other very important factors which led to the creation of airline economic regulation in 1938. The Great Depression had shaken our society's confidence in the free market system, and led to a number of laws which substituted direct Government economic regulation of business organizations for the maintenance of free competition. Also, air transportation in the 1930's was thought to suffer from undue division of governmental regulatory authority among the Commerce Department, the Post Office Department, and the Interstate Commerce Commission, and it was considered a very important function of the 1938 act to combine and coordinate all of these functions within one agency.

The drafters of the act, however, vehemently denied any intention to allow the Board to restrain competition or create monopolies. The act itself directed the Board to maintain "competition to the extent necessary" to pursue other rather inclusive goals, and explicitly directed the Board to observe conventional antitrust principles in deciding merger and interlocking control cases.

The act's reliance upon competition among air carriers shows that the Congress clearly did not regard air transportation operations as having "natural monopoly" characteristics which required Government control in the place of the discipline of competition. Instead of detailed control of the rate base, regulation was extended to fares, entry and exit from specific routes, and agreements and mergers.

MERGERS-REASONS FOR

The first category of major CAB economic cases are those in which the basic structure of the airline industry itself was at issue. In the last 15 years, the Department of Justice has opposed three major trunk air carrier merger proposals, which had they been approved, would have substantially redrawn the route map of the U.S. domestic system, and considerably increased the already very great concentration of the airline industry in the hands of a very few large trunk air carriers.

Since 1962, we have opposed before the Board the proposed mergers of American with Eastern, Western with American, and National with Northwest.

In the last few years, the Department also has studied several other major airline merger proposals which were never filed and litigated at the CAB.

As a result of studying, testing, and arguing the evidence in these cases, we have come to the conclusion that in the absence of economic regulation, the air transportation industry probably would have a reasonably flexible, competitive structure which would serve the public better than the present Government-controlled structure. Experience under economic regulation, and in unregulated air transportation where available, indicates that the industry tends to have a "competitive" structure, rather than being a "natural monopoly" which must be regulated in the interests of the public.

Evidence is quite abundant that there are no important economies of scale in air transportation; that is, larger firms are not more efficient or less costly simply because of their size. In fact, other things being equal, the largest air carriers tend to have a higher level of unit costs,

and there are some indications that these increased costs are caused by the difficulties of managing an airline of very large size.

The airlines' "right-of-way" is the air itself, and their "tracks,” if any, are the air traffic control guideways maintained by the Federal Government. Well over 80 percent of the airlines' investment is in flight equipment, which is among the most mobile of assets, rather than in fixed assets, as is the case in the classical "natural monopoly." Not only does this make competitive service economically feasible, but it makes duplication of routes far less risky, because competitors can more easily adjust their operations by rescheduling an aircraft from one city-pair to another-assuming that the Government does not prevent them from doing so.

In view of this conclusion, why have so many mergers been proposed? Perhaps the most important reasons for mergers among the regulated air carriers have been the effects of regulation itself. Air carriers know that when they hold a certificate, it is the nature of economic regulation that the Board will to a greater or lesser degree. protect them from entry by new competitors on that route. Similarly, the air carriers know that they cannot expand onto a new route without obtaining a certificate. Consequently, any certificated air carrier, no matter how poorly run and how debilitated financially and operationally, has one very valuable asset-its route certificate. This asset typically has been sold by merger of weak carriers into stronger carriers. As a result, no large federally certificated air carrier has gone out of business other than through merger with another federally certificated air carrier. Because the Board has allowed virtually no new firms to join the ranks of the certificated air carriers, there has been a steady diminution in the number of air carriers with certificates from the Federal Government.

It has been observed that during the period when California intrastate airlines were essentially free from economic regulation, many firms entered and left the market, but none of them left the market through merger One very careful economic study of this phenomenon, and the contrast between unregulated California airlines and the regulated interstate airlines makes a convincing and apparently unrebutted case that in the absence of economic regulation there probably would have been many more competing airlines in the United States than the CAB has allowed to exist.

As long as new certificates are not freely given, one would expect that there would be some transfer of certificates as carriers seek to reorganize their route authorities. However, sale or trade of certificate authority has been fairly rare, although not unprecedented, because until lately the Civil Aeronautics Board did not encourage such "trafficking in certificates." Recently, the Board's willingness to consider transfer of certificate authority has led to a number of "route swap" proposals. Generally speaking, route transfers-including the reciprocal route transfers currently called route exchanges are merely partial mergers. Consequently, as with mergers, there would be far fewer route transfers, if any, in the absence of entry restrictions.

Other asserted reasons to regulate entry and exit from air transportation markets are that without such regulation, there would be "destructive." or predatory conduct by airline firms, and "chaotic" conditions would constitute a serious public detriment. Let us examine these fears in turn.

UNFAIR COMPETITION

In order for predatory conduct to pay off, it is necessary for a firm to go through two processes: First, it must drive competitors from the market by using predatory practices, such as below-cost price cuts. This kind of conduct is costly to the would-be predator. Second, the predator must recoup those costs by using the resulting freedom from competition to behave like a monopolist. This second step will not be possible if the firms which were driven out can reenter the market quickly and easily. As I have explained, entry into air transportation markets generally would not be difficult to accomplish quickly if there were no Government restriction. Accordingly, the economists who have written on this matter have concluded that the prospects for profitable predatory conduct are poor in this industry. Given these economic facts, Government regulation of entry actually can cause the predatory conduct it is supposed to prevent. A Government prohibition on entry can be the most effective insurance possible for a predator which is trying to recoup the costs of predatory conduct.

SERVICE COMPETITION

Of course, if predatory conduct should take place in the airline industry, it is subject to the antitrust laws just as it is in another industry, if it is not somehow immunized by Government action. In terms of pricing policy, the key point here is that the economic characteristics of the airline industry are such that even when the Government eliminates price competition, carriers still have the incentive to compete, and will compete any way they can, if only through "frills" which are less important to passengers than price. Once a flight is scheduled, the cost of carrying additional passengers in the airplane is very low compared to the cost of flying the airplane in the first place. Thus, the marginal passenger on a flight is very profitableany competitive initiative which diverts passengers onto an airline's flight may pay off richly.

In scheduled service, it appears that next to price, the variable most important to the passenger on a scheduled airline flight is the ability to find a seat on a flight at or near his preferred departure time. Consequently, when the price is fixed, competitive rivalry is diverted into capacity competition-competing carriers offer large numbers of flights in an attempt to cover as many preferred departure times and attract as many customers as possible. The evidence in the recent capacity reduction agreements case is quite convincing that, even under the present system of uniform fares, carriers do not have the incentive to offer ruinous amounts of capacity simply because of this phenomenon. But it is clear that fare regulation has caused the airlines. to offer the consumer large numbers of flights and empty seats instead of cheaper transportation. Stated another way, they have tended to "compete away" the "monopoly profits" generated by excessively high regulated fares.

EVALUATION OF THE DOMESTIC PASSENGER FARE INVESTIGATION

Allowing price competition by the airlines would give them an incentive to offer consumers a choice as to the combination of fare and

load factor they want, and all the evidence is that the result would be that lower fares would be available to the users of scheduled interstate flights. The experience of the intrastate carriers in California and Texas confirms this. Of course, higher load factors also would be involved-but all this tells us is that the public would rather pay considerably less for travel, even at the price of being somewhat less certain of getting on their first choice of flight. Accordingly, we were disappointed when the Board rejected the arguments of the Depart ments of Transportation and Justice in favor of allowing air carriers to price freely within a "zone of reasonableness" instead of requiring a rigid adherence to one identical fare for all carriers offering service in a particular market.

We were gratified that the Board decided in Phase 6 of the Domestic Passenger Fare Investigation to base its fare decisions upon load factor and seating configuration standards which excluded from the rate base any service amenity not included in the Board's standards for such service. Under the Phase 6 policy, the fare is based on the amount of capacity associated with a standard load factor, in a standard aircraft configuration set by the Board, rather than the actual load factor and configuration of a particular carrier or the industry. We believe this approach can allow carriers greater freedom to experiment with different levels of capacity and types of service without being deprived of the motive to keep their services as economical as possible. In Phase 6 and the related coach lounge proceeding, we argued that the Board violated the spirit of its Phase 6 policy by attempting to punish a carrier offering a different type of service by requiring that carrier to charge a different fare, rather than simply requiring that carrier to charge a fare based upon the more economical aircraft configuration which the Board adopted as its standard. This was the first proceeding in recent years in which we carried our disagreement with the Board to the court of appeals, and this matter is now pending rehearing en banc on the Board's motion after a decision favorable to our position.

We also have pending in the court of appeals a review of the Boards' decision to extend rate regulation to the charter field for the first time, despite numerous arguments in opposition.

The Board generally has applied a specific "rule of reason" standard when it decides whether or not to approve an agreement which restrains competition. That is, if an agreement would have substantial anticompetitive effects under established antitrust principles, it will not be approved unless approval is the only way to meet a serious transportation need or secure important public benefits. Until very recently, the Department of Justice has not participated in very many proceedings concerning air carrier conduct subject to regulation by the Civil Aeronautics Board. In recent years, we have opposed capacity restraint agreements which have been in effect in several markets on the basis of various purported justifications. The capacity agreement question, too, is pending in the court of appeals.

CAB POWER TO GRANT ANTITRUST IMMUNITY

Let me if I might go into detail briefly on the issue of antitrust immunity, which is one of the questions that will be rising later here. Under the present aviation act, the Board has power to approve or disapprove mergers (section 408), control relationships (section 409),

and agreements among air carriers (section 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." (40 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.

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.

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.

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.

Let me if I might now, Mr. Chairman, just very briefly address several conclusions.

There are a variety of problems that we have addressed in the statement. 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.