Kennedy and Airline Deregulation
By David Henderson
My Hoover colleague, Thomas G. Moore, has a letter on his office wall from Senator Kennedy thanking him for his contributions to transportation deregulation. As many bloggers have noted (here and here), the late Senator Kennedy had a large role in allowing competition in the airline industry. Some highlights on airline deregulation from my unpublished article, “Is Freedom Contagious?”:
The second example of a little freedom of exchange spreading and creating a lot more freedom is the case of airline deregulation in America. I remember sitting on a Hughes Air West flight from Los Angeles to Las Vegas in 1974. The young couple beside me was scrutinizing a map because they had thought, correctly, that Los Angeles and Las Vegas were much closer than L.A. and San Francisco, and yet, they noticed, their air fare to Las Vegas was much higher than the fare between L.A. and San Francisco. I explained to them that because L.A. and San Francisco are both in California, that route was not subject to federal regulation. Therefore, a solely intrastate airline, PSA (Pacific Southwest Airline), had arisen to take advantage of this loophole in the law. PSA, therefore, was outside the airline cartel that the federal government’s agency, the Civil Aeronautics Board (CAB), was enforcing, and PSA competed by cutting fares. The federally regulated airlines competed by pricing lower due to PSA’s presence. Over the years, many people noted the California anomaly and a similar anomaly in Texas, where Southwest Airlines escaped regulation by serving 3 cities solely within Texas–Dallas, Houston, and San Antonio. Southwest, similarly, charged much lower fares than were charged on comparable city pairs that crossed state lines. Thus was generated some of the public support for deregulation.
But the public support for deregulating airlines would probably not have gotten nearly as far were it not for the support by intellectuals, some lawyers but mainly economists, who were systematically studying the effects of airline regulation. In his 1964 presidential address to the American Economics Association, George Stigler pointed out that from the founding of economics as a discipline in the 18th century until the early 1960s, almost all economists, although willing to advocate or oppose regulation, studiously avoided studying its effects. As only Stigler could put it, “The economic role of the state has managed to hold the attention of scholars for over two centuries without arousing their curiosity. . . . Economists have refused to leave the problem alone or to work on it.” But there were a few exceptions in the profession. And one of the areas in which many of these exceptions worked was on the economics of airline regulation.
Three of the early exceptions were Lucille Keyes, Richard Caves, and Sam Peltzman. As early as 1949, Ms. Keyes had seen through the public-interest rationale for airline regulation, pointing out that the CAB’s actions were protecting airlines from competition. In 1962, economist Richard Caves wrote a scholarly, evidence-filled tome in which he pointed out that the CAB was suppressing competition and that such a restriction on freedom to compete was difficult to reconcile with the public interest. In 1963, Sam Peltzman, a graduate economics student at the University of Chicago, wrote a piece in the New Individualist Review, drawing on the work of Keyes and Caves, and making a concise, carefully reasoned, empirical case against federal regulation of air fares and entry into the airline industry. While we take for granted today that economists will actually study the effects of government regulation, Keyes, Caves, and Peltzman were pioneers in their field.
Another early exception was a lawyer named Michael Levine who had also been trained in economics. In 1965, Levine wrote a study in the Yale Law Journal pointing out how well the market worked–and how low fares were–in the unregulated California market.
With some customers informed about the high price they were paying for airline regulation, and with a core of economists and lawyers writing about the high cost of regulation, the stage was set for deregulation. In their book, The Politics of Deregulation, political scientists Martha Derthick and Paul J. Quirk tell the fascinating story of how airlines (as well as trucking and telecommunications) were deregulated in the late 1970s. Rather than repeat their story here, let me give the highlights. For those who want the important punch line, it is this: John Maynard Keynes was right when he wrote that what matters in the long run is not special interests but the ideas of academic scribblers. The early critics of regulation had such a large impact on the thinking of the economics profession, and of other academics who paid attention to regulation, that one deregulation advocate, Roger Noll, could say, in testimony to Senator Kennedy’s subcommittee:
The nice thing about being a student of industrial organization and regulation is that . . . you never have to run the risk of being dead wrong [in] saying regulation has been foolish in a particular sector. I know of no major industrial scholarly work by an economist or political scientist or lawyer in the past 10 years that reaches the conclusion that a particular industry would operate less efficiently and less equitably [without] than with regulation.
Because of the scholarly work critical of regulation, and because of the publicity much of this work was given, the view that economic freedom in the airline industry was good and regulation was bad became widespread among not only academics but also policy makers in the Ford and Carter White Houses, in Congress, and even some of the regulators themselves. A number of lawyers and economists joined the cause, with Carter-appointed CAB chairman Alfred Kahn being the most prominent, working both on Capitol Hill and in the regulatory agencies to achieve more economic freedom in the industry. Interestingly, although Kahn is now thought of, rightly, as the father of airline deregulation, even he had many doubts about the wisdom of deregulating quickly, but felt himself compelled by the prevailing intellectual climate to do so. Kahn wrote to CAB staff member Roy Pulsifer, a strong advocate of regulation:
I do not myself know to what extent I declare a commitment to gradualism insincerely, merely to reassure Congress and the industry that I am not a madman, and that I am solicitous of the financial fortunes of the industry, and anxious not to impair them. I am sure I do so also because I don’t believe in any economic prediction with more than, say, 65% conviction. Undoubtedly an additional reason is my lack of opportunity to have absorbed the work of others who have studied this industry. (italics in original)
One member of the CAB’s staff, lawyer J. Michael Roach, came to believe in deregulation through what he called a “Saul-on-the-road-to-Damascus” experience. In 1969, he had been tasked to write the board’s decision in a route case. He was given the name of the winning airline and no other information. So he crafted the board’s “reason” for its decision. Afterward, the board did not change a word of what he wrote. This convinced him that the CAB’s rationales for route awards were not the real reasons, but just made-up reasons for decisions reached on other grounds.
Interestingly, the airline deregulation story illustrates that the public choice view of regulatory agencies being captured by the industry they regulate, though applicable, is not the last word. It was precisely staffers and Commissioners in the CAB who pushed for deregulation. Ironically, one of the main economists who believed that regulatory agencies are captured by the regulatees was the late George Stigler. Why is this ironic? Because Stigler, more than any other single economist, was responsible for the economics profession’s shift to using empirical data to study the actual effects of regulation. These studies helped convince some of the regulators and thus helped pave the way for deregulation.
Addendum: I’ll take slight credit for deregulation. That was one of my areas during the summer of 1973 when I was a summer intern with Herb Stein’s Council of Economic Advisers. My immediate boss, Bob Tollison, left 3 weeks after I arrived, but before leaving, persuaded Herb to make me an acting senior economist until Bob’s replacement arrived. During that time I wrote memos favoring deregulation and represented CEA at interagency meetings with Assistant Secretaries and Undersecretaries. Herb asked me one day, “Do you think the Council should just drop this issue because it has such a small chance?” I answered that we shouldn’t and he kept it going. Future CEAs kept it going also and contributed to the eventual victory.