The Board is also very restrictive with respect to route awards. During the past 5 years, the Civil Aeronautics Board has enforced a de facto route moratorium, pursuant to which it has virtually refused to set for hearing applications for new route authority and has generally denied applications for new competitive authority in cases already in progress.

The Federal Aviation Act grants the Board wide discretion in determining entry and route awards. This discretion has been inappropriately exercised to restrain entry and frustrate the operations of the market. Under the Act the Board is required to set applications for new route authority for public hearing and to dispose of all such applications "as speedily as possible" (Section 401 (c)). In spite of that mandate, few route applications have been set for hearing over the last 5 years. For example, the Board declined to set for hearing an application by North Central Airlines to provide first competitive service (with American Airlines) in the Boston-Detroit market and refused as well to hear an application by North Central to provide competitive service between Philidelphia and Milwaukee even though the two carriers authorized in that market had virtually eliminated nonstop service. The Board's rationale has been that the new service offered limited public benefits which were outweighed by the harm which competition would have on the entrenched carrier.

Under Board procedures applicants for operating authority are placed on the horns of a serious dilemma. In spite of the fact that the Board is required by law to hear all applications filed, the application often sits in the docket without any action taken unless the applicant also files a petition for expedited hearing. By a new regulation adopted in the fall of 1973, the Board now dismisses all applications which are the subject of such a petition for an expedited hearing upon denial of that petition. And the Board most always denies such petitions. Thus, a carrier has the grim choice of requesting expedited hearing, which will probably be dismissed, or having no action taken at all. As a result, the number of new route applications being filed has slowed to a mere trickle.

During the route moratorium, those cases already in progress have advanced slowly with final Board decision still pending in some cases originally instituted in the sixties, such as the additional service to Omaha and Des Moines case and the Reno-Portland/Seattle nonstop investigation. The Atlanta-Detroit/Cleveland and Cincinnati investigation was before the Board over 5 years (February 1969 to May 1974) before being decided, and its decision was based on an issue not in the case when initially filed-the national fuel shortage. The delay of the proceedings has cast a heavy burden upon the industry.

A few route cases have been decided during the moratorium period, but with the general result that applications for competitive route authority have been denied. In reaching these decisions the Board has placed little emphasis on competition and on the needs of the public for additional service. Instead, it has placed major emphasis on the financial impact which the services of new carriers would have on the incumbent carriers. For example, the Board denied an application for competitive service in the San Diego-Denver market on the ground that such an award would cause revenue diversion from Western Air Lines. (That case is now before the U.S. Court of Appeals.) Even where the Board does consider competition, it views it in the narrow perspective of service adequacy in terms of capacity, rather than the potential for lower prices. Potential applicants have learned that it is bad strategy to base their case on lower prices. Failure of the Board to consider lower prices is a serious deficiency in the Board's decision making process. The result of Board's entry policy is that the American consumer is not afforded the range of price and service options that an efficient market would provide and often must purchase more service than he wants or needs.

What we need in terms of entry is a 2-pronged approach. First we need to weigh the entry standard more heavily in favor of competition and efficiency. Second, we need a requirement that cases before the Board be decided promptly. The Board must focus upon the needs of the public and the need for competition and innovation, and place less emphasis on the impact upon the existing carrier. Adoption of this approach would not necessarily lead to the addition of new carriers on each domestic route nor even the addition of new carriers to the majority of domestic routes. Rather the basic result of this new approach will be the introduction of potential competition to ensure that the domestic air markets operate efficiently and that the consumer obtains the price and service option of his choice. The threat of potential entry will police and discipline market behavior and ensure competitive market results. Liberalized entry will place firms

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on the edge of the market, able and ready to step into that market when the consumer is dissatisfied with the existing service and price. This dissatisfaction will attract entrants. But we think that the existing firms will act as an intelligent businessman, improve their efficiency and keep their prices low enough to keep new firms out. This is the concept of threshold pricing. Prices are kept high enough to make reasonable profits, and low enough to keep new competition out. The consumer benefits. Occasionally, an outsider will be able to enter the market because he will be an innovator and offer a new service or be more efficient. Because of the costs associated with entry, however, he will be the exception to the rule, but the fear of his presence will spur the existing carriers to even greater efficiency and to their own innovation. We are confident the result will be a more efficient and innovative airline industry, providing the public with better service and more price-service options.

Even though this hearing deals with entry, it is important to consider entry in the context of price flexibility. As you will remember, Acting Secretary Barnum testified in favor of the need for more pricing flexibility before this subcommittee. One criticism of pricing flexibility is that only the strong firms will take advantage of it, and they will either drive the prices up or, in the alternative, drive the prices down temporarily to destroy competition, and then increase the price when the competition is gone. Liberalized entry and the threat of potential entry is the regulator and the enforcer which assures that pricing flexibility will not be misused. With liberalized entry, the strong firms will not be able to drive the price up because of the threat of competition. With liberalized entry, the strong firms will have little incentive to underprice their services to drive out old competitors, because there is always the threat of new competition.

There is another aspect of this connection between pricing flexibility and entry that must be mentioned. Many would ask why in an industry where there is existing overcapacity, and where the predictions indicate that future growth will be somewhat slower than in the past, do we want more entry. We have already indicated that we do not believe that easing entry will necessarily increase the number of carriers in the market. But the essential answer to this question is that liberalized entry is the other side of the coin to increased pricing flexibility. Because prices are rigid, competition has concentrated on service and overcapacity has been the result. Only through pricing flexibility will there be a reduction in this overcapacity, and as indicated above, pricing flexibility without liberalized entry would not achieve the full benefits of regulatory change.

In summary, the Board has pursued a restrictive entry and route award policy which has denied the American consumer the full benefits of an efficient air industry that offers him the range of services and prices that it should. We intend to introduce legislation which will turn the focus of the Board away from the protection of existing carriers to the interests of competition, innovation, and the consumer.

Hon. EDWARD M. KENNEDY,
U.S. Senate,

Washington, D.C.

OFFICE OF THE SECRETARY OF TRANSPORTATION,

Washington, D.C., Apr. 25, 1975.

DEAR SENATOR KENNEDY: In the course of our participation in the recent hearings held by your subcommittee on economic regulation of aviation, a number of questions were asked of the Department which required supplementary written response. Our answers to your questions follow.

Question 1. What is the Department's response to the subcommittee's recent staff report on minimum charter air fares?

Answer. Among the procedural suggestions which the staff report discusses are: providing public hearings prior to major Department policy decisions; allowing for public comment in the context of a rulemaking proceeding; establishing an agency official to represent consumer views; requiring that all meetings be held in public; making public transcripts of meetings; providing Federal Register notices of all meetings and hearings; appointing a Department official to decide which decisions require consumer representation or public hearings; institutionalizing methods for soliciting public and consumer views; establishing mechanisms for monitoring compliance with agency orders designed to protect the public; and providing consumer-oriented, in-house antitrust expertise to insure that agency action will further the policies behind antitrust laws.

The general objective of these procedural suggestions-to protect consumer interests from the “vagaries of 'informal' decisionmaking”—are worthy, especially if one accepts the premise that those views are not already adequately considered. The suggestions are innovative. Taken as a group, they represent a departure from traditional policymaking approaches. We believe that some are already effectively being accomplished, others would be difficult or infeasible to administer, and still others have merit and are being discussed, in some form, within the Department.

I think the record of this Department's performance confirms that we are mindful of consumer interests. As public officials, we act in accordance with what we believe to be the public interest. In determining public interest, we recognize the importance of creating a strong national transportation system, of providing an economic climate in which carriers can provide quality service at reasonable profits, of healthy competition, and of consumer needs for safe, reliable, energy-efficient and low-cost transportation. We do not believe that the present system of transport regulations is adequately meeting these objectives and, therefore, we have sought to bring about changes in regulatory policy. The basic thrust of our approach has been to allow wider scope for the operation of market forces in transportation.

Of necessity, in fulfilling our statutory charge, we must take into consideration not only consumer interest but also other national policies which require a healthy transportation system, energy conservation, travel safety, and environmental quality, among other goals. Weighing these sometimes competing considerations is a challenging process.

Reasonable men may differ in judging the degree of our success. But any implication that consumer views are not among the most important of those factors considered in making policy in the Department would not square with the facts.

In general, we believe the administrative burdens of opening to public hearings all Department policy decisions or of requiring that all meetings be public would outweigh the benefits. Allowing public comment in the context of rulemaking proceedings, or having periodic policy conferences which are open to all interested parties, on the other hand, may have more merit. At present, the Department has an official specifically charged with representation of consumer interests who is involved in many, although certainly not all, policy decisions. Public comments are always welcomed and are considered. Department officials speak to industry and consumer groups and meet with each to explain our programs and to solicit comments. The interchange is productive.

To further ensure adequate representation of consumer views, the Department is effecting some changes along lines of the subcommittee staff's suggestions. With respect to determining the level of compensatory charter rates, for example, the Department has developed proposed criteria which have been circulated to other interested executive branch agencies, air carriers and consumer groups. The Department invited interested consumer groups, carriers and other government agencies to participate in an open meeting at the Department on April 11 to discuss our proposed criteria. A member of your staff and consumer representatives were present. To increase consideration of consumer views in our decisionmaking process, we recently published a notice in the Federal Register asking for comments on various specific areas of the present review of international aviation policy. The Department intends to hold a hearing on that review when the work is further along and we welcome consumer, government agency, Congressional and carrier comments throughout the review. These comments will be placed in a public docket. We are also considering holding an open meeting to discuss proposed aviation regulatory reform legislation.

We will continue to review our procedures for public participation and will continue to make every effort to ensure that consumer views are fully considered in all the Department's policy decisions.

Question 2. Does the Department have any studies on the extent to which cross-subsidy exists in the current air system?

Answer. As part of our preparation for the Domestic Passenger Fare Investigation (DPFI), the Department extensively studied air carrier operations in many markets and examined carrier load factors, relevant carrier costs and levels of operations. On the basis of that examination, the Department concluded that carriers are continuously adjusting operations in individual markets so as to achieve a "break-even" level (including profit), but some relatively few city-pair markets probably do not cover fully allocated costs (including profits).

However in those markets, the carriers normally covered variable costs, thus making a positive contribution to the carriers' overall operation.

Markets which make a positive contribution will undoubtedly be retained by the carrier, regardless of the level of federal regulation. The existing CAB accounting system and the costing procedures developed in the DPFI do not recognize that many markets cover the relevant carrier costs if revenue is properly assigned. The analysis which I have described was not embodied in a formal report, study or memorandum.

A theoretical discussion of the cross-subsidy issue was offered as part of the Department's direct case in phase 9 of the DPFI and a copy of our presentation is included. This theoretical analysis was confirmed by our review of carrier costs, load factors and market data.

Other studies of the cross-subsidy issue have been made. They include "Economic Regulation of Domestic Air Transportation: Theory and Policy," by George W. Douglas and James C. Miller III (see, e.g., pp. 53–54, 87-94); "The Local Service Airline Experiment," by George Eads; and the CAB staff study of "Service to Small Communities." With the exception of United's testimony at your hearings, we are not aware of any evidence on cross-subsidy offered by the carriers, although carriers often say there is cross-subsidy. We have not examined the raw data on which United's study is based, but would be pleased to do so if we had access to the data, and make the results of our analysis available to you.

Practical experience over the last 10 years suggests that there is little if any real cross-subsidy in the domestic trunk system. Trunk carriers have been withdrawing from markets which they do not consider economic. Most of these markets are now served either by local service carriers or commuter air carriers. In recent years, trunk carriers have not sought to eliminate service in many markets, even in unprofitable years. This provides some valuable evidence that they do not perceive these markets as uneconomic.

Question 3. If we move to more liberal entry and pricing, what routes will be affected? How many are there? Where are they? Will people on those routes get service?

Answer. Every route may be affected to some extent. Service should increase on some routes and decrease on certain other routes. In some few cases, carriers may suspend service, in which event local service or commuter carriers would probably institute service. In a few cases, direct subsidies from the local communities might be necessary to insure continued service. In some instances, alternate forms of transportation may become relatively more attractive.

We expect that service will be rationalized on grounds of economic justification and that carriers will not serve routes on which they cannot cover their variable costs. It is not possible to do a route-by-route analysis indicating which lowdensity routes would be eliminated without specific carrier cost and revenue data for the routes in question.

Question 4. Can we submit questions on cross subsidy which the subcommittee could address to the ATA and carriers?

Answer. Our General Counsel's office has already provided certain questions for your staff. One reason for the difficulty in assessing the extent to which one route supposedly subsidizes another route is that it depends upon which accounting system is used. Also, accounting systems do not properly measure the economic costs. Each trunk carrier should be requested to identify both profitable and unprofitable routes, the routes they claim are cross subsidized, and the accounting methods used to arrive at the conclusion.

Question 5. What comments do we have on problems of transition to liberalized entry and pricing? How can establi hed carriers be protected or not hurt too badly?

Answer. Transition will depend upon the extent of dercgulation. Phased transition is being discussed. If the industry were to be totally deregulated (which the Administration has not advocated), a transition period would certainly be required.

The airline industry has shown considerable ability to adapt to changing conditions and to meet competitive service innovations. We expect that they will prove similarly resilient and that, far from being injured, their overall economic health will improve as the result of our proposals.

Question 6. Will airline safety be affected by increased competition?

Answer. Regardless of the degree of regulatory reform we propose, we do not have any intention of permitting any deterioration in aviation safety. The Department considers that supervision of aircraft safety standards should be entirely independent of economic regulation. The FAA will continue to maintain high standards. We have discussed the matter of airline safety within the Office of the Secretary and with the FAA. Many changes in the Act which would improve Board procedures and encourage the Board to foster more competition would not require any changes in the existing FAA safety programs or underlying statutes. On the other hand, if complete deregulation of air carriers were envisioned, some statutory changes in the FAA safety authority would be required. As a practical matter, if a number of new carriers were authorized to enter, the FAA workload would be increased in the short run as the carriers went through necessary steps to secure the requisite safety authority from the FAA. Also, the FAA would almost certainly have to increase its inspection activities to ensure that each new carrier was meeting all applicable safety standards. Inspection would be particularly important for carriers that do not appear to have the requisite financial backing to mount sound economic operations.

You are aware that there are a number of carriers which do not operate pursuant to CAB authority which are also required to meet the same safety standards as CAB-regulated carriers. These include Pacific Southwest Airlines in California and Southwest Airlines in Texas. The FAA resources necessary to meet the requirements for increased safety supervision which would accompany any regulatory reform proposal will depend on the specific proposal. We do not anticipate a large increase in FAA safety staff, absent complete deregulation. We will not permit any diminution in strict enforcement of safety standards.

In addition, a number of questions were submitted by Senator Thurmond. Our response to those questions follow.

Question 7. Are you aware of any reliable figures, from any source, which will enable the subcommittee to get some idea on the extent to which price determines the consumer's choice between airlines, trains, buses, or some other public transportation?

Answer. For the most part, the studies which have been completed regarding the effect of price (or other factors) and the choice of transportation mode have not been conclusive or reliable. The primary reason for this is the lack of information which describes how many people are traveling by all of the available transportation modes in individual city-pair markets. There have been several studies completed in particular markets which do provide some insight. These studies show that the sensitivity of mode choice to price is very much dependent upon the purpose of the trip, its distance and the socioeconomic status of the traveler. For example, business travelers are far less sensitive to price than are individuals traveling for recreation purposes. Similarly, higher income people exhibit less concern about trip cost than do lower income travelers. Frequency of service is also an important factor, especially for the business traveler. Additionally, the comparative trip times, including both time spent on the line-haul part of the trip and the time needed to get to and from the terminals, affect an individual's choice of travel mode. The sensitivity of modal choice to any of these factors is further affected by the range of choice which the traveler has in choosing among competing modes. The greater the competition, the more sensitive is the individual's decision with respect to price.

Question 8. (a) What percentage of tourist travel in the United States is by means of passenger aircraft? (b) What percentage of tourist travel in California is by means of passenger aircraft? (c) In Texas?

Answer. Statistics from the 1970 U.S. Census indicate that approximately 7 percent of personal trips for nonbusiness purposes of 100 miles or greater in length are made by air. Of all such trips having at least one end in California, some 14 percent are made by air. This latter figure includes travel leaving or entering California, subject to CAB-regulated rates, and travel within California subject to the lower PUC rates. If it is assumed that trips entering or leaving California have percentages of travelers using air transportation similar to those reported by the U.S. Census for the nation as a whole, then the overall 14 percent figure may suggest that one reason for the higher percentage of California air travel is the lower PUC rates. The similar figure for Texas is 7.5 percent.

Question 9. What costs enter into the consumer's decision to elect air travel over some other method of transportation? Compare the percentages among Los Angeles-Oakland, Los Angeles-San Jose (where somewhat lower fares are in effect), and Boston-Washington or Montreal-Toronto.