December 08, 2003

A Look Back at Deregulation

Alfred Kahn argues that airline and telecommunications deregulation was a very good idea:

Economist.com | Economics focus: ...Not so, as Mr Kahn's methodical analysis makes plain. Deregulation of the airline industry has been, he says, "a nearly unqualified success, despite the industry's unusual vulnerability to recessions, acts of terrorism and war." The benefits to consumers have been estimated at in excess of $20 billion a year, mainly in the form of lower fares and huge increases in the availability of fast one-stop services between hundreds of cities. Consumers do complain that standards of service have fallen. So they have--because passengers are unwilling to pay for them. Through competition, the market has discovered that consumers prefer cheap tickets to frills. Such discoveries are the whole point.

American telecoms deregulation is a more complicated tale, but here, too, Mr Kahn draws attention to several large and clear benefits: much cheaper rates for long-distance calling; vastly cheaper cellular and other wireless services; and, in both cases, correspondingly hug increases in usage. Reluctant as consumers may be to believe it, competition is far and away their best friend in economic policy...

http://www.aei-brookings.org/admin/authorpdfs/page.php?id=303

Posted by DeLong at December 8, 2003 09:29 AM | TrackBack

Comments

The consumer may have saved a bundle. I wonder how much bank lenders, aircraft lessors, and shareholders have lost in bankruptcy cases and in renegotiations. I wonder how much airline workers have lost?

And for consumers, prices are low, but comfort has gone by the board. People who would be willing to pay some higher price for a bit of extra legroom in coach have no alternatives except to pay the enormous cost of first or business class.

Posted by: Masaccio on December 8, 2003 09:58 AM

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It's easy to quantify success on lower prices. But how about factoring in, in the airlines:
* Numerous collapses, and all the attendant fallout
* Government bailouts (why were the airlines sooo weak, soo undercaptalized, that a 7-day slump in Sept 2001 wiped them out?)
* Hub-and-spokes systems which led to multi-legged flights and left many middle-sized cities isolated, unable to hold businesses, while swelling larger areas;
* Inflexible service for customers without gouging on flight changes; price gouging for short-notice flights
* General customer dissatisfaction, from service to near-bogus extra miles incentives
* and still, today, a very frail, undercapitalized industry

What's good about all that? Only that it's not easily measurable in immediate economic terms?
Paulo,http://whosecapitalism.typepad.com/

Posted by: pauo on December 8, 2003 10:19 AM

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Sounds great to me. I will buy what they are saying. Now, let's hear an explanation of how electricity deregulation and water deregulation is going to be good for me. A warning, I live in California, so the explanation better be good.

Posted by: .David E on December 8, 2003 10:51 AM

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I'm the last one to defend the airlines as good businesses, but over the last three years the majors have lost something like $20 billion. We're not talking about a 7-day slump. And I'm not sure how many industries could lose that much money and not seem frail.

I'm not sure how the problems of the airlines demonstrate that we should have kept regulation, though. Of course the major airlines were better off in a regulated environment. They didn't have to worry about competition and their profits were determined by how successfully they could lobby regulators. But government should not be in the business of guaranteeing corporations profits. Southwest and JetBlue have proven that you can make money flying. If the majors haven't been able to do that, that's their fault. In a competitive market, economic profits are supposed to be zero.

And this idea that competition has somehow eliminated choice doesn't make any sense. If a sizeable number of consumers were willing to pay extra for a little legroom, some airline would offer them that. (JetBlue's seats are actually relatively roomy.) It's a little more complicated than that, because the fact that takeoff slots at airports are often controlled by the majors makes it hard for competitors, but that's an argument for more deregulation, not less.

Posted by: James Surowiecki on December 8, 2003 10:54 AM

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"American telecoms deregulation is a more complicated tale, but here, too, Mr Kahn draws attention to several large and clear benefits: [...] vastly cheaper cellular and other wireless services;"

Yep, the reason we didn't have cheap cellular technology in 1980 was over-regulation.

msw

Posted by: msw on December 8, 2003 11:00 AM

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As Robert Kuttner has pointed out in Everything for Sale, the price of airline tickets dropped far further and far faster under a regulated regime than after it. Furthermore, since deregulation, the price of oil has fallen substantially. Since that's a major input to flying, claims of savings resulting from deregulation need to be taken with a grain of salt. Granted, of course, that the earlier drop in air fare is mostly a function of the experience curve, technological advance, the broadening of air travel to include the middle class and so on. Even so, I think that one can't pronouce this an unqualified success without examining the externalities that Pauo and Masaccio mention

Alfred Kahn is, by all reports, a wonderful man, the sort of person who should be placed in charge of any deregulatory effort. On evaluating air deregulation, he has a conflict of interest and should recuse himself.

Posted by: Charles on December 8, 2003 11:22 AM

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James Surowiecki's comments still raise the question, why is a necessary public good so constantly fragile and requiring bailouts, or disrupting the economy when the participating companies collapse? They needed bailouts even before 9/11.

These are semi-public goods. There is only so much space in the sky. Building airports are huge community projects, not simply easy-come easy-go private investments. The nation, the economy needs the industry to survive.

All that points to certain kinds of regulation, though certainly not all of the pre-Kahn type. I find no problem in having regulation that guarantees a certain level of profit in exchange for stable service that meets local-national-regional goals. Many countries which develop private power feeding into a nationally-controlled distribution network, a certain margin, based on fuel prices and other factors,is required by companies to make the investment for a 30-year return. What consumers and industry get is stable supply at reasonably predictable (not fixed) prices. No problem there.

Paulo, http://whosecapitalism.typepad.com/

Posted by: paulo on December 8, 2003 11:40 AM

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The Economist writes:
"Excellent reading on this is a new paper by Alfred Kahn, doyen of America's regulation economists†. In a study jointly published by the American Enterprise Institute and the Brookings Institution, Mr Kahn assaults the widely held view that America's deregulation of airlines and telecoms has been a terrible failure—and the main cause of the financial disasters lately visited upon those industries."
I do not agree with that. I think most people view deregulation in these two sectors as an overall success. I think also that most people see electricity deregulation (of which The Economist has been an enthusiastic supporter) as a failure.
Having worked (outside the US) in an agency in charge of regulating gas and electricity, my take on liberalization / deregulation of any sector would be:
- do not to jump to conclusions
- study the specifics of the sector (the devil can really be in the details)
- do not assume that "the market" or technological progress will by magic solve all the problems.
I am not competent enough regarding telecommunications and air transport, but I have repeatedly found that the articles of The Economist regarding electricity deregulation were not very good (because too ideological and not very well researched).

Posted by: fberthol on December 8, 2003 11:45 AM

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It's easy to say that deregulation has been successful when one looks at a few short term advantages it provides (mainly lowering costs). But what about the long-term effects of deregulation? What happens when competition becomes so intense in the telephone business that smaller companies begin closing their doors leaving an oligopoly of large distributors? I don't think we can fairly assess the effects of deregulation for quite some time. Population ecologists have shown that after competition reaches some sort of carrying capacity thereby trimming out weaker competitors, one is likely to see more concentration in an industry, which might lead to higher prices again, only without regulation this time.

Posted by: brayden on December 8, 2003 12:04 PM

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If I were to guess, this probably underestimates the benefits of deregulation of the industries. Air travel became a daily thing which allowed business to be conducted easily across great distances. The fact that businesses are failing is not a bad thing, it is what happens in capitalism.

As to phone service, there are some problems with how it was done, and TCA of 1996 is a mess. But that Lilly Tomlin's operator is now a footnoe instead of a telling type should say enough.

None of this means that water and electricity deregulation would work as well.

Posted by: Rob on December 8, 2003 12:26 PM

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There's a bit of bait-and-switch here; the "consumers" who are saving money on telephony are largely businesses; residential users make mostly local calls, and local rates have gone up. The old regulatory scheme where long-distance subsidized was designed to subsidize residential users.

And an honest price for cell service is probably $5/month or below--there is no capital investment in wire plant, you see?

And if I want to fly to NYC on Southwest, I can fly to Islip, Long Island.

Posted by: Randolph Fritz on December 8, 2003 12:32 PM

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The claim that "customers prefer cheap tickets to frills" is pretty much baloney based on the available evidence. Most of the "frills" that customers might prefer, such as rigorously on-time departures and arrivals, shriek-free flights or absolute reliability in luggage routing, are not within the power of airlines to deliver -- the first and last because they are subject to the tragedy of the commons, among other causes. Furthermore, what little information there is about airline quality along these lines is unreliable because the reporting definitions are not designed to tell prospective passengers what they want to know.

So the correct statement would be something like, "In the absence of reliable information about any airline quality other than price, passengers prefer cheap tickets." Duh.


Posted by: paul on December 8, 2003 12:33 PM

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Paulo says "I find no problem in having regulation that guarantees a certain level of profit in exchange for stable service that meets local-national-regional goals."

I must rather strongly disagree. The idea that there are rational 'local-national-regional goals' for any commodity is, to me, totally bogus.

The market has rather clearly determined what we value in air travel. We value low prices for individuals who plan ahead and high prices, pain, and inconvenience for frequent travelers.

That seems like a rather populist, and even proper, outcome.

Air travel is uncomfortable and inconvenient because people benefit so much from air travel that they are willing to pay that price.

Posted by: Rich on December 8, 2003 12:44 PM

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pauo writes:

> It's easy to quantify success on lower prices.

And therefore very hard for me to accept arguments that rely on non-price measures. If it isn't raw price, or what it costs me for added time (given how I value my time), your measure is probably pretty theoretical at best. So:

> But how about factoring in, in the airlines:
> * Numerous collapses, and all the attendant fallout

But prices have generally gone down, so what fallout could be relevant here? (But also see below)

> * Government bailouts (why were the airlines sooo weak,
> soo undercaptalized, that a 7-day slump in Sept 2001
> wiped them out?)

But government bailouts would kind of be the opposite of deregulation, so how can you blame de-regulation for what is essentially political weakness?

> * Hub-and-spokes systems which led to multi-legged
> flights and left many middle-sized cities isolated, unable to
> hold businesses, while swelling larger areas;

I do not understand this argument. The most successful airlines under de-regulation are *precisely* those that DID NOT HAVE big hub-and-spokes systems, like Southwest. You do have a point about costs and/or convenience of flights in smaller markets going down. I live in Columbia, MO, and we feel that pain here *severely*. But why should most or all fliers be interested in subsidizing flights into smaller markets like mine that may or may not be commercially viable? And if being large enough to support air traffic is economically important, what is to be gained from subsidizing places too small to be important?

And there's another interesting irony here. Again, I live in mid-Missouri, and our airline service currently lives or dies with American. Recently, American has closed down a *lot* of their routes into St. Louis. In one sense, this potentially hurts people into Columbia, since we now have fewer options for travel than when St. Louis was a hub. But, as it happens, a lot of flights out of Columbia were to places like Chicago, and there likely will be economically viable Columbia-Chicago flights now that service through St. Louis has become more expensive and less available. A few direct flights from Columbia to Chicago would be massively more useful for us than shuttles to a hub like St. Louis.

> * Inflexible service for customers without gouging on flight
> changes; price gouging for short-notice flights

If there is real competition, there can't be price-gouging. As far as what you pay for a short-notice flight is concerned, that could be anywhere between ultra-cheap (for stand-by) to a royal premium depending on (wait for it...) market conditions.

> * General customer dissatisfaction, from service to near-
> bogus extra miles incentives

Customer dissatisfaction generally exists when people feel they are paying too much for a service or lack options. To the extent that de-regulation fosters competition, I don't see how dissatisfaction is the likely outcome *unless* you were one of the passengers who previously benefited from a subsidy. Anybody who lives by "extra miles" incentives instead of choosing the cheapest flights probably deserves what they get (more expensive travel).

> * and still, today, a very frail, undercapitalized industry

Some companies have performed very poorly indeed during de-regulation. Most of these were companies that locked in high labor costs, obsolete hub/spoke networks, and all the other things we're now suspicious of. It is true that in a regulated environment, more of these companies could (inefficiently) be allowed to operate. But then prices would have to go up.

So I have to say, I don't buy it. If people really don't like air travel, than let them ride buses or trains. And let them compare prices in a principled way. If I had to take a round-trip to LA, it would take me at least 4 days of sheer driving and cost about $.30 per mile. On a plane, it will now take me 4 hours tops and cost (if I plan ahead) about $.10 per mile. Via bus, I think I could shave a day and maybe $50 off the cost. Really, this is no contest. Flights would have to get much more expensive for me to be unhappy.

Posted by: Jonathan King on December 8, 2003 12:49 PM

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Paulo says "I find no problem in having regulation that guarantees a certain level of profit in exchange for stable service that meets local-national-regional goals."

I must rather strongly disagree. The idea that there are rational 'local-national-regional goals' for any commodity is, to me, totally bogus.

The market has rather clearly determined what we value in air travel. We value low prices for individuals who plan ahead and high prices, pain, and inconvenience for frequent travelers.

That seems like a rather populist, and even proper, outcome.

Air travel is uncomfortable and inconvenient because people benefit so much from air travel that they are willing to pay that price.

Posted by: Rich on December 8, 2003 12:49 PM

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The problem with the debate about deregulation, is that the term "deregulation" is often very misleading.
In some industries (trucking industry or airlines), deregulation has effectively resulted in the suppression of some regulations that prevented competition.
But in other sectors (electricity and to some extent telecommunications) on the contrary, "deregulation" consists in artificially creating competition within sectors where vertical integration seemed natural. That is why the so-called "deregulation" processus resulted in lot more regulations designed and enforced by a flourishing new bureaucracy of regulators (assisted by a no less consulting industry which tends understandably to produce a lot of papers in favour of dergulation).

With regard to electricity, there are plenty of problems with the electricity supply markets that have been created:
- The functioning of these markets involves very large transaction costs (for a result which is in the short term usually less efficient than the traditional merit order dispatching of electric utilities),
- Market power can be very problematic because of the lack of demand response and the non-storability of electricity,
- Regulatory risk: these markets have been artificially created, as a result market rules are artificial and can be changed with a potential large impact on the value of generation assets – this is very serious problem in a sector which require huge investments in long lived assets (in this regard, the experience in a country like the UK should be a lesson for potential investors).

Artificially creating competition has a cost, and such a process should not be decided before a serious cost-benefit analysis.

Posted by: fberthol on December 8, 2003 01:30 PM

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What is your time worth? How many hours do you spend figuring out which telephone company, cell phone company, electric company, gas company, and so on you should sign up with and then watch their rates change so you have to spend more time watching them.

My wife went to visit her sister and charged me with finding a new cell phone plan for her. It's too technical for her. Right. She knows I'm cheap enough to obsess on this

Posted by: Josh Halpern on December 8, 2003 08:05 PM

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I read somewhere that long distance rates under AT&T fell continuously for over five decades

Posted by: Lee A. on December 8, 2003 11:04 PM

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The biggest problem with "deregulation", be it telecommunications, airlines or any other industry,is that in every case the dominant players were given advantages over newcomers. By erecting barriers to entry into a "deregulated" industry, first best economic choices are non existent.

One only needs to look at the recent attempts to deregulate electricity. I believe in every state that has tried to open the market, the existing utilities were given an opportunity to recover "stranded costs" at ratepayers and would be newcomers expense. So called proponents of market oriented economies have allowed political and financial incentives to compromise truly efficeint markets.

Posted by: nanute on December 9, 2003 04:38 AM

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Paulo says "I find no problem in having regulation that guarantees a certain level of profit in exchange for stable service that meets local-national-regional goals."

I must rather strongly disagree. The idea that there are rational 'local-national-regional goals' for any commodity is, to me, totally bogus.

The market has rather clearly determined what we value in air travel. We value low prices for individuals who plan ahead and high prices, pain, and inconvenience for frequent travelers.

That seems like a rather populist, and even proper, outcome.

Air travel is uncomfortable and inconvenient because people benefit so much from air travel that they are willing to pay that price.

Posted by: Rich on December 9, 2003 09:41 AM

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Paulo says "I find no problem in having regulation that guarantees a certain level of profit in exchange for stable service that meets local-national-regional goals."

I must rather strongly disagree. The idea that there are rational 'local-national-regional goals' for any commodity is, to me, totally bogus.

The market has rather clearly determined what we value in air travel. We value low prices for individuals who plan ahead and high prices, pain, and inconvenience for frequent travelers.

That seems like a rather populist, and even proper, outcome.

Air travel is uncomfortable and inconvenient because people benefit so much from air travel that they are willing to pay that price.

Posted by: Rich on December 9, 2003 09:46 AM

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RE: Nanute: “One only needs to look at the recent attempts to deregulate electricity. I believe in every state that has tried to open the market, the existing utilities were given an opportunity to recover "stranded costs" at ratepayers and would be newcomers expense. So called proponents of market oriented economies have allowed political and financial incentives to compromise truly efficeint markets.”

Recent experience with deregulating electricity would seem to suggest that the business community is not nearly as technically sophisticated as academic analysis might suggest - or perhaps business is a little bit smarter? Draw your own conclusions. California deregulated the wholesale electricity markets, but kept the retail markets capped!! (Whether or not this was intentional corruption is still a mystery - to me.)

Bankruptcies flourished. Finger pointing dominated the nightly news. And the Gray Davis administration negotiated long term contracts with energy providers to reduce dependency on the volatile spot markets. Surprise, surprise, surprise. No sooner was the ink dry than the markets tanked, leaving the Davis administration holding about (if I ‘recall’ correctly) $9 billion in over-priced contracts. It went into court and we in California are anxiously waiting to see how our new Governor deals with the pending court case.

RE: health of the deregulated airline industry.

The Pension Benefit Guarantee Corp (PBGC) is currently facing bankruptcy because, as the insurer of single-employer pension plans, it was forced to absorb the financial liability for underfunded pension plans from the steel industry and the airlines. Any analysis of the overall effect of deregulation should include the body blow dealt to pension plans, which are the first to go when the competitive forces of deregulation begin to squeeze profits.

Posted by: Ann on December 9, 2003 03:42 PM

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