Ganesh Sitaraman, a law professor and well-known advisor to Senator Elizabeth Warren, has a new book coming out in November arguing for regulation of airlines. And he uses the news hook of Delta SkyMiles changes in The Atlantic to lay out his case.
There’s no description of how air travel would be better, only a litany of complaints and a suggestion that the 1978 Airline Deregulation Act didn’t live up to what he says were its promises.. even though most of the problems can be chalked up to a barriers the government has erected to competition and a failure to develop infrastructure. There’s a lot of selective history being told, too.
SkyMiles Are The News Hook For Re-Regulating The Airlines
Talking about changes to loyalty programs Professor Sitaraman says that “getting mad at airlines is perfectly reasonable, the blame ultimately lies with Congress.”
- That’s sort of true, there’s no duty of good faith or fair dealing with customers as is traditional in common law for frequent flyer programs.
- That’s because the Airline Deregulation Act pre-empts state regulation of airlines, and common law contract claims are considered by the Supreme Court to be state-level claims (under Northwest v. Ginsberg)
- So a consumer’s only avenue of redress is the Department of Transportation, whose own Inspector General has said that the agency improperly ignores complaints about frequent flyer programs.
You can’t sue, and the government agency that’s supposed to take the place of the courts ignores you. Maybe it’s the fault of the Department of Transportation and Supreme Court as much as Congress. Maybe it shouldn’t be high on the list of national priorities, but Congress has done little to fix it.
Sitaraman doesn’t talk about this at all. Instead, he longs for the days of the Civil Aeronautics Board when they told airlines where they could fly and what they could charge, when prices were higher, and high service levels were used to attract that lucrative business – and when there were no frequent flyer programs at all. He wants “modernized set of rules” to avoid critiques of old rules, without specifying here what those would be.
An Odd History Of How Frequent Flyer Programs Were Born
In many ways Sitaraman tells an odd history of airline pricing and frequent flyer miles.
Unleashed from regulation, airlines devised new tactics to capture the market. American Airlines was one of the most aggressive. In the lead-up to the deregulation bills, it created discount “super saver” fares to sell off the final few remaining seats on planes. That meant cheap prices for last-minute travelers and more revenue for American, because the planes were going to take off whether or not the seat was filled. But these fares upset business travelers, who tended to buy tickets further in advance for higher prices. So in 1981, American developed AAdvantage, its frequent-flier program, to give them additional benefits. Other airlines followed suit.
Leaving aside the strange take that business travelers buy their tickets farther in advance than leisure travelers, or that new discount fares were primarily a last minute phenomenon, Super Saver fares weren’t so much about filling incremental seats at above marginal cost as a defensive tactic to address the rise of discounters. Through customer segmentation American could still charge high fares to business travelers and low fares to leisure customers and do it on the same plane without additional cost, undercutting new market entrants.
AAdvantage wasn’t originally a response to angry business travelers, and it didn’t initially provide additional ‘benefits’ as such. It was initially conceived of as a lower fare for loyal customers and ultimately was intended as a way to get passengers to choose one airline over another even at the same price, or to take a slightly inconvenient flight a couple of hours earlier or later. Gold status only came later.
Sitaraman identifies American’s Citi AAdvantage credit card in 1987 as a watershed moment changing these programs, but it wasn’t the first card. That honor belongs to the Continental OnePass TravelBank MasterCard from Marine Midland Bank (now HSBC). United’s card launched in 1987 as well.
Far from leading to a decline in air travel, it helped to democratize and save it.
- The most successful marketing innovation in history, most firms see marketing as an expense line but for airlines they are a profit center. Other businesses rent their program to market their own products.
- Miles gave customers access to low cost aspirational airfare, initially with seats that airlines expected to go unsold. They also democratized the first class cabin through upgrades, redistributing seats from wealthy and top executives to middle class road warriors as well as occasional flyers.
- And they served as a source of funds dating to United’s bankruptcy 20 years ago, to advances on mileage sales for liquidity during the Great Recession, and finally as collateral for borrowing $6.5 to $10 billion each for the largest U.S. airlines during the pandemic.
The “proliferat[ion in] the number of fare classes, charging differential prices for ticket” has helped to lower prices as well as fill cabins, both for coach passengers and for first class. No longer would the front cabin be a flat price, or even just two prices, but frequently now an upcharge from the prevailing lowest coach fare. That has helped to fill more seats (further bringing down price) and fill better seats at lower prices benefiting consumers by putting them within reach of a better experience (in recent times at the expense of upgrades).
Oddly as well Sitaraman sees a huge shift in Virgin America’s introduction of a revenue-based frequent flyer program.
Virgin America realized that the amount people spend on a flight, based on the fare class, is more important to their bottom line than the number of miles flown. So, in 2007, it introduced a loyalty program rewarding money spent rather than mileage accrued.
In fact Virgin America eleVAte began offering members free flight awards in fall 2008, and wasn’t a huge influence on the industry. It was Delta’s move towards becoming more revenue-based, following a rich history that in the U.S. dated to America West FlightFund in the 90s and abroad to Air New Zealand Airpoints, that led to copycats. And fare paid isn’t in fact equivalent to value (a $400 ticket one way New York LaGuardia – Washington National isn’t less valuable than a $500 roundtrip between the U.S. and Asia).
You can’t tell the history of frequent flyer programs without talking about the role of consolidation, not just from a competitiveness standpoint vis-a-vis travelers but also banks. There were fewer big partners for banks to work with in marketing credit cards to customers, and that improved airline bargaining power.
And you can’t tell the story without the role of the U.S. tax code in incentivizing airlines to move part of the fare into fees – the U.S. industry collecting around $5 billion a year in baggage fees alone means around $375 million in tax savings. Government policy is making air travel worse, not the absence of it, and frequent flyer programs and their associated co-brands have taken on a greater role in alleviating some of these pain points.
He Doesn’t Want There To Even Be Loyalty Programs?
Sitaraman is far too flip regarding the economics of mileage programs, suggesting “They incur no costs from points until they are redeemed—or ever, if the points are forgotten.”
As a technical matter that’s both wrong and misleading. In many businesses costs are incurred at the point of service provision. But the accounting for miles is not like putting beans in a magic box.
- Revenue recognition rules require airlines to account for the value of transportation to be provided in the future when awarding points from ticket sales, and to split the revenue from miles sold into constituent parts (brand, benefits like checked bags or lounge access, renting of member lists, future transportation) for miles sold to third parties.
- The accounting could be better, but the billions of dollars in liability on airline balance sheets show that the cost of miles are being accounted for long before they’re redeemed.
He also throws a bone to those who would regulate the cost of credit card acceptance, requiring Visa, Mastercard and American Express to provide their services to merchants at a lower price.
Certainly the system is bad for Americans who don’t have points-earning cards. They pay higher prices on ordinary goods and services but don’t get the points, effectively subsidizing the perks of card users, who tend to be wealthier already.
His ‘certainly’ here is anything but. Credit cards don’t redistribute money from poorer consumers to wealthier ones, they redistribute from wealthier cardholders who revolve debt to those who do not. Credit cards are less expensive for merchants to accept than cash (since cash means incorrect change and clerks pocketing funds). And where price controls have been applied to interchange, consumer prices haven’t gone down.
And he thinks that airlines selling miles for more than they’re worth means consumers are getting fleeced.
Online analysts try to offer estimates of points’ cash value, but airlines can reduce these values after the fact and change how points can be redeemed. Airlines even sell points at above their exchange-rate valuation, meaning that people are paying for something worth less than the money they’re buying it with, in part because it’s so hard to know what the real value is.
Here he seems to misunderstand subjective value (people value points, and the things they can buy at different amounts) and marginal value (points bought to top off an account towards a specific award are worth more than the average value of points, buying them speculatively without a specific award in mind).
I do think consumers often overvalue points, and maybe some people are misled by The Points Guy about how much their points are worth, but a gap between sale price and estimated value in itself proves little.
In any case, the regulated world he longs for is one in which airlines do not compete, do not invest in marketing programs (miles), and the economics of co-brand credit cards and miles no longer make sense.
Misdiagnosing The Loss Of Small Community Air Service
Air travel in the U.S. is a scarce resource. Because of various government regulations there aren’t enough pilots, there aren’t enough gates at many airports, and there’s not enough air traffic control capacity. Since airlines therefore need to make choices about where to serve and which aircraft, they choose routes with more passengers that will pay higher fares. If you want more abundant air travel, including for these small cities, you’d address these constraints.
Instead, Sitaraman says that proponents of deregulation said that “Small cities wouldn’t lose service.” That’s the opposite of what many expected and the reason the Essential Air Service program was contemporaneously created to subsidize service to small cities.
Now, that temporary 10 year program has been in place for 45 years (“Nothing is so permanent as a temporary government program” – Milton Friedman) and often funds service to towns where no one wants to fly, often because there are better options a short drive away.
The reason though that small cities today are losing service, though, is because of special interest government regulation that makes that service uneconomic. There’s a shortage of pilots, and so airlines focus on routes where the increased cost of those pilots can be amortized across 140 or more seats per passenger instead of carrying mere dozens.
There was no legitimate safety justification for the 1,500 hour rule for co-pilots that contributed to this shortage, just a pilot union play to create barriers to entry and enhance their bargaining position. (Contemporaneous rules around pilot fatigue do benefit safety.) And when airlines seek to offer direct service within current rules that’s ignored by major airlines, the federal government moves to block it at the behest of the same unions.
Rather than Sitaraman’s conclusion that “without mandated service, cities and regions across the country have lost commercial air service, with serious consequences for their economies” it’s the federal government standing in the way of small community service in many cases.
Airline Subsidies And Stock Buybacks Aren’t A Reason For More Regulation
There’s a bit of a ‘throw the kitchen sink at the airlines’ litany of complaints on offer, rather than a coherent theory of what harms were actually caused by deregulation and what specific rules would lead to net improvements. So we get claims like this,
And when a crisis like 9/11 or the coronavirus pandemic comes along, the airlines—which prefer to direct their profits to stock buybacks rather than rainy-day funds—need massive financial relief from the federal government.
I warned early in the pandemic that one consequence of airline bailouts would be a call for greater regulation. Airlines were rushing to ‘get theirs’ and willing to even let the federal government take ownership stakes in exchange for subsidies for equity holders.
If it’s true, as Delta CEO Ed Bastian says, that there’s a government put on airline stocks now – that the government will always be there with bailouts if needed – then Sitaraman may be right about the need for greater government control (though this assumes government would do a better job financially managing airlines, which is doubtful).
The better solution would have been to allow the bankruptcy process to wipe out equity, and redistribute gates and aircraft and pilots to stronger employers (letting American Airlines and possibly United go bankrupt, allowing Southwest and Delta to grow, but also allowing new entrants into the market – including foreign carriers).
Meanwhile the standard criticism of stock buybacks are simple economic illiteracy. Buybacks do not enrich shareholders! It is better to transfer assets from low return businesses, back to shareholders to invest in higher social return opportunities. That’s good for the economy and society.
- When airlines generate cash that belongs to shareholders they can invest it or return it. Airlines are generally low growth businesses, and there are usually better opportunities for investment outside the airline. So dividends/buybacks move the cash to more productive places – that is good for society because it means money invested in productive, innovative businesses.
- Buybacks don’t even generally raise share price in a materially lasting way. Share price includes the cash held by the company. When they distribute the cash the airline has a lower value, because they have less cash. They also have fewer shares.
- Stock buybacks literally cannot make shareholders wealthier. The cash held by the company already belongs to the shareholders. It is in the company’s account. The company distributes the cash. The company is worth less, moving the cash from its balance sheet over to shareholders (who invest it elsewhere).
- Buybacks have historically been more tax-efficient than dividends though of course there will now be a 1% tax. No one seems to complain about dividends even though they’re basically the same thing for the company (but many investors prefer them for tax-efficiency).
Stock buybacks are simply a tax-efficient form of dividends that move cash from low productivity investments to higher productivity ones, that cannot ‘make shareholders wealthier’ by definition.
There’s potentially an argument that buybacks bump share prices briefly, and that companies orchestrate their timing to coincide with pre-planned insider stock sales. That might be bad! But it’s a narrow concern that’s not fully demonstrated empirically in any case.
Deregulation Is What Brought Us Lower Airfares
The most compelling argument for the success of deregulation that’s usually presented is that post-deregulation fares fell dramatically. In inflation-adjusted terms, even inclusive of fees, average fares fell 40% in the four decades following deregulation.
So proponents of regulation find themselves in the uncomfortable position of trying to argue that deregulation wasn’t even good for fares.
Deregulation even failed to deliver the one thing it is sometimes credited with: lowering prices. Airfare did get cheaper in the years after the 1978 deregulation law. But the cost of flying had already been falling before deregulation, and it kept falling after at about the same rate.
Arguing that ‘fares were falling anyway’ implies that they would have just continued to do so on their own, as if that were the natural order of things, dismissing deregulation as a driver of lower costs. But that sleight of hand fails to address reasons why airfares fell prior to 1978, and their long-term decline after that.
The introduction of jet aircraft like the Boeing 707 and the 747 allows airlines to carry more passengers at a lower cost per passenger, making lower fares possible. However most lowering of fares was still illegal, and government “rate cases” dragged on for years.
Declines in prices in recent years are attributable to:
- New airlines, such as low cost carriers Frontier and Spirit Airlines (and Southwest Airlines before them) – carriers and business models that weren’t legally permitted prior to deregulation (though seeing the writing on the wall, the Civil Aeronautics Board ‘experimented with price competition in 1976 and 1977, allowing carriers like Texas International to match Southwest’s intra-Texas fares)
- Consolidation, which has helped airlines to fill more seats and operate at lower cost per passenger carried. While there are fewer airlines than there used to be, there’s no shortage of airlines as such simply a limited diversity of business models such that airlines compete predominantly on price.
- Densification and decline in passenger experience – air travel has become a commodity that many more people can afford as airlines squeeze more passengers onto planes. The high service era was precisely the result of regulating high prices, reserving air travel for the wealthy, while the deregulated era has led to low service, low prices, and accessibility.
There’s a version of this claim that suggests the rate of decline was greater prior to deregulation as well, the underlying basis for which is a 2007 study published in the Journal of the Transportation Research Forum which argues fares became more dispersed after deregulation — premium fares went up and discount fares went down, which isn’t an argument Sitaraman wants to make. (It’s also a claim which may have been true 15 years ago when the study was published but is no longer true as fares have compressed – premium fares now sold at a discount – which is why there are fewer upgrades to go around.)
The Purpose Of Regulation Was High Prices
The idea of regulation, contra Sitaraman, wasn’t “to set prices that were fair for travelers and that would provide airlines with a modest profit” but to ensure profitability under the thinking that this was the only way to ensure safety (that unprofitable airlines would skimp on safety). This theory turned out to be wrong.
There’s a long history of airlines remaining safe as they approach bankruptcy, of safety violations happening at the most profitable airlines (e.g. Southwest, where government paperwork oversight failed), and safety has gotten much better during the time since deregulation.
Deregulation was championed as a consumer issue by Senator Ted Kennedy, and opposed by nearly all incumbent airlines.
Airlines Are Among The Most Heavily Regulated Businesses Today
Nearly everything in air travel is regulated – just no longer where airlines can fly and how much they can charge. An anomaly relative to much of the world, airports in the U.S. are generally owned by governments; security isn’t just regulated by government but screenings are performed by government; and air traffic control is directly provided by government, telling airlines exactly where their planes must be at any moment.
Everything inside the plane is heavily regulated, too! When airlines wanted to give out hand sanitizer at the start of Covid-19, that wasn’t a decision they could make on their own, it involved multiple levels of the FAA even though that agency had already determined sanitizer didn’t represent a risk.
When governments gift slots at congested airports to incumbent airlines, keeping out new competitors, and government-owned airports either keep out new entrants or make their space inconvenient to work with, that’s a function of regulatory capture. The drive for more regulation is highly naive, thinking it is somehow consumers that will benefit instead of incumbent airlines at the expense of competition.
Higher Fares Are The Result Of Government Failures And Bad Rules
To the extent that airfares stagnate or even rise, it’s as much or more a failure of government.
- There are more people demanding more air travel
- But U.S. infrastructure hasn’t kept up. Governments run commercial airports in the United States, and the U.S. has become bad at building things with too many reviews and chokepoints in the process. The last major airport opened almost 30 years ago (Denver) and new gates can take as long to build in the U.S. as entire large airports in many parts of the world.
- The federal government’s inability to staff air traffic control or manage technological upgrades has led to their asking airlines to limit flights. The best practice for safety is to have a separate regulator and service provider for air traffic control but the FAA regulates itself and limits the supply of air travel.
- As demand for travel grows, and government limits its supply, we can expect higher prices.
Blaming an inability for the government to expand infrastructure or air traffic control throughput on deregulation is.. bizarre.
When Governments Run Airlines They Do Worse, Not Better
Sitaraman thinks we should regulate airlines as a monopoly, after all there are “only four major carriers” – which is actually a lot of major players in many industries – and doesn’t factor the role of regional carriers like Alaska and JetBlue, or the role of discounters like Spirit, Frontier, and Allegiant. He thinks barriers to entry, which limit competition, are a reason for regulation when they are the result of regulation.
Government-run airlines are corrupt and inefficient the world over. Many have either recently gotten out of the business of directing airlines day to day (and exploiting them for political purposes) or are in the process of doing so. Making the U.S. airline industry more like what India, Pakistan, and Sri Lanka are trying to get away from makes very little sense.
Yet Sitaraman sees airlines better as a government-directed utility “just like railroads, the electric grid, and communication networks.”
Turning Delta and United into Amtrak wouldn’t be an improvement. Even in the Northeast the primary advantage of government trains is their ability to avoid the limitations of government air traffic control, government security checkpoints at airports, and weather. (Delta, JetBlue and JSX even do a better job providing internet in the sky than Amtrak does on the ground.)
And while technology has made communications networks – able to transmit through satellites and not just over fixed transmission lines – less like the 1950s model of a natural monopoly, Sitaraman wants to “arrest the trajectory of airlines becoming” more technology-drive, “financialized e-commerce platforms” with “making air travel less miserable” only a “maybe” out of the whole thing.
This wouldn’t be bad for everyone, or else we might not see it advocated! Remember that every airline except for United and Frontier opposed deregulation in the first place. And a “cost-plus” model where airlines charge a fixed amount over what it costs them to fly, and aren’t allowed to compete to lower prices, benefits labor. Why tolerate a strike when you can just raise fares and the government will force everyone else to do so? Regulation becomes a tool to redistribute wealth from consumers to labor, at the expense of fewer people able to fly – a huge cost to the overall economy.
What’s important here is there’s a shot across the bow of aviation – an intellectual case is being made for airlines to revert to the status of public utilities. Sitaraman’s upcoming book can be seen as a starting gun for arguments over regulating the airline industry. The arguments for this used to be unserious, by folks like Robert Kuttner. That’s changing, and with a direct line to people in power.
People who care about not making air travel worse need to wake up to the threat, though there is also much we should be doing that would make air travel better.