Everyday, the world becomes a smaller place. Globalization is becoming more of a reality as commerce between nations increases and the interchange of ideas, cultures, and values continue. For the world’s airlines, globalization represents an incredible challenge and opportunity. It’s a chance to become stronger drivers of economies and necessary elements for growth. It also represents an opportunity for improved stability within the commercial aviation industry, opening the door to additional sources of capital and more agile and efficient route networks.
The airline industry has become significantly more globalized and less regulated over the last 30 years. In the United States, the 1978 Airline Deregulation Act freed the nation’s airlines from the Civil Aeronautics Board, an agency in the Department of Commerce that dictated the routes each airline could fly, how frequently they could be flown, how much the carrier could charge on that route, etc. In addition, the appearance of code-sharing networks (i.e. OneWorld, Star Alliance, etc.) and joint ventures allowed access to larger networks for carriers through partnerships with other airlines.
Despite this level of deregulation, there remain two important obstacles that are preventing complete globalization and freedom in the markets: ownership laws and restrictive air service agreements. These politically polarizing issues create an inconsistent marketplace with varying policies and degrees of enforcement,
In 1926, the United States congress enacted the Air Commerce Act, which stipulated that the nation’s airlines required at least 51% ownership by U.S. citizens (this would later be increased to 75% in 1938) and that two-thirds of the board of the directors also be U.S. citizens. At the time, it made sense, with the reasoning behind the stipulation being that the U.S. government could access the U.S. airline fleet at any time as a reserve fleet if necessary. If under foreign control, that access would be threatened. Many other countries also formed similar policies. However, since many military fleets today consist of numerous capable transport aircraft, this policy does not seem to make sense and is out-dated. The government will occasionally contract the airlines to charter troops, but even that is rare. Nevertheless, since the Chicago Conventions of 1944 outline that nations have the regulatory authority to impose any rules on carriers operating in their borders, most governments have also adopted ownership laws of varying degrees (Figure 2).
Unsurprisingly, the issue is very political. Airlines are traditionally national icons, and many countries used to operate and some still have “flag” carriers, or airlines that are officially endorsed by the state (i.e. Iran Air, Aerolineas Argentinas, etc.). In the United States, there is no official flag carrier since there are numerous international carriers based in the country. Regardless, the thought of allowing ownership of an American carrier to foreign hands still does not sit well with many politicians. Meanwhile, many executives of American carriers are pushing for relaxed foreign ownership laws, since it would increase sources of capital and attempt to make the razor-thin-margin industry more stable.
Laws on airline foreign ownership are becoming more relaxed in more developed countries, albeit slowly. The advantages are clear, but the political will is required to jump this hurdle. This 2003 report to the United States Senate Subcommittee on Aviation cites another 1992 report that recommended increasing the ownership restriction from 25% to 49%, but has yet to be acted on. The failure of numerous investments, such as the proposed alliance between British Airways and US Airways in the 1990s, is attributable to the failure to increase the ownership stake in U.S. airlines by foreign hands. Unfortunately, progress might only be seen through re-negotiation of the Air Service Agreements between countries, which will be covered next.
AIR SERVICE AGREEMENTS
Restrictive Air Service Agreements (ASAs) are the second major barrier preventing air carriers today from becoming truly globalized. An ASA is a bilateral or multilateral agreement negotiated between governments that outlines the policies of the air service between the countries. In its most restrictive form, it can set capacity and price limits, and can restrict a carrier to only flying to certain cities within a country’s borders. For example, the current ASA between the United States and China is moderately restrictive since all air carriers operating between the two countries must seek approval to the fly routes they want and must also request approval for each additional frequency on the route.
However, the last 15-20 years have seen more and more relaxed ASAs with a type of agreement known as “Open Skies” becoming more popular. Instead of defining capacity and route restrictions, an Open Skies agreement allows for a completely free market where the air carrier determines the proper frequency, capacity, and price of each route between two countries based on market conditions. No applications for government approval are required, and most Open Skies agreements allow for flexibility for air carriers to fly to any city in either country. Today, the United States has over 100 Open Skies agreements with many countries that allows for fully liberalized international air service without government intervention.
The economic benefits of Open Skies agreements are numerous. For one, an air carrier can determine how to operate a certain route with the proper aircraft, frequency, and price based on the principles of supply and demand. In addition, it allows for increased competition since there are no restrictions on which carriers can operate specific routes. For example, until the Open Skies agreement was established between the United States and the European Union, only American Airlines and United Airlines were permitted to fly into London’s Heathrow Airport. All other U.S. carriers had to fly to Gatwick Airport, which had much less service and fewer connection options.
So, to what degree are ASAs liberalized around the world? To determine this, a number of ASAs were researched and categorized based on the restrictiveness of the language. Figure 3 illustrates the findings on a regional and trans-regional basis. Admittedly, this was a high-level and subjective analysis, but the general idea is captured.
The research concludes that liberalized aviation markets are becoming more common, but there remain a few heavily regulated markets. The reason for this often leads to two explanations: infrastructure or politics.
Many developing economies are finding themselves in a tough position to play catch-up and quickly develop the infrastructure to handle liberalized air services. For example, despite being one of the fastest growing aviation markets, China is still heavily regulated, both domestically and internationally. While the Chinese government has shown interest in liberalized air service, one of the major barriers preventing it in the country is the military-operated airspace, which frequently experiences system delays. Indonesia is also struggling as the country pleads to the Association of Southeast Asian Nations (ASEAN) trade bloc to delay the implementation of the Open Skies agreement in order to have more time to establish the infrastructure for increased capacity.
Like the foreign ownership laws explained above, many governments maintain regulated ASAs to protect their national carrier. Thus, politics is the more common explanation for the lack of liberalized air service. For example, Africa as a region is denoted here as being heavily regulated. In fact, the Yamoussoukro Agreement of 1999 had language to liberalize the air service in the region; however, even though many governments were signatories to this agreement, protectionist measures have remained and the agreement has yet to be implemented in most of the region.
South America is also an interesting case since the region still has some work to do until it is considered liberalized. The U.S. currently maintains Open Skies agreements with Chile, Peru, Paraguay, and Colombia, while an agreement with Brazil is set to go into effect in 2015. However, the services to Ecuador, Argentina, Venezuela, Bolivia, and Suriname remain regulated. Between Brazil and the European Union, Open Skies is set to begin in 2015. Within the region, there are two separate multilateral agreements; one is between the nations within the Comunidad Andina (CAN) trade bloc (Colombia, Peru, Ecuador, and Bolivia) and another is between the MERCOSUR nations (Argentina, Brazil, Venezuela, Paraguay, and Uruguay). Besides specific agreements between some countries, there is no connection between the two trade blocs, which makes air service policy in South America function as if it were two separate regions.
In addition, air service agreements can be used for political purposes. For example, Panama and Peru allowed for 5 daily frequencies between Panama City (PTY) and Lima (LIM), but the Peruvian government denied Copa Airlines the rights to a 5th daily PTY-LIM frequency for a long time until Copa acquiesced and agreed to also operate a route to a secondary Peruvian city, Iquitos. In other words, Copa flies to Iquitos twice a week in exchange for a 5th frequency to Lima.
Argentina is also notorious for protecting its national carrier, Aerolineas Argentinas, at the expense of other carriers like Chile-based LAN. In these cases, although the language in the ASAs calls for fair opportunities for all carriers, the rule of law is inefficient and not well enforced. Ultimately, this leads to favoritism, protectionism, and high barriers for new entrants into the market. Furthermore, because of the lack of competition, customer service is very poor at the carrier since there is no incentive to invest in it. Therefore, in the end, consumers are the ones who pay the price.
In summary, despite the goal of many major airlines to be global carriers, foreign ownership laws and restrictive air service agreements are challenging this goal. Foreign ownership laws are preventing cross-border investments and with them, the added stability of additional capital to the industry. Moreover, restrictive air service agreements limit opportunities for carriers and often lead to protectionism of national carriers. While many regions are in a transitional stage towards air service liberalization, the process often takes years to take effect and is subject to time-varying political will. Thus, although the process is slow, globalized carriers are becoming more of a reality. The day may come in our lifetime when carriers have stable and reliable sources of capital, and can operate wherever they wish in a completely free market.