The Evolution of the Philippine Airline Industry
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PHILIPPINE AIRLINE ANALYSIS The Evolution of the Philippine Airline Industry This article documents the changes in the Philippine airline industry since 1995, the year the government liberalized the civil aviation industry. A monopoly for more than 20 years, liberalization trans- formed the domestic industry into virtual duopolies in major airline markets while minor routes remain virtual monopolies, suggesting that the government’s goal to make the industry more competitive has not been realized. By Wilfred Manuela To spearhead policymaking for the cross-subsidization allowed PAL to passenger airline industry, the provide airline service in thinly trav- Philippine Government passed the eled routes. Civil Aeronautics Act (Republic Act 776) in 1952. It gave the Civil The Social Costs of Monopoly Power Aeronautics Board (CAB) and the Air Regulation of the US airline industry Transportation Office (ATO) the resulted in a government-supervised authority to promote adequate, eco- cartel (Keeler 1972; Poole and Butler nomical, and efficient passenger air- 1999), while the Philippines’ one-air- line service and those of other carriers line policy resulted in a government- at reasonable charges and promote authorized monopoly. Although the competition between passenger air- government compelled PAL to subsi- between 1994 and 1995 even without lines and other carriers to the extent dize missionary routes, increasing a competitor to preempt a potential necessary in order to ensure the devel- output for the entire domestic indus- rival, indicating that PAL has been opment of the Philippine air trans- try, the airline restricted the number of restricting output before liberaliza- portation system. CAB administers departures and passenger seats in a tion. Although the mere transfer from the economic regulation of the indus- number of high-density markets. passengers to PAL does not, by itself, try while ATO supervises the techni- affect efficiency, the restriction of out- cal aspect. The government liberal- The number of passenger seats in the put below competitive levels in some ized the airline industry in 1995 under Manila–Cebu and Manila–Davao markets has resulted in efficiency Executive Order (EO) 219. markets increased 38 percent and 75 losses. Economists have estimated percent, respectively, from the previ- that the deadweight loss that results The passage of two Letters of ous year when Grand Air entered from restriction of output and higher Instructions (151 and 151A) in 1973 these markets in 1995 (see table 1), prices ranges from a negligible ushered in a major policy shift for the indicating that PAL restricted output amount to as much as 13 percent of industry, granting Philippine Airlines before the industry was liberalized. gross national product and that even a (PAL) a virtual monopoly of the coun- The entry of three airlines in the relatively small deadweight loss may try’s civil aviation industry. The pas- Manila–Iloilo market in 1996 also be associated with a large redistribu- sage of Presidential Decree 1590 in resulted in a 61 percent increase in the tion of wealth (Carlton and Perloff 1978 gave PAL a new franchise but number of passenger seats from a year 1994). The resources used to hire with a provision that the franchise earlier, while the Manila–Cagayan de economists, lobbyists, and lawyers to should not be interpreted as an exclu- Oro market experienced a 30 percent argue the case of PAL before the sive grant of privileges. The industry, increase in the number of passenger Philippine congress is also a cost to however, remained uncontested seats between 1995 and 1996. society because these resources could between 1973 and 1994 compelling PAL increased the number of passen- have been used for more productive the government to regulate fares to ger seats supplied in the ends. The airline monopoly in the prevent PAL from engaging in Manila–Bacolod market by 42 percent Philippines resulted in financial losses monopoly pricing, capping the air- line’s return on investment (ROI) to 12 percent. The ROI regulation allowed PAL to recover losses through government subsidies and to charge higher fares in high-density markets to subsidize unprofitable routes. Although extremely inefficient Table 1: Total Passenger Seats in the Top Five Markets Source: Civil Aero- and a drain on government coffers, the nautics Board e-zine edition, Issue 36 1 for PAL, largely due to its misman- operating permits, approves the routes sales (Carlton and Perloff 1994). The agement and inefficiency (Austria that airlines serve, and still reviews CR4 for the period 1996–2003 is 2000), while limiting output in some and approves airfares in single-airline shown in table 2. The annual CR4 markets may have resulted in higher markets. CAB is also a member of the ratio indicates that the industry is fares before 1995 (see Manuela government panel that negotiates air basically an oligopoly with two domi- 2007). service agreements with other coun- nant firms. PAL, however, still domi- tries. nates the market with more than 50 The use of bigger aircraft by PAL percent share of the industry’s rev- after 1994 and the choice of bigger Market Structure under Liberalization enues except in 1999 when it with- aircraft by Cebu Pacific and Air The airline industry has changed dras- drew from missionary routes. PAL’s Philippines indicate that PAL has been tically since 1995—PAL was priva- revenue share has hovered between 50 using smaller aircraft than what is tized and restrictions on entry and and 54 percent although Cebu Pacific required by demand and passenger capacity were lifted. Moreover, gov- has managed to take away revenue preferences before liberalization, ernment controls on the number of share from the incumbent, indicating resulting in more seats per flight. domestic routes served and flight fre- that Cebu Pacific is able to compete quency have also been eliminated, as against PAL. Cooper (1999), however, The Role of CAB under Liberalization well as restrictions on fares, except in argues that an industry must have The airline industry was liberalized in markets with only one airline. In the more than six firms in order for it to 1995 under EO 219, establishing the years following liberalization, the sustain competition in the long run. domestic and international civil avia- domestic airline industry has attracted tion liberalization policy in the coun- as many as five entrants, but this num- The Herfindahl-Hirschman Index try. The EO stipulates the removal of ber has dwindled to three following (HHI), a measure of industry concen- restrictions on routes and flight tration, sums the squared frequencies, as well as govern- Liberalization appears to result in market shares of each firm ment control on fares and in the industry (Carlton and charges. On market entry, the a sizeable increase in passenger Perloff 1994). When the provision encourages at least domestic airline industry is two operators in any route and traffic in most of the 15 biggest taken as a single market, operators are free to leave any airline markets in the country the HHI is basically stable unprofitable routes. With (see table 3). The US regard to fare, markets with at least the failures of Grand Air (national Department of Justice contends, how- two operators are deregulated, while operator) and Mindanao Express ever, that an HHI above 1,800 is con- regulation still applies in single-air- (regional operator). The demise of sidered highly concentrated (Cooper line markets. new entrants in a relatively short peri- 1999). The much higher HHI od is comparable to the US experience observed in the Philippines is due to It may appear on the surface that fares in the early 1980’s (Kahn 1988 and the dominance of PAL in most routes and flight frequency are still regulated Borenstein 1992). With the entry of and the near duopoly that exists by CAB due to the airlines’ practice of South East Asian Airlines (SEAir) in between PAL and Cebu Pacific in informing CAB of their intentions. the scheduled airline sector in 2003, almost all markets served by both air- However, the practice of readily three airlines now compete in major lines. granting the airlines’ requests for revi- markets (PAL, Cebu Pacific, and Air sions in airfare and flight frequency Philippines) while two airlines serve When the industry is divided into and schedule in a matter of days seem short-distance routes (Asian Spirit and major (more than 20,000 passengers to indicate that CAB has been imple- SEAir), giving passengers at least two annually) and minor routes, major menting the provisions of EO 219. It choices in some markets, offering routes appear to be more concentrated simply monitors rates and charges in them a range of fares, departure fre- than the entire industry, while minor the domestic airline industry to pro- quency, and service quality. routes are almost twice as concentrat- mote competition and the welfare of ed as the entire industry (see table 3). consumers. The steady decline in PAL’s market The numbers seem to indicate that share, from 96 percent in 1995 to 49 minor routes are virtually single-air- Austria (2000) observes that the role percent in 1999, indicates that compe- line markets while major routes are of CAB has been limited to regulating tition has intensified after liberaliza- virtual duopolies. capacity, flight frequency, and airfare tion. The four-firm concentration ratio in the international air transport sector (CR4) measures the revenue share of High-Density Markets under after 1995. CAB, however, still issues the four largest firms to total industry Liberalization Liberalization appears to result in a sizeable increase in passenger traffic in most of the 15 biggest airline mar- kets in the country (see table 4). Between 1994 and 2003, the number of markets with an annual passenger traffic of at least 100,000 increased from 11 to 15, although most of these markets are virtual duopolies.