Academic journal article Contemporary Economic Policy

U.S. Domestic Airline Alliances: Does the National Welfare Impact Turn on Strategic International Gains?

Academic journal article Contemporary Economic Policy

U.S. Domestic Airline Alliances: Does the National Welfare Impact Turn on Strategic International Gains?

Article excerpt

JOSEPH A. CLOUGHERTY [*]

The six largest US. airlines announced in the beginning of 1998 the formation of three domestic alliances, but the size and scope of these alliances spurred significant public interest concerns. GAO analysis suggests a rough equivalence between the domestic costs and benefits of alliances, yet the international competitive effects have not been considered. I argue that the national welfare merits of domestic airline alliances turn on positive international competitive effects. Empirical tests--run on comprehensive panel data covering the international airline markets among 21 nations over the 1983-1992 period--support domestic market concentration resulting in strategic international gains; hence, domestic airline alliances likely improve national welfare. (JEL L10, L40, L93)

I. INTRODUCTION

The six largest U.S. airlines, in the beginning of 1998, announced intent to form three domestic airline alliances: the pairings include United and Delta Airlines, American and U.S. Airways, and Northwest and Continental Airlines. These alliances have already resulted in limited marketing arrangements and reciprocal frequent flyer programs, and allying airlines hope to further enhance these partnerships by code sharing on certain routes. Code sharing allows airlines to sell seats on a partner's flight as if that flight were its own; thus, airlines can expand route networks without adding actual flights. Allying airlines claim that consumers benefit from domestic airline alliances; however, public interest concerns have been strong due to the size and scope of these alliances (U.S. Senate, 1998). The three alliances would control almost 70% (85%) of the U.S. domestic market in terms of passengers enplaned (revenue passenger miles); additionally, 30 million domestic airline consumers face the prospect of forme r competitors allying in their market (U.S. GAO, 1999). Accordingly, the Departments of Justice and Transportation (DOT and DOT) now review the national welfare implications of these alliances. Also, the DOJ filed suit--in a case watched by the other allying airlines for precedent setting--to prevent Northwest Airlines from acquiring control of Continental Airlines and code sharing on certain routes (U.S. GAO, 1999).

Domestic airline alliances involve a number of different benefits and costs that make factoring the national welfare merits of these alliances a challenge. Potential domestic benefits include enhanced competition on certain routes, improved airline service, more attractive frequent-flyer programs, and efficiency gains by allying airlines. Potential domestic costs include decreased competition on certain routes, the market power implications of enhanced frequent flyer programs, and efficiency losses by nonallying airlines. The U.S. General Accounting Office (GAO) has submitted two reports to Congress that begin determining whether domestic airline alliances improve national welfare (U.S. GAO, 1998, 1999). These reports await more substantive reviews by the DOT and DOJ, but suggest a rough equivalence between the domestic benefits and costs of alliances.

The GAO reports do not, however, analyze the impact of domestic airline alliances on international markets. This omission appears problematic when considering two points: first, the above-mentioned equivalence between domestic costs and benefits; second, improved performance in international markets underlies the rhetoric behind the alliances. Each alliance appears to have a significant international dimension: Delta lacks extensive international routes, which United has, to match with its large domestic network; U.S. Airways provides East Coast passenger feed where American Airlines has gaps; Northwest can use support from Continental to compete with new transpacific alliances (U.S. Senate, 1998). This analysis concentrates on the improved international performance claims of allying airlines. If the domestic benefits and costs of alliances roughly equate, then a positive international effect guarantees that domestic airline alliances improve national welfare--the national welfare impact of alliances hinges, then, on a positive and significant international effect. …

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