Prelude to Deregulation
n Chapter 3 we saw that government regula – 1 tion of public utilities in the United States is grounded primarily on the concept of economic necessity, supported by legal authority. Since 1887, the railroads had been considered to be monopolistic, quasi-public corporations, although privately owned and operated. This meant that the public interest (the right of the public to equal access to travel opportunity and to non-discriminatory passenger fares and freight rates) and the governmental interest (in having a reliable interstate transportation system) had to be protected by federal law. The administration of this function was performed by the Interstate Commerce Commission, the agency whose rules and regulations largely controlled how the railroads operated, who could operate them, where they could operate, and how much they could charge. It also mandated safety regulations.
We also saw how the early airmail routes operated by the Post Office generally followed the railroad lines laid down across the country, with air fields in or near the settlements and towns created during the westward expansion of the emerging nation. The early airlines were largely controlled by the Post Office through airmail subsidies, and the airmail routes awarded by the Post Office gradually evolved into passenger
and freight routes operated by established, independent airline companies. The government viewed the airlines in the same light as the railroads and, in turn, regulated them in a similar manner.
We know that the first federal regulation of aviation occurred with the passage of the Air Commerce Act of 1926, with a modest mandate from Congress to promote air commerce. Beginning with the licensing of airmen and aircraft and the creation of navigational aids and other mostly safety-oriented rules, government regulation expanded in lockstep with the expansion of the commercial aviation industry itself. The government assumed control of airline labor relations and air traffic control and, with the passage of the Civil Aeronautics Act of 1938, the government began deciding who could enter the airline business, as well as where they could fly and how much they could charge. Approval of mergers and rate and route regulation were performed mainly by the Civil Aeronautics Board, with safety regulation ultimately residing with the Federal Aviation Administration.
Historically, the government’s interest in regulating transportation has also extended to insuring that the various modes of transport (water, overland, railroad, air) remain
individually viable by limiting or forbidding interlocking relationships between them, thus insuring competition. When the United States took over the former French construction of the Panama Canal under the Panama Canal Act of 1912, for example, the railroads were precluded from having any ownership interest in competing water carrier companies that would operate through the canal. The fear was that the railroads would compromise the promise of the Panama Canal and doom its success by cutthroat competition amongst the coastwise trade carriers, thus preserving their transcontinental railroad monopolies. Likewise, when the airlines came along the railroads were forbidden from owning any interest in those fledging airline companies so as to insure that airline passenger and freight markets were unfettered and free to develop on their own and in their own way.
Before launching into the historical developments that precipitated the dismantling of federal economic regulation under the Airline Deregulation Act, let us take a look at the economic nature of transportation in general.
1 The Economic Nature of Transportation
Unlike most consumer services, transportation provides an intermediate product—only a means to an end. In air transportation specifically, hardly anyone flies in the airline system just to go for an airplane ride. The reason people fly is to accomplish another goal, whether it is for a business purpose or a personal one.
This characteristic of the transportation industry likens it to a commodity, for example, wheat or petroleum. Wheat is not purchased because anyone wants a bushel of wheat, but rather to create something else, perhaps a cake or a loaf of bread. Oil has no use except to facilitate a secondary purpose, like the lubrication of machines or as a means of propulsion.
There are no unique characteristics within a class of commodity; one bushel of wheat is like any other. One quart of oil is indistinguishable, and worth no more, than any other quart of oil. Economic theory teaches that the price of a commodity will seek the lowest possible level based on supply and demand. If the supply of a commodity is adequate to the demand, unit profit on any given quantity of a commodity will be very small and the price will be low.
If an airline seat is like a bushel of wheat, its price will be valued like any other airline seat absent some distinguishing characteristic, assuming an adequate supply of airline seats. Government economic regulation of the airline industry effectively thwarted this economic truth by controlling the supply and the price of airline seats. The cost of air transportation was, therefore, very high causing the system to be mainly used for business travel. By the 1960s, economists and others began to ask “Why?”