PROCEEDINGS- Twenty-second Annual Meeting

Theme: • "Opportunities and Challenges in the New Environment of Transportation"

November 4-5-6, 1981 Golden Gateway Holiday Inn , California

Volume XXII • Number 1 1981

TRANSPORTATION RESEARCH FORUM 542 Regulatory Moves in Canadian Air Transport Pragmatists at Work by J. J. Smith*

1. INTRODUCTION membered the duplications of the rail- way expansion and the Depression was HE LAST YEAR has seen the a recent memory. (a) T publication of a number of It is also apparent that extensive ef- papers on the subject of the economic forts were made to avoid outright gov- regulation of air transport. In particu- ernment ownership if at all possible. The lar: McGill paperl lists three proposals aim- Economic Regulation and Competition ed at accommodating public and private in the Domestic Air Carrier Industry: A interests in a consortium. In the end, discussion paper prepared by Transport the CPR withdrew from the last at- Canada - Air, Canadian Transport Com- tempt, unwilling to accept a proposal of mission and the Department of Consum- a nine-director Board in which it would er and Corporate Affairs (February have only three seats in the face of the 1981). CNR's three and the Minister of Trans- The Administrative and Regulatory port's three. Environment of Air Carriers in Canada: Having CNR as sole owner was, in a Problems and Prospects: University of real sense, the last choice. Given the , Institute for Transportation development of an airway Studies (December 1980). system, the were running out Legal, Economic and Socio-political of time and they knew it. Even then, implications of Canadian Air Transport: Mr. Howe appeared to leave the door McGill University, Centre for Research open during the debate on the Trans- of Air and Space Law: sponsored by Canada Act saying that "the Transport Canada, Canadian Transport Canadian National Railways will under- Commission and the Transportation De- write. in the first instance, the stock of partment Agency (Spring 1980). this company and distribute it among Air Policy in the 80's: Guy Roberge, firms at present engaged in aviation in Q.C., Canadian Transport Commission: Canada which wish to participate."2 Notes for a panel discussion at the Air The use of the CNR as a channel for Transport Association of Canada Annual financing the infant avoided at- Meeting in Calgary (November 2, tracting too much Parliamentary atten- 1980). tion. The passage of the Annual Financ- Airline Deregulation: A Review after ing and Guarantee Acts provided a tra- two years: Melvin A. Brenner Associ- ditional session of CNR-bashing which ates Inc. (January 1981). left little time for TCA-bashing. That (b) The nature of this paper— came much later. The capital expendi- The papers listed above provide a tures for the little airline were, in any wealth of historical data. This paper case, insignificant compared with the tries to illumine that history with some sums being requested for the railway. personal flashes of recollection. This The use of the CNR channel had an- method is not always dependable, but it other effect. The Railway had enough fi- is quick and provides amusement, if not nancial troubles of its own without ac- instruction. cepting the risk of airline losses as well- This paper asserts the presence of a. This problem was met by an arrange- strong pragmatism in the economic regu- ment by which capital advances passing lation of air carriers in Canada. It sets through the CNR to the airline, what- out to demonstrate such a presence, and ever the form of obligation, were al- in general, approves of it. ways rewarded as if a fixed interest ob- ligation was in place. Eventually, the 2. 1937 TRANS-CANADA AIR LINES tradition arose of taking all capital ad- vances in debt form. This was an awk- It is clear from the record that the ward habit which the young airline was Mackenzie King government were con- not able to kick until it was 40 years old, vinced of the need for a single strong in 1977.3 The airline tried hard, but its transcontinental air carrier. They re- parent was not easily persuaded. There was another reason for the air- *Vice President, Economics & Airport line's low profile in Parliament in those Affairs, Air Transport Association of early days. It was remarkably successful Canada. at breaking even after paying its inter- REGULATORY MOVES IN CANADIAN AIR TRANSPORT 543 est charges. Mr. Howe's political um- these curves of operating cost versus brella allowed the management to get stage length on that Clayton Glenn draws? with the job. Go and construct a set of fares which will follow the cost curve." The fares 3. 1944 THE AIR TRANSPORT came into effect on January 1, 1961. BOARD The Interdepartmental study4 gives an. excellent account of the ensuing devel- The creation of the Air Transport opment (since 1970) of cost formula Board in 1944 fares derived from the provided Canadians with a fixed Terminal form, if not the substance, of eco- Charge and a Line Haul charge per mile. no.mic regulation by a quasi-autonomous The study is careful to point out that tribunal. However, the Board had two such a method major does not eliminate cross- constraints: its obligation to ap- subsidy. The Terminal and Line Haul prove route licence applications, filed by charges TCA are derived from Domestic Sys- under the terms of the Trans-Can- tem data, and therefore do not fit per- ada Qontract, and the overriding powers fectly the circumstances of the of individual Minister of Transport. routes and stations. It is possible to rep- resent flying costs for selected stage 4- 1948 CROSS SUBSIDY IS BORN lengths reasonably well so long as the mix of aircraft types does In not change reading recent literature, one can too much. However, it is unlikely that get the impression that cross-subsidy the Terminal Charge would wasas correctly re- some kind of inspired policy prac- flect the ground handling costs at both tised by benign government planners. and Charlottetown. The The utili- truth is otherwise. zation of personnel and equipment at In 1947 a new aircraft arrived, the Charlottetown is constrained by the low- Canadair North Star. By 1948 it was er traffic density and schedule frequency. serving much traffic. of the trans-continental So there is a kind of residual cross- Fares within Canada in those subsidy, evolved by airline and not by daYs were constructed on a constant rate Per government. A Dale shadow. Not like the mile basis, about six cents per mile. old days. In spite of the talk of market Any departure from such a scheme would forces, have the cost of production ideas of been considered sharp practice. The St. Thomas Aquinas have come a long North Star's direct flying costs were way in domestic ;bout fare setting since 1958. two cents per seat mile; the DC- Not bad for him, considering his Were age. three cents per seat mile. North A final footnote Stars were deployed haul on pragmatic cross- on the longer subsidy in the early days. It routes where the incidence of ground decided handling which Canadian carrier would serve the costs is also lower. It followed Pacific in 1949. My .11at with a recollection is that constant six cents per mile Mr. Howe asked Mr. McGregor 1°ng haul routes with North Stars could first to 1ake do• it, and that Mr. McGregor declined profits, and short haul routes with on the ground that -uC-3's generally it would drive TCA made losses. into the red during the developmental Cross-subsidy arrived with a new air- years. raft and not with a policy. The age of pinocence ended in 1948. The support of !small-town" Canada by Transcontinen- 5. 1958 WAS THE YEAR OF THE tal and Atlantic passengers was substan- FIRST ATTACK ON THE TCA tial in TRANS-CONTINENTAL o those days. Its extent was known the regulators and sensed with pleas- MONOPOLY riure by many in public life. The great The Board 'aYsL of cross-subsidy lasted from 1948 was unimpressed by any tio 1961. notion that competition for competition's You may ask if 1961 saw a sake was change in regulatory a desirable policy.5,6 The Board policy. No. 1960 found that additional transcontinental w,as the year that the late Gordon Mc- air -Iregor services could not be introduced at that got hooked on St. Thomas Aqui- time without nas and Just Price. He was hooked in- major detrimental effects dir to existing operations (meaning TCA). eetlY• It all started with Stephen They also Arheatcroft who asserted in 1958 that found, however, that the posi- tion of CPA• as an international carrier °ss-subsidy was bad social accounting. needed strengthening, 111r. McGregor dismissed and that they this idea, pre- should be licenced to sumably since "social accounting" was operate a daily ,1-'3t language transcontinental service to connect consonant with his own CPA's existing international llabits of thought and speech. operations at and . The monop- Some time in 1960, Mr. McGregor ad- oly was uressed cracked. The slogan "regulated a man named Norman Taylor in competition" was used to Words roughly cover a sys- as follows: 'You know tem of administered market shares. 544 TRANSPORTATION 11SEARCH FORUM

6. 1958 HEES AND EARLY tion arises." No decision on U.S. routes DEREGULATION was to be made pending a new bilateral treaty. The mainline carriers were to The then Minister of Transport, help each other and stop quarreling. George Hees, gave notice in a policy On the domestic mainline scene, he speech that the government of the day undertook to study what further compe- intended to reduce licensing requirements titive initiatives might be taken wit1.1- for charter services through a form of out driving into the red. Thls deregulation. What happened was that led to the 25% market share to CP Air persons seeking a charter licence and. concept, which lasted fourteen yeaFs. proposing the utilization of small air- Good or bad, the rules were known. Air- craft (i.e., up to 4,000 lbs. take-off craft orders and schedules tacitly con- weight) need not show that the service formed to the rules. On his summary on intended was required in the public in- June 1, 1965,8 Mr. Pickersgill lets us terest—in other words licences applied glimpse the truth. "In the domestic field for would be granted freely by the Air a degree of competition will remain to Transport Board provided the financial provide the public with the advantages and other capabilities of the applicant that can result from a competitive a- were satisfactory and an operating cer- mosphere; while at the same time this tificate obtainable. policy will avoid the excesses of com- The rush for licences was such that petition which were ruinous to all but it produced a chaotic excess of capacity one of the main railways of Canada for that segment of the charter indus- • • •" Mr. Pickersgill knew the folk mind try. very well. It rapidly became apparent to the Air fpr Transport Board that the public interest Mr. Pickersgill's quest for order the second level carriers expressed it- was not being served and the govern- regions. ment was quickly persuaded to re-in- self as a set of geographical While emphasis was on North/Smith state the requirement to prove need. Mr. main- Diefenbaker's government had made an traffic, some competition with the experiment, presuming some benefits of line carriers was contemplated. How- ever, big boys must not use their size competition among small charter oper- from ators. The pragmatists picked up the and strength to drive smaller boys pieces and. carried on. such competitive routes. If this happens, "the Air Transport Board will, if exercise appropriate control tonecessary, pro- 7. THE PICKERSGILL YEARS vide a chance for a fair competitive re- lationship." Administered market shares: The events of 1958 leave the observer competitive atmosphere again. Regionals with the impression that,the government work .Transport might try some domestic charter and its Air Board were con- and this would be encouraged. They tent to tinker.• • No serious investment might try some international charters, could be made in the .industry by . pri- too entrepreneurs until and that this would be encouraged vate sector the gov- was implicit in the October 20, 19669 ernment would declare the rules of the statement. game and undertake to stick with them for ten years or so. Mr. Pickersgill set out to make everything clear, starting 8. AFTER THE REGIONAL POLICY in 1964.7 and In a nutshell, he tried to state the The Regionals saw the green light route licence rules: jumped at it. All obtained large equipment and proceeded to try their (a) which carriers would be serving hands at the charter/inclusive tour busi- which international routes ness. None succeeded. All regional car- (b) no'domestic licence would be grant- riers have now withdrawn from the use ed to anyone which could put Air of dedicated long range equipment in Canada in the red the charter business. The experiment (c) what the regionals would be allowed was fatal for , in spite of the to do. granting of a scheduled life-line into Toronto. bought control of On international routes a variety of dis- and even mergers PWA, and PWA took Transair in swops, partnerships tress. The Alberta transcontinental had were discussed. Mr..Pickersgill asked the presidents, accompanied by its inaugural flight June 1, ten days age. mainline We may sigh for plans of their railway mentors, to talk. So they the best-laid the status quo. mice and men. talked, but settled on their The message was. that "the geographi- The surviving Regionals learned each should be lesson. They concentrated their 737 cal areas now served by business defined and extended . ." Africa was to equipment on their scheduled, be "left aside until some practical ques- oriented markets and then sought to de- REGULATORY MOVES IN CANADIAN AIR TRANSPORT 545

Ploy the surplus night hour and week- er will show a decline. Foreign origina- end capacity in the U.S. and tions now outnumber Canadians on At- vacation markets. lantic services. In the dedicated long range charter The words of Guy Roberge of the CTC market, World Air tried and come to mind.lo "The absence of easy so- failed. lives on alone and with lutions does not imply the absence of high repute. solutions. The success of this search will Wardair has met the conditions of depend, as always, on the imagination survival in long haul markets—wide- and common sense of the entrepreneurs." bodied fuel efficient aircraft and the "It has been my experience that prog- marketing. ability to keep them flying ress relies on entrepreneurial skill rath- and reasonably full. The market risks er than on the confines of policy or regu- are substantial. Wardair sought and ob- lations." tained the rights to operate domestic charters, and to top up one-third of the seats with individual passengers in the 10. The mainline and regional carriers seven days prior to departure. If the have been feeling their way toward mainline and regional carriers can choose meeting both the business markets Where and when to behave as scheduled, (Connaisseur, Empress Class, Business charter or part charter carriers, Ward- Jet) and discretionary markets (surplus air argues that all they want is the seats, charter class, Skybus) while keep-. right to compete "on equal terms," ing in their own hands the options lead- Meaning to have the choice of where and ing to higher market share, higher load When to be a charter, part charter, or factors and higher aircraft utilization. scheduled carrier. Ian Gray of CP Air By their prices and fences they have said, on one of our ATAC platforms, sought to add to net income, increase "Why don't you apply for a licence, efficiency and contain their risks. The Max?" thrust on route applications, however, and on aircraft orders, has not been to- wards containment, but towards expan- 9. 1975 ON — CHANGING MARKET sion. ENVIRONMENT A situation unique in our history now The search for the discretionary spend- presents itself. While the world, and we, er, and for the prices and conditions debate the U.S. experiment in deregula- that he would accept, began in tion, it is now possible to travel on regu- in the 1950's and has continued with lar services between Toronto and Van- growing intensity around the world. couver on Air Canada, CP Air, PWA The Canadian mainline carriers have and Wardair. It is now possible to trav- adapted. If surplus seats could be suc- el between Montreal and Toronto on Air cessfully predicted and sold in controlled Canada, CP Air, , and volumes, lower fares could compete with Eastern Provincial. charters, with the limited numbers of This is quite unlike the administered si.ich seats constraining the erosion of market share situation. The special stat- Yield. Domestic schedule service load fac- us of Air Canada before the ATC had tors on Air Canada and CP Air together been swept away with the 1977 revis- rose from 61% in 1976 to 68% in 1980. ions to the Air Canada Act. The winds The marketing initiatives taken by the which have blown across the border Canadian scheduled airlines in this adap- since 1978 have brought "competitive at- tive process, surplus seat sales, Charter mosphere" with a vengeance, and this Class fares, and the whole aircraft meth- time it is real, at least in the dense ods Skybus, etc., have markets. This is competition where pric- of Night Hawk, ing been well described by the CTC Research initiatives are there in plenty, and low priced air the capacity offered is limited largely tranch in "A Review of by fares 1979." what the air carrier wishes to ven- home ture, and on the record, entry regula- These initiatives were taken at tion can hardly be called restrictive on In Canada. Traffic between Canada and these dense traffic routes. That deregu- Europe moves at fares which cannot be lation in the debate, which many of us have so inconsistent with those available enjoyed, has been overtaken by events. Inuch larger U.S.A.-Europe market. This The carriers have pursued their market is also true to the Orient. To this diffi- opportunities, and the Euro- Canadian regula- culty we must add the trends in tors, while retaining their powers, have Pean and Japanese general price levels, not stood in the way. relative to our own, the serious depre- ciation of the Canadian dollar in foreign exchange, and the knowledge that 1981 11. The aircraft orders tell their story. Will be the fourth successive year in Taking Air Canada, CP Air, PWA and Which real disposable income per work- Wardair the firms orders are: 546 TRANSPORTATION RESEARCH FORUM

Boeing 727 8 Guy Roberge made a graceful admi- Boeing 737 15 sion last Novembern of the pragmatic Boeing 767 20 role of the economic regulators of air L1011 - 500 6 transport. The charm of the paper lay DC-10-30 3 in the way he rendered his graceful ad- A 310 6 mission also as a spirited defence. It has been my privilege to suggest, The cost of these firm orders with through the view of history which recol- spares and ground equipment is: lection allows, that much of the spirited U.S.$ millions defence was justified. Air Canada 955 CP Air 549 REFERENCES PWA 254 socio-political Wardair 500 1. Legal, economic and implications of Canadian Air Trans- 2,218 port: Institute of Air and Space Law, McGill University 1980. 2. Hon. C. D. Howe: Hansard, March When the declared option orders are 25, 1937. counted in the total comes to about $4 3. Revised Air Canada Act passed in billion. These are not the actions of a 1977. set of carriers shivering in some policy vacuum. The orders 4. Economic Regulation and Competi- rather suggest that In- the carriers, at least, know what they tion in the Domestic Air Carrier want to dustry: A discussion paper prepared do and are betting on being Commit- able to do it. Canadian Aviation for the Interdepartmental maga- Regulation zine, speaking of the Wardair A 310 or- tee on Competition and der, says "The fact that he (Mr. Ward) in Transportation: Circulated bY has no assurance from that he Transport Canada February 1981. will be able to operate the A 310 on a 5. Statement on Air Transport Board scheduled air service licence does not Report, Hon. George Hees, House of seem to worry him in the least." Commons January 21, 1959. • 6. Air Transport Board Decision Serial 12. IN SUMMARY No. 1229 February 19, 1959. 7. Statement of Aviation Policy Prin- Certain events have cast very long ciples, Hon. J. W. Pickersgill, April time shadows: the choice of the CNR 24, 1964. to own Trans-Canada Air Lines, the con- 8. Statement of Aviation Policy Prin- straints of the Trans-Canada Contract ciples, Hon. J. W. Pickersgill, June upon the regulators, the memories of 1, 1965. railway failures and the depression, the unpredicted effects of cross 9. Statement of Principles for Region- subsidy. Pickers- Some more recent events have changed al Air Carriers, Hon. J. W. the habits of forty years: the removal of gill, October 20, 1966. any regulatory privilege for Air Canada 10. Air Policy in the 80's: Notes for a and the U.S. experiment. panel discussion at the Air Trans- In dense markets there has been ex- port Association of Canada Annual tensive pricing initiative, remarkable Meeting, Calgary, November 2, freedom of entry, bold aircraft ordering 1980. and a low rate of corporate failure. 11. Ibid.