The
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Avoiding the Maple Syrup Solution

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W. T. Stanbury and Thomas W. Ross

There is no denying that the Canadian airline industry is going through a very difficult period. The current situation has produced calls for intervention by the federal government from many quarters including shareholders and potential shareholders, employee groups, and Parliamentarians.

We agree that policy and legislative changes are needed, but believe that most of the recommendations made to the Minister of Transport by these groups, and most of the initiatives that the Minister has thus far indicated an interest in pursuing, are wrong-headed. In our view, the Minister’s focus on the health of the Canadian carriers is misplaced. It is the well-being of Canadian air travellers that should be the subject of the Minister’s concern.

The central goal of the federal government’s policy making relating to any restructuring should be the achievement of an economically efficient industry. Efficiency demands, first, that services should be produced at the lowest cost consistent with the desired quality and safety levels, and second, that the "right" amount of the services should be produced. This generally requires that prices be set at competitive levels.

Efficiency is a critical goal, not as an end in itself but because it is a central means to higher-order ends, namely, an abundant and growing economy. Thus, to protect the interests of air travellers and to ensure an efficient industry, the federal government should consider and use all the possible policy levers available to it to facilitate the growth of competition for the dominant (near monopoly) air carrier that may emerge from the restructuring process.

It is hard to exaggerate the importance of barriers to entry in understanding the degree to which a market is likely to be competitive. If barriers are very low, even a true monopolist cannot exploit its customers by raising prices and/or reducing the quality of service.

In his letter to the Minister (on October 22, 1999), the Commissioner of Competition highlighted a number of important barriers to entry over which the government has some control. Relaxing or removing these barriers would have a very beneficial effect on competition.

These barriers include the restriction on foreign ownership of Canadian carriers, the 10 percent ownership rule for Air Canada, the scarcity of good take-off and landing slots and terminal facilities at some airports, the current rules governing the computerized reservation systems, various restrictions in international bilateral agreements, and the strict rules on how large a foreign market must be before a second Canadian carrier is approved to serve it. In addition, the Commissioner identified a number of strategies that the government could consider to reduce barriers created by the firms in the industry. These strategies include opening up established frequent flier programs to new entrants, requiring code-sharing and interlining agreements requested by new entrants, restrictions on the use of travel agent commission overrides, and new legislation to control predatory conduct.

Restrictions on foreign ownership of Canadian carriers may protect certain domestic interests but they are inefficient for a number of reasons. First, they raise costs of production by attenuating the pressures of competition and, second, they raise prices paid by domestic consumers. Nevertheless, the Minister seems determined to maintain these barriers in what we call his "maple syrup solution." He has not explained why it is better for Canadians to be exploited by Bay Street investors than to fly at lower fares with better service on a carrier financed by Wall Street. This is a case where the late Premier Deng Xiaoping’s point has great force: it doesn’t matter whether the cat is black or white, so long as it catches mice.

An unvarnished, and hence unromantic, examination of the airline industry in Canada and all industrialized countries indicates that it is now essentially a producer of commodity-grade services using familiar technologies in a highly routinized fashion. In other words, the Canadian airline industry is little more than a fleet of intercity buses with wings.

That does not mean that the performance of the industry is unimportant to Canadians - but that is true of many industries. What we are urging is realism in thinking about our airline industry. While there are no grand, strategic considerations here, there are important matters about which Parliament (and indeed all Canadians) should be concerned, namely, the future price of air travel, the availability of air service to remote communities, the frequency of service (since time is very important to business travellers), the quality of ancillary services (but no more or less than people are willing to pay for), and the rate of innovation and the diffusion of innovations deemed valuable to travellers.

Significantly, eliminating the controls on foreign ownership (and cabotage, which involves a foreign air carrier offering service between two or more points within Canada) does not mean that the federal government will not or could not exercise notable controls over the industry. For example, the federal safety regulation regime is unchanged (as it is properly independent of economic regulation). The Competition Act applies to all rivals operating in Canada, regardless of ownership. And in the event of a national emergency, the federal government, by Cabinet order, could seize any aircraft on the ground in Canada and direct its use as it sees fit.

Another barrier to entry that should be addressed is the prohibition of cabotage - even if it must be done unilaterally.

While no "silver bullet," permitting cabotage will allow Canadian air travellers on at least a few routes to benefit from increased competition. If unilateral cabotage cannot be supported, the Transport Committee should endorse the Commissioner’s proposal for "modified sixth freedom rights" which would allow US carriers to offer one-stop service across Canada via US hubs.

Policy makers should be leery of promises by the proponents of any restructuring deal that very few jobs will be lost if their proposal is implemented. It cannot be true that Canada is too small for two national and international airlines, and also that it is necessary for the one big airline to retain almost the same number of employees as presently work for Air Canada and Canadian Airlines International (CAI). If there is as much wasteful duplication as some people have suggested, a large number of jobs should be lost. If not, Canada will have the worst of all possible worlds - an inefficient, bloated, near-monopolist.

As we should expect, the airline unions are determined to protect their members’ interests at all costs. That is their job. What came as a surprise was that the transport minister shouldd indicate that his government’s central objective is to protect the dominant (near-monopoly) air carrier in any restructuring. This is just what he did in remarks quoted by the National Post on October 28, 1999 (pp. C1, C5).

It may be desirable to share more widely the cost to employees of restructuring. The government might assist in this by helping them shift to other jobs, but to support these workers by maintaining surplus jobs is unfair and inefficient: unfair in the sense that air travellers alone pay the unnecessarily high costs, and inefficient because those costs continue indefinitely.

It should also be pointed out that a competitive industry will typically produce more output than a monopolized one, which suggests that employment levels may eventually be higher if we foster a competitive industry. This has certainly been the experience in the United States.

There appears to be another alternative worth exploring, namely, the restructuring (or re-engineering) of CAI while under protection from its creditors. If CAI were to secure protection from its creditors, most of the corporate capability - in its equipment, its organization, and the skills of its people - will remain. The question which merits more attention from policy makers is whether current CAI owners and managers, or others in their places, can make more of the airline given temporary protection. Note that what we have in mind might involve a complete redesign of CAI, including changes to its route structure, choice of hubs, and the overall scale of the airline. We do not pretend to have the answers to these questions, but we do believe they merit further study. There are examples of airlines in the United States such as Continental, TWA, and America West that have gone through such a process and emerged as stronger competitors.

Finally, the Minister of Transport’s statements about the conditions that may be imposed on the near-monopoly carrier suggest that the government may reintroduce economic regulation with the Minister of Transport as the regulator. This is far less desirable than having a specialized regulatory agency with a reasonably well-defined statutory mandate and which has considerable independence. u

[This is a summary of our longer paper of the same name published by The Fraser Institute (Policy Sources, Number 32, November 1999) and available from the Institute for $7.49 (including shipping, handling, and GST by calling 1-800-665-3558].

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