Andrew Orals

Marty Perry
Econ 102: Microeconomics
21 December, 2021
Airline Deregulation in the United States
Introduction
In 1978, the 95th United States Congress passed the Airline Deregulation Act, which
removed the Civil Aeronautic Board’s regulatory powers over the air industry and initialized
gradual dissolution of the board. The legislation came in response to growing concern over the
efficiency of regulated airlines while demand for air travel rose and technological developments
made larger airplanes commercially viable. At the same time, the oil crisis of 1973 and the
corresponding spike in fuel prices contributed to poor airline performance, spurring arguments
for regulatory change. The resulting deregulation initially gave way to new entrants into the air
travel industry as well as new competitive developments like hub and spoke networks, frequent
flyer programs, and sophisticated pricing strategies. However, while airlines performed quite
well through the 1990’s, deregulation left the industry vulnerable to market fluctuations,
recessions, terrorism, and war, leading to waves of airline bankruptcy filings in the United States.
Airline Deregulation in the United States undoubtedly improved the efficiency of air
travel, producing lower fares and wider destination variety. However, there still exists criticism
of the deregulation process and the role of regulation in modern air travel. In this project, my
goal is to provide a brief history of airline regulation in the US and describe the most prominent
reasons for deregulation, to present some of its effects on the air travel industry, and
contextualize these effects with an outline of recent research to evaluate the trend of frequent
bankruptcies in the airline industry.
History of Regulation
The American economy at the time of airline deregulation was much different than it is
today: large economic sectors were regulated by the federal government. These included finance,
insurance, and real estate, public utilities, and transportation. Regulation of the transportation
sector began with the Interstate Commerce Act of 1888, which was designed to curb
monopolistic practices in the railroad industry. The associated Interstate Commerce Commission
(ICC) regulated all common carriers. A common carrier denoted any person or company that
transports goods or people for any person or company and is responsible for any possible loss of
the goods during transport, (Longman Business English Dictionary). While the federal
government could not explicitly set rates, the legislation disallowed price discrimination on
especially long or short routes. When airlines became viable in the 1930’s for freight transport,
especially mail transport, they naturally fell under the same classification of “common carriers.”
When demand for passenger travel began to rise in the 1930’s, the federal government
required a more robust entity for awarding routes, regulating fares, and assuring air safety. This
prompted the Civil Aeronautics Act of 1938 and the resultant Civil Aeronautics Board (CAB).
The CAB was composed of five members (with no more than three from the same party),
appointed by the President with consent from the US Senate. The CAB had nearly
comprehensive authority over the airline industry, including the ability to control entry into and
exit from individual routes, control over mergers and acquisitions, and fare regulation (Pitt &
Norsworthy, 1999).
In the post-war era, the regulatory practices of the CAB appeared to be working quite
well. The economy was well-equipped to produce aircraft after World War II, due to a surplus of
experienced manufacturers and mechanics along with aircraft manufacturing facilities and
machines from the wartime effort. The United States GDP rose every quarter from 1960 to 1970
(U.S. Economy at a Glance, 2021), and a general optimism brought on by the increased
prosperity in post-war America made individuals and families more inclined to fly. Substantial
developments in airplane technology yielded jet aircraft, such as the Boeing 707 in 1958 to the
Boeing 747 and DC-10 in 1970 and 1971 respectively, also improving industry productivity. For
example, revenue yield per passenger-mile fell by nearly 50 percent, when adjusted over time for
inflation (Bailey, E., Graham, & Kaplan, 1985). As a result, the aircraft industry grew at an
annual rate of approximately 8.9% from 1929 to 1966 (Mowery & Rosenberg). This growth left
the Civil Aeronautics Board largely uncriticized.
Impetus for Deregulation
Into the 1970’s, economic stresses exposed the airline industry’s inefficiencies. The first
oil crisis of 1973 caused a sharp increase in fuel prices which increased airline operating costs.
Between 1973 and 1976, the cost of fuel for U.S. trunk domestic service per available seat mile
rose by 28 percent (Transportation Research Board). At the same time, a period of “stagflation”
in America, wherein unemployment rose while inflation continued, reduced demand for air
travel. The consumer price index (CPI) rose 6.2% into 1973 and 11.1% into 1974 and the
unemployment rate in 1975 peaked at 8.5% (U.S. Bureau of Labor Statistics, 2021).The
subsequent poor performance of the interstate trunk carriers prompted the Subcommittee on
Administrative Practice and Procedure of the U.S. Senate Judiciary Committee to compile a
report on CAB practices and procedures. The report concluded that CAB control over domestic
air route entry and exit limits competition and fare regulation decreases load factors, ultimately
making the CAB ineffective in maintaining low fares, thus violating its declaration of policy in
the Civil Aeronautics Act of 1938.
Air Fare Regulation
The first issue that prompted serious discussion of reform is the CAB’s regulation of air
fares. The CAB had broad and general authority to set reasonable fares. In general, routes of
similar distance were set at similar fares regardless of traffic density and based on average costs,
targeting a 12% rate of return for carriers (Volume 2, 1975). Furthermore, the CAB prohibited
price discrimination. The main intent was to protect carriers and ensure reasonable service across
the country, considered primarily in the context of the fledgling industry of the 1930’s. Instead,
when higher-capacity planes became viable in the 1960’s and 70’s in conjunction with economic
recession, the CAB increased fares to protect carriers at the expense of consumers. Airlines
competed by offering more luxurious cabins, free hospitalities, and extravagant inflight meals.
Lack of price discrimination thus burdened the public with high air fares for features that many
didn’t need or want. The air fare issue was even further amplified on long-haul routes. The CAB
set higher fares on long-haul routes with the intention of cross-subsidizing smaller and less
profitable routes (Pitt & Norsworthy, 1999). Thus, amid the “stagflation” of the 1970’s, critics
argued that high fares and unnecessary luxuries made air travel infeasible for many families and
vacationers while catering to luxury travelers and businesspeople.
The CAB’s fare regulation practices sometimes worked against the industry entirely. One
specific issue is the 20% fare increase that the CAB approved from 1973 to 1974, as discussed in
the Subcommittee’s report. From the second quarter of 1973 to the second quarter of 1974,
operating profit of the North Atlantic trunks fell by 35% (Volume 2, 1975). Airlines responded
with a series of panicked, temporary discount fares to win back customers. High fares, and
overall poor industry performance then propelled reform.
Route Entry and Exit Regulation
 The second issue that reformers saw in the CAB is its exclusive control over service in
different markets. The operational routes ran point-to-point and were established from the
existing routes of the 16 existing airlines (the trunks) when the CAB formed. Any existing
operator or new entrant requested authorization from the CAB, awarding a “certificate of public
convenience and necessity” on approval (Brenner, Leet, & Schott, 1985). For such certificates,
airlines proved to the CAB that they were able to service the route “properly” and that such
service benefitted the public. The CAB was further entitled to attach to these certificates terms
and conditions specifying exactly how and through what stops airlines should service the routes.
Finally, airlines were not permitted to discontinue service without CAB approval.
During the airline industry’s growth period, this approach proved beneficial as it
incentivized service by granting airlines exclusive control over routes. Furthermore, it ensured
the public a guaranteed level of service with the CAB’s enforcement. However, once the trunk
airlines saturated the major routes, the CAB barred new entrants from beginning new service. In
the decade leading up to 1974, only 142 certificates were granted to serve the 100 most-
trafficked interstate routes out of 1,800 applicants. Even further, from 1950 to 1974, no non-
trunk airline was granted trunk status out of 94 applicants (Volume 1, 1975).
Critics posited that the lack of competition stifled air travel innovation and fostered
inefficiency. Once the routes were saturated and the CAB restricted new entries into city-pairs,
airlines lacked productive avenues of competition. Since flight frequency remained unregulated,
airlines competed with one another by simply offering more flights in newer planes. This
afforded a competitive edge by reducing passenger opportunity cost, or the delay experienced by
passengers who couldn’t depart at their preferred time. However, higher flight frequency
naturally reduced the quantity of passengers on each flight, leading to average load factors as low
as 55% in 1974 (Volume 2, 1975). Operating more flights with low load factors increases fuel,
labor, and aircraft maintenance costs per passenger. The necessity to operate newer aircraft
decreased the time to obsolescence, which further increased operating costs. The airlines
inefficient use of resources during the recession compounded by the oil embargo instigated
substantial interest in reform.
Intrastate Carriers before Deregulation
The final and most empirically compelling argument for deregulation came from existing
interstate carriers. In California and Texas, interstate carriers were not regulated by the CAB,
making the interstate markets a microcosm for researching the possible effects of deregulation.
Such interstate airlines appeared to offer satisfactory service at substantially lower costs and
fares. A study conducted in 1974 by Dr. William Jordan, Professor of Managerial Economics,
found that short-haul (0-250 mile) regulated flights had 40-70% higher fares than unregulated
intrastate flights, and medium-haul (250-1000 mile) flights 75-100% higher fares (Volume 1,
1975). The main reasons Dr. Jordan found for the lower prices on unregulated airlines include
aircraft utilization, aircraft replacement, and maintenance costs. As previously discussed,
regulated airlines typically had average load factors of 55%, whereas intrastate carriers had at
least 65% load factors (Volume 1, 1975). The lower aircraft utilization for regulated flights
associated with higher flight frequency increased costs of service because more fuel, labor, in-
flight food, and other resources were required to run the more frequent flights. Intrastate carriers
also predominantly operated homogenous fleets of airplanes such as the Boeing 737. This
allowed parts, skilled maintenance labor, and pilots to be specialized. In contrast, diversified
pilots and maintenance crews increased costs for regulated interstate carriers. Finally,
unregulated intrastate carriers replaced their airplanes less frequently. Regulated airlines
typically replaced their aircraft often as one of very few avenues to compete against competition.
The premature replacement further increased costs for regulated carriers. Therefore, increased
costs which ultimately contributed towards increased regulated interstate carrier fares produced a
convincing empirical argument for deregulation.
One particularly inspirational interstate carrier to the interest of deregulation is Southwest
Airlines. Southwest’s success proved that there was a market for low-cost and “no-frills” air
travel in the United States. In the early 1970’s, Southwest created a business model focusing on
low and unrestricted fares, high flight-frequency, and timely service, doing away with in-flight
meals and assigned seats. Southwest was also one of the first airlines to use a dual-fare system.
For example, Southwest charged a $25 fare from 8 a.m. to 5 p.m. and a $15 fare at all other times
(Official Airline Guide, 1974). As a result, Southwest generated service not just by drawing
customers from other airlines, but by attracting vacationers and business travelers from ground
travel, such as buses and cars. Southwest CEO Herb Kelleher stated, “We are not competing with
other airlines, we’re competing with ground transportation,” (Freiberg and Freiberg 1996). Based
on the number of passengers Southwest airlines flew since 1971 and the flights’ high load
factors, it was clear that the low-cost model could significantly improve the well-being of the
American public. Since deregulation would potentially allow low-cost alternatives to compete
with longstanding trunks, Southwest’s publicly appealing intrastate model helped make a
compelling argument for airline deregulation.
Effects of Deregulation
In 1975, the Ford administration sponsored the first deregulation bills. At the same time,
CAB internal practices changed with the appointment of Alfred Kahn in 1977, who relaxed the
board’s policies on route entry and exit by reducing the certificate length and accepted more
applications from airlines offering lower fares. Finally, Congress passed the Airline Deregulation
Act in 1978.
The dominant narrative of the Airline Deregulation Act of 1978, second only to
promoting the utmost safety, was competition. The Act demands of the Civil Aeronautics Board
“maximum reliance on competition in providing air transportation services,” and the
“encouragement of entry into air transportation markets by new carriers,” (Airline Deregulation
Act, 1978). Lifted route entry and geographic restrictions along with fare deregulation
immediately catalyzed changes in the airline industry.
Hub and Spoke Networks
One of the most visible changes in the airline industry was that from predominantly
point-to-point networks to hub-and-spoke networks. Prior to regulation, airlines were heavily
incentivized by the CAB and by their customers to fly point-to-point. This is because the CAB
defined “dormant authority” as any route segment not served non-stop; these routes the CAB
could then disburse to other carriers more fit and willing to serve (Bailey, E., Graham, & Kaplan,
1985). Naturally, some routes were much more viable than others, so airlines structured their
networks with backup links which balanced out routes with lower traffic. The CAB often added
cities to airlines expressly to make point-to-point systems viable. This was further stabilized by
the CAB’s cross-subsidization, discussed above. Overall, this resulted in carrier networks with
predominantly city-pair links with only a few incident links per city.
After deregulation, new market forces made point-to-point systems inviable and highly
incentivized hub-and-spoke systems. For one, backup links for the trunk airlines were no longer
reliable, because the CAB could not protect against new entrants into the backup routes. The
intrastate traffic that previously fed into backup lines diminished substantially, because the
smaller airlines could now expand their service into routes previously inaccessible. Smaller
carriers even began to divert traffic from long-haul routes, because fare deregulation allowed
them to offer substantial discounts for multi-hop flights.
In reaction to the new market forces, airlines quickly developed hub and spoke systems.
This configuration minimizes the risk of diversion by consolidating as many route links as
possible into one central hub city. The main service advantage to this approach is that it
multiplies the number of cities accessible to a passenger. For example, while a point-to-point
system connecting 4 cities to 4 other cities only affords 4 city-pairs, a hub and spoke system
connecting these same 8 cities via a central hub city affords 36 pairs (28 leaf city pairs plus the 8
hub-city pairs). This provides the consumer with a much wider variety of possible destinations.
Hub and spoke networks also allow airlines to make more efficient use of resources.
Brueckner and Spiller show in their 1994 paper “Economies of Traffic Density in the
Deregulated Airline Industry” that a one standard-deviation increase in spoke traffic for a certain
carrier reduces the marginal cost of carrying an extra passenger by 17.6 percent. Other
researchers have shown that total cost increases only 80 percent as rapidly as total traffic,
(Caves, 1984). While the calculations are beyond the scope of this paper, such economies of
traffic density come from the airlines’ ability to use larger planes and more flexibly allocate
resources to higher and lower-trafficked spokes from the hub. Therefore, hub and spoke systems
demonstrate how market forces improved the efficiency of the airline industry.

Hub and spoke systems also have other, possibly adverse effects. Specifically, carriers
are highly incentivized to dominate hub airports and capitalize on customer traffic arriving to and
departing from the hub. For example, from the table above, the percentage of all carrier
enplanements at the listed hubs in 1988 were minimum 79% and maximum 88.2%,
demonstrating more than three-quarters airport domination. Furthermore, the airline’s destination
variety makes the frequent flyer program more valuable to local residents, making them more
loyal to the carrier (Borenstein, 1989). This creates a positive feedback loop, increasing the
carrier’s market power at the hub. Research shows that that this dominance leads to higher fares
for local residents in the hub city (Brueckner & Spiller, 1994). Furthermore, hub dominance can
increase airport congestion. Since many city-pairs connect through hubs, at peak hours the hub
can act as a bottleneck in the traffic flow. This bottleneck phenomenon can compound with
inclement weather and airport construction. Therefore, while hub and spoke systems increase
destination variety and minimize risk of passenger diversion, they also contribute to potentially
higher hub-local fares and airport congestion.
Frequent Flyer Programs
Along with hub and spoke networks, another distinctive effect of airline deregulation is
the frequent flyer program. These programs emerged out of a new tendency for airlines to
compete by aggressively discounting fares. Before deregulation, only 30% of trunk revenue
passenger-miles were flown with discounts, whereas in 1983, 82% of revenue passenger-miles
were flown with discounts (Brenner, Leet, & Schott, 1985). To ensure predictable revenue,
airlines needed a way to maintain customers. Airlines initially experimented with “loyalty fares,”
which offered incremental discounts to passengers on passing recurrent travel thresholds.
However, this approach did not adequately reward the most frequent flyers, specifically business
travelers, relative to less frequent flyers. The frequent flyer program thus emerged as a type of
loyalty program where flyers earn points that each flyer can incrementally redeem for free or
reduced fares.
Frequent flyer programs began as simple mechanisms to increase customer loyalty based
on mileage flown with the airline. Most programs consisted of four components: membership,
typically free to all potential passengers; mileage accrual; mileage redemption; and distinction
between award miles and status miles, where award miles can be used to redeem flights while
status miles only buy additional perks, (Knorr, 2017). One prominent example is American
Airlines’ AAdvantage program, which was the first of such programs to emerge after
deregulation. In the beginning, travelers only earned points from miles flown. Once the traveler
accumulated enough points, they would earn a reward as designated in the frequent flyer award
chart (InsideFlyer.com, 2006). The program was remarkably successful, and other airlines
quickly developed their own analogous programs, such as United’s Mileage Plus program. The
resulting competition spurred American Airlines to add more perks to the program, by partnering
with other firms that might be of interest to the business traveler or vacationer. For example, car
rentals by Avis, hotels by Sheraton, and cruises by Holland America (Travel Weekly, Spring
1984). American even partnered with British Airways such that their miles were redeemable for
international flights. This cooperation made American Airlines more attractive for business
travelers, who represented a lucrative portion of the market.
More recently, frequent flyer programs have ascended beyond distance and flying, and
instead form a virtual currency that constitutes a large portion of an airline’s value. Since airlines
began partnering with credit card firms, which allows mutual customers to earn miles based on
purchases, air travelers now earn most miles on the ground (The Economist, 2019).
Correspondingly, just as customers earn miles from flights, airlines sell miles to other
corporations for revenue. Given the plethora of earning opportunities, airlines strategically
devalue miles using policy changes to reduce liability. For example, most airlines now use a
fare-based point earning model, as opposed to a distance model, rewarding the most valuable
passengers, and reducing rewards for low-fare passengers, (Knorr, 2017). As such, deregulation
has fostered an evolution of the frequent flyer program from a simple loyalty program to a
complex virtual currency.
New Pricing Strategies

Trends in Average Revenue and Seat-Mile Cost Since 1978. Source: Brenner, 34

A final interesting effect of airline deregulation is new pricing strategies, otherwise

known as “yield management.” Post-deregulation, pricing became the principal battleground of
the airline industry. The initial effect of deregulation on fares is best illustrated by examining
airline industry-wide revenue versus cost per seat mile. From 1978 until 1983, the growth in
airline revenue did not exceed the growth in unit costs once, with the disparity peaking at 4%.
Most notably, due to fare wars in 1983, airline unit costs were 55% above those of 1978, while
revenues were only up 31% since 1978. Only in 1984 did revenues finally exceed costs (Brenner,
Leet, & Schott, 1985). In effect, competition prevented airlines from setting fares that reflected
actual costs.
Underneath the industry-wide averages, individual city-pair fares were extremely volatile
compared to regulated fares. For example, under the CAB’s regulation, there was generally a
strong correlation between air fares and distance traveled. After deregulation, distance and fares
became weakly correlated. For example, in April of 1984, the New York to Norfolk one-way
coach fare was 19% below that of 1978 but the St. Louis to Cincinnati route one-way coach fare
was 231% higher than that of 1978, even though the two routes only differ by 11 miles in
distance (Brenner, Leet, & Schott, 1985). To maintain a competitive edge in the extraordinarily
volatile market, large airlines developed some of the first big data analysis. As the Wall Street
Journal pointed out in its August 24, 1984 issue, at the beginning of a typical day at Delta’s
headquarters, “the Tariff department compares at least 5,000 industry pricing changes against
Delta’s more than 70,000 fares,” (Wall Street Journal, 1984).
Air fares experienced significant variation both across routes and over time due to “fare
wars” and other competitive forces. In specific city-pairs, there were several reasons for this
practice. First, a carrier might enter a city-pair route and offer a lower fare simply because any
fare level over marginal cost would be better than none. New entrant carriers might suddenly
offer lower fares due to their reduced operating costs. Furthermore, carriers could consider the
marginal cost of filling an empty seat on a medium or large size airplane effectively zero. This
encouraged carriers to participate indirectly in long-haul routes through connecting flights. These
carriers could offer incredibly low fares because the carrier would otherwise fly with empty
seats. Finally, some carriers would try to stoke brief traffic surges by cutting fares to quickly earn
cash. The interaction of these competitive forces on each individual city-pair thus fueled the
chaotic and complex fare variations.
By 1984, airlines realized that fare wars were not sustainable, so airlines developed more
nuanced pricing models. Airlines attempted to optimize the types of passengers on each plane
based on willingness to pay. For example, business passengers need flights on short notice, but
are willing to pay higher fares, while vacationers plan flights well in advance, but have much
lower willingness to pay. As such, airlines slowly decrease fares over the time to a critical point
before the flight, and then increase them sharply when more desperate travelers buy tickets (Pitt
& Norsworthy, 1999). Airlines also developed peak and off-peak pricing schemes to disperse
traffic from peak travel times, with varying success. In theory, this improves efficiency and
reduces costs by making consistent use of latent resources. However, data showed that off-peak
discounts had little effect, when travelers could receive a similar discount from another carrier at
more convenient times of the day (Brenner, Leet, & Schott, 1985). Finally, many carriers
developed bait-and-switch tactics. Airlines would advertise enticingly low fares to create ticket
demand far exceeding the number of available seats, then offering significantly higher fares
when travelers booked flights (Pitt & Norsworthy, 1999). Therefore, competitive forces led
carriers to develop more complex and efficient pricing schemes.
Airline Bankruptcy and Deregulation
The airline industry was deregulated to foster efficiency and low prices through
competition while still ensuring expedient service throughout the United States. However, it is
still unclear whether the Airline Deregulation Act has been successful in achieving these ideals.
There remain questions as to what extent airlines should be protected by bankruptcy law after
recent research raised concerns about unfair cost advantages of bankrupt airlines, leaving the
airline industry in a perpetual cycle of bankruptcies.
Following deregulation, bankruptcy has been prevalent throughout the air travel industry.
Since 2001 alone, every major carrier in the United States has filed for Chapter 11 bankruptcy at
least once (Bock, 2020). Research suggests that the structure of the deregulated industry is
particularly inclined to bankruptcy (Ghemawat & Nalebuff, 1998). Airlines have high fixed costs
relative to other industries due to equipment, gate leases, and labor. However, in the deregulated
market airlines are also vulnerable to market fluctuations and competitive forces. The result is
that airlines compete in fare-cutting, a “war of attrition,” where the firm generating the lowest
cash flows in the weakest financial position ultimately files for bankruptcy protection (Ciliberto
& Schenone, 2012). Typically, airlines seek protection under Chapter 11 of the United States
Bankruptcy Code, or even liquidate under Chapter 7. On filing for Chapter 11 bankruptcy, the
airline is either denied protection, converted to Chapter 7 bankruptcy, or reorganized. If an
airline reorganizes, they are permitted to retain control of operations while implementing a
comprehensive restructuring plan with court approval. While the bankruptcy laws are designed
to temporarily protect carriers during economic hardship whose position is fixable with
restructuring, maintenance of an inefficient carrier is ultimately detrimental to the industry. It is
possible that deregulation has made airlines dependent on bankruptcy, thus making the industry
inefficient and unprofitable.
Some research criticizes bankruptcy in the deregulated airline industry for allowing
carriers to unfairly lower costs. Due to the public necessity of quality air travel, Chapter 11 of the
United States Bankruptcy Code includes provisions specific only to airlines. For example, a
bankrupt carrier that has defaulted on its aircraft lease payments has a 60-day period to make the
payments and keep the aircraft, after which the lessor may repossess the aircraft (U.S.
Bankruptcy Code). However, lessors rarely repossess the aircraft because the lessor would then
have to redeploy it elsewhere in an industry already under economic stress (Ciliberto &
Schenone, 2012). This flexibility allows the airline to reduce costs temporarily with bankruptcy
status. Another way in which carriers can reduce costs exclusively under bankruptcy status is by
reducing obligations to employees and retirees. In the past, legacy carriers have overturned labor
contracts with court authority to significantly reduce costs. Soon after the Deregulation Act,
Continental Airlines filed for bankruptcy and “abrogated its collective bargaining agreements
with its various unions, imposing wage cuts of up to 50 percent,” (Delaney, 1999). In Delta
Airlines’ 2005 bankruptcy, the company also rescinded union labor contracts (Reuters, 2007).
Through exclusive provisions for airlines under Chapter 11 bankruptcy, such as lease grace
periods and contract exceptions among other provisions, airlines are able to unfairly cut costs.
Many different research endeavors have studied the effects of airline bankruptcy on the
bankrupt carrier’s price and industry prices. For example, Barla and Koo (1999) model the price
at the route level to examine the role of bankruptcy protection on pricing from 1987 to 1993. In
their model, Barla and Koo further consider the mix of passengers paying full and discounted
fares on each flight. This allows the model to incorporate changes in the number of low-fare and
full-fare seats, which would change the price without the airline changing its fare structure. They
find that bankrupt carriers lower prices per route by approximately 2.34 percent, while other
carriers on the same route lower their prices by 5 percent relative to pre-bankruptcy prices. This
might suggest a competitive strategy, wherein the other carriers attempt to liquidate the bankrupt
carrier. In addition, Ciliberto and Schenone (2012) analyze the flight frequency, capacity, and
prices per route of airlines that have filed for bankruptcy between 1997 and 2007. Ciliberto and
Schenone also find that bankruptcy correlates with a reduction in prices throughout the industry.
Specifically, they find that bankrupt firms lower their prices by approximately 3 percent and
raise prices by approximately 4.4 percent on emerging, with both metrics relative to pre-
bankruptcy prices. These data suggest a strong correlation between airline bankruptcy and
decreasing industry prices.
Research finds that bankruptcy has an even more pronounced effect on U.S. airlines in
international markets. Bock, et al. (2020) builds off the research by Barla and Koo and Ciliberto
and Schenone in analyzing the different impact of Chapter 11 bankruptcy on domestic and
international markets. Bock et al. finds corroborating results in domestic markets but a dramatic
fare reduction of about 30 percent in European-US markets. They suggest that passenger risk
drives fares lower in European-US markets. Since passengers have less variety for international
flights and are hesitant to fly with a bankrupt airline, lower fares act as compensation. Airline
bankruptcy’s amplified effect on international markets further qualifies the scope of cycles of
bankruptcy on American air travel.
Overall, recent research suggests that unfair cost advantages afforded by Chapter 11
bankruptcy correlate with lower prices across the airline industry, both domestic and
international. These trends can facilitate a perpetual “race to the bottom,” as carriers perpetually
collapse and restructure. Given the persisting low fares for the consumer and high load factors
indicating high efficiency, this is not a case to regulate air travel again; however, it may be a
compelling argument to reconsider airline bankruptcy, as low profits are detrimental to
innovation and service quality.
Conclusion
This essay discussed a brief history of airline deregulation, detailing the formation of the
CAB from the Civil Aeronautics Act of 1938, ultimately derived from the Interstate Commerce
Act of 1888. Next, the essay outlined a few motivating contentions for deregulation. These
include the CAB’s problematic fare and route regulation, which ultimately led carriers to
compete in an unproductive manner. Additionally, empirical data from existing deregulated
intrastate carriers showcased more efficient airline structures and a market for low cost, no-frills
air travel.
This essay then built context for the Airline Deregulation Act of 1978 and further
expounded on some of its most salient effects, the first of which being hub and spoke networks.
Such networks minimize the risk of passenger diversion and multiply the number of destinations
available to the traveler, while simultaneously resulting in single-carrier airport dominance.
Frequent flyer programs serve to enhance hub and spoke systems by building customer loyalty,
especially at the hub, while making carriers less vulnerable to fare fluctuations throughout the
industry. These frequent flyer programs have become complex systems of virtual currency,
constituting a significant portion of an airline’s value. Deregulation also resulted in new pricing
schemes, which maximize airline revenue based on the different needs of individual passengers.
Finally, this essay examined the resultant patterns of airline bankruptcies from
deregulation. These occur due to the inherently high fixed costs of airlines coupled with
competitive forces and market fluctuations. Some research suggests that bankruptcy protection
incentivizes airlines to race to the bottom, only to be revived with a slight competitive advantage.
While this cycle maintains low prices for consumers, these same low prices reduce profits for
airlines, which may be harmful to innovation and service quality.
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