1.2 – Europe and Developments in the Transatlantic Air Market

By Kenneth Button

buttonThe past 30 years have seen the radical liberalization of many parts of the air transport industry. Domestic reforms in the US were followed by changes within Europe and within many other markets that freed fares setting, market entry, or embraced privatization. International markets have largely been freed from market intervention on a bilateral basis, often involving some variant on the Open Skies approach of the US. The retraction of regulations governing air transport infrastructure, in particular airports and air navigation systems, has normally been more piecemeal, but nevertheless provided some complementary effects. The focus here is on what we can expect from the recent agreement between the EU and US to further liberalize the transatlantic airline market.

The North Atlantic is a large air transport market and is important to the macro‐economies on both sides. The EU and US are each other’s main trading partners, and air transport contributes to this in many ways. It constitutes about 60 per cent of global air traffic activity, but is particularly supportive for major growth industries, such as those involving high technology and tourism. Like most international markets in air services, the one between the US and EU has traditionally been highly regulated.

The US began to press for reform of its restrictive international air service agreements in 1979, when the term “Open Skies” was first mentioned, but it did not negotiate its first European major “Open Skies” agreement, which was with the Netherlands, until 1992. A number of other similar agreements, notably with Germany, followed. This freed up the ability, on a bilateral basis, for the provision of market‐based services on some routes, but still restricted the ownership of the carriers involved and their rights to provide unfettered services beyond initial gateways. There were also some major routes that remained highly regulated, notably those between the US and the UK.

In March 2007, European transport ministers approved an Open Skies‐style agreement with the US to liberalize the transatlantic airline market. At the April 30 US/EU summit in Washington, they signed an agreement to further liberalize air services taking effect in April 2008. The first‐stage Air Transport Agreement replaces all existing bilateral agreements between the US and the 27 EU member states and establishes an Open Skies‐type framework between them. Any EU airline will be able to fly to any point in the US from anywhere within the EU, while any US carrier will be able to serve Heathrow and internal EU routes. This, in particular, removes restrictive arrangements between the US and UK. The agreement does not, however, provide for a free transatlantic air transportation market, because it only relates to air services and does not free up factor markets, limitations, for example, the extent to which US investors can put money into EU airlines and vice versa.

While the change is likely to generate benefits for the air traveler, it is unclear what the exact implications will be for the air transport industry, and for different regions of Europe.

The inclinations of airlines and airports, when confronted with institutional barriers, are to exploit those elements of the regime that help their financial position, and to circumvent those that damage it. Hence, we have traditionally seen, for example, airlines expending considerable resources in lobbying to gain bilateral air service rights. The major transatlantic carriers have sought to circumvent limitations on cross‐national investment by forming alliances, and these have also added to their scale advantages. The large airports serving the transatlantic market enjoyed a quasi‐monopoly position and their returns indicate significant rents, setting aside any inefficiency that can go with potential “gold‐plating” of facilities.

The airlines and the airports will feel the most immediate effect of the changes in international regulations, but the exact effects are uncertain. Ex ante studies have shown that the outcome of the enlarged transatlantic market will be complex, because of changes in feeder networks within Europe. In particular, given the slot limitations at the main London airports, it is likely that there will be reallocations towards long‐haul services there, as new carriers move into the London facilities, and existing ones modify their networks. There is also the issue of separating any existing trends from the impacts of the transatlantic reforms. The former include not only the secular long‐term growth in traffic, but also such things as the restructuring of networks that has been taking place on both sides of the Atlantic, as low‐cost carriers have been taking larger shares of markets within the US and the EU. The legacy carriers have been forced to focus more on long‐haul markets and on those protected by institutional arrangements.

But what will this mean for the airlines involved? Airlines are becoming more efficient as management techniques evolve, hardware improves, and as infrastructure, such as air navigation services, is gradually updated and systems integrated. Like many industries, air transport is dynamic and change is continual. Transatlantic liberalization will inevitably not only result in a continuation of developments already in train, but will also bring about unforeseeable structural shifts. Given the enhanced competition that will come about, the least we can say is that there will have to be innovative thinking on the parts of airlines if they are to retain some of the €377 million in economic surplus the UK’s Civil Aviation Authority has forecast it will generate for the aviation industry, rather than it all being dissipated in lower fares to be enjoyed by the predicted 34 per cent increase in passengers. The deregulated scheduled‐airline industry within both the US and EU finds it difficult to make a viable return, and, while there may be short‐term profits to be earned in a liberalized transatlantic market, it will require new thinking to ensure that these prove enduring.

What about the wider economic benefits? The EU and US combined are responsible for about two fifths of world trade: trade flows across the Atlantic amount to €1.7 billion a day. The “transatlantic workforce” is estimated at 12 to 14 million, of which roughly half are Americans, who owe their jobs directly or indirectly to EU companies. In 2005, exports of EU goods to the US amounted to €250 billion, while imports from the US amounted to €234 billion. In terms of trade in services, EU exports to the US amounted to €108.6 billion in 2004 while EU imports from the US were €93.0 billion. Air transport plays a multiplicity of roles in allowing all this to happen; it is one of the lubricants in the transatlantic economic engine.

The official line within the European Commission is that the new agreement will generate $16 billion in economic benefits, and that it will create 80,000 new jobs over the next five years. These figures are at least speculative, but in addition, from a political perspective, the way benefits are distributed can be as important as their overall size. This is actually what we have the least information on, and is, by far, the most difficult thing to forecast. The transatlantic services network is currently changing, as airlines add secondary hubs to their networks to avoid congestion at major airports, and also to meet the new demands of changes in the economic geography of Europe and the US. Since 16 countries in the EU already had some form of Open Skies arrangement with the US, the new agreement may have limited impact on them. But even at the London locations, it will take time for the slots to be reallocated at Heathrow to reflect the new environment. Thus, while overall traffic will grow, there is no reason to expect that it will significantly affect the overall pattern that would have emerged without it, unless there is government interference.

So overall, from an economic point of view, the new agreement is to be welcomed. But we must be aware of the reason we have markets, and that is that markets are normally more efficient than planned and regulated systems. This is because the world is a complicated place, and because we understand very little of it. Market forces allow better use of resources, but what the outcome will be is simply unpredictable. So what will actually happen will be full of surprises.

About the Author
Dr. Kenneth Button is Professor of Public Policy at the George Mason School of Public Policy and Director of the Center for Transportation, Policy, Operations, and Logistics, and Director of the Aerospace Policy Research Center at the George Mason University.

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