Abstract:Studies by academic economists were a significant force in the movement towards deregulation of the domestic airline industry in the early 1970s. During the critical 1977-78 period in which deregulation was imposed first de facto by the Civil Aeronautics Board (CAB) and then de jure by Congress, the chairman and vice-chairman of the CAB were economists. For the 14 years since deregulation, economists have continued intensive study of the industry, in part because of the unusual availability of reliable firm- and transaction-level data and in part because of the rare opportunity to observe an industry as it evolves from strict economic regulation to fairly unimpeded competition and strategic behavior.

The simplest prediction of economists about airline deregulation, and one of the few on which nearly all economists agreed, was that deregulation would improve consumer welfare in comparison to continued price and entry regulation. Fourteen years later, nearly all economists still agree on this, though the degree of enthusiasm for the deregulation outcome varies considerably. There was substantial disagreement among economists about the market structure that would result. Because studies of scale economies in the airline industry had concluded that none existed beyond the scale of the smaller major airlines of the 1970s, many economists argued that deregulation would result in more than the 11 major airlines that existed at the time of deregulation. Others predicted that only a few, or possibly only one, airline would survive at a large scale. Two noted University of Chicago economists, Sam Peltzman and Lester Telser, made a bet in 1979 on whether the 4-firm concentration ratio would be above or below 90 percent by 1985. Peltzman bet that it would be below 90 percent and, as he put it, "won the bet, but lost the war." Nationwide, concentration decreased during the first few years following deregulation, but has turned upward since then.

Though comparisons of the airline industry under regulation and deregulation continue, this is not my primary focus here. As the time since deregulation grows, such comparisons to the "straw man" of regulation are increasingly speculative and decreasingly relevant to the issues at hand. Regulation under the CAB was far from ideal; if it were reimposed today, it would probably be more efficient than the pre-1978 regulation. Deregulation has also entailed missteps that would not be repeated were the process to be replayed. Therefore, an estimate of the net welfare gain (or loss) resulting from deregulation gives little guidance about the relevant choices that will face policy-makers in the future.

For the most part, the lessons that have been learned from the deregulated domestic airline industry are not about government regulation or the process of deregulation, but about the tactics, strategies, and results of competition in a dynamic, complex, and innovative service industry. These lessons are more likely to inform economists about the market process in, for instance. the hotel or fast-food industries than in electric power distribution or other traditional areas of regulation.

The next section reviews the evolution of the domestic airline industry since the late 1970s, when it was abruptly freed from most regulatory constraints on pricing, entry and exit. (International air travel is considered here only as it relates to competition in the domestic industry. This is due both to space limitations and because international air travel remains heavily and idiosyncratically regulated.) The following sections will examine the competitive issues that have arisen since deregulation; the conclusions, and in some cases consensus, that economists have reached on these issues; and the public policy options in dealing with the airline industry in light of these issues.