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has led to a fare structure on many routes which economists agree is far higher than that which would prevail if the industry were charaeterized by price competition and free entry. Sereral conditions flow from this fact.

The absence of any real price competition coupled with higher than competitive rates leads to large amounts of nonprice competition. One important type of nonprice competition is in terms of frequency of flights. This in turn leads to large amounts of excess capacity. It is not unusual today for several planes to fly almost identical schedules each with a small fraction of its seats filled on some flights.

Senator KENNEDY. That makes two of us. I have done a lot of flying.

I just found that out last Thursday evening when I was flying to San Francisco. There were two major flights within 5 minutes of each other, both going nonstop to San Francisco from Dulles Airport. Noticing that we had these particular hearings, I looked at both of them, and the first class in both were full and the rest about one-third full, and they landed within 5 minutes of each other. I have a staff assistant who is consultant for our Health Committee, who makes the trip once a month, and he has been doing a little informal review of this as well, and has found the exact same thing. He finds it going both ways. The point is well made.

Ýr. Engman. I have noticed the same situation. It is also true with other pairs of markets; Chicago, for instance.

In short, what we have is economic waste—the classic cost-plus syndrome. The air passenger who finds himself next to an empty seat may be pleased with this state of affairs. He is able to spread out a little. But I wonder how pleased he would be if he were aware that he had paid not only for the seat he was sitting in, but for the seat his briefcase was sitting in, too.

In addition, fixed rates have created a sort of phony war, a war in which airlines compete for business, not on the basis of price, but on the basis of scheduling and comfort. All of us today have standing invitation to fly Cheryl or Karen or Trixie or even Bruce. Those invitations are no more or less than confessions on the part of the airlines that our decision as to which to fly pretty much boils down to whether Cheryl is more attractive than Bruce.

This bogus competition along with creature comforts and the pressure to raise the number of flights can be explained by the simple economics of the airline industry. We start with an increase in fares. In the absence of price competition, each airline tends to compete away the "profits” from the fare increase by engaging in various forms of increased nonprice competition.

More frills are added. Witness the great free-drink battles of recent times or the lounge wars of some time back. Often flight frequencies are also increased. Unfortunately, this tends to reduce overall load factors on all the planes. Rates of return go down, and soon we are told a new fare increase is "required" to maintain the existing rates of return. The whole nonproductive cycle starts all over again.

ANALOGY TO SECURITIES INDUSTRY

The situation is analogous to that which existed in the securities industry a few years ago when it was operating on fixed rates across the board. Since brokerage houses could not offer the customer lower rates, they offered frills—counseling services and the like. The brokerage houses argued that these frills were worth the extra money, but the institutional investors knew better, and they made the brokers give them the equivalent of rebates under the table. The American consumer of air transportation does not have that power. I wonder how he would act if he did.

Comfort and scheduling are undoubtedly worth something to consumers. But are they worth the price he must pay for them? Obviously, they are worth nothing to those who cannot afford to fly because of the high prices. There is evidence which suggests also that they are not worth it even to those who can and do fly. If it were true, given the choice, some people would choose to pay the higher rates for deluxe or frequent service, why does the industry and the Government shy away from giving them that choice? For surely that has been the pattern in recent years.

RESTRICTIONS ON CHARTERS

Our current system of regulation has prevented the entry of new carriers willing to fly for less. And it has frustrated charter operations willing to lay on “barebone” service at a fraction of the going rates.

It is argued that these limitations are necessary to prevent socalled undue diversion from the scheduled carriers. We can recognize that argument for what it is. “Diversion” would not occur if people thought frequent flights and frills were worth the price.

Do not misunderstand me. I have nothing against Cadillacs. But I question the equity of a system that forbids the sale of Pintos. And I also wonder about a system which permits producers of a “big ticket” item like air transportation to avoid the issue of price except when it is to tell the consumer that a special rate awaits him if he is leaving on a Wednesday morning, plans to remain at his destination for precisely 53 days, is carrying no luggage, and is a charter member of the Flat Earth Society.

COST OF REGULATION

It may be impossible to get a precise measure of how much our system of regulation actually costs the airline customer and the American public. But we can get a rough idea from examining prices in those few markets where regulated carriers face competition from intrastate carriers not subject to Federal regulation. Two such markets currently exist in California and Texas, as the acting Secretary indicated, and you have doubtless already heard and read much about them. Suffice it to say that the unregulated intrastate carrier entered the market with substantially lower fares in each instance. In the case of Texas, the price differential remains today with the result that consumers are offered a lower cost alternative offered it, I might add, by a financially successful airline, Southwest Airlines. In the case of California, the low-cost competition offered by Pacific Southwest Airlines forced the interstate carriers to appeal for and finally to get from the Government permission to lower their rates to the level of the competition. But you need only step across the State line to appreciate the local character of this consumer benefit. It still costs much more to fly the 226 miles from Los Angeles to Las Vegas than it does to fly the 347 miles from Los Angeles to San Francisco.

The cost to the consumer of continued regulation is suggested also by a 1972 economic study in which the costs of airline operations were compared with fares for flights between 30 different pairs of cities. These comparisons showed that, in markets where there was no competition from an unregulated carrier, fares exceeded costs, costs being defined to include a 7.5 percent return on investment, from 47 percent to 84 percent. Since, with competition, fares could be expected roughly to parallel costs, this wide variation would seem to suggest that the experiences in Texas and California do not reflect unique circumstances.

These then are at least some of the costs that have been imposed on the public in stressing stability and comprehensive service. Whether one has been worth the other is a policy question which Congress should consider.

But any weighing of costs and benefits surely should be preceded by a close examination of their relationship. For it can be argued that many of the costs incurred were not necessary to the attainment of the benefits intended.

SMALL TOWN SERVICE (CROSS-SUBSIDY) Consider first the benefit of comprehensive service—that is, service to parts of the country where traffic is too light to support a scheduled airline. It is often argued that high fares on heavily traveled routes are needed to subsidize losses on sparser runs which the regulated carriers are required to fly. I frankly have to tell you I do not know how much of this “cross-subsidization” actually occurs, but assuming that there is some, it has the effect of putting the entire industry on a de facto cost-plus system of return, a system which experience has indicated is a very poor check on inefficiency. Also, requiring one air passenger to subsidize the flight of another raises a serious question of equity. If it is a desirable thing to have air service between two small towns, why should only one class of citizens be asked to bear the cost of it?

Finally, the system raises the question of resource allocation, for there can be no question that a subsidy paid from high fares on heavily traveled routes causes misallocation of resources.

Higher fares on denser routes inhibit travel on those routes. The "right” amount of air travel on those routes would be the amount which people would buy at a price which just covered all costs of providing the service. Higher prices will cause them to buy less than that amount. And the resulting loss to society is the same as it would be had the higher price been the result of private price fixing or monopoly.

I express no view on the question of whether some flights should be directly subsidized. I suggest simply that if we are to have a system under which some people subsidize service to others, we should, at the very least, be able to identify its costs so that we can intelligently examine alternate forms of subsidy and so that we can periodically reassure ourselves that the benefits are worth the costs.

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DESTRUCTIVE COMPETITION

The other pillar-in addition to comprehensive service-on which our current regulatory system stands is the need to prevent "cut

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throat” competition which could threaten the industry's stability and perhaps result in a single-firm monopoly.

This has not happened in California, and I see no reason to expect that it would be a general problem.

The number of firms present in any industry depends largely on whether there are large economies of scale relative to market demand. If there are, there will be only a few firms in the industry. In the most extreme cases, there be only one.

But the airline industry does not have large economies of scale. The basic unit of production is the airplane itself. Economic studies indicate that an efficient airline can be run with only a few of them. They can be—and are—easily shifted from one route or one carrier to another.

Single firm service may emerge on some lightly traveled routes because of the small size of the market. But it is doubtful that such firms could charge monopoly prices because of the constant threat of entry by other firms, if it were permitted. The ability to shift planes easily from one market to another makes the threat of entry quite credible in this industry.

Much of what I have just said you have doubtless heard from others. The question is, “what do we do about it?”

CAB asks airlines for data on their liquor costs. I know what they are doing

That is one of the purposes of these hearings, and because the answer to the question of what we can do about it is really not all that clear, perhaps, but there are two points, Mr. Chairman, which are quite clear to me.

First, I believe that no one is going to be able to provide a complete answer until we have a better accounting of the costs and benefits of the current system. At present, neither the Federal Trade Commission, nor the Congress nor the American public has any idea of what the current system of regulation costs or what it produces. My interest in this question as a Federal official is not as important as my interest as an air traveler-incidentally, with three young sons—and as a taxpayer since I, along with millions and millions of other Americans, am paying the bills.

COST OF REGULATION Senator KENNEDY. You cannot really tell how much they would save the consumer?

Mr. Excmax. The precise number is one which is beyond our ability to know. As you, Mr. Chairman, cited a study which I have cited in the past, the question of $17-$18 billion range, that has been cited across the board, that of course includes surface transportation, too, studies indicating the range from 48–84 percent overcharging on the 30 selected flights indicated there, and certainly we are talking about hundreds of thousands and probably millions of dollars each year.

I think in terms of specifics as to some of these cost questions, such as to whether or not how much do we really know, how much cross subsidies do we really have going on, or is this a kind of issue that has just been raised to tend to confuse the issue would be helpful, and we have to work to continue to improve the information we have available to us.

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