1.1 – Policy Developments in the Airline Sector

Introduction: A Changing Scene
The airline industry has traditionally been a protected and regulated industry, with a high degree of government intervention, for both strategic and economic reasons. Already in 1919, the Paris Convention stipulated that states have sovereign rights in the airspace above their territory. Consequently, a series of bilateral agreements was established between countries that the airlines wished to fly to or over. The Chicago Convention (1944) made a distinction between various forms of freedom for using the airspace, ranging from the 1st freedom (the right to fly over the territory of a contracting state without landing) to the 8th freedom (the right to transport passengers and cargo within another state between the airports in that state). The global airline industry ultimately became an overregulated – and thus inefficiently operating – industrial sector in the post‐war period.

The US Airline Deregulation Act (1978) set the tone for a clear market orientation of the aviation industry in the USA, where US‐based airlines were allowed to autonomously determine their routes, destinations, frequencies and airfares on their domestic flights, while new firms that were fit, willing and able to properly perform air transportation were free to enter the market. The resulting competition led to a rise in efficiency and innovative strategies in the airline industry and resulted in lower airfares, in the entry of many new companies, and in a significant increase in demand.

The airline deregulation in Europe took a much slower pace, due to the heterogeneity among European countries, the diversity of air traffic control systems and nationalistic motives for promoting a national carrier. Since the year 1988, Europe has gradually introduced a series of steps (so‐called packages) to ensure a full deregulation of the European airline industry by the end of the last century, based on an integrated airline market characterized by fair competition and sound economic growth.

The next step in this deregulation process has been the Open Skies Agreement between the USA and the EU, which has opened up many more opportunities for carriers on both sides of the Atlantic to increase their financial viability and their market shares in a free competition across the Atlantic.

Policy Consequences for the European Aviation Industry
The changes in regulatory regimes in the European airline industry have prompted various new actions and strategies of European carriers in the past decade, such as mergers, takeovers and alliances. But the fierce competition has also led to bankruptcy of several existing carriers (such as Swissair and Sabena). More competition in a free market in Europe has largely had the same effects as in the USA, except for the fact that flag carriers still kept a large share of the market. But there are striking similarities in developments, and, in particular, these are:
– A trend towards the development of hub‐and‐spoke networks of the existing major airlines in Europe (though less pronounced than in the USA, because of the greater diversity in Europe);
– The trend towards advanced computer reservation systems and electronic booking systems, in order to reduce transaction costs;
– The emerge of a wide variety of – often less transparent – airfare systems, which can even fluctuate daily, depending on demand and capacity (yield management systems);
– The growth in in loyalty programs in order to create bonds with various groups of frequent‐flyer passengers;
– The development of various forms of airline alliances, not only within Europe, but also worldwide (such as SkyTeam and Star Alliance), allowing for efficient forms of code‐sharing among participating companies as well;
– The emergence of low‐cost carriers, which have taken a significant market share in the European aviation industry, next to charter companies, based on an aggressive pricing policy.

The above‐mentioned trends are largely similar to those in the USA, but there are a few marked differences:
– Europe is still strongly influenced by nationally oriented carriers (although flag carriers are rapidly losing their influence);
– Most European flights are international, but only cover relatively small distances, so that competition with the railway system (especially with the high‐speed trains) is also emerging;
– The European air traffic control system is still made up of a patchwork of various systems, and this hampers an efficient management of the air control system in Europe;
– The charter market in Europe is well‐developed, and has become a serious competitor to the scheduled airline sector (in contrast to the USA);
– Airports in Europe are still often largely in the hands of national or regional governments or authorities, and, as a consequence, their operation often does not meet the highest efficiency standards.

Recent Responses in the European Airline Industry
The European airline industry has witnessed rapid changes and challenges in recent years, in particular (i) disruptions caused by external conditions (e.g., September 11, 2001, the Iraq war, the SARS virus), (ii) the emergence of low‐cost carriers (LCCs) with a rapidly rising market share, and (iii) the need to comply with environmental standards. Nevertheless, there has been a general trend towards more competition, more passengers, more mergers, more entries of new firms, a decline in airfares, and more variability in forces in most markets.

In Europe, we currently observe – as a result of the deregulation packages – three airline business models: (i) full‐service carriers (offering a variety of services and network linkages); (ii) LCCs (offering a limited number of services on specific segments of the network (e.g., regional airports) at low prices; (iii) charter companies (offering various services to specific holiday destinations). The changing scene in competition in response to the deregulation has prompted a variety of network strategies (ranging from hub‐and‐spoke systems to point‐to‐point systems) and yield management practices (e.g., through market segmentation, product differentiation, booking classes, price setting and distribution channels). Various alliances have also occurred, but less mergers, to strike a balance between scale advantages and national identity/visibility.

One of the most striking facts in Europe has been the rapid emergence of LCCs (e.g., Ryanair, EasyJet). Despite the relatively low fares, most LCCs manage to be profitable and to conquer a significant part of the (rising) passenger demand. In most cases, they offer basic services and fly uniform – but often modern – aircraft. A major challenge for the near future will be the question whether – and to which extent – LCCs will be able to befit from the Open Skies Agreement on transatlantic routes.

In conclusion, deregulation policy has had a deep impact on the airline industry in Europe, in terms of airfares, number of passengers, market coverage and product variability. A new major question will now be how the industry will respond to tighter environmental policy constraints (e.g., noise, CO2 emission). This will be decisive for the future of the aviation industry in Europe.

Literature
Button K., and J. Drexler (2006). The Implications on Economic Performance in Europe of Further Liberalization of the Transatlantic Air Market, Study Report School of Public Policy, George Mason University, Fairfax, VA
Cento A. (2006). Challenges to the Airline Industry, PhD Dissertation, Free University, Amsterdam
Doganis R. (2001).The Airline Business in the 21st Century, Routledge, London
Nijkamp P. (2007) Liberalization of Air Transport in Europe, Swiss Journal of Economics and Statistics, vol. 132, no. 3, pp. 257‐278

About the Author
Peter Nijkamp is professor in regional and urban economics and in economic geography at VU University, Amsterdam. He is the former president of the European Regional Science Association, of the Regional Science Association International, and of the Royal Netherlands Academy of Arts and Sciences (KNAW).

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