EAST-WEST CENTER

EAST-WEST CENTER SPECIAL REPORTS

Number 4 October 199 s

THE ASIA-PACIFIC

AIRLINE INDUSTRY:

ECONOMIC BOOM

AND POLITICAL

CONFLICT SUMNER J. LA CROIX DAVID JONATHAN WOLFF

The rapid growth of air traffic and related industries servicing Asia is straining existing facilities as well as threatening the framework of bilateral agreements that have governed Asia-Pacific aviation since the end of World War II. A U.S. call for free international trade in airline services is getting a wary reception from many Asian governments.

East-West Center Special Reports are authored by scholars, journal• ists, and other commentators and examine issues of importance to the Asia-Pacific region and the United States. EAST-WEST CENTER fast-West Center Special Reports The contents of this paper may be present a thoughtful synthesis of reproduced lor personal use. If you The East-West Center is a public, knowledge on issues of importance to would like to reprint, excerpt, or adapt nonprofit educational and research the Asia-Pacific region and the United the contents, or for additional copies institution located in Honolulu, States. Special Reports are authored or other information, please write or Hawaii. Established by the U.S. by scholars, journalists, and other fax the series editor. Congress in I960, the Center's commentators. They are intended for East-West Center mandate is to foster mutual under• those who make or influence policy Publications Program standing and cooperation among the decisions in the United States, Asia, 1777 East-West Road governments and peoples of the Asia- and the Pacific, including educators, Honolulu, Hawaii 96848 Pacific region, including the United scholars, journalists, business people, States. Principal funding comes from and individuals with a broad interest Telephone: (808)944-7197 the U.S. government, with additional in Asia or the Pacific. Facsimile: (808) 944-7376 support provided by private agencies, E-mail: [email protected] The views expressed in this publica• individuals, corporations, and more tion are those of the authors and do than 20 Asian and Pacific govern- not necessarily reflect the views of the East-West Center. EAST-WEST CENTER SPECIAL REPORTS

EAST-WEST CENTER Number 4

1777 East-West Road October 7995

Honolulu, Hawaii 96848

THE ASIA-PACIFIC

AIRLINE INDUSTRY:

ECONOMIC BOOM

AND POLITICAL CONFLICT

SUMNER ]. LA CROIX

DAVID JONATHAN WOLFF

CONTENTS Summary 2

The Ascent of Asian Airlines 4 Losses, Cost-Cutting, and Consolidation in the Global Industry 4 Entry, Expansion, and Profits in Asia 5 Summary 16

Bilateral Relations 17 Fifth Freedom Rights 17 Fifth Freedom Rights and the U.S.-Japan Aviation Treaty 19 The Future of Bilateral Agreements in Asia 24

Moving Beyond the Bilateral Regime 25 U.S. Views on Aviation Liberalization 25 Asian Views on Aviation Liberalization 26 Asia-Pacific Economic Cooperation (APEC) and Civil Aviation 28 From Restricted Bilateral to Open Skies Arrangements! 30 Asia-Pacific Aviation and the WTO 31

Conclusion 35

Endnotes 36.

References 37 2

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Sumner f. La Croix is a senior fellow at the SUMMARY East-West Center and High rates of economic growth in Asia are spurring the rapid expansion of professor of economics at the University of commercial aviation industries serving Asia and the Pacific. The number of Hawaii. His primary passengers carried across the Pacific increased at an annual rate of 8.6 per• research interests are modern Asian indus• cent during 1982-92, compared with 5.4 percent on all other routes. And tries; property rights in with 16 of the world's 25 busiest air routes, Asia's major airports are already land, resources, and intellectual innova• near capacity. The region will soon account for the world's largest increase tions in the Asia-Pa• in aircraft purchasing, maintenance, and repair, generating tremendous cific region; and eco• nomic history. revenues for firms that service the industry.

David fonathan Wolff, Although many Asia-Pacific nations are benefiting from the boom in air currently a consultant traffic, the continued expansion threatens the framework of bilateral agree• at the East-West Cen• ter, was recently ap• ments that have governed Asia-Pacific aviation since the end of World War pointed to the U.S. n. Growth in the number of passengers, airlines, and routes has stimulated Foreign Service. He formerly served as a competition and intensified aviation disputes, thereby increasing tensions foreign affairs aide in in the international relations of the region. Potentially, such tensions could the United States Sen• ate and has an M.A. fuel increased protectionism. from George Washing• The United States has been actively campaigning for countries in Asia to ton University adopt an "Open Skies" regime that would allow free international trade in

airline services. Although liberalization would have positive effects, such as

lower fares and more efficient airline management, some Asian govern•

ments worry that it could also lead to predatory pricing, a retreat from low-

demand routes, and a tendency toward oligopoly. And many Asian airlines,

which owe their profitability in part to restrictive bilateral treaties, are

partially government-owned; therefore, governments may be reluctant to

adopt new competitive arrangements that eliminate or reduce these profits.

Although free trade is usually superior to protected trade, it also gener•

ates losers—countries whose national airlines would shrink or even disap•

pear in a liberalized regime. Unless losing counties receive some compensa•

tion, they are unlikely to support a free-trade regime. The Asia-Pacific Eco•

nomic Cooperation (APECJ Working Group on Transportation could provide

a forum for the formulation and discussion of new policies for international

cooperation in aviation throughout the Asia-Pacific region. 3

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Asia's explosive economic growth has direct foreign investment flows to been accompanied by a rapid expan• Asia over the last 20 years.5 Finally, sion and transformation of the region's leisure travel has become the main airline industry. Between 1982 and source of demand on most interna• 1992, the number of passengers car• tional routes. Tourism is the primary ried across the Pacific increased at an industry for a number of the Pacific annual rate of 8.6 percent, and the Island nations and is growing in im• number of passengers traveling be• portance throughout the region. Be• tween Europe and the Asia-Pacific tween 1960 and 1992, the Asia-Pacific region increased at an annual rate of region's share of worldwide tourism 11.4 percent. On all other scheduled revenues grew from 3 percent to 16 international and domestic air routes, percent.* Rapidly rising per capita passenger traffic increased at an an• incomes in Asia hold promise for nual rate of only 5.4 percent.1 The dramatic increases in intra-Asian International Civil Aviation Organiza• tourism and air travel over the next - Expansion of air tion (ICAO} predicts that Asia-Pacific decade. transportation is air passenger growth rates will fall to This report provides a three-part critical to Asia's lower levels (6-8 percent) over the overview of this important and rapidly export-driven next 20 years but will continue to growing industry. First, we identify economies outstrip air passenger growth rates in and analyze major economic trends in 2 the rest of the world. the industry. Among these are in• For several reasons, air transporta• creased demand for new aircraft and tion is expected to play a larger role in ancillary services, growth in airport this booming and geographically far- infrastructure investment, privatiza• flung region than anywhere else in the tion of Asian flag carriers, relaxation world. First, the high population and of entry and price regulations, and income growth rates in many Asian increased intra- and interregional countries, will produce an astounding cooperation.* Next, we discuss.how increase in the demand for air trans• rapid expansion and transformation of portation services. The region already the region's aviation industry have led accounts for more than 50 percent of to increased political controversy. the world's population, and, by the Analysis of the bilateral system that end of the century, more than half of currently characterizes international the 25 most populous cities in the aviation services and of key bilateral world will be found in Asia. Second, disputes in the region illustrates this vast distances separate many Asia- increased level of international ten• Pacific countries (see map on pages sion. Finally, we consider the possibil- 20-21). About 60 percent of the air routes in the region are between cities * The report focuses on major trends in the Asia- that are at least 2,000 kilometers Pacific airline industry rather than the situation apart/ and a number of the countries within each country in the region. The analysis also focuses on the provision of air passenger in the region are islands or archipela• service, paying only passing attention to aircraft gos with few alternatives to air pas• manufacture and the air cargo industry. Thus, all senger travel. Third, expansion of air references to the "airline industry" pertain only transportation is critical to the region's to passenger air service. References to the "Asia- Pacific region" include the South Asian countries 4 export-driven economies. Business of India, Pakistan, Bangladesh, and Sri Lanka. demand for air travel has also been Service to the Pacific islands (with the exception enhanced by the rapid increase in of Hawaii| is excluded from the analysis. ity of improving the region's current ica, Europe, and Australia experienced international air service regime large cyclical losses in the early 1990s through the development of a multi• and have returned to profitability only lateral regime that would better unify since 1994. For example, in the early Asian markets. Such a system is 1990s, Japanese airlines suffered large needed if the region is to cope effec• losses as a result of high operating tively with the dramatic develop• costs, an appreciating currency, and ments affecting the Asia-Pacific avia• the prolonged Japanese recession tion industry. The report concludes by (Table 1). The downturn prompted presenting several proposals for a new Japanese airlines to initiate a series of Asia-Pacific aviation regime. cost-cutting measures, such as hiring expatriate crews, freezing salaries, holding bonuses to a record-low for•

THE ASCENT OF ASIAN mula, and cutting back on perks. AIRLINES Despite its slow pace, the restructur• ing allowed Japan Airlines (JAL) to Research on developments in Asia- earn a ¥2.8 billion profit in fiscal year Pacific aviation has documented 1994, a major improvement from a several important factors affecting the ¥26.1 billion loss in fiscal year 1993,* current state of and prospects for the and All Nippon Airways (ANA) to industry. rebound from its first loss in 27 years (¥2.9 billion) in fiscal year 1993 to a Losses, Cost-Cutting, and profit of ¥4.2 billion in fiscal year Consolidation in the Global Industry 1994.7 The boom in the Asian airline indus• * JAL's net profit stems from the sale of its 5 try has been remarkable given that percent stake in Air New Zealand. JAL recorded most airlines in Japan, North Amer• an operating loss of ¥9.8 billion in FY1994. 5

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Table 1. Corporate financial results of selected Asian, European, and North American airlines: slowdown in 1990-92, members of the Fiscal years 1993 and 1994 (USS thousands) Orient Airlines Association (OAA) Operating profit/loss Net income reported US$2.2 billion in profits over

Airline 1993 1994 1993 1994 the same period;* the financial condi• tion of most Asian airlines remains Asia-Pacific strong (Table 1). This solid perfor• Air India u u 63,500 20,310 All Nippon u u -33,000 47,000 mance has occurred against a back• Caihay Pacific 294,500 333,331 293,974 306,153 ground of new routes, new entrants, Caruda -88,870 27,770 -3,110 76,210 and changes in passenger demand. JAL u -110,000 -293,000 31,500 Several factors have stimulated the Korean 384,422 346,317 14,566 46,779 establishment of new routes and the Malaysia u u 4,290 37,362 Qantas 24,346 223,332 -278,832 115,514 entry of new carriers on existing routes Singapore 583,000 629,000 533,000 586,000 (see box on page 6). First, strong in• Thai -107,946 -4,191 40,360 123,561 come growth in East Asian and South•

Jnited States east Asian countries has led to more American 374,000 586,000 -314,000 -7,000 international travel, prompting Delta -212,200 -217,000 -225,900 -159,000 smaller domestic carriers to move into Northwest 272,400 830,400 -115,300 295,500 the international market in direct United 295,000 513,000 -50,000 51,000 competition with established national USAir -149,106 -516,971 ^118,797 -716,183 flag carriers. Second, over.the last de• iurope cade, several Asian countries, such as Air France u u -1,531,544 -247,940 Taiwan and South Korea, have gradu• British Airways 705,600 939,200 360,000 478,400 Lufthansa u u -34,000 197,000 ally decreased restrictive regulations on foreign travel, and other countries, Source: Various airline reports, such as China, have started to allow u—unavailable. overseas tourism travel. Third, privat• ization of national flag carriers and The losses by Japanese airlines pale abatement requirements. Increased relaxation of domestic entry and pric• in comparison, however, to the mas• airport landing fees arid new taxes also ing regulations have allowed smaller sive losses incurred by U.S. airlines." contributed to higher costs during a new airlines to gain a niche in several Between 1988 and 1992, the U.S. air• time of stagnant demand. A sustained domestic markets. The new entrants line industry went from a US$1.7 bil• recovery in the U.S. economy since are not burdened by the relatively high lion profit to a US$10 billion loss, its 1992, significant reductions in airline labor and capital costs of recently worst performance since the 1930s.9 labor costs, and major route consolida• privatized national flag carriers, whose The losses derived from several tion finally returned most U.S. global expenditures, while protected from sources. With the unexpected down• carriers to profitability in 1994 (Table competition, sometimes have more to turn in travel after the Gulf War, many 1). Asian airlines are now worried that do with politics and prestige than with airlines were left with too many new American carriers, strengthened by efficiency.10 planes and an overextended route net• their recent success in cutting operat• This expansion may at first seem work. New government regulatory ing costs, will become even more for• somewhat surprising given that the actions added to their woes by requir• midable competitors. region is home to hundreds of millions ing such costly add-ons as airport ac• of people who cannot afford to fly. But, cess control systems, installation of Entry, Expansion, and Profits In Asia whereas only 6 percent of the people aircraft Traffic and Collision Avoid• The strong performance of the Asian in the region are air travelers (com- ance Systems (TCAS), modifications airline industry in the 1990s is par• to aging aircraft, and implementation ticularly remarkable given the prob• of systems designed to meet cargo fire * The only major international carriers in Asia lems of the rest of the world's airlines. containment, wind shear, and noise- that do not belong to the Manila-based OAA are Despite the worldwide economic China's airlines and the Japan Air System. pared with 25 percent in Europe and Australia. In South Asia, increased 35 percent in the United States), the demand for air services is expected to percentage of Asian travelers is grow• result from India's recent efforts to ing and is expected to double by the open its economy to foreign invest• year 2000." Air passenger traffic to ment and international trade. Simi• and from Taiwan, for example, in• larly, strong growth in China should creased by 29 percent in 1992.12 In stimulate both international and developed countries in the West, the domestic passenger flows. With the number of kilometers flown by the opening of diplomatic relations be• population is often many times greater tween the United States and Vietnam than the number of people in the in July 1995, air traffic to and from country. The potential for air travel Hanoi and Ho Chi Minh City should growth in the Asia-Pacific region, with continue to increase, although 1994's its rapidly growing economies and 50-percent growth rate may be hard to huge populations, is tremendous (see match. Regional carriers should earn Figure 1). According to a report by the most of the increase in business as Air Transport Action Group (ATAG), long as they are able to raise addi• the largest increase in Asian air travel tional capital to purchase (or lease) is likely to take place on routes cross• new aircraft and to cope with the ing the South China Sea, that is, in organizational stresses encountered by Southeast Asia.13 Among Asia-Pacific all rapidly growing firms. countries, Indonesia is expected to record the fastest annual growth in Demand for New Aircraft and Ancil• international arrivals during the lary Services Because of the expected 1990s, followed by Malaysia and massive increases in demand for air

New Airlines and Subsidiaries

New Entrants Some new carriers, such as Asiana and Airline Country Sempati, compete with established carriers in providing international service on major trunk Asiana South Korea routes. Others, such as East-West Airlines, Eva Taiwan compete only on domestic routes. Mandarin Taiwan Other "new" carriers, such as Dragonair, East-West India are owned by an established airline in their Jet Airways India home country. For example, the parent com• Sempati Indonesia pany of Dragonair is Cathay Pacific. Most Aero-Asia Pakistan subsidiary carriers, such as the Garuda subsid• Hajvairy Pakistan iary Merpati, provide service from smaller New Subsidiaries cities to the major hub airports, where passen• Airline Country gers then fly on trunk routes serviced by the parent carrier. Other subsidiaries, such as the Dragonair Hong Kong Singapore International Airlines subsidiary Silkair Singapore Silkair, were set up to produce a "differenti• Merpati Indonesia ated" product, in this case to serve resort destinations. 7

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Figure 1. Estimated Asia- IT. Pacific populations 1200 240 C HI Population s, (1995) and airline traffic a I I Passenger-kilometers flown 0 (1992) 1000 200 ,4

d 3 800 160

u 600 120 V H _c 400 SO -5 CO M

200 40 d u

0

Note: "Passenger-kilometers flown" is equal to the number of kilometers flown for all passengers whose flights originated in that country.

Source: Data derived from Population Reference Bureau (1995) and ICAO (1995: table 2-9!

travel in the region, a variety of new generation of commercial aircraft— planes will be added to existing fleets jumbo jets capable of holding 600 to of aircraft, and planes already serving 900 passengers, twice the capacity of the Pacific are likely to be flown more current airliners.* frequently and for longer periods of Although increased sales will time. The Asia-Pacific region will clearly benefit manufacturers in therefore account for the world's larg• Europe and North Americat—the est increase in aircraft purchasing, dominant suppliers of commercial jet maintenance, and repair, generating aircraft—they will also provide oppor• tremendous revenues for firms that tunities for joint development projects service and supply the aviation indus• between Western and Asian aerospace try. For example, Singapore Interna• companies. It is becoming increas• tional Airlines (SIA) expects to double ingly evident that such cooperative its fleet of 90 aircraft over the next six ventures will characterize the devel• years to cope with increased demand. opment of future aircraft. For example, From 1982 to 1992, Asia-Pacific carri• in May 1994, Boeing, Japan Aircraft ers accounted for 24 percent of world• Industry, and China National Aero- wide expenditures on commercial Technology Import and Export Cor- jets.14 Boeing's commercial airplane group forecasts that Asian airlines will * In July 1995, Boeing and Airbus concluded that purchase an additional 3,340 planes at the world market for a 600-900 passenger jumbo a cost of US$280 billion over the next jet was not yet sufficiently large to begin design• 15 years. Eventually, the larger Asia- ing such an aircraft. Pacific airlines are also expected to f Specifically, the European Airbus consortium provide the primary market for a new and the Boeing and McDonnell Douglas compa• nies in North America. 8

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poration announced that they will ity. Nine of the 25 busiest routes have cooperate in a joint study of market Tokyo's Haneda or Narita airports as demand for a small jetliner in Asia. their source or destination. Even if New Asian ventures (see box below), regional airlines purchase larger air• established without European and craft, increase load factors, and allot North American partners, are also less space to each passenger, most trying to capture part of the expanding growth in capacity must come from an market. The joint development ar• increased number of flights.15 To Many Asian rangements are attempts to use Asia's handle more flights, countries are airports are already low-cost labor and preserve existing investing heavily in new airports, near capacity market shares. By locating manufac• airport expansion, and related aviation turing plants in high-growth Asian infrastructure (see box on pages 12- countries, foreign aircraft manufactur• 13). A few major projects have re• ers provide subtle incentives for na• cently been completed, more are tional carriers to continue buying under construction, and several mas• their planes. sive projects are moving from the planning stages to construction. Infrastructure Investment The ex• Although the expansion of airports tent to which Asian countries can across Asia is long overdue, the cur• accommodate growth in civil aviation rent construction boom also raises is limited by the region's airport infra• some concerns. First, most construc• structure. Although the Asia-Pacific tion projects are concentrated in larger region contains 16 of the world's 25 "hub" cities. Most "spoke" airports in busiest routes (Table 2], it only has smaller cities have not been remod• five of the world's 25 busiest airports eled and will be unable to handle

(Table 3); many are already near capac• much more traffic from the hubs. The

New Asian Ventures to Manufacture Aircraft

Asian joint ventures to produce small- to medium-size aircraft are in the works. In March 1994, South Korea and China agreed to develop a new 100- seat passenger jet. Samsung Aerospace Industrial Company, South Korea's largest aircraft manufacturer, formed a consortium with 31 Korean firms in September 1994 to serve as the Korean partner in the joint venture. The two sides are planning to invest US$1.2 billion to develop a prototype by 1998, although some observers believe the project will ultimately cost US$3 billion- $4 billion. China has urged Korea to allow Boeing to join the project to provide critical technology and know-how." Indonesia's state-owned Industri Pesawat Terbang Nusantara (IPTN) is also developing and assembling a new commercial passenger aircraft, the N-250, a 70-seat twin-engine turboprop. The Indonesian government has already in• vested US$1.6 billion in the project, which is viewed skeptically by some foreign analysts. Flight testing and certification are expected to take two years, with commercial production expected in 1998. In June 1995, IPTN announced plans to develop a US$I00-million assembly plant in Mobile, Alabama, in partnership with international companies. 9

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next step in the process of upgrading Table 2., International scheduled passenger airport infrastructure will be to ex• traffic: City pairs with highest traffic pand and improve facilities at the (year ending 30 June 1992) smaller airports. Second, the rush by No. of arriving and many cities in Southeast Asia and departing passengers South China to build very large air• City pairs (in thousands) ports that could serve as regional hubs 1 London «-» Paris 3,403 raises concerns about overinvestment 2 London <-» New York 2,249 and underutilized runways and termi• 3 Hong Kong Taipei 2,177 nals in some locations. Coordination 4 Honolulu «-> Tokyo 2,128 5 Kuala Lumpur <-> Singapore 2,112 among Asian governments could help to avoid excessive investment in hub 6 Hong Kong «-> Tokyo 2,103 7 Amsterdam *-* London 1,731 airport capacity. 8 Bangkok «-* Hong Kong 1,730 9 Dublin <-> London 1,678 Privatization of Asian Flag Carriers 10 Seoul Tokyo 1,650 Flag carriers in Australia, Japan, Ma• 11 Jakarta *-» Singapore 1,408 laysia, New Zealand, the Philippines, 12 New York <-> Paris 1,281 Singapore, China, and Thailand are 13 Singapore Tokyo 1,247 14 either wholly or partially owned by Frankfurt *-» London 1,235 15 Taipei«-»Tokyo 1,100 private parties. This regional trend is part of a worldwide movement toward 16 Los Angeles «-> Tokyo 1,097 17 Hong Kong *-* Manila 1,096 privatization in the airline industry* 18 Hong Kong <-> Singapore 986 that is expected to increase airline 19 Bangkok <-» Singapore) 980 efficiency and wean carriers from the 20 Brussels <-> London 954

national treasury. The movement is 21 London <-> Los Angeles 948 occurring at a critical time for Asia- 22 London *-> Tokyo 936 Pacific civil aviation, when survival 23 Bangkok«-»Tokyo 926 dictates that the region's airlines be 24 London «-> Zurich 913 more responsive to the demands of a 25 Guam Island *-* Tokyo 903

changing marketplace. Privately oper• Source: 1CAO (1992:175). ated carriers are perceived to be more flexible than state-owned airlines and in a better position to gain access to tection for the national carrier. This Privatization in the capital markets for the financing of option would have to be pursued with airline industry is fleet expansion programs. several countries, however, and, in the Privatization, although proceeding long run, would do little to improve ultimately an slowly in Asia, is ultimately an infec• the efficiency of the country's airlines. infectious process tious process. If a national airline A second option is for the government privatizes and reduces its costs, it will to remain as the owner, but to cut be able to increase its share of passen• costs. This choice is politically dan• gers on authorized international routes. gerous, as workers are likely to blame Over time, the increased competition the government for wage cuts and job will affect the bottom line of a second losses. Third, the carrier and its home country's national carrier. That carrier government can sell the airline to and its home government then face * In 1991, two-thirds of Latin America's airlines several difficult choices. They can were state-owned. By October 1994, only three negotiate a change in the treaty gov• state-owned airlines remained and they are in the erning the route and obtain more pro- process of being sold to private buyers. 10

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Table 3. Top 25 airports in the world: Domestic and international passenger traffic

Passengers handled

Airport (code) Terminal3 International Domestic

1 Chicago O'Hare Int'l (ORD) 65,091,168 5,899,466 59,191,702 2 Dallas/Forth Worth Int'l (DFW) 49,654,730 2,105,427 47,549,303 3 Los Angeles Int'l (LAX) 47,844,794 11,945,032 35,899,762 4 Atlanta Hartsfield (ATL) 47,751,000 2,416,582 45,334,418 5 London Heathrow (LHR) 47,601,733 40,843,527 6,758,206

6 Tokyo Haneda (HND) 41,507,354 747,219 40,760,135 7 Denver Stapleton Int'l (DEN) 32,626,956 259,170 32,367,786 8 San Francisco Int'l (SFO) 32,042,186 4,608,777 27,433,409 9 Frankfurt Rheim (FRA) 31,930,903 25,290,239 6,640,664 10 Miami Int'l (MIA) 28,660,396 12,373,223 16,287,173

11 New York JFK (JFK) 26,796,036 14,821,136 11,974,900 12 Newark Int'l (EWR) 25,809,413 3,412,036 22,397,377 13 Paris Charles de Gaulle (CDG) 25,695,366 23,336,134 2,359,232 14 Paris Orly (ORY) 25,250,654 10,075,158 15,175,496 15 Hong Kong (HKG) 24,420,646 24,420,646 na

16 Detroit Metro Wayne County (DTW) 24,170,570 2,025,043 22,145,527 17 Boston Logan Int'l (BOS) 24,038,178 u u 18 Phoenix Sky Harbour Int'l (PHX) 23,542,372 107,578 23,434,794 19 Minneapolis/St. Paul Int'l (MSP), 23,402,412 566,184 22,836,228 20 Osaka Int'l (OSA) 23,298,583 5,225,519 18,073,064

21 Seoul Kimpo Int'l (SEL) 22,633,606 10,327,303 12,306,303 22 Las Vegas McCarran Int'l (LAS) 22,492,156 561,436 21,930,720 23 Honolulu Int'l (HNL) 22,061,953 5,173,365 16,888,588 24 Orlando Int'l (MCO) 21,466,033 2,722,189 18,743,844 25 Amsterdam Schiphol (AMS) 20,770,350 20,658,100 112,250

Source: Airports Council International (1993); IATA (1994:14). a. Sum of terminating passengers arid transfer passengers. (Transfer passengers are counted twice, on arrival and on departure from the airport.) na—not applicable, u—unavailable.

private parties who would have the particular routes and promote high incentive to cut costs and improve prices. Thus, in concert with the Many countries service quality. The last choice not privatization movement, many coun• only raises revenue for the govern• tries in the Asia-Pacific region are are moving to ment but also delinks it from politi• moving to deregulate the civil aviation deregulate the civil cally damaging cost-reduction mea• industry. Although regulatory policies aviation industry sures. Thus, the ongoing process of vary widely within the region, there privatization in Asian flag carriers will has clearly been an overall shift in re• likely continue at a measured pace cent years toward more liberal price- over the next decade. entry policies. The pace of deregula• tion for international routes has, how• Price-Entry Deregulation A critical ever, varied considerably across coun• implication of the privatization of car• tries, with differences centering on the riers in the region is that it sets the competitive position of a country's stage for relaxing regulations (price- airline industry, the existence of a entry policies) that restrict entry on large domestic passenger base, and the 11

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Hong Kong's Kai Tak International Airport, the fifteenth busiest airport in the world, operates on a single runway and has no room for expansion.

potential to serve as a regional hub. state-controlled Civil Aviation Ad• Countries with a large, affluent base ministration of China (CAAC) of most of origin/destination traffic, such as regulatory responsibilities. Once the Japan, have tended to protect that restrictions on competition were profitable asset with strict interna• lifted, 35 new regional and provincial tional regulatory policies, whereas airlines entered the market, and more countries with a smaller base of ori• applications are pending. Passenger gin/destination traffic, such as Singa• growth peaked at 32 percent in 1992, pore, have promoted their main air• but has declined somewhat since ports as regional hubs and encouraged then, the result of a high accident rate a more liberal competitive environ• and the new freedom of Chinese trav• ment. The pace of deregulation for do• elers to choose foreign carriers for mestic routes has also varied, with international travel. In 1994, China's India, China, Pakistan, Australia, and Security Regulatory Commission an• New Zealand undertaking notable re• nounced that two state airlines, China forms, and Japan, the Philippines, In• Southern and China Eastern Airlines, donesia, and Thailand lagging behind. had received Beijing's approval to float equity shares on foreign stock markets. China's domestic liberalization has been rapid and turbulent. Five years The rush of new carriers into Chi• ago, the government divested the na's market severely strained the 12

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Asia-Pacific Airport Infrastructure Projects

The extent to which the region can accommodate the projected growth in Asia-Pacific aviation is limited by the capacity of its airport infrastructure. The International Air Transport Association (IATA) reports that nearly half of the major airports in the region will have to begin turning flights away this year unless substantial improvements are made. To keep up, many of the countries in the region are therefore investing heavily in airport infrastructure.

Japan The Narita and Haneda airports are both critically short of space, and expansion plans are underway. The New Kansai International Airport, two miles offshore of Osaka, opened in 1994. It is designed to handle 30 million passengers a year. In all, Japan is spending US$24 billion (1992-97) on its airport improvement program. In addition, the new Five-Year Airport Expan• sion Program Interim Report calls for construction of offshore airports near Tokyo and Nagoya. ~

China A The People's Republic of China faces particularly serious infrastruc• ture problems and has endorsed an ambitious plan to upgrade 100 of its air• ports. Seventeen new airports were under construction in the beginning of 1994, with nine additional projects initiated later that year. In South China, a new airport has opened in Macao, and others are underway in Shenzhen, Zhuhai, and Guangzhou: The latter, expected to open in 1999, will be the largest airport in China. A dispute between Beijing and the British governor of Hong Kong over financing for the proposed Chek Lap Kok International Air• port was settled in 1994, and construction is now underway. Never in dispute was how critical the project is to Hong Kong's future as an international busi• ness center. The current facility, Kai Tak International Airport, operates on a single runway, must adhere to a noise curfew, and has no room for expansion. The new airport, off the north coast of Lantau, will have two runways and operate around the clock. It is expected to handle 80 million passengers per year. Across the Taiwan Straits, Taipei is planning a major airport expansion program to meet the dramatic increase in demand by Taiwan's air travelers.

South Korea The Republic of Korea's (ROK) New Seoul Metropolitan Airport is planned as a 14,000-acre complex on tidal flats in the Yellow Sea off Inchon. It may dwarf all other facilities in the region, handling 70 percent more passen• gers per year than are presently being serviced by Chicago's O'Hare Airport— currently the world's busiest. The facility, which will be located 31 miles from the center of Seoul, is envisioned as a major Northeast Asia hub and gateway for the ROK's burgeoning trade with China. It will eventually accommodate 100 million passengers per year and will cost US$10 billion.

ASEAN The ASEAN countries are expected to spend US$20 billion on airport construction and expansion over the next decade. Malaysia plans to complete its new $3.5 billion Kuala Lumpur International Airport in time for the 1998 Commonwealth Games; Thailand is hoping its proposed NongNgu Hao Inter• national Airport will serve as a major hub for Asia-Pacific air travel, 13

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quadrupling the current capacity of Bangkok's Don Muang Airport. The new facility is expected to handle 25 million passengers per year. The cost of the airport and supporting infrastructure will exceed US$8 billion. Indonesia is preparing to construct three new airports in Medan and Padang in Sumatra and in central Lombok over the next three years. The Philippines plans to expand Ninoy Aquino International Airport in Manila, and to invest US$3 billion in the conversion of Clark airfield into a second passenger and cargo facility. Singapore added a second terminal in 1990 to its Changi International Air• port—the second busiest airport in Southeast Asia. It is now looking to develop facilities there into a one-stop engineering service center to pro• vide the newer long-range aircraft with turnaround maintenance service. Kansai International Even the newest ASEAN member, Vietnam, is planning to improve its Airport, which opened in 1994, is the world's first Hanoi and Ho Chi Minh City airports and to build a new airport in offshore airport. Located Danang, for a combined cost of US$500 million. These projects are likely two miles offshore of to be financed primarily by foreign donors and the Asian Development Osaka, fapan, the airport Bank. is designed to handle 30 million passengers a year. 14

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country's already-inadequate infra• strictly regulated entry, capacity, and structure and caused shortages of fares in domestic markets. The next experienced personnel.* The result three years saw a nationwide pilot was a wave of air disasters16 that strike, a new entrant to the domestic prompted Beijing to slow the pace of market, a fare war, and large losses by deregulation. In response to the recent all domestic airlines. In February air accidents, CAAC has upgraded its 1992, Prime Minister Keating's One safety enforcement activities, major Nation Statement announced the Chinese airlines have arranged for dismantling of the barrier between pilot training in the United States and domestic and international aviation, other foreign countries, and smaller thereby allowing competition with Inadequate airlines have been limited to short Qahtas, the government-owned inter• infrastructure and flights within their home provinces. national airline. In May 1992, Qantas a shortage of China's experience demonstrates that, merged with Australian Airlines and experienced although price-entry deregulation has began to provide domestic service. personnel have led many economic advantages, the suc• Qantas' entry via merger into the to a wave of air cess of newly liberalized regimes is domestic market was countered by tied to the upgrading of airport infra• the entry of the second major domes• disasters in China structure and organization and to the tic carrier, Ansett Australia, into the vigorous enforcement of basic safety international market in 1'993.17 In that and personnel training policies. same year, the government sold 25 Similar price-entry deregulation percent of Qantas' shares to British has occurred in India's small aviation Airways and is currently planning to industry. Only 10 million of India's float an additional 24 percent of the nearly 900 million people flew in equity. The new industry structure 1993. Until the 1990s the market was and a reviving economy are now lift• dominated by state-run Indian Air• ing Australian airlines to profitability lines and its international sister, Air after several years of large losses. India.* Several recently established private carriers have been-particularly Lower Labor Costs The expansion of successful in cutting into Indian Air• Asian airlines has been accompanied lines' market share on routes connect• by modernization of their fleets and ing the major business centers of the adoption of cutting-edge manage• Bombay, Bangalore, and New Delhi. ment techniques. As the differences Among the most successful of the among international airlines become new players are East-West Airlines, Jet less pronounced, the lower labor costs Airways India, Modiluft, Archana of most Asian carriers become more Airways, and Damania Airways. The important to the industry. Labor costs, increased competition has prompted which typically amount to 30-35 Indian Airlines to markedly improve percent of total operating costs for its in-flight and ground services. The North American international air• government plans to partially priva• lines, comprise only 10-20 percent of tize the two state companies in 1995. In Australia, the October! 98 7 * China's airlines will require approximately 600 new pilots per year, but its single aviation college notice that the "Two Airline Policy" graduates only 200 new pilots annually. (TAP) would terminate in three years f India's national carrier had been protected unleashed several years of turbulence against competition by a 1953 law declaring the in the airline industry. The TAP had state-run airlines a monopoly business. 15

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total operating costs for many Asian trade associations, the Association of carriers (with the exception of the South Pacific Airlines (ASPA) and the Japanese airlines}.18 Although some Orient Airlines Association (OAA), Asian carriers are unionized, the are actively promoting such cost- unions are generally less powerful sharing arrangements. than their counterparts in the United Cooperation also cuts across re• States or Europe.* gions. The worldwide trend toward As labor costs have risen recently "strategic alliances," in which com• in some Asian countries, several air• peting firms negotiate cooperative lines in the region have moved labor- agreements for certain activities, is intensive jobs to lower-wage coun• clearly exhibited in multiple agree• tries. For example, to cut wage costs, ments among Asian, American, and Cathay Pacific is offering offshore European airlines. For example, SIA, basing to its primarily expatriate Swissair, and Delta are experimenting crews and has moved some of its ac• with joint marketing and a schedule

counting work to Guangzhou, China; integration program that involves Singapore International Airlines (SIA) more than 300 destinations. North• is moving its data processing and west Airlines and Air New Zealand computer software development to have linked frequent flyer programs Bombay, India; and aircraft repair and and have agreed to share airport facili• maintenance firms are investing in ties and sales support. the Indonesian island of Batam, just "Code-sharing" arrangements, in south of Singapore, in the hope of which a passenger is ticketed on one establishing a new, low-cost mainte• airline for a multiflight trip but travels nance center near several major hubs. on flights operated by a second airline for part of the trip, are being imple• Increased Inter- and Intra-Reglonal mented by virtually all major interna• Cooperation Over the last five years, tional airlines in the region. Success• airlines in the region have negotiated ful code-sharing involves careful Several Asia-Pacific several cooperative arrangements, coordination of the two airlines' flight airlines have moved pooling their resources to compete schedules so that they can "feed" each labor-intensive jobs effectively against American carriers other passengers. SIA and Delta have to lower-wage with sophisticated marketing cam• code-sharing arrangements on Singa• countries paigns. The creation of ABACUS, a pore's service to New York, enabling computerized reservation system passengers to take connecting flights owned jointly by major Asian airlines, on Delta to other U.S. cities under a is an indication of this trend. Another single flight designation on SIA. Thai is the launching of Passages, a fre• Airways, Lufthansa, and United have quent flyer program for business and worked out an arrangement in which first-class passengers initiated in 1993 passengers can fly to more than 500 by SIA, Malaysia Air System, and destinations as though they were Cathay Pacific. Carriers from some of flying on a single airline.' The three the smaller countries in the region, which have traditionally faced high * Low labor costs do not directly translate into inventory holding costs, are also competitive advantage, as they may also be an indicator of low labor productivity. trying to remain economically viable 1 by sharing maintenance and training The United-Thai Airways code-sharing agree• ment has not yet been approved by the two costs with other airlines. Two regional governments. 16

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airlines have also agreed to share baggage will be lost or delayed, and a lounges and terminal facilities, pool higher probability that connecting frequent flyer programs, and cooperate flights will be held for passengers on in cargo services.* delayed flights from the same airline. Limited equity investments by one Third, it is easier to accumulate fre• code-sharing airline in a second code- quent flyer points on a large airline sharing airline may be efficient de• that serves many destinations. Thus, Firms that reduce vices to ensure that the incentives of whereas traditional economies of costs to compete in the two airlines are closely aligned scale, which allow large firms to domestic markets and that one airline does not use the produce a given product at a lower arrangement to benefit at the expense average cost, are quickly exhausted, also become more of its partner.19 Examples include large firms still have an advantage due effective cross-shareholding or equity stakes to their ability to produce higher international linking British Airways, Qantas, and quality products. competitors USAir,- SIA, Delta Air Lines, and Summary Swissair; and KLM Royal Dutch Air• lines and Northwest Airlines.f Increased demand for air travel, an The new alliances stem from par• ongoing process of flag carrier privat• ticular advantages that accrue to large ization, and price-entry deregulation firms in the airline market. Among in the domestic markets of several these are economies of scale. In many major countries are all intensifying industries, large firms prosper from competition in both domestic and decreases in average costs as output international air passenger markets in increases. Similarly, in the airline the Asia-Pacific region. Measures that market, air carriers benefit from econ• increase competition in domestic air omies of traffic density, when unit markets, such as those in place in the costs fall as more flights or more seats United States, Australia, India, and per flight are added to a given route, Pakistan, have potentially important and from economies of firm size, effects on international air markets. when the network expands to service Firms that have reduced costs to a larger number of cities.20 However, compete effectively in the domestic studies of airline costs show that market also become more effective increases in network size and traffic competit'ors in the international mar• density do not reduce average costs ket. The cost reductions allow lower after a minimum level of traffic den• prices and better capacity utilization sity is reached.21 Despite the lack of on international routes and often long-term benefits from economies of scale, large airlines may nonetheless * Virgin Airlines (United Kingdom) and Malay• have an advantage over smaller air• sian Airlines have an extensive code-sharing lines related to three demand-side arrangement that effectively ties their European forces.22 First, information costs may and Asian networks. Asiana (South Korea) and Northwest have also implemented a code-sharing induce a consumer to pick a large arrangement and have linked their frequent fliers airline that flies to several destina• programs.

tions, rather than gather information fTwo recent studies commissioned by the U.S. on smaller airlines. Second, larger government have concluded that code-sharing airlines often provide higher quality arrangements generally benefit consumers. They increase revenue and traffic for the allied airlines, service—shorter waiting times for but this is partly at the expense of airlines with• connections, a lower probability that out alliances. See Jennings (1995) for a summary. 17

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impose losses on foreign airlines Uruguay Round World Trade Organi• serving these markets. These foreign zation Agreement, the agreement does airlines are then faced with the choice not cover air passenger service.* of asking their home governments for Meanwhile, passenger growth in increased protection on these re• the Asia-Pacific region has combined stricted routes or undertaking the with congested airport facilities to difficult task of reducing costs and place stress on bilateral aviation rela• improving service quality. The result tions and open unexpected avenues of is typically either bilateral friction competition between growing Asian between the governments of the two airlines and the more established countries or labor unrest as the pro• airlines of Australia, Japan, North tected carrier moves to cut costs. The America, and Europe. The next two growing number of bilateral disputes sections review the major issues in in the region provides ample testi• the ongoing disputes and consider the mony that increased competition in differing views of the participants. the region's air passenger industry is The third section discusses the future stressing the political framework, of bilateral agreements in Asia. governing international civil aviation. Fifth Freedom Rights

Huge losses experienced in the early BILATERAL RELATIONS 1990s by airlines based in Australia, Japan, and the United States have ag• Since the end of World War II, the glo• gravated bilateral relations over com• bal aviation industry has operated on mercial aviation issues. Recent dis• the premise that international routes putes among these three countries arc closed unless governments agree over the interpretation of "Fifth Free• to open them. This has resulted in dom Rights" provide the most notable approximately 3,000 bilateral air-ser• examples. Fifth Freedom Rights vice agreements. These agreements [sometimes called "Beyond Rights"} refer to the right of a carrier from one Increased typically specify the airlines permitted to fly a particular route and the fre• country to take on additional passen• competition is quency and capacity of those flights. gers or freight in a second country for placing stress For one country's airlines to gain ac• a flight to a third country (see box on on the political cess to a second country, the second page 18). Fifth Freedom Rights are framework country's airlines must be allowed extensively used in Asia by European, governing similar access to the first country. The North American, and Asian airlines. international overall effect of the bilateral regime is In 1994, airlines operated 493 Fifth civil aviation to provide a limited degree of protec• Freedom routes weekly within Asia; tion to the two countries' airlines

serving each route. Since the number * Until the 1970s, the international airlines also of flights offered by each airline serv• colluded on setting prices on most routes, with ing a route is fixed by the bilateral the International AirTransport Association (IATA) serving as a facilitator and watchdog for agreement, the maximum number of such arrangements. The arrangements began to passengers that one country's airline is break down in the 1970s as more intensive com• allowed to carry is fixed or, in the lan• petition began on trans-Atlantic routes between guage of international trade, subject to the United States and Europe. LATA's current role in setting prices is much diminished, and on a quota. Although quotas are discour• many routes it docs not significantly affect aged in other industries by the 1994 market prices. 18

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Asian carriers operated 31 percent of Singapore, Taipei, Hong Kong, and these routes, U.S. carriers 30 percent, Seoul. Asian carriers usually acquire European carriers 19 percent, and Fifth Freedom rights within Asia by an other carriers 20 percent.23 Within exchange of aviation rights. Japan would like to Asia, 25 to 50 percent of the flights Fifth Freedom operations by U.S. repudiate its 1952 flown between city pairs with Fifth airlines center on Tokyo, Seoul, and and 1959 aviation Freedom service are Fifth Freedom Taipei, all of which are used by U.S. agreements with flights. airlines as "hubs." Passengers origi• the United States Fifth Freedom routes operated by nating from different locations in Asia Asian carriers are concentrated in are "rebundled" at the hub onto flights

Definitions of the Six Air Freedoms First Freedom The right to fly over another country without landing. Relaxation of restrictions on First Freedom Rights by republics of the former Soviet Union has intensified competition between airlines in Europe and Asia as well as opened up routing options for aircraft flying to other destinations in Europe and Asia.

Second Freedom The right to make a landing for technical reasons (e.g., refueling) in another country without disembarking or picking up new revenue traffic.

Third Freedom The right to carry revenue traffic (passengers and freight) from an airline's own country to a second country with which the airline has an air services agreement.

Fourth Freedom The right to carry revenue traffic to an airline's own country from a second country with which the airline has an air services agreement.

Fifth Freedom The right of an airline from country A to carry revenue traffic between a second country B and a third country C (B to C, C toB).

Sixth Freedom The right of a country to exercise two sets of Third and Fourth Freedom Rights (B to A and A to C) to carry rev• enue traffic from B to C.

Cabotage Rights The right of an airline from one country to carry revenue traffic between two points within a second country. Cabotage rights are rarely granted.

The first five freedoms are negotiated in bilateral air-services agreements. Sixth Freedom Rights are seldom-used supplementary rights not formally recognized in air-services agreements. When they are used, supplementary rights are usually addressed through a Confidential Memorandum of Under• standing between two or more countries. 19

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bound for various U.S. destinations, and vice versa. Hub operations of U.S. Multilateral Aviation Disputes In Asia airlines are concentrated in Tokyo, but Fifth-Freedom service by U.S. carriers between Australia and Japan has gener• congestion at Narita Airport has ated a contentious dispute among the three countries. In 1992, two American helped to promote Seoul and Taipei as carriers, United Airlines and Northwest Airlines, announced their intention to alternative hub locations. Some coun• use Fifth Freedom Rights to fly from the United States to Osaka, pick up tries, notably China, allow U.S. air• passengers, and then fly to Sydney or Kuala Lumpur. When the Japanese gov• lines to operate Fifth Freedom flights ernment refused to approve this arrangement, United Airlines filed a com• only with strict capacity limitations. plaint with the U S. Department of Transportation. Citing a broad interpreta• Fifth Freedom Rights for American tion of Fifth Freedom Rights, United contended that the 1952 U.S.-Japan bilat• carriers have recently come under eral aviation treaty, and the subsequent 1959 memorandum between the two concerted attack in Asia. An example governments, gave it the right to start new services from Japan to other desti• is Hong Kong's policy on package nations in the Asia-Pacific region. The 1959 document stated that applications delivery services. Federal Express has for new services would be granted and then reviewed six months after opera• regularly petitioned Hong Kong for tions start if the Japanese government had reservations about the changes. The Fifth Freedom Rights to deliver cargo Japanese government preferred a narrower interpretation of the Fifth Freedom to other Asian countries, but, to pro• clause, insisting that all new services must be individually approved and that tect Cathay Pacific's base, Hong Kong the 1959 agreement would not be applied to new route applications. has repeatedly declined to grant these Northwest experienced similar treatment in 1991 when it applied to the rights." Federal Express has responded Japanese government to extend its New York-Osaka route to Sydney. Citing by moving its hub operations to Subic Article 12 of the aviation treaty, Tokyo attached conditions stipulating that at Bay Airport in the Philippines. United least 50 percent of the passengers going on to Sydney had to have been on the Parcel Service (UPS), which used to initial flight from the United States. Tokyo cited the treaty's provision that the serve Taiwan via Hong Kong, has agreed services must retain the traffic capacity between the starting point and begun direct flights to Taipei to bypass the ultimate destination as the "primary objective." Northwest opted to pur• the restrictive policies of the Hong sue a conciliatory approach by attempting to comply with the restrictions, Kong aviation authorities. With the blaming United for inflaming the situation by not agreeing to do the same. development of competing airports in In February 1993, the U.S. Department of Transportation ruled that Japan's Macao and Southern China, Hong actions were illegal and considered imposing sanctions. To protect its own Kong's policy of protecting Cathay market share on the routes to Japan, Australia vowed to revoke Northwest Pacific's Hong Kong base may not be Airlines' right to operate three New York City-Osaka-Sydney flights per week, viable in the long run. claiming that as many as 90 percent of the passengers joined the flight in Osaka in violation of Northwest's agreement that the passengers joining the Fifth Freedom Rights and the U.S.- flight in Japan would account for no more than 50 percent of the passengers. Japan Aviation Treaty This dispute was largely settled in December 1993 when Australia and the Fifth Freedom Rights with Japan have United States agreed that startup capacity on the route could be the equivalent been particularly controversial (sec of three B747 services per week, with'growth ol at least one service annually. box at right), in part because they stem from a 1952 aviation treaty (and a 1959 memorandum) that the Japa• point and the ultimate destination as Japanese travel demand to the point nese would like to repudiate. The the "primary objective." Given the where, by the 1990s, a substantial accord allows three carriers—North• travel restrictions on Japanese resi• number of passengers on Fifth Free• west, Federal Express, and United—to dents and their low per capita income dom routes operated by U.S. airlines open virtually unlimited Fifth Free• in the 1950s, few Japanese flew on from Narita are Japanese nationals. dom flights beyond Japanese interna• Fifth Freedom flights. Since then, tional airports. The treaty specifies however, large increases in per capita * Moreover, Hong Kong has stated that airlines that these services must retain the cannot add new routes or capacity after the Chek income and the relaxation of travel Lap Kok Airport is completed unless Cathay traffic capacity between the starting restrictions have markedly increased Pacific also desires to expand on similar lines. 20

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160°W

22

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The Japanese airline industry conse• though European and South American quently argues that the change in markets could be destinations for Fifth passenger composition has greatly Freedom flights, the profitability of increased the value of Fifth Freedom these routes is questionable. The Rights granted to U.S. airlines and route from Japan to Europe over that the distribution of benefits is no Northern Russia—opened since the longer equitable." end of the Cold War—is more direct American carriers currently fly 23 than the route over North America, routes Unking Japan with other coun• and, although Japanese trade with and tries in the region. By comparison, the travel to South and Central America only Japanese air service from the are expanding, the demand by Japa• United States to a third country is nese tourists and businessmen for JAL's twice-weekly route from Los these flights is still relatively small. Angeles to Sao Paulo, Brazil. Even on Third, Japan is a valuable gateway to that route, JAL is limited to picking Asia for U.S. airlines bringing passen• up 3,000 passengers annually in Los gers from a wide variety of locations Angeles. The United States has previ• in the United States. The ability to ously approved Fifth Freedom Rights rebundle these passengers at a hub for JAL to provide service to European airport for onward flights to East and and South American cities, but all Southeast Asian cities allows U.S. routes (except for Sao Paulo) have airlines to operate more efficiently. A been discontinued. For example, in the hub located in Japan also provides 1970s JAL provided service from access to the large Japanese traveling Tokyo's Narita Airport to London's public, a group with arguably the Heathrow Airport by using Fifth Free• highest per capita income in the dom flights from New York. world. A central conclusion of our analy• Japan's advantageous position as a sis, and the primary reason why Japan gateway to Asia provides Japanese does not make full use of its Fifth airlines with some locational advan• Fifth Freedom Freedom Rights, is that Fifth Freedom tages. By using Third and Fourth routes from Japan routes from Japan are more valuable Freedom Rights, Japanese airlines can than Fifth Freedom routes from the provide passenger and cargo service are more valuable United States. There are several rea• from other Asian countries to the than Fifth Freedom sons for this. First, Japanese airlines United States. Japanese airports can be routes from the have higher operating costs than U.S. used as hubs to rebundle passengers United States airlines and are unlikely to be able to and cargo originating in different compete effectively with U.S. airlines Asian cities to be sent to different U.S. for business on Fifth Freedom routes cities, and vice versa. The rights to originating in the United States. Sec• serve such routes, using two sets of ond, Japanese airlines do not highly Third and Fourth Freedom Rights, are value Fifth Freedom Rights from U.S. informally called "Sixth Freedom airports because only two large coun• Rights" (see box on page 18}. They are tries, Canada and Mexico, arc rela• not explicitly mentioned in bilateral tively close to the United States, and agreements, but some countries refuse neither is likely to be receptive to to allow foreign airlines to coordinate expanded Fifth Freedom service from their flight schedules to facilitate such the United States. Furthermore, al• service because it cuts into the market 23

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The Japanese traveling public has the highest per capita income in the world. (Shown: Tokyo's Haneda Airport during

Golden Week, when many Japanese take their vacations. Golden Week, which begins April 29th, contains three holidays.)

for the second and third country's by awarding Fifth Freedom Rights to airlines. U.S. airlines. U.S. airlines have argued that the Although the U.S.-Japan aviation explicit Fifth Freedom Rights granted treaty may not be as one-sided as to U.S. carriers are balanced by the in• some Japanese airlines allege, it con• formal Sixth Freedom Rights granted tains two key features that are clearly to Japanese carriers. For example, in leftovers from the 1950s aviation era. the absence of Fifth Freedom Rights, First, it allows the United States to the benefits to a U.S. airline of flying start new service unilaterally from between San Francisco and Tokyo are Japan to Asian cities, such as Hanoi. confined to extra profits gained from Within the current framework of the additional point-to-point traffic. bilateral aviation accords, however, On the other hand, the benefits to a new service by one country's airlines Japanese airline of flying between San is initiated only when the two coun• Francisco and Tokyo include the extra tries can agree on an exchange with profits gained from the additional the second country, that is, by opening point-to-point traffic as well as the a new route to its airlines. Moreover, a ability to implement Sixth Freedom recent dispute with Japan indicates service between, for example, Bang• that unilateral opening of air service kok and San Francisco. This implies by the United States is at an end. that, all other things being equal, a When Federal Express requested the Japanese airline will value a route to addition of seven cargo flights from the United States more than a U.S. air• Narita and Kansai Airports to several line will value a route to Japan. The Asian destinations, including its new difference in value could be made up hub at Subic Bay, the Japanese govern- 24

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ment refused the request, leading to to outpace that in North America. an increasingly tense dispute with the From the perspective of American United States. The dispute was settled carriers, the Asia-Pacific region ap• in July 1995 after Tokyo granted the pears the most promising of all. Pas• desired routes to Federal Express and senger flows between Asia and North Washington granted new routes to the America constitute the largest compo• United States for Japanese cargo carri• nent of interregional traffic. In fact, ers. That agreement, in effect, marked the top two passenger flows in the the end of the unilateral opening of world involving a city in Asia and a new services, now replaced by the city in any other region are the Hono• international standard of exchange of lulu-Tokyo and Los Angeles-Tokyo flight rights. routes." The second outdated provision of Despite the many challenges the U.S.-Japan aviation treaty is that threatening the survival of some U.S. American carriers the restrictions on Japanese Fifth airlines, Asian carriers have reason to need access to Freedom service in the United States be nervous about American competi• gateways in Asia are unduly protectionist. The require• tion over trans-Pacific and intra-Asian ment that Japanese airlines providing service. With or without government and Europe, where Fifth Freedom service from New York assistance, U.S. airlines are beginning growth in air travel City must first stop in San Francisco to return to profitability, with costs is projected to serves only to impose additional costs markedly reduced by radical cost- outpace that in on the service and to reduce the desir• cutting measures taken over the last North America ability of such flights to most passen• four years. In addition, new forms of gers. The limitation on the number of airline organization that tie employee passengers who can board in Los compensation to airline performance Angeles on Los Angeles-Sao Paulo have emerged and could be successful flights is grossly inconsistent with the in cutting costs further.* rights of U.S. airlines in Tokyo. In The growing international market addition, given the low value of Fifth has not only stressed U.S. bilateral Freedom flights from the United relations with Japan but has also led to States, the limitations on Fifth Free• controversies with the governments of dom gateways provided to Japanese Thailand, Australia, Hong Kong, and airlines serve little purpose. the Philippines.' Although most of the disputes revolve around U.S. requests The Future of Bilateral Agreements In to open Fifth Freedom flights, some do Asia not involve the United States. For American pressure for expanded Third, example, Thailand and Australia have Fourth, and Fifth Freedom Rights recently formed a study panel to in• stems from the increasing importance vestigate the effect that Qantas Fifth of foreign flights. In 1992, revenues Freedom flights from Bangkok to Eu• from scheduled international flights of rope would have on Thai airlines. U.S. carriers reached 25 percent of Most Asian countries are also irritated their gross revenues, up from 16 per• cent in 1982.25 To continue to prosper, * The recent takeover of United by its employees American carriers need greater access is the most dramatic of these new forms of organization. to foreign gateways, particularly in 1 U.S. aviation relations with the Philippines have Asia and Europe, because growth in been complicated by U.S. allegations that some air travel in both regions is projected Philippine airports are unsafe. 25

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at the relatively liberal aviation poli• take advantage of their geographic creating a multi-national operating cies of South Korea, Singapore, and location, thereby placing pressure on environment for airlines free of dis• Taiwan, which promote their airports protectionist countries. More unilat• crimination and restrictions," and that as regional hubs. The other Asian eral liberalization could also occur as "liberal, multi-national'agreements be countries have generally adopted poli• Asian economies continue to grow negotiated that encompass provisions cies to protect their national carriers and the demand for air services for passenger and cargo services; char• and have recently used stronger pro• changes. Nonetheless, unilateral ters; cross-border investment and tectionist rhetoric at international liberalization is unlikely to sweep ownership; comparable traffic rights; forums. the region anytime soon. fifth/sixth freedom traffic rights; fair The fight over Fifth Freedom Rights market access and doing business highlights the protectionist nature of opportunities; system capacity; gov• the current international civil aviation MOVING BEYOND THE ernment subsidies, and customs and u system. The interests of commercial BILATERAL REGIME immigration facilities." To set.an and private consumers of aviation example, the Commission also recom• services are not given primary consid• Asia-Pacific aviation is still governed mended that "The Federal Aviation eration in bilateral negotiations. In• by bilateral treaties that restrict com• Act be amended to allow the U.S. to stead, emphasis is placed on a "fair" petition and divide the profits from negotiate bilateral agreements that division of the economic profits gener• higher than competitive prices be• permit foreign investors to hold up to ated by air cargo and air passenger tween two countries' airlines. A few 49 percent voting equity in U.S. air• services. The "sorry mishmash of promising trends suggest, however, lines, providing those bilateral agree• bilateral service agreements whose that the region may be on the thresh• ments are liberal and contain equiva• complexity increases with every old of a new era. Among these are the lent opportunities for U.S. airlines; the international destination included on slow spread of domestic deregulation foreign investor is not government a flight" is indicative of the core prob• and privatization of national carriers owned; there are reciprocal investment lem in the Asian aviation industry: that are gradually producing market rights for U.S. airlines, and the invest• governments continue to insist that conditions consistent with a more ment will advance the national inter• their national carriers retain a signifi• liberal multilateral aviation regime. est and the development of a liberal 29 cant share of international aviation Still, many Asian countries arc op• global regime for air services."

27 service to and from their countries. If posed to further liberalization and are U.S. Secretary of Transportation this policy had been adopted in every suspicious of U.S. efforts to promote a Federico Peria incorporated many of industry, current levels of world trade multilateral regime. This section the Commission's ideas into his No• and investment would never have presents differing viewpoints on liber• vember 1994 statement on interna• been reached. In other industries, alization, reviews the potential for a tional aviation policy. The statement arrangements similar to Fifth Freedom regional multilateral regime, and calls for an examination of "the feasi• Rights exist as a matter of course: an discusses the benefits of incorporating bility of achieving multilateral air enterprise will ship partially processed negotiations on aviation into the service agreements among trading goods from its home country to a ongoing trade negotiations conducted partners. Although such negotiations second country, value is added in a within the World Trade Organization may be more complex and difficult subsidiary in the second country, and (WTO). because of the number of parties in• the goods arc then shipped to a third volved, they should be undertaken U.S. Views on Aviation Liberalization country. when they present a reasonable pros• Several trends point, however, to a In August 1993, the National Com• pect for further.liberalization."10 The better environment for future liberal• mission to Ensure a Strong Competi• statement also advocated unrestricted ization of air services. National flag tive Airline Industry issued a report to Fifth Freedom Rights; the lifting of carriers are being privatized, albeit the U.S. President and Congress en• regulations on carrier pricing, flight very slowly. Some countries, Taiwan titled Change, Challenge and Compe• frequency, and flight capacity; the elim• and Singapore in particular, have tition. The report reiterated that "U.S. ination of government subsidies; and unilaterally liberalized air services to negotiating efforts [should] focus on reduced foreign investment barriers. 26

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The statement's focus on liberaliza• service to and from Taiwan. Another tion is counterbalanced, however, by a source of concern for the United focus on strategic issues. For example, States is that its recent bilateral dis• the statement notes that "We will putes with Japan are feeding a growing offer liberal agreements to a country desire by Tokyo to renegotiate the or group of countries if it can be justi• post-occupation aviation treaty. There fied economically or strategically" is mounting evidence that Japan may (emphasis added).31 In other words, a now be far less willing to maintain the liberal agreement will be offered only agreement merely to avoid damaging if the United States expects that its its larger relationship with the United airlines will gain. This strategic em• States. In May 1995, JAL's Vice Presi• phasis in U.S. policy is a mistake, as it dent for Corporate Planning an• Asian carriers have encourages other countries to also act nounced that JAL favored cancellation reason to be strategically and to agree on liberal of the Japan-U.S. bilateral treaty before nervous about aviation policies only when their initiating new negotiations.*2 American airlines also gain. Rather than a blue• A number of Asian governments competition print for international reform, the U.S. are, however, wary of the dangers of international aviation policy looks increased liberalization in Asian mar• like the nationalistic policy of one kets." Malaysian Transport Minister country. A major improvement over Dr. Ling Liong Sik has cautioned that the current U.S. policy would be the multilateralism cannot be imple• extension of liberalization offers to all mented in Asia until there are some countries on equal terms. experiments with more limited liber• alization. Akiyoshi Kitada, the Japa• Asian Views on Aviation Liberalization nese delegate to the 1994 Conference With the end of the Cold War and the of Director-Generals of Civil Aviation, ensuing shift in national priorities, has stressed that, although liberaliza• domestic economic concerns have tion could have some positive effects, come to the forefront of relations such as lower fares and more efficient between the United States and its airline management, it could also lead Pacific allies. The lessening of secu• to predatory pricing, a retreat from rity concerns resulting from the disso• low-demand routes, and a tendency lution of the Soviet Union and the toward oligopoly. The South Korean growth of Asian economies to rival government has indicated that it will those in the West have significantly not consider joining a multilateral altered the former patron-client nature regime until its airline industry can of bilateral relations between the compete effectively within such a United States and many countries in framework. Pressure in the Philippine the region and has given a number of Congress is also mounting for Manila Asian countries more flexibility in to renounce its bilateral agreement challenging long-standing arrange• with the United States. Viewed as ments with the United States. Two one-sided, it allows unlimited U.S. examples are Thailand's renunciation access to destinations in the Philip• of its bilateral aviation agreement pines and unrestricted U.S. Fifth Free• with the United States and the deci• dom Rights by October 1996 while sion of the Philippines to use the allowing Philippine Air Lines access airfield at the former U.S. military to only nine U.S. cities.34 base at Subic Bay to develop new air Discussions on multilateral liberal- 27

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ization at the November 1994 Interna• tional Civil Aviation Organization Europe's Multilateral Aviation Experiment (ICAO) conference on worldwide air A multilateral aviation arrangement has been developed in Western Eu• transport reinforced these views.35 The rope in tandem with the formation of the European Union (EU). Can this U.S. delegation proposed that member multilateral aviation experiment provide a model for the Asia-Pacific countries adopt a liberal multilateral airline industry? international aviation regime, known In 1993, the EU began to allow one country's airlines to pick up passen• as an "Open Skies" policy, but Japan gers in a second country and fly to a third country, i.e., to extend unlim• and most of the African countries, ited Fifth Freedom Rights within the EU to EU-based airlines. Limited with many Asian countries in agree• cabotage rights (the right of one EU country's airline to carry revenue ment, vigorously opposed the U.S. traffic between two cities within a second EU country) have also been proposal, arguing that there is a "need initiated and will expand further in 1997. In addition, EU airlines are now to rebalance the existing bilateral free to set fares unilaterally on intra-EU flights. Although change has been agreements before liberalizing fur• gradual, EU airlines are beginning to assert their new freedoms more ther."16 The United States impeded aggressively. The most significant move to date has been the start of Brit• progress on the issue through "its ish Airways service to Paris, Munich, Copenhagen, and Stockholm. Other insistence on arguing against the need European carriers, such as SAS and Lufthansa, arc following suit in unilat• for safeguards or a dispute resolution erally opening new routes. mechanism in a liberal regime—a The multilateral experiment is likely to affect the European civil avia• need recognized by virtually all mem• tion industry in a number of significant ways. Some mergers and acquisi• 17 ber states."- The result was a rejec• tions will no doubt follow as larger carriers seek to expand into markets tion of the Open Skies proposal. Par• previously closed to them. In other cases, the trend toward cooperative ticipating countries instead asked arrangements is likely to continue, particularly where carriers with rela• ICAO to "do additional work on a tively small home markets—KLM (Netherlands), SAS (Scandinavia), and number of issues and to focus on Swissair—can make use of strategic cooperation agreements to remain safeguards and safety nets against viable in the global network. Such alliances also serve to improve profit• unfair competition as a prerequisite to ability while safeguarding nationalistic identities. any liberalization of market access."* The transition to an open aviation market has been rocky, as red ink is The delegates concluded that a liberal still flowing at nearly all European airlines. In addition, only five of the 15 multilateral agreement is unlikely in largest European airlines have been privatized. A 1994 EU "Wise Men the near future and that "liberaliza• Committee" report on the European aviation industry recommended tion on a regional and subregional curtailing state aid to ailing national carriers and allowing competitive level is a more imminent prospect." forces to reorganize the industry in an efficient fashion. The state-owned The positions of Asian govern• carriers in France and Greece have pursued the alternative course of peti• ments at the ICAO conference reflect tioning for multibillion-dollar aid injections from their governments. The two obstacles to multilateral liberal• new subsidies (which are being contested in the European Court), as well ization. First, Asian airlines have gen• as recent attempts by the Italian and French governments to deny access erally been profitable, in part because to airports serving Paris and Milan, demonstrate that the transition to a of restrictive bilateral treaties. Be• competitive market in 1997 will continue to be difficult. cause many Asian carriers are still partially government-owned, govern• ments may be reluctant to adopt new ment in Europe (see box) has already ways, European governments have competitive arrangements that elimi• been hampered by government owner• shown great reluctance to proceed nate or reduce these profits. Enhanced ship of 10 of Europe's 15 largest carri• competition will reduce flag carriers' ers. As increased competition has re• " Reports on the potential for regional, subre• profits and possibly lead to layoffs or duced the profits of a number of Euro• gional, and global liberalization are due in 1996 from the Organisation for Economic Cooperation wage cuts at the government firms: pean flag carriers, including Air France, and Development and the United Nations Devel• The far-reaching liberalization experi• TAP Air Portugal, and Olympic Air• opment Fund. 28

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with the European Union's phased-in exchange data, and enhance safety and liberalization. A second obstacle cen• security. ters on enforcement. European coun• The region is already moving to• tries or airlines can appeal to the Euro• ward marked expansion of primary pean Court and the European Com• airport capacities (see box on pages mission if other countries are not 12-13} to alleviate the congestion on implementing Europe's aviation agree• many airline trunk routes in East Asia ment properly. Asia has no institu• and between Asia and North America. Satellite-based tions of even a remotely comparable Upgrading secondary gateways and. navigation systems scope. linking them directly to other second• can reduce the need In sum, an Asia-Pacific experiment ary gateways will be necessary to meet for additional with multilateral aviation arrange• the diversification and development investments in ments is unlikely to be implemented needs of the region's aviation market. anytime soon. The 1994 ICAO confer• Investments in airport capacity are runway capacity ence illustrates the difficulty of nego• not independent; expansion of facili• tiating more liberalized trade in nego• ties at one end of a route makes little tiations involving just one industry. difference if facilities at the other end Within such a framework, it is almost cannot handle additional traffic. The impossible to compensate losing value of airport investments in the countries whose national airlines will region can be maximized only if coun• shrink or even disappear in a liberal• tries coordinate their investments. To ized regime. Unless losing countries that end, APEC's Working Group on receive some compensation, they are Transportation has initiated a "Conges• unlikely to support such a regime. tion Points Study" designed to identify The next section discusses the neces• key congestion points, coordinate in• sity of bundling negotiations over the dustry roundtable discussions on the world aviation regime into the WTO issue, and discuss cooperative mecha• framework. We begin, however, by nisms for addressing bottlenecks.38 considering the role of APEC in coor• An alternative to additional invest• dinating other important aspects of air ment in tarmac would be to imple• services in the region. ment a satellite-based navigation system, such as the Future Air Navi• Asia-Pacific Economic Cooperation gation System (FANS), the Global (APEC) and Civil Aviation Positioning System (GPS), or the APEC has emerged in this decade as a Global Navigation Satellite System viable mechanism within which Asia- (GNSS)/ which precisely tracks air- Pacific governments can discuss eco• nomic policies" and could provide a * APEC's 18 member economies are the United suitable forum for the formulation and States, Canada New Zealand, Australia, South discussion of a menu of new policies Korea, Japan, Taiwan, China, Hong Kong, the for international cooperation in avia• Philippines, Thailand, Malaysia, Singapore, Indonesia, Brunei, Chile, Mexico, and Papua New tion throughout the Asia-Pacific re• Guinea. gion. APEC already has an active ' GPS is the only system currently in place. It is Working Group on Transportation, comprised of 24 satellites operating on six orbital which has been charged with studying planes at a height of 10,900 nautical miles. Other and recommending ways to improve countries have been hesitant to adopt GPS as it is a U.S. military system, and the U.S. military has infrastructure, facilitate movement of reserved rights to its use in certain circum• passengers and freight, collect and stances. EAST-WEST CENTER

craft locations in the air and on the tion. A solid report that evaluates the ground. By reducing the amount of effects, both positive and negative, of runway time required for an aircraft to multilateral liberalization could alert land or take off, these systems can policymakers to the potential gains reduce costs and increase runway from such cooperation. Ultimately, capacity, without jeopardizing safety. APEC could also provide a forum for Given the high land and capital costs negotiation of an aviation agreement. of expanding existing airports in urban Because the organization currently areas, adoption of a satellite naviga• lacks the institutional infrastructure tion system in the Asia-Pacific region for monitoring and enforcement, a is critical. The United States has regional agreement would need to decided to implement GPS as its create new mechanisms for such pur• prime navigation system by 1997, and poses or be structured as self-enforc• Australia, New Zealand, and the ing. Member countries have not yet South Pacific Islands are set to imple• been able to agree, however, on the ment FANS over the next year. How• future direction of APEC. In the short ever, most Asian governments are not run, therefore, the organization will yet committed to the rapid introduc• not have sufficiently developed en• tion of a satellite system. APEC's forcement and monitoring mecha• Working Group on Transportation nisms to be the vehicle for such a stands out as the best regional forum fundamental reform.

available for encouraging countries to At the 1994 APEC conference in implement a region-wide satellite Bogor, Indonesian delegates urged navigation system. individual APEC countries to develop Studying the gains from multilat• trade liberalization measures that eral liberalization in Asia-Pacific avia• could be implemented unilaterally. tion should also be high on the agenda Purging the U.S.-Japan aviation treaty of the Working Group on Transporta• of its outdated provisions could be a 30

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focus of U.S. unilateral measures. A similar strategy in Asia would First, Washington could eliminate the face the same questions. To date, no burdensome requirement that Japa• Open Skies treaties have been negoti• nese airlines must stop in San Fran• ated in Asia. In Europe, the larger cisco on Fifth Freedom flights to countries resisted liberalized service Europe. Second, Washington could agreements because their airlines have allow Japanese airlines to operate Fifth higher operating costs than those of Freedom flights from any U.S. interna• U.S. carriers. In the Asia-Pacific re• tional airport to any third country in gion, Japanese carriers tend to have Unilateral Europe, Central America, or South higher operating costs per tonne- liberalization America. Although such service can• kilometer available than U.S. carriers of Fifth Freedom not begin without the third country's (JAL = $.52 compared with American Rights would approval, a policy of unlimited Fifth Airlines = $ .39)." In an Asia-Pacific Freedom Rights to Japanese carriers aviation market in which carriers are impose few costs would be more consistent with the free to enter and exit and to set prices, on U.S. airlines U.S. policy of encouraging competi• Japanese carriers could suffer major tion on international routes. These losses in market shares and are likely unilateral liberalizations of Fifth to continue to oppose such Open Skies Freedom Rights would impose few arrangements/ costs on U.S. airlines but would help It is possible that the United States to create a level playing field for Japa• will follow the pattern set in Europe nese airlines. and negotiate Open Skies treaties with smaller Asian countries, in particular From Restricted Bilateral to Open Singapore. In this scenario, China, Skies Arrangements? Japan, and some ASEAN countries The first Open Skies aviation agree• would probably resist U.S. pressure to ment was signed by the Netherlands liberalize and continue with the cur• and the United States in September rent system of restricted bilateral 1992. It allows for deregulation of agreements. Until air-service negotia• pricing and route capacity, expanded tions can be structured to provide route flexibility, Fifth Freedom opera• compensation to losing countries, tions, a double-disapproval fare struc• liberalization of air service in Asia is ture (which allows a fare to be offered likely to continue to be negotiated on unless both governments veto it), a country-by-country basis. Providing code-sharing opportunities, and en• compensation may best be achieved hanced access to computerized reser• by linking air-service negotiations vation systems.* In 1995, the United with other trade negotiations. Coun• States signed Open Skies agreements tries that lose under a liberalized air- with nine other small European coun• service regime could then be provided tries, thereby greatly expanding U.S. with concessions on other trade is• airlines' access to the European mar• sues. As discussed below, the best ket and placing pressure on the larger forum for this type of "linkage" may European states to reconsider their air policies. Whether or not traffic diver• sion to Open Skies countries will force * Although the agreement breaks new ground in them to reconsider their bilateral permitting "the greatest flexibility" for airlines to agreements with the United States is do business, it also contains several conditions. still an open question. For example, access is limited to several major U.S. airports. 31

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be the trade negotiations conducted Asia-Pacific Aviation and the WTO under the auspices of the World Trade The Uruguay Round of the GATT Organization (WTO). negotiations (concluded in December Asian opposition to U.S. Open 1993) achieved significant reductions Skies proposals has, however, not in tariff and nontariff barriers to stopped three countries—Thailand, trade." The new WTO Agreement Malaysia, and Indonesia—from enter• achieved significant breakthroughs, ing into a memorandum of under• including major reductions in tariff standing to set up Asia-Pacific's first and nontariff barriers to trade, new multilateral aviation.regime in the rules for trade-related intellectual "Growth Triangle" districts of each property, and a widening of WTO's country. The Growth Triangle encom• scope to include trade in some ser• passes Southern Thailand, the Malay• vices. International air services were, sian peninsula, and Sumatra. Each however, specifically excluded from country has designated three cities the new WTO provisions and will from which two airlines from each continue to be regulated (outside of country can start air service. No Fifth Europe) by bilateral aviation agree• Freedom or cabotage flights are cur• ments. In addition, the Uruguay rently allowed.40 Whereas the Growth Round did not address the issue of Triangle Pact is a multilateral venture, closed domestic aviation markets. its provisions are still relatively re• With the exception of New Zealand, strictive and represent only a small all domestic markets in the Asia- step forward from traditional bilateral Pacific region, including the large pacts. U.S., Japanese, and Chinese markets, The Growth Triangle pact raises are closed to participation by foreign the possibility that liberalization of carriers.1 aviation.service may occur via a pro• Despite government protests to the liferation of small, multilateral avia• contrary, nothing in the economic tion agreements within: Asia. Since structure or organization of the inter• some countries' opposition to liberal• national airline industry warrants the ization stems from a fear of domina• protection of domestic airlines in tion by U.S. carriers, the pact could be Some countries' either international or domestic mar• a harbinger of regional multilateral kets. Economic theory provides no opposition to aviation agreements that do not in• justification for excluding air passen• liberalization stems clude the United States. Such pacts ger services from a future WTO agree• from a fear of will be difficult to negotiate, however, ment.' domination by U.S. because cost differences among Asian carriers airlines would produce the same problems as a pact that includes the " GATT is the General Agreement on Tariffs and Trade. The GATT Secretariat is being replaced in United States. Unless a method of 1995 by a new organization, the World Trade compensating losing countries is Organization |WTO).

devised, liberal regional aviation 1 Most countries allow limited foreign investment agreements in Asia will not be viable. in domestic carriers, but do not allow foreigners to In sum, a regional multilateral avia• own a controlling share in the country's carriers. tion pact, with or without the United * This analysis draws heavily from the discussion States, is unlikely to be implemented in Kasper (1988) despite the different conclusions drawn in this paper concerning the feasibility of in the near future. including airline services in a future WTO agree• ment. 32

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Although the policy distance from ing this issue, although China is the current protectionist bilateral allowing limited foreign investment in regime to an open worldwide multi• its airlines. Unless large countries lateral regime is clearly enormous, the begin to consider opening their domes• Uruguay Round dismantled a protec• tic markets to foreign carriers, objec• Economic theory tionist trading system of equal com• tions to international liberalization provides no plexity and political sensitivity—the abound. If there are "economies of justification for Multifibre Agreement regulating trade scope" with respect to domestic ser• excluding air in textiles. Given that the conclusion vice and international service, i.e., if of the next round of WTO trade nego• the cost of providing international passenger services tiations is at least 10 years away, there service falls as more domestic service from future World is sufficient time for policymakers and is produced, then airlines from large Trade Organization industry analysts to consider the countries with closed markets will agreements general framework within which the have cost advantages on international principles of the WTO could be routes. applied to civil aviation; for interested National security concerns over parties to formulate and critique access by foreign airlines to domestic specific policy proposals; for the aviation markets are usually cited as media to publicize the proposals and the rationale behind the ban. Most to alert the public of the potential for countries want to maintain sufficient lower prices and expanded interna• capacity in domestically owned air• tional air service; and for international lines to ensure airlift capacity during a civil aviation organizations, airlines, civil or military emergency. Such and governments to make prepara• security concerns, although obviously tions for policy implementation. A vital, can be addressed with relatively WTO resolution on the current straightforward policy measures. First, protectionist air traffic regime should a country's government could require be grounded in the fundamental foreign airlines to register a fixed principles of the WTO: opening of percentage of their planes in that domestic markets, transparency, country. These planes could be requi• tariffication, and nondiscrimination in sitioned in an emergency. Second, few trade. governments have treaty commit• ments that require long-haul capabil• Opening of Domestic Markets In its ity to send troops overseas. Most report, the U.S. National Commission countries with treaty obligations, such was enthusiastic about U.S. entry into as the industrialized democracies, are new multilateral international air likely to retain significant domestic service arrangements.41 The report is, capacity even if foreign carriers sig• however, noticeably silent as to nificantly penetrate the market. As whether the recommendation applies long as domestic carriers are not to the huge U.S. domestic market. In reduced to a trivial market share, November 1994, the U.S. Department enough domestic capacity is likely to of Transportation issued a policy paper be retained to fulfill military obliga• on international air transportation, tions. For example, the U.S. airlift of which contained no proposals for troops to Saudi Arabia during the Gulf opening the closed U.S. market.42 War required only a fraction of the China and Japan are also not discuss• U.S. air-passenger capacity. 33

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Asia-Pacific airlines are More important, a country may not parency, the WTO stresses the conver• expected to provide an be pleased if an airline from an un• sion of nontariff trade barriers into important market for friendly country attains a substantial tariff barriers.* Once nontariff barriers Boeing's 777, the world's share of its aviation market. This to trade have been converted into newest jumbo jet. consideration could, however, be tariffs, negotiations between countries overcome by regularly reviewing the concerning the reciprocal reduction of licenses of airlines allowed to fly tariff barriers can proceed under the domestic routes. Airlines from un• WTO framework. friendly countries would be decertified Trade barriers in aviation are or more intensely regulated. Citizen• clearly not characterized by transpar• ship requirements for all employees, ency. Whereas the bilateral system of with the exception of senior manage• aviation agreements is relatively easy ment, of foreign service corporations to understand, the treaty system (banking, insurance, etc.) would also obscures the way in which restrictive help to alleviate security concerns.

* Measuring the effective rate of protection is Transparency and Tarif f ication A still a problem whenever tariffs cover intermedi• ate goods and raw materials. Nonetheless, it is central principle of the WTO process easier to measure the cost of a tariff barrier than is transparencv. To encourage trans• the cost of a nontariff harrier 34

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arrangements affect airline prices. National Treatment For tariffication Such effects would become immedi• to be successful, governments must be ately apparent if countries had to held to the WTO principles of nondis• impose tariffs to prevent foreign pen• crimination and national treatment in etration of air-service markets. There the airline industry. These two prin• is no reason why quotas in civil avia• ciples assert that two firms from tion could not be converted into tariffs different foreign countries will receive on the price charged to ticket holders the same treatment from a govern• on foreign airlines. The tariffs could be ment and that a foreign firm will set as a percentage of the ticket price receive the same treatment from the or the cargo value. government as a domestic firm. The The switch from a system of nego• two principles are particularly impor• tiated, limited-access quotas to open- tant in the aviation industry because Asia-Pacific access tariffs is important primarily air service requires not only permis• commercial because it would set the stage for the sion to fly to a country but also ar• aviation will likely transition to a free market in aviation rangements to use complementary services.. First, it would allow a ceiling services at the country's airports. remain a mix of to.be placed on market imperfections. The need for guarantees of national transnational In many other, industries, govern- . treatment is best illustrated by the agreements"'. rrients have agreed that they will not problem of foreign airline access to raise tariffs but will only consider domestic' airports. Many Asia-Pacific reducing them. Converting restric• airports are already near capacity, and tions in airline markets into tariffs others reach capacity during peak and then binding the tariff structure operating hours. Thus, lower tariffs would, constitute an important first would not necessarily increase the step toward free trade in airline ser• number of flights to a country because vices and set a foundation for future its airports could not handle the addi• negotiations. tional capacity. Governments could Second, setting tariffs on airline take the path of deregulating interna• services would allow these services to tional air service but continue to use be bundled with other goods and mechanisms to allocate landing and services in WTO negotiations. This is take-off slots that favor domestic important, as some countries' airline firms, i.e., grandfathered allocations of industries will lose when the air- slots. service market is liberalized. When Of course, nondiscriminatory slot the airline industry is grouped with allocation mechanisms do exist. Air• other industries in trade negotiations, port authorities could, for example, however, losses in one industry may allocate landing slots at airports by be outweighed by gains-in other indus• auction. An auction would ensure that tries. Daniel Kasper has correctly airlines offering the most desirable noted that this negotiating framework price/quality combination to consum• rewards countries with extensive ers would be awarded the slot. This trade barriers, as the barriers are con• would provide additional incentives verted into valuable bargaining for domestic and foreign airlines to chips.43 Nonetheless, the process also lower operating costs and to offer a provides a feasible mechanism for competitive product mix. Moreover, moving toward a free-trade regime. the amount of revenue raised from 35

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slot auctions would provide a signal free trade is usually superior to pro• costly duplication of regional hub concerning the value of additional tected trade, it also generates losers. facilities airport capacity. Whatever the merits Until a method is devised for compen• • Regional implementation of the of the auction allocation system, sating the losers, Open Skies proposals FANS or GPS satellite navigation WTO must ensure that the slot alloca• are unlikely to fly. An objective and system, thereby saving national tion mechanism is compatible with in-depth analysis of the impact of an governments billions of dollars national treatment and nondiscrimi• Open Skies regime on the airlines of nation so that restrictive slot alloca• developing countries is critically * Regional implementation of auc• tion mechanisms do not merely re• needed before such proposals are tions to allocate airport landing and place the current restrictive system of likely to be considered seriously. takeoff slots during peak times bilateral treaties. In the near term, it is likely that • Regional price-entry deregulation. Asia-Pacific commercial aviation will remain a somewhat turbulent mix of Two reports on global liberalization are due in 1996 from the Organisation CONCLUSION transnational agreements and ultrana- tional confrontations. With fair and for Economic Cooperation and Devel• This report has provided an overview effective international leadership, opment (OECD) and the United Na• of the current status of aviation in the however, we believe that mutually tions Development Programme Asia-Pacific region, analyzed the beneficial negotiation of an Open (UNDP). APEC should use these political and economic issues behind Skies regime, most probably through reports as a foundation for further, the region's increasingly numerous WTO trade negotiations, is ultimately more detailed research on the feasibil• aviation disputes, and discussed the possible. ity of a more liberal aviation regime in potential for regional cooperation in In preparing for the future, it would the Asia-Pacific region. developing a new institutional frame• be wise to learn from the lessons of 2. Asian governments should con• work for the region's air passenger the past. The history of the U.S. air• tinue to privatize national flag carriers industry. Our research shows that, line industry clearly demonstrates to facilitate lower-cost airline opera• over the past two decades, high rates that deregulation of fares and routes tions and enhanced access to interna• of economic growth in Asia have does not mean the end of government tional capital markets. Until airlines spurred the rapid expansion of com• involvement. Even in a deregulated are under private ownership, a liberal mercial aviation industries servicing multilateral aviation regime, many aviation regime cannot succeed in the the region. Many Asia-Pacific coun• governments will continue to provide region. tries have benefited from this boom, airport infrastructure, allocate airport 3. Researchers in the aviation but the continued expansion is now slots and routes, review mergers, industry, academia, and government leading to the breakdown of the frame• scrutinize foreign ownership applica• should develop detailed proposals for work of bilateral agreements that have tions, and set and enforce safety regu• including airline services in the next governed Asia-Pacific aviation since lations. Price-entry deregulation can• WTO agreement. the end of World War II. Expansion in not fully succeed unless it is coupled The clear challenge for both the the number of passengers, airlines, with'appropriate government policies airline industry and governments in and routes has stimulated competition and adequate infrastructure invest• the Asia-Pacific region is to recognize and intensified aviation disputes, ments. the proper role for each party and thereby increasing tensions in the Our analysis leads to three specific thereby facilitate an efficient and international relations of the region. policy recommendations that stem ongoing response to changing passen• Potentially, such tensions could fuel from this recognition of the continued ger demands, new technologies, and increased protectionism. role of government in the aviation increasing competition. Proponents of an Open Skies policy industry. argue that liberalization of the current 1. APEC should act to facilitate: system would produce even greater • Regional coordination of infrastruc• economic benefits. However, whereas ture investment, thereby avoiding ENDNOTES 31. U.S. Department of Transportation (1995: 21845).

1. ICAO (1994b). 32. JAL: Cancel U.S. bilateral. Airline Business (June 1995: 12). 2. ICAO (1994c). 33. Asia puts up resistance to U.S. version of 3. ICAO (1986:3). airline liberalization. Bangkok Post (10 October 4. Naya(1994). 1994:x).

5. Hansen and Gerstein (1991). 34. Asia close to united front. Airline Business (November 1994: 18). 6. South Asia is excluded from these data. Mak (1993); World Tourism Organization (1993). 35. ICAO delegates shun U.S. free-market stance. Aviation Week e) Space Technology (2 January 7. Japan Airlines and ANA post losses for year. 1995:37-38). Asian WallStreet Journal (1 June 1994: 1). 36. Coming clean aeropolitics. Airline Business 8. See Borenstein (1992) for a lucid discussion of (March 1995:31). changes in the U.S. airline industry. 37: Coming clean aeropolitics. Airline Business 9. Clinton to focus on helping U.S. airlines. New (March 1995:31). Also see Windle (1991). York Times (25 December 1992: CI). 38. Windmuller (1994: 5-7). 10. Findlay and Forsyth (1992); Kasper (1988). 39. Doganis(1991: 129). 11. More skies to open as U.S. signs pacts. Avia• tion Week eO Space Technology 5 (October 1992: 40. Three points to open Asia. Airline Business 35). (December 1994: 18).

12. More skies to open as U.S. signs pacts. Avia• 41. National Commission (1993: 20-23). tion Week ed Space Technology 5 (October 1992: 42. U.S. Department of Transportation (1995). 35). 43. Kasper (1988: 97-100). 13. ATAG (1992).

14. Aircraft firms urged to look to Asia for future growth. Journal of Commerce[6 May 1993: 2B).

15. ATAG (1992).

16. Uhalley (1994).

17. Grimm and Milloy (1993).

18. Doganis(1991: 133).

19. Williamson (1985).

20. Caves, Christensen, and Tretheway (1984); Tretheway (1990).

21. Gillen. Oum, and Tretheway (1986).

22. Tretheway (1990:360); also see Pustau (1992).

23. The fifth dimension. Airline Business (De• cember 1994: 22-26)..

24. See Alexander (1994) for a more extensive discussion of U.S.-Japan aviation issues.

25. National Commission (1993:136).

26. Taneja(1988: 136).

27. Flighty ideas: Air travelers pay political price. Far Eastern Economic Review (1 September 1994: 5)

28. National Commission (1993: 22).

29. National Commission (1993: 22-23).

30. U.S. Department of Transportation (1995: 21843). 37

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AVAILABLE EAST-WEST CENTER SPECIAL REPORTS

No. 3 Democratic Transition in Asia: The Role of the International Commu• nity, by Muthiah Alagappa. October 1994. 35 pp.

No. 2 Porpoises Among the Whales: Small Navies in Asia and the Pacific, by Joseph R. Morgan. March 1994. 48 pp.

No. r Intruding on the Hermit: Glimpses of North Korea, by Bradley K. Martin. July 1993. 31 pp.

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No. 23 "The Rise of Global Intellectual Property Rights and Their Impact on Asia," by Sumner J. La Croix. August 1995. 8 pp.

No. 22 "Indonesia in the 1990s: More than Meets the Eye," by Adam Schwarz. July 1995.8 pp.

No. 21 "Memory Wars: The Politics of Remembering the Asia-Pacific War," by Geoffrey M. White. July ^95. 8 pp.

No. 20 "Pacific Transitions: Population and Change in Island Societies," by Peter Pirie. July 199s. 8 pp.

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No. 11 "UN Peacekeeping Missions: The Lessons from Cambodia," by Judy L. Ledgerwood. March 1994. 10 pp.

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