US airlines have been making loud noises over how unfair it is that they have to compete with some Gulf airlines. They want the administration to take steps against Qatar, Emirates, and Etihad.
For foreign policy reasons this is highly unlikely. But the noise – and the overheated rhetoric – have been loud enough that the argument has gotten attention.
One Mile at a Time runs a piece titled, “Other Carriers Can’t Compete With Gulf Airlines Under The Current System” and concludes,
Open Skies is intended to eliminate government intervention and “free” markets. And there’s no arguing that the Middle Eastern airlines aren’t operating within the spirit of the agreement.
…But when every aspect of an operation is being run in order to generate a loss and increase market share for the purposes of developing a country rather than an airline, then Emirates, Etihad, and Qatar really aren’t playing within the spirit of Open Skies
Open Skies are more complicated than just opening markets. They:
- Allow (more or less) unrestricted takeoffs and landings in a country
- Facilitate passengers and cargo
- Pave the way for airline investment, subject to foreign ownership restrictions.
- Permit airline joint ventures and cooperative marketing
- Commit to safety standards
They drive down prices for consumers, and make it possible for goods as well as people to move more freely. That contributes to economic development in both countries. Open skies agreements aren’t wholly about the businesses engaged in air transport.
And the truth of ‘US free market versus government-subsidized foreigners’ is much more complicated.
US and Middle Eastern carriers don’t really compete on most routes.
There’s very little US carrier service between the US and Dubai, Abu Dhabi, and Doha. United flies Washington Dulles – Dubai. Delta flies Atlanta – Dubai.
The Middle Eastern carriers are flying passengers to India, Pakistan, and the Middle East. There’s very little US carrier service there as well. American ceased flying Chicago – Delhi nearly three years ago. United flies between Newark and Mumbai and Delhi. But they don’t fly to Chennai, Thiruvananthapuram, Kochi, and any other number of cities in India served by the Gulf carriers. And they don’t fly to Pakistan or Sri Lanka.
In other words, most of the routes that the Middle Eastern mega carriers fly complement rather than compete with US airline offerings.
Emirates, of course, has their Milan flight. They’d like to do more fifth freedom routes to the US. And US airlines don’t want competition.
The Early Days of the US Airline Industry Were Completely Shaped by Government
Many current travelers remember or are aware of the 1978 Airline Deregulation Act. But few remember how the airlines came to be regulated in the first place.
In the early days of US civil aviation the largest airline customer was the federal government in the form of the US Postal Service.
The 1925 Kelly Act authorized the Postal Service to contract with private airlines to carry the mail. That led to airlines received most of their revenue carrying mail. Often priced to the customer by the piece regardless of weight, with the government charged for weight, airlines were known to mail bricks and other large objects to themselves in other cities to pump up their revenue.
The 1930 Air Mail Act changed how mail was priced and gave broad contracting powers to the Postmaster General. The Postmaster used this power to consolidate contracts under three major airlines, forcing many airlines out of business. This came to fruition out of a 1930 meeting that became known as the ‘Spoils Conference’.
The government had dictated which airlines would survive and prosper, and awarded contracts to airlines that hadn’t been the lowest bidder. When the story of what transpired finally came out, it was a scandal that led to the cancellation of contracts and to the Roosevelt administration enlisting the Air Force to carry mail. They weren’t equipped to do this.
Accidents and deaths followed the Air Force takeover of air mail, and contracts were finally returned to the private sector. None of the incumbent carriers were permitted to carry mail, so airlines changed their names. None of the executives involved earlier could run airlines obtaining postal contracts and so leadership was jettisoned from the airlines. United and Boeing were broken up into separate companies.
It’s Impossible to Unbundle Subsidies and Figure Out What’s Fair
Airlines are one of the most heavily regulated businesses in the world. Nearly all US airports are owned by governments. Safety regulations are precise and myriad. Consumer protection laws dictate how airfares can be displayed, how long customers have to change their minds, and even how long passengers may be onboard a plane and pushed back from a gate.
Airlines buy aircraft from Airbus, which received European government support at its launch, and from Boeing whose commercial planes receive cross-subsidies from US military research and development investments.
The US airlines did receive payments after 9/11, when the US aviation system was shut down. And airlines receive tax subsidies (Delta gets big fuel tax subsidies from the state of Georgia, for instance — Pennsylvania also subsidized Delta’s purchase of an oil refinery in 2012.). They receive marketing subsidies. They receive funds to support ‘Essential Air Service’ to communities that might not otherwise have flights.
The Fly America Act requires US government travel purchases, and those purchases of government contractors using government funds, to be made through US airlines. Employees take US airline flights, and when not possible they favor US airline codeshares. And one of the biggest buyers of travel in the world is.. the US government.
Delta CEO Richard Anderson, who raised the specter of 9/11 in criticizing the Gulf carriers, was formerly CEO of Northwest Airlines. So he’s well aware of the privileged position that Northwest, formerly Northwest Orient, held in Tokyo with unique rights there stemming from US military conquest of Japan in World War II.
US Airline Partners Are Government-owned and Subsidized
To name just a few, Malaysia Airlines has become state-owned, and is a partner of American and member of oneworld.
Saudia – the flag carrier of Saudi Arabia – is a Delta partner and member of Skyteam.
South African Airways, a Star Alliance carrier, has been on state-funded life support while it works to sell a stake in itself to… Gulf carrier Etihad.
US airlines gain from these government entity partners (which is why they enter the partnerships).
US Carriers Have Advantages the Gulf Carriers Can’t Match
US airlines have advantages with US customers that no Gulf carrier can match. They have domestic destinations to fly you to. The Gulf mega-carriers essentially are without a domestic route network and only offer international travel.
American customers favoring a single airline can travel most of the world, and their own country, on that airline. They have to deviate from their preferred carrier in order to fly on a Gulf airline.
US airlines have their frequent flyer programs to leverage as marketing vehicles to win the business of US customers. (Perhaps if they’re concerned with international competition, they’d be wise not to cut back here.)
Their elite programs deliver upgrades more easily and reliably than the Gulf carriers do. Emirates has just tightened its upgrade rules. No carrier monetizes its forward cabins through auctions and buy ups like Etihad does. While US carriers do tend to still reward at least top tier elites through complimentary, confirmable upgrade certificates.
On the redemption side the Gulf carriers tend to be expensive for long haul awards and to add fuel surcharges to awards.
The US airline route network and elite passenger policies gives them a huge leg up with the US customer base.
Fair Competition Isn’t the Point
Etihad may be more interested in building Abu Dhabi as a world connecting hub than in driving profits, but there have long been mad airline investment schemes. That’s why Warren Buffet has quipped that the fastest way to become a millionaire is to start out with a billion dollars and invest in an airline. It’s been said the best thing for investors would be to go back in time and kill Orville and Wilbur Wright.
The ashes of airline history are littered with airlines that pursued bad business models, or that lit money on fire with cheap fares on the belief that somehow they’d attract customers or drive competitors out of the market. Whether Braniff or Independence Air, it was their capital to waste.
Consumers in the meantime benefited from the flights, fares, and service. A wise airline is one that steers clear, preserves its capital and seeks out routes where profit can be made.
While the Civil Aeronautics Board intentionally held prices high, in order to ensure airlines received a ‘normal’ level of profit, the purpose of the Airline Deregulation Act — championed by the late Senator Ted Kennedy — was as a consumer benefit. It drove down pricing. And that’s just what the Middle Eastern carriers do, along with higher levels of service.
The major difference between Emirates and Etihad and Braniff and Independence Air is that the former are foreigners with deep pockets, and the latter were US entities whose capital eventually ran out.
But even Emirates’ funds aren’t unlimited — during the Great Recession Dubai World was essentially insolvent and had to restructure.
Meanwhile US airlines – for all of their complaints – are earning record profits. The US airlines are profitable, certainly more so than the Gulf airlines.
‘Shut Up and Compete’ is the Wrong Answer, ‘Shut Up’ is Closer to Right
The refrain of Gulf carriers that ‘if US airlines weren’t so bad, consumers would choose them, so quit whining and improve your product’ isn’t quite right.
Gulf carriers face lower costs for a variety of reasons, some having to do with state subsidies (although it’s hard to argue their fuel costs are abnormally low when they lose money on fuel hedges, regardless of whether they ultimately bear those losses) and some having to do with geography.
There are many airlines in the world with lower labor costs than US airlines face. Their Southeast Asia, African, and Indian partners have lower costs as well.
Nonetheless, facing different cost structures and reporting to government owners rather than shareholders, their business decisions rationally differ. Their corporate cultures differ. And their customer expectations differ.
The answer isn’t that US airlines should invest in product at the level of Gulf carriers, and it isn’t that they should reduce wages to the level of Gulf carriers.
Instead, it’s that they should do exactly what they’ve done — strategically partner with those carriers where it makes sense (or with other airlines in the region), concentrate on routes where they can make money (and indeed they’re making billions presently), and recognize that different actors behave in ways that match their own self-interest, but that definitions of self-interest can vary. US policy isn’t likely to change the world.
To be clear this is not a defense of the Gulf carriers.
It may not be wholly satisfying, but it’s necessary to recognize the limits of what can be accomplished and that the world itself is far more complicated than what’s painted by the two sides. US airlines don’t want free markets, they want protectionism, but that’s bad for consumers and the economy and likely ultimately bad for security as well.
I agree with you Gary.
The reality is that the United States government picks winners and losers across lots of industries. We subsidize the agricultural industry because we want that industry to survive and flourish, level playing field or free market economics be damned. That is both acceptable and politically palatable.
The U.S. airlines are hypocrites for complaining of such tactics by the Middle Eastern carriers, especially when they themselves fed at the government sponsored trough post-9/11 (which, by any standard, was a government subsidy providing an unfair advantage).
As you point out,t he U.S. airlines receive many advantages by virtue of their base, and by virtue of their long-term relationships with government. To that end, I think their grievances are overstated.
Good, thought provoking post.
What did you mean with your last line about security?
Bravo, Gary! Well said.
Now please, Delta, shut up!
Love the actual partnership idea. Trouble is Anderson et al seem to want take their proverbial ball and go home.
These “partnerships” are seldom clear cut(earnings limits, redemption glitches etc.) so they end up being confusing to almost anyone not wholly schooled in them.
Given the amount being made, albeit in different ways, seems that nothing positive will come from this for passengers until the next downturn when these airline CEO’s/spoiled brats actually need one another for survival.
Finally, an article which could be correctly titled: “Shut Up, He Explained”
US airlines have benefited immensely from the US government allowing them to merge into an oligopoly. Meanwhile US law restricts foreign ownership of US airlines. As a result they legally engage in ‘soft’ antitrust behavior on a regular basis without fear of competition from other global airlines.
I agree that the US airlines need to shut up about getting any sort of ‘raw deal’ vs. any foreign carrier. Strip away their consumer-unfriendly government protections and allowances and then they might have a point.
As it stands, they are the pot calling the kettle black.
Great summary of the complex issues involved; should be required reading for all media and politicians involving themselves in the topic. Although I do think your prior opinion about there being low barriers to entry into the US airline industry should be similarly qualified by the incumbent advantages you mention here, in addition to many other network and scale issues.
I usually enjoy Lucky’s writing, but he really should consult with folks like you before expounding on economic and political issues where he hasn’t done much research.
+1 to kokomutz’s point about oligopolistic nature of the US industry, and also the anti-trust immunity granted to trans-atlantic and trans-pacific alliances.
@Jig there’s no question that incumbent carriers have an advantage, which is why I often write with skepticism about startups who “only need to capture 1% of the market” on a route like New York – London, without corporate contracts, a loyalty program, significant frequencies, etc.
@kokomutz writes “US airlines have benefited immensely from the US government allowing them to merge”
That’s a pretty strange view of government help — the government not stopping voluntary action as some kind of a subsidy. Certainly not the ‘conventional view’, from a pretty unconventional fella!
US airlines also benefit from government interference in labor negotiations by virtue of the Railway Labor Act, which is designed to prevent disruptions to transportation through strikes.
Yes, the kid gloves with which the US government has treated these mergers is clearly a form of government support.
The DOJ bared its teeth momentarily, daring to compare nonstop flights to spoke and hub flights, but ultimately curled up in the lap of the AA/US merger. So now over 80% of US domestic air-travel market in the hands of only four airlines.
And those 4 airlines have oligopoly control over the world’s most lucrative airline market. With no threat whatsoever of competition from incumbent global carriers.
Sometimes government help is proactive, as it is when the US government limits competition by keeping global carriers out of the US domestic market. Sometimes it is passive such as when it limited competition by allowing the domestic carriers to form an oligopoly.
The loser in both cases is the consumer. Sadly, there is nothing unconventional about that at all.
Isn’t that a Richard Branson quote (with launch instead of invest in)? I see no other attribution to Warren Buffet other than it being previously mentioned on this blog.
Just because an argument is hypocritical doesn’t mean that it is incorrect.
Yes, US airlines have benefited government handouts and subsidizes in the past and get a small amount of largess now.
The 3 big gulf airlines are in reality extensions of their respective governments. They have near-zero borrowing costs and pretty much unlimited checkbooks for bailouts.
Here is the deal, without the big pockets of their respective governments those airlines would be a whole lot smaller and have worse service. They really don’t have the population and internal demand to support those levels.
Trade agreements and the WTO protect other industries from dumping and selling below cost for market share. It is not unreasonable to hold the airline industry to the same standards. Yep, SA, JL, and AI would be under the microscope also.
EFS, there is nothing inherently wrong with state-owned enterprises acting as market participants, even if profit is not their only motivating factor. There are several sovereign wealth funds that invest all over the world that don’t limit their activity to the strict pursuit of ROI, but have political objectives as well.
@Polk it’s generally attributed to Buffet, stemming from his investment in US Air (see for instance http://www.fool.com/investing/general/2012/05/23/if-you-have-to-invest-in-airlines-dont.aspx)
Isn’t this sort of like the argument about for-profit companies competing with non-profits. A charity that operates a non-profit hospital gets a tax advantage from the government and is under no obligation to shareholders to turn a profit. Still for profit hospitals must compete with them.
Wasn’t there a pi$$ing contest between Boeing and Airbus a few years back. Any winner or might the future be lower cost commercial airplanes built by Chinese companies.
IMHO, placing barriers on these Gulf carriers could cause Boeing to lose sales. But can Airbus meet an increase in demands or not.
I very much thought that your article would go somewhere along “US Airlines should start flying A380’s with showers and beds, and serve Caviar, Dom, and Krug in business class to compete against ME3”. Turns out, this is one of most well written articles on this topic.
@X the security point was that cooperation in aviation is pretty crucial. Though US airlines hate that the government extended immigration pre-clearance to Abu Dhabi, almost entirely at the UAE’s expense, the reason they did it is because it gave them the opportunity to stop people from boarding planes rather than stopping them at the border when they’re already in the US. That’s just one example.
What’s more, US diplomatic relations with Gulf states are crucial if the US sees its interest as restraining ISIS. The US will need their support – for political cover, to use their bases – at a minimum.
Sorry, Gary, but I think your argument is weak and Lucky has this one exactly right.
While I enjoyed your history lesson on “subsidies through the ages,” it’s a red herring in the current dispute. To some extent, every country has “subsidized” their airlines. Some more than others, and some more effectively than others. But, that said, the subsidies didn’t “change the game.” Here, the Middle Eastern airlines are on a wild, mind-boggling expansion spree — despite their countries’ tiny population, they account for half the widebody order book of Boeing and Airbus. No one in aviation history has ever done this, and their business models defy everything known about airline economics. For instance, NO ONE has ever made money offering luxury connecting travel on huge airplanes from a small city. Emirates already serves 9 USA cities with widebody flights: if they had to actually make money with this service, perhaps they’d serve one (JFK).
This is obviously harmful to the USA airline industry — as well as the airline industry in every other part of the world except the Middle East. There is certainly less nonstop service from the USA to India — an obviously important market for the future — because it’s nearly impossible to make a buck on those flights with Emirates flooding the market with nearly unlimited capacity. Maybe you’re OK with the UAE picking up this tab, but I think most Americans would like their own airlines to have a fair shot at carrying these passengers, creating jobs and wealth in our own country.
To me, this is no different than a Middle Eastern nation throwing tens of billions into airline manufacturing and selling below-cost planes to drive Boeing out of business. Would that “bother you”?
I have a home in Kochi (India) and because of the gulf carriers (qatar,emirates,etihad,gulf air,oman air,kuwait airways,flydubai),i can fly wherever in the world whenever i feel with >3 hours transit in dubai or any other hub.Compare that with the 12 hours ill have to spend in uae to fly united.From a passenger point of view, would you like to fly an airline which charges you for exceeding your baggage allowance by 1 pound or an airline which doesnt mind if you carry 20 pounds extra??
The US airlines found that they cant compete on a passenger level, so they are competing on the government level (if you knw what i mean :P)
The Gulf airlines do not normally compete with US carriers, so who care about government help? The facts are that the US carriers are reaping record profits. In the meantime two of the three biggest liars in the industry continue to lie and whine at the same time, all the while treating their employees like dirt. Like to see parker and schmuck find new employment in another industry.
You say American stopped service Chicago – Delhi three years ago, and US carriers don’t serve other Middle Eastern cities, but you don’t mention that this is because US carriers have pulled out due to subsidized Gulf carrier competition. Sure the US carriers are profitable at this moment in their history, and anyone who understands airline history knows that this is temporary. What is wrong with US carriers being profitable? Why is the US airline industry the only industry not allowed to make a profit? You are so accustomed to US carriers losing money in a race to the bottom that you want to prop up foreign carriers to throw US carriers back into losses. Your argument is to “benefit consumers” but consumers are now experiencing the lowest airfares since 2007.
@Henry Wiley – American ended Chicago – Delhi service 5.5 years ago, when Gulf carriers weren’t nearly running so much capacity to and from the US.
A very good article I thought. I think the whining in the US about the cost of flights tends to overlook the fact that flights really aren’t much more expensive than they were 20 years ago. Yes, there were 10 big airlines back then, but they didn’t all make money – at least there are now 4 big stable carriers.
Boeing is hugely subsided by the US government, much more so than Airbus, so I really have very little sympathy for them too – particularly given the way they are encouraging the US government to pick on Bombardier at the moment.