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The international regulation of air transport : changing regimes and price effects Dresner, Martin Elliot 1989

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THE INTERNATIONAL REGULATION OF AIR TRANSPORT: CHANGING REGIMES AND PRICE EFFECTS By MARTIN ELLIOT DRESNER B.Comm., The Un i v e r s i t y of Toronto, 1979 M.B.A., York University, 1980 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY i n THE FACULTY OF GRADUATE STUDIES FACULTY OF COMMERCE AND BUSINESS ADMINISTRATION We accept t h i s thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA Ju l y 1989 © Martin E l l i o t Dresner, 1989 In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Co Department of The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 Date ABSTRACT The t h e s i s c o n s i s t s of two major sections. In the f i r s t section, regulatory changes i n the i n t e r n a t i o n a l a i r transport industry were traced from the Second World War to the present. A modified v e r s i o n of hegemonic s t a b i l i t y theory was formulated and applied to the industry i n an attempt to explain the developments. In that hegemonic theory could not adequately explain some of the major developments, a d d i t i o n a l domestic p o l i t i c a l and market s t r u c t u r a l v a r i a b l e s were introduced i n order to a r r i v e at a more comprehensive model of regime change. The comprehensive model added s i g n i f i c a n t l y to the explanation of regime developments. F i n a l l y , the model was used to p r e d i c t future developments i n the industry. I t was predicted t h a t t h e r e was s t i l l p o l i t i c a l c r e d i t to be gained from a i r services l i b e r a l i z a t i o n i n developed areas of the world, such as Europe, and that regulations i n these areas are l i k e l y to be l i b e r a l i z e d . In the second part of the t h e s i s , a model was developed from p r o f i t -maximizing p r i n c i p l e s to explain p r i c e differences on i n t e r n a t i o n a l a i r r o u t e s . Major assumptions of the model were that a i r l i n e s competing on l i b e r a l i z e d a i r routes engaged i n Bertrand p r i c i n g behaviour, while c a r r i e r s competing on n o n - l i b e r a l routes colluded to set p r i c e s . These assumptions were c o n s i s t e n t w i t h i n d u s t r y p r a c t i c e s . Data were gathered on 51 i n t e r n a t i o n a l a i r routes between the years 1976 and 1981, the period when the U n i t e d S t a t e s f i r s t i n t r o d u c e d l i b e r a l b i l a t e r a l agreements. Several empirical versions of the model were used to t e s t for p r i c e e f f e c t s that arose from the l i b e r a l agreements. The findings were that the l i b e r a l agreements c o n t r i b u t e d to s i g n i f i c a n t l y lower d i s c o u n t fares but not n e c e s s a r i l y to s i g n i f i c a n t l y lower normal f a r e s . The f i n d i n g s were consistent with the use of greater p r i c e d i s c r i m i n a t i o n under the l i b e r a l b i l a t e r a l agreements. i i i TABLE OF CONTENTS ABSTRACT i i TABLE OF CONTENTS . i v LIST OF TABLES x LIST OF FIGURES x i i ACKNOWLEDGEMENTS x i v PART ONE: INTRODUCTION I. INTRODUCTION 1 A. Research Issues 1 B. Contributions of the Thesis 4 C. Limitations of the Thesis 5 1. Limitations on the Discussion of A i r Freight 5 2. Limitations of the Econometric Model to Price Comparisons . 7 D. Structure of Thesis 7 I I . DEVELOPMENTS IN INTERNATIONAL AIR TRANSPORT 9 A. Industry Growth 9 1. T o t a l and International Growth Levels . 9 2. Regional Growth 13 3. Scheduled vs. Charter Growth 16 B. The United States' P o s i t i o n i n A i r Transport 19 C. IATA's P o s i t i o n i n A i r Transport 21 D. Trends i n A i r C a r r i e r Fleets 31 E. Trends i n P r i c i n g and Products 32 F. F i n a n c i a l P o s i t i o n of the A i r l i n e Industry 34 G. A i r Transport Safety 37 H. Summary 39 i v PART TWO: HEGEMONIC THEORY AND REGIME CHANGES IN INTERNATION AIR TRANSPORT I I I . HEGEMONIC STABILITY THEORY AND ITS CRITICS 42 A. Introduction 42 B. C r i t i c i s m s of Hegemonic S t a b i l i t y Theory 44 C. Empirical Tests of Hegemonic S t a b i l i t y Theory 45 1. Jonsson (1987) 49 2. Busza (1987) 56 D. Reformulation of Hegemonic S t a b i l i t y Theory 64 E. O t h e r F a c t o r s R e l e v a n t t o the E x p l a n a t i o n of Regime Development 67 1. Domestic A f f a i r s 69 a) P o l i t i c i a n s 69 b) Bureaucrats 70 c) Interest Groups and t h e i r Lobbyists 72 d) Voters 74 2. S t r u c t u r a l Factors 77 a) Number of Producers 78 b) New Technology 79 c) Economic Downturns 80 d) Height of Entry (and Exit) B a r r i e r s 80 3. Overriding State Interests 80 F. Summary 82 IV. APPLYING HEGEMONIC STABILITY THEORY TO REGIME CHANGES IN INTERNATIONAL AIR TRANSPORT 84 A. Introduction 84 B. The 1946 Bermuda Regime 85 1. Developments Leading to the Formation of the 1946 Bermuda Regime 89 a) The Regulation of A i r Transport before World War Two . 89 b) The Chicago Conference of 1944 91 c) The Formation of IATA 93 d) The Bermuda 1 Agreement 94 v 2. A n a l y s i s of the Formation o f the Regime Us i n g the Modified Hegemonic S t a b i l i t y Theory 96 3. Results from the Analysis Using the Modified Hegemonic S t a b i l i t y Theory 101 4. Other Factors i n the Explanation of the Adoption of the 1946 Bermuda Regime 101 a) Domestic A f f a i r s 101 b) S t r u c t u r a l Factors 108 c) Overriding State Interests 108 5. Summary 109 C. The 1965 Post-Bermuda Regime 110 1. Developments Leading to the Formation of the 1965 Post-Bermuda Regime 115 a) B i l a t e r a l Regulation 115 b) IATA and M u l t i l a t e r a l P r i c e - S e t t i n g 118 c) Non-IATA A i r Transportation 122 d) Post-Bermuda Developments - A Summary 124 2. A n a l y s i s of the Maintenance of the Regime Using the Modified Hegemonic S t a b i l i t y Theory 125 3. Results from the Analysis Using the Modified Hegemonic S t a b i l i t y Theory 130 4. Other Factors i n the Explanation of the Adoption of the 1965 post-Bermuda Regime 132 a) Domestic A f f a i r s 132 b) S t r u c t u r a l Factors 134 c) Overriding State Interests 137 5. Summary 138 D. The 1981 L i b e r a l Regime 139 1. Developments Leading to the 1981 L i b e r a l Regime 143 a) Pre-Liberal Developments - 1966-1977 143 b) The U.S. Pro-Competitive P o l i c y - 1977-1981 149 c) Further Developments 156 d) Developments Leading to the 1981 L i b e r a l Regime - A Summary 159 v i 2. Analysis of the Formation of the L i b e r a l Regime Using the Modified Hegemonic S t a b i l i t y Theory 160 3. Results From the Analysis Using the Modified Hegemonic S t a b i l i t y Theory 164 4. Other Factors i n the Adoption of the 1981 L i b e r a l Regime . 165 a) Domestic A f f a i r s 165 b) S t r u c t u r a l Factors 169 c) Overriding State Interests 175 5. Summary 175 E. The 1986 Post-Liberal Regime 176 1. Developments Under the Pos t - L i b e r a l Regime 177 a) The U.S.-E.C.A.C. Memorandum of Understanding . . . . 181 b) The Re-Establishment of a P r o - A i r l i n e P o l i c y by the U.S 182 c) L i b e r a l i z a t i o n i n Europe and Elsewhere 185 d) Developments Under the P o s t - L i b e r a l Regime - A Summary 187 2. Analysis of Post-Liberal Developments Using the Modified Hegemonic S t a b i l i t y Theory 188 3. Results from the Analysis Using the Modified Hegemonic S t a b i l i t y Theory 191 4. Other Factors i n the Adoption of the 1986 Pos t - L i b e r a l Regime 193 a) Domestic A f f a i r s 193 b) S t r u c t u r a l Factors 195 c) Overriding State Interests . 196 5. Summary 197 F. Conclusions and Future Prospects 198 1. Conclusions 198 a) 1946 Bermuda Regime 198 b) 1965 Post-Bermuda Regime . . 199 c) 1981 L i b e r a l Regime 199 d) The 1986 Post-Liberal Regime 199 2. Future Prospects . 200 v i i PART THREE: PRICING ON INTERNATIONAL AIR ROUTES V. PRICING ON INTERNATIONAL AIR ROUTES 204 A. Introduction 204 B. Research Methods for Comparing A i r l i n e Prices 205 1. Informal Approach 205 2. Simple Regression Approach 207 3. Single Equation, Mu l t i p l e Regression Approach 208 4. M u l t i p l e Equation Approach 209 5. Cost-Based Approach 213 C. A T h e o r e t i c a l Model f o r Comparing P r i c e s Across A i r l i n e Markets 214 1. P r i c i n g Assumptions Under the T r a d i t i o n a l and Competitive Agreements 214 2. The Cost Equation 218 3. The Price Equation Under a Competitive Agreement 219 4. The P r i c e E q u a t i o n Under a T r a d i t i o n a l B i l a t e r a l Agreement 220 5. Reconciling the Prices 221 6. Using the Model w i l l Route S p e c i f i c Data 223 7. Comparison to Previous Work 226 D. Estimation: Model and Data 226 1. The Model 226 a) Price 227 b) No Competitive B i l a t e r a l 228 c) Route S p e c i f i c Costs 230 d) Passengers 232 e) Form of Estimation 232 2. The Data 235 a) Routes 235 b) Prices 235 c) Passengers 237 d) Distance 237 e) Non-Competitive Routes 238 f) Population and Income 239 g) Descriptive S t a t i s t i c s 239 v i i i E. Results of Estimation 242 1. Regressions on the F u l l Price 242 a) Linear Regressions 242 b) Log-Linear Regressions 249 c) Summary of Major Results 255 2. Regressions on the Discount Price 255 a) Linear Regressions 255 b) Log-Linear Regressions 261 c) Summary of Major Results 267 F. Residual Analysis 267 G. Conclusions 268 PART FOUR: CONCLUSIONS AND FUTURE RESEARCH VI. CONCLUSIONS AND FUTURE RESEARCH 271 A. Regime Changes 271 1. Conclusions 271 2. Future Research 271 B. Price E f f e c t s 272 1. Conclusions 272 2. Future Research 272 APPENDICES 274 Appendix A: Data Tables Corresponding to Figures i n Text 275 Appendix B: Freedoms of the A i r 290 Appendix C: Evidence of C a r r i e r S p e c i f i c P r i c i n g on the North A t l a n t i c and North P a c i f i c 291 Appendix D: Regressions Using D i f f e r e n t F i r s t Stage Equations . . .292 Appendix E: Errors i n Variable Problem 303 REFERENCES 305 i x LIST OF TABLES Table 3.1 P a r t i c i p a n t s i n the Policy-Making Process: Goals and Roles 75 Table 3.2 S t r u c t u r a l Factors Influencing the Maintenance of a C a r t e l 81 Table 4.1 Snap-Shot of the 1946 Bermuda Regime and Related Environmental and Industry Factors 86 Table 4.2 Snap-Shot of the 1965 Post-Bermuda Regime and Related Environmental and Industry Factors I l l Table 4.3 Snap-Shot of the 1981 L i b e r a l Regime and Related Environmental and Industry Factors . . . . 140 Table 4.4 Snap-Shot of the 1986 Post-Liberal Regime and Related Environmental and Industry Factors 178 Table 4.5 Applying Modified Hegemonic S t a b i l i t y Theory to the D i f f e r e n t Regulatory Regimes 192 Table 5.1 Advantages and Disadvantages of the Approaches to the Comparison of A i r Fares 215 Table 5.2 Descriptive S t a t i s t i c s - Routes 240 Table 5.3 Descriptive S t a t i s t i c s - Variables 241 Table 5.4 Linear Regressions on the F u l l Price 243 Table 5.5 Log-Linear Regressions on the F u l l Price 250 Table 5.6 Linear Regressions on the Discount Price 256 Table 5.7 Log-Linear Regressions on the Discount Price 262 Table A l Scheduled A i r l i n e Services - Tonne Kilometres 275 Table A2 Scheduled A i r l i n e Services - Passenger Kilometres . . . . 276 Table A3 Scheduled A i r l i n e Services - Passengers 277 Table A4 Scheduled A i r l i n e Services - Average Annual Growth i n Passenger-Kilometres 278 Table A5 Scheduled A i r l i n e Services - Regional Breakdown of T r a f f i c 279 Table A6 Scheduled A i r l i n e Services - Growth Rates i n Regional Tonne-Kilometres 280 Table A7 Charter A i r l i n e Services - International Tonne-Kilometres and Percent of T o t a l A i r l i n e T r a f f i c 280 x Table A8 U.S. Scheduled A i r l i n e Service - Passenger Kilometres and Percent of World Scheduled T r a f f i c 281 Table A9 Schedule A i r l i n e Services - To t a l Passenger-Kilometres and Percent of World T r a f f i c - Top Ten Countries i n 1985 . . 282 Table A10 Scheduled A i r l i n e Services - International Passenger-Kilometres and Percent of To t a l I n t ernational T r a f f i c -Top Ten Countries 282 Table A l l IATA A i r l i n e s ' T r a f f i c - Tonne-Kilometres and Percent of World Scheduled T r a f f i c 283 Table A12 IATA and To t a l Scheduled Services - Comparison of Growth Rates i n Tonne-Kilometres 284 Table A13 IATA A i r l i n e s ' International T r a f f i c - Tonne-Kilometres and Percent of International Tonne-Kilometres 284 Table A14 IATA Membership by Type of Member 285 Table A15 Active IATA Membership - A i r l i n e s of Developed Non-Communist, East Bloc and Developing Countries 286 Table A16 IATA Members' A i r c r a f t F leet 286 Table A17 D i s t r i b u t i o n of IATA Fare Classes on Scheduled North A t l a n t i c Services 287 Table A18 Scheduled A i r Ca r r i e r s - Operating Revenues and Operating P r o f i t s 288 Table A19 Safety on Scheduled A i r Services - A i r c r a f t Accidents Involving Passenger F a t a l i t i e s and F a t a l i t i e s per 100 M i l l i o n Passenger-Kilometres 289 Table Dl Regressions on the F u l l Price Using D i f f e r e n t F i r s t Stages 293 Table D2 Regressions on the Discount Price Using D i f f e r e n t F i r s t Stages 297 x i LIST OF FIGURES Figure 2.1 Schedule A i r l i n e Services: T o t a l Tonne-Kilometres and International Tonne-Kilometres, 1950-1985 10 Figure 2.2 Scheduled A i r l i n e Services: T o t a l Passenger-Kilometres and International Passenger-Kilometres, 1945-1985 . . . . 11 Figure 2.3 Scheduled A i r l i n e Services: T o t a l Passengers and International Passengers, 1945-1985 12 Figure 2.4 Scheduled A i r l i n e Services: Growth i n Total Passenger-Kilometres and International Passenger-Kilometres, 1951-1985 14 Figure 2.5 Scheduled A i r l i n e Services: Regional Breakdown of A i r l i n e T r a f f i c , 1951-1985 15 Figure 2.6 Scheduled A i r l i n e Services: Growth Rates i n Regional A i r l i n e Tonne-Kilometres, 1951-1985 17 Figure 2.7 Charter A i r l i n e Services: International Tonne-Kilometres and Percent of To t a l International T r a f f i c , 1971-1985 . . 18 Figure 2.8 U.S. Scheduled A i r l i n e Services: U.S. Passenger-Kilometres and Percent of World Scheduled T r a f f i c , 1955-1985 . . . . 20 Figure 2.9 Scheduled A i r l i n e Services: T o t a l Passenger-Kilometres and Percent of World T r a f f i c - Top Ten Countries, 1985 22 Figure 2.10 Scheduled A i r l i n e Services: International Passenger-Kilometres and Percent of To t a l International T r a f f i c -Top Ten Countries, 1985 23 Figure 2.11 IATA A i r l i n e s ' T r a f f i c : IATA Percent of World Scheduled Services, 1955-1985 . . . . 24 Figure 2.12 IATA and To t a l Schedule Services: Comparison of Tonne-Kilometre Growth Rate, 1955-1985 26 Figure 2.13 IATA A i r l i n e s ' International T r a f f i c : IATA International Tonne-Kilometres and IATA Percent of Int e r n a t i o n a l Scheduled Services, 1965-1985 . 27 Figure 2.14 IATA Membership: T a r i f f Coordination, Trade A s s o c i a t i o n and Associate Members, 1951-1987 29 x i i Figure 2.15 Active IATA Membership: A i r l i n e s of Developed Non-Communist, East Bloc and Developing Countries, 1950-1985 30 Figure 2.16 IATA Members' A i r c r a f t Fleet, 1960-1985 33 Figure 2.17 D i s t r i b u t i o n of IATA Fare Classes: Scheduled North A t l a n t i c Services, 1950-1986 35 Figure 2.18 Scheduled A i r C a r r i e r s : Operating Revenues and Operating P r o f i t s , 1960-1985 36 Figure 2.19 Safety on Scheduled A i r Services: A i r c r a f t Accidents Involving Passenger F a t a l i t i e s and F a t a l i t i e s per 100 M i l l i o n Passenger-Kilometres, 1950-1985 38 Figure 3.1 The Post-Bermuda Regime i n the Context of the Modified Hegemonic S t a b i l i t y Theory 68 Figure 3.2 Public Choice Model of Policy-Making 76 Figure 4.1 The Bermuda Regime i n the Context of the Modified Hegemonic S t a b i l i t y Theory 102 Figure 4.2 The Post-Bermuda Regime i n the Context of the Modified Hegemonic S t a b i l i t y Theory 131 Figure 4.3 The L i b e r a l Regime i n the Context of the Modified Hegemonic S t a b i l i t y Theory 166 x i i i Acknowledgements I g r a t e f u l l y acknowledge the f i n a n c i a l assistance provided by U.B.C.'s I n s t i t u t e o f International Relations and the Transport Canada U n i v e r s i t y Programme and the h e l p and guidance from the f o l l o w i n g : My t h e s i s supervisory committee c o n s i s t i n g of Michael Tretheway (supervisor), Tae Oum, William Stanbury, I l a n Vertinsky and Mark Zacher; my many Ph.D. colleagues and f r i e n d s who were always a v a i l a b l e to discuss research ideas and to provide advice on research i n progress; Dave Hobden, who was instrumental i n gathering data, constructing the data base, doing many of the preliminary estimations f o r t h i s thesis and producing the figures i n Chapter 2; Sue Lui who d i d most of the word processing and acted as my Vancouver contact a f t e r I moved to Maryland; and l a s t but c e r t a i n l y not l e a s t , my wife L o r r i e , who not only helped me gather data but provided the emotional support I needed to complete the t h e s i s . x i v PART ONE: INTRODUCTION I. INTRODUCTION A. Research Issues The l a s t f o r t y years have seen profound changes i n i n t e r n a t i o n a l a i r transport. C i v i l a v i a t i o n had come to a v i r t u a l h a l t during World War Two. Since that time, a i r transport has grown to become, by f a r , the primary means of transporting passengers over long distances. 1 In the l a s t four decades, i n t e r n a t i o n a l a i r transport has emerged as one of the key b u i l d i n g blocks i n the c r e a t i o n of what i s widely preferred to as our global v i l l a g e . This thesis examines developments i n i n t e r n a t i o n a l a i r transport i n two ways. F i r s t , the thesis uses regulatory developments i n i n t e r n a t i o n a l a i r transport since World War Two to tes t a p o l i t i c a l theory of regime changes-the t h e o r y of hegemonic s t a b i l i t y . Second, an econometric model i s constructed to t e s t the p r i c e e f f e c t s from the change to a more competitive regime i n the l a t e 1970s. The s p e c i f i c research issues addressed i n t h i s thesis include the following: Does the theory of hegemonic s t a b i l i t y p r o v i d e an adequate explanation of regime changes i n i n t e r n a t i o n a l a i r transport? Can 1 On the North A t l a n t i c , f o r example, a i r l i n e s surpassed ocean l i n e r s i n terms of passengers c a r r i e d i n 1958. In 1952, a i r l i n e s c a r r i e d only 34 percent of North A t l a n t i c passengers. By 1957, t h i s f i g u r e had r i s e n to j u s t under 50 percent, and by 1960, to 69 percent (Armstrong, 1961, p. 223). Currently, v i r t u a l l y a l l North A t l a n t i c passengers t r a v e l by a i r . 1 a d d i t i o n a l p o l i t i c a l and economic factors add s i g n i f i c a n t l y to our understanding of the developments? What are the p r i c e e f f e c t s from the regime change? How can an a p p r o p r i a t e model be c o n s t r u c t e d from basic p r o f i t maximizing assumptions and be used to test the p r i c e e f f e c t s from the change to a more competitive regime? These i s s u e s are important f o r s e v e r a l reasons. The problem of explaining regime changes using the theory of hegemonic s t a b i l i t y has been the s u b j e c t o f much debate i n the i n t e r n a t i o n a l r e l a t i o n s l i t e r a t u r e . 2 A r t i c l e s have been produced that both support and are c r i t i c a l of t h i s theory. However, very few rigorous tests of the theory have been conducted and not many a l t e r n a t i v e explanations f or regime changes have been proposed. 3 T h i s t h e s i s p r o v i d e s both a r i g o r o u s e m p i r i c a l t e s t of the hegemonic s t a b i l i t y theory as well as a l t e r n a t i v e factors u s e f u l i n the explanation of regime changes. The problem of developing a model to te s t f o r p r i c e changes due to r e g u l a t o r y s h i f t s i s important because much of the previous work on the comparison of p r i c e s across markets has not been formulated using basic p r o f i t maximizing ( n e o - c l a s s i c a l economic) assumptions. With the p r i o r formulations, researchers have not been c e r t a i n of which v a r i a b l e s to include i n t h e i r models, the expected signs of the regression c o e f f i c i e n t s , or the 2 See Chapter III f o r a review of the hegemonic s t a b i l i t y l i t e r a t u r e . 3 See Haggard and Simmons (1987) for a discussion of alternate theories of regime developments. 2 i m p l i c i t assumptions of t h e i r models. A rigorous formulation of a model based on p r o f i t maximizing assumptions can eliminate these issues. The i n t e r n a t i o n a l a i r t r a n s p o r t i n d u s t r y i s a p p r o p r i a t e to test hegemonic theo r y and the p r i c e model because of the evolution of the i n d u s t r y . The i n t e r n a t i o n a l a i r transport regime had a long period of r e l a t i v e s t a b i l i t y a f t e r the regime was formed following World War Two. This period of s t a b i l i t y ended i n the l a t e 1970s when the regime was dramatically transformed. The industry thus provides a good t e s t for the hegemonic model i n that i t can be tested both i n the explanation of the period of s t a b i l i t y and of the regime s h i f t . An adequate model of regime development should be able to explain both of these phenomena. The i n t e r n a t i o n a l a i r transport industry also i s a good industry for t e s t i n g the p r i c e model because of the a v a i l a b i l i t y of reasonably good data. Data were c o l l e c t e d on 51 i n t e r n a t i o n a l routes over the period 1976-1981, allowing f o r the construction of a panel data set of 612 observations. In a d d i t i o n to the methodological considerations, the a i r transport i n d u s t r y was s t u d i e d because of i t s importance i n the world economy. A i r l i n e s operate i n v i r t u a l l y every country of the world. 4 Most people own, through t h e i r governments or p r i v a t e l y , shares i n an a i r l i n e . M i l l i o n s of people f l y on a i r l i n e s each year, and m i l l i o n s more who do not, meet friends, 4 A i r l i n e s from 101 countries reported data to the International C i v i l A v i a t i o n Organization i n 1985. Since data are reported on a voluntary basis, the 101 countries represented only a subset of countries with a i r l i n e s (ICAO, 1985b, pp. 53-61). 3 r e l a t i v e s or business contacts who have flown. Thousands of businesses r e l y on a i r f r e i g h t to carry t h e i r goods to markets. In short, a i r t r a v e l has become ubiquitous. B. Contributions of the Thesis This thesis contributes to the advancement of knowledge i n a number of d i f f e r e n t ways: I t develops a rigorous method for t e s t i n g the explanatory powers of the hegemonic theory of regime change. I t p o s i t s and examines c a r e f u l l y a set of economic and p o l i t i c a l f a c t o r s useful i n the explanation of the evolution of regulatory regimes i n i n t e r n a t i o n a l a v i a t i o n . I t develops a model to t e s t p r i c e changes on i n t e r n a t i o n a l a i r markets from basic p r o f i t maximizing assumptions. Previous models have not been derived from such a well-developed theory. I t uses a method that allows for the a priori p r e d i c t i o n of the s i g n of the c o e f f i c i e n t of one of the key v a r i a b l e s i n the econometric model. This allows the researcher to be more confident of the estimated r e s u l t s . 4 The thesis shows that the c o e f f i c i e n t of the passengers v a r i a b l e i n the p r e d i c t i o n of p r i c e has two e f f e c t s ; a demand e f f e c t and a cost e f f e c t . Under normal operating conditions both e f f e c t s should be p o s i t i v e . Previous researchers have interpreted the c o e f f i c i e n t as measuring economies of density (a negative e f f e c t ) and have been unable to e x p l a i n the low magnitude or the wrong sign of the estimated c o e f f i c i e n t . I t s p e c i f i e s the assumptions required when aggregating a i r l i n e s p e c i f i c data into route s p e c i f i c data. Previous researchers have only made these assumptions i m p l i c i t l y . I t measures the p r i c e e f f e c t s from the change to a competitive i n t e r n a t i o n a l regime from a regulated regime. Previous models have been used mainly to measure p r i c e e f f e c t s i n the U.S. domestic industry. C. L i m i t a t i o n s of the Thesis 1. Limitations on the Discussion of Air Freight Although the importance of a i r f r e i g h t to the a i r l i n e s and to society i s acknowledged, 5 i t i s not dealt with e x p l i c i t l y i n t h i s t h e s i s . The analysis i s confined to explaining the changing regulatory regimes of passenger a i r 5 A i r f r e i g h t i s not j u s t an important source of revenue to the a i r l i n e s , i t i s also a f a s t e f f i c i e n t means f o r businesses to market t h e i r products. A i r c a r r i e r s have a r o l e i n transporting a number of d i f f e r e n t types of f r e i g h t , including emergency goods, perishables, and products with a high value to weight r a t i o . 5 t r a n s p o r t , and to the impact of the l i b e r a l i z a t i o n of i n t e r n a t i o n a l a i r regulations on passenger a i r fares. In 1983, the world's scheduled a i r l i n e s performed 145 b i l l i o n tonne-kilometres of scheduled a i r services (ICAO, 1984b, p. 19). Freight and mail accounted for 27 percent of that t o t a l . However, the 27 percent figure o v e r s t a t e d , somewhat, the v a l u e of f r e i g h t transport to the scheduled a i r l i n e s . In terms of t o t a l operating revenues, f r e i g h t and mail accounted f o r only 13 percent of t o t a l revenues for scheduled a i r l i n e s (ICAO, 1984b, p. 25). This fi g u r e declined s l i g h t l y from 14.6 percent i n 1974. F r e i g h t r e p r e s e n t s a v a l u a b l e "by-product" of the o p e r a t i o n s of i n t e r n a t i o n a l scheduled a i r l i n e s (Doganis, 1985, pp. 244-245). A i r l i n e s carry f r e i g h t i n order to recover part of t h e i r passenger-related c o s t s . 6 I t i s because of t h i s r e s t r i c t i v e "by-product" view of a i r f r e i g h t by a i r l i n e s that the impact of a i r f r e i g h t on the i n t e r n a t i o n a l a i r system has not been great. 7 A i r l i n e s have mainly been in t e r e s t e d i n ca r r y i n g passengers and the r e g u l a t o r y regimes have generally been designed to c o n t r o l passenger a i r 6 For example, i n 1982, B r i t i s h Airways estimated that 51 percent of f r e i g h t revenues on passenger a i r c r a f t went to cover f r e i g h t - r e l a t e d costs, while the remaining 49 percent were used to cover costs that would have been incurred whether or not f r e i g h t was transported (Doganis, 1985, p. 244). 7 In a d d i t i o n to f r e i g h t c a r r i e d by passenger a i r l i n e s i n the cargo compartments of a i r c r a f t , f r e i g h t may also be transported i n whole airplanes b u i l t or r e c o n s t r u c t e d i n t o " f r e i g h t e r s " . Doganis (1985, pp. 235-236) reported that the operation of these a i r c r a f t experienced a decline i n the 1970s and 1980s. On the North A t l a n t i c , f o r example, the f r e i g h t e r s ' share of the market declined from 62 percent of t o t a l f r e i g h t i n 1969 to 31 percent i n 1983. The advent of the wide-bodied a i r c r a f t , equipped with large cargo compartments, was a major contributing f a c t o r to the decline i n the usage of f r e i g h t e r s . 6 t r a f f i c . The l i m i t a t i o n of t h i s thesis to the r e g u l a t i o n of passenger a i r t r a f f i c , therefore, s t i l l allows for the discussion of the major issues regarding the industry. 2. Limitations of the Econometric Model to Price Comparisons A l i m i t a t i o n of the econometric work i n t h i s thesis i s that i t i s r e s t r i c t e d to the comparison of a i r l i n e prices. P o l i c y analysts generally b e l i e v e that the worthiness of governmental p o l i c i e s should be judged by t h e i r e f f e c t on society's welfare. Although a p o l i c y which r e s u l t s i n lower p r i c e s c a n be j u d g e d to be b e n e f i c i a l to consumers' w e l f a r e , the disadvantages to producers' welfare may outweigh the consumer b e n e f i t s . Therefore, the low p r i c e p o l i c y may be detrimental to society, as a whole. Since only p r i c e s w i l l be compared i n t h i s t h e s i s , no statements on the o v e r a l l b e n e f i t s of a pro-competitive i n t e r n a t i o n a l a i r p o l i c y to society may be proclaimed. The econometric work i n t h i s t h e s i s , therefore, can only be viewed as the f i r s t step towards the assessment of welfare changes a r i s i n g from the l i b e r a l i z a t i o n of a i r regulations. The f i r s t step, however, i s an important one to make. Even though the thesis cannot, by i t s e l f , provide a d e f i n i t i v e answer to the question of the merits of " i n t e r n a t i o n a l deregulation", i t can serve as an important f i r s t step i n determining the answer. 7 D. Structure of Thesis The t h e s i s i s d i v i d e d i n t o f o u r p a r t s . P a r t One c o n t a i n s t h i s i n t r o d u c t i o n as well as a chapter on the development of the a i r transport industry since World War Two. Part Two consists of one chapter reviewing the l i t e r a t u r e on hegemonic s t a b i l i t y theory and formulating the procedure for t e s t i n g a modified v e r s i o n of the theory used i n t h i s t h e s i s . The chapter also examines a set of economic and p o l i t i c a l factors that w i l l be used to add to the explanations of regime developments. The second chapter i n Part Two p r o v i d e s the t e s t of the m o d i f i e d hegemonic t h e o r y u s i n g regime developments i n the i n t e r n a t i o n a l a i r transport industry since World War Two. I t also uses the economic and p o l i t i c a l factors described i n the previous chapter to a i d i n the explanation of the developments. Part Three consists o f a review of models used previously to t e s t p r i c e differences across markets, the formulation of the model used i n t h i s paper, the estimation of the model, and the i n t e r p r e t a t i o n of the r e s u l t s . Part Four i s comprised of one chapter drawing some f i n a l conclusions from the thesis and i l l u s t r a t i n g p o s s i b i l i t i e s f o r future research. 8 I I . DEVELOPMENTS IN INTERNATIONAL AIR TRANSPORT The purpose of t h i s chapter i s to h i g h l i g h t some of the important trends and developments i n i n t e r n a t i o n a l a i r transport from the Second World War to the present. This analysis w i l l provide the reader with a general i n d i c a t i o n of how the industry has changed over the past f o r t y years. The understanding o f how the i n d u s t r y has changed i s a necessary f i r s t step towards the development of t h e o r e t i c a l explanations f o r why the regime changed, as presented i n the next part of t h i s t h e s i s . A. Industry Growth 1. Total and International Growth Levels Figure 2.1 shows the growth, i n tonne-kilometres, experienced by the scheduled a i r transport industry since World War Two.1 The top l i n e i n the fig u r e i l l u s t r a t e s the growth i n t o t a l tonne-kilometres, while the bottom ( d a s h e d ) l i n e i n d i c a t e s the growth i n t o n n e - k i l o m e t r e s c a r r i e d on i n t e r n a t i o n a l routes only. The two graph l i n e s i n d i c a t e the dramatic growth i n a i r t r a n s p o r t since 1950. The figu r e also shows that i n t e r n a t i o n a l scheduled t r a f f i c has accounted f o r approximately one-half of t o t a l scheduled t r a f f i c , i n terms of tonne-kilometres. Figures 2.2 and 2.3 show much the same p i c t u r e as Figure 2.1, but i n terms o f s c h e d u l e d p a s s e n g e r - k i l o m e t r e s and sc h e d u l e d passengers 1 Tonne-kilometres i s a measure of the t o t a l passengers, f r e i g h t , and mail c a r r i e d by the a i r l i n e s . Note that the data f o r t h i s and other figures i n the chapter i s p r i n t e d i n table form i n Appendix A. 9 FIGURE 2 . 1 180 = 120-100-SCHEDULED AIRLINE SERVICES Total Tonne-Kilometres and International Tonne-Kilometres 1950 to 1985 / / •* t t • • * > .P." i f ' ' > - ^ \ . . o - . - - ' ' ' 3 S O U R C E S : IATA (18 e). Wor ld Air Transport Stat i s t ics , various i ssues. ICAO (18 b). Civi l Aviat ion S ta t i s t i c * o l the Wor ld , var ious issues. NOTES: 1. Date for the years 1950-1969 exclude the USSR. 2. Data for 1986 are preliminary. Legend O TOTAL • INTERNATIONAL 1950 1955 1960 1965 1970 Year 1975 1980 1985 FIGURE 2.2 1400 1200-= 1000-£ 800-600-400-200-0 ^ SCHEDULED AIRLINE SERVICES Total Passenger-Kilometres and International Passenger-Kilometres 1945 to 1985 i / ' t * 1945 1950 1965 1960 1965 Year 1970 1975 S O U R C E S : IATA (19 t ) . W o r l d Air Transport S u t l a t i c a . v s n o u * i sauaa. ICAO (19 b). Civil Av ia t ion S tat ia t ica of th« W o r l d , var ious iaauaa. NOTES: 1. Data for the years 1945-1969 exclude the USSR. 2. Data for 1985 are preliminary.  Legend O TOTAL • INTERNATIONAL 1980 1985 FIGURE 2.3 SCHEDULED AIRLINE SERVICES Total Passengers and International Passengers 194S to 1985 900 8 0 0 -7 0 0 -c o 3. 500 O) 4 0 0 c <D CO w 300 200 100 > — ^ J" ^ T - r T I I I I I I I S O U R C E S : IATA (19 a ) . W o r l d A i r T r a n s p o r t S t a t i a t i c s . v a r i o u a i s s u e s . I C A O (19 b ) . C i v i l A v i a t i o n S t a t i a t i c a o f th« W o r l d , v a r i o u a i s s u a a . NOTES: 1. Data for the years 1946-1973 exclude the USSR. 2. Data for 1985 are preliminary.  1945 1950 1955 1960 1965 Year 1970 1975 1980 1985 r e s p e c t i v e l y . The major difference between the figures i s i n the percentage o f t o t a l t r a f f i c accounted f o r by i n t e r n a t i o n a l t r a f f i c . Whereas i n t e r n a t i o n a l tonne-kilometres t y p i c a l l y accounted for about one-half of t o t a l tonne-kilometres, i n t e r n a t i o n a l passenger-kilometres accounted for only about f o r t y p e r c e n t o f t o t a l p a s s e n g e r - k i l o m e t r e s , and i n t e r n a t i o n a l passengers f o r about o n e - f i f t h to one quarter of t o t a l passengers. These v a r i a t i o n s can be e x p l a i n e d by the l o n g e r average stage l e n g t h s i n i n t e r n a t i o n a l a i r transport (as compared to domestic a i r transport) and by the r e l a t i v e l y g r e a t e r importance of f r e i g h t and m a i l t r a f f i c to i n t e r n a t i o n a l a i r transport. Figure 2.4.presents a d i f f e r e n t view of t r a f f i c growth from the previous three f i g u r e s . F i g u r e 2.4 shows average annual t r a f f i c ( d e f i n e d as passenger-kilometres) growth rates f or i n t e r n a t i o n a l and t o t a l t r a f f i c , for four periods: 1951-1959; 1960-1969; 1970-1979; and, 1980-1985. I t can be c l e a r l y seen from t h i s f i g u r e , that f or both t o t a l and i n t e r n a t i o n a l t r a f f i c , the average annual growth rates declined somewhat i n the 1970s, and then again, sharply, i n the 1980s. The decline i n t r a f f i c growth, experienced during the 1980s, may be a t t r i b u t e d , i n part, to the world-wide economic downturn of the e a r l y 1980s, and perhaps also to the o v e r a l l maturation of the a i r l i n e industry. 2. Regional Growth Figure 2.5 provides a breakdown of a i r transport growth by regions of the w o rld. I t can be seen t h a t North America and Europe have been, re s p e c t i v e l y , the l a r g e s t and second l a r g e s t markets f o r a i r transport from 13 FIGURE 2*4 16 -i 14-12-10-SCHEDULED AIRLINE SERVICES Growth In Total Passenger-Kilometers and International Passenger-Kilometers 1951 -1986 S O U R C E S : I A T A (19 a ) . W o r l d A i r T r a n s p o r t S t a t i i t i c a , v a r i o u s i s s u e s . I C A O (18 M . C i v i l A v i a t i o n S t a t i s t i c s o f t h e W o r l d , v a r i o u s I s s u e s . NOTES : 1. Data for the years 1951-1969 exc lude the USSR. 2. Data for 1985 are preliminary.  Legend CZ2 TOTAL m INTERNATIONAL FIGURE 2.5 100-1 SCHEDULED AIRLINE SERVICES Regional Breakdown of Airline Iraffic 1951 to 1985 * -S>N J$> J 3 ^ »-* N ^ ^ 8> ^ Ncj-Year S O U R C E S : I C A O (19 b ) . CWII A v i a t i o n S t a t i a t i c s o f t h e W o r l d , v a r i o u a i a a u e a . NOTES: 1. Data for the years 1951-1969 exclude the USSR. 2. Data for 1985 are preliminary.  the 1950s to the present. However, during the l a s t several years, the growth rates i n these two developed regions of the world have lagged behind the growth rates i n other regions, such as the Middle East and Asia. D i f f e r e n t i a l growth rates are also i l l u s t r a t e d i n Figure 2.6, which compares the average annual growth rates for the d i f f e r e n t regions between 1951 and 1985. The figure shows, that since the 1960s, the Middle East, and A s i a and the P a c i f i c regions have c o n s i s t e n t l y had the highest a i r t r a f f i c growth rates i n the world. During the 1970s, the lowest rates of growth were achieved i n the f u l l y developed regions of North America and Europe, while i n the 1980s, only L a t i n America t r a i l e d the developed regions i n a i r t r a f f i c growth. Also note, that i n the 1980s, growth rates were lower than the growth rates of the 1970s i n a l l regions of the world. As stated above, this was l i k e l y due, i n large part, to economic recession, but might also be p a r t l y explain by the maturation of the a i r l i n e industry, i n the developed regions of the world. 3. Scheduled vs. Charter Growth Charter t r a f f i c , which may be defined as t r a f f i c which does not operate on a regular published time table, has been i n existence since the Second World War. However, i t was not u n t i l the 1960s, that charter services became p o p u l a r v e h i c l e s f o r t r a n s p o r t i n g d i s c o u n t and vacation t r a v e l l e r s on i n t e r n a t i o n a l a i r routes. L i t t l e data are a v a i l a b l e on the volumes of i n t e r n a t i o n a l charter t r a f f i c p r i o r to the 1970s. Figure 2.7, therefore, examines charter t r a f f i c only from 1971 to 1985. I t can be seen, from the 16 FIGURE 2.6 25-r 2 0 -SCHEDULED AIRLINE SERVICES Growth Rates In Regional Airline Tonne-Kilometers 1951 to 1985 S O U R C E S : I C A O (19 b ) . C i v i l A v i a t i o n S t a t i a t i c a o f t h e W o r l d , v a r i o u a i a a u e a . NOTES : 1. Data for the years 1951-1969 exc lude the USSR. 2. Data for 1985 are preliminary.  Legend • i NORTH AMERICA EZ2 EUROPE m ASIA & PACIFIC m LATIN AMERICA O MIDDLE EAST C 2 AFRICA FIGURE 2.7 CHARTER AIRLINE SERVICES International Tonne-Kilometers and Percent of Total International Traffic 1971 to 1985 CO C O S CO <D L _ • + - ' CD E o i2 I CD c c ,o 16 \ \ \ > C a \ • / • / •  % ' , / * O % . .. . \ '. CL • ^ \ : ! ; ; : [ ] 40 35 o 30 *5 K= 15 2 5 . 1 CO c CD c 15 "55 10 o 1971 1973 1975 1977 1979 Year 1981 1983 1985 IATA 119 el. WotttJ At* ItMtoort Statiatloa. varioua laauaa. ICAO (18 b). Civil AwiallOA Suuatioa of tfca Wot Id. »a*»oua iauoa. N O T E S : 1. O a t s t o r 1 9 8 6 ar» p r e l i m i n a r y . Legend O T O N N 6 - K I L O M 6 T E R S • P C R C E N T OF T O T A L f i g u r e , that the volume of i n t e r n a t i o n a l charter t r a f f i c has held reasonably steady during the 1970s and 1980s. However, the figu r e also shows that the r e l a t i v e importance of i n t e r n a t i o n a l charter t r a f f i c has greatly declined since 1971. Charter t r a f f i c ' s percentage of t o t a l i n t e r n a t i o n a l t r a f f i c f e l l from about 39 percent i n 1971 to 13 percent i n 1985. The drop may be at t r i b u t e d , i n large part, to increased low-priced competition from scheduled operators. B. The United States' P o s i t i o n i n A i r Transport The examination of the p o s i t i o n of the industry leader can play an important part i n determining the reasons f o r regime s h i f t s i n an industry. The United States has held a dominant p o s i t i o n i n a i r transport since the Second World War, but i t s dominant p o s i t i o n declined i n recent years. Figure 2.8 presents data f o r the years 1955 to 1985. The figu r e shows that the United States' a i r transport industry has grown f a i r l y s t e a d i l y over the p e r i o d , from p r o d u c i n g 39 b i l l i o n passenger-kilometres i n 1955 to the production of 532 b i l l i o n passenger-kilometres i n 1985. However, the U.S. industry d i d not grow as f a s t as the world industry. The U.S. share of world t r a f f i c stood at 64 percent i n 1955, but only 39 percent i n 1985.2 This represents a s i g n i f i c a n t decline i n the dominance of the United States i n the industry. 2 These figures are somewhat misleading because USSR data were included i n the 1985 world t r a f f i c f i g u r e , but not i n the 1955 t o t a l . However, i f the USSR figures were excluded from the 1985 t o t a l , the U.S. share of world t r a f f i c was s t i l l only 45 percent. 19 FIGURE 2.8 Although the p o s i t i o n of the U.S. c l e a r l y declined i n the decades following the Second World War, the U.S. i n 1985, remained the undisputed leader i n the a i r transport industry. Figure 2.9 presents the breakdown of passenger-kilometres performed and percent of world t r a f f i c , of the leading ten a v i a t i o n nations. I t can be seen that the United States performed nearly three times the t r a f f i c of the second l a r g e s t a v i a t i o n country, the USSR, and more than eight times the t r a f f i c of the t h i r d and fourth l a r g e s t a v i a t i o n countries. In f a c t , the United States performed a larger volume of t r a f f i c than the other nine top countries combined. The dominance of the Uni t e d States i n the a i r transport industry, however, i s not as pronounced when an examination i s made of i n t e r n a t i o n a l passengers, only. As Figure 2.10 shows, U.S. a i r l i n e s performed 18 percent of i n t e r n a t i o n a l passenger-kilometres i n 1985, compared to the second highest t o t a l of 10 percent, performed by a i r l i n e s of the United Kingdom. In the case of i n t e r n a t i o n a l passenger-kilometres, the bottom nine of the top ten countries, combined, outperformed the U.S. by a r a t i o of two to one. C. IATA's P o s i t i o n i n A i r Transport An important aspect i n the e x p l a n a t i o n of regime changes i n the in t e r n a t i o n a l a i r l i n e industry l i e s i n the determination of the strength of the industry's p r i c e - s e t t i n g International A i r Transport A s s o c i a t i o n (IATA). Figure 2.11 provides an i n d i c a t i o n of the growth of IATA services, and of the penetration of IATA i n the industry. The figu r e shows that IATA t r a f f i c increased from 6 tonne-kilometres i n 1955 to 107 tonne-kilometres i n 1985. 21 FIGURE 2.9 SCHEDULED AIRLINE SERVICES Total Passenger-Kilometers and Percent of World Traffic - Top Ten Countries 1986 FIGURE 2 . 1 0 SOfEDULED AIRLINE SERVICES tnternatlonal Passenger-Kilometers and Percent of Total International Traffic - Top Ten Countries 1986 S O U R C E S : ICAO (1885b). Civil Aviation Statlatios 01 the World. FIGURE 2 . 1 1 IATA AIRLINES' TRAFFIC IATA Tonne-Kllometera and IATA Percent of World Scheduled Services 1955 to 1985 1955 1960 1965 1970 1975 1980 1985 Year But during the same period, IATA's share of t o t a l t r a f f i c decreased from about 85 percent to 64 percent. 3 The major decline i n IATA penetration (disregarding the "decline" i n 1970 due to the i n c l u s i o n of USSR figures i n the world t o t a l f o r the f i r s t time) occurred between 1973 and 1981, when IATA's penetration decreased from 76 percent to 64 percent, before l e v e l l i n g again. F i g u r e 2.12 h i g h l i g h t s the differences i n growth rates between IATA c a r r i e r s , and scheduled a i r l i n e s , as a whole. During the periods 1955-1959 and 1960-1969, IATA c a r r i e r growth exceeded t o t a l industry growth rates. However, t h i s s i t u a t i o n was reversed during the 1970s when industry growth out-paced growth by IATA c a r r i e r s . 4 Figure 2.13 examines IATA's share of i n t e r n a t i o n a l scheduled t r a f f i c , only. This f i g u r e , l i k e Figure 2.11, shows a decline i n IATA penetration over the years surveyed. 5 IATA's market penetration i n i n t e r n a t i o n a l t r a f f i c declined from 94 percent i n 1965 to 73 percent i n 1980, before recovering to 3 The f i g u r e s are somewhat misleading because Soviet data were only included i n t o t a l c a l c u l a t i o n s a f t e r 1969. However, i f Soviet t r a f f i c i s excluded from the 1985 t o t a l , the IATA penetration i n that year was s t i l l only 73 percent. 4 One reason f o r the low IATA growth rate of the 1970s was, that towards the end of the decade, a number of important U.S. a i r l i n e s (such as Pan American and TWA) were forced to withdraw from IATA. Most of these c a r r i e r s ( i n c l u d i n g Pan American and TWA) rejoined IATA i n the 1980s, but, as Figures 2.11 and 2.12 show, IATA was s t i l l not able to recover i t s market share. 5 Comparing Figures 2.13 and 2.11, i t can be seen that IATA c a r r i e r s h i s t o r i c a l l y have had a higher percentage of i n t e r n a t i o n a l t r a f f i c than of t o t a l scheduled t r a f f i c . This i s to be expected since active membership i n IATA requires a c a r r i e r to be an i n t e r n a t i o n a l operator. 25 FIGURE 2 . 1 2 IATA and Total Scheduled Services Comparison of Tonne-Kilometer Growth Rates 1965 - 1985 S O U R C E S : I A T A (19 a ) . W o r l d A i r T r a n s p o r t S t a t i s t i c s , v a r i o u a I s a u a s . I C A O (19 b ) . C i v i l A v i a t i o n S t a t i s t i c s o f t h a W o r l d , v a r i o u s i s s u a s . NOTES: 1. Data for the years 1955-1969 exclude the USSR. 2. Data for 1985 are preliminary.  Legend ZZ2 IATA m TOTAL -J c o CO CO 03 k_ •*-> CD E o 52 i CD C c FIGURE 2 . 1 3 IATA AIRLINES' INTERNATIONAL TRAFFIC IATA International Tonne-Kilometers and IATA Percent of International Scheduled Services 196S to 1986 100 to CO c o '*-< CO c l _ CD c CD U k _ CD CL IATA (19 a). World Air Transport Slallaues. varloua iasuaa. ICAO lt« 01. Civil Aviation Statlatloa or tha WoclO. varloua laayaa. N O T E S : t. D a t a l o r t h a y e a r s 1 9 8 6 • 1 9 S 9 e x c l u d e t h e U S S R . 2 . D a t a l o r 1 9 8 6 a r e p r e l i m i n a r y .  Legend O T O N N E - K I L O M E T E R S • P E R C E N T OF T O T A L about 80 percent i n the following years. 6 The major period of decline i n market share was during the 1970s. 7 Figure 2.14 provides an i n d i c a t i o n of the growth i n IATA membership since 1950, s h o r t l y a f t e r the Asso c i a t i o n was formed. The fig u r e shows that t o t a l membership increased from 64 c a r r i e r s i n 1950 to 161 c a r r i e r s i n 1987. However, growth i n membership has not been even among the various classes of IATA members, e s p e c i a l l y during the 1980s. The major growth i n membership during the 1980s has been with i n t e r n a t i o n a l c a r r i e r s that do not p a r t i c i p a t e i n IATA t a r i f f - c o o r d i n a t i o n ( i . e . "Trade Association" members) and with domestic c a r r i e r s , which also do not p a r t i c i p a t e i n t a r i f f - c o o r d i n a t i o n ( i . e . "Associate" members). T a r i f f coordination membership a c t u a l l y peaked i n the l a t e 1960s and early to mid-1970s at about 90 c a r r i e r s . In 1987, only 81 IATA c a r r i e r s p a r t i c i p a t e d i n the A s s o c i a t i o n ' s t a r i f f - c o o r d i n a t i o n conferences. Figure 2.15 provides a d i f f e r e n t assessment of IATA's growth. Figure 2.15 shows how IATA's growth has been d i s t r i b u t e d among a i r l i n e s of non-Communist developed c o u n t r i e s , a i r l i n e s of Eastern bloc countries, and a i r l i n e s of developing countries. I t can be seen that Eastern bloc c a r r i e r s 6 The large drop i n IATA's market share.in 1979 can be explained by the withdrawal of U.S. c a r r i e r s from the Asso c i a t i o n (most notable Pan American and TWA). Likewise, the gain i n market share, experienced by IATA i n 1981, can be mainly explained by the U.S. c a r r i e r s r e j o i n i n g IATA. 7 Although the major decline i n IATA's market share was during the 1970s, i t must be noted that the IATA market share figures f o r the years a f t e r 1980 include a c t i v i t y by those members that do not p a r t i c i p a t e i n IATA t a r i f f coordination. Before IATA rules were a l t e r e d i n 1979, a l l active IATA members had to p a r t i c i p a t e i n IATA p r i c e - s e t t i n g . 28 FIGURE 2 . 1 4 180 IATA Membership Tariff Coordination, Hade Association and Associate Memebers 1951 to 1987 A N A *b A<3 / A A°J 0, S? «?>v ^ ^ ^ ^ •$? S O U R C E S : I A T A (19 a ) . W o r l d A i r T r a n s p o r t S t a t i s t i c s , v a r i o u s i s s u e s . I A T A , I A T A R e v i e w , v a r i o u s i s s u e s . I A T A . A n n u a l R e p o r t , v a r i o u s i s s u e s . I A T A . I A T A B u l l e t i n , v a r i o u s i s s u e s . Year FIGURE 2 . 1 5 Active IATA Membership Airlines of Developed Non-Communist East Bloc and Developing Countries 1950 to 1985 S O U R C E S : I A T A . I A T A R e v i e w , v a r i o u t i s s u e s . I A T A . A n n u a l R e p o r t , v a r i o u s I s s u e a . I A T A . I A T A B u l l e t i n . v a r i o u s I s s u e s . N O T E S : 1. T h a a i r l ine t o t a l t o r d e v e l o p i n g c o u n t r i e s I n c l u d e s , in the ear l i e r y e e r s . o e r r l e r s r e p r e s e n t i n g c o l o n i e s . 2. A c t i v e IATA m e m b e r s h i p o n o l u d o s A s s o o l e t e m e m b e r s . 1950 1955 1960 1965 1970 1975 1980 1985 Year members, by a i r l i n e s of developing countries. As of 1985, a i r l i n e s of d e v e l o p i n g c o u n t r i e s comprised 62 percent of IATA's ac t i v e membership, compared to 34 percent for a i r l i n e s of non-Communist developed countries, and 4 percent for the Eastern bloc c a r r i e r s . The h i g h growth r a t e i n IATA membership of c a r r i e r s of developing countries i s a r e f l e c t i o n of both the emergence of T h i r d World countries i n the 1960s, and of the desire of these countries to operate t h e i r own national a i r l i n e s . As w i l l be d e s c r i b e d l a t e r i n the t h e s i s , t h i s s h i f t i n d i s t r i b u t i o n of IATA membership has created tensions within the Association, as c a r r i e r s of developing countries often have d i f f e r e n t views on optimal p r i c i n g p o l i c i e s from c a r r i e r s of developed countries. D. Trends i n A i r C a r r i e r Fleets Technological developments r e s u l t i n g i n the introduction of new types of a i r c r a f t may p l a y a r o l e i n the i n s t i t u t i o n of regime changes i n the i n t e r n a t i o n a l a i r l i n e industry. Technological improvements, such as the i n t r o d u c t i o n of j e t a i r c r a f t i n the l a t e 1950s, can r e s u l t i n increased p r o d u c t i v i t y . P r o d u c t i v i t y improvements lower costs, and lower costs, i n turn, can put downward pressures on p r i c e s i n an industry. Industries, such as i n t e r n a t i o n a l a i r transport, with a p r i c e f i x i n g authority, must f i n d ways to cope with pressures for lower prices within the e x i s t i n g p r i c e - f i x i n g i n s t i t u t i o n s , or else face the p o s s i b i l i t y of the demise of the p r i c e - f i x i n g authority. 31 Figure 2.16 shows how the a i r c r a f t f l e e t of IATA c a r r i e r s has changed between the years 1960 and 1985. Three developments can be c l e a r l y seen from the f i g u r e . The f i r s t was the demise of the p i s t o n a i r c r a f t . Piston a i r c r a f t were the dominant type of airplane i n the IATA f l e e t i n 1960, but by 1980, they had been completely replaced. The second development was the tremendous r i s e of narrow-bodied j e t a i r c r a f t i n the 1960s. There were only 382 of t h i s type of airplane i n the IATA f l e e t i n 1960, but by 1970, t h i s f i g u r e had r i s e n to 2,900. The t h i r d development was the increase i n wide-bodied j e t s during the 1970s and 1980s. whereas there were les s than 100 wide-bodied j e t s i n the IATA f l e e t i n 1970, by 1985 the f i g u r e was over 1,200. E. Trends i n P r i c i n g and Products The a i r l i n e industry, u n t i l 1952, o f f e r e d t r a v e l l e r s a s i n g l e product-f i r s t c l a s s a i r l i n e seats. Since 1952, the industry has introduced a number of other products - economy seats, budget fares, excursion fares, and other s p e c i a l f a r e s . 8 The trend, during the post-war period, toward a greater 8 The various seat classes are defined by not only p r i c e but also the r e s t r i c t i o n s placed around the use of t i c k e t s and the q u a l i t y of in-plane s e r v i c e . Discount t i c k e t s (budget, excursion and s p e c i a l fares) generally must be purchased on a return t r i p basis a number of days i n advance of the f l i g h t and are only p a r t i a l l y refundable (or are non-refundable). These t i c k e t s can often be purchased at as l i t t l e as 30 - 40 percent of economy fares. Capacity c o n t r o l l e d excursion fares d i f f e r from regular excursion fares i n that only a r e s t r i c t e d number of seats at the capacity c o n t r o l l e d fare are s o l d f o r a given f l i g h t . Economy t i c k e t s ( i . e . , f u l l fare t i c k e t s ) and f i r s t c l a s s t i c k e t s do not have to be purchased i n advance and may be bought f o r one-way t r a n s i t as well as return t r i p use. These higher priced t i c k e t s ( e s p e c i a l l y f i r s t c l a s s t i c k e t s ) generally e n t i t l e the passenger to h i g h e r q u a l i t y i n - f l i g h t service such as better meals, larger seats and greater leg room. 32 FIGURE 2 . 1 6 v a r i e t y of product o f f e r i n g s i s important because the more products that are offered, the greater the d i f f i c u l t y there i s i n coordinating p r i c e s . Figure 2.17 provides an i l l u s t r a t i o n of trends i n fare o f f e r i n g s during the period 1950 to 1986. The fig u r e shows the d i s t r i b u t i o n of the various fares, charged by IATA c a r r i e r s on the North A t l a n t i c , during the period. I t can be seen, that s h o r t l y a f t e r economy fares were introduced i n 1952, they comprised the vast majority of seats i n the North A t l a n t i c market. However, s i n c e the l a t t e r p a r t o f the 1960s, economy fares, i n turn, have been supplanted by other fare o f f e r i n g s . By 1986, economy fares comprised only twenty p e r c e n t of the market. The l a r g e s t fare category i n 1986 was ca p a c i t y - c o n t r o l l e d excursion, with close to f i f t y percent of the market. F. F i n a n c i a l P o s i t i o n of the A i r l i n e Industry The f i n a n c i a l p o s i t i o n of an industry can be a co n t r i b u t i n g f a c t o r to the changing of regimes. I f an industry i s not performing well, companies w i t h i n t h a t industry may seek new rules, regulations, or procedures, to govern the industry. Figure 2.18 shows operating revenue and operating p r o f i t changes f or scheduled a i r l i n e s , f o r the period 1960 - 1985. The f i g u r e indicates a reasonably steady increase i n revenues during the period, but f l u c t u a t i n g p r o f i t s . The worst period f o r the a i r l i n e industry, i n terms of p r o f i t s , appeared to be between 1980 and 1982, when the industry suffered three consecutive years of operating losses. This period coincided with the 34 F I G U R E 2 . 1 7 CO CO J2 CJ CD CO CD CJ c CD T3 'o C Distribution of IATA Fare Classes Scheduled North Atlantic Services 1950 -1986 100 - I S O U R C E S : I A T A (19 a ) . W o r l d A i r T r a n s p o r t S t a t i s t i c s , v a r i o u s i s s u e s . N O T E S : 1. T o u r i s t c l a s s , w i t h d r a w n i n I 9 6 0 , i s c l a s s i f i e d u n d e r ' E c o n o m y ' . 2 . I A T A b e g a n t o r e p o r t ' E x c u r s i o n ' a n d ' O t h e r ' f a r e a a e p e r a t e l y f r o m ' E c o n o m y ' f a r e s i n 1 9 8 4 . 3 . ' O t h e r ' f e r e s I n c l u d e b u d g e t , s t a n d b y , y o u t h f s r e s , e t c . 4 . ' F i r s t C l a s s ' i n c l u d e s C o n c o r d e f l i g h t s .  Year us cn CO C g bo CO CD 3 C CD > CD or O) c CO k _ CD Q. o 130-r FIGURE 2.18 SCHEDULED AIR CARRIERS Operating Revenues and Operating Profits 1960 to 1985 1960 1965 1970 1975 Year 1980 1985 r5500 -5000 --500 IATA (II >>. World Air transport Slatlatlea. various isauaa. ICAO (19 bl. Civil Aviation Ststlatloa ol th* World, varloua laauaa. NOTES: t. Oata for tha yoara 1860-1872 ancluda tha USSR and for tho yoara 1873-1886 Includo only tha interna-tional oparationa of tha USSR oar-rlor. -1000 l i b e r a l i z a t i o n of regulations governing i n t e r n a t i o n a l a i r transport, and with world-wide economic recession. The industry was able to recover from these losses and post i t s best year ever ( i n terms of t o t a l operating p r o f i t s ) i n 1984. G. A i r Transport Safety A i r s a f e t y i s one f i n a l f a c t o r which could r e s u l t i n a change of regimes. I f government o f f i c i a l s b elieved that the a i r transport industry was not operating i n a safe manner, then new regulations could be brought to bear on the i n d u s t r y . These regulations could a f f e c t not only safety considerations, but also economic aspects of the in d u s t r y . 9 F i g u r e 2.19 p r e s e n t s s t a t i s t i c s on a i r s a f e t y f o r scheduled a i r services, f o r the period 1950 to 1985. The fig u r e shows, that whereas the number of a i r accidents i n v o l v i n g f a t a l i t i e s d i d not change s u b s t a n t i a l l y over the t h i r t y year p e r i o d , the number of passenger f a t a l i t i e s per passenger-kilometre of service declined s i g n i f i c a n t l y . The i n t e r n a t i o n a l a i r industry has, i n f a c t , been able to hold the absolute number of accidents constant, while s u b s t a n t i a l l y increasing the quantity of service offered. 9 For example, there have been some discussions i n the United States that domestic deregulation of the a i r transport industry has compromised a i r safety i n that country. I f t h i s were found to be true, there could be increased pressure on the government to "re-regulate" the industry. 37 FIGURE 2 . 1 9 u> SAFTEY ON SCHEDULED AIR SERVICES Aircraft Accidents Involving Passenger Fatalities and Fatalities per 100 Million Passenger-Kilometers 1960 to 1986 ICAO (11 bl. CIvH Aviation Statlattaa of tha World, varioua laauoa. NOTES: 1. Data Iron 1880 to 1874 axefcjda tha USSR and China and from 1876 to 1888 o«cludo lha USSR Legend O F A T A L A C C I D E N T S • F A T A L I T Y R A T E 1960 1955 1960 1965 1970 Year 1975 1980 1985 H. Summary This s e c t i o n of the thesis examined a number of industry trends and developments. These can be summarized as follows: Industry Growth: The industry growth rate declined i n the 1970s and 1980s from the previous years. During the past f i f t e e n years, growth has been lowest i n developed regions. Charter t r a f f i c has declined i n r e l a t i v e importance (to the industry as a whole) from the e a r l y 1970s to the present. The United States' Position: The market share of the United States declined i n the post-War period, although the U.S. remains the dominant c o u n t r y i n a i r transport. The U.S. dominance, however, i s not as pronounced when only i n t e r n a t i o n a l a i r transport i s considered. IATA's Position in Air Transport: IATA's share of a i r t r a f f i c declined i n the 1970s. IATA's membership has increased s i g n i f i c a n t l y i n the post-War period, but most of the recent membership growth has been with n o n - t a r i f f coordinating members. The composition of the organization has changed since the Association's founding, with most c a r r i e r s now representing developing countries. Trends in Air Fleets: New technologies r e s u l t e d i n the demise of the p i s t o n a i r c r a f t and i n the introduction of the j e t i n the l a t e 1950s, and of the wide-bodied j e t i n the l a t e 1960s. Trends in Pricing and Products: Several new p r i c i n g i n i t i a t i v e s were u n d e r t a k e n by the i n t e r n a t i o n a l a i r l i n e i n d u s t r y f o l l o w i n g the 39 i n t r o d u c t i o n of economy fares i n 1952. In 1985, c a p a c i t y - c o n t r o l l e d excursion fares formed the l a r g e s t c l a s s of seats on the North A t l a n t i c . Financial Position of the Airline Industry: The industry showed steady revenue growth f o r most o f the post-War period, but p r o f i t s have fl u c t u a t e d from year to year. The industry's worst years were i n the e a r l y 1980s, but by 1894 the industry had recovered with i t s highest aggregate operating p r o f i t s . Air Transport Safety: A i r safety improved s u b s t a n t i a l l y i n the post-War period. 40 PART TWO: HEGEMONIC THEORY AND REGIME CHANGES INTERNATIONAL AIR TRANSPORT 41 I I I . HEGEMONIC STABILITY THEORY AND ITS CRITICS A. Introduction How and why do i n t e r n a t i o n a l regulatory regimes form? Why are stable i n t e r n a t i o n a l regulatory regimes constituted f o r some in d u s t r i e s (e.g. postal services) but not for others (e.g. f o r e s t products)? Why do some stable regimes erode over time? These are the type of questions that i n t e r n a t i o n a l r e l a t i o n s scholars have attempted to address using the theory of hegemonic s t a b i l i t y . K r a s n e r (1982, p.185) d e f i n e d an i n t e r n a t i o n a l regime as the " p r i n c i p l e s , norms, rul e s , and decision-making procedures around which other expectations converge i n a given issue area". Regimes, therefore, r e f e r to the form of i n t e r n a t i o n a l organization and decision-making procedures which predominate, by i n t e r n a t i o n a l convention, i n a given issue area (such as trade, i n t e r n a t i o n a l a v i a t i o n , e t c . ) . The t h e o r y of hegemonic s t a b i l i t y arose f i r s t from the work of Kindleberger (1973) who sought to determine what events produced the world depression of 1929; why the depression was so widespread; and why i t last e d so long. Kindleberger (1973, pp.291-292) a t t r i b u t e d the s e v e r i t y of the depression to the B r i t i s h i n a b i l i t y and the U.S. unwillingness to take a leadership r o l e i n the world economy. Kindleberger believed that the U.S. could have reduced the seve r i t y of the depression by maintaining a r e l a t i v e l y open market f o r imports, by r e c y c l i n g c a p i t a l to countries with trade 42 d e f i c i t s , and by creating l i q u i d i t y i n the world monetary system. The United States, however, declined to exercise a leadership r o l e and chose instead to i s o l a t e and protect i t s economy. Kindleberger's conclusion was that a leadership r o l e must be exercised to maintain an open trading regime. His findings have been developed into the theory of hegemonic s t a b i l i t y by i n t e r n a t i o n a l scholars such as Keohane (1980). Keohane theorized that a dominant power or hegemon was important i n maintaining stable regulatory regime. Keohane (1980, p.136) summarized the theory as follows: A c c o r d i n g to t h i s theory, s t r o n g i n t e r n a t i o n a l economic regimes depend on hegemonic power. Fragmentation of power between competing c o u n t r i e s l e a d s to f r a g m e n t a t i o n of i n t e r n a t i o n a l economic regimes; concentration of power contributes to s t a b i l i t y . Hegemonic powers have the c a p a b i l i t y to maintain i n t e r n a t i o n a l regimes they favour. They may use coercion to enforce adherence to r u l e s ; or they may r e l y l a r g e l y on p o s i t i v e sanctions - the pr.ovision of b e n e f i t s to those who cooperate. Both hegemonic powers and the smaller states may have incentives to collaborate i n maintaining a regime - the hegemonic power gains the a b i l i t y to shape and dominate i t s i n t e r n a t i o n a l environment, while providing a s u f f i c i e n t flow of benefits to small and middle powers to persuade them to acquiesce. T h e r e f o r e , a c c o r d i n g to Keohane (1980) a dominant power may use e i t h e r p o s i t i v e or negative sanctions to enforce the terms of a regime. In the next s e c t i o n of t h i s chapter, c r i t i c i s m s of the theory are presented. Section C reviews empirical tests of the hegemonic s t a b i l i t y theory, concentrating on the two studies which tested the theory against regime changes i n i n t e r n a t i o n a l a i r transport. Section D outlines the 43 framework used i n t h i s paper f o r t e s t i n g a modified v e r s i o n of the hegemonic s t a b i l i t y t h e o r y . S e c t i o n E p r e s e n t s a number of factors other than leadership which may be relevant i n the explanation of regime developments. F i n a l l y , s e c t i o n F summarizes t h i s chapter. B. C r i t i c i s m s of Hegemonic S t a b i l i t y Theory The u s e f u l n e s s of hegemonic s t a b i l i t y theory i n the explanation of regime changes has been the subject of much debate i n the i n t e r n a t i o n a l r e l a t i o n s l i t e r a t u r e . Most of the debate has r e s u l t e d from empirical tests of the theory, but there have also been t h e o r e t i c a l c r i t i c i s m s . McKeown (1983), f o r example, c i t e d a number of conceptual d i f f i c u l t i e s with hegemonic s t a b i l i t y t heory. F i r s t , McKeown asked, "When i s a state hegemonic?" McKeown argued that proponents of the theory have not adequately answered t h i s question. Next, McKeown questioned the r o l e of secondary powers i n an i n t e r n a t i o n a l regime. He reasoned that i f secondary powers were opposed to the hegemonic regime, then the dominant power would have d i f f i c u l t y i n mai n t a i n i n g the regime. Third, McKeown analyzed the notion of power i n hegemonic s t a b i l i t y theory. Proponents o f the theory have described p o t e n t i a l economic power as being the primary c h a r a c t e r i s t i c i n describing a hegemon. McKeown stated that actual economic power might be a more important f a c t o r f o r a hegemon. McKeown c i t e d "access to the markets of the hegemonic state" as being an important economic power base. He stated that a hegemon might be able to use t h i s power base more e f f e c t i v e l y i f the regime i s characterized by a seri e s of b i l a t e r a l agreements, rather than by a single m u l t i l a t e r a l agreement. F i n a l l y , McKeown questioned the hegemonic s t a b i l i t y 44 theory's requirement that there must e x i s t a single power to overcome the f r e e - r i d e r problem and supply the public good required to maintain a stable regime. McKeown stated that a small group of non-dominant states could overcome the f r e e - r i d e r problem and supply the p u b l i c good. 1 According to McKeown, the existence of a hegemonic state might be a s u f f i c i e n t condition f o r a stable regime, but i t should not be considered a necessary condition. McKeown's (1985) arguments were supported by Snidal (1985). Snidal showed that secondary powers may have incentives to provide a stable regime, so that the decline of a hegemonic power w i l l not n e c e s s a r i l y lead to the c o l l a p s e o f a regime. S n i d a l concluded th a t the theory of hegemonic s t a b i l i t y provided only a " s p e c i a l case" explanation of how world power can lead to the existence of a stable regime. C. Empirical Tests of Hegemonic S t a b i l i t y Theory A number of authors have attempted to t e s t hegemonic s t a b i l i t y theory to determine whether or not world leadership can, i n f a c t , be used to p r e d i c t regime developments. Krasner (1976) used the theory to analyze the world trading system between 1820 and the mid-1970s. His hypothesis was that under a hegemonic system (defined as a system i n which a s i n g l e state i s much larger and r e l a t i v e l y more advanced than i t s trading partners), the dominant state would use i t s c a p a b i l i t i e s to create an open trading system. This i s because an open trading system would increase aggregate n a t i o n a l income and 1 Olson (1971, pp. 22-36) argued that small groups have incentives to s u p p l y a p u b l i c good, although the supply of t h i s good w i l l l i k e l y be suboptimal. 45 growth r a t e s i n the dominant s t a t e . I t would, as well, increase the p o l i t i c a l power of the dominant state, as the state's trading partners became more dependent on the hegemon's markets. Krasner found that while the existence of a hegemon was associated with a l i b e r a l trading regime during c e r t a i n time periods, t h i s was not true during other times. He concluded that the structure of the i n t e r n a t i o n a l trading system d i d not move " i n lockstep" with changes i n the d i s t r i b u t i o n of power among states. He further stated that i t was external events (such as war or famine) that triggered changes i n the nature of the i n t e r n a t i o n a l trading system. Keohane (1980) offered a somewhat d i f f e r e n t v e r s i o n of the hegemonic s t a b i l i t y theory. He stated, that according to the theory, the existence of a hegemonic power leads to a strong regime; not n e c e s s a r i l y a strong liberal regime. Hegemonic powers have the c a p a b i l i t i e s of maintaining a regime that they favour. They may use coercion or p o s i t i v e sanctions to maintain the regime. The advantage to the hegemon of maintaining a regime i s that i t may shape the regime to i t s b e n e f i t . Other countries achieve b e n e f i t s flowing from the stability of the regime. Keohane tested the theory on three i n t e r n a t i o n a l regimes - the monetary regime, the trading regime and the petroleum regime - between the years 1967 and 1977. He stated, that i n order to conclude that hegemonic s t a b i l i t y theory can explain regime changes, i t must do the following: account for the g e n e r a l p a t t e r n of i n c r e a s i n g weakness of a l l three regimes during the 46 period; explain why the o i l regime experienced the most serious changes and the t r a d i n g regime the l e a s t serious changes; and, provide a p l a u s i b l e a c c o u n t i n g f o r how the d e c l i n e i n U.S. l e a d e r s h i p contributed to the weakening of the three regimes. Keohane examined the decline i n U.S. power a t t r i b u t e s on a regime by regime b a s i s . He found that d e c l i n i n g U.S. influence accounted well f o r the weakening of the petroleum regime, but not as well f o r the weakening of the other two regimes. He concluded that hegemonic s t a b i l i t y theory, although c l e a r l y u s e f u l as a f i r s t step i n explaining regime changes, should be employed with caution when used as a powerful theory to explain events. Cowhey and Long (1983) tested the hegemonic s t a b i l i t y theory using changes i n the post-World War Two automobile regime. As a basis f o r comparison, Cowhey and Long also attempted to use a theory of "surplus capacity" to account f o r changes i n the regime. The authors presented data showing the decline i n U.S. leadership i n the world automobile industry between 1950 and 1980. Cowhey and Long stated that, i f the hegemonic s t a b i l i t y theory held, there should be a t i g h t linkage between the decline i n U.S. leadership and regime changes. The authors d i d not f i n d such a linkage. On the ot h e r hand, Cowhey and Long found that the existence of surplus capacity was a good pre d i c t o r of regime changes. Aggarawal (1985) f i r s t s p e c i f i e d a framework f o r using hegemonic s t a b i l i t y theory, and then applied t h i s framework to analyzing the post-World War Two t e x t i l e regime. Aggarawal's framework distinguished regimes from 47 meta-regimes. He defined an i n t e r n a t i o n a l regime as a system of rules and procedures designed to regulate n a t i o n a l actions. A meta-regime, on the oth e r hand, was d e f i n e d as the p r i n c i p l e s and norms u n d e r l y i n g the development of regimes. 2 Aggarawal's framework also d i f f e r e n t i a t e d between the strength, nature and scope of regimes. Strength r e f e r r e d to the stringency with which the r u l e s o f the regime are enforced. Nature, r e f e r r e d to the objectives promoted by the rules of the regime, such as l i b e r a l i s m or protectionism. F i n a l l y , scope r e f e r r e d to the range of issues or products regulated by the regime. According to Aggarawal's framework, a meta-regime w i l l e x i s t i f there i s a general consensus among countries about the norms and p r i n c i p l e s of the meta-regime. 3 However, for hegemonic s t a b i l i t y theory to be supported, there must e x i s t a s i n g l e major power associated with a strong regime, within the meta-regime. The nature of the regime ( l i b e r a l or p r o t e c t i o n i s t ) w i l l depend on the desires of that major power. Aggarawal used h i s framework i n an attempt to explain regime changes i n the post-war i n t e r n a t i o n a l t e x t i l e industry. Aggarawal found, that given h i s 2 As an example of a meta-regime, Aggarawal (1985, p. 19) c i t e d the b e l i e f , among most countries, i n the p r i n c i p l e of " l i b e r a l trade". Whereas t h i s meta-regime has p e r s i s t e d since World War Two, there have been numerous changes i n the rules and procedures of i n t e r n a t i o n a l trade, as embodied i n the regime governed by the General Agreement on Trade and T a r i f f s (GATT). 3 For example, i f there i s a general consensus among countries that a l i b e r a l i z e d trading system i s desirable, then a meta-regime can be formed embodying the norms and p r i n c i p l e s of l i b e r a l i z e d trade. 48 framework, hegemonic s t a b i l i t y theory could explain the regime changes. Erosion of U.S. power contributed to a weakening of the t e x t i l e regime, and to a regime more p r o t e c t i o n i s t i n nature, representing the growing authority of the protectionist-minded Europeans. Two authors have used hegemonic s t a b i l i t y theory, s p e c i f i c a l l y , to t e s t regime developments i n the i n t e r n a t i o n a l a i r transport industry - Jonsson (1987) and Busza (1987). These papers are analyzed i n more depth below: 1. Jonsson (1987) Jonsson's study was an attempt to explain regime formation and change i n the i n t e r n a t i o n a l a i r l i n e industry. More s p e c i f i c a l l y , Jonsson stated that h i s paper would pursue the following two questions (p.11): What regimes can be i d e n t i f i e d i n the i n t e r n a t i o n a l a v i a t i o n issue area? How can regime formation and transformation be accounted for? Before addressing these questions Jonsson defined what he considered to be a change i n regimes (from Krasner, 1982, pp.187-189): A regime change i s s a i d to involve a l t e r a t i o n of p r i n c i p l e s and norms. Changes i n rules and decision-making procedures, on the other hand, are r e f e r r e d to as changes within regimes; incoherence among the regime's p r i n c i p l e s , norms, rules and procedures or inconsistency between the regime and actual behaviour implies the weakening of a regime. Jonsson i d e n t i f i e d what he considered two successful attempts at regime formation or change and one unsuccessful attempt at regime change i n the i n t e r n a t i o n a l a i r l i n e industry. The f i r s t regime, termed the "unrestricted 49 sovereignty" regime, was formed following the f i r s t World War and l a s t e d u n t i l 1944. The regime was i d e n t i f i e d by u n r e s t r i c t e d state c o n t r o l over na t i o n a l a i r space. This p r i n c i p l e was incorporated into the regime's norm, that each state had ultimate power to determine what a i r transport took place i n i t s n a t i o n a l a i r space. The major regime r u l e was that government approval was required f o r a l l o v e r f l i g h t s and landings by f o r e i g n c a r r i e r s . F i n a l l y , the d e c i s i o n making procedure p r a c t i c e d under t h i s regime was b i l a t e r a l government negotiations for o v e r f l i g h t and landing r i g h t s . 4 The second regime i d e n t i f i e d by Jonsson was the "Chicago-Bermuda" regime, formed a f t e r World War I I . A c c o r d i n g to Jonsson (p.34), the p r i n c i p l e of state sovereignty under t h i s regime was d i l u t e d by i n t e r n a t i o n a l regulation, i n the form of the Chicago Convention. An agreement signed i n Chicago i n 1944 provided for the c r e a t i o n of an intergovernmental regulatory body - the I n t e r n a t i o n a l C i v i l A v i a t i o n Organization (ICAO) - mainly to regulate t e c h n i c a l and safety issues. As well, the International T r a n s i t Agreement, which received wide support following Chicago, provided for the m u l t i l a t e r a l exchange o f the f i r s t two freedoms o f i n t e r n a t i o n a l a i r transport. 5 Jonsson (p.34) i d e n t i f i e d two norms of the Chicago-Bermuda regime. The f i r s t was t h a t n a t i o n s had some claim on t r a f f i c o r i g i n a t i n g i n t h e i r 4 Jonsson's (1987) d e s c r i p t i o n of the decision-making procedure p r i o r to World War II was not e n t i r e l y correct. O v e r f l i g h t and landing r i g h t s were determined through a i r l i n e - g o v e r n m e n t n e g o t i a t i o n s as well as through b i l a t e r a l government negotiations. See, for example, Taneja (1980, pp. 3-4). 5 See Appendix B for a d e s c r i p t i o n of the freedoms of i n t e r n a t i o n a l a i r transportation. 50 country. This norm was expressed by the concept of a i r freedoms. The second norm was one of m u l t i l a t e r a l i s m , embodied i n the Bermuda b i l a t e r a l agreement s i g n e d by the U n i t e d S t a t e s and U n i t e d Kingdom i n 1946. The Bermuda agreement sanc t i o n e d the IATA conferences as the means f o r e s t a b l i s h i n g fares, on a m u l t i l a t e r a l b a s i s . The Bermuda agreement also provided the necessary rules and decision-making procedures to be followed by governments i n order to f a c i l i t a t e the operation of i n t e r n a t i o n a l a i r s e r v i c e s . The unsuccessful attempt at regime change, as described by Jonsson, was the e f f o r t at i n t e r n a t i o n a l deregulation launched by the United States i n 1978. Jonsson (p.39) stated that the United States' e f f o r t r e s u l t e d i n changes within the Chicago-Bermuda regime rather than i n a change to another regime. Jonsson be l i e v e d that the Chicago-Bermuda p r i n c i p l e of i n t e r n a t i o n a l regulation, and the norms of national claims on t r a f f i c and m u l t i l a t e r a l i s m , survived. Only rules and d e c i s i o n making procedures were modified, such as those r e s u l t i n g from changes i n the IATA t a r i f f - c o o r d i n a t i n g procedures. 6 In order to explain the successful and unsuccessful regime changes, Jonsson used f i v e competing t h e o r i e s . The f i r s t t h e o r y focussed on technological explanations for regime changes. According to t h i s theory, developments i n a i r c r a f t or a i r navigation technology would be the primary 6 In 197 8, IATA i n s t i t u t e d a number of changes. These included a d i v i s i o n of the membership i n t o two groups - c a r r i e r s which wished to p a r t i c i p a t e i n t a r i f f coordination and c a r r i e r s which wanted to p a r t i c i p a t e only i n IATA's trade a s s o c i a t i o n a c t i v i t i e s . Before 1978, a l l IATA active members had to p a r t i c i p a t e i n t a r i f f coordination. As well, IATA modified i t s unanimity r u l e , allowing for the adoption of fares by sub-groups within t r a f f i c conferences. Before 1978, fares required the unanimous consent of a l l c a r r i e r s i n a t r a f f i c conference. 51 causes of regime changes. Jonsson (p.40) found that neither the breakthrough i n p r o p e l l e r technology of the 1930s, nor the j e t r e v o l u t i o n of the 1960s c o n t r i b u t e d to a change i n regimes. Jonsson (p.41) concluded t h a t t e c h n o l o g i c a l f a c t o r s d i d not appear to be e i t h e r a necessary nor a s u f f i c i e n t c o n d i t i o n f or regime change. The second theory used by Jonsson was a theory of surplus capacity. According to t h i s theory, excess capacity i n an industry can contribute to a change i n regimes. Jonsson d i d not believe that t h i s theory was u s e f u l i n the explanation of regime formation a f t e r the F i r s t and Second World Wars, but could add to the understanding of the attempted regime change i n the 1970s. According to Jonsson (p.43), excess capacity i n the 1970s - r e s u l t i n g from the in t r o d u c t i o n of wide-bodied j e t s , from stagnant demand due to the o i l p r i c e - induced recession, and from service increases by non-scheduled c a r r i e r s - contributed to the introduction of low fares by the scheduled c a r r i e r s . The United States government, i n turn, sought even lower prices through reforms to the regulatory system. The t h i r d theory used by Jonsson to explain regime changes was the theory of hegemonic s t a b i l i t y . In Jonsson's general v e r s i o n of the theory, o v e r a l l power l e v e l s i n the world determine the nature of a regime. In h i s i n d u s t r y - s p e c i f i c v e r s i o n of the model, the d i s t r i b u t i o n of power within the i n t e r n a t i o n a l a i r transport industry, determines the type of regime. Jonsson (1987, pp.44-45) found that the general model was h e l p f u l i n explaining the regime formed following the F i r s t World War, but was not good 52 at p r e d i c t i n g the formation of the Chicago-Bermuda regime. Following World War I, t h e r e was not a dominant m i l i t a r y power. The i n t e r n a t i o n a l a i r transport regime formed a f t e r World War I r e f l e c t e d the absence of a dominant influence. The b i l a t e r a l regulatory system promoted the power of the weak countries to an equal status with the more powerful states. On the other hand, the power structure following World War II was b i p o l a r , but one power-the U.S.S.R. - d i d not p a r t i c i p a t e at a l l i n the establishment of the Chicago-Bermuda regime. The i n d u s t r y - s p e c i f i c v a r i a t i o n o f the s t r u c t u r a l theory was more h e l p f u l , according to Jonsson, i n explaining the formation of the Chicago-Bermuda regime. Jonsson (pp.46-47) c i t e d two major sources of power i n i n t e r n a t i o n a l a i r transport - geographic p o s i t i o n and aeronautical know-how. F o l l o w i n g World War I I , the U n i t e d S t a t e s was dominant i n a i r c r a f t technology, but the United Kingdom had c o u n t e r v a i l i n g powers i n the form of access to Commonwealth t e r r i t o r i e s . 7 The United States was forced to compromise with the United Kingdom i n the Bermuda 1 agreement i n order to acquire the necessary landing r i g h t s i n Commonwealth lands. The i n d u s t r y - s p e c i f i c s t r u c t u r a l model, however, according to Jonsson (p. 49), was less successful i n the explanation of the f a i l e d attempt at regime change i n the 1970s. The United States s t i l l was the overwhelming leader i n i n t e r n a t i o n a l a v i a t i o n i n the 1970s. The s t r u c t u r a l model should 7 Newfoundland, f o r example, was then an important stop on trans-A t l a n t i c crossings. 53 have p r e d i c t e d that the U.S. would have been successful at changing the regime. The f o u r t h model used by Jonsson to explain regime changes was a s i t u a t i o n a l model. This model looks at choices facin g nations at the times regimes are formed or changed, and predicts the nature of the regime that i s formed by the choices a v a i l a b l e to the nations. For example, Jonsson (pp.50-51) stated that following World War I, nations were faced with an important choice i n determining the nature of the i n t e r n a t i o n a l a i r transport regime. S t a t e s c o u l d choose freedom o f the a i r which would contribute to a i r commerce, or they could choose state sovereignty over a i r space which would contribute to p r o t e c t i o n against warfare. Jonsson bel i e v e d that given the fresh experiences of the World War, the choice of state sovereignty could be predicted from t h i s model. The choices facin g nations following the Second World War and i n the 1970s were more complex, and the explanations of regime outcomes were, based on the use of the s i t u a t i o n a l model, not as h e l p f u l . The f i n a l model used by Jonsson to explain regime changes was a process model. T h i s model was designed to explain regime changes based on the process of d e c i s i o n making. Jonsson (pp.60-61) l i s t e d two major components of the process model. F i r s t , bargaining and c o a l i t i o n formation among groups w i t h i n s t a t e s and across states i s an important determinant of regimes. Second, the nature of organizations performing the bargaining and t r y i n g to form c o a l i t i o n s can also a f f e c t the type of regime produced. Jonsson (p.70) further explained that e f f e c t i v e i n t e r n a t i o n a l regimes are associated with 54 the existence of transnational networks of organizations and with a strong informal network of contacts between organizations and i n d i v i d u a l s . Jonsson used the process theory i n an attempt to explain the formation of the two post-war regimes and the f a i l e d attempt by the United States at regime change i n the 1970s. With respect to the formation of the f i r s t regime, Jonsson (pp.86-87) found that the common concern of the policy-makers was to extend sovereignty over natio n a l a i r space. No attempt was made by proponents of a l i b e r a l i n t e r n a t i o n a l regime to form c o a l i t i o n s i n order to mount a f i g h t f o r freedom of the a i r . Jonsson, using the process model, analyzed i n d e t a i l , the bargaining and c o a l i t i o n f o r m a t i o n s u r r o u n d i n g the Chicago Conference and the Bermuda Conference leading to the establishment of the post-World War II regime. No agreement was reached on the economic reg u l a t i o n of a i r transport at Chicago, l a r g e l y because of the i n a b i l i t y of the U.S. and U.K. delegations to agree on a system of capacity regulation. The United States and B r i t a i n were able to reach a compromise agreement i n Bermuda because of bargaining concessions made by both sides. F i n a l l y , Jonsson used the process model to analyze the f a i l e d attempt by the United States at regime change i n the 1970s. He a t t r i b u t e d the lack of success by the U n i t e d States l a r g e l y to the a b i l i t y of IATA to form a c o a l i t i o n o f c a r r i e r s , governments, and sympathetic U.S. o f f i c i a l s i n opposition to U.S. deregulatory i n i t i a t i v e s . 55 In conclusion, Jonsson (p.153) found the technology and surplus capacity models inadequate i n the explanation of regime changes. Jonsson (p.153) considered the theory of hegemonic s t a b i l i t y and the s i t u a t i o n a l model to be better, although also inadequate at times. The process model was found to be the best of the models considered. 2. Busza (1987) The second work that has been completed recently on regime changes i n the i n t e r n a t i o n a l a i r l i n e industry i s a masters thesis by Busza (1987). Busza's work focussed on the changes i n the r o l e of the International A i r T r a n s p o r t A s s o c i a t i o n i n the r e g u l a t i o n of i n t e r n a t i o n a l a i r transport. Busza wanted to determine why the post-World War II i n t e r n a t i o n a l a i r transport regime incorporated the International A i r Transport Association. More s p e c i f i c a l l y , Busza sought the answers to the following two questions ( p . l i ) : Why do states cooperate to support an i n t e r n a t i o n a l c a r t e l ( i . e . IATA)? Why do states cease to support a c a r t e l ? Busza (p.iv) postulated three competing theories that might be h e l p f u l i n providing answers to these questions. The f i r s t was Busza's economic theory which claimed that states may support c a r t e l s i n order to promote consumer welfare and global i n d u s t r i a l growth. The second theory was that states may support c a r t e l s to help the s u r v i v a l and success of t h e i r a i r c a r r i e r s . F i n a l l y , the t h i r d theory postulated by Busza was that states may 56 support a c a r t e l due to the a c t i v i t i e s of a hegemon, which promotes t h i s type of arrangement ( i . e . the hegemonic s t a b i l i t y theory). Busza (p.x) continued that the hegemon, or dominant power, w i l l only promote an i n t e r n a t i o n a l order i f the order i s i n i t s best i n t e r e s t s . As well, the dominant power must have the resources to bear the costs involved i n maintaining the economic order. The f i r s t regime change t h a t Busza analyzed, using the competing theories, was the formation of the Chicago-Bermuda regime during the period 1944-1946. Busza (p.4) d e s c r i b e d the major d i f f e r e n c e s between the n e g o t i a t i n g p o s i t i o n s of the B r i t i s h and the Americans at the Chicago Conference. The B r i t i s h favoured a t i g h t l y regulated i n t e r n a t i o n a l a i r transport industry, with a c e n t r a l authority empowered to c o n t r o l capacity a l l o c a t i o n s , while the Americans favoured a les s regulated industry, with route r i g h t s negotiated b i l a t e r a l l y between governments. The B r i t i s h also f a v o u r e d r a t e - r e g u l a t i o n , while the United States supported market-based p r i c i n g . The well-known r e s u l t of the Chicago Conference was the f a i l u r e to reach agreement on an economic regulatory regime f o r a i r transport. The basis of the economic regulatory system was established at Bermuda, where the United States and United Kingdom met to conclude t h e i r f i r s t post-war b i l a t e r a l . The Bermuda 1 b i l a t e r a l between the two countries required the United States to authorize IATA m u l t i l a t e r a l rate-making i n return f or the U n i t e d Kingdom a c c e p t i n g some f l e x i b i l i t y i n the determination of capacity ( i n c l u d i n g f i f t h freedom t r a f f i c ) . Busza, however, down-played the f l e x i b i l i t y o f Bermuda 1 i n a l l o w i n g the c a r r i e r s of each country to determine c a p a c i t y l e v e l s on ro u t e s s p e c i f i e d i n the agreement. She 57 maintained that countries operating under Bermuda agreements were guaranteed market shares of at l e a s t f o r t y percent of t r a f f i c on major routes (p.22). Therefore, a i r l i n e s only had the f l e x i b i l i t y to provide capacity s u f f i c i e n t f o r the carriage of a maximum of s i x t y percent of t r a f f i c on routes covered by these agreements. In her analysis of the adoption of the Chicago-Bermuda regime, Busza (pp. 39-40) concluded t h a t the outcome c o u l d best be explained by the hegemonic s t a b i l i t y theory. Busza f e l t that, given i t s dominance of the post-war a v i a t i o n i n d u s t r y , the U.S. d i d not receive maximum economic b e n e f i t s from the Chicago-Bermuda regime. R e s t r i c t i o n s on c a p a c i t y determination and the IATA m u l t i l a t e r a l t a r i f f structure served to remove the competitive edge, then enjoyed by U.S. c a r r i e r s . The reduction i n economic b e n e f i t s was the p r i c e that the United States was w i l l i n g to pay to e s t a b l i s h the regime i n support of i t s security i n t e r e s t s ; the strengthening of the a i r t r a n s p o r t i n d u s t r y of i t s a l l i e s . Other c o u n t r i e s were w i l l i n g to p a r t i c i p a t e i n the regime because i t was i n t h e i r c a r r i e r s ' best i n t e r e s t s , given t h e i r high costs of operations, to have a hig h l y regulated regime, such as the Chicago-Bermuda regime. Under a free market regime, the i n e f f i c i e n t c a r r i e r s would not have been able to e f f e c t i v e l y compete against the low-cost U.S. c a r r i e r s . Busza found the two other theories to be less h e l p f u l i n the explanation of the Chicago-Bermuda regime. The welfare maximization theory would not be appropriate because c a r t e l s generally are hardly s o c i a l welfare maximizing a c t i v i t i e s . The promotion of c a r r i e r s ' i n t e r e s t s theory was also not too 58 h e l p f u l , because i t could not explain why the United States s a c r i f i c e d the economic i n t e r e s t s of i t s c a r r i e r s when i t signed the Bermuda 1 agreement. A f t e r completing the analysis of the formation of the post-war regime, Busza then turned to analyzing the maintenance of the regime from 1947 to the mid-1960s. Busza (p.43) c a l l e d t h i s period "the heyday of the c a r t e l " . Most other countries i n the world followed the lead of the United States and the U n i t e d Kingdom and s i g n e d Bermuda-type b i l a t e r a l s . The one difference between Bermuda 1 and many of the post-Bermuda 1 b i l a t e r a l s was that the post-Bermuda 1 b i l a t e r a l s required the pre-determination of c a p a c i t i e s on r o u t e s . A c c o r d i n g to Busza (pp.44-45) the pre-determination of capacity clauses r e s u l t e d i n each country achieving one-half of the capacity on major routes, rather than a minimum of f o r t y percent of capacity, as was the case with Bermuda 1. The difference between the two types of capacity clauses i n p r a c t i c e , therefore, was not great. Busza again f e l t that the hegemonic s t a b i l i t y theory provided the best explanation of regime structure. Busza (p.63) be l i e v e d that U.S. c a r r i e r s would have fared better i n an unregulated environment but that the U.S. was w i l l i n g to accept le s s than maximal performances from i t s i n t e r n a t i o n a l c a r r i e r s i n order to maintain the post-war regime. The U.S. was w i l l i n g to do t h i s because maintaining the s e c u r i t y of i t s a l l i e s was s t i l l i t s most v i t a l i n t e r e s t , and s e c u r i t y maintenance was b e s t achieved through a regulated a i r transport system. 59 The t h i r d period Busza examined was the time between the mid-1960s and 1977, a period during which the IATA m u l t i l a t e r a l t a r i f f system was weakened. Busza (pp.73-85) d e s c r i b e d f i v e developments t h a t c o n t r i b u t e d to the weakening of the IATA t a r i f f system: An increase i n the number of scheduled c a r r i e r s , making t a r i f f coordination d i f f i c u l t ; The i n t r o d u c t i o n of wide-bodied j e t s i n the 1970s, creating p r o b l e m s o f o v e r c a p a c i t y and c o n t r i b u t i n g to i n c i d e n t s of discounting of IATA fares; The f u e l c r i s i s of the 1970s, reducing the growth rate i n passenger demand and exacerbating the overcapacity s i t u a t i o n ; An i n c r e a s e i n the number of scheduled c a r r i e r s that d i d not p a r t i c i p a t e i n IATA t a r i f f coordination; and, The r e l a x a t i o n of c h a r t e r r e g u l a t i o n s , p e r m i t t i n g low-priced charter operators to compete, i n a greater way, with IATA c a r r i e r s . Busza (p.111) f e l t , again, that the importance attached to U.S. security i n t e r e s t s was a d e c i s i v e f a c t o r i n accounting f o r the weakening of the regime. Busza (p.107) argued that as European states became stronger, the U.S. downgraded s e c u r i t y i n t e r e s t s i n favour of economic i n t e r e s t s . The U.S., therefore, acted to a l t e r the system so that i t favoured the economic i n t e r e s t s of U.S. c a r r i e r s , by implementing p o l i c i e s to l i b e r a l i z e the regime (such as the r e l a x a t i o n of charter regulations). 60 The next period examined by Busza was between the years 1977 and 1981. I t was during the time that the United States launched i t s pro-competitive i n t e r n a t i o n a l a i r t r a n s p o r t p o l i c y i n an e f f o r t to achieve g r e a t e r competition and lower prices to consumers on U.S. i n t e r n a t i o n a l routes. The pro - competitive p o l i c y consisted of the signing of l i b e r a l "free-market" b i l a t e r a l agreements; the threat of a n t i - t r u s t actions against IATA; the passing of pro-competitive l e g i s l a t i o n governing i n t e r n a t i o n a l a i r transport; and the i n t r o d u c t i o n of a competitive charter p o l i c y . The U.S. pro-competitive approach was not emulated by any other country and was openly opposed by a good number of states. Developing countries were vehement i n opposition and they sought strengthened economic re g u l a t i o n under the auspices of the International C i v i l A v i a t i o n Organization. IATA, too, organized opposition to the pro-competitive p o l i c y , e s p e c i a l l y with respect to the threatened a n t i - t r u s t action. Busza (p.170) argued that the r a t i o n a l e f or the U.S. pro-competitive p o l i c y was an attempt, by the United States, to gain dominance i n the industry. The United States thought that increased competition would b e n e f i t i t s c a r r i e r s . Busza (p.171) l i k e Jonsson (1987) believed that the United States was not successful i n achieving a change i n regimes. Busza (p.172) c i t e d the f a i l u r e by the U.S. to sign l i b e r a l b i l a t e r a l s with major a v i a t i o n powers such as Japan, France, the United Kingdom and I t a l y , as evidence of the U.S. f a i l u r e to achieve i t s way. Busza believed that a c o n t r i b u t i n g f a c t o r to the 61 U n i t e d S t a t e s ' f a i l u r e was that i t s power and leverage had diminished. However, the U.S. s t i l l could have forced a regime change, despite the loss i n power, had i t been w i l l i n g to act against the wishes of i t s a l l i e s . The r e l u c t a n c e of the U.S. to act against i t s a l l i e s ' wishes, Busza (p. 174) continued, could be seen as a de facto loss of power. In summary, Busza (p.174) f e l t that the downgrading of U.S. security i n t e r e s t s i n favour of the economic i n t e r e s t s of i t s c a r r i e r s was the reason for the launching of the pro-competitive p o l i c y . But the United States chose not to take f u l l advantage of i t s economic i n t e r e s t s , by f o r c i n g a regime change, because i t was concerned about a d d i t i o n a l s e c u r i t y i n t e r e s t s ( i . e . , the United States d i d not want to alienate i t s a l l i e s ) . The f i n a l p e r i o d that Busza examined was the period 1981 to 1987. During t h i s time, the United States changed i t s i n t e r n a t i o n a l a i r transport p o l i c y away from a s t r i c t l y pro-competitive approach to a p o l i c y that considered countries on a case by case basis (p.182). The United States signed l i b e r a l b i l a t e r a l s with some countries but not with others, depending on what ben e f i t s would flow to the United States from each approach. As well, during t h i s period, there was a movement to l i b e r a l i z e a i r transport w i t h i n Europe, although l i t t l e was a c t u a l l y changed. Busza a t t r i b u t e d the abandonment of the United States' pro-competitive p o l i c y to a number of fa c t o r s , i n c l u d i n g the following: F i r s t , the U.S. was not s a t i s f i e d with the r e s u l t s of the pro-competitive p o l i c y and decided, therefore, to adopt an a l t e r n a t i v e strategy (p.205). Second, the United 62 S t a t e s was not s u f f i c i e n t l y powerful to ensure that the pro-competitive p o l i c y met with success; i . e . , the United States could not persuade powerful countries to sign l i b e r a l b i l a t e r a l s nor could i t stop f o r e i g n countries from t a k i n g measures to discriminate against U.S. c a r r i e r s i n the marketplace (pp.205-207). Third, the U.S., under the Reagan administration, adopted a p o l i c y s t r e s s i n g g r e a t e r c o o p e r a t i o n with f o r e i g n governments (p.209). Fourth, a r e s t r u c t u r i n g of IATA, that permitted c a r r i e r s to r e f r a i n from p a r t i c i p a t i o n i n t a r i f f coordination, decreased the urgency f o r U.S. action against IATA (p.208). F i n a l l y , the United States may have been concerned about i t s aerospace industry l o s i n g business due to f r i c t i o n with countries which had na t i o n a l a i r c a r r i e r s that bought U.S. equipment (p.210). The movement by the United States to restore the i n t e r n a t i o n a l regime, complete w i t h m u l t i l a t e r a l t a r i f f c o o r d i n a t i o n , r e f l e c t e d , t h e r e f o r e , an acknowledgement of defeat (the f i r s t and second p o i n t s ) , a p a r t i a l v i c t o r y (the f o u r t h p o i n t ) , U.S economic i n t e r e s t s (the f i f t h p o i n t ) , and U.S. se c u r i t y i n t e r e s t s (the t h i r d p o i n t ) . Busza (p.203) found the European movement towards the l i b e r a l i z a t i o n of i t s markets simpler to explain than the U.S. movement away from i t s pro-c o m p e t i t i v e p o l i c y . She (p.203) found t h a t the European states most i n t e r e s t e d i n l i b e r a l i z a t i o n were those c o u n t r i e s w i t h e f f i c i e n t a i r c a r r i e r s , or with c a r r i e r s that could b e n e f i t from the carriage of f i f t h and s i x t h freedom t r a f f i c . Busza, t h e r e f o r e , saw the push f o r European l i b e r a l i z a t i o n as being no more than states pursuing regulatory changes i n support of t h e i r c a r r i e r s . 63 In conclusion, Busza (1987, pp.213-215) found the hegemonic s t a b i l i t y theory to be most useful i n explaining regime changes. The theory that p o s t u l a t e d t h a t s t a t e s support regimes that favour t h e i r c a r r i e r s was somewhat les s u s e f u l , while the t h i r d theory - that states support regimes to maximize society's welfare - was the l e a s t u s e f u l . D. Reformulation of Hegemonic S t a b i l i t y Theory I t would seem e v i d e n t from the studies c i t e d i n the previous two sections that the theory of hegemonic s t a b i l i t y has a n a l y t i c a l shortcomings (e.g. , How strong does a country have to be to be a hegemon?) and has performed i n c o n s i s t e n t l y i n empirical t e s t s . 8 One way to a l l e v i a t e the a n a l y t i c a l shortcomings and to achieve more consistent r e s u l t s i s to state more p r e c i s e l y what needs to be tested i n order to f i n d evidence i n support of, or i n c o n t r a d i c t i o n to, the theory. This can be done by d i v i d i n g the theory into constituent parts and by t e s t i n g t h i s modified v e r s i o n of the theory, i n d i v i d u a l l y , against key questions r e l a t e d to the constituent parts. The theory may be broken down as follows: A dominant power i s required to e s t a b l i s h and maintain a stable regime; 8 For example, of the two tests conducted on the i n t e r n a t i o n a l a i r l i n e industry, one author (Jonsson, 1987) found the theory to be only moderately u s e f u l while the other author (Busza, 1987) found the theory to be most us e f u l i n the explanation of regime changes. 64 The dominant power must have the c a p a b i l i t i e s to maintain a regime i t favours, that i s , the dominant power must have the economic resources required to absorb the costs of a regime; The dominant power must want to form and maintain the regime. This implies that the dominant power must expect to receive benefits from the regime t h a t are l a r g e enough to compensate for the expected costs of maintaining the regime. A dominant power that d i d not receive s u f f i c i e n t benefits from a regime would be expected to withdraw support from the regime; Smaller powers must e i t h e r w i l l i n g l y p a r t i c i p a t e i n the regime or be coerced into cooperating i n the regime. This implies that there must be p o s i t i v e i n c e n t i v e s to smaller countries to cooperate and/or the dominant country must have the a b i l i t y to force smaller countries to cooperate; and, A regime, once formed, may weaken i f the dominant country loses i t s dominance, or i f i t decides that the costs of maintaining the regime can no longer be j u s t i f i e d by the be n e f i t s accruing from the regime. 9 As well, the smaller countries may no longer p a r t i c i p a t e i n the regime i f they decide that the incentives f o r p a r t i c i p a t i o n 9 Note that the subordinate countries could attempt to s h i f t a d d i t i o n a l costs onto the dominant country, once a regime i s formed, and t h i s could r e s u l t i n the dominant country deciding that a regime i s no longer worth maintaining. 65 have diminished or i f the dominant country loses the c a p a b i l i t y to enforce the rules of the regime. The q u e s t i o n s t h a t can be asked to determine whether or not the conditions c i t e d above hold at a given time may be stated as follows: Was there a dominant power capable of forming a regime?; I f so, were there incentives f o r the dominant power to form a regime?; Were there costs to the dominant power i n forming and maintaining a regime?; and What incentives (inducements) or coercive measures were used to e n l i s t smaller countries into the regime? A p o s i t i v e answer to the f i r s t question i s required to e s t a b l i s h that an i n t e r n a t i o n a l leader e x i s t s . I t i s assumed that the dominant power acts i n i t s s e l f - i n t e r e s t so there must be i d e n t i f i a b l e incentives for the hegemon to form a regime (question 2) . The hegemonic s t a b i l i t y theory assumes that there are costs incurred i n forming the regime by the hegemon, so these costs should be i d e n t i f i a b l e (question 3). F i n a l l y , the theory p r e d i c t s that small countries w i l l cooperate ( i f r e l u c t a n t l y ) i n adhering to the rules of the regime, so th e r e must be some means of e n l i s t i n g the support of these c o u n t r i e s ( q u e s t i o n 4) . I f s u i t a b l e answers can be found to a l l four 66 questions, then the formation or maintenance of a regime may be explained by the modified hegemonic s t a b i l i t y theory. Figure 3.1 provides an example of how the modified hegemonic theory can be t e s t e d a g a i n s t regime formation and maintenance i n i n t e r n a t i o n a l a i r t r a n s p o r t . The regime examined i s the post-Bermuda regime (1946-1977, approximately). I f i t i s assumed that the United States i s the hegemon, the U.S. should incur costs i n maintaining the regime (e.g. higher p r i c e s for consumers and/or fewer opportunities f o r U.S. a i r c a r r i e r s ) . But, assuming the U.S. i s not a l t r u i s t i c , the U.S. should also receive b e n e f i t s from the regime (e.g., access to defense i n s t a l l a t i o n s i n Europe; and monopoly p r o f i t s f o r U.S. f l a g c a r r i e r s on c e r t a i n i n t e r n a t i o n a l routes). As w e l l , there s h o u l d be i d e n t i f i a b l e b e n e f i t s or c o e r c i v e measures to e n l i s t the p a r t i c i p a t i o n of smaller countries into the regime (e.g. IATA p r i c i n g f o r i n e f f i c i e n t f l a g c a r r i e r s ; a d d i t i o n a l U.S. routes for f o r e i g n f l a g c a r r i e r s ) . I f these conditions can a l l be i d e n t i f i e d , then the questions r a i s e d above can be answered, and the hegemonic theory supported. E. Other Factors Relevant to the Explanation of Regime Development The e m p i r i c a l t e s t i n g o f the m o d i f i e d hegemonic s t a b i l i t y theory i n d i c a t e d that world leadership, alone, cannot always explain the emergence or maintenance of i n t e r n a t i o n a l regimes. Other p o l i t i c a l and economic factors could also be considered. For the purpose of t h i s paper, factors are d i v i d e d into three categories: domestic a f f a i r s ; s t r u c t u r a l f a ctors; and, o v e r r i d i n g state i n t e r e s t s . 67 F i g u r e 3.1 The P o s t - B e r a u d a R e g i a e i n t h e C o n t e x t o f M o d i f i e d H e g e a o n i c S t a b i l i t y T h e o r y P o s t - Bermuda R e g i m e cn 'co U n i t e d S t a t e s ( T h e Hegemon) 4-i n c e n t i v e s and c o e r c i v e m e a s u r e s ( I A T A p r i c i n g ; U.S. r o u t e s ) COSTS ( R e d u c t i o n i n o p p o r t u n i t i e s f o r A i r C a r r i e r s and h i g h e r p r i c e s f o r c o n s u m e r s ) BENEFITS ( D e f e n c e b a s e s , e x c e s s p r o f i t s f o r U.S. c a r r i e r s on c e r t a i n r o u t e s ) M u l t i l a t e r a l T a r i f f C o o r d i n a t i o n ( I A T A ) s u b j e c t t o g o v e r n m e n t a p p r o v a l B i l a t e r a l R e g u l a t i o n o f R o u t e s and C a p a c i t i e s Bermuda 1 o r p r e - d e t e r m i n e d c a p a c i t y r e s t r i c t i o n s O t h e r C o u n t r i e s 1. Domestic Affairs The hegemonic s t a b i l i t y theory indicated that a hegemon w i l l choose to pay the costs of supplying a regime as long as i t believes i t i s r e c e i v i n g or w i l l receive s u f f i c i e n t benefits (economic or otherwise) as compensation. As wel l , other countries may p a r t i c i p a t e i n a regime i f they receive benefits from p a r t i c i p a t i o n . A problem a r i s e s , however, i n d e t e r m i n i n g what consti t u t e s a b e n e f i t . Monopoly p r i c i n g through IATA, f o r example, can be thought of as a benefit to a i r l i n e s but as a cost to consumers. When, then, would a hegemon choose to supply a regime incorporating IATA p r i c i n g , or another country choose to p a r t i c i p a t e i n such a regime? I t i s evident that t h i s would happen only when a government perceives b e n e f i t s to a i r c a r r i e r s as being important benefits to achieve ( i . e . , important enough to outweigh the costs to consumers). Therefore, a country's p o l i t i c a l process, i n that i t determines whose i n t e r e s t s are to be more important, can be a fa c t o r i n the establishment or maintenance of a regime. There are a number of groups which may p a r t i c i p a t e i n the p o l i t i c a l process around the choice of a pu b l i c p o l i c y which w i l l convey costs and bene f i t s on d i f f e r e n t sectors of society. The goals and r o l e s of a number of important p a r t i c i p a n t s i n the policy-making process are discussed below: a) Politicians Downs (1957, p.137), i n one of the f i r s t attempts to develop a p o s i t i v e economic theory to explain p o l i t i c a l processes, o u t l i n e d the primary goal of p o l i t i c i a n s ; i . e . , to obtain votes. According to Downs: 69 [ P o l i t i c i a n s ] do not seek to gain o f f i c e i n order to carry out pre-c o n c e i v e d p o l i c i e s or to serve any p a r t i c u l a r i n t e r e s t groups; rather they formulate p o l i c i e s and serve i n t e r e s t groups i n order to gain o f f i c e . Obtaining and maintaining p o l i t i c a l power, therefore, i s seen as the p r i m a r y g o a l of p o l i t i c i a n s . What i s t h e i r r o l e i n the policy-making process? This depends on whether or not the p o l i t i c i a n s form the government or are i n opposition. The r o l e of government p o l i t i c i a n s i s to formulate p o l i c i e s most l i k e l y to keep them i n power. The r o l e of opposition p o l i t i c i a n s i s to formulate a l t e r n a t i v e p o l i c i e s i n an attempt to gain power. Governments, according to S t i g l e r (1971) are able to use t h e i r power to coerce i n order to m a i n t a i n power. Governments exchange fav o u r a b l e r e g u l a t o r y p o l i c i e s with industry groups for promises of votes, campaign contributions or p o s i t i v e p u b l i c i t y . (Opposition p a r t i e s promise favourable l e g i s l a t i o n should they be elected.) Governments may even undertake an entrepreneurial r o l e and seek large voting blocks (e.g. farmers) i n order to provide them with favourable l e g i s l a t i o n i n the a n t i c i p a t i o n of obtaining votes from group members ( S t i g l e r , 1971, p.13). 1 0 b) Bureaucrats The goals and rol e s of bureaucrats depend, i n large part, on t h e i r p o s i t i o n s i n governments. Two types of bureaucrats w i l l be distinguished-the regulator and the departmental bureaucrat. The regulator i s a p o l i t i c a l A more general i n t e r e s t group model was formulated by Becker (1983). 70 appointee, often nominated f o r a p o s i t i o n on a regulatory board f o r a f i x e d time period. The goals of the regulator depend on h i s or her ambitions. H i l t o n (1972) s t a t e d that since many regulators seek a p o s i t i o n i n the regulated industry, once t h e i r terms have expired, the major objectives of the regulators would include appeasing the regulated industry. As i s often the case, i f few s p e c i f i c p o l i c y d i r e c t i v e s are handed to the regulatory agency from the p o l i t i c i a n s , then the regulators would have a reasonably free r e i n to adopt p o l i c i e s favourable to the regulated industry. On the other hand, i f p o l i t i c i a n s wish to change the d i r e c t i o n of the regulatory agency, then outsiders with d i f f e r e n t views (e.g., pro-deregulation views) can be a p p o i n t e d to the regulatory commission and new p o l i c y d i r e c t i v e s can be issued. The r o l e of the regulatory agency v a r i e s from industry to industry. Generally, the agency engaged i n economic regulation must c o n t r o l the p r i c e s , output or rate of return of firms i n the industry. This involves conducting regulatory hearings at which intere s t e d p a r t i e s present b r i e f s as to how they f e e l the outcome of the h e a r i n g s should be decided. The r o l e of the r e g u l a t o r , t h e r e f o r e , i n c l u d e s a c t i n g as an a r b i t e r between competing i n t e r e s t s i n order to a r r i v e at a regulatory outcome. The departmental bureaucrat, unlike the regulator, i s not a p o l i t i c a l a p p o i n t e e , but a c a r e e r t e c h n o c r a t ( p u b l i c s e r v a n t ) . Departmental bureaucrats are not n e c e s s a r i l y interested i n plumbing f o r p o s i t i o n s outside the bureaucracy but i n promoting t h e i r p o s i t i o n s w i t h i n i t . Bureaucrats pursue t h e i r own purposes by d e f i n i n g issues and then by promoting these 71 issues to p o l i t i c i a n s , to other bureaucrats and to the p u b l i c . 1 1 Bureaucrats enhance t h e i r p o s i t i o n and power by pursuing p o l i c i e s designed to expand t h e i r areas o f i n f l u e n c e ( d i s c r e t i o n ) and t h e i r budget. G e n e r a l l y , bureaucrats i n departments with s p e c i f i c c l i e n t groups (e.g., a g r i c u l t u r e , f i s h e r i e s , labour) have considerable contact with members of t h e i r c l i e n t group and are sympathetic to t h e i r concerns. One would expect, therefore, that as the bureaucrats i n these departments administer t h e i r departments i n purs u i t of t h e i r goals ( i . e . , to expand and enhance t h e i r departments), the preferred p o l i c i e s would be those favourable to the needs of t h e i r c l i e n t groups (Blake and Walters, 1987, p.221). 1 2 c) Interest Groups and their Lobbyists I n t e r e s t groups or p r e s s u r e groups, and t h e i r l o b b y i s t s , are non-governmental actors which seek to use the p o l i t i c a l system to promote t h e i r own i n t e r e s t s (pecuniary and non-pecuniary). These groups can, therefore, be seen as s e l f - i n t e r e s t groups, which act i n a r a t i o n a l way i n an attempt to obtain favourable p o l i c i e s from the government. Downs (1957) claimed that i n t e r e s t groups are a necessary feature of the democratic p o l i t i c a l system because of imperfect information. I f p o l i t i c i a n s had p e r f e c t knowledge of the preferences of the e l e c t o r s , then p o l i c i e s could be designed, with c e r t a i n t y , to appeal to the majority. As well, i f electors 1 1 Kegley and Wittkopf (1987, p.481) defined the goals of a bureaucratic department as follows: "...to pursue i t s own purposes, to promote i t s own power, and to enhance i t s own p o s i t i o n i n the government hierarchy". 1 2 An important secondary r o l e f o r the bureaucrat i s to a r b i t r a t e among various c l i e n t groups when the views of these groups c o n f l i c t . 72 had p e r f e c t knowledge of the p o l i c i e s of p o l i t i c a l p a r t i e s , then voting decisions could be made, with c e r t a i n t y , i n an e f f o r t to maximize expected u t i l i t y . But, i n the r e a l world, knowledge i s not perfe c t . P o l i t i c i a n s are not sure of the preferences of the elect o r s and el e c t o r s are not c e r t a i n of the p o l i c i e s of the p o l i t i c i a n s . There e x i s t s room f o r i n t e r e s t groups, as intermediaries, to promote t h e i r views to the p u b l i c and to convince the p o l i t i c i a n s that t h e i r views are accepted by the p u b l i c . As Downs (1957, p. 140) stated: On one hand [the i n t e r e s t groups] attempt to convince the government that the p o l i c i e s they stand f o r - which are of d i r e c t b e n e f i t to themselves - are both good f o r and desired by a large p o r t i o n of the electorate. On the other hand, they t r y to convince the ele c t o r a t e that these p o l i c i e s are, i n f a c t , d e s i r a b l e . Democratic forms of government are more f a v o u r a b l e to l o b b y i s t s representing producer groups than to lobbyists f o r consumer groups 1 3 (Downs, 1957, pp.148-149). Since a given producer tends to have more at stake r i d i n g on the outcome of a regulatory p o l i c y a f f e c t i n g h i s or her industry, than does a consumer, the producer would be more l i k e l y to commit resources to lobby the government f o r a favourable p o l i c y . Consumer groups, representing a l a r g e r constituency than producer groups, would also have more trouble overcoming the f r e e - r i d e r problem i n an attempt to c o l l e c t resources f o r an e f f e c t i v e lobbying e f f o r t . 1 4 The r e s u l t i s that producers tend to be more 1 3 Rent con t r o l i s an obvious counter example not discussed by Downs (1957). 1 4 See: Olson (1971). 73 successful l o b b y i s t s than do consumers, and therefore are more l i k e l y to achieve favourable government p o l i c i e s . d) Voters The l a s t group of p a r t i c i p a n t s which w i l l be discussed i s the voters. In a democratic society, voters have the important r o l e of choosing among p o l i t i c a l p a r t i e s and t h e i r candidates. The major goal of voters i s to s e l e c t a government which can provide them with the greatest b e n e f i t s ( i n the form of p o l i c i e s ) (Downs, 1957, p.138). However, due to bounded r a t i o n a l i t y and to the c o s t s i n v o l v e d i n o b t a i n i n g information, voters base t h e i r d e c i s i o n s on l i m i t e d and s e l e c t i v e information, or perhaps j u s t on the perceived p e r s o n a l i t i e s of the p o l i t i c i a n s . Table 3.1 provides a b r i e f summary of the major goals and roles of p a r t i c i p a n t s i n the policy-making process. I t should be noted that i n a l l cases, the goals of the p a r t i c i p a n t s are consistent with u t i l i t y maximizing b e h a v i o u r . The r o l e s l i s t e d are only the major role s executed by the p a r t i c i p a n t s i n the policy-making process. The p a r t i c i p a n t s i n t e r a c t i n a complex process i n order to produce p u b l i c p o l i c i e s . The policy-making process, as adapted from Stanbury (1986, p.139), i s i l l u s t r a t e d i n Figure 3.2. 1 5 From the top of the f i g u r e , p o t e n t i a l gainers from changes i n governmental p o l i c i e s ( i . e . , i n t e r e s t groups) h i r e lobbyists to promote favourable government p o l i c i e s . The lo b b y i s t s appeal d i r e c t l y to 1 5 The process model i s i l l u s t r a t e d f o r a parliamentary democracy, but s i m i l a r models could be derived for other forms of governments. 74 Table 3.1 Participants In the Policy-Making Process: Goals and Roles Participant Major Goals Major Roles Government Politicians Maintenance of power Formulation of policies Opposition Politicians Regulators Departmental Bureaucrats Interest Groups Gain power Appeasement of regulated industry and/or fulfillment of independent objectives Expansion of their departments Adoption of policies by the government favourable to the group members Formulation of policy alternatives to those offered by the government Regulate firms in the industry under the general policy guidance of the government Undertake administrative role under general direction of the government Lobby the government, regulators and bureaucracy on behalf of group interests and disseminate information to voters in order to sway public opinion in support of their cause Voters (General Public) Elect a party which has policies that maximize their individual u t i l i t i e s Voting 75 F i g u r e 3.2 P u b l i c Choice Model of Policy-Making Large Absolute P o t e n t i a l Gainers ( l o s e r s ) from Changes i n Government P o l i c y ( I . e . , Interest Groups] Persuasive Communications Money, Information money. Information promises of b e n e f i c i a l p o l i c i e s luppoft ( i or In k i n d ) " Greater . L i k e l i h o o d of Favourable Rul trigs and I n i t i a t i v e s POL ITICAL PARTIES operating i n c o n s t i t u e n c i e s ) persuasive Information and promises of p o l i c i e s p o l i c i e s which confer b e n e f i t s and costs majori t y party GOVERNMENT (with c o n t r o l over l e g i s l a t u r e and executive) P o l i c y Advice and I n i t i a t i v e s P o l i c y D i r e c t i v e s Information and Job Promises DEPARTMENTAL BUREAUCRATS REGULATORS regulatory r u l i n g s which confer b e n e f i t s and costs Source: Adapted from U.T. Stonbury (1986. p.139). the v o t e r s by o f f e r i n g them p e r s u a s i v e i n f o r m a t i o n supportive of the l o b b y i s t s ' p o s i t i o n . The lobbyists attempt to portray p o l i c i e s favourable to the i n t e r e s t groups they represent, as also being b e n e f i c i a l to the voters, i n an attempt to a l t e r voter behaviour. The l o b b y i s t s also exchange campaign contributions and s e l e c t i v e information with p o l i t i c a l p a r t i e s f o r promises of b e n e f i c i a l p o l i c i e s ; and information and job promises with bureaucrats and regulators f o r the greater l i k e l i h o o d of favourable regulatory r u l i n g s and bureaucratic i n i t i a t i v e s . P o l i t i c a l p a r t i e s attempt to influence voters by promising a t t r a c t i v e p o l i c i e s and by providing information to support t h e i r causes. Voters weigh the p o l i c y options and information from the p o l i t i c i a n s and l o b b y i s t s and support the p a r t which w i l l l i k e l y b r i n g them the greatest amount of b e n e f i t s . Support i s i n the form of votes and campaign contributions. The majority party i n a parliamentary democracy forms the government. The government, w i t h a d v i c e and h e l p from the bureaucracy, i n s t i t u t e s p o l i c i e s which impose c o s t s and b e n e f i t s on members of society. The government also issues p o l i c y d i r e c t i v e s to i t s regulators (and uses the patronage system to h i r e new regulators to replace appointees from previous governments) who, i n turn, issue regulatory r u l i n g s which also impose costs and b e n e f i t s on members of society. 2. Structural Factors In a d d i t i o n to domestic p o l i t i c a l a f f a i r s , s t r u c t u r a l factors may also a f f e c t the functioning of regimes. The s p e c i f i c s t r u c t u r a l factors depend, 77 to some extent, on the i n s t i t u t i o n s comprising the regime. One type of i n s t i t u t i o n t h a t i s of gr e a t importance to the explanation of regime maintenance and change i n the i n t e r n a t i o n a l a i r l i n e industry i s the c a r t e l . The discussion i n t h i s s ection of the chapter w i l l focus, therefore, on the s t r u c t u r a l f a c t ors which influence the maintenance of a c a r t e l , although s i m i l a r discussions could also be written f o r other regime arrangements. Four factors are i d e n t i f i e d and discussed below: a) Number of Producers A c a r t e l may encounter problems i n the maintenance of p r i c e s , output l e v e l s or p r o f i t s , i f new producers are able to enter the industry. The c a r t e l has two options with respect to the new producers: i t can exclude the new producers from the c a r t e l arrangement and attempt to compete with them or to drive them out of business; or i t can allow the new producers to enter the c a r t e l arrangement. Competing with the new producers can be a h i g h - r i s k strategy, because the new producers are often able to under-price the c a r t e l producers. However, i n v i t i n g the new producers into the c a r t e l also creates problems. Scherer (1980, p.199) provided three reasons why more s e l l e r s i n an industry can lead to greater problems f or c a r t e l s i n coordinating p r i c e s or output l e v e l s . F i r s t , as the number of s e l l e r s increase, firms are more l i k e l y to ignore the p r i c e and output decisions of other c a r t e l members. The p r i c e and output decisions of an i n d i v i d u a l f i r m i n an industry becomes less s i g n i f i c a n t , as the number of firms i n that industry increases, ceterus paribus. Firms become less l i k e l y to recognize or to punish a firm that 78 deviates from the c a r t e l p r i c e standards or from the firm's output quota. Second, as the number of s e l l e r s increases, so does the p o s s i b i l i t y that there w i l l be at l e a s t one maverick firm, within the c a r t e l , pursuing an independent p r i c i n g or output strategy. F i n a l l y , as the number of s e l l e r s increases, there i s a higher l i k e l i h o o d that the firms w i l l have d i f f e r e n t cost structures. Firms with d i f f e r e n t cost structures w i l l tend to want to set d i f f e r e n t outputs or p r i c e s , so that agreement on the t o t a l l e v e l of output or on the p r i c e to be charged by c a r t e l members, w i l l be more d i f f i c u l t to achieve. b) New Technology The i n t r o d u c t i o n of new technology into an industry may a f f e c t a c a r t e l ' s a b i l i t y to m a i n t a i n p r i c e s or l e v e l s of output. I f the new technology i s not adopted simultaneously by the c a r t e l members, some c a r t e l members w i l l have, f or a time, a cost advantage over other members. This could r e s u l t i n d i f f i c u l t i e s i n obtaining p r i c i n g agreements. Even i f the technology i s adopted by a l l members, the c a r t e l may be slow to respond with changes i n p r i c e s or output l e v e l s . This would create the incentive f o r members to undercut the c a r t e l p r i c e or to o f f e r goods above quota l e v e l s . New technology may also be adopted by a second industry, making the functioning of the c a r t e l more d i f f i c u l t . I f the second industry, using the new technology, i s able to compete more e f f e c t i v e l y with the c a r t e l members, then the c a r t e l p r i c i n g or output p o l i c y i s l i k e l y to break down. 79 c) Economic Downturns Changes i n the general state of the economy can undermine a c a r t e l . Downturns i n the economy may create problems of oversupply, e s p e c i a l l y i f there i s no easy e x i t from the industry. This would provide incentives f o r c a r t e l members to break ranks and undercut the c a r t e l p r i c e , i n order to maintain output l e v e l s . d) Height of Entry (and Exit) Barriers16 A change i n the height of b a r r i e r s to the entry into an industry may a f f e c t the s t a b i l i t y of a c a r t e l (Posner, 1969, p.1569). The height of these b a r r i e r s may be changed due to economic fac t o r s , such as a new technology, or to p o l i t i c a l f a c t o r s , such as changes i n regulations regarding entry. I f the b a r r i e r s are lowered, then new firms may enter the industry c r e a t i n g more d i f f i c u l t y i n the coordination of pr i c e s (due to the larger number of firms). Table 3.2 provides a summary of the s t r u c t u r a l factors which may a f f e c t the s t a b i l i t y of a c a r t e l and how each f a c t o r can influence c a r t e l s t a b i l i t y . 3. Overriding State Interests In a d d i t i o n to the domestic p o l i t i c a l and the economic factors discussed above, t h e r e may be o v e r r i d i n g s t a t e i n t e r e s t s t h a t can a f f e c t the e s t a b l i s h m e n t or maintenance of a regime. An example of an overriding n a t i o n a l or state i n t e r e s t would be nationa l defense, e.g. countries may 1 6 The b a r r i e r s are important determinants of the c o n t e s t a b i l i t y of the industry. 80 T a b l e 3 . 2 S t r u c t u r a l F a c t o r s I n f l u e n c i n g The M a i n t e n a n c e o f a C a r t e l Factor  Number of Firms in Industry Increases Cartel Stability Decreases Cartel Stability Reduction of firms Increase in firms Cost-Saving Technology No new technology Introduction of technology Economic (or Business) Cycle Stable or growing economy (or industry) Economic downturn (or industry downturn) Height of Entry Barriers Raised Lowered 81 choose to form or maintain a regime, notwithstanding economic interests, i n order to ensure the defense of t h e i r borders. Another example of an overriding state i n t e r e s t may be the maintenance of (a) n a t i o n a l f l a g c a r r i e r ( s ) . V i r t u a l l y every country i n the world has s e e n f i t to e s t a b l i s h , e i t h e r p u b l i c l y or p r i v a t e l y , at l e a s t one i n t e r n a t i o n a l a i r l i n e , regardless of the economic r a t i o n a l e . 1 7 Gidwitz (1980, pp.21-22) c i t e d two p o l i t i c a l reasons f o r operating an i n t e r n a t i o n a l c a r r i e r . F i r s t , she claimed that an i n t e r n a t i o n a l a i r l i n e was a source of s t a t u s , e s p e c i a l l y f o r d e v e l o p i n g c o u n t r i e s . Second, she stated that countries often wish to operate routes for p o l i t i c a l , rather than economic reasons (e.g. service to former c o l o n i e s ) . A d i s t i n c t n a t i o n a l f l a g c a r r i e r i s required to operate these p o l i t i c a l routes. F. Summary In t h i s chapter the theory of hegemonic s t a b i l i t y was stated and the c r i t i c i s m s and empirical tests of the theory reviewed. I t was found that the t e s t s o f the theory have produced i n c o n s i s t e n t r e s u l t s - some tests supporting the theory and others co n t r a d i c t i n g the theory. In order to test the theory i n a more rigorous manner than has been done previously, i t was thought b e n e f i c i a l to modify the theory by d i v i d i n g i t into a number of constituent parts. Questions were then formulated to check f o r agreement with the theory on each of the constituent parts. 1 7 Exceptions would be Denmark, Sweden and Norway, which j o i n t l y operate SAS and eleven A f r i c a n countries which j o i n t l y operate A i r Afrique. 82 A d d i t i o n a l f a c t o r s , aside from hegemonic s t a b i l i t y , which may also be relevant to the explanation of regime developments, were ou t l i n e d i n the c h a p t e r . These f a c t o r s were grouped into three categories - domestic a f f a i r s , s t r u c t u r a l factors and overriding state i n t e r e s t s . Domestic a f f a i r s r e f e r r e d to i n t e r n a l p o l i t i c a l f a c t o r s which may a f f e c t the choice of government p o l i c i e s . S t r u c t u r a l factors discussed were those which could a f f e c t the functioning of an i n t e r n a t i o n a l c a r t e l . F i n a l l y , o verriding state i n t e r e s t s r e f e r r e d to n a t i o n a l p r i o r i t i e s chosen by governments regardless of economic consequences. In the next chapter, snapshots of four post-World War Two i n t e r n a t i o n a l a i r transport regimes are presented and the events surrounding the adoption and maintenance of the regimes used to t e s t hegemonic s t a b i l i t y theory. The elements of the o t h e r f a c t o r s are employed to add to the explanations provided by hegemonic s t a b i l i t y theory. 83 IV. APPLYING HEGEMONIC STABILITY THEORY TO REGIME CHANGES IN INTERNATIONAL AIR TRANSPORT A. Introduction How w e l l does the theory of hegemonic s t a b i l i t y account f o r regime developments i n i n t e r n a t i o n a l a i r transport? Do the other f a c t o r s , described i n the previous chapter, add s i g n i f i c a n t l y to the understanding of why the a i r t r a n s p o r t regime was formed, maintained or changed? These are the questions that are addressed i n t h i s chapter. The s t r u c t u r e of the chapter i s as follows: Section B tests the m o d i f i e d hegemonic s t a b i l i t y theory against the events leading to the formation of the 1946 Bermuda regime. Sections C, D and E, i n a s i m i l a r manner, t e s t the theory against events leading to the establishment of the 1965 post-Bermuda regime, the 1981 l i b e r a l regime, and the 1986 p o s t - l i b e r a l regime, r e s p e c t i v e l y . 1 F i n a l l y , Section F provides conclusions as to the effectiveness of the modified hegemonic s t a b i l i t y theory i n explaining regime developments i n i n t e r n a t i o n a l a i r transport, and uses the r e s u l t s of the analysis to assess the future prospects of i n t e r n a t i o n a l a i r regulation. 1 The exact years studied ( i . e . , 1946, 1965, 1981 and 1986) were chosen to r e f l e c t "snap-shots" of the d i f f e r e n t post-World War Two a i r transport regimes. , 84 B. The 1946 Bermuda Regime In t h i s s e c t i o n of the chapter, the events leading to the formation of the Bermuda regime of 1946 are reviewed, followed by attempts to explain the development of the regime using the modified theory of hegemonic s t a b i l i t y . The usefulness of the theory i s assessed and the other explanatory factors are introduced to a i d i n the analysis. A "snap-shot" of the Bermuda regime and r e l a t e d environmental and i n d u s t r y factors i s shown i n Table 4.1. Important c h a r a c t e r i s t i c s of the regime included: almost u n i v e r s a l p r i c e -s e t t i n g by IATA, subject to governmental approval; a t e c h n i c a l r o l e f or ICAO; and, the b i l a t e r a l r e g u l a t i o n of routes and c a p a c i t i e s . Environmental factors important to the development of i n t e r n a t i o n a l a v i a t i o n included a strong U.S. economy, but weak post-war economies i n most of the r e s t of the world. Important c h a r a c t e r i s t i c s of the 1946 a i r transport industry included i t s extremely small s i z e (compared to today's industry); a large extent of government ownership of a i r l i n e s , except f o r the U.S.; the dominance of scheduled transport over charter a c t i v i t i e s ; and the dominance of the U.S. a i r l i n e s i n the industry, with three-quarters of the t o t a l business. How and why d i d the 1946 regulatory regime come about? The next sub-sec t i o n w i l l o u t l i n e how i t came about, and the following sub-sections w i l l attempt to explain why i t resulted. 85 T a b l e 4 . 1 S n a p - s h o t o f t h e 1946 Bermuda Reg ime a n d R e l a t e d E n v i r o n m e n t a l a n d I n d u s t r y F a c t o r s C h a r a c t e r i s t i c or 1946 Bermuda Factor Regime 1. Regime Characteristics a) Role of IATA i n Prices set by IATA Setting Prices (subject to government approval) on v i r t u a l l y a l l major routes. b) Membership i n IATA V i r t u a l l y a l l major i n t e r n a t i o n a l scheduled c a r r i e r s . Membership was 60 a i r l i n e s (1945) with about one-third of active members repre-senting developing countries or colonies. c) Role of ICAO Involvement i n economic matters envisioned although only t e c h n i c a l r o l e assigned. d) B i l a t e r a l Capacity Clauses Primary objective of the pr o v i s i o n of capacity was to meet t r a f f i c demand between country of n a t i o n a l i t y of a i r c a r r i e r and country of ultimate destination. Capacity l e v e l s subject only to ex post facto reviews (known as Bermuda b i l a t e r a l clause) e) Regulation by Regional Organizations No regional organizations. 86 Table 4.1 (Continued) Environmental Factors a) The World Economy b) Third World Development c) U.S. Government Industry Factors a) Maturity of Airline Industry b) State of Technology c) Government Ownership d) Role of Charter Operators e) Size of Industry f) Product Offerings 87 The United States had a strong economy but the economies of Europe and Japan were devastated following the War. Many developing countries part of colonial empires. Liberal, Democratic administration working to halt expansion of communism through the creation of an open trading environment among U.S. a l l i e s . Infant industry, recovering from vi r t u a l cessation of activity during the War. Piston aircraft; many converted from military usage to c i v i l i a n use. Government ownership of most national airlines, except U.S. L i t t l e charter activity. The industry performed 19 b i l l i o n passenger-kilometres (1947 data). Only f i r s t class seats were offered. Table 4.1 (Continued) g) " I l l e g a l " Gifts and promotions Discounting used to entice passengers. Resolutions against i l l e g a l discounting not yet passed by IATA. h) U.S. Dominance of Air Transport U.S. airlines performed over three-quarters of the world's a i r services, as measured in passenger-kilometres (1949 data). 88 1. Developments Leading to the Formation of the 1946 Bermuda Regime a) The Regulation of Air Transport before World War Two As most a v i a t i o n scholars and laymen, a l i k e , are aware, heavier-than-air f l i g h t s had t h e i r s t a r t with the Wright brothers i n 1903. However, i n t e r e s t i n commercial a v i a t i o n grew very slowly i n the years following the Wright Brothers' f i r s t f l i g h t (Chuang, 1972, p.16). I t was only following the F i r s t World War, a f t e r s u f f i c i e n t experience had been gained i n the manufacture and f l y i n g of a i r c r a f t , that commercial a v i a t i o n developed. I t was also following World War I that the major underlying p r i n c i p l e of the "meta-regime" of i n t e r n a t i o n a l a i r transport was accepted. The p r i n c i p l e was that of n a t i o n a l sovereignty over a i r space. This p r i n c i p l e had been debated by representatives of nineteen states before the war i n P a r i s . At that time, the delegates had recognized that n a t i o n a l sovereignty r i g h t s were superceded by the p r i n c i p l e of freedom of passage f o r f o r e i g n a i r c r a f t (Goedhuis, 1955, p.211). However, at the Paris Convention following World War I, i n an era characterized by a post-war mentality of d i s t r u s t f o r other n a t i o n s , the p r i n c i p l e of f u l l n a t i o n a l sovereignty over a i r space was affirmed. This p r i n c i p l e was reaffirmed at the Havana Convention of 1928 and the Chicago Conference of 1944, and has remained the underlying p r i n c i p l e of the i n t e r n a t i o n a l a i r transport meta-regime, to t h i s day. National sovereignty over a i r space implied that there must be b i l a t e r a l or m u l t i l a t e r a l agreements i n order to permit i n t e r n a t i o n a l f l i g h t s to take place. B i l a t e r a l agreements were signed by governments as e a r l y as 1913, although most pre-World War II agreements were signed following the Paris 89 Convention of 1919 (Haanappel, 1984, p.25). In some cases, the pre-World War II b i l a t e r a l s were not negotiated between two countries but between an a i r l i n e and a country. This was e s p e c i a l l y true with U.S. i n t e r n a t i o n a l routes operated by the country's "chosen" a i r l i n e , Pan American Airways. 2 According to S t o f f e l (1959, p.120): Arrangements were made with l o c a l governments who were anxious to have the transport service provided by Pan American. As they had no n a t i o n a l c a r r i e r s of t h e i r own capable of conducting i n t e r n a t i o n a l o p e r a t i o n s , they d i d not fear competition. In exchange f o r such r i g h t s Pan American, i n many c o u n t r i e s , p a r t i c i p a t e d i n the e s t a b l i s h m e n t and development of l o c a l a i r l i n e s . B e fore the Second World War, there was no formal organization with authority to f i x i n t e r n a t i o n a l a i r t a r i f f s . T a r i f f s were established e i t h e r u n i l a t e r a l l y by c a r r i e r s or through agreements by a i r l i n e s operating s i m i l a r routes. There was, however, an a i r c a r r i e r organization with authority i n areas o t h e r than p r i c e - f i x i n g , c a l l e d the I n t e r n a t i o n a l A i r T r a f f i c A s s o c i a t i o n or "Old IATA". Old IATA, formed i n 1919 by s i x European a i r l i n e s , was concerned w i t h matters such as sc h e d u l e s , t i m e t a b l e s , c o n d i t i o n s of c a r r i a g e , procedures and documents f o r the settlement of accounts between c a r r i e r s , and f l i g h t l i a b i l i t y (Chuang, 1972, p.20). By the time i t s operations were disrupted by World War I I , Old IATA had grown to twenty-nine members from twenty-four countries and four continents (Chuang, 1972, p.20). The operations of Old IATA remained dormant during the war, and the organization was o f f i c i a l l y disbanded i n 1945 (Brancker, 1977, p.10). 2 Chuang (1972, p.19) claimed that Pan American's negotiations were conducted, presumably, with the t a c i t consent of the U.S. State Department. 90 b) The Chicago Conference of 1944 During the Second World War, commercial a v i a t i o n v i r t u a l l y ceased. The ongoing f i g h t i n g made f l y i n g extremely hazardous i n parts of the world and, as well, the war e f f o r t required resources to be expended on m i l i t a r y , rather than c i v i l i a n , a i r c r a f t . However, towards the end of the war, when i t appeared that h o s t i l i t i e s were going to end, a conference was c a l l e d f or Chicago to discuss the regulatory framework f o r post-War a v i a t i o n . The Chicago Conference was convened by P r e s i d e n t F r a n k l i n D. Roosevelt on November 1, 1944, and was attended by r e p r e s e n t a t i v e s o f f i f t y - f o u r countries. O'Connor (1971, p.19) l i s t e d the aims of the Chicago Conference as follows: the founding of a permanent i n t e r n a t i o n a l organization for c i v i l a v i a t i o n ; the establishment of interim bodies to cope with immediate post-War problems; the regulation of safety and navigational aspects; and, the regulation of economic aspects of i n t e r n a t i o n a l a i r transport. The conference was successful i n reaching an agreement on the f i r s t t h r e e aims. The Chicago Convention (ICAO, 1980f) p r o v i d e d f o r the establishment of the P r o v i s i o n a l International C i v i l A v i a t i o n Organization and, i n 1947, for the formation of ICAO. The conference also provided ICAO with the authority to recommend i n t e r n a t i o n a l standards f o r t e c h n i c a l and safety issues. ICAO, however, was not given any d i r e c t authority over the 91 economic r e g u l a t i o n of a i r transport, so the fourth aim of the conference was not achieved. The major reason for the lack of a consensus on the economic regulation of a i r transport has been a t t r i b u t e d to the i n a b i l i t y of the United States and the United Kingdom, the two major a v i a t i o n powers of the time, to agree to an acceptable regulatory formula. 3 The p o s i t i o n of the United States was that the granting of route r i g h t s should r e s u l t from b i l a t e r a l negotiations, between governments, and that any intergovernmental organization, such as ICAO, should have only consultative powers on economic matters (O'Connor, 1971, p. 20). The United States was i n favour of broad exchanges of route r i g h t s , i n c l u d i n g f i f t h freedom r i g h t s ( i . e . , the r i g h t of a i r l i n e s of Country A to t r a n s p o r t passengers between Countries B and C on routes beginning or ending i n Country A) . With respect to t a r i f f s , the United States, while opposed to t a r i f f s e t t i n g by an i n t e r n a t i o n a l a i r authority, was not a g a i n s t a system whereby the a i r l i n e s , themselves, though an "operators conference", could agree to t a r i f f l e v e l s (Haanappel, 1984, p.13; O'Connor, 1971, p.22). The B r i t i s h p o s i t i o n d i f f e r e d from the p o s i t i o n of the United States i n that the B r i t i s h wanted the creation of an i n t e r n a t i o n a l regulatory authority with r e a l powers. The authority would be responsible f o r determining and d i s t r i b u t i n g frequencies and capacity l e v e l s among a i r l i n e s , and for f i x i n g rates, while routes would be agreed to on a b i l a t e r a l basis (Chuang, 1972, p.22). 3 See, for example, O'Connor (1971, p.31). 92 The p o s i t i o n s of the B r i t i s h and the U n i t e d States could not be re c o n c i l e d at Chicago. There were, however, two agreements concerning route r i g h t s which were l e f t open for signing. The f i r s t , known as the "Two Freedoms" agreement, provided f or a m u l t i l a t e r a l exchange of n o n - t r a f f i c a i r freedoms. This agreement received wide acceptance and i s s t i l l i n force, today, with close to 100 signat o r i e s . The second agreement was the "Five Freedoms" agreement, which provided f or a m u l t i l a t e r a l exchange of the f i r s t f i v e freedoms of a i r transport. This agreement was promoted by the United S t a t e s , but d i d not receive wide acceptance. 4 Although s t i l l open for signatures today, the Five Freedoms agreement i s v i r t u a l l y a dead i s s u e . 5 c) The Formation of IATA A number of a i r l i n e o f f i c i a l s attended the conference i n Chicago. When i t became apparent that the conference would not conclude an agreement on the economic r e g u l a t i o n o f i n t e r n a t i o n a l a i r t r a n s p o r t , the a i r l i n e r e p r e s e n t a t i v e s d e c i d e d to h o l d t h e i r own meeting. The a i r l i n e representatives appointed Mr. J.C. Cooper of Pan American Airways to head a committee to d r a f t the a r t i c l e s of a s s o c i a t i o n f o r a new and world-wide a i r l i n e organization (Chuang, 1972, p.26). A second meeting was held i n Havana, i n 1945, and f i f t y - s e v e n c a r r i e r s agreed to the formation of the 4 The United States signed t h i s agreement, but denounced i t two years l a t e r , a f t e r i t was apparent the agreement would not be widely accepted. Although the agreement c a l l e d f o r a multilateral exchange freedoms, i t was apparent that the U.S. believed that the agreement would apply only a f t e r route r i g h t s were f i r s t negotiated i n a bilateral basis (O'Connor, 1971, p.45). 5 As of 1980 the agreement had twelve signatories (Rosenfield, 1984, Vol . 1, Booklet 4, p.5). 93 International A i r Transport Association (IATA, 1985d, p.3). 6 IATA's a r t i c l e s o f a s s o c i a t i o n s authorized the establishment of "member t r a f f i c and rate c o n f e r e n c e s as may be required and permitted under applicable laws and r e g u l a t i o n s " (quoted i n Brancker, 1977, p.122) and formal conference machinery was established i n 1946. d) The Bermuda 1 Agreement F o l l o w i n g the Chicago Conference, both the United States and United Kingdom negotiated b i l a t e r a l agreements with a number of states, based on the regulatory systems they each favoured (The Economist, August 3, 1946, p.165; Haanappel, 1984, p.17). However, i t remained c l e a r that an a i r agreement between the two major a v i a t i o n countries would be required i n order to spur the development of the post-War a i r transport industry. With t h i s i n mind, a meeting was held i n Bermuda, i n 1946, between the United Kingdom and the United States. The meeting was successful and an agreement known as "Bermuda 1" (or j u s t "Bermuda") (United States, 1946) was reached. The agreement represented a compromise between the positions of the two countries. The United States accepted ultimate governmental control over t a r i f f s while the United Kingdom agreed to allow the c a r r i e r s to determine ca p a c i t i e s and frequencies, subject only to ex post facto review. Major features of the Bermuda 1 agreement included the following: The r i g h t of each country to designate more than one c a r r i e r to operate a given route ( A r t i c l e 2); 6 This organization had no formal connection to Old IATA. 94 The approval by the U.S. C i v i l Aeronautics Board of IATA's t a r i f f -f i x i n g c onference machinery (Annex I I ) . T h i s a p p r o v a l was i n i t i a l l y provided f o r one year but was subsequently extended for a d d i t i o n a l time periods u n t i l i t was given permanent approval i n 1955. The United Kingdom, without the same s t i f f a n t i - t r u s t rules as the United States, d i d not have to provide s i m i l a r approval; A requirement that a l l t a r i f f s be f i l e d by a i r l i n e s f o r approval by both governments (Annex I I ) ; A requirement that t a r i f f s be f i x e d at reasonable l e v e l s , with a t t e n t i o n p a i d to "relevant f a c t o r s " , such as operating costs, p r o f i t s , and competitors' rates (Annex I I ) ; A l i s t of the routes allowable for the c a r r i e r s of each country (Annex I I I ) . U.K. c a r r i e r s were allowed f l i g h t s into seven U.S. c i t i e s from Great B r i t a i n , none further west than Chicago, and beyond r i g h t s to L a t i n America only out of New York. U.S. c a r r i e r s were allowed beyond r i g h t s from London and Prestwick to several c i t i e s i n Europe and Asia. Other routes were s p e c i f i e d f o r service to and from B r i t i s h colonies; A s p e c i f i c a t i o n as to how capacity l e v e l s were to be determined ( F i n a l A c t ) . A i r transport capacity between the two countries was to bear a close r e l a t i o n s h i p to transport demand. C a r r i e r s must have a f a i r and equal opportunity to operate on the s p e c i f i e d routes. C a r r i e r s were not to unduly a f f e c t the services of other c a r r i e r s . F i n a l l y , the primary objective f o r c a r r i e r s must be the p r o v i s i o n of c a p a c i t y to meet the t r a f f i c demand between the country of n a t i o n a l i t y of the c a r r i e r s and the country of ultimate 95 destination. F i f t h freedom t r a f f i c must be subsidiary to t h i r d and fourth freedom t r a f f i c ; and, The allowance that i f e i t h e r government were d i s s a t i s f i e d with the capacity provided by the a i r l i n e s of the other country, that the two countries undertake consultations to resolve the differences ( F i n a l A c t ) . This i s the ex post facto review process, now widely found i n Bermuda 1-type agreements. A f t e r c o n c l u d i n g Bermuda 1, both the United States and the United Kingdom announced that i t was t h e i r i n t e n t i o n to use Bermuda 1 as a basis for the signing of agreements with other countries. 2. Analysis of the Formation of the Regime Using the Modified Hegemonic Stability Theory In t h i s s e c t i o n of the chapter an attempt i s made to analyze the adoption of the Bermuda regime using the modified hegemonic s t a b i l i t y theory. As the reader w i l l r e c a l l , the modified hegemonic s t a b i l i t y theory predicts that a regime may be formed i f there e x i s t s a leading country capable of forming the regime and w i l l i n g to bear the costs of supplying the regime to the r e s t of the world. The major features of the Bermuda regime were as follows (see Table 4.1): b i l a t e r a l negotiation of route r i g h t s ; m u l t i l a t e r a l p r i c e - s e t t i n g by IATA, subject to government approval; and, Bermuda 1 capacity clauses r e q u i r i n g a i r l i n e s to provide capacity primarily to meet t h i r d and fourth freedom t r a f f i c but allowing 96 a i r l i n e s to provide capacity for subsidiary f i f t h freedom t r a f f i c . Capacity l e v e l s were not pre-determined but subject only to ex post facto review. In order f o r the modified hegemonic s t a b i l i t y theory to be supported, the following questions must be addressed: Was there a dominant power capable of forming the regime? I f so, were there incentives for the dominant power to form the regime? What would be the costs to the hegemon i n maintaining the regime? What incentives or coercive measures were used to e n l i s t smaller countries into the regime? These questions are addressed, i n turn, below: a) Was there a dominant power capable of forming the regime? Writers on hegemonic s t a b i l i t y theory have i d e n t i f i e d the United States, at the end of World War I I , as being a power capable of hegemony.7 Unlike Europe and Japan, the U n i t e d States emerged from the Second World War r e l a t i v e l y unscathed. The U.S. had the r e s o u r c e s necessary, and the i n f r a s t r u c t u r e i n place, to support i n t e r n a t i o n a l regimes. The United States had e s p e c i a l l y strong c a p a b i l i t i e s i n the a i r l i n e industry. As Thornton (1970, p.24) stated: 7 See, f o r example: Keohane (1980), Cowhey and Long (1983) and Russett (1985) . 97 [T]he U.S. [ a i r c r a f t ] f a c t o r i e s were the only ones capable of immediate conversion to commercial business. B r i t a i n ' s industry was geared to purely m i l i t a r y types and France's was of course t o t a l l y n o n - e x i s t e n t . I t was obvious that none of the Axis countries would be permitted to r e t a i n a c a p a b i l i t y f o r a i r c r a f t production. Thus, the United States had an almost unconditional monopoly on transport a i r c r a f t production... The U.S, therefore, was the undisputed leader i n the production of a i r c r a f t s u i t a b l e f o r commercial uses. As well, U.S. p i l o t s had considerable experience operating long distance routes, as the United States had assumed r e s p o n s i b i l i t y f o r supporting A l l i e d troops i n Europe, A f r i c a and Asia. b) Were there incentives for the United States to form an international air transport regime? I t appears that there were incentives f o r the United States to form an i n t e r n a t i o n a l a i r transport regime. These incentives can be divided into two c a t e g o r i e s : g e n e r a l s e c u r i t y incentives and economic incentives. The g e n e r a l s e c u r i t y incentives would be s i m i l a r to the incentives that the United States had i n undertaking the Marshall Plan or i n forming a stable monetary regime. The United States wanted to ensure a prosperous, and u n i f i e d Western community, as a buttress against communism. A healthy a i r transport industry could act as a u n i f y i n g force f o r the non-communist world, s i n c e the development of an i n t e r n a t i o n a l a i r t r a n s p o r t system would f a c i l i t a t e t r a v e l and business l i n k s between the U.S. and i t s a l l i e s . The U n i t e d S t a t e s a l s o had economic i n c e n t i v e s to promote an i n t e r n a t i o n a l a i r transport regime. At l e a s t three short-term economic incentives can be i d e n t i f i e d . F i r s t , as described above, the U.S. was the 98 l e a d i n g manufacturer of transport a i r c r a f t . A healthy i n t e r n a t i o n a l a i r transport industry would increase the market f o r the U.S. a i r c r a f t . Second, as S t o f f e l (1959, p.126) outlined, U.S. c a r r i e r s required a d d i t i o n a l route r i g h t s following the War. A regime f a c i l i t a t i n g the negotiation of these r o u t e r i g h t s would be b e n e f i c i a l to U.S. c a r r i e r s . F i n a l l y , a large percentage of post-War i n t e r n a t i o n a l a i r t r a v e l l e r s were Americans. A stable and reasonably l i b e r a l a i r transport regime would be b e n e f i c i a l to U.S. t r a v e l l e r s . 8 c) What were the costs to the United States in maintaining the regime? Hegemonic s t a b i l i t y theory generally assumes that the hegemon must bear some costs i n supporting a regime. The Bermuda a i r transport regime l i k e l y d i d impose costs on both U.S. t r a v e l l e r s and U.S. c a r r i e r s . The IATA p r i c i n g arrangement most c e r t a i n l y r e s u l t e d i n higher i n t e r n a t i o n a l a i r p r i c e s than would have been a v a i l a b l e under a more l i b e r a l regime. As we l l , the Bermuda 1 l i m i t a t i o n s on f i f t h freedom ca p a c i t i e s r e s t r i c t e d , to some extent, the operations of U.S. c a r r i e r s . In the post-War years, U.S. c a r r i e r s had lower costs than t h e i r competitors, 9 so that reductions i n the operating freedom of U.S. c a r r i e r s l i k e l y r e s u l t e d i n l o s t opportunities f o r them. d) What incentives or coercive measures were used to enlist smaller countries into the regime? The major stumbling block f o r the United States i n implementing the Bermuda regime was the agreement of the United Kingdom. The U.K. favoured a 8 See: K i t t r i e (1963, p.4). 9 See: Goedhuis (1955, p.221). 99 r e s t r i c t i v e regulatory regime because i t was concerned about U.K. c a r r i e r s b e i n g a b l e t o c o m p l e t e w i t h U.S. c a r r i e r s u n d e r a more l i b e r a l arrangement. 1 0 The U.S., therefore, had to "convince" the U.K. to accept a reasonably l i b e r a l regime (at l e a s t , with regards to capacity determination) such as Bermuda. The U n i t e d States was able to obtain the agreement of the U.K. by o f f e r i n g incentives and, perhaps, through the use of diplomatic blackmail. A major incentive o f f e r e d to the B r i t i s h was the promise that the U.S. would make av a i l a b l e i t s surplus transport a i r c r a f t f o r t h e i r use (The Economist, October 7, 1944, p.471). This would allow B r i t i s h c a r r i e r s to compete more e f f e c t i v e l y with American c a r r i e r s . Other incentives o f f e r e d to the B r i t i s h included the U.S. agreement to r e s t r i c t f i f t h freedom capacity and to use IATA t a r i f f coordination as per the Bermuda 1 b i l a t e r a l . This a l l e v i a t e d the fear of the B r i t i s h that the U.S. a i r l i n e s would completely dominate the post-War a i r l i n e industry. The p o t e n t i a l blackmail used to obtain B r i t i s h agreement to the Bermuda regime concerned the ongoing negotiations over a U.S. loan to a l l e v i a t e a severe B r i t i s h balance of payments c r i s i s . There was some discussion that the U.S. l o a n to the B r i t i s h was used as a bargaining chip to obtain B r i t a i n ' s signature on Bermuda 1 (Thornton, 1970, pp.35-36; Haanappel, 1984, p.27). 1 0 See: quote by C h u r c h i l l i n O'Connor (1971, p.38). 100 3. Results from the Analysis Using the Modified Hegemonic Stability Theory The c i r c u m s t a n c e s of the Bermuda regime f i t w e l l w i t h hegemonic s t a b i l i t y theory: A hegemon existed; there were benefits to the hegemon i n the formation of the regime; the formation of the regime imposed costs on the hegemon; and, there were incentives, and, perhaps, coercive measures used to implement the regime. Figure 4.1 provides an i l l u s t r a t i o n of the Bermuda regime under the modified hegemonic s t a b i l i t y theory. These are, however, q u e s t i o n not answered i n the a n a l y s i s using hegemonic s t a b i l i t y theory. Perhaps the major question i s , "Why d i d the U.S. agree to c a r t e l p r i c i n g through IATA against the i n t e r e s t s of a i r passengers? In a more general sense, why d i d the U.S. (as well as other countries) agree to s a c r i f i c e consumer i n t e r e s t s and form a c a r t e l ? I t i s evident that consumer i n t e r e s t s were subsumed by s e c u r i t y and a i r l i n e i n t e r e s t s i n the e s t a b l i s h m e n t of the c a r t e l . Whereas the modified hegemonic theory was u s e f u l i n explaining why a regime was formed, these other factors are useful i n explaining the nature of the regime chosen ( i . e . , p r o - a i r l i n e or pro-consumer) . 4. Other Factors in the Explanation of the Adoption of the 1946 Bermuda Regime a) Domestic Affairs I t i s the purpose of t h i s s e ction to analyze p o l i c y choices by the various countries that p a r t i c i p a t e d i n the formation of the Bermuda regime. The greatest a t t e n t i o n w i l l be paid to the policy-making process of the U.S. 101 U n i t e d S t a t e s ( T h e Megeraon)«J-I n c e n t i v e s and C a e r e i ve M e a s u r e s o f f e r o f t r a n s p o r t a i r c r a f t I i m i t a t i o n s on f i f t h f reedom t r a f f i c fflu 11 i l a t e r a l p r i c e - f i x i n g t h r e a t o f r e f u s i n g U.S, l o a n t o t h e U.K. O t h e r C o u n t r i e s F i g u r e 4 .1 The B e r a u d a R e g i a e i n t h e C o n t e x t o f t h e M o d i f i e d H e g e a o n i c S t a b i l i t y T h e o r y COSTS Bermuda Regime R e d u c t i o n i n o p p o r t u n i t i e s f o r a i r c a r r i e r s due t o r e s t r i c t i o n s on f i f t h f r e e d o m r i g h t s and h i g h e r p r i c e s t o t r a v e l l e r s b e c a u s e o f IATA t a r i f f c o o r d i n a t i o n ; BENEFITS G e n e r a l s e c u r i t y b e n e f i t s and s h o r t t e r m e c o n o m i c b e n e f i t s i n t h e f o r m of a m a r k e t f o r U.S. a i r c r a f t m a n u f a c t u r e r s , a d d i t i o n a l r o u t e r i g h t s f o r c a r r i e r s , and a p a r t i a l l y l i b e r a l r e g i m e f o r t r a v e l l e r s M u l t i l a t e r a l T a r i f f C o o r d i n a t i o n ( I A T A ) B i l a t e r a l R e g u l a t i o n of R o u t e s and C a p a c i t i e s Bermuda 1 C a p a c i t y C l a u s e s because of the importance of the U.S. as the leading a v i a t i o n country. However, before the U.S. policy-making process i s examined, t h i s paper w i l l b r i e f l y d i s c u s s the p o l i c y - m a k i n g p r o c e s s e s o f o t h e r c o u n t r i e s t h a t p a r t i c i p a t e d i n the negotiations over the Bermuda regime. There i s l i t t l e evidence t h a t the p o l i c y p o s i t i o n s of the other countries r e f l e c t e d anymore than a desire to maximize the p o t e n t i a l of t h e i r own a i r c a r r i e r s . ( E x c e p t i o n s are the p o s i t i o n s of A u s t r a l i a and New Zealand, as discussed below.) That i s , the policy-making processes of these countries r e f l e c t e d the dominance of the a i r c a r r i e r s as i n t e r e s t groups. Three examples are provided below: i) The Policy of the U.K. The U n i t e d Kingdom supported the e x i s t e n c e of an i n t e r n a t i o n a l r e g u l a t o r y agency which would have r e a l powers to co n t r o l p r i c e s and c a p a c i t i e s on i n t e r n a t i o n a l routes. The U.K. was e s p e c i a l l y against a m u l t i l a t e r a l exchange o f route r i g h t s i n v o l v i n g f i f t h freedom t r a f f i c (O'Connor, 1971, p.27). Why was this? U.S. c a r r i e r s had lower operating c o s t s than the B r i t i s h c a r r i e r , BOAC, following the war. The U.K. was concerned with protecting i t s c a r r i e r against U.S. competition. A t i g h t l y regulated regime would be the best way of ensuring BOAC received i t s " f a i r share" of t r a f f i c . i i ) The Policies of the Netherlands and Sweden. Two European countries, the Netherlands and Sweden, supported a f a i r l y l i b e r a l regime, including an exchange of f i f t h freedom r i g h t s . Both Sweden 103 and the Netherlands supported the U.S. (rather than the B r i t i s h ) p o s i t i o n at the Chicago Conference. Why d i d these countries advocate a reasonably l i b e r a l regime? These were small countries with l i t t l e t r a f f i c generating a b i l i t y . Their a i r l i n e s would have to r e l y on f i f t h freedom t r a f f i c (or more generally, on c a r r y i n g t r a f f i c o r i g i n a t i n g i n other countries) i n order to p r o s p e r . A l i b e r a l exchange of t r a f f i c r i g h t s , t h e r e f o r e , would be b e n e f i c i a l to the c a r r i e r s of these countries. Although t h i s p o l i c y i s also "pro-consumer", there i s no evidence that consumer i n t e r e s t s played a r o l e i n the formation of the p o l i c y . Hi) The Policies of Australia and New Zealand. A u s t r a l i a and New Zealand proposed, at Chicago, an internationally-owned c a r r i e r to transport passengers on i n t e r n a t i o n a l routes. The formation of t h i s p o l i c y must be viewed i n l i g h t of the market p o s i t i o n of these two countries. The two countries were small and i s o l a t e d so that launching t h e i r own a i r l i n e s , i n competition with f o r e i g n c a r r i e r s , would have required a tremendous expenditure of resources. The p o l i c y of the Australians and New Zealand may be viewed as a c o s t - e f f e c t i v e method of achieving i n t e r n a t i o n a l s e r v i c e . Again, however, there i s no evidence that the formation of a monopoly c a r r i e r would, at a l l , be a pro-consumer p o l i c y . In summary, the positions of the countries, other than the U.S., i n the negotiations over the Bermuda regime, can be viewed as being " p r o - c a r r i e r " . I t would not appear that consumer i n t e r e s t s played much of a r o l e i n the formation of the regime. This i s , i n f a c t , what i s to be expected, given p u b l i c c h o i c e theory. Under the public choice model (see Figure 3.2), 104 governments develop p o l i c i e s to s a t i s f y s p e c i a l i n t e r e s t groups i n a country. The major group interested i n a i r transportation would be the a i r l i n e s . Since very few people a c t u a l l y t r a v e l l e d on i n t e r n a t i o n a l f l i g h t s following World War I I , one would not expect consumer i n t e r e s t s to be strong. iv) The Policy of the United States. As discussed above, the U.S. favoured a wide exchange of route rights ( i n c l u d i n g f i f t h freedom t r a f f i c ) within a b i l a t e r a l framework. The U.S. also supported, somewhat informally, a c a r r i e r organization that would have p r i c e - f i x i n g authority. As well, the U.S. was s t r i c t l y opposed to providing any r e a l power to an intergovernmental organization i n the determination of routes and c a p a c i t i e s . Why d i d the U.S. take these positions? I t seems l i k e l y that the U.S. was i n favour of a l i b e r a l exchange of route r i g h t s f o r the same reason that the B r i t i s h were opposed to the plan; i . e . , i t would b e n e f i t low-cost U.S. c a r r i e r s . U.S. c a r r i e r s would be e s p e c i a l l y concerned with acquiring f i f t h freedom r i g h t s , since " f i l l - u p " t r a f f i c was v i t a l on the long-haul, multi-stop routes that existed at the time. The reasons for the U.S. support of m u l t i l a t e r a l p r i c e - s e t t i n g are less c l e a r . Would not a system of m u l t i l a t e r a l p r i c e - s e t t i n g negate the advantage U.S. c a r r i e r s had because of lower operating costs? Two reasons are advanced for the U.S. d e c i s i o n to support a system of m u l t i l a t e r a l p r i c e - s e t t i n g . F i r s t , the U.S. a i r l i n e s r e a l l y supported the idea. (As Chuang (1972, p.26) outlined, Pan American was one of the a i r l i n e s instrumental i n the formation 105 of IATA.) U.S. c a r r i e r s were concerned with the prospects of having to compete a g a i n s t s u b s i d i z e d , n a t i o n a l l y - o w n e d c a r r i e r s , so t h a t an organization which established minimum rates would be most welcome. The second reason was that the CAB supported m u l t i l a t e r a l t a r i f f coordination i n order to strengthen i t s p o s i t i o n . This had to do with the f a c t that the CAB l a c k e d d i r e c t statutory c o n t r o l over rates charged by U.S. i n t e r n a t i o n a l c a r r i e r s (Bebchick, 1958, p.11). The CAB c o u l d , however, i n d i r e c t l y e s t a b l i s h c o n t r o l over these rates, i f the rates were set by U.S. c a r r i e r s i n c o n j u n c t i o n w i t h fo r e i g n c a r r i e r s such as through IATA. 1 1 A number of authors have c i t e d t h i s l e g i s l a t i v e q u i r k as the r e a s o n behind the w i l l i n g n e s s o f the U n i t e d S t a t e s to approve the p a r t i c i p a t i o n of U.S. c a r r i e r s i n IATA t r a f f i c conferences. 1 2 K o f f l e r (1966, pp.228-229) stated, f o r example: I t i s q u i t e p o s s i b l e t h a t IATA would never have come to f r u i t i o n had Congress given the CAB the same ratemaking authority over fo r e i g n a i r commerce as i t had over domestic a i r commerce. Notwithstanding the express manifestation of congressional intent to the contrary, i t i s c l e a r that one of the prime objectives of the CAB at the Bermuda Conference was to obtain a greater measure of c o n t r o l over ratemaking i n i n t e r n a t i o n a l a v i a t i o n . . . By g i v i n g i t s b l e s s i n g to IATA, of which the United States i n t e r n a t i o n a l c a r r i e r s were members, and by v i r t u e of i t s ratemaking machinery, the CAB was acting to ensure and perpetuate i t s own c o n t r o l over i n t e r n a t i o n a l a i r fares. 1 1 T h i s was because a meeting among c a r r i e r s , without CAB approval, would contravene U.S. a n t i - t r u s t laws. 1 2 See: K o f f l e r (1966); Jones (1960); Bebchick (1958); and, Gazdik (1949). 106 F i n a l l y , the question as to why the U.S. preferred b i l a t e r a l i s m to m u l t i l a t e r a l i s m must be addressed. 1 3 I t i s obvious, from the market strength o f the U.S., t h a t i t c o u l d achieve superior gains f o r i t s a i r l i n e s by n e g o t i a t i n g on a b i l a t e r a l , rather than a m u l t i l a t e r a l , b a s i s . As an example, a m u l t i l a t e r a l exchange of route r i g h t s , i n c l u d i n g f i f t h s freedom r i g h t s , would allow fo r e i g n c a r r i e r s beyond r i g h t s from the U.S. and U.S. c a r r i e r s beyond r i g h t s from the f o r e i g n countries. But by negotiating on a b i l a t e r a l basis, the U.S. often would not have to cede beyond r i g h t s to f o r e i g n c a r r i e r s to gain these r i g h t s f o r i t s own a i r l i n e s . The U.S. could use i t s bargaining strength i n b i l a t e r a l negotiations to obtain r i g h t s for i t s c a r r i e r s without having to cede s i m i l a r r i g h t s to f o r e i g n c a r r i e r s . In summary, the bargaining p o s i t i o n of the U.S. appeared to r e f l e c t the i n t e r e s t s of the U.S. c a r r i e r s and the CAB. Consumer i n t e r e s t s d i d not enter p r o m i n e n t l y i n t o U.S. d e c i s i o n s r e g a r d i n g the f o r m u l a t i o n of i t s i n t e r n a t i o n a l a i r transport p o l i c y . This would, i n f a c t , be what the p u b l i c choice model would pre d i c t , given the small number of a i r t r a v e l l e r s at that time, and the problem consumers encounter i n a r t i c u l a t i n g t h e i r views to governments ( i . e . , i n overcoming the f r e e - r i d e r problem). 1 3 I t s h o u l d be noted t h a t a l t h o u g h the U.S. was instrumental i n supporting a m u l t i l a t e r a l exchange of route r i g h t s at the Chicago Conference ( i . e . , the "Five Freedoms" agreement), the U.S. supported t h i s only i n the context of b i l a t e r a l i s m . In other words, a b i l a t e r a l agreement f i r s t had to be signed a l l o c a t i n g routes between the countries, before the m u l t i l a t e r a l agreement came into force. For a discussion of t h i s point, see O'Connor (1971, p.45). 107 b) Structural Factors A number of s t r u c t u r a l factors were described i n Chapter 3 which could adversely a f f e c t the functioning of a c a r t e l and therefore r e s u l t i n a regime change. These factors included (Table 3.2): changes i n the number of firms i n an industry; the introduction of new technology into an industry; downturns i n the economy; and changes i n the height of entry b a r r i e r s into an industry. The factors are mainly concerned with the functioning of a c a r t e l already in place and not with the formation of a new c a r t e l , so are not p a r t i c u l a r l y h e l p f u l i n the explanation of the adoption of the 1946 Bermuda regime. c) Overriding State Interests The t h i r d f a c t o r discussed as p o s s i b l y i n f l u e n c i n g the formation or maintenance of a regime was overriding state i n t e r e s t s . I t was discussed, i n Chapter 3, that states appeared to have an o v e r r i d i n g i n t e r e s t i n having an i n t e r n a t i o n a l f l a g c a r r i e r , i n much the same way that they have an overriding i n t e r e s t i n defending t h e i r borders or i n economic growth. Was t h i s over-r i d i n g i n t e r e s t relevant i n the formation of the 1946 Bermuda regime? The answer must be yes. The argument can be made as follows: i ) The vast majority of governments f e e l that f o r reasons of prestige, sovereignty and symbolism, t h e i r countries require an i n t e r n a t i o n a l f l a g c a r r i e r ; i i ) Some f l a g c a r r i e r s have higher costs than others; i i i ) The governments with high cost c a r r i e r s must seek ways of subsidizing t h e i r c a r r i e r s ; iv) Government treasuries, however, are not unlimited; 108 v) An i n e x p e n s i v e way f o r governments to subsidize t h e i r i n e f f i c i e n t c a r r i e r s i s by having the c a r r i e r s form a c a r t e l . This allows the subsidies to be paid not out of the p u b l i c purse but through higher t i c k e t p r i c e s , thus r e l i e v i n g the government of the o b l i g a t i o n to provide d i r e c t payments to i t s f l a g c a r r i e r . G iven the ravaged post-World War Two economies, and the r e l a t i v e i n e f f i c i e n c y of most c a r r i e r s vis a vis U.S. c a r r i e r s , i t i s not s u r p r i s i n g that the IATA c a r t e l received considerable support. The c a r t e l r e l i e v e d the governments of the o b l i g a t i o n to provide d i r e c t subsidies (or at l e a s t a p o r t i o n of the required subsidies) to t h e i r c a r r i e r s . 5. Summary In t h i s section, the events leading to the formation of the 1946 Bermuda regime were described, and the modified hegemonic s t a b i l i t y theory tested against the events. The modified theory of hegemonic s t a b i l i t y predicted that a stable regime would be formed i f there e x i s t e d a hegemon capable and w i l l i n g to pay the cost of e s t a b l i s h i n g the regime. In order f o r t h i s theory to be supported, the following had to be established: There must have been a hegemon; There must have been incentives for the hegemon to form the regime; There must have been incentives or coercive measures used to e n l i s t smaller countries to j o i n the regime; and, There s h o u l d have been i d e n t i f i a b l e costs, to the hegemon, i n e s t a b l i s h i n g the regime. 109 These points were, i n f a c t , a l l established and the modified theory of hegemonic s t a b i l i t y , therefore, supported. Other factors - most notably domestic a f f a i r s and overriding state i n t e r e s t s - proved u s e f u l i n providing an explanation f o r the nature of the regime that was formed. I t was seen t h a t the dominance of the policy-making processes of governments by a i r c a r r i e r s and the o v e r r i d i n g i n t e r e s t s of governments i n maintaining national c a r r i e r s , l i k e l y contributed to the formation of the IATA c a r t e l . C. The 1965 Post-Bermuda Regime In t h i s s e c t i o n of the chapter, the major events a f f e c t i n g the regulatory structure of i n t e r n a t i o n a l a i r transport between 1946 and 1965 are reviewed and analyzed. However, before these events are discussed, i t would be h e l p f u l f i r s t to examine the c h a r a c t e r i s t i c s of the 1965 regime. These c h a r a c t e r i s t i c s , as well as r e l a t e d industry and environmental fa c t o r s , are shown i n Table 4.2. The regulations of the 1965 Post-Bermuda regime were, i n f a c t , s i m i l a r to those of the 1946 Bermuda regime i n most respects. IATA s t i l l had a pre-eminent r o l e i n p r i c e - s e t t i n g on scheduled routes. ICAO continued to play a part only i n the regulation of t e c h n i c a l and safety matters. Two regional intergovernmental organizations had been formed between 1946 and 1965, but t h e i r involvement i n economic regulatory matters was minor. The major regulatory d i f f e r e n c e between the two regimes was i n the b i l a t e r a l capacity clauses i n use. Whereas the Bermuda regime c a l l e d f o r the use of Bermuda 1 capacity clauses, which l e f t c a r r i e r s to e s t a b l i s h capacity l e v e l s subject to 110 T a b l e 4 . 2 S n a p - s h o t o f t h e 1965 P o s t - B e r m u d a Regime a n d R e l a t e d E n v i r o n m e n t a l a n d I n d u s t r y F a c t o r s Characteristic or Factor 1965 Bermuda Regime 2. Regime Characteristics a) Role of IATA in Setting Prices b) Membership in IATA Prices set by IATA o n v i r t u a l l y a l l major routes, although there is some " i l l e g a l " discounting. Virtually a l l major international scheduled carriers, except some Eastern bloc. Membership was 97 airlines with about one-half of active members representing developing countries and colonies. c) Role of ICAO d) Bilateral Capacity Clauses e) Regulation by Regional Organizations Involvement in technical and safety matters only. Widespread use of bilaterals which required the pre-determination of capacity levels or memoranda of understanding which required equal division of capacities. U.S., however, generally adhered to 1946 regime. European C i v i l Aviation Conference was founded in 1954 to promote development of air transport in Europe and the Arab C i v i l Aviation Council was founded in 1965 to promote a i r transport in the Arab world. There was l i t t l e or no involvement by these organizations in economic regulatory matters. 111 Table 4.2 (Continued) Environmental Factors a ) T h e W o r l d E c o n o m y S t r o n g g r o w t h a n d l o w u n e m p l o y m e n t i n m o s t o f t h e w o r l d . b ) T h i r d W o r l d D e v e l o p m e n t E m e r g e n c e o f n e w l y i n d e p e n d e n t c o u n t r i e s , m a i n l y i n A f r i c a , a n d A s i a . c ) U . S . G o v e r n m e n t D e m o c r a t i c a d m i n i s t r a t i o n , c o n c e r n e d w i t h U . S . i n v o l v e -m e n t i n S o u t h e a s t A s i a . Industry Factors a ) M a t u r i t y o f A i r l i n e I n d u s t r y I n d u s t r y e x p e r i e n c e d h i g h g r o w t h r a t e s . b ) S t a t e o f T e c h n o l o g y J e t s , i n t r o d u c e d w i d e l y d u r i n g t h e 1 9 6 0 s , s u p p l a n t e d t h e s m a l l e r a n d s l o w e r p i s t o n a i r c r a f t . c ) G o v e r n m e n t O w n e r s h i p G o v e r n m e n t o w n e r s h i p o f m o s t n a t i o n a l a i r l i n e s , e x c e p t U . S . d ) R o l e o f C h a r t e r O p e r a t o r s B e g i n n i n g o f l a r g e - s c a l e g r o w t h o f c h a r t e r s , s t a r t i n g w i t h a f f i n i t y c h a r t e r s . e ) S i z e o f I n d u s t r y T h e i n d u s t r y p e r f o r m e d 1 9 9 b i l l i o n p a s s e n g e r - k i l o m e t r e s ( c o m p a r e d t o 1 9 b i l l i o n i n 1 9 4 7 ) . f ) P r o d u c t O f f e r i n g s B o t h f i r s t c l a s s a n d e c o n o m y c l a s s e s w e r e o f f e r e d , a l o n g w i t h s o m e e x c u r s i o n o r d i s c o u n t f a r e s o n m a j o r r o u t e s . 112 Table 4.2 (Continued) g) "I l l e g a l " Discounting Incidents of i l l e g a l discounting, especially on routes with over-capacity due to introduction of jets. h) U.S. Dominance of U.S. airlines' share of Air Transport world air services (in passenger-kilometres) stood at about 50 percent. 113 ex post facto reviews, the Post-Bermuda regime was characterized by the widespread use of pre-determination of capacity clauses. These agreements r e q u i r e d a pre-determination of capacity l e v e l s f o r the c a r r i e r s before service could take place, generally r e s u l t i n g i n a f a i r l y even d i s t r i b u t i o n o f c a p a c i t y between the c a r r i e r s on a route. The pre-determination of capacity b i l a t e r a l s can, therefore, be seen as more r e s t r i c t i v e than the Bermuda 1 b i l a t e r a l s . The U.S., however, generally maintained i t s support f o r the Bermuda 1-type agreements. A notable environmental development during the period 1946-1965 was the de-colonization of much of A s i a and A f r i c a . The newly independent countries generally wanted t h e i r own n a t i o n a l c a r r i e r s , so the period was characterized by a large growth i n Third World a i r l i n e s (see Figure 2.15, f o r example). Other developments included: the introduction of economy fares i n the 1950s, and of discount fares i n the early 1960s (see Figure 2.17) the introduction of j e t s i n the l a t e 1950s (see Figure 2.16); the growth of charter transport; the continued strong growth of the industry as a whole (see Figure 2.4); and, the c o n t i n u e d dominance of the U.S. i n the industry (see Figure 2.8), although with only h a l f , rather than three quarters, of t o t a l passenger-kilometres. Why were there so few changes i n the regulation of i n t e r n a t i o n a l a i r transport between 1946 and 1965, despite these s i g n i f i c a n t developments? The hegemonic theory and other factors w i l l be used to analyze the events of the period to a r r i v e at an answer to t h i s question. 114 2. Developments Leading to the Formation of the 1965 Post-Bermuda Regime Before an analysis i s undertaken of the reasons why there were so few regulatory changes between 1946 and 1965, a review w i l l be conducted of some of the important developments during the period. F i r s t , developments with respect to the b i l a t e r a l regulation of a i r transport are discussed. This i s followed by a review of developments r e l a t i n g to IATA and m u l t i l a t e r a l p r i c e -s e t t i n g . F i n a l l y there i s a discussion of non-IATA a i r transport during the post-Bermuda period. a) Bilateral Regulation i) The Failure to Reach Agreement on Multilateral Intergovernmental Price-Setting F o l l o w i n g the f a i l u r e to achieve agreement on the m u l t i l a t e r a l r e g u l a t i o n of a i r transport at Chicago i n 1944, and the d e c i s i o n by the U.S. and U.K. to sign a b i l a t e r a l regulatory agreement i n Bermuda i n 1946, there were two a d d i t i o n a l attempts to conclude a m u l t i l a t e r a l agreement. The f i r s t attempt, proposed i n 1946, consisted of a d r a f t m u l t i l a t e r a l exchange of the f i r s t f i v e freedoms of a i r transport, based on Bermuda 1 capacity p r i n c i p l e s (O'Connor, 1971, pp.49-52). Individual a i r l i n e s or governments would be free to u n i l a t e r a l l y e s t a b l i s h rates, as long as they were "reasonable". When disputes arose over t a r i f f s or capacity l e v e l s , governments would have the r i g h t to appear before an i n t e r n a t i o n a l regulatory board that had f u l l powers of judgment. The d r a f t agreement was rejected by the P r o v i s i o n a l International C i v i l A v i a t i o n Organization (the predecessor to ICAO) (O'Connor, 1971, pp.54-55). 115 The major c r i t i c of the agreement was the United States, which was against c o n s t i t u t i n g an i n t e r n a t i o n a l board with r e a l powers over the economic regu l a t i o n of i n t e r n a t i o n a l a i r transport. A second post-Bermuda attempt at a m u l t i l a t e r a l agreement followed one year l a t e r , i n 1947. The 1947 d r a f t was s i m i l a r to the 1946 d r a f t agreement, except t h a t there would be no i n t e r n a t i o n a l regulatory board. Instead, disputes would be s e t t l e d on a b i l a t e r a l b a s i s . This agreement was rejected by both the U.S. and U.K., countries which helped to produce a minority report i n favour of b i l a t e r a l r e gulation (O'Connor, 1971, pp. 55-58). One f i n a l attempt at d r a f t i n g an agreement for the m u l t i l a t e r a l exchange of route r i g h t s , i n Geneva, i n 1947, was unsuccessful. Instead of producing yet another d r a f t m u l t i l a t e r a l agreement, the Geneva conference concluded that b i l a t e r a l i s m should be the basis for the exchange of route r i g h t s i n the future (0'Conner, 1971, p.58). i i ) Post-Bermuda Bilateral Agreements Following, the conclusion of Bermuda .1, there was a spate of b i l a t e r a l s i g n i n g s . 1 4 The U n i t e d S t a t e s generally stayed true to the Bermuda 1 capacity p r i n c i p l e s (Haanappel, 1984, p.35), 1 5 although i t was reluctant to grant f i f t h freedom r i g h t s to foreign c a r r i e r s . The United States negotiated i t s b i l a t e r a l s based on an "equitable exchange of b e n e f i t s " ( S t o f f e l , 1959, 1 4 Jones (1960, p.231) reported that by 1949, there were over 200 agreements signed. 1 5 An exception was the U.S. b i l a t e r a l agreement with India, signed i n 1956. See: L i s s i t z y n (1964, p.251). 116 p.127). Since the United States market was much larger and more l u c r a t i v e than i t s b i l a t e r a l partners, the U.S. f e l t that an equal exchange of benefits should involve extra p r i v i l e g e s i n the form of f i f t h freedom r i g h t s f o r i t s c a r r i e r s . As well, the U.S. considered i t s market to be a "natural terminus" as opposed to the European "natural stop-over" markets (on the way to As i a or A f r i c a or to other European countries) ( S t o f f e l , 1959, p.128). In a d d i t i o n to bargaining f o r Bermuda 1 capacity provisions and f i f t h freedom r i g h t s f o r i t s c a r r i e r s , the United States also i n s i s t e d on the m u l t i p l e d e s i g n a t i o n of a i r c a r r i e r s i n i t s post-Bermuda b i l a t e r a l s . Although t h i s d i d not always mean two U.S. c a r r i e r s operated the exact same r o u t e , i t d i d r e s u l t i n s i g n i f i c a n t "area competition" (e.g., one U.S. c a r r i e r f l y i n g New York-Paris, and a second U.S. c a r r i e r f l y i n g Washington-P a r i s ) ! 1 6 S t o f f e l (1959, p.132) reported that by 1959, there were at le a s t two U.S. c a r r i e r s authorized to serve a l l major t r a f f i c points abroad. The U.S. reluctance to grant f i f t h freedom r i g h t s to for e i g n c a r r i e r s encountered s i g n i f i c a n t opposition. During the 1950s, a number of countries demanded that the U.S. renegotiate t h e i r b i l a t e r a l agreements. Jones (1960, p. 234) r e p o r t e d that three countries, the Netherlands, France, and West Germany were successful i n renegotiating t h e i r agreements to obtain f i f t h freedom r i g h t s to L a t i n America. 1 6 See: Keyes (1968, p.7) for a d e s c r i p t i o n of t h i s p o l i c y with respect to U.S. P a c i f i c routes. 117 While the U.S. was negotiating b i l a t e r a l s based on Bermuda 1 p r i n c i p l e s , many other countries were signing more r e s t r i c t i v e agreements (Jones, 1960, p.231; Haanappel, 1984, p.35). These agreements often contained clauses which pre-determined c a p a c i t i e s and frequency l e v e l s , r e s u l t i n g i n a f a i r l y even d i v i s i o n of business between the a i r l i n e s operating on a route. When c a p a c i t i e s were not pre - determined i n the agreement, they were often r e s t r i c t e d i n a secret diplomatic note, known as a c o n f i d e n t i a l memorandum of understanding (Slotemaker, 1966, p.903). In a d d i t i o n to containing capacity sharing agreements, many of the b i l a t e r a l s that were signed by countries, other than the U.S., also had revenue pooling p r o v i s i o n s . 1 7 These agreements not only allowed c a r r i e r s to r e s t r i c t competition by d i v i d i n g capacity, but they also allowed c a r r i e r s to equalize revenue on a route. In summary, the post-Bermuda b i l a t e r a l s may be characterized as a mix of Bermuda 1-type agreements and more r e s t r i c t i v e agreements. whereas the U.S. generally kept to Bermuda p r i n c i p l e s , other countries, including the United Kingdom, d i d not. b) IATA and Multilateral Price-Setting i) IATA Conference Machinery I n o r d e r to "set r a t e s ( s u b j e c t to governmental a p p r o v a l ) on i n t e r n a t i o n a l r o u t e s , IATA e s t a b l i s h e d t r a f f i c c o n f e r e n c e machinery. 1 7 Haanappel (1984, p.36) states that i n the case of the United States, the CAB c o n s i s t e n t l y found pooling agreements to be anti-competitive, and adverse to the public, i n t e r e s t . 118 O r i g i n a l l y nine conferences were formed on a geographical basis, but t h i s number was reduced to three i n 1947. According to Bebchick (1958, p.22), the number of conferences was reduced, " i n recognition of the interdependency of many routes... and the i m p r a c t i c a l i t y of dealing with such routes i n i s o l a t e d segments...". The three conferences covered the following areas of the world: Conference 1 - the Americas; Conference 2 - Europe, A f r i c a , and the Middle East; and, Conference 3 - A s i a and the P a c i f i c . As well, " j o i n t conferences" were convened to e s t a b l i s h t a r i f f s on i n t e r -regional routes (e.g., North A t l a n t i c or North P a c i f i c ) . Membership i n the t r a f f i c conferences during the post-Bermuda regime, for a c t i v e IATA members, was compulsory. 1 8 T a r i f f s f o r major routes had to be agreed unanimously by the conference members and were generally set for a one to two year p e r i o d . 1 9 T a r i f f s f o r other routes were constructed by IATA, based on a mileage formula. As well as e s t a b l i s h i n g l e v e l s f o r the various classes of t a r i f f s ( i . e . , f i r s t c l a s s , economy, e t c . ) , IATA also set the service conditions for a i r l i n e o p e r a t i o n s . This included such things as the minimum allowable seating 1 8 IATA also had (and s t i l l has) associate members. These are a i r l i n e s that operate only domestic routes and do not p a r t i c i p a t e i n t a r i f f coordination. 1 9 I f an agreement c o u l d not be reached, an "open rate" s i t u a t i o n r e s u l t e d . A i r l i n e s , however, were precluded from charging "unacceptable" rates, by the ultimate control with which governments had over i n t e r n a t i o n a l t a r i f f s . 119 density, the type of meal service and i n - f l i g h t entertainment that could be o f f e r e d , and t h e l e v e l o f commission payable to t r a v e l agents on i n t e r n a t i o n a l f l i g h t s . IATA members found v i o l a t i n g these conditions of service, or charging t a r i f f s below the IATA l e v e l , could be fined, or even expelled from the a s s o c i a t i o n . 2 0 i i ) Multilateral Price-Setting in the Post-Bermuda Regime IATA r a t e - s e t t i n g d u r i n g the p e r i o d 1946-1965 was f r a u g h t with d i f f i c u l t i e s . IATA's major problem stemmed from the desire of the U.S. C i v i l Aeronautics Board, generally with the support of U.S. c a r r i e r s , to have lower f a r e s . 2 1 The most s i g n i f i c a n t disagreement between the CAB and IATA, during the post-Bermuda p e r i o d , was the "Chandler C r i s i s " of 1962-63. Before a t t e n d i n g the 1962 t r a f f i c conference i n Chandler, A r i z o n a , the CAB i n s t r u c t e d the U.S. IATA members not to agree to t a r i f f increases ( P i l l a i , 1969, p.33). The CAB f e l t i n t e r n a t i o n a l c a r r i e r s , at that time, were earning 2 0 Although no a i r l i n e s were expelled from the association, Tauber (1969, p. 8) reported that during the post-Bermuda period, IATA l e v i e d fines t o t a l l i n g s e v e r a l hundred thousand d o l l a r s on i t s members. This t o t a l , however, was l i k e l y small compared to the benefits from "cheating". 2 1 The CAB, i n f a c t , rejected the North A t l a n t i c t a r i f f s a r i s i n g from the f i r s t IATA rate agreement. The CAB was d i s s a t i s f i e d with the f a i l u r e of IATA to p r o v i d e c o s t data to support i t s fare request. The CAB l a t e r overturned i t s d e c i s i o n and approved the IATA fares (Bebchick, 1958, p.25). In 1956, the CAB, again, r e j e c t e d the IATA North A t l a n t i c t a r i f f r e q u e s t . Under i n t e n s e l o b b y i n g pressure from fo r e i g n governments and c a r r i e r s , the CAB reversed i t s decision and granted approval to the IATA fares. The reason provided by the CAB for i t s change of p o s i t i o n was that i t d i d not want to be responsible for the chaos that would r e s u l t from f o r c i n g c a r r i e r s to change t h e i r t i c k e t i n g and schedules at a l a t e date (Bebchick, 1958, p.26). 120 r e a s o n a b l e r a t e s of return, and that a fare increase was not j u s t i f i e d (Keyes, 1964, p.183). 2 2 The r e s u l t of the Chandler conference was, however, a f i v e percent increase on round-trip fares. This increase was disapproved by the CAB, but c o n s i d e r a b l e p r e s s u r e was placed on the CAB to reverse i t s d e c i s i o n . 2 3 F i n a l l y , the CAB d i d reverse i t s d e c i s i o n a f t e r IATA made a minor adjustment to i t s t a r i f f f i l i n g s . In a d d i t i o n to i t s disagreements with the CAB, IATA encountered at l e a s t three other major d i f f i c u l t i e s during the period 1946-1965. The f i r s t was maintaining market share i n the face of competition with non-IATA (mainly charter) c a r r i e r s . (Charters are discussed i n the next sub-section of the c h a p t e r . ) The second problem was the d i f f i c u l t y i n achieving unanimous agreement on t a r i f f s and conditions of service from all conference members.24 D u r i n g the period, major disagreements arose between U.S. c a r r i e r s which wanted lower fares, and European c a r r i e r s which were reluctant to reduce f a r e s . As w e l l , there were a number of d i s p u t e s over conditions of 2 2 Chuang (1972, pp.118-119) noted that on t h e i r t r a n s - P a c i f i c routes, both Northwest A i r l i n e s and Pan American Airways were earning returns well i n excess of. the CAB guideline of a 10.5 percent return on Investment. Returns on North A t l a n t i c routes for TWA and Pan American were, however, lower than the allowable guidelines. 2 3 Pressure came from foreign governments and c a r r i e r s , as well as from the U.S. State Department ( P i l l a i , 1969, pp.7-8; Keyes, 1964, p.182). 2 4 P i l l a i (1969, p.95) stated, that most t r a f f i c conference meetings ended i n e i t h e r recess or adjournment due to disagreements among c a r r i e r s . 121 s e r v i c e , 2 5 i n c l u d i n g the l e v e l of surcharge that was to be demanded f o r j e t transportation. The introduction of j e t s i n the l a t e 1950s, and the "excess capacity" t h a t r e s u l t e d , c o n t r i b u t e d to IATA's t h i r d problem - the " i l l e g a l " discounting of i t s t a r i f f s (Keyes, 1964, pp.177-178). According to Tauber (1969, p.11), the 1962 IATA annual meeting was "dominated" by the discussion of t a r i f f enforcement problems. The problem was not a l l e v i a t e d u n t i l the l a t e 1960s, by which time there had been s u f f i c i e n t increases i n demand to make use of much of the excess capacity. A l t h o u g h ,IATA d i d e n c o u n t e r s i g n i f i c a n t problems w i t h t a r i f f c o o r d i n a t i o n d u r i n g the post-Bermuda p e r i o d , i t should be noted that agreements were reached, and enforced to a great degree. 2 6 IATA enjoyed widespread support from governments and there was l i t t l e d i scussion about completely repl a c i n g the IATA system. c) Non-IATA Air Transportation There were two types of non-IATA a i r transportation during the post-Bermuda p e r i o d - non-IATA scheduled and c h a r t e r ( a l s o known as non-scheduled) . The percentage of scheduled passenger-kilometres performed by IATA c a r r i e r s was very, high at close to ninety p e r c e n t , 2 7 so that non-IATA 2 5 See, f o r example, Carter's (1965) discussion of the dispute over the o f f e r i n g of i n - f l i g h t movies on the North A t l a n t i c . 2 6 The CAB even acted to enforce IATA t a r i f f s . See Tauber (1969). 2 7 See Figure 2.11. 122 scheduled a i r transport was r e l a t i v e l y i n s i g n i f i c a n t . 2 8 Far more s i g n i f i c a n t was charter t r a n s p o r t . 2 9 The Chicago Conference of 1944 had distinguished between scheduled and charter transport. Whereas the conference could not agree on a formula f o r the m u l t i l a t e r a l r e g u l a t i o n of scheduled a i r transport, i t was agreed that charter transport should operate r e l a t i v e l y unhindered. However, as Haanappel (1978, p.146) outlined, governments were quick to u n i l a t e r a l l y regulate charter transport. In p r a c t i c e , rather than operating r e l a t i v e l y unfettered, charter c a r r i e r s had to conform with both the regulations of the o r i g i n country and of the de s t i n a t i o n country of t h e i r f l i g h t s . 3 0 In the l a t e 1940s and i n most of the 1950s, governments, including the U.S. government, were r e l u c t a n t to authorize many charters f o r fear of hurting the operations of the scheduled c a r r i e r s . The scheduled c a r r i e r s were g e n e r a l l y s u b s i d i z e d , so the promotion o f c h a r t e r s , against the 2 8 The only (reasonably) major non-IATA i n t e r n a t i o n a l scheduled c a r r i e r s were Icelandic and a few from the. Eastern bloc countries (Tauber, 1969, p . l ) . 2 9 Charter transport, at l e a s t during the post-Bermuda period, could be viewed as transport that d i d not operate based on a published schedule or w i t h f l i g h t s so regular or frequent that they c o n s t i t u t e d a systematic, recognizable s e r i e s . See Haanappel (1978, p.145). 3 0 IATA, too, sought to regulate charter operations. In 1953, IATA adopted a r e s o l u t i o n which governed the charter market u n t i l 1972 (Haanappel, 1978, p.147). The r e s o l u t i o n allowed IATA c a r r i e r s to perform charter services at a p r i c e (per passenger) lower than IATA scheduled rates only i f one of three conditions was met: the airplane was chartered by a single e n t i t y (e.g., by a company); the airplane was chartered by a study group; or, the airplane was chartered by an " a f f i n i t y group". The a f f i n i t y group had to have an aim or purpose and " s u f f i c i e n t a f f i n i t y " prior to t r a v e l . According to Haanappel (1978, p.148), the r e a l importance of the IATA r e s o l u t i o n lay i n the f a c t that i t was adopted by many governments i n the 1950s and 1960s, and sub s e q u e n t l y a p p l i e d to non-IATA c h a r t e r c a r r i e r s , thereby r e s t r i c t i n g charter competition. 123 i n t e r e s t s o f the scheduled c a r r i e r s , could cost governments a d d i t i o n a l s u b s i d i e s . In 1957, however, the U.S. ended i t s subsidies of scheduled i n t e r n a t i o n a l c a r r i e r s (Hammarskjold, 1979, p.32, Marx, 1981, p.136). This spurred the U.S. Congress to enact l e g i s l a t i o n , and the CAB to relax i t s r e g u l a t i o n s , p e r m i t t i n g the growth o f c h a r t e r o p e r a t i o n s on U.S. in t e r n a t i o n a l routes. Although data on charter operations before. 1970 are scarce, Goldklang (1961, p.99) reported that i n 1960 on the North A t l a n t i c , charters had eleven percent of the business at the height of the t o u r i s t season. Charter t r a f f i c increased , throughout the 1960s, and by 1971 had close to f o r t y percent of i n t e r n a t i o n a l tonne-kilometres. 3 1 d) Post-Bermuda Developments - A Summary The post-Bermuda p e r i o d w i t n e s s e d the l a s t f a i l e d attempts at e s t a b l i s h i n g a m u l t i l a t e r a l method of regulating entry and capacity on i n t e r n a t i o n a l r o u t e s . B i l a t e r a l agreements d u r i n g the p e r i o d were c h a r a c t e r i z e d by the i n c r e a s e d use of r e s t r i c t i v e pre - determination. of capacity clauses, except on U.S. i n t e r n a t i o n a l routes. IATA remained the primary means of e s t a b l i s h i n g p r i c e s f o r i n t e r n a t i o n a l r o u t e s . The A s s o c i a t i o n was able to withstand feuds with the CAB over p r i c e l e v e l s , i n t e r n a l b i c k e r i n g over t a r i f f l e v e l s and conditions of service, problems of i l l e g a l d i s c o u n t i n g , and c o m p e t i t i o n from non-IATA services. Charter services, however, d i d increase i n popularity, e s p e c i a l l y during the 1960s. 3 1 See Figure 2.7. 124 The regulations of the post-Bermuda regime were, f o r the most part, s i m i l a r to those of the Bermuda regime. The major task i n the analysis h a l f of t h i s s e ction of the chapter i s , therefore, to explain why there were no major regulatory changes despite the developments during the period 1946-1965. 2. Analysis of the Maintenance of the Regime Using the Modified Hegemonic Stability Theory In t h i s s e c t i o n of the chapter, an attempt i s made to analyze the maintenance of the post-Bermuda regime using the modified hegemonic s t a b i l i t y theory. Hegemonic s t a b i l i t y theory predicts that a regime can be sustained as long as there continues to e x i s t a dominant power capable of maintaining the regime and w i l l i n g to continue to bear the costs of supplying the regime to the r e s t of the world. As was shown i n the analysis of the formation of the Bermuda regime, the United States was the hegemon i n 1946. Given t h i s f a c t , i n order to determine i f hegemonic s t a b i l i t y theory i s to be supported, the following questions must be addressed? Did the United States continue as the dominant power, capable of maintaining the regime, during the period 1946-1965? I f so, what were the incentives for the U.S. to continue to support the regime? What were the costs, to the U.S. i n maintaining the regime? What incentives or coercive measures were used to maintain the support of other countries for the regime? These questions are addressed, i n turn, below: 125 a) Did the U.S. Continue as the Dominant Power During the Period 1946-1965? During the post-Bermuda regime, the United States continued, not only to lead the a i r l i n e industry, but to support the l a r g e s t economy i n the world and one of the two strongest m i l i t a r y forces. The United States was both a m i l i t a r y and economic superpower, as well as the world's foremost a v i a t i o n country. With respect to a i r transport, the United States was able to maintain a g r e a t e r than f i f t y p e r c e n t share of the world market. 3 2 However, as L i s s i t z y n (1964, pp.257-258) indicated, the U.S. c a r r i e r s ' share of the North A t l a n t i c market d i d s l i p from 60 percent i n 1950 to under 40 percent i n the e a r l y 1960s. L i s s i t z y n a t t r i b u t e d the decline i n U.S. market share to the r e v i t a l i z a t i o n of European and Japanese a i r l i n e s and to the stronger economies i n these regions. In summary, i t would appear that the U.S. was able to maintain the dominant p o s i t i o n i n the a i r transport industry during the period 1946-1965, although i t s dominance di d decline during those years. The si z e and strength of the U.S. economy and m i l i t a r y force would indi c a t e that the U.S. was also capable of maintaining the a i r transport regime, i f i t so chose. 3 2 See Figure 2.8 for the U.S. share of the world's scheduled passenger-kilometres for the period 1955-1965. 126 b) What were the Incentives for the U.S. to Maintain the Regime? The incentives f o r the U.S. i n maintaining the regime can be divided i n t o two categories - national s e c u r i t y and economic. Thornton (1970b, pp.681-682) c i t e d examples of b i l a t e r a l negotiations where the U.S. appeared to exchange p r o f i t a b l e routes to be used by f o r e i g n c a r r i e r s f o r increased U.S. s e c u r i t y . Thornton provided two n a t i o n a l security-based reasons f o r the U.S. actions: The f i r s t aspect i s a r e s u l t of t e c h n i c a l f a c t o r s . From 1949 u n t i l about 1962 the United States Strategic A i r Force required f o r e i g n bases and other f o r e i g n a s s i s t a n c e to reach possible t a r g e t s i n the S o v i e t Union e f f e c t i v e l y . Faced w i t h t h i s o v e r r i d i n g need, i n an environment i n which aggression was feared more by the United States than by i t s a l l i e s , s elected key nations found themselves i n extremely strong bargaining p o s i t i o n s . I t a l y , Spain, Portugal, the United Kingdom, Japan, the Netherlands and several other states a l l were able to bargain e f f e c t i v e l y f o r a v a r i e t y of concessions from the United States... The second aspect of the U.S. need for f o r e i g n agreements i s probably p a r t i a l l y a r e s u l t of the f i r s t one. I t i s the United States' desire to pursue a forward strategy. U.S. p o l i c y c a l l e d f o r maintenance of non-communist governments i n a l l states not a l r e a d y communist. Thus, when a f o r e i g n country begged f o r favorable treatment from the United States government for t h e i r a i r l i n e , the U n i t e d S t a t e s , f e a r f u l of weakening a f r i e n d l y government or of r e s t r i c t i n g the f o r e i g n exchange earning power of the seeker, f e l t , o b l i g e d to a s s i s t . In a d d i t i o n to national s e c u r i t y i n t e r e s t s , there were also economic reasons for the United States to maintain the regime. As was o u t l i n e d above, u n t i l 1957, the U.S. provided subsidies to i t s i n t e r n a t i o n a l c a r r i e r s . The maintenance of IATA p r i c e s , and the r e s t r i c t i o n s p l a c e d on c h a r t e r operations, were seen as ways of promoting the p r o f i t a b i l i t y of the scheduled c a r r i e r s , and of reducing subsidy payments (Goldklang, 1961, p.101; p.107). 127 In addition, the maintenance of the IATA c a r t e l l i k e l y provided economic bene f i t s to U.S. i n t e r n a t i o n a l c a r r i e r s . Although there i s some evidence that the U.S. c a r r i e r s would have preferred lower-than-IATA p r i c e s , 3 3 there i s no evidence that the c a r r i e r s would have preferred, as an a l t e r n a t i v e , a f r e e - p r i c i n g regime. As U.S. subsidy support was withdrawn, and as foreign c a r r i e r s grew stronger, the IATA c a r t e l provided the U.S. c a r r i e r s with h e l p f u l p r o t e c t i o n against f o r e i g n competition. In summary, there were both s e c u r i t y and economic incentives for the U.S. to maintain the post-Bermuda regime. Security reasons pertained to the support of NATO a l l i e s while economic concerns involved the l i m i t a t i o n of subsidies and the support of U.S. c a r r i e r s . c) What were the costs to the U.S. in maintaining the regime? The major costs of maintaining the post-Bermuda regime, assumed by the U.S., were paid by t r a v e l l e r s and shippers. IATA p r i c e s were undoubtedly higher than what would have r e s u l t e d under a more competitive regime, costing t r a v e l l e r s and shippers a d d i t i o n a l monies to use a i r transport. Since U.S. c i t i z e n s were disproportionately high users of i n t e r n a t i o n a l a i r t r a n s p o r t , 3 4 3 3 Lower fares, e s p e c i a l l y i n the 1950s, were seen by U.S. c a r r i e r s as a means f o r expanding t h e i r markets (Chuang, 1972, p.117). Pan American, for example, was i n s t r u m e n t a l i n the introduction, by IATA, of t o u r i s t and economy services i n the 1950s (Keyes, 1964, p.177). 3 4 L i s s i t z y n (1964, p.257) reported, for example, that between 1950 and 1962, U.S. c i t i z e n s comprised over s i x t y percent of i n t e r n a t i o n a l t r a v e l l e r s on routes touching down i n the U.S. 128 U.S. c i t i z e n s had to bear a d i s p r o p o r t i o n a t e share o f the c o s t s of maintaining the regime. . U.S. c a r r i e r s paid, as well, a share of the costs of maintaining the regime. The U.S. provided incentives to smaller countries, i n the form of favourable route awards, to p a r t i c i p a t e i n the regime. The r e s u l t was a reduction i n valuable routes a v a i l a b l e , on a monopoly or duopoly basis, to U.S. c a r r i e r s (Thornton, 1970b, p.681; L i s s i t z y n , 1964, p.252). d) What Incentives or Coercive Measures were used to Maintain the Support of Other Countries for the Regime? There i s l i t t l e doubt that the major aim of most countries was to secure as many be n e f i t s as possible for t h e i r n a t i o n a l c a r r i e r s . According to one p a r t i c i p a n t i n the negotiation of post-Bermuda b i l a t e r a l s (Slotemaker, 1966, p.901): The nat i o n a l a i r l i n e s a c t u a l l y set the course for negotiating [ b i l a t e r a l s ] and n o t f o r i n s t a n c e the n a t i o n a l t o u r i s t o r g a n i z a t i o n , the national h o t e l l e r i e or business organizations l i k e Chambers o f Commerce. Generally speaking, not a s i n g l e element of the n a t i o n a l economy, except the a v i a t i o n industry, had influence on these negotiations. The incentives, therefore, that countries wished from the U.S. to secure support for the post-Bermuda regime, were i n the form of b e n e f i t s f o r t h e i r c a r r i e r s . These were two major incentives that were procured by countries for p a r t i c i p a t i n g i n the regime. The f i r s t , and most important, was IATA 129 p r i c i n g . High IATA prices were desired by c a r r i e r s to increase revenues and by governments to ease subsidy payments to i n e f f i c i e n t c a r r i e r s (Chuang, 1972, p.123). The second b e n e f i t was i n the form of favourable route awards from the U.S. According to Thornton (1970b, p.681), there appeared to be a number of instances of the U.S. providing favourable route awards to foreign c a r r i e r s against the better i n t e r e s t s of U.S. c a r r i e r s f o r s e c u r i t y reasons. 3. Results from the Analysis Using the Modified Hegemonic Stability Theory Figure 4.2 provides an i l l u s t r a t i o n of the post-Bermuda regime i n the context of the modified hegemonic s t a b i l i t y theory. I t can be seen, from the fi g u r e , that the U.S. continued as the hegemon. The U.S. paid costs to support the regime i n the form of h i g h p r i c e s to U.S. t r a v e l l e r s and shippers, and a reduction i n monopoly/duopoly routes f o r i t s c a r r i e r s . In return, the U.S. received both s e c u r i t y and economic b e n e f i t s . F i n a l l y , o t h e r c o u n t r i e s b e n e f i t e d from p a r t i c i p a t i n g i n the regime through IATA p r i c e - s e 11 i n g and by r e c e i v i n g f a v o u r a b l e U.S. route awards. The circumstances of the post-Bermuda regime f i t n i c e l y , therefore, with the theory of hegemonic s t a b i l i t y . The other explanatory factors described i n Chapter 3 may also be h e l p f u l i n providing an explanation for the s t a b i l i t y of the regime during the post-Bermuda period. These factors are examined below. 130 F i g u r e 4.2 The P o s t - B e r a u d a Regime i n t h e C o n t e x t o f t h e M o d i f i e d H e g e a o n i c S t a b i l i t y T h e o r y U n i t e d S t a t e s ( T h e Hegemon) I n c e n t i v e s IATA p r i c e s f o r c a r r i e r s f a v o u r a b l e r o u t e a w a r d s COSTS H i g h p r i c e s t o t r a v e l l e r s and s h i p p e r s ; r e d u c t i o n i n m o n o p o l y / d u o p o l y r o u t e s a v a i l a b l e t o U.S. c a r r i e r s B ENEFITS P e r c e i v e d g e n e r a l s e c u r i t y b e n e f i t s and e c o n o m i c b e n e f i t s i n t h e f o r m of d e c r e a s e d s u b s i d y p a y m e n t s by t h e U.S. g o v e r n m e n t and i n c r e a s e d r e v e n u e s and p r o f i t s f o r U.S. c a r r i e r s P o s t - B e r m u d a Regime M u l t i l a t e r a l t a r i f f c o o r d i n a t i o n t h r o u g h IATA Some n o n - I A T A t r a n s p o r t , e s p e c i a l l y c h a r t e r s B i l a t e r a l r e g u l a t i o n o f r o u t e s and c a p a c i t i e s B ermuda 1 and p r e -d e t e r m i n a t i o n o f c a p a c i t y b i l a t e r a l s O t h e r C o u n t r i e s 4. Other Factors in the Explanation of the Adoption of the 1965 post-Bermuda Regime a) Domestic Affairs Why d i d countries continue to support a regime, the major components of which were the b i l a t e r a l exchange of route r i g h t s and the m u l t i l a t e r a l s e t t i n g of prices? The hegemonic s t a b i l i t y theory argued that the regime was maintained because of a continuation of U.S. leadership i n the a i r transport industry. However, domestic p o l i t i c a l factors also appeared to play a role i n the maintenance of the regime, e s p e c i a l l y with respect to m u l t i l a t e r a l t a r i f f coordination, an aspect of the regime favourable to a i r l i n e s . I t seems f a i r l y c l e a r that the a i r l i n e s , given t h e i r large stake i n the outcomes, were able to dominate the a i r transport policy-making processes of most countries. There was considerable input by c a r r i e r s i n the formulation of government p o l i c i e s and negotiating p o s i t i o n s . 3 5 Consumer groups were not involved, to any extent, i n these processes (Slotemaker, 1966, p.901). One reason for the close connection of a i r l i n e s to government p o l i c y -making i n many countries was due to government ownership or c o n t r o l . Chuang (1972, pp.161-164) found that, as of 1970, 68 of 92 active IATA c a r r i e r s were e i t h e r f u l l y or p a r t l y government owned. But t h i s was not the case with the U.S. where the c a r r i e r s were p r i v a t e l y owned. Did U.S. p o l i c y choices also r e f l e c t a p r o - a i r l i n e bias? U.S. c a r r i e r s d i d manage to work c l o s e l y with the CAB, and were powerful actors i n the determination of U.S. p o l i c y . Even 3 5 See: Slotemaker (1966, p.901); and S t o f f e l (1959, pp.124-125), with respect to the United States. 132 the CAB's actions to press f o r lower fares within the IATA system coincided with the i n t e r e s t s of U.S. c a r r i e r s (Bebchick, 1958, pp.25-26; Chuang, 1972, p.117; Keyes, 1964, p.177). 3 6 I t would appear t h a t the major i n t e r e s t s represented i n the U.S. i n t e r n a t i o n a l a i r policy-making processes, aside from the a i r l i n e s , were those o f f o r e i g n governments, f o r e i g n c a r r i e r s , and the U.S. Defense Department. F o r e i g n governments and c a r r i e r s lobbied through the State Department i n order that t h e i r views be represented ( P i l l a i , 1969, p . 7 ) . 3 7 The Defense Department was concerned with securing U.S. overseas bases and ensuring the s t a b i l i t y of NATO. The department was l i k e l y instrumental i n decisions to trade route r i g h t s , to be used by fo r e i g n c a r r i e r s , f o r U.S. sec u r i t y objectives. 3 6 U.S. c a r r i e r s , e s p e c i a l l y i n the 1950s, were concerned with expanding the market f o r i n t e r n a t i o n a l a i r t r a v e l and supported the introduction of low f a r e s e r v i c e s . Chuang (1972, pp.117-119) noted that the U.S. c a r r i e r s ' support f o r lower fare proposals by the CAB, within the IATA system, was stronger before 1960 than a f t e r 1960. A f t e r 1960, p r o f i t returns were high f o r U.S. c a r r i e r s , and they therefore were les s eager to t r y to expand the market through the o f f e r of lower fares. The l i b e r a l i z a t i o n of charter rules by the U.S. i n the 1960s also may be viewed as a move i n support of U.S. c a r r i e r s . The U.S. c a r r i e r s ' share of the North A t l a n t i c market had declined during the 1950s. By expanding the charter market, the CAB hoped that U.S. charter c a r r i e r s would be able to expand the t o t a l U.S. share of the market (Hammarskjold, 1979, p.33). I t should be noted that the U.S. scheduled c a r r i e r s also had a large share of the charter market, so they were not completely adverse to the expansion of the charter market. 3 7 Foreign governments and c a r r i e r s were generally against CAB and U.S. c a r r i e r s ' demands for lower fares and against CAB e f f o r t s to block IATA agreements i n order to achieve the lower fares. 133 In summary, i t would appear that the dominance of a i r l i n e i n t e r e s t s i n i n t e r n a t i o n a l a i r policy-making helped to ensure the maintenance of the post-Bermuda regime. Other i n t e r e s t s , such as that of the Defense Department i n the U.S., were represented to a l e s s e r degree. Consumers were not able to overcome the f r e e - r i d e r problem and p a r t i c i p a t e i n the policy-making processes of t h e i r governments. b) Structural Factors Four s t r u c t u r a l developments were out l i n e d i n Chapter 3 which could have an impact on m u l t i l a t e r a l p r i c e - s e t t i n g i n i n t e r n a t i o n a l a i r transport (see Table 3.2). These were: a change i n the number of a i r c a r r i e r s ; the intr o d u c t i o n of new cost-saving technology; a downturn i n the economic cycle; and, a change i n the height of entry b a r r i e r s into the industry. Neither of the l a t t e r two developments would have contributed to i n s t a b i l i t i e s i n the industry during the post-Bermuda period, since there were no serious economic downturns and since b a r r i e r s to entry ( e s p e c i a l l y regulatory b a r r i e r s ) d i d not change s i g n i f i c a n t l y . However, there were s i g n i f i c a n t increases i n the number of c a r r i e r s and the introduction of new cost-saving technology ( i . e . , j e t s ) between 1946 and 1965. Both of these developments could have undermined the s t a b i l i t y of the regime, but d i d not. The reasons why a stable regime was maintained despite these developments are discussed below: i) Increase in Number of Carriers An increase i n the number of c a r r i e r s can contribute to the i n s t a b i l i t y o f the regime, whether or not the c a r r i e r s p a r t i c i p a t e d iri IATA p r i c e -s e t t i n g . I f the.new c a r r i e r s d i d p a r t i c i p a t e i n IATA p r i c e - s e t t i n g , then a 134 unanimous p r i c i n g d e c i s i o n would be d i f f i c u l t to achieve because of the l a r g e r number o f c a r r i e r s involved i n deciding on p r i c e s . I f the new c a r r i e r s d i d not p a r t i c i p a t e i n IATA p r i c i n g , then IATA t a r i f f coordination could become vulnerable to low-price competition. Between 1946 and 1965, there were increases both i n IATA members and non-IATA c a r r i e r s (mainly charters). Figure 2.14 indi c a t e d that the number of t a r i f f - c o o r d i n a t i o n members of IATA increased from about 60 i n 1951 to over 80 i n 1965. How d i d IATA continue to achieve and maintain p r i c i n g agreements despite the increased numbers of c a r r i e r s ? There were a number of factors which contributed to the a b i l i t y of IATA to reach and to maintain p r i c i n g agreements. F i r s t , side payments were off e r e d to c a r r i e r s reluctant to agree to a p r i c i n g schedule against t h e i r b e t t e r i n t e r e s t s ( P i l l a i , 1969, p.79). Second, once agreements were i n place, IATA used i t s enforcement branch to investigate breaches of the IATA agreements and to f i n e members g u i l t y of undercutting IATA fares. Third, governments enforced the provisions of the IATA agreements. 3 8 F i n a l l y , the r e s t r i c t i o n i s t b i l a t e r a l s and revenue pooling agreements, introduced during the post-Bermuda regime, reduced the incentives f o r c a r r i e r s to engage i n p r i c e competition. I f the c a r r i e r s were r e s t r i c t e d to a f i f t y percent share of revenue or t r a f f i c , there were few incentives to charge lower p r i c e s than "competitors". 3 8 See: Tauber (1969) for a discussion of the CAB i n v e s t i g a t i o n into breaches of IATA agreements. 135 The major factor which contributed to the a b i l i t y of IATA to maintain i t s p r i c e s despite charter competition was the r e s t r i c t i o n placed by both IATA and governments on charter operations. IATA and government regulations r e s t r i c t e d the sale of charters to recognizable " a f f i n i t y " groups (Haanappel, 1978) . Charter c a r r i e r s were not allowed to compete d i r e c t l y with IATA for i n d i v i d u a l passenger business. In summary, there were increases i n the numbers of both IATA and non-IATA c a r r i e r s during the post-Bermuda regime. However, measures undertaken by IATA and by governments were a b l e to p r o t e c t m u l t i l a t e r a l t a r i f f coordination and maintain the s t a b i l i t y of the regime. b) Introduction of Jet Aircraft The introduction of j e t s , i n the late. 1950s, represented a technological l e a p over the a i r t r a n s p o r t equipment t h a t was p r e v i o u s l y a v a i l a b l e . According to Straszheim (1969, p.84), the j e t engines produced, "greater thrust, greater speeds, and hence much lower costs f o r f u e l , maintenance, and labour per ton-mile of payload." Jones (1960, p.240) found that the j e t s could transport over three times as many passengers as the p r o p e l l e r a i r c r a f t they replaced due to t h e i r increased speed and s i z e . The i n t r o d u c t i o n of j e t s caused two problems for IATA. F i r s t , because of t h e i r greater payload, the j e t s added a considerable amount of capacity to major routes, such as the North A t l a n t i c . The a d d i t i o n a l capacity l e v e l s contributed to low load factors and to the " i l l e g a l " discounting of IATA fares (Keyes, 1964, pp.177-178). The second problem r e s u l t e d because j e t s 136 were not introduced simultaneously by a l l c a r r i e r s . Passengers wanted to t r a v e l with c a r r i e r s that had the new equipment, and t h i s r e s u l t e d i n moves by the home countries of non-jet operators to r e s t r i c t the use of j e t s . 3 9 The excess capacity problem was a l l e v i a t e d i n large part by the mid- to l a t e 1960s, because of the strong growth l e v e l s i n the industry (see Figure 2.4). IATA d e a l t with the problem of non-uniform d i f f u s i o n of the new technology by i n s t i t u t i n g a surcharge on j e t transport on the North A t l a n t i c (Cohen, 1960, p.154). The surcharge was i n e f f e c t f o r the period 1959-1961, by which time j e t technology was more widely used. In summary, there were two developments - an increase i n the number of c a r r i e r s , and the introduction of j e t technology - which could have weakened the IATA rate-making system. However, due to a c t i o n s by IATA and governments, and to the strong growth i n the industry, damage to the IATA rate-making system was l a r g e l y avoided and the p r i n c i p l e s of the post-Bermuda regime maintained. c) Overriding State Interests I t was argued above that countries appeared to have o v e r r i d i n g state i n t e r e s t s i n maintaining n a t i o n a l c a r r i e r s and that the IATA c a r t e l . was a means of providing i n d i r e c t government support for the c a r r i e r s . Changes i n t h i s state i n t e r e s t could lead to regime changes, given that IATA might no longer be required to provide support for i n e f f i c i e n t c a r r i e r s . There i s no evidence, however, that overriding state i n t e r e s t s i n the maintenance of 3 9 See examples i n Straszheim (1969, p.45). 137 n a t i o n a l c a r r i e r s waned during the post-Bermuda period. Newly independent countries were, i n f a c t , anxious to own and operate n a t i o n a l c a r r i e r s and to e n r o l l t h e i r c a r r i e r s i n the IATA c a r t e l . * 0 The IATA c a r t e l appeared to continue to be a popular means for countries to provide i n d i r e c t support for t h e i r c a r r i e r s . 5. Summary In t h i s s ection of the chapter, regulatory developments during the post-Bermuda regime (1946-1965) were outlined, and the modified hegemonic theory used to analyze the developments. The theory predicted that a stable regime could be maintained, as long as there existed a dominant power w i l l i n g to support the regime. Although the p o s i t i o n of the U.S. declined during the post-Bermuda regime, i t remained the dominant power capable of assuming the c o s t s of the regime. The hegemonic s t a b i l i t y theory was, therefore, supported by the f a c t the post-Bermuda regime was maintained. Other factors were also used to assess why the regime -- e s p e c i a l l y the system of IATA t a r i f f coordination -- was maintained. I t was seen that there were two developments that could have caused a regime change - an increase i n the number of c a r r i e r s and the introduction of j e t s - but that these two developments were s u c c e s s f u l l y countered by IATA and government forces, and by the strong growth of the industry. ' 4 0 F i g u r e 2.15 i n d i c a t e d t h a t the number of IATA c a r r i e r s from developing countries more than doubled from 21 to 44 between 1950 and 1965. 138 In summary, both the modified hegemonic theory and the other factors were s u c c e s s f u l l y used to show why the post-Bermuda regime remained r e l a t i v e l y stable. In the next section of the chapter, the period 1966-1981 w i l l be examined, during which time the l i b e r a l regime was adopted. D. The 1981 L i b e r a l Regime During the period 1966-1981, the i n t e r n a t i o n a l a i r transport industry experienced i t s greatest regulatory changes since the Bermuda regime was adopted i n 1946. The major changes were brought about i n large part as a r e s u l t of the U.S. pro-competitive p o l i c y , launched i n 1977. The p o l i c y d r a s t i c a l l y undermined the IATA m u l t i l a t e r a l p r i c i n g mechanism, which had c h a r a c t e r i z e d the Bermuda and post-Bermuda regimes. As a r e s u l t , competitive, rather than m u l t i l a t e r a l p r i c i n g , emerged on U.S. i n t e r n a t i o n a l routes. In markets not greatly influenced by the U.S. i n t e r n a t i o n a l p o l i c y (e.g., E u r o p e - A s i a ) , m u l t i l a t e r a l p r i c e - s e t t i n g was maintained, although problems of " i l l e g a l " discounting of IATA fares p e r s i s t e d . Table 4.3 i l l u s t r a t e s the p r i c i n g and other c h a r a c t e r i s t i c s of the 1981 l i b e r a l regime, as well as relevant industry and environmental f a c t o r s . The t a b l e shows t h a t although IATA continued (or attempted to continue) to e s t a b l i s h p r i c e s on most i n t e r n a t i o n a l r o u t e s , the p r i c e s were often disregarded. Instead, competitive prices were established or IATA prices were " i l l e g a l l y " discounted. Other points to note from the table include: the renewed involvement of ICAO i n regulatory matters; the introduction of " f r e e market" or " l i b e r a l " b i l a t e r a l s on some U.S. routes; the growing 139 T a b l e 4 . 3 S n a p - s h o t o f t h e 1981 L i b e r a l Reg ime a n d R e l a t e d E n v i r o n m e n t a l a n d I n d u s t r y F a c t o r s Characteristic or Factor 1981 Liberal Regime 1. Regime Characteristics a) Role of IATA in setting prices b) Membership in IATA Prices set by IATA on most routes but often not adhered to by air-lines. Widespread use of "free market" pricing and i l l e g a l discounting. Major international scheduled carriers excluding: most U.S. carriers; some important carriers of developing countries; and some Eastern bloc carriers. Membership was 111 airlines with about 6 0 percent of active members representing developing countries. c) Role of ICAO Involvement in technical and safety matters plus recommendations on economic matters d) Bilateral Capacity Clauses Introduction of the "free-market" or l i b e r a l approach to the determination of capacities on U.S. inter-national routes. Predetermination of capacities wide-spread on other routes. e) Regulation by regional organizations Several regional inter-governmental and inter-a i r l i n e organizations operating, especially in the developing world. The organizations of the developing countries had 14.0 Table 4.3 (Continued) Environmental Factors a) The World Economy b) Third World Development c) U.S. Government become advocates for rest r i c t l o n i s t regulatory approaches. Economic growth slowed considerably in much of the world during the year, signalling the beginning of a recession. Uneven development in the Third World, depending on o i l resources and/or a b i l i t y to take advantage of low-wage labour. Conservative, Republican administration concerned with countering communist influence in the world and rebuilding U.S. defenses. Previous administration, however, was l i b e r a l , Democratic. 3. Industry Factors a) Maturity of Airline Industry b) State of Technology c) Government Ownership d) Role of Charter Operators e) Size of Industry Growth rates levelled as industry matured. Wide-bodied aircraft operated by most major carriers on long distance routes. Government ownership of most national airlines, except U.S. Easy access to charters on many routes, although charter t r a f f i c declined from the early 1970s due to low price competition from the scheduled carriers. The industry performed 1,119 b i l l i o n passenger-kilometres (compared to 199 b i l l i o n in 1965). 141 Table 4.3 (Continued) f) Product Offerings Fi r s t class, economy class and discount ticket prices available on international routes; especially U.S. international routes. Discount tickets offered on a capacity-controlled basis. g) "Il l e g a l " Discounting Widespread discounting. h) U.S. Dominance of Air Transport U.S. airlines' share of world air services (in passenger-kilometres) was 35 percent. 142 influence of regional organizations i n the regulation of i n t e r n a t i o n a l a i r transport; the moderating of industry growth rates; the l i b e r a l i z a t i o n of charter r u l e s ; and, the decline i n dominance of the U.S. i n the industry. In examining the developments of the l i b e r a l regime, the format of the two p r e v i o u s s e c t i o n s w i l l be f o l l o w e d . Developments leading to the formation of the regime w i l l f i r s t be reviewed, followed by an analysis of the developments using modified hegemonic theory and the other explanatory f a c t o r s . The major question that must be addressed i n t h i s s e ction of the chapter is.why was there a movement to a competitive or l i b e r a l regime. 1. Developments Leading to the 1981 Liberal Regime a) Pre-Liberal Developments - 1966-1977 There were a number of important developments t h a t preceded the adoption, by the United States, of a pro-competitive policy, i n 1977. Three of these developments are discussed below: changes i n the charter industry; the adoption of i n c r e a s i n g l y protective measures by the United States; and, the s i g n i n g of the Bermuda 2 b i l a t e r a l by the United States and United Kingdom i n 1977. i) Development of the Charter Industry The impetus for the strong growth of the charter market i n the l a t e 1960s and e a r l y 1970s was l i n k e d by some authors to the Chandler " c r i s i s " . ' ' 1 The Chandler c r i s i s of 1963 involved a dispute between the CAB and IATA over 4 1 See, For example, Lowenfeld (1975, p.41). The " c r i s i s " was named a f t e r the town of Chandler, Arizona where IATA held i t s 1962 meeting at which p r i c e hikes were adopted. 143 the l e v e l o f f a r e s . The CAB desired lower fares while IATA wanted to increase fares. The c r i s i s was resolved when the CAB retreated from i t s p o s i t i o n under pressure from foreign governments, c a r r i e r s , and the U.S. State Department. The IATA proposal f o r higher fares held, with only minor changes. The response of the CAB, although not e x p l i c i t l y stated, was to l i b e r a l i z e charter regulations i n order to allow charter operators a better opportunity to provide the low-fare services the CAB desired (Lowenfeld, 1975, p.41). The f i r s t l i b e r a l i z a t i o n occurred i n 1964 when the CAB authorized " s p l i t charters". These were charter f l i g h t s that could be shared by two or more to u r groups. In 1966, there was a further l i b e r a l i z a t i o n when the CAB authorized i n c l u s i v e tour charters; i . e . , charters that incorporated ground services into the tour package. The rules for a f f i n i t y charters were also relaxed by the U.S. (as well as by other countries) during the l a t t e r h a l f of the 1960s.''2 The r e l a x a t i o n of the rules increased the popularity of the a f f i n i t y charters, but by the early 1970s i t became apparent that much of the increased p o p u l a r i t y was due to the emergence of bogus groups. These were groups formed s o l e l y to take advantage of low charter fares (Haanappel, 1978, p.148). The a f f i n i t y charter rules had become unenforceable. A number of countries met i n 1972 i n order to f i n d ways of regaining c o n t r o l over the charter market. The countries decided to i n s t i t u t e a new form of charter known as the advance booking charter. These charters would 4 2 As d e s c r i b e d above, a f f i n i t y c h a r t e r s were c h a r t e r s s o l d to recognizable groups or clubs. Soon, such groups were created s o l e l y for t r a n e l purposes! 144 not r e q u i r e the e x i s t e n c e o f an a f f i n i t y group, or the requirement to purchase ground services, but only that charter t i c k e t s be purchased ninety days i n advance.* 3 The advance booking charters proved popular, and quickly r e p l a c e d the a f f i n i t y c h a r t e r s as the primary form of non-scheduled service. The charter c a r r i e r s , however, were not able to increase t h e i r market share i n the 1970s, as the scheduled c a r r i e r s introduced new discount fares to compete i n the low p r i c e range. The scheduled c a r r i e r s drove down the charter share of the market from 40% i n 1971 to 27% i n 1977, and to under 15% i n 1985 (see Figure 2.7). In conclusion, during the p r e - l i b e r a l period, there were large gains i n charter t r a f f i c following the r e l a x a t i o n (and flaunting) of charter r u l e s . But by the 1970s, the scheduled c a r r i e r s were able to regain much of t h e i r l o s t market share by o f f e r i n g lower promotional fares. The r e s u l t was a market s t i l l dominated by the scheduled c a r r i e r s but with a wider range of discount p r i c e o f f e r i n g s . i i ) The Adoption of New Protective Measures By the l a t e 1960s, v i r t u a l l y a l l b i l a t e r a l s , other than those signed by the U n i t e d States, incorporated means of pre-determining capacity l e v e l s 4 3 Advance purchase requirements have since been lowered to t h i r t y days i n some s i t u a t i o n s (Haanappel, 1978, p.149). 4 4 Lowenfeld and Mendelsohn (1979, p.483) stated that by 1977, the advance booking charters had over two-thirds of the U.S. o r i g i n a t i n g charter market, compared to twelve percent f o r the a f f i n i t y charters. 145 (Harbison, 1982, p . 3 ) . 4 5 The Bermuda 1 p r i n c i p l e of having only ex post facto reviews of capacity l e v e l s had been replaced by the ex ante d i v i s i o n of c a p a c i t y between c a r r i e r s . Pre-determination of capacity b i l a t e r a l s had become the norm on routes, other than those i n v o l v i n g the United States. But i n the mid-1970s, the United States, too, changed i t s p o s i t i o n and began promoting capacity sharing agreements as a means of p r o t e c t i n g i t s f l a g c a r r i e r s . The e a r l y 1970s had been a d i f f i c u l t time f o r the U.S. c a r r i e r s . The c a r r i e r s had invested heavily i n wide-bodied a i r c r a f t (a new technology), but expectations of continued high increases i n passenger demand had not been r e a l i z e d (due, i n large part to the economic recession r e s u l t i n g from o i l p r i c e increases). The r e s u l t was low load f a c t o r s 4 6 and severe f i n a n c i a l problems f o r the two major U.S. i n t e r n a t i o n a l c a r r i e r s , Pan American and TWA (Dempsey, 1978, p.417). In order to improve the p o s i t i o n of the U.S. c a r r i e r s , the CAB, i n 1975, authorized Pan American and TWA to discuss capacity reduction agreements with t h e i r B r i t i s h counterparts. The discussions r e s u l t e d i n agreements to reduce the number of f l i g h t s between London and four U.S. c i t i e s (Dempsey, 1978, p.417). 4 5 Capacity c o n t r o l agreements may have been included i n the b i l a t e r a l s , themselves, or i n c o r p o r a t e d into accompanying c o n f i d e n t i a l memoranda of understanding. 4 6 ICAO (1981f) showed that the weight load factors for i n t e r n a t i o n a l a i r transport averaged between 50 and 55 percent i n the e a r l y 1970s. They d i d not r i s e above 55 percent u n t i l 1977. 146 In a d d i t i o n to allowing carriers to reach capacity reduction agreements, the U.S. sought to negotiate capacity agreements at a b i l a t e r a l governmental l e v e l . The United States was d i s s a t i s f i e d with the share of t r a f f i c c a r r i e d by U.S. a i r l i n e s i n a number of North A t l a n t i c m a r k e t s . 4 7 T h i s d i s s a t i s f a c t i o n l e d to negotiations with f o r e i g n governments i n an attempt.to increase the market shares of the U.S. c a r r i e r s . 4 8 In summary, by the e a r l y 1970s, r e s t r i c t i v e , pre-determination of c a p a c i t y agreements had become the norm on a l l r o u t e s , except U.S. i n t e r n a t i o n a l routes. But i n the mid-1970s, the U.S. also sought capacity agreements, i n an e f f o r t to increase market shares f o r i t s c a r r i e r s . i i i ) The Bermuda 2 Bilateral Between the United States and the United Kingdom Although the United States' c a r r i e r s had been performing poorly on a number of North A t l a n t i c routes, they had been doing well i n the U.S.-U.K. market. In t h i s market, i t was the B r i t i s h who were d i s s a t i s f i e d with the percentage of t r a f f i c transported by t h e i r c a r r i e r s (Bridges, 1977, pp.116-117; Larsen, 1977, p.85). The U.K. f e l t that U.S. c a r r i e r s received the majority of benefits from the e x i s t i n g b i l a t e r a l a i r agreement, Bermuda 1. Consequently, i n 1976, the U.K. gave the required one year's notice f o r the denunciation of Bermuda 1. 4 7 Lowenfeld (1975, p.11) showed that U.S. c a r r i e r s had l e s s than twenty percent of the market share to f i v e out of s i x i n t e r i o r or northern European countries i n the e a r l y 1970s. 4 8 See, f o r example, Haanappel (1976) f o r a d i s c u s s i o n of the negotiations between the United States and the Netherlands. 147 In the negotiations over a new b i l a t e r a l agreement, the United Kingdom ou t l i n e d a number of demands aimed at r e s t r i c t i n g competition, including the following (Larsen, 1977, pp.85-88): an equal d i v i s i o n of the U.S.-U.K. market between B r i t i s h and American c a r r i e r s ; the designation of only one c a r r i e r per country per route; a c o n t i n u a t i o n of IATA p r i c e - s e t t i n g , and c l o s e r b i l a t e r a l governmental cooperation to ensure the support of IATA p r i c e s ; and, a severe r e d u c t i o n i n f i f t h freedom routes a l l o c a t e d to U.S. c a r r i e r s . The U.K. was not able to f u l l y achieve i t s aims, but the Bermuda 2 agreement, as the new b i l a t e r a l was known, was more r e s t r i c t i v e than Bermuda 1. Unlike Bermuda 1, Bermuda 2 required a i r l i n e s to submit schedules for governmental approval prior to operations taking place. A f t e r reviewing these submissions, e i t h e r government could, with some l i m i t a t i o n s , c u r t a i l increases i n capacity l e v e l s (Bridges, 1977, p.117). As well, Bermuda 2 r e s t r i c t e d the designation of c a r r i e r s per country to one each on a l l routes but two (where each country could designate two c a r r i e r s ) , and removed some of the f i f t h freedom r i g h t s previously a l l o t t e d to U.S. c a r r i e r s . iv) Pre-Liberal Period - A Summary During the p r e - l i b e r a l period (1966-1977) there was, concurrently, a r e l a x a t i o n i n c h a r t e r r e g u l a t i o n s but a t i g h t e n i n g of the b i l a t e r a l regulations governing scheduled a i r transport.. Charter transport's share of the i n t e r n a t i o n a l market increased u n t i l the early 1970s, and then f e l l a f t e r 148 the IATA c a r r i e r s i n s t i t u t e d lower promotional fares. The U.S. jo i n e d the r e s t of the wor l d i n o p t i n g f o r c a p a c i t y agreements on i n t e r n a t i o n a l scheduled routes, e s p e c i a l l y on those routes where the U.S. c a r r i e r s had low market shares. F i n a l l y , at the urging of the B r i t i s h , the U.S. and the U.K. signed a new b i l a t e r a l agreement, Bermuda 2, which was more r e s t r i c t i v e than the agreement i t replaced. b) The U.S. Pro-Competitive Policy - 1977-1981 In 1977, U.S. i n t e r n a t i o n a l a i r p o l i c y abruptly changed d i r e c t i o n s . While the United States had been following an i n c r e a s i n g l y r e s t r i c t i o n i s t p o l i c y , culminating i n the signing of Bermuda 2, i t reversed d i r e c t i o n s and began promoting a pro-competitive, consumer oriented p o l i c y . O u t l i n i n g the basis f o r the pro-competitive p o l i c y , the new chairman of the CAB, A l f r e d Kahn (1978, p.159) stated: [It] i s our b e l i e f that the function of economic p o l i c y i s to serve consumers rather than protect producers, and that the best way to do that i s by promoting competition at home and abroad rather than c a r t e l i z a t i o n . The underlying premise i s that t h i s i s not a zero sum game; that the pub l i c benefits by mutual extensions o f c o m p e t i t i v e o p p o r t u n i t i e s ; and t h a t once we think of our c o n s t i t u e n t s as t r a v e l l e r s and shippers, rather than a i r l i n e s , there are indeed things that those importunate foreigners have to o f f e r us - most prominently, as assured h o s p i t a l i t y to competition - m u l t i p l e d e s i g n a t i o n s and low - f a r e s c h e d u l e d s e r v i c e , an acceptance of l i b e r a l charter rules - as well as the competing services that t h e i r own c a r r i e r s are so anxious to o f f e r us. Our in t e n t i o n i s to trade l i b e r a l i z a t i o n s f o r l i b e r a l i z a t i o n s , o f f e r i n g f o r e i g n governments expanded access to our markets instead of capacity l i m i t a t i o n s , r e s t r i c t i o n s on gateways, and p r o h i b i t i o n s of pr i c e competition. The United States sought to i n s t i t u t e i t s pro-competitive p o l i c y i n f i v e ways: through the promotion of low cost scheduled services, e s p e c i a l l y Laker 149 Airways' Skytrain; through the further l i b e r a l i z a t i o n of charter regulations; by signing " l i b e r a l " b i l a t e r a l agreements; by ordering concerned p a r t i e s to "show c a u s e " why IATA t a r i f f c o o r d i n a t i o n s h o u l d c o n t i n u e on U.S. i n t e r n a t i o n a l r o u t e s ; and f i n a l l y , by p a s s i n g l e g i s l a t i o n to support competition on i n t e r n a t i o n a l routes. Each of these p o l i c i e s i s discussed, b r i e f l y , below: i ) Laker Airways Laker Airways was formed i n B r i t a i n , i n 1966, by Freddie Laker ( l a t e r knighted). The company operated charter services i n various parts of the world, but i n 1971 a p p l i e d , f o r the f i r s t time, f o r scheduled route authority. Laker Airways wished to o f f e r a low-priced scheduled service between London and New York, known as the "Skytrain". Under the Bermuda 1 b i l a t e r a l agreement, the United Kingdom had the authority to designate Laker as an a d d i t i o n a l c a r r i e r on the New York-London route. A f t e r a lengthy review, i n 1973, the U.K. f i n a l l y accepted the Laker a p p l i c a t i o n and designated the c a r r i e r . The United States, however, refused to permit Laker service, causing the Skytrain to remain grounded. 4 9 In 1974, the U.K. reversed i t s decision, and decided that Laker should no longer be a designated c a r r i e r on the New York-London route. The U.K. adopted a "spheres of influence" p o l i c y , which divided i n t e r n a t i o n a l routes 4 9 Banks (1982, pp.39-40) noted that the CAB never provided reasons for i t s r e f u s a l to permit Laker to operate the Skytrain, although there was a f e e l i n g that the CAB wished to protect U.S. money-losing c a r r i e r s , TWA and Pan American. The CAB also had been unhappy, i n the past, with Laker because the a i r l i n e had flaunted a f f i n i t y rules f or charter carriage. 150 between B r i t i s h Airways and B r i t i s h Caledonian. There was no p r o v i s i o n for Laker to operate i n t e r n a t i o n a l services. Laker s u c c e s s f u l l y challenged t h i s p o l i c y i n court on two occasions and was f i n a l l y awarded a route designation again, i n 1977. 5 0 By 1977, the p o l i c i e s of the United States had changed. . The CAB began promoting, rather than r e s t r i c t i n g , competition on i t s i n t e r n a t i o n a l routes. CAB Chairman Kahn (and the CAB) saw Laker as a v e h i c l e f o r the implementation of i t s new pro-competitive p o l i c i e s , and Laker was thus permitted to begin service i n September 1977. The fares o f f e r e d by Laker were comparable to charter fares and about f i f t y percent below the discount fares o f f e r e d by IATA c a r r i e r s (Adkins, et. a l . , 1982, p.10). The IATA c a r r i e r s responded by i n s t i t u t i n g new low fares of t h e i r own to compete with Laker. Laker provided low-priced service on the North A t l a n t i c from 1977 to 1982, when the a i r l i n e f o l d e d . 5 1 The low fares ushered onto the North A t l a n t i c by Laker, however, remained. i i ) The Liberalization of Charter Regulations A second pro-competitive p o l i c y of the United States was the. further l i b e r a l i z a t i o n of U.S. charter, regulations. As o u t l i n e d above, rules had been relaxed i n the e a r l y 1970s with the introduction of advance booking 5 0 I t was thought that the reason for the U.K. deciding to r e l e n t to double d e s i g n a t i o n on two r o u t e s i n the Bermuda 2 agreement was to accommodate Laker Airways. See Banks (1982, p.54). 5 1 See Banks (1982) for a discussion of the reasons behind Laker's coll a p s e . 151 c h a r t e r s . In 1978, the U n i t e d S t a t e s went one step further with the i n s t i t u t i o n of p u b l i c charters. The p u b l i c charters required no minimum group s i z e , no advance purchase requirement, no requirement f o r the purchase of ground services, no length of stay r u l e s , no minimum p r i c e , and no round t r i p requirement (Lowenfeld and Mendelsohn, 1979, p.484). The public charters were, f o r a l l intents and purposes, scheduled services operated by non-scheduled c a r r i e r s . Hi) Liberal Bilaterals52 U n t i l the advent of the " l i b e r a l " b i l a t e r a l , v i r t u a l l y a l l agreements contained one clause regulating capacity and a second clause allowing e i t h e r of the governments to r e j e c t fare l e v e l s . The l i b e r a l b i l a t e r a l s , on the other hand, t y p i c a l l y allowed the a i r l i n e s to f r e e l y determine capacities without governmental interference, and r e s t r i c t e d governmental disapproval authority over fare l e v e l s . In some of the l i b e r a l b i l a t e r a l s , both of the governments had to r e j e c t fare l e v e l s before they were disapproved. 5 3 In o t h e r b i l a t e r a l s , only the country from which a f l i g h t o r i g i n a t e d could r e j e c t t h a t f a r e . Other features which were incorporated into l i b e r a l b i l a t e r a l s included (Rosenfield, 1982, pp.478-479): Mu l t i p l e designation of a i r l i n e s . Each country could designate any number of c a r r i e r s to serve routes between the two states; Reduction i n route r e s t r i c t i o n s . More routes between more c i t i e s i n the two countries were allowed. As well, r e s t r i c t i o n s were 5 2 This sub-section i s adapted from Dresner and Tretheway (1987a). 5 3 This method i s known as "double disapproval" or "mutual disapproval" and i s the type of clause contained i n the U.S. model l i b e r a l b i l a t e r a l agreement. See Bogosian (1981, pp.1030-1032). 152 eased on incorporating t h i r d countries into the routes between or beyond the signatories to the l i b e r a l b i l a t e r a l ; The i n c l u s i o n o f c h a r t e r f l i g h t s . The t r a d i t i o n a l b i l a t e r a l s governed only scheduled services. The l i b e r a l b i l a t e r a l s also contained a section regulating charter f l i g h t s . The clause stated that charters were allowed as long as they conformed with the laws o f the country i n which the f l i g h t s o r i ginated. This clause a l l o w e d the United States' c a r r i e r s to conduct p u b l i c charters without having to seek the permission of the d e s t i n a t i o n country; and, A f a i r and competitive p r a c t i c e s clause. This stated that each designated a i r l i n e must be allowed a f a i r and equal opportunity to compete on a i r routes regulated by the b i l a t e r a l . Between 1978 and 1982, the U.S. signed 23 l i b e r a l or p a r t i a l l y l i b e r a l b i l a t e r a l s (Haanappel, 1984, Appendix 3). Although the l i b e r a l b i l a t e r a l s d i d not s p e c i f i c a l l y rule out the authority of IATA to set p r i c e s , they d i d c r e a t e a c o m p e t i t i v e environment making i t more d i f f i c u l t to coordinate fares. The l i b e r a l agreements allowed s u f f i c i e n t numbers, of new scheduled and non-scheduled c a r r i e r s onto major routes (such as the North A t l a n t i c ) to e f f e c t i v e l y undermine the IATA f a r e - s e t t i n g procedures. 5 4 The l i b e r a l agreements also encouraged the U.K. to l i b e r a l i z e the Bermuda 2 b i l a t e r a l , f o r fear of l o s i n g North A t l a n t i c business to other European gateways (Gomez -Ibanez and Morgan, 1984, pp.119-120). 5 4 I t i s shown i n the next chapter of t h i s paper that the l i b e r a l b i l a t e r a l s contributed to s i g n i f i c a n t l y lower prices on long-distance routes. 153 iv) Show-Cause Order Against IATA A f o u r t h method the U.S. used to implement i t s p r o - c o m p e t i t i v e i n t e r n a t i o n a l a i r transport p o l i c y was to i n s t i t u t e show-cause proceedings against IATA. These proceedings, i n i t i a t e d by the CAB i n June 1978, required IATA and other i n t e r e s t e d p a r t i e s to "show cause" why IATA t a r i f f conferences should continue to be exempted from U.S. a n t i - t r u s t laws (United States, C i v i l Aeronautics Board, 1978). The U.S. show-cause proceedings attracted considerable opposition from other c o u n t r i e s . 5 5 Despite t h i s opposition, the CAB, i n 1980, issued i t s tentative findings that IATA proceedings were i n v i o l a t i o n of a n t i - t r u s t laws, and these findings were made f i n a l i n 1981. However, due to intense p o l i t i c a l pressure, the show-cause order against IATA was f i r s t stayed, and ul t i m a t e l y dropped. 5 6 A major consequence of the show-cause proceedings was that i n 1979 IATA was r e s t r u c t u r e d . The reorganization made i t possible f o r a i r l i n e s to p a r t i c i p a t e i n IATA trade a s s o c i a t i o n a c t i v i t i e s without p a r t i c i p a t i n g i n IATA t a r i f f coordination procedures. (Previously, p a r t i c i p a t i o n i n t a r i f f coordination a c t i v i t i e s had been compulsory f o r a l l active members.) The trade a s s o c i a t i o n option has proved to be a popular choice f o r i n t e r n a t i o n a l c a r r i e r s (see Figure 2.14). 5 5 See, f o r example, ICAO (1980g), pp.34-35. 5 6 Haanappel (1984, p.162) reported that the CAB received l e t t e r s from the European C i v i l A v i a t i o n Conference, the L a t i n American C i v i l A v i a t i o n Commission, the U.S. State Department, and President Reagan supporting a stay of execution of the order. 154 Pro-Competitive Legislation The f i n a l method the U.S. used to promote competition i n i n t e r n a t i o n a l a i r t r a n s p o r t a t i o n was by passing new pro-competitive l e g i s l a t i o n . The International Air Transportation Competition Act of 1979 (United States, 1980) c a l l e d f o r the United States to develop a negotiating p o l i c y which emphasized "the g r e a t e s t degree of competition compatible with a well-f u n c t i o n i n g i n t e r n a t i o n a l a i r t r a n s p o r t a t i o n system." Among the goals o u t l i n e d f or U.S. i n t e r n a t i o n a l a i r p o l i c y were the following: the strengthening of the competitive p o s i t i o n of United States a i r c a r r i e r s to at l e a s t assure equality with f o r e i g n a i r c a r r i e r s . . . ; freedom of a i r c a r r i e r s and for e i g n a i r c a r r i e r s to o f f e r fares and rates which correspond with consumer demand; the fewest possible r e s t r i c t i o n s on charter a i r transportation; the maximum degree of m u l t i p l e and p e r m i s s i v e i n t e r n a t i o n a l authority f o r United States a i r c a r r i e r s so that they w i l l be able to respond quickly to s h i f t s i n market demand; the e l i m i n a t i o n of operational and marketing r e s t r i c t i o n s to the greatest extent possible; an increase i n the number of nonstop United States gateway c i t i e s ; opportunities f o r c a r r i e r s of for e i g n countries to increase t h e i r access to United States points i f exchanged f o r benefits of s i m i l a r magnitude for United States c a r r i e r s or the t r a v e l l i n g p u b l i c . . . vi) The U.S. Pro-Competitive Policy - Summary The United States used f i v e methods to. implement i t s pro-competitive p o l i c y - i t allowed Laker Airways (as well as other low-priced c a r r i e r s ) to 155 operate on U.S. i n t e r n a t i o n a l routes; charter regulations were l i b e r a l i z e d ; l i b e r a l b i l a t e r a l s were signed; a show-cause order was brought against IATA; and, new pro-competitive l e g i s l a t i o n was enacted. Major r e s u l t s of the pro-competitive i n i t i a t i v e included: lower p r i c e s and increased competition on U.S. i n t e r n a t i o n a l routes; the r e s t r u c t u r i n g of IATA to permit c a r r i e r s to p a r t i c i p a t e i n trade a s s o c i a t i o n a c t i v i t i e s without having to take part i n t a r i f f coordination; and, the l i b e r a l i z a t i o n of the Bermuda 2 b i l a t e r a l . There has been l i t t l e research conducted to determine the e f f e c t of the pro-competitive p o l i c y on the f i n a n c i a l health of a i r c a r r i e r s . Figure 2.18 showed that there were large f l u c t u a t i o n s i n operating p r o f i t s i n the years following the implementation of the p o l i c y . This could imply that the pro-competitive p o l i c y increased the operating r i s k of the industry. c) Further Developments Two a d d i t i o n a l developments during the period under study (1966-1981) were noteworthy. These were the attempt, by ICAO, to re-enter the economic r e g u l a t o r y f i e l d and the emergence of regional regulatory organizations, e s p e c i a l l y i n the T h i r d World. Each of these developments are b r i e f l y discussed, below: i) ICAO and Economic Regulation As was o u t l i n e d above, during the 1970s there was a movement f i r s t to l i b e r a l i z e charter regulations and then to make i n t e r n a t i o n a l a i r transport,, as a whole, more competitive. The impetus for t h i s l i b e r a l i z a t i o n movement came, f o r the most part, from the developed world, and e s p e c i a l l y from the 156 United States. There was, however, a large bloc of countries opposed to l i b e r a l i z i n g i n t e r n a t i o n a l a i r transport regulations. Among the countries i n t e r e s t e d i n a return to a more t i g h t l y - r e g u l a t e d regime were many from the developing w o r l d . 5 7 These countries were d i s s a t i s f i e d with the r o l e s t h e i r a i r l i n e s played i n IATA, b e l i e v i n g that organization to be dominated by large c a r r i e r s of the developed w o r l d . 5 8 Consequently, the developing countries l o o k e d to ICAO as a v e h i c l e f o r a c h i e v i n g t h e i r economic regulatory o b j e c t i v e s . 5 9 Haanappel (1984, p.167) c i t e d the f o l l o w i n g examples of ICAO's involvement i n economic issues during the l a t t e r part of the 1970s and early 1980s: the development of a standard b i l a t e r a l t a r i f f clause; attempts to d e f i n e s c h e d u l e d and non-scheduled services; the convening of ICAO a i r transport conferences; and, the establishment by ICAO of "panels of experts" to examine the regulation of a i r transport and the machinery f o r e s t a b l i s h i n g 5 7 The f e e l i n g among some developing countries was that t h e i r c a r r i e r s could only receive a f a i r share of the market i f the i n t e r n a t i o n a l system was t i g h t l y regulated. (Major exceptions to t h i s l i n e of thinking included a number of Southeast Asian countries, such as Singapore and Hong Kong.) For example, at ICAO's Th i r d A i r Transport Conference, India, Tanzania, Mexico, Lebanon, and Pakistan put forward the following recommendation (ICAO, 1985f): W i t h the o b j e c t i v e to promoting a j u s t and e q u i t a b l e i n t e r n a t i o n a l c i v i l a v i a t i o n order, and with a view to achieving greater cooperation between the nations of the world i n order to discourage u n i l a t e r a l measures and reduce u n f a i r competition and growth of unhealthy practices the Conference recommends that the C o n t r a c t i n g S t a t e s r e c o g n i z e the p r i n c i p l e that a i r services between them should r e s u l t i n an equitable and f a i r sharing of b e n e f i t s by the concerned States and t h e i r c a r r i e r s f o r t h e i r mutual advantage. 5 8 See, for example, Feldman (1983, p.52). 5 9 See Ellingsworth (1977, p.32). 157 t a r i f f s . However, as Haanappel (1984, p.24) stated, although ICAO adopted numerous recommendations on economic r e g u l a t o r y matters, "very l i t t l e concrete ac t i o n " has r e s u l t e d . 6 0 I t must be noted that countries are under no o b l i g a t i o n to obey the ICAO recommendations. i i ) The Growth of Regionalism. A number of regional a i r transport organizations have been formed, both at the governmental and a i r l i n e l e v e l s . 6 1 Amer A. S h a r i f (1983, p.109) of the Arab A i r C a r r i e r s Organization, provided four reasons as j u s t i f i c a t i o n f o r regionalism. F i r s t , he stated that regional a i r l i n e organizations e x i s t b e c a u s e , " t h e y g i v e t h e i r members an i d e n t i t y . . . I n the r e g i o n a l o r g a n i z a t i o n s . . . the members f e e l they can have a more e f f e c t i v e impact." Second, he claimed that, "A world meeting i s too heterogeneous and d i f f i c u l t to d i r e c t . . . [whereas the] s m a l l e r r e g i o n a l groups tend to be more homogeneous." The t h i r d reason c i t e d was that many regional problems are not of i n t e r n a t i o n a l i n t e r e s t , so that, "[t]he i n t e r n a t i o n a l meeting would riot devote enough time for such matters while the regional body would go into d e t a i l " . S h a r i f ' s fourth reason was, "that the regional body i s an excellent 6 0 An i n d i c a t i o n of ICAO's poor r e s u l t s i n the economic f i e l d has been t h a t i s s u e s are debated y e a r : a f t e r year at ICAO meetings but are not resolved.; An example of such an issue i s the p r a c t i c e of the " i l l e g a l " discounting of IATA t a r i f f s . Recommendations against t h i s p r a c t i c e were made at the three ICAO a i r transport conferences i n 1977, 1980, and 1985. See ICAO (1977f, p.6; 1980g, p.58; 1985g, p.64). 6 1 At the governmental l e v e l , these organizations include the Arab C i v i l A v i a t i o n Council, the A f r i c a n C i v i l A v i a t i o n Commission and the European C i v i l A v i a t i o n Conference.- At the a i r l i n e l e v e l , r e g ional organizations i n c l u d e the A s s o c i a t i o n of A f r i c a n A i r l i n e s , the Arab A i r C a r r i e r s Organization, the A s s o c i a t i o n des Transporteurs Aeriens de l a Zone Franc, the A s s o c i a t i o n of European A i r l i n e s , the International A s s o c i a t i o n of L a t i n American A i r Transport and the Orient A i r l i n e s Association. 158 forum at which to d i s c u s s i n t e r n a t i o n a l problems before going to the i n t e r n a t i o n a l meetings". The countries of the regional organization may then present a u n i f i e d p o s i t i o n at the i n t e r n a t i o n a l forum. In the 1970s, some of the regional organizations i n the developing world became i n v o l v e d i n t a r i f f c o o r d i n a t i o n . The involvement of these organizations i n t a r i f f and other economic matters has been a t t r i b u t e d to the d i s s a t i s f a c t i o n of developing countries and t h e i r c a r r i e r s with IATA p o l i c i e s (Feldman, 1983, p.52; Gidwitz, 1980, p.86). 6 2 T h i r d World countries, and t h e i r c a r r i e r s , have sought to insulate themselves from IATA p o l i c i e s and regulate economic matters on a regional b a s i s . d) Developments Leading to the 1981 Liberal Regime - A Summary The period leading to the 1981 l i b e r a l regime can be divided into two p a r t s . From 1966 to 1977 there was a trend towards more r e s t r i c t i v e regulations governing scheduled transport but more l i b e r a l charter r u l e s . A f t e r 1977, i n a movement l e d by the United States, there was a dramatic l i b e r a l i z a t i o n o f b o t h s c h e d u l e d and c h a r t e r a i r t r a n s p o r t . The l i b e r a l i z a t i o n p o l i c y was opposed by a number of countries, e s p e c i a l l y those of the developing world, which preferred more r e s t r i c t i v e p o l i c i e s . In an e f f o r t to counter the l i b e r a l i z a t i o n trend and to insu l a t e themselves from t h i s trend, the developing countries sought to involve ICAO and regional organizations i n the economic regulation of a i r transport. 6 2 G r i f f i t h s (1978, p.30) found, f o r example, that the c a r r i e r s of developing countries were d i s s a t i s f i e d with the IATA r e s t r u c t u r i n g of 1978. These c a r r i e r s would have preferred the requirement that a l l active c a r r i e r s p a r t i c i p a t e i n t a r i f f coordination to have remained. 159 In the next section of t h i s chapter, the hegemonic theory and other factors w i l l be used to analyze the reasons behind these developments. Most importantly, hegemonic theory, i f i t i s to be supported, must show why the a i r t r a n s p o r t regime changed i n much of the world to a l i b e r a l regime, i n v o l v i n g the replacement of IATA t a r i f f coordination with market-based p r i c i n g . 2. Analysis of the Formation of the Liberal Regime Using the Modified Hegemonic Stability Theory There were a number of changes i n the way i n t e r n a t i o n a l a i r transport was r e g u l a t e d d u r i n g the p e r i o d 1946 to 1977. C h a r t e r r u l e s were l i b e r a l i z e d , the IATA conference mechanism was streamlined, and there was an increased use of r e s t r i c t i v e b i l a t e r a l agreements. These changes, however, d i d not substantially change the way i n t e r n a t i o n a l a i r transport was r e g u l a t e d : r o u t e s and c a p a c i t i e s were s t i l l negotiated b i l a t e r a l l y , by governments, and most fares were s t i l l coordinated m u l t i l a t e r a l l y , through IATA. The i n t e r n a t i o n a l a i r transport regulatory regime remained b a s i c a l l y i n t a c t . The f i r s t major post-war change i n regulatory regimes occurred with the i n s t i t u t i o n o f the l i b e r a l regime. IATA t a r i f f c o o r d i n a t i o n became i r r e l e v a n t on major a i r routes, as i t was replaced by competitive p r i c i n g . The conclusion that there was, i n f a c t , a regime change i n the l a t e 1970s contradicts the findings of Busza (1987) and Jonsson (1987), described 160 i n the previous chapter. Both Busza and Jonsson contended that because only a very few l i b e r a l b i l a t e r a l s were signed ( r e l a t i v e to the t o t a l number of b i l a t e r a l agreements) and because other•countries d i d not follow the lead of the U.S. and adopt a pro-competitive p o l i c y , then there was no regime change. Results are presented i n Appendix C which support the contention that there was a regime change i n that m u l t i l a t e r a l t a r i f f coordination was l a r g e l y abandoned on major routes, i n favour of u n i l a t e r a l p r i c e s e t t i n g . Can the modified theory of hegemonic s t a b i l i t y explain t h i s regime change? The modified theory of hegemonic s t a b i l i t y states that a regime w i l l be maintained i f there e x i s t s a dominant country w i l l i n g to support the regime and capable o f m a i n t a i n i n g the c o s t s of the regime, and as well, i f s u f f i c i e n t incentives or coercive measures e x i s t to e n l i s t smaller countries into the regime. Therefore, i n order f or a regime to change ( i . e . , to not be maintained) at l e a s t one of the following must occur: The hegemon must l o s e i t s dominance or the c a p a b i l i t i e s of maintaining the regime; The hegemon must no longer receive s u f f i c i e n t net be n e f i t s to j u s t i f y the maintenance of the regime; or, The incentives and/or coercive measures used to e n l i s t the smaller countries into the regime must be diminished to make p a r t i c i p a t i o n i n the regime no longer worthwhile. Each of the possible explanations f or the change i n regimes i s examined below: 161 a) Did the United States Lose its Dominant Position in the Airline Industry or the Capabilities of Maintaining the Air Transport Regime? The extent to which, the dominance of a hegemon must decline before i t i s incapable of supporting a regime i s not c l e a r i n the hegemonic s t a b i l i t y l i t e r a t u r e . 6 3 What, i s c l e a r i s that U.S. leadership i n the world i n general and i n the a i r l i n e industry i n p a r t i c u l a r declined during the period 1965-1981. What i s also c l e a r , i s that despite t h i s decline the U.S. maintained, by f a r , the l a r g e s t p o s i t i o n i n both the world economy and the a i r l i n e i n dustry. 6 4 Was the decline i n the p o s i t i o n of the United States responsible f o r the change i n regimes? Although the United States declined i n importance during the 1960s and 1970s, i t s t i l l possessed the l a r g e s t a i r market i n the world. Countries continued to desire routes into the United States. By awarding l u c r a t i v e routes to the a i r l i n e s of other countries (e.g., with Bermuda 2), the U.S. s t i l l could buy the acquiescence of smaller countries,, i n support of Bermuda-like b i l a t e r a l s . The f a c t that the regime was not maintained would not appear to be due to a decline i n the p o s i t i o n of the U.S. 6 3 See, f o r example, Russett's (1985) c r i t i q u e of the theory. 6 4 F i g u r e 2.8 showed that U.S. c a r r i e r s maintained j u s t under f o r t y percent of the world a i r transport market i n 1977, the year the U.S. pro-competitive p o l i c y was launched. Figures 2.9 and 2.10 showed the s i z e of the U.S. a i r transport industry i n r e l a t i o n to the a i r transport industry of o t h e r major a v i a t i o n c o u n t r i e s . Depending on the data used, the U.S. industry was about twice as large as the industry of the next l a r g e s t country. 162 b) Were There S t i l l Sufficient Benefits to the United States from Maintaining the Post-Bermuda Regime? I t was apparent t h a t U.S. c a r r i e r s were not r e c e i v i n g substantial b e n e f i t s on a number of routes (e.g., U.S.-Netherlands, U.S.-Scandinavia). These markets were dominated by the c a r r i e r s of the f o r e i g n countries. I t was also apparent that, on routes where U.S. c a r r i e r s were doing well (e.g., U.S.-U.K.), a d d i t i o n a l benefits had to be conceded to the f o r e i g n country (e.g., Bermuda 2 vs. Bermuda 1) i n order to maintain the regulatory regime. But were there s t i l l s u f f i c i e n t benefits accruing to the United States to support the post-Bermuda regime, i f i t so chose? The answer i s equivocal. From the t r a d i t i o n a l a i r transport perspective of measuring t o t a l benefits by only looking at b e n e f i t s to c a r r i e r s , the answer i s yes, there were s t i l l s u f f i c i e n t b e n e f i t s . There d i d not appear to be a decrease i n b e n e f i t s to U.S. c a r r i e r s , between the e a r l y and l a t e 1970s, s i g n i f i c a n t enough to j u s t i f y the sudden r e j e c t i o n of the post-Bermuda regime. 6 5 The reason for the r e j e c t i o n of the post-Bermuda regime may more l i k e l y be a t t r i b u t e d to a change i n the way b e n e f i t s were viewed. With the pro-competitive p o l i c y , the primary objective became achieving benefits for consumers rather than for a i r l i n e s . Seen i n t h i s l i g h t , the post-Bermuda regime suddenly f e l l short of achieving s u f f i c i e n t b e n e f i t s f o r the United States, thus p r e c i p i t a t i n g the regime change. 6 5 Adkins, et al (1982, p. 18) showed that nearly a l l c a r r i e r s - U.S. domestic, U.S. i n t e r n a t i o n a l , and f o r e i g n - earned rates of return, i n the 1970s, below the average for U.S. non-financial corporations. Rates of return, however, generally tracked the business cycle and the period 1975-1977 was one of strong p r o f i t growth for Pan American and TWA on the North A t l a n t i c . 163 c) Were There S t i l l Sufficient Incentives for the Smaller Countries to Participate in the Post-Bermuda Regime? There were a number of countries d i s s a t i s f i e d with t h e i r share of the b e n e f i t s from the post-Bermuda regime. Prominent among these countries were many from the T h i r d World. The developing countries attempted to work through ICAO to achieve a larger share of the b e n e f i t s from i n t e r n a t i o n a l a i r transport. As well, the developing countries sought to capture a d d i t i o n a l b e n e f i t s by conducting t a r i f f coordination on a regional b a s i s . Although regionalism may have weakened IATA's p o s i t i o n as the t a r i f f coordinator, i t d i d not p r e c i p i t a t e the adoption of the l i b e r a l regime. The developing countries were interested i n achieving a d d i t i o n a l b e n e f i t s through pr o t e c t i v e , not l i b e r a l , - p o l i c i e s . Neither regionalism, nor the economic involvement o f ICAO, contributed to the l i b e r a l i z a t i o n of a i r transport regulations. The e f f e c t of these " c o u n t e r - l i b e r a l " measures on the change i n regimes appears to be minimal. 3. Results From the Analysis Using the Modified Hegemonic Stability Theory The modified hegemonic s t a b i l i t y theory (used f o r t h i s thesis) predicted that a regime w i l l be maintained i f there continued to e x i s t the following: a hegemon both w i l l i n g to maintain the regime and capable of supporting the regime; and, s u f f i c i e n t benefits accruing to smaller countries to remain i n the regime. From the analysis above, i t would appear that the major reason for the regime change was that the United States modified i t s views on what i t considered to be "benefits" from benefits to a i r l i n e s to benefits to 164 consumers. As a r e s u l t , the U.S. f e l t there were no longer s u f f i c i e n t b e n e f i t s a r i s i n g from the post-Bermuda regime and that i t could no longer be supported. The f a c t that there were developing countries d i s s a t i s f i e d with t h e i r share of b e n e f i t s from the post-Bermuda regime d i d not contribute to the regime change. The developing countries were not powerful enough to p r e c i p i t a t e a change i n regimes. Figure 4.3 i l l u s t r a t e s the l i b e r a l regime i n the context of the modified hegemonic s t a b i l i t y theory. I t must be noted that the ( p a r t i a l ) regime, as shown i n the f i g u r e , existed only i n those areas of the world af f e c t e d by U.S. pro-competitive p o l i c i e s ( i . e . , c h i e f l y the North A t l a n t i c and North P a c i f i c ) . 6 6 The U n i t e d States o f f e r e d the c a r r i e r s of other countries, increased route opportunities i n exchange for a competitive regime. The major cost to the United States i n supporting t h i s regime was the loss of monopoly routes (and perhaps, monopoly p r o f i t s ) a v a i l a b l e to U.S. c a r r i e r s . 4. Other Factors in the Adoption of the 1981 Liberal Regime a) Domestic Affairs I t was evident from the discussion e a r l i e r i n t h i s s e c t i o n that U.S. i n t e r n a t i o n a l a i r p o l i c y changed from p r o - a i r l i n e to pro-consumer i n 1977. The p u r s u i t of consumer ben e f i t s , rather than a i r l i n e b e n e f i t s , helped to p r e c i p i t a t e the change i n regimes--especially the demise of IATA t a r i f f coordination on major i n t e r n a t i o n a l routes. The key question that must be addressed i s "Why d i d t h i s happen?" 6 6 In o t h e r p a r t s of the world, the post-Bermuda regime remained, although under attack by p r i c e discounters. 165 F i g u r e 4 . 3 The L i b e r a l R e g i a e i n t h e C o n t e x t o f t h e M o d i f i e d H e g e a o n i c S t a b i l i t y T h e o r y COSTS D e c r e a s e d m o n o p o l y / d u o p o l y o p p o r t u n i t i e s f o r U.S. c a r r i e r s cn U n i t e d S t a t e s — (T h e Hegemon) «J-I n c e n t i v e s and C o e r c i v e M e a s u r e s BENEFITS I n c r e a s e d o p p o r t u n i t i es f o r c a r r i e r s Lower p r i c e s and g r e a t e r p r o d u c t c h o i c e f o r t r a v e l l e r s and s h i p p e r s and g r e a t e r r o u t e f l e x i b i l i t y f o r c a r r i e r s T h r e a t of t r a f f i c d i v e r s i o n L i b e r a l Regime - Compet i t i ve p r i c e - s e t t i ng - B i l a t e r a l r e g u l a t i o n o f r o u t e s - L i b e r a l b i l a t e r a l s a l l o w i n g i n d i v i d u a l c a r r i e r s t o d e t e r m i n e c a p a c i t y l e v e l s O t h e r c o u n t r i e s The development o f the pro-competitive i n t e r n a t i o n a l a i r transport p o l i c y can be viewed as an adjunct to U.S. domestic d e r e g u l a t i o n . 6 7 Behrman (1980) d e s c r i b e d the p o l i t i c a l processes behind the i n s t i t u t i o n of U.S. deregulation. Before the mid-1970s, the case f o r deregulation was taken s e r i o u s l y by v i r t u a l l y no-one other than academic economists (p.91). The CAB p r o m o t e d a n t i - c o m p e t i t i v e p o l i c i e s , p r o t e c t i v e of the i n t e r e s t s of established c a r r i e r s (pp.96-98), and there was no widespread opposition to these p o l i c i e s . In 1974, however, t h i s began to change. Senator Edward Kennedy (a p o s s i b l e Democratic P a r t y p r e s i d e n t i a l c a n d i d a t e ) was s e a r c h i n g f o r a p o p u l a r t o p i c on which to hold public hearings. A i r l i n e deregulation was chosen for the hearings because i t was thought to appeal to a broad audience: consumers, because of the p o t e n t i a l f o r lower p r i c e s ; l i b e r a l s , because of the perceived business-government c o m p l i c i t y between the a i r l i n e s and i t s regulators; and conservatives, because o f the p o t e n t i a l f o r reducing "big government" (Behrman, 1980, p . 1 0 0 ) . The Kennedy h e a r i n g s i n t o the a i r l i n e i n d u s t r y a t t r a c t e d c o n s i d e r a b l e press coverage and provided a forum f o r the a i r i n g of pro-deregulation views (p. 101). The hearings also provided the impetus for the Ford Administration to press for regulatory reform s i g n i f i c a n t l y sooner and more vigorously than would otherwise have been the case (p.102). Among h i s i n i t i a t i v e s , President Ford appointed John Robsoh as the f i r s t reform-minded chairman of the CAB i n 1975. 6 7 The domestic and i n t e r n a t i o n a l p o l i c i e s were i n i t i a t e d simultaneously i n the l a t t e r h a l f of the 1970s. 167 In the 1976 p r e s i d e n t i a l campaign, James Carter campaigned on a platform of l e s s government involvement i n the marketplace. According to Harbison (1982, p.23): I t was not s u r p r i s i n g therefore that on taking o f f i c e i n January 1977 he followed the advice of h i s White House a v i a t i o n a d v i s o r s to support strongly the domestic a v i a t i o n deregulation moves already underway. J u s t i f y i n g t h i s approach, inter alia, was the thesis that 'support (for a v i a t i o n deregulation l e g i s l a t i o n ) may produce a quick h i t , to f u l f i l l campaign commitments, to cut outdated and unnecessary programs, b e n e f i t consumers, challenge s p e c i a l i n t e r e s t influence over the bureaucracy'. 6 8 In 1977 C a r t e r appointed the pro-deregulation economist, Dr. A l f r e d Kahn, to head the CAB. Kahn quickly f i l l e d key CAB s t a f f p o s i t i o n s with people who shared h i s views (Behrman, 1980, p.112). The CAB s t a f f became committed to the course of deregulation. The Congress and the public, however, s t i l l had to be convinced of the merits of deregulation, and Kahn took i t upon himself to become the c h i e f spokesman f o r the cause , (Behrman, 1980, p.114). Kahn was so successful i n h i s e f f o r t s that, by 1978, even a few U.S. a i r l i n e s began to support a i r l i n e deregulation (Behrman, 1980, pp.119-120). 6 9 In 1978, the Airline Deregulation Act (United States, 1978) was passed and the U.S. s i g n e d i t s f i r s t l i b e r a l b i l a t e r a l (with the 6 8 The quote (within the quotation) was from a memo to Carter from members of h i s T r a n s i t i o n Advisory Team. 6 9 I t s h o u l d be n o t e d t h a t the o p p o s i t i o n t o i n t e r n a t i o n a l l i b e r a l i z a t i o n from the U.S. a i r l i n e s was not as u n i f i e d as the opposition to d o m e s t i c d e r e g u l a t i o n , s i n c e t h e r e were fewer c a r r i e r s o p e r a t i n g i n t e r n a t i o n a l routes. Many c a r r i e r s which were not i n t e r n a t i o n a l operators, i n f a c t , l i k e l y favoured some i n t e r n a t i o n a l regulatory reform as a means of obtaining designations on i n t e r n a t i o n a l routes. See Hight (1981, p.19). 168 Netherlands). U.S. p o l i c y had changed completely i n the course of a few years from p r o t e c t i o n i s t to pro-competitive. In c o n c l u s i o n , the impetus f o r r e g u l a t o r y reform came when new information was provided by economists to p o l i t i c i a n s such as President Ford, Senator Kennedy, and President Carter. These p o l i t i c i a n s saw the p o l i t i c a l advantages t h a t c o u l d a r i s e from r e g u l a t o r y reform. The p o l i t i c i a n s ( e s p e c i a l l y Carter) used regulatory reform as a campaign issue, i n order to a t t r a c t votes from c i t i z e n s i n t e r e s t e d i n l e s s government ( i . e . , lower taxes) and lower p r i c e s . The a i r l i n e d e r e g u l a t i o n p o l i c y was implemented by a p p o i n t i n g key people, such as Kahn, who were committed to a i r l i n e deregulation. Kahn was able to promote the p o l i c y s u c c e s s f u l l y enough to receive the support i n Congress necessary to pass deregulation l e g i s l a t i o n . b) Structural Factors Four factors were i d e n t i f i e d that could have an impact on m u l t i l a t e r a l p r i c e - s e t t i n g i n the i n t e r n a t i o n a l a i r l i n e industry. These were: changes i n the number of a i r c a r r i e r s ; the introduction of new cost-saving technology; a downturn i n the economic cycle; and a change i n the height of entry b a r r i e r s to the industry. Each of these factors are examined, i n turn, below: i) Changes in Number of Air Carriers I t was argued i n the t h e o r e t i c a l section of t h i s chapter that an i n c r e a s e i n the number of f i r m s would, ceterus paribus, make i t more d i f f i c u l t f o r the coordination of p r i c e s . I t was argued, as well that the p r i c e c o o r d i n a t o r ' s d i f f i c u l t i e s would be compounded i f the new firms 169 possessed d i f f e r e n t cost structures from e x i s t i n g c a r r i e r s or i f the new c a r r i e r s d i d not j o i n the c a r t e l . IATA did, i n f a c t , experience problems coordinating fares i n the 1970s 7 0 and the problem can, i n part, be a t t r i b u t e d to increases i n the number of c a r r i e r s , with divergent views on fares to be charged. During the 1970s there was f i r s t , an increase i n charter c a r r i e r s ; second, an increase i n c a r r i e r s from developing countries; and t h i r d , the i n s t i t u t i o n of service by the c o s t - c u t t i n g c a r r i e r Laker Airways. IATA responded to the low p r i c e d charter competition i n two ways: 7 1 by t r y i n g , unsuccessfully, to e n l i s t the c h a r t e r c a r r i e r s i n t o the c a r t e l (Haanappel, 1978, pp. 150-151); and by a t t e m p t i n g to compete w i t h the charters by o f f e r i n g a l a r g e r array of discount fares (see Figure 2.17). However, with a larger array of fares to consider, t a r i f f coordination became more d i f f i c u l t . C a r r i e r s of developing countries caused problems f o r IATA because they were generally against measures to l i b e r a l i z e t a r i f f coordination procedures. As high-cost operators, these c a r r i e r s were opposed to measures which would 7 0 See, f o r example, the discussion i n ICAO (1977g, pp.42-47) on the problems that IATA encountered f i x i n g rates i n 1976.. 7 1 Charter c a r r i e r s have been able to o f f e r lower than regular scheduled fares f o r the following reasons (Gidwitz, 1980, p . l ) : Overhead c o s t s are low since tour operators handle commercial procedures such as promotion and r e s e r v a t i o n s , and t r a f f i c management f u n c t i o n s , s u c h as passenger s e r v i c e , a i r p o r t organization, and ground transport; Charter c a r r i e r s generally operate at an average capacity of close to one hundred percent, since they do not maintain a schedule during off-peak periods. 170 l i k e l y r e s u l t i n the lowering of IATA p r i c e s . The dissension between the c a r r i e r s of developing and developed countries, within IATA, contributed to the advent of regional t a r i f f coordination and to the attempt to have ICAO enter the economic regulatory f i e l d . 7 2 F i n a l l y , Laker caused problems f o r IATA because i t , l i k e the charters, o f f e r e d f a r e s below IATA l e v e l s . 7 3 Laker forced the IATA c a r r i e r s to i n t r o d u c e a new a r r a y of p r o m o t i o n a l f a r e s , thereby making t a r i f f coordination even more d i f f i c u l t . In summary, the increase i n c a r r i e r s during the 1970s caused problems fo r IATA i n coordinating fares. Problems were exacerbated because the new c a r r i e r s often d i d not adhere to IATA fares ( i . e . , the charters and Laker) or had d i f f e r e n t c o s t s t r u c t u r e s from many e x i s t i n g IATA c a r r i e r s ( i . e . , c a r r i e r s of developing countries). i i ) Introduction of New Technology The i n t r o d u c t i o n of new technology can cause problems i n coordinating p r i c e s because companies that use the new technology w i l l have d i f f e r e n t cost structures from companies that do not, and w i l l , therefore, want to charge 7 2 Voting procedures at ICAO made that organization more amenable than IATA to the wishes of the developing countries. ICAO operated by means of majority voting, unlike IATA, where resolutions had to be passed unanimously. Therefore, at ICAO, the developing countries could use t h e i r majority to pass resolutions favourable to t h e i r i n t e r e s t s . 7 3 In a d d i t i o n to Laker, there were other . non-IATA c a r r i e r s that, discounted IATA p r i c e s , such as the Southeast Asian c a r r i e r s : Thai Airways International, Malaysian A i r l i n e System, Cathay P a c i f i c Airways (Hong Kong) and Singapore A i r l i n e s . 171 d i f f e r e n t p r i c e s . As well, i f the c a r t e l does not lower p r i c e s to respond to the lower i n d u s t r y c o s t s , then t h i s can l e a d to problems of i l l e g a l discounting, as companies lower p r i c e s on t h e i r own. The major technological breakthrough during the period 1965-1981 was the int r o d u c t i o n of wide-bodied j e t s i n 1969. The wide-bodied j e t s lowered the costs of transporting passengers over high density r o u t e s . 7 4 The wide-bodied j e t s a l s o i n c r e a s e d the c a p a c i t y a v a i l a b l e f o r i n t e r n a t i o n a l routes, c o n t r i b u t i n g to low load factors i n the e a r l y 1970s. 7 5 Although i t i s d i f f i c u l t to separate the e f f e c t of wide-bodied j e t s from other e f f e c t s (e.g., economic recession, an increase i n the number of c a r r i e r s , e t c . ) , the wide-bodied j e t s undoubtedly contributed to IATA t a r i f f coordination problems i n the 1970s. Hi) Economic Downturns The a i r l i n e business i s c y c l i c a l with a i r l i n e performance generally tracking the performance of the economy as a whole. 7 6 This i s because a large part of a i r transport demand i s disc r e t i o n a r y , and d i s c r e t i o n a r y demand generally declines during periods of recession. I f a f a l l i n demand i s not 7 4 Doganis (1985, p.108) i l l u s t r a t e d the r e l a t i o n s h i p between airplane s i z e and cost per seat-kilometre. The larger a i r c r a f t , l i k e the Boeing 747, had a s i g n i f i c a n t l y lower cost per seat-kilometre than the smaller a i r c r a f t . 7 5 See: ICAO (1981f, p.44). 7 6 Adkins et al (1982, p.28) presented beta c o e f f i c i e n t s f o r the stocks of twelve p u b l i c l y traded a i r l i n e s f o r the periods 1954-1965, 1966-1975 and 1976-1981. A l l the c o e f f i c i e n t s , but one, were g r e a t e r than unity, i n d i c a t i n g that the a i r l i n e s have a high degree of operating r i s k . 172 met by a reduction i n capacity or a lowering of p r i c e s , then t h i s can lead to problems of i l l e g a l discounting of c a r t e l p r i c e s . A major economic recession, during the period under study, occurred i n the mid-1970s, following the dramatic o i l p r i c e increases of 1973. The a i r transport growth curves (Figures 2.1, 2.2, and 2.3) showed that there was, i n f a c t , a moderation i n the growth of a i r transport during the period. This economic downturn l i k e l y contributed to problems of i l l e g a l discounting as i t coincided with increases i n industry capacity, due to the introduction of wide-bodied j e t s . iv) Changes in the Height of Entry and Exit Barriers I t was argued that a reduction i n entry b a r r i e r s could lead to problems i n p r i c e coordination. I f b a r r i e r s were lowered, then new companies could more e a s i l y e n t e r (or p o t e n t i a l l y e n t e r ) a market. New entrants (or p o t e n t i a l e n t r a n t s ) might choose not to charge c a r t e l p r i c e s , thereby undermining the effectiveness of the c a r t e l . Entry b a r r i e r s into a i r l i n e markets were lowered i n two ways during the p e r i o d 1966-1981. F i r s t , through a r e l a x a t i o n of charter rules which permitted charter c a r r i e r s to operate with fewer r e s t r i c t i o n s on more routes. Second, through the introduction of the l i b e r a l b i l a t e r a l , which lowered the b a r r i e r s to .entry of scheduled c a r r i e r s onto a d d i t i o n a l routes. The l i b e r a l 173 b i l a t e r a l s turned monopoly or duopoly routes into competitive (or p o t e n t i a l l y competitive) r o u t e s . 7 7 A r e s u l t of the i n s t i t u t i o n of l i b e r a l b i l a t e r a l s was that IATA t a r i f f c o o r d i n a t i o n became more d i f f i c u l t . As i s i l l u s t r a t e d i n Appendix C, c a r r i e r - s p e c i f i c p r i c e - s e t t i n g became the norm on major routes, rather than m u l t i l a t e r a l p r i c e - s e t t i n g . The IATA t a r i f f c o o r d i n a t i o n system was undermined by the i n t r o d u c t i o n of the pro-competitive l i b e r a l b i l a t e r a l p o l i c y . I t should be noted that the major e x i t b a r r i e r s were not concomitantly lowered. Governments of nearly every country i n the world s t i l l i n s i s t e d on p u b l i c l y or p r i v a t e l y owned f l a g c a r r i e r s , and those with i n e f f i c i e n t c a r r i e r s were not prepared to allow t h e i r c a r r i e r s to e x i t from i n t e r n a t i o n a l markets. High e x i t b a r r i e r s only compounded IATA's ratemaking d i f f i c u l t i e s . In summary, there were a number of factors that weakened IATA t a r i f f coordination during the period 1966-1981. These included: an increase i n the number of c a r r i e r s ( e s p e c i a l l y non-IATA c a r r i e r s ) ; the i n t r o d u c t i o n of wide-bodied j e t s which contributed to problems of overcapacity and i l l e g a l d i s c o u n t i n g ; an economic r e c e s s i o n i n the mid-1970s t h a t exacerbated overcapacity and i l l e g a l discounting problems; and f i n a l l y , the lowering of r e s t r i c t i o n s on charter operations and the introduction of l i b e r a l b i l a t e r a l s which served to increase competition on i n t e r n a t i o n a l a i r routes. 7 7 Rosenfield (1982, p.473) found that four, previously domestic U.S. c a r r i e r s entered i n t e r n a t i o n a l markets to take advantage of opportunities r e s u l t i n g from the U.S. pro-competitive p o l i c y . 174 c) Overriding State Interests The t h i r d f a c t o r discussed as po s s i b l y i n f l u e n c i n g regime developments i s o v e r r i d i n g state i n t e r e s t i n the maintenance of n a t i o n a l c a r r i e r s . This f a c t o r l i k e l y had the e f f e c t of weakening IATA t a r i f f coordination i n two ways: F i r s t , because a number of states achieved independence i n the 1960s and 1970s, and because most of these states formed n a t i o n a l a i r l i n e s ( i . e . , due to the ov e r r i d i n g state i n t e r e s t ) , coordination of t a r i f f s became more d i f f i c u l t because of the larger numbers of c a r r i e r s . Second, coordination of t a r i f f s was undermined by d i f f e r e n c e s between developed and developing countries on how to best support nation a l c a r r i e r s . Developing countries f a v o u r e d s t r i c t e r c o n t r o l over p r i c e s and c a p a c i t i e s than d i d developed countries, because t h i s would best ensure t h e i r c a r r i e r s received a " f a i r share" of t r a f f i c regardless of a i r l i n e e f f i c i e n c y . 5. Summary The modified hegemonic theory and other factors were used to examine the developments i n the i n t e r n a t i o n a l a i r transport industry between 1966 and 1981. The major development that had to be explained was the change to a l i b e r a l regime d u r i n g the p e r i o d 1977-1981. The theory of hegemonic s t a b i l i t y explained the change i n terms of a r e c l a s s i f i c a t i o n of what the U.S. viewed as "benefits". whereas, under the post-Bermuda regime the U.S. was prepared to support the regulatory framework i n exchange f o r benefits to i t s c a r r i e r s , under the new U.S. view, b e n e f i t s had to flow to U.S. consumers. The new d e f i n i t i o n of benefits r e s u l t e d i n a change to a pro-competitive regulatory regime from a p r o - a i r l i n e framework. 175 The other factors helped to explain why the regime was being weakened even p r i o r to the change i n U.S. p o l i c y , and why the U.S. decided to change i t s regulatory p o l i c y . The regime was weakened due to a number of s t r u c t u r a l f a c t o r s , most notably the growing number of c a r r i e r s , the introduction of wide-bodied j e t s , and a slowdown i n a i r transport growth. These factors c o n t r i b u t e d to i n d u s t r y o v e r c a p a c i t y and r e s u l t e d i n the " i l l e g a l " discounting of IATA t a r i f f s . F i n a l l y , the U.S. changed i t s a i r transport p o l i c y a f t e r the release of new information on the deleterious e f f e c t s of economic r e g u l a t i o n o f a i r t r a n s p o r t made domestic d e r e g u l a t i o n and i n t e r n a t i o n a l l i b e r a l i z a t i o n p o l i t i c a l l y a t t r a c t i v e . P o l i t i c i a n s were able to c o u n t e r a c t the influence of a i r l i n e s i n the policy-making process by forming a broad c o a l i t i o n of l i b e r a l s and conservatives i n favour of deregulation, and by appointing advocates of deregulation to key p o s i t i o n s i n the CAB. The use of l i b e r a l b i l a t e r a l s weakened the already f a l t e r i n g IATA system of m u l t i l a t e r a l t a r i f f coordination on U.S. i n t e r n a t i o n a l routes, thus crea t i n g a competitive p r i c i n g system on these routes. E. The 1986 Post-Liberal Regime In t h i s s ection of the paper, the major developments that have occurred since 1981 are o u t l i n e d and discussed. During the period 1977-1981 the U.S. implemented i t s pro-competitive p o l i c y with f u l l force. Since 1981, the United States has retreated from the f u l l - s c a l e implementation of t h i s p o l i c y to a more t r a d i t i o n a l p r o - a i r l i n e stance. At the same time, other states have begun to l i b e r a l i z e t h e i r regulations over i n t e r n a t i o n a l a i r transport. 176 I t should be noted, however, that despite these p o s t - l i b e r a l developments, the major features of the l i b e r a l regulatory regime have remained i n t a c t . Table 4.4 presents the c h a r a c t e r i s t i c s of the 1986 p o s t - l i b e r a l regime as w e l l as r e l a t e d i n d u s t r y and environmental f a c t o r s . As the table in d i c a t e s , the p o s t - l i b e r a l regime represents, i n most ways, a continuation of the l i b e r a l regime. There i s s t i l l a mixture of m u l t i l a t e r a l and u n i l a t e r a l p r i c e - s e t t i n g . B i l a t e r a l forms continue to range from l i b e r a l to r e s t r i c t i o n i s t . The United States has maintained i t s leadership p o s i t i o n i n a i r transport. The major difference between 1986 and 1981, i s that i n 1986 there was no longer the commitment by the U.S. to the extension of pro-consumer regulatory p o l i c i e s . As well, by 1986, there had been some movement by countries, other than the U.S., to regulatory reform. The next s e c t i o n describes the major events of the p o s t - l i b e r a l period. T h i s i s f o l l o w e d by an analysis of the developments using the modified hegemonic theory and other f a c t o r s . 2. Developments Under the Post-Liberal Regime Three major developments are discussed i n t h i s section: the signing of a m u l t i l a t e r a l agreement between Europe and the United States i n 1982; the change by the U.S. from a pro-consumer p o l i c y back to a p r o - a i r l i n e p o l i c y ; and the t r e n d towards the l i b e r a l i z a t i o n of a i r regulations i n c e r t a i n regions of the world, e s p e c i a l l y Europe. 177 T a b l e 4 . 4 S n a p - s h o t o f t h e 1986 P o s t - L i b e r a l R e g i m e a n d R e l a t e d E n v i r o n m e n t a l a n d I n d u s t r y F a c t o r s C h a r a c t e r i s t i c o r F a c t o r 1986 P o s t - L i b e r a l R e g i m e Regime Characteristics a ) R o l e o f I A T A i n S e t t i n g P r i c e s b ) M e m b e r s h i p i n I A T A c ) R o l e o f I C A O P r i c e s s e t b y I A T A o n m o s t r o u t e s b u t o f t e n n o t a d h e r e d t o b y a i r l i n e s . W i d e s p r e a d u s e o f " f r e e -m a r k e t " p r i c i n g a n d " i l l e g a l " d i s c o u n t i n g . M a j o r i n t e r n a t i o n a l s c h e d u l e d c a r r i e r s e x c l u d i n g : s o m e U.S. c a r r i e r s ; s o m e c a r r i e r s o f d e v e l o p i n g c o u n t r i e s ; a n d s o m e E a s t e r n b l o c c a r r i e r s . M e m b e r s h i p w a s 147 a i r l i i n e s w i t h a b o u t 60 p e r c e n t o f a c t i v e m e m b e r s r e p r e s e n t i n g d e v e l o p i n g c o u n t r i e s . I n v o l v e m e n t i n t e c h n i c a l a n d s a f e t y m a t t e r s p l u s r e c o m m e n d a t i o n s o n e c o n o m i c m a t t e r s . d ) B i l a t e r a l C a p a c i t y C l a u s e s M i x t u r e o f l i b e r a l b i l a t e r a l s , p r e - d e t e r m i n a t i o n o f c a p a c i t y b i l a t e r a l s , a n d B e r m u d a b i l a t e r a l s . e ) R e g u l a t i o n b y R e g i o n a l O r g a n i z a t i o n s T h e E u r o p e a n C i v i l A v i a t i o n C o n f e r e n c e p l a y e d a n a c t i v e r o l e i n f i x i n g p r i c i n g z o n e s o n r o u t e s b e t w e e n t h e U.S. a n d E u r o p e . R e g i o n a l o r g a n i z a t i o n s i n t h e d e v e l o p i n g w o r l d s t a r t e d t o c o o d i n a t e p r i c e s . 17.8 Table 4.4 (Continued) Environmental Factors a) The World Economy b) Third World Development c) U.S. Government Industry Factors a) Maturity of Airline Industry b) State of Technology c) Government Ownership d) Role of Charter Operators e) Size of Industry f) Product Offerings Relatively strong economic prospects in much of the developed world. Many of the countries of the developing world experienced low or nega-tive growth rates, and were burdened by heavy foreign debts. Continued uneven development with many countries burdened by large foreign debts. Conservative, Republican administration concerned with countering communism. Congress, however, more concerned with finding ways to alleviate huge trade d e f i c i t . Positive, but lower growth rates than during 1950s, 1960s and 1970s. Wide-bodied jets operated on long haul routes. Airlines of developing countries using much of the old equipment. Government ownership of most national airlines, except U.S., but trend towards privatization and development of independent carriers. Easy access to charters on many routes but restrictions designed to protect scheduled carriers on other routes. The industry performed 1,485 b i l l i o n passenger-kilometres (1985 data) compared to 1119 b i l l i o n in 1981. Several ticket prices available on many international routes, especially on U.S. international routes 179 Table 4 .4 (Continued) g) "I l l e g a l " Discounting Widespread discounting. h) U.S. Dominance of U.S. airlines' share of world Air Transport a i r services (in passenger-kilometres) was 40 percent. 180 a) The U.S.-E.C.A.C. Memorandum of Understanding A memorandum of understanding (MoU) was signed by the United States and twelve European countries on May 2, 1982.7 8 The agreement was negotiated on behalf of the European countries by the European C i v i l A v i a t i o n Conference (ECAC), and i s known as the U.S.-ECAC Memorandum of Understanding. 7 9 The MoU p r o v i d e d f o r the c r e a t i o n of reference fares and fare zones (about the r e f e r e n c e f a r e s ) on N o r t h A t l a n t i c r o u t e s by a U . S . - E u r o p e a n intergovernmental working group. C a r r i e r s were free to e s t a b l i s h prices without governmental approval within the fare zones. Outside of the zones, f a r e s were subject to the approval conditions of the relevant b i l a t e r a l agreement. 8 0 A major importance of the agreement to the Europeans was that i t e f f e c t i v e l y ended the U.S. show-cause order against IATA (Haanappel, 1984, p.163). 8 1 A condition of the MoU was that countries agree to allow t h e i r c a r r i e r s to p a r t i c i p a t e i n IATA t a r i f f coordination. The Europeans also 7 8 The MoU i s reprinted i n Haanappel (1984, pp.191-199) and Rosenfield (1984, Booklet 14, pp.71-79). The twelve European countries were Belgium, France, Germany, Greece, Ireland, I t a l y , the Netherlands, Portugal, Spain, Switzerland, the United Kingdom and Yugoslavia. The MoU was i n i t i a l l y signed fo r a s i x month period, but has been since renewed a number of times (the l a t e s t being February, 1987). Three a d d i t i o n a l countries, Denmark, Sweden and Norway, are now party to the agreement. 7 9 The European C i v i l A v i a t i o n Conference i s an organization of twenty European countries a f f i l i a t e d with ICAO. 8 0 For example, i f the b i l a t e r a l r e q u i r e d f a r e a p p r o v a l by both governments, then both governments had to approve fares outside of the fare zones. 8 1 As o u t l i n e d e a r l i e r i n t h i s chapter, the show-cause order was issued by t h e U n i t e d S t a t e s and r e q u i r e d IATA to "show-cause" why t a r i f f coordination should continue to be exempted from a n t i - t r u s t laws. 181 wanted the agreement because they thought that i t might restore some order to the North A t l a n t i c market. As the president of the ECAC stated (quoted i n Hudson, 1985, p.4): "ECAC Member States wish to see greater s t a b i l i t y i n the North A t l a n t i c a i r transport market and i n p a r t i c u l a r to avoid disruptive fares which may not be consistent with costs of operation." The major importance of the MoU to the United States was that i t provided p r i c i n g f l e x i b i l i t y f o r U.S. c a r r i e r s on routes to countries not party to l i b e r a l b i l a t e r a l s . A number of European countries, such as France, I t a l y and S w i t z e r l a n d , had not signed l i b e r a l b i l a t e r a l s with the U.S. Therefore, all p r i c e s on routes to these countries, before the signing of the MoU, were subject to approval by both the U.S. and the relevant European country. A f t e r the signing of the MoU, only fares outside the p r i c i n g zones required governmental approval. The s i g n i f i c a n c e of the MoU to North A t l a n t i c operations i s d i f f i c u l t to determine. Some evidence, however, was presented by Hudson (1985, Appendix 7) . He showed that a large percentage of North A t l a n t i c p r i c e s were set by a i r l i n e s outside of the U.S.-ECAC t a r i f f zones. I t would appear from t h i s evidence that market forces remained prime factors i n the establishment of North A t l a n t i c fares. b) The Re-Establishment of a Pro-Airline Policy by the U.S. Shortly a f t e r Ronald Reagan assumed the presidency i n 1981, the United States began to evaluate i t s pro-competitive p o l i c y . The evaluation r e s u l t e d i n a change back from a pro-consumer p o l i c y to a more t r a d i t i o n a l p r o - a i r l i n e 182 s t a n c e . 8 2 The new U.S. negotiating stance stressed evaluating b i l a t e r a l s i t u a t i o n s on a case by case basis i n order to obtain maximum bene f i t s f o r U.S. c a r r i e r s . As a r e s u l t of the new p o l i c y , post-1981 U.S. b i l a t e r a l s ranged from l i b e r a l to r e s t r i c t i v e . A l i b e r a l b i l a t e r a l , f o r example, was signed with Switzerland i n 1986, while the same year a b i l a t e r a l with a revenue pooling agreement was signed with the U.S.S.R. In each case there were strong pro-a i r l i n e reasons f o r signing the b i l a t e r a l s . 8 3 There were at l e a s t three reasons f o r the U.S. adopting a p r o - a i r l i n e b i l a t e r a l negotiating stance under the Reagan administration. The f i r s t r e l a t e d to a i r l i n e complaints of "unfair", competitive p r a c t i c e s against f o r e i g n countries and c a r r i e r s . 8 4 According to a Transportation Department o f f i c i a l , competition had not been "a two-way s t r e e t " (quoted i n Ott, 1984, p.28). The new American p o s i t i o n was that U.S. c a r r i e r s were often placed at an u n f a i r competitive advantage under l i b e r a l b i l a t e r a l s because the other countries' c a r r i e r s d i d not compete f a i r l y . 8 2 See, f o r example, Banks (1982, p.144), Kozicharow (1982, p.128) and, Feldman (1984, p.29). 8 3 The probable reason f o r the U.S. agreeing to a l i b e r a l b i l a t e r a l with Switzerland was because U.S. c a r r i e r s required p r i c i n g f l e x i b i l i t y i n order to compete with the high service Swiss c a r r i e r , Swissair. U.S. c a r r i e r s charging the same rates as Swissair had d i f f i c u l t y competing f o r passengers, so t h a t p r i c i n g f l e x i b i l i t y was desired. With respect to the U.S.S.R. b i l a t e r a l , the U.S. c a r r i e r t r a d i t i o n a l l y has had d i f f i c u l t y competing with the Soviet c a r r i e r . A e r o f l o t because Soviet passengers have been d i r e c t e d to t h e i r own nationa l c a r r i e r . A revenue pooling agreement, therefore, would ensure that the U.S. c a r r i e r , Pan American, achieves a reasonable share of the revenue from the route. 8 4 See Conahan (1981) f o r an outline of the all e g e d u n f a i r p r a c t i c e s . 183 A second reason f o r the U.S. p o l i c y change was that the influence of the CAB i n U.S. a v i a t i o n policy-making f i r s t declined and then was removed altogether. Under the provisions of the Airline Deregulation Act (United S t a t e s , 1978), the CAB was disbanded on December 31, 1984, and i t s i n t e r n a t i o n a l a i r t r a n s p o r t p o l i c y r o l e s passed to the Department of Transportation. Department of Transportation o f f i c i a l were, unlike the CAB under President Carter, not committed to a pro-competitive p o l i c y . 8 5 F i n a l l y , U.S. p o l i c y was changed because of a general pro-business stance under the Reagan administration. In accordance with the Reagan stance, U.S. c a r r i e r s lobbied for and received greater input into U.S. a i r transport policy-making. 8 6 I t should be strongly noted, however, that despite the U.S. switch back to a p r o - a i r l i n e negotiating stance, the gains that had already been won by consumers under the l i b e r a l regime were not r o l l e d back. The l i b e r a l b i l a t e r a l s a l r e a d y i n force were not repealed. The f a c t that e x i s t i n g b i l a t e r a l s were not repealed reduced the market e f f e c t s of the change i n U.S. n e g o t i a t i n g p o s t u r e . L i b e r a l b i l a t e r a l s already i n place on the North A t l a n t i c and North P a c i f i c ensured a continuation of competitive p r i c e -s e t t i n g on these major routes. 8 5 See, for example, Feldman (1984, p.29). 8 6 See, Banks (1982, p. 144) and Aviation Week and Space Technology (1982, p.149). 184 c) Liberalization in Europe and Elsewhere In the decades f o l l o w i n g the Second World War, intra-European a i r transport r e g u l a t i o n grew in c r e a s i n g l y p r o t e c t i o n i s t . Even though b i l a t e r a l a i r t r a n s p o r t agreements may have i n c o r p o r a t e d Bermuda 1 p r i n c i p l e s , c o n f i d e n t i a l memoranda of understanding, pooling agreements and cooperative p r i c i n g through IATA ensured that capacity would be evenly divided between t h i r d and fourth freedom c a r r i e r s . A report commissioned by the European C i v i l A v i a t i o n Conference (1982) found the following i n d i c a t i o n s of i n t r a -European protectionism: Although i n two-thirds . of the b i l a t e r a l agreements investigated there was no l i m i t a t i o n on the number of a i r l i n e s that could be designated per route, only eight percent of country p a i r s had more than one c a r r i e r operating per country (p.19); and, Between seventy-five and e i g h t - f i v e percent of the tonne-kilometres performed on intra-European scheduled routes was subject to revenue pooling agreements (p.37). The combination of capacity f i x i n g , c o n f i d e n t i a l r e s t r i c t i o n s on c a r r i e r entry, revenue pooling and rate-making through IATA undoubtedly contributed to the high l e v e l of fares found i n Europe. 8 7 8 7 The European C i v i l A v i a t i o n Conference (1981) summarized a number of studies that compared fares i n Europe and North America i n the l a t e 1970s. The stu d i e s i n d i c a t e d that European fares were s i g n i f i c a n t l y higher than North American fares. One study, for example, found that the B r i t i s h Airways short-haul y i e l d was twenty-one percent higher than that of a comparable U.S. c a r r i e r operating i n 1976 before U.S. deregulation (p.9). I t should be noted that some of the p r i c e v a r i a t i o n s can also be a t t r i b u t a b l e to "unmanageable" cost differences between Europe and North America, such as more c i r c u i t o u s routes and higher landing fees. 185 During the 1980s a debate ensued over the p o s s i b i l i t y of changes to the r e g u l a t o r y structure of intra-European a i r transport i n order to achieve lower p r i c e s f o r scheduled s e r v i c e s . 8 8 P a r t i c i p a n t s i n the debate included a number of European p o l i t i c a l and regulatory organizations, a i r l i n e groups and consumer groups. Consumer groups and regional a i r c a r r i e r s ( i . e . , non-flag c a r r i e r s ) wanted the wide-scale l i b e r a l i z a t i o n of regulations; the f l a g c a r r i e r s or n a t i o n a l a i r c a r r i e r s wanted only l i m i t e d changes; while the p o l i t i c a l and r e g u l a t o r y o r g a n i z a t i o n s g e n e r a l l y positioned themselves between the above two groups. 8 9 A f t e r much debate, a p o l i c y was f i n a l l y f o r m u l a t e d i n 1987 by the t r a n s p o r t m i n i s t e r s o f the twelve European Community c o u n t r i e s f o r l i m i t e d l i b e r a l i z a t i o n . Plans included (Melly, 1987): new opportunities for discount p r i c i n g during off-peak periods; the multiple designation of c a r r i e r s on high density routes; new routes allowed between major and regional c i t i e s i n d i f f e r e n t countries; and, the opportunity for l i m i t e d f i f t h freedom t r a f f i c r i g h t s . Neither revenue pooling nor capacity sharing, however, was abolished. - Probably more s i g n i f i c a n t to European a i r transport than the l i m i t e d regulatory reforms described above were the f i v e l i b e r a l b i l a t e r a l s signed by 8 8 I t s h o u l d be noted t h a t a p p r o x i m a t e l y f i f t y percent of i n t r a -European a i r transport was conducted by charter c a r r i e r s . 8 9 For consumer views, see Bureau Europeen des Unions de Consummateurs (1985). For the regional a i r l i n e s p o s i t i o n , see Bonhoff (1985). For the p o s i t i o n of the IATA c a r r i e r s , see IATA (1985e). For the p o s i t i o n of various government and r e g u l a t o r y agencies, see the Commission of the European Communities (1981; 1984); the European C i v i l A v i a t i o n Conference (1982, 1985); and, Haanappel (1985, pp.110-114). 186 the United Kingdom. During 1984 and 1985, the U.K. signed l i b e r a l agreements with the Netherlands, Luxembourg, Belgium, West Germany, and Switzerland. R e s u l t s showed t h a t the agreements c o n t r i b u t e d to the i n i t i a t i o n of a d d i t i o n a l routes between the U.K. and Continental Europe, as well as to the o f f e r i n g of new discount fares (Aviation Week and Space Technology, 1985). A number of countries outside of Europe also sought to l i b e r a l i z e t h e i r i n t e r n a t i o n a l a i r transport p o l i c i e s , at l e a s t under l i m i t e d circumstances. Prominent among these countries were A u s t r a l i a and Canada. In 1985, the A u s t r a l i a n Trade Practices Commission (1984; 1985) eliminated the authority of IATA to enforce i t s t a r i f f agreements. Although c a r r i e r s could s t i l l attend IATA conferences, they could no longer be compelled to charge IATA fares. Canada (Department of External A f f a i r s , 1985) proposed an extremely l i b e r a l agreement with the United States that would include not only p r i c i n g and capacity f l e x i b i l i t y , but also cabotage. 9 0 Although an agreement has not been reached on t h i s p r o p o s a l , two l i m i t e d l i b e r a l agreements covering commuter a i r s e r v i c e s and u n d e r u t i l i z e d a i r p o r t s have been concluded by Canada and the U.S. 9 1 d) Developments Under the Post-Liberal Regime - A Summary D u r i n g the p o s t - l i b e r a l regime there was, concurrently, the "de-l i b e r a l i z a t i o n " o f U.S. i n t e r n a t i o n a l policy-making and the movement to l i m i t e d l i b e r a l i z a t i o n i n other developed regions of the world such as 9 0 Cabotage i s the r i g h t to enplane passengers and to transport them to a d e s t i n a t i o n i n the same country. See Appendix B f o r a d e s c r i p t i o n of cabotage and the other a i r freedoms. 9 1 See Canada, Department of External A f f a i r s (1984a; 1984b). 187 Europe, Canada, and A u s t r a l i a . The U.S. reverted to a more t r a d i t i o n a l pro-a i r l i n e stance i n i t s b i l a t e r a l n e g o t i a t i o n s w h i l e o t h e r c o u n t r i e s , e s p e c i a l l y i n Europe, attempted to accommodate on a l i m i t e d basis the views of i n t e r e s t e d p a r t i e s other than the nat i o n a l c a r r i e r s i n a i r transport p o l i c y formulation. During the p o s t - l i b e r a l period there was also the signing of the f i r s t s i g n i f i c a n t m u l t i l a t e r a l agreement covering the economic reg u l a t i o n of scheduled a i r transport since m u l t i l a t e r a l i s m was abandoned i n favour of b i l a t e r a l i s m i n the 1940s. The U.S.-ECAC Memorandum of Understanding provided f o r the establishment of fare zones on North A t l a n t i c routes. D e s p i t e these developments, the p o s t - l i b e r a l regime remained l a r g e l y s i m i l a r to the l i b e r a l regime. P r i c i n g continued to be set m u l t i l a t e r a l l y i n some parts of the world and competitively i n other markets ( i . e . , mainly on routes influenced by U.S. i n t e r n a t i o n a l p o l i c y such as the North A t l a n t i c and the North P a c i f i c ) . Routes and c a p a c i t i e s continued to be established b i l a t e r a l l y . 2. Analysis of Post-Liberal Developments Using the Modified Hegemonic Stability Theory J u s t as the post-Bermuda regime represented, f o r the most part, a continuation of the Bermuda regime, the p o s t - l i b e r a l regime represented a c o n t i n u a t i o n of the l i b e r a l regime. Cer t a i n l y , the U.S. d i d change i t s n egotiating stance from a pro-consumer to a p r o - a i r l i n e p o s i t i o n , but there was not a wholesale r o l l b a c k of l i b e r a l b i l a t e r a l s already negotiated. As 188 w e l l , the Europeans d i d not change regulatory a f f a i r s substantially, with t h e i r l i m i t e d l i b e r a l i z a t i o n . Capacity and routes remained regulated on a b i l a t e r a l basis while p r i c e s continued to be set m u l t i l a t e r a l l y . Perhaps the most s i g n i f i c a n t r e g u l a t o r y change between the l i b e r a l and p o s t - l i b e r a l regimes was the i n s t i t u t i o n of the multilateral U.S.-ECAC Memorandum of U n d e r s t a n d i n g . However, as was discussed above, the agreement di d not eliminate u n i l a t e r a l or market-based p r i c i n g on the North A t l a n t i c . How can the hegemonic s t a b i l i t y t h e o r y be used to analyze these developments? The theory predicts that a regime w i l l be sustained as long as there continues to e x i s t a dominant power capable of maintaining the regime and w i l l i n g to continue to bear the costs of supplying the regime to.the r e s t of the world. The issues that must be addressed, therefore, are whether or not the U.S. remained the dominant power capable of maintaining a regime; what incentives the U.S. had f o r maintaining the regime; and, what incentives other countries had to p a r t i c i p a t e i n the regime. These issues are discussed below: a) Did the U.S. Continue as the Dominant Power in the Post-Liberal Regime? The U.S. p o s i t i o n i n the i n t e r n a t i o n a l a i r transport industry remained r e l a t i v e l y stable during the f i r s t h a l f of the 1980s. Figure 2.8 indicated that the U.S. share of the world's scheduled passenger-kilometres increased between 1981 and 1985, to j u s t under f o r t y percent. Figures 2.9 and 2.10 showed that other countries t r a i l e d f a r behind the U.S. i n percent of t o t a l t r a f f i c and percent of i n t e r n a t i o n a l t r a f f i c . I t i s safe to say, therefore, that the U.S. d i d continue as the dominant power i n the p o s t - l i b e r a l regime. 189 b) Were There Incentives for the U.S. to Continue to Support the Regime? I t i s evident that under the p o s t - l i b e r a l regime, the U.S. again became mainly i n t e r e s t e d i n obtaining benefits f o r i t s c a r r i e r s . Did the post-l i b e r a l regime provide s u f f i c i e n t benefits f o r U.S. c a r r i e r s ? U.S. c a r r i e r s performed very poorly i n t h e i r i n t e r n a t i o n a l operations during the early 1980s, before recovering i n the mid-1980s. 9 2 Although the poor performance can l a r g e l y be a t t r i b u t e d to economic recession, i t can be argued that a regime more favourable to a i r l i n e s (such as the post-Bermuda regime, with a predominance of m u l t i l a t e r a l p r i c e - s e t t i n g ) would have better insulated U.S. c a r r i e r s from the recession. The incentives f o r the U.S. to continue to support a pro-consumer regime while following a p r o - a i r l i n e b i l a t e r a l p o l i c y appeared weak, e s p e c i a l l y i n l i g h t of the recession. c) What were the Incentives for Smaller Countries to Participate in the Regime? The incentives f o r small countries to p a r t i c i p a t e i n the regime were the same as under the l i b e r a l regime. Smaller countries could achieve benefits f o r t h e i r a i r c a r r i e r s under a l i b e r a l i z e d regulatory framework if the carriers were reasonably competitive. C o m p e t i t i v e c a r r i e r s (such as Singapore I n t e r n a t i o n a l and KLM) from smaller countries could use the operating freedoms under a l i b e r a l i z e d regime to increase the carriage of f i f t h and s i x t h freedom t r a f f i c . 9 2 See Brenner, et al (1985, pp.114-117) for an assessment of U.S. c a r r i e r s ' p r o f i t a b i l i t y i n the 1970s and early 1980s. 190 Other countries with i n e f f i c i e n t c a r r i e r s , or without f i f t h and s i x t h freedom o p p o r t u n i t i e s f o r t h e i r c a r r i e r s , would not b e n e f i t from the l i b e r a l i z e d regime. Some of these countries were coerced into j o i n i n g the regime (on a r e a l or de facto basis) because of the threat of t r a f f i c d i v e r s i o n . Often countries were able to p a r t i a l l y i n s u l a t e t h e i r c a r r i e r s from the competitive e f f e c t s of the regime by allowing t h e i r a i r l i n e s to p a r t i c i p a t e i n regional rate-making associations. 3. Results from the Analysis Using the Modified Hegemonic Stability Theory The U n i t e d S t a t e s m a i n t a i n e d i t s l e a d e r s h i p p o s i t i o n i n the in t e r n a t i o n a l a i r transport industry i n the p o s t - l i b e r a l period. The U.S. changed i t s p o l i c y of pressing f o r consumer benefits to a p o l i c y of pressing f o r b e n e f i t s f o r U.S. c a r r i e r s . The f a c t that the l i b e r a l regime was not transformed to any large degree to r e f l e c t the change i n U.S. preferences cannot be properly addressed using the hegemonic s t a b i l i t y theory. Table 4.5 i l l u s t r a t e s the problem of explaining the developments of the p o s t - l i b e r a l regime i n the context of the hegemonic s t a b i l i t y theory. The f i g u r e s shows that under the Bermuda and post-Bermuda regimes, when the preference of the U.S. government was for bene f i t s to c a r r i e r s , rather than to consumers, the regimes d i d i n f a c t favour c a r r i e r s . This supports the hegemonic s t a b i l i t y theory because there were incentives to the U.S. i n maintaining these regimes - i . e . , to obtain b e n e f i t s f o r i t s c a r r i e r s . The r e s u l t s of the l i b e r a l regime also support the hegemonic s t a b i l i t y theory. Under t h i s regime the U.S. defined incentives i n terms of benefits to consumers, and the regime did, i n f a c t , favour consumers. However, under the 191 T a b l e 4 .5 A p p l y i n g M o d i f i e d Hegemonic S t a b i l i t y T h e o r y t o t h e D i f f e r e n t R e g u l a t o r y R e g i m e s Regime Dominant Country Primary Concerns of Dominant Country Major Recipient Agreement with of Benefits Modified Hegemonic From the Regime Stability Theory Bermuda (1946) U.S. Security and airl i n e interests Airlines Yes Post-Bermuda (1965) U.S. Airline and security interests Airlines Yes Liberal (1981) U.S. Consumer interests (travellers, shippers) Consumers Yes Post-Liberal (1986) U.S. Airline interests Consumers (primarily) No 192 p o s t - l i b e r a l regime, when the U.S. reverted to a p o l i c y of favouring a i r l i n e s over consumers, the b a s i c pro-consumer features of the l i b e r a l regime remained. 4. Other Factors in the Adoption of the 1986 Post-Liberal Regime a) Domestic Affairs P o l i t i c a l developments per t a i n i n g to the i n t e r n a t i o n a l a i r transport industry i n the United States, Europe, and elsewhere were described e a r l i e r i n t h i s section. The U.S. s h i f t e d , under the Reagan administration, from a pro-consumer to a more t r a d i t i o n a l p r o - a i r l i n e p o l i c y , despite r h e t o r i c to the contrary; European states and other developed countries, such as Canada and A u s t r a l i a , have moved towards the l i m i t e d l i b e r a l i z a t i o n of a i r transport regulations. Developing countries, with few exceptions, have continued to support r e s t r i c t i v e a i r r e g u l a t i o n s . 9 3 The major reasons f o r the s h i f t i n U.S. p o l i c y have already been discussed: There were problems with u n f a i r competitive p r a c t i c e s of other countries and states; the influence of the pro-competitive CAB declined and then was eliminated; and, the U.S. government under Reagan was more receptive to a i r l i n e lobbying than was the Carter administration. In addition, there were no f u r t h e r b e n e f i t s t h a t c o u l d be a c h i e v e d by p o l i t i c i a n s from regulatory reform. The Carter administration had already received the c r e d i t from implementing the pro - c o m p e t i t i v e p o l i c y so there were no further 9 3 These exceptions include a number of Southeast Asian countries (most prominently Singapore) with reasonably e f f i c i e n t a i r c a r r i e r s . 193 b e n e f i t s to be achieved by appealing d i r e c t l y to voters and by-passing the a i r l i n e lobbying groups. Some of the reasons f or the l i m i t e d l i b e r a l i z a t i o n of p o l i c i e s i n Europe and other developed countries have also been discussed. Consumer groups and regional c a r r i e r s have c a l l e d f o r regulatory reform. These groups have been able to use the experiences of United States' deregulation as ammunition i n t h e i r quest f o r regulatory reform i n t h e i r own countries. As well, the p r i v a t i z a t i o n of nation a l c a r r i e r s has l i k e l y , i n some cases, distanced n a t i o n a l a i r l i n e o f f i c i a l s from the government policy-making p r o c e s s . 9 4 P r i v a t i z a t i o n has opened the policy-making process to other views, such as those from consumers and regional a i r c a r r i e r s . F i n a l l y , the reasons why most developing countries continue to support r e s t r i c t i v e regulatory measures have also been discussed. A large part of the a i r f l e e t of developing countries' a i r l i n e s i s comprised of old, noisy a i r c r a f t with high operating c o s t s . 9 5 C a r r i e r s of many of these developing countries cannot e f f e c t i v e l y compete with the more e f f i c i e n t c a r r i e r s of the developed world. As a r e s u l t , developing countries support measures to 9 4 Countries that have p r i v a t i z e d or have plans to p r i v a t i z e a l l or part of t h e i r n a t i o n a l c a r r i e r s include I t a l y , Belgium, the United Kingdom, Canada, West Germany, Japan, Singapore and Malaysia. 9 5 ICAO (1984h, p.21) reported, f or example, that one-third of A f r i c a ' s a i r f l e e t was s u f f i c i e n t l y outdated that i t could not meet new ICAO noise standards. 194 r e s t r i c t competition i n order that t h e i r c a r r i e r s can obtain a " f a i r share" of t r a f f i c . 9 6 b) Structural Factors Four factors were i d e n t i f i e d as having an impact on p r i c e - s e t t i n g i n the i n t e r n a t i o n a l a i r l i n e industry. These were: changes i n the number of a i r c a r r i e r s ; the introduction of new cost-saving technology; a downturn i n the economic cycle; and a change i n the height of entry b a r r i e r s into a i r l i n e markets. I t was o u t l i n e d i n the d i s c u s s i o n of the l i b e r a l regime that the developments were g e n e r a l l y moving i n the d i r e c t i o n of making t a r i f f coordination more d i f f i c u l t . In the years before and during the l i b e r a l p e r i o d t h e r e had been: large increases i n the number of i n t e r n a t i o n a l c a r r i e r s ; the i n t r o d u c t i o n of new c o s t - e f f i c i e n t a i r c r a f t ' technology; a slowdown i n economic growth; and a lowering i n the b a r r i e r s to entry into a i r l i n e markets. Most of these developments continued into the p o s t - l i b e r a l period. F i r s t , F i g u r e 2.14 p r o v i d e d an i n d i c a t i o n o f how the number of i n t e r n a t i o n a l c a r r i e r s increased i n the p o s t - l i b e r a l period. From the fi g u r e , i t can e s p e c i a l l y be noted that the increase has been l a r g e l y among c a r r i e r s not p a r t i c i p a t i n g i n IATA t a r i f f coordination. 9 6 See, for example, ICAO (1985f) which contains the recommendation of Indian, Tanzania, Mexico, Lebanon and Pakistan f o r an "equitable and f a i r sharing of b e n e f i t s " from a i r services. 195 Second, new c o s t - e f f i c i e n t a i r c r a f t continued to be introduced by the major manufacturers during the p o s t ; l i b e r a l period. Many of the o l d a i r c r a f t have been s o l d to the a i r l i n e s of developing countries, exacerbating cost differences between developing and developed countries' c a r r i e r s . Third, industry growth continued to slow i n the e a r l y 1980s. Figure 2.4 in d i c a t e d that the i n t e r n a t i o n a l a i r transport growth rate during the period 1980-1985 was les s than one-half the growth rate during the period 1970-1979. F i n a l l y , the b a r r i e r s to entry continued to be lowered into c e r t a i n markets. The f i v e l i b e r a l b i l a t e r a l s signed by the U.K., and the l i m i t e d l i b e r a l i z a t i o n of the European Community, for example, lowered b a r r i e r s to entry by smaller c a r r i e r s into some European markets. In summary, there has been a continuation i n the external p o l i t i c a l and economic developments which served to make t a r i f f coordination d i f f i c u l t to achieve. The trends of the p r e - l i b e r a l and l i b e r a l period have not been reversed. c) Overriding State Interests The o v e r r i d i n g state i n t e r e s t i n operating n a t i o n a l c a r r i e r s remained despite the movement towards the p r i v a t i z a t i o n of state-owned a i r l i n e s and to the l i b e r a l i z a t i o n of European and other i n t e r n a t i o n a l routes. During the p o s t - l i b e r a l p e r i o d , no c o u n t r i e s were w i l l i n g to s e l l t h e i r national c a r r i e r s to more e f f i c i e n t f oreign competitors nor were countries w i l l i n g to have t h e i r i n t e r n a t i o n a l routes operated e x c l u s i v e l y by fo r e i g n c a r r i e r s . 196 Countries protected t h e i r national c a r r i e r s by l i m i t i n g f i f t h freedom t r a f f i c and by negotiating b i l a t e r a l agreements based mainly on what was favourable to the c a r r i e r (rather than to the t r a v e l l i n g p u b l i c ) . 5. Summary During the p o s t - l i b e r a l period, the U.S. retreated from a pro-consumer i n t e r n a t i o n a l a i r p o l i c y to a more t r a d i t i o n a l p r o - a i r l i n e stance. Despite t h i s change of stance, the major features of the l i b e r a l period, including u n i l a t e r a l p r i c e - s e t t i n g , remained i n t a c t . This was not what was predicted using the modified hegemonic theory, so that the theory proved to be not h e l p f u l i n explaining the developments of the p o s t - l i b e r a l period. The other factors proved to be more us e f u l i n explaining p o s t - l i b e r a l developments. I t was shown that there was no longer p o l i t i c a l incentives for U.S. p o l i t i c i a n s to continue a pro-consumer i n t e r n a t i o n a l a i r policy--thus the reversion to a p r o - a i r l i n e stance. In other parts of the world, however, p o l i t i c a l i n c e n t i v e s for l i b e r a l i z a t i o n were not yet exhausted and t h i s e x p l a i n e d , i n p a r t , the movement ( i n Europe and elsewhere) towards l i b e r a l i z a t i o n . As well, the economic factors continued to mitigate against m u l t i l a t e r a l t a r i f f coordination rendering IATA impotent i n t h i s area. In the next section of the chapter, conclusions w i l l be drawn from the analysis of regime changes and future prospects w i l l be predicted for the i n t e r n a t i o n a l a i r transport regulatory regime. 197 F. Conclusions and Future Prospects 1. Conclusions The purposes of t h i s chapter were twofold: F i r s t , to t e s t the modified theory of hegemonic s t a b i l i t y to determine how well i t could explain regime developments i n i n t e r n a t i o n a l a i r transport. Second, to determine whether or n o t t h e o t h e r e x p l a n a t o r y f a c t o r s c o u l d add s i g n i f i c a n t l y to the u n d e r s t a n d i n g o f regime developments. The developments leading to the adoption of four regimes were used to t e s t the theory and to determine the relevance of the other explanatory f a c t o r s . The r e s u l t s of the analysis showed the following: a) 1946 Bermuda Regime The m o d i f i e d theory of hegemonic was able to c o r r e c t l y p r e d i c t the formation of the regime. There existed a dominant country ( i . e . the U.S.) capable of forming the regime and there were i d e n t i f i a b l e b e n e f i t s to the U.S. f o r e s t a b l i s h i n g the regime as well as for smaller countries i n j o i n i n g the regime. As w e l l , as the theory predicted there were costs that had to be born by the U.S. i n maintaining the regime. The other factors proved h e l p f u l i n explaining the nature of the regime that was adopted. The dominance of a i r t r a n s p o r t policy-making by a i r c a r r i e r s as well as o v e r r i d i n g state i n t e r e s t s i n maintaining national a i r c a r r i e r s l i k e l y contributed to the formation of that IATA c a r t e l . 198 b) 1965 Post-Bermuda Regime The m o d i f i e d theory of hegemonic s t a b i l i t y c o r r e c t l y predicted the maintenance of the a i r transport regime during the post-Bermuda period. The U.S. remained the dominant power i n a i r transport and the world economy, i n general, and was capable of paying the costs of regime maintenance. The o t h e r factors were also helped i n explaining the regime s t a b i l i t y . The powerful p o s i t i o n of a i r c a r r i e r s i n the domestic policy-making process of the United States and elsewhere acted to s o l i d i f y government support for the IATA rate-making system and • maintain the major features of the Bermuda regulatory regime. c) 1981 Liberal Regime The m o d i f i e d hegemonic theory c o u l d not p r e d i c t , on i t s own, the t r a n s f o r m a t i o n from m u l t i l a t e r a l to u n i l a t e r a l p r i c e - s e t t i n g during the l i b e r a l regime. The United States maintained i t s dominant p o s i t i o n i n a i r transport yet the regime was. s t i l l transformed. Only when other factors were considered--most notably the change i n the U.S. p o l i c y to one that favoured s e c u r i n g b e n e f i t s f o r consumers rather than f o r U.S. c a r r i e r s - - c o u l d the transportation be explained. d) The 1986 Post-Liberal Regime The modified hegemonic theory could not explain the maintenance of the l i b e r a l regime into the p o s t - l i b e r a l period i n l i g h t of the r e v e r s a l of the U.S. l i b e r a l p o l i c y . I f the dominant power, the United States, preferred a p r o - a i r l i n e p o l i c y , hegemonic theory predicted that i t should support a "pro-a i r l i n e " regime. Yet the p o s t - l i b e r a l regime, with i t s predominance of 199 u n i l a t e r a l p r i c e - s e t t i n g on major r o u t e s , remained a regime l a r g e l y favourable to consumer i n t e r e s t s . I t was only a f t e r economic factors were examined, which i n d i c a t e d how the i n d u s t r y was t r a n s f o r m e d to make c o o r d i n a t e d p r i c e - s e t t i n g extremely d i f f i c u l t , that the reasons for the maintenance of u n i l a t e r a l p r i c e - s e t t i n g became c l e a r . U n i l a t e r a l p r i c e -s e t t i n g was maintained because the IATA c a r t e l was no longer capable of coordinating p r i c e s i n l i g h t of factors such as: the growth i n the number of c a r r i e r s ; the lowering of the b a r r i e r s to enter i n t e r n a t i o n a l markets; and the increase i n the percent of IATA members from developing countries. In summary, the modified theory of hegemonic s t a b i l i t y was able to explain the adoption of the Bermuda regime and the maintenance of the post-Bermuda regime but c o u l d not e x p l a i n the l i b e r a l and p o s t - l i b e r a l developments. The other explanatory factors were able to add s i g n i f i c a n t l y to the understanding of these developments and thus proved u s e f u l . 2. Future Prospects Since the modified hegemonic theory d i d not prove h e l p f u l i n p r e d i c t i n g recent developments i n a i r transport, the predictions made w i l l be based on the other explanatory f a c t o r s . The analysis showed that during the 1970s and 1980s, the f a c t o r s (mainly an increase i n the number of c a r r i e r s and a lowering of entry b a r r i e r s into markets) served to make t a r i f f coordination more d i f f i c u l t . The economic f a c t o r s h e l p e d to render IATA t a r i f f coordination nearly obsolete on major i n t e r n a t i o n a l routes such as the North A t l a n t i c and the North P a c i f i c . 200 There has been a r e c e n t t r e n d , however, to the amalgamation or u n i f i c a t i o n o f i n t e r n a t i o n a l c a r r i e r s a c r o s s n a t i o n a l boundaries. Developments have ranged from code sharing among c a r r i e r s , 9 7 to cooperative marketing arrangements (such as between B r i t i s h Airways and United A i r l i n e s ) , to actual equity investments between c a r r i e r s (such as the investment i n U.S.-based Texas A i r Corp. by Scandinavian A i r System). One might expect that the trend towards the close cooperation between i n t e r n a t i o n a l c a r r i e r s c o u l d lead to a lessening of competition i n the i n t e r n a t i o n a l arena and perhaps to a renewal of p r i c e - f i x i n g (although not n e c e s s a r i l y through IATA). Is t h i s possible? Even though there has been l i m i t e d l i b e r a l i z a t i o n i n Europe and o t h e r developed c o u n t r i e s , government p o l i c y has generally remained supportive of c a r r i e r i n t e r e s t s (with the exception of the United States during the period 1977-1981). This i s to be expected given the large stake a i r l i n e s have i n government p o l i c y formulation. Therefore, i t i s l i k e l y t h a t governments w i l l support arrangements, such as code-sharing, c o o p e r a t i v e marketing, and even ( m i n o r i t y ) e q u i t y investments, t h a t strengthen t h e i r c a r r i e r s i n i n t e r n a t i o n a l o p e r a t i o n s . 9 8 Consequently, i t i s predicted that i n developed areas of the world there w i l l be a lessening of p r i c e competition as c a r r i e r s continue to coordinate t h e i r operations. 9 7 Code sharing allows one a i r l i n e to advertise a f l i g h t as i t s own when a second c a r r i e r i s a c t u a l l y operating the a i r c r a f t . For a discussion of i n t e r n a t i o n a l code sharing, see Feldman (1988). 9 8 A u s t r a l i a , f o r example, approved without exception, twenty-five commercial agreements inv o l v i n g i t s n a t i o n a l c a r r i e r QANTAS. See A u s t r a l i a , Trade Practices Commission (1985b). 201 In developing areas of the world, countries w i l l continue to protect t h e i r i n e f f i c i e n t c a r r i e r s i n an e f f o r t to capture a " f a i r " share of t r a f f i c . This w i l l l i k e l y imply an increase i n regional t a r i f f coordinating and an increase i n r e s t r i c t i v e measures against "outside" c a r r i e r s . 202 PART THREE: PRICING ON INTERNATIONAL AIR ROUTES 203 V. PRICING ON INTERNATIONAL AIR ROUTES A. Introduction Part Two of the thesis provided explanations f o r regime changes i n the i n t e r n a t i o n a l a i r transport industry since the Second World War. In t h i s chapter of the thesi s , an analysis w i l l be conducted as to the e f f e c t on a i r l i n e p r i c e s of one regime change - the movement to a l i b e r a l regime i n the l a t e 1970s. The major question to be addressed i s , "Did the l i b e r a l i z a t i o n of regulations on i n t e r n a t i o n a l a i r routes contribute to lower p r i c e s ? " The analysis of the e f f e c t of l i b e r a l i z a t i o n on i n t e r n a t i o n a l a i r fares i n t h i s t h e s i s i s important f o r a t l e a s t two p o l i c y reasons and one t h e o r e t i c a l r e a s o n . F i r s t , i f the a n a l y s i s shows t h a t the U.S. l i b e r a l i z a t i o n d i d indeed r e s u l t i n lower a i r l i n e p r i c e s , then t h i s could provide the impetus f or the l i b e r a l i z a t i o n of regulations i n other regions of the world. Second, i f the analysis shows that the U.S. l i b e r a l i z a t i o n i n i t i a t i v e d i d not lower p r i c e s , then t h i s would indicate that sterner a c t i o n would have to be undertaken to c r e a t e a more c o m p e t i t i v e climate i n the a i r l i n e industry. Possible reasons f o r the U.S. l i b e r a l i n i t i a t i v e not r e s u l t i n g i n lower a i r l i n e p r i c e s could be the continuing strength of IATA or the a n t i -c o m p e t i t i v e p r a c t i c e s of governments seeking to protect t h e i r national a i r l i n e s by negating the e f f e c t s of l i b e r a l agreements. 204 Third, from a t h e o r e t i c a l viewpoint, the analysis provides an improved approach f o r developing models to analyze the e f f e c t of regime changes on p r i c e s i n the a i r l i n e industry. This approach, based on oli g o p o l y theory from the i n d u s t r i a l organization l i t e r a t u r e , allows f o r a rigorous economic t h e o r e t i c a l j u s t i f i c a t i o n f o r the choice of empirical models, and may be used to analyze both domestic and i n t e r n a t i o n a l p r i c e data. In order to present the analysis of i n t e r n a t i o n a l a i r l i n e p r i c e s , t h i s chapter has been divided i n the following way: The next section, Section B, provides a review of the methods that have been used to assess differences i n a i r l i n e p r i c e s . Section C develops the t h e o r e t i c a l model f o r the chapter. Section D presents the models used for estimation and describes the data used to estimate the models. Section E presents the r e s u l t s of the estimation, while Section F draws conclusions from the a n a l y s i s . B. Research Methods f o r Comparing A i r l i n e Prices Five broad approaches have been used by researchers f o r the comparison o f p r i c e s between a i r r o u t e s . The f i v e approaches are the following: informal; simple regression; si n g l e equation, multiple regression; multiple equation; and, cost-based. I. Informal Approach The informal approach to the comparison of a i r l i n e fares, used by IATA (1983b; 1984c), Taneja (1983) and the Canadian Transport Commission (Canada, Canadian Transport Commission, 1985), consists of obtaining a sample of fares 205 and comparing the fares on a p a i r by p a i r basis. Paired comparisons are g e n e r a l l y made between ro u t e s o f appr o x i m a t e l y the same distance and passenger density with one route i n each p a i r from one part of the world (e.g. Europe) and the second route from another region (e.g. the U.S.A.). The researcher may then conclude that of the n comparisons conducted, i n m cases fares were higher i n Region A while i n n-m cases, fares were higher i n Region B (assuming that fares were never i d e n t i c a l w i t h i n route p a i r s ) . An example would be the paired comparisons found i n IATA (1984c, p.19). Eight paired comparisons were made on a range of fares between routes i n the United States and Europe. The routes were paired based on s i m i l a r distances. Using the study, one could conclude, f o r example, that i n seven of the eight paired comparisons, the U.S. route had the lowest a v a i l a b l e normal fare. The major advantage of the informal approach i s s i m p l i c i t y . A study using the informal approach i s easy to conduct, and also easy to present to rea d e r s not a c q u a i n t e d w i t h s t a t i s t i c a l methods. There are two major disadvantages with t h i s approach. F i r s t , the sample s i z e used i s usually i n s u f f i c i e n t to allow the r e s u l t s to be generalized to the t o t a l population of routes. This i s because a randomly selected sample of routes, large enough to d e r i v e s t a t i s t i c s , showing d i f f e r e n c e s i n p r i c e s between p o p u l a t i o n s , i s not used. Second, i t i s not p o s s i b l e to a t t r i b u t e d i f f e r e n c e s i n pr i c e s to one or more causes (e.g. cost differences between routes), since there has been no accounting f o r these causes i n the analysis. 206 2. Simple Regression Approach The simple regression approach to the comparison of a i r fares, used by Jordan (1982) and the European C i v i l A v i a t i o n Conference (1981), consists of c o l l e c t i n g a sample of fares f o r a i r routes and regressing the fares on a constant plus an independent v a r i a b l e (usually distance). The sample of fares can be c o l l e c t e d from two or more regions, and regressions estimated separately f o r each region. Then, predicted fare values may be compared using computed regional regression c o e f f i c i e n t s . The researchers can then conclude that the predicted fare f o r a route k kilometres i n length i s higher i n Region A than i n Region B, or that there i s no dif f e r e n c e i n predicted fares between the regions f o r a route of that length. An example of t h i s method can be found i n the report by the European C i v i l A v i a t i o n Conference (1981, pp.29-30). The European C i v i l A v i a t i o n Conference (ECAC) c o l l e c t e d data on normal economy fares f o r 560 i n t r a -European routes and 150 U.S. domestic routes. Separate simple regressions were run f o r the European and U.S. routes with fare per kilometre as the dependent v a r i a b l e and d i s t a n c e ( i n kilometres) as the right-hand-side v a r i a b l e . 1 The r e g r e s s i o n r e s u l t s were then p l o t t e d f o r the U.S. and European data, and i t could be seen that the U.S. regression l i n e was "co n s i s t e n t l y below" the European l i n e . No attempt was made (or at le a s t r e p o r t e d to have been made) to conduct confidence i n t e r v a l s around the regression l i n e s , although t h i s procedure could have been undertaken. 1 A c t u a l l y , three sets of regressions were run. The f i r s t set had distance as the independent v a r i a b l e . The second set had the log of distance as the independent v a r i a b l e . F i n a l l y , the t h i r d set had the inverse of distance as the independent v a r i a b l e . 207 The major advantage of the simple regression approach i s that i t i s p o s s i b l e , when using the appropriate s t a t i s t i c a l sampling techniques and tes t s , to generalize the r e s u l t s from the sample of routes to the population of routes. The major disadvantage of t h i s approach i s that there may be several factors c o n t r i b u t i n g to pr i c e differences between routes, and that only one fa c t o r i s e x p l i c i t l y accounted for i n the model. 3. Single Equation, Multiple Regression Approach T h i s approach, used by Keeler and Abrahams (1981), C a l l and Keeler (1985) and Moore (1986) involves regressing p r i c e s c o l l e c t e d f o r a sample of a i r l i n e routes on a number of factors l i k e l y to account for differences i n the l e v e l of fares between routes. A s i g n i f i c a n t c o e f f i c i e n t f o r a given f a c t o r implies that the fac t o r i s an important v a r i a b l e i n the explanation of pr i c e differences across routes. As an example of t h i s approach, Moore (1986, pp.16-23) regressed coach a i r fares f o r 134 U.S. domestic routes on the length of the route, the number of c a r r i e r s competing i n the market, dummy va r i a b l e s f o r various market structures, the population of the c i t y of o r i g i n , and dummy va r i a b l e s f o r major d e s t i n a t i o n c i t i e s . The c o e f f i c i e n t s f o r each of the right-hand-side v a r i a b l e s were estimated, and the e f f e c t s of the v a r i a b l e s on the coach p r i c e determined. Moore c o u l d then conclude which of the v a r i a b l e s had a s i g n i f i c a n t impact on p r i c e . 208 T h e m a j o r a d v a n t a g e o f t h e s i n g l e e q u a t i o n , m u l t i p l e r e g r e s s i o n a p p r o a c h , o v e r t h e s i m p l e r e g r e s s i o n a p p r o a c h , i s t h a t a l a r g e n u m b e r o f v a r i a b l e s , r e l e v a n t t o t h e e x p l a n a t i o n o f p r i c e d i f f e r e n c e s , m a y b e i n c o r p o r a t e d i n t o t h e m o d e l . T h e r e a r e , h o w e v e r , t w o m a j o r d i s a d v a n t a g e s r e m a i n i n g w i t h t h i s a p p r o a c h . 2 F i r s t , t h e m o d e l i s n o t g e n e r a l l y f o r m e d f r o m e c o n o m i c p r o f i t m a x i m i z i n g p r i n c i p l e s s o t h e r e i s n o t a s t r o n g t h e o r e t i c a l b a s i s f o r t h e i n c l u s i o n o f a g i v e n s e t o f v a r i a b l e s . S e c o n d , e n d o g e n o u s e x p l a n a t o r y v a r i a b l e s c a n n o t b e t r e a t e d p r o p e r l y i n t h e m o d e l s i n c e t h e y w o u l d b i a s e s t i m a t e s o f t h e r e g r e s s i o n c o e f f i c i e n t s a n d m u s t t h e r e f o r e b e e x c l u d e d . 4. Multiple Equation Approach T h e m u l t i p l e e q u a t i o n a p p r o a c h o v e r c o m e s o n e o f t h e s h o r t c o m i n g s o f t h e s i n g l e e q u a t i o n , m u l t i p l e r e g r e s s i o n m e t h o d , i n t h a t i t t r e a t s e n d o g e n o u s e x p l a n a t o r y v a r i a b l e s p r o p e r l y i n e s t i m a t i o n . T h i s m e t h o d , u s e d b y G r a h a m , K a p l a n a n d S i b l e y ( 1 9 8 3 ) a n d B a i l e y , G r a h a m a n d K a p l a n ( 1 9 8 5 ) , c o n s i s t s o f f i r s t r e g r e s s i n g e n d o g e n o u s v a r i a b l e s , o t h e r t h a n p r i c e , o n t h e e x o g e n o u s v a r i a b l e s , a n d t h e n r e g r e s s i n g p r i c e o n t h e e x o g e n o u s v a r i a b l e s a n d t h e f i t t e d v a l u e s o f t h e o t h e r e n d o g e n o u s v a r i a b l e s ; i . e . , a t w o s t a g e l e a s t s q u a r e s ( 2 S L S ) p r o c e d u r e . A m a j o r a d v a n t a g e o f t h i s a p p r o a c h i s t h a t t h e 2 S L S p r o c e s s r e s u l t s i n a c o n s i s t e n t e s t i m a t i o n o f t h e r e g r e s s i o n c o e f f i c i e n t s w h e n o n e o r m o r e e x p l a n a t o r y v a r i a b l e s i s i t s e l f e n d o g e n o u s . A m a j o r r e m a i n i n g d i s a d v a n t a g e 2 I t s h o u l d b e n o t e d t h a t t h e s e d i s a d v a n t a g e s w o u l d a l s o a p p l y t o t h e s i m p l e r e g r e s s i o n a p p r o a c h . 2 0 9 i s that the model i s s t i l l formulated without e x p l i c i t l y l i n k i n g the standard n e o c l a s s i c a l , profit-maximizing model to the empirical t e s t s . Bailey, Graham and Kaplan (1985), for example, using data from 5053 U.S. domestic markets, proposed the following three equations f o r the estimation of a i r fares on U.S. domestic routes: i ) P = M(Structure) x C where: P = average p r i c e of t i c k e t s as measured by average y i e l d ; M = mark-up of pr i c e over cost and i s dependent on the structure of the market; and, C = cost of serving the market. i i ) C = f(DIST, PAX, TS, NEWC, CHI, NYC, WASH) where: C = cost of serving the market; DIST = distance of market; PAX = density of market; TS = time s e n s i t i v i t y of passengers; NEWC = whether market i s served by new entrant; CHI = Chicago i s e i t h e r the o r i g i n or destination; NYC = New Y o r k C i t y i s e i t h e r t h e o r i g i n or destination; and, WASH = Washington i s e i t h e r the o r i g i n or destination. 210 i i i ) PAX - f(P, DIST, INC, POP, TS) where: PAX = density of market; P = p r i c e of t i c k e t ; DIST = distance of market; INC = measure of income f o r t r a v e l l e r s i n a market; POP = measure of the population of the o r i g i n and desti n a t i o n c i t i e s ; and, TS = time s e n s i t i v i t y of t r a v e l l e r s . As well, BGK were not c e r t a i n as to whether market structure should be considered as an endogenous or exogenous v a r i a b l e . BGK estimated the system of equations both ways. When market s t r u c t u r e was considered as an endogenous v a r i a b l e , a fourth equation was also estimated: iv) STRUCTURE = f(PAX, DIST, HUB) where: PAX = density of market; DIST = distance of market; and, HUB = whether or not one of the c i t i e s i n the market i s a major hub. Before estimating the model, BGK took the following steps: Computed logs f o r a l l the v a r i a b l e s , but the i n d i c a t o r v a r i a b l e s ; Introduced proxies f o r the time s e n s i t i v i t y v a r i a b l e . BGK argued that, the t i m e s e n s i t i v i t y of passengers i n a market should increase as income increased, and should be higher i n business than i n t o u r i s t markets. Therefore, BGK used an income v a r i a b l e 211 and t o u r i s t i n d i c a t o r v a r i a b l e s as p r o x i e s f o r the time-s e n s i t i v i t y v a r i a b l e ; Introduced a c i r c u i t y v a r i a b l e , CIRC, set equal to the average distance t r a v e l l e d by a l l passengers i n a market, divided by the non-stop distance. This v a r i a b l e was used to account for the possible differences i n p r i c e between markets serving mainly non-stop t r a v e l l e r s , and markets serving one-stop and multi-stop t r a v e l l e r s ; and, I n t r o d u c e d a v a r i a b l e , INT, to account f o r the number of t r a v e l l e r s i n a market that make i n t e r l i n e connections. However, when estimating the model, BGK d i d not make e x p l i c i t use of the t h e o r e t i c a l r e l a t i o n s h i p that was s p e c i f i e d , connecting p r i c e , mark-up and cost ( i . e . P = M(Structure) * C) . Instead, BGK estimated the p r i c e equation i n l o g - l i n e a r form, with the independent v a r i a b l e s being structure (represented by the H i r f i n d a h l Index) and those drawn from the cost equation. The major d i f f i c u l t i e s w i t h u s i n g d i f f e r e n t f u n c t i o n a l forms i n the t h e o r e t i c a l and empirical versions of the problem are two-fold. F i r s t , i t becomes d i f f i c u l t to make a priori predictions as to the signs of the regression c o e f f i c i e n t s i n the empirical model, based on predictions from a d i f f e r e n t model ( i . e . , the t h e o r e t i c a l model). 3 Second, the r e s u l t s from the empirical model become d i f f i c u l t to i n t e r p r e t since the expected signs are not known. 3 An e x c e p t i o n would be i f . the e m p i r i c a l model was a monotonic transformation of the t h e o r e t i c a l model. 212 5. Cost-Based Approach The cost-base approach to the comparison of a i r fares was used by Keeler (1972) to estimate hypothetical unregulated fares f o r regulated U.S. domestic routes. Keeler compared the estimated unregulated fares to the actual regulated fares for each of the routes. A large d i f f e r e n c e between the e s t i m a t e d and a c t u a l f a r e s on a route ind i c a t e d that the a i r l i n e s operating that route were not using " e f f i c i e n t " operating p r a c t i c e s . 4 In order to estimate hypothetical unregulated fares, Keeler f i r s t had to estimate a cost function for the U.S. trunk c a r r i e r s . ( A i r l i n e s with s u b s t a n t i a l i n t e r n a t i o n a l operations were excluded from the analysis because i t was thought that i n t e r n a t i o n a l costs were d i f f e r e n t from the costs of operating domestic routes.) Keeler (1972) next adjusted the cost function f o r the " e f f i c i e n t " operating p r a c t i c e s (such as higher load factors and seating d e n s i t i e s ) of the non-CAB regulated C a l i f o r n i a i n t r a - s t a t e c a r r i e r s . Keeler (1972) then computed the " e f f i c i e n t " long-run marginal costs of the U.S. trunk c a r r i e r s f o r each market. Keeler assumed that the e f f i c i e n t long-run marginal cost of operating on a route should approximate the p r i c e charged on a route i n a competitive, unregulated market. By comparing actual fares to the estimated competitive fares, Keeler could determine whether or not trunk c a r r i e r s were p r i c i n g at competitive l e v e l s . 4 No attempt was made to determine how large the diff e r e n c e had to be f o r i t to be s t a t i s t i c a l l y s i g n i f i c a n t . 213 The major advantage of Keeler's approach was that i t r e l i e d on sound economic the o r y . The major disadvantages of the approach were that i t required the use of extensive cost data, much of which i s d i f f i c u l t to obtain or to estimate, and that i t required the assumption of cost uniformity across routes within route groups (thus, the exclusion of c a r r i e r s with extensive i n t e r n a t i o n a l operations). Although t h i s assumption may have been acceptable f o r Keeler, i t cannot be used for t h i s study where cost uniformity across routes i s not assumed. Table 5.1 provides a summary of the advantages and disadvantages of the d i f f e r e n t approaches to the comparison of a i r fares. . C. A T h e o r e t i c a l Model f ° r Comparing Prices Across A i r l i n e Markets 1. Pricing Assumptions Under the Traditional and Competitive Agreements In t h i s s e c t i o n , a model i s developed t h a t may be used as the t h e o r e t i c a l basis f o r explaining p r i c e differences across markets. The model i s s p e c i f i c a l l y formulated to account f o r differences i n p r i c e s between markets covered by t r a d i t i o n a l b i l a t e r a l agreements, and markets covered by l i b e r a l or competitive b i l a t e r a l agreements. An assumption o f the model i s t h a t a i r l i n e s o p e r a t i n g under a t r a d i t i o n a l b i l a t e r a l agreement engage i n c o l l u s i v e p r i c i n g behaviour. The t r a d i t i o n a l agreement ( i . e . Bermuda agreement or pre-determination of capacity agreement) t y p i c a l l y promotes and often requires a i r l i n e s to engage i n c o l l u s i v e p r i c i n g behaviour. An example of how the t a r i f f clause i n t h i s 214 T a b l e 5.1 A d v a n t a g e s a n d D i s a d v a n t a g e s o f t h e A p p r o a c h e s t o t h e C o m p a r i s o n o f A i r F a r e s Approach Advantages Disadvantages Informal simple to conduct and to analyze Simple Regression Single Equation, M u l t i p l e Regression M u l t i p l e Equation able to generalize r e s u l t s from a sample to the population able to incorporate a large number of explanatory v a r i a b l e s into the model can accomodate more than one endogenous v a r i a b l e sample s i z e u s u a l l y n o t s u f f i c i e n t t o generalize from the sample to the population cannot a t t r i b u t e p r i c e differences to s p e c i f i c causes does not assess impact of more than one factor on p r i c e differences model does not allow f o r the c o r r e c t t r e a t -ment of right-hand-side endogenous va r i a b l e s does not e x p l i c i t l y l i n k empirical to t h e o r e t i c a l model d i f f i c u l t to make a priori predictions and to i n t e r p r e t r e s u l t s Cost-Based based on n e o - c l a s s i c a l micro economic theory requires extensive data assumption that a i r l i n e costs are homogeneous across routes wi t h i n route groups 215 type of agreement i s worded i s taken from the Canada-Greece b i l a t e r a l agreement (Canada, 1984c) and c i t e d below: ... The t a r i f f s r e f e r r e d to ... s h a l l be agreed upon between the designated a i r l i n e s of the Contracting P a r t i e s ; such agreement should be reached, whenever possible, through the i n t e r n a t i o n a l t a r i f f coordination mechanism of the International A i r Transport Association. The agreement further stated that, "No t a r i f f s h a l l come into force i f the aeronautical a u t h o r i t i e s of e i t h e r Contracting Party are d i s s a t i s f i e d with j i t . . . " . 5 In a d d i t i o n , the t r a d i t i o n a l b i l a t e r a l s often contain other measures designed to ensure c o l l u s i v e behaviour, such as required agreements on a i r l i n e c a p a c i t i e s or l i m i t a t i o n s on the number of c a r r i e r s allowed to operate each route. 6 The t a r i f f clause i n a l i b e r a l b i l a t e r a l agreement i s d i f f e r e n t from the t a r i f f c l a u s e i n a t r a d i t i o n a l agreement, i n t h a t i t encourages c o m p e t i t i v e , rather than c o l l u s i v e , p r i c i n g behaviour. An example of a l i b e r a l t a r i f f c l a u s e , taken from the U.S. model l i b e r a l agreement (Bogosian, 1981, pp. 1030-1031), i s c i t e d below: . . . Each Party s h a l l allow p r i c e s f o r a i r transportation to be e s t a b l i s h e d by each designated a i r l i n e based upon commercial 5 An e x c e p t i o n was made i f both c o u n t r i e s agreed to a l l o w the International C i v i l A v i a t i o n Organization to s e t t l e a t a r i f f dispute. . 6 For example, a study by Dresner and Tretheway (1987) of b i l a t e r a l agreements signed by Canada between 1978 and 1986 found that 8 of the 13 agreements l i m i t e d each country to one c a r r i e r per route and that 7 of the b i l a t e r a l s required agreement on capacity l e v e l s . 216 considerations i n the marketplace, s h a l l be l i m i t e d to: Intervention by the Parties (a) prevention of predatory or discriminatory p r i c e s or p r a c t i c e s ; (b) p r o t e c t i o n of consumers from p r i c e s that are unduly h i g h or r e s t r i c t i v e because o f the abuse of a dominant p o s i t i o n ; and (c) p r o t e c t i o n o f a i r l i n e s f r o m p r i c e s t h a t are a r t i f i c i a l l y low because of d i r e c t or i n d i r e c t government subsidy or support. In a d d i t i o n , l i b e r a l b i l a t e r a l s further discourage c o l l u s i v e p r a c t i c e by allowing the c a r r i e r s to f r e e l y determine capacity l e v e l s on a i r routes, and by allowing governments to designate a number of c a r r i e r s (instead of j u s t one) to operate any given route. Even though the l i b e r a l b i l a t e r a l s encourage competitive p r a c t i c e s , l i b e r a l a i r l i n e markets cannot, i n the n e o - c l a s s i c a l economic sense, be termed "competitive", with n small c a r r i e r s operating on each route. The a i r l i n e industry i s o l i g o p o l i s t i c (on a route by route b a s i s ) , rather than competitive, even on l i b e r a l routes. Therefore, an o l i g o p o l i s t i c p r i c i n g model, which r e f l e c t s the competitive conditions of the l i b e r a l agreement, i s appropriate f o r use to simulate p r i c i n g p r a c t i c e s on l i b e r a l routes. Although an argument could be made that a i r l i n e s on l i b e r a l routes choose q u a n t i t i e s , rather than prices ( i . e . , the Cournot duopoly model), i t was assumed for t h i s paper that p r i c e s were the key d e c i s i o n v a r i a b l e s . The model used to simulate p r i c i n g on l i b e r a l routes, therefore, was the Bertrand (or Bertrand-Nash) model, which postulates that a company chooses p r i c e s i n a c o m p e t i t i v e environment. The Bertrand model was chosen because i t i s 217 appropriate when modelling a price-competitive industry such as the a i r l i n e industry under l i b e r a l i z a t i o n . 2. The Cost Equation Before p r i c e equations can be derived under the c o l l u s i v e and Bertrand cases, a cost function must f i r s t be stated. A cost function f o r an a i r l i n e , i , operating on a given route, may be stated as follows: ^ ( A ^ x . q , ) — FC i (AA ) + VC A (q A ,x) (5.1) where: (A,) VCL ( x , q i ) the t o t a l cost of operating on a route; the f i x e d or overhead cost of operations on a route, dependent only on the a i r l i n e and not on the route, i t s e l f ; the v a r i a b l e c o s t o f o p e r a t i n g on a r o u t e , dependent on a vector of route c h a r a c t e r i s t i c s , x, (such as the distance of route and input p r i c e s on a route) and on the number of passengers the a i r l i n e c a r r i e s on a route, qL . I t i s assumed t h a t the v a r i a b l e c o s t f u n c t i o n i s increasing, but at a decreasing rate i n quantity. The major r e s t r i c t i o n s placed on the cost function are that v a r i a b l e cost i s decreasing i n quantity and that f i x e d costs do not depend on route-218 s p e c i f i c f a c t o r s . The f i r s t r e s t r i c t i o n , as o u t l i n e d above, i s consistent with the findings of Caves, Christensen and Tretheway (1984). The second assumption would l i k e l y make t h i s cost equation more us e f u l f o r modelling the costs of a large c a r r i e r ( i . e . , a c a r r i e r that serves a large number of points) than f o r a small c a r r i e r . This i s because f o r a large c a r r i e r , f i x e d costs would be l e s s dependent on any given route served. 3. The Price Equation Under a Competitive Agreement The assumption, as o u t l i n e d above, i s that under a competitive or l i b e r a l agreement c a r r i e r s engage i n Bertrand p r i c i n g behaviour. A i r l i n e s choose p r i c e s to maximize p r o f i t s i n a c o m p e t i t i v e manner. P r o f i t maximization f o r a i r l i n e i , on a route segment with two a i r l i n e s operating, can be i l l u s t r a t e d as follows: Max nL = p ^ C P i . P j ) - V C ^ q ^ x ) - FC ± (AA ) (5.2) Pi where: nL = the p r o f i t s a i r l i n e i derives from operating on a given route segment; pi = the p r i c e chosen by a i r l i n e i ; and, the other v a r i a b l e s are as indicated above. P r o f i t s are maximized when the d e r i v a t i v e of (5.2) with respect to pt i s set to zero, given the assumption that A i r l i n e , j , holds i t s p r i c e constant: dir. aq. 9q. T-3* = q. + p. ~ - MC. -T^ - 0 a p i M i * i d?i I ap t V (5.3) 219 given that the slope of the v a r i a b l e cost curve determines marginal cost. Equation (5.3) can be rearranged with p r i c e , alone, on the l e f t hand side as follows: p i - M C i - < i S ^ ( 5 - 4 ) The same a n a l y s i s may be undertaken f o r the o t h e r a i r l i n e , j , operating on the route, with the outcome being the p r i c e shown i n Equation 5.5: a P P. = MC. - q. T~~^  (5.5) J J J dqj U. The Price Equation Under a Traditional Bilateral Agreement As o u t l i n e d above, i t has been assumed that under a t r a d i t i o n a l agreement, a i r l i n e s engage i n c o l l u s i v e p r i c i n g behaviour. Following Bresnahan (1987), when choosing a p r i c e on a route, an a i r l i n e must consider the p r o f i t s of i t s c o m p e t i t o r s . For the two a i r l i n e case, p r o f i t maximization f o r a i r l i n e i , given a i r l i n e j , can be i l l u s t r a t e d as follows: Max O A + 7T. ) = P i q ^ P i . P j ) - V C ^ . x ) - FCL (A A) + (5.6) Pi P j q j ( P i , P j ) " VCjCqj.x) - F C J ( A J ) 220 Taking the d e r i v a t i v e of (5.6) with respect to p t while holding p^ constant, and s e t t i n g the d e r i v a t i v e equal to zero produces the following r e s u l t : 3q. dq. dq. dq. q. + p. T- 1 - MC. -r-2- + P. T-1 - MC- ~ 0 (5-7) M i * i 9p i l ap £ j 8v± J 3p, The extra terms i n Equation 5.7, as compared to Equation 5.3, r e f l e c t the e f f e c t of changes i n i ' s p r i c e on j ' s p r o f i t s . Equation 5.7 can be re-arranged with p r i c e on the l e f t hand side to y i e l d : 3p. dq. dp. A s i m i l a r equation to (5.8) can be written for the other a i r l i n e , j , i n the market, as shown i n Equation 5.9: dp. 3q. 3p. p. - MC. - q. T- 1 - (P. - MC.) 7-^ T-1 (5.9) J J J q j 1 1 P j q j 5. Reconciling the Prices I t can be seen, from examining Equations 5.4 and 5.8, that the d i f f e r e n c e i n p r i c e s charged by a i r l i n e i , between the two p r i c i n g s t r a t e g i e s , depends on the following term: 3q. ap. ( pj " " V i i j < 5 1 0 ) 221 The term shown i n Equation 5.10 appeared i n the equation d e f i n i n g the p r i c e charged by a i r l i n e i under a t r a d i t i o n a l b i l a t e r a l agreement, but not i n the equation d e f i n i n g the p r i c e charged under a l i b e r a l agreement. This i s because only under the t r a d i t i o n a l agreement w i l l A i r l i n e j change i t s output to r e a c t to changes i n A i r l i n e i ' s p r i c e . The term, therefore, r e p r e s e n t s the d i f f e r e n c e i n p r i c e s charged under the two regulatory arrangements, ceterus paribus. I t i s possible to sign t h i s term i n order to determine under which b i l a t e r a l arrangement should p r i c e s be higher or lower. F i r s t , pj - MCj should be p o s i t i v e given p r o f i t maximization and assuming no s u b s i d i e s u n d e r th e model. Second, dq^ /dpL must be p o s i t i v e i f s u b s t i t u t a b i l i t y of a i r s e r v i c e s i s assumed between a i r l i n e s i and j . F i n a l l y , the expression dpi/dqi must be negative given a normal demand curve f a c i n g a i r l i n e i . I f the expressions are m u l t i p l i e d together, the term shown i n (5.10) must be p o s i t i v e . A single expression f o r determining the p r i c e charged by a i r l i n e i on a route can then be written as follows: a P p. = ^[NLIB] + MC.( q i,x) - ^ q. aq, (5.11) aq, ap. where: ^ - -(p. - MC.) ^ ^ In equation 5.11, NLIB i s an i n d i c a t o r v a r i a b l e coded 1 when there i s no l i b e r a l or competitive b i l a t e r a l and 0 when there i s a l i b e r a l or competitive b i l a t e r a l . I f the p r i c i n g scenario described above holds true, then 0X should be p o s i t i v e . 222 One important f a c t to note from Equation 5.11 i s that the v a r i a b l e f o r passengers, qi , e n t e r s into the equation i n two separate places--as an argument i n the marginal cost formulation and with -d^>i/dqi as a c o e f f i c i e n t . The i n c l u s i o n of passengers i n the estimating equation can have both cost and demand e f f e c t s on p r i c e s . The demand e f f e c t of passengers on p r i c e , as r e p r e s e n t e d by the c o e f f i c i e n t -3p i/3q i , w i l l be p o s i t i v e . Increasing passenger demand on a route leads, ceterus paribus, to higher p r i c e s . The marginal cost e f f e c t of passengers on p r i c e t y p i c a l l y i s p o s i t i v e i n most markets ( i . e . , firms operating i n the range characterized by r i s i n g marginal c o s t s ) . Some researchers, however, have found evidence of d e c l i n i n g short run average costs i n the a i r l i n e industry ( i . e . , economies of density) and these may be associated with d e c l i n i n g marginal costs. To the extent that t h i s i s true, the marginal cost e f f e c t on p r i c e may be negative. 7 6. Using the Model with Route Specific Data Researchers, such as Bailey Graham and Kaplan (1985), have estimated t h e i r models with r o u t e - s p e c i f i c rather than a i r l i n e - s p e c i f i c v a r i a b l e s . The use of r o u t e - s p e c i f i c data requires a number of assumptions to be made about the a i r l i n e s o p e r a t i n g on a r o u t e . These assumptions have not been e x p l i c i t l y o u t l i n e d i n previous work. The assumptions, however, can be c l e a r l y made from the model used i n t h i s thesis since the s t a r t i n g point of the model has been an a i r l i n e - s p e c i f i c profit-maximizing problem. Assume, fo r the purposes of t h i s exposition, that there are two c a r r i e r s i n a market, 7 Declining costs pose a problem f o r marginal cost p r i c i n g i n that a subsidy w i l l normally be required. The a i r l i n e industry, however, has the a b i l i t y to p r i c e discriminate, thus allowing i t to operate i n the d e c l i n i n g range without need f o r subsidy. 223 A i r l i n e i and A i r l i n e j . The p r i c e equation f o r A i r l i n e i was given i n Equation 5.11 and a s i m i l a r equation can be written f o r A i r l i n e j . The two equations are as follows: p. = p1 NLIB + MC.( q i >x) - — q. (5.12) 4 i P j = a x NLIB + MC^qj.x) - ^  q j (5.13) Assume that the cost e f f e c t s of passengers on p r i c e can be separated from the other r o u t e - s p e c i f i c cost e f f e c t s and that v a r i a b l e s representing the e f f e c t s are entered into the p r i c e equation separately. The two equations can then be wr i t t e n as follows: p. = px NLIB + p2 x + £ 3q. (5.14) Pj = NLIB + c*2 x + a^q (5.15) where: £ 3 = -d'pi/d(\i plus the cost e f f e c t s of passengers on p r i c e and a3 = -dpj/dqj plus the cost e f f e c t s . fiz and a2 represent the e f f e c t of the route s p e c i f i c c o s t v a r i a b l e s (other than number of passengers) on p A and pj re s p e c t i v e l y . Equations 5.14 and 5.15 can be summed to produce the following equation: P t + Pj = <*-,_) NLIB + (P2+ a2) x + 0 ^ + o^q.. (5.16) 224 i f i t i s assumed that the r o u t e - s p e c i f i c costs f o r A i r l i n e i are equal to the r o u t e - s p e c i f i c costs f o r A i r l i n e j . F i n a l l y , i f i t i s assumed that the prices charged on the route by the two c a r r i e r s are the same ( i . e . , p A = Pj = p), and that the e f f e c t of passengers on p r i c e i s the same f o r both c a r r i e r s ( i . e . , /33 = O J 3 ) , Equation 5.16 can be divided by 2 to produce the following equation: p - 0[ NLIB + p'2 x + Q (5.17) h + al where: B^ = ~ ; h + a2 ?2 = 2 B3 + a 3 ^3 = 2 '• ' a n d ' Q = the t o t a l passenger t r a f f i c on the route. The r e s u l t i n g equation (5.17) i s a route s p e c i f i c , rather than c a r r i e r s p e c i f i c equation. Although the assumptions that must be made to a r r i v e at Equation 5.17 are reasonable ( i . e . p r i c e s and costs should be f a i r l y s i m i l a r f o r a i r l i n e s on a p a r t i c u l a r route), they are r e s t r i c t i v e . Given the a v a i l a b i l i t y of data, i t would be less r e s t r i c t i v e to use a i r l i n e - s p e c i f i c rather than r o u t e - s p e c i f i c data. 8 The author has l e f t t h i s f o r future research. 225 7. Comparison to Previous Work The model shown i n Equation 5.17 represents an improvement on previous work on three accounts. F i r s t , the model has been derived from the p r o f i t maximizing equations. This means the v a r i a b l e s to be included i n the model have also been derived from the p r o f i t maximizing assumptions so there i s not the uncertainty over which v a r i a b l e s to include. Second, i t i s possible, under the model s p e c i f i c a t i o n , to sign one of the key c o e f f i c i e n t s of the model. The c o e f f i c i e n t f o r "no l i b e r a l b i l a t e r a l " should be p o s i t i v e , as in d i c a t e d above. As well, i t should be noted that the c o e f f i c i e n t f o r the passengers v a r i a b l e c o n t a i n s a p o s i t i v e demand-side e f f e c t . This i s important because r e s e a r c h e r s have, i n the p a s t , m i s i n t e r p r e t e d the c o e f f i c i e n t f or the passengers v a r i a b l e i n p r i c e models. Bailey, Graham and Kaplan (1985, p.165), for example, interpreted the c o e f f i c i e n t as a measure of r e t u r n s to d e n s i t y when the correct i n t e r p r e t a t i o n must include the p o s i t i v e demand effect of passengers on price. F i n a l l y , the s p e c i f i c assumptions necessary for estimating a r o u t e - s p e c i f i c rather than a c a r r i e r -s p e c i f i c model have been o u t l i n e d . T h i s has a l l o w e d f o r a b e t t e r understanding of the l i m i t a t i o n s of the model. D. Estimation: Model and Data 1. The Model The empirical model to be estimated i s developed from the t h e o r e t i c a l model, shown i n Equation 5.17. The left-hand side of the model contains the p r i c e v a r i a b l e , while the right-hand side of the equation contains a dummy va r i a b l e i n d i c a t i n g the absence of a l i b e r a l or competitive b i l a t e r a l on a 226 route, a v a r i a b l e representing the cost of operating a route, and a v a r i a b l e i n d i c a t i n g the number of passengers c a r r i e d on a route. Each of these v a r i a b l e s w i l l be discussed, i n turn, below: a) Price As i l l u s t r a t e d i n E q u a t i o n 5.17, p r i c e i s the l e f t - h a n d - s i d e or dependent v a r i a b l e i n the model; i . e . , the v a r i a b l e to be estimated. There generally are a number of pr i c e s a v a i l a b l e on each route, such as f i r s t c l a s s , economy or f u l l fare, and a v a r i e t y of excursion or discount prices; The question becomes, which fare to use. There are two approaches that could be taken. The f i r s t approach i s to take a weighted average fare, weighted by the number of passengers who have used each fare c l a s s on a route. The major advantage o f t h i s approach i s that i t i s possible to determine how the regulatory agreement i n place has a f f e c t e d the average t r a v e l l e r on a route. The second approach that may be taken, and the one used i n t h i s paper, i s to use actual fares as left-hand-side v a r i a b l e s . Changes i n f u l l fares, f o r example, can then be compared across routes to determine the e f f e c t of a regulatory change on non-discretionary t r a v e l l e r s . The second approach was chosen f o r two reasons. F i r s t , i t was thought, a priori, that the change on some routes, from a t r a d i t i o n a l to a competitive agreement would not have the same impact on a l l fare classes. I f the l i b e r a l regime allowed c a r r i e r s more d i s c r e t i o n i n s e t t i n g p r i c e s , then the c a r r i e r s may have r e s o r t e d to g r e a t e r p r i c e d i s c r i m i n a t i o n between groups of t r a v e l l e r s . This could imply that the non-discretionary t r a v e l l e r might not be n e f i t , as much, from lower p r i c e s due to a l i b e r a l regime, as would the 227 d i s c r e t i o n a r y t r a v e l l e r . The second reason that t h i s approach was chosen was because of data a v a i l a b i l i t y . The breakdown of number of passengers per fare c l a s s , or the weighted average fare on a route, were not p u b l i c l y a v a i l a b l e . The p r i c e s used f o r t h i s thesis were the lowest a v a i l a b l e f u l l p r i c e 9 and the lowest a v a i l a b l e discount p r i c e that may be used f o r a fourteen-day return t r i p . F u l l fares were used to represent the p r i c e s paid by time s e n s i t i v e t r a v e l l e r s (e.g., business people), who could not t r a v e l under the advance-booking or time l i m i t a t i o n requirements of discount fares. Discount fares were used to represent fares paid by d i s c r e t i o n a r y passengers (e.g., those t r a v e l l i n g on vacation). b) No Competitive Bilateral The t h e o r e t i c a l model (Equation 5.17) implied that a v a r i a b l e should be employed to indic a t e the absence of a competitive or l i b e r a l b i l a t e r a l . A d e f i n i t i o n a l problem a r i s e s i n d e t e r m i n i n g e x a c t l y what constitutes a c o m p e t i t i v e b i l a t e r a l , i n t h a t t h e r e are degrees of " l i b e r a l n e s s " or competitiveness. I t was decided f or t h i s paper to use a broad d e f i n i t i o n of a competitive b i l a t e r a l , encompassing the following types of markets: i) Routes regulated by bilaterals with the following provisions: C a r r i e r s are able to f r e e l y determine capacity l e v e l s ; 9 The f u l l p r i c e was defined as the rate charged by an a i r l i n e which allowed the following: t i c k e t s to be purchased without advance-booking requirements; i n t e r l i n e connections; and, stopover p r i v i l e g e s . 228 A i r l i n e s are free to set p r i c e s without the approval of the foreign government; A d d i t i o n a l a i r l i n e s are f r e e to e n t e r routes covered by the agreement. These routes are the t r u l y l i b e r a l routes, allowing f o r c a r r i e r s to u n i l a t e r a l l y set p r i c e s and capacity l e v e l s , without government interference. i i ) U.S.-U.K. routes operated by the Laker Skytrain As was o u t l i n e d i n the l a s t chapter of t h i s t h e s i s , the l i b e r a l regime began on the North A t l a n t i c with the i n s t i t u t i o n of the Skytrain service i n the f a l l of 1977. This was the f i r s t service to open the North A t l a n t i c scheduled market to a large degree of p r i c e competition. Therefore, even though the service was of f e r e d under the n o n - l i b e r a l Bermuda 2 agreement, "Laker routes" between the U.S. and U.K. can s t i l l be s a i d to be p r i c e -competitive . 1 0 Hi) Non-liberal but competing routes These are routes not covered by l i b e r a l b i l a t e r a l s but which had to "compete" with l i b e r a l routes or with the Laker Skytrain i n order to minimize t r a f f i c d i v e r s i o n . These routes include markets where t r a f f i c can e a s i l y be d i v e r t e d to l i b e r a l routes i f c a r r i e r s are not price-competitive. Routes c l a s s i f i e d as n o n - l i b e r a l but competing markets included a l l routes between North America and a continent (or sub-continent i n the case of Asia) where 1 0 Similar points have been made by a number of authors. See: Adkins, et. al. (1982, p.10); Harbison (1982, p.187); and Gomez-Ibanez and Morgan (1984, pp.114 and 120). 229 the U.S. had signed a l i b e r a l b i l a t e r a l (or i n the case of Europe, where Skytrain service operated). The broad d e f i n i t i o n f o r competitive routes appeared to conform well w i t h e m p i r i c a l evidence i n that p r i c e reductions were observed on "non-l i b e r a l but competing routes" as well as on t r u l y l i b e r a l routes and routes operated by the Laker Skytrain. c) Route Specific Costs The t h e o r e t i c a l model indicated that the cost of operating a route should be included as a right-hand v a r i a b l e . The model also i n d i c a t e d that the cost of operating a route was dependent on r o u t e - s p e c i f i c f a c t o r s . In economic theory, these factors are generally s p e c i f i e d i n the form of input p r i c e s and an output v a r i a b l e . With respect to the a i r l i n e industry, the input p r i c e s would include such v a r i a b l e s as the p r i c e of labour and the p r i c e of f u e l on a given route. The output f a c t o r can be thought of as the number of passengers transported by a c a r r i e r on a route. U n f o r t u n a t e l y , r o u t e - s p e c i f i c i n p u t p r i c e s could not be obtained. Labour p r i c e s were not a v a i l a b l e on a r o u t e - s p e c i f i c b a s i s . Fuel p r i c e s were a v a i l a b l e on a regional basis only. Landing fees were a v a i l a b l e on a route by route b a s i s , but t h i s v a r i a b l e was d i f f i c u l t to employ since the fees depended on the type of a i r c r a f t used and often on a i r c r a f t landing times. Due to the d i f f i c u l t y i n obtaining route s p e c i f i c input costs, input costs were not d i r e c t l y employed i n the estimating equations. Two versions 230 of the empirical model were employed, each using proxies or instrumental v a r i a b l e s to account for possible differences i n cost factors across routes. In the f i r s t v e r s i o n of the model three types of v a r i a b l e s were used to account f o r c o s t d i f f e r e n c e s . F i r s t , an i n d i c a t o r v a r i a b l e was used to account f o r possible input p r i c e differences between routes which were and were not c l a s s i f i e d as "competitive" during any of the time periods of the study. This v a r i a b l e would account for p r i c e differences between competitive and n o n - c o m p e t i t i v e r o u t e s a t t r i b u t a b l e to r o u t e - s p e c i f i c f a c t o r cost d i f f e r e n c e s , rather than to the regulatory e f f e c t . Second, time i n d i c a t o r v a r i a b l e s were used to account for input p r i c e changes due to technological s h i f t s on routes across time p e r i o d s . 1 1 (Time s h i f t v a r i a b l e s were needed because of the panel data used f o r the study.) F i n a l l y , a distance v a r i a b l e was employed to account for route cost differences dependent on the length of the route, rather than on the l e v e l of factor input p r i c e s . In the second vers i o n of the model, route i n d i c a t o r v a r i a b l e s were used to account for cost differences across r o u t e s . 1 2 The route i n d i c a t o r v a r i a b l e s accounted for cost differences due to both v a r i a t i o n s i n f a c t o r costs across routes and to differences i n route length. Time i n d i c a t o r v a r i a b l e s were employed i n t h i s 1 1 I t should be noted that the time s h i f t v a r i a b l e s would also account f o r i n f l a t i o n a r y changes i n input p r i c e s . One would expect, therefore, that a g i v e n time s h i f t v a r i a b l e would account f o r p r i c e changes due to t e c h n o l o g i c a l s h i f t s as well as p r i c e changes due to i n f l a t i o n . As an example, i f the time s h i f t v a r i a b l e was larger f o r March 1978 than for March 1977, the d i f f e r e n c e i n magnitude between the two s h i f t e r s would equal i n f l a t i o n a r y changes net of p r o d u c t i v i t y improvements, over the one year period. 1 2 I t should be noted that when estimating the model one route d i d not have an i n d i c a t o r v a r i a b l e , to avoid s i n g u l a r i t y of the variance-covariance matrix. 231 v e r s i o n of the model, as well, to account f o r i n f l a t i o n a r y p r i c e changes and technological s h i f t s over time. d) Passengers The f i n a l v a r i a b l e to be included i n the p r i c e equation, as out l i n e d i n the t h e o r e t i c a l model, i s a passengers v a r i a b l e . The c o e f f i c i e n t of the passengers v a r i a b l e w i l l account f o r p r i c e differences on a route due to demand e f f e c t s ( i . e . , the greater the demand for passengers, the greater the p r i c e , ceterus paribus) and to cost e f f e c t s . The c o e f f i c i e n t f o r th i s v a r i a b l e can thus be interpreted as the t o t a l e f f e c t ( i . e . , the demand e f f e c t plus the cost e f f e c t ) of t o t a l passengers on p r i c e . e) Form of Estimation The model could not be used to produce unbiased and consistent estimates of the parameters, using ordinary l e a s t squares, because the passengers v a r i a b l e was endogenously determined ( i . e . , the number of passengers influences p r i c e but the p r i c e also influences the number of passengers). A two stage approach, on the other hand, could provide consistent estimates of the parameters, and was therefore employed. In the f i r s t stage, a demand equation was estimated with passengers as the left-hand v a r i a b l e . The r i g h t -hand side of the equation included v a r i a b l e s f o r population, route distance and income, a l l of which were exogenously determined. 1 3 In the second stage, 1 3 A number of versions of the f i r s t stage of the model were tested. I t was suspected that when time s h i f t and/or route s h i f t v a r i a b l e s were included i n the f i r s t stage of the model, that there was c o l l i n e a r i t y between these v a r i a b l e s and the f i t t e d value of passengers i n the second stage of the model. Although the c o l l i n e a r i t y d i d not a f f e c t the major r e s u l t s of the study, i t d i d a f f e c t the c o e f f i c i e n t s f o r the time, route and passengers v a r i a b l e s . As a r e s u l t , the time and route v a r i a b l e s were not included i n 232 p r i c e was regressed on the explanatory v a r i a b l e s (as ind i c a t e d above) but w i t h the f i t t e d value for passengers r e p l a c i n g the actual value of t h i s v a r i a b l e . The f i r s t stage of the estimation i s o u t l i n e d below: PASS = . B0 + B1 POP + B2 INC + B3 DIST (5.18) where: PASS POP INC DIST = t o t a l number of passengers c a r r i e d by scheduled a i r l i n e s on a route; = the mean population of the metropolitan areas of the o r i g i n and d e s t i n a t i o n c i t i e s ; = the mean income of the o r i g i n and d e s t i n a t i o n c i t i e s ; = the g r e a t c i r c l e d i s t a n c e between the o r i g i n and des t i n a t i o n c i t i e s ; and, the BL 's were the parameters to be estimated. The second stage of the model was estimated, with both the f u l l p r i c e and the discount p r i c e as left-hand side v a r i a b l e s , and with and without route i n d i c a t o r v a r i a b l e s on the right-hand side f o r each case (for a t o t a l of four estimations). The model, without route i n d i c a t o r v a r i a b l e s , was as follows: the f i r s t stage of the estimation. See Appendix D f o r the estimating r e s u l t s under d i f f e r e n t versions of the f i r s t stage of the model. 233 PRICE = BQ + y^NLIB + £ 2DIST + ^PASSFIT + /34 ATLPAC + £ ^ t T I M E t ( 5- 1 9) r where: PRICE = e i t h e r the lowest a v a i l a b l e f u l l or discount fare, on a route, depending on the estimation; NLIB = an i n d i c a t o r v a r i a b l e coded 1 i f the route was not regulated by a competitive or l i b e r a l b i l a t e r a l and 0 otherwise; DIST = the g r e a t c i r c l e d i s t a n c e between the o r i g i n and de s t i n a t i o n c i t i e s ; PASSFIT = the predicted value f o r passengers from the f i r s t stage of the model; ATLPAC = an i n d i c a t o r v a r i a b l e coded 1 for routes which crossed the A t l a n t i c or P a c i f i c and which had e i t h e r an o r i g i n or d e s t i n a t i o n i n North America ( i n c l u d i n g Hawaii). These were the t o t a l of the routes which, during the period of the sample, were regulated at some point by competitive b i l a t e r a l s ; and, TIME t's = i n d i c a t o r v a r i a b l e s for the d i f f e r e n t time periods. When the model was estimated with route i n d i c a t o r v a r i a b l e s , DIST and ATLPAC were removed and replaced by the route s h i f t v a r i a b l e s . The models were estimated i n both l i n e a r and l o g - l i n e a r forms. 234 2. The Data a) Routes Fifty-one u n i d i r e c t i o n a l i n t e r n a t i o n a l routes were randomly chosen from the routes f o r which the following conditions h e l d : 1 4 There were complete data a v a i l a b l e over the time period of the study - 1976-1981. Data were c o l l e c t e d f o r March and September of each year; There were at l e a s t four f l i g h t s per month i n the periods of the study. T h i s c o n d i t i o n e l i m i n a t e d t h i n l y t r a v e l l e d "natural monopoly" routes, and those routes which might have one or two f l i g h t s per month operated for p o l i t i c a l purposes; and, The routes were over 4,000 kilometres i n length. This condition e l i m i n a t e d short and medium haul routes i n an e f f o r t to guard against p r i c e e f f e c t s due to inter-modal competition. Althoug h the r o u t e s were randomly chosen from those which met the conditions, as s p e c i f i e d , the requirements precluded the s e l e c t i o n of many routes between developing countries. Complete information was more r e a d i l y a v a i l a b l e on routes between c i t i e s i n developed countries, and the sample of routes r e f l e c t e d t h i s b i a s . b) Prices Both f u l l and discount prices were gathered from the appropriate issues 1 4 The a v a i l a b l e routes were l i s t e d from f i r s t to l a s t and the actual routes chosen using a random number generator. 235 of the Official Airline Guide (Worldwide E d i t i o n ) . 1 5 When pri c e s were not a v a i l a b l e from t h i s source, they were c o l l e c t e d from issues of the ABC World Airways Guide. Extreme care was taken to ensure appropriate fares (based on the c r i t e r i a stated i n the previous section of the chapter) were chosen. A p o t e n t i a l problem with the use of published p r i c e s i s that they may not, i n a l l cases, r e f l e c t the actual t i c k e t fares paid by t r a v e l l e r s . This might happen i f a i r l i n e s changed t h e i r p r i c e s a f t e r the p u b l i c a t i o n dates of the guides, or i f t r a v e l agents discounted the published p r i c e s . Since the guides are published monthly, the f i r s t s i t u a t i o n hopefully i s not of major concern. The second problem - that actual p r i c e s and published p r i c e s may d i f f e r due to t r a v e l agency discounting - i s l i k e l y a bigger concern. "Bucket shops" or discount t r a v e l agencies are prevalent i n many parts of the world. Unfortunately, there i s l i t t l e that one can do to c o r r e c t f o r t h i s problem, s i n c e bucket shop pr i c e s are not known. I t should be noted, however, that the cheaper t i c k e t p r i c e s o f f e r e d by bucket shops overstate savings to consumers because the p r i c e s exclude search costs inherent i n f i n d i n g the discount t i c k e t s . The p r i c e s chosen were those that were i n force on the f i r s t day of each period on which data were c o l l e c t e d ( i . e . , March and September, 1976-1981). When p r i c e s changed during the month, a p o t e n t i a l errors i n v a r i a b l e problem was created. This was e s p e c i a l l y a problem f o r September when pr i c e s often 1 5 A l l p r i c e s were c o n v e r t e d to U.S. d o l l a r s on the basis of the exchange rates that existed on the f i r s t working day of the appropriate month. 236 changed from the high season rates to the "shoulder" rates towards the end of the month. 1 6 c) Passengers Passenger data were taken from the appropriate issues of the ICAO p u b l i c a t i o n , Traffic By Flight Stage. This p u b l i c a t i o n l i s t e d the number of s c h e d u l e d p a s s e n g e r s t r a v e l l i n g d u r i n g a g i v e n month on non-stop i n t e r n a t i o n a l routes, or route-legs. The major o m i s s i o n from t h i s data source was the number of non-scheduled or charter passengers. Charter data were not a v a i l a b l e on a route by route b a s i s , and therefore, could not be included. One might expect, a priori, that greater numbers of charter passengers would have had a downward influence on scheduled fares due to competitive pressures. However, the European experience, with a huge charter market (larger than the scheduled market) and some of the world's highest scheduled fares, shows that t h i s a priori assessment need not hold true. S u f f i c e i t to say, therefore, that the d i r e c t i o n of the bias, i f any, i n p r e d i c t i n g p r i c e , caused by the omission of a charter passengers v a r i a b l e , i s not known. d) Distance Route distances were gathered from the IATA p u b l i c a t i o n , Air Distances Manual. Although the manual l i s t s great c i r c l e distances, rather than actual 6 The errors i n v a r i a b l e problem i s discussed i n Appendix E. 237 f l i g h t d i s t a n c e s , d i s c r e p a n c i e s between these two fi g u r e s , on the long distance routes included i n the sample, should have been r e l a t i v e l y small. e) Non-Competitive Routes An i n d i c a t o r v a r i a b l e was used to d i f f e r e n t i a t e non-competitive routes, from competitive routes. Data on l i b e r a l routes were found i n Haanappel (1984) and Toh and Shubat (1985). Laker Airways i n s t i t u t e d i t s Skytrain i n September 1977. The f i r s t North A t l a n t i c l i b e r a l agreement was signed by the United States and the Netherlands i n March 1978, while the f i r s t P a c i f i c l i b e r a l agreement was signed by the United States and South Korea i n March 1979 (Haanappel, 1984, Appendix 3). A l l North A t l a n t i c routes were coded non-competitive u n t i l September 1977, and competitive following that date. P a c i f i c routes were coded non-competitive u n t i l March 1979 and competitive afterwards. Other routes i n the sample were coded as non-competitive for the ent i r e time period, since no competitive agreements a f f e c t e d these routes. I t i s important to note, therefore, that the dummy v a r i a b l e f o r "non-c o m p e t i t i v e r o u t e " does not mean "non-North A t l a n t i c or North P a c i f i c routes". This i s because even the North A t l a n t i c routes were coded non-c o m p e t i t i v e u n t i l September 1977 (when Laker i n i t i a t e d service) and the P a c i f i c r o u t e s u n t i l March 1979 (when the Korean l i b e r a l b i l a t e r a l was signed). There was a separate dummy v a r i a b l e used to indic a t e North A t l a n t i c / North P a c i f i c Routes. This v a r i a b l e , as described above, was used to account f o r c o s t d i f f e r e n c e s between these routes and other routes that might 238 otherwise be a t t r i b u t e d to a regulatory e f f e c t . I t was used when the route i n d i c a t o r v a r i a b l e s were not employed. f) Population and Income Population and income data, required f o r the estimation of the f i r s t stage of the model, were gathered from various United Nations and government s o u r c e s . The p o p u l a t i o n v a r i a b l e was computed as the mean of the metropolitan populations of the o r i g i n and d e s t i n a t i o n c i t i e s . C i t y s p e c i f i c data, however, were not a v a i l a b l e f o r income. The income v a r i a b l e , therefore, was computed as the mean per c a p i t a income ( i n U.S. d o l l a r s ) of the o r i g i n and d e s t i n a t i o n countries. When population or income data were not a v a i l a b l e f o r a s p e c i f i c year, i n t e r p o l a t i o n was used to provide estimates of the missing data. g) Descriptive Statistics Table 5.2 provides a summary of the routes i n the sample, the distance of the routes, and an i n d i c a t i o n of whether or not these routes came under the influence of competitive b i l a t e r a l s during the course of the time period under study. I t can be seen that 37 of the 51 routes were on the heavily-t r a v e l l e d North A t l a n t i c c o r r i d o r , f i v e were on the North P a c i f i c , four between North and South America, two within Asia, two between Europe and A s i a and one between Europe and South America. Table 5.3 p r o v i d e s d e s c r i p t i v e s t a t i s t i c s f o r the v a r i a b l e s i n the model. From t h i s table i t can be seen, f o r example, that the mean one-way f u l l p r i c e f or the observations was $494, while the mean one-way discount 239 Table 5.2 D e s c r i p t i v e S t a t i s t i c s - Routes O r i g i n D e s t i n a t i o n Code Geographical Area Route Distance L i b e r a l ( k i l o m e t r e s ) Influence Beginning Amsterdam Anchorage AMSANC North A t l a n t i c 7,195 March 78 Amsterdam Chicago AMSCHI North A t l a n t i c 6,614 March 78 Amsterdam Montreal AMSMON North A t l a n t i c 5,503 March 78 Anchorage Copenhagen ANCCOP North A t l a n t i c 6,935 March 78 Anchorage Hamburg ANCHAM North A t l a n t i c 7,123 March 78 Anchorage London ANCLON North A t l a n t i c 7,235 March 78 Bangkok Tokyo BANTOK I n t r a - A s i a 4,581 None Be I era Miami BELMIA N.- S. America 4,557 None Bombay Frankfurt BOMFRA Europe - A s i a 6,564 None Boston P a r i s BOSPAR North A t l a n t i c 5,534 March 78 Br u s s e l s New York BRUNEW North A t l a n t i c 5,881 March 78 Chicago Frankfurt CHIFRA North A t l a n t i c 6,966 March 78 Chicago London CHILON North A t l a n t i c 6,373 March 78 Edmonton London EDMLON North A t l a n t i c 6,844 March 78 Frankfurt Boston FRABOS North A t l a n t i c 5,886 March 78 Frankfurt Montreal FRAMON North A t l a n t i c 5,855 March 78 Frankfurt New York FRANEW North A t l a n t i c 6,185 March 78 Frankfurt Toronto FRATOR North A t l a n t i c 6,340 March 78 Glascow New York GLANEW North A t l a n t i c 5,158 March 78 Honolulu Seoul HONSEO North P a c i f i c 7,289 Sept. 79 London Bombay LONBOM Europe - A s i a 7,207 None London Boston LONBOS North A t l a n t i c 5,265 March 78 London Calgary LONCAL North A t l a n t i c 7,050 March 78 London Chicago LONCHI North A t l a n t i c 6,373 March 78 London Montreal LONMON North A t l a n t i c 5,248 March 78 London S e a t t l e LONSEA North A t l a n t i c 7,698 March 78 London Toronto LONTOR North A t l a n t i c 5,735 March 78 London Washington LONWAS North A t l a n t i c 5,898 March 78 Miami Be I em HIABEL N.- S. America 4,557 None Montreal Amsterdam HONAMS North A t l a n t i c 5,503 March 78 Montreal F r a n k f u r t MONFRA North A t l a n t i c 5,855 March 78 Montreal L i sbon M0NL1S North A t l a n t i c 5,248 March 78 New York Copenhagen NEWCOP North A t l a n t i c 6,184 March 78 New York Frankfurt NEWFRA North A t l a n t i c 6,185 March 78 New York Glascow NEWGLA North A t l a n t i c 5,158 March 78 New York L i sbon NEWLIS North A t l a n t i c 5,400 March 78 New York Rio de Ja n e i r o NEWRIO N.- S. America 7,725 None P a r i s Boston PARBOS North A t l a n t i c 5,534 March 78 Rio L i sbon RIOLIS Europe - S. America 7,710 None Rio Miami RIOMIA N.- S. America 6,712 None Rome Montreal ROMMON North A t l a n t i c 6,612 March 78 San Francisco Tokyo SANTOK North P a c i f i c 8,280 Sept. 79 S e a t t l e Copenhagen SEACOP North A t l a n t i c 7,805 March 78 S e a t t l e London SEALON North A t l a n t i c 7,698 March 78 Seoul Honolulu SEOHON North P a c i f i c 7,289 Sept. 79 Tokyo Bangkok TOKBAN I n t r a - A s i a 4,581 None Tokyo Los Angeles TOKLOS North P a c i f i c 8,808 Sept. 79 Tokyo S e a t t l e TOKSEA North P a c i f i c 7,708 Sept. 79 Toronto Amsterdam TORAMS North A t l a n t i c 5,987 March 78 Toronto London TORLON North A t l a n t i c 5,735 March 78 Washington London WASLON North A t l a n t i c 5,898 March 78 2 4 0 Table 5.3 D e s c r i p t i v e S t a t i a t i c e - V a r i a b l e s (unbiased estimates) INPUT STANDARD VARIABLE MEAN DEVIATION VARIANCE MINIMUM MAXIMUM MEDIAN F u l l P r i c e 494 147 21,525 198 1,027 474 (one-way, % U.S.) Discount 338 145 21,052 88 1,023 315 P r i c e (one-way % U.S.) Route 6,338 1,016 1,032,400 4,557 8,808 6,185 Distance (kilometres) Passengers 7,220 6,229 38,799,600 175 41,973 5,548 No .48 .50 .25 0 1 0 Competitive B i l a t e r a l A t l a n t i c or .82 .38 .15 0 1 1 P a c i f i c route Population 5,737 3,110 9,673,730 553 13,510 6,054 (000's) Income 7,492 2,512 6,311,050 1,500 13,075 7,331 ($ U.S.) p r i c e was about $338. 1 7 The average route distance i n the sample was over 6,300 kilometres, while the average number of passengers, per month, was 7,200. The e x h i b i t a l s o shows t h a t j u s t under f i f t y percent of the observation points were coded "non-competitive". E. Results of Estimation 1. Regressions on the Full Price a) Linear Regressions Table 5.4 contains the r e s u l t s of the l i n e a r regressions on the f u l l p r i c e . The f i r s t two columns i n the table are the ordinary l e a s t squares regressions, the f i r s t without route i n d i c a t o r v a r i a b l e s , and the second with route i n d i c a t o r v a r i a b l e s . 1 8 The t h i r d and fourth columns are two stage estimations, the t h i r d without route i n d i c a t o r v a r i a b l e s and the fourth with the i n d i c a t o r v a r i a b l e s . Since ordinary l e a s t squares regressions produce inconsistent estimates of the parameters, the discussion has been focused on the two stage regressions. The r e s u l t s from the t h i r d column show that the c o e f f i c i e n t of the v a r i a b l e no competitive b i l a t e r a l was of the expected sign, but insignxfrcant at the f i v e or even ten p e r c e n t l e v e l . T h i s implies, that the n u l l 1 7 Note that discount p r i c e s were l i s t e d i n the p r i c i n g guides on the basis of return t r i p s . The one way p r i c e was c a l c u l a t e d as one-half of the return p r i c e . 1 8 On a l l estimations with i n d i c a t o r v a r i a b l e s , one route v a r i a b l e had to be dropped from the regressions to avoid c o l l i n e a r i t y problems. The route i n d i c a t o r v a r i a b l e excluded was f o r Miami-Belem the low volume route i n March 1976. 242 T a b l e 5 . 4 L i n e a r R e g r e s s i o n s o n t h e F u l l P r i c e ( S t a n d a r d E r r o r s I n P a r e n t h e s e s ) C o e f f i c i e n t O L S O L S 2 - S t a g e 2 - S t a g e C o n s t a n t - 2 9 . 7 0 2 2 3 8 . 3 5 7 - 2 2 . 0 1 9 2 6 7 . 5 8 9 ( 3 6 . 2 2 4 ) ( 3 1 . 0 8 0 ) ( 3 5 . 5 7 5 ) ( 3 1 . 0 3 0 ) N o C o m p e t i t i v e 2 0 . 3 7 3 2 8 . 6 7 7 1 5 . 6 0 1 3 6 , . 6 0 4 B i l a t e r a l ( 1 7 . 3 4 6 ) ( 1 3 . 6 0 7 ) ( 1 7 . 0 5 5 ) ( 1 3 . 7 3 9 ) D i s t a n c e . 0 7 0 . 0 7 4 ( . 0 0 4 ) ( . 0 0 4 ) P a s s e n g e r s - . 0 0 3 - . 0 0 2 ( . 0 0 1 ) ( . 0 0 1 ) P a s s e n g e r s - - . 0 0 7 . 0 3 7 F i t t e d V a l u e ( . 0 0 1 ) ( . 0 1 1 ) A t l a n t i c o r - 5 9 . 5 3 4 - 5 5 . 7 9 8 P a c i f i c R o u t e ( 1 5 . 4 1 0 ) ( 1 5 . 1 6 6 ) S e p t e m b e r 7 6 5 4 . 1 4 1 5 1 . 4 9 0 4 5 . 6 4 2 4 7 , . 7 7 5 ( 1 9 . 0 9 2 ) ( 1 4 . 5 6 8 ) ( 1 8 . 7 0 1 ) ( 1 4 , . 0 5 7 ) M a r c h 7 7 1 8 . 4 8 9 1 8 , . 0 6 2 1 9 . 4 7 9 5 , . 7 6 3 ( 1 9 . 0 0 2 ) ( 1 4 . . 1 7 6 ) ( 1 8 , . 7 0 5 ) ( 1 4 . 4 3 2 ) S e p t e m b e r 7 7 9 7 . 8 8 1 9 5 , . 4 1 0 9 2 . 6 8 5 7 8 , . 4 4 5 ( 1 9 . 0 8 0 ) ( 1 4 , . 5 1 5 ) ( 1 8 . 7 0 5 ) ( 1 4 . 4 6 2 ) M a r c h 7 8 7 3 . 2 3 5 7 8 . . 6 7 8 7 5 , . 3 1 0 4 6 . . 9 1 5 ( 2 2 . 8 0 4 ) ( 1 7 . . 3 4 0 ) ( 2 2 , . 4 4 8 ) ( 1 8 . , 9 5 5 ) S e p t e m b e r 7 8 1 5 7 . 1 8 2 1 5 9 , . 3 9 2 1 4 9 , . 9 0 6 1 1 8 . . 0 7 6 ( 2 3 . 0 2 1 ) ( 1 8 . . 3 0 5 ) ( 2 2 , . 4 5 3 ) ( 1 9 , . 3 3 0 ) M a r c h 7 9 9 2 , . 3 3 0 9 7 . . 0 1 4 9 7 , . 3 2 3 3 7 . , 6 6 4 ( 2 2 , . 8 3 5 ) ( 1 7 . . 4 8 3 ) ( 2 2 , . 5 0 4 ) ( 2 3 . , 2 5 0 ) S e p t e m b e r 7 9 1 8 8 . . 7 4 2 1 9 0 . . 6 9 3 1 8 2 . , 9 3 0 1 2 2 . , 0 0 7 ( 2 4 , . 1 2 1 ) ( 1 9 . . 6 0 9 ) ( 2 3 , . 4 7 0 ) ( 2 4 . , 1 5 5 ) 24.3 Table 5.4 (Continued) March 80 178. (23. 165 862) 182.886 (18.489) 185. (23, .906 .552) 94 (29 .930 .533) September 80 287. (23. 835 982) 291.061 (19.019) 291. (23. .610 .564) 196 (30 .912 .253) March 81 244. (23. 322 851) 249.215 (18.439) 255, (23, .022 .602) 149 (32 .575 .384) September 81 269.693 (24.094) 271.874 (19.494) 268, (23. .926 .539) 182 (28 .153 .731) FRANEW 168.152 (45.107) -335 (134 .507 .003) NEWFRA 19.880 (45.707) -485 (134 .091 .003) SANTOK 146.737 (32.062) -283 (122 .862 .864) TOKLOS 286.522 (34.945) -278 (157 .304 .997) LONMON 47.855 (32.642) -206 (74, .478 .797) LONWAS 35.781 (34.735) -287. (91. .387 .172) LONBOM 299.366 (31.608) (86, .997 .445) WASLON 10.956 (34.725) -312, (91, .179 .172) ANCLON 95.973 (31.950) -190. (84. .582 .365) NEWRIO 130.585 (30.552) -393. (150. ,401 .577) NEWCOP 45.571 (32.405) -388. (124. ,033 ,448) LONCHI 130.259 (33.676) -269. (113. .052 .306) CHILON 107.038 (33.994) -293. (113. 468 306) 244 Table 5.4 (Continued) AMSMON BRUNEW AMSANC TORLON MONAMS TOKSEA RIOLIS SEALON LONTOR LONSEA LONBOS CHIFRA SEOHON AMSCHI HONSEO PARBOS ANCHAM 144.624 (31.595) 22.450 (31.593) 328.771 (31.112) 48.685 (33.722) 28.604 (31.514) 273.532 (31.183) 310.342 (30.266) 134.337 (32.207) 91.936 (33.832) 165.922 (32.079) .060 (35.055) 141.647 (31.892) 146.629 (30.314) 224.630 (31.372) 115.228 (30.220) 59.893 (30.996) 222.430 (31.120) 13.778 (45.680) -422.895 (129.009) 170.507 (52.732) -234.184 (81.221) -101.722 (45.680) -74.920 (101.066) 183.929 (43.859) -162.615 (86.815) -191.351 (81.221) -130.365 (86.815) -302.233 (85.196) -152.421 (86.490) -12.235 (52.406) -45.153 (80.809) -42.819 (52.406) -259.459 (95.134) 38.576 (58.941) 245 Table 5.4 (Continued) SEACOP ANCCOP TORAMS BANTOK NEWGLA GLANEW BOSPAR MONFRA FRAMON ROMMON BOMFRA NEWLIS TOKBAN FRATOR RIOMIA FRABOS MONLIS 206.621 (30.977) 225.237 (30.869) 55.618 (30.952) 65.246 (29.545) -26.417 (30.948) -18.771 (30.914) 31.079 (31.109) 43.890 (30.691) 175.630 (30.676) 99.163 (30.841) 321.577 (29.425) 4.350 (31.501) 109.779 (29.385) 225.439 (31.161) 68.758 (29.800) 156.462 (31.021) 8.694 (30.662) 56.715 (51.054) 92.051 (47.492) -94.213 (51.096) -163.503 (70.468) -413.721 (114.123) -405.721 (114.123) -289.292 (95.134) -99.656 (50.404) 32.344 (50.404) -29.396 (46.538) 151.950 (55.638) -342.038 (101.502) -117.003 (70.468) 52.670 (56.124) -129.347 (61.871) -30.053 (59.826) -21.508 (31.229) 246 Table 5.4 (Continued) L O N C A L 1 4 9 . 9 2 1 - 8 8 . . 8 8 1 ( 3 0 . 7 2 9 ) ( 7 4 . , 1 9 7 ) B E L M I A - 3 7 . 1 7 6 - 3 7 . , 0 8 3 ( 2 9 . 2 0 3 ) ( 2 8 . , 9 6 0 ) E D M L O N 9 1 . 1 1 0 - 1 4 5 , . 4 8 9 ( 3 0 . 7 0 9 ) ( 7 3 . . 6 9 7 ) R 2 . 5 8 3 7 8 7 5 9 6 , 7 9 0 B a s e d o n 6 1 2 o b s e r v a t i o n s . 247, hypothesis, that there i s no difference i n f u l l p r i c e s due to a "regulatory e f f e c t " , cannot be rejected. The c o e f f i c i e n t for the Distance v a r i a b l e was o f the expected s i g n , and s i g n i f i c a n t at the one percent l e v e l . The c o e f f i c i e n t f o r the f i t t e d passengers v a r i a b l e was negative and s i g n i f i c a n t . This implies that cost savings due to economies of density may have had an influence on p r i c e . The c o e f f i c i e n t for the i n d i c a t o r v a r i a b l e covering a l l North A t l a n t i c and North P a c i f i c routes ( i . e . , routes which experienced a "competitive regulatory e f f e c t " during the l a t t e r part of the time period of the study) was negative and s i g n i f i c a n t . This would i n d i c a t e that the f u l l p r i c e s on these routes were, f o r cost or other reasons, lower than f u l l p r i c e s on o t h e r r o u t e s , r e g a r d l e s s of the b i l a t e r a l regulatory regime. F i n a l l y , the time i n d i c a t o r v a r i a b l e s showed that there was a d r i f t upwards i n p r i c e s from 1976 to 1981. The i n d i c a t o r v a r i a b l e f o r March 1976 was omitted, so that March 1976 can be used as the base case. The existence of p o s i t i v e c o e f f i c i e n t s for the remaining time i n d i c a t o r v a r i a b l e s implies that p r i c e s were higher i n those periods, than i n March 1976. I t can also be noted that the c o e f f i c i e n t s for September were higher than the c o e f f i c i e n t s fo r March i n each of the years. This cannot be due to technology s h i f t s or to i n f l a t i o n , but must be a t t r i b u t e d to an errors i n v a r i a b l e problem (see Appendix E). The r e s u l t s of the two stage regressions on the f u l l p r i c e with the route i n d i c a t o r v a r i a b l e s i s shown i n the fourth column of Table 5.4. In t h i s regression, the c o e f f i c i e n t f o r No Competitive B i l a t e r a l i s p o s i t i v e and s i g n i f i c a n t at the one percent l e v e l . This would imply that p r i c e s on the n o n - c o m p e t i t i v e r o u t e s were s i g n i f i c a n t l y h i g h e r than p r i c e s on the 248 competitive routes. The c o e f f i c i e n t f o r the f i t t e d passengers v a r i a b l e was p o s i t i v e and s i g n i f i c a n t at the one percent l e v e l . This could imply that when a more thorough account i s made of cost differences between routes ( i . e . , when the route i n d i c a t o r v a r i a b l e s are used), the demand e f f e c t s of passengers on p r i c e i s predominant. F i n a l l y , the c o e f f i c i e n t s f o r the time i n d i c a t o r v a r i a b l e s are s i m i l a r to the c o e f f i c i e n t s i n the estimation without the route i n d i c a t o r v a r i a b l e s . In summary, the r e s u l t s of the l i n e a r regressions on the f u l l fare i n d i c a t e d that the absence of a competitive b i l a t e r a l may or may not have had a s i g n i f i c a n t l y p o s i t i v e e f f e c t on p r i c e s . S i g n i f i c a n t r e s u l t s were obtained only when route i n d i c a t o r v a r i a b l e s were included i n the estimation. b) Log-Linear Regressions The r e s u l t s from the l o g - l i n e a r regression on the f u l l p r i c e without i n d i c a t o r v a r i a b l e s (Table 5.5, column 3) were s i m i l a r to the r e s u l t s obtained i n the corresponding l i n e a r regression. The signs of most of the c o e f f i c i e n t s were the same i n both of the estimations. The c o e f f i c i e n t for No C o m p e t i t i v e B i l a t e r a l remained p o s i t i v e and i n s i g n i f i c a n t . The c o e f f i c i e n t f o r Distance remained p o s i t i v e and s i g n i f i c a n t . F i n a l l y , the c o e f f i c i e n t s f o r the f i t t e d passengers v a r i a b l e and the A t l a n t i c or P a c i f i c route v a r i a b l e , remained negative and s i g n i f i c a n t . The r e s u l t s from the l o g - l i n e a r regression with the route i n d i c a t o r v a r i a b l e s were s i m i l a r to the corresponding l i n e a r regression except, most importantly, f o r the c o e f f i c i e n t of No Competitive B i l a t e r a l . In t h i s case 249 Table 5.5 Log-linear Regressions on the F u l l Price (Standard Errors In Parentheses) Coefficient OLS OLS 2-Stage 2 -Stage Constant -.217 -.503 -.286 .902 (.063) (.084) (.061) ( .374) No Competitive .022 .014 .027 _ .022 Bilateral (.034) (.028) (.033) ( .029) Distance .950 1.102 (.051) (.054) Passengers -.031 .004 (.010) (.017) Passengers - -.127 .738 Fitted Value (.017) ( .192) Atlantic or -.144 -.115 Pacific Route (.031) (.030) September 76 .134 .119 .120 .127 (.038) (.030) (.036) ( .028) March 77 .047 .044 .050 .011 (.038) (.029) (.036) ( .030) September 77 .241 .225 .233 .192 (.038) (.030) (.036) ( .030) March 78 .161 .152 .179 .026 (.045) (.035) (.044) ( .048) September 78 .338 .312 .342 .180 (.046) (.038) (.044) ( .049) March 79 .198 .183 .222 .005 (.045) (.036) (.044) ( .060) September 79 .384 .354 .396 .157 (.048) (.040) (.046) ( .063) Table 5.5 (Continued) March 80 ( .372 .047) .353 (.038) ( .403 .046) .104 (.075) September 80 ( .545 .048) .521 (.039) ( .573 .046) .266 (.076) March 81 ( .482 .047) .465 (.038) ( .519 .046) .188 (.081) September 81 ( .512 .048) .483 (.040) ( .534 .046) .237 (.074) FRANEW .229 (.091) -1.228 (.388) NEWFRA -.126 (.091) -1.583 (.388) SANTOK .278 (.078) -1.374 (.437) TOKLOS .489 (.082) -1.369 (.490) LONMON .018 (.079) -.911 (.252) LONWAS -.039 (.083) -1.208 (.313) LONBOM .511 (.075) -.531 (.280) WASLON -.080 (.082) -1.249 (.313) ANCLON .168 (.077) -1.134 (.347) NEWRIO .268 (.073) -1.292 (.412) NEWCOP .038 (.078) -1.363 (.372) LONCHI .193 (.081) -1.161 (.360) CHILON .157 (.081) -1.197 (.360) 251 Table 5 .5 (Continued) AMSMON .254 -.289 (.075) (.156) BRUNEW -.027 -1.419 (.073) (.370) AMSANC .565 .192 (.072) (.117) TORLON .031 -1.036 (.080) (.287) MONAMS .007 -.535 (.075) (.156) TOKSEA .494 -.969 (.075) (.388) RIOLIS .561 -.121 (.072) (.189) SEALON .245 -1.124 (.077) (.364) LONTOR .108 -.960 (.080) (.287) LONSEA .286 -1.083 (.077) (.364) LONBOS -.120 -1.129 (.083) (.273) CHIFRA .253 -1.022 (.076) (.340) SEOHON .298 -.683 (.071) (.264) AMSCHI .409 -.774 (.074) (.316) HONSEO .241 -.741 (.070) (.264) PARBOS .103 -1.043 (.071) (.306) ANCHAM .399 -.306 (.072) (.195) 25,-2 Table 5.5 (Continued) SEACOP .379 -.485 (.071) (.235) ANCCOP .405 -.020 (.070) (.128) TORAMS .086 -. 588 (.070) (.187) BANTOK .154 -.464 (.067) (.173) NEWG1A -. 123 -1.273 (.070) (.307) GLANEW -.112 -1.263 (.070) (.307) BOSPAR .013 -1.133 (.071) (.306) MONFRA .068 -.623 (.066) (.191) FRAMON .334 -.357 (.066) (.191) ROMMON .191 -.636 (.069) (.225) BOMFRA .588 -.320 (.066) (.245) NEWLIS -.053 -1.129 (.074) (.289) TOKBAN .238 -.381 (.065) (.173) FRATOR .408 -.402 (.071) (.221) RIOMIA .156 -.817 (.068) (.262) FRABOS .293 -.537 (.070) (.226) MONLIS -.018 -.326 (.065) (.102) Table 5.5 (Continued) LONCAL .269 (.066) -.930 (.319) BELMIA -.070 (.059) -.070 (.058) EDMLON .176 (.066) -.994 (.312) R2 .583 .778 .613 .784 Based on 612 observations. 254 the c o e f f i c i e n t was negative and i n s i g n i f i c a n t , i n d i c a t i n g that there was no regulatory e f f e c t on the f u l l p r i c e . c) Summary of Major Results Four two stage regressions were estimated f o r the f u l l p r i c e . In three of the four regressions, the regulatory e f f e c t was i n s i g n i f i c a n t . This would imply that whether or not a route i s regulated by a competitive or non-competitive b i l a t e r a l has l i t t l e e f f e c t on the f u l l p r i c e . 2. Regressions on the Discount Price a) Linear Regressions The regressions on the discount p r i c e produced very d i f f e r e n t r e s u l t s from the regressions on the f u l l p r i c e . Table 5.6 shows the OLS and two stage l i n e a r regression r e s u l t s . The two stage regressions are i n columns 3 (without route i n d i c a t o r v a r iables) and 4 (with route i n d i c a t o r v a r i a b l e s ) . The regressions c l e a r l y showed a p o s i t i v e e f f e c t on the discount p r i c e due to the absence of a c o m p e t i t i v e b i l a t e r a l . In both two stage regressions, the c o e f f i c i e n t f o r no competitive b i l a t e r a l was s i g n i f i c a n t at the one percent l e v e l . This would imply that the absence of a competitive b i l a t e r a l contributed s i g n i f i c a n t l y to higher discount p r i c e s . The c o e f f i c i e n t s of the other v a r i a b l e s i n the estimation without the route i n d i c a t o r v a r i a b l e s (column 3) , were s i m i l a r to the c o e f f i c i e n t s from the corresponding regression on the f u l l p r i c e : the c o e f f i c i e n t f o r Distance was p o s i t i v e and s i g n i f i c a n t ; the c o e f f i c i e n t f o r the f i t t e d passenger 255 Table 5 . 6 L i n e a r R e g r e s s i o n s o n t h e D i s c o u n t P r i c e (Standard Errors In Parentheses) Coefficient OLS OLS 2-Stage 2-Stage Constant -133.186 (35.460) 75, (28, .951 .304) -131.802 (34.890) 68 (28 .802 .474) No Competitive Bilateral 165 (16 .987 .980) 144, (12, .685 .392) 164 (16 .033 .726) 142 (12 .421 .607) Distance ( .061 .004) ( .065 .004) Passengers ( .001 .001) C .000 .001) Passengers -Fitted Value ( .005 .001) ( .010 .010) Atlantic or Pacific Route -108 (15 .638 .085) -102 (14 .661 .873) September 76 31, (18. .737 .689) 27, (13. .986 .266) 28 (18, .832 .341) 28 (12 .614 .899) March 77 12, (18, .448 .601) 11, (12. .843 .910) 13 (18, .605 .345) 15, (13, .010 .243) September 77 60, (18. .409 .677) 56. (13. ,913 .219) 59, (18. .577 .345) 61. (13, .036 .270) March 78 57. (22. ,937 ,323) 41. (15. ,659 791) 60. (22, .980 .016) 49, (17. .769 .394) September 78 162. (22. ,983 .535) 142. (16. .131 .670) 163, (22, .181 .020) 152, (17. .322 .737) March 79 99, (22. ,973 ,353) 82. (15. 621 922) 105. (22. .868 ,070) 97. (21. ,859 ,334) September 79 126. (23. .765 ,613) 102. (17. ,304 857) 129. (23. ,295 ,018) 119. (22. ,508 ,165) 256 Table 5.6 (Continued) March 80 132, (23, .771 .358) 112.230 (16.837) 141.553 (23.098) 134 (27 .844 .100) September 80 195.221 (23.476) 172.565 (17.320) 202.934 (23.110) 196 (27 .606 .761) March 81 137. (23. ,529 .348) 117.233 (16.792) 148.157 (23.147) 142 (29 .930 .716) September 81 174. (23. .299 586) 150.164 (17.753) 180.047 (23.086) 172 (26 .908 .364) FRANEtf 116.769 (41.078) 245 (122 .347 .964) NEWFRA 19.800 (41.625) 148 (122 .639 .964) SANTOK 173.430 (29.199) 285 (112 .023 .743) TOKLOS 289.633 (31.824) 435 (144 .745 .980) LONMON 24.743 (29.726) 90 (68 .207 .635) LONWAS -3.459 (31.632) 79. (83, .527 .661) LONBOM 376.613 (28.784) 454. (79. .075 .323) WASLON 8.089 (31.623) 91. (83. .069 .661) ANCLON 83.641 (29.096) 157. (77. 766 414) NEWRIO 93.364 (27.823) 229. (138. 731 172) NEWCOP 37.590 (29.510) 150. (114. 093 196) LONCHI 37.550 (30.668) 140. (103. 725 972) CHILON 46.103 (30.958) 149. (103. 517 972) 257 Table 5.6 (Continued) AMSMON 110.642 144.104 (28.773) (41.917) BRUNEW 65.060 180.919 (28.772) (118.381) AMSANC 218.009 258.877 (28.333) (48.387) TORLON -15.819 56.839 (30.710) (74.530) MONAMS 24.287 57.646 (28.699) (41.917) TOKSEA 296.808 387.145 (28.398) (92.740) RIOLIS 395.403 427.713 (27.562) (40.246) SEALON 62.786 139.549 (29.330) (79.663) LONTOR 38.848 111.589 (30.810) (74.530) LONSEA 44.668 121.299 (29.214) (79.663) LONBOS 5.995 83.444 (31.924) (78.177) CHIFRA 67.747 143.861 (29.043) (79.365) SEOHON 186.308 227.330 (27.607) (48.088) AMSCHI 157.689 227.646 (28.570) (74.152) HONSEO 143.346 184.205 (27.521) (48.088) PARBOS 66.133 149.270 (28.228) (87.297) ANCHAM 174.369 221.936 (28.341) (54.086) 258 Table 5.6 (Continued) SEACOP 149.712 188.468 (28.210) (46.848) ANCCOP 174.772 209.218 (28.112) (43.579) TORAMS 49.471 88.223 (28.187) (46.886) BANTOK 83.350 142.824 (26.906) (64.663) NEWGLA 2.520 103.490 (28.184) (104.721) GLANEW 1.715 102.615 (28.153) (104.721) BOSPAR 45.222 128.562 (28.330) (87.297) MONFRA 31.922 69.236 (27.950) (46.251) FRAMON 140.682 177.944 (27.936) (46.252) ROMMON 136.378 169.632 (28.087) (42.704) BOMFRA 382.382 426.456 (26.797) (51.054) NEWLIS 17.012 106.984 (28.687) (93.140) TOKBAN 187.908 246.990 (26.761) (64.663) FRATOR 162.842 207.484 (28.378) (51.501) RIOMIA 128.550 179.848 (27.139) (56.774) FRABOS 149.003 197.323 (28.250) (54.897) MONLIS 28.777 36.429 (27.923) (28.657) 259 Table 5.6 (Continued) LONCAL 78.508 140.739 (27.985) (68.085) BELMIA 63.393 63.375 (26.595) (26.574) EDMLON 44.111 105.785 (27.966) (67.626) R2 .591 .819 .603 .819 Based on 612 observations. 260 v a r i a b l e was n e g a t i v e and s i g n i f i c a n t ; the c o e f f i c i e n t f o r A t l a n t i c or P a c i f i c routes was negative and s i g n i f i c a n t ; and, the c o e f f i c i e n t s f o r the time i n d i c a t o r v a r i a b l e s showed a reasonably steady increase i n pr i c e s over the period of study (except f o r the errors i n v a r i a b l e problem). Similar r e s u l t s were obtained i n the estimation with the route i n d i c a t o r v a r i a b l e s except the c o e f f i c i e n t f o r the f i t t e d passengers v a r i a b l e was not s i g n i f i c a n t . ( I t was p o s i t i v e and s i g n i f i c a n t when the f u l l p r i c e was regressed on the explanatory v a r i a b l e s , including the route " s h i f t e r s " . ) b) Log-Linear Regressions The r e s u l t s from the l o g - l i n e a r regression on the discount p r i c e without the i n d i c a t o r v a r i a b l e s shown i n Table 5.7 were s i m i l a r to the r e s u l t s of the l i n e a r regression without the i n d i c a t o r v a r i a b l e s . On the other hand, the r e s u l t s of the l o g - l i n e a r regression with the i n d i c a t o r v a r i a b l e s were, i n f a c t , d i f f e r e n t from the corresponding l i n e a r regression. The c o e f f i c i e n t of the f i t t e d passengers v a r i a b l e was p o s i t i v e and s i g n i f i c a n t rather than negative and i n s i g n i f i c a n t . As well the time s h i f t v a r i a b l e s were mainly i n s i g n i f i c a n t at the f i v e percent l e v e l . One explanation f o r these r e s u l t s could be c o r r e l a t i o n between the passengers v a r i a b l e and the time s h i f t e r s ; that i s , the passengers v a r i a b l e tracks a time trend, increasing over time. The i n t e r e s t i n g f a c t about the l o g - l i n e a r regressions was that since the c o e f f i c i e n t s may be interpreted as e l a s t i c i t i e s , i t i s pos s i b l e to asce r t a i n the magnitude o f the " r e g u l a t o r y e f f e c t " on the discount p r i c e . The c o e f f i c i e n t f o r No Competitive B i l a t e r a l was estimated at .48 on the two 261 Table 5.7 Log-linear Regressions on the Discount Price (Standard Errors In Parentheses) Coefficient OLS OLS 2-Stage 2-Stage Constant - .337 - .689 - .414 .845 ( .090) ( .118) ( .088) ( .529) No Competitive .478 :389 .482 .347 Bilateral ( .049) ( .039) ( .048) ( .041) Distance 1 .129 1 .306 ( .073) ( .078) Passengers _ .042 _ .002 ( .014) ( .024) Passengers - _ .152 .794 Fitted Value ( .024) ( .271) Atlantic or _ .260 _ .228 Pacific Route ( .044) ( .043) September 76 .108 .091 .089 .097 ( .054) ( .042) ( .052) ( .040) March 77 .031 .027 .034 _ .009 ( .054) ( .040) ( .052) ( .042) September 77 .193 .176 .182 .138 (. .054) ( .042) ( .052) ( .042) March 78 .063 _ .005 .084 _ .143 (• .064) ( .050) ( .063) (. .068) September 78 .402 .314 .403 .167 (. ,065) ( .053) (. .063) (. .070) March 79 ,195 .121 .222 .085 (• 065) (. .050) (• .063) ,085) September 79 ,305 .205 .315 _ ,013 068) .056) .066) ,090) 262 Table 5.7 (Continued) March 80 ( .332 .067) .245 (.053) ( .367 .066) -.027 (.105) September 80 ( .526 .068) .434 (.054) ( .557 .066) .154 (.108) March 81 ( .309 .067) .224 (.053) ( .352 .066) -.077 (.114) September 81 ( .417 .068) .318 (.056) ( .439 .066) .048 (.105) FRANEW .339 (.128) -1.255 (.549) NEWFRA .001 (.129) -1.593 (.549) SANTOK .506 (.109) -1.290 (.617) TOKLOS .745 (.115) -1.275 (.693) LONMON -.047 (.111) -1.066 (.357) LONWAS -.137 (.116) -1.416 (.443) LONBOM .793 (.105) -.345 (.396) WASLON -.075 (.116) -1.354 (.443) ANCLON .217 (.108) -1.201 (.490) NEWRIO .288 (.103) -1.408 (.583) NEWCOP .043 (.110) -1.483 (.527) LONCHT .054 (.114) -1.422 (.510) CHILON .084 (.114) -1.392 (.510) 2 6 3 Table 5.7 (Continued) AMSMON .303 -.297 (.106) (.221) BRUNEW .137 -1.376 (.103) (.523) AHSANC .604 .188 (.101) (.165) TORLON -.216 -1.383 (.113) (.406) MONAMS -.016 -.616 (.105) (.221) TOKSEA .751 - .841 (.105) (.549) RIOLIS .841 .091 (.101) (.268) SEALON .143 -1.348 (.109) (.515) LONTOR .013 -1.155 (.112) (.406) LONSEA .077 -1.413 (.108) (.515) LONBOS -.076 -1.183 (.117) (.386) CHIFRA .156 -1.233 (.107) (.481) SEOHON .521 -.548 (.099) (.374) AMSCHI .447 -.841 (.104) (.447) HONSEO .421 -.648 (.098) (.374) PARBOS .146 -1.100 (•100) (.433) ANCHAM .493 -.280 (.101) (.276) 264 Table 5.7 (Continued) SEACOP .422 -.521 (.099) (.332) ANCCOP .482 .012 (.098) (.181) TORAMS .035 -.702 (.098) (.265) BANTOK .255 -.421 (.094) (•244) NEWGLA -.107 -1.357 (.098) (.435) GLANEW -.121 -1.371 (.098) (.435) BOSPAR .074 -1.172 (.100) (.433) MONFRA .005 -.748 (.093) (.270) FRAMON .383 -.369 (.093) (.270) ROMMON .385 -.516 (.097) (.319) BOMFRA .805 -.184 (.092) (.347) NEWLIS -.043 -1.216 (.104) (.408) TOKBAN .487 -.189 (.091) (.244) FRATOR .449 -.436 (.101) (.313) RIOMIA .366 -.694 (.096) (.370) FRABOS .396 -;510 (.099) (.320) MONLIS .007 - .332 (.092) (.144) 265 Table 5.7 (Continued) LONCAL .154 (.093) -1.146 (.451) BELHIA .195 (.083) .195 (.083) EDMLON .056 (.093) -1.212 (.441) R2 .578 .780 .599 .783 Based on 612 observations. 266 stage run without route i n d i c a t o r v a r i a b l e s and .35 on the two stage run with the route i n d i c a t o r v a r i a b l e s . This would imply that the absence of a competitive b i l a t e r a l r e s u l t e d i n discount p r i c e s approximately 35 to 48 percent higher than on routes under the influence of a competitive agreement. c) Summary of Major Results Four two-stage estimations were made of the discount p r i c e . The major r e s u l t s showed that there was a s i g n i f i c a n t regulatory e f f e c t . The lowest a v a i l a b l e discount p r i c e s were s u b s t a n t i a l l y higher i n markets where there was no competitive b i l a t e r a l agreement. The comparison of discount fare r e g r e s s i o n s to the estimations with the f u l l fare as the left-hand-side v a r i a b l e , h i g h l i g h t s the regulatory e f f e c t . The values of the c o e f f i c i e n t f o r No Competitive B i l a t e r a l were 15.6 and 36.6 ( t - s t a t i s t i c s equal 0.9 and 2.7 resp e c t i v e l y ) on the l i n e a r two stage estimations with the f u l l fare as the left-hand-side v a r i a b l e . In contrast, the values of the c o e f f i c i e n t f o r No Competitive B i l a t e r a l were 164 and 142 ( t - s t a t i s t i c s equal 9.8 and 11.3, resp e c t i v e l y ) f o r the l i n e a r two stage estimations with the discount fare as the dependent v a r i a b l e . This would imply that the absence of the l i b e r a l b i l a t e r a l c o n t r i b u t e d to s i g n i f i c a n t l y higher discount p r i c e s , but not ne c e s s a r i l y to higher f u l l fares. F. Residual Analysis A number of tests were conducted on the resi d u a l s from the estimations to determine whether or not there were ind i c a t i o n s of h e t e r o s c e d a s t i c i t y or autocor r e l a t i o n . Heteroscedasticity tests were conducted based on the tes t 267 proposed by Johnston (1984, pp. 298-300) f o r measuring the equality of variances across panel data. The observations were grouped both by time period ( i . e . across routes) and by route cross-section f o r t e s t i n g purposes. For none of the estimations could the hypothesis of homoscedastic variances be r e j e c t e d at the f i v e or ten percent error l e v e l s . The r e s u l t s from the rou t e c r o s s s e c t i o n t e s t s d i d show, however, a tendency to have less h e t e r o s c e d a s t i c i t y when route v a r i a b l e s were included i n the estimations. T e s t s were a l s o c o n d u c t e d to check f o r f i r s t o r der temporal a u t o c o r r e l a t i o n . The data base was reconstructed on the basis of a l l observations f o r one route ( i . e . across time) followed by a l l observations for a second route, etc., and the Durbin-Watson s t a t i s t i c s computed. 1 9 The magnitude o f the Durbin-Watson s t a t i s t i c s i n d i c a t e d t h a t f i r s t order a u t o c o r r e l a t i o n was present but the autocorrelation was eliminated when diff e r e n c e equations were estimated, without a f f e c t i n g the major findings of the o r i g i n a l estimations. G. Conclusions The purposes of t h i s study were two-fold. F i r s t , to improve on the e x i s t i n g methodology f o r the comparison of a i r l i n e p r i c e s (fares) across markets. Second, to apply a model to i n t e r n a t i o n a l p r i c e data to determine the e f f e c t of competitive b i l a t e r a l s on a i r f a r e s . 1 9 A sampling command was used to exclude possible c o r r e l a t i o n between the l a s t observation of one route and the f i r s t observation of a second route i n the c a l c u l a t i o n of the Durbin-Watson s t a t i s t i c s . 268 The model developed f o r t h i s study was an improvement on e x i s t i n g models because: i t was developed from basic p r o f i t maximization assumptions; i t o u t l i n e d the v a r i a b l e s to be included i n the estimations and the functional form to be used; i t allowed for the researcher to make a priori predictions as to the sign of a key c o e f f i c i e n t i n the model; and, because i t c l e a r l y s p e c i f i e d the assumptions required i n the use of r o u t e - s p e c i f i c data. The model was used to compare pr i c e s on long-distance i n t e r n a t i o n a l a i r routes during the period 1976-1981. Data were gathered on f i f t y - o n e routes and several v a r i a t i o n s of the model tested. The r e s u l t s showed that the existence of a competitive b i l a t e r a l agreement had a large negative e f f e c t ( b e n e f i c i a l e f f e c t ) on discount p r i c e s , but only a small or no e f f e c t on f u l l f a res. This i s an i n d i c a t i o n of the a b i l i t y of c a r r i e r s to p r a c t i c e greater p r i c e d i s c r i m i n a t i o n under a competitive regime. F i n a l l y , a number of tests were conducted to examine the r e s i d u a l s from the regression models. The major problem with the r e s i d u a l s appeared to be temporal f i r s t - o r d e r autocorrelation. Difference models were estimated which eliminated the autocorrelation problems without a f f e c t i n g the major r e s u l t s of the study. 269 P A R T F O U R : C O N C L U S I O N S A N D F U T U R E R E S E A R C H 270 VI. CONCLUSIONS AND FUTURE RESEARCH A. Regime Changes 1. Conclusions The major research questions pertaining to the regime change se c t i o n of the thesis were posed at the outset of Chapter IV: How w e l l does the theory of hegemonic s t a b i l i t y account for regime developments i n i n t e r n a t i o n a l a i r transport?; and, Do other factors described i n t h i s t h e s i s add s i g n i f i c a n t l y to the understanding of why the a i r transport regime was formed, maintained, or changed? The conclusion reached was that the modified theory of hegemonic s t a b i l i t y could explain the adoption of the post-World War Two Bermuda regime and the maintenance of the regime during the 1940s, 1950s, and early-to-mid-1970s, but could not, by i t s e l f , explain the change to the l i b e r a l regime and the p o s t - l i b e r a l developments. P o l i t i c a l and economic f a c t o r s added s i g n i f i c a n t l y to the explanation of these l a t t e r developments. 2. Future Research Work needs to be undertaken on the formulation of an al t e r n a t e theory or model to explain regime developments. The theory of hegemonic s t a b i l i t y has l i m i t e d e x p l a n a t o r y powers l a r g e l y because of i t s s i n g l e - v a r i a b l e construction ( i . e . world dominance by a country i s the s i n g l e f a c t o r used to explain regime developments) . Clearly, factors such as economic events and domestic p o l i t i c a l a f f a i r s are important i n the explanation of regime developments and should be incorporated into future theories or models. 271 B. P r i c e E f f e c t s 1. Conclusions The major question posed at the outset of Chapter V was as follows: Did the change to the l i b e r a l regime i n the l a t e 1970s contribute to lower prices on i n t e r n a t i o n a l a i r routes? In order to answer t h i s question, a model was f i r s t formulated and then used to t e s t f o r p r i c e e f f e c t s due to the s h i f t to the l i b e r a l regulatory regime. The model represented an advance on previous work because of i t s t h e o r e t i c a l underpinnings, which determined the variables to be included, the expected sign of the c o e f f i c i e n t f o r a key va r i a b l e ( i . e . , the regulatory s h i f t v a r i a b l e ) and the necessary assumptions f o r using r o u t e - s p e c i f i c data. Results obtained from the empirical tests supported the hypothesis derived from the t h e o r e t i c a l model - that markets a f f e c t e d by c o m p e t i t i v e b i l a t e r a l s had lower d i s c o u n t p r i c e s than non-competitive markets. F u l l fares were l a r g e l y unaffected by the change to the l i b e r a l regime. 2. Future Research There are at l e a s t four d i r e c t i o n s f o r future research that may a r i s e from the p r i c i n g work i n t h i s t h e s i s . F i r s t , the work can be extended to determine the welfare e f f e c t s a r i s i n g from the change to a l i b e r a l regulatory regime i n the a i r transport industry. This work would provide policy-makers with a greater understanding of the winners and losers from the change to a l i b e r a l regulatory regime. Second, the model can be tested to determine the p r i c e e f f e c t s from regulatory p o l i c i e s i n s p e c i f i c regions of the world. For example, the model might be used to determine the p r i c e e f f e c t s a r i s i n g from 272 European regulatory developments. Third, the p r i c i n g model can be adapted to ot h e r i n d u s t r i e s to measure the e f f e c t on pr i c e s of regulatory s h i f t s . Trucking i n North America might be an industry s u i t a b l e f o r t h i s type of anal y s i s . F i n a l l y , the model can be estimated on an a i r l i n e s p e c i f i c basis ( i . e . , one observation per a i r l i n e per market) rather than on a market-s p e c i f i c b a s i s . Estimation i n t h i s disaggregated form could be used to tes t the assumptions made when the data were aggregated. 273 APPENDICES 274 Appendix A Data Tables Corresponding to Figures i n Text Table Al Scheduled Airl i n e Services - Tonne Kilometres Year To t a l Tonne-Kilometres International Tonne-Kilometres ( B i l l i o n s ) ( B i l l i o n s ) 1950 4 1 1951 4 1 1952 5 2 1953 5 2 1954 6 2 1955 7 2 1956 8 3 1957 9 3 1958 10 4 1959 11 4 1960 12 5 1961 13 6 1962 15 7 1963 17 8 1964 20 10 1965 23 12 1966 28 12 1967 33 14 1968 39 16 1969 43 19 1970 57 22 1971 60 24 1972 68 28 1973 76 33 1974 81 35 1975 85 37 1976 93 42 1977 100 47 1978 114 53 1979 127 61 1980 131 64 1981 135 68 1982 138 70 1983 146 74 1984 158 82 1985 167 86 275 Table A2 Scheduled A i r l i n e Services - Passenger Kilometres Year To t a l Passenger-Kilometres International Passenger-Kilometres ( B i l l i o n s ) ( B i l l i o n s ) 1945 8 N.A.. 1946 16 N.A. 1947 19 N.A. 1948 21 N.A. 1949 24 N.A. 1950 28 11 1951 35 12 1952 40 13 1953 46 15 1954 52 16 1955 61 19 1956 71 23 1957 81 27 1958 85 30 1959 97 35 1960 109 43 1961 117 49 1962 130 57 1963 147 65 1964 171 77 1965 199 89 1966 229 91 1967 273 104 1968 316 114 1969 351 133 1970 460 162 1971 494 173 1972 560 206 1973 618 236 1974 656 250 1975 697 270 1976 764 302 1977 818 332 1978 936 385 1979 1,060 440 1980 1,089 466 1981 1,119 494 1982 1,142 497 1983 1,187 510 1984 1,271 554 1985 1,361 590 276 Table A3 Scheduled A i r l i n e Services - Passengers Year T o t a l Passengers International Passengers (mill i o n s ) ( m i l l i o n s ) 1945 9 N. A 1946 18 N.A 1947 21 N.A 1948 24 N.A 1949 27 N.A 1950 31 6 1951 42 •7 1952 46 8 1953 52 9 1954 58 10 1955 68 12 1956 77 14 1957 85 16 1958 87 18 1959 97 20 1960 106 23 1961 111 27 1962 121 30 1963 135 34 1964 155 38 1965 177 44 1966 200 46 1967 233 51 1968 265 55 1969 293 64 1970 311 74 1971 333 79 1972 368 87 1973 404 96 1974 514 102 1975 534 108 1976 576 118 1977 610 129 1978 679 143 1979 754 158 1980 748 163 1981 752 173 1982 764 170 1983 795 173 1984 841 184 1985 891 194 277 Table A4 Scheduled A i r l i n e Services - Average Annual Growth i n Passenger-Kilometres Period Total Services International Services (percent) (percent) 1951 - 1959 14 14 1960 - 1969 14 13 1970 - 1979 10 12 1980 - 1985 5 5 278 Table A5 Scheduled A i r l i n e Services - Regional Breakdown of T r a f f i c Year Regional Breakdown of To t a l Tonne-Kilometres A f r i c a Middle East L a t i n America A s i a & P a c i f i c Europe N. America 1951 2 .0 0 .6 10 .4 8 .5 18, .5 60 .0 1952 1. .9 0 .6 9 .8 8 .0 i s ; .4 61 .3 1953 2 .1 0. .8 9 .0 7. .3 18 .4 62 .4 1954 2 .3 0, .8 8 .6 7 .0 18, .2 63 .1 1955 2 .4 0. .8 7, .5 6 .8 18, .2 64 .3 1956 2 .1 0, .9 8 .1 6 .9 18, .4 63 .6 1957 2 .3 1. .0 8 .1 6 .5 19, .5 62 .6 1958 2 .4 1. .1 8 .2 6 .5 20, .7 61 .1 1959 2 .3 1. .3 7, .6 6 .6 19, .9 62 .3 1960 2 .2 1. .3 7, .3 7, .0 22, .6 59, .6 1961 2 .3 1. .4 6. .8 7, .3 24, .4 57, .8 1962 2 .6 1. .5 6. .1 7. .5 25, .0 57 .3 1963 2 .8 1. .5 5, .2 7, .8 23, .8 58 .9 1964 2 .7 1. .4 5, .5 8 .2 23, J 58 .5 1965 2 .4 1. .5 4. .9 8 .2 23, .4 59 .6 1966 2 .4 1. .6 4, .9 7, .8 23. .2 60 .3 1967 2, .2 1. .5 4. .3 7, .8 22, .1 62 .1 1968 2 .1 1. .6 4, .1 7, .8 20. .7 63 .7 1969 2, .1 1. .6 4. .4 9, .1 22. .4 60 .4 1970 1. .9 1. .4 3. .7 7. .8 35. .6 49, .6 1971 2, .1 1. .7 4. .0 8. .2 35. ,5 48, .5 1972 2. .0 1. .8 4. .0 8. .6 36. ,0 47, .6 1973 2. .1 1. .8 3. .9 9. .8 36. ,3 46, .1 1974 2. .3 2. .1 4. .5 10. .8 36. .1 44, .2 1975 2. .4 2. .4 4. .8 11. .9 36. .9 41. .6 1976 2. .2 3. ,2 4. 3 12. .9 36. ,6 40, .8 1977 3. .0 3. ,0 5. .0 12. .9 35. ,6 40. .5 1978 2. .6 2. .6 5. ,3 13, .2 35. .1 41. .2 1979 2. .5 3. ,0 5. ,0 14. .1 33. ,7 41. .7 1980 2. ,7 3. ,0 5. 3 15. ,2 34. 2 39. .6 1981 3. .0 3. 0 5. .2 16. .3 34. 8 37. ,7 1982 2. ,9 3. 6 5. .0 17. .3 33. 8 37. ,4 1983 2. ,7 3. .4 4. ,8 17. ,8 33. 6 37. .7 1984 2. .5 3. 8 5. .1 17. ,7 32. 9 38. 0 1985 2. ,8 3. 5 4. ,9 17. .9 32. 8 38. 1 279 Table A6 Scheduled A i r l i n e Services - Growth Rates i n Regional Tonne-Kilometres Period Average Annual Growth Rate N. America Europe A s i a & P a c i f i c L a t i n America Mid. East A f r i c a 1951-1959 1960-1969 1970-1979 1980-1985 13 15 7 4 13 15 9 4 9 18 17 8 8 9 13 3 24 18 19 8 15 15 13 6 Table A7 Charter A i r l i n e Services - International Tonne-Kilometres and Percent of T o t a l A i r l i n e T r a f f i c Year Tonne-Kilometres Percent of To t a l T r a f f i c 1971 9 39 1972 11 38 1973 11 34 1974 10 30 1975 11 28 1976 11 27 1977 13 27 1978 13 25 1979 13 21 1980 12 19 1981 12., 17 1982 12 17 1983 12 16 1984 13 16 1985 13 13 280 Table A8 U.S. Scheduled Airline Service - Passenger Kilometres and Percent of World Scheduled T r a f f i c Year U.S. Passenger-Kilometres Percent of World Scheduled T r a f f i c ( b i l l i o n s ) 1955 39 64 1956 44 63 1957 50 62 1958 51 60 1959 58 60 1960 63 57 1961 64 55 1962 70 54 1963 81 55 1964 94 55 1965 111 56 1966 239 56 1967 159 58 1968 183 59 1969 202 48 1970 210 46 1971 218 44 1972 245 44 1973 261 42 1974 262 40 1975 262 38 1976 288 38 1977 311 38 1978 364 39 1979 411 39 1980 409 38 1981 396 35 1982 409 36 1983 444 37 1984 480 38 1985 532 39 281 Table A9 Scheduled Airline Services - Total Passenger-Kilometres and Percent of World Traffic - Top Ten Countries i n 1985 Country Passenger-Kilometres Percent of World T r a f f i c ( b i l l i o n s ) United States 526 39.0 USSR 188 14.0 Japan 64 4.7 United Kingdom 64 4.7 France 40 2.9 Canada 36 2.6 A u s t r a l i a 28 2.1 West Germany 24 1.8 Singapore 22 1.6 Netherlands 19 1.4 Table A10 Scheduled A i r l i n e Services - International Passenger-Kilometres and Percent of T o t a l International T r a f f i c - Top Ten Countries Country Passenger-Kilometres Percent of International T r a f f i c ( b i l l i o n s ) United States 107 18.0 USSR 60 10.0 Japan 31 5.3 United Kingdom 28 4.7 France 22 3.7 Canada 22 3.7 A u s t r a l i a 19 3.2 West Germany 17 2.9 Singapore 17 2.9 Netherlands 13 2.2 282 Table A l l IATA Airlines' Traffic - Tonne-Kilometres and Percent of World Scheduled Traf f i c Year Tonne-Kilometres Percent of World Scheduled T r a f f i c ( b i l l i o n s ) 1955 6.0 85 1956 7.0 85 1957 7.7 84 1958 8.5 89 1959 9.6 87 1960 10.7 87 1961 11.9 88 1962 13.5 89 1963 14.9 88 1964 17.4 88 1965 21.2 90 1966 24.9 89 1967 29.7 90 1968 34.0 87 1969 39.0 91 1970 42.9 75 1971 45.0 75 1972 51.6. 76 1973 58.0 76 1974 58.9 73 1975 59.0 69 1976 65.0 70 1977 70.8 71 1978 76.5 67 1979 83.6 66 1980 85.0 65 1981 86.3 64 1982 90.0. 65 1983 64.0 64 1984 102.0 65 1985 107.0 64 283 Table A12 IATA and T o t a l Scheduled Services -Comparison of Growth Rates i n Tonne-Kilometres Period IATA Growth Rate T o t a l Growth Rate 1955-1959 1960-1969 1970-1979 1980-1985 12.5 15.5 7.7 4.7 11.6 14.9 9.3 5.0 Table A13 IATA Airlines' International Traffic - Tonne-Kilometres and Percent of International Tonne-Kilometres Year Tonne-Kilometres ( b i l l i o n s ) Percent of International Tonne-Kilometres 1965 10 94 1966 12 97 1967 13 94 1968 15 92 1969 18 93 1970 21 94 1971 22 92 1972 26 93 1973 30 91 1974 31 88 1975 32 86 1976 36 85 1977 39 84 1978 45 83 1979 45 75 1980 47 73 1981 54 . 80 1982 56 80 1983 58 90 1984 65 80 1985 68 79 284 Table A14 IATA Membership by Type of Member Year T a r i f f Coordination Number of Members Trade A s s o c i a t i o n Associate Total 1951 59 5 64 1952 58 - 4 62 1953 63 - 4 67 1954 64 - 5 69 1955 66 - 5 71 1956 68 - 5 73 1957 69 - 6 75 1958 72 - 8 80 1959 78 - 8 86 1960 80 - 10 90 1961 80 - 9 89 1962 84 9 93 1963 83 - 9 92 1964 84 - 9 93 1965 81 - 11 92 1966 84 - 13 97 1967 86 - 14 100 1968 88 - 13 101 1969 89 - 14 103 1970 91 - 15 106 1971 90 - 16 106 1972 89 - 19 108 1973 91 - 22 113 1974 87 - 23 110 1975 88 - 24 112 1976 88 - 22 110 1977 89 - 18 108 1978 88 - 17 105 1979 85 - 18 103 1980 76 10 17 103 1981 76 18 17 111 1982 81 22 19 122 1983 82 23 18 123 1984 84 27 23 134 1985 85 34 21 140 1986 86 35 26 147 1987 81 51 29 161 285 Table A15 Active IATA Membership -Airlines of Developed Non-Communist, East Bloc and Developing Countries Year , Number of Active IATA A i r l i n e s Non-Communist Developed East Bloc Developing Total Countries Countries Countries 1950 41 2 21 64 1655 37 3 28 68 1960 42 3 35 . 80 1965 37 3 44 84 1970 37 3 '51 91 1970 37 3 • 51 91 1975 35 3 50 88 1980 30 3 53 86 1985 40 5 74 119 Table A16 IATA Members' Aircraft Fleet Year Number of A i r c r a f t P iston Turbo-Prop Narrow-Bodied J e t Wide-Bodied J e t To t a l 1960 2,477 480 382 0 3,339 1965 1,539 657 1,226 0 3,422 1970 422 552 2,901 89 3,964 1975 239 418 3,201 209 4,067 1980 0 494 2,779 796 4,069 1985 0 519 3,039 1,248 4,806 286 Table A17 D i s t r i b u t i o n of IATA Fare Classes on Scheduled North A t l a n t i c Services Year Percent of North A t l a n t i c Services F i r s t Class Economy Regular Excursion Other Capacity-Controlled Excursion 1950 100 0 0 0 0 1951 100 0 0 0 0 1952 56 44 0 0 0 1953 37 63 0 0 0 1954 31 69 0 0 0 1955 29 71 0 0 0 1956 27 73 0 0 0 1957 24 76 0 0 0 1958 21 79 0 0 0 1959 22 78 0 0 0 1960 17 83 0 0 0 1961 13 87 0 0 0 1962 9 91 0 0 0 1963 8 92 0 0 0 1964 8 54 20 18 0 1965 8 55 23 14 0 1966 8 48 26 18 0 1967 8 46 23 20 0 1968 7 43 25 25 0 1969 8 36 27 29 0 1970 7 26 39 28 0 1971 6 24 33 37 0 1972 5 18 38 40 0 1973 5 18 41 36 0 1974 5 23 42 29 0 1975 5 24 36 28 7 1976 5 24 32 27 11 1977 6 26 25 27 17 1978 6 22 18 27 27 1979 6 20 14 23 37 1980 6 21 14 19 40 1981 6 20 14 18 42 1982 5 22 14 18 41 1983 5 20 12 17 47 1984 4 19 11 17 49 1985 4 19 9 16 52 1986 4 20 10 21 46 287 Table A18 Scheduled A i r C a r r i e r s - Operating Revenues and Operating P r o f i t s Year Operating Revenues Operating P r o f i t s ($ b i l l i o n s ) ($ b i l l i o n s ) 1960 5 42 1961 6 (118) 1962 7 97 1963 7 326 1964 8 612 1965 9 900 1966 11 1,025 1967 13 913 1968 14 734 1969 16 874 1970 18 450 1971 20 610 1972 23 810 1973 27 1,200 1974 33 790 1975 38 730 1976 43 2,160 1977 50 2,630 1978 59 3,100 1979 71 740 1980 88 (640) 1981 93 (690) 1982 93 (160) 1983 98 2,100 1984 105 5,100 1985 112 4,000 288 Table A19 Safety on Scheduled Air Services - Aircraft Accidents Involving Passenger Fatalities and Fatalities per 100 Mill i o n Passenger-Kilometres Year F a t a l Accidents F a t a l i t y Rate (per 100 m i l l i o n passenger-kilometres) 1950 27 1.97 1951 20 1.27 1952 21 0.97 1953 28 0.77 1954 28 0.85 1955 26 0.67 1956 27 0.78 1957 31 . 0.62 1958 30 0.72 1959 28 0.63 1960 34 0.80 1961 25 0.69 1962 29 0.60 1963 31 0.49 1964 25 . 0.36 1965 35 0.35 1966 31 0.44 1967 30 0.25 1968 35 0.29 1969 32 0.27 1970 28 0.18 1971 31 0.21 1972 42 0.26 1973. 36 0.17 1974 29 0.24 1975 20 0.08 1976 20 0.12 1977 24 0.07 1978 25 0.09 1979 31 0.10 1980 21 0.09 1981 21 0.04 1982 25 0.08 1983 20 0.08 1984 15 0.02 1985 22 0.09 289 Appendix B Freedoms of the Air The p e r m i s s i o n f o r a i r l i n e s to e n t e r the a i r space of foreign countries i s granted by foreign governments i n accordance with the "freedoms of the a i r . " Eight freedoms have been recognized, and are ou t l i n e d below: F i r s t Freedom - The r i g h t to o v e r f l y the t e r r i t o r y of another country. Second Freedom - The r i g h t to stop i n another c o u n t r y f o r tech n i c a l purposes, such as r e f u e l i n g . T h i r d Freedom - The r i g h t to transport passengers from your country to another country. Fourth Freedom - The r i g h t to transport passengers from another country to your country. F i f t h Freedom - The r i g h t to t r a n s p o r t passengers from one foreign country to another on an a i r route that begins or ends i n your home state. Sixth Freedom - The r i g h t to t r a n s p o r t passengers from one f o r e i g n c o u n t r y to another while making an intermediate stop i n your home country. Seventh Freedom - The r i g h t to transport passengers d i r e c t l y from one f o r e i g n c o u n t r y to another ( i . e . s i x t h freedom without the intermediate stop). Eighth Freedom - The r i g h t to transport passengers between two points i n one fore i g n country. This freedom i s also known as cabotage. 290 Appendix C Evidence of Carrier-Specific Pricing on the North Atlantic and North Pacific D i r e c t evidence of the weakening of m u l t i l a t e r a l p r i c e s e t t i n g on the North A t l a n t i c and North P a c i f i c , following the U.S. l i b e r a l i z a t i o n e f f o r t , was found by t h i s author while gathering econometric data. The table below shows the development of c a r r i e r - s p e c i f i c fares on the North A t l a n t i c and North P a c i f i c routes used i n the econometric analysis f o r t h i s t h e s i s . The table indicates on how many routes, a l l c a r r i e r s d i d not o f f e r the i d e n t i c a l fare. So, f o r example, i n September 1979, on sixteen North A t l a n t i c routes no fares were c a r r i e r - s p e c i f i c . The chart c l e a r l y indicates the explosion of c a r r i e r -s p e c i f i c economy and excursion fares beginning i n 1979. North A t l a n t i c North P a c i f i c Time Period Economy Excursion Economy Excursion March 1976 September 1976 March 1977 September 1977 March 1978 September 1978 March 1979 September 1979 March 1980 September 1980 March 1981 September 1981 0 0 0 0 0 0 0 16 22 24 24 24 0 0 0 0 0 1 0 21 23 24 23 30 0 0 0 0 0 0 0 0 2 4 5 5 0 0 0 0 0 0 0 0 2 1 4 5 Notes: 1. Tota l number of North A t l a n t i c routes i n study was 37 and t o t a l number of North P a c i f i c routes was 5. The excursion fares were only those that permitted a fourteen day round t r i p . 2. Source: Official Airline Guide, Worldwide E d i t i o n , various issues. 291 Appendix D Regressions Using D i f f e r e n t F i r s t Stage Equations The f i r s t stage of the two stage regressions used i n t h i s chapter i n v o l v e d e s t i m a t i n g a passengers e q u a t i o n w i t h population, income and distance as explanatory v a r i a b l e s . 2 0 The f i t t e d value f o r passengers was then used as an explanatory v a r i a b l e i n the second stage of the estimation with p r i c e as the dependent v a r i a b l e . The statement was made i n the body of the chapter that various forms of the f i r s t stage of the model could be employed without a f f e c t i n g the major findings of the study. Table Dl and Table D2 present the regression r e s u l t s f o r the f u l l and d i s c o u n t p r i c e , r e s p e c t i v e l y , using three d i f f e r e n t f i r s t stages of the model. The f i r s t stage equations used i n the f i r s t , second, and t h i r d columns of each of the tables are presented, r e s p e c t i v e l y , i n Equations Dl, D2 and D3: PASS = 60 + B1 POP + B2 INC.+ B3 DIST + J, Pt TIME t' Dl PASS = B0 + B1 POP + B2 INC + £ Px ROUTEr D2 PASS B0 + B1 POP + B2 INC + £ Bt TIMEt + £ Px ROUTEr D3 See Equation 5.18. 292 Table Dl R e g r e s s i o n s o n t h e F u l l P r i c e U s i n g D i f f e r e n t F i r s t S t a g e s C o e f f i c i e n t F i r s t S e c o n d T h i r d C o n s t a n t 3 0 8 . 9 4 0 2 6 2 . 0 1 6 3 1 0 . 9 5 2 ( 3 5 . 4 3 0 ) ( 3 1 . 2 2 4 ) ( 5 3 . 2 1 6 ) N o C o m p e t i t i v e 3 7 . 1 7 6 2 1 . 4 9 2 2 0 . 2 7 2 B i l a t e r a l ( 1 3 . 7 8 0 ) ( 1 3 . 5 4 9 ) ( 1 3 . 9 7 7 ) P a s s e n g e r s - . 0 3 3 . 0 3 1 . 0 3 1 F i t t e d V a l u e ( . 0 1 0 ) ( . 0 1 3 ) ( . 0 2 1 ) S e p t e m b e r 7 6 - 4 6 . 9 4 1 4 7 . 0 3 4 - 4 0 . 3 9 8 ( 3 0 . 4 5 1 ) ( 1 4 . 1 2 7 ) ( 5 9 . 9 3 9 ) M a r c h 7 7 2 . 1 8 9 9 . 7 2 6 3 . 2 4 4 ( 1 4 . 7 0 8 ) ( 1 4 . 4 4 2 ) ( 1 7 . 0 0 0 ) S e p t e m b e r 7 7 3 . 6 8 7 8 2 . 5 8 9 9 . 7 8 4 ( 2 8 . 8 3 0 ) ( 1 4 . 4 6 3 ) ( 5 6 . 0 9 0 ) M a r c h 7 8 6 3 . 2 2 5 4 9 . 7 8 6 5 2 . 3 9 8 ( 1 7 . 4 3 0 ) ( 2 0 . 0 4 8 ) ( 2 3 . 1 3 6 ) S e p t e m b e r 7 8 2 3 . 9 1 8 1 2 2 . 1 4 0 2 1 . 0 7 0 ( 4 0 . 2 5 7 ) ( 2 0 . 4 0 6 ) ( 8 8 . 1 6 3 ) M a r c h 7 9 5 3 . 3 9 3 5 0 . 5 5 4 4 4 . 4 3 8 ( 2 0 . 4 4 4 ) ( 2 4 . 0 5 7 ) ( 3 6 . 4 4 3 ) S e p t e m b e r 7 9 1 6 . 1 6 9 1 3 4 . 5 6 9 1 4 . 3 1 4 ( 5 0 . 3 4 8 ) ( 2 5 . 1 9 1 ) ( 1 1 1 . 8 8 0 ) M a r c h 8 0 1 1 1 . 2 3 2 1 1 6 . 9 8 3 1 0 2 . 5 3 9 ( 2 5 . 9 5 5 ) ( 2 9 . 9 5 1 ) ( 5 2 . 7 2 6 ) S e p t e m b e r 8 0 1 6 3 . 8 9 9 2 2 0 . 2 5 7 1 5 8 . 8 9 7 ( 3 8 . 4 7 0 ) ( 3 0 . 5 4 1 ) ( 8 4 . 3 4 3 ) M a r c h 8 1 1 8 3 . 9 6 8 1 7 5 . 2 8 8 1 7 4 . 8 5 0 ( 2 4 . 7 0 8 ) ( 3 2 . 7 3 9 ) ( 4 9 . 1 8 0 ) S e p t e m b e r 8 1 1 0 5 . 8 8 3 2 0 1 . 3 8 3 1 0 3 , 4 6 2 ( 4 8 . 1 6 5 ) ( 2 9 . 7 3 2 ) ( 1 0 6 . 9 0 0 ) 293 Table Dl (Continued) FRANEW -299.364 -722.462 -701.325 (124.077) (341.167) (550.821) NEWFRA -448.947 -893.231 -871.537 (124.077) (349.734) (564.706) SANTOK -247.190 -167.243 -160.046 (112.804) (123.227) (196.019) TOKLOS -228.741 -203.969 -192.397 (144.209) (189.425) (304.308) LONMON -185.609 -241.310 -235.077 (69.433) (114.007) (180.819) LONWAS -263.724 -392.978 -383.286 (84.897) (166.049) (266.260) LONBOM 33.774 -35.835 -27.529 (77.166) (131.417) (209.237) WASLON -288.516 -417.224 -407.545 (84.897) (165.831) (265.904) ANCLON -169.302 -133.717 -128.958 (78.787) (92.295) (144.720) NEWRIO -340.624 -118.285 -112.118 (135.879) (99.500) (156.576) NEWCOP -352.602 -224.405 -218.647 (114.748) (106.955) (169.140) LONCHI -235.289 -233.052 -224.981 (104.118) (141.526) (226.122) CHILON -259.705 -276.792 -268.212 (104.118) (149.196) (238.694) AMSMON 18.199 -49.032 -45.165 (44.784) (79.420) (123.039) BRUNEW -388.616 -171.094 -167.230 (119.619) (79.381) (122.972) AMSANC 174.586 195.512 197.882 (51.845) (58.767) (87.372) TORLON -211.840 -317.639 -309.494 (75.389) (142.651) (227.967) 294 Table Dl (Continued) MONAMS -97.301 -156.130 -152.484 (44.784) (76.282) (117.705) TOKSEA -45.971 31.714 37.123 (93.256) (96.677) (152.083) RIOLIS 205.001 89.961 95.422 (39.519) (89.142) (139.315) SEALON -136.798 -118.760 -113.420 (79.995) (100.786) (158.890) LONTOR -169.006 -281.562 -273.239 (75.389) (145.332) (232.362) LONSEA -104.548 -75.764 -70.707 (79.995) (96.636) (151.975) LONBOS -278.962 -447.063 -436.915 (79.076) (172.955) (277.538) CHIFRA -133.028 -82.445 -77.824 (81.404) (90.277) (141.339) SEOHON 5.267 1.822 4.828 (48.363) (62.420) (94.013) AMSCHI -27.874 56.598 59.830 (76.331) (70.474) (107.769) HONSEO -25.316 -15.539 -12.881 (48.363) (57.752) (85.825) PARBOS -236.837 -55.436 -53.510 (89.117) (53.024) (77.087) ANCHAM 44.819 87.867 90.270 (57.490) (59.194) (88.127) SEACOP 66.212 94.521 96.367 (48.933) (52.018) (75.259) ANCCOP 95.972 132.601 133.965 (46.683) (46.192) (64.450) TORAMS -88.324 -52.143 -50.404 (49.802) (50.683) (72.816) BANTOK -139.238 -59.100 -56.019 (64.233) (55.745) (82.223) 295 Table D l (Continued) NEWGLA -380.400 -133.573 -131.849 (105.053) (50.498) (72.477) GLANEU -372.400 -119.851 -118.278 (105.053) (48.666) (69.090) BOSPAR -266.670 -101.747 -99.388 (89.117) (58.625) (87.121) MONFRA -93.121 -7.045 -6.714 (48.971) (35.785) (43.511) FRAMON 38.879 129.167 129.386 (48.971) (34.918) (41.589) ROMMON -18.444 12.090 13.316 (44.229) (44.615) (61.445) BOMFRA 169.196 221.583 224.061 (51.513) (48.051) (68.363) NEWLIS -308.728 -178.898 -175.290 (92.512) (75.761) (116.819) TOKBAN -92.738 19.182 21.427 (64.233) (45.246) (63.160) FRATOR 60.675 85.010 87.558 (54.269) (61.127) (91.536) RIOMIA -108.465 -95.846 -91.767 (56.684) (69.338) (105.853) FRABOS -21.080 37.082 39.109 (57.691) (54.299) (79.391) MONLIS -17.315 -33.152 -33.047 (30.962) (34.090) (39.709) LONCAL -67.730 88.447 89.038 (68.768) (38.055) (48.364) BELMIA -37.083 -35.586 -35.626 (28.961) (29.118) (29.230) EDMLON -124.723 34.984 35.443 (68.375) (36.866) (45.849) R2 .79 .79 .79 Based on 612 observat ions. 296 Table D2 Regressions on the Discount Price Using Different F i r s t Stages Coefficient F i r s t Second Third Constant 54.796 94.465 266.531 (32.498) (28.209) (47.397) No Competitive 141.689 139.821 129.071 Bilateral (12.640) (12.241) (12.449) Passengers - -.010 .041 .091 Fitted Value (.009) (.011) (.018) September 76 58.147 30.416 -228.364 (27.930) (12.763) (53.384) March 77 16.707 2.385 -29.494 (13.491) (13.047) (15.141) September 77 85.019 47.969 -181.966 (26.443) (13.067) (49.957) March 78 46.110 9.312 -25.971 (15.988) (18.113) (20.606) September 78 183.359 108.962 -238.076 (36.925) (18.436) (78.522) March 79 95.703 29.902 -58.369 (18.752) (21.735) (32.458) September 79 155.459 48.487 -383.303 (46.181) (22.759) (99.646) March 80 133.864 37.206 -105.469 (23.807) (27.059) (46.960) September 80 211.207 95.824 -189.693 (35.286) (27.592) (75.120) March 81 136.903 31.300 -83.780 (22.663) (29.578) (43.802) September 81 200.704 77.059 -313.219 (44.179) (26.862) (95.210) 297 Table D2 (Continued) FRANEW 256.894 -954.859 -2303.670 (113.807) (308.229) (490.589) NEWFRA 160.186 -1078.960 -2461.840 (113.807) (315.969) (502.956) SANTOK 294.434 -203.675 -679.165 (103.468) (111.330) (174.585) TOKLOS 447.417 -300.361 -1043.190 (132.273) (171.137) (271.032) LONMON 95,652 -321.483 -759.356 (63.687) (103.000) (161.046) LONWAS 87.180 -518.048 -1167.350 (77.870) (150.017) (237.145) LONBOM 457.459 -27.669 -535.354 (70.779) (118.729) (186.357) WASLON 98.722 -505.801 -1154.220 (77.870) (149.821) (236.828) ANCLON 164.894 -190.853 -538.647 (72.266) (83.384) (128.895) NEWRIO 239.093 -206.795 -583.727 (124.633) (89.894) (139.455) NEWCOP 160.142 -285.491 -694.300 (105.251) (96.629) (150.645) LONCHI 149.279 -398.102 -948.274 (95.500) (127.862) (201.395) CHILON 158.070 -414.296 -995.545 (95,500) (134.792) (212.593) AMSMON 148.706 -120.390 -413.607 (41.077) (71.753) (109.585) BRUNEW 192.151 -165.838 -458.886 (109.719) (71.717) (109.525) AMSANC 265.156 59.820 -141.921 (47.554) (53.093) (77.818) TORLON 63.043 -455.105 -1009.840 (69.150) (128.879) (203.039) 298 Table D2 (Continued) MONAMS 62.248 -195.984 -475.687 (41.077) (68.917) (104.834) TOKSEA 395.013 6.737 -359.459 (85.537) (87.343) (135.453) RIOLIS 426.889 129.603 -204.179 (36.248) (80.536) (124.081) SEALON 145.716 , -239.938 -623.183 (73.374) (91.055) (141.516) LONTOR 117.793 -409.091 -974.692 (69.150) (131.301) (206.954) LONSEA 127.467 -244.294 -610.256 (73.374) (87.307) (135.357) LONBOS 90.105 -530.742 -1207.850 (72.531) (156.257) (247.190) CHIFRA 151.977 -199.994 -539.308 (74.666) (81.562) (125.884) SEOHON 229.440 13.241 -206.024 (44.360) (56.393) (83.733) AMSCHI 235.356 -42.439 -296.847 (70.013) (63.670) (95.985) HONSEO 186.315 -12.787 -210.786 (44.360) (52.176) (76.440) PARBOS 157.982 -70.429 -245.015 (81.741) (47.905) (68.658) ANCHAM 228.834 14.608 -189.109 (52.731) (53.479) (78.491) SEACOP 192.691 17.044 -152.650 (44.883) (46.996) (67.029) ANCCOP 214.394 65.579 -74.634 (42.820) (41.732) (57.403) TORAMS 93.584 -77.964 -241.086 (45.680) (45.789) (64.854) BANTOK 146.481 -66.623 -254.955 (58.917) (50.363) (73.232) 299 Table D2 (Continued) NEWGLA 112.330 -124.185 -286.392 (96.358) (45.623) (64.552) GLANEW 111.455 -117.662 -270.667 (96.358) (43.967) (61.535) BOSPAR 137.274 -112.444 - -313.531 (81.741) (52.965) (77.595) MONFRA 74.243 -26.976 -104.032 (44.918) (32.330) (38.753) FRAMON 182.952 87.178 16.895 (44.918) (31.547) (37.041) ROMMON 172.390 33.894 -97.895 (40.568) (40.308) (54.726) BOMFRA 429.379 261.781 110.334 (47.249) (43.412) (60.887) NEWLIS 113.524 -201.468 -478.923 (84.855) (68.447) (104.045) TOKBAN 250.648 78.640 -58.576 (58.917) (40.877) (56.254) FRATOR 213.250 -3.992 -216.592 (49.777) (55.226) (81.527) RIOMIA 182.888 -69.978 -319.282 (51.993) (62.643) (94.278) FRABOS 203.548 7.555 -173.165 (52.917) (49.056) (70.710) MONLIS 36.441 -19.159 -82.450 (28.399) (30.799) (35.367) LONCAL 145.981 6.898 -86.120 (63.077) (34.381) (43.075) BELMIA 63.375 65.311 67.719 (26.564) (26.307) (26.034) EDMLON 111.051 -21.047 -105.964 (62.716) (33.306) (40.836) R2 .82 .82 .83 Based on 612 observations. 3 0 0 where: PASS the number of passengers on a route; POP the mean population of the o r i g i n and dest i n a t i o n c i t i e s ; INC the mean income of the o r i g i n and destination countries; TIMER'S eleven time i n d i c a t o r v a r i a b l e s ; and, ROUTEr's f i f t y route i n d i c a t o r v a r i a b l e s . The second stage of the model was the same as that employed i n the body of the chapter (with the route i n d i c a t o r v a r i a b l e s ) . 2 1 The r e s u l t s shown i n Tables Dl and D2 indicate that changing the f i r s t stage of the model has the following r e s u l t s : L i t t l e or no e f f e c t on the c o e f f i c i e n t f o r No. Competitive B i l a t e r a l . The f u l l p r i c e r e s u l t s s t i l l show no n - s i g n i f i c a n t or m a r g i n a l l y s i g n i f i c a n t c o e f f i c i e n t s w h i l e the discount p r i c e r e s u l t s show highly s i g n i f i c a n t c o e f f i c i e n t s ; Changes i n the values of the time i n d i c a t o r c o e f f i c i e n t s when time s h i f t e r s are employed i n the f i r s t stage of the model. This i s evident i n columns 1 and 3 of Table Dl and e s p e c i a l l y i n column 3 of Table D2. I t was thought that c o l l i n e a r i t y between the f i t t e d passengers v a r i a b l e and the time s h i f t e r s contributed to these value changes; and, 2 1 See the f o u r t h columns of Tab l e s 5.4 and 5.6 f o r comparative purposes. 301 Changes i n the values of the route i n d i c a t o r c o e f f i c i e n t s when route s h i f t e r s were used i n the f i r s t stage of the model. I t was thought that c o l l i n e a r i t y between the route s h i f t e r s and the f i t t e d passengers value contributed to the changes. Due to the suspected c o l l i n e a r i t y problems, i t was thought best not to employ the time and route s h i f t e r s i n the f i r s t stage of the model. As i n d i c a t e d above, the absence of these s h i f t e r s d i d not a f f e c t the major findings of the study concerning the "regulatory e f f e c t " on p r i c e s . 302 Appendix E Errors i n Variable Problem As noted i n the body of the chapter, the September pr i c e s used i n the analysis were c a l c u l a t e d as of the f i r s t of the month. However, i n fa c t , there was a change from the high to the shoulder season during September for many of the routes. Therefore, the average September pr i c e s were a c t u a l l y lower than the p r i c e as at the f i r s t of the month such that: P R I C E F I R S T = PRICE A V E + 7 E l where: PRICE. F I R S T PRICE 'AVE the p r i c e i n e f f e c t on the f i r s t of September; the average September p r i c e ; and, the difference (a p o s i t i v e number) between the two pr i c e s . I f , as the empirical model would pre d i c t , the true or average p r i c e i s a function of the explanatory v a r i a b l e s , then the equation that was a c t u a l l y predicted was the following: P R I C E F I R S T = B0 + ^NLIB + B2HIST + y33PASSFIT 5 + /34 ATLPAC + Bt Y MARCHt t - 1 (E2) + (Pt + 7 > I SEPTEMBER,. t - 1 303 where: MARCHt's = the f i v e time indi c a t o r s included f o r March (1977-1981), remembering that the i n d i c a t o r f o r March 1976 was excluded from the regression; SEPTEMBER 'S = the s i x in d i c a t o r v a r i a b l e s f o r the September periods included i n the regression; and, the other v a r i a b l e s are as indicated above. Note that the erro r i n var i a b l e ( 7 ) causes the c o e f f i c i e n t s f o r the SEPTEMBER 'S to be higher than what they should have been i f the average September prices had been used. 304 REFERENCES 305 ABC World Airways Guide (19--), Dunstable, U.K., various issues. Adkins, Douglas L., Martha J . Langelan and Joseph M. Trojanowski (1982), "Is Comp e t i t i o n Workable i n North A t l a n t i c A i r l i n e Markets", report prepared for the C i v i l Aeronautics Board, Washington, D.C. Aggarawal, V i n o d K. (1985), Liberal Protectionism: The International Politics of Organized Textile Trade, Berkeley, C a l i f o r n i a : U n i v e r s i t y of C a l i f o r n i a Press). Armstrong, Warren (1961), Atlantic Highway, (London: George G. Harrap & Co. Ltd. ) . A t t e r t o n , Harry K. (1985), &q