Economic Regulation of Airlines

Early economic regulation of airlines by the government concerned mainly their participation in the airmail system. The Air Mail Act of 1925 allowed the U.S. government to pay airlines for carrying the mail. The McNary-Watres Act of 1930 let the Post Office Department review the accounting practices of the mail carriers and protected certain carriers from competitive bidding for their airmail routes—protection that other airlines and the public thought unfair.

The Air Mail Act of 1934 extended the payment of money to the airmail carriers by the Post Office. The Act also prohibited mail carriers from combining their companies or buying other airmail companies in a way that would lead to a monopoly of the aviation business in their part of the country. The 1935, amendment to this Act prohibited airmail carriers from competing with each other in certain ways. This Act and amendment regulated only the airline companies that held government contracts to carry the mail.

The airline companies that did not hold government contracts to carry the mail remained unregulated, and from 1930 to 1938, they grew quickly, competing for passengers by reducing their prices. But lower prices also meant lower profits, and the government concluded that these companies were earning too little to enable them to buy safer and larger aircraft or to build new passenger facilities. In 1935 the Federal Aviation Commission recommended that the entire air transportation industry, not just the airmail carriers, be regulated much as the Interstate Commerce Commission regulated railroads. 

Under the Civil Aeronautics Act of 1938, Congress created a new Civil Aeronautics Authority (CAA) with powers that included economic regulation of the airlines. The terms of this regulation, however, remained unclear. Congress said that economic regulation of airlines should be “in the public interest,” and “in accordance with the public convenience and necessity,” but did not define these terms. In 1940, a reorganization created a new, five-member Civil Aeronautics Board (CAB) to carry out airline economic regulation. The CAB allowed competition among airlines on a limited scale to meet the needs of commercial business—as interpreted by the CAB.

Between 1938 and 1958, the CAB led Congress to make at least 25 amendments to the 1938 Civil Aeronautics Act. The CAB regulated airfares and decided how many and which airlines could fly between cities. The Board regulated the number of flights during a given time period and the airline capacity, or the number of seats available.

The CAB said that new airlines needed to obtain a “certificate of public convenience and necessity” before offering flights between particular cities. The Board used these certificates as a way of regulating the number of competing airlines, issuing more certificates in good economic times and fewer in slow economic times or when fuel costs were high.

Existing airlines also needed CAB approval to serve any new locale, and they could not eliminate service without CAB permission. Further, airlines needed approval to combine with other companies and to buy other companies.

The Federal Aviation Act of 1958, which established the Federal Aviation Agency (FAA), repealed the 1938 Civil Aeronautics Act. Under this new act, the FAA assumed safety regulation of aviation, but economic regulation of the airlines remained the responsibility of the CAB. The CAB could still regulate airlines that flew across state lines, called interstate carriers. Airlines that flew only within a single state—intrastate carriers—were not affected by CAB economic regulation.

Over the next 20 years, the CAB wrote so many regulations that they became difficult for the airlines to follow. During the 1970s, a movement to reduce economic regulation of the industry became popular. Congress thought the CAB should step back from economic regulation and let the airlines themselves decide where to fly and how much to charge. On October 24, 1978, Congress passed the Airline Deregulation Act of 1978 (ADA). This Act ended most economic regulation in a series of steps over several years, and directed that CAB cease operations by the end of 1984. 

The ADA allowed intrastate carriers to expand their service beyond their home state. It grouped airlines into new economic categories based on their annual revenue—how much money they made each year. Airlines earning more than $1 billion annually were called major airlines. Airlines earning less were grouped into categories ranging from national, to regional, to commuter airlines.

Airlines could now offer new routes and drop routes that lost money. But the government recognized the need to guarantee service to communities where the airline made little profit and where it might want to eliminate service, leaving travelers in these communities without air service. Under a program called Essential Air Service, airlines were prevented from dropping service to certain communities even though the airline might not want to keep operating them. The federal or local government was allowed to subsidize an airline to ensure that it provided “essential” air service. The Essential Air Service rules were renewed on December 20, 1987, as part of the Airport and Airway System Capacity Act and are still in effect.

Even in the early phase of implementation of the ADA, airlines could reduce their airfares by up to 70 percent without CAB approval. Air travel became very popular and, by the end of 1978 alone, 248 new air routes had been developed and authorized. Competition among airlines also increased on certain routes. Passengers enjoyed the resultant lower airfares, but some airlines found that there were too few passengers to sustain the extra service. Many airlines were flying with empty seats and losing money. A large number of new airlines began flying, but many also closed and people lost their jobs.

On February 15, 1980, President Jimmy Carter signed the International Air Transportation Competition Act (IATCA). The IATCA continued to remove economic regulation of airlines in stages. By January 1, 1982, under the IATCA, the Federal Government could no longer deny an airline permission to offer a new route and could exercise control only by refusing to grant an operating certificate.

The Civil Aeronautics Board Sunset Act of October 4, 1984, transferred the remaining functions of the CAB to the Department of Transportation (DOT), and the CAB was dissolved at the end of the year. The responsibility for Essential Air Service was among the functions transferred to the DOT.

Since passage of ADA and IATCA legislation, the airlines have been examined by the Department of Justice when they act in a way that might involve unfair competition. Between 1985 and 1993, many airlines merged or bought other airlines, and these business deals cost some airlines a lot of money. Some major airlines could not pay their loans and needed government protection from their lenders. The Secretary of the Department of Transportation strengthened the requirements for airlines to get new certificates to operate, using a new test to determine the economic fitness of an airline. 

Since 1993, major airlines have often made business deals with smaller airlines, called feeders because they feed passengers into airports called hubs. From these hubs, the airlines then fill their larger airplanes with more passengers and send them out on different routes, like spokes of a wheel. The system of “hub-and-spoke” routes has led to an overload at airport gates and air traffic control at certain times. The system also makes it difficult for new airlines to compete against a strong airline that dominates a particular hub. The Federal Government is considering new kinds of economic regulation to relieve this bottleneck, such as charging higher fees to airlines that fly at the busiest times, to encourage them to spread out their schedule.

--Roger Mola

Selected Bibliography and Further Reading

Bilstein, Roger E. Flight in America, From the Wrights to the Astronauts. Revised Edition. Baltimore: Johns Hopkins University Press, 1994.

Brenner, Melvin A. Leet, James O., and Schott, Elihu. Airline Deregulation. Westport, Conn.: Eno Foundation for Transportation, Inc., 1985.

Burkhardt, Robert. The Federal Aviation Administration. New York: Frederick A. Praeger, 1967.

Komons, Nick A. Bonfires to Beacons. Washington, D.C.: Smithsonian Institution Press, 1989.

O'Connor, William E. An Introduction to Airline Economics, Fifth Edition. Westport, Conn.: Praeger, 1995.

Taneja, Nawal K. U.S. International Aviation Policy. Lexington, Mass.: Lexington Books, 1980.

“Congestion Pricing and the Economic Regulation of Airports.” http://nationalacademies.org/trb/publications/ec027/ec027.pdf.

FAA Historical Chronology. http://www.faa.gov/docs/A-INTRO.htm.

International Aviation Competition Issues. http://ntl.bts.gov/data/GAO/rc97103t.pdf.

National Transportation Library, Department of Transportation. Aviation Economics and Finance. http://ntl.bts.gov/display.cfm?sub=a3&cat=1