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and the agencies. We appreciate that and we have found it very informative and very helpful.

I want to thank you very much. That has been a good presentation. Mr. BARNUM. Thank you, Mr. Chairman.


Thank you for your invitation to present the views of the Administration on the important subject of regulation of air transportation and how it can be improved.

The Department is vitally interested in the issue. Since DOT's inception in 1967, we have participated in many ·proceedings before the Civil Aeronautics Board. In our Board filings, the Department has been a strong advocate of improving the economic performance of air transportation through increased reliance on competitive market forces. The unifying theme that runs through virtually all of our filings before the CAB is that greater reliance on competitive market forces will improve the economic performance of the industry and result in lower, more cost related rates, will reduce excess capacity and will provide the air traveling public with a wider and more desirable range of service and price options.

I believe we are now at a regulatory watershed. For the past several months, the administration has been reviewing the transportation regulatory system with a view to improving both performance and economic efficiency. The reform proposals presently being prepared by the administration mark a major departure from the regulatory regime we have relied upon in the past. The administration will submit to Congress in the near future a proposal which will fundamentally redirect our air transportation regulatory policy. Your hearings, therefore come at an opportune moment. Today I will outline the administration's position on regulation of air transportation.

The need for an air regulatory reform act is demonstrated both by economic research and by our experience. At present, for example, air carriers, shippers, and passengers frequently face a web of restrictive government regulations which stifle competition, discourage innovation, and foster inefficiency. In many respects, the present air regulatory structure is outdated, inequitable, inefficient, uneconomical and irrational. It often misplaces incentive and disincentive, distorts competitive advantage, protects inefficient carriers from effective competition, over-restricts market entry, artifically inflates rates and misallocates our Nation's resources. Under the current system, many consumers pay an artificially inflated price for air transportation because ratesetting, unnecessary entry restrictions, capacity agreements and other forms of shelter from competition sanctioned by the Board protect the least efficient carriers, permit rates substantially above an efficient cost level and distort competitive market forces. The resulting economic waste and associated inefficiency is substantial.

The present air regulatory system is the product of a different era. While the needs and conditions on which air regulation was first predicated some 40 years ago have changed, the goals and practices of government regulation have not. It is unfortunately a truism that regulation begets further regulation and that regulations outlive their rationale.

In 1938, when the Civil Aeronautics Act was passed, government assistance through protection, subsidy, promotion and regulation was a necessary factor in the development of a new and struggling industry. Thirty-seven years later, conditions have changed. The air travel market is mature. Traffic has grown. Growth has led to stability. The industry is vigorous. But the regulatory system which protected it and made it that way has not kept pace.

The problems once faced have been largely solved. Now we are faced with problems that are a byproduct of that success. The promotion which once fostered growth now causes inefficiency. The restriction which once guaranteed stability now retard competition. The regulatory protection which once insured existence now prevents savings.

We need a better system which comes closer to producing optimum social and economic results, one which maximizes efficiency, economies and consumer options and which produces the best mix between low-cost and high-quality service.

The most pressing problems in the airline regulatory field cluster in three broad areas: ratemaking and pricing flexibility, market entry and exit, and anticompetitive agreements. Each area is in need of reform. Let me identify what we see as the major difficulties involved, the actions DOT has taken, and the future direction which the administration suggests.

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May Langen wind prefer the opportunity to select carriers based on price in aditions, type of serTisk. Some passengers would prefer tigh load-factor, Antw-fare site. (rher are willing to pay for more comfortable and mare entir vriek. Present percetares do not produce that rariety of price seroter wins. Often, present regulation causes fares well above those which would result in a more competitive air transportation martet. With prices fixed at leveix atve market rates, arriers rempete so the basis of service. Such servlee mpetitim prone substantial used capacity and unnecessary low loadfactors, presently averaging about 57 percent. In the transcontinental market, for example, rates are set sufficiently high to permit the carriers to earn a reawomable return with load factors in the mid-40 percent range. DOT believes that many transcontinental jassengers would prefer the minor inconveniences assodates with higher lead factors in return for less expensive tickets. In a more competitive market, carriers would respond by providing such low cost service.

One recent study showed that at an average load factor of 75-percent prices could be 27 percent lower than at a 50-percent load factor. While 75-percent load factors are higher than DOT has recommended in most markets, this example illustrates the potential savings associated with pricing flexibility.

Preunt Board policies encourage lower than optimal load factors. DOT's testimony in the CAP's Domestic Passenger Fare Investigation (DPFI) showed that when load factors increase beyond a breakeven level (defined to include profits), carriers schedule additional capacity, thereby lowering load factors to the break-even level again.

Because of this inflexibility, in the Domestic Passenger Fare Investigation, DOT', among other things, urged the Board to establish a 15-percent "zone of reasonableness" above and below the fare structure curve. The zone would not apply in monopoly markets, as defined by the CAB, where the Board would continue to review and suspend rates. Within the zone, carriers would be permitted to compete on the basis of price, free from regulatory interference. Outside the zone, the Board could continue to suspend rates it believed unlawful under its ratemaking standards. The limits of the zone ensure that neither dramatic price increases nor destructive price wars would ensue. The Departmont position rested on the premise that greater reliance on market forces would result in the establishment of rates based on costs and would afford the public a wider and better range of price/service options. We emphasized that the lack of price competition in the air industry was the primary cause of "seat wars" and other service competition which resulted in undue unused capacity, inflated cost levels, and too rapid obsolescence of equipment.

In ite DPFI decisions, the Board did recognize that fares should be more closely aligned to costs. It largely adopted our conclusion that low fares for Mhort-haul passengers should not be subsidized by higher fares for long-haul paneengers. The Board was unwilling at that time, however, to adopt the broader princinle of pricing flexibility, constrained only by costs.

Another procedural prohlem associated with nricing is CAB delay in deciding whether rates are reasonable. We believe the CAB should be required to render a final decision on rate proposals promptly. Also, streamlined nrocedures should enable the Board to dispose of some cases on the basis of pleadings alone, without formal hearings. Large scale investigations such as the DPFI may take longer, of course.

The administration strongly supports greater pricing flexibility for the airline industry. We expect that our legislation will incorporate proposals for pricing flexibility and expedited decisionmaking.

Another major problem with the present regulatory system is the Board's restrictive entry and exit policies. These policies have also restricted competition and increased costs to consumers.

Section 401 of the Federal Aviation Act gives the CAB control over entry into the industry; the Board is given authority to determine which carriers may operate in scheduled interstate service and on which routes they may operate. The applicant must be found fit, willing, and able to perform the service properly, and the transportation must be required by public convenience and necessity. CAB permission is also required for exit.

In practice, industry entry has been tightly controlled. Other than the 16 carriers operating when the 1938 Act took effect, there has not been a single new trunk carrier certificated in the Board's history. Through merger the 16 original trunks have shrunk in number to 10 which account for 90 percent of the total domestic market. The Board has, however, certified local service carriers, some of which are now as large as the smaller trunks.

Until recently, and especially in the late sixties, existing carriers were granted applications for new routes, thereby substantially reducing the number of monopoly markets. In the last few years, however, the CAB has put into effect a de facto moratorium on route awards. New route applications have not been set for hearing; processing applications which had been set for hearing has been delayed. The restrictive policy with respect to carrier entry has now been matched by a restrictive policy with respect to route entry.

The economic result of a restrictive CAB policy is that carriers do not enter and leave markets solely for business and profit reasons. New firms are discouraged by the standards applied and by the results they see, including the high cost of the application process and the delay in Board decisionmaking. The Board has protected incumbent carriers rather than encouraged healthy competition. As a result, in the majority of trunk markets, most passengers are carried by only one or two airlines.

The administration does not necessarily believe that additional carriers are required on every route to improve the working of the air transportation system. We do believe, however, that the present system removes the ability of the carriers to adjust services and realine the markets they serve as economic conditions warrant. This results in increased costs to the public.

The present system also does not recognize the importance of potential competition as an economic force. Thus, the carriers on an existing route need not be concerned about new competition unless the Board has a route case pending. In such circumstances, the existing carriers may be less diligent in providing the type of service and price/quality options desired by the public than they would be if they were aware that a competitor could enter at any time to provide new or higher quality service.

Another way of improving competition is by liberalizing charter rules and thereby offering the consumer a broader range of price and service options.

The administration believes a fundamental shift is required away from overprotection of existing carriers to one which focuses on consumer needs and requires that more weight be placed on competitive principles in evaluating new applications for entry. We also believe that the CAB should not be permitted to delay decisionmaking as a means of limiting entry.

Route exit has in some cases also been restrained by the CAB. While we recognize the importance of service to communities of varying sizes, carriers should not be forced to lose money or operate on the assumption that other routes subsidize those producing inadequate revenue. Cross-subsidies are inefficient economically and in practice do not work.

Where communities deem service essential, the carriers operate at a loss, and the route does not justify federal subsidy, alternatives must be considered. These alternatives include replacement services by another carrier or subsidies by the community itself.

In this regard, I should note that we will not propose any immediate changes in the local subsidy program. However, we believe the CAB has an obligation to identify the cost of such subsidies by route and by city. This has not been done.

The administration strongly supports liberalization of entry into the air carrier industry and our forthcoming proposal will provide for substantial entry and exit liberalization.

One of the most objectionable features of present CAB regulation is the approval of capacity reduction agreements in our domestic markets. At present, under section 412 of the Federal Aviation Act, if the Board finds capacity, pooling and other anticompetitive agreements not adverse to the public interest, it may approve them ; in so doing, it immunizes them from action under the antitrust statutes.

Capacity agreements were originally justified because of immediate, short-term, severe financial distress. The Board has since permitted use of capacity agreements to resolve problems of unused capacity, fuel allocation, and low profits in certain markets. By apportioning capacity, such agreements effectively determine market share. As a result of Board actions, capacity limitation agreements have proliferated to the point where about 29 percent of the revenue passenger miles of the three largest carriers are now covered. One economic effect is that, given the level of service provided, fares in covered markets are excessive. One can scarcely imagine agreements more anticompetitive in their effect. Such problems are far better resolved through market forces operating in a competitive environment.

DOT opposed the capacity agreements before the Board and has joined with the Antitrust Division of the Justice Department to oppose approval of the agreements before the District of Columbia Court of Appeals.

In contrast, some agreements arguably subject to challenge under antitrust laws do serve valid transportation objectives. These include interline agreements, airline scheduling committee agreements at congested airports, equipment leases, fuel supply agreements, reservations and ticketing arrangements, and technical agreements with foreign air carriers.

We distinguish between the two types of agreements, the one anticompetitive in a way which contributes to economic inefficiency, the other which meets necessary transportation objectives. The administration believes that anticompetive agreements such as those for capacity limitation should be restricted or eliminated but that agreements which serve efficient transportation needs should be continued.

Section 408 of the Act authorizes the Board to approve mergers. Mergers may be permitted unless the Board finds that they will be inconsistent with the public interest, would create a monopoly and thereby restrain competition, or would jeopardize another nonparty carrier. In our view, the standard used by the Board in determining whether mergers or consolidations are approved should be changed to require that competitive principles be weighed against transportation needs.

In DOT's filings to date, we have encouraged the CAB to find less anticompetitive solutions to many of the problems I have discussed. It is now clear that more decisive reform is necessary. In times of inflation, recession and energy difficulties, the Nation can ill afford the extravagances created by the present air regulatory system. The administration proposal will get to the heart of the difficulties in each of the areas discussed by changing the regulatory structure which helped produce them. The air regulatory reform bill which we will present will address each of these issues in detail and will implement the basic policy objectives which I have outlined in my testimony.

We look forward to working with the subcommittee to explore each of these areas in more detail. We share the desire to modernize our regulatory structure and let the fresh air of competition make our transportation industry operate more efficiently at lower cost to the consumers we serve.

Senator KENNEDY. Our second witness, Mr. Engman, since February 1973, has served as chairman of the Federal Trade Commission. He has directed particular attention to the agency's responsibilities in the area of antitrust law enforcement. He is ontspoken on regulatory reform, and we are anxious to have his views on CAB regulation.



Thank you, Mr. Chairman.

Last year in November when I was asked to present the Federal Trade Commission's views on governmental restraints in the market

place, I expressed concern that, like so many fashionable topics, it would be the subject of much discussion but little action. It is gratifying, therefore, to know that concern with this vital subject has continued into the 94th Congress, and I commend this committee for its role in continuing the inquiry.

At a time when rising prices threaten the welfare of every American, it would be folly indeed, if we were to fail to address this one area where such large efficiencies appear to be available to us without offsetting economic costs.

I am, therefore, pleased to be here, Mr. Chairman, and to have this opportunity to offer my views on Federal regulations affecting the airline industry.

Senator KENNEDY. You have an extensive statement here, and I want you to proceed in whatever way you feel comfortable, but if you want to highlight it or summarize it, I think, that will be helpful.

Mr. ENGMAN. I normally do that, Mr. Chairman, and I think this will not take long.

Lest someone else feel compelled to say it for me, I must state at the outset that I am no expert on the technical aspects of the airline industry. I suggest, however, that one need be no expert to perceive that something is amiss with the way the Government currently construes its responsibility toward the American consumer of air transportation.

As spokesman for an agency broadly charged with insuring that the consumer receives the best that the marketplace can provide for him, I find this situation disturbing.

The Federal Trade Commission is committed to the principle that people are best served by the effective operation of a free and competitive open market.

Today, those conditions are conspicuously absent in our airline industry. They are absent because, over 35 years ago, the Congress, after examining the needs of a then infant industry struggling to raise capital, decided that the public welfare demanded an exception to the principle of competition-demanded that the airline industry be given partial immunity from the antitrust laws and from the rigors of price competition. The arguments mustered in support of that decision were essentially two: That it was necessary to insure the industry against cutthroat competition, and that it was necessary to provide service to localities which would not otherwise receive it.

I was not around at that time. I did not hear the arguments made for and against what was done. But whatever arguments were made at that time and whatever industry conditions they reflected as you indicated, should be of little consequence to us today. For the relevant question now is, where has it all brought us?

There can be little doubt that much of what was intended has been achieved. Whether it is because of, or in spite of, regulation, I do not know, but today we have beyond question the most comprehensive air transportation network in the world. Moreover, despite the current depleted condition of several of our major carriers, the industry over the years has been characterized by extraordinary stability.


But these objectives have been achieved at a very high cost. Our system, which severely inhibits price competition and restricts entry,

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