Alfred Kahn
Chairman of the Civil Aeronautics Board, 1977-1978
Why Regulation Seemed Like a Good Idea
ALFRED KAHN: [Behind the idea of regulating the airline industry was] the notion that unrestricted competition, particularly in the presence of heavy fixed investment costs, had a tendency to be destructive; that is to say, to drive prices below levels that would cover average total cost. That would prevent continued maintenance of facilities and renewal of facilities and innovation by forcing down to bare bones operating costs, thereby threatening the progress of the industry and indeed safety. That was the conception. In trucking, the conception was that small competitors who were regarded as chiselers and irresponsible would drive unsafe trucks and not maintain them, and so there would be increased accidents on the highways.
Ideology Aside, Airline Deregulation Accomplished Its Goal
ALFRED KAHN: I don't know what weight to place on government regulation as a contributor to the stagflation problem as we saw it, in the '70s in particular, any more than I know how to weigh the beneficial effect of deregulation. In a macroeconomic sense, it's fashionable to say today that the great success of the American economy in the last 20 years has been in an important measure attributed to deregulation. It's not in my interest to minimize the small role that I played in that. But I rather suspect that there is -- just as in the '30s -- a clear erroneous tendency to attribute to micro-organization and micro-intervention the blame for what proved to be a massive macroeconomic cataclysm. Partly on ideological grounds, there's a tendency now to parade the virtues of a deregulative economy. Having offered all those qualifications, I don't think there's any question that deregulation has contributed, in these particular sectors of the economy, to revitalization, to increased entrepreneurial effort, to increased pressure for increase of productivity.
Pros and Cons of Regulating the Telephone Industry
ALFRED KAHN: In many ways, the total monopoly of AT&T permitted AT&T to run one of the best research laboratories in the world. And when I regulated the utilities in New York State, we required them to set aside one percent of their revenues to do research that would not otherwise be done, particularly in conservation, in environmental protection. And we could do that because it was a regulated industry. At the same time, having said that, I think that the explosion of technology that is occurring in telecommunications clearly owes a great deal to the break-up of the AT&T monopoly.
INTERVIEWER: Bell Labs was a great lab, but they kept inventing things they never marketed, like mobile phones...
ALFRED KAHN: That's right. I remember that I was a member of the National Economic Advisory Committee to AT&T for six years, and all they were pushing was the picture phone, which for whatever reason proved to be a total failure. So in the exploitation of innovation, in developing alternative sources of ideas, there's nothing as effective as an open market.
My first recognition of the importance of deregulation had no relationship whatever with the stagflation phenomenon. I was born and grew up a strong advocate of competition. It was... somewhere in the '60s that I became intensely aware of how many cases [there were] in which regulation was being used as a form of cartelization.... I began to press for deregulation in the telecommunication industry, which was widely regarded as a natural monopoly, even before I became a member of the National Advisory Committee to AT&T. And one of the major pieces that I produced for AT&T was called a Grand Competitive Strategy for the Bell System. And the general argument -- this was the late '60s -- was [that] competition is coming; it's technologically necessary; why don't you prepare for it and instead of fighting it, accept it, but demand alterations in the regulation that will enable you to compete effectively in that new environment? It appeared that the leadership of AT&T at that time was receptive to that kind of argument. But then there was a change in the leadership, and AT&T proceeded to do the very opposite to what I was recommending. They brought upon themselves the antitrust suit. And the rest, as they say, is history.
The Real Beneficiaries of Regulation
ALFRED KAHN: There are two ways of demonstrating [what harm the regulation was doing]. Look at who politically was pushing for the motor-vehicle regulation act restricting price competition. The railroads were the prime exponents, because the truckers, free to compete, were wreaking havoc on the railroad rate structure. They were pointing [out] that freight rates were very, very high, and offering them better service [for] things that were small, of great value, and [required] door-to-door service. So the truckers by their competition with the railroads were taking business away -- and undermining the complicated rate structure of the railroads. The other major advocates were the Teamsters, because they wanted the protection of competition for their wages, which were indeed, by various estimates, 35 to 50 percent above the level of people with comparable skills in the competitive industry, and the American Trucking Association who didn't want competition. In precisely the same way, when I was pushing for deregulation [of the airline industry] the prime proponents of retaining regulation were the airlines and the airline unions. And [there] was the growing recognition that this competition [in favor of regulation] was at the expense of the consumer....
So in general, the political lineup tells you that the essential component [of regulation] was protecting people from competition -- and cartelization had at its core restricting competitive entry, restricting competitive pricing. The best estimate that I can find is that there may have been 15 percent of air travel that was subject to discount fares in 1976. [In 2001], 96 percent of all mileage was at discount price. That took competition. United Airlines came to us and said we would like to offer [ski insurance to people traveling to Denver and Colorado's] ski resorts. Buy your tickets in advance, we'll give you discounts [on insurance], and in addition we'll make it attractive: If there's no snow, we'll refund your money. The [Civil Aeronautics Board], my lawyers, said to me, "You can't permit them to do that, because that's a departure from a tariff." Eastern Airlines was very cash poor; they were badly run; they had poor labor relations. They needed advertising [and] they couldn't pay for it, so they wanted to pay for it by giving free tickets. The [Civil Aeronautics Board] lawyers said: "You can't permit them to do that; that's a no-no. That's a departure from a tariff; it's a discount; discounts are not permitted."
Freddy Laker's "Skytrain" vs. the Major Carriers
ALFRED KAHN: Freddy Laker was a very enterprising tour operator who got the idea of introducing a very different kind of service. The one thing to be said about air service was that it was quite good. Planes were only 50 percent full. The lines were short; there was very little congestion. Service was good [and] you paid a high fare. Freddy Laker said: "I'm going to introduce a different kind of service -- no reservations. I'll run a sky bus. People will come; they'll get in line; I'll charge instead of $1,000 or $1,500 across the Atlantic," I think at that time, "$250. And I'll schedule enough flights so that we'll fill the flights." Well, the carriers got together, and they introduced new special low fares that exactly matched Freddy Laker's fares. I remember being visited by Freddy Laker. And I said -- he wasn't yet Sir Freddy -- "Mr. Laker, I think you're a public benefactor; I love what you've done, but I'm terribly worried that [the major carriers are] going to get together and drive you out of business." He said, "Don't worry about me, Dr. Kahn; I'm a survivor." The fact is, they drove him out of business. I persuaded the board that that response was a predatory response.
The Long-term Effects of Deregulation
ALFRED KAHN: [With deregulation] the situation changed dramatically. Within a few years we had a flood of new entrants. Instead of some 15 incumbent dominant airlines, we had hundreds now. Most of them disappeared. In fact, in the first wave every one of them ultimately disappeared except for America West. Of the second wave in the '90s, many of them have disappeared, but we still have several [that] continue to operate... That was dramatic. There hadn't been a single new airline formed in the '40s, '50s and '60s and early '70s. And then, of course, what was equally dramatic was the explosion of discounting, facilitated by the happily advantageous circumstance that the airlines had engaged in an orgy of buying new capacity in the later '60s and early '70s. They had all these jumbo jets with empty seats. And once they were free to compete, you began to get super-saver fares and super-apex fares and potato fares and peanuts fares. An explosion of discounting and competition [occurred].
There's no question that with competition has come real problems. The first thing to say is, by the most definitive estimates, consumers are saving $17 to $20 billion a year as a result of the price competition and the explosion of discounting that has occurred. It is perfectly true, second, that that has been accompanied by increased congestion, crowding of planes, longer lines, and poorer service. That is what we wanted. The trouble with the regulated market was that it offered consumers only one option: good service equals high price. A competitive price market offers options. And the option that we ended up giving people, without fully appreciating it, was low-quality, cheap service. And I mean, there is no free lunch. So I regard it a success that 96 percent of all mileage last year was at very deeply discounted fares, average discounts of more than 70 percent. On the other hand, there's no question either that while average fares have gone down, inflation adjusted, more than 40 percent. Full fares have gone up dramatically -- fivefold in monetary terms, and something like 70 percent in inflation-adjusted terms. In part, that is inevitable: [You do have to pay more] for better service, for more origins, for more destinations, for ability to get service at the last moment, to get on insurance lines, to get upgraded to first class. And in order to fill the planes and make possible those bigger planes and the more convenient service you have to offer discount to fill the seats. But it does raise a threat of monopoly exploitation.
The same kind of evidence is clearly visible in trucking and in telecommunications. In the case of trucking, average rates have gone down. In the case of telecommunications, you've had an enormous improvement in rates. The most obvious and important case of that is long-distance services. I can remember when I watched my watch whenever I called long distance. And whenever I visited anybody, I would insist that I would pay. Well, now [I use] long-distance service like tap water. I mean 10 cents, nine cents, eight cents a minute -- that's still well above even the average total cost. And what also has been dramatic is the explosion of all kinds of services. I mean, just think about cellular wireless services as a major example, and now the development of high-speed data service and Internet access. There's just an explosion of services. |
