among air carriers (Sec. 412). Section 414 of the Federal Aviation Act provides that the antitrust laws shall not apply to persons affected by CAB orders issued under these three sections of the Act, to the extent "necessary to enable such person to do anything authorized, approved, or required by such order." (49 U.S.C. 1384). The public interest would be better served if each of the three types of transactions as to which the Board can confer immunity were evaluated under the standards of the antitrust laws, rather than the general "public interest" rubric of an administrative agency.

If economies of scale were more prevalent in the air transport industry than in the general economy, and these economies were considered more important than the advantages of having an unconcentrated air transport industry, there might be a basis for applying agency review and antitrust immunity with respect to the three areas subject to the section 414 immunity provision. It is manifest, however, that such economies of scale do not exist, and there is no other evidence that anticompetitive industry structure or conduct is any more in the public interest in the air transport industry than in the economy in general. Thus, these types of transactions should be subject to the standards of antitrust law, not administrative law.

It would be desirable to remove the antitrust immunity provisions of section 414 even if these three types of transactions remain subject to administrative review. This would insure that the administrative agency would not follow a less procompetitive standard than that of the antitrust laws; the safest way to do this is to eliminate any inference that the Board's approval brings immunity from an antitrust lawsuit. See, e.g., United States v. Philadelphia National Bank, 374 U.S. 321 (1963). The agency thus would be free to apply a higher standard of protection for competition but not a lower one. This is the approach of the Atomic Energy Act of 1954 (42 U.S.C. Sec. 2135).

The existence of the section 414 immunity provision creates the possibility of a lowering of competitive standards not only in the regulated air transportation industry, but also in industries not regulated by the CAB. In a recent decision, the Supreme Court held that a private antitrust action against Hughes Tool Co., a person engaged in aeronautics, was barred by the Board's approval of and continuing jurisdiction over the control relationship which was the basis of the antitrust complaint. The antitrust complaint had centered upon the approved transactions' competitive effects in the commercial aircraft manufacturing industry, not in the air transportation industry which is regulated by the Board. (Hughes Tool Co. v. Trans World Airlines, Inc., 409 U.S. 363, 366). Thus, the effect of the Court's decision may be to allow the Board to create immunity from the antitrust laws-presumably applying the standards of administrative lawin industries where it has only limited jurisdiction to protect competition, or no jurisdiction at all.

If any special characteristics of air transportation require departure from the undiluted application of the antitrust laws, such departure should be effected by a procedure similar to that of the Bank Merger Act of 1966. Under that statute a specialized regulatory agency first passes upon whether a merger would violate the antitrust laws, and whether it should nevertheless be allowed because of specific overriding public benefits which could not be obtained by any other means. The transaction is then subject to de novo review by the United States in a District Court.

III. CONCLUSIONS

The Board has used its comprehensive powers and amorphous policy mandate in part to promote what it perceives as stability and "financially sound conditions" in the industry. Each regulated air carrier is confined to a particular class or type of service on particular routes. Along with mergers and route protection, the result has been an ever dwindling number of competitors within each regulated category. There is abundant evidence that this protection against competition has in itself led to considerably higher prices and lower efficiency than would be available in the absence of entry control.33

This imposes serious economic costs directly upon consumers of air transportation, and indirectly upon the entire economy. In addition to these direct costs, regulation restricts the freedom of air carriers to enter and leave markets as market forces indicate, and instead require them to go through expensive, time

33 See sources cited in Douglas and Miller, supra 42, 54; 172.

consuming and unpredictable legal processes before engaging in normal rearrangements of their operations. This has generated waste, inflexibility, and insensitivity to the desires of consumers. It also has kept out of the industry many firms which could have made valuable contributions.

The fare policy of the CAB appears to have taken a turn for the better in some respects as a result of the DPFI. As I have explained above, actual enforcement of the load factor standards could bring considerable progress toward breaking the declining load factor, escalating price cycle. Also in the DPFI, the Board found that cross-subsidization is inefficient and adverse to the public interest, and moved to reduce the cross-subsidization inherent in the present fare structure. As the discussion above indicates, however, it remains to be seen whether the Board will follow through on these principles and apply them everywhere they need to be applied.

In the area of pricing flexibility, there has been little change. The Board reaffirmed in the DPFI the practice of pricing on an industry average basis so that all regulated carriers, regardless of their relative efficiency, will continue to survive, and none will have too great an incentive to develop a greater level of efficiency than that of its fellow regulatees. This "cost-plus" pricing policy has deprived consumers of a variety of price and quality options. Given the carriers' tendency to engage in service competition which the Act allows the Board to regulate only indirectly, the result is not even high profits-just waste.

All of these problems, plus the recent economic downturn and fuel price crisis, have led the Board in recent years to move into one area it previously had largely avoided the approval and even promotion of anticompetitive agreements such as pooling, capacity restraint agreements and "route swaps" which in reality amount to enforceable agreements not to complete. The common goal in each of these recent agreements has been to decrease or at least stabilize competition and increase the rate of return in the industry. The result, in many instances, has been a serious decline in the quality of service coupled with a dramatic increase in prices over and above increases required by costs such as the increased cost of fuel.

What can be done about this? The Department of Justice and other litigants sometimes can help maintain a degree of reliance on competition, but under no circumstances do we believe such litigation brings optimum results. Parties seeking to influence the Civil Aeronautics Board toward more competitive policies are hampered by the vagueness and inclusiveness of the statutory standards among which the Board may choose to justify its decisions, and are hampered by judicial restraint in reviewing crucial aspects of agency decisionmaking. This is exacerbated by the very serious costs and delays of litigating economic issues, both before the Board and in the courts.

These problems will be dealt with in greater detail in later sessions of these hearings. It will suffice to say now that we do not believe the serious problems of air transport economic regulation will be satisfactorily corrected by litigation under present statutory standards, although such litigation can help somewhat. Neither do we believe that the optimum answer lies in the reform of procedures under which air carrier economic regulation is carried out. Unnecessary regulations is still expensive even if carried out under clear standards and optimum procedures. It would be possible to have a much narrower statute seeking specific goals with definite safeguards for competition and economic efficiency. In air transportation, the fundamental goal would be the provision of efficient air transportation to the public by qualified common carriers using safe planes and qualified crews. A tightly drawn statute would prevent the Board from limiting competition unless it made findings on the record that competition would compromise safety or reliability of service. Even under such a statute, the problem of preventing regulation from pursuing other, anticompetitive goals might prove difficult.

Specifically, we believe that new legislation should move toward the following goals. First, entry and exit restrictions should be greatly liberalized. Second, rate flexibility should be introduced through a phased process, perhaps initially using a zone of reasonableness. Regulatory intrusion with regard to rates within that zone would not be permitted. Finally, existing antitrust immunities should be removed, along the lines suggested earlier in this statement.

There is a broad consensus that reform must proceed along all three of these fronts. The Administration has thus concluded that it would be appropriate to

34 Order 74-3-82, p. 72 (March 18, 1974).

move toward much more reliance upon competition in the air transportation industry, and much less reliance upon government economic regulation. We expect to present specific legislative proposals within a short time to the Congress, and specifically to this Committee.

Senator KENNEDY. Mr. James Miller, currently senior staff economist for the Council of Economic Advisers, received his Ph. D. from the University of Virginia in economics, formerly served on the senior staff for the Republican Party from 1969 to 1972. In 1973-74 he was an assistant associate professor, now on leave; he edited a number of books, including economic regulation of domestic air transport. We also received a statement from his coauthor, Mr. George Douglas which we will make a part of the record.

[The prepared statement of George Douglas, professor of economics, University of Texas, is included at the end of the testimony of this day (February 6, 1975), p. 437, below.]

STATEMENT OF MR. JAMES MILLER, SENIOR STAFF ECONOMIST, COUNCIL OF ECONOMIC ADVISERS

Mr. MILLER. Thank you.

Mr. Chairman, we have a prepared statement that I ask be inserted into the record. Mr. Seevers is unable to be here and sends his regrets. As you know, today the Joint Economic Committee is hearing testimony by the full Council on the economic report.

Senator KENNEDY. That is where I am supposed to be, too.

Mr. MILLER. In our testimony we deal basically with three issues. The first is the cost of airline regulation. The second is the efficiency of a hypothetical totally deregulated market. Finally, we outline, as Messrs. Barnum and Kauper did, the kinds of proposals the administration is presently discussing in formulating a legislative package.

On several occasions this morning, questions have arisen about aspects of less regulated or totally deregulated markets that many people question. We deal with several of these in the testimony. I would like to briefly respond here.

SAFETY AND COMPETITION

First, on the question of safety, the Federal Aviation Administration is the governmental instrumentality charged with regulation of safety in the airlines. On the basis of theory and evidence, there is a lot of question the allegation that economic regulation is needed to assure safety of operations. As mentioned in the testimony, we performed such a test on data and found that while the results were statistically insignificant, meaning that regulation had no effect on safety, the nature of the result actualy give an appearance of a positive relationship between air fatality rates and the airlines' rate of return on investment.

I agree that in formulating any kind of regulatory reform measure one should be very cognizant of the safety issue, but I do not believe economic regulation is the appropriate means of assuring air safety.

SMALL-TOWN SERVICE (CROSS-SUBSIDY)

Second, with respect to question of small communities' losing air service because of regulatory reform, this first presumes that there is a lot of cross-subsidy going on. The work I accomplished with my coauthor, George Douglas, indicates that the amount of cross-subsidy is grossly overstated. Professor George Eads who is scheduled to testify later, will probably have some additional remarks on this issue. We have also observed that commuter airlines have replaced trunk and local service carriers quite successfully. We have no reason to believe that with less regulation their effectiveness would be diminished.

RELATIONSHIP BETWEEN FARE AND ROUTE ENTRY FLEXIBILITY

The question of pricing flexibility hinges very much on the question of entry. On the low side, as long as entry is relatively free, the carrier which is trying to predatorily price one of its competitors out of the market stands nothing to gain, because as soon as it runs the last one out, it has to confront the possibility of a new entry. On the high side, it is again important that entry be relatively free. A carrier wishing to charge excessively high fares would be restrained from doing so because of the threat of entry.

On fly-by-night operators, even if you had less economic regulation, you would still have the constraints of safety regulation. This would mean that such operators would have to meet safety standards. They might by fly-by-night in the sense of going in the market and leaving the market in a very short period of time, but I do not see what real damage that would do to the consumer.

Senator KENNEDY. I suppose the damage to the consumer is unreliability. Here is one carrier in the market one day making his reservations and plans, and the carrier is out of the market the next.

Mr. MILLER. Senator, I do not think we should underestimate the value of a reputation in something like this. The carrier which is new to the market will be viewed skeptically. It is through trustworthy service that a carrier generates new traffic.

NEED FOR LEGISLATION

I would like to make a final remark about the issue of CAB discretion. I think it is true that the CAB could promulgate many of the reforms that we have talked about this morning through the existing statute. However, I do not think it will do so, and I think the evidence of regulation in the past is a very forceful argument to make us skeptical about their being willing to move forward with this kind of reform in the future.

Senator KENNEDY. Why is that?

Mr. MILLER. I think incentives the regulator faces are not generally consistent with economic efficiency. I think the statute itself-for example, the declaration of policy, section 102-is drawn in such a way as to give emphasis to a lot of different conflicting objectives. A regulator who does not want to be concerned with efficiency can find an easy excuse for not doing so.

Also, as a matter of procedure, even if you had a compromising Civil Aeronautics Board, five economists whose sole objective was to maximize economic efficiency, to the extent they would be changing precedent and moving in very new directions, I would imagine there would be a significant protest of such activity. I am not an expert on law, but I am not confident this kind of activity would survive court tests.

Senator KENNEDY. Let me just ask you from the point of view of the Council whether you feel from that vantage point that the idea of greater competition in terms of rates and entry would be beneficial from an overall economic point of view for our economy or from the consumer point of view.

Mr. MILLER. I think it is the major objective of the Council to recummend policies or present analyses which focus on economic efficiency questions as they pertain to regulation and other types of governmental controls. This, of course, counts the consumer to a very large measure. After all, Senator, the ultimate objective of production is consumption. Senator KENNEDY. Could you develop your thoughts briefly on the question of cross-subsidization. Then secondly, it is really an unrelated question, with this proliferation of new airlines and different prices, how will the consumer know where to go to get a ticket, will we have mass confusion or do you think this is a manageable problem Would you talk on those two questions?

CHAOS

Mr. MILLER. I will be glad to. Let me take the latter first. Information is a scarce resource, and when consumers know a producer charges a specific rate, and these rates are not likely to be changed, the producer's reputation is enhanced. Consumers find out this information; producers advertise as well. In a freely competitive airline market, consumers would learn the prices that are charged and the carriers that provide good service the same way as in existing competitive, unregulated markets.

CROSS-SUBSIDY (SMALL TOWN SERVICE)

Now, on the question of cross-subsidy, we essentially model the airlines in the following way: Because there is a lot of competition today— most markets are served by two or more carriers-the Board is really in the business of setting the quality of service. They set the price and carriers compete on the frequency of schedules and other means so as to bring the cost level up to the price level. For example, transcontinental markets were referred to a few minutes ago where the prices are such that carriers can break even at 40 to 45 percent load factors. Carriers do, in fact, schedule up to the point where they are breaking even at those load factors. If the Board lowered the price, then the carriers' break even point would be higher. They would restrict scheduling. This would drive up load factors. So in these markets the carriers are earning neither excess profit nor losses.

On short-haul markets where the fare taper is such that the pricevis-a-vis the cost of a constant load factor service-is too low, the carriers simply cut back on scheduling and provide fairly poor service.