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.

Senator KENNEDY. Why wouldn't some of the stronger official carriers just lower their rates until they drive the competition out?

Mr. BARNUM. That might be the result if you didn't simultaneously make a change with respect to your entry. If you do make the concomitant change in entry, in the event you suggest another carrier would come into that market, when rates rise above a competitive level. Senator KENNEDY. But how can a carrier come back in? I would think it would take a very considerable amount of investment, and once they get right back in, the fare could be lowered again to drive them out. I would think the people would bet the idea pretty quickly after two or three people lose their shirts.

Mr. BARNUM. Many of the markets you are talking about are markets that could be served or not served by existing carriers.

The easy case, of course, is a market in which a carrier serves both end points anyway, let's say New York-Cincinnati. TWA may be serving Cincinnati from Chicago, and New York from a number of places. It drops the New York-Cincinnati leg for one reason or another, or perhaps it is not now in the New York-Cincinnati leg. But if other carriers were to raise fares as you suggest, TWA would promptly go right back into the New York-Cincinnati market. That is the easy case.

The more difficult case would be a market where a carrier did not have a base at one of the end points.

In any event, you must have a different practice with respect to entry in order to make rate flexibility meaningful and to avoid the very result you are talking about.

Senator KENNEDY. How do you know they just wouldn't go ahead and charge the ceiling, too. Perhaps if one carrier found out that another is going up to the ceiling, the first carrier would say, well, since Airline X is charging the ceiling and getting a good return on investment, I think we will, too, and then we would end up having the same kind of competition that you have outlined earlier?

Mr. BARNUM. Well, I think you would find there would be a number of carriers that would charge a higher rate at those times of the day; for example, where there is such a demand that they can get it.

But what we would like to see happen is illustrated in the hypothetical case of Chicago-Los Angeles. It may be that the 6 p.m. flight would find a rate toward the high end of the zone because there is high demand for it, there are a lot of people that want to fly at that time, and indeed the major carriers, the trunkline carriers, might charge the same rate at the high end of the scale. But price flexibility would permit them to charge a lower rate during the middle of the day when they could attract people to use planes now operating with a lower load factor, such as the 2 p.m. flight, when there is not such a great demand. You could get price flexibility which would spread out the demands of the airline and increase the load factor, which is what we are really shooting at.

The limits of the zone we proposed in DPFI ensure that neither dramatic price increases nor destructive price competition would ensue. The Department 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 and service options. We emphasize 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 and inflated cost levels.

In its Domestic Passenger Fare Investigation decision, the Board did recognize that fares should be more closely alined to costs. It largely adopted our conclusion that low fares for short-haul passengers should not be subsidized by higher fares for long-haul passengers.

SMALL TOWN SERVICE (CROSS-SUBSIDY)

Senator KENNEDY. Well, now, I come from a part of the country where we had up to-well, the last 8 or 9 years we had service into a number of smaller communities in Massachusetts. We had air service into New Bedford, Worcester, Springfield, down in Hyannis, and of course that was replicated in a variety of different smaller communities all over northern New England.

As you are probably aware, Northeast flew in New England and then they got their ticket to go down to Miami and they primarily focused on that, and they claimed at least to use cross subsidy. They abandoned New England routes. I think there is one flight a day in through Hyannis and the Islands, and the smaller airlines have taken over, and let me say quite frankly they have been very good, at least in our part of the country, at least in the areas of New England in which I have traveled.

But if you reject the cross-subsidy argument aren't you just saying that you are virtually abandoning some of these smaller communities, that maybe they will, as took place down on Cape Cod, with DownEast Air Lines or Pilgrim Air Lines that fly out to Provincetown; aren't you really saying to smaller communities—and I am sure this is true in other parts of the country-you fellows are on your own. If there is an enterprising smaller company that can put together the financing and find the pilots and all the rest, maybe you will get good service, but otherwise you are on your own. Aren't you telling that to hundreds of smaller communities all over the country by this suggestion?

Mr. BARNUM. I think not. I think we should avoid confusing a number of the subelements of the cross-subsidy question.

The principal issue addressed by the Board in the Domestic Passenger Fare Investigation proceeding I am talking about came up in the context of fare construction and the way in which an airline should build up its fares related to its cost: A certain amount to ticket the passenger; a certain amount per mile for the first 500 miles; and a decreasing amount for further miles.

We felt at that time the long-haul passenger was subsidizing the short-haul passenger. For example, because the passenger going from New York to San Francisco had very few other ways in which to take that trip, the airlines were able to charge him a higher fare relative

to cost than they were in the situation, say, from Boston to New York, where there were alternative means of transportation and where the air carrier had to take into account the fares of Amtrak and of innercity buses. Because of the intermodal competition, the shorter haul fares were lower and, to a degree, we felt, cost-subsidized by the long hauls. That is just an economic analysis of what it costs the air carrier to operate long haul and short haul. That is the cross subsidization that we objected to, and the CAB objected to, in Phase 9 of the Domestic Passenger Fare Investigation.

I think that position is entirely appropriate and I don't think your question was really criticizing that kind of position on crosssubsidization. So I would like to put that aside for a minute.

I would also like to put aside the problam created by seasonal demands. When you talk about the Islands and Cape Cod-and I fly those same flights myself—you are talking about a seasonal demand, and that obviously presents a separate problem.

But let's talk now about the smaller communities that are in jeopardy of not getting continued service, if that service is not economic and cannot be cross-subsidized by the profitable routes that the carrier services. Now, of course, there is at the present time a local subsidy operation available to the CAB. It is exercised now at the level of about $68 million last year and about $66 million in the forthcoming budget. By and large, local subsidies have been going down, relatively, as inflation has come along.

To the extent that a trunk line cannot economically serve a smaller community, we do not think it should be required to continue to provide that service. In the last 5 years, we have seen a dramatic substitution of second level service for some of the trunkline service that previously existed. The very region of the country you are talking about is a dramatic example of that. Allegheny has provided substituted service in a number of cities that it previously served or that Mohawk served prior to the Allegheny-Mohawk merger. New England speaks very well to the point that many carriers in a less regulated climate would be prepared to come in and provide the service that you are talking about.

The specific proceeding before the CAB on New England service. laid out a good record where service could be provided by trunk carriers and secondary carriers, and it also gave you some evidence that intercity passenger services such as buses were available to get people from Bangor to New York or Bangor to Boston and there was not the need for certificated air service as existed in some other parts of the country.

I agree with you that it is something we have to keep our eye on, but I don't believe you should permit cross-subsidy as the answer. Would you like me to pursue that?

Senator KENNEDY. Why don't you continue. We will come back to this.

DESTRUCTIVE COMPETITION

Mr. BARNUM. The Board was unwilling at that time, however, to adopt the broader principle of pricing flexibility, constrained only by

costs.

Senator KENNEDY. In reaching this position you must have done some work or some studies that would give you some assurances that you wouldn't have cutthroat competition in this kind of thing and drive people out of the market. Have you studied this in reaching this decision on pricing flexibility and expediting decisionmaking? What about cutthroat competition that would destroy the competition basically? You are satisfied that that won't be the case?

Mr. BARNUM. We are. We did do just that examination and we submitted some of that evidence in Phase 9 in the Domestic Passenger Fare Investigation.

I think if you combine this with easier entry provisions, you would not get the cutthroat competition to drive competitors out. We are not talking about requiring the CAB to permit destructive price competition. If you will permit greater flexibility entry, you will get threshold pricing in these markets so that the carriers who are in these markets will price at a level just high enough to discourage the other carriers able to come in from coming in because the very startup costs will prevent them from coming in and making it

Senator KENNEDY. You think that this threshold cost is the most effective cost for the consumer?

Mr. BARNUM. That has got to be the most effective cost to the consumer; yes.

Now, there has to be a basic cost element in here that, of course, we in the Department of Transportation are always mindful of. We are not just talking about selling oranges. We are talking about selling air transportation. There has to be a very basic and substantial cost here for safety. We are mindful, as I am sure you are, of the ingredients of operating an airline. We are not in any way inviting you to open up the pricing of transportation so that safety would be derogated.

Another procedural problem associated with pricing is CAB delay in deciding whether rates are reasonable.

SAFETY AND COMPETITION

Senator KENNEDY. Have you got any study about the performance of new carriers in the area of competition on the basis of safety? Have you drawn any conclusion or made any study of how much of an issue that would be or whether that is a question to be resolved?

Mr. BARNUM. It hasn't been an issue among trunk carriers because there haven't been any new trunk carriers. It is an issue when we talk about air taxies, and this is a very serious problem. I am afraid our record of accidents of air taxies is not as good as we would like. A lot of these people are starting up and do not have all the elaborate safety practices and manuals the trunk carriers have been able to develop over the years.

Senator KENNEDY. What about intrastate carriers, in terms of safety. Isn't that a problem?

Mr. BARNUM. I think the safety record of the principal intrastate carriers is excellent.

Senator KENNEDY. But how will you make sure that is going to be the case in other places?

Mr. BARNUM. Well, of course, the FAA has broad authority with both certification of types of aircraft and maintaining the operating

status of aircraft. That is really more an FAA function. It would address itself to any type of aircraft being operated. I agree with you, however, that it is something we should continue to keep our eye on, but given that mandate to the FAA, I think we can put it to one side.

Mr. BARNUM. I made reference to the CAB and its procedural 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 procedures 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.

CAB'S SECOND MAJOR POWER: INDUSTRY ENTRY AND ROUTE ENTRY 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 ben set for hearing has ben delayed. The restrictive policy with respect to new carrier entry into the industry has now been matched by a restrictive policy with respect to new route entry for established carriers.

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