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Forecast: Open Skies Ahead

Friday, May 18, 2007

A new U.S.-European pact will mean more competition, less red tape, and—probably—lower fares.

Good news for free trade and free travel: on April 30, the United States and the European Union signed an “open skies” agreement designed to liberalize transatlantic air travel. Scheduled to take effect in March 2008, the agreement removes most restrictions on routes and fares between the United States and Europe—with a few caveats.

The United States currently has open skies agreements with most European countries, but each one was negotiated individually, beginning with the Netherlands in 1992. Since the early 1990s, aviation has became increasingly open in the EU, regardless of an airline’s country of registration—to the extent that today you can fly nonstop between Rome and Milan on Irish discounter Ryanair or between Palma de Mallorca and Budapest on Air Berlin. The EU opening has done wonders for European skies, making ossified, nationalist state-owned carriers shape up (British Airways, Air France, KLM) or bow out (Swissair, Sabena). It also led to much lower fares and more innovative business models. Deregulation of routes and fares had the same effects in the United States in the 1980s and 1990s. Why not attempt something similar for the Atlantic Ocean?

Granting U.S. airlines intra-Europe flying rights is harmless to EU carriers, but the reverse would shake things up dramatically here.

Regulatory barriers to competition on routes invariably lead to higher fares and poorer service. Look, for example, at U.S.-Chinese air travel. There are currently far fewer routes than the high demand would support. New routes are granted one by one and inspire spirited bidding by U.S. carriers, while several of the routes granted to the less competitive Chinese airlines are not actually flown. Free access to trans-Pacific routes would expand competition. Unsurprisingly, U.S. and Chinese officials are currently negotiating a bilateral liberalization agreement.

So, what exactly does the new U.S.-EU agreement accomplish? It includes the hallmarks of traditional open skies agreements:

  • No restrictions on routes. Any EU airline can fly from any EU airport to any U.S. airport; any U.S. airline can fly from any U.S. airport to any EU airport.
  • No regulation of transatlantic fares.
  • No preferential treatment for homegrown airlines.
  • No subsidies to airlines. Goodbye, money-losing flag carriers!

But some things will stay the same. Fares may still be taxed by the countries which a flight serves, so long as they are taxed at rates in line with other airlines’. Non–U.S. citizens may still only own 25 percent of a U.S. airline’s voting stock. This matter held up European support for the agreement for some time.

Among the noteworthy aspects of the new agreement are its rules on domestic flying and its effects on tax competition. Under open skies, U.S. airlines can fly within Europe, so long as they do not fly between two points in any member state. European airlines cannot fly domestic U.S. routes. This is not important at the moment, but had the Europeans gotten their way, it would have been. EU airlines want access to the U.S. domestic market, and if they got it, they would do very well.

The future of air travel, as I see it, is market segmentation into two broad airline types: budget and premium. There will be variations within the types, of course, but the basic model will emerge: low fares for few amenities and higher fares for more amenities. Most big U.S. airlines, however, are stuck in the past, when airlines tried to offer all things to all people in a single cabin. Our own domestic market is beginning to divide itself with the introduction of ultra-discounter Skybus and, at the other end of the spectrum, options like United’s Premium Economy. The success (so far) of all-business-class airlines like Silverjet and Eos confirms this hypothesis. But Europeans are much farther along this path than we are: their big legacy carriers have better reputations for quality than ours, and their budget carriers are much cheaper than ours. A U.S. airline, then, would pose little challenge to a European carrier; it would compete on neither price nor service. But if European airlines were free to compete in America, a British Airways would blow a Northwest away in quality and a Ryanair would undercut a Southwest on price. Granting U.S. airlines intra-Europe flying rights is harmless to EU carriers, but the reverse would shake things up dramatically here.

The other interesting effect is on tax competition. With routes free and open, countries can compete for flights by lowering taxes. With routes opened up, countries will be able to tailor their taxes to attract flights, promoting price competition throughout the continent. Britain’s recently doubled air passenger duty raised fares to London by as much as £160.00 round trip, which has caused shifts in traffic away from London (traditionally a cheaper European gateway) to Amsterdam, Frankfurt, and other European hubs. When countries compete to cut taxes on air travel, the traveler wins.

The United States has much more to talk about with Europe. The agreement calls for further talks to begin in spring of 2008, and they will cover thorny issues like foreign ownership, domestic flights, environmental issues, and airport slots. Labor issues—Should European pilots be able to work for U.S. carriers?—and common security concerns deserve to be addressed too, and the new agreement will help Europe and the United States negotiate these issues more efficiently. Opening the skies over the Atlantic is a victory for both free trade and the free-spirited traveler.

Evan Sparks is an editorial assistant at the American Enterprise Institute.

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