THE ECONOMIC IMPACT OF AN EU-US OPEN AVIATION AREA DECEMBER 2002 Prepared for the European Commission Directorate-General Energy and Transport by The Brattle Group This report was prepared by Boaz Moselle James Reitzes Dorothy Robyn John Horn with the assistance of Richard Caldwell Bryan Church Carl Coscia Stephen Gelband Adam Schumacher 15 Berners Street 1133 20th Street, NW London W1T 3LJ Washington, DC 20036 United Kingdom USA [email protected] [email protected] tel: +44-20-7907-1180 tel: 202-955-5050 fax: +44-20-7907-1181 fax: 202-955-5059 TABLE OF CONTENTS Page Executive Summary..................................................................................................................iii 1. EU-US Air Transport Market: Economic Controls and Their Distortive Effects on Competition ...................................................................................................................... 1-1 1.1 Introduction................................................................................................................1-1 1.2 Liberalisation of EU and US Aviation Markets: Progress to Date.............................1-2 1.3 Remaining Restrictions .............................................................................................. 1-6 1.4 Distortive Effects of the Current Regulatory Regime ................................................1-9 1.5 EU-US Open Aviation Area..................................................................................... 1-13 1.6 Conclusion................................................................................................................ 1-16 2. Analytical Framework: Trade and Investment Theory.....................................................2-1 2.1 Potential Sources of Economic Benefits from Aviation Liberalisation .....................2-1 2.2 Quantification of Economic Benefits......................................................................... 2-5 3. The Economic Benefits of More Efficient Firms Replacing Less Efficient Firms ..........3-1 3.1 Cost Savings from the Elimination of Inefficiencies .................................................3-1 3.2 Estimate of Potential Cost Savings to European and US Carriers from an Open Aviation Area...................................................................................................... 3-3 3.3 Increased Efficiency and Output Expansion .............................................................. 3-6 3.4 The US Experience with Deregulation....................................................................... 3-9 3.5 Conclusion................................................................................................................ 3-11 4. The Economic Benefits of Pricing Synergies Due to Transatlantic Integration...............4-1 4.1 Increased Pricing Synergies as a Result of an Open Aviation Area........................... 4-1 4.2 Estimated Consumer Benefits from Price Coordination ............................................ 4-2 5. The Economic Benefits of Eliminating Output Restrictions ............................................5-1 5.1 Evidence from Previous Liberalisations: Impact on Traffic Volume.........................5-1 5.2 Evidence from Previous Liberalisation: Impact on Route Structure........................5-11 5.3 Implications for an Open Aviation Area .................................................................. 5-14 5.4 Employment Effects................................................................................................. 5-16 5.5 Conclusions.............................................................................................................. 5-16 6. Total Economic Impact of an Open Aviation Area..........................................................6-1 6.1 Traffic Volume........................................................................................................... 6-1 6.2 Consumer Surplus ...................................................................................................... 6-2 6.3 Direct Employment Effects........................................................................................ 6-3 6.4 Revenue Impact on Directly Related Industries......................................................... 6-4 6.5 Risk of “Double Counting”........................................................................................ 6-7 7. Would an Open Aviation Area Jeopardise US National Security? .................................. 7-1 7.1 Introduction................................................................................................................7-1 7.2 The CRAF Program ................................................................................................... 7-1 7.3 Would Foreign Ownership Threaten CRAF Dependability? ..................................... 7-7 7.4 Market Access Restrictions and CRAF.................................................................... 7-17 7.5 Conclusion................................................................................................................ 7-21 i 8. How Would an Open Aviation Area Affect Airline Workers and Wages?...................... 8-1 8.1 Introduction and Overview......................................................................................... 8-1 8.2 Labour Substitution: A Framework for Analysis.......................................................8-2 8.3 Labour Perspective..................................................................................................... 8-2 8.4 EU-US Wage Differences .......................................................................................... 8-3 8.5 Legal and Institutional Barriers to Labour Mobility ..................................................8-6 8.6 Potential Impact of Liberalisation on Workers and Wages......................................8-10 8.7 Options for Protecting or Compensating Labour ..................................................... 8-16 8.8 Conclusion................................................................................................................ 8-18 9. Would an Open Aviation Area Harm Airline Safety?...................................................... 9-1 9.1 Introduction................................................................................................................9-1 9.2 International Regulatory Regime for Aviation Safety................................................9-3 9.3 Concerns about International Competition and Safety...............................................9-7 9.4 FAA Concerns about Liberalisation......................................................................... 9-12 9.5 Conclusion................................................................................................................ 9-14 Appendix I : Bilateral Air Services Agreements between the United States and EU Member States and Accession Countries........................................................................................ A1 Appendix II : Limitations on Foreign Ownership of US Airlines .......................................... A2 Appendix III : Economies of Scale, Scope, and Density in the Aviation Industry................. A7 Appendix IV : Details on Cost Data ..................................................................................... A10 Appendix V : Consumer Surplus Calculation....................................................................... A14 Appendix VI : Open Skies Impact Evaluation Methodology ............................................... A20 Appendix VII : Direct and Indirect Economic Effects ......................................................... A26 ii Executive Summary I. Introduction Despite the success of airline deregulation in their domestic markets, and the benefits from partial liberalisation of the transatlantic market, the United States and Europe still maintain substantial controls on transatlantic competition and investment in aviation. Bilateral “Open Skies” agreements, which govern competition between the United States (US) and eleven European Union (EU) Member States, stop short of complete liberalisation. Most important, they deny foreign entities the ability to own and control an existing domestic air carrier, or establish a new one (“right of establishment”); restrict important traffic rights, such as a foreign carrier’s right to provide domestic service (“cabotage”); limit opportunities for leasing foreign aircraft and crew; and impose domestic content (“Fly America”) requirements. Transatlantic competition between the United States and the four remaining EU Member States (Greece, Ireland, Spain, and the United Kingdom) is governed by bilateral agreements that are even more restrictive. This patchwork system of bilateral agreements significantly distorts competition and constrains the ability of air carriers to adjust to market conditions, particularly within Europe and in the transatlantic market: • EU carriers can fly directly to the United States only from their own country, which limits competition on transatlantic routes and within the European Union. • EU carriers from Open Skies countries cannot merge with those from non-Open Skies countries without losing US traffic rights, which thwarts integration and liberalisation of the internal EU market, further limiting competition. • Mergers of US and EU carriers are prohibited altogether, which puts many of the benefits of globalisation out of reach. • Limits on cross-border investment mean that failing