Americans are being asked to make these harsh and difficult sacrifices. Many of these sacrifices cannot be justified on their own; but they stand in even starker contrast with the continuing drain on our economy that regulatory agencies impose.

The direct effects of regulation by the Civil Aeronautics Board are translated into the prices the public pays to get from one city to another-whether for business, pleasure, or family emergencies. Some critics have estimated that as a direct result of CAB regulation the public pays from 32 to 47 percent in excess air fares. These inflated costs are passed on to the consumer by the sellers of goods and services who must utilize the airplane to transport its products and employees. CAB economic regulation is thus of vital concern to every American. Although the way the CAB regulates may be complex, the effects of that regulation are dramatic and clear.

The administration has asked Congress to create a commission to study regulatory reform. While I support that proposal, I also believe that the President and the Congress have a duty to propose something concrete to bring about reform.

Throughout our hearings we will be asking two questions about the CAB's practices and procedures: First, are they effective? Do they result in reasonably priced air transportation for the consumer and reasonable incentives for the airlines to provide that service? Second, are they fair? Do they give the public, as well as the airlines, an adequate opportunity to present their points of view before important decisions are made?

Last November the subcommittee began this process by examining the CAB's decision to set minimum charter rates. We concluded that in this instance the decisionmaking process operated neither fairly nor effectively. The CAB's actions in this area will unjustifiably add millions of dollars to the public's bill for air travel. Subsequently, the Court of Appeals for the District of Columbia issued an indefinite stay of the CAB's minimum charter rate policy.

Today, we will begin with a broad overview of CAB policies and procedures. Next week we will examine the fares and service provided by intrastate carriers, and the performance of State regulations of airlines who are not regulated by the CAB. We will ask why Stateregulated airlines in California and Texas provide profitable, unsubsidized service at fares that are sometimes 50 percent lower than those charged by the CAB-regulated carriers. We want to know the reasons for these differences. The subcommittee will ask whether, as is so often charged, regulation by the CAB is responsible for them.

We will go on to review the Board's procedures for determining proper rates. In the past 14 months, the Board has granted direct fare increases of over 16 percent. It has eliminated special fares for children and vacationers, producing an average fare increase of more than 20 percent. Neither inflation nor rising fuel costs can fully explain these fare increases.

So again we must ask, is CAB regulation responsible? Do the Board's procedures ensure that low airline profits lead to quick, automatic, fare increases, while high airline profits are neither quickly nor automatically translated into fare cuts? Do its ratemaking procedures reward the inefficient, unprofitable carriers with industrywide fare

increases that efficient carriers do not need and would not impose in a competitive environment? Do the Board's procedures work to produce rates based on, in the words of the Federal Aviation Act of 1958, the "lowest cost consistent with the furnishing of adequate service"? More fundamentally, if the task of regulating air fares is so inherently complex that imperfections and higher costs will result no matter what. ratemaking procedures are used, then we will ask to what extent reform can be accomplished by returning the determination of prices to the marketplace and the laws of supply and demand.

The subcommittee will also analyze the Board's procedures for awarding routes. It has been claimed that a more flexible entry policy— a policy that more freely awarded routes to qualified applicantswould itself help keep prices low. The fear of attracting competition may also act as an additional constraint on airline pricing policies. Yet the CAB has adopted precisely the opposite approach in recent years. But, it has never decided to adopt this policy formally, as required by the Administrative Procedure Act. The subcommittee will examine the Board's past behavior, as well as its recently announced proposals for procedural change, to determine whether both the public and the industry are being adequately served by Board actions.

The subcommittee will also look at the CAB's use of its enforcement powers. We will ask whether the agency has devoted disproportionate resources to stamping out low-fare transportation charters-air travel clubs that put pleasure travel within the reach of millions of average citizens while doing little, if anything, about airline overcharge.

Finally, the subcommittee will look at the Board's use of its power to grant antitrust exemption to several carriers who reached agreements to curtail service competition in selected markets. Has the Board imposed safeguards sufficient to assure that the public will not suffer unnecessary curtailment of service? Have the reduced costs of the carriers who have curtailed service been passed on to those consumers who now receive that reduced service? Does the CAB too easily ignore the policies of the antitrust laws, allowing the airlines to engage in collusive action to divide up markets and profits?

The scope of these hearings is broad and our time is limited. But we have been substantially aided by the cooperation of the airlines, several executive agencies, and the CAB itself. Even before these hearings were announced last December, the airlines and the CAB were compiling data and submitting responses to detailed and extensive questionnaires from the subcommittee. Some of our questions asked for data and analyses that neither the CAB nor the airlines had previously compiled.

The responses have been immeasurably helpful to the subcommittee. The Board, executive agencies, and the airlines have had an opportunity to reexamine their own assumptions in preparing for these hearings. Just last week, I am happy to report, the Board itself announced that it was establishing an internal study group to reexamine its functions and the need for regulation. I hope that study group will pay close attention to the evidence we will be developing in these hearings. The subcommittee will certainly monitor the progress of the group's work and will closely study its final report.

The Department of Transportation, the Department of Justice, the President's Council of Economic Advisers, and the Council on Wage

and Price Stability have lent substantial assistance to our efforts. They have developed concrete proposals for reform that will be explained by them during the course of these hearings.

Today, we will hear from several government agencies, some experts on economic regulation, and representatives of the scheduled airline industry. These witnesses have been asked to tell us whether there is a need for reform and to suggest the direction reform should take. Thus, today's hearing will provide an overview of the major problems involved in airline regulation. Proposals for reform will be set before the public by various witnesses, and these proposals will provide a framework for the examination that will continue more specifically in the future hearings this month and next.

Our first witness this morning is Mr. John Barnum, who came to Washington from his New York law practice in 1971 to become General Counsel of the Department of Transportation. In 1973, he assumed the job of Deputy Secretary of Transportation and is presently Acting Secretary of Transportation.

As I indicated in my opening statement, the DOT, both Mr. Barnum and Mr. Binder, have been extremely helpful to us in preparing for these hearings.

We are pleased to have you with us and we look forward to your testimony this morning.

STATEMENT OF JOHN W. BARNUM, ACTING SECRETARY OF TRANSPORTATION, ACCOMPANIED BY WILLIAM A. KUTZKE, OFFICE OF THE GENERAL COUNSEL, DEPARTMENT OF TRANSPORTATION Mr. BARNUM. Thank you, Mr. Chairman, and thank you for the kind words concerning Assistant Secretary Binder and Assistant Secretary Snow, who are not available at this time.

I would like to introduce William A. Kutzke who has been on the firing line for the DOT in the CAB proceedings in which the Department participates.

I would also 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 Aeronautic 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 sadly irrational. It often misplaces incentive and disincentive, disorts 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 rate setting, unnecessary entry restriction, 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 predicted 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.

I fully agree with the statements you made in your opening remarks that regulatory practices developed 40 years ago are not suitable to the last quarter of this century.

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 this 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 by-product of that success. The promotion7 which once fostered growth now causes inefficiency. The restrictions which once guaranteed stability now retard competition. The regulatory protection which once insured existance 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.

CAB'S FIRST MAJOR POWER: FARES

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 future direction which the Administration suggests.

A major difficulty with CAB policy has been ratemaking and the carrier inability to raise and lower rates in response to the demands of the marketplace. This in turn forces carriers into costly and uneconomic service competition, deprives the traveling public of the range of price and service options which would otherwise be available, and results in substantial economic waste and inefficiency.

Section 404 of the Federal Aviation Act requires carriers to establish just and reasonable rates. Section 1002 permits the Board to prescribe maximum or minimum rates if it is of the opinion that the rates charged are unjust, unreasonable, preferential, or discriminatory. In deciding whether a rate is too high or low the Board takes into account, among other factors, whether the rate is compensatory, providing the carrier with sufficient revenue.

The result of the Board administration of these sections has been the elimination of price competition, thereby restricting competition to service. Passengers find airlines competing for their patronage through elaborate cuisines, free drinks, attractive stewardesses, multicolored planes, and piano bars. But they do not have a menu where different quality service is related to different prices. This is a serious loss.

Many passengers would prefer the opportunity to select carriers based on price in addition to type of service. Some passengers would prefer high-load factor, low-frill, low-fare service. Others are willing to pay for more comfortable and more costly service. Present pro [cedures do not produce that variety of price and service options. Often, present regulation causes fares well above those which would occur in a more competitive air transportation market. With prices fixed at levels above market rates, carriers compete on the basis of service. Such service competition produces substantial unused capacity and unnecessarily low-load factors, presently averaging about 57 percent in the domestic market. In the transcontinental market, for example, rates are set sufficiently high to permit the carriers to earn a reasonable return with load factors in the mid-40-percent range. DOT believes that many transcontinental passengers would prefer the minor inconveniences associated with higher load 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 unrealistic in most markets, this example illustrates the potential savings associated with pricing flexibility.

"ZONE OF REASONABLENESS" FOR FARES

Present Board policies encourage lower than optimal load factors. 'DOT's testimony in the CAB's Domestic Passenger Fare Investigation showed that when load factors increase beyond a break-even 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 15percent "zone of reasonableness" above and below the fare structure curve. The zone would not apply in monopoly markets, as defined by