1997, resulting in more routes, more airline competitors, and lower fares. The European market is distinct from the airline market in North America, where both U.S. and Canadian regulations prohibit foreign-owned airlines from offering domestic flights--that is, from picking up and dropping off a passenger in-country--within the United States or Canada. North American policymakers would do well to follow Europe's example and establish open-skies agreements.
Key points in this Outlook:
- Despite Europe's significantly higher taxes and fees on air travel, European consumers can find far better deals on airfare than can North American consumers.
- The European Union's (EU) open-skies policy lowers airfares by creating a single aviation market among all member countries; increased competition leads to greater choice and lower fares.
- While the United States and the EU signed an open-skies agreement in 2007, foreign airlines still do not have full access to the U.S. internal market.
While the United States is generally considered less regulated than Europe, there are a few market lessons we can learn from our friends across the pond, particularly from Europe's experience with an obscure set of delineated rights generally referred to as "cabotage." According to Merriam-Webster, the original French definition of cabotage was "to sail along the coast." Over time, cabotage has also come to mean the right to engage in transportation, as well as the set of regulations that restrict the right of transport.
Cabotage regulations control transportation within and between countries, generally for the sake of protecting a domestic transportation sector from foreign competition. For example, while a U.S. airline can take you anywhere within the United States and to and from other countries, it cannot pick you up within, say, Canada and drop you off elsewhere in Canada. The same is true of Canadian airlines: they can take you to or from Canada, but if you want to fly Air Canada from New York to Los Angeles, you are out of luck.
In Europe, this restriction on consumer transportation choices began to weaken in 1987, when the EU began to liberalize airline-competition policy, a move that fully blossomed in 1997 when any airline within a member EU state was given the right to full cabotage--the right to pick up and drop off passengers within another member country. The EU notes that subsequent developments include a 120 percent increase in intra-EU routes between 1992 (before full liberalization) and 2008; a 320 percent increase in the number of routes with more than two competitors between 1992 and 2008; the emergence of low-cost carriers, which now constitute one-third of all intra-EU scheduled capacity; and, not surprisingly as a result of the above, lower fares.
The EU department responsible for overseeing the open market in airline competition--the European Commission, Mobility and Transport--attributes the expansion in the number of airlines, higher employment levels in aviation, increased travel, more cities served (and competed for), and low fares to the removal of barriers to competition:
This is largely due to the creation of a single market for aviation in the 1990s. Air transport had been traditionally a highly regulated industry, dominated by national flag carriers and state-owned airports. The internal market has removed all commercial restrictions for airlines flying within the EU, such as restrictions on the routes, the number of flights or the setting of fares. All EU airlines may operate air services on any route within the EU.
On prices, the EU makes clear that its open-skies policy has benefited a wide swath of European society: consumers, airlines, employees of aviation-related businesses, and airports. Moreover, as the European Commission notes, choices and quality are up and prices are down:
Prices have fallen dramatically, in particular on the most popular routes. But it is especially in terms of choice of routes that progress is impressive. European policy has profoundly transformed the air transport industry by creating the conditions for competitiveness and ensuring both quality of service and the highest level of safety. Consumers, airlines, airports and employees have all benefited as this policy has led to more activity, new routes and airports, greater choice, low prices and an increased overall quality of service.
The European market contrasts sharply with the airline market in North America. Presently, Air France can fly a passenger from Paris and drop him off in New York City or Los Angeles (or any other U.S. destination to which the airline flies), but Air France cannot pick up a New York passenger and fly him to Los Angeles. As a result of this restrictive and anticompetitive policy, both the airline industry (which might otherwise expand) and the American consumer suffer.
North American Prices versus European Prices
There is no question about which continent's passengers are better served. In Europe, as the following tables demonstrate, consumers can find a far better deal than can American consumers. For these comparisons, I used the same assumptions for all flights: a twenty-five-day advance booking and a six-day trip beginning on Wednesday, May 5, and returning on Tuesday, May 11. All fares come from Kayak.com, a website that tracks cheap airfares. The cheapest airfare was selected for each flight. I used TravelMath.com to calculate the flight distances between cities, doubling them to reflect the return-ticket nature of the fare, a total distance I then used to calculate both the base fare per mile (before taxes and fees) and the total fare per mile (including all taxes and fees).
Cost Comparisons with In-Country Flights: Europe Wins. As table 1 shows, an in-country UK flight between London and Edinburgh can be found for as little as $61.37 on EasyJet. With a total return flight distance of 666 miles, that is akin to a Los Angeles-San Francisco flight (694 total return miles), but the cost for the latter is $119.38 on Virgin America (see table 2). The difference is not due to taxes and fees. On the London-Edinburgh fare, taxes and fees make up $33.77, or 55 percent, of the total ticket price. In contrast, taxes and fees on the Los Angeles-San Francisco flight are $21.40, or just 18 percent, of the total ticket cost.
On a per-mile basis, a comparison of in-country flights in the United States (Los Angeles-San Francisco, New York-Boston, Chicago-Detroit, Denver-Las Vegas, and Miami-Orlando) to in-country flights in Europe (London-Edinburgh, Paris-Nice, Milan-Rome, Dusseldorf-Berlin, Barcelona-Madrid) reveals that U.S. air travel is significantly more expensive than European air travel. The total average fare per mile in the United States for the above five flights was twenty-three cents per mile; in Europe, it was eleven cents. Remove the taxes and fees, and Europe's cut-rate airfare advantage is even clearer: the base fare per mile in the United States for the five return flights is nineteen cents; in Europe, it is just six cents per mile--one-third of the U.S. cost.
Put another way, a traveler could book all five U.S.-based flights, travel a total (return) distance of 3,172 miles, and pay $722.98, all taxes and fees included (which constitute 16 percent of the cost). For the five European flights, the total distance traveled would be slightly more, at 3,338 miles, but the total price for flights on this European vacation would be just $379.28. That is almost half the similar five-flight deal in the United States. And in Europe, taxes and fees account for 51 percent of the total fare--far above the 16 percent for the five U.S. fares.
Tables 1 and 2
Cost Comparisons with Cross-Border Flights: Europe Wins. A similar result is found in a comparison of cross-border flights in Europe vis-à-vis North America. As table 3 shows, the cheapest ticket found between New York and Toronto was $261.93 on Continental, with taxes and fees accounting for $65.20, or 25 percent, of the total ticket cost. This New York-Toronto flight logs 688 total return miles. Now examine a slightly longer return flight in Europe, from Munich to Rome, of 868 miles (see table 4). The fare for that trip is just $152.70 on Alitalia, with taxes and fees accounting for 61 percent of the cost. So despite the significantly higher taxes and fees in Europe, compared with the cross-border flight in North America, the European flight is still considerably cheaper.
Similarly, consider the total cost of five cross-border flights in North America when compared to Europe. In my comparison, I chose flights from five U.S. cities to destinations in either Canada or Mexico, America's North American Free Trade Agreement partners. For the five cross-border flights chosen (New York-Toronto, Houston-Mexico City, Denver-Calgary, Dallas-Mexico City, and Seattle-Vancouver), the total return distance traveled would be 6,080 miles. That would set a consumer back $1,685.91, with 26 percent devoted to taxes and fees (see table 3).
The five European cross-border flights (Dublin-Berlin, Munich-Rome, Vienna-Athens, Prague-Barcelona, and London-Paris) would generate a total return distance of 6,212 miles. That five-country jaunt would cost just $872.42, almost half as much as the American equivalent, even though Europe's fees and taxes are much higher at 47 percent of the total cost (see table 4).
On a per-mile basis, the total average fare for the five North American cross-border flights is twenty-eight cents, or twenty-one cents before taxes and fees. In Europe, the total fare per mile is fourteen cents--half that of the American cost. The base fare for the European flights (before taxes and fees) was just seven cents per mile, or one-third of the American cost. Simply put, whether in-country or between countries, Europe's airfares are more competitive
Tables 3 and 4
Who Is to Blame? A Protectionist U.S. Congress
Some European fares are likely loss leaders, but their existence highlights the lack of open skies in North America. Currently, only "domestic" airlines can pick up and drop off passengers within the United States; furthermore, there are restrictions on what counts as a domestic airline. In 2006, talks between the United States and Europe about bringing an EU-style open-skies policy to the United States temporarily stalled when the Bush administration stuck to existing rules for what makes an airline "U.S. controlled." The rules required that U.S. citizens own or control at least 75 percent of the shareholders' voting interest and that the president and two-thirds of the directors and the managing officers must be U.S. citizens.
To be fair to the previous administration, then-transportation secretary Mary E. Peters withdrew a set of proposed reforms that would have liberalized air travel only after the 2006 midterm elections and after Democratic senators Frank Lautenberg (N.J.) and Daniel K. Inouye (Hawaii) moved to block the administration's proposed more liberal rules. At the time, Lautenberg was quoted as follows in one media report: "Letting foreign entities control our nation's airlines is a dangerous proposition. The Bush administration saw that the Democratic Congress will not put up with this bad idea and backed off."
Lautenberg's assertion was simply fearmongering. He used the security issue in the service of domestic protectionist sentiment. After all, it is not as if Air Canada, Swiss Air, British Airways, or Japan Airlines would have posed a security threat to U.S. interests or passengers. A liberalized flying regime would have allowed foreign airlines merely to extend what they already did: to pick up passengers in U.S. cities in addition to dropping them off.
An open-skies agreement was eventually signed between the EU and the United States in 2007 (effective as of March 30, 2008). However, that agreement, still in force, is far from the type of open-skies agreement between countries within the EU. The agreement does allow non-U.S. investors to own up to 49.9 percent of nonvoting equity in U.S. air carriers--a move the International Air Carrier Association (IACA) characterized as allowing EU airlines only to "mimic access to the U.S. internal market"--but foreign airlines still do not have full access to the U.S. internal market. This is a source of some frustration, given that U.S. carriers have gained full access to the EU internal market, a note the IACA again pointed out in March of this year as progress toward a second open-skies agreement dragged on.
Canadians Fare Even Worse
If there is any comfort for U.S. fliers, it might be that the Canadian domestic market is even less competitive, with just two national airlines and a minority Conservative government that has thus far resisted an EU-style open-skies agreement with either the United States or Europe. In a five-city comparison of the domestic market in Canada, five in-country flights would cost a Canadian consumer $1,358.23 (see table 5). That is almost double the U.S. cost of $722.98 for a similar distance flown (see table 2) and three and a half times the European cost of $379.28 for similar miles traveled (see table 1).
In a cross-border comparison using only Canadian and U.S. cities, traveling distances similar to the cross-border U.S. and European examples would cost Canadian consumers $2,076.44 (see table 6). That is 23 percent higher than the North American cross-border example ($1,685.91, see table 3) and 138 percent higher than European cross-border flights ($872.42, see table 4).
In November 2006, the Canadian government announced a "blue-sky" policy to liberalize air transport between Canada and other countries, but it was thin gruel. While it touted basic freedoms such as no limits on the number of airlines permitted to operate in Canada or on the frequency of service, the Conservative government--led by a free-market economist, Prime Minister Stephen Harper--pointedly rejected EU-style open competition. Transport Canada, the agency responsible for airline policy in Canada, states bluntly and clearly what is not included in its policy approach to air-transportation negotiations: "Under no circumstances will the policy approach include cabotage rights--the right for a foreign airline to carry domestic traffic between points in Canada."
Tables 5 and 6
How Everyone Loses--Even the Airlines
Canadians may be worse off, but American consumers are in a better position only due to a significantly larger domestic market and thus more domestic airlines that must compete for consumers. However, the lack of an EU-style open-skies agreement among all three entities--the United States, Canada, and the EU--still means all consumers lose, both those living in the United States or Canada and those in Europe who travel in North America. The EU ambassador to the United States, John Bruton, estimated in 2006 that the savings to all consumers under a truly open-skies policy would amount to $5 billion annually once the agreement was fully implemented.
Consumers are not the only ones who lose because of continued protectionism in North America. The airlines take a hit to their bottom line as well. As the EU experiment has shown, lower prices lead to a significant increase in passenger traffic, which benefits airlines. As the EU notes in a recent briefing,
Today, the U.S. retains some of the most restrictive laws on the foreign ownership and operation of airlines in the world, starving its airlines of capital and limiting their options for recovery, growth, and participation in a rapidly globalizing industry.
The results, as the EU points out, are "higher costs and lower employment for airlines, generating unrecoverable losses for consumers, aviation employees, investors and businesses."
Prospects for Reform
The potential benefits of greater access to markets and foreign airlines are significant--for travelers and the airline industry. With a protectionist-minded president in the White House and Democrats in control of Congress, however, prospects for airfare liberalization seem slim. In fact, the best chance of cracking open the U.S. market might be if the Canadian government reverses policy and pursues open skies with Europe on its own, similar to how Canada's government has long pursued and signed more general free trade agreements worldwide while U.S. politicians have dragged their collective heels since 2006.
In that scenario, pressure could be put on the U.S. market if Canadian fares came down enough to make it worthwhile for U.S. passengers in border cities to travel to Canadian departure points, the way some Canadians now do in reverse. Still, even that marginal pressure and an example of Canadian-EU open skies might not be enough.
But there is one other possibility for hope. Back in the 1970s, it was a left-leaning president from the Democratic Party who first began to deregulate the airline industry. The boom that followed was proof enough of the wisdom and usefulness of competitive markets. There is no reason why, over two decades later, another left-leaning president, Barack Obama, cannot finish the work Jimmy Carter began.
Mark Milke (email@example.com) is director of research for the Frontier Centre for Public Policy, a Canadian think tank.
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