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A Transaction Cost Analysis of Scheduled international Air Transport of Passengers

Ravoo, M.

Publication date 2000 Document Version Final published version

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Citation for published version (APA): Ravoo, M. (2000). A Transaction Cost Analysis of Scheduled international Air Transport of Passengers. Universiteit van Amsterdam.

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Download date:10 Oct 2021 AA TRANSACTION COST ANALYSIS OFF SCHEDULED INTERNATIONALL AIR TRANSPORT OFF PASSENGERS I I

MONIQUEE RAVOO AA TRANSACTION COST ANALYSIS OFF SCHEDULED INTERNATIONAL AIRR TRANSPORT OF PASSENGERS S 1 1 AA TRANSACTION COST ANALYSIS OFF SCHEDULED INTERNATIONAL AIRR TRANSPORT OF PASSENGERS S

ACADEMISCHH PROEFSCHRIFT terr verkrijging van de graad van doctor aann de Universiteit van Amsterdam opp gezag van de Rector Magnificus prof.. dr J.J.M. Franse tenn overstaan van een door het college voor promoties ingestelde commissie,, in het openbaar te verdedigen in de Aula der Universiteit opp woensdag 25 oktober 2000, te 12.00 uur doorr Monique Ravoo geborenn te Amsterdam Promotorr prof. dr A. Heertje

Co-promotor:: prof. drs J.B. Polak, emeritus

Faculteit:: Economische wetenschappen en econometrie

Preface e

Too many people, air transport resembles the world of Peter Stuyvesant: glamorous, adventurous and tingedd wim danger. Even if environmental damage and a number of accidents have somewhat changed matt image, air transport still has a trace of the spectacular. The image confirms the idea that 'the pleasuree of travelling is in the journey.' Travellingg inside, as you do when writing a doctoral thesis, indeed generates pleasure but also pain: thee 'pain' of tracking down «formation, clarifying key questions, developing a model, refining knowledgee of fundamental economics, working hours on end, rethinking, rewriting, checking, editing...and,, finally, seeing light at the end of the tunnel but not seeing it come closer. Even worse, beingg m the light for a short while, only to discover that there is another tunnel ahead. When I began mis thesiss more than five years ago, I could never have imagined what lay ahead of me.

Whyy would anybody m their right minds embark on a thesis, you may ask? Well, because there is also pleasuree ahead. Finding that pleasure requires a strong interest in the subject of investigation. Speaking forr myself, this was certamry the case, wfth a job at Schiphol at the time and a father who had worked theree since I was two years old. To my first memories belong walking with my dad in the Amsterdam woodss and finishing our walk drinking a cup of cocoa at parking lot P3. Who would have thought thenn ? Writingg a thesis gives pleasure when assumptions are confirmed, new thoughts spring to mind, the scopee for improvement becomes clear, or a line of reasoning appears sound: the 'aha erlebnis'. The journeyy has taken me more than five years. It has both cost me and given me a lot. Now uiat me journey hass ended, I'm glad mat it's over.

Theree are many people who have in one way or another helped me to continue my trip. I am indebted to myy supervisors, Professor Heertje and Professor Polak, for providing me with the inspiration needed to conductt research. They were able to extract the best from me through a unique combination of knowledge,, character and incentives. I also wish to mention Professor Wassenbergh, the well-known professorr of air law at Leyden University, who showed me and my fellow students some years ago how challengingg a course in air law could be. And how you should not proceed from 'what is' but be willing too turn your mind to 'what can be'! The term 'lege fèrenda' should sound familiar to all those who have hadd die opportunity to attend his classes. Thanks are due to my 'paranimfen' - Jacques, who read a lot aboutt what his job implied but didn't fail to act upon k, and Rene, who was busy developing his businesss but always found time to give advice on a whole range of matters - and bom their wives, Dady andd long-time friend Sandra. Jan-Willem, explained a lot to me about the publishing business and was alwayss willing to talk about it over dinner somewhere.

-i-- Family,, friends and colleagues, especially my former employer, Schiphol Group, did not always understandd what I was doing (and why I didn't do all the things a young woman is supposed to do), but sometimess provided great insight into my motives for writing a thesis. Their opinions helped me grow duringg my research. II certainly need to mention Ivette at this point, who was able with bottomless energy and insurmountablee logic to point out the not so logical parts of both my English and my reasoning. Often, thee solution to our discussion was to delete a sentence. We became masters at leaving things out, notwithstandingg that the book has still reached more than 200 pages! AWiough it may have seemed as if II did not like our discussions, this may have been due more to frustration on my side than anything else. Again,, I learnt a lot. Lastt but not least, I am greatly indebted to Jan, who facilitated and supported the journey in many ways.. Words fail me here. It's good to know that we have some real travel ahead of us.

Moniquee Ravoo Amstelveen,, September 2000

-11 1 Contents s

Preface e l l Tablee of abbreviations and acronyms vii i

P«fe e Chapterr I Introducbon n

1.11 - Objective of the thesis 1.22 -Context of the thesis 1.33 - Central questions 1.44 -Methodology 1.55 - Scope of the thesis 1.66 -Organisation of the diesis

Chapterr II Transactionss and transaction cost .n»tv<^

2.11 - Introduction 9 9 2.22 Transactions 9 9 2.33 - Transaction costs 12 2 2.44 - Factors influencing transaction 15 5 2.4.11 -Frequency 15 5 2.4.22 - Uncertainty 17 7 2.4.33 - Asset specifiry 19 9 2.4.44 - Bounded rationality 21 1 2.4.55 - Opportunism 22 2 2.55 - Effectiveness 27 7 2.66 Industry environment 31 1 2.77 - Governance structures 31 1 2.7.11 - Non-specific structure 31 1 2.7.22 - Semi-specific structure 32 2 2.7.33 - Transaction-specific structure 33 3 2.7.3.11 -General comment 33 3 2.7.3.2-Thee 6nn 34 4 2.7.3.33 -TheState 35 5 2.88 - Concluding remarks 40 0

Chapterr m- Thee Bilateral stmchms

3.11 n 42 2 3.2-Bilateralism m 45 5 3.3-Partiess to the transaction 50 0 3.3.1-States s 50 0 3.3.1.1-- Psychological goal 51 1 3.3.1.22 - Financial goal 52 2 3.3.1.3-Politicall and social goal 54 4 3.3.1.44 - Implementation of the air transport goal in the Bilateral structure 56 6 3.3.1.4.11 - Traffic votume 57 7 3.3.1.4.22 * Fleet composition 57 7 3.3.1,4.3-Markett behaviour 58 8 3.3.1.55 - Interstate relations 59 9 3.3.22 - Airlines 59 9 3.3.33 - Airports 64 4 3.3.4-Internationall organisations 69 9 3.44 - The object of the exchange and property rights 71 1 3.5-Thee transaction process 75 3.5.11 -Contact phase 75 3.5.22 - Contract phase 76 6 3.5.33 n phase 78 8 3.5.44 - Compliance and enforcement 80 0 3.66 - Characterization of the Bilateral structure 83 3 3.77 - Further developments g4

Chapterr IV- The Community structure

4.1'Introductionn 37 4.22 - European integration, EC Treaty and air transport 89 9 4.33 - European air transport packages 95 5 4.44 - Current Community structure 95 4.55 - Parties to the transaction 99 4.5.1-- EC Commission 99 9 4.5.22 - EC Council of Ministers 100 0 4.5.33 - EC Parliament 102 2 4.5.4-ECCourts s 102 2 4.5.55 - Objectives of the EC institutions 104 4.5.66 - Member States 105 5 4.5.6.11 - General remarks 105 5 4.5.6.22 - Implementation of the air transport goal in the Community structure 109 4.5.6.2.11 - Traffic volume 109 9 4.5.6.2.22 - Fleet composition 109 9 4.5.6.2.33 - Market behaviour 109 9 4.5.6.33 - Interstate relations 110 0 4.5.77 - Community carriers U2 4.5.88 - Community airports U5 4.5.99 - International organisations Hg 4.66 - The object of the exchange and property rights 119 4.77 - The transaction process 120 4.7.1-Contactt phase 120 4.7.22 - Contract phase 120 4.7.33 - Execution phase 126 4.7.4-- Compliance and enforcement 128 4.88 - Characterization of the Community structure 130 4.99 - Further developments 131

Chapterr V - Comparison of the Bilateral «id Cmnmmiiiv structures

5.1-Introductionn 133 5.22 -Characteristics of and trends the air transport industry 134 5.2.1-Internationall nature 134 5.2.22 - Co-operation 134 5.2.33 - State intervention and deregulation 13g 5.2.44 - Industry environment 139 5.2.55 - New market players 141 1 5.33 - Core dimensions 141 1 5.44 - Features of the Bilateral structure 143 5.5-- Effectiveness of die Bilateral structure 145 5.66 -Transaction cost efficiency of the Bilateral structure 147 5.6.11 - Transaction frequency 147 5.6.22 - Uncertainty 149 5.6.33 - Asset specificity 151 5.6.44 - Opportunism 153 5.77 - Features of the Community governance structure 158 5.88 - Effectiveness of the Community structure 160 5.99 -Transaction cost efficiency of the Community stmcture 163 5.9.11 - Transaction frequency 163 5.9.2-Uncertaintyy t64 5.9.33 - Asset specificity 167 5.9.44 - Opportunism 168 5.100 -Optimal governance structure 175

Chapterr VI Kmnm«rv .M coremskms

6.11 n 182 6.22 -Summary of the model 184 6.3-Summaryy of findings 185 6.44 - Recommendations and suggestions for improvement 186 6.4.11 - Suggestions for improvement fromm e perspective of the state ass member of the Community 186 6.4.1.1-Effectivenesss 186 6.4.1.2-Transactionn cost efficiency 190 6.4.22 - Suggestions for improvement from a state-industry perspective 190 6.4.2.11 - Effectiveness 190 6.4.2.22 - Transaction cost efficiency 191 6.55 Evaluation 192

Summaryy in Dutch ] 95 Literaturee and references 202 Epiloguee 217 Indexx 220

Tablee of abbreviations and acronyms

ACII - Aiiports Council International A£AA - Association of European Airlines AWBB -the Dutch General Law on Administrative Procedures BNCC - Working Group for the assessment of new Commission Proposals CAAA - Dutch Civil Aviation Air Transport Division CABB - Civil Aeronautics Board CMLRR - Common Market Law Review CoCoo - Inter-ministerial Co-ordination Committee for European Integration and Assoc^^ COCOHANN - High Level Co-ordination Committee COMM - Commission document Commissionn - The Commission of the European Community COREPERR - The Committee of Permanent Representatives Councill -The Council of Ministers of the European Community CRSS - Computerised Reservation System DOTT - Department of Transport (United States) ECC - European Community ECAC-- European Civil Aviation Conference ECOFINN - The Council of Economic and Finance Ministers of the European Community ECRR - Official report of cases before the European Court of Justice in English EEAA - European Economic Area EFTAA - European Free Trade Association EUU - European Union FAAA - Federal Aviation Authorities GATSS - General Agreement on Tariffs and Trade IATAA - International Airlines Association D3VV - Integrale Beleidsvisie ICAOO - International Civil Aviation Organization ICERR - Interdepartmental Subcommittee on European law JJ AA - Joint Aviation Authorities JARR - Joint Aviation requirements KEPDD - Key Environmental Planning Decision OJJ - Official Journal of die European Communities PASOO - Plan van Aanpak Schiphol en Omgeving REIAA - Council for European and International Affairs SEAA - Single European Act SIDD - Standard Instrument Departure TACISS - Technical Assistance forme Commonwealth of Independent States TENN - Trans-European Network TEUU - Treaty on European Union VROMM - Ministry of Housing, Regional Development and die Environment WTO-Worldd Trade Organisation

-vu--

Chapterr 1 - Introduction

1.1-- Objective of the thesis Thiss thesis aims to examine and analyse the governance of international passenger air transport.. Such governance may take place via one of two alternative structures, namely the traditionall Bilateral structure and the structure that applies within the European Community', alsoo known as the 'Community structure*2. More specifically, the objective is to examine: 1) thee ability of the state to realise certain policy goals in the field of air transport and 2) the transactionn costs which are incurred in that process under each of the two structures. The primaryy focus will be on the Netherlands. Given the reality that the Netherlands are a Member Statee of the European Community, a secondary objective is to investigate possible ways of improvingg the current Community structure. The investigation adapts the theory of transaction costs,, developed by Coase among others, and applies it to the Dutch air transport system. The transactionn that is analysed is the exchange between states of certain rights 1) to enter a foreign airr transport market, 2) to use the airspace to transport people to and from that market and 3) too capture the benefits from such use. These rights will also be referred to as 'air transport rights'. rights'.

1.22 - Context of the thesis Thee transaction (i.e. exchange) process covers the preparation, conclusion and execution of transactionss and leads to a claim on productive resources. This claim is referred to as 'transactionn costs*. The level of transaction costs varies with the governance structure within whichh the transaction occurs. This structure may be defined as 'the institutionalised matrix in whichwhich transactions are being negotiated and executed' (Williamson, 1986: 105). It is thus formedd by the total of rules and institutions that govern the transaction process. A governance structuree may give parties to a transaction the wrong incentives, or the structure may be too inflexiblee to govern the transaction adequately, thus generating transaction costs and necessitatingg an alternative way of governing the transaction. Modelling the governance structuree as an endogenous variable is an integral part of transaction cost economics as its

11 The European Community (or: 'EC') is based an the Treaty of Rome of 1957 ('EC Treaty'). The EC comprisess the EEC, Euratom and ECSC and acquired the name'European Coninmiihy'ibllowing the Treaty onn European Union ('Maastricht Treaty') of February 1992 (entered into forceo n 1 November 1993). The Europeann Union (or 'EU*) consists of the European Conumimty, augmented by the fields tf affairss and a common foreign and security policy. Since the European Gmniiunily, but not the European Union,, possesses legal personality, this thesis uses the tenn'EC'to ktaMify the eruity that enacts legislation, to addition,, articles trom the EC Treaty are referred to by the lumbers applicable situs fe Treatyy of Amsterdam in May 1999 (treaty agreed on 2 October 1997, approved for the Netherlands by law of 24 Decemberr 1998, STB 737). Where necessary thee original numbers will be footnoted.

1 1 purposee is to analyse governance structures from the perspective of finding efficient combinationss of governance structures and transactions. Efficiency in this context is looked at fromfrom the perspective of transaction costs, in the sense that an efficient governance structure minimisess those costs. This notion of efficiency will be referred to as 'transaction cost efficiency'.. The definition ignores efficiency of the production process, which reflects the level off production costs associated with the transaction. In a standard transaction cost analysis, transactionn cost efficiency is the sole criterion used to differentiate governance structures. The modell developed below extends existing theory by explicitly introducing a second criterion, namelyy the ability of a governance structure to realise the objectives of transacting parties. Suchh objectives underlie any transaction but are usually not explicitly taken into account. A traditionall objective pursued by the individual is utility maximisation, while the state is often seenn as a social welfare maximiser. The ability of a governance structure to attain given objectivess will be called its 'effectiveness*. More specifically, the definition captures the extent too which certain policies and instruments enable the parties to realise their objectives. The transactionn cost efficiency and effectiveness of a governance structure may interact in the sense thatt a higher effectiveness can imply higher transaction costs and vice versa. For example, a policymakerr may choose to spend more time gathering information on the reputation of a servicee provider, thus increasing the chance of a high quality service. In doing so, the policymakerr may incur transaction costs. Conversely, the policymaker may opt to refrain from informationn gathering and select the service provider on the basis of general information, therebyy running a greater risk of a low quality service. A policymaker may thus have to make a trade-offf between efficiency and effectiveness in choosing the optimal structure. Thee thesis focuses on air transport and, in particular, on the exchange of air transport rights. Thee state makes use of airlines and airports to execute these rights. Although not in line with standardd literature, in what follows, these industry players together will be referred to as the 'airr transport industry' to capture the idea that air transport services as well as airport services aree an essential part of the execution of air transport rights. At present, the air transport industryy is in turmoil and transition. Whereas it used to be tightly regulated, in recent years the trendd has been towards liberalisation. This is manifest in greater freedom of market access and operation,, which is in turn reflected in such factors as growing market instability, the formation off alliances and the development of transport networks. For many states in Western Europe, liberalisationn is occurring in the context of the more general economic integration pursued withinn the Economic Community. Transport developments as well as general economic integrationn have required transacting states to revise their positions. In Western Europe, one

Thee 'Community structure' is used to refer toth e structure governing die exchange «fair transput right* betweenn EC member states. The structure coiop^ otherr rules and institutions governing such exchange. 33 The term usually refers to the airline sector. 2 2 importantt consequence of the move towards liberalisation has been a radical transformation of thee structure governing economic exchange. This has had major implications for the states' abilityy to realise certain air transport objectives. There are some good reasons for studying governancee structures in the transport sector. Transport is seen as a facilitator of integration andd a transport sector that functions well stimulates general economic development. Transport cann also help attain social objectives such as the development of regions that are lagging behind.. These functions make it important to know how well a governance structure performs inn the transport sector. Moreover, transport is becoming more important because the trend towardss globalisation is stimulating demand for the transport of persons and goods. The developmentt of transport is enhanced further by the increased modularisation of the production process,, whereby separate modules are produced where production costs are lowest. The relativee importance of air transport as a mode of transport has grown (Schipper, 1999: 1). At thee same time air transport contributes to environmental pollution. Twoo structures are of primary relevance to this thesis, namely the Bilateral structure, which governss most exchanges of air transport rights, and the Community structure, which governs exchangess of those rights within the European Community. The two structures are built on entirelyy different foundations. The Bilateral structure proceeds from sovereignty and equality. Thee states hold the property rights to the airspace above their territory. Agreements on the use off airspace are concluded between two states, each regarded as sovereign and equal to the otherr in status. Every agreement is formulated as an international treaty and, in line with the principlee of sovereignty, there is no supranational authority. Relationships are very important too the content of the transaction. A central feature of Bilateralism is that the market is closed andd not opened up until a transaction is concluded, and a carrier is designated by the state to operatee the air transport service. The state holds substantial ownership and effective control withh respect to the carrier. In contrast, the Community structure is based on a multiparty agreementt and Community legislation as well as case law have limited the sovereignty of states.. The transaction process and rules are standardised and there is a supranational dispute resolutionn mechanism. The air transport rights are largely delegated to industry players and airliness are subject to a Community ownership and control requirement.

Thee above description shows that more than two parties participate in the exchange of air transportt rights. Although states are the only parties authorised to implement every phase of thee transaction, they use airlines and airports to exercise those rights. These parties are usually privatee entities rather than part of the government administration. In economics, agency theory iss used to discuss the relationship between two parties one of which (the principal) uses the otherr (the agent) to perform services on its behalf; and to analyse the problems of opportunism thatt may arise when the objectives of the agent are not consistent with the objectives of the

3 3 principal.. The standard textbook example is the employer-employee relationship (for instance, Holstrom,, Milgrom, 1991). The relationships between the state and the players in the air transportt industry are very similar4. Here, the state is the principal and airlines and airports are thee agents. As private parties, the agents may have objectives that conflict with those of the state.. It may be argued that the relationship between the state and the air transport industry is nott one of agency because the state does not really have a contract with the industry to pursue itss objectives. The relationship is, in fact, no different from that between the state and a shoe manufecturerr that generates foreign exchange income for the state. However, the state issues permitss to carriers and designates airlines and airports to provide services on its behalf. There iss no such explicit agreement between the state and the shoe manufacturer, so that the two situationss are different. It may, however, be possible that the state does not pursue any clear objectives,, in which case the set of objectives is empty. In such a situation agency theory is indeedd not applicable. As will be argued in Chapter ID, the Dutch state as well as industry have clear,, yet different, objectives. Moreover, the state has concluded an increasing number of covenantss with the industry providing explicit agreement to pursue government objectives so thatt the possibility of the empty set does not apply. Thus, apart from a state's ties with other states,, its relationships with various agents play a role in this thesis.

1.3-- Central questions Thee previous description of the context and key issues of the thesis leads to the following centrall questions: 11 Which of the Bilateral and Community structures is more effective? 22 Which of the two structures is more efficient in terms of transaction costs? 33 What suggestions can be made to improve the Community structure?

Thesee questions will be answered from the perspective of the Netherlands as a sovereign state andd as a Member State of the European Community. The individual state perspective has been chosenn because, as will be seen in Chapters III and TV, current governance structures approach thee exchange of air transport rights from the perspective of a state. In addition, bounded rationalityy on the part of the researcher has limited the analysis to the perspective of the Dutch state.. Finally, this thesis aims to give recommendations to Dutch policymakers. However, the applicabilityy of the model developed below is not limited to situations where the Dutch state is onee of the transactors. The parties to the exchange may include any state or even groups of states. .

Buttonn (1996:284) refers to the state-airline relationshipa s one of agency in noting that Ihe oljectivcs of principall and agents sometimes coincide. See also Noonialiavm (1990), who discusses the i^^ betweenn the slate and firms that receive subsidies as an agpnry «4^w»diip 4 4 1.4-Methodology y AA central governance structure in this thesis is the State. As explained in Section 1.2, the states aree the only parties with full authority over the transaction. They derive this authority from theirr ownership of the property rightst o the airspace above their territories. Furthermore, their (legal)) power to coerce others within their jurisdiction, gives the states a higher status than any otherr party involved in the exchange of these rights, and makes the states responsible for the welfaree of the public. These features have implications for the nature of the transaction process andd hence for the optimal governance structure. A state's sovereignty and monopoly of power, forr instance, make it relatively immune to sanctions imposed by other states via legal compliancee mechanisms. The Bilateral and Community governance structures, outlined in Sectionn 1.1, may be considered as variants of the State. The analysis of these governance structuress is based on models of transaction costs developed by Williamson (1971, 1985) and Vann der Zaal (1997). In these models, transactions are differentiated according to a number of coree dimensions, namely the frequency of a transaction, the uncertainty arising from the transactionn and the specific investment needed to prepare and execute the transaction. Each coree dimension has certain implications for the level of transaction costs. To illustrate, the need too make investments that are specific to a given transaction increases the dependence of the investingg party on continuation of the relationship and may induce it to search forcertaint y and protection.. In this way, the party incurs transaction costs. In addition to elements that differentiatee transactions, there are two important factors that differentiate transaction parties. First,, they may differ in their ability to understand the issues in hand and in their ability to transmitt this information. Second, parties may differ in the degree of opportunism in their behaviour.. Each of the in total five core dimensions will be studied in terms of the variables thatt influence them. With this model, the transaction cost efficiency of the two governance structuress can then be analysed. Thee characteristics of the state make it difficult to evaluate the effectiveness of a governancee structure directly. Although the state's overriding objective may be a general goal suchh as social welfare maximisation, this objective is really an amalgamadon of a number of subgoals.. A contribution to one goal may adversely affect other goals. It is also very difficult to attributee observed effects to given policies without making some strong ceteris paribus assumptions.. This is particularly problematic for the long-term relationships that exist between statess and between states and the industry. The effectiveness of a governance structure will thereforee not be measured directly in terms of the effects of a policy on society. Rather, effectivenesss will be measured indirectly in terms of the characteristics of the interstate and state-industryy relationships. If a governance structure is to be effective in the sense of attaining

5 5 thee state's goals, then these relationships need to contain appropriate mechanisms5. Furthermore,, the state's goals will be made concrete by translating them into requirements pertainingg to the provision of air transport and airport services. A governance structure may be consideredd relatively effective if it contains mechanisms inducing the industry to meet these requirements.. Finally, the approach towards measuring the transaction cost efficiency and effectivenesss of a governance structure will be qualitative rather than quantitative. The purpose off the analysis is to explore the nature rather than exact size of the connections between governancee structures and the variables that determine their efficiency and effectiveness.

1.5-- Scope of the thesis Sectionn 1.2 observed that transaction cost economics focuses on transaction costs and not on benefits.. Although transport generates substantial benefits by allowing a better spatial distributionn of labour and specialisation, these are not considered explicitly here. Nor does the analysiss address the effects of a governance structure on the welfare of the final consumer. Evenn though the state is an important party in the analysis and is considered a social welfare maximiser,, consumer welfare is not the primary focus of the thesis6. Furthermore,, the notion of efficiency is defined in terms of transaction costs. The analysis sayss very little about the effect of governance structures on production costs. There may be somee interaction between the two types of cost. The use of information technology, for example,, may enable higher output and at the same time reduce uncertainty. A new method designedd to reduce production costs may thus at the same time reduce transaction costs. Similarly,, tying a private firm to public goals by given it an exclusive concession for an unlimitedd period, which may reduce transaction costs, may limit competition and thereby reducee production cost efficiency. As stated in Section 1.4 the analysis essentially focuses on thee Dutch situation although many comments apply more generally to the area where the Communityy structure applies or even air transport relations between states. Thee scope of the thesis is further limited to scheduled passenger transport and does not considerr charters for passenger transport nor any kind of freight transport7. Scheduled passengerr traffic is the best known, and from the point of view of the thesis, the most interestingg of the various submarkets. It is the form of transport that is most important in meetingg the demand for air transport and consequently receives the greatest attention in regulationn as well as in public and political debate. Freight transport usually follows passenger transportt if sufficient destinations are offered. Further, freight transport is limited to long distancee transport with a high value to weight ratio and air freight transport within Europe is

Suchh mechanisms might revolvearoun d financialincaitive s or the riglttioexiHiid operations. Seee Schipper (1999) for an extensive wenare analysis of regulator reform m aviation. Thee distinction between charters and scheduled traffic has virtually disappeared in the air transport legislationn of the European Community. 6 6 almostt negligible (Berechman and De Wit, 1996: 263). Passenger aircraft are responsible for moree than half of total freight capacity (at Schiphol airport and world-wide). Al Schiphol airport,, freighters are responsible for less than 4% of the total number of aircraft movements. Moreover,, for the Netherlands, passenger transport is crucial to attracting new businesses as thee potential of this transport affects the attractiveness of the Netherlands as a location for Europeann Headquarters and distribution centres. The effects of air transport on non-aviation industriess play an important role in Dutch air transport policy (see, for instance, the 1995 Key Environmentall Planning Decision, or *KEPD\ discussed in Section 3.3.1). The country's small territoryy further implies a relatively small amount of originating and destination traffic. If it is too benefit from any scale-related economies (see Section 5.2.4), it must exploit passenger transportt by transferring large numbers of passengers*.

1.66 - Organisation of the thesis Inn Chapter II, the model outlined above is developed in greater detail. The chapter identifies thee core dimensions of transactions and transaction parties and analyses their determinants and theirr effects on the level of transaction costs. The traditional transaction cost model is then augmentedd by the notion of the effectiveness of governance structures. This is followed by a descriptionn of a number of governance structures, including the State and some variants of the State. . Chapterr ID gives a detailed description of the Bilateral structure. It covers the basic elementss of the structure, including the transaction process, parties active in that process, their motivess and their relationships. Chapter IV engages in an analogous discussion of the Communityy structure. The description of the Bilateral and Community transaction will be organisedd around phases and subgoals. The alternative approach of describing one particular exchange,, would not suffice to adequately illustrate the two structures. Thee material in Chapters H, III and IV provide the basis for an analysis of the two structuress in Chapter V. It applies the terminology developed in Chapter II to the air transport contextt and summarises the distinguishing features of each structure. It then looks at the effectivenesss and transaction cost efficiency of each structure and makes comparisons between thee two structures. In this way Chapter V answers the first two central questions, namely whichh of the two structures is more effective and which is more transaction cost efficient.

Thee margins on transfer traffic are not high but transfer enables a condonation of transport flows. This is vital too a hub-and-spoke netwoifc (sec Section 3.3.3). It atb»^ passengen wlv> are not destined for or do not originatee from the transfer country, thereby increasing the market potential of that country. Transfer traffic is, however,, mach inore susoepti)te fo changes in aircraft it is nott captive) (CPB, 1997).

7 7 Chapterr VI contains a summary and conclusions. The chapter also gives some recommendationss for how to improve the current Community structure, with the aim of answeringg the third central question. Thee analysis covers developments up to January 2000.

8 8 Chapterr II - Transactions and transaction cost analysis

2.11 - Introduction Chapterr I introduced the notion of transactions in air transport rights and noted the various elementss pertaining to such transactions. A detailed analysis of these transactions will be given inn Chapters in and IV. The present chapter analyses the concept of transactions and transactionn costs in the general context of any private good or service. Section 2.2 defines transactionss and elaborates on what is needed in order to conclude and execute them. This sectionn also introduces the concept of governance structures. Section 2.3 explains the concept off transaction costs, while Section 2.4 analyses the factors that are responsible for such costs. Sectionn 2.5 expands conventional transaction cost analysis by introducing the notion of effectiveness.. Section 2.6 introduces the industry environment. Section 2.7 then describes somee of the most frequently found governance structures. Section 2.8 summarises the purpose off this thesis and indicates how the thesis will apply transaction cost theory to the exchange of airr transport rights.

2.22 - Transactions Thee exchange of scarce goods in a market is a central theme in economics. Man's objective is thee maximisation of utility and he tries to satisfy his needs through exchange. Participants in an exchangee expect that the benefits will outweigh the costs of the exchange. Exchange can be equatedd with the term 'transaction', the latter referring to both the material (or physical - emphasiss added> and contractual aspects of exchange (Francis, Turk, Willman, 1983: 6). To be ablee to conclude and execute transactions, several conditions need to be met. The present thesiss distinguishes the following factors: the existence of an object of trade, property rights, information,, parties, a medium of exchange and a governance structure. These factors are explainedd more fully below. Thee execution of an exchange requires an exchange object. This could be anything from whichh an individual derives utility or satisfaction, such as a good. Exchange also requires the existencee of property rights with respect to the good. The owner of these property rights can excludee others from free access to the good and can determine what to do with the good (Pejovich,, 1990: 28). Without a system of property rights, exchange is greatly discouraged sincee the execution of a transaction is not guaranteed. Who guarantees, for example, that the agentss who claim competence to decide on the use of a certain good are entitled to conclude a transactionn with respect to the good, and who guarantees that no one can frustrate the exchangee by contesting their claims? Furthermore, the absence of property rights can lead to resourcee depletion. There will be a tendency to overuse the resource as the costs of depletion aree shared with other people, and not to protect the resource as others benefit from any

9 9 investments.. Similaiiy, investments made to produce a good other than for direct use are discouragedd since there is no certainty that the investments will be recouped. Property rights cann then be defined as 'sanctioned behavioural relations among men that arise fiom the existencee of scarce goods and pertain to their use' (Pejovich, 1990: 27-28). Property rights comprisee four elements: 1.. the right to use an asset (usus), 2.. the right to capture benefits from the asset (usus fhictus), 3.. the right to change the form, content or location of the asset (abusus) and 4.. the right to transfer all or part of the rights in 1, 2 and 3 to someone else at a mutually agreedd price1.

Inn addition, property rights have to be measurable if they are to exclude others from the use of thee good and thus create incentives for its optimal use. For some goods exclusion is not possible.. Collective goods are an example. One of the characteristics of these goods is that theyy are not divisible into individual units so that others cannot be excluded from their use2. Excludabilityy is also ruled out if the costs of creating or supervising it are prohibhively high. Thiss can change, however, as a result of technological developments that lower these costs. An examplee is the creation of rights to protect intellectual property such as material distributed via thee internet, or the introduction of electronic pricing, which enables the use of road infrastructuree to be priced individually and more cheaply than toU booths. Another example, relevantt to this thesis, are property rights to airspace. To be sure, excludability does not mean unlimitedd rights. There are limits, but these have to be based on legislation or case law (North, 1981:: 36). Another factor that is necessary to conclude and execute transactions is infor- mation.. Information is needed about the characteristics of the good, the trading partner, the partner'ss objectives, the terms of the exchange, and conditions and routines that pertain to the exchangee process. If there is no information, or if information is incorrect, there may not be anyy exchange. For example, a seller may not know that there is a willing buyer. Information failuress could also lead to an exchange that is 'wrong' in the sense that the price at which a goodd is traded does not reflect opportunity cost, or in the sense that the good does not end up withh the person who values it most. Transactions require two or more parties. If a party wants too exchange a good, it needs to identify a trading partner. The identification process can be organisedd in many ways, including various types of markets (e.g. physical markets and auctions),, intermediaries (e.g. travel agencies) and lobbying. In some exchange situations,

11 The right of ownership is not identical to the term 'i«pcrly rigto'used in Üw Eiiglish litcratare Thefonaer alsoo covwsthe rightso f tresiassh^ usumict, ose (^^ termterm property rights can be equated with the Dntch term B«rf.iHri«ipiiTr|rtfn' AA second feature of collective goods is their ram-rivabycharacter , which nua^ individuall does not diminish the amount available to other people. 10 0 identificationn does not pose great difficulties. It is not difficult to identify a monopolist or a sellerr of goods that are standardised and supplied on a regular basis. In the case of barter, however,, the identification of a trading partner can be very difficult and time-consuming. The availabilityy of a uniform medium of exchange (usually some form of money), with a stable or predictablee value, can facilitate the process considerably. Finally, there should be a governance structure.. The governance structure is a special part of the institutional environment, namely 'thee institutionalised matrix in which transactions are being negotiated and executed' (Williamson,, 1986: 105), and offers a certain method of allocating and distributing resources. Onee aspect of the governance structure is a system of norms and instruments that guarantees compliancee with the terms of transactions. In the absence of institutional restraints, the inclina- tionn of man to promote his own interests, and the consequent risk that the other party will not complyy with the terms of the transaction, will rule out the possibility of concluding complex exchangess (North, 1990a: 33 and 1984: 259). The guarantee can be internalised completely (i.e.. be within the relation itself), such as when an employer exercises authority over an em- ployee.. Enforcement can also occur through the expectation that non-compliance will be penalised,, for example through severance of a relationship. Sometimes this is the only way of penalisingg a violator, for instance, when parties are unwilling or unable to submit their dispute too a third party. Under these circumstances, the agreement can only work if it is self-enforcing, i.e.. if non-performance is against the interest of each party (Telser, 1980). A party will not breachh the relationship if the terms of the agreement or value of the relationship (including the possibilityy of beneficial future trade) are such that the benefits outweigh the costs of adherence. Thee incentive to adhere to the agreement is reinforced in cases where parties do not know whichh transaction will be the last (ibid.: 28, Axelrod, 1984: 188, Zajac, Olsen, 1993: 137, OECD,, 1997: 84). Internal guarantees are sometimes the most efficient as the parties concernedd can devise more satisfactory solutions to their disputes than can professionals who aree constrained to apply general rules on the basis of their limited knowledge of the dispute (Williamson,, 1999a: 130, citing Galanter, 1981). In other situations internal guarantees leave thee parties with too much uncertainty and fail to protect their property rights adequately. An externall compliance mechanism is then necessary. There are various forms of external mechanisms.. They include social norms, which can exert environmental pressure upon a party, andd most importantly they include a system of legal enforcement by a third party. The creation andd maintenance of such a system of third party enforcement is traditionally a task of the state becausee the state has sovereign powers. This implies that sovereignty, or a sovereign power, is importantt for a system of property rights (North, 1981: 21 and 1984, Dugger, 1993: 183 and 189).. In addition to compliance mechanisms, a governance structure contains a system of communicationn to convey information on the good and associated conditions to the trading partners.. The conclusion and execution of the transaction also call for processes and routines,

11 1 ass well as 'a set of constraints or arrangements that govern the behavioural relations amongst individualss and groups' (North, 1991: 97). These institutions can help to structure the relationshipss among individuals in a predictable way (Shepsle, 1986: 52), thereby towering uncertaintyy and diminishing the need for guarantees that would otherwise be an explicit elementt of the governance structure3. Inn traditional microeconomics the market is the governance structure that co-ordinates resourcee allocation. However, there are other governance structures, as will be seen in Section 2.7.. The next sections describe the costs associated with transactions and the factors that accountt for their existence.

2.33 - Transaction costs Thee central tenet of transaction cost economics is that economic activities will be organised efficiently,, in the sense that the total costs incurred in the transaction process will be minimised (Vann der Zaal, 1997: 155). Efficiency is usually considered from the perspective of the costs of physicall production. However, as observed in Section 2.2, the maximisation of utility requires exchange44 and transacting involves a claim on productive resources, i.e. it generates costs. Thesee 'transaction costs' do not flow from production as such, but constitute the 'costs of runningg the economic system* (Williamson, 1985: 18): they are the costs incurred to prepare, concludee and execute transactions. They are also referred to as 'the costs of running the contractuall relation', emphasising the contractual elements of the transaction (MacNeU, 1981: 1018-1063,, Kneppers, 1988: 59)5. Williamson (1985: 1-2) refers to transaction costs as the economicc equivalent of friction in physical systems. The word 'friction* can give rise to misunderstanding,, since it might suggest that exchange is problematic. Even when exchange proceedss smoothly, however, costs will be incurred in the transaction process, as will be seen inn this section.

Economistss did not pay any attention to transaction costs until the publication of 'The naturee of the firm' by Coase (1937). Following Commons (1934), who gave the transaction a centrall place in his analyses, Coase posed the question of why not all exchange takes place via thee market, given that the market supposedly co-ordinates any exchange through the price mechanism.. He saw the answer in the costs generated by the use of the market, arguing that

Thee institutional environment influences the options fromwhic h individuals can choose. In this way, the institutionall environment can influence the course of development of a society (North, 1990a: 78). Note that the institutionall environment itself may also change over time (North, 1978). Thee Coase theorem states that externalities and ouw econoimc inefficiencies wül be cone^ betweenn thee affected parties (Saroodson, Nordhsus, 1992:732). Tlu^ however, is based on the unrealistic assumptionn that transactions can be prepared, conchided and executed costtessly. Otherr definitions of transaction costs are 'costs of the exchange of titles of ownership' (Demsetz, 1990:64), andd 'apparently any costs necessarily incident to a tiansactiofl or series ofbinsactioiis above and beyond productionn costs' (Maiuand, 1985:60). 12 2 thesee costs justified the existence of the firm as an alternative governance structure6. Sometimes,, the firm is the best resource allocation mechanism, and sometimes the market servess best. Differential transaction costs will give rise to a discriminating assignment of transactionss to governance structures (Williamson, 1996b: 16-17). In his article 'The problem off social cost' (I960), Coase extends the argument to the assignment of property rights to productivee resources. In Coase's opinion, the efficiency of an allocation does not depend on thee initial distribution of property rights provided that there are no transaction costs. Starting fromm a certain assignment, parties will conclude transactions to arrive at a result that maximises utility.. In reality, however, the transaction process generates costs so that the initial assignment off property rights matters. According to Coase and the theory of property rights developed subsequentlyy (Vromen and Groenewegen, 1996: 368,375), property rightsnee d to be assigned inn a manner that minimises transaction costs. Givenn sufficiently high costs, some transactions might not take place, resulting in a lower welfaree than would otherwise be possible. Similarly, a suboptimal allocation of property rights mayy generate unnecessary transactions7. Thee literature (among others: Williamson, 1985: 20-21, Kneppers, 1988: 59) generally categorisess transaction costs as follows: 1.. the pre-contractual costs associated with gathering information (e.g. on the relevant prices, trustworthinesss and creditworthiness of the other party) and searching for a contract partner, , 2.. the costs associated with concluding (negotiating) the agreement, 3.. the costs associated with drafting the agreement, 4.. the costs associated with executing the agreement, 5.. the costs resulting fromcheckin g compliance with the agreement, 6.. the costs generated by conflicts arising between the parties after the conclusion of the agreement, , 7.. the costs incurred in amending the agreement and 8.. the costs associated with enforcing compliance with the terms of the agreement.

Thee costs in 1, 2 and 3 are incurred prior to concluding the agreement. They constitute the ex antee transaction costs of identifying a transaction opportunity, selecting a trading partner, negotiatingg and drafting the agreement and organising supervision. After the agreement has beenn concluded a number of costs will arise. The parties might feel a need to monitor the

Inn this explanation, other factored can e ignored.. This is one of the critiasrns of transaction cost analjró. Fiuthermore, Sawyw (1993: 33) opines th^, sincee te primary nmctkm of a firai s piod^ alsoo Fourie (1993:44) and infra, pp. 27-28. Chapterr VI will look into the option of a different assignment of property rights. 13 3 executionn of the agreement, and in case of a deviation from its terms, it might be necessary to enforcee compliance using legal remedies. Furthermore, the agreement will not cover every contingency,, and responding to unforeseen events will lead to ex post transaction costs. A changee in circumstances that prevailed when the transaction was concluded may require a changee in the agreement and generate negotiating costs. A distinction between ex ante and ex postt costs can be arbitrary. Consider, for example, a situation where two parties foresee a sequencee of transactions with each other. The costs that are ex post with respect to one transactionn may alter behaviour - and thereby the level of transaction costs - in a subsequent transactionn (Bokkes, 1989: 37-38). For instance, recurrent transacting can lead to trust, which couldd induce parties to put less effort into fully detailing the terms of any agreement and to foregoo some compliance monitoring. However, a division of the transaction process into phasess is useful in that the factors responsible for transaction costs may be analysed more accurately.. The analysis below uses an extended version of a division by Noteboom (1996: 340).. The transaction process is split into three stages, the first two stages accounting for ex antee costs and the third for ex post costs8. 1.. the contact phase - identifying a transaction opportunity, searching for and evaluating potentiall trading partners, 2.. the contract phase - drafting and negotiating the terms of the transaction and 3.. the execution phase - execution of the transaction, performance monitoring, compliance andd dispute resolution as well as minor adjustments of conditions not requiring a formal negotiation. . Thee costs incurred in performing the activities belonging to a particular phase will be ascribed too that phase.

Somee authors define transaction costs as the costs incurred to create, use or change a governancee structure and suggest using the term 'co-ordination costs*. They argue that this termm makes clear that not only transactions but also ways of allocating resources not readily associatedd with exchange are covered (for example, Bokkes, 1989, or Kay, 1993: 257). Raes andd Willekens (1994: 25) also refer to costs incurred to arrange for the allocation of resources. Apartt from the costs associated with exchanges between parties, transaction costs include costss resulting from unilateral decisions by the state that affect a governance structure. Some exampless are the cost of imposing a new regulation on firms and the cost of compliance with thiss regulation. These costs are important in the early existence of a new governance structure9,, but they are one-off costs that are negligible in the long run. For this reason, they

88 The phase during which the transaction is implemented is refaral toas'ex^ ^ phase',, which is the term used by Noteboom, to avoid any confusion wittitt» tem'eralior off opportunism (infia, Section 2.4.5). Forr instance, they influence the ease with which an mdiistry adapts to new conditions. 14 4 willl not be included in the analysis, although Chapter VI will comment on the costs of creating thee current Community structure in the context of air transport. Whilee there is common agreement on the notion that transacting will give rise to certain costs,, there is less unanimity on the content of the concept. Transaction costs are not easy to operationalisee (Phelis, 1993: 12) and there is a danger that all costs will be subsumed under the concept.. As a result, transaction cost analysis has attracted a great deal of criticism10. A start too giving more operational content to transaction costs can be made by defining and analysing thee factors that are responsible for their existence. This will be done in the next section.

2.44 - Factors influencing transaction costs Ass Williamson suggests (1985: 30) transaction costs can be explained by the presence and interactionn of two types of factors, namely individual attributes and transaction characteristics. Theyy will be referred to as 'core dimensions', following Van der Zaal (1997). The individual attributess are the behavioural assumption of opportunism and the human attribute of bounded rationality,, which will be described in Sections 2.4.4 and 2.4.5. The transaction characteristics aree discussed below. Inn a society characterised by numerous combinations of resources, used to create numerous productss and services, there are numerous transactions. These transactions exhibit a variety of characteristics.. Abstracting from such differences as the object of trade and the objectives of parties,, the characteristics of a transaction can be reduced to (Williamson, 1986: 111): 1.. the frequency with which the transaction occurs, 2.. the uncertainty that is associated with the transaction and 33 the degree of asset specificity associated with the transaction. Thee following sections explain the factors that determine these characteristics.

2.4.11 -Frequency Ann important factor influencing transaction costs is the frequency of the transaction. Frequency cann be characterised as one-time, occasional and recurrent. On the one hand, one-time transactionss are relatively simple. Parties agree to meet only once, they do not have a relationshipp and are not looking to create one. A motorist, for example, engages in a one-time transactionn when he refuels on a long-distance trip far from home (De Vos, 1987: 272-290, Kneppers,, 1989: 65). On the other hand, the absence of a prior relationship and consequent lackk of a reputation for reliability could mean that a party will feel a need to devise safeguards againstt a breach of agreement by the other party. In the refuelling example, the question could arisee of who will guarantee that the amount of petrol paid for is actually obtained. This could leadd to elaborate monitoring or a legal system of obligatory calibration of petrol pumps,

IS S coupledd with an awareness that non-compliance is penalised. This knowledge influences (constrains)) behaviour (Van Dijk, 1998). One-time transactions thus need not be simple at all. However,, few transactions are truly one-time. The following discussion of the factors that influencee the transaction frequency apply not to one-time transactions but to occasional and recurrentt transactions. Onee determinant of the transaction frequency is the nature of the good or service transacted.. Public transport, for example, has a high frequency of exchange because of both productt and demand characteristics: it is consumed regularly but it is perishable. For a given levell of consumption, the more perishable is a good, the higher the frequency of transacting. Thee frequency of the transaction is also increasing in the number of alternatives. A large numberr of alternative suppliers and strong competition among them lowers the cost of swit- chingg to other sources of supply. The transaction frequency also rises with an increase in the dynamismm of the environment. For a given agreement, the more dynamic the environment, the moree quickly the agreement becomes inadequate and the greater the need to re-negotiate. Finally,, the flexibility of the relationship affects the transaction frequency. This determinant appliess to the transaction process as well as the ultimate document which formalises the transaction.. If the transaction process is flexible, parties can tailor their relationship by taking intoo account every single need. However, if the ensuing agreement is rigid, the terms of the agreementt will eventually cease to reflect economic conditions. For instance, prices fixed in the agreementt may cease to reflect opportunity costs. The agreement will then give parties inappropriatee production and consumption incentives. Furthermore, a party that feds disadvantagedd by a misalignment between the agreement and the market has an incentive to deviatee from the contract or to negotiate more favourable terms. In order to bring the agreementt back into line with economic conditions, it might be necessary to conclude a new transaction.. A lack of flexibility thereby raises the transaction frequency. Conversely, flexibility offeredd by a framework agreement or an agreement containing procedures that allow parties to adjustt to new circumstances is likely to reduce the transaction frequency (Crocker, 1996: 94). Tablee 2.1 shows the relationship between the transaction frequency and its determinants.

Determinant t Effectt on transaction frequency

Perishability y Positive e

Existencee of alternatives / competition Positive e

Dynamismm of the environment Positive e —. . 100 For example, Hodgson (1993) and Pilelis (1996). 16 6 Flexibilityy of the relationship, i.e. of the transac- Negative tiontion process and the agreement Tablee 2.1

Itt might seem that a high transaction frequency should generate high transaction costs. The argumentt is simple: new transactions lead to new negotiations and more drafting. But, as total costss rise, a higher frequency can induce transacting parties to standardise the transaction process,, thus lowering average transaction costs. Reinforcing the downward effect on transactionn costs are the information and reputation effects of repeated dealings with the same parties.. Repeated transactions enable parties to learn about and monitor each other, while informationn acquired in earlier transactions can be used in later transactions (Ménard, 1996: 158).. Parties also need to gather and process less information because they can re-negotiate or easilyy amend their relationship to bring it into line with economic conditions. An established reputationn engenders trust and reduces the incentive to engage in opportunistic behaviour and hencee the need for elaborate contracting and monitoring mechanisms. The influence of opportunismm is lowered even further as adjustments in the relationship during the execution phasee require fewer corrective measures and less haggling in the contract phase (ibid.: 160). A highh frequency can thus reduce the level of ex ante as well as ex post transaction costs. If conditionss that prevail at the conclusion of the agreement tend to change unexpectedly, then frequentt re-negotiation can prevent the costs associated with agreements that become outdated.. In this way a high frequency can offer the flexibility that may not be provided by an agreement,, once h has been negotiated. The ultimate effect of the transaction frequency on transactionn costs is indeterminate and very much dependent on the relative strength of the factorss discussed above.

2.4.22 - Uncertainty Inn addition to differences in frequency, transactions exhibit various degrees of uncertainty. Uncertaintyy means ignorance and the need to act on the basis of opinion rather than knowledge orr fact (Knight, 1965: 268). When there is uncertainty, a party cannot determine the probability thatt an event will occur and is therefore unable to cover the negative consequences of the eventt through insurance11. Uncertainty can pertain to many elements of the transaction. It can pertainn to the characteristics of the good transacted, the objectives of the transacting parties, futuree market conditions, or the terms of the transaction. Transactions that are certain are relativelyy uninteresting from the perspective of this thesis. All situations could be anticipated

111 Uiicertainty is not the same as risfc In a situation of risl^ throughh actuarial compulation. With this ooinpntation^ a premium can be established and insurance be^ possiblee (North, 1990a: 126). 17 7 andd taken into consideration in the relationship. The governance structure used would become irrelevant;; only the time needed to reach agreement would vary. In the real world, however, uncertaintyy is prevalent. Followingg Van der Zaal (1997: 142-144), four factors are identified as determinants of uncertainty.. These are the complexity of the transaction, the dynamism of the environment as welll as the information gathering and information processing capacities of the parties12. The transactionn may be complex because of such factors as the objectives of parties, the charac- teristicss of suppliers, or changes in the institutional environment. The environment may be dynamicc because of a large number of competitors and the absence of barriers to market entry. Thee level of uncertainty associated with a transaction increases as the transaction becomes moree complex or the environment more dynamic. The parties' information gathering capacities determinee their ability to access the information relevant to the transaction and transaction partner.. Their information processing capacity enables them to co-ordinate between possibly conflictingg objectives or to deal with changes in the institutional environment. A greater informationn gathering or processing capacity reduces uncertainty as it enables better and faster insightss into new developments and allows information on the nature of the good or the objectivess to be understood more easily. Tablee 2.2 summarises the effects of these variables on the level of uncertainty.

Determinant t Effectt on uncertainty

Complexityy of the transaction Positive e

Dynamismm of the environment Positive e

Informationn gathering capacity Negative e

Informationn processing capacity Negative e Tablee 2.2

Peoplee generally prefer a sure thing to uncertainty and, if transactors face uncertainty, they will tryy to limit its influence by stracturing their relationship accordingly. They might engage in costlyy information-gathering activities during the contract phase or write elaborate agreements. Theyy might also spend more time negotiating. In this way uncertainty can lead to high ex ante transactionn costs. Ex post transaction costs are also affected because uncertainty will induce

Unlikee Van der Zaal, there is no division into internal and external factors. Complexity, considered an externall factor by Van der Zaal, can also be internal in the sense u^ ü can ar*ty to UK objectives of transactingg parties. 18 8 partiess to expend resources on monitoring the execution of the transaction and enforcing compliance.. Uncertainty might even cause fewer transactions to take place. An example is givenn by Van Waarden (1998) of the taxi market, where uncertainty, combined with a risk of opportunisticopportunistic behaviour by the taxi driver in determining the fare or the route as well as consumers'' inability to eliminate this risk, might lead consumers to choose another form of transport. .

2.4.33 - Asset specificity Thee third transaction characteristic is the degree of asset specificity, i.e. the extent to which a transactionn requires parties to make specific investments whose value depends on the continuationn of a particular relationship. In some cases, a party to a potential transaction needs too make a durable investment that has a much lower value to alternative users or in alternative usess (Williamson, 1985: 55). These investments result in assets that are specialised in the sense thatt their value depends on one particular relationship. Stated differently, the relationship itself iss an asset". In a situation of asset specificity a large-numbers bidding competition at the outsett may be transformed into a small-numbers supply relation during the execution phase and att the contract renewal intervals. A bilateral monopoly could arise where both transacting partiess are effectively locked in14. Acquiring specific assets might be a requirement for entering aa market. An example is the need to meet certain accounting standards and licensing requirements,, as is the case in air transport. A different example of transaction-specific investmentt is lobbying, i.e. the costs incurred in order to influence decision-makers. Other exampless include investments in the location of a production facility to save on transport and storagee costs, or investments in human capital, such as training programmes (Williamson, 1986a:: 142). Thee determinants of the level of asset specificity include the scope of the relationship. More particularly,, the relationship may have such a long duration, or a trading partner may be so importantt to the outcome, that the parties are locked in. Williamson (1999b: 136) uses the termm 'dedicated assets' for those assets that are acquired specifically with the prospect of sellingg a significant amount of produce to a specific customer. Lobbying was listed as a form of transaction-specificc investment. Lobbying is determined by various elements in the institutional structure.. One element is the susceptibility of a decision-maker to being influenced by side payments.. There may also be room to influence decision-makers via technical iriformation or

Theree may seem to be a subtle but important difference between these two definitions: a pl^skal asset can presumablyy be soid, whereas a relationship cannot (Milgrom, Roberts, 1990:62,236). However, the two dementss cannot be separated because the asset derives its van» from the relationship. "" These conditions, indnrHnp the importance of amtiming IIM» relationship, might make Classical market contractingg inappropriate and lead to a more relational type of contracting (MacNeü, 1978, Williamson, 1996b:

19 9 thee reputation of one of the parties. On the other hand, any such room may be limited because off close relationships between industry players and decision-makers. Another element is the set off rules determining the conduct of state representatives and the organisation of the transaction process,, such as rules allowing for interest group representation. These conditions are collectivelyy captured in the variable 'susceptibility to lobbying'. Technical requirements can alsoo lead to transaction-specific investments. Examples include requirements in the high tech industry,, such as requirements forth e construction of a facility specifically designed to produce missiles.. Sometimes these investments flow from state-imposed requirements in the form of regulation,, as is the case in the construction of some airport facilities that aim to reduce noise pollution.. Finally, transaction cost economics presumes that parties consciously choose the amountt of transaction-specific investment they are willing to make (Groenewegen and Vromen,, 1996: 376). In their decisions, uncertainty about the trustworthiness of the other partyy and the risk that the other party will breach the agreement play a role. The existence of elementss in the institutional environment protecting a party against that risk thus influences the willingnesss of that party to make a transaction-specific investment. These elements, which will bee referred to as 'institutional guarantees', can arise from the possession of superior knowledgee or from state support. A situation of mutual exposure, where both parties face downsidee effects from a breach of contract, is another example of an institutional guarantee. Alternatively,, the parties may have certain values in common. They may also undertake to explicitlyy formulate required performance so that it can be enforced in court. In this way, they legallyy tie their hands with regard to variables that they can otherwise manipulate to hold up theirr trading partners (Klein, 1985: 597). Lastly, an external compliance mechanism is a form off institutional guarantee. Tablee 2.3 summarises the relationship between asset specificity and its determinants.

Determinant t Effectt on asset specificity

Scopee of the relationship Positive e

Susceptibilityy to lobbying Positive e

Technicall necessity or regulation Positive e

Institutionall guarantees Positive e Tablee 2.3

degreee of asset specificity determines the extent to which parties can sever relations and

20 0 findfind another buyer or source of supply. For instance, if transacting parties choose a specific technologyy over a multi-purpose technology, then they become more dependent on each other. Sunkk investments create a stream of quasi-rents that gives one party some ex post bargaining power13.. The fear of a disturbance in the relationship creates incentives to try to protect the investment.. The parties can do this by making credible commitments to infuse confidence into theirr relations. They may also turn to a third parry such as the state to provide financial support.. Alternatively, the parties may spend more time negotiating, or they may incorporate finesfines for premature termination into their agreement. These ways of protecting transaction- specificc investments generate transaction costs.

2.4.44 - Bounded rationality Transactionn cost economics departs from some traditional assumptions of neo-classical economics,, including the assumption that individuals have complete information about every relevantt factor and that there is no limit to the human capability to interpret and use this information.. Unlike the neo-classical assumption, the condition of bounded rationality used in transactionn cost economics presupposes that the human mind does have limits16. These physical limitss pertain to the ability to receive, store and transfer information. In addition, they result fromfrom failures in language when formulating and resolving matters. As a result, individuals are onlyy partly able to realise their intentions to behave and act rationally. Further, they are not ablee to accurately monitor the behaviour of others. If rationality were unbounded, it would be possiblee to negotiate complete and efficient agreements. Given that rationality is bounded, agreementss cannot be complete and, even if they were, their terms would not be fully under- stood,, nor would the behaviour of parties be adequately characterised. People deal with the factt that their rationality is bounded, among other things, by gathering and processing informa- tionn up to the point where marginal costs exceed marginal benefits. Further, transaction cost economicss assumes that transactors will try to limit the effects of bounded rationality by realisingg a transaction via the governance structure that - given the characteristics of the transactionn (and opportunism) - is best able to deal with this individual attribute. Although the effectt of bounded rationality is influenced by the quality and availability of information, boundedd rationality is a parameter and implies a limit on a party's capacity to process information.. In what follows, bounded rationality wilt therefore be treated in the context of uncertainty. .

1SS The balancg nay shift, depending on the sitnatio^ supplier,, and thee supplier has an advantage over the buyer Alternatively, if demand falls thghiyer mpy acquiree a strong bargaining position vis-a-vis the supplier. Simonn (1957:198) states that The capability of the human mind tor fonnulatingairi solving complex problemss is very small compared with the size of the problems whose soluü^U required for ob^ rationalrational behaviour in the real world'. Williamson (1975:9). 21 1 Thee analysis of uncertainty and bounded rationality would be less important if all parties weree completely trustworthy. However, this is not the case; at least, complete trustworthiness iss not assumed here. This is where the behavioural assumption of opportunism comes into play.

2.4.55 - Opportunism Opportunisticc behaviour is any action taken by a trading partner to exploit an informational (or other)) advantage to the economic detriment of others. Opportunism, or 'self-interest seeking withh guile', is the strongest form of the pursuit of one's private interest. It extends the conventionall assumption that individuals are guided by considerations of self-interest to make allowancee for strategic behaviour (Williamson, 1975: 26)17. Strong forms of opportunism includee lying and cheating. A weaker form is giving truthful information but withholding some relevantt information, while a more subtle form entails lowering the quality of a service once the otherr party has committed to an exchange. Opportunistic parties will deviate from promises madee earlier, when this is beneficial to them. Transaction cost economics employs a uniform opportunismm assumption in the sense that opportunistic behaviour can occur in each of the transactionn phases. To be sure, it is not assumed that all individuals are opportunistic to the samee degree, but opportunism cannot easily be discovered ex ante. Safeguards will therefore alwayss be necessary (Noorderhaven, 1993: 2). AA risk of opportunism arises whenever there is an agency relationship. Opportunism thus affectss the exchange of market access in air transport, which involves such relationships. An 'agencyy relationship' is defined by Jensen and Meckling (1976: 308) as a contract under which onee or more persons (the principal) engages another person (the agent) to perform a service on hiss behalf. This entails delegating some decision-making authority to the agent. The agent has somee discretion in the execution of his task. His decisions affect the benefits accruing to the principal,, who therefore wants the agent to act in his interest. The agent, however, will not do thiss of his own accord and might need an incentive. In the context of this thesis the state is consideredd the principal, who wants to realise certain goals, while the industry players, i.e. the Dutchh airlines and airports, are the agents used to realise these goals. Generally speaking, the agencyy relation is characterised by information asymmetry and conflicting interests. The principall is confronted with an information problem, in the sense that his information about the agentt and the input on which this is based are imperfect18. The principal is often not able to monitorr the ex post behaviour of the agent and the agent frequently has more information than thee principal. These situations can lead to forms of opportunism such as adverse selection or morall hazard.

'Guile** can be translated as 'trickery' or 'tfeachenwsness' (ibid.). Althoughh the agent might be uncertain as to the principal's objectives, his power or his alternatives, this is nott what makes han agency problem. For a different opinion, see Van der Zaal (1997:78,163). 22 2 likee other core dimensions, opportunism is influenced by some determinants. One determinantt is the fairness of a transaction as perceived by the parties. The greater the degree off volition and fairness in an exchange, the greater the chance that the parties will comply with itss terms (North, 1981: 37, 1990: 76, MacNeil, 1985: 499). The notion of perceived fairness captures,, among other things, the extent to which the transaction process and terms of the final agreementt reflect the real division of power between the parties. It also reflects the influence of sociallyy mediated norms, especially in situations where the relationship between parties rules outt formal compliance mechanisms. A second determinant of opportunism is the net gain expectedd from opportunism. Assuming that parties are utility maximisers, larger gains from opportunisticopportunistic behaviour will make them more willing to accept any costs of deviating from an agreement.. When the gains of deviating outweigh the costs, opportunistic behaviour might occurr so that the agreement is not self-enforcing. The nature of the costs and benefits plays a role.. Often, it is easier to acknowledge costs especially if these, but not the benefits from complying,, are clearly identifiable. The more tangible and immediate the benefits, the greater thee chance of voluntary compliance (Noorderhaven, 1990: 34). One benefit of compliance that mayy be clear is the prospect of continuing trade through future transactions. Hence, a continuingg relationship tends to limit the level of opportunism as parties will take into account thee effect of their behaviour on future dealings with each other19. The constraint is reinforced inn those cases where the victim of a deviation can retaliate or easily terminate the agreement. Thee possibility of future transactions warrants an additional comment. It might seem that in the casee of long-term agreements the effect of opportunism on future transactions is not relevant. However,, a single transaction giving rise to a long-term agreement can in some instances be likenedd to a series of separate transactions between the same parties. A long-term agreement, involvingg continuous decision-making, can be seen as the outcome of a large number of interrelatedd mini-transactions that require information, decisions on amendments, and so on. Ratherr than being determined once and for all at the moment of conclusion, the agreement is continuallyy re-negotiated, as in the case of a series of separate transactions (ibid.: 96, note 51). Thiss means that, notwithstanding the likely prospect of continuing business, parties to a long- termm agreement will take into account the effect of their behaviour on the ease of going throughh the execution phase.

Thee constraining effect that the costs of deviation may have on opportunism resembles the effectt of reputation (Klein, Leffler, 1981, Noorderhaven, 1993: 5)20. Calculating agents can

199 Supra, p. 11. 200 Noorderhaven (1990:102)consklei5 reputation a source* obligate transactionss between the deviating party and other moidjers of society. In contrast, tne present author believes thatt reputationplay s a role in the context of trust between transacting parties. Nooiderhaven (19%: 110) notes thatt reputation is a functional equivalent of or a substitute fix duuacter trust The pcese^ consideiss reputation clcfier to system trast, because r^ 23 3 consciouslyy honour commitments in order to build a reputation that allows others to trust them.. In this way they expand their options for profitable exchange. Hence, trust is an impor- tantt factor determining whether an agreement is self-enforcing. Trust is a concept that is occasionallyy referred to in transaction cost economics, usually in the context of opportunism (e.g.. Noorderhaven, 1990, 1993, 1996, Lyons, 1999: 304). There, it is used to explain why, despitee a risk of opportunism, trusting parties may refrain from devising new ways of protectingg an agreement, or may be satisfied with less than complete information about the transaction.. There is, however, no unanimity on the definition of trust. If agents are calculating individuals,, then trust refers to the belief that another party will not deviate from an agreement forr reasons of self-interest. When reputation plays a role, a party relies on the record of past transactionss in deciding whether to adhere to an agreement. Similarly, continuing business with aa party who has proven to be trustworthy may constitute rational behaviour21. This form of trustt is referred to as 'situational trust' (or 'system trust') as it depends on the characteristics off the situation or on guarantees inherent in the institutional system (Noorderhaven, 1990: 106).. System trust can derive from elements such as symmetric access to relevant information orr mutual dependence. In addition, a longer history of previous exchanges with a co-operative partyy will mean more information and a greater degree of trust, as will the value and intensity off the relationship. A second form of trust is 'character trust'. Unlike system trust, which dependss on the situation, this form of trust is based on a belief in the other party's inherent trustworthiness,, i.e. its disposition to live up to coinimtments. Character trust is more difficult too account for in transaction cost economics. Yet, transacting parties sometimes live up to promisess made earlier, even though they might benefit from deviating. An explanation for such behaviourr is found in sociological theory, which suggests that people act differently in a relationshipp that is defined as one between friends or acquaintances than in a relationship whh a stranger.. In the latter situation, the focus is on gain maximisation; in the former, gain maximisationn is constrained by considerations of equity and solidarity. Consequently, the interactionn process associated with an exchange may enhance a party's trustworthiness in that exchangee if it causes him to perceive the relationship as one between friends or acquaintances (Noorderhaven,, 1996: 115-116). Compared to other forms of trust, character trust is more robustt in a dynamic environment, where changes in circumstances are frequent22. A problem withh character trust, however, is that it depends on a party's personality traits and on whether thee assumptions about the motivations of that party hold, which means that it usually leaves considerablee uncertainty. Thee forms of trust discussed above tend to enhance the attractiveness of not breaching an

211 Telser's analysis (1980:35-36) excludes the effect of previous transactions m adheringg to ann agreement. However, Noorderhaven (1990:97) in discussiDgKJein, 1985 (as wcU as the currem author) believess that trustworthy behaviour in a series of transactions is relevant to the calcqiafipn Anyy system trust may disappear doe to changes in the environment. 24 4 agreement.. In contrast, legal enforceability and environmental pressure (including informal ruless and norms which are socially mediated) enhance the disadvantage of breaching an agreement.. Trust is especially relevant where the option of legal enforceability or environmentall pressure is insufficient, perhaps because of a lack of power or because no outsidee party has the information needed to assess disputes. In these situations agreements needd to be self-enforcing. Whether a party to a transaction emphasises trust or legal enforceabilityy depends on the relative strength or weakness of that party. A party that is relativelyy strong, i.e. expects the other party to be dependent on him more often than vice versa,, will most likely rely on trust rather than invoke or threaten to use legal remedies. A relativelyy weak or dependent party, on the other hand, will attach more importance to the use off legal remedies. In what follows these considerations will be used to shed light on some aspectss of compliance and enforcement in the absence of external enforcement systems. Thee introduction to this section explained that the extent of opportunism depends on the presencee of certain safeguards that improve the degree of control over the behaviour of the parties.. These mechanisms include methods used to check ex post behaviour, performance incentives,, such as the reward schedules common in agency relationships, as well as various systemss of external enforcement. The principal could devise a fee schedule that minimises the agent'ss propensity to shirk and motivates him to choose an action that maximises the residual accruingg to the principal. Another strategy imposes restrictions on the set of options open to thee agent, prohibiting those actions that have an adverse effect on the pay-off of the task. If the agentt chooses an action outside his permitted action set, his fee will be lower (Noorderhaven, 1990:: 62-63, Van der Zaal, 1997: 77-80). The choice between these two strategies will depend,, among other things, on the ability of the principal to limit the agent's options and to exercisee control over his performance. A further distinction is possible between output control andd behaviour control. Output control involves checking the output by sampling results. This formm of controlling the agent is usually the simpler, because the agent's behaviour can be ignored.. An understanding of the transformation process and a reliable and valid measure of desiredd outputs must, however, be available and difficulties will arise in those cases where outputss are joint or where the agent's behaviour may have effects going beyond the agency relationshipp (for example, political effects). Behaviour control requires the specification of rightsrights and an ability to monitor and control the behaviour of the agent. In situations where the sett of formalrule s and procedures to specify behaviour is more complete, there is less need for outputt control. When, as in some situations, behaviour cannot be adequately monitored, the transformationn process is not known and outputs cannot be measured, only ritualised control cann be used. Situations such as these often show a heavy reliance on the selection process. A finall determinant of opportunism is the harmonisation of interests. The parties may share some objectives.. If they do not, their interests can be harmonised in various ways. One method is

25 5 collectivee ownership, which internalises transactions previously conducted in the market. The partiess may also create interdependenties When the agent aims at harmonising his interests withh those of the principal, the term 'bonding' is used (Van der Zaal, 1997: 79). Bonding mechanismss can be in the form of measures to guarantee that the agent will not take certain actionss which would harm the principal, or to ensure that the principal will be compensated if thee agent does take such actions. An example is the forfeiture of a deposit or a licence. Bondingg may also occur via signalling. An agent can send signals to the principal, for example onn his reputation or quality, with the purpose of reassuring the principal and thereby bonding him.. Some examples of signals are diplomas and ISO certificates (Spence, 1973, Van der Zaal, 1997).. In this case, bonding mechanisms are used to infer relevant information23. Finally, the durationn of the relationship affects not only the net gains from opportunistic behaviour but also thee degree of interest harmonisation (Klein et al., 1978: 304). The longer the relationship, the greaterr the likelihood that parties develop common objectives. Thee following table summarises the determinants of opportunism.

Determinant t Effectt on opportunism

Perceivedd fairness Negative e

Nett gains from deviation Positive e

Control l Negative e

Harmonisationn of interests Negative e Tablee 2.4

Opportunismm has some important consequences for transaction costs. The existence - or rather, threatt - of opportunistic behaviour combined with factors like uncertainty leads to more encompassingg agreements and the need for periodic checks and supervision during the executionn phase. In addition, it becomes worthwhile, prior to concluding the agreement, to pay attentionn to harmonising parties1 interests2* and taking precautions. Some examples are the

Williamsonn (1999b: 131, mentioning Grossman and Hart, 1982) distinguishes between bonding and signalling.. In the case of bonding agents communicate uwr endog^ius intentions, while in the case of signallingg agents communicate their exogenous characteristics. Bondtiig referst o the incenthres of agen^ contractt execution stage, whüe signalling involves inferriiig the otherwise unobsenobte ex ante attnlutes of agents. . 244 In other words, it pays to search lor ways of inducing parties to honour their commitiiieita cannott rely on external compliance mechanisms. Ai^ s*staiitial raterestlamumisatio n us^ tliann precedes conchision of an agreement createdd and, if ongoing, might harmonisation occur. 26 6 calibrationn of petrol pumps mentioned earlier, the use of detailed, long-term agreements and thee organisation of standby facilities. Resources will thus be used to protect the agreement. Havingg analysed the various core dimensions, the influence of the core dimensions on the levell of transaction costs can now be summarised as follows:

Coree dimension Effectt on transaction costs

Transactionn frequency Indeterminate e

Uncertainty y Positive e

Assett specificity Positive e

Opportunism m Positive e Tablee 2.5

Thee analysis of transaction characteristics and individual attributes shows a departure from the notionn of a homogeneous market characterised by fully rational, trustworthy participants who aree capable of preparing, concluding and executing transactions without incurring costs. When traditionall assumptions break down, the need to incur transaction costs arises and transactions becomee more costly. The time and effort taken to deal with uncertainty, the measures needed too protect specific investments and the monitoring of opportunistic agents are just some exampless of the way in which deviations from the traditional market place can generate transactionn costs.

2.55 - Effectiveness Currentt transaction cost theory focuses on the relative transaction cost efficiency of governancee structures. However, a transaction cost analysis is relevant only when transactions aree related to an objective. Transaction cost analysis usually fails to take objectives explicitly intoo account, or points out the possibility that objectives may not be fully realised because of prohibitivelyy high transaction costs. Williamson, for example, notes that positive transaction costss either deprive the organisation of some activities altogether or give rise to discriminating (i.e.. transaction cost minimising) assignment of activities to governance structures29. Turvani (1996:: 197), too, states that 'It is usually understood that when the costs of market usage causee its failure, exchanges run into several difficulties or do not occur at all.' Prtelis (1996: 278-280),, however, criticises the assumption in transaction cost economics that a certain governancee structure exists because it economises on transaction costs. In his view, the

27 7 assumptionn that a firm's objective is to reduce market transaction costs is at odds with the conventionall neo-classical assumption that firms are profit maximisers. The correct objective is profitt maximisation and not transaction cost minimisation. In line with this criticism, the presentt thesis explicitly addresses the ability of a governance structure to meet the objectives off the transactors. This ability will be referred to as the 'effectiveness' of the governance structure.. One implication of explicitly addressing effectiveness is that a trade-off may have to bee made. In comparing governance structures, one structure may be less cost-efficient but it mayy come closer to realising an objective than another structure. Consider, for instance, a buyerr who wants to acquire a particular service. In one structure, the costs of finding a producerr and defining the terms of the transaction are high but the service can also be obtained att a high quality. In an alternative structure, there is more information, which facilitates the transactionn process, but the quality of the service is lower. In such situations the choice betweenn governance structures involves a trade-off between the higher effectiveness of one structuree and the higher transaction cost efficiency of another structure. Too evaluate the effectiveness of a governance structure, it is important to have a precise definitionn of the objectives to be attained and a methodology for measuring the extent to which thosee objectives are attained26. These points are now addressed in turn. Inn the governance structures examined in Chapters III and IV, the main players are producerss and the state. Producers are interested in maintaining continuity, while the state is assumedd to maximise social welfare. In the case of producers, this objective is not entirely consistentt with the neo-classical producer, who is modelled as a profit maximiser. The continuityy assumption recognises that the objective of profit maximisation does not imply that thee producer actually realises maximal profits. The attribute of bounded rationality, discussed inn Section 2.4.3, is one important reason why a producer often seems to follow a strategy of satisficing,, leading to a satisfactory rather than a maximal level of profits (Jansen, 1982). Furthermore,, a producer may be motivated by factors other than profit maximisation. Importantt stakeholders, for example, may be able to influence the objectives as well as the behaviourr of producers through lobbying and other activities. Sometimes, public support is necessaryy before a firm can operate or expand its activities. Such factors could enter the producer'ss objectives and lead him to adopt the objective of continuity. Continuity does not supplantt profit maximisation but is broader in that h combines profit maximisation with satisfyingg the needs of various stakeholders (Herkstroter, 1998). A strategy of continuity seemss particularly relevant to the air transport industry because of public concern about the industry'ss harmful effect on the environment. In Western Europe, and in the Netherlands specifically,, air transport has attracted a great deal of attention as a result. The industry is

255 Supra, p. 13. 266 Preferably, there is a unique, clear, consistent and comprehensive objective (Bakkes, 1989:58,192-193). 28 8 tightlyy regulated and in recent years court cases have restricted it further. The industry is dependentt upon public support and a stable operating environment as is reflected in the mission statementss and annual reports of KLM Royal Dutch Airlines (hereafter 'KLM') and Schiphol airport27.. These two companies also publish annual environmental reports and subject themselvess to environmental audits and certification (ISO). Continuity will therefore be adoptedd below to capture the objectives of the air transport industry2*. Thee objective of the state employed in this thesis is based on the theory of the Contract Social.. In this theory, it is presumed that the state has obtained elaborate powers in exchange forr a fiduciary responsibility to enhance social welfare. The objective of the state may then be definedd as the pursuit of those goals that enhance social welfare (Hennipman, 1977: 63 and 95: xx)299 In identifying the goals of the state they should not be confused with the goals of various otherr parties. In particular, they should not be confused with the goals of those (e.g. politicians)) who initiated or designed government policy. The latter goals may be partly or completelyy private, reflecting individual utility and political opportunity rather than official goals.. The goals are also to be distinguished from the goals of those who implement governmentt policy, as these parties also pursue private as well as state goals. The goals are furthermoree not identical to the more narrowly defined 'technical goals', which result from the translationn of (often implicit) social aims into concepts that are needed to implement the policy. Otherr problems include the operationalisation of those social aims. If technical policy goals are tooo narrowly defined to serve as an approximation of the state's goals, the researcher will have too formulate these goals himself, again giving rise to the introduction of private goals. Althoughh these subjectivity problems may be reduced by gathering as much information from ass many sources as possible, an element of subjectivity is likely to remain. The next question is thee measurement of goal attainment. One approach to evaluating the attainment of a given objectivee is to measure certain variables that directly capture the objective. For instance, if

Att present, KLM's mission statement does not refer to the interests of stakeholders. Its annual report for 1998-1999,, however, emphasises in various places the ckise relationslup between tlie oonn»!^ and I>itch societyy awl the significant inve&inents in em^ Schiphors mission is to be a leadingg international airport organisation. In achieving this goal, it aims to take into account the interests of all stakeholderss (annual report for 1999). SchiphoTs annual reportsincreasingl y focus on the city element of the airportt and the experience of being at thee airport ('Airport City^. It is üi frciiart contact with thee local connranrityy to discuss the airport operation and sa^ for fiMnie

29 9 environmentall protection is the objective, then the level of pollution might be one such variable.. The problem is that a favourable value of the variable chosen does not irrefutably implyy that the policy has been effective unless an extremely dubious ceteris paribus assumption iss employed. This problem of causality is fundamental. Even if a substantial change is observed inn the variable targeted by the policy, it may be difficult to tell whether this change is caused by thee policy or by other factors. Conversely, if a limited change is observed, the effect of the policyy may have been offset by other factors. Although some studies have tried to establish cause-effectt relationships by combining econometric studies with company interviews, this approachh does not offer a fundamental solution to the problem (Noorderhaven, 1990: 9). Noorderhavenn (ibid.: 10) has developed an alternative approach. Rather than measuring variabless capturing the objective directly, this approach looks at the relationships between essentiall players. In the context of the exchange of air transport rights, there are relationships betweenn states and between state and industry. The interstate relationships define limits within whichh the transaction is executed and influence the scope and content of the state-industry relationships.. The state's ability to realise its goals depends on the contribution to the state's goalss by foreign states and the industry and hence on interstate as well as on state-industry relationships.. This contribution, in turn, depends on the attributes of the governance structure. Forr example, the industry is more likely to act appropriately if the governance structure promotess interest harmonisation and provides performance incentives (for instance, rewarding thee use of noise friendly equipment via lower aircraft charges). Similarly, a governance structuree that allows the state to prescribe how the industry is to provide air transport and airportt services and enables it to monitor compliance should increase the industry's contribution.. Rather than evaluating the effectiveness of a governance structure by measuring changess in those variables that capture the objectives themselves, that structure may thus be evaluatedd in terms of the interaction between states and between the state and its agents. To thiss end, the state's air transport goal will be translated into subgoals, which in turn will be translatedd into requirements that pertain to the production of air transport and airport services (forr instance, noise pollution levels generated by production processes). Governance structures thenn differ in thee ability to meet these requirements30. This is the approach that will be adopted inn this thesis. It is well-suited to air transport and airport services because the characteristics of thesee services do not seem to be influenced by the governance structure that is used. Too conclude, the analysis performed in this thesis extends conventional transaction cost analysiss by explicitly addressing the question of effectiveness. It focuses on alternative structuress in terms of their ability to realise an objective at minimal transaction cost. In other governancee structure. In other words, the state should cluxïse a stnictnre which best meets otgectives, ghcn any constraints. . 300 Bokkcs (1989: 68) adopts a similar approach. He uses this aprxoadi, however, in anal^ng tninsacüoo costs 30 0 words,, it looks at whether a structure is effective and whether it is transaction cost efficient Thee next section discusses a final element influencing these properties. Section 2.7 then reviewss some broad categories of governance structures.

2.66 - Industry environment Inn addition to the elements described in the previous sections, the industry environment influencess the effectiveness and transaction cost efficiency of a governance structure. After all, thee process of concluding and executing transactions does not occur in a vacuum. The concept off 'industry environment' used in this thesis captures the structure of the industry, which may bee described as 'the relatively stable economic and technical dimensions of an industry that providesprovides the context in which competition occurs' (Bain, 1972: hi, 170). It reflects the degree off competition among firms in the industry, product differentiation, any scale economies and demandd characteristics. The industry environment influences the behaviour of firms and hence thee industry. It is an industry-wide feature, unlike the core dimensions, which apply at the level off the transaction.

2.77 - Governance structures Sectionn 2.2 defined a governance structure as the institutionalised matrix in which transactions aree being negotiated and executed, and observed that there are a number of alternative structures.. In Williamson's writings, each generic mode of governance is also supported by a distinctivee form of contract law (Williamson, 1989: 233-261, 1999a: 126). Some aspects of thesee governance structures also characterise the structure examined in this thesis, namely the 'State'31,, and may suggest ways of improving the State. Williamson calls the structures non- specificc (classical contract), semi-specific (neo-classical contract) and very specific (relational contracting).. The next sections will review some of the existing theory on governance structuress fromth e perspective of transaction cost efficiency.

2.7.11 - Non-specific structure Inn a non-specific governance structure, anonymous buyers and sellers meet each other to exchangee homogeneous goods at standard prices. A long-term relationship is not important andd new relations are created with ease. Uncertainty and the frequency of transaction do not playy a role. This structure is appropriate for transactions that do not require specific investments.. The costs generated by the structure derive mainly from negotiating separate and recurrentt transactions between independent agents. A legal system facilitates executing the transactionn but is not crucial, partly because the uncertainty associated with the transaction is

Notee that the 'State' will be used to denote a particular govcniaiK^ structure and the'slate'to deootc one (^ thee main actors in that structure. 31 1 nott relevant and the agreement is extensively worked out. The structure is supported by 'Classicall contracting' (Williamson, 1985: 69). Formal documents are important, formal provisionss apply in case of a dispute and compliance procedures, including remedies, are narrowlyy described. Onee example of a non-specific structure is the competitive market. The concept of a market wass originally defined as a physical place where buyers and sellers meet. Since then, the definitionn has evolved from a physical place to a process. Here, the market is seen as an abstractt exchange process formed by the total of factors determining demand and supply, with thee price mechanism as a co-ordinating system. Full-scale operation of the market will lead to ann equilibrium between demand and supply. For a market to exist, it is necessary to have propertyy rights, standards of weight and measure, and a uniform medium of exchange with a fixedfixed or predictable value. A market also requires channels for physical exchange (e.g. a shop) andd transaction routines governing initiation of the exchange (who can act) and the exchange processs including dispute resolution (Dugger, 1993: 192). A market is thus not a spontaneous institutionn but a product of institutional evolution. In a perfectly competitive market the goods transactedd are homogeneous, so that there is perfect substitutability, there are large numbers of buyerss and sellers who can contact each other freely without influencing the price (they are pricee takers), information about market conditions is freely available and there is no uncertainty.. Finally, there are no obstacles preventing complete mobility of resources, either intoo or out of an industry (Phillips, 1969: 31-32). The competitive market leads to a socially efficientt allocation of resources (ibid.). Not much can go wrong in this process. In real life, however,, most exchange situations do not meet the above conditions and market failures exist. Thee provision of services may generate negative externalities, or specific investments may be neededd to effect a transaction. Section 2.4.3 showed that in these situations continuity of the relationshipp becomes important. Furthermore, additional precautions will be needed to protect partiess from a breach of contract and to induce them to accept the risk associated with undertakingg the necessary investments or proceeding on the basis of imperfect information. As Coasee (1937) stated so succinctly, these elements will lead to transaction costs and may war- rantt the use of an alternative governance structure.

2.7.22 - Semi-specific structure Accordingg to Williamson, the semi-specific structure is often best-suited to non-standardised transactionss that occur incidentally and require an average amount of transaction-specific investment.. Compared to a non-specific structure, this structure offers a more flexible way of adjustingg to change and relationships last longer. In the event of a dispute, so-called 'trilateral governance'' applies, as the resolution of disputes will be placed in the hands of a specialised thirdd party via an arbitrage or complaint procedure. Given their specific assets, the parties find

32 2 hh too risky to submit disputes to a judge, while the frequency of contracting is too low to warrantt creating an internal dispute-resolution mechanism. The structure is supported by 'Neo- classicall contracting1. Regulationn falls into this category. Regulation can be described as a very incomplete form of long-termm contracting, where the regulated party is guaranteed a just return, in exchange for whichh the contract is amended gradually in response to changed circumstances, without the costlyy negotiating that would arise with a greater autonomy (Goldberg, 1976: 439, Williamson, 1976:: 91, 1986a: 276). Regulation thus involves some delegation of property rights to a third party. .

2.7.33 - Transaction-specific structure

2.7.3.11 - General comment Whenn non-standardised transactions occur frequently or a long-term agreement covers a multitudee of mini-transactions, the transaction-specific structure is the most appropriate form. Inn these cases the heterogeneous character of the transactions (and the ensuing risk posed by markett transactions) warrants introducing a specific structure. Williamson distinguishes the 'bilaterall structure*32 and the 'hierarchy' or 'unified structure'. Thee bilateral structure is best-suited to transactions that occur with a high frequency and needd an average amount of transaction-specific investment. In this structure, parties retain their autonomy.. There is no integration since economies of scale can be realised through procurement.. It is also possible that integration is not feasible, perhaps because parties value theirr independent status. The bilateral structure is problematic whenever a change in the relationshipp is needed. If a change is not foreseen at the start, a new agreement must be reached.. The following dilemma occurs: both parties will benefit from continuing the relationship,, but each parry also has a certain profit expectation that may be jeopardised by any changee in the existing agreement. This complicates any amendment, especially given the interdependencee between parties. Moreover, if a party expects its trading partner to behave opportunistically,, it may choose not to co-operate in an amendment, or to insist on lengthy negotiationss and elaborate drafting, generating high transaction costs. Any proposal to make a changee might be accompanied by a threat to end the relationship. Since the transaction-specific structuree involves sizeable investments, the threatening party will be faced with the substantial costt of creating a new relationship if it carries out any threat. Such costs diminish the potential gainss from opportunism and serve as a constraint on such behaviour. They will, however, not reducee the length or complexity of negotiations.

Notee that this bilateral structure is not the same as the Bilateral stnM^uregoveniing air tninsport The latter derivess its name from the bi-paitite treaties used toewhang e air transport rights. 33 3 Thee internal organisation of transactions within a unified structure has advantages in case of veryy specific transactions occurring with a high fiequency. Procurement is a possibility but the levell of asset specificity makes internal organisation more efficient. The benefits of this structu- ree include ready access to information and the ability to adjust the relationship with relative ease.. Problems surrounding amendments are minimal because there are procedures to guide anyy change and because interests tend to be harmonised. Thee transaction-specific structure is supported by 'Relational contracting' (MacNeil, 1981: 1043).. Here, not the text of the agreement, but the relationship as it has developed forms the startingg poinffor an interpretation of the fects. A contract is more relational to the extent that transactingg parties are incapable of reducing important aspects of an exchange to well-defined obligations.. In relational contracting, the longer, the more complex and more uncertain an anticipatedd relationship, the less significance will generally be attached to any price and quantityy variables at the formation stage33. The emphasis will be upon establishing (explicitly or byy way of tacit assumptions) rules to govern the relationship or transaction process. These includee rules covering unanticipated adjustments to the relationship, risk-sharing, the assignmentt of authority and its scope as well as rules concerning termination of the relationship (Noorderhaven,, 1990: 89-90).

2.7.3.22 - The firm Thee firm is an example of a hierarchy. The firm, in Coase's view (1988: 42), is a system of relationss that is created when decisions on the allocation of inputs become dependent on the directionn of a manager. Like the market, the firm needs property rights, transaction routines andd standards of weight and measure. But whereas the market involves separate transactions betweenn independent parties, the firm requires just one transaction. A long-term relationship is created,, in which transacting parties agree - within certain limits - upon working under the directionn of one of them, namely the manager. Production takes place team-wise. A hierarchy, furthermore,, enables the use of authority to end prolonged disputes and replaces the price mechanismm as a means of co-ordination34. Property rights are allocated to a single entity. Williamsonn (1999a: 106) considers fiat and forbearance to be central to the description of firms.firms. Fiat refers to the authority of the manager to fill in blanks left in contracts, which fccilitatesfccilitates detailing and adjusting the relationship. Any further detailing is embedded in certain structuress and processes of the relationship, thus ünüting the risk of opportunism. Forbearance impliess that a third party will not hear disputes between internal divisions. Access to courts beingg denied, parties have to resolve disputes among themselves. The firm can thus act as its

See,, however, Chapter III on the Bilateral governance structure. 344 Hierarchy is not the same as authority, as only the Ibnner is bacbxi by a specific instiiution^ (Menard,(Menard, 19%: 155). -*-—. «IBHIIWU 34 4 ownn court of ultimate appeal. These elements reveal the aspect of relationalcontractin g in the firm. firm. Thee firm might perform better than the market for a number of reasons. To begin with, it requiress fewer transactions. Its ongoing nature stimulates the availability of information and reducess the need to process information when the agreement is amended. It also enables any problemss to be solved at the moment they occur and lowers negotiating costs. In addition, the objectivess of transacting parties are more harmonised than they are in the market, reducing the riskk of opportunistic behaviour. This is not to say that there is no such risk. In a firm environment,, where there is bureaucracy, incentives to allocate the means of production efficientlyy are weaker than in the market since suboptimal behaviour might not directly affect outputt levels and, when there is team production, is harder to detect. There is also a risk of morall hazard in the form of shirking. In a team, every individual knows that his efforts affect thee reward of the team While every team member shares in the reward, the individual will bear thee full cost, which might induce him to lower his productive effort. The foregoing shows that, ass in the case of the market, there are costs involved in the use of the firm. There are direct costss of control, such as the resources needed to detect violators. The manager himself, furthermore,, does not generate a directly productive effort but concentrates on monitoring and supervisingg production. In order to be effective, monitoring requires the development and maintenancee of well-defined internal norms and routines, which also generates costs. The extra outputt of the team has to compensate for the costs of organising, controlling and disciplining thee members of the team (Alchian, Demsetz, 1972: 779).

2.7.3.3-TheState e Anotherr structure that can govern resource allocation is the State (amongst others Coase, 1988:: 115, Simon, 1993: 28, Pitelis, 1993: 8). In most governance structures, the state exerts influencee by, for example, guaranteeing the system of property rights. The State as a governancee structure, however, refers to a situation where the state holds the property rights too the good transacted and government actions constitute a specific way of preparing, concludingg and executing transactions. The state's possession of property rights is the defining characteristicc of the State. The state may also play a regulatory part. In this case the resulting governancee structure can be seen as a hybrid between the State and the semi-specific structure off regulation. North (1981: 21) defines the state as 'an organization with a comparative advantageadvantage in violence, extending over a geographical area, whose boundaries are determined byby its power to tax constituents'. This comparative advantage in violence puts it in a position too specify and enforce property rights. North goes on to explain the State using two theories, namelyy contract theory and predatoryy or exploitation theory. The former is a logical extension off the theorem of exchange (ibid.: 22), in which the state plays the role of social welfare 35 5 maximiser.. Since exchange foims the core of this thesis, North's contract-based definition of thee State is adopted for purposes of analysis. Thee state comprises all separate authorities, legal persons and bodies corporate that possess thee competence to issue laws or regulations. All these persons can be reduced to the term 'be- stuursorgaan',, as defined in the General Law on Administrative Procedures ('Algemene Wet Bestuursrecht'Bestuursrecht' - hereafter: 'A WB f\ In a representative democracy, like the Netherlands, the statee is entrusted with promoting efficiency and equity, fostering balanced growth and stability (amongg others Herniipman, 1977 and 1995), and creating conditions for exchange. The state mayy also be directly involved in the transaction process. Examples are the conclusion of treaties,, issuance of permits and commissioning of infrastructure! projects. These examples showw that, for the state to play a direct role, it need not engage in any production itself. It couldd make a third party responsible for the production or distribution of a product or service, underr contract, through regulation (Bokkes, 1989: 26) or both. Various factors can demand an activee role by the state (among others Hennipman, 1977: part I § 8). The state may have politicall motives such as the safety of its territory or relations with other states. An apt examplee is the state's involvement in air transport. The economic reasons for an active role by thee state can be categorised as market Mure and income redistribution (Berechman, 1993: 56- 60).. The transport sector offers many situations where these motives lie behind government interventionn (Phillips, 1969: 23, 31 and 43). For example, transport is claimed to be a merit goodd whose public provision at affordable prices is considered the best way to assure its widespreadd availability. Externalities, such as pollution through air transport, can also lead to statee intervention. The costs of negotiation with the producers who generate the externality mightt prevent any agreement. In such a case, government regulation may force people to acceptt some pollution in exchange for certain benefits36. Inn some situations, the State can be compared to a firm. The internal structure of a ministry underr the direction of a manager-bureaucrat is one such case. In addition, both the State and thee firm are based on continuing relationships. However, the State differs from the firm and the markett in some crucial respects. A central feature of the State is universal membership. More specifically,, a party residing in a particular country has no choice but to be subject to rules prevailingg in that country. It could choose to leave the territory but, while there, H is subject to applicablee rules and regulations. A second central feature is the legitimate power of coercion, i.e.. the monopoly of power. The state ranks higher than other agents and can exercise control

355 Article 1 para 1 of the AWB defines the state as 'on authority or a legal person person which has been established underunder public law, or another person or body corporate which is invested with any public authority, such as the centralcentral government, provinces or local «**oritf«y\ A cradaletemeiit in ÜK definition is u^ orderr ('bestuif); see Article 1 para 3 AWB. 366 See Coase (1960) making a powerful argument against the needier state interferemx in such a case, assuming,, however, the absence of traiisaction costs. The same argument appIiK 1994:22-23). . 36 6 overr their activities (Hennipman, 1977: 31 and 1995: 2). This has as result that transactions whichh might be viewed as beneficial from a Paretian viewpoint but are not realised in the privatee sector can be realised through some kind of coercion by the state (Stiglitz, 1989: 21). Thee above pollution example may be a case in point The legitimate use of coercion can be basedd upon the theory of the Contract Social (among others North, 1984, Stiglitz, 1988: 110). Itt means that the state is able to define and to enforce property rights.I n exchange for these extensivee powers, the state carries some heavy duties and responsibilities, the most important beingg the duty and responsibility to promote the welfare of its citizens. It is difficult to determinee what this objective entails since the concept of *welfare* is actually a collection of individuall objectives. Given the difficulty of gathering and processing information on each individuall objective, it is also difficult to arrive at a measure of social welfare. Even if the necessaryy information could be collected, it is virtually impossible to satisfy every individual's preferencess and to aggregate individual objectives in a way that is immune to manipulation. Apartt from satisfying current interests, the state looks to satisfy the needs of future generations andd any non-material aims covered by the broad concept of welfare. The state has to base its decisionss on an assessment of interests and wishes, guided by its own judgements and valuationss (Hennipman, 1977: part 1 § 8 and 1995: 25-26). The problem is exacerbated by the factt that, in politics, a vague and reassuring formula is often preferred to a precise and binding definitionn (Nicolson, 1964: 50). Furthermore, the state does not have a direct mechanism, like thee price mechanism, to measure the costs and benefits of alternative decisions. Decisions in a democracyy are usually taken on the basis of a weighing of the stated or revealed preferences of individualss with respect to the good. The mechanism effecting a decision is essentially a politicall process, characterised by lags, bottlenecks, coalitions, vote trading and so on (Wolf, 1994:: 63-64) and the causal relationship between the outcome of an election and individual preferencess is vague. Moreover, according to the theory of the Contract Social, not only shouldd decisions be directed at promoting social welfare, they also have to be seen as just by thee people involved (Stiglitz, 1989: 28-29). Deciding what is just is difficult. In the case of industriall policy, for example, should the state aid an ailing industry or enhance the competitive powerr of a successful industry? Not only does it lack a satisfactory notion of social welfare, the statee is also hampered in its pursuit of social welfare. Unlike firms or market participants, the statee does not face competition, which might make its actions less efficient. Compared with the market,, there may be fewer incentives to use productive factors in the most efficient way37. Thee absence of incentives also applies to the internal organisation of the state, where bonuses orr extra pay might be in conflict with the legitimacy of the state discussed earlier (ML: 26-27). Moreover,, the absence of competition reduces the ability to measure the quality of output

377 Although this may also apply to the fiim, the problem is greater here because with the State, the state does nott run the risk:o f default 37 7 producedd by the state. In the market place, information about output quality is transmitted to producerss via consumer choices. When there is no private alternative, quality comparisons are virtuallyy impossible (Wolf, 1994: 52-55, Chapter IV). The state's performance is further impairedd because it lacks the means or information needed to influence the effect of its actions inn the market. One reason is that the state generally needs outside parties to realise its goals andd that relations with these parties may generate agency problems such as moral hazard or adversee selection. In the context of a project geared toward realising a social benefit, adverse selectionn pertains to the selection of agents who misrepresent the social benefits stemming fromm the project. Moral hazard occurs when during the execution phase the agent deliberately failss to act as agreed, for instance, by using equipment other than prescribed. Although the state,, as a principal, has the ability to coerce, the existence of multiple goals may reduce the agent'ss awareness of the actions that are desired or required of him. The state, in turn, faces difficultiess monitoring the actions of the agent and relating them to its own goals. In order to reducee these problems, the state may choose to focus on resolving the conflict between its own interestss and those of the agent, rather than detailing appropriate behaviour through additional regulationn or trying to devise effective monitoring schemes. This strategy will be elaborated in thee following chapters. Problemss of adverse selection or moral hazard can also arise within the state organisation. Whenn the public calls for government intervention, it assumes that opportunism will be absent, sincee the state is entrusted with promoting the welfare of its citizens. Civil servants are expec- tedd loyally to serve all constitutional governments, irrespective of political party sentiments. Thee government, in return, is expected to place its trust in every civil servant, irrespective of hiss supposed party sympathies. A private firm, pursuing profit or continuity, will supposedly nott act in the public interest (Stiglitz, 1988: 62). Such assumptions fail to take into account the idea,, already present in the days of Adam Smith, that social welfare might be best served if everyonee served his own interests. They further deny the possibility that civil servants might placee private interests above the common interest. Yet, assuming that utility maximisation by ann elected civil servant means a desire to increase the chance of being re-elected, he will follow aa strategy to maximise votes and might be influenced by lobby groups. A civil servant who is appointedd will strive for promotion or other benefits and will therefore also be the target of variouss factions. Because the state has multiple goals, leaving considerable discretionary powerss to civil servants, the risk of moral hazard is greater within the State than the firm (Niskanen,, 1971: 36, Stiglitz, 1988: 199-203). Too summarise, the key features of the State as a governance structure are: 1.. universal membership, 2.. highest rank, 3.. elaborate powers (i.e. monopoly of power, ability to coerce) and 38 8 4.. multiple goals Thesee features make the State a transaction-specific structure.

Thee 'highest rank' feature warrants an additional comment. It means that the state has the abilityy to coerce citizens. Compared to other economic agents, the state has access to a broaderr set of instruments and mechanisms to motivate appropriate behaviour. In addition to regulation,, the state may use agreements, it may organise competition, H may introduce a hierarchyy by nationalising an industry, or it may stimulate the development of institutional guarantees.. In the relationship between states, 'highest rank' implies sovereignty and equality. Sovereigntyy makes it difficult to devise compliance mechanisms because it generally precludes thee use of external enforcement to resolve disputes. Unless a state explicitly accepts formal rules,, there are none, except for options under the Charter of the United Nations providing for compliancee mechanisms that make it possible to adjudicate states or to impose formal sanctionss ". Sovereign states jealously guard their independence and fear any erosion of their status.. This implies that states will not submit to adjudication on any significant issue unless theyy are certain that the decision will go their way (Shaw, 1991: 679). A decision in favour of onee state might also be meaningless when other states refuse to implement it and might, in fact, seriouslyy damage relations. The states therefore have to try to resolve any conflict amongst themselves.. They could agree to enforcement by a third party, but a prior commitment is seldomm seen (Shepsle, 1986: 71). In this sense, there is a lack of an external compliance mechanismm and a consequent incentive to behave opportunistically. This may constitute a seriouss shortcoming of the State as a governance structure. At the same time, earlier sections notedd the possibility that transactions may be self-enforcing. Trust, norms such as mores and traditions,, and environmental pressure all play a role and can make a state honour its commitments.. In the following chapters, the structures governing the exchange of air transport rightss will be analysed in terms of these sources of obligation. Too conclude, the above description of alternative governance structures aims to make clear thatt every governance structure has special features that influence the transaction process and thee level of transaction costs. Although the market has a central place in microeconomics, the discussionn shows that the market might not be the most appropriate governance structure for everyy transaction and that alternative structures are sometimes called for. As an example, if the characteristicss of a transaction call for elements of coercion and universal membership then the Statee would be the preferred governance structure. These might be transactions that would otherwisee not be realised because there are too many parties, or because they involve the productionn of collective goods. The differences among the non-specific, semi-specific and

Thiss does not mean an absolute freedom because only 'acts of state' arc exempted, i.e. actions by the state in relationn to another state (Shaw, 1991:128). 39 9 transaction-specificc structures described in this section mainly concern the flexibility of these structuress and the degree to which relationships are ongoing. In some structures changes are easilyy made within the existing agreement, whereas in other structures it is easier to sever the relationshipp and conclude a new agreement. In some cases it pays to amend the agreement only whenn h expires; in other cases it is preferable to leave a suboptimal relationship intact to avoid re-negotiationn costs. Further, a non-specific structure is not optimal for complex transactions andd a transaction-specific structure is a costly way of exchanging homogeneous goods at standardd prices. Traditional transaction cost analysis ranks governance structures in terms of transactionn costs, ft should be clear from Section 2.5 that effectiveness also matters.

2.88 - Concluding remarks Thee imperative in neo-institutional economics is to save on the sum of production and transactionn costs. With respect to transaction costs, this can be achieved by analysing a particularr transaction, given certain individual attributes and the governance structures within whichh it could be organised, and then choosing the structure that produces the lowest transactionn costs. In making a choice, the effectiveness of the governance structure also needs too be considered. In the next chapters the effectiveness of the governance structure will be analysedd in terms of the interaction between states and, following Noorderhaven, in terms of thee attributes of state-industry relationships. Its transaction cost efficiency will be analysed by lookingg at the cost effects of the transaction in the interstate and state-industry relationships. Thee analysis uses an integrative framework (see Sections 2.4.1-2.4.5) based on Van der Zaal (1997:: 148 onwards), which identifies and analyses the core dimensions of a transaction. Finally,, the industry environment influences the effectiveness and transaction cost efficiency of thee governance structure. The optimal structure may be a hybrid, combining features from severall alternative structures, recognising that each structure can improve the operation of the otherr (Wolf, 1994: Chapter 8). Any statements about the effectiveness and efficiency of a governancee structure will be formulated in qualitative terms. Rather than giving quantitative estimatess of transaction costs, such as a percentage of GNP or equivalent tax burden, they will givee some insight into the fundamental nature of and reasons for these costs39. Onee final comment is in order. It may be that the state does not pursue any goals in air transport.. In such a situation the approach may not be useful. The next chapter will show that thee state does pursue an explicit goal in the area of air transport.

Feww studies address this use of productive resources in finaiidal terms. Ooe example is DeVor (1992), who analysess the growth of government and relates transactional to tteanioum of reswmxs (as a pe^ GNP)) that a society devotes to the economic exchange piwess.TlüsisiKrtarwaysthebestwayofanah'sraga transactionn where the state is heavily involved (Bokkes: 19«9:193). Multiple objectives are a probl^ ass the &ct that the state's services are often hard to identify dearly. 40 0 Thee analysis is organised as follows. Chapter Dl identifies the reasons behind state involvement inn air transport. For the Netherlands, these reasons are translated into an air transport goal, a numberr of subgoals and concrete requirements that pertain to the provision of air transport and airportt services. The chapter continues with a discussion of the parties involved in the transaction,, the interstate and state-industry relationships and the transaction process. The focuss is on the traditional treaty structure governing the exchange of air transport rights. Chapterr IV addresses the Community structure, which seems to be essentially one of regulation.. Chapter V analyses for each governance structure the ability of the structure to attainn the air transport goal of the Dutch state, core dimensions of the transaction and the structure'ss transaction cost efficiency. The chapter thereby aims to determine which of the two structuress is more effective and more transaction cost efficient.

41 1 Chapterr III - The Bilateral structure

3.11 -Introduction Chapterr II classified transactions and governance structures using elements from transaction costt analysis. These elements are now applied to air transport, following the approach describedd in that chapter. Section 3.2 outlines the history and content of the Bilateral transaction.. Sections 3.3-3.5 consider the parties involved in the transaction, their objectives, thee nature of the transaction and the transaction process in greater detail. The focus is on the traditionall Bilateral structure as implemented in the Netherlands and, in particular, on the relationshipp between the state and KLM and Schiphol airport, these being the largest Dutch industryy players. Section 3.6 categorises the Bilateral structure using the classification of the previouss chapter and Section 3.7 looks at some further developments.

Recalll that this thesis analyses the exchange and regulation of air transport rights1 through whichh access to the market for scheduled international passenger air transport is obtained2. Markett access comprises various rights to use airspace for transit and transport and the right to capturee the benefits from this use. The states hold the property rights to the airspace above theirr territories, which means that only states are entitled to engage in every phase of the transaction.. The execution of the transaction is partly delegated to third parties, namely airportss and airlines. Thee various rights to use airspace and to capture the resulting benefits are also known as 'thee freedoms of the air'3, but in fact there is no real question of freedom. A central feature of thee Bilateral structure is complete and absolute sovereignty of a state with respect to the airspacee above its territory. The property rights to airspace belong exclusively to the state and itss explicit permission is necessary prior to any transport. This has not always been the case: untill the time airspace could be used for commercial (productive) purposes, there were no clearlyy defined property rights to the upper airspace. The rights to the lower airspace rested withh the owners of the land underneath, who were entitled to the undisturbed use of their land. Onlyy when technological developments opened up possibilities to use the upper airspace did it becomee worthwhile to create property rights. When these rights were specified, they were assignedd to states. From an economic point of view, this was an efficient decision because it wass expected that political factors would cause states to claim these rights. A direct allocation

Thee air transport rights form the bulk of the property rightst o airspace. Ass staled in thee introduction, this thesis does not look into freight transport or chattels. An extensive overvieww of regulationi n die air cargo sector is provided by Fennes (1997). 3Thee referencet o these rights as 'freedoms' can be traced back to the Slate ofthe Union speech fcy President Rooseveltt in 1941, who referredt o a new world order after the war in which there vv-ould be freedom or speech andd religion as well as freedom from want and fear (O'Connor, 1971:13). 42 2 madee it unnecessary to conclude transactions (Demsetz, 1966: 66). There are strong political motivess for assigning the property rights to states. States have been very much involved in air transportt from the outset. At first, the primary motivation was to guarantee safety on the ground,, which could be harmed by hazardous materials transported by air. The Peace Conferencee at The Hague in 1899, for example, issued a declaration in which the signatory statess agreed not to transport explosive materials during a flight or to throw materials trom a balloon.. Also in 1899, a conference took place in Paris with the objective to research possible wayss of developing air transport. The conference revealed two attitudes regarding air transport regulation.. The first promoted freedom of the air, stating that free flight does not cause any damage.. The second, at that time primarily supported by the British, strongly favoured state sovereigntyy with respect to airspace above their territories. Aircraftt were first used for military purposes in the first world war. Until then, they had beenn used mainly for communication or observation purposes. The effects could be seen at the Peacee Conference that took place in Paris in 1919, as well as in the text of the ensuing Paris Conventionn . At the conference, there was a common understanding among the delegates that thee free transport principles applicable to sea and inland water transport5 should not apply to airr transport (Mendes de Leon, 1992: 13, Fennes, 1997: 60). The main reason for such an exclusionn was that, at the time, the consequences of such freedom could not be foreseen. Furthermore,, routes and airports along these routes had been developed with substantial investmentt by the states, which had to be recouped (Bin Cheng, 1962: 8-9); the French wanted too protect Paris; and the British wanted free air traffic to their overseas territories (Bouwens, Dierikx,, 1996: 27-28). The conference resulted in the establishment of the principle that states shouldd have complete sovereignty with respect to airspace above their territories, which meant completee assignment of property rights to states. Sovereignty notwithstanding, parties acknowledgedd in principle the righto f free thoroughfare and the right to use civil airports in otherr states. To be sure, this was not a natural right but a privilege to be granted by the sovereignn power (Verptoeg, 1963: 13-14). Althoughh the Paris Convention did not deal with exploitation issues, the provisions of the treatyy had a great impact. Sovereignty on the one hand impeded transport, since it could only takee place when an approval had been given. This requirement further made airspace a valuable nationall asset, which could be used in trade negotiations (Doganis, 1991: 26). On the other hand,, sovereignty stimulated transport in and between signatory states because an approval guaranteedd an undisturbed operation. This provided the industry with the confidence needed to embarkk on ever-increasing investments in, for instance, aircraft or airport facilities (Bin Cheng, 1962:: 8, Barzel, 1989: 73) and motivated the Netherlands to ultimately ratify the treaty in 1928

Conventionn relating to the Regulation of Aerial Navigation of 13 October 1919. A5Uadöbwn,forexanip)eJnUM:MaiutheiraCoiivetiüonoff 17 October 1868. 43 3 (Bouwens,, Dierikx, 1996: 28). Duringg the second world war, civil air transport in Europe came to a virtual standstill. At thee end of the war, there was again a clear division between states that favoured a completely unrestrictedd development of air transport and states that wanted to retain sovereignty. Every statee did, however, agree that, since air transport had become part of world-wide trade negotiations,, H was necessary to reorganise the industry's institutional structure. During the war,, initiatives had already been taken towards an international conference that would deal withh these aspects. The conference began in Chicago in November 1944. It showed considerablee disagreement between the European states and larger states that made greater use off air transport. The Europeans mainly looked at air transport as an instrument specifically designedd to safeguard links with their (former) colonies. This instrumental function is to some extentt reflected in the names of national airlines, which often refer to the respective countries wheree the airlines are established: they carry the flag ('flag carriers') (Kasper, 1988: 70, Havel, 1997:: 85-86). The United Kingdom, furthermore, thought of air transport as an infant industry thatt needed protection. In their opinion, freedom could only exist with sufficient regulation. Forr this purpose the British proposed establishing a multinational 'International Air Authority' thatt would have regulatory powers in such areas as the exchange of transport rights, tariffs6, frequenciess and capacity. To the United States a transfer of political powers in the trade domainn to an international organisation was unacceptable. The delegates could not come to an agreementt on these fundamental issues and the conference ended with a treaty - the Chicago Conventionn - which essentially deals with air traffic (i.e. operational) issues rather than exploitationn issues7. Off primary importance for the post-war development of air transport is Article 1 of the Chicagoo Convention. This article formulates the absolute and complete sovereignty of a state withh respect to airspace above its territory. Together with Article 6, which states that schedu- ledd air transport over or to a state can only take place with an explicit approval or permit from thatt state, the basic elements of the market were put in place. Exploitation issues were partly deferredd to a future conference and partly addressed in two annexes to the Convention, namely thee 'Air Services Transit Agreement' and 'Air Transport Agreement'. In these annexes, for the firstt time, the air transport rights were divided into 'freedoms'. The Air Services Transit Agreementt codified the first two freedoms, while the Air Transport Agreement embodied the firstt five. Note that the annexes did not grant any right of transport as most states wanted to addresss the political aspects of their air transport relations through bilateral arrangements (Wassenbergh,, 1957: 15-18, O'Connor, 1971: 43-45). Furthermore, the annexes, especially the

AA tariff is the price charged for the carnage of passengers, baggage or caigo(exchidinginail) and the conditionss governing its availability and use (ICAO definition Doc 9587, Part n-A). 77 Convention on International Civil Aviation, opened I6rsignadarec« 7 December 1944. As at 16 June 1999,

44 4 Airr Transport Agreement, were not widely accepted.

3.22 - Bilateralism Althoughh formal treaties were used to exchange air transport rights as early as the period after thee Paris Convention, it became an accepted practice after the Chicago Convention was concluded.. It should be stressed that neither the Chicago Convention nor international law madee this mandatory, although Article 6 of the Chicago Convention opened up the possibility off subjecting a foreign carrier receiving access to national laws". To facilitate the conclusion of formall treaties, the delegates to the Chicago Convention agreed on a model Air Services Agreementt (also known and referred to as a 'Bilateral'), which became an annex to the Chicagoo Convention. The manner in which Bilateral treaties govern the exchange and operationn of air transport rights became known as 'Bilateralism*. Inn 1946, the United States and the United Kingdom concluded a Bilateral in Bermuda, dealingg with the exchange of air transport rights over the North Atlantic. This Bilateral was a compromisee between the two countries1 positions at the Chicago conference. The United Kingdomm gave up its demand for a prior approval of frequency and capacity, whilst the United Statess accepted the tariff-setting procedure of the International Air Transport Association (hereafter:: 'IATA')9. This 'Bermuda I treaty' has operated from 1946 onwards as a standard forr Bilaterals concluded around the world. In 1959 the European Civil Aviation Conference (hereafterr 'ECAC')10 issued model clauses (hereafter: 'Standard Clauses') based on experiencee acquired under the Bermuda I Bilaterals and the model from the Chicago Convention.. Both ECAC and the International Civil Aviation Organization (hereaften 'ICAO') calledd upon their members to make use of the Standard Clauses. In practice, a more or less fixedfixed Bilateral structure has emerged. It consists of three parts, namely the actual treaty, the annexx and often an 'Exchange of Notes* or 'Memorandum of Understanding' (hereafter the 'Memorandum'). . Thee treaty itself provides market access. Two central provisions relate to tariff setting and capacity.. The Bermuda I Bilaterals frequently state that tariffs will be set by the carriers that willl operate services, where operational costs, a fair profit and tariffs of other carriers should bee taken into account. This concept is also embodied in Article 7.1 of the Standard Clauses.

1855 states were party to the Chicago Convention. Source: ICAO1999. 88 An alternative way of arranging approval (Gidwhz,, 1980:154-155), which was common practice in the interwar period Nowadays permits are mainly usedd by scheduled carriers in anticipation of an aineridniem of a Bilateral, for eatample to enable an extra frequency,, such as the Bilateral between (he Neuwlanc^ and Ai^entina. Tliei» of perrnits is increasing as markett deregulation leads to an increase in charter operations arid charters operate on tfie basis of pennits. 99 Intra, Section 3.3.4. 100 Infra, Section 3.3.4. 45 5 Thee establishment of a tariff may be referred to the tariff setting procedures of IATA11, with transactingg states retaining the right to approve or reject the outcome. AA basic principle of Bilateralism is the sovereignty and fundamental equality of the transactingg states. This involves non-nliscriinination and equal treatment with respect to operationaloperational issues and mutual acceptance of licences and certificates of airworthiness. In addition,, there is mutual acknowledgement of national laws and regulations regarding such issuess as navigation, entry and clearance. There is no general uniformity in these rules, as noted byy Balfour (1995: 30-31), who discusses the problems associated with having to meet various requirementss related to aircraft certification, aircraft maintenance and crew licensing. Another consequencee of the principle of equality is reciprocal exchange. The capacity clause often statess that the primary objective of any transport should be to provide adequate capacity to and fromfrom the home country. In determining capacity, the interests of the other carrier need to be takenn into account as both carriers should have a 'fair and equal opportunity'. This 'quid pro quo'' is a fundamental element of Bilateralism and mirrors domestic law. Klabbers (1986: 26 andd 86-87), for instance, observes that in many domestic legal systems agreements can only be consideredd legally binding if they involve a real exchange: if there is literally a 'quid pro quo'. Althoughh the doctrine of consideration has never met with general acceptance in international law,, in Bilateralism the concept of quid pro quo is a central theme. The content of the fair and equall opportunity principle varies greatly from an equal starting position, with the creation of 'opportunity** guaranteeing 'fairness', to the opposite extreme, which explicitly lays down the numberr of passengers that a carrier is allowed to transport within a given period (Dempsey, 1987:: 63, Fennes, 1997: 90-93). The Netherlands adhere to the first interpretation which is alsoo the current trend (ICAOa, 1998). Fennes (1997: 202) describes the practice of the United States,, which often aim for maximum market access because they cannot secure an equal outcomee in transactions with smaller states. A case in point is the 1992 Open Skies Bilateral withh the Netherlands (also Bouwens, Dierikx, 1996: 226)12. Note that the Americans used the agreementt in a strategy directed at creating a precedent in relations with larger countries13. However,, even an Open Skies Bilateral requires a form of reciprocity since every transaction is aimedd at obtaining benefits of similar magnitude14. A typical reaction on the part of states confrontedd with falling market shares for their carriers is to insist on frequency caps, schedule

111 Infra, p. 70. 122 The Open Skies Bilateral will not be analysed in this thesis because it diffen; significaitUy &ora a tradilioiial Bilateral.. Rights and benefits are exchanged on the basis rf(suslaiiied) competition aiid there is no prior regulationn of access, capacity or price (Fames, 1997:206). Furthermore, although Open Skies Bilateral* are economicallyy important to the Netherlands, tradilionaJ Bilatoals arc s^ far r«)re noroerous. Thee Americans followed an all-or-nothing söategy(HaYeU997:191, note 315), U.eh^ HH ff*? ïthe a«rec,neBte «WW «* «** **>

Fifthh freedom is the right to fly into the territory of a foreignn state and there take on or discharge traffic destinedd for,o r coming from a third state. Havel (ibid: 181) notes France's relationshipwit h the United Slates. Thee French tactic of forcing the US to accept capaciiy restrictingW M nothing Ws t*wi a total (temnciafkm of

47 7 compliancee and enforcement. Thee Bilateral exempts airlines from duties and charges for equipment, oil and other technical provisionss necessary to operate aircraft. It further contains technical and operational provisions andd covers designation and authorisation of the carrier that is to operate the rights exchanged. Eachh state designates a competent carrier or carriers to operate certain routes, where 'competent'' means permitted under the laws and regulations of the designating state to engage inn the type of operations covered in the agreement. The carrier is also subject to a nationality requirement,, which is motivated by safety and political factors. A state only wants to grant rightsrights to a specific state and wants to be certain about which carrier will operate any flights. It doess not want carriers from other states to take care of the transport and so benefit from the exchange.. In this respect, the Bilateral resembles a preferential trading arrangement, based on ruless of origin. Since air transport entails the provision of a service by way of cross-border movements,, the traditional rule of origin is replaced by a rule of ownership (OECD, 1997: 94). Thee nationality requirement means that substantial ownership and effective control of the airlinee have to be in hands of the citizens of the state to which the rights have been granted. Traditionally,, the requirement is met when the board is mostly national and the carrier operates flightss with domestic crew and aircraft. Current Bi laterals may contain a rather weak test, namelyy that the designated airline be incorporated and have its principal place of business in the designatingg state (ICAO, 1998a: 22). This demonstrates that under Bilateralism each state is effectivelyy free to decide what exactly is meant by 'substantial ownership' (OECD, 1997: 76)16. . Manyy countries (including the Netherlands) follow a policy of single designation, if not formallyy then in practice, and authorise a single carrier to operate the rights exchanged. An ECC AC survey found that, although two-thirds of the Bilaterals do not require single designati- on,, in only 8% of all cases has more than one carrier per country been designated (Williams, 1994:: 70). The limited use of multiple designation can be attributed to the attitude of transactingg states and to the small number of carriers interested in the operation of certain routes.. Single designation contributes to a close bond between the state and flag carrier.

Thee second part of the Bilateral is an annex that makes specific the rights that have been exchanged.. It addresses routes, commercial rights and accessory provisions. Route regulation iss important to a carrier because the route is an important cost factor, and because route

itss Bilateral. Havell (1997:421) mentions a de faclo waiver of the nationality requirement in the case of Aerolinas Argentinas.. hi 1997, Iberia acquired a majority slake in the Argentinean flag carrier, but Aerolinas Argentinas remaüxxlttedeagnatedd airline of itó off Transport (hereafter: 'DOT') accepted Uns, and o^^looked the violation of the nationality clause in the parties'' 1985 Bilateral. In December 1999 Singapore airlines acquired a 51% majority shareholding in t>^ Britishh carrier Virgin airlines. Controversies similar to those of the Aerolinas Argentinas case may arise 48 8 flexibilityflexibility enables it to enhance the value of its transport network by adding intermediate points inn case of sufficient traffic potential. Bilateralism shows no uniformity in route regulation, whichh might vary from a freedom to fly to any point in the destination country and choosing anyy stop along the route to an explicit mention of an airport that is to be sole point of departuree or arrival. The Air Transport Agreement contains the principle that a route should formm 'a reasonably direct line' to and from the home state of the carrier. According to the Unitedd States at the Chicago Conference, 'reasonably direct' means the shortest distance. Otherr countries, including the Netherlands, feel that operational and commercial criteria should alsoo be taken into account in choosing a route (Wassenbergh, 1957: 37). In practice, the economicc importance off route flexibility has meant that disputes are not uncommon. Finally,, in executing the transaction, use is made of rights influencing the exercise of freedomfreedom rights (also known as 'hard rights'). These accessory provisions deal with such matterss as ground handling, sales and marketing, limits on the export of currencies and the use off computerised reservation systems (De Murias, 1989: 16, Fennes, 1997: 384). The provisi- onss are usually referred to as 'soft rights* or 'doing business rights'17. A lack of fare flexibility, causedd by the need for governmental approval, increases the relevance of non-price competition.. Soft rights enable a differentiation of air transport services, which makes them importantt for the competitive strength of an airline. In general, soft rights are unregulated, leavingg each state free to grant or refuse any soft rights and even to cancel rights previously agreedd during operation. The resulting uncertainty has led to increasing efforts in negotiations too make these valuable rights part of the Bilateral18.

Thee Bilateral frequently contains a third part, namely the Memorandum. Whereas the Bilateral mustt be registered with ICAO, the Memorandum is not subject to any such requirement. This offerss the benefit of secrecy and allows the document to serve multiple purposes. First, it can bee used to make additional arrangements without the need to go through a formal domestic approvall process. This is also an advantage whenever the Bilateral is being amended. A Bilaterall is entered into for an unlimited period, although termination is possible upon 6 or 12 months'' notice. Revisions may be required if the industry operates in a dynamic environment. Becausee a Memorandum can often be entered into by civil aviation authorities, the use of this instrumentt requires fewer formalities. Moreover, the Memorandum can be used to significantly deviatee from the (publicly known) Bilateral without prejudicing future negotiations with third states.. Secrecy can enhance the likelihood of reaching and quickly implementing an agreement, iff only because the public and parliament in the home country remain unable to form an

177 Fennes (1997:348,3S3-387) objects to the use of the term soft rights because they are crucial to the operationn of flights and in this respect as 'hard' as the so-called 'hard rights' 18Infta,p.74. . 49 9 adequatee opinion on pertinent issues and will not interfere in the negotiation process (Bracke, 1995,, 158, Williams, 1996: 70, Fennes, 1997: 357). A Memorandum therefore constitutes a meanss of achieving flexibility.

Thee analysis now turns to a description of the parties that are relevant to the exchange.

3.33 - Parties to the transaction Chapterr II pointed out that the analysis of any governance structure requires an investigation intoo the nature of and relationships between the parties involved. In air transport, where the statee uses airlines and airports to realise its goals, certain agency aspects warrant particular attention.. Sections 3.3.1 - 3.3.4 describe the respective roles of states, airlines, airports and the mainn international organisations.

3.3.11 -States Bilateralss are concluded between formally equal states that hold the property rights to the airspace.. In the Netherlands, the Civil Aviation Air Transport Division (hereafter 'CAA'), part off the Ministry of Transport, Public Works and Water Management (hereafter: 'Ministry of Transport'),, is responsible for air transport. The Dutch Ministry of Transport has multiple roles.. First, within the governmental organisation, it is the ministry responsible for air transport policy.. As such, it is responsible for the negotiation of Bilaterals. It also issues regulations, sometimess in co-operation with the Ministry of Housing, Regional Development and the Environmentt (hereafter 'Ministry of VROM') and is entrusted with securing and monitoring compliancee with these regulations. Finally, h holds financial interests in the air transport sector resultingg from ownership in, for instance, Schiphol airport and KLM. A more detailed look intoo the ministry's responsibilities shows that the combination of these roles is a potential sourcee of conflict. Safety concerns, for example, could call for measures that harm financial interests.. Furthermore, because some of its responsibilities lie outside air transport, the ministry willl often look at factors other than the industry's performance19. Ass noted above, the Ministry of Transport is not the only department involved in air trans- port.. A close link with foreign and environmental policies creates areas of responsibility and competencee for the Ministry of Foreign Aftairs and the Ministry of VROM. The Ministry of Foreignn Aflairs usually has three roles (Gidwitz, 1980: 120). First, it establishes a general internationall civil-aviation policy to guide the government in its air transport relations with otherr states. For example, it might endorse the operation of commercially non-viable routes for

199 This potential source off conflict has been acknowtedgedbythcMinisterof Tranqxm, wboin 1998 announcedd a process of disentanglement ('bestuurlijke ontvlechting') to reduce the multiplicity of roles and thuss the chance of any conflict 50 0 foreignn policy reasons. Second, it provides the political or economic background necessary to evaluatee air transport relations with specific foreign countries. It investigates the likely impact onn general bilateral relations of various options available in any negotiations. Third, it is part of thee delegation that negotiates the Bilateral. The Ministry of VROM holds competence in areas mainlyy related to land use and the environment. Thee direct relationship between the state and air transport discussed above follows from the assignmentt of the property rights to airspace to the states and the sovereignty of states. These elementss are reflected in Articles 1 and 6 of the Chicago Convention20, which in turn stem from nationall interests (for example, OECD, 1997: 72-73, Frames, 1997: 61-62). Although policies differr among countries, the state's air transport goal can generally be translated into three groupss of reasons for state involvement. These are psychological factors, financial motives and politicall motives (O'Connor, 1971: 89, Wheatcroft, 1964: Chapter 3, Wassenbergh, 1957: 21- 22).. The second category of financial motives warrants some comment. The literature on air transportt policy usually refers to this type of motive as 'economic'. However, any objective of thee state in so far as it uses up scarce resources can be deemed economic. In this sense, there aree no economic ends (among others: Robbins, 1952: 16, 145, Hennipman, 1977: part 1 § 7 andd 1995: Chapter I, more specifically pp. 20-21 and 27). The essential characteristic of a policyy defined as 'economic' is the government pursuit of social welfare, encompassing every motivee conceivable, by allocating the goods available within the economy and by influencing theirr use. For purposes of analyses, in this thesis the state's social welfare objective (see Chapterr U) will be translated into a sectoral air transport goal, and this goals will be translated furtherr into subgoals. In addition, to be consistent with the literature on welfare economics, the usee of the term 'economic' is avoided. The goals that are considered 'economic' in the aïr transportt literature generate monetary and derived financial benefits for the state. Therefore, theyy are referred to as 'financial' goals below. A final comment that needs to be borne in mind throughoutt the analysis is that this thesis is not a welfare analysis- The goals are now consideredd in greater detail.

3.3.1.11 - Psychological goal Internationall 'prestige' is frequently cited as a reason for government involvement in air transport.. Prestige can be described as the opinion the world holds of a carrier or a state, in a generall or technological sense. It can be acquired through a domestic air transport industry and nationalityy requirements, such as the substantial ownership and effective control requirement applicablee to airlines. The importance of prestige is diminishing with air transport being increasinglyy considered as a regular economic activity. However, for some countries, such as

Articlee 1 formulates the sovereignty of states with respect to the airspace above their territories, while Article 66 lays down the requirement of a specific permission prior to any transport 51 1 developingg countries and France, it is still very important. For developing countries, the operationn of a domestic air transport industry puts them on an equal footing with developed countriess and enhances self-confidence, while for France the existence of a flag carrier contributess to feelings of national identity. Dierikx (1999: 149) observes that financial aid to KLMM after the second world war was motivated by prestige. Currently, prestige plays a limited rolee in the Netherlands. KLM, for example, is not majority owned by the state and the state's ownershipp of Schiphol airport does not seem to be prestige related. A further example of the apparentt absence of national prestige is the removal of the Dutch crown on KLM aircraft flying too Taipei, based on a request by the Chinese government21. The Scandinavian Airlines System* (SAS),, a joint holding company incorporated by the Scandinavian states of Sweden, Norway andd Denmark, also illustrates that for some states national prestige in air transport is unimpor- tant.. SAS is designated to operate the majority of international route rights. The states no longerr have their own flag carrier, instead SAS aircraft fly under a single name and are not clearlyy recognisable as carriers from any particular state22. The designating state can no longer claimm the benefits flowing from a good performance by the airline as it has to share any benefits withh its partners. However, prestige is not altogether absent. Li the Netherlands, the government'ss decision to allow the Dutch aircraft manufacturer, Fokker, to go bankrupt causedd a public outcry (Jagersma, 1994). A more recent illustration is the 1999 decision by Britishh Airways to reinstate the English flag on its aircraft to comply with public sentiment23.

3.3.1.2-Financiall goal AA further reason for state involvement is the financial goal. The state derives revenues and otherr financial benefits from air transport. In particular, the airline's income contributes to foreignn exchange reserves, while airport and airline services produce tax revenues24, direct valuee added and indirect value added in related industries such as aircraft manufacturing25. The airr transport industry is a considerable source of employment. In 1999, 51,093 persons found aa job in the air transport industry itself while a similar number of jobs were estimated to be held inn industries related to air transport (Amsterdam Airport Schiphol, 2000). Because of these derivedd benefits, Dutch air transport policy actively stimulates location decisions by firms. The

Thee flights arc even operated by a separate KLM subsidiary (Dierikx, 1999:336). Swedenn controls 3/7 of the shares, Denmark and Norway 2/7 each. National quotas are maintained National registrationn remains necessary to meet the nationality requirement imposed b>r the Bilalerals NRC,, De Firma, Rood-Wit-Blauw, 11 June 1999. 244 Note that VAT is excluded on international airline tickets, while public ownership of Schiphol airport e- xemptss it from corporate income tax levied by the Dutch state. 255 This is only relevant to the extent that domestic awliKS buy aircraft reduced b (O'Connor,, 1971:93). Dierikx (1999:160,163) comments that whereas French and British carriers were requiredd to operate with domestic material, IOJ^ was free to order fiom foreign marfuochiiersard obligedd to acquire Fokker aircraft. This provided KLM wito a awnpeütive advantage. 52 2 mainportt Schiphol is important in this context26. State ownership of shares in airlines and airportss is a further source of state revenue. In the case of the Netherlands, KLM and Schiphol respectivelyy paid NLG 28,9 billion and NLG 26,5 billion in dividends in 1998. The sale of KLMM shares in 1998 contributed NLG 717,5 billion27. Air transport also plays a role in promotingg and facilitating transport and trade2*. This facilitating role is often overlooked becausee of its interaction with other factors. The viewpoint of air transport as a facilitator of transportt and trade partly reflects a desire to co-ordinate the entire transport sector. Any such co-ordinationn is frustrated when the terms of competition differ across the various transport modes.. Thus, Article 73 EC declares the provision of aid to the transport sector, with a view too such co-ordination, compatible with the EC Treaty. Especiallyy in a trade-oriented country such as the Netherlands, air transport plays a strategic role.. Various policy documents and decisions (for instance, Voorlopige Raad voor Verkeer en Waterstaat,, 1991, KEPD, Ministry of Transport, 1997, Ministry of Transport, 1999b) contain referencess to that effect. The financial benefits to the state vary in size and can be substantial forr a small country with a large air transport industry. A state may thus want to use its influencee to protect or improve its current position. Inn formulating its air transport policy, the state faces some dilemmas. The performance of thee industry as a whole may come into conflict with the performance of an individual firm. Moree specifically, the public may benefit from an expansion of capacity even though a particularr airline is experiencing excess capacity. The dilemma is complicated by the fact that a decreasee in capacity to boost load factors could lead to a transfer of potential customers to otherr forms of transport. The state faces another difficult situation in its choice between the interestss of the national carrier and the interests of the public. Citizens are generally equally well-servedd by foreign companies. In deciding whether a foreign airline should be allowed to operatee a route in competition with domestic airlines, the state is usually persuaded by financial interestss and domestic lobbies to restrict entry by the foreign airline. Most routes are thus dominatedd by the airlines of the final destination countries. An example of the opposite situationn is given by Forsyth (1998: 76-77). In Australia, the government realised that it would bee very difficult to restrict Asian airlines carrying passengers from Australia to Europe on a sixthh freedom basis . Since many of these passengers were Australian, the government was preparedd to allow them low fares rather than protect the domestic airline. Australia has not

266 'Mainport' is a term coined by Dutch policymakers and is defined in the 1995 Key Environmental Planning Decisionn ('Planologische Kernbeslissing', hereafter: 'KEPD') as 'an airport that is the home base of and central Europeann airport for at least one of the future dominating airlines'. 277 Source: CAA, Annual figures 1998. 288 Note that the promotion of transport and bade has both income and redistribution effects. Sixthh freedom traffic is a combination of two freedom rights, namely, the third (transport from the home countryy to a third country) and fourth (transport frca a tlwdoouinty to the h^ sixthh freedom right is traffic from country A to country B via a carrier's home country. Infra, p. 72. 53 3 beenn as prepared to allow foreign carriers to operate routes on which its nationals make up onlyy a small proportion of the passengers. AA dilemma of a different nature is the conflict between financial goals and concerns for the environment.. These concerns will be discussed in the next section.

3.3.1.33 - Political and social goal Thiss category covers the entire range of political and social goals which a state could pursue. Derivedd from the ultimate objective to guarantee the continuing existence of the state, impor- tantt considerations include military motives, such as the ability to draw on a civil air transport industryy during military emergencies (Borenstein, 1997: 529), the creation and development of domesticc airports, as well as the accumulation of expertise. An example falling into this categoryy of goals is given by Gidwitz (1980: 146), who describes the American acquiescence too Icelandair's low-fare service between the United States and certain European points in exchangee for Iceland's membership of NATO and the location of a key American air force base onn its territory. Once again, conflicts might arise. Security considerations could lead to a particularr route being closed, thus increasing the costs faced by an individual airline. Political considerationss are also present in the maintenance of air links between (former) colonies and thee mother country and in the promotion of air transport to countries where the state wants to increasee its influence. Dierikx (1999: chapter II) gives many examples of how these factors havee influenced the air transport relationship between Indonesia and the Netherlands after Indonesiaa became independent. Thee exchange of air transport rights is associated with good relations among states. Gidwitz (1980:: 23-24) cites the Bilateral between the United States and the former Soviet Union. A furtherr example is Taiwan's national carrier, which operates flights between the Netherlands andd Taiwan on the basis of an agreement at the airport level. The absence of a Bilateral can be attributedd to the controversy over Taiwan's position as a sovereign state. In discussing the Unitedd States' procedure for accepting foreign designations, Havel (1997: 167) also notes the importantt role of foreign policy. For instance, the President of the United States may review DOTT decisions with respect to the award or transfer of route authority and may reject a DOT actionn on grounds of'foreign relations or national defence considerations'. Sociall considerations lie behind the provision of air transport to remote regions as a means off developing or integrating such regions. The establishment of an air link in such cases is cheaperr and faster than constructing a road. In many instances regulatory structures have implicitlyy embraced this role of air transport by fostering cross-subsidisation of services (OECD,, 1997: 103). Other social goals cover such areas as external safety, healthcare and workingg conditions in the industry. Environmental protection is gaining importance as a social goal.. Air transport generates negative externalities in the form of noise problems, the emission 54 4 off pollutants, accident rides and congestion . While the share of air transport in global environmentall pollution is still small, this share is growing steadily due to high growth rates in airr travel. Environmental problems may be quite severe at a local level (Schipper, 1999: 184, Button,, forthcoming), while local environmental lobbies tend to be powerful at that level (Van denn Bergh, 1994: 68). Reflecting these pressures, the Dutch KEPD formulates requirements thatt capture a dual objective ('dubbel doelstelling') of strengthening Schiphors 'rnainport' functionn whilst simultaneously improving the quality of the airport environment31. The KEPD layss down strict environmental conditions, including a noise zone delimiting the operation of Schipholl airport and a maximum of 44 million passengers annually by the year 2015. Local air qualityy and accident risks are to be kept at predetermined levels. Environmental provisions havee been part of the Dutch model Bilateral since the mid-1990s, in line with growing concerns forr the environment, which form a general feature of the Western European economies (Kirchner,, 1992: 44). The Bilateral provisions vary between requiring a best effort and an explicitt mention of the aircraft type to be used. The multiple options available indicate the roomm for manoeuvre desired by states as they tailor their Bilaterals to meet the demands of any givenn relationship. Notee that there is no economic incentive for any single country to initiate internalisation strategiess beyond those with immediate national implications (Button, forthcoming). This may providee a reason for dealing with environmental issues at an international level. Chapter V will lookk into tins issue further, when discussing the effectiveness of the Community structure.

Thee above discussion shows that in the air transport industry, as in other industries, the state pursuess various goals. These goals may conflict and may also change, depending on financial orr political circumstances (Hennipman, 1995: 34). The inclusion of environmental provisions in thee Dutch Bilaterals illustrates the point, as do the examples given by Havel (1997, 183, note 274).. He explains how the German government adjusted its attitude according to the financial positionn of Lufthansa when negotiating a new Bilateral with the United States. Dutch policy traditionallyy aimed at acquiring a maximum of transport rights to support the transport networkk (for instance, Voorlopige Raad voor Verkeer en Waterstaat, 1991: 34-3532, Ministry off Transport, 1998b). The relatively small potential of originating and destination traffic to and

300 Pollutants include carbon dioxide, benzene, methane «id caAmt monoxide Ktofr tM PO«e iHiwamcfr is gettingg the most attention in terms of public concern and poUcy issues (Schipper, 1999:43-44). Thiss dual objective may be considered 'poldennodeT.. This model is claimed to he a modification of the «waltod Hhinrfamri nw« «*ir* ^^1^ 9 regulatedd market economy with a oomprehensive system of social sectuity and where govermnent^ organisationss and laboor mrions consult each oAef about tig g"^ to fe P1™*^ a^ ^'^ r^^'^tniments tobeused(Bolkestein,, 1999:97-98). The extensive consultations lead to vague decisions and compromises, oftenn incorporating confKrting goals Thee opinion of the 'Voorlopige Raad voor Verkeer en Waterstaat* also 'mstainaKiiiy' h«t moree in the sense of a sustainable link between the carrier and Utt Netherlands. Infi^ section 4.5.5. 55 5 fromfrom the Netherlands and the limitations inherent in a strict interpretation of the fair and equal opportunityy requirement have meant a preference for liberalisation (Bouwens, Dierikx, 1996: 114)) In recent years, there has been a change away from acquiring a maximum of rights to- wardss a policy that will optimise a selective network of air links to, from and via the Nether- landss (Ministry of Transport, 1998b). The policy contains elements of selection and differentiation.. More specifically, the state should select the transaction partner that offers the greatestt contribution to the development of the 'mainport', yet minimises the claims on scarce environmentall and infrastructural capacity. Together these aims may be dubbed the selective networkk goal. It is a complex goal because it does not, in feet, capture a single goal but all of thee aspects described in Sections 3.3.1.1-3.3.1.3. Moreover, liberalisation remains important as aa prerequisite for selectivity because a strict interpretation of the fair and equal opportunity requirementt harms states that lack physical or economic size. These states are restricted in theirr ability to negotiate agreements based on equality and cannot afford to be selective. Liberalisationn can reduce this disadvantage by stimulating the elimination of strict requirements34. . Chapterr n noted some of the problems that arise when there are multiple objectives. Althoughh multiple objectives create a certain flexibility, they may be difficult to realise if they cannott be prioritised. Moreover, the vagueness of some of the goals listed above makes it difficultt to determine whether they are being realised and, if they are, whether this is happening inn the most efficient way. The reliance on agents, namely airlines and airports, to gather information,, make decisions and execute the transaction complicates things further as these agentss have to assign a weight of their own to each of the goals (Goldberg, 1976: 432).

3.3.1.44 - Implementation of the air transport goal in the Bilateral structure Thee previous sections identified the elements that constitute the selective network goal. In orderr to evaluate the extent to which the state has achieved its goal, these elements need to be translatedd into requirements to be met by the industry when providing air transport and airport services.. To induce the industry to meet these requirements the state needs appropriate instrumentss (e.g. interest harmonisation, a reward structure, monitoring). The Dutch state has partiallyy translated the selective network goal in a memorandum (Ministry of Transport, 1998b)) formulating requirements that pertain to the provision of air transport and airport services.. The memorandum identifies three areas for special attention: 1.. the volume of traffic,

Thee Oxford dictionary defines 'liberalisation' as 'making liberal', which in turn is defined as 'making fiee, favouringg ftee trade and gradual political and social refbnn that tends tcwaids individual freed^ or democracy'.democracy'. Chapter IV will elaborate on lftjeralisatkm in u^ooirtext of the European Comimmity. Onn the other hand, liberalisation coupled with a oon^scri mination requirement may limit the state's ability too be selective. Chapters IV and V will discuss this dilemma farther. 56 6 2.. the composition of the fleet that uses Schiphol airport and 3.. market behaviour.

Notee that the Selectivity memorandum does not explicitly address the financial, psychological orr political elements of the government air transport goal. These elements are, however, coveredd in other policy documents, such as the KEPD, the 1998 Cabinet decision and the MIT 1999-2003".. For instance, the MIT discusses the maximisation of economic benefits subject to aa given claim on scarce environmental capacity. Note also that none of the documents rank the goalss in order of importance36.

3.3.1.4.11 - Traffic volume Requirementss aimed at the volume of traffic include a cap on the volume of traffic at Schiphol airportt and a ban on night flights using certain types of aircraft. In addition, Bilateral capacity clausess may be used leading to requirements on the frequencies available to airlines. The instrumentss used to force or stimulate the industry to meet the requirements are the airline and airportt designations, various permits, slot co-ordination and access policy for charter traffic andd incidental flights37. Access policy involves deciding requests on the basis of political variabless affecting air transport.

3.3.1.4.22 - Fleet composition Requirementss aimed at the composition of the fleet include restrictions in Bilateral agreements onn the types of aircraft to be used. In addition, states may - on a multilateral or even on a globall basis - agree to requirements on the phasing out of noisy aircraft. As an example, ICAO memberr states have agreed to phase out Chapter II aircraft38. For member states of the Europeann Community, European legislation formulates additional measures39, which are interpretedd very strictly. They have even been expanded at the domestic level, adding further requirementss on the use of the airport40. The Selectivity memorandum also mentions developingg a 'Marshall plan' aimed at less developed countries and airlines with fewer financial resources.. The plan would involve financial aid to induce recipient countries or airlines to acquiree modern aircraft, thus lowering noise pollution around Schiphol airport and enabling

355 The MIT plan ('meerjarenplan infrastructuur and transport') contains actions that need to be taken to realise thee government's policy agenda with respectt o transport. 366 These factors indicate the difficulty of arriving at a clear air transport gnql AA *slot* is the scheduled time of arrival or departure availabte to an aircraft inovemenl on a speriffc date at an airportt IATA Scheduling Procedures Guide, 20th edition, July 1996. 388 Resolution of 1990, incorporated in Volume I of Annex 16 to the Convention on International Civil Aviation. . 399 Infra, p. 109. 400 'Regeling operationele beperkingen lawaaiige tuchtvaartuigen Schiphol', Regulation of 2 May 1997, DGRLD/JBZ/L97.5O021O,, STC 1997, no. 86. 57 7 moree aircraft movements. A more detailed development of this plan has been delegated to the airlines. .

3.3.1.4.33 - Market behaviour Requirementss aimed at market behaviour include the KEPD requirement that, by the year 2015,, five million airline passengers should have switched from aircraft to trains for short journeyss (Project Mainport en Milieu, Schiphol, 1993: 144, annex 3). In addition, the state aimss to be selective in choosing the countries with whom Bilaterals will be concluded and the frequenciesfrequencies to be agreed. Domestically, Schiphol is obliged to introduce a tariff regulation imposingg differential aircraft charges and a system of bonuses or fines to silent or noisy aircraft.. The Ministry of Transport uses its right of approval as an instrument. There are also proposalss for fiscal measures at the international level, such as a tax on aircraft fuel or value addedd tax on international airline tickets, which may lead to domestic legislation. Finally, the Selectivityy memorandum suggests that a covenant with the sector can produce more concrete targetss and stronger commitments regarding environmental protection. Inn addition, a 1998 Cabinet decision adds that the industry should initiate technical and operationall measures as part of a new 'Optimisation strategy* (Ministry of Transport, 1998c: 19). .

Sectionn 2.5 explained that the effectiveness of a governance structure can be inferred from interstatee and state-industry relationships. For example, the structure of the relationships betweenn the state, airlines and airports influences the industry's ability to determine how the state'ss goals should be prioritised. At the same time the governance structure should contain instrumentss that enable the imposition and realisation of requirements that capture those goals. Thee policy documents outlined above are consistent with this approach, in that many of their requirementss depend upon the co-operation of the airports and airlines. Moreover, the focus onn Schiphol airport in the state's air transport policy and the acknowledgement that a 'mainport'' status requires the presence at the airport of a mega-carrier confirm the importance off state-industry relationships41. The next three sections describe in greater detail the interstate relationships,, the relationships between the state and its agents, and some of the tools available too induce the agents to co-operate. The discussion focuses on the situation prevailing in the Netherlands,, but some remarks also apply to relationships in air transport outside the Dutch context. .

AA roegaKxurier is defined in the explanatory roemoraiuiDnit o u^ 165) as an alliance between airliness that operate a world-wide hob-and-spoke system. The rocmorandumfiiitber states (ibid: 15) that there cannott be a mega-carrier without a 'mainport' nor a 'nudnpoft' without a mega-carrier. 58 8 3.3.1.55 - Interstate relations Bilateralismm allows for a policy aimed at the volume of traffic because it is possible to incorporatee in a Bilateral provisions on such variables as capacity and time of operation. The actuall implementation of this policy requires a system of slot allocation. Similarly, it is possible too pursue a policy aimed at the composition of the fleet through Bilateral clauses, which becomee part of domestic legislation. Measures that steer market behaviour are more problematic.. Transacting states may try to promote other forms of transport, such as high speedd trains, but this option is usually limited to transport between adjacent countries. Tax measuress may be used but require protection against free riding. It was noted above that the Bilaterall structure allows states to discriminate as they can freely select the countries with whichh Bilaterals will be concluded. However, the number of states with which the Netherlands doo not have a Bilateral is negligible, so that this instrument only applies in the event of an amendment,, such as negotiating an extra frequency42. There is a more general problem with requirementss imposed at the interstate level. Even if the governance structure permits impositionn of certain requirements and the use of appropriate instruments, the domestic state mustt be able to get them accepted by the foreign state. The Bilateral features of state sovereigntyy and equality are important factors influencing that ability. With respect to its agents,, however, the state has the power of coercion. The next two sections will focus on the state-industryy relationships.

3.3.22 - Airlines Thee state executes the rights exchanged through an airline (and an airport), though the airline iss not a party to the Bilateral43. In the Netherlands, as in most countries, the relationship betweenn the state and airline in terms of the airline's decision-making power is created by designationn (Wassenbergh, 1993: 83-84). Designation turns the airline act into agent for the state. . Presently,, a significant number of air carriers have their principal place of business on Dutch territory.. Of these, KLM, Transavia Airlines, Martinair and Air Holland44 are the most impor- tantt agents. Except for KLM, the carriers began their operations in the non-scheduled market butt have, over the past few years, also offered scheduled services. The motivation behind this actionn is that the scheduled market offers greater certainty, especially by making possible a year-roundd rather than a seasonal operation. KLM holds the majority of shares in two of the

422 In October 1999 thee number of Bilaterals with the Netherlaiuk as a party stood at arjproximately 135. 433 The airlines are not entitled to claim rights derived fiwn the BilaieraL Ha^( 1997:188, note 302) discusses ann indirect claim: US carriers may contest actions by foreign governments via a dofnesticprocednre and the DOTT may take corrective action, such as suspending the operation ofa route by another state's designated carrier. . 444 Air Holland has often had financial difficuhks and at Uie end of 1999 suspctukri 19999 it became known that Air Holland would again start operations with new shareholders. 59 9 threee competing carrière . It also participates in other European and non-European carriers andd has concluded a number of co-operation agreements46. In this respect, KLM resembles manyy other air carriers. What is not so common is the relatively strong position that KLM holdss in relation to its captive market. It is the 14th airline in the world in terms of passenger kilometress flown47. AA carrier qualifies for designation on the basis of domestic rules. Generally, a carrier first hass to obtain a licence. In addition, it can only apply for designation in the state where it is locatedd and where the nationality requirement is met. In the Netherlands, the applicable proce- duree is laid down in the Air Transport Act of 1958, as amended. Note that the procedure distinguishess between Community and third country traffic. With respect to the latter category designationn requires an explicit consideration48. In addition, the designation regime depends on thee carrier in question. KLM holds a so-called 'open permit', which means that it can fly any routee without a specific reference in its permit (Ministry of Transport, 1994: 10). The permit of anyy other Dutch scheduled airline is route-specific, and every additional designation requires an amendmentt of that permit. KLM's elaborate route network generally offers the greatest potentiall to contribute to the selective network goal. This means that if single designation is thee outcome of a Bilateral negotiation and KLM has expressed an interest in operating a given service,, an application for designation by the other Dutch carriers will usually be refused. In suchh a case, a carrier can appeal the decision via an administrative procedure. However, the limitedd chance of succeeding without damaging future relations with the state has meant that thee procedure has only been used once49. If KLM is not interested, applications from other carrierss will be examined by the CAA as early as the contact phase. This examination takes placee on the basis of business plans submitted by the carriers and CAA's own information. Factorss such as the opinion of the other state and rights that have recently been granted to a carrierr are also important. There is no formal selection process or procedure but there might be ann informal hearing in which applicants can present their plans. Oncee an airline has been designated, it becomes the agent of the state. Whether the airline

455 Martinair 50 % and Tiansavia 80 %. KLM reached an understanding to obtain tne remaining 50% of MartLnairr in 1998. However, after an investigation by the EC Commission into the effects of this agreement on competition,, KLM decided not to proceed It was expected that too many conditions would be attached to an approvall of the agreement The agreement was subsequently dissolved. 466 KLM has agreements with Northwest, Alitalia, KLM Cityhopper, Biaathens, Regional, Martinair, Transavia, Kenyaa Airways, KLM UK and Eurowings. It has cooperation agreements with, among others, ALM, Maersk, Cypruss Airways, Tyrolean, KLM (Air) Exel and Ansett In 1998 KLM and Alitalia signed an extensive co- perationn agreement with far-reaching consequences. 4141 Source: Airline Business, September 1999. 488 The question may arise whether such explicit consideration is consistent with EC legislation, given that Regulationn 2408/92 in respect of Community carriers only allows for an operating licence and an air operator's certificate.. This question will be looked at in Sections 4.4 and 4.5.7. 44 This was a legal procedure started by Air Holland against the CAA ccflcetning a Bilateral with Nepal (Reisrevue,, 1998). 60 0 actss in the interest of the state depends on the extent to which the state's goals overlap with thosee of the airline and, if there is no complete overlap, on the structure of the state-airline relationship.. The following points are worth noting.

Inn the Dutch case, the state aims to build a selective network, while the airline aims at continuityy (see Section 2.S). The airline's continuity objective implies that the state's interests ass an important stakeholder are at least partly taken into account. Moreover, KLM is listed on thee stock exchange and has to satisfy shareholders' interests. This means that the airline's objectivee overlaps with financial elements of the selective network goal. However, there is no fulll overlap between objectives. One problem faced by the state is that the selective network goall may embrace social aspects that conflict with the airline's objective. These aspects may leadd to requirements that restrict airline operations. Slot co-ordination and night restrictions at Schipholl airport are examples. The state therefore has to use additional tools to co-ordinate its relationshipp with the airline. These tools were identified for the general agency problem in Sectionn 2.5 as the reward schedule facing the agent, various control mechanisms and interest harmonisation.. They will be addressed in turn. Itt is difficult to structure the airline's reward schedule appropriately. The pay-off to the airlinee consists of additional income from the operation of designated services and its size is moree or less independent of the airline's contribution to the state's goals. The designation process,, for example, is not based in any significant way on information or expectations concerningg the airline's behaviour or output. Moreover, there is a strong preference for KLMM . The airline's load factors, which determine operating income, largely depend on the airline'ss marketing activities and yield management Thee set of instruments used by the state to control the airline is in line with the areas targetedd by the state in its attempt to build a selective network (see Section 3.3.1.4). One importantt requirement targets flight operations. There are, for instance, procedures for departingg aircraft which determine the preferred flight path. They are known as 'SIDs'51 and aree established by the Ministry of Transport on the basis of consultations between ATC, the carrierss and an advisory commission on noise pollution ('Commissie Geluidhinder Schiphol'). Duringg a flight, the actual flight path, which is registered, must stay within a given tolerance zonee determined by elements like toad factors and weather conditions. Subject to the condition thatt flight safety takes top priority, deviations from the zone may be enforced through criminal laww (the firm is prosecuted). There are also technical requirements on incoming and outgoing aircraftt to ensure a safe and efficient flight operation. These requirements are part of the

Designationn does entail an indirect comparison of airfines. The rcalisatwnofa selective netwwk is more likelyy with the KLM network and thus implies a preference for KLM. 511 An SID is a 'Standard Instrument Departure'. 61 1 aircraftt manual, ICAO annexes and JAR OPS52. The airline is required to train its crew accordingly.. In addition, aircraft are allocated to routes. Although there are no legal requirementss prescribing the use of routes, Schiphol airport and ATC determine on the basis of ann agreement the preferred order of runways to be used53. Their ranking is established on the basiss of safety, efficiency and environmental impact, whereby safety prevails in case of a conflict.. A further area of attention targeted by the state is the composition of the fleet. The typee of aircraft used is influenced directly via the required registration of the aircraft. Certain aircraftt types will not be entered into the register. It is also influenced indirectly via airport chargess and a number of requirements directed at Schiphol airport. There is a slight differentiationn of airport charges across aircraft type, and some aircraft types may not be used att Schiphol airport at certain times. The composition of the fleet is also being addressed via the 'Marshalll plan', whose development has become the responsibility of the Dutch airlines54. The additionall capacity at Schiphol airport flowing from the use of silent aircraft will, however, benefitt all airlines. The area of market behaviour reveals further incentive problems. Although thee PASO covenant55 and KEPD require the industry to promote a substitution of rail for air transport,, so far any concrete actions have been limited for a lack of incentives. Exacerbating thee situation is the difficulty of monitoring performance during the execution phase. The state's monitoringg abilities are impaired because the airline's activities take place largely outside the territoryy of the state, which makes undesirable behaviour difficult to uncover. Any behaviour controll is therefore limited to operations in the Netherlands. Output control is feasible to some extentt because it is possible to analyse the tax and foreign exchange income. On the whole, however,, the airline has ample opportunities to manipulate information. Designated carriers, forr instance, are often able to conclude commercial agreements without revealing the contents too the state. Most importantly, none of the control mechanisms really motivate the airline to behavee appropriately. The indirect instrument of designation provides only a limited incentive, givenn the strong preference for KLM56. Any punishments (e.g. fines, revocation of permit) are eitherr not severe enough or are not used in practice57. This makes interest harmonisation an

Thee JAR OPS are rules established by thee Joint Aviation Authorities ('JAA'), a group of Ecropcan Air Trafficc Control Organisations that deals with operational issues. Infra, Section 4.4. Agreementt of 1997. The noise preferential runway use system is also part of Ü^ airport's Operations Plan. Infra,, Section 3.3.3. ** Note that the Marshall plan has not led to any tangible rneasuies and has iiifonnaUy been abandoned. 'Plann van aanpak Schiphol en omgeving', a policy covenant between public and private parties. Parties to PASOO were Schiphol airport, the Ministries of VROM and Ecoi»omicAiEÜR»Ü«CAA,tteiiiiiniciiJa%of Haarlemmermeerr and the province of North Holland The 1989 PASO was sigoed by these parties plus the nmnicipünyofArostenlaitLTherKüjecto o pluss representatives of KLM and the Ministry of Home Affiun. The covenam ibiniulates agreements between thesee parties to implement the state's goals. 566 See also 'Voorlopige Raad voor Verkeer en Waterstaat' (1991:49). 577 The airline rather than ttie pk* is cha^ disincentivee is not strong enmigh to influence behaviour. 62 2 importantt instrument in the state-airline relationship. Theree are certainly opportunities to harmonise interests. In the first place, the airline de- pendss on the state for market entry. A policy of single designation, in particular, creates certaintyy and induces the airline to co-operate. This applies specifically to the flag carrier. In thee case of KLM, a large network makes the state attentive to KLM's objectives when formulatingg air transport policy. KLM's shareholding in two of the three other main Dutch carrierss extends the argument beyond KLM. In addition, state-airline relations are long-term andd close. In some cases the airline has been made financially dependent on the state. Over the years,, the Dutch state has given KLM guarantees for the repayment of debt and has subscribed sharess at times when market conditions would not support a private placement (KLM, 1987: 9, Dierikx,, 1999: 149-150). It may seem that the airline uses some bonding in the form of adherencee to global common standards (e.g. maintenance standards). However, these activities aree not primarily aimed at the state but at foreign airlines who are potential buyers of maintenancee services at foreign stations. A home carrier may provide maintenance services to otherr carriers. Generally speaking, the airline need not convince the state of its eligibility to operatee air transport services because existing long-term relationships provide the state with amplee information about the characteristics of the airline. Finally, common ownership has been identifiedd as an instrument that can harmonise interests (also: Balfour, 199S: 29, Button et al, 1998:: 66-68). The Dutch state has not exploited this option to any degree, although it held a maximumm in KLM's share capital for a long period of time. Currently, the state holds 14% of KLM'ss shares and is represented on the supervisory board31. Shareholding is not the main elementt determining the closeness of the bond between state and airline.

Too sum up, the overlap between the state's selective network goal and the airline's continuity objectivee is sufficiently strong so that the airline tends to act in the financial interests of the state.. There is less overlap between the airline's objective and other aspects of the state's air transportt goal. The state has formulated various requirements to influence airline behaviour, suchh as restrictions on flight operations. However, the state lacks well-designed control mechanismss making it difficult to completely eliminate moral hazard. Moreover, traditional remediess for moral hazard are not effective. The reward schedule facing the airline is flawed andd monitoring is seriously impaired. Enforcement mechanisms, such as the ability to withdraw permitss or impose fines, are rarely used or not effective in motivating the airline. Nevertheless, state-airlinee relations are close and the level of interest harmonisation sufficiently high to inducee the airline to co-operate with the state.

KLMM has always been a private entity. The state's shai^oktiiig was also nntivatcd by the nationality requirementt (Dierikx, 1999:28). To be able to respond to other states invoking the nationality requirement, the reductionn in shareholding was combined with a procedore enabling the state to ÜKneaseh^ interest to 50.1%

63 3 3.3.33 - Airports Thee Dutch airport system comprises one national airport in addition to five regional airports andd twelve smaller airfields59. The airport's facilities are necessary to execute the exchange of airr transport rights. An airport is designated as an airport under national law. The airfield designationn provides the airport with a right to serve and domestic law provides that aircraft cann only land at an airport. At the same time citizens have a right to be served. Because the rightsrights assigned to the airport reduce opportunities available to the public, the airport's designationn also provides that the airport must allow all traffic. The airport designation is usuallyy the only formal relationship between the airport, on the one hand, and the state (or designatedd carriers), on the other. The Bilateral, more specifically the route scheme and frequencyy provisions, determines the use of the airport, but the airport is not a party to the agreement60. . Airportss are utilities, which are characterised by important economies of scale and scope. Thee assets of most utilities are highly specific and cannot be deployed elsewhere. Furthermore, utilitiess typically serve a substantial proportion of the national voting population. The first two characteristicss imply that there are unlikely to be many providers of basic utility services. Widespreadd domestic consumption implies that the prices charged by utilities will always be a politicall issue. Huge quasi-rents make utilities very vulnerable to administrative expropriation, whichh can occur via the setting of prices below long-run average cost or via specific investmentt requirements. These factors help to explain the extensive regulation that is used to influencee the airport's behaviour. Moreover, unlike airlines, airports are relatively easy to monitorr and control, making them a prime target for state regulation. However, while regulationss do succeed in constraining airport behaviour, they fail to co-ordinate activities in thee industry and can lead to inefficiencies (Gidwitz, 1980: 119). To give an example, the airportt has to make substantial investments with long lead times. These investments might not bee tailored to potential demand, as the airport may have insufficient information on the exact contentt of a Bilateral agreement or on the way in which the state influences the operation of thee Bilateral. Another inefficiency arises from the obligatory provision of facilities for some governmentall functions, like customs or border control. These facilities have to be provided freefree of charge, and their use is based more on budgetary and political objectives than on market

(Naamlozee Vennootschap, 1998:147-148). Thee national airport is Schiphol aiiport The regional airports are Rotterdam, Maastricht, Groningen, Eindhovenn and Twente. 600 The Bilateral can mention the airport, not as a separate party, but as a point rfófstiiiatk^ An exception is thee annex to the second Bermuda agreement (in^, p. 85), which led to a sfjecmc reguJalion on airport charges combiningg revenue from aviation and non-aviation activities in establishing aiiport charges (single till). The regulationn is still applied in the United Kingdom (MMC, 1996), although the requirement to maintain a single tilll approach has been abolished (Starkie, 1999:10). 64 4 considerations.. Regulations used by the state often limit the flexibility that airports need to createe an efficient operation. Ass is true of airlines, Schiphol airport strives for continuity, which means that its objective is nott fully consistent with the state's air transport goal. Differences in objectives mean that alternativee co-ordination tools are needed. Onee such tool is the reward schedule. The schedule facing the airport shows a weak link betweenn behaviour and pay-off. For instance, the state will almost always offer Schiphol as a destinationn in Bilateral negotiations as it is the only airport with 'mainport' status and the facilitiess needed to conduct elaborate transfer operations. A further tool is behaviour control, whichh has led the state to translate its selective network goal into a variety of behavioural requirements.. In particular, the 1995 KEPD, apart from addressing financial aspects, lays down strictt environmental conditions. They include requirements on emission levels allowed around thee airport, a noise zone and a cap on passenger throughput annually by the year 2015. In 1996,, the airfield designation of Schiphol airport was changed to include the noise zone and thee passenger cap, thereby formally limiting the volume of passengers. A formal compliance systemm was introduced which imposed the obligation to produce an Operations Plan setting out thee way in which the airport intended to conduct its operations within given the limits during thee coming year. In the Operations Plan the airport was to specify the maximum number of aircraftt movements per year, the preferred order of runways to be used, as well as measures thatt would be taken if the noise zone were to be breached. The airport was to be held accountablee if established limits were exceeded. However, it did not have any instruments at its disposall to control the number of aircraft movements. This compliance problem led to the impositionn in 1997 of slot co-ordination as an instrument to control the airport's behaviour. Slott allocation has been in effect since April 199861 and the regulation requires that, twice a year,, Schiphol airport gives a capacity declaration to the slot co-ordinator on the basis of the Operationss Plan. The slot co-ordinator, which is an independent party, translates this capacity intoo slots, taking into account the volume of traffic and spread of flights through the day. Availablee slots are matched with the demand for slots at slot conferences organised by IATA62 onn the basis of a procedure derived from IATA and EC rules. The use of the airport is subject too a monthly check of aircraft movements by a CAA department and the airport itself*3. A ministeriall order issued in July 1999 introduced additional monitoring and information requirementsrequirements on aircraft movements in connection with safety64. Although slot co-ordination helpss to control airport behaviour, it also limits the airport's ability to make efficient use of its

611 Regulation of 13 January 1998, DGRLD/JBZ/L 98.210002, STC 13 January 1998, no. 15. Slot regulation is generallyy not used for these types of concerns. Infia, p. 110. 622 Infra, p. 71. 633 Required on the basis of Article 25h of the Air Transport Act 644 Regulation of 15 Jane 1999, DGRLD/VT/L99.360178, STC 1999, no. 119. 65 5 facilities.. In general, landing and take-off slots are allocated according to a set of administrativee principles. The principles underlying traditional (IATA) slot allocation are simple:: fundamental is the concept of grandfather rights, which lays down that an airline using aa slot in one traffic season is entitled to its use in the same traffic season the following year. Secondaryy criteria include such factors as aircraft size, curfews at other airports and the need forr a mix of services. The EC Regulation65 that was needed because of the potential anti- competitivee effect of the IATA rules, improves these rules by, for example, allowing new entrantss to take up under-used slots or new slots via a 'use it or lose it' rule. However, it fails too allocate scarce capacity where it is valued most as slot transfer is prohibited (Button et al., 1998:: 83-86)60. Moreover, the airport has no say in the allocation of slots and holds no propertyy rights to them. Inn 1998, the set of instruments was expanded by the introduction of a new regulation that thee airport had to close a runway preventively (i.e. before breaching the noise zone) if it was in dangerr of exceeding official limits. Thee discussion illustrates that, notwithstanding the extensive use of behaviour control and elaboratee monitoring, the state-airport relationship is not well-designed. The airport's contributionn to one element of the selective network goal could harm other elements, which in turnn might reduce the airport's pay-off. The airport's pay-off may decrease as a result of its obligationn to close a runway preventively, or because the Minister of Transport closes a runwayy in the event that the airport fails to act. The KEPD provisions may also give rise to conflict:: strict environmental regulation could deter new business and so endanger financial opportunities.. Neither the principles underlying the KEPD restrictions nor the relationship betweenn these regulations and market developments have been completely worked out and growthh trends in the air transport industry have generally been disregarded. Moreover, some criticss believe that the number of passengers flown is not the right criterion for measuring noise pollutionn and that the focus should be on aircraft type, time of operation and load factors67. In addition,, existing instruments have not succeeded in confining airport operations to established limitss and the state has been required to tolerate various noise overruns. In 1998, following an evaluationn of the KEPD, a cap on the volume of aircraft movements was introduced as a new requirement.. In the same year the government decided to allow an annual increase in aircraft

6565 Infra, Section 4.4. 6666 Although United States legislation denies the existence of any righto f ownership in a dot itseltaiid the F AA mayy grant and withdraw slots, a transfer of allocated domesüc slots is allowed al a few airports in the United Statess (Borenstein, 1997:531). International slots cannot be transfened Transfer is also proMjited under the Comnmnityy structure. The ability to transfer slots does not seem to haw affected congestion delays. (See aim Haanappel,, 1994:201-202, Havel, 1997:100,212, Morrison and Winston, 1997:494, note 32). See,, tor example, Van der VUst (1998). The criticisms have been taken into account in the integrated poücy viewss ('Integrate Beleidsvisie', or *IBV) on the future of air transport iji tte NetiKstawk. See also the coaliüon agreementt and Dutch Cabinet Decisions of 18 December 1998 a«l 17 Decanb» 1999 (K^^ 1998c,, Ministry of Transport, 1999b). 66 6 movementss of 20,000, simultaneously requiring a decrease in the number of houses affected by aircraftt noise, until the year 2003 (letter from Cabinet to Parliament of 6 March 1998), in preparationn of the new fifth runway. At the same time it was decided to revise methods of computation,, zoning and enforcing compliance with environmental policy, taking into account environmental,, physical and other restrictions and thus achieve a better use of existing infrastructure.. The measures developed to achieve this aim are part of the Optimisation strategy.. The new system is scheduled to apply as of 2003. In the meantime the current system willl continue to apply with slight adjustments, such as the annual growth in aircraft movements. . Thesee adjustments do not eliminate the compliance problems confronting the airport. It still hass to accept all traffic, which makes it dependent on airline operations. If the airport complies withh the requirements imposed by the state, the state may be in breach of its obligations under existingg Bilaterals. This might happen if the airport is closed because it has violated the noise zone6*.. Another state might invoke its Bilateral rights, claiming that the Bilateral implies a right too transport and that this right has been unduly harmed. Such a claim has been made with successs by some United States carriers as a threat to obtain slots. One case is US Airways, whichh requested access to Schiphol airport for daily flights from Philadelphia in January 1999. Initiall access was denied due to a lack of slots at Schiphol. US Airways then considered asking thee United States government not to renew the anti-trust immunity enjoyed by the alliance betweenn KLM and Northwest Airlines. Eventually slots were made available. The compliance mechanismm facing the airport relies heavily on formal sources of compliance, and legal enforcementt is frequently used by environmentalists as well as by the state. Inn the early years of air transport, the state and airport had largely overlapping interests. For thee Netherlands, where there was only one national airport, where the state's aim was to acquiree transport rights to support the network, and where there were no infrastructural or environmentall capacity constraints, opportunities to harmonise interests were substantial and reinforcedd through ownership relations. Schiphol airport was part of the local governmental organisation,, namely the municipality of Amsterdam. When it was turned into a limited liability companyy in 1957*9, its shares continued to be fully owned by public authorities and the supervisoryy board was strongly influenced by the state70. Schiphol airport in turn took shares in threee of the other significant Dutch civil airports71. In the past, the airport usually refrained fromfrom actively participating in marketing opportunities and for a long time accepted a

688 See, for example, Staatscourant 22-10-98 (202) 'KLM en "Open Skies'", p. 3. 699 Law of 11 December 1957. Thee stale put 5 directors on the supervisor board, representing the national government (2 directors),, and thee municipalities of Amsterdam (2) and Rotterdam (l) 711 Rotterdam Airport, N.V. Luchthaven Lelystad and N.V. Eindhoven Airport The latter is a military airport withh civil co-use. 67 7 facilitatingg role as an infrastructure provider. This included an administrative rather than market-basedd mechanism for allocating capacity. Even if the market indicated that services by neww or expanding carriers were the most efficient (as shown by the price that carriers would be willingg to pay for using airport capacity), there were only limited ways of gaining access. Consequently,, the airport did not strive for any active involvement in Bilateral negotiations. Ann overlap of interests also characterised the airport's relationship with the home carriers. Thesee relationships were not formalised. There were agreements for the rental of office space, butt they did not include a specific airline-airport element. In the United States, many airlines ownedd and operated airport terminals and contracts between airlines and airports covering the usee of facilities and timing of investments were common practice (Air Transport Association, 1998).. In the Netherlands and in Europe generally, no such formal relations existed. In the Netherlandss there was a fiction, based on private law, that an agreement was created as soon ass an aircraft landed on the premises of the airport. Payment for airside facilities (such as aircraft,, handling and fuel charges) was derived from this agreement. Formally the airport did nott differentiate between foreign and domestic airlines, as this was prohibited under the Chicagoo Convention72. However, loyalty and a strong mutual dependence between the home carrierss and the airport created special ties between these parties. The home carriers were the primaryy users of the airport's facilities and this sometimes led to substantial transaction-specific investments.. Sometimes special arrangements existed, such as preferential use agreements and chargingg policies. The specific investments, along with the nationality requirement and dependencee on the state for market access, forced airlines to maintain their home base at the airportt and forged a long-lasting bond with the home airport. Changingg market conditions, such as liberalisation and high air traffic growth rates, have influencedd the airport's position in the air transport system. Liberalisation has intensified competitionn between airlines, which among other things has increased the importance of transportt networks. The ability to realise economies via a network type of operation has made 'hub-and-spokee systems' a central feature in the market73. Not only airlines but passengers, too,, may benefit from greater flight frequency, easier connections and more non-stop flights. Thee airport plays an essential role in developing and maintaining such networks, if it can meet thee demand for capacity and punctuality. The greater traffic volume and long lead time of investmentss have further increased the importance of those airports endowed with an abundancee of space in the air as well as on the ground. Liberalisation has also increased the

Articlee 15 Chicago Convention. These arrangements may further be in conflict with EC competition law Infra,, Chapter IV. "" These transport systems use a central airport (a 'hub^ to coiisolidate tiaffic ftows from a intoo one traffic flow to another hub. They have a loiig history to EvirorK due to a cwiceiu^^ earnerr at a domestic home base rjut have not bem ojjeral^ (Buttonn etaL, 1998:21). - .» 3 68 8 airport'ss marketing opportunities. Concurrent with these developments, some countries are experiencingg a shift in attitudes towards recognising the importance of the environment. A growingg perception that air transport harms the environment has gradually meant a more criticall stance towards air transport (OECD, 1997: 98). The industry, however, has no incentivee to incorporate environmental damage into its own cost calculations. This has ushered inn new airport regulations. Collectively these factors are increasing the extent of interest divergencee and hence the risk of conflict between the airport and state. Opportunism, in the formm of inadequate reporting or insufficient investment, has become a real issue. At the same timee new requirements, introduced by the Optimisation strategy, have intensified relationships andd increased the interdependence between the airport and the state74.

Inn conclusion, the state relies on a growing body of legislation to specify the airport's rights. It carefullyy monitors airport behaviour but, rather than alleviating certain agency problems, behaviourr control seriously restricts the airport's freedom of operation and may encourage opportunism.. In Bilateralism, any agency problems in state-airport relations may still be limited becausee of a substantial overlap in interests. This may not last, however, as current developments,, such as infrastructural capacity constraints and environmental concerns are reducingg the extent of interest harmomsation.

3.3.44 - International organisations Forr a complete picture, something must be said about the international organisations which fromfrom the beginning have played an important role in Bilateralism. These are ICAO, ECAC and IATAA . None of these organisations has formal regulatory powers, which would of course not bee consistent with the fundamental sovereignty of states. ICAO does have some regulatory powerss in technical matters. ICAOO is a specialised agency of the United Nations. Its purpose is to ensure the safe and orderlyy growth of international civil air transport, to encourage the development of airways, airportss and navigation facilities, to prevent economic waste caused by unfair competition and too ensure that the rights of contracting states are fully respected and that every contracting statee has a fair opportunity to operate international airlines76. ICAO's powers are primarily in

44 Schiphol airport, the home carriers and ATC have started a pre^ calkd'Pnqect Opüraalisatk SchiphoJ'. Thee profeet studies the scope for improvements in the curratt system, wtikh arc to eirter ii^ force in 2003, as welll as the ability to accommodate the yearly growth in aircraft movements antil 2003. 755 'ICAO*: International Civil Aviation Organization, established by the Chicago Convention on 4 April 1947. 'ECAC:: European Civil Aviation Conference, established by ICAO recommendation in November 1955 and 'IATA*:: International Air Transport Association, established on 18 December 1945 as a continuation of the Internationall Traffic Association, formed in 1919. One other very important organisation, namely thee European Community,, will be dealt with in Chapter IV. 766 Article 44 Chicago Convention. 69 9 thee technical field, although h can issue advice on economic matters and is also a party to environmentall discussions, for instance on the phasing out of noisy aircraft or global restrictionss on emissions. It tries to harmonise rules and procedures through standardisation ('Standards'' and 'Recommended Practices'). After reaching general agreement, ÏCAO submits aa new rule or procedure to the member states. It will be applicable three months later, without separatee ratification, unless at that time a majority of the member states have informed the councill of their dissent. Apart from harmonisation, ICAO's most important function is offering aa forum for discussion and guaranteeing a common interpretation of the provisions of the Chicagoo Convention. Some Bilaterals give the ICAO council a role as an arbitrator in the resolutionn of disputes. However, because of the problems surrounding arbitration between statess and the fact that ICAO is made up of representatives of member states, which essentially makess it a political organ (Dempsey, 1987: 300-302), this role is seldom invoked. ECACC is a European organisation of air traffic authorities that was established following discussionss on co-operation in air transport matters in the Council of Europe (Bin Cheng, 1962:: 56-57, Havel, 1997: 124)77. ECAC was established in November 1955 by an ICAO recommendationn of 19 Western European states. The organisation deals with the development off European civil air transport through co-ordination and co-operation. ECAC issues resolutionss and policy statements, which may be incorporated into the domestic legislation of eachh member state. It can further act as a forum for discussions with other states. An example off this function is the negotiations with the United States on the subject of non-scheduled air transportt over the Atlantic, which resulted in a multilateral agreement in 1975. ECAC is an inter-governmentall organisation. It enables states to act as one forum, yet binds a state only to thosee negotiation resolutions and results that have been explicitly accepted through a separate domesticc approval process. At best, agreement in ECAC gives rise to a political or moral commitmentt to start such a process. This makes it an expensive and time-consuming form of co-operation78. . IATAA (Chuang, 1972, Brancker, 1977, Havel, 1997: 119-123) is a world-wide non-govern- mentall organisation of airlines. Strictly speaking, it is a private organisation, but h is very much influencedd by state interests, partly because of government control and interference in air transportt (e.g. ownership of airlines). In a sense, IATA fills the gap left by the states after the secondd world war regarding the creation of a multilateral regime to exchange traffic and transportt rights. The purpose of IATA is to promote the safe, regular and efficient use of air transportt and the investigation of related issues. From the moment its tariff-setting procedures weree accepted in the Bermuda I Bilateral, the organisation has had an enormous influence.

777 The plans of Sforza, Van de Kkft and Bonnefoos. 788 The EC seems to have reduced the role of ECAC, because of restrictions on the powers of member states. See,, however, infra, p. 118. 70 0 Apartt from tariffs, conditions of traffic are negotiated at the conferences. These are primarily aimedd at facilitating interlining79.1 ATA operates the 'Clearing House', a central facility used by airliness to clear payments for the common use of tickets, interlining and other services. The Clearingg House obviates the need for bipartite agreements between carriers, which would be veryy difficult and time-consuming because airline services are often not comparable, while cost structuress vary (Fennes, 1997: 38). IATA also facilitates slot co-ordination. IATAA helps airlines create a coherent, global structure of interlinked tariffs and conditions ass well as uniform standards and procedures in such areas as ground handling and conditions of carriage.. This reduces uncertainty and stimulates the development of air transport. A disadvantagee is lATA's rigid structure and the consequent stiffing effect on the industry. Prior too 1978, the rules made it impossible to experiment with tariffs or service levels, despite a demandd for such flexibility due to a growing acceptance of air transport, coupled with the marginall results of the industry. This gap on the demand side was partly filled by charter carriers.. Another development was liberalisation, which led to a more flexible bilateral tariff regimee and thus a diminishing need for IATA's facilitating role80. These developments pressuredd IATA into eliminating some rules and processes, while maintaining trade organisationn activities, such as the facilitation of slot co-ordination. Despite a reduction in formall powers, IATA continues to be influential (Havel, 1997: 119-123). Finally,, there are several types of non-governmental institutions that exert influence. These includee trade associations and lobbying organisations (for example, the airport organisation 'Airportss Council International' or 'ACF) that monitor government legislation and other rele- vantt issues. Through persuasion of parliament, legislative aides and other persons considered influential,, they try to obtain the best possible operating conditions for their member corporati- ons.. General and air transport media also exercise some influence. News reports can stimulate publicc interest in legislative inquiries into various air transport practices, while editorials and otherr forms of advocacy journalism may promote regulatory changes (Gidwhz, 1980: 129).

3.44 - The object of the exchange and property rights'1 Sectionn 3.2 explained that states hold the property rights to the airspace. The market is closed andd access is given through a bilateral exchange of air transport rights. In these exchanges, the conditionss of access are also regulated. At first sight, it might seem odd to regard the air as 'property*.. It does not seem possible to create, hold or enforce property rights with respect to airspace.. A more careful look, however, shows that it is possible to create exdudability and

799 Agreements authorising carriers to sell each other's services. 800 A farther&do r was the ami-coropetiüve oatuie of some prooedures. In 1978, IATA had to prove why hs proceduress should continue to have immunity from US ami-trust laws. Recalll fiom Section 2.2 that property rights capture the right to use an asset, to capture benefits from the asset,, to alter the asset and to transfer all or some of these rights. 71 1 preventt people from using airspace. Foreign aircraft, for example, can effectively be banned fromfrom the air. Furthermore, the use of airspace can be measured by dividing airspace into individuall units, using registrations by Air Traffic Control authorities. Thus, the state may use thee airspace, capture the benefits from this use, alter the rights to use airspace and transfer thesee rights to other states. The property rights to use the airspace and capture the resulting benefitss are divided into eight different (freedom) rights: two traffic rights and six transport rights.rights. Following Bin Cheng (1962: 9-16), the following rights can be identified:"2 1.. the right to fly and carry traffic non-stop over the territory of the grantor state"3, 2.. the right to fly and carry traffic over the territory of the grantor state and to make one or moree stops for non-traffic purposes, 3.. the right to fly into the territory of the grantor state and there discharge traffic coming from thee flag state of the carrier, 4.. the right to fly into the territory of the grantorr state and there take on traffic destined for the flagg state of the carrier, 5.. the right to fly into the territory of the grantor state for the purpose of taking on, or dischar- ging,, traffic destined for, or coming from, third states, 6.. the right to fly into the territory of the grantor state and there discharge, or take on, traffic ostensiblyy coming from, or destined for, the flag state of the carrier, which the carrier has eitherr brought to the flag state from a third state on a different service or is carrying from thee flag state to a third state on a different service, 7.. the right of a carrier, operating entirely outside the territory of the flag state, to fly into the territoryy of the grantor state and there discharge, or take on, traffic coming from, or desti- nedd for, a third state or third states and 8.. the right to carry traffic from one point in the territory of a state to another point in the samee state (also known as 'cabotage').

Thee first five rights are part of the Air Transport Agreement, yet are explicitly included in everyy Bilateral, reflecting the wish on the part of states to strictly regulate access to their airspace.. The first two rights, i.e. the traffic rights, are essential to the right to transport, but usuallyy no compensation is involved in their exchange. An exception is made by Russia for routess over Russian territory. Russia is not a party to the Air Services Transit Agreement and takess the position that the right of overflight takes away income that would be obtained in the eventt of a landing so that a payment is in order. The right of overflight has to be specifically arrangedd with the Russians and payments are made because of the tremendous financial

822 Some authors, including Mendes de Leon (1992, annex), distinguish nine freedoms. In this categorisation, thee eighth freedom is the same as the seventh but is combüiedwnli a UMidw fourth fieedom right Inn this listing, the carrier's state of origin is called 'flag state\ referring to uw f^ ü^ the earner's aircraft

72 2 consequencess of having to bypass the Russian airspace84. Thee third, fourth and fifth freedom rights form the core of a traditional Bilateral. The sixth andd seventh freedom rights are developed in practice and, not being formally laid down, are referredd to as 'so-called freedoms'. The eighth freedom right, namely cabotage, is laid down in thee Chicago Convention, but granting it can be problematic. The Chicago Convention formula- tess the principle that a state is not allowed to offer cabotage on an exclusive basis. Some interprett these words as containing a most-favoured-nation clause, with states fearing that, oncee they grant it, they will be forced to allow domestic transport by an airline from a state withh whom they want only limited contact. Others believe that a de facto exclusivity is allowed, butt that a refusal cannot be upheld by exclusivity (among others: Fennes, 1997: 74). Uncertaintyy surrounding cabotage has meant that this right is not frequently granted13. Thee Chicago Convention grants its member states separate rights according to the origin or destinationn of traffic instead of a single right to take on and discharge international traffic, whichh motivates the concept of the ownership of traffic (among others: Mendes de Leon, 1992:: 101)w. Traffic potential is thus seen as an 'estate', a notion which is also present in the 'Ferreiraa doctrine'. Wassenbergh (1957: 104) ties the concept to a state's responsibility for the welfaree of its economy and consequent requirement to make optimum use of its economic resources.. The rights to traffic potential constitute a central feature of the Bermuda I Bilate- ral^^ which grant the right to transport originating from a state primarily to carriers from that state.. Traffic potential also forms the basis for establishing capacity in Bilateral negotiations. Thiss limits the efficient development of air transport because it implies that the state with the smallestt third freedom potential acts as a ceiling on the total amount of traffic allowed. Alt- houghh some leeway can be created by a liberal interpretation of the fair and equal opportunity requirementt or by exploiting fifth freedom rights, these options are risky. To give an example, noo state accepts the magnitude of fifth freedom rights outweighing the amount of third freedomm traffic. If the amount of fifth freedom traffic becomes too large, the state of embarkmentt or of final destination may refuse further traffic because its own third and fourth freedomm traffic suffers (see, for example, De Murias, 1989:120, HaveL 1997: 186-187).

bearr thee flag of that country. The 'grantor state' is thee tra*ng partKrJ.c. Üie st^c alk>wing the transport. Thee payments are part of a commercial arrangement between fbfeign carriers and the Russian carrier Aetoflott The unpositioii, their size and d^ thee EC member states to take the matter to an im^matiorialkvd. It was discussed oaring an ECACnieeting in Pariss in March 1999. The issue is also part of the (technical) ICAO discusaon on ATC (air traffic control) capacity.. In addition, the Association of European Airliiics ('AEA') lias soggested creating a specific rund for thesee payments, which could be linked to uieTACIS programme (*TeduiicalAssistattoefe the Conimonweahhh of Independent States'), a teclmical assistance programine ran by thee EC, to towardss a market economy and a democratic society. So far every efiort to reach a solution has tailed. Thee SAS consortium is an exception because it involves thee granting of cabotage rightst o each of the participatingg states. The rights are not exclusive, but wm cease to be in effect if and when a thi^ cabotage. . 866 See Article 44 (f) Chicago Convention. 73 3 Thesee limits became increasingly apparent when technological innovations enabled states to attractt traffic not originating from, or destined for, their own territory. This opportunity was of greatt value to the Netherlands, especially, given its limited potential of originating and destinationn traffic. Routes (links) were created by combining third and fourth freedom segments.. Here too, it would have been possible to classify the traffic as fifth freedom traffic, butt the previous discussion suggests that this option was risky. Pool agreements were also insufficientt and new concepts were created. The first was the 'sixth freedom*. This was - accordingg to the states that benefitted from it - no more than a combination of third and fourth freedomfreedom rights, to which they were already entitled (ICAO, 1994: 14, Dierikx, 1999: 149-156). Throughh this interpretation, the transport became 'primary*87. While such reasoning is accepted inn practice, it may lead to problems when there is a need to increase the capacity allowed under aa Bilateral. Again, the state of origin or destination could refuse an increase or tie approval to a monetaryy payment, because of the effect of sixth freedom traffic on its own traffic potential. Thiss sum can vary from a reasonable sum to 'a dollar for a dollar*. Sixth freedom rights are not formallyy recognised in Bilaterals, although several Memoranda make implicit reference to them,, especially when dealing with capacity issues (Doganis, 1991: 347). Another concept developedd in practice is the 'seventh freedom*, which is a combination of third and fourth freedomfreedom rights outside the flag state. The eighth freedom right is cabotage. The seventh and eighthh freedom rights are always explicitly mentioned in Bilateral agreements but seldom granted.. With the maturing of the air transport industry, accessory provisions, i.e. soft rights, havee gained importance. Initially, these rights were not part of Bilateral agreements, which generatedd uncertainty about their future exploitation. As the financialimportanc e of soft rights hass grown, so has the call for greater certainty. Some efforts have now been made to include softt rights in Bilaterals (Fennes, 1997: 383-384). Three soft rights, namely ground handling, linee maintenance and the use of computerised reservation systems, have been included in the 19933 General Agreement on the Trade of Services ('GATS')". Untill they were defined, the freedom rights and soft rights rested in the public domain. They weree created only when expected benefits exceeded the costs of defining, negotiating and executingg the rights (Barzel, 1989: 64-65). The expected benefits have increased through both technologicall developments and changes in travel habits. Technological developments, for instance,, have helped to exploit traffic potential by linking route parts, thus creating the opportunityy to realise scale-related economies (see Section 5.2.2). Technological factors have

Dierikxx (ibid.: 154-156) describes the complex air transport relations between the Netherlands and the US in earlyy years. The main problem was KLM's sixth freedom opentóoos, wïirch can^romised tt^ principle of reciprocalreciprocal exchange. The stales concluded their first Bilateral in 1957. 888 Final act of the MTN/UR of 15 December 1993 MTWFA D-A1B (UR-93-0246). Negotiations covering air transportt services took place during the Uruguay iwmdandfi)cuscdcmtiafficrigbte.ttwas,lujweverJnot possiUetocometoanagn^mentonthego^niajiceofÜieserights. . 74 4 alsoo reduced the cost of supervising the exercise of freedom rights, further motivating an explicitt formulation of these rights. On the demand side, there has been a stronger need to differentiatee services. An additional reason for an explicit formulation is the fact that Bilateralismm is based on specific approvals.

Thee object of the exchange has now been defined. The next section takes a closer look at the transactionn process. The description follows Noteboom (see Section 2.3) and addresses in turn thee contact phase, contract phase and execution phase. Part of the execution phase, namely compliancee and enforcement, will be dealt with separately as the sovereign nature of states has implicationss forthes e issues.

3.55 - The transaction process

3.5.11 - Contact phase Anyy transaction presupposes a need. In air transport, this need is often voiced by the airline, whichh usually has a good feel for new opportunities. In the Netherlands, the transaction might bee initiated as follows. On the basis of a request by an airline, the CAA might decide to initiate aa preparatory meeting of representatives of KLM and possibly other carriers'9, Schiphol airport andd the Ministry of Foreign Affidrs. The purpose of the meeting is to identify the parties* objectivess via the exchange of information. The Ministry of Foreign Affairs provides informationn on any factors that could influence the transaction. These include the political or economicc situation in the country with which the transaction is to be concluded, the existence off other Bilaterals and conditions in the air transport industry (e.g. market potential, capacity effects,, presence of other carriers, competition). The ministry is in a good position to provide informationn because its representatives are stationed in the country concerned. These informationn gathering and processing activities are continuous, if only because air transport relationshipss are one element of the permanent relationships between states. Industry players alsoo provide information. The airport might provide information supporting a preference for a particularr airline or time of operation. The airlines will often share their private information in orderr to maximise the chance of a successful negotiation outcome. They will also support their demandss with business plans or other means. The actual exchange of information starts at the initiall domestic poationing. At first, rt might not be clear whether KLM is interested in ct>eratirjgg the rights awl hence whether other carriers are butt this will become clear at an early stage. Frequently, contacts between carriers fromth e two statess have by this stage already led to a tentative commercial accord. Additional sources of informationn include internal research material and data from manufiicturing companies, while

75 5 organisationss such as ICAO, IATA and the World Travel and Tourism Council also provide material.. Thus, some information may already be available, particularly if the states maintain closee relations or have negotiated Bilateral agreements before. Theree will be an attempt to calculate the value of the transaction, although bounded rationa- lityy makes this difficult. The Bermuda I Bilaterals base the value of the transaction directly on thee anticipated potential of third and fourth freedom traffic but, depending on domestic air transportt policy, other factors will also be included in the calculation. For example, in the case off the Dutch state, the contribution to the selective network is the correct measure, which impliess that environmental factors should be included. This means that assumptions about the usee of equipment or, more generally, about the state's attitude towards environmental issues needd to be made. In determining the value of the transaction, the foreign state's environmental viewss of and, if negotiations also cover fifth freedom traffic, the position of third states need to bee taken into account. After one or more meetings, an internal position might be established. Thiss usually covers the full range of acceptable negotiation outcomes as well as the choice of ann airline. The position is not put into writing because the CAA wants to retain flexibility in its negotiationss with the other state. Havingg established an internal position, the state forms a delegation. The delegation is made upp of airline representatives, the Ministry of Foreign Affairs and the CAA and is led by the CAA.. The airport seldom participates90. The participation of the airline is not formalised but is basedd on custom, its status as one of the main beneficiaries of the rights to be acquired, as well ass its ability to provide valuable information. Negotiations are initiated following one of two mainn approaches. The state wishing to initiate negotiations may approach the appropriate agencyy of the other state. In other instances, negotiations may be opened (or renewed) accordingg to provisions of an existing Bilateral, such as a provision requiring a periodic review.

3.5.22 - Contract phase Despitee an initial need for a transaction, it may not come to a negotiation. The state will weigh thee chance of succeeding and any potential benefits against the costs of creating or amending a Bilateral.. These costs derive from gathering, providing and processing information, negotiating,, drafting and so on. There are also costs associated with attempts to influence preferencess and secure a position favourable to lowering ex post transaction costs, such as the costss of organising a system through which compliance can be checked (Bokkes, 1989: 44-46). Iff the expected benefits outweigh the costs, the state will initiate negotiations. These negotiationss differ from negotiations between businessmen. They do not follow strict formal

Thiss depends MI the services requested (scheduled or chartered) and designation policy (dual or single). 9090 One exception is the participation of the Commercial Director of Schiphol airport in the negotiation of the 19922 Open Skies Bilateral with the United States. 76 6 miess but take place through consultation, which is essentially a diplomatic process based on credit,, confidence, consideration and compromise. There is no time frame and an agreement needd not be reached in a single negotiation round: states can stop and restart negotiations as theyy see fit (ICAO, 1994: §2.1). Thee unlimited duration of Bilateral agreements, and the need to preserve state relationships moree generally, make it very important that states reacha n agreement that is favourable with regardd to the substance as well as process of the transaction. The agreement will, of course, neverr be complete and unequivocal and parties will anticipate this fact. They will view it as bothh a problem and an opportunity. Neither party knows whether an exchange will turn out advantageous,, nor how the costs and benefits will be allocated. Much depends on any contingenciess and the states* response to these contingencies. But incompleteness and equivocalityy also open up possibilities to interpret the agreement opportunistically. Each party willl try to negotiate a position that gives it the greatest potential to exploit such possibilities. Ass the actual implications of an agreement will only unfold after the close of negotiations, each party'ss say in decisions to be made during the execution phase is crucial. The 'trick' is to get competencee without countervailing responsibility. A party will thus try to get as much clarity ass possible regarding its own competence and the other party's responsibilities,whil e inclining towardss vagueness about its own responsibilities and the other party's competence. At first sight,, this reasoning does not seem to apply to interstate relations in Bilateralism, because of suchh factors as explicit approvals and the reciprocity requirement. There seems to be little roomm for leaving issues unaddressed or creating unequal outcomes. However, Bilateralism is alsoo based relational contracting and diplomacy so that the agreement will not detail every contingency.. Furthermore, the states will always choose to leave certain matters unaddressed, becausee the costs of negotiating and drafting agreements and the costs associated with potentiall inflexibilities deter complete contracting (Lyons, 1998: 302). As an example, Bilateral agreementss do not cover sixth freedom services, although states increasingly include soft rights.rights. The states will weigh the riskassociate d with leaving matters unspecified91 against the riskrisk of not reaching agreement. In their decisions, the extent to which states trust then- respectivee trading partners plays a role. Inn some situations a party will be confident that, whatever the formal agreement may be, it iss assured of the lion's share of decision-making power. It may, for instance, have access to superiorr information during the execution phase. Under these circumstances, the party may try too minimise its formal competence in exchange for less responsibility (Noorderhaven, 1997: 121-122).. This seems to apply to the relationship between the state and airline. The airline's sayy in the decision-making process is secured essentially through its information advantage. By creatingg a position where its formal competence is limited (as is the case under designation),

77 7 favourablee events can be exploited and unfavourable events passed on to the state. Inn air service negotiations, the Netherlands are almost always the requesting party, due to thee strong position of KLM (relative to its captive market) and a relatively small potential of thirdd and fourth freedom capacity on the Netherlands' side. The country's small traffic potentiall makes it difficult to meet the requirement of a fair and equal opportunity but has also madee Dutch negotiators very creative. To compensate for the lack of air transport reciprocity, theyy have at times resorted to threats on non-air transport issues. For example, the Netherlands havee threatened to withhold contributions to NATO until the United States granted specific concessionss to KLM, and support for Israel in negotiations with the European Community unlesss Israel granted KLM additional frequencies on the Amsterdam-Tel Aviv route. Such a negotiationn tool is known as a 'non-aviation quid pro quo'. While seldom acknowledged publicly,, any quid pro quo is formalised in the Memorandum. Examples given by Gidwitz (1980:: 148) and De Murias (1989: 120) illustrate that this method is certainly not exclusively Dutch. . Afterr one or more negotiation rounds, which might take as long as several years92, the negotiatorss might reach agreement. Depending on the status of the agreement (i.e. a Memo- randum,, a new Bilateral or an amendment to an existing Bilateral), it will be implemented in accordancee with domestic rules. Once agreement is reached, the state will designate an airline.

3.5.33 - Execution phase Thee Bilateral will enter into force on the date specified in the agreement, again subject to domesticc rules. These rules can differ substantially between states. In the Netherlands, for example,, Bilaterals are formal treaties that have to be approved by parliament. In the United States,, a Bilateral is an 'executive agreement' that can be entered into by the president without thee advice and consent of the US Senate (Havel, 1997: 40). It should be mentioned that in foreignn affairs - especially when concluding treaties - parliamentary influence is often limited (Klabbers,, 1996: 132). In the Netherlands, the approval procedure for treaties on air transport iss neither difficult nor time-consuming. The ease of approval can partly be attributed to secrecy.. Although the ratification process does provide some information, on the whole, there iss a lack of publicly available material. Parliament is therefore unable to formulate an opinion or takee a position93. Thee Dutch model Air Services Agreement provides that the agreement will apply provisio-

911 For instance, the suspension of a service. 922 Negotiations may in fact be permanent, with states meeüng each other on air iransport issues at regular intervals.. Examples are the Bilateral negotiations with SoiMh Korea, as vvell as Japan. Separate negmi^ion roundss may only lead to piecemeal results. The Din^h slate has, for instance, spent c)ver 20 jears öying to increasee its rights on thee route to Tokyo By contrast, when Nagcya airport was opened reaching agreement tookk only one negotiation round. 933 Supra, p. 49. 78 8 nallyy fromth e thirtieth day after signature and formally after domestic requirements have been met.. Most states, including the Netherlands, agree that, pending the outcome of the constituti- onall process and depending on that outcome, the designated carriers are allowed to start operationss on the basis of a permit. At the same time, entry into force of the agreement does nott mean that every right will be used immediately (Rekenkamer, 1998: 53) nor that state involvementt stops. The state remains involved to protect the interests of its carrier (Dempsey, 1987:168,, HaveL 1997: 157). Often, the total frequency allowed is not fully exploited, or only onee of the carriers operates the rights,sometime s on the basis of a pool agreement. In all cases thee rights exchanged can only be used after designation by each flag state. The grantor state hass to accept every designation and issue an operational permit to the foreign carrier. The ECC AC Standard Clauses (see Section 3.2) consider this acceptance and the issue of a permit an obligation,, provided that the nationality requirement is met and the carrier can be expected to adheree to the rules of the grantor state. Although authorisation can be seen as an implicit consequencee of the exchange of rights, it is not automatic. Fennes (1997: 121-123) describes a conflictt between the Netherlands and Israel in which the Netherlands wanted to use a wet- leasedd aircraft from Southern Air Transport, an American cargo carrier. Israel refused to issuee a permit on the grounds of the nationality requirement. Some states further require that, whenn a permit is issued, a statement should be made regarding the welfare effects of the transport.. In discussing the United States* practice, Havel (1997: 164 note 191) lists some criteriaa used by the DOT, namely any implications for market structure, fare and service proposalss and the effect on competition in the domestic industry. Furthermore, the DOT has at timess linked the determination of the statutory public interest issues to the conclusion of an Openn Skies agreement between the United States and the foreign carrier's home state95. Bin Chengg (1962: 360-364) observes that this situation might even result in a reopening of negotiations,, but many authors (for instance, Dempsey, 1987: 123, Havel, 1997: 166) consider thiss unlikely to happen.

Beforee starting a new service, the airline will have to incur costs. These are partly incurred inn the destination country and consist of surveying local conditions, including relevant legislation,, organising housing and ground handling, acquiring slots and adjusting timetables. Additionall costs may arise from co-operative arrangements. The largest component of these investmentss consists of arranging aircraft capacity. The airline has to free aircraft previously usedd on other routes, lease aircraft or even acquire new aircraft. Like the costs incurred during thee contract phase, these costs are partly sunk. The operation of the rights exchanged means additionall income for the designated airline in the form of operating revenues minus tax. The airportt will also experience an additional use of its premises. The increase in its pay-off is

944 'Wet lease' is the leasing of an aircraft including crew. 955 This strategy is not exclusively American, infra Section 5.2.2. 79 9 composedd of aircraft charges, handling and fuel charges, property income and revenues from duty-freee shopping. Thee pay-off to the state is the contribution to the selective network of services to, from and viaa the Netherlands. Section 3.3.1 explained that the potential benefits of this goal are partly financial.financial. The state can also use Bilaterals as an instrument in its relations with other states. Realisingg these benefits may, however, be difficult. For example, the airline's behaviour during thee execution phase influences the state's reputation96. The state generally has little information onn whether the airline is making a serious attempt to attain the state's goals (see Section 3.3.2),, primarily relying on interest harmonisation. To realise a selective network, the state furtherr requires the timely availability of airport facilities. It uses an elaborate set of instrumentss and mechanisms to control the airport's behaviour including extensive performancee monitoring. Yet, these measures are not very effective ways of motivating the airportt to make appropriate investments or use its facilities efficiently. Again, interest harmonisationn is important. Anyy change in the conditions underlying the agreement, any breach of these conditions, or anyy new market developments may lead to a new contact phase. At this point, it is worth recallingg that Bilateral agreements do not have expiration dates and in practice tend to be long- term.. A long-term agreement may be difficult to amend if there are no procedures governing change.. The problem is particularly acute in a transaction-specific bilateral structure, where interdependenciess between transaction parties make any amendment of the agreement very costlyy (see Section 2.7.3.1). The severity of the problem depends on the nature of the change. Inn general, a change resulting from exogenous events, such as an increase in traffic volume causedd by changing patterns of travel, is easier to accomplish than a change resulting from opportunisticc behaviour (e.g. change in the time of operation). Even if there are procedures structuringg a change, negotiations may still be complex. The level of complexity can be reducedd through the use of an objective change mechanism. An example of such a mechanism iss the inclusion in the agreement of a general index clause that will become applicable once an easilyy verifiable exogenous event takes place, such as the ex post facto review clause in air transport.. Practice shows that the use of this mechanism is declining. An alternative way of amendingg Bilateral agreements is the Memorandum, but this method does not meet the standardd of objectivity.

3.5.44 - Compliance and enforcement Thee long duration of the agreement and limited opportunity for change once the agreement has

9696 An example ofan opposite situation is given by Havel (1997:187). Northwest complained that the Australian governmentt had imposed strict numerical limitations on its ft^ freedom rights. Qaiilas, bring c^ thee risk of retaliatory countcrroeasures, cotóended u^ it vv^Mt part of U^eAusti^iaii government aiKlsknild

80 0 beenn concluded can lead to disputes during the execution phase when the terms of the agreementt no longer reflect economic conditions. Havel (1997: 86-87, note 276) gives some exampless of the discriminatory treatment of foreign carriers such as sudden changes in arrival orr departure times at a destination airport, the refusal of fares, or assignment to inconvenient airport-terminall locations. In creating a dispute, a state will take into account the risk of disruptingg relations with the foreign state. It will be less inclined to run such a risk if the foreignn state is politically or economically important. In the event that a foreign state or carrier breachess the agreement, the state may choose to retaliate. In air transport, most states take the positionn that, in case of a dispute, they have the right to protect their position and preserve the benefitss derived from the agreement until the dispute is resolved. Thus, a state might restrict thee operation of a foreign airline if it determines that the rights under the agreement are being infringedd by that airline's national government (Kasper, 1988: 105, Havel, 1997: 161, 167). Becausee the airline's transport rights are frequently part of a complicated route network, suspensionn of a service will have serious effects on other services. Likewise, the inconvenience causedd to the public (the voters), the effect on future relations with the state concerned and anyy third state, as well as the high level of political visibility inherent in retaliatory exchanges increasee the cost of deviating and create strong incentives for states to comply with the terms off the agreement and to resolve any dispute rapidly (Axelrod, 1984: 179). Although the strengthh of these factors and hence the degree of compliance will vary across states, practice showss that disputes mostly end prior to turning into real conflicts. In the event of a dispute, anyy method used to resolve it should take into account the following points97: 1.. state sovereignty, 2.. mutuality, 3.. economic interests, 4.. efficiency and 5.. (legal) vulnerability of the agreement, given that a Bilateral can be terminated at any time98.

Thesee factors seriously complicate the compliance mechanism in Bilateralism. The fact that severall sovereign states are involved makes the Bilateral subject to at least two domestic regulatoryy systems as well as international law. The sources of international law are equally diversee with rules deriving from the Chicago Convention, Vienna Convention99, as well as customm and case law. The multiplicity of rules creates problems for the states and the airlines. nott be penalised for government actions that Northwest found otyectionaNe. 977 The list is based on Bin Cheng (1988:18) but adds the sovereignty öctor. ** This poii* is largely academk since Bü Bermudaa I Bilateral by the United Kingdom. Threats of termination do occiu-, however, and usually serve as a meanss of pressure or discipline (Dempsey, 1987: 37 and 176). 999 A Bilateral is a treaty in the sense of the Vienna ConvnentiooontheLawofTreatiesof 1969 ('Vienna Convention'). . 81 1 Itt is virtually impossible to learn alt the relevant laws and regulations, while the rules of internationall law are often obscure. Yet, airlines, as agents of the state, are obliged to comply withh these rules and can harm the state's goals if they fail100. A complicating factor is that the Bilaterall agreement leaves certain items unspecified so that the state and the airline do not alwayss know if they are in compliance. Furthermore, sovereignty makes the states very sensitivee about their position and their status as equals and hence about any loss of control overr the outcome of a dispute. Sovereignty generally rules out the feasibility of an external enforcementt system, which is indeed the case in Bilateralism101. Section 3.2 mentioned that relationshipss between states are managed by consultation and essentially governed by informal norms,, such as morals and manners, and by political concerns. Consultation is indeed the methodd most commonly used in air transport to both prevent and resolve disputes. States can givee consultation an exclusive role as a dispute resolution mechanism or they can make their choicee of method dependent on the nature of the dispute. A specific procedure which applies consultationn to disputes over tariffs and capacity was chosen in the second Bermuda agreement,, concluded in 1977. Consultation often applies to disputes over the meaning of certainn provisions or the application of an agreement. The Dutch model Bilateral, for instance, containss a consultation clause. As an alternative, the Dutch model Bilateral contains arbitrage clauses,, whereby parties undertake to comply with the decision of an arbitrator. These clauses doo not contain any reference to applicable rules or procedures and parties are free to choose theirr own arbitrator. The clauses are an example of a general procedure. The principal advantagee of consultation to resolve disputes is that H is a familiar method, usually engaging peoplee who understand the issues, while states retain control over the outcome of the dispute. Thee principal disadvantage is that the only parties involved are those who are likely to have establishedd views on the issues and are thus less likely to be sufficiently objective and flexible too resolve the dispute. This might lead to protracted discussions and seriously harm transport interests. . Thee compliance mechanisms in the agency relationships between the state on the one hand andd airport and airline on the other seem less complicated. Firstly, there are opportunities for legall enforcement such as domestic courts. The applicable rules and procedures are known to thosee affected, thus reducing the level of uncertainty. In addition, the relationships between the statee and industry players show mutual dependencies with opportunities for self-enforcement. Sectionn 2.4.4 noted that whether any party to an agreement will resort to legal enforcement or relyy on self-enforcement in case of a dispute depends on their relationship and relative strength. Inn the case of air transport, the airline, for example, has an information advantage during the

See,, however, the example on page 80 where state actions harm the carrier's operations. Onee exception is the regulation of three soft rights in the context of GATS. Here, general and binding rules havee been created, including a binding dispute resolutionmechanism . Supra, p. 74. 82 2 executionn phase, which often makes h stronger than the state. In its relations with the state the airlinee tends to rely on the strength of its position rather than immediately resort to legal remedies-- The feet that in the Netherlands only one airline has ever invoked the opportunity offeredd by law to contest a designation supports the above statement. However, the position of thee state is equally strong during the contact and contract phases, as the airline depends on the statee for market access, while its relationship with the airline is generally close. Both parties willl therefore be reluctant to turn to legal enforcement. The state-airport relationship is also close,, but the distribution of power differs due to sizeable transaction-specific investments madee by the airport. The high degree of asset specificity enables the airport to significantly influencee the pay-off to the state and the state will more easily resort to legal enforcement in casee of a conflict.

3.66 - Characterisation of the Bilateral structure Sectionn 2.7 classified governance structures into three categories. The description of the transactionn process in Sections 3.4-3.6 shows that Bilateralism has traces of a transaction- specificc structure. The frequency of negotiating and concluding Bilaterals is low, but the relationshipp between states creates permanent contacts. Further, the execution phase leads to permanentt contacts between designated airlines, acting as agents for the states. The permanent interstatee relationships and differences across these relationships (the relationship with the Unitedd States is very different from that with South Africa), the opportunities to use air transportt as a foreign policy instrument, and state sovereignty all warrant the creation of a specificc governance structure. Because of the importance attached to state sovereignty, the formationn of a hierarchy or unified structure has not been feasible. Rather, a bilateral structure hass been designed where states exchange rights through a form of procurement (barter). The variouss examples of how the value of the relationship affects the conditions attached to the provisionn of market access show that Bilateralism is based on relational contracting. One examplee is the applicability of the environmental provisions in the Dutch standard Bilateral, whichh varies depending, among other things, on the state with which the agreement is to be concluded.. A state with few financial resources and hesitant about giving access to Dutch carrierss will entice Dutch negotiators less than a state with substantial resources and similar viewss on the environment. Similarly, the Bilateral agreement is not detailed through extensive wordingg and, in case of a dispute, is not subject to a legalistic interpretation. Legally correct wordingg is unimportant, definitions are incomplete or vary across agreements and principles leavee room for different interpretations (MacNeil, 1978: 890, appendix: 902-905). The fact thatt the Standard Clauses (see Section 3.2) only deal whh technical-administrative matters supportss the argument. Feimes (1997: 96) characterises the Bilateral as a 'typical economic agreement',, whose primary aim is to deal with domestic political and economic concerns. In 83 3 contrastt to traditional relationalcontracting , Bilateralism shows a high recognition of recipro- cityy in the exchange (e.g. the quid pro quo requirement) and places a strong emphasis on price (approval)) and quantity variables at the formation stage102. Thee relationships between the state and its agents combine a transaction-specific structure andd a semi-specific structure of regulation. The transaction-specific element is reflected in certainn features resembling hierarchy (full state ownership of Schiphol airport and partial state ownershipp of KLM) and procurement (designation of airline and airport). Both relationships aree governed by relational contracting, as evidenced by the absence of or limited attention to incentivee systems, the absence of a careful selection process as well as the reluctance to use formall compliance mechanisms in the case of airlines. Regulation was defined in Section 2.7.2 ass a very incomplete form of long-term contracting whereby the regulated are guaranteed a just returnn - for instance, in terms of a secure operating environment and a more efficient industry - inn exchange for a successive introduction of changes. In the case of airlines, regulation governs thee process of obtaining a permit and a designation to operate services. The permit and designationn serve as a contract between the airlines and the state. The airfield designation and KEPD,, which govern the state's relationship with the airport, are also examples of regulation. Inn conclusion, Bilateralism is a form of hybrid governance structure, consisting of a transaction-specificc structure at the state level and a combination of a transaction-specific structuree and a semi-specific structure of regulation at the state-industry level.

3.77 - Further developments Thiss chapter has described the traditional structure governing the exchange of air transport rights.. The focus has been on the structure created by the Bermuda I Bilaterals. This structure comprisess the Bilaterals, the accompanying principles, the provisions of the Chicago Convention,, international law, domestic rules, as well as the rules of international organisations.. The structure can be characterised as very rigid on the one hand, and very flexibleflexible on the other hand. Never meant to be permanent, it was subjected to severe criticism duringg the 1970s. In 1977, the United States saw the coming to power of the Carter administration.. This presidency strongly believed in the benefits of greater competition and wantedd to increase its share in international air transport (Doganis, 1991: 53-54). In Texas and California,, the deregulated interstate airline markets had shown an ability to generate costs substantiallyy lower than the costs experienced by their regulated counterparts (Williams, 1994: 11).. Termination by the United Kingdom of the Bermuda I Bilateral in 1976 (because the Unitedd Kingdom felt that its traffic share on the relevant route was too small) created an opportunityy for the United States to incorporate the new policy into a new Bilateral, even

Ann exception to the emphasis on price and quantity in Bilateralism is the Open Skies Bilateral, Supra, p 46 Note,, however, the termination by Thailand of its Opea Sides Bü^enü wuli the US, mentioned in fooüwte 14 84 4 thoughh the various objectives had not been fully clarified at the time (Doganis, 1991: 157). The Bermudaa II agreement concluded with the United Kingdom in 1977 was not a success. The agreementt was much less liberal than the Bilaterals that followed shortly thereafter and in the Unitedd States was attacked within a year as being too protectionist (Havel, 1997: 46-48). The agreementt concluded with the Netherlands in 1978103 became a trend-setter for subsequent Bilateralss concluded by the United States. However, uniformity across Bilaterals generally diminishedd because, like the United States, many states were in the process of revising their transportt policy. Furthermore, groups of states were embarking upon co-operation initiatives. Thee criticisms of the Bilateral structure and its strict regulation have to be seen in the light off developments in economic theory. As early as the 1960s and early 1970s, the effectiveness off regulation was closely scrutinised (e.g. by the 'Chicago Schoor). It was found that regulati- onn frequently failed to benefit the public, among other things, because it enabled firms to appropriatee the vast rents associated with their position, because it enabled the regulators to expandd the reach of regulation to include ancillary activities (Williamson, 1976: 89) and becausee it failed to provide sufficient performance incentives. Some critics judged the air transportt industry capable of generating adequate results without regulation, partly because theree seemed to be enough potential competitors (see Section 5.2.4). In this environment, the Unitedd States domestic air transport market was deregulated in 1978. Industry performance improved,, but there was also a restructuring of the domestic air transport industry and an ** 104 increasee in concentration

Duringg the 1980s, the air transport industry was in one of its worst recessions. The consequent pressuree on revenue created strong incentives for carriers to obtain greater flexibility, both in theirr relations with the state and in IATA. These developments were influenced by events associatedd with general trade liberalisation (OECD, 1997: 116). Although the profitability of thee airlines improved during the 1990s, the liberalisation trend continued both on a regional andd on a global plane. Another factor typical of the 1990s was the concern for the environment,, which was increasingly reflected in air transport regulation. In Europe, especially, thesee concerns continue to be considerable. Furthermore, the strict Bilateral regulations frequentlyy prevent the airline and airport from using their facilities optimally. These factors havee slowly undermined the Bilateral structure. Thee ICAO conference of 1994, celebrating the 50th anniversary of the organisation, was usedd to discuss some fundamental proposals for change. However, it became apparent that at a globall level no agreement could be reached on any radical reform of the governance structure.

1033 Protocol, amending the 1957 Bilateral between the Netherlands and the United States. ,ww Borensteiii (1993) gives a good overview of these effects. See Havd (1997: §3.3) fi»ra n overview of the Unitedd States1 international aviation policy. 85 5 Thee resistance from developing countries, which feared a cannibalising effect on their infant industry,, was too strong. The hesitancy at the global level does not reflect regional initiatives thatt are often part of more encompassing forms of co-operation. One example is the initiative takenn by the European Community, which will be discussed in the following chapter.

86 6 Chapterr IV- The Community structure1

4.11 - Introduction Thee previous chapter described the Bilateral structure which traditionally governs the exchange off air transport rights. The Bilateral governance structure no longer applies to that transaction whenn the Member States are involved, having been gradually replaced by a specific European structure22 This Community structure is the subject of the current chapter. First, some general remarkss are made about the views of the European states on air transport. Sections 4.2 and 4.3 lookk at the development of the Community structure, while Section 4.4 describes the structure inn its present form. Section 4.5 discusses the parties to the transaction, namely the Community institutionss as well as more traditional parties. Section 4.6 describes the transaction, and Sectionn 4.7 the various phases in the transaction process. Section 4.8 then characterises the Communityy structure and Section 4.9 concludes with some comments about the future developmentt of the structure.

Thee air transport industry in Western Europe and the Community structure cannot be analysed withoutt looking at European integration within the framework of the European Community. Forr a long time, the Bilateral structure governed the exchange of air transport rights between Westernn European states, who were party to the Chicago Convention and entered into bilateral treaties.. Not until recently (1997) was a specific Community structure implemented. Co- operationn was, however, already a common feature. Motivated by the growing co-operation betweenn some Western European states, the Council of Europe was established in 1949. In 1957,, the Treaty of Rome was concluded by six Western European states, with the objective of integratingg the economies of the participating member states (hereafter: 'Member States')3. Thiss objective was pursued for political as well as for economic reasons. They included the desiree of the Member States to end the threat of renewed hostility between France and Germany,, the demise of the colonial empires, and the dramatic change in the balance of powers whilstt the states still aimed for an influential role in the world (among others: Jansen, De Vree, 1985).. Each state had its own reasons to join the Community and this applies equally to the statess that joined later. In many cases, these different interests, concerns and circumstances are stilll of relevance today and influence the conduct of Member States in their European policy-

Recalll that in this thesis 'Community structure' referst o the structore governing the exchange of air tran^ort rightss between Member Stales. The Community structure comprises UK rules of tlie EC Treaty, secoiKbry legislationn and all other rales and institutions governing such exchange. 22 The Community structure applies to tlie member states of the European E&moimc additionn to the EC member slates, it covers Norway, Iceland and Liechtenstein. Infta, p. 96. 33 The Treaty of Rome was opened forsignatur e on 27 March 1957. It forms the basis of the EEC Treaty, which wass renamed 'EC Treaty' following the Maastricht Treaty mentioned on p. 1. 87 7 making. . Chapterr DI observed that views on air transport differed between European states, on the onee hand, and countries such as the United States on the other. The reasons are both political andd geographical. Historically, air transport in the United States was essentially domestic. The policyy focus was on competition with the railways, which, unlike those in Europe, had not been damagedd by the first world war. Not until Charles Lindbergh had completed his international flightflight in 1927 did air transport become more internationally oriented. Like the European states, thee United States government needed to provide financial aid because of the sector's marginal profitability.. It intervened in the industry primarily by awarding contracts for the transport of maill and regulating these services. In Europe, the industry was very much influenced by the smalll size of individual states and relationships with the (former) colonies. The European geographyy gave the industry an international orientation from the outset as it generated a large volumee of international flights, which in turn raised questions of sovereignty. Furthermore, eachh state had a flag carrier which made hub-and-spoke systems a natural development (among others,, Williams, 1993: 85, Nero, 1995: 137). The relatively short flying distances also resulted inn high operational costs and led to financial aid from the state. The means employed tended to bee more direct than in the United States. They included subsidies and even nationalisation. Thesee intercontinental differences are not to deny some wide differences within Europe. The French,, for example, subsidised the sector from the outset, whilst the English were very reluctantt to provide financial aid (Sampson, 1985: 31)4. Generally speaking, however, Europeann states had a stronger tradition of air transport regulation than the United States (Buttonn et ai., 1998: 27). Thee international orientation of the European states and close relations between them strengthenedd initiatives for co-operation in air transport at an early stage. This included state initiatives,, such as the creation of ECAC in 1955, which offered a forum for exchanging views andd agreeing on common policies. ECAC further constituted an instrument for negotiating as a group,, thus enabling the states to exercise more influence. There were private actions as well, suchh as the establishment of a research institute, 'ITA\ and the Air Union project5. Traditionally,, European carriers were party to pool agreements and participated in each other's capitall (Williams: 1993, 118). The states accepted these participating interests, mainly for financialfinancial reasons. Any shareholdings were, however, tied to a maximum to be able to comply

Ass was stated in Section 3.1, the British attitude was coinplc(ely different after the second world war. This illustratess the extent to which the relative value of objectives can affect behaviour. 55 The ITA was established in 1954 by KLM, together with the six largest Eiiiopean carriers. The Air Union projectt was started in 1957 by Lufthansa together with Air France, and joined by Sabena and Alitalia. It entailedd the establishment of a pool agreement, wrunieby flights would be operated under a conunon flight schedule.. Abbati (1987: §7.2.11) points out the link between this initiative and state acüons on air transport co- operation. . 88 8 withh the requirements of substantial ownership and effective control. None of the initiatives succeeded,, primarily because states did not want to give up their sovereign rights.

Thee next section will take a closer look at European integration and at the role of air transport inn the EC Treaty.

4.22 - European integration- EC Treaty and air transport Ann analysis of the Community as a governance structure requires an understanding of the featuress characterising that structure and the relationships between Member States, which are responsiblee for concluding air services agreements. This, in turn, requires some information on thee general objectives of the EC Treaty and elements specific to the international co-operation betweenn Member States6. Given the important role assigned to case law in the formation of the Communityy structure, this section also discusses some court cases. The developments will be discussedd in chronological order. Thee European Community (formerly the European Economic Community) was created by thee Treaty of Rome. The treaty's goal can be described as the economic integration of Member Statess and, more specifically, as the promotion of a harmonious development of economic activities,, an increase in stability, and an accelerated rise in the standard of living. One of the meanss to realise these objectives is a 'common market'. A common market is characterised by thee free movement of goods, persons, services and capital, a common competition policy and harmonisationn of national laws, in so far as differences would inhibit the formation of such a markett (Matmjsen, 1990: 124). The establishment of a common market can be pursued by way off positive as well as negative integration (Hellingman, Mortelmans, 1983: 121-123). 'Positive integration** means the creation of equal conditions across various sectors of the economy. This iss done through 'harmonisation*, which is the creation of a new rule at the Community level or harmonisationn of existing national rules. 'Negative integration' entails the elimination of obstacless to the free movement noted above and is also referred to as 'liberalisation*7. Whilst liberalisationn has the potential to create more freedom, harmonisation requires that domestic powerss be limited or even transferred to a higher (supranational) level. This makes harmonisationn more difficult to accomplish than liberalisation (Corbey, 1993: 100-101). Indeed,, harmonisation is not usually a feature of co-operation between states. In view of the

66 An extensive overview can be found in Kapteyn, VerLoien van Themaat (1998). 77 In the EC the term 'liberalisation' is used mostly to denote a firang up of the market The tenn 'deregulation'' is avoided to appease political scnümafe SeeHavd(1997: 92) foradb^ssicmofthcdiffcrei^ betweenn liberalisation and deregulation. He opuies that llmalisation 0&e regulator stagingg post on the journey to foil deregulation. On thee other hand, Miberalisation'was defined in Chapter III ass 'making tree'. One way of making free is deregulation. 89 9 broadd treaty objectives, however, harmonisation forms an integral part of the EC8. Apart from harmonisation,, there are more elements differentiating European integration from traditional inter-governmentall co-operation between states. In inter-governmentalism, there is no separationn of powers and the participating states act independently of other institutions and eitherr consensualh/ or not at all. The EC Treaty creates a binding force that goes fiir beyond suchh co-operation in limiting the powers of Member States. Limitations include the direct applicabilityy of Community law, and in cases before the European Court of Justice it has been establishedd that this law holds primacy over national law9. The EC is provided with its own institutionss and has legal personality. It is vested with real powers arising from a limitation of competencee or a delegation of certain powers from states to the Community (Kapteyn, VerLorenn van Themaat, 1998: 78). In some cases, Community institutions enjoy primacy over nationall governments because qualified majority voting as laid down in the EC Treaty gives themm the necessary legal powers. The objectives of the treaty encompass every policy field and thee transfer of Community measures to domestic legal systems is substantial. Although the Memberr States in practice can still stop decisions, policies or agreements from being reached, theyy have found it all but impossible to go back on decisions and policies previously introduced.. In other words, Member States have become constrained in their policy-making andd are no longer sovereign in the traditional sense. Notwithstanding these limitations, the EC structuree generally leaves Member States a relatively high degree of flexibility to implement the policiess or rules that have been agreed. The structure contains a large number of immmum norms,, optional clauses, exceptions and opportunities sometimes enabling a state to go beyond thee provisions of the EC Treaty or secondary legislation. Furthermore, some provisions require legislativee action by Member States. As an example, Regulation 1617/93, concerning slot co- ordinationn makes the operation of the rules dependent on the declaration by a Member State thatt an airport is slot co-ordinated10. Fennes (1997: 242) compares the EC Treaty to a frameworkframework treaty, which essentially sets out general principles and objectives. Community institutionss have to provide more detailed rules through secondary legislation, comprising Regulations,, Directives, Decisions, Recommendations and Opinions11. These features create

Fromm a transaction cost perspective liberalisation has an advantage over policy harmonisation in that acceptingg proposals denianding inactive activelyy (Coibey, 1993:100-104). However, harmonised policies save on information and search costs, which is especiallyy important in thee internationally oriented air transport sector. 99 Hellingman, Mortelmans (1983:126). See also, court cases: Costa v. ENEL, case 6/64, 1964 ECR 585 and Vann Gend en Loos, case 26/62,1963 ECR 1. "" Regulation 1617/93, CM 1993 L 155, amended by Regulation 1093/99, OJ 1999 L 131. Notee that these instruments differ in their applicability. A Regulation for e andd directly applicable in thee Member States, whilst a Directive Ü; binding as to the results (o be achieved but leavess thee choice of form and method to Member States' authortöes. Decisiom are Wiidii^ theyy are addressed Recommendations and Opinions are not binding. 90 0 flexibilityflexibility and enable Member States to cope with varying circumstances and to accommodate - too a certain extent - domestic sentiments. By thus increasing the chance of state co-operation in thee process of policy making and implementation, a layered structure can facilitate the integrationn process. However, there are also disadvantages, such as a greater risk that regimes willl diverge, as well as the difficulty of knowing all the rules applicable at any one time. Dormerr et al. (1998: 124-125) cite the Dutch practice of dynamic referral, whereby - in the casee of Directives containing a provision delegating power to the Commission - an imple- mentingg law contains a reference to the original Directive (or certain provisions or annexes) withoutt amending or clarifying the text. Future amendments are transposed automatically. Althoughh the procedure increases the speed of implementation and eliminates the risk of incorrectt implementation, future changes in any rules are likely to remain obscure. Thee EC Treaty contains various provisions that elaborate the EC's objectives and serve to implementt them. An important part of the treaty deals with the realisation and operation of the commonn market. It also contains various provisions on relations with third countries as well as onn the powers of Community institutions. The transport sector is given separate attention12. Thee draftsmen justified their decision of not dealing with transport in the section on services in termss of the distinctive features of the transport sector, drawing, in part, on the controversy overr whether transport is to be seen as an instrument of economic policy or as a sector importantt in its own right. In the final analysis, they considered transport a means of realising thee common overall purpose of the EC Treaty rather than an end in itself (among others Abbati,, 1987: 18-19, Kapteyn, VerLoren van Themaat, 1998. 1172-1173, Button, forthcoming)13.. The relevant treaty articles reflect this by emphasising intervention and harmonisationn rather than liberalisation. Article 3 para 1 (f) EC is a good example as it formulatess an obligation to adopt a common policy on transport. Button (forthcoming), in the contextt of the Common Transport Policy, also points to the early focus on harmonisation as a wayy of creating a level playing field. It may thus seem surprising that negative integration has beenn common in air transport, as will be seen in this chapter. Within the special transport regime,, the draftsmen created an even stronger exception for air and sea transport. Article 80 paraa 2 EC states that the EC Council of Ministers determines whether, to what extent, and by whatt procedure, appropriate provisions (for air transport) may be adopted. The treaty's section onn transport further envisages the elimination of various barriers to the free movement of

"" Title V in the second part of the EC Treaty, Articles 7CMS0 EC (prevkwsfy 74^ EC). Even though tiansprot iss a service, the freedom to provide transport services is not part of the Tnaty's chapter on services. Article 51 ECC states that such freedom will be governed by the transport title. 13Transportt was seen as vital to the establishment of a cwnmon niaita* Moreover, te traiisport highlyy regulatedi n all the founding Member States and contained swne special features srch as Ü» cr^ off uniastracture and associated iiroblem implyingg a capacity adapted to peak demands. 91 1 servicess in the transport sector, as it does for ever other sector in the economy. Thee general integration process proceeded very well during the first years of the treaty's existencee and action was taken on various issues. A far more cautious approach was chosen for thee transport sector. In practice, the Council of Ministers as well as the other European institutionss delayed taking action towards establishing a Common Transport Policy until a fairlyy late stage. This was partly because the relevant treaty provisions did not contain a time framee for the adoption of measures and partly because political and financial interests had to be protected14.. Ultimately, the European Parliament objected to the inactivity of the Council of Ministerss and lodged a complaint against h in 1983l5. To be sure, the above is not to imply a lackk of pressure on states to relax their policies on air transport regulation. Although states weree used to dealing with air transport relations on a country-by-country basis and to a system whichh gave national flag carriers substantial protection against competition, the European Courtt of Justice ruled the general provisions of the treaty to be applicable to sea and air transportt as early as the 1974 French Seamen case16. In addition, over the years, charter airliness in particular became adept at devising measures circumventing regulations, thereby effectivelyy liberalising the industry (Williams, 1993: 69)17. Inn the second half of the 1980s the situation changed and legislative action was taken as part off the Community's internal market programme. This programme was issued in 1985 in responsee to a deterioration of the Community's competitive position, an increasingly pressing needd to integrate and a strengthening of nationalism within the Community. The Commission's 'Whitee paper on the completion of the internal market' ('White Paper') set the date of com- pletionn at 31 December 1992 and listed the barriers still in place and preventing the establish- mentt of the internal market, the measures that would be required to eliminate those barriers, as welll as a time path18. Air transport was explicitly mentioned as a sector where the internal markett was to be realised The 1986 Single European Act (hereafter: 'SEA')19 facilitated the

Jarzembovskii (1998: 10) notes that the failure did not result from a lack of ideas but rather from the inability off the Council to reach a compromise. In the context of air transport, the Commission issued a first policy memorandumm in 1979, namely 'Air Transport: "A Community Approach"'. Bulletin of the European Commission,, supplement 5/79. Com (79) 31. Also in 1979, the Council decided on a procedure, prescribing consultationn on air transport matters with third countries, Council Decision 80/50, OJ1980 L 18. In 1983, Directivee 416/83 was adopted concerning the authorisation of scheduled inter-regional air passenger, mail and cargoo services between Member States. OJ 1983 L 237. 155 Case 13/83, Obligations of the Council, 1985 ECR 1513. 166 Case 167/73, Commission v. French Republic, 1974 ECR 359. Havell (1997:418) notes that the development of the charter industry was to some extent an outgrowth of the insistencee on managed trade for scheduled airlines. The tiaditiorial understanding was U^ consumer iiiterests couldd be served by low fare charter operations, while 'national' interests (commerce, services to peripheral and underservedd regions) would be performed through scheduled services. 188 Commission: 'Completing the Internal Market'. Com (85) 310. Thee Single European Act was signed at Luxembourg on 17 February 1986 and The Hague on 28 February 1986,, OJ 1987L 169 and entered into force on 1 July 1987. On 12 September 1985 the (Transport) Council 92 2 adoptionn of various measures aimed at establishing the internal market by changing the decision-makingg rule of unanimity into qualified majority. Shortlyy before the White Paper was published, the Commission issued a second memorandumm on air transport20. An important impulse was the decision of the European Court off Justice in the 'Nouvelles Frontières' case, which dealt with tariff agreements between airlines21.. The 1974 French Seamen case mentioned above had already clarified that air transportt is subject to the general rules of the Treaty, which included the competition provisions.. However, the effective operation of these provisions, Articles 81 (prohibition of anti-competitivee agreements, decisions and conceited practices which eliminate, reduce or distortt competition, unless specific exemptions have been granted22) and 82 EC (abuse of a dominantt position)23 requires an implementing Regulation. Such a Regulation was created in 19622 (Regulation 17/62), but in the same year a second Regulation (Regulation 141/62) excludedd transport from its applicability24. In the Nouvelles Frontières case the European Courtt of Justice had to clarify how the competition provisions could be applied in the absence off secondary legislation. In doing so, the court noted that article 84 EC imposes on authorities inn the Member States, pending implementing rules under Article 83 EC, the obligation to apply Articless 81 and 82 EC. With respect to Article 85 EC, on the powers of the Commission, the courtt noted that the Commission may investigate cases of suspected infringement. Although thee decision itself neither declared any specific illegalities nor imposed upon national authoritiess or the Commission a legal obligation to act, the court did allow national as well as Commissionn action against tariff agreements (including their governmental approval). The Commissionn sensed an opportunity to use its court-validated competence under Article 85 EC. Thee Member States for their part preferred a say in any final proposals over and above Commissionn infringement procedures. The decision of the European Court of Justice thus stimulatedd both the Commission and the Member States to take action (Haanappel, 1989: 74- 75,, Havel, 1997: 296-297, Button et aJ, 1998: 41). Inn the second memorandum, the Commission analysed the status of the industry and formu- latedd objectives with regard to its future development. It concluded that measures were needed too increase the efficiency and profitability of the sector, as well as improve the quality and adoptedd a resolution agreeing to establish a Common Transport Micy by 1 Jaxiuar>'1993 (Kaptcyii, VerLoren vanThemaat,, 1998: 1177). Airr Transport, Com (84) 72, 'Progress towardsth e development of a Community Air Transport Policy*. Also referredd to as'Second Memorandum'. 211 Case 209-213/84,1986 ECR 1425. 222 Article 81 para 3 EC notes that the prohibition of Article 81 para 1 may be declared inapplicable, either individuallyy or generally. 233 Previously Articles 85 and 86 EC. 244 Regulation 17/62, QI1962 L 13 and Regulation 141/62, OJ1962 L 124. When transport is not at issue, Regulationn 17/62 applies. 93 3 lowerr the prices of its services. Competition policy was assigned an important role. The memorandumm did not address services to third countries. In its analysis the Commission drew onn experience gained in the United States, where the domestic air transport market had been deregulatedd in 1978 and where a radical restructuring of the industry had occurred25. Although thee initial situation in the United States differed substantially from that in Western Europe, in formulatingg Hs proposals, the Commission was aware that certain sensitivities made it importantt to avoid any repetition of the US experience in Europe (Second Memorandum, 1984:: at 42-43, Button, 1996: 276). ft thus decided upon a dhTerent course. The strategy adoptedd was a phase-wise liberalisation which would be accompanied by a common policy. Thee Commission thus preferred a 'learning by doing approach' to a 'Big-Bang approach', as hadd been chosen in the United States (differently, Havel, 1997: 140-141). The EC programme comprisedd three main packages of measures, each independent of the other two and not fully planned.. They were aimed at liberalising the sector in three phases: 1987-1990, 1990-1992 and 19933 onwards. Emphasis was thereby placed on the process, with a gradual implementation of measuress enabling an analysis of their effects and a tailored amendment of rules in each successivee phase. This allowed Member States at least partially to accommodate domestic sentimentss and to create a structure considered fair by each of the parties. It also lowered uncertainty,, which was fiirther reduced by explicit goals and phases that were part of the White Paper.. Some uncertainty remained due to the vagueness inherent in the internal market conceptt In addition, the programme was not entirely clear about the regime that should ultimatelyy prevail in the market, nor about the level of intervention that would still be allowed inn order to protect the public. Finally, an 'internal market' disregards the global character of air transport. . Apartt from actions taken at the Community level and actions taken by charter airlines, liberalisationn occurred through changes in existing Bilaterals. The first was the 1978 protocol amendingg the 1957 Bilateral between the United States and the Netherlands, which had a spill- overr effect on other European states (Schreurs, 1983: 91, Havel, 1997: 157-159). In 1984, the Unitedd Kingdom and the Netherlands agreed on a Bilateral that basically freed the market betweenn the two countries (Doganis, 1991: 64, 79). It was soon replaced by an even more liberall agreement. InIn 1987, the EC AC member states concluded an agreement whereby they could share capacityy up to a maximum range of 45%-55%. A trial period of two years was agreed. Another elementt was the introduction of tariff zones, whereby tariffs within a zone would automatically

255 Supra, p. 85. Articlee 13. Tbc internal market differs from the common maikct concept defined eariier in that the latter conceptt is wider (Mathijsen, 1990:126). Differently, SEW (1998: 223), discussing a book by Schiauwen, Marchéé Intérieur (1998). 94 4 bee approved (recall that governments could require approval of tariffs agreed through IATA procedures).. This had a limited deregulatory effect and facilitated the introduction of Communityy measures.

4.33 - European air transport packages Thee first regulatory package was agreed in December 198727. The package contained the measuress from the ECAC agreement mentioned above and included legislation on tares, markett access and capacity determination. In addition, Regulation 3975/87 implemented the competitionn provisions by setting out the customary procedural provisions in the air transport sectorr relating to obtaining individual exemptions, with an opposition procedure, the Commission'ss powers of investigation and hs powers to impose tines (Kapteyn, VerLoren van Themaat,, 1998: 1205)2*. Since some of the customary industry agreements had a positive effectt on transport and could potentially benefit the public, a second Regulation, namely Regulationn 3976/87, empowered the Commission to grant block exemptions29. The block exemptionss that were issued applied, among other things, to capacity and pooling agreements, computerisedd reservation systems and ground handling agreements30. The first package was limitedd in territorial applicability to traffic between Member States, and its effect was small. Thee greatest effects were seen in those states that were already prepared for a freer market, suchh as the United Kingdom. France, by contrast, declared that it would keep its national markett closed and maintain a policy of single designation (Dempsey, 1987: 97, Doganis, 1991: 81).. A small number of new carriers entered the market and a few regional carriers expanded theirr activities, while some carriers made use of larger fifth freedom opportunities.

Thee second package, issued in July 1990, elaborated on the measures from the first package31.. The effect of this phase was equally small, mainly because the prevalent economic situationn did not stimulate firms to start up new activities but rather provided an incentive for consolidation. . Alsoo in 1990, an initiative of the EFTA countries32 led the Commission to start negotiations

277 Regulations 3975/87 and 3976/87, Directive 87/601 dealing with tariffs and Council Decision 87/602 regarduigcapacny.QJregarduigcapacny.QJ 1987 L 374. Havel (1997:285, note 304) notesthat the word "package' has become a phrasemafcerr in the liberalisation process. "" Regulation 3975/87, OF 1987 L 374, most recently amended by Regulation 2410/92, QJ 1992 L 240 Regulationn 3976787, QJ1987 L 374, amended by Regulation 2344/90, OJ 1990 L 217, aiidRegiüation 2411/92,, QJ 1992 L 240. Most recently amended by the Act of Ai&rian, Finmsh and Swede* Accession (1994),, (as adapted by Dec. 95/1, QJ 1995 LI). Procedural matters are governed by Regulation 4261/88, QJ 19888 L376. "Att the time of writing the block exemjaions have aU expired except forte OKhnationn (Regulation 1617/93, QJ 1993 L 155, as amended by Directive 1083/99, QJ 1999 L 131) ~~ Regulations 2342/90,2343/90 and 2344/90, QJ 1990 L 217. 322 The Eiiropean Free Tia

4.44 - Current Community structure Thiss section describes the main features of the current Community structure. Loosely speaking, thee structure is built around six items, namely price approval (tariffs and charges), market accesss (including routes), capacity, competition policy, harmonising measures and measures aimedd at airports. These items will be addressed in turn.

Thee airlines may freely determine tariffs without governmental approval. As a way of protectingg the public, Member States may require tariffs for scheduled services to be filed in advancee and to be made public. Further, a safeguard clause allows Member States or the Commissionn to intervene when an extremely high or low tariff is issued in a market in which theree is already an opposite trend. A proposal for the regulation of airport charges is pending att the Community level35. Ass to market access, Bilateral agreements among the Member States and the EEA states no longerr apply. The agreements no longer have practical relevance, apart from incidental provisionss that extend beyond what Community rules provide or provisions that cover a differentt area . Bilaterals with third countries have remained in force. A carrier with an air

333 Regulation 2407/92 on licensing of air carriers, Regulation 2408/92 on access for Community air carriers to intra-Cornmntiilyy air routes, Regulation 2409/92 on fores and rates forai r services, Regulation 2410/92 amendingg Regulation 3975/87 and Regulation 2411/92 amending Regulation 3976/87. OJ1992 L 240. 344 NRC 11 December 1998, 'EU accoord over handel met Zwitserland'. For the text of the agreement see http:/www.euiopaa admin, ch/e/inl/abmdex. htm. 355 Commission proposal for a Council Directive on airport charges; Com (97) 154. 366 An example of a provision that (until April 1997) extended beyoiid (^ntinumty provisions was cabotage. The Bilaterall between the Netherlands and the United Kingdom imtially also cnitpaced Üw grad^ mentt of the new order (Havel, 1997:303). An example of a provision that covers a different area is a Bilateral provisionn dealmgwft*fnlhrreeckm traffic Kapteyn,, VerLoren van Themaat (1998:1203, footnoote421) , stating that such behaviour is no longer allowed onn the basis of the ERTA doctrine. Section 4.5.6.1 will krak at u^ieniauiingrxiwersofthe Member States 96 6 operator'ss certificate can obtain an operating licence, which has to be issued if the carrier has thee financial means to adhere to the rules that apply to service provision during the first two yearss of its existence, is willing to comply with those rules and is able to do so ('fit, willing and able').. The carrier has to maintain its principal place of business in the state that issues the licence.. The provisions of the EC Treaty have also influenced the traditional Bilateral nationalityy requirement. A fundamental feature of the EC Treaty is the right of establishment andd free movement of goods, services, persons and capital, which implies that every Communityy airline has a right of establishment in any Member State. As a result, the nationality requirementt no longer applies at the domestic level but at the Community level. 'Community carrier',, both chartered and scheduled, have unlimited market access. This is not to say that theyy are allowed to start operating a service, because access is subject to a route authority for scheduledscheduled services or a charter permission and may include an authorisation procedure. Regulationn 2408/92, however, implies that access cannot be withheld without an objective reason38. . Capacityy may be freely determined and the equal opportunity requirement is interpreted as ann equal starting position. Thee relaxation of ex ante rules has increased the role of competition policy. Section 4.3 notedd that Articles 81 and 82 EC have been implemented by Regulation 3975/87, while Regulationn 3976/87 has empowered the Commission to grant block exemptions. The Regulationss have been amended over time, as have the block exemptions. At present the only blockk exemption that is still valid is Regulation 1617/93 dealing with slot co-ordination. Article 866 ECr also needs to be mentioned here. Firms in the air transport industry often have a speciall position in the economies of Member States, which may affect the application of treaty rules40.. Member States may, for instance, give domestic firms a preferential treatment, or firms mayy claim that the special tasks with which they are entrusted exempts them from some of the treatyy provisions. Article 86 para 1 EC confirms that the treaty provisions are applicable to the actionss of Member States in relation 'to public undertakings and undertakings to which Memberr States grant special or exclusive rights', while Article 86 para 2 EC provides for a

Thee certificate certifies that the carrier possesses the professional skill and organisation needed for the safe operationn of air transport activities listed in the certificate. 388 Supra, p. 63. 388 OJ L 373 of 16 December 1991.Article 3 para 2 Regulation 2407/92 states that thee licence does not in itself conferr any access to specific routeso r markets. See Case BO. VTI/AMA/I/93, OF 1993 L 140 (Viva Air), mentioningg an automatic authorisation to exercise tratfo riglte otherwise.. The list of exceptions includes puNfc service nxju^ements, nd^ eirvironmentall protection, as well as restAaiors ate to slot co-oidii>atioiL aa short time frame(Havel , 1997:320, footnote 517). 399 Previously, Article 90 EC. 400 Note that stale ownership in itself does not detennine whetiier tlie artide is ai^

Thee existence of a formal procedure by which these obligations arc imposed and the derogation from (he generall regime of Regulation 2408/92 may seem to have reduced the scope for airlines to resort to Article 86 paia2EC.. Similarly, in the airport sector the Commission has more than once rejecteda n appeal on this provisionn (see Slot, Skudder (2000:1-9)). However, the actual operation of Article 86 para 2 EC calls for an investigationn into the treaty provision that is being mfrmgeda^ the operatiraofthe service Ü^ requires an exemption.. This is essentially a case-by-case approach. Finns may thus still invoke the provision, for instance, too justify differential tariffs or a discriminatory treatroenL Supra,, p. 62. 433 Regulation 3922791, OJ 1991 L 373. 444 Agreement of 14 June 1985 between the governments of the BENELUX coiintries, Germany and France 455 Council Decision 1692/96, OJ 1996 L 228. 98 8 thee ground handling markets at Community airports will gradually be opened up until 200146.

Moree recently, the Commission has issued proposals dealing, among other things, with the implementationn of the competition provisions on external air transport and external air transportt relations generally (Balfour, 1995: 29, 168, Kapteyn, VerLoren van Themaat, 1998: 120S)) , but in this area no real progress has been made. Some progress has been achieved in decision-making,, however. The 1992 Treaty of Maastricht introduced the co-operation proceduree into decision-making in air transport, while the 1995 Treaty of Amsterdam replaced co-operationn by co-decision. Thee air transport packages and accompanying measures described in this section aim to providee an all-encompassing regime. The Community structure is unique in the sense that no otherr group of countries has integrated their air transport markets to such an extent. Nonetheless,, air transport is a global activity and the Community is not a self-contained market.. Many carriers from third countries are active on the internal market. In 1999, for example,, passenger throughput at Schiphol airport was 36,425,113, of whom 20,168,638 travelledd to and from the 15 EC Member States (Amsterdam Airport Schiphol, 2000), which meanss that approximately 44% of total passenger traffic was governed by structures other than thee Community. The activities of third country carriers within the internal market and remainingg Bilaterals with third countries continue to affect the Community structure.

Thee next section describes the most important participants in the exchange of air transport rights.. Some of these parties also appear in the Bilateral structure (see Section 3.3) while otherss are specific to the Community. The differences between the Bilateral and Community playerss identified here will help explain the differences between the Bilateral and Community structuress identified in Chapter V48.

4.5-- Parties to the transaction

4.5.1-- EC Commission Thee Commission is a non-partisan body comprised of representatives of the Member States. As att 1 January 1997, following the accession of Sweden, Austria and Finland, the number of memberss stood at 20. Members are appointed by the Member States, in principle by common accordd of their governments. In practice, however, each government announces its choice

4646 Directive 96/67, OJ 1996 L 272. 477 Com (97) 218. Forr a general overview and elaborate discussion of the Community institutions sec, for instance, Kapteyn, VerLorenn van Themaat (1998), Chapter IV, specifically, sections 1-7 and 10. 99 9 unilaterally.. The appointment is for five years and is renewable. In performing their duties, Commissionerss are required to be independent and neither to seek nor take instructions from anyy quarter. The Commission meets weekly and in principle decisions are taken by a simple majority.. Although it acts in close co-ordination with the Council of Ministers, the Commission,, unlike the Council of Ministers, enjoys some measure of autonomy from the influencee of member governments. One reason is that the Commission acts as a whole. As a result,, members can only be sent home collectively and not individually. The Commission has severall tasks. For instance, it can render Opinions and issue Recommendations to the Council off Ministers on issues related to the EC Treaty as well as execute policies which have been decided.. It may also represent the Community and sometimes negotiates on behalf of the Community,, examples being the EEA negotiations (see Section 4.3) and the GATS negotiationss in the early 1990s. Furthermore, the Commission is responsible for proposing new legislationn and revising existing legislation. Finally, the Commission has a duty to oversee EC developmentss and to ensure that business transactions are conducted in conformity with the relevantt provisions of the EC Treaty. This supervisory function includes the power to investigatee alleged infringements of competition law and has been important to the developmentt of the Community structure. Despitee appearances, the actual power exercised by the Commission is limited. A few factorss play a role. To begin with, although the Commission has powers of its own, informationn asymmetry may in effect make the Commission dependent on co-operation of Memberr States in reporting violations of competition law and in effectively eliminating these violations.. From an institutional point of view, the co-operation of the Member States is neededd in the adoption of legislation and realisation of their intended effect. Finally, the Communityy institutions only have those rights that are explicitly conferred on them.

4.5.22 - EC Council of Ministers Thee Council of Ministers (hereafter: 'Council') is the governing body of the EC, as well as a negotiationn and executive body, ultimately responsible for realising the objectives of the EC Treaty.. The Council is not the same body as the European Council, which consists of the heads off state and government of the Member States meeting with the President of the Commission andd assisted by Ministers of Foreign Affairs and other Commission members. The Council is thee institution in which Member States are represented as such and through which they participatee in the political and legal activities of the EC (Kapteyn, VerLoren van Themaat, 1998:: 187). The Council is made up of representatives of the Member States who act in accordancee with instructions given to them by their respective governments and who are authorisedd to bind their governments. In performing their tasks, members of the Council

100 0 alwayss have to take into account the instructions from and their relationship with the home country,, where the proposal has to be defended and approved. In this respect the Council differss from the Commission, whose members are independent. In some Member States relationshipss between the delegates and the state are essentially formalised. Denmark, for example,, uses a system whereby a delegate operates under an explicit mandate from its nationall parliament, the Folketing (Westlake, 1995: 59, 346-348). On the one hand, such a mandatee could form an obstacle to efficient decision-making as it limits the opportunity for makingg compromises. On the other hand, the mandate provides guidance to the representative andd helps the state to control the representative's behaviour. Furthermore it increases the chancee that an agreement - when concluded in accordance with the mandate - will be upheld domesticallyy and so generates lower implementation costs49. Thee composition of the Council depends on the policy field. For instance, there is a Council off Ministers of Finance, of Industry and of Transport. Each of these sectoral Councils develops itss own distinctive character and practices. In part this follows from treaty provisions on voting requirementss and decision-making procedures as well as from the nature of the subject matter. Itt can also result fromth e status of ministers. The members of any given Council often develop aa sense of familiarity especially if their Council meets frequently.Thi s in turn can lead to an 'espritt de corps* and a strong sense of corporate identity, particularly vis-a-vis other sectoral Councilss and institutions and even vis-a-vis domestic institutions (Westlake, 1995: 60). The frequencyfrequency of Council meetings varies. The General Affairs Council, for instance, meets once a monthh whereas the Transport Council only meets about four times a year. In the intervals betweenn meetings, there is frequentcontac t and proposals for decision-making are processed byy both administrative and political auxiliary bodies of the Community, such as the Committee off Permanent Representatives (Van Schendden, 1996: 533). The Presidency of the Council rotatess among the Member States and the President has become increasingly important for resolvingg matters, for instance through brokerage. In addition, the Presidency may try to influencee legislation through setting the agenda and issuing a legislative programme at the start off its 6-month term. During its Presidency in the first half of 1997, the Netherlands, for example,, tried to get an agreement on the introduction of a tax on emissions in air transport as welll as a Commission proposal on 'non-addition* of noisy aircraft belonging to the 'Chapter nrr category (Ministry of Transport, 1998). The Council is the only Community institution withh decision-making power, except where and to the extent that power has been entrusted to otherr organs or institutions. An example of such delegation is the Commission's competence in competitionn policy. Even though the EC structure is relatively open, Council meetings are

499 A different view of the relationship between the representative and domestic coiistituei^ Coibey(1993:170-172),, who points out thai the EC provides the opportunity of taking lutpofxilar decisions

101 1 secret.. Public discussions, it is believed, could frustrate an agreement. Thee Council is aided by the Committee of Permanent Representatives, or 'COREPER'. COREPERR is formed by representatives of the Member States, seconded to Brussels. It preparess Council meetings and performs certain executive tasks. The preparation of meetings entailss the process of agreeing on and formulating material to be submitted to the Council. This functionn in effect exerts a powerful influence on decision-making, and some studies estimate thatt about 90% of Council decisions are actually taken at this level (Westlake, 1995: 291, 294- 295,, 370). Furthermore, COREPER constitutes the exclusive communication channel between thee Commission and Member States, thus performing important information gathering and processingg tasks. In practice, COREPER members tend to adopt a frame of reference broader thann their own countries' needs or at least understand the requirement of satisfying the national interestss of individual Member States and the additional interest of the Community (Kirchner, 1992:: 76). The Committee thus serves as a harmonising force.

4.5.3-- EC Parliament Thee political system in Europe requires democracy at every level. Accordingly, the Communi- ty'ss institutional structure needs to be subject to democratic control (Nicol and Salmon, 1994: 226-228),, which is the role of the European parliament (hereaften 'Parliament'). Parliament consistss of directly elected representatives of the citizens of the Member States. It serves to advisee the Council on matters pertaining to the development of the Community and holds certainn decision-making powers. Thee repeated criticism that the Community's law-making process is too far removed from thee people and is not subject to a democratic control mechanism has over the years led to an increasee in Parliament's powers. For example, a procedure has been introduced whereby the Commissionn and Parliament agree on a legislative programme annually. Parliament's influence hass also increased as a result of the practice of the Presidency presenting its legislative programmee at the beginning of its term and reporting back on its achievements at the end (Westlake,, 1995: 342). Specific to air transport has been the introduction of the co-decision proceduree in air transport which has made Parliament a legislative partner completely equal to thee Council.

4.5.44 - EC Courts Thee EC Courts are the European Court of Justice and the Court of First Instance, established inn 1988. The Court of Justice holds adjudicative powers vis-a-vis Member States, institutions

withoutt risking the alienation or frustration of the domestic electoral base. 102 2 andd individual persons, including firms which arc located in the Community30. The Court of Firstt Instance handles disputes between individual persons, but is not competent in disputes betweenn Member States, or between Member States and Community institutions. Individuals cann bring an action against a Member State in a national court for infringement of any directly effectivee provision of Community law, whether or not it has been incorporated into national law.. Member States and Community institutions may also ask the Court of Justice to establish ann infiingemenl of the EC Treaty by the Council, the Commission or Parliament for failing to act,, having been called on to do so. Note that the European Courts operate alongside domestic courts,, which are required to apply Community law. It may be argued that the national courts shouldd adjudicate every dispute because of their superior local information. However, in the matterr of air transport the argument loses force in the light of the international nature of these activities.. Moreover, the adjudication of international cases by domestic courts may lead to difficultt questions of competence and uncertainty. Thee existence of international courts, capable of issuing binding verdicts and imposing sanctionss is a fundamental feature of the Community governance structure. Apart from adjudi- catingg specific cases, the EC Courts play a harmonising role through their case law. This enabless and sometimes obliges domestic courts to ask for an interpretation of a provision via a preliminaryy ruling51. Sectionn 4.7.4 will look at some specific aspects of the Community's dispute resolution mechanismss in air transport.

Twoo final parties need to be mentioned, namely ECOSOC and the Committee of the regions. ECOSOCC represents employers, workers and independent persons. Numerous articles of the ECC Treaty - including those on air transport - require the committee to be consulted by the Councill and the latter also consults the committee optionally. The committee's opinions are nott binding on the Council. The Committee of the Regions consists of representatives of regionall and local bodies. It has advisory functions and must be consulted where the EC Treaty soo provides. The Treaty of Amsterdam requires that the committee be consulted on matters relatingg to air transport. Given their consultative roles, the influence of these committees is greatestt at working group level during the contact and contract phases.

Inn some cases even third country firms,se e Coinmission Decision 202/85 and Cases 89 104 114 116 117 125/129/85,19888 ECR 5193 (Wood Pulp). Although this case is not specmcally relatolt o air transport, there' aree some implications as it deals with the trapcMtionoffiiiesontrüidcounliyfüra cc-<>idinationn activities. These a^ markett (Haanappel, 1989:78). 311 This opportunity was used in thee French Seamen case (soera, p. 92V The Enwyem flan «in aU* initio neww policies and legislation. An example is the 1983 case rfl^liainent against Comiitission (suina, p. 92), whichh raotwatcd the Commission to become more active in (fevetopuig the Coi^^ * 103 3 4.5.55 - Objectives of the EC institutions Thee overriding objective of the EC Treaty has already been identified as the economic integrationn of the Member States. An efficient transport sector can help to realise this objective andd the treaty requires a Common Transport Policy. According to Jarzembowski (1998: 15) thee goal of this policy is to 'further integration in the transport sector so as to create a functionall European transport market, and in addition *to create long-term stable mobility", combiningg the business" and citizens* desire for mobility with the citizens' desire for protection off the environment'. The key term is 'sustainable mobility'52. On air transport, Balfour (1995: 268-269,, 271) opines that the Community's objective is to try and realise the benefits of the internall market by eliminating barriers to the free movement of services and by developing a commonn policy. The Second Memorandum (1984) notes that such a common policy would be directedd at raising the efficiency and profitability of the sector, as well as lowering prices and improvingg the quality of its services. The memorandum includes some social objectives, such ass those concerning the mutual conditions of licences and employee working conditions. These objectivess are limited, however, given that Member States do not hold a common view on the questionn of whether social Europe is an integral part or merely a by-product of economic Europee (Molle, 1990: 420, Kirchner, 1992: 102-103). The above description illustrates that the Europeann Community is a collection of different Member States and institutions each with then- ownn objectives, making it difficult to formulate a 'Community objective'. More recently, environmentall protection has been introduced into policy documents and it is now acknowledgedd that air transport has serious consequences for the environment (Jarzembowski, 1998:: 16). The greater attention to environmental protection may also be inferred from the Treatyy of Amsterdam, which inserts into the EC's institutional structure the obligation to integratee environmental policy with other policies. At the same time, the integration requirementt does not mean that environmental interests are given preference, nor that the Communityy will be able to ensure an adequate level of protection53. Turningg to the individual European institutions (Second Memorandum, 1984: 3-5), various proposalsproposals and memoranda show that the Commission has been the most vocal proponent of amendingg the traditional structure. This is only natural, given the Commission's role as

Thee objective of sustainable development is also inserted in Article 6 EC and embraces the preservation, protectionn and improvement of the quality of the emironment as well as the prudent and raüonalutüisalio n of naturall resources (Kapteyn, VerLoren van Themaat, 1998:1356). See also the Communication from the Commission,, 'Air Transport and the Environment, Towards meeting the Challenges of Sustainable Development',, Com (99) 640. 533 In many instances the competitive position of the air tiansport mdustry is at stake aiid there is a pnrferenre forr developing proposals at a global level (in ICAO) (For instance, Kinnock, 1999). Section 5.8 will further discusss the effectiveness of the Community stnictare in pursumg the goal of aiviionn^ 104 4 guardiann of the treaty and EC development. Parliament has been of the opinion that the performancee of the air transport industry both can and roust be improved, but has favoured a 'go-sloww approach', pointing to the extremely complex nature of the industry. The opinion of ECOSOCC has been even more conservative and has concerned safety and the interests of airlinee employees. The Committee has suggested that action should be considered on several of thesee social issues. The opinion of the Council has varied depending on the proposal being decided,, and the economic conditions, traditions and air transport policies in the Member States.. The position of the Member States that make up the Council will be detailed further in Sectionn 4.5.6. Itt should be noted that the objectives described in this section only concern internal policy. Inn its proposals on an external air transport policy (supra, Section 4.4), the Commission has alreadyy stated in general terms the objectives of such a policy. Broadly speaking, it should enablee all Community carriers to take advantage in the international context of benefits created byy the internal market and thus to relax bilateral constraints, while at the same time ensuring reciprocityy of opportunities. The policy should further the interests of users, who are generally servedd by a removal of regulatory and competitive constraints on carriers and not by national protectionism,, and the interests of regions, by facilitating access to regional airports (Balfour, 1995:: 278).

4.5.66 - Member States

4.5.6.11 - General remarks Thee position of the states has changed as a result of their participation as Member States in the developmentt of the Community and a gradual implementation of the various air transport packages.. The exchange of air transport rights still takes place between states, but the nature off the exchange has changed from an intergovernmental treaty to EC legislation, which is a typee of semi-specific governance structure. The sovereign position of the states has been restrictedd by their status as EC Member States. Community co-operation has meant state interdependencee and a reduction in domestic powers. The greater powers at the Community levell have increased the need for co-ordination between domestic and European positions. To facilitatee such co-ordination, each Member State has set up a European secretariat in Brussels, wheree the ministries' views and interests can be reconciled into a co-ordinated position. These imer-ministeriall forums are responsible for preparing and commissioning messages to the Brussels,, or permanent, representatives of the states (Dinan, 1998: 297-301). As at December 1999,, the permanent representation of the Netherlands had a staff of 48, with diplomatic status ass well as support services (Interinstitutioneel Jaarboek, 1999). The staff are either members of

105 5 thee diplomatic service or seconded to it from the home country (Nicoll, Salmon, 1994: 69). Everyy ministry has its representatives in the permanent representation and hence a direct representationn of its own interests as well as a 'barometer' of its specific policy areas. Contact cann be established more directly and efficiently than via formal co-ordination channels. At the samee time, each representative is also in frequent contact with his home country. As is true for aa Council representative, a permanent representative needs to have the confidence of the party hee represents in order to be effective. Sectionn 4.3 made clear that the current regulatory package does not exclude the ability for Memberr States to pursue a domestic air transport policy (also, Balfour, 1995: 275). Yet, this abilityy has been reduced in the following ways. First,, Bilaterals are no longer used as an instrument in air transport by and between Member States.. The domestic market of each Member State has been opened up to carriers for whom thee requirements of effective ownership and substantial control apply at a Community level. Theree is the requirement of a route authority and there may be some entry barriers in the form off slot co-ordination or public service requirements54. However, these instruments can only be e justifiedd on the basis of objective criteria, such as infrastructural constraints. Member States aree further constrained by the central principle of Community membership, namely Community loyaltyy (or: solidarity), as laid down in Article 10 EC. This provision binds all national institutionss that hold public authority, requiring them to take all the steps needed to comply withh the obligations imposed by the EC Treaty and to facilitate the tasks of the Community. It alsoo obliges them to refrain from any action that impedes the realisation of the treaty's objectives.. In addition, Article 10 EC touches upon the Member States' powers to conclude Bilateralss with third countries or to determine their content. Some provisions are more expresslyy directed at these powers. An example is Decision 80/50, recniiring Member States to consultt each other on air transport matters being handled in international organisations55. The Decisionn also requires Member States to provide information to the Commission and other Memberr States on developments in their air transport relations with third countries (Balfour, 1995:: 265). The 'ERTA doctrine' is another direct constraint56. According to this doctrine, wheneverr the Community lays down rules with a view to implementing a common policy envisagedd by the EC Treaty, Member States acting individually or even collectively lose the rightright to contract toward third countries obligations affecting that policy. The doctrine has been

AA public service requirement is defined as an activity exercised b>'either a pubHcfy or a ptivalely cm-ned enterprisee which is generally in the public interest and earned ortundCTgpve^ torntorn (Second Memorandum, 1994: annex IV, p. 16). By 1996 more than 100 intra-Community routes had been openedd under the new Regulation (Commission, 1996:7) 555 Supra, p. 92. 566 Case 22/70,1971ECR 263. 106 6 expandedd in Opinion 1/7637, which has found that the Community also has exclusive competencee if internal measures can only be adopted after an arrangement with third countries hass been concluded, provided that such an arrangement is also necessary to achieve an internal Communityy objective (Kapteyn, VerLoren van Themaat, 1998: 1178-1179). The Commission triedd to obtain more clarity on the division of powers between the Community and the Member Statess at the time when the GATS agreement was concluded (1993). In a request to the Europeann Court of Justice it wanted to find out whether the Community had exclusive competencee to conclude the agreement or whether both the Community and the Member Statess should become signatories. One of the arguments was that international trade in services formedd part of the commercial policy (implying an exclusive Commission competence on the basiss of Article 109 EC58) (ibid. 1278, Mahler, 1995). This view was rejected by the Court of Justice.. With respect to transport services, which were an element of GATS, the court noted explicitt provisions in the transport title covering these services foreclosing the subsumption of transportt services within the common commercial policy. The Court of Justice further rejected thee attribution of competence based on the mere establishment of common internal rules in transport,, particularly when not all transport matters were already covered by common rules. Exclusivee Community competence would have 'to be established on the basis of the ERTA doctrinee or on the basis of specific clauses in EC legislation ... dealing with negotiations with thirdd countries* (Kapteyn, VerLoren van Themaat, 1998: 1279,1348)59. Thee situation has become more complicated as, in 1996, the Council granted the Commissionn a 'split mandate', namely to open multilateral aviation talks with the United States,, but to conduct negotiations in two discrete, mutually dependent cycles. The current mandatee covers only soft rights. Furthermore, the Commission has started infringement proceedingss (based on Article 226 EC) against various Member States that have concluded Openn Skies Bilaterals, claiming that these actions may distort the operation of the common air transportt policy60. The Netherlands is one of the Member States targeted, notwithstanding that itss Open Skies agreement with the United States was concluded long before the Community structuree had been implemented61. At present, it is unclear how and when the Commission's competencee will be fully implemented as the ERTA doctrine requires a case-by-case approach (Balfour,, 1995: 288-290). As a result, Member States face an increasingly complex

577 European Laying up Agreement for Inland Waterway Vessels, 1977ECR741. 588 Previously Article 113 EC. 599 Advisory Opinion 1/94 of 15 November 1994, CRS1-5267. 6060 Article 226 EC (previously Article 169 EC) Cases G466/98 Commission against United Kingdom, C- 467/98,, Commission against Denmark, C-468/98 Commission against Sweden, C/469/98 Commission against Finland,, C-471/98 Commission against Belgium, C-472/98 Commission against Luxembourg, C-475/98 Commissionn against Austria, C-467/98 Commission against Germany (Kapteyn, VerLoren van Themaat, forthcoming). .

107 7 environmentt in which they are uncertain as to the exact division of powers. Finally,, competition law imposes an important constraint, both within and outside the Community.. Article 86 EC and the provisions on state aid, in particular, prevent Member Statess from frustratingcompetitio n through preferential treatment of the domestic air transport industryy and similar measures62. Notwithstandingg any loss of domestic powers, the Community's framework structure makes statess the key to realising the treaty's objectives (also, Schout, 1999: 21). Various provisions makee the states responsible for giving effect to these objectives. To illustrate, states must providee for the implementation of Directives, and the actual operation of provisions in Regulationss may depend on domestic action. Regulation 2407/92, for instance, allows Member Statess to issue licences and to attach conditions to these licences. This position may in some instancess hinder integration as Member States are ambivalent about the overall benefits of integration.. While they acknowledge that there are benefits, they are reluctant to accept proposalss in individual cases (Jansen, De Vree, 1985: 374). Moreover, they differ in their policiess and attitudes towards the Community and in their ways, methods and opinions (Wallacee et al., 1983: 7). Smaller states, for example, traditionally fear domination by France andd Germany. Ironically, these two states joined, if not formed, the European Community to endd the recurring hostilities between them and to tie Germany to Europe (Jansen, De Vree, 1985:: 99). The difference in views on European co-operation can also be witnessed in the transportt sector (Dinan, 1998: 297-301). Generally speaking, larger economies, or those in whichh airline operations are small relative to the size of the market and commercially weak, havee less incentive to support a more open system (OECD, 1997: 95), whereas countries that aree small in terms of population and area have a stronger interest in a more open regulatory system.. The Dutch preference for liberalisation (see Section 3.3.1.3) supports the claim. Their preferencee for liberalisation is in line with the Community's objective of integration, but does nott imply a complete harmonisation of interests. The element of environmental protection, for example,, which has been identified as an important Dutch air transport goal, has led to stricter requirementss than the equivalent obligations at the Community level. In addition, the rights to thirdd country traffic in any future development of Community policy form a potential source of conflictt for the Dutch because larger Member States are likely to claim a large part of those transportt rights. Disputes over the allocation of transport rights earlier prevented any substantiall co-operation among European states. Such controversies may hinder the operation off the Community structure.

611 Letter fromth e CoBimissioii (SG(99)iy339 98-2094) of 19 January, 1999. Also, Coraelisse (1999:2-3).

108 8 4.5.6.22 - Implementation of the air transport goal in the Community structure Thee above discussion shows that Member States face legal and practical limitations both in formulatingg and realising domestic policy goals. At the same time Member States are essential too the EC development and there are many instances where there are opportunities to influence thee course of that development. These factors raise the risk of opportunism but also increase thee need to be well-prepared in interstate negotiations and to maintain well-designed state- industryy relationships. Before turning to these relationships, this section addresses the implementationn of the Dutch air transport goal within the Community structure. The requirementss that capture the selective network goal and the instruments that have been createdd too realise the goal fall into the following categories (see also Section 3.3.1.4): 1.. the volume of traffic, 2.. the composition of the fleet of aircraft that use Schiphol airport and 3.. market behaviour.

4.5.6.2.11 - Traffic volume Sectionn 3.3.1.4.1 listed the requirements imposed on the industry, namely a cap on the volume off traffic, restrictions on night flights and capacity clauses dictating a specific capacity. Instrumentss available to force the industry to meet these requirements are the airport designation,, slot co-ordination and access policy (i.e. authorisation of ad hoc flights or charters).. The Community structure, which is based on free market access, has complicated the impositionn of some requirements.

4.5.6.2.22 - Fleet composition Thee requirements targeting fleet composition include certain Bilateral clauses and the delegationn of responsibility to develop the 'Marshall plan' to airlines. States may agree on phasingg out noisy aircraft. This instrument is addressed at the Community level by Directive 92/14,, which aims to phase out 'Chapter II' aircraft by 1 April 200263 and has also been introducedd at the domestic level. For Dutch airlines, it implies restrictions on the use of aircraft belongingg to the noisiest types within the 'Chapter HI7 category. The 'Marshall plan' addresses statess with whom Bilateral relations are maintained rather than the Member States themselves. Itt will therefore not be discussed further in this chapter.

4.5.6.2.33 - Market behaviour

6262 Cases include Sabena, OJ L 216 and ANA (Slot, Stadder, MOO). A private finn may abu« its dominant position.. Such abuse may, however, be the result of governmental regulation. 633 Directive 80/51, QJ 1980 L 8, amended by Elective 83/206, OJ 1983 L 117. Directive 92/14, OJ 1992 L 76, amendedd by Directive 98/20, OJ 1998 L 107. 109 9 Thee airport is required to implement a charges policy that differentiates between aircraft and a systemm of bonuses or fines to silent or noisy aircraft. The state aims to be selective in the choicee of countries with whom Bilaterals will be concluded and the frequenciest o be agreed. Theree are also several measures aimed at stimulating other forms of transport such as high speedd trains as well as fiscal measures.

4.5.6.33 - Interstate relations Thee Community structure restricts both the imposition of requirements and the use of certain mechanismss and instruments at the interstate level. The many parties involved in the transactionn reduce the ability to make secret arrangements. Some instruments, such as the selectivee choice of a Member State as a trading partner, are not allowed, while the use of other instrumentss is problematic. For instance, Bilateral clauses between Member States, while not prohibitedd as such, may be interpreted as a contravention of the ERTA doctrine and lead to legall claims. They are not used as a result. Likewise, any cap on volume conflicts with an importantt element of the Community structure, namely free market access. At the same time, thee right to market access is not identical to the ability to exercise that right. Moreover, the Communityy structure may allow an implementation that is consistent with domestic interests. Nott all Dutch instruments are therefore ruled out by the Community structure. Slot co- ordination,, for example, has been permitted at Schiphol airport to protect the environment evenn though the Community officially allows slot co-ordination only when capacity problems dictatee its use. The system in practice serves as a volume cap. A Member State can also pursue policiess that encourage substitution towards other forms of transport, notably (high speed) railways.. The TEN initiative, for instance, targets the development of train infrastructure. Similarly,, the Community structure partly allows a policy directed at fleet composition. Finally, thee option of tariff differentiation is permitted. Too avoid the risk that measures going beyond EC rules will be considered in breach of the Community'ss market access or non-discrimination agreements, the state could adopt the alternativee strategy of pursuing issues at the Community level. With respect to the important sociall goal of environmental protection, Section 4.5.5 noted that some EC policy documents (forr instance, Commission, 1996: v) suggest introducing into the Community structure a larger rolee for environmental protection. The phasing out of noisy aircraft and taxation of aircraft fuel aree being discussed both at the Community and at a global level. On the one hand, a Communityy approach may increase the likelihood that a state's policy goals will be realised. Thiss may be especially relevant to a small country like the Netherlands. On the other hand, a statee must realise that its domestic influence is limited by the Commission's righto f initiative, thee multi-party nature of agreements and the feet that the veto is not part of the Community's

UO O wayy of decision-making. Givenn that air transport is a global industry, not limited to the territory of the Member States,, and that Bilaterals still govern relations with third states, some mention of third countriess is in order. Third country traffic is especially important for the Netherlands because off a small captive market and a significant transfer operation at Schiphol airport. Section 4.5.6.11 showed that Member States no longer fully control the content nor conclusion of Bilaterall agreements. As an example, a Bilateral usually provides that domestic rules apply, whichh - given the incorporation of Community law - means that the operation of traffic rights byy third country carriers is subject to Community rules. Further, the ERTA doctrine prohibits agreementss on Community traffic between domestic powers and third countries. To secure a favourablee position before new Community legislation prevents this, Member States and third countriess have tried to revise existing Bilaterals. The Open Skies Bilateral in particular has beenn used as an instrument to secure access to the Community market, in exchange for Memberr State access to foreign markets, which they would otherwise not be able to acquire. Thus,, there is an Open Skies Bilateral between the United States and the Netherlands. More recentt initiatives are the Open Skies Bilaterals between France and the United States and betweenn the United States and Italy, concluded in 1998. However, Section 4.5.6.1 noted the infringementt procedures initiated by the Commission and the ongoing process of policy formationn is creating an increasingly complex situation regarding the competence of Member States.. New Community legislation is an additional source of uncertainty and it is not clear howw third countries will respond to further restrictions on their Bilateral rights. Apart from the Openn Skies strategy, third countries can try to form alliances at the carrier level. This route wass initially chosen by Switzerland64. Its national carrier, Swissair, secured access to the Communityy market via a shareholding in the Belgian carrier Sabena and participation in *Qualifryer\\ A special category of third countries consists of states that are candidates for EC membership.. Currently, negotiations are taking place between the Community and ten Europeann states (Commission, 1999: 16). Prior to their accession, these states will become boundd by the corpus of Community legislation and commitments, the 'acquis communautaire', inn force at the time65. ECAC acts as an important facilitator in this process. Too summarise, a smaller influence at the interstate level and a wish to improve environmentall protection have ted the Netherlands to go beyond Community rules. The strategyy of expanding domestic legislation, liberalisation at the Community level and spill-over

Recalll from Section 4.3 that the EC and Switzerland have concluded a tradee agreement also covering air transport,, in 1998. *55 According toHave l (1997: 249, note 89) acquis communautaire literally means 'Community patrimony' - 'Thee provisions of the constitutive trades and te secondary legislatkm aoop^ lefeientially,, the judicial and quasi-judicial decisions of the various EUinstinitiora

111 1 effectss from third country traffic are altering interstate relations and the competitive position of thee Dutch air transport industry. The state has chosen to tighten its regulation of the industry andd this has increased the state's reliance on the industry. Yet, without appropriate incentives, thee industry is unlikely to pursue the state's goals. As an example, the KEPD requirement that thee airport should encourage passengers to use public rather than private transport is being pursuedd in an opportunistic way: the airport seems to be taking advantage of the requirement byy raising its parking fees and hence its revenues. Rather than improving the airport's accessibilityy to the public, it has turned its attention to real estate activities and the attraction of firmsfirms to the airport area. Although there has been an increased use of public transport, on the whole,, accessibility has deteriorated. There is a more general problem with tighter domestic regulationn and greater freedom at the Community level. As the industry is confronted with stricterr regulation than what applies to its Community competitors, there is a growing risktha t thee industry's competitive position will be harmed, that the Netherlands will infringe their treatyy obligations and that existing agency problems will be exacerbated. The next two sections lookk at the relationships between the state and the airline and airport, respectively, and elaboratee on some of the problems identified above.

4.5.77 - Community carriers Thee Community carriers were divided on the issue of liberalisation. The carriers represented in thee Association of European Airlines (AEA) did not support it, contending that their high operationall costs justified safeguards. The weak financial status of some airlines provided an additionall argument and, in part, accounted for the gradual approach that was chosen to amend thee governance structure. Note that during the formation of the Community structure most carrierss took a seemingly hypocritical position, opposing changes in the regulatory regime, whilee at the same time actively infringing price regulations by supplying tickets below agreed ratess to non-licenced agents (Williams, 1993: 73-74). The Dutch airlines favoured liberalisation.. This was especially true fbr KLM (Van den Polder, 1993). It had built up a large networkk through sixth freedom traffic and was aiming to be one of the few surviving global carriers.. It had a small captive market, yet wanted to obtain a large market share. It was constrainedd in its efforts because its competitive strength made many European states unwilling too enter into liberal Bilaterals with the Netherlands. Liberalisation was seen as an opportunity. Integrationn and market access for Community carriers, once certain pre-defined criteria havee been met, have loosened the relationship between the airline and the state. Instead of a permitt and a designation, airlines now require a certificate, a licence and a route authority. Althoughh a licence in itself does not confer any right of access to a route, access can only be

Courtt of Justice and the Court of First Instance'. 112 2 withheldwithheld on the basis of an explicit provision in Community legislation. Some examples are the existencee of restrictions at slot co-ordinated airports and routes where public service requirementss apply. The certificate and licence are issued on the basis of more or less harmonisedd rules. The new licensing procedure involves submission of a business plan backing thee statement that the relevant criteria have been met. An operating licence can only be granted,, and is only valid, if the operator also holds an air operator's certificate, certifying its operationall fitness. If there is a change in the material supporting a licence, the airline is obligedd to inform the Ministry of Transport. It may then be required to submit a new business plan.. The Ministry of Transport may formulate conditions when issuing licences, provided that theyy are compatible with Regulation 2407/9266. Compared to the Bilateral licensing procedure, thee procedure and the information that the airline needs to submit are more elaborate. On the otherr hand, the information requirements have been standardised. Moreover, standardisation of thee procedure and restrictions on conditions have made the grant of a route authority easier thann an evaluation of a designation request. The procedure does not differentiate between KLMM and other carriers. As in Bilateralism, the ministry may rescind the licence when the licenseee has not fulfilled the given conditions. Thee freedom to provide services offers airlines more scope to realise their continuity objective.. It has led to new airline alliances and has made airlines less dependent on the state. Thee licence conditions are a weaker instrument than Bilateral designation. The already weak linkk between the airlines' performance and pay-off has weakened further, as has the state's monitoringg ability. Slot allocation and the prescription of the types of aircraft allowed have becomee the main regulatory instruments but, in their current form, do not give appropriate incentivess as slot transfers and differentiation across aircraft types are prohibited. In addition, thee increased formation of international airline alliances limits the effectiveness of any instrumentss even further as it reduces the bond between the home carrier and home state. Thee airline's co-operation may continue to be elicited through interest harmonisation and thiss is partly stimulated by the institutional structure. The Dutch carriers operate both Communityy and Bilateral services, which provides an incentive to take into account the effect off any opportunistic behaviour on their relationship with the state. An example of such harmonisationn can be found in an unpublished memo on the selective network goal (Ministry of Transport,, March 1998) where it is stated that, outside the Community, preference is given to thosee routes that strengthen the international network. This means that scheduled services and aa large network are valued. Because KLM is a scheduled carrier and the main operator of the

666 Balfour (1995: Chapter X), Femes (1997:282, note 168), Havel (1997:392 note 885) and Daalder et aL (1998:144)) all note that Regulation 2407/92 gives Member States some freedom in graiiüng a licence, theieby influencingg market competition. As an example, the airline needs to prove that His able to coinpfywhli various requirementss and that it needs to do so to the 'satisfaction of the state'. See also Ministiy of Transport (1994). 113 3 currentt network, while its open permit facilitates designation, KLM is generally preferred. Its strongg position continues to provide the airline with incentives to co-operate. To strengthen its positionn in the Dutch air transport system, KLM has increased its shareholding in Martinair (Dierikx,, 1999: 352)67. Thus, smaller domestic airlines (except for Air Holland) are also inducedd to co-operate with KLM and so indirectly with the state. The state could choose to harmonisee interests through financial dependence. Intensified competition and rapid change in a liberalisedd environment generate some opportunities, because stronger pressure on profits may bringg some carriers into financial difficulties. By supplying aid, tying it to certain conditions, andd developing adequate monitoring instruments, the state can continue to exert influence. Thiss option has been anticipated at the Community level, however, and in recent years the provisionn of state aid has been scrutinised more closely, among other things, through the obligationn to inform the Commission of any proposed aid prior to its distribution. Furthermore, whilee Member States are creative in circumventing rules, control through financial dependence iss not a long-term solution68. Competition law and a supranational compliance mechanism are influencingg the state-industry relationship. The states' ability to give preferential treatment to theirr own carriers, for instance, by restricting access to certain airports or routes, is subject to Commissionn scrutiny and corrective action69. Within the Community, the competition rules are fullyy operative. The absence of secondary legislation implementing the competition provisions inn respect of air transport between Member States and third countries limits their effectiveness too some extent, but by no means entirely given the powers of Member States and the Commissionn described in Section 4.2™.

Inn brief; the Community has eliminated some of the instruments available to the state to structuree its relationship with the airline and has imposed restrictions on other instruments that mayy lead to a preferential treatment of and a closer relationship with the airline. At the same time,, the state increasingly relies on the industry, including airlines, to realise its transport goal. Thiss reliance has primarily taken the form of new regulations, but the state has failed to create

Dierikxx (ibid. 307-308) notes that this has been a general trend in Europe. Note, however, that Section 3.3.2 mentioned,, the dissolution of KLM's agreement to bay the remainingshare s in Martinair because of the conditionss the Commission would have attached to its approval. NRC,, 19 January 1999 'Staatssteun krijgt steeds nieuwe vermomming'. In a communication on the resultso f liberalisation,, the Commission clearly states that it authorised stale aid as a one-off measure to help national carrierss adjust to the liberalised single market during tiaiisitioii, and that this tiansition phase is over (1999: 3) Forr example, Ommüssion Decision 290/94, Decision 291/94, OJ 1994 L127 (TAT/Orry) and Decision 710/98,, OJ 1998 L 337 (Malpensa). ,00 Kapteyn, VerLoren van Themaat (1998:1200, footnote 400 and 1205, footnote 437) notes that this transport iss subject to the 'Asjes Saeed regime', Le. the combined effect of the veidicts m tte NouveÜ« Fiontièies and thee Saeed Fhiegreisen cases. In brief, Article 81 EC is not dinxtty effective and can oiily be applied through Articless 84 and 85 EC. Article 82 EC is directly effective. However, the Commission does not possess the normall powers of investigation, of imposing fines or lierioc^ penalties, or of grantmgiiMlividualexenTptions 114 4 appropriatee incentives, nor has it adapted its instruments to the new environment. A looser relationshipp and continued absence of performance incentives have reduced the airline's incentivee to contribute to the state's selective network goal, while the greater freedom within thee Community has made it more difficult for the state to monitor airline behaviour. Similarly, increasedd regulation contrasts with greater freedom at the Community level and has led to a growingg tension between the interests of the state and airline. Although institutional factors mayy harmonise interests to some extent, they do not compensate for a reduced dependence on thee state. Potential agency problems have become more apparent as a result.

4.5.88 - Community airports Thee Community airports generally welcomed liberalisation, which they viewed as an opportu- nityy to loosen their ties with the state and to start operating as commercial undertakings rather thann mere infrastructure providers and being seen as such. But, despite favourable passenger growthh rates and greater marketing opportunities, the airports have failed to take full advantagee of their new environment. This can be attributed to a number of reasons. Too begin with, the increased use of hub-and-spoke systems, due in part to liberalisation, has ledd to strong traffic growth at some airports71. These airports have become more dependent on theirr home carriers. In contrast, other airports, primarily servicing feeder-carriers, have experiencedd a fall in traffic because of a re-routing of traffic flows. This has made the developmentt of airport operations less predictable and has created uncertainty. There has also beenn a downward pressure on average aircraft size as network carriers increasingly compete in termss of frequency. Airports experiencing growth have run into capacity problems, while hub operationss feature wave-type patterns which require tremendous capacity during peaks. These developmentss have generated significant investment needs. The 1985 Schengen Treaty (see Sectionn 4.4) has contributed to the need to invest. Airports using a single terminal concept, suchh as Schiphol airport, have needed substantial alteration. Long lead times and in some cases aa lack of funds have resulted in widespread congestion. In Europe, it is estimated that US$65- US$800 billion will have to be spent on airports and related infrastructure over the next ten to fifteenn years (Arthur Andersen, 1999). Since governments are often unable or unwitting to meett these needs, more airports are now developing new financing strategies involving the privatee sector. This has contributed to a demand for more industry freedom and has strengthe- nedd privatisation trends in the industry72. Schiphol airport, for example, aims to be privatised in

Dataa from 33 major European airports indicate an increase in passenger throughput of 6.4% and an increase inn aircraft movements of 5.4% in 1998. This follows increases of 7.8% in passengers and 6.4% in aircraft movementss in 1997 (ACI, 1997). 722 See, for example, the 1999 AerRianta report'Privatisation ' refers to the transfer of government corporate assetss to full or partial private ownership. 115 5 thee near future. Section 3.3.3 observed that the presumption that air transport harms the environmentt has resulted in a more critical approach towards the sector and has limited opportunitiess for expansion. Finally, the introduction of new regulations at the domestic level andd the absence of liberalisation at the Community level has contributed to the airports' inabilityy to take advantage of the new environment. Onee of the reasons behind airport regulation is that the airlines take a critical stance towards thee development of airports as commercial undertakings and have tried to counter this development73.. The Comité des Sages (1994: 37), for example, considers airports part of the overalll public infrastructure providing services to airlines74. The committee's report further statess that, because of their central position, airports are required to make available the capacitiess necessary for current and future air traffic loads, regardless initially of any economic considerations,, and to provide take-off and landing facilities for all licensed aircraft on a non- discriminatoryy basis75. The Commission also supports airport regulation on the grounds that airportss are often entrusted with special or exclusive rights and should be prevented from abusingg their privileged position76. Domestically, the feasibility of behaviour control in the state-airportt relationship has led to an expansion of the use of regulatory instruments. Regulationss include slot co-ordination and the liberalisation of ground handling activities77. Chapterr ID showed that the state's air transport goal is broader than the objective of the airport.. The airport's fixed infrastructure makes it dependent on local conditions, including its relationshipp with the state, but a growing divergence of interests resulting from new marketing opportunities,, the growing volume of legislation and a changing view of its own position have increasedd the likelihood of agency problems. As an example, whereas the state mentions a tariff policyy to promote the use of certain types of aircraft, Schiphol airport mentions tariff setting as ann instrument to improve its competitive position (Amsterdam Airport Schiphol, 2000: 28). Thee Community has witnessed stronger capacity and environmental concerns and greater industryy freedom. The single terminal concept, which has traditionally been a factor

733 See Section 3.3.3 for some other reasons. Tbee 'Comité des Sages' was formed by a group of experts in the air transport sector. They investigated the statuss of (he air transport sector and made suggestions for new poUcy objectives on behalf of the Conmiission. AA dissenting opinion in the report addresses airports as independent commercial enteiprises. See also Monopoliess and Mergers Commission (19%: 220) in a referencet o thee UK Department of Transport's opinion onn airport policy. The UK DOT opined that airports should operate on a commercial basis, and government aimedd to keep its intervention in airport development and management to the minimum necessary to secure its objectivess for the environment, safety and security and economic regulation. Thee regulation of airports has largely been left to the Member States, whose actions have been closely scrutinizedd by Community institutions (Slot, Skudder, 2000). The Conummiry structure has not liberalised the airportt sector. Directivee 96767, supra, p. 99. The Directive has reó^uc^ the ainiort's abüiry to oiganise its fecilities optimally,, however, because it requires the airport to provide access to those aieastliat are sensitive for capadty andd security reasons. Only in extreme cases may an exception be granted 116 6 contributingg to the success of Schiphol airport, has reached its physical limits. Although some instrumentss designed to elicit desired behaviour may still be used (e.g. the Operations plan and agreementss on a noise preferential use of runways), the airport's reward structure has not been adaptedd to the new environment. At the same time, the airport faces greater uncertainty, as a resultt of liberalisation and hub-and-spoke type transport operations, which has made it more reluctantt to invest. The Community showed some sensitivity to the problem of uncertainty whenn it initiated the Trans-European Network initiative (see Section 4.4). However, at present onlyy a small number of airport projects are included in the TEN scheme, and these are mainly studiess and pilot projects. Italy's Malpensa airport is the only air transport infrastructure projectt among the TEN's 14 priority projects. A wish to reduce uncertainty has given the airportt an incentive to formalise its relationships with other industry players, which is in line withh the state's proposed instrument of concluding covenants with the sector. These covenants alsoo allow the industry to influence the content of future legislation. The PASO covenant and thee 'Uitvoeringsmemorandum' of 1998 are examples78. Airports, in general, have also worked onn improving their co-operation with airlines, in part through an ACI-AEA project involving thee establishment of model use agreements. The Optimisation strategy is another development stimulatingg co-operation. Since 1998 the main home carriers, Dutch Air Traffic Control and Schipholl airport have been meeting frequently to co-ordinate their actions and try to devise a neww system of environmental norms and compliance mat enables them to optimise their operationss (known as the 'Schiphol Optimisation Project'). At the same time, EC competition laww places limits on such co-operation79. Too reduce its dependence on the home carriers and increase its financial revenues, Schiphol furtherr seeks to conclude co-operative agreements with other airports and to diversify its activities.. It has, for instance, shifted its focus towards retail and real estate. The abolition of taxx and duty free sales on Community flights in Jury 1999 and the wish to be privatised have givenn these initiatives an extra impulse*0. The strategy of diversification carries with it a new riskrisk for the users of the airport. For example, investments may be delayed because of an expansionn of retail facilities.

Thee discussion has shown that, in thee Dutch situation, a diminishing ability to realise domestic objectivess at the interstate level has led to tighter domestic regulation. Many requirements are

788 The'Uitvoeringsineiiiofaiidum'is inenta 1998 from the Minister of Transportt to parliament (Kamerstuk 25 466, no 9). 1919 Some cases involve discounts based on a certain volume of filgfüs,o r disooonls on domestic flights. For exainpie,, Commission Decision 198/99, OJ1999 L 69, prohibited the discounts on domestic flights given by thee Finnish airport operator nmatlnbitos LafivartsferkeL Abo, Section 4.7.4. 800 Regulation 91/680, OJ 1991L 376, amending Directive 77/388, QJ1977L 145. Directive 92/12 OJ 1992 L 76,, amended by Directive 94/74, OJ 1994 L 365 and 96/99, Of 1997 L 008. 117 7 aimedd at Schiphol airport, making close co-operation between the state and the airport crucial. Thee Community structure has influenced the Member States* ability to regulate. Although somee traditional domestic instruments may still be used, there is a general lack of performance incentives,, a growing divergence of interests, and hence a greater risk of moral hazard. One consequencee is that there is frequent recourse to mechanisms that control the airport, resulting inn many court cases between the state and airport. Similarly, airlines operating at Schiphol airportt are increasingly involved in court cases concerning operations at the airport81. Finally, uncertaintyy and greater marketing opportunities available to airports have led to a formalisation off state-airport and industry relations.

4.5.99 - International organisations Sectionn 3.3.4 discussed the role of the main international organisations in air transport, namely ICAO,, LATA and ECAC. The discussion now turns to the effect of the Community structure onn these organisations.

ICAOO was established by the Chicago Convention, which is the basic document governing internationall air transport. The global nature of the organisation has meant that the creation of thee Community structure has not had much effect. The Convention makes clear that only a statee can be a member of the Chicago Convention and thus of ICAO. Each Member State is a partyy to ICAO, whereas the European Community only holds an observer status. Memberr States, but again not the Community, are also party to ECAC. The role of ECAC seemss to have decreased because of growing interdependencies and the ERTA doctrine, limitingg the right of Member States to discuss a proposal in any other forum once the proposal iss being discussed in a Community context. Nevertheless, the organisation plays a very importantt role. Its conferences keep other European states, who may be candidates for EC membership,, informed about relevant Community policies. Any legislation can be introduced graduallyy and in a non-threatening way because of separate ratification requirements. ECAC co-operationn can also be used strategically by Member States in the sense that they can form coalitionss on subjects to be discussed in a Community context. Chapterr III observed that the liberalisation of the airline industry has reduced the role of LATA.. Section 3.3.4 discussed this trend and shed further light on IATA's current position. Thee Commission is an official LATA observer (Havel, 1997: 122). Finally,, liberalisation has stimulated co-operation among airports and has led to a bigger rolee for ACI EUROPE, the European division of the world-wide airport institution, ACI

Somee of these cases concern actual or potential restrictioiis on airciafi opetatiom at Schiphol airport, imposedd because the limits of the annual OrxraticnTS Plan had beca reached.Carrier s are often una^ 118 8 (Bouwens,, Dierikx, 1996: 353). Thee absence of Community membership in these organisations and potential information problemss have made h more important to exchange information and co-ordinate positions that Memberr States should take in negotiations. Commission Decision 80/50, which requires consultationn and the provision of information, only partly meets the need for such activities.

4.66 - The object of the exchange and property rights82 Chapterr III defined the transaction as the barter exchange between states of air transport rights.rights. These rights comprise the right 1) to enter a foreign air transport market, 2) to use the airspacee to transport people to and from that market and 3) to capture the benefits from such use.. Restrictions placed on the operation of these rights may vary depending on the policies of thee states involved, but in every exchange reciprocity and a balance between rights and obligationss are paramount. In the Community structure, separate Bilaterals no longer govern thee provision of market access by and between Member States. Instead, market access is coveredd by a regulatory package, created by the Member States. Whereas Bilateralism is based onn a categorisation of the rights to use the airspace (freedom rights), the Community structure ultimatelyy eliminated that categorisation when it introduced full cabotage rights in 1997. There iss one exception, namely the public service requirement. The fair and equal opportunity requirementt has been reinterpreted as a requirement that starting positions should be equal. Thee centre piece of the Community structure is the creation of market access, comprising eachh of the freedom rights, for Community carriers meeting certain predefined, objective criteria.. The rights to use the airspace have been largely delegated to the carriers but they are nott allowed to exchange any air transport rights. Nor can the airlines formally after those rights becausee only Member States can change Community legislation. However, the way in which airliness operate their rights (e.g. route combinations or alliances) enables them to alter them in practice. . InIn Bilateral relations with third countries, the traditional categorisation of the rights to use thee airspace is still intact and, apart from the limitation of the powers of Member States, the samee applies to the categorisation of property rights to airspace. The discussion in Section 3.4 willl not be repeated here.

Inn line with the description of the Bilateral structure, the following section looks at the Community'ss transaction process. The contact, the contract and the execution phases are consideredd in turn, while a separate section looks at compliance. theirr flight schedules at short notice. Recalll front Section 2.2 that these aie the rightst o use an asset, to capture the benefits from that use, to alter 119 9 4.77 - The transaction process

4.7.11 - Contact phase Thee contact phase has been defined as the phase during which potential transaction partners searchh for an opportunity to transact, and try to identify and evaluate other potential partners. Thee Community's transaction process does not include a search for transaction partners in the traditionall sense because the ultimate parties are known. If a Member State wants to form a coalitionn it may need to search for those Member States that are willing to join. The identificationn of a transaction involves launching new ideas and creating support for proposed policyy initiatives. Even though the Commission has the exclusive right to issue proposals, new policiess or innovations also depend on new ideas and developments in Member States and on thee ability of states to push these ideas through at Community level (Schout, 1999: 21). In addition,, a Member State that holds the Presidency formulates its legislative priorities and tries too get these accepted. Prior to the formal initiation of a negotiation, there may be frequent contactss between representatives trying to get a feel for the position of Member States on a proposal.. The initial phase is particularly important for small Member States since their influencee is generally limited at the time when decisions are taken within the Council (ibid.: 10, 55).. Sometimes, in order to start a discussion or to get a feel for the views of relevant stakeholders,, the Commission issues a 'green paper', in which items for discussion are set out. Thiss is followed by expert meetings and leads to a 'white paper'. The procedure was followed forr the internal market objective as well as for the air transport packages.

4.7.22 - Contract phase83 Thee contract phase formally starts with a proposal drafted by one of the directorates of the Commission,, namely DG VU in the case of air transport and DGIV in the case of competition policy.. The legal basis of a proposal determines the procedure and the majority needed to pass thee proposal. The regulation of air transport matters is based on Article 80 para 2 EC and is subjectt to the co-decision procedure. Although the influence of Parliament and the Member Statess in this procedure is considerable, it is the Commission that holds the monopoly of legislativee initiative. Preparatory work on legislation begins in working groups composed of Commissionn representatives, Member State officials, some of them experts, representatives fromfrom industry, permanent representatives and civil servants. The Dutch consider activities duringg this phase to be informal. 'Instructions for issuing regulations' have been formulated, thee asset and to transfer all or some of these rights. 833 This section is partly based on Nicoll, Salmon (1994:69-70). 120 0 whichh bind each Dutch representative working under ministerial responsibility*4 but these are tooo general to exert a major influence. Specific instructions will not be formulated until the Councill phase. The working group meets under the serving President. This group sets out to preparee a report which will show what can be agreed and what remains disputed at this level. Estimatess show that almost 80% of any differences of opinion are resolved at this stage. The chairman,, Commission representatives and individual delegates may also seek to devise compromisess or act as brokers between different viewpoints. This includes negotiations outsidee the conference room and negotiations between delegations and the Commission. The Generall Secretariat of the Council provides assistance in the search for a compromise. This searchh occurs at all levels, but everything done below the level of the Council is informal. At thiss stage Dutch civil servants are generally regarded as independent experts and any co- ordinationn will be informal and bilateral. Nevertheless, the experts' opinions will be taken more seriouslyy if they can present an overall picture of the view of their national government, which providess an incentive to co-ordinate (Schout, 1999: 187) Afterr agreement is reached at working group level, the Commission will receive a draft proposal.. The proposal is accompanied by various explanatory memoranda, including a state- mentt on subsidiarity'5. Each proposal must also be accompanied by a budgetary statement of itss costs to the Community and a statement, in the name of deregulation, of its effects on small andd medium-sized firms (Nicoll, Salmon, 1994: 63). These statements are not comparable to thee explanatory memorandum that accompanies a legislative proposal in the Netherlands. This 'memoriee van toelichting* is far more elaborate (Bracke, 1996: 80). Nonetheless, the amount off information provided by these documents is far greater than what is generally the case in transactionss between states. If the Commission agrees to the text, it will be submitted to the Council.. The Council phase consists of three levels: negotiations between officials in working groups,, negotiations between ambassadors in COREPER and the political decision in the Councill of Ministers. In contrast to the contact phase, officials in working parties formally representt their respective Member States and therefore have to present co-ordinated negotiatingg positions. The Council will start treatment of the proposal by consulting Parliament andd ECOSOC as soon as the proposal has been translated into each of the official languages. Theirr reports are sent to the various working groups established by COREPER and consisting off civil servants who then deal with the proposal. The conclusions reached by officials are passedd on to COREPER for formal approval. Proposals on which working groups have not

MM The'Aanwijzingen voor dcregdgeving\MiiiistiyrfJustke, 1992, The Hague. The instructions arc not confinedd to Community legislation, although they contain a separate chapter on U. Accordingg to the Subsidiarity doctrine, which is hated mi rha «wial tpaq-hing^ty Vatican, wt fflrti " thf encyclicall Qnadragesimo Anno of 1931, people should be ciosety invoh^ in decisiom that an«a them, whik

121 1 beenn able to reach agreement are also sent to this committee for farther discussion. In principle,, there is no time limit for consideration by COREPER but the Presidency may try to influencee the period needed for discussion, for example, if the proposal forms part of its legislativee priorities (Westlake, 1995: 378). During this phase and until the Council takes a commonn position, the Commission may modify the proposal. The way in which the Commissionn uses its prerogatives influences and is influenced by the attitude of other delegates.. A change to accommodate one delegate, for example, will not always please other delegates.. In addition to satisfying the Member States, the Commission has to be sensitive to thee attitudes of Parliament and ECOSOC. A permanent representative in turn will have to act fastt in order to respond to proposals the Commission might be inclined to accept. The Presidentt might further try to influence the negotiation outcome through his responsibility for thee organisation and course of Community affairs (De Zwaan, 1993: 290-291, Westlake, 1995: 43)86. . Givenn the reduced powers of the state, the various state interdependencies and the decision- makingg procedure of co-decision and qualified majority, a thorough preparation is crucial to realisingg a favourable negotiation outcome. Through careful co-ordination (i.e. 'a set of actions aimedd at the adoption by all the members of a group .. of mutually consistent decisions', Schout,, 1999: 6) states can process information, ensure a common national line, and become moree adept at managing the environment (Westlake, 1995: 368). Their tasks include discussing negotiationn strategy (identifying possible trade-offs), interpreting multiple goals, centralising authoritativee guidance on Community issues as well as 'line clearing'. Individual ministries may knowknow exactly what they require to negotiate a piece of legislation, but they may wish to ensure thatt other ministries have been informed and have sorted out any issues important from their ownn perspective. Some states find the task of co-ordination easier than others. The German Basicc Law, for instance, is relatively clear about the competencies of the different layers of governmentt (Kreis, Land and Bund), which facilitates adding a European layer (Westlake, 1995,, more generally: Schout, 1999). The Netherlands face more difficulties as may be illustratedd by the following description of the current Dutch procedure (De Zwaan, 1993: 50,

thee bodies that take decisions should be close to them. Europe documents, no. 1759 of 7 February 1992 1994 OJJ C 341. Differently: Ten Napel (1998:67). 866 The Commission may, but is not obliged to, decide to modify its proposal on the basis of the discussions. Whenn a rnodification is substantial, Parliament will have tob e consorted for a second time, wMchconsüüites a new'firstt reading\ The Councü takes a'oomnKm posuiOT^ thee (possibly revised) Commission proposal. F^liaroem then exarnincs and votes on the common position, needingg a qualified majority of at least half hs members to piopose amenAneius (the'seccmd icadiiigO. The Councill considers Parliament's readings wilhüi uVa: irronths, wtuch is exleridiWc lo four nwnths and the Commissionn has one month to express an opinkm on the CoimcU's ooininon positioiL ff thee Council has not decided, the proposal is dead. 122 2 1998:: 363-367)". Ass soon as a proposal is submitted to the Council, it is sent by the Dutch permanent repre- sentativee to the Ministry of Foreign Affairs. The proposal is discussed in the interdepartmental Workingg Group for the assessment of new Commission Proposals ('Werkgroep Beoordeling nieuwee Commissievoorstellen' or 'BNC'). Each ministry is represented and the group's essentiall task is to establish whether the new proposal affects other national or Community legislation,, to assess its financial implications, and to define responsibilities for negotiations in thee Council (Schout, 1999: 192). It is not until this time that the formal co-ordination process startss with the formulation of specific instructions (ibid., De Zwaan, 1993: 289-300). These mightt relate to the subject under consideration, the content of the proposal and negotiation tactics.. Member States should make sure that these instructions are clear and leave room for manoeuvre,, especially when a proposal has already been discussed for some time. At the BNC meetingg a filing card ('fiche') is prepared by the ministry with prime responsibility for the proposal,, in this case the Ministry of Transport, which provides relevant information (Van der Flier,, Van den Oosterkamp, 1994: 745). The ministry is also responsible for an implementation plann (ibid.: 733) which entails verifying if there is any need to consult the relevant national advisoryy bodies and representative organs. Thee Dutch permanent representative attends weekly instruction meetings in The Hague. The meetingss are chaired by the Ministry of Foreign Affairs and are used to exchange information andd to prepare the position that the Netherlands will take in COREPER and the Council. Anotherr meeting that is used for this purpose is the inter-ministerial Co-ordination Committee forr European Integration and Association Problems ('Coördinatie Comissie Europese integra- tiee en associatievraagstukken' or 'CoCo'), chaired by the State secretary for Foreign Affairs. CoCoo prepares Cabinet decisions concerning national positions and Council meetings. The positionss which ministers present in Council meetings are officially agreed in Cabinet. The wish too rationalise the process of preparing national EU policy has led to the creation of a senior- levell co-ordination committee, namely the High Level Co-ordination Committee ('Coördinatie comitéé op hoog niveau' or 'COCOHAN'), which consists of representatives at the level just beloww the minister. It meets on matters of a more strategic nature and provides civil servants withh guidelines on major policies. The conclusions of both committees are submitted to the Councill for European and International Affairs ('Raad voor Europese en Internationale Aangelegenheden'' or 'REIA'), which is a sub-council of as well as to the Dutch Cabinet. The Securitell Decision has led to some changes to improve the exchange of information. It has led

"" The problems were also illustrated by the Securitel decision (Case C-194/94, CIA Security International, Jar 1996,1-2201).. In this case, it was found that in many instances the Netherlands had failed to comply with variouss notification requirements relating to technical conformity, which were laid down in EC legislation. The breachh meant that any domestic regulations based on these rales were invalid 123 3 too a greater role for REIA and the establishment of a new group, namely the Interdepartmental Subcommitteee on European law ('Interdepartementale subcommissie Europees recht* or '- ICERR % divided into a working group on matters of preparation (ICER-V) and one on matters off execution (ICER-U). The procedures aim at a fast approval and at imnimising the need for advicee and consultation during the execution phase, which explains the frequent information exchangee among the various groups. It also means that parliament is more closely involved in Communityy procedures than is generally the case in international affairs". Information to parliamentt is provided on a quarterly basis and parliament receives the annotated agenda of the Council.. Further, 'fiches' are sent to parliament if the Ministry of Transport opines that the proposall has substantial consequences for domestic law, which is the case if a formal law is necessaryy to implement the proposal. Nevertheless, some problems remain. There is a lack of clarityy on ultimate responsibilities as well as a split between those responsible for preparing and thosee responsible for executing (i.e. implementing) new legislation (De Zwaan, 1998: 364). In addition,, specific instructions are only formulated at a very late stage, while the short time framee between formulating a national position and the Council meeting where the proposal is discussedd limits the opportunity to exert any significant influence (Schout, 1999: 213)89. Furthermore,, the low administrative level of representatives at domestic co-ordination meetingss makes these meetings rather ineffective. Finally, the equality principle (i.e. equal rank off the ministries) implies that ministries may contribute to the content of policies in earlier phasess (such as in expert meetings)90 and thus makes the ultimate responsibility of the Ministry off Foreign Affairs to co-ordinate Council decisions redundant. It also means that all items on thee agenda are given equal weight and no priorities are set, making it impossible to concentrate lobbyingg and negotiating in Brussels on a few hems of special importance (ibid.: 28, 30, 208, 212). . Thee conclusion of the transaction entails acceptance of the Commission proposal by the Memberr States acting through the Council. When COREPER reaches a common understan- ding,, the proposal is sent to the Council as an 'A point', which means that delegations have foundd that there is agreement, or the necessary majority can be obtained. These A points are formallyy approved in Council meetings. Decisions on the other - 'B* - points are seldom taken, unlesss the item is a B point because a delegate or Commission representative wants to give an

Parliament,, however, is Eur less attentive to Community than domestic policy management. Schout (1999:29, ^3)partIyascf^thistoagener^ ^ Thee COREPER instruction meeting takes place approxiinately ten days liefoie a Coundl meeüng. Schout (ibid:: 209) notes that a position should be ready abcn* thiee weelo before the nwriiig, Le. when to agendaa of the Council meeting is available, Member States are k*b>ing and coaliüons start taking shape. Forr items belonging to the common foreign and security rx>Ucy, the respoiisiNiity fo^ mostlyy with the Ministry of Justice. Furthermore, u« Ministry of Justice is respoimT^ Zwaan,, 1998: 364-365). ^^ 124 4 explanationn of or make a statement on his position. The division into A and B points enables thee President to structure the meeting and makes meetings more efficient. There is also a writtenn procedure (De Zwaan, 1993: 200-205, Westlake, 1995: 85) for cases of extreme urgencyy as well as for simple administrative matters, such as the accreditation of third country representativess to the Community. Leaving aside this last category, a survey by De Zwaan (1993:: 204) shows that the written procedure is followed in approximately 30 cases per annum. . Whenn comparing the above description of the contract phase with the corresponding phase inn Bilateralism, the elaborate procedures, extensive availability of information and large number off parties involved stand out. The existence of deadlines that serve to structure negotiations alsoo differentiates the Community from the Bilateral structure. The broader scope of Communityy negotiations has led to new opportunities for trade-offs. At both the domestic and Communityy levels, a ministry has to search for coalitions, identify compromises and show greaterr sensitivity to the opinions of other states and institutions. In all cases, the negotiation processs runs more smoothly if representatives in the Council have similar rank or political clout (Westlake,, 1995: 58-59). Yet, representatives frequently differ in power because of such factorss as seniority or in the position of the home country with respect to the issue. The relativee size and economic strength of a Member State are also important, as are domestic events,, such as elections. Furthermore, states are no longer equal in their decision-making power99 . Of course traditional formal equality need not imply actual equality. The economic andd thus often the bargaining power of a large Member State is generally greater than that of a smalll state, such as the Netherlands, although a monopoly or superior information in a policy fieldd could alter the balance. But, whereas equality is a central feature of Bilateralism, the EC Treatyy has formalised differences in power through a system of weighted voting, whereby each Memberr State has been allocated a number of votes. In qualified majority decision-making, whichh is applicable to air transport, the Netherlands are entitled to five votes in the Council. Decisionss are taken if 62 out of the 87 votes are in favour, which means a vote in favour by eightt Member States92. In addition to enhancing the need for a careful preparation, these factorss have also increased the solidarity among Member States. Member States empathise withh each other and try very hard to accommodate individual requests. Furthermore, although thee 'Luxembourg compromise'*3 no longer seems part of the Member States' mentality in the

Theree are some remaining cases that do rely on unanimous derision-making. rara The resolinion of Ü« Edinburgh Einxjpean Council of 1992, amended in 1995, following accession of Finland,, Austria and Sweden, introduced a quorum requiiement of eight states out of fifteen. 933 The 'Luxembourg compromise' was arrived at afler a marathon session ^February 19% (Bulletin EEC no.3-1966,, page 5 onwards) and contains the rule that a Member State - in a situation where it believes that fundamentall interests are at state - can Mock decision-making in the Council through a veto. This has ted, amongg other things, to a preference forreachin g o>rist3isus. Since the SEA entered iiMo force tliere has only 125 5 Council,, a situation is conceivable in which a Member State, whilst not formally invoking the compromise,, makes clear that it feels a fundamental issue is at stake. Given the Council's consensuall instincts, it is equally conceivable that the other Member States will not force an issuee under such circumstances, especially if they recognise the strength of the Member State's case.. The Member States are aware that they might be in the same position one day. Such conductt might be termed a 'de facto veto'. Apart from these sensitivities, domestic factors are important.. Domestic objectives, mandates and political views influence the conduct of the representatives.. If a proposal is placed on the Council agenda as a B point and a discussion is necessary,, these factors can lead to package deals or marathon sessions. From the point of vieww of a Member State or its constituents, it matters whether a representative silently acquies- cess in or votes in favour of a measure. In the event of a vote, a Member State's representative mightt even choose to be outvoted in order to demonstrate to a domestic audience his inability too secure a particular outcome (Kirchner, 1992: 107. Differently, Corbey, 1993: 103). As a resultt the Council's decision-making process can be characterised by a strong accent on politics,, co-ordination and consensus with the Council seldom taking a vote94.

4.7.33 - Execution phase Thee Community rules apply after publication in the Official Journal. A Regulation applies directlyy and requires no separate domestic approval. A Member State may not even incorporatee the provisions of a Regulation into domestic law, except when implementing measuress are necessary. With respect to a Directive, implementation is needed and the text will stipulatee the period in which this has to occur. A Member State that has failed to take the necessaryy measures at the expiration of this period is in breach of its treaty obligations. When thee text of the Directive is clear and unambiguous, some provisionss might be directly applicable evenn without implementation and it might be possible to invoke these provisions against the state95.. Community legislation must be issued in every official language of the Community, and everyy version has the same status. Translation is carried out by the legal linguistic division withinn the translation group of the Community. This constitutes a high cost in the decision- makingg process, but can be traced to a sensitivity about equality among the Member States. In addition,, it is crucial that all Member States should be My aware of the contents of the Communityy rules. Ass stated earlier, the Community's layered structure requires the continuous co-operation beenn one attempt, by Greece, to use the veto when a de\-aluati(m of the stxallexl'green Drachma'in an agriculturall price settlement was proposed. The attempt failed (Westlake, 1995:103-110). ww The President can initiate a vote. Voting is also required on theuiitiativeoftteCbuiKflortiw providedd that a majority of the members so decide. If no vote is held, the President simply notes that the requiredd majority (or unanimity) exists (Westlake, 1995:148-151). 126 6 off Member States if the Community is to realise its goals. In the case of Directives, this need is exemplifiedd by the responsibility of the Member States to provide for implementation. Domesticc structures may complicate the process. The Dutch system, for example, adheres to thee principle that rules can only be changed by rules of at least the same order. When a formal laww is involved, as is often the case, the period needed to amend this law usually outruns the officiall implementation period. Although Schout (1999: 217) describes the Dutch implementationn record as average, the Netherlands race the risk of breaching their obligations underr the EC Treaty. This has motivated the use of dynamic referral, which is applied wheneverr possible96. For example, it is incorporated in Article 16a of the Air Transport Act. Too speed up the implementation process, the Dutch AWB contains a chapter aimed at facilitatingg the implementation of Community legislation. Articles 1 para 7 and 1 para 8 AWB, respectively,, provide that in the case of decisions serving to implement Community law, the generall procedure of advice and consultation can be disregarded, unless exceptions apply97. Informationn on implementing rules can be found in a domestic register of Directives. There is noo equivalent register for Regulations, but some Regulations oblige Member States to inform thee Commission of the legislation brought into force to comply with the relevant provisions. Ann example is Article 17 of Regulation 2407/92. Finally, the Securitel Aflair prompted some changess in co-ordination procedures to improve the implementation of Community legislation. Onn the basis of the above procedures, the Air Transport Act was amended in 19939* to complyy with the various regulatory packages. The amendments covered the licensing procedu- ress and implementation of the JARs mentioned in Section 4.4. The new licensing procedures enteredd into force in mid-1993 and, because of the direct applicability of the Regulation, had a retroactivee effect. Under the new procedure, any Community carrier that has its principal place off business in the Netherlands can apply for an air operator's certificate and a licence in the Netherlands.. It can start to operate scheduled services after obtaining these and a route authority.. Slot co-ordination and the ground handling Directive were introduced in the Nether- landss in 1997 and 1999 respectively. Neww operations generate additional income for the airline. Sectionn 4.S.7 explained that the elimination of designation has weakened the already limited directt link between the airline's pay-off (e.g. designation or additional rights under a Bilateral) andd performance. There is just one exception, namely the operation of a route based on a publicc service requirement, but this opportunity has not been exploited in the Netherlands. The investmentss that the carrier needs to make to support a new operation are generally the same

955 Cases C-6/Ö en C-9/90,1991 ECR, 1-5357 ('Franoovich ct aL vs. Italy). 9696 Supra, p. 91. 977 An example is a Directive that Memher Stales can impjen^m yfrh substantial policy fmdp™ (Vfl"

4.7.44 - Compliance and enforcement Sectionn 3.5.4 explained that compliance in the Bilateral structure is influenced by the sovereign naturee of states and by the general absence of an external compliance mechanism. In addition, internationall law and various domestic legislations apply simultaneously, creating uncertainty aboutt the applicable rules, which is reinforced by a lack of uniformity in domestic compliance procedures.. The adverse effects of uncertainty and opportunism are likely to be even more seriouss at the Community than at the global level because of a greater risk of trade diversion withinn the Community. However, the long and close relationships between Member States havee made the environment more conducive to self-enforcement at the state level. The Communityy structure also contains an enforcement system that allows the adjudication of disputess between states. Community institutions (e.g. the European Courts and, in competition cases,, the Commission) may adjudicate and sanction Member States in case of a breach of treatyy obligations. This includes cases where a state fails to implement a Directive within the allottedd period. Thee use of legal enforcement mechanisms has gained importance in practice". Regulations placee a greater emphasis on legal wording, which facilitates legal enforcement. Moreover, the distributionn of power has changed and states as well as industry players seem to be less afraid off any adverse effects on their relationships that might result from invoking legal remedies. The Commissionn is not susceptible to such concerns because of its independent position, which also contributess to a more frequent use of legal enforcement. Earlier sections noted the important effectt of the Commission's supervisory function in matters of competition law. In the light of increasedd competition and a loss of powers at the interstate level, Member States may try to resortt to special arrangements with domestic firms to compensate for a loss in other fields. Statess may thereby distort competition. Familiar cases are those on the provision of state aid,

128 8 suchh as the Sabena , Aer Lingus and Air France cases. These cases show that domestic measuress providing state aid to the industry are being carefully scrutinised and that the approvall of state aid may be tied to strict conditions. Legal enforcement is also used by the Commissionn in its action against several Member States, including the Netherlands, contesting thee conclusion of Open Skies Bilaterals (supra, Section 4.5.6.1). Another example concerns the privatisationn of the two Rome airports, Fiumicino and Leonardo da Vinci. Italy has limited the maximumm shareholding of foreign state entities in its Rome airports to 2%. This is being contestedd by Schiphol airport on the grounds that it discriminates against foreign investors. Thee Commission is looking into this matter to determine if H inhibits the free movement of capital.. The existence of EC Courts and the obligation of domestic courts to apply Community laww have strengthened the incentivee to abide by the rules. Inn relations with third countries, the Bilateral dispute resolution mechanisms still apply.

Thee greater delegation of air transport rights to industry players in the Community structure impliess a more important role for the legal remedies that can be used against these parties. One areaa where they are particularly important is the ex post monitoring of behaviour through competitionn law. To give some examples, industry players may contest competitors' agreementss and the Commission may investigate infringements, such as the abuse of dominant positionss by refusing access to ground handling activities103 or the discounts on domestic flightss mentioned in Section 4.5.8. Competition provisions 81 and 82 EC have been implementedd via specific air transport Regulations, while Regulation 17/62 applies where air transportt is not involved104. In addition, air transport on non-Community routes is subject to thee interim regime of Articles 84 and 85 EC105. The existence of multiple rules, each with its ownn compliance procedures, is an element of concern, as it creates a complex situation. There are,, for instance, differences in the notification requirements for proposed co-operation agree- ments.. On the other hand, every Regulation allows any party to an agreement to ask the Commissionn to certify that the agreement does not infringe the competition rules. Further, theree are no exceptions to the general corrective measures, which include the power of the

999 The method of consultation is not ruled out In addition to being the traditional way of maintaining interstate relations,, Article 6, para 4 of Regulation 2409/92, mentions oonsutettioiisanwng Member States to review a situationn where a Member State has intervened in price setting by an airline. 1000 Decision 91/555 OJ 1991, L 300. 1011 Derision 94/118, OJ 1994 L 54. 1022 Commission Decision 92/8 OJ 1992 L 5 and 94/662 OJ 1994 L 258. Cases T-371/94 and 394/94 British Airwayss et al., better known as 'Air France', 25 Jury 1998,1998,11-2405, discussed in Barents (1999: 442- 457).. Also Kapteyn, VerLoren van Themaat (forthcoming). 11 ra Commission Decision 98/190, OJ 1998 L 72 (FAG). 1044 For example, this Regulation applies to ground handling services. See Conimission Decision 121/85, OJ 19855 L 46 (Olympic Airways) on the interplay between Regulations 17/62 and 141/62. 1055 Supra, p. 93. 129 9 Commissionn to issue fines when it finds an infringement, suspend a transaction, take interim measuress as well as adopt a Decision requiring termination of an illegal act. Inn the domestic state-industry relationships, the distribution of power influences the preferredd form of enforcement. In this regard, the Community resembles Bilateralism. Howe- ver,, the weaker interdependencies, the wider differences between state and industry objectives andd the greater marketing opportunities in the industry have weakened state-industry relationships,, altered the distribution of power and increased the likelihood that the parties will usee legal enforcement to resolve conflicts.

4.88 - Characterisation of the Community structure Inn terms of the categorisation of governance structures outlined in Chapter H, the Community structuree of formal rules, and informal norms and values can be seen as a hybrid of a transaction-specificc structure and the semi-specific structure of regulation. The complicated naturee of state relationships is a feature of relational contracting and a transaction-specific structure.. The same is true of the framework character of the EC Treaty and its secondary legislation.. While the latter features make it less of a semi-specific regulatory structure, the air transportt packages are examples of regulation based on the EC Treaty. The regulated parties aree the Member States, as well as, indirectly, airlines and airports. The autonomy of the regulatorr derives from its right of initiative, decision-making rules involving qualified majority andd broadly worded policy memoranda. Yet, there are some features that are more consistent withh a non-specific structure. These include the importance of legal wording, detailed law- makingg procedures and independent courts. Notwithstandingg extensive powers to regulate in order to realise the objectives of the EC Treaty,, the Community institutions face limitations on these powers. One feature of the Communityy is that its institutions only have those powers that have been explicitly conferred onn them. Moreover, the Community's framework structure implies that the treaty's objectives cannott be attained without co-operation on the part of Member States. Any secondary legislationn must be essential and effective, as well as proportional to the other goals of the Memberr States. This general rule was strengthened by the 1992 Subsidiarity doctrine, accordingg to which the Community should only act if and when it is in the best position to do so106.. A procedure was created for the application of the principle, with pre-proposal consultationn by the Commission as one of its requirements (Nicoll, Salmon, 1994: 299, Bekkerss et al., 1995: 30)107 This principle has in practice come to mean that many actions are

1066 Supra, p. 121. Bekkerss (ibid.) describes two alternative tests aeated to evaluate wbether a decision is taken at the right level.. These arc a value added test, which aims to judge whether action by the EC might have added value becausee of its ability to take into account international effiKts, aiul a comparative effiri^ 130 0 generallyy taken by national powers rather than the Community, but in air transport its influence iss limited due to the global nature of the industry. Finally, formal rules governing the transactionn process constrain Community institutions. The emphasis on procedures contrasts withh the traditional process governing the creation of international rights and obligations (Bracke,, 1996: 76-87). Chapter III explained that the traditional process is rather informal, characterisedd by rules of diplomacy, fundamental equality and sovereignty. Thee relationships between the state and the airlines and airports are further examples of regulation. .

4.99 - Further developments Thiss chapter has provided a description of the Community governance structure. On the one hand,, the structure seems simpler than Bilateralism, because of the abolition of separate air transportt agreements between Member States, the introduction of clearer rules, and the existencee of enforcement mechanisms. On the other hand, differences between domestic and Communityy objectives, the existence of Bilaterals with third countries and various airline agreementss with third country carriers have resulted in gaps and overlap and have made the structuree more complex. It is the task of the next chapter to analyse and compare the effectivenesss and transaction cost efficiency of the Bilateral and Community structures. Before turningg to that analysis, some remarks on the future development of the Community structure aree in order. Itt has already been observed that air transport is a global activity. The relationships with thirdd countries are of great economic and political relevance for the functioning of the internal market.. This factor as well as the broad scope of the EC Treaty make it almost imperative that thee development of the governance structure should focus on external relations. It is generally easierr to reach agreement on external than on internal issues (Wallace et al., 1983: 75), but this hass not been the case in air transport. Although at present there is no disagreement on the notionn that air transport policy is part of the Community's institutional structure, a consensus onn the future development of this policy is still lacking, and the Community is limited in its powerss vis-a-vis international organisations and third countries. From time to time, the Commissionn has issued proposals dealing with precisely this aspect but the Council has tended too reject these. The Commission has also used the option of going to court to pursue the policy further.. The case initiated when GATS was concluded is one example, as are the infringement proceedingss against Member States (see Sections 4.5.6.1). It is not yet clear when the Communityy structure will be completed and what form it will ultimately take. Given the thee resources of the Member State. The efficiency test implies that the Community should only take action whenn competition between Member States is not producing an efficient outcome. 131 1 sensitivee nature of air transport services and their link with foreign policy issues, some commentatorss (including the current author) assume that further progress will not result from anyy spill-over. Chapter VI will look into some elements surrounding further development of thee Community structure.

132 2 Chapterr V - Comparison of the Bilateral and Community structures

5.11 -Introduction Sectionn 2.7 described three alternative governance structures, namely non-specific, semi- specificc and transaction-specific. The purpose of the analysis performed below is to allocate the exchangee of air transport rights to the governance structure that concludes and executes this transactionn in a way that is both effective and transaction cost efficient. The exchange of air transportt rights was denned in Chapter I as the right to enter an air transport market, to use foreignn airspace for traffic and transport purposes and to capture the benefits flowing from that use.. Chapters III and IV described two alternative governance structures, namely the Bilateral andd the Community structures, and the process that generally guides such transactions. These chapterss concluded that each structure is a hybrid between a transaction-specific structure calledd the 'State' and the semi-specific structure of regulation. The state as a party to the transactionn has elaborate powers in exchange for which it must pursue social welfare. The 'State'' as a governance structure has certain features that enables the state to do so. For instance,, the state's monopoly in violence enables it to coerce others. The attainment of social welfaree is difficult to measure, however, because it covers many individual objectives. On this account,, it was decided in Chapter II to measure the effectiveness of the State via a translation off the state's objective (based on, for instance, policy documents and legislation) into concrete requirements.. More specifically, the state's social welfare objective has been treated as a collectionn of sectoral goals, of which the air transport goal has been translated into detailed subgoals.. These have been formulated in terms of requirements that must be included in any interstatee agreement and that must be met by airlines and airports. The effectiveness of a governancee structure is the extent to which instruments and mechanisms derived from the structuree lead the industry to meet the given requirements. The transaction cost efficiency of thee structure is evaluated in terms of the transaction costs that are incurred to meet the requirements.. These costs, in turn, depend on the core dimensions of the transaction. The entiree analysis is conducted from a qualitative perspective, focusing on the abstract nature ratherr than exact size of the various interactions. Thee air transport goal of the Netherlands has been defined as the realisation of a 'selective network'' of airlinks to and from the Netherlands. It comprises the creation and operation of an airr transport network that contributes to the psychological goal of national prestige, the financiall goal of generating (tax) income and derived benefits, the political goal of maintaining goodd interstate relations and various social goals, of which environmental protection is the mostt important. Section 3.3.1 noted that the goal contains elements of selection and differentiation.. In the presence of scarce environmental and airport capacities the state aims to selectt the transaction partner that economises on these resources. The elements of the air

133 3 transportt goal that fall into the domain of social welfare are environmental protection, the facilitationn of transport and trade, which creates new business opportunities, the protection and enhancementt of efficiency, and any public service element. In translatingg the air transport goal intoo specific requirements, the state focuses on the following areas: 1.. traffic volume, 2.. fleet composition, and 3.. market behaviour.

Thee analysis below builds on the description of the Bilateral and Community governance structuress and the transaction process given in the previous chapters. The analysis will take placee from the viewpoint of the Netherlands, as a Member State of the European Community. Thee chapter is organised as follows. Section 5.2 describes some characteristics of and trends in thee industry. Section 5.3 applies the determinants of the core dimensions identified in Chapter III to the context of air transport, Section 5.4 looks at the features of the Bilateral structure, andd Sections 5.5 and 5.6 discuss the effectiveness and transaction cost efficiency of this structure.. The same is done for the Community structure in Sections 5.7, 5.8 and 5.9. Finally, Sectionn 5.10 answers the questions of which structure is more effective and which structure is moree transaction cost efficient.

5.22 - Characteristics of and trends in the air transport industry

5.2.11 - International nature Airr transport is an important industry for the Netherlands, given its traditionally open economy andd strong service sector. In 1999, approximately 56% of the passenger traffic at Schiphol airportt was subject to the Community structure, which means that the remaining 44% was subjectt to Bilateral and Open Skies agreements (e.g. with the United States and Singapore)1. Domesticc transport accounts for less than 1%. These numbers illustrate the international nature off air transport services.

5.2.22 - Co-operation AA second feature of the air transport industry is strong co-operation. There are close relations- hipss between the state and the airlines and airports, as well as various co-operative agreements betweenn industry players. An important role is played by airline alliances. The term 'alliance' is generic,, with no precise definition. It can mean some degree of equity ownership, but more oftenn it is interpreted in looser terms. Alliances may take many forms, such as code sharing,

11 Supra, p. 99. 134 4 blockedd space agreements2, frequent flyer programmes3, scheduling agreements, joint marketingg agreements, service agreements and purchasing agreements. Joint marketing agreementss especially, such as the Sabena-Swissair alliance known as 'Qualiflyer'4 or the 'Star Alliance'5,, are important because the requirement of substantial ownership and effective controll generally prohibits conventional corporate mergers. The Northwest-KLM alliance is an examplee of an alliance that is based on a significant share transfer6. Co-operationn among airlines is stimulated by various factors, such as institutional factors, thee existence of scale-related economies and strategic behaviour. Institutional factors include thee fair and equal opportunity requirement prevalent in Bilateralism. This requirement has motivatedd joint efforts to circumvent some of the limitations created by states and to secure accesss to otherwise closed markets. Second, the Bilateral policy of single designation has dividedd the market at the route level into a duopoly. In addition, when states believe that the principlee of fairness and equality is not being met in practice, they can impose a 50-50 division off traffic by requiring the carriers to enter into a pool agreement. Liberalisation is a third institutionall factor inducing co-operation as it can reduce the uncertainties and risks associated withh free markets. The past ten years have shown a widespread emergence of significant airline alliances,, extending far beyond the more traditional pool or marketing agreements. Airr transport exhibits economies related to the nature and size of operations (Berechman andd De Wit, 1996: 253, OECD, 1997: 58, Button et at, 1998: 16-17). International airlines producee a range of outputs: they usually operate more than one service on any city-pair route andd provide a number of interconnected routes. Co-operation with the aim of combining routes enabless the creation of scale-related economies, such as economies of scope, density and experience.. There are economies of scope if the total cost of producing multiple outputs (e.g. bothh scheduled and chartered services) using a single firm is less than the total cost of producingg each product separately using different firms. These economies arise from the

AA Mocked space agreement is a contractual arrangement between an airline and a thitd party, e.g. a travel agent,, touroperator, freight forwarder or another airline, whereby a specified number of passenger seats or amountt of cargo space is allocated between two or more points on a earner's rotate for a given period of time. A code-sharingg agreement is a variation. In essence, this is an agreement between two airiines by which an aircraftt from one airline operating a given flight canies its own flight number as weU as thai of the otb«r airline,, thus allowing the non-operating airlitie to seU the flighta s ite OWIL Tne agieem off an agreed number of seats. Code-sharing frequently includes sclieduU^ soo that two airlines feed traffic to each other (Groenewege, 1996). 33 A frequent flyer programme is an incentive programme, whereby a frequera passen accumulatedd mileage with free or discounted travel privileges on fuüirefughts. This type of tr^ programmee may vary across airlines and partkapatkmmiglM involve non-oiriine parties rentall companies (ibid). ** At the time of writing, Qiialiftyer consisted of Sabeiia, Swissair, TAP, ACM Frew* AirUnes, Tiukish Airlines,, Austrian, Crossair, Lauda Air, Tyrolean, Air Littoral and Air Europe. 55 At the lime of writing, Star Alliance was formed by Air Canada, SAS, Lufthansa, Thai Airways, Varig, Air Neww Zealand, All Nippon Airlines, Ansett Australia and United Airlines. 66 This alliance was the first major international allianoe grven aim-trust inimunfy

135 5 opportunityy to concentrate resources and better utilise crew and aircraft in a network type of operation,, such as a hub-and-spoke system. In addition to the cost savings that these systems generate,, they are used to create a diversity of services, thereby increasing market visibility and enhancingg the attractiveness of frequent flyer programmes. As a result, hub carriers can realise additionall income and reach a level of service that rival airlines not operating from a hub cannott easily match. Hub-and-spoke systems thus form an effective barrier to entry (Williams, 1993:: 18, 28, 53). Apart from scope effects, the air transport industry also seems to exhibit economiess of standardisation, i.e. economies in operating a standard fleet of aircraft, as well as considerablee economies of density. Economies of density exist when unit costs fall as the size off the market increases. They stem from the ability to use larger aircraft that are cheaper to operatee per seat kilometre and that can offer more frequent services (OECD, 1997: 59). Finally,, incumbent carriers often benefit from economies of experience, which capture goodwill,, knowledge and organisational skills (ibid.: 60). Extensivee regulation in domestic and international air transport markets of routes, market entry,, capacity and fares has created considerable sources of economic rents. The consequent movess to liberalise the industry have threatened those rents, motivating the airlines to limit competitionn through strategic alliances (Youssef; Hansen, 1994).

Whilee institutional factors may stimulate co-operation, they may also complicate co-operation. InIn many instances states interfere in negotiations because of the special rights that have been grantedd to airlines and the nationality requirement. In addition, different rules govern the foreignn ownership of airlines. Principles are tempered in practice, allowing some investment andd a measure of foreign influence when it can be politically supported (Havel, 1997: 65, 77- 78),, perhaps because the trade partner is important. The US DOT, for example, allowed a continuedd designation of Aeorolinas Argentinas, although the nationality requirement was no longerr met (see Section 3.3.2). In some cases the states have linked their approval of an alliancee to Bilateral negotiations. The Northwest-KLM alliance, the Lufthansa-United alliance (ibid.:: 2.5.2.1.2, 2.5.3.1,107, 116) and the OneWorld alliance between American Airlines and Britishh Airways are illustrations. Co-operationn may be easier to realise when states have a common set of rules. Thus, the harmonisationn of rules on proposed co-operation agreements in the EC may facilitate co- operation.. Chapter IV observed that co-operation among European airlines has been a familiar featuree for many years, reflecting a common background and close trade relations. The introductionn of the Community structure has stimulated and facilitated co-operation further. Somee contributing factors are the harmonisation of rules more generally, the right of establishmentt and the introduction of the Community carrier concept. However, the reasons etal.,, 1998: 100,103-104,109). 136 6 forr alliances listed earlier suggest that these factors alone do not determine the form, success, orr members of an alliance. The nationality requirement still applies to Bilateral traffic and third countriess may resist the transfer of Bilateral rights to a carrier that is no longer substantially ownedd or effectively controlled by its contracting partner. Member States may be afraid of losingg control over their carrier. The fear of a 'Dutch invasion*, for example, has prevented the possibilityy of a share transfer under the KLM-Alitalia agreement. At the same time, most Communityy carriers already had agreements with carriers fromthir d countries. The investments inn these relations constitute sunk costs and limit the opportunity of switching to a Community partner.. Furthermore, an intercontinental partner offers better prospects for network synergies. Inn practice therefore, existing alliances are mostly structured around a number of large airlines whichh form the core of the alliance and give global reach. Usually, one ahiine is American, at leastt one is European and one Asian. The most important members have tended to be the majorr United States carriers, which in 1998 held 34% of the total volume of scheduled passengers,, freight and mail service (ICAO, 1998b)7. Finally, the competition provisions of the ECC Treaty may prevent co-operation. Section 3.3.2. noted the dissolution of the agreement by whichh KLM would obtain the remaining part of Martinair shares because of the conditions that wouldd be tied to the acquisition. The most obvious example of European co-operation is 'transborderr franchising',whereb y a carrier is (partly) owned and effectively controlled by a carrierr from another Member State. An example is the arrangement between Deutsche BA and itss franchiser, British Airways, which has a 65% shareholding (ICAO, 1998a: 18). The Dutch airlinee 'BASE1 is another franchisee of British Airways, but this agreement is not based on any shareholding. . Thee airline alliances and their dynamic nature also motivate co-operation between airlines andd airports. One consideration is the enormous influence that the formation of alliances can havee on the traffic flow at an airport. Changes in the number of destinations served, the mix of long-haull and short-haul services and passenger throughput can be significant for a hub airport (Arthurr Andersen, 1999) and demand closer co-operation between industry players. Another reasonn for co-operation is that strong growth in air travel is generating capacity problems. The airportss are seeking commitments that will guarantee a fair return on any new investments. At thee same time, the airlines are facing fiercer competition in a liberalised environment and are exertingg pressure on airports to reduce charges. Co-operation might thus be aimed at spreading risk,risk, improving efficiency or introducing innovative charging structures. One example is the Dutchh Optimalisatkwi strategy, whereby the main Dutch airlines, Dutch Air Traffic Control and Schipholl airport meet frequently to co-ordinate actions. Another example is the ACI-AEA projectt on the development of standard airport use agreements (see Section 4.5.8). Again, EC competitionn law may pose a constraint. In line with the development of airline networks, co-

77 On international services, United States carriers accounted for 18% of all traffic. 137 7 operationn among airports has also increased. Examples include the position that BAA is establishingestablishing in Europee and the rest of the world. Schiphol airport is also pursuing this strategy withh shareholdings in New York and Brisbane. Alliances between airports are scarce. There is ann agreement between Schiphol and Vienna Airport, with a 1% shareholding as well as a masterr agreement. In 1999, Schiphol entered into an alliance agreement with Frankfurt.

5.2.33 - State intervention and deregulation Anotherr feature of air transport is a high degree of state intervention. Section 3.3 listed the reasonss for state intervention in air transport, including the existence of negative externalities. Theree are two other types of market feilure associated with air transport. These are informationn asymmetries and market power (Schipper, 1999)8. Travellers, for example, are limitedd in their ability to compare airline services, especially if computerised reservation systemss are biased towards a certain airline. Market power can stem from technology and from entryy barriers caused by congestion, the ownership of computerised reservation systems and strategicc airline behaviour (ibid.: 21). As an example, the airline alliances discussed in the previouss section may restrict competition and encourage higher feres and poorer service, as hass happened in some instances in the deregulated United States air transport market. These markett failures are a reason for state intervention. One form of intervention is regulation.. Some regulationss formulate requirements in the areas of market entry and the conduct appropriate to markett participants. Information asymmetries are a source of safety regulation as well as regulationn to protect the general public. Regulatory instruments include permits, price regulationn and competition policy. In many cases regulation has taken the form of restricting competitionn (ibid.: 91). Intervention designed to handle externalities includes direct regulation (e.g.. noise contours) and sometimes charges (ibid.: 12). The level of regulation is determined byy more than market imperfections alone. Political and financial objectives in the area of trade alsoo play a role in regulatory decisions, as does the widespread perception of air transport as a publicc service that must be provided to the community (among others: Wheatcroft, 1964: 46, Fennes,, 1997: 65-66). Finally, regulators often show a proclivity to expand the reach of regulationn thereby including ancillary activities. On their part, regulated companies want to protectt their economic rents and generally defend regulation. Thee state also holds important property rights to the airspace above its territory and any statee wishing to use the airspace of another state needs to obtain the approval of that state. In otherr words, a transaction between states has to occur. The states entrust the airlines and airportss with the special rights needed to execute the transaction. Furthermore, the state often

Tliee existence of multiple market failures has implicaüons forpubli c poücy. The welfare gains of higher outputt doe to liberalisation may lave to be traded o^ environmentall damage (Schipper, 1999:91). 138 8 holdss shares in airports and airlines. Each of these factors makes the state a crucial market player. . Overr the years, state involvement in air transport and the extensive level of regulation have comee under scrutiny and have been reduced as a result. An example is the United States market,, which was deregulated more than twenty years ago. The Community market has also beenn opened up to more competition, but in this structure the states have retained a greater influence.. They also opted for a more gradual liberalisation process, beginning in the late 1970s andd lasting until 1997.

5.2.44 - Industry environment Sectionn 2.6 introduced the industry environment as a factor influencing the performance of a governancee structure. This section will discuss some elements of the industry environment. Att the start of the deregulation process in the United States, some economists opined that thee air transport industry was a 'contestable market', i.e. a market where economies of scale andd scope may exist, but barriers to entering or leaving the industry are absent. Any such barrierss result from regulation, physical factors, and special costs or investments that cannot be recoupedd at the time of exit. Potential carriers have the same information as incumbents, they usee the same production methods and face the same demand conditions. A new firm looks at thee possibility of entry on the basis of the existing price level. Entry occurs when the carrier expectss that it can charge a lower price, whilst still covering costs. If incumbents respond by loweringg their prices, exit is possible without any loss of investments made. For instance, aircraftt can be sold at the time of exit or used on a different route. Under these circumstances, thee potential threat of entry and hence competition has a disciplinary effect on the incumbents, sincee too high a price will attract entry, and can generate performance that maximises market welfaree (Morisson, Winston, 1997; 484). A further test of these criteria and the experience withh US deregulation, however, have shown an absence of contestabilhy (among others: Barrett,, 1993: 104, Williams, 1993: 34, 58-59). Before an airline can enter a new market it has too establish a relationship with the state and acquire a permit. It also has to organise capacity, whichh is difficult because the interdependence of the frequencies operated in a network reduces thee opportunity to reallocate aircraft to another route. Market entry includes the need to make non-triviall unrecoverable investments in advertising, initial operations and facilities in order to assemblee the gates and landing slots required in a hub-and-spoke system (Oum et al., 1995: 840).. In addition, a hub-and-spoke system enables a hub carrier to dominate the hub and to behavee strategically (Borenstein, 1989, Oum et al., 1995). Important barriers to entry and exit thuss exist. Airport investments constitute an even higher barrier. Providing landing and take-off facilitiess requires the airport to make substantial specific investments, which can only be recoupedd if there are sufficient air transport operations. The state in turn has to make 139 9 significantt investments in the ground infrastructure and facilities for ground transportation aroundd the airport9. These factors reduce the disciplinary effect from any potential competitors, makingg actual competition more important in securing economic efficiency. At best, the industryy is imperfectly contestable. Thee air transport industry has also been studied using core theory. This approach focuses on costt and demand structures as determinants of market structure. An empty core arises wheneverr capacity (defined as the output associated with the minimum short-run average cost) inn the industry exceeds the quantity demanded at the price equal to that minimum average cost. Competitivee equilibrium in such an industry requires that at least one firm shut down in the shortt run, with the resultant price above minimum average cost. As a result competition may bee destructive and may not lead to an efficient outcome (among others: Telser, 1978, Button et al,, 1998: 122-123, 158). Competition might be destructive because firms may be led to reduce pricess to cover only marginal costs in order to drive out rivals, thus weakening themselves. As ann example, suppose that there are indivisibilities in supply: a route would ideally be served by 1.55 planes of a given size but obviously only 1 or 2 can be used. In this case, one airline may offerr the service and obtain high profits on its daily flight but, in doing so, attract a second carrier.. Two carriers cannot generate sufficient revenue to maintain a viable operation and so onee or both drop the service. If the carriers have rational expectations, no carrier will even startt to offer a service knowing that the probable outcome will be destructive competition. In suchh a case the core is said to be empty. A number of conditions need to be satisfied to generatee an empty core. For instance, demand has to be divisible, and capacity indivisible. Furthermore,, entry has to be restricted. Empirical tests in the air transport market by Button (1996)) and Button et al. (1998) have given only tentative support for an empty core. They do opine,, however, that the concept of the empty core is implicitly present in recent air transport debatess in the European Community, and in some regulatory instruments, such as the block exemptionss enabling co-operation and the opportunity provided by Article 9 of Regulation 2- 408/92408/92 to freeze capacity when there is a structural market disequillibrium. Thee air transport market is not contestable and (presumably) does not have an empty core. Analysess by, among others, OECD (1997) have found that the industry has features enabling it too function sufficiently well (in terms of market clearance) if left to competitive devices. The mostt realistic characterisation may be that, on the basis of cost structures and demand characteristics,, the air transport industry seems to work more or less like a competitive market (Forsyth,, 1998)10.

99 The entry and exit barriers faced by the industry are siniilar to the notion of asset sperifirity as defined in transactionn cost analysis (Baumol et al., 1982, Zajac, CHsen, 1993:136). 100 Various documents (for example, OECD, 1997, Button et al, 1998:19,116) use the term 'workable competition'' to characterise the functioning of the a» timisport market T^iere are, however,'as inany definitionss of this term as there are workable economists' (Henmpman, 1966:19-21, referring toMason , 1957) 5.2.55 - New market players AA final industry trend is the emergence of low fare carriers, such as Ryan Air and Easy Jet. Unlikee traditional carriers, these carriers consider prices as the main instrument of competition. Loww fare carriers do not offer many of the service elements provided by traditional carriers, so ass to avoid costs that cannot be recovered through their pricing structures. Thus, they operate directt short-haul services on very tight schedules and focus intently on cost containment throughh a rapid turnaround of aircraft, an approach that is essential to achieving a sustainable competitivee advantage. From an airport management viewpoint, the network and low fare carrierss have different needs. Network carriers look at airport services from a broad perspectivee (which includes quality), whereas low fare carriers are primarily interested in costs. Theirr operations have exacerbated current capacity problems and have contributed to the complexityy of the environment.

Havingg described some features of and trends in the air transport industry, the analysis now turnss to the core dimensions in the context of air transport.

5.33 - Core dimensions Chapterr n described an integrative framework of analysis, in which the core dimensions of the transactionn were identified and analysed in terms of their determinants. The description of the Bilaterall and the Community governance structures in the last two chapters permits the appli- cationn of this framework to air transport. The following table applies the abstract description of thee determinants in Sections 2.4.1-2.4.5 to the air transport context.

Determinant t Applicationn to air transport

Perishability y Rightss to use foreign airspace

Existencee of alternatives / competition Alternativee suppliers of freedom rights, con- ditionss attached to (the use of) those rights

Dynamismm of the environment Changess in balance between originating and destinationn traffic, travel trends, instability of alliances,, institutional reform

Flexibilityy of the relationship Abilityy to tailor rights and obligations into uniquee relationship, rigidity of agreement, andd the term lacks a clear and unambiguous "wming For this reason, the term is not used in this thesis. 141 1 includingg ability to amend agreement

Complexityy of the transaction Predictingg demand, interpreting objectives, coalitionn formation, barter, (absence of) uniform rules s

Informationn gathering capacity Existencee of sources of information and mecha- nismss for collecting information, accessibility of information n

Informationn processing capacity Organisingg contact and contract phases, co- ordinatingg between various branches of governmentt and industry, interpreting policy goals s

Scopee of the relationship Extentt to which states depend on other states as aa source of supply, extent of hold-up in state- industryy relationships

Susceptibilityy to lobbying Institutionall environment, room for interest groupp representation, intensity of state-industry relationships s

Technicall necessity or regulation Requirementss on runway layout (length, locati- on),, facility layout, equipment, nature of operations s

Institutionall guarantees Symmetricall access to information, enforcement system,, mutual exposure to risko f deviation

Perceivedd fairness of the transaction Interpretationn of reciprocity requirement, conditionss attached to use of air transport rights

Nett gains from opportunistic behaviour Tradee diversion, loss of future trade opportu- nities,, mutual dependence on contoiuation of trade e

Harmonisationn of interests Overlapp between objectives of states or of state andd industry

Control l Monitoringg ability, performance incentives, enforcementt mechanism Tablee 5.1

Althoughh the air transport sector can be governed in a variety of ways, the present thesis L 142 2 limitedd to an analysis of the Bilateral and the Community governance structures because these aree the most important structures for the Netherlands. The following sections analyse each structuree in terms of its features and the implications of these features for the effectiveness and transactionn cost efficiency of the structure.

5.44 - Features of the Bilateral structure Chapterr ID described the Bilateral structure and transaction process. This section highlights the essentiall features of that structure: 1.. Sovereign states and agreements based on equality, 2.. Reciprocity requirement, 3.. Allocation of property rights to states, 4.. Multiple state goals, 5.. Informal transaction process, emphasis on relationships, 6.. Secrecy, 7.. Barter exchange via a treaty, 8.. Two party agreements, 9.. Flexible negotiations, rigid agreements and 10.. Compliance mechanism dominated by non-legal enforcement.

Thee following briefly expands on each of these features.

Sovereigntyy and equality of states Bilateralismm proceeds trom the notion that participant states are sovereign and that explicit approvalss are needed to use foreign airspace. States are considered equal, regardless of any differencess in wealth, population or natural resources.

Reciprocityy requirement Inn line with the principle of equality, exchange has to be reciprocal. This is exemplified by the requirementt of a fair and equal opportunity, which takes into account potential third freedom trafficc (i.e. traffic from the flag state to the grantor state). This requirement is often interpreted ass a need to reach an equal outcome, but even when a looser interpretation applies, there must alwayss be some form of equality (Havel, 1997: 195). A quid pro quo requirement can also be derivedd from the regulation of cabotage or foreign ownership11. uu Havd (1997:79) cites an article in Airline Business (1993) reflecting airline comments

143 3 Allocationn of property rights to states Statess hold the property rights to the airspace. These rights have to a very limited degree been delegatedd to industry players. The rights to use the airspace and to capture the resulting benefitss are divided into eight different rights.

Multiplee state goals Thee states' air transport goals derive from their obligation to promote social welfare. The objectivee of the Dutch state has been identified as the creation of conditions that are favourable too realising an eflScient and effective air transport sector and that will optimise a selective networkk of air links. The selective network goal captures psychological, financial, political and sociall subgoals.

Informall transaction process, emphasis on relationships Thee Bilateral transaction process has a diplomatic character and is thus relatively informal. Negotiationss are not limited in time and factors such as credit, confidence, consideration, politicss and compromise are important. There is a strong emphasis on relationships. For instance,, the interpretation of a fair and equal opportunity, the interpretation of the nationality requirement,, and the level of foreign ownership that is allowed in an alliance may all be tailored too the interstate relationship.

Secrecy y Notwithstandingg the compulsory registration of every Bilateral with ICAO, secrecy is a feature off Bilateralism. It is reflected in the lack of formal position papers at the start of negotiations, thee incomplete provision of information to parliament at the moment of domestic approval, as welll as the use of secret Memoranda.

Barterr exchange Exchangee occurs via a treaty without a separate medium of exchange (such as a form of money). .

Twoo party agreements Thee Bilateral involves only two parties.

Flexiblee negotiations, rigid agreements Bilateralismm is a flexible structure because contracting is relational (an aspect of its transaction-

Airr 'to set by precedent an extremely low level of voting and equity influence by foreign airlines... principlee but because there was no satisfectoiy trade-off'. .... not on 144 4 specificc character) and because of the two-party element. The content of Bilateral agreements cann vary significantly from very liberal to very restrictive. At the same time, Bilateralism is a rigidrigid structure. It focuses on two-party negotiations and so precludes the accommodation of internationall network traffic flows, which are multilateral by nature; it imposes the requirement off a fair and equal opportunity; and it lacks mechanisms that facilitate adjustment to changes in thee environment.

Compliancee mechanism dominated by non-legal enforcement Thee Bilateral is governed by multiple systems of international and national rules. In addition to differencess in content, the record of enforcement differs across states. The parties may use a varietyy of instruments to stimulate compliance. Because of the sovereign nature of states, an externall enforcement system is largely absent and disputes are resolved via non-legal methods. Thee relationships with airlines are close and long-term, power is distributed evenly, and disputess are therefore primarily solved through negotiation. Legal enforcement features more oftenn in the state-airport relationship.

Thee implications of these features for the effectiveness and transaction cost efficiency of the Bilaterall structure will become apparent in the next two sections

5.55 - Effectiveness of the Bilateral structure Thee assignment of property rightst o the state in the Bilateral structure gives the Dutch state controll over the transaction process and enables it - at least in theory - to realise its selective networkk goal. Certain features of Bilateralism enable the state to impose requirements on the industryy and foreign state and to use various instruments optimally and thus realise all its subgoals.. More specifically, relational contracting, baiter and secrecy enable the state to differentiatee its relations with other states. The limited number of people participating in the exchangee also enhances the state's ability to prepare and co-ordinate the entire negotiation process.. The state can thus negotiate Bilaterals selectively. The state can also specify how air transportt services are to be provided by stipulating in the agreement the nature of equipment or timee of operation. In this way, the state can make progress towards the important social goal off environmental protection. In addition, Bilateralism enables the state to pursue the psychologicall goal of prestige, although this subgoal is less important than it used to be. The two-partyy nature of Bilateral agreements limits the number of people taking part in the exchange,, which fosters a close bond between the state and industry and so contributes to the nation'ss prestige. The nationality requirement applicable to the flag carrier strengthens the bondd between state and industry even further. However,, relational contracting and the feature of reciprocity imply that a state's political 145 5 weightt and bargaining power influence actual demands made in negotiations and thereby the contentt of Bilateral agreements (e.g. equipment specifications). This is disadvantageous to thosee states that lack physical, economic or political size. They are limited in their ability to forcee other states to use certain equipment, prescribe the destination airport or the time of operation.. A small capacity of originating and destination traffic, coupled with a strict interpretationn of the reciprocity requirement, may also limit the state's ability to attain the financialfinancial goal. A further weakness of Bilateralism that has implications for all of the state's goalss is the system's rigidity. Although the negotiation process itself is flexible, new agreementss are concluded infrequently and existing agreements are difficult to amend. As a resultt Bilaterals concluded earlier are not geared towards goals introduced in later years. Thus, inn the Dutch case, some Bilateral agreements may lack clauses aimed at environmental protectionn and may therefore fail to reflect this social goal. Smalll size and a lack of economic importance notwithstanding, the Bilateral structure has allowedd the Netherlands to build a strong position in air transport. The country's size disad- vantagee has been partly offset by good co-ordination, the informal nature of the transaction processs and compliance mechanisms, a creative negotiating strategy and by barter exchange, whichh has enabled the use of non-aviation quid pro quos. These features have also allowed the statee to negotiate requirements that target environmental protection. It has been more difficult too compensate for a lack of equality in traffic potential. A creative approach towards freedom rightsrights (e.g. devising the sixth freedom right) has contributed to a successful transfer concept, whichh is essential to the operation of hub-and-spoke networks. The country's preference for liberalisationn has been especially important in making the Netherlands an attractive partner for somee stronger countries that, because of their strength, have been unable to conclude liberal Bilateralss with larger countries. This has partly compensated for the lack of traffic potential. Ann important contributor to this success has been the US encirclement strategy (see Section 3.2),, which made the Netherlands an attractive partner for an Open Skies agreement with the US.. Havel (1997: 403) points out that the encirclement strategy has led to a 'KLM syndrome'12.. In 1999 passenger travel on the North Atlantic route accounted for 14% of the passengerr traffic at Schiphol airport, which is far higher than traffic to and from Asia (8%) or Africaa (4%) (Amsterdam Airport Schiphol, 2000). However, the Open Skies Bilateral differs considerablyy from the traditional Bilateral. In particular, there are no restrictions on such variabless as price and quantity. When the contribution of the Open Skies agreement is excluded,, the Netherlands' lack of physical and economic size has limited the country's ability

uu DOT, Issues Papers, International Aviation Policy - US Negotiation Policy, in Airline Commissioii Documents,, Dkt No. 000000, at 75. This syndrome derives fixmi the fact that small countries welcome US entreatiess to sign pro-coinpetition agreements, while major players, defending inefficient flag carriers, shun the openn skies promised by liberal Bilaterals. US carriers then öoe imeiisffied conipeü^n rrom ireU-posrüoned smallerr country carriers, without compeTisating acce^ to larger, more liK^ativc gateway maitets 146 6 toto attain the financial goal. Thee need for reciprocity does not play a role in the state-industry relationship. The Dutch state'ss position in air transport has been enhanced by the strong performance of and good co- ordinationn with the industry. The state's control over the property rights to airspace enables it too formulate requirements that must be met by the industry during the execution phase. Tight statee control as well as interest hannonisation through interdependencies and close relations putt the state in a position to realise its air transport goal. In particular, the state and industry havee similar financial objectives, and close relations, sometimes based on ownership, induce the industryy to incorporate the other subgoals into its continuity objective.

5.66 - Transaction cost efficiency of the Bilateral structure Thee transaction cost efficiency of the Bilateral structure will be analysed in terms of the core dimensionss and their determinants.

5.6.11 - Transaction frequency Thee determinants of the transaction frequency were identified in Section 2.4.1 as the perishabi- lityy of the object exchanged, the existence of alternative sources of supply, the dynamism of the environmentt and the flexibility of the transaction process and agreement. Thee transaction involves the exchange of air transport rights, which can be effected over an indefinitee period of time. Unlike the transport services governed by these rights, the rights themselvess do not perish. If an agreement is re-negotiated, it is not because a right has ceased too exist in any physical sense. Furthermore, the idiosyncrasy of the interstate relationships and differencess in the value attached to these relationships imply that a Bilateral with one state cannott be considered a substitute for a Bilateral with another state. Likewise, a traveller typicallyy needs to arrive at a specific destination for which there are no close substitutes. These factorss limit the availability of alternative sources of supply and the degree of competition. Somee competition exists among small states in their air transport relations with distant states, becausee in such situations the time needed to travel to an airport in a neighbouring state will nott weigh heavily in the choice of route. The airports of Brussels and Schiphol and thus the statess of Belgium and the Netherlands are competitors to some extent. A similar reasoning appliess to alternative transfer locations in the case of sixth freedom traffic. The facilities for suchh activities at Schiphol airport and the KLM network contribute to a significant extent to thee Dutch air transport position and take away some traffic from neighbouring states. Ultimately,, however, no state will be motivated by competition to completely substitute one Bilaterall relationship for another13. Thesee factors generate a low transaction frequency and long-term agreements, which

147 7 inducess states to expend considerable resources during the contact and contract phases to securee a good position during the execution phase. Bilateralism makes this possible because thee contract phase is governed by diplomacy and negotiations are not subject to any time limits.. Furthermore, negotiations are complicated as barter trade entails difficult comparisons off the nature and value of the various rights being exchanged (OECD, 1997: 92). Practice showss that negotiations tend to be long. States will therefore incur considerable ex ante transactionn costs. Sectionn 2.4.1 also made clear that a long-term agreement enables low ex post transaction costs.. The long duration eliminates the need to negotiate and draft new agreements, while ongoingg relationships foster trust and so enhance self-enforcement. Environmental dynamism is onee important variable determining whether ex post transaction costs will in feet be low. Liberalisationn and changes in patterns of travel make the air transport environment very dynamic.. As a result, after a Bilateral has been operative for some time, the actual division of trafficc will frequentlyn o longer reflect the terms agreed. Although airline pool agreements may capturee some inequalities, any substantial divergence will often require an adjustment in the states'' positions. If this is not possible, the states have an incentive to deviate from the agreement.. It is therefore important that the interstate relationship (i.e. the transaction process andd the ultimate agreement) should be flexible. Thee description of the transaction process in Chapter in shows that the contact and the contractt phases are very flexible. The quid pro quo requirement, however, causes rigidity. Furthermore,, the two-party structure of Bilateralism cannot accommodate multilateral route networks.. For example, a state may acquire fifth freedom rights, but it cannot use them unless theyy are also specified in the Bilateral with the third country in question14. Most importantly, oncee a Bilateral is entered into, it is not easy to amend the agreed balance of rights and obligations.. Section 3.5.3 noted that the ease of amending the Bilateral agreement is influenced byy the mechanisms available to guide the process. Any mechanism should protect parties againstt manipulation. Short of a full re-negotiation, the states are essentially limited to the use off Memoranda and ex post fecto review clauses. The latter mechanism is an objective mechanismm and thus provides protection, but the use of the mechanism has decreased, while thee more widely used Memorandum carries the risk of manipulation. On the whole, it is not easyy to amend agreements, providing the transacting parties with an incentive to deviate. Compliancee monitoring is therefore important, contributing to ex post transaction costs. Att the level of the airlines and airports, the contact and contract phases do not generate highh costs. Although airlines actively prepare for and participate in negotiations, it is the CAA

133 Competition might, however, influence the ftequencyo f operations agreed within one Bilateral "" Another example is cabotage. Most states refuse to grant any stale the right of cabotage because uiey fear that evetyy other state will then automatically claim the same right 148 8 thatt leads the negotiations. The airport's role is limited. Moreover, the element of regulation thatt characterises state-industry relationships facilitates adjustment to any new Bilateral agreement.. The costs are limited to an amendment of the permit. KLM is exempted from even thiss requirement (because of hs open permit), as is the airport. Despite the ease of adjusting relationss with the state, industry players, like the state, are severely limited by the rigidity of Bilaterall agreements and are prevented from making the changes needed in a dynamic industry. Twoo inhibiting factors are the Operations Plan and slot allocation at Schiphol. They prevent nott only the airport but also carriers operating at Schiphol - home carriers especially - from adjustingg their operations whenever there is a change in the environment13. The transaction costss from executing the agreement are commensurately high. Inn conclusion, a low transaction frequency and an absence of procedures and negotiation deadliness contribute to high ex ante transaction costs. The long-term interstate relationships reducee the need for new transactions and create opportunities to build trust, so that ex post transactionn costs tend to be relatively low. However, the dynamic nature of the industry and thee rigidity of agreements make it less likely that agreements are self-enforcing. Frequently, actuall conditions will eventually start to diverge from the terms of agreement made, but amendingg agreements to bring them back into line with reality is difficult. The consequent frictionfriction increases the need for monitoring and so raises ex post transaction costs. The industry alsoo incurs significant costs during the execution phase. Both the state and industry players thuss face high transaction costs on account of the frequency variable.

5.6.22 - Uncertainty Thee determinants of uncertainty were identified in Section 2.4.2 as the complexity of the transaction,, the dynamism of the environment, as well as the information gathering and informationn processing capacities of the parties. Bounded rationality will also be treated in this sectionn given its close link with the concept of information processing capacity (see Section 2.4.4). . Thee Bilateral transaction is complex for a number of reasons. Contracting states have multiplee goals that are often vague, the wide differences between states increase the likelihood thatt statements made in negotiations are vague and general, and there is an absence of rules structuringg the transaction process. Moreover, the feature of barter trade frequently makes the elementss of an agreement hard to measure. This not only complicates negotiations but impedes monitoringg and creates considerable uncertainty during the execution phase. Equally complex iss the process of predicting the future development of air transport in what is a dynamic

Thee existence of a 'slot pool' as introduced by Community legislation eiiables some adjustment by new entrants.. However, the party deciding the issuance of new slots is ÜK slot coK>niinalor and not the industry. Furthermore,, an airline may be required to retain skrts in order to protect hs futorc interest 149 9 environment.. While income growth has traditionally been a central factor in forecasting the demandd for air transport services, other interdependent factors such as the rapid transformation off the world economy, general transport trends and developments in the air transport industry itselff have also started to influence that demand (Commission, 1999: 5, 7-10)16. Too cope with these difficulties the state is engaged in a continuous process of information gatheringg and processing. The process enables the state to formulate its foreign policy, of whichh air transport is a part, translate its own goals into strategies that can be used in a negotiation,, and form an opinion on the position of the foreign state. States are never able to meett all their informational needs. This is because interstate relations tend to be rather loose andd the text of Bilateral agreements vague, while there may also be secret Memoranda with thirdd states or secret airline agreements. The relational and diplomatic nature of the transaction processs and the nature of interstate relations prevent available information from being fully exploitedd (Havel, 1997: 48). These findings may seem to conflict with the long-term nature of Bilaterall relationships, which tend to generate ample information and high levels of trust. However,, only a few states maintain close relations. Domestically, information processing entailss co-ordination between various branches of government in order to prepare for negotiations.. In the Bilateral structure, it is important to co-ordinate between the Ministries of Transport,, Foreign Affairs and VROM. The small number of parties involved in the negotiation processs and clarity on the role of the Ministry of Transport facilitates co-ordination. Sections 2.4.22 and 2.4.4 observed that the capacity to process information partly depends on the extent too which rationality is bounded. At the interstate level, bounded rationality has a strong influence.. The states differ in their backgrounds, rules and traditions, and the meaning of terms usedd in agreements differs across domestic systems of legislation. The states have only partly succeededd in reducing the influence of bounded rationality through standardisation. Examples includee the use of Standards and Recommended Practices17 and the ECAC Standard Clauses. Similarly,, the IATA standard conditions were introduced to create uniformity in airline operations.. Bilaterals are also standardised and often require that the official language should bee English. Thee complexity of the transaction and dynamism of the environment influence the state- industryy relationship in a number of ways. Multiple state goals and the absence of a hierarchy off goals make the transaction complex. The state is unable to prescribe consistently the behaviourr required of the industry. One cause is the Dutch 'poldermodel', which encourages compromisess at the expense of clear instructions. The airlines face many technological innovationss that affect their operating costs, the changing environment makes alliances

"Thee existenoe of these factors highlights the importance of information and partly explains the airlines' widespreadd use of data-interchange and computerised reservation systems. 177 Supra, p. 70. 150 0 unstable,, principles vary and are almost never applied in their pure form, and there are no uniformm rules and conditions (apart from the IATA conditions noted above). There are, for example,, different rules governing the foreign ownership of airlines so that investors are not certainn as to what is allowed. The airports have to make long-term investments in a dynamic environmentt as well as differentiate their services to meet the needs of various types of airlines. Itt may seem that long-term relationships, a limited number of parties, dose co-operation and clarityy on roles and responsibilities should limit the effect of bounded rationality in the state- industryy relationships, implying strong information gathering and processing capacities. The state-airportt relationship affords good monitoring opportunities, but the state has found it very difficultt to monitor the behaviour of airlines. In the absence of a hierarchy of requirements, industryy players incur costs as they have to interpret the various goals and validate their interpretations.. The airport especially is in a poor position to acquire information as there are noo mechanisms to elicit information from the state or airline. Internationally,, the requirement of an explicit permission to use foreign airspace provides thee airlines with a relatively certain operating environment. However, rights and obligations are nott always explicitly laid down, and an airline starting up a new service incurs costs as it searchess for information on the local environment and relevant rules. Information about rule enforcementt in the grantor state is especially tricky as it does not become available until the executionn phase. Although the airport is not subject to foreign rules, its long-term, capital- intensivee investments create strong information needs. On the whole, the state and industry incurr high transaction costs as they try to deal with uncertainty. Inn brief, Bilateralism relies heavily on information gathering and processing. This is because airr transport relations are a foreign policy element, because air transport services involve activitiess outside the state, and because the environment is very dynamic. In addition, the states aree required to process multiple goals as well as the elements of what is essentially a barter exchange.. Only few interstate relationships are truly close, which means that trust is generally tooo weak to eliminate the need for information, detailed agreements and performance monitoring.. Uncertainty therefore generates high transaction costs at the interstate level. Industryy players, too, operate in a very complex and dynamic and hence uncertain environment.. The airlines lack information on local conditions and gathering this information is costlyy because of the absence of uniformity in legislations. Despite close state-industry relations,, both airlines and airports incur costs as they try to interpret the requirements imposedd by the state. The state Hself incurs costs as it needs to stipulate these requirements andd monitor industry compliance.

5.6.33 - Asset specificity Thee determinants of asset specificity were identified in Section 2.4.4 as the scope of the 151 1 relationship,, the susceptibility of decision-makers to lobbying, requirements of a technical or regulatoryy nature, and the existence of institutional guarantees against the loss of investments. Mostt investments in the air transport industry do not seem to satisfy the strict definition of assett specificity, because it is often not possible to relate investments (e.g. in runways) to one speciacc transaction. Nevertheless, these investments are specific to air transport in that they cann only be used for other purposes by incurring extra costs.

Ass there are no alternatives to a given relationship between states (see Section 5.6.1), the scopee of the agreement is important. Even though the interstate relationships go for beyond the elementt of air transport, the sectoral nature of Bilateral negotiations, barter exchange and the needd for an approval prior to transport may produce investments that are specific to a transaction.. An investment in the form of a non-aviation quid pro quo might be made in responsee to a request from a state that is important politically or otherwise. An example is the airr force base in Iceland, which resulted from the United States-Iceland Bilateral (see Section 3.3.1.3).. Under Bilateralism lobbying at the state level is minimal and performed mainly by the Ministryy of Foreign Affairs. An important factor limiting the need for transaction-specific investmentss by the state is the state's reliance on airlines and airports to execute the transaction.. This generally eliminates technical and regulatory specific investments at the interstatee level and so also eliminates the need to protect such investments. Specificc investments play a larger role at the industry level. The Netherlands are a small countryy with one flag carrier occupying a central position in the industry. The single designationn policy and industry shareholdings reinforce KLM*s dominant position. Similarly, onlyy one Dutch airport has the status of 'mainport' and the size of the market is too small to accommodatee any competitors. These factors increase the scope of the agreement and the risk off hold-up. The susceptibility to lobbying may differ among states. Lobbying is carried out mainlyy by the airlines in the grantor state during the contact and contract phases to increase the chancee of being designated given a successful negotiation outcome. Close relations with the statee reduce the need for lobbying on the domestic front. Technical requirements, however, frequentlyfrequently entail transaction-specific investments. Prior to a new operation, an airline has to makee agreements with local parties, acquire slots, arrange aircraft capacity and rearrange flight schedules.. The airport needs to invest large sums of money in terminal and runway capacity withoutt being able to dispose of these assets. Regulatory requirements are another source of assett specificity. An important reason is that the state uses regulation to pursue its transport goal.. The consequent investments are sizeable. However, the need to protect these investments iss generally limited due to the existence of various institutional guarantees. To begin with, the state-industryy relationships are long-term and sometimes involve ownership relations. The state andd industry are also mutually dependent: the state has granted special rights to the industry

152 2 andd the industry depends on the state for market access. Similarly, the state has invested in groundd infrastructure, and the airport has invested in airport facilities. The state is exposed to retaliationn in the interstate relationship, and the airline has to invest in the transport network. Bothh state and industry are exposed to the risk that the agreement will be infringed and investmentss jeopardised. These factors greatly reduce the need to create external guarantees (Williamson,, 1999b: 138-141)18. Nevertheless, when significant investments are at stake, industryy players might search for additional protection. In such a case they may turn to the statee in particular because the state is closely involved. Protection might be in the form of financiall aid, such as subsidies and loans at below market prices, or a best effort obligation on thee part of the state to amend regulations. Chapter in mentioned the use of covenants to specifyy relationships in greater detail. By improving monitoring capabilities a covenant can offerr better protection of specific investments. In the Netherlands, the PASO covenant (Sectionn 3.3.1.2) binds Schiphol, KLM and various government players and improves the protectionn of investments without generating high transaction costs19. In addition, the covenant offerss the state an additional instrument to stimulate co-operation by the industry. The industry benefitss from greater clarity on the nature of any requirements and the state's intentions. As a result,, transaction costs at the state-industry level are low. Inn conclusion, the states make transaction-specific investments essentially to maintain relationships,, but the size of these investments is negligible. The transaction cost effects of assett specificity at the interstate level are therefore ininimal. The industry players are confrontedd with state-imposed requirements that target the state's policy goals and need to makee more specific investments than the state. However, close relations and mutual exposure too hold-up limit the need to protect any investments made. The transaction costs arising from assett specificity are therefore low in the state-industry relationship.

5.6.44 - Opportunism Thee determinants of opportunism were identified in Section 2.4.4 as the perceived fairness of thee transaction, net gains from opportunistic behaviour, the mechanisms of control and harmonisationn of interests. This section will discuss opportunism in the various phases of the Bilaterall transaction process.

A.. - Contact phase Thee Bilateral principles of reciprocity and a fair and equal opportunity seem to enable an outcomee that is considered fair by both contracting states. Yet, the Netherlands do not

"" The state's exposure to hold-up is greatest in the relationship wnh tbc aiiport. This is one reason for a greaterr reliance on legal enforcement to secure the airport's compliance (see Section 3.5.4).

153 3 considerr a strict interpretation of these principles fair. The requirement of an explicit permissi- onn prior to any transport also reduces the element of volition in any agreement. The sectoral naturee of Bilateralism enables states to identify possible gains from opportunistic behaviour relativelyy easy. However, the states cannot realise any gains, as they are merely surveying the possibilitiess of an exchange. Thus, thee contact phase does not require significant control at the statee level and the degree of interest harmonisation is not very important either. Duringg the contact phase, the potential gains from opportunistic behaviour by the airline are limitedd because, as noted above, the states are merely trying to determine whether there is a basiss for an exchange. In addition, it is easy to monitor the airline because it actively participatess in preparing the negotiations and because any information on transport opportunitiess or industry trends provided by the airline can be checked against alternative sources.. The airline may enter into secret airline agreements but secrecy is essentially irrelevant inn this phase as interests are largely harmonised. Harmonisation derives from the single designationn policy, the preference for KLM, and long-standing relationships20. The airlines dependd on the state's success in negotiations, while the negotiators take airline interests into accountt (Button, 1996: 284). Airlines will therefore often share private information to increase thee chance of a successful negotiation outcome. Button et al. (1998: 164) refer to the politicianss as 'the negotiating arm of the airlines', pointing out the overlap between the goals off the state and airlines in this phase. Section 5.2.2 further noted the close link between air transportt negotiation and the formation of airline alliance. The airport does not play a role in thee contact phase other than through the provision of information. Its ability to provide informationn selectively is limited (but not ruled out entirely) by the existence of various sources off information on airport capacity and use.

B.. - Contract phase Whenn the transaction is concluded, the states should feel that they have reached a fair outcome.. As suggested by the previous section, whether an agreement is considered fair dependss on the trading partner's attitude in formulating Bilateral conditions. A strict interpretationn of the fair and equal opportunity requirement might tempt a state with only a smalll traffic potential to act opportunistically and so secure a larger portion of the traffic to be transportedd and agreed in the Bilateral. Such a state may, for instance, add the amount of sixth freedomfreedom traffic to its originating traffic to obtain the contractual right to a higher volume of traffic.. Further, the difficulty of amending an agreement increases a state's incentive to be vaguee about its own responsibilities and to obtain the authority to change a situation during the

Sectionn 2.4.3 mentioned that the specification of rightsan d obligations in agreements has the effect of raising transactionn costs. In this situation the higher costs are more than compensated by better guarantees.

154 4 executionn phase21. Thee contract phase gives rise to gains from opportunistic behaviour. Again, the sectoral naturee of Bilateral negotiations is conducive to identifying such gains, while the limited number off people involved in negotiations facilitates domestic co-ordination and increases the chance thatt those gains materialise. Furthermore, the vagueness inherent in the diplomatic process governingg negotiations leaves ample room for manipulating information in an advantageous way.. The permanent nature of interstate relations may seem to constrain opportunism, since anyy current behaviour will influence the execution of the transaction (e.g. the foreign state mightt discriminate against the flag carrier) and may jeopardise future transactions. However, thiss applies only to those situations where a foreign state is important to realising the goals of thee state (i.e. where the interstate relationship is valuable) and where there is a high risk of retaliation.. Only here are the net gains from opportunism correspondingly low. In general, the nett gains from deviation are not low enough to protect against opportunism. Notwithstanding long-termm agreements, the need for prior permission to operate and equality between states, thee bond between states is weak and hence the extent of mutual trust is low. Statee control over the transaction tends to be limited because of physical distance and the predominancee of informal over formal rules in the transaction process. Moreover, the Bilateral featuree of secrecy implies that states have no knowledge of the contents of other Bilaterals and cannott determine whether a condition is fair. Even though the absence of negotiation deadlines enabless states to spend many years negotiating until they fully understand all the issues, this aspectt does not compensate for the effects of secrecy and physical distance. Finally,, interest harmonisation is enhanced by the permanence of state relationships. States mayy also share some objectives, but the differences between states imply a wide range of goals. Thee fairness of negotiation outcomes as perceived by the airline depends on the attitude of thee foreign state and on the competitive strength of the airline. Close and long-term state- airlinee relations limit the risk of adverse selection during the domestic selection process22. Althoughh the secrecy of commercial agreements between designated airlines limits the effectivenesss of any control mechanisms, the danger of harming relations and more or less overlappingg interests reduce the risk of opportunism in this phase. Thee airport's behaviour during the contract phase resembles its behaviour in the contact phase. .

200 While these factors are strangest in the relationship between the stale and KIJvl, the lattcr's sharehoidiiig ia twoo of the three other main Dutch carriers extends thee argumetó beyond KLM (see Section 3.3.2). 211 Supra, p. 77. 222 Section 3.3.2 showed that the importance of selection is limited whenever KlJtf expresses an uterest in operatingg a service. Should there be any risk of adverse selection, it can he reduced hy haying an iw4frpen

2323 Section 3.3 3 noted that the Netherlands were wilting to mate dcwncstic carn^ gw i?> slots followiiig claimss from US Airways because of thevahie of Dutch-US relations. 156 6 reducedd further by differences across domestic regulatory systems and by the international naturee of airline activities. The Bilateral compliance system does not help to control state behaviourr since it relies mainly on informal compliance mechanisms. These mechanisms are complicated,, relying on retaliation, the need to maintain equality, and so on. The most commonlyy used mechanism of consultation, for example, leaves considerable uncertainty, is time-consumingg and centres around the state rather than an independent party. Arranging compliancee tinder Bilateralism is a costly affair24. Thee absence of adequate control mechanisms creates an additional role for interest harmonisation.. The permanent nature of interstate relationships and any overlap between the states'' objectives, which are important factors in the contract phase, continue to be important inn the execution phase. Thee industry's perception of the fairness of a Bilateral also depends on its content. An airlinee may be highly competitive, yet impeded in its activities by strict Bilateral conditions. The airlinee may then be tempted to act opportunistically. The vagueness of the Bilateral generates opportunisticc gains and reinforces the temptation to deviate. The Bilateral control mechanisms falll short here. The state can check the airline's use of equipment and the time of domestic operationn via the slot system at Schiphol airport and information provided by the airport, but itss ability to adequately supervise the airline's behaviour is limited by the international nature of thee airline's activities and by secret airline agreements. The instrument of output control (i.e checkingg tax and foreign exchange income) provides some protection but cannot prevent the airlinee from using private information to pursue its own goals rather than those of the state25. Thee mechanisms used by the state to tie the airline's reward to performance provide no more thann weak incentives. Legal enforcement is scarcely used. At the same time, the airline risks severelyy damaging its relations with the state if it deviates and - given its dependence on the statee for market entry - this may form a high enough cost to prevent any deviant behaviour. Thee state-airport relationship is more conducive to state control. The state has many instrumentss to monitor the airport's behaviour and resorts to legal instruments and severe sanctionss to enforce compliance. The discussion of the various instruments in Section 3.3.3 illustratedd that the state-airport relationship suffers from a lack of performance incentives. In addition,, elaborate regulations limit the flexibility of the airport's operations and tend to harm itss continuity objective. This increases the potential gains from opportunism, while the absence off an equivalent airport alternative reduces the costs of deviating. In practice, it is difficult to guaranteee compliance and to eliminate moral hazard completely. To illustrate, even though the

244 Inefficiencies can become so burdensome (e.g. when there is a need for stability or when substantial finat>ciai interestss are at state) that stales are willing to give up some sovereignty and turn to formal compliance mechanisms.. This is what lias happened with soft rights. Inn some cases, the state's representation on the supervisory board may help in controlling the airline. The samee applies to the aiipoit 157 7 airportt is obliged to accept all traffic, it is able selectively to assign gates and allocate ground handlingg facilities to those parties that are important to the airport's revenue stream (e.g. passengerr spending in the air terminal). Bothh the state-airline and state-airport relationships show closely aligned interests. The state'ss financial goal overlaps with the continuity objective of the industry (see Sections 3.3.2 andd 3.3.3). The closeness of their ties, overlapping views on the 'mainport' strategy and the state'ss position as an important stakeholder provide the industry with incentives to act in line withh the other subgoals. As an example, Schiphol's airport charges policy imposes lower chargess on transfer traffic than on originating and destination traffic. Such a policy benefits the airport,, KLM's sixth freedom traffic as well as the Dutch transport network. The interests of thee state and airline are harmonised further by the state's part ownership of KLM, by KLM's contributionn to the transport network and by the airline's dependence on the state for market entry.. Schiphol airport also depends on the state for market entry. Moreover, the airport's futuree development depends on the state's position and decisions taken in parliament. In addition,, Schiphol is fully owned by the state. Finally, there is substantial cross ownership contributingg to interest harmonisation. Too summarise, the conditions attached to the exchange are often perceived as unfair by the Netherlands.. As the mechanisms for control are limited, any constraints on opportunistic behaviourr derive mainly from the costs associated with deviation and the extent of interest harmonisation.. The difficulty of amending agreements encourages opportunism whenever agreementss grow out of line with reality. Interest harmonisation between distant states is generallyy limited and the resolution of disputes generates considerable costs. Opportunism thus createss high transaction costs at the state level. The state's system of controlling the industry lackss adequate performance incentives. Nonetheless, its relations with airlines and airports are generally,, albeit not entirely, protected against opportunism by limited net gains (airline), variouss control mechanisms (airport) and strong interest harmonisation. The transaction costs arisingg from the state-industry relationships are correspondingly low.

Thee analysis now moves to the Community structure to see whether this structure comes closerr to achieving the state's air transport goal and minimising transaction costs than the Bilaterall structure.

5.77 - Features of the Community structure Thee essential features of the Community structure are summarised below and can be compared directlyy with the essential features of the Bilateral structure in Section 5.4. 11 Absence of traditional state sovereignty and equality, 2.. Absence of reciprocity requirement, 158 8 3.. Delegation of property rights to industry, 4.. Multiple state goals, 5.. Formalised transaction process, 6.. Absence of secrecy, 7.. Regulation, 8.. Multiparty agreements, 9.. Flexibility and 10.. Supranational compliance mechanism.

Absencee of traditional state sovereignty and equality Thee Member States have tost some of their sovereign rightsa s a result of legal constraints and variouss interdependencies. Decision-making in air transport takes place via the co-decision procedure,, which uses qualified majority voting. The states are no longer equal as votes are allocatedd on the basis of economic importance.

Absencee of reciprocity requirement Itt is no longer necessary to base agreements on reciprocity. Equality is interpreted as an equal startingg position.

Delegationn of property rights to industry Inn the Community structure air transport rights are largely delegated to the industry players, whilee the Community institutions have restricted the exercise of property rights remaining at thee state level. There is no categorisation of rights to use the airspace. The property rights that remainn with states enable them to change any legislation and so indirectly engage in transactionss regarding the use of Community airspace. The Member States still hold the propertyy rights to third country traffic.

Multiplee state goals Domesticc goals have been supplemented by Community goals. There is a greater risk of conflictt between the various goals.

Formality y Thee process of creating and amending Community legislation is governed by formal rules. Timee limits as well as procedures structure the transaction process.

Absencee of secrecy Communityy legislation is published, starting in the contract phase. Their exact content is 159 9 publiclyy known.

Regulation n Thee exchange of air transport rights is captured in regulation. The EC Treaty, secondary legislationn and the Community's policy documents formulate ultimate goals, and aim to providee a just return, in exchange for which the Member States have agreed to give up some of theirr powers.

Multipartyy agreements Thee transaction involves 15 Member States, the Community institutions and the EEA states.

Flexibility y Thee Community structure is a framework structure, it comprises the EC Treaty, secondary legislationn and other elements of the 'acquis communautaire' as well as domestic legislation.

Supranationall compliance mechanism Thee Community structure has facilitated compliance via a substantial harmonisation of rules. Theree are supranational courts that may adjudicate states. The Commission has a supervisory role.. The option of a preliminary ruling helps to standardise enforcement. There are greater opportunitiess for seIf-«nforcement while, in case of disputes, formal enforcement systems have begunn to replace consultation at the interstate level.

Thee following sections analyse the performance of the Community structure in terms of its effectivenesss and transaction cost efficiency.

5.88 - Effectiveness of the Community structure Thee Bilateral and Community structures share certain features of the transaction-specific and semi-specificc structures but operate within radically different institutional environments. Some importantt features of the Community structure are the considerable delegation of air transport rightss to industry players, and the absence of traditional state sovereignty. These features constrainn the state in its ability to differentiate its relations with other states and to pursue domesticc goals. Moreover, the multi-party nature of agreements implies that not individual statess but Member States and EC institutions collectively determine the opinions of the Council andd the outcome of negotiations (Corbey, 1993: 76-77, 154). The Community has introduced neww goals which have to be met by the state, yet may be in conflict with domestic goals. At the Communityy level, this has increased co-ordination requirements, which have become more difficultt to meet as a resulto f multi-party dealings and the absence of a veto. The Community

160 0 structuree does not preclude pursuit of the selective network. For instance, respect for, knowledgee of and close relationships among Member States constitute a substitute for the psychologicall goal of prestige. The right of market access and absence of reciprocity make it easierr to realise the financial goal26 and the broad scope of Community co-operation is consistentt with the political goal of maintaining good relations. Realising the environmental goall has proved more difficult27. To be sure, the close relationships have led to a convergence off the Member States' views on environmental protection. The EC Treaty calls for an integrationn of environmental policy with other policy fields (Article 6 EC) while Article 174 ECC extensively describes the objectives of the Community's environmental policy, expressly mentioningg the Community's right to co-operate and conclude agreements with third states and internationall organisations. Moreover, the Subsidiarity principle has tended to centralise decision-makingg as a result of externalities and prisoners' dilemmas. Externalities exist in the formm of pollution, which has spill-over effects on other states. Section 3.3.1.3 already pointed outt that no state would have an incentive to internalise external effects beyond those with immediatee national implications. Moreover, states are not equally affected by pollution externalities.. Both conditions support a centralised approach. Prisoner's dilemmas may arise fromm flexible environmental regulations, such as those governing the use of Chapter n aircraft andd noise emission levels, which may be exploited to attract foreign firms. States may also be laxx in implementing Directives or monitoring compliance. Where there are international rules too alleviate transport-related pollution externalities, a different problem arises. If a state is too smalll to influence pollution levels, it is rational for the state to free-ride on the pollution- abatementt efforts of larger states. Even if other states fail to implement any pollution measures, itt is again optimal for a small state not to implement such measures. Yet every state would ultimatelyy benefit if all the states actively tackled pollution. Reflecting these concerns, Communityy legislation to some extent captures the environmental goal. Regulation 92/14, for example,, prohibits the operation of Chapter II aircraft within the Community as of 1 April 2002.. On the whole, however, the volume of Community measures targeting the environment inn air transport is limited. Member States want different levels of environmental protection and superiorr local information may favour decision-making at the local level. Decision-making has provedd difficult. Existing legislation or international agreements may constitute a problem. Directivee 92/8121, for instance, exempts the taxation of commercial aviation fuel. Finally, the factt that environmental problems often have a strong local effect means that environmental

266 Chapter IV observed that, prior to the introduction of the Qmunanhystnictu^ wass fearedb y other European carriers, which accounted for strict inteipretau\»is of rccipiocny in Bilatends withh European countries. However, KLM's limited honie mailKtt provides a strong incentive to find an Europeann alliance partner. 277 Tbc following is partly based on Van den Bergh (1994: § 3.1) and Button (forthcoming) 288 Directive 92/81, OJ 1992 L 316. 161 1 lobbyistss are most effective at this level than at the Community level29. The Dutch selective networkk goal goes beyond the level of environmental protection required by the EC. The Community'ss framework structure enables a state to do so. In the case of the Netherlands a locall approach may be more fruitful, for instance, because of superior local information. At the samee time, the Netherlands are aware that they might damage their competitive position by takingg unilateral action30. Section 4.5.2 noted that this was why the Netherlands tried to get the Commissionn interested in regulating CCb emissions. Further initiatives include actions at the Communityy and ICAO levels to introduce VAT on airline tickets and a surcharge on kerosine, whilee the Dutch aim to remove fiscal advantages to stimulate the use of other modes of transportt \ These initiatives are unlikely to be successful given the Dutch domestic co- ordinationn processes (see Section 4.7.2). At the interstate level most traditional instruments thatt target the environment are no longer available in the Community structure: there are no Bilateralss and hence no clauses on the environment such as those prescribing the type of equipment. . InIn the Netherlands, the main effect of the reduction in state powers has been an increase in thee domestic regulation of the industry. New requirements have been introduced geared specificallyy to the way in which air transport and airport services are to be provided. There are, forr instance, restrictions on the permitted time of operation and aircraft type. The state has also introducedd slot co-ordination as a way of meeting environmental considerations. Many instru- mentss targeting the selective network were introduced in the second half of the 1990s, concurrentt with the introduction of the Community governance structure32. By unduly restrictingg market access rights, this strategy carries the risk that the Netherlands will breach theirr obligations under the EC Treaty and harm the competitive position of the industry. Furthermore,, the use of domestic regulation has led to a divergence of state and industry interests.. A further factor influencing the performance of the governance structure is the growingg use of co-operation agreements between industry players. Within the Community, harmonisationn of rules, the 'Community carrier' concept, a relatively small territory and the prospectt of consolidation and general economic integration, all stimulate co-operation and facilitatee intra-European agreement. This development hampers the state's control over the industry.. The existence of firms with multiple nationality restricts the state's ability to prescribe behaviourr or to control output and may ditmmsh state revenues. Firms may no longer fall withinn a certain jurisdiction or may choose to transfer activities to other countries. A multiple

^Tbee opposite is true for the industry. To be sure, these proNems arc not specific to the Community stni^ Theyy may be encountered in any international approach to environmental pollutioa Sectionn 4.5.5 already noted that the compettóveposracmoftheiiuiustiy also plays are level,, e.g. in relations with the U.S.. 3IQuestiOTsbyDutehPariiamemmie^^^ 11 June 1999 «Too be sure, these regulations apply withwa regaid to the destination of ^ beenn invoked by the EC and are therefore discussed in the context of tlie Commiuihy stiucture 162 2 nationalityy also poses problems in connection with the Bilateral nationality requirement. The greaterr freedom implied by liberalisation, a greater use of international co-operation agreementss among industry players, and the greater delegation of air transport rights have madee it more difficult to motivate the industry to meet state-imposed requirements and to monitorr its compliance. These developments have made the absence off performance incentives moree apparent.

Thee next section will analyse the transaction cost efficiency of the Community structure.

5.99 - Transaction cost efficiency of the Community structure

5.9.11 - Transaction frequency Thee determinants of the transaction frequency are the perishability of the object exchanged, the existencee of alternative sources of supply, the dynamism of the environment and the flexibility off the transaction process and agreement. An analysis of these determinants within the Communityy context leads to the following conclusions. Thee gradual change of the governance structure implied by the learning by doing approach ledd to a relatively high transaction frequency during the period 1987-1992. The current rules aree mostly permanent, as is the co-operation among Member States. The remarks made in Sectionn 5.6.1 on perishability also apply in the Community structure, which means that this determinantt implies a low transaction frequency. The form and intensity of EC co-operation rulee out alternatives outside the EC, since no third country can offer the use of its airspace underr the same conditions as a Member State33. However, the consequent low transaction frequencyy does not lead to the usual upward effect on transaction costs because there are proceduress governing the transaction process, including time limits and decision-making with qualifiedd majority34. Liberalisation has made the environment more dynamic (although this trendd cannot be attributed to the Community structure alone) making the flexibility of the relationshipp a crucial factor. Flexibility is offered by the framework nature of the Community structure,, which enables states to respond to change within existing relationships. This lower bothh ex ante as well as ex post transaction costs. Thee framework structure of the EC has also put the airlines in a better position to adjust theirr operations to changed circumstances in a dynamic environment. Although an airline needs aa route permission (and sometimes a slot) to start a new Community operation, the procedures aree objective and harmonised and contain time limits. Domestic operations at Schiphol airport,

3JJ The EEA states are an exception, since their participation in the internal ak transport niaiket approximates thee position of Member States. Havel (1997:276) mentions some differences, such as the intergovernmental characterr of the EEA and the absence of tax harmonisation.

163 3 onn the other hand, are strictly regulated and severely constrain the industry's ability to adjust itss position. In addition to domestic requirements, Community rules on ground handling and thee competition provisions have restricted the airport's freedom to conduct its operation. Inn brief; the current rules and co-operation among Member States are mostly permanent, resultingg in a low transaction frequency. Any upward effects on ex ante transaction costs are limitedd by the formalisation of the contract phase. The environment has become more dynamic, butt the framework character of the Community makes it a flexible structure and so keeps down thee costs associated with executing the agreement. The Community structure has facilitated operationall adjustments for the airlines, but not the airports. For both airlines and airports domesticc regulations have become stricter. Overall, the transaction costs attributable to the frequencyy variable have remained high in the state-industry relationships.

5.9.22 - Uncertainty Thee determinants of uncertainty are the complexity of the transaction, the dynamism of the environment,, as well as the information gathering and information processing capacities of the parties. . Somee elements that make the Bilateral structure complex also prevail in the Community structure.. These include the difficulty of predicting demand and the existence of multiple state goals.. The Community has in fact introduced additional goals (see Section 4.5.5). Furthermore,, the exact division of powers between the Community and domestic levels is obscure,, as is the extent to which states may use domestic instruments. The transaction process iss also complex because many parties are active in various phases and it is unclear exactly where,, when, and by whom a decision is taken (Kirchner, 1992: 6, Hirsch Ballin, 1992: 19-21). Thee broad range of subjects dealt with in COREPER or in Council meetings requires delegates too make package deals and to find compromises on often more than just air transport issues35. Att the same time, the Community has simplified the environment. The transaction process has beenn formalised to a large extent and there is a greater use of legal language. The use of the semi-specificc structure of regulation implies that transacting parties have accurate and up-to- datee information when renegotiating agreements. Most importantly, the Community structure, withh one legislative package governing a multitude of mini-exchanges, has shifted the emphasis too the execution phase, which has become less complex at the state level due to the conside- rablee delegation of air transport rights to industry players. This has reduced the state's need to monitorr the behaviour of other states and has, on the whole, simplified the interstate relationship. .

344 The lack of co-ordination in the Dutch ex ante phases generates some additional costs. 355 Note that this may facilitate agreement See Broncker's (1999:414) discussion of the World Trade Organization. . 164 4 Thee Community structure is well-suited to deal with environmental dynamism. Some factors aree its framework nature and an absence of the predetermined price, access and quantity variabless that are part of Bilateralism. These features reduce the informational burden created byy the need to adjust to new developments. Thee Community structure has improved information gathering capacities by fostering close andd long-term interstate relations. Close relationships, in turn, have increased the level of trust, therebyy reducing the need to gather information. The transaction process and Community legislationn are well-publicised. The Commission uses green papers to provide information and initiatee debates. There are many sources of information, such as the media, weekly Commission presss conferences, Parliamentary press releases, specialised publications (e.g. Agence Europe), variouss Internet pages and databases, and a large group of lobbyists. The use of A and B points duringg the contract phase provides information on various positions and sheds light on possible coalitions,, which makes the system transparent with the exception of Council meetings, COREPERR meetings (De Zwaan, 1993: 138) and voting outcomes. Although the layered structuree of the EC Treaty and secondary legislation may make it difficult to stay fully informedd about applicable rules, there are many opportunities to overcome this problem. For example,, some rules require states to inform the Commission of the way in which domestic legislationn has been changed to comply with the relevant provisions. Thee picture of the states' information processing capacities is less clear. On the one hand, closee and long-term relationships, the emphasis on legal wording and harmonisation of rules36 reducee the need to process information and limit the effects of bounded rationality. On the otherr hand, smaller domestic powers and increased dependencies necessitate additional informationn processing activities, as states try to attain their own policy goals. Domestically, civill servants have to co-ordinate between the two potentially conflicting views of ministers andd their officials on the one hand and the various levels of government and the private sector likelyy to be affected by new legislation, on the other. This involves far more people than does Bilateralism,, as proposed Community legislation entails meetings with all the appropriate ministriess and various domestic and Community committees. The absence of clear responsibilitiess at the domestic level creates the risk of other policy goals being introduced. Statess must also ensure that domestic goals are correctly voiced and that representatives in Brusselss stay attuned to these goals. This may be difficult because frequent meetings and contactss between the permanent representatives create strong ties with the Community. These contactss can harmonise relations, and so generate information, but can also lead to an opaque decision-makingg process in which communication is effective only among knowledgeable initiatess (Westlake, 1995: 115-116). These features, the differences that remain in the political

366 These include rules on the drafting and layout of secondary rales.Resoluüo n of the European Council of 8 Junee 1993, OIC 166. 165 5 systemss of Member States and the fact that Community legislation is issued in all of the official languagess suggest that bounded rationality may still constitute a constraint. Thee Community structure has also affected the industry's ability to deal with a dynamic environment.. The airports have been confronted with stricter domestic regulations, while the Communityy structure has not liberalised their environment. Airlines have benefited from certain Communityy measures which facilitate airline co-operation and hence risk spreading. The absencee of designation enables airlines to easily adjust their operations. Moreover, the Commu- nityy structure has simplified their environment. Licensing criteria are objective and non- discriminatory.. The harmonisation of rules has improved the capacities to gather and process informationn on local rules. The Community structure also seems to have made the state-airline relationshipp less dependent on information. The licensing criteria have been harmonised and, unlikee the Bilateral structure, where a new Bilateral agreement requires an amendment of a permit,, the Community structure involves periodic revisions using standardised information. However,, the reduction of state powers and restrictions on licensing criteria have increased the uncertaintyy faced by states. Greater freedom at the Community level has reduced the informationn gathering and processing capacities of the state in its relations with the industry. Thee Dutch state has responded by imposing new regulations on the industry. The state incurs higherr ex ante transaction costs as it needs to stipulate industry behaviour as well as higher ex postt costs of monitoring compliance. The industry, in turn, has to meet an increasing number off requirements and may feel uncertain about what constitutes appropriate behaviour. Too sum up, although the contact and contract phases have introduced new complexities and havee increased the importance of information processing, overall the transaction has become lesss complex at the state level. Many rules have been harmonised and legal wording has gained importance.. The fact that only one transaction covers a multitude of transport possibilities with manyy states puts the emphasis on the execution phase, which has become a less complex phase att the interstate level. In addition, the Community's framework structure makes it flexible and soo better able to deal with a dynamic environment. The opportunities for information gathering havee improved, while close and long-term relationships have increased the availability of informationn and reduced the need for a costly specification of the terms of the agreement. Thus,, even though information processing requirements have increased, uncertainty has been reducedd at the interstate level. Thee airlines generally face less uncertainty at the Community level due to a harmonisation of ruless and a greater ability to adjust operations. The airports, in contrast, have not benefited fromfrom a relaxation of rules. Both the airline and airport face stricter domestic regulation, which callss for more information gathering and processing. The state has a greater need to prescribe andd monitor industry behaviour. At the level of state-industry relations, the transaction cost effectss of uncertainty continue to be high.

166 6 5,9.33 - Asset specificity Thee determinants of asset specificity are the scope of the relationship, the susceptibility of decision-makerss to lobbying, requirements of a technical or regulatory nature and institutional guarantees.. Section 5.6.3 concluded that in the Bilateral structure asset specificity at the interstatee level is mainly determined by the need to achieve reciprocity. The Community structuree may have broadened the scope of the interstate relationship, yet the need for transaction-specificc investments has decreased with the greater delegation of property rights to industryy players and limitation of state powers. Moreover, the absence of sectoral negotiations andd elimination of the reciprocity requirement have lowered the need for non-aviation quid pro quos.. The structure shows a greater susceptibility to lobbying because more parties are involvedd in the negotiations and because the EC has acknowledged the lobbying function throughh ECOSOC (Van den Bergh, 1994: 23). Lobbying expenditures have risen as a result but,, overall, the transaction costs arising from asset specificity are even lower than in Bilateralism. . Thee previous section noted that at the Community level, the airlines face less regulation and greaterr freedom. There has been some harmonisation of working conditions and environmental legislationn but the already high Dutch standards have meant that compliance has not generated anyy substantial new investments37. The airline's reduced dependence on the state for market entryy seems to have decreased the scope of the state-airline relationship. In practice, however, thee state's loss of powers has made this relationship more important to the state in the pursuit off its goals. It has led to new regulations limiting the airline's behaviour, such as requirements onn aircraft equipment and an obligation to finance the insulation of houses in the neighbourhoodd of the airport. In addition, liberalisation has increased the use of hub-and-spoke networkss and investments in these networks are specific. These factors have increased the airline'ss exposure to the risks associated with asset specificity. The airport has to meet even moree requirements. The alteration of the Schiphol terminal layout following the Schengen Treatyy (see Section 4.4) is an example of an investment required at the Community level. Domesticc regulations aimed at the environmental aspect of the transport goal require the airportt to make various investments and to restrict its operations. For instance, the approval of continuedd growth at Schiphol requires significant investments in runway layout. These investment-increasingg factors, combined with an increasingly dynamic environment, enhance thee need for institutional guarantees. The Community structure offers some guarantees, such as thee absence of secrecy, the harmonisation of rules and a system of legal enforcement. The TEN programmee is a source of financial guarantees. At the domestic level, the Community structure

377 Generally speaking, harmonisation has a greater effect on transaction-specific investments than liberalisation.. On the whole, the Community has embraced liberalisation more than harmonisation. 167 7 offerss fewer guarantees. The domestic provision of financial guarantees has become very problematic,, among other things, because of a requirement to notify aid prior to its distribution andd closer scrutiny on the part of the Commission. Other preferential measures may conflict withh treaty provisions such as Article 86 EC. In addition, both state and industry have become lesss exposed to the possibility of hold-ups. For instance, the airline is free to start operations in otherr Member States. Similarly, the state aims to reduce its exposure in the state-airport relationshipp as can be seen from the various requirements imposed on Schiphol airport in the Optimisationn and IBV initiatives, which hold the sector responsible for a certain outcome. Somee policy documents (for example: Ministry of Transport, 1998c: 83) refer to the industry's ownn responsibility to make investments and to provide finance. State and industry players have respondedd to these developments by an increased use of covenants and closer co-operation at thee industry level, but they are to some extent restricted by the competition provisions of the ECC Treaty. There is also a greater reliance on external safeguards, such as performance monitoringg by the state, and Schiphol airport has made some attempts to diversify its activitiess Each of these factors has raised transaction costs. Finally,, lobbying at the Community level has increased. In the past, lobbying tended to occurr at the national level because the function of interest aggregation was performed largely byy member governments. Various state interdependencies and a reduction of domestic state powerss imply that the industry has to lobby Community institutions as well. The fact that relationshipss between the Community institutions and industry players are weaker than domesticc relationships has led to higher expenditures and a more substantial role for groups likee ACI Europe and the AEA. InIn conclusion, the Community structure has led to some transaction-specific investment in thee form of relationship-buüding. The broad range of issues and the opportunities for making compromisess have reduced the need for transaction-specific investments at the interstate level. Investmentt needs have grown at the level of the industry, which has become more dependent onn lobbying and is subject to a larger number of state-imposed requirements. This has led to an increasedd need for information gathering, a greater use of covenants and more monitoring. The nett effect is that asset specificity generates higher transaction costs at the state-industry level.

5.9.44 - Opportunism Sectionn 5.6.4 described how each of the determinants of opportunism, namely the perceived fairnesss of a transaction, the net gains from opportunistic behaviour, the mechanisms for controll and harmonisation of interests affects every transaction phase in the Bilateral structure. Thee same will be done below for the Community structure. First, however, a general remark is

»» Schiphol has devised the concept of a 'Schiphol City', which incorporates non^viatioii elements such as retailretail and property development into the aiiport's activities. 168 8 inn order. Chapter IV explained that each Member State had its own reasons for joining the Communityy and over time has developed its own position on the objectives of the EC Treaty, theirr correct interpretation in terms of domestic objectives and broader aspects of European integration.. As integration proceeds, every state will find itself confronted more and more with thee fact that the abstract benefits of integration may amount to tangible measures that harm domesticc goals. This is certainly the case in air transport, which has been identified with such factorss as prestige and good relations with other states. The development of the Community air transportt policy and integration generally will continue to reduce the powers of Member States.. Differences in objectives, any remaining domestic powers and information asymmetries aree likely to carry a high risk of opportunism.

A.. - Contact phase Nott only has the Community structure with its decision-making procedure of qualified majority acceleratedd the transaction process, it has also caused a shift in the point at which Member Statess are most effective in influencing decisions. This is now the period before the Commissi- onn submits its proposals to the Council. Small Member States, in particular, have to be active inn this phase because they carry little weight in final Council decisions. This means that co- ordinationn in order to identify the positions of other states and alternative coalition strategies is veryy important. The Commission's support is crucial because without it a proposal will not be submitted.. A coalition joined by representatives of the Ministry of Transport is more likely to contributee to the perception that an agreement is fair. Moreover, domestic co-ordination and supportt from domestic ministries other than the Ministry of Transport is crucial if the potential gainss from opportunism are to materialise. These gains are sometimes difficult to identify, as negotiationss involve many issues. Here, the Dutch procedures are lacking because they fail to sett priorities and formal instructions are only given at a very late stage, namely when negotiationss reach the political level. The Netherlands* ability to turn potential into actual gains iss therefore not fully exploited. Thee lack of ability to capture the potential gains from opportunism is reinforced by improvedd control mechanisms. There is an absence of secrecy, there is a European parliament, theree are EC Courts and an independent Commission. Compliance mechanisms have become moree sophisticated. The frequent interstate contacts and stationing of representatives in Brusselss also facilitate monitoring the actions of Member States. Section 5.9.2 argued that, domestically,, opportunities to monitor civil servants tend to be limited because of information asymmetries.. A Brussels1 representative, under the harmonising influence resulting from close relationships,, may commit himself to proposals that are not consistent with domestic goals. Domesticc civil servants active in negotiations may also place their own private goals above

169 9 officiall goals39 Schout (1999: 198) observes that officials from expert departments sometimes accompanyy the international negotiators, not only to support them with technical details but alsoo to control their behaviour. Via behaviour control the state can stimulate the agent's contributionn to realising the state's goals. Behaviour can be specified via detailed instructions andd checked via reporting requirements40. However, the use of behaviour control requires a systemm of selective reward and the state generally lacks such a system. It cannot easily provide financialfinancial incentives as this may be in conflict with the legitimacy of the state41. Alternative incentivess (e.g. a promotion or budget increase) are possible, but the state relies mostly on indirectt methods, such as a representative's sense of loyalty to his own country and institutionall guarantees42. Inn addition to greater control, the interstate level shows greater interest harmonisation. The ECC constitutes a total of rules and codes aimed at integrating the economies of Member States. Commonn norms, values and beliefs are continuously being shaped in the context of an institutionall framework, contributing to a high degree of interdependence. The Member States empathisee with each other and their interests overlap more than in traditional interstate relationshipss (for instance, Westlake, 1995: 376). Nonetheless, differences between Communityy and domestic goals and hence the possibility that a proposal might seriously harm domesticc air transport goals can stimulate opportunistic behaviour. The Dutch - as a small Memberr State with a relatively large amount of third country traffic - may wish to act opportunisticallyy in negotiations on the division between Member States and Community institutionss of the powers regarding air transport with third countries. The Commission has accusedd those Member States who re-negotiated Bilaterals with third countries of opportunisticc behaviour and argues that the Netherlands is trying to benefit from trade diversion43.. States may further act opportunistically if liberalisation threatens the viability of the domesticc air transport industry, and recent years have indeed seen a wider variety of financial supportt schemes. These factors frustrate the effective functioning of the market. They have led too a tightening of the EC rules on state aid and criteria for subsidies as well as an increasing

399 Supra, p. 38. 400 The use of output control is less appropriate because npgrtiation outcomes cannot be dctenniiied by tbe representative. . 411 Supra, p. 37. Note, however, that the legitimacy problem regarding the use of financial incentives essentially amountss to an information problem as activiti<» caimot be vahied acanatdy (Stigli^ 1989:26). Were this to bee solved, pay could be tied more closely to performance. 422 WRR (2000: 58) pleads for a greater use of and more elicit reliance on the instrument of institutional guaranteess because a focus on the public interest is one of the elements di^ngricfang 3 ^ii ^^^m fa^ 3 privatee sector employee. This focus is not freeing riska s a civüseivart may devatefi^^ claimingg that he has a better understanding of the public iitteiest tlian his superior !! n^xf!™ ren^"addres^ to dI M 1"^-However,, the Commission may also be Jgall procedure as a way of extending its mandate from ««Dtiatingonfy soft rights to neg Openn Skies agreement with thee United States. 170 0 numberr of Commission Decisions and court cases (Commission, 1999: 29-34)**. Bothh the airline and airport can participate in Commission working groups and engage in lobbyingg during the contact phase. There are potential gains from opportunistic behaviour, whichh may be captured by inducing the Commission to submit a proposal selectively benefiting industryy interests (for instance, aircraft manufacturers). The industry's behaviour is not co- ordinatedd with that of the Member State and the large number of groups active in this phase reducess the state's monitoring ability. Moreover, the interests of the state and industry have diverged.. The airline no longer depends on the state for designation, while the state will no longerr always act in the airline's interest because the package deals that characterise Communityy policy-making can divert attention to other policy fields. The feet that special rightsrights have been granted and that any opportunistic behaviour by the airline might affect its relationshipp with the state does not fully compensate for the loss of state instruments needed to uncoverr such behaviour and to impose sanctions. Thus, the airline has less incentive to act in a trustworthyy fashion. Similarly,, the interests of the airports have diverged from those of the state as a result of the state'ss tighter regulation and the general trend of liberalisation.

B.. - Contract phase Thee framework nature of Community legislation and a preference for liberalisation over harmonisatjonn enable the states to structure negotiation outcomes in a way that best meets theirr demands. In the case of the Netherlands, the abolition of the fair and equal opportunity requirementrequirement has made it easier to attain the financial goal, thus contributing to a feeling of fairness.. On the other hand, Community legislation fails to fully capture the environmental elementss of the Dutch transport goal. Thee conclusion of the transaction, i.e. the acceptance of a Commission proposal by the Memberr States, often occurs without voting. When voting occurs, decision-making with qualifiedd majority and the broad range of issues on the table encourage the formation of coalitions.. This form of decision-making prevents a state from benefiting too much at the expensee of others (Weingast, Marshall, 1998: 512-513). A majority will have to benefit from thee proposal, which limits the ability to realise any gains through opportunism. There are also betterr control mechanisms than under Bilateralism. For example, an injured party may go to courtt if a Community principle is breached, there is a strong reliance on legal language, and closee contacts between states make it possible to monitor behaviour. At the same time, the multi-partyy nature of negotiations and the package deals give rise to new ways of acting

Notee that the Netherlands have not often been the accused party. The Netherlands and Diilch indnstiy players have,, however, at times resorted to compliance procedures to obtain access to markets or attack discriminatory treatment. . 171 1 opportunistically.. A state may, for instance, vote in favour on one issue to obtain a concession onn another (Wallace et al., 1993: 13). France is said to use the veto as part of a strategy called 'takingg hostages', whereby agreement is blocked on one issue where the veto applies so as to obtainn concessions on another where the veto does not apply (Westlake, 1995: 102-103). Memberr States can also exploit the Subsidiarity principle. This principle enables states to manipulatee decision-making by claiming that an issue is better handled at the domestic than the Communityy level45. The international nature of air transport activities generally rules out an increasee in powers at the domestic level, but the principle can be used in reverse: a Member Statee wanting to regulate an issue without damaging its competitive position might choose to takee the matter to a European level. Section 5.8 gave an example in thee field of environmental protection. . Onn the whole, the interstate relationships are more likely to be self-enforcing. The Communityy has created close and long-term relationships that are very valuable to Member Statess and foster character trust, while the voting procedures, equal access to information and thee need to form coalitions generate system trust. Moreover, the costs generated by opportu- nisticc behaviour have risen because of strong interdependenties. Finally,, the factors that harmonise interests during the contact phase continue to play a role duringg the contract phase. Interests are harmonised further by the Community's voting proceduress and strategies. The limited number of votes allocated to the Netherlands makes it cruciall that the Dutch should join coalitions. In this way, the Community stimulates the interdependencee between states. Thee remarks on the behaviour of the airline and airport during the contact phase also apply too the contract phase.

C.. - Execution phase Thee description of the first two transaction phases has shown that various elements in the Communityy structure (e.g. extensive monitoring abilities, difficulties of acquiring potential gains)) reduce the risk of opportunism in those phases. The substantial delegation of air transportt rights to the industry has shifted the risk of opportunism to the execution phase. As ann example, a Member State may resist operations in hs own territory by carriers from other Memberr States on the grounds of infrastructural shortages, or by forming an airport system, whilee the resisting Member State's own airlines freely fly to and from other Member States thatt have invested in airport facilities (Havel, 1997: 101). This strategy has been tried by some

Thee Subsidiarity doctrine is not easy to apply. Endless aigumcnte can arise about which level of decision- makingg will obtain the best results. 172 2 Memberr States (ibid.: 101,394)40. Although the Community rules take precedence, monitoring theirr implementation requires separate action and legal action against opportunistic behaviour dependss on such matters as complaints being made and pursued in court. Yet, the risk of opportunismm remains limited as is explained below. Too begin with, there are more opportunities to achieve a fair outcome. The reciprocity requirementt has been eliminated and the Community's framework structure enables some accommodationn of domestic concerns. A Directive, for instance, leaves more room for domesticc adaptation than a Regulation, which is the main instrument used to create the air transportt governance structure. Even if Regulations are used, the Community's framework structuree allows a state to go beyond what the EC Treaty provides and it is often possible to implementt legislation in a way that promotes domestic goals without violating Community rules47. . Thee relatively large volume of Regulations limits the ability to realise opportunistic gains sincee Regulations require a far stricter implementation than Directives. More generally, the gainss from opportunism are limited by close interstate relationships, which have contributed to characterr trust and increased the costs of deviating and by the potential harm to the competitivee position of the industry players. For instance, a state that uses its powers to extend Communityy legislation at the domestic level will affect domestic firms disproportionately and in somee instances this serves as a restraint. Thee Community structure has strengthened the state's control over the foreign (Member) state.. There is an integrated and largely transparent compliance mechanism, while the greater knowledgee about other Member States has improved behaviour monitoring at the state level. Finally,, interest harmonisation has been promoted by setting common objectives. Even if the currentt differences between Community and domestic goals make clear that harmonisation is nott complete, on balance, the greater interdependencies have reduced the incentive to behave opportunistically. . Liberalisationn has increased the chance that the Dutch airlines will perceive negotiation outcomess as fair4*. There has been a contrasting development, however, in the form of increasedd domestic regulation. The Community structure has reduced the airline's dependence onn the state for market entry. The elimination of the nationality requirement at the domestic

466 Fiance has used the strategy of creating an airport system to disuibute traffic, fuimeUing the bulk of n^ Communityy services to Charles de Gaulle airport and aw3>-from Oriy airport and resdicüng o^nipetition o^ certainn lucrative ex-Orfy domestic routes ïncwqxriised by Airliner. Italy has used the same strategy, reallocatingreallocating most of the international tiaffic to the iiew Milan airport, Mahjiens* complaintss from several carriers, strongly protested against the Italian practice aiid, rc ^ wass amended and tanporarih/ postponed (Air Bulletin, 1998, vol.2, no. 48). Infra, Section 4.5.7. 477 The stateimay also make bilateral arrangements wnh other Member States. Oiapter IV, however, ooted that thiss option is not used much because such arrangements will often have a discriminatory effect Recalll fromSectio n 4.5.7 that the majority of Coairounhy carriers waoted to retain pro^ increasedd competition following liberalisation. These carriers were not in favour of liberalisation. 173 3 levell and the freedom of establishment laid down in the EC Treaty have further reduced the airlines'' dependence on the domestic home base. These factors taken together have increased thee incentive to behave opportunistically by increasing the associated gains and reducing the costs.. Opportunism might occur in the form of airline threats to extract state concessions. As ann example, in 1999 KLM announced that it would facilitate traffic growth at Malpensa airport (onee of the hubs of its alliance partner, Alitalia) in response to capacity problems at Schiphol airport.. This may have been one reason why the state was willing to revise the strict KEPD requirements.. In addition, although the elimination of the designation requirement might seem too have reduced the risk of adversely selecting airlines, the looser relationship has also made it moree difficult to see whether airlines are contributing to the state's goal. As is true for the contactt phase, the constraining effect of the risk that state-airline relations will be harmed is tooo weak to rule out opportunistic behaviour, especially given the reduced monitoring abilities off the state. Thee airport feels disadvantaged by the outcome of the liberalisation process. Section 4.5.8 notedd that its output and behaviour are increasingly subject to control. Some examples are the requirementt of an annual operations plan, various reporting requirements, the instrument of slott co-ordination and systematic compliance checks. The airport's interests, like those of the airline,, have diverged from the state's goals. Access to greater marketing opportunities, the growthh in traffic and constraints on capacity make it more and more difficult to meet the requirements.. The imposition of new requirements carry the risk of further reducing the airport'ss ability to use its assets efficiently. The revision of the compliance and monitoring systemss suggested by the Optimisation strategy is an attempt to counter this trend. However, Sectionn 4.5.8 showed that new forms of opportunistic behaviour have resulted such as discriminatoryy tariff setting, diversification and co-operation with other airports. Thee overall effect of these developments is that the state is forced to incur higher costs to specifyy behaviour, monitor performance and enforce compliance in case of a dispute.

Inn conclusion, the framework nature of the Community structure and absence of reciprocity increasee the chance of agreements that are considered feir at the interstate level. Although it seemss more difficult to pursue domestic goals, in many instances the framework Community structuree enables a state to implement legisation in a way that is consistent with domestic goals.. In addition, the Member States share many views. The procedures surrounding the conclusionn of a transaction seem to make the transaction prone to opportunistic behaviour, but thee greater use of legal language restricts the ability to acquire any opportunistic gains. Moreover,, the complicated nature of negotiations implies that the process must be well co- ordinatedd if any gains are to be captured. The close relationships between states have also increasedd the costs of opportunistic behaviour and made h more likelyy that agreements are self-

174 4 enforcing.. Control mechanisms at the interstate level have improved. States are well-informed aboutt each other and in frequent contact so that behaviour can be monitored. Integration has madee Member States highly dependent on other Member States in the pursuit of domestic goals.. The scope, intensity and duration of interstate co-operation have also aligned interests49. Eachh of these factors limits the risk of opportunism and hence the cost of protecting interstate agreements.. Finally, the supranational compliance system has lowered the cost of dispute resolution. . Whereass liberalisation has facilitated agreements that seem fair to the industry, stricter domesticc regulation has had the opposite effect. The continued pursuit of certain domestic goalss that conflict with greater industry freedom has led to a divergence of interests and has increasedd the net gains from opportunistic behaviour. The state's control over the airlines has weakened,, and the airlines are less likely to be sanctioned for deviant behaviour. Airports are strictlyy regulated and have not benefited from liberalisation. The overall outcome has therefore beenn a greater risk of opportunism at the industry level, motivating both the state and industry too incur costs to protect their agreements.

5.10-- Optimal governance structure Chapterr 10 described the various subgoals which the Dutch state pursue to attain its goal of a selectivee network. Those subgoals are the psychological goal of prestige, the goal of generatingg financial benefits, the political goal of maintaining good interstate relations and sociall goals aimed primarily at the protection of the environment. The analysis performed in thiss chapter has shown that both the Bilateral and Community structures enable the state to formulatee and impose requirements that need to be met by foreign states and the industry and thuss to pursue the selective network goal. Although some instruments are no longer allowed or mayy not be fully exploited in the Community structure, other instruments remain available, whilee the Community's framework structure frequently accommodates the demands of domesticc policymakers. The features of the two structures differ sharply. In Bilateralism, for instance,, the state has control over the transaction process through its sovereign status, the twoo party nature of agreements and its possession of the property rights to the airspace. In theory,, therefore, the state should be able to attain all of its goals. The informality of the transactionn process in Bilateralism, with its emphasis on the relationship, and the features of secrecyy and barter exchange make it possible to differentiate between transaction partners. Theree is a complicated compliance mechanism enabling states to use various measures to obtainn concessions. Furthermore, in the state-industry relationship, the state's control over the propertyy rights and the close relations between the state and industry created by the many

499 Although the air transport regulations are relatively recent, they are part of a long-term alliance in the form off the EC (including the treaty, secondary legislation, acquis and consequent inteidependencies). 175 5 dependendess stimulate the industry to act in the state's interest. The situation is very different inn the Community. The public nature of negotiations and agreements, the many legal restraints, andd the feature of regulation prevent the state from differentiating hs air transport relations. Thee air transport rights have largely been delegated to the industry and Community institutions andd the states have lost their traditional sovereignty. The delegation of rights to the industry hass reduced the ability of the state to prescribe industry behaviour and monitor compliance and hass made the state increasingly dependent on alternative ways of motivating the industry to pursuee the selective network goal. Somee features of the Bilateral and Community structures have implications for specific parts off the selective network goal. In Bilateralism, the ability to differentiate implies that the state cann pursue its financial goal by selecting those trading partners who make a sizeable contributionn to the transport network. In practice, however, the reciprocity requirement makes thiss impossible for states that have a small potential of third and fourth freedom traffic. The factt that the Netherlands have been able to build a strong position in air transport and that this sectorsector has contributed considerably to the state's financial goal can be attributed more to the Openn Skies agreement with the US than to the Bilateral structure. The Community does not imposee any reciprocity requirements and for this reason performs better than the Community structuree in terms of the financialgoal 50. Thee Bilateral structure is more effective in achieving the social goal of protecting the environment.. The state's property rights and sovereignty enable it to differentiate its air transportt relations. Similarly, the features of secrecy and baiter exchange enable the state to selectt transaction partners that operate with modern equipment and to stipulate the use of such equipmentt and the time of operation in the Bilateral agreement. It can use domestic regulation too prescribe the behaviour of the industry, in particular the way in which it should provide airportt and air transport services. Dutch negotiators are also well-organised and creative in Bilaterall transactions, making strategic use of non-aviation quid pro quos. As a result, Bilate- ralismm has made a solid contribution to environmental protection, despite the country's small size.. Realising the same goal in the Community is problematic. Although the Community structuree contains some elements aimed at protecting the environment and although the goal mayy be pursued at a domestic level, the Dutch wish to improve environmental protection beyondd what is required at the corresponding Community level carries the risk that the state willl breach its treaty obligations and will antagonise the industry. The goal of prestige has becomee less important and thus attractss less attention than other goals. Note, however, that the two-partyy agreements and the use of non-legal enforcement mechanisms in Bilateral state-

500 Section 5.8 noted that other Member States aimed for restrictive Bilaterab with the Netherlands becau^ KLM'ss strong competitive position. The wish to protect uieir own carrière may influence

176 6 airlinee relations have forged a close bond between the state and industry, thus contributing to thee nation's prestige. In the Community structure, the delegation of property rights and a growingg divergence of interests have loosened state-industry relations. In addition, respect for, knowledgee of and close relationships among Member States have become a substitute for the goall of prestige. The political goal of maintaining good interstate relations is pursued in very differentt ways under the Bilateral and Community structures. The Bilateral structure emphasisess the relationship. Control over the property rights, the two-party nature of agreements,, the secrecy surrounding the transaction process and the ability to differentiate in Bilateralismm enable the Dutch state to tailor its air transport agreements according to the value off its relationship with a specific state. In the Community, the content of agreements is largely determinedd at the Community level and discrimination between Member States is prohibited. However,, the resulting inability to tailor agreements to individual states is more than compensatedd by the tact that relations between Member States are much closer than Bilateral interstatee relations. Thee above discussion implies that it is not possible to give an unambiguous answer to the firstfirst question in Chapter t, namely which of the Bilateral and Community structures is more effective.. Nevertheless, the thesis has shed some light on the nature of the problems faced in eachh structure. The Community harmonises the interests of the states but not completely. The advantagess associated with a greater knowledge about other Member States do not compensatee the disadvantages arising from the loss of control over the transaction process. Thee Bilateral structure outperforms the Community in one area that is important, namely the abilityy to differentiate between transaction partners. This feature enables the state to create a selectivee transport network. Even if the ability to select and differentiate may be restricted somewhatt because of the reciprocity requirement and the Dutch lack of economic and political power,, this limitation applies mainly to the financialgoal . The Community structure does not imposee any reciprocity requirements, which makes h better suited to the financial goal. The Bilaterall structure falls short of the Community's performance in the area of good interstate relationss and performs better in terms of the relatively unimportant goal of prestige. Whether thesee findings imply that the Community structure can be considered more effective than Bilateralismm depends on the weights assigned to each of the goals. This is primarily a political issue. .

Thee features of the two structures that influence their effectiveness also influence their transactionn cost efficiency. For instance, the extensive delegation of property rightst o industry playerss in the Community structure has reduced the state's control over the transaction process allocationn of traffic rights and hence the Dutch abmty to retain their position if and when the Comm unity becomess responsible for air transport relations with third craintTigy 177 7 andd has increased the risk of opportunism at the state-industry level. Similarly, the ongoing integrationn of the economies of the Member States has reduced the risk of opportunism at the interstatee level. The following table summarises the transaction cost effects derived in Sections 5.4.1-5.4.44 and 5.7.1-5.7.4. For each governance structure and core dimension, the table distinguishess between the interstate and state-industry relationships. It also gives an indication off the level of transaction costs associated with a given core dimension and relationship. For instance,, the entry 'high* in the top left hand cell indicates that under Bilateralism, the transactionn frequency variable generates high transaction costs in the interstate relationship.

Bilaterall structure Communityy structure FREQUENCY Y Interstate e

Loww frequency of contracting and rigid contract Loww frequency of contracting but flexible structure.. Amendments needed in a dynamic structuree enables adjustments (e.g. environmentt hard to realise. High ex ante infrastructure).. No need to realise best ex ante negotiatingg costs to realise best position. High ex position.. Procedure if amendment needed postss costs of amending and monitoring. High h Low w State-industry y

Easyy to amend relationship with state, difficult to Frameworkk structure enables airline to adjust adjustt operations in dynamic environment due to operation.. Community imposes increasingly rigidd structure. High cost of executing the strictt regulations on airport. Domestic agreement. . requirementss reduce ability to adjust in a dynamicc environment. High h High h UNCERTAINTY Y Interstate e

Loosee relationships. Complex transaction pro- Closee relations. More information processing cesss and dynamic environment. Ex ante costs neededd to realise domestic goals. Simplified high.. Ex post costs high due to difficulty of structuree and good information gathering capa- gatheringg information on compliance. Rigid cities.. Framework structure and delegation of structuree increases need to monitor performance. propertyy rights to industry reduce need for ex postt monitoring of foreign state. High h Low w State-industry y

Highh uncertainty. No uniform rules. Information Airlinee faces less uncertainty on applicable essentiall to adjusting operations in a dynamic Communityy regime. Industry faces more environmentt and processing domestic re- domesticc requirements, increasing the need for quirements.. Information garnering and pro- informationn processing. High uncertainty about cessingg costly. appropriatee behaviour. Framework structure increasess need for state to monitor industry's executionn of transaction. High h High h ASSETT SPECIFICITY Interstate e

Loww specific investment needs, no need to incur Loww specific investment needs, no need to incur transactionn costs. transactionn costs. Minimal l Minimal l State-industry y

Averagee need forspecifi c investment, but long- Increasedd requirements, reduced mutual ex- termm relationships and mutual exposure protect posure.. Airline is able to relocate operations. bothh parties. Limited need to devise external Statee aims to reduce exposure. Strong need to protectivee measures. devisee external protective measures. Low w High h OPPORTUNISM M Interstate e

Highh risk of opportunism due to limited control, Mechanismss for control more effective, greater limitedd constraints on realisable net gains from tendencyy to see agreements as fair, interest deviation.. Limited interest harmonisation. High harmonisation.. Increased delegation of property compliancee monitoring and enforcement costs. rightss to industry. Bom factors reduce need to monitorr compliance by other states. High h Low w State-industry y

Riskk of opportunism limited by good control Controll mechanisms less effective in state-airline mechanismss in state-airport relationship. Fewer relationship.. Diverging state and industry safeguardss in state-airline relationship. Industry interests.. Higher gains from deviation. Strong fecesfeces high costs of deviation, constraining needd to prescribe industry behaviour and monitor opportunism.. Extensive interest harmonisation. performance. . Low w High h Tablee 5.2

Thee table shows a complicated picture. The Bilateral structure allows a differential treatment off trading partners and thus makes it possible to tailor agreements to specific needs. This makess the negotiation process flexible. Once an agreement is entered into, however, the

179 9 rigidityrigidity of the structure prevents states from responding to developments. On the whole, the relationshipp is therefore not flexible and the transaction costs of executing the agreement in a dynamicc environment are high. Further, the loose interstate relationships and multiple state goals,, combined with the features of barter and secrecy, make the Bilateral transaction complex.. Secrecy impairs the states' information gathering capacities, and barter exchange placess high demands on their information processing capacities. These features cause uncertaintyy and require the states to incur high transaction costs in the pursuit of domestic goals.. The rather loose interstate relationships and the sovereignty of the state, which hampers compliance,, produce a high risk of opportunism and so generate a need to monitor behaviour. Thee state's monitoring abilities are limited, however, creating a need for other safeguards. The coree dimensions of frequency, uncertainty and opportunism thus generate high transaction costss in the interstate relationship. Bilateralism generally does not require states to make transaction-specificc investments so that the degree of asset specificity and the associated transactionn costs are rninimal. In the Community structure states do not need to make transaction-specificc investments either. Moreover, the framework nature of the structure increasess the flexibility of the relationship, which facilitates adjustment to changes in the environmentt and prevents agreements from growing out of line with reality. The close relationshipss between the Member States, the publicity surrounding the transaction process, as welll as its formality simplify the transaction and improve the information gathering and processingg capacities of the Member States. Although some uncertainty remains, the associatedd transaction costs are lower than under Bilateralism. Furthermore, the close interstatee relations in the Community, the public nature of the transaction process, improved monitoringg at the state level, as well as the existence of European Courts reduce the risk of opportunismm and the transaction costs associated with this core dimension. The interstate relationshiprelationship therefore generates lower transaction costs in the Community structure than in the Bilaterall structure. Thesee findings contrast with the results at the state-industry level. It is true that the rigid structuree of Bilateral agreements prevents the industry from adjusting its operations in a dynamicc environment. The industry also faces a high degree of uncertainty because it lacks uniformm rules and because there are state-imposed requirements. On the other hand, close relationss and strong interdependencies improve the state's monitoring abilities and induce the industryy to take the state's interests into account. These features lower the risk of opportunism,, and thus the need to devise additional safeguards. The same features and the mutuall exposure to hold-ups also greatly reduce the need to protect transaction-specific investments.. The Owiimunity operates in a very different way. Although its framework structuree provides airlines with a flexibleenvironmen t at the Community level, tighter domestic regulationn prevents the industry from adjusting hs operations. The airport faces strict 180 0 regulation.. The industry has to meet a growing number of domestic requirements, which has increasedd the complexity of the transaction. The extensive use of domestic regulation and the changingg environment have caused a divergence of interests. The greater delegation of propertyy rights to industry players has increased their ability to pursue their own objectives. In otherr words, in the Community structure every core dimension generates high transaction costs att the industry level. Suchh a mixed picture on the transaction cost effects of the two structures makes it difficult too draw an unambiguous conclusion on their transaction cost efficiency. Whereas the Communityy structure generates lower transaction costs at the interstate level and is thus more efficientt at that level, the Bilateral structure generates lower transaction costs and is more efficientt at the state-industry level. Neither structure dominates the other. In each structure somee core dimensions lead to high transaction costs, while others generate low transaction costs.. What the analysis has shown, however, is that the assignment of property rights plays a cruciall role in the distribution of transaction costs within a given structure. The party that holds thee property rights is confronted with high levels of uncertainty and opportunism and therefore highh transaction costs in these problem areas. Thus, in Bilateralism, where the state has control overr the property rights to airspace, the claim on productive resources tends to be relatively highh in the interstate relationship. In the Community structure, on the other hand, the state has moree or less delegated the air transport rights to the industry and the state-industry relationship showss a relatively high claim on productive resources. This raises the question of which relationshipp can more easily be adjusted in a way that would reduce the problems of uncertaintyy and opportunism. Section 2.7.3.3, which discusses two crucial features of the state, namelyy sovereignty of the state and its power to coerce others within its territory, may shed somee light on this issue. On the one hand, the state can exert influence on the behaviour of the industry;; on the other hand, it cannot determine the conduct of other states that are themselves sovereign51.. It may therefore be more fruitful to find ways of reducing transaction costs at the state-industryy level rather than at the interstate level.

Thee next chapter will give some suggestions on how the performance of the Community structuree may be improved.

511 Note that the reduction of slate sovereignty in the EC has affected every Member State. 181 1 Chapterr VI - Summary and conclusions

6.11 - Introduction Thiss thesis has investigated two alternative structures for the governance of air transport. It has analysedd the exchange between states of air transport rights, i.e. the rights to cross the airspace off another state and to access that state's air transport market. These rights form the bulk of thee property rights to airspace. The model used to analyse this transaction has been derived fromfrom existing transaction cost theories, which aim to find the optimal combinations of transactionss and governance structures. The analysis has examined governance structures from thee traditional point of view of transaction cost efficiency, which looks at transaction costs incurredd during the transaction process. The analysis has also explicitly addressed the effectivenesss of governance structures, recognising that a governance structure may in fact not enablee transacting parties to attain their objectives. Thee focus has been on the Netherlands, as a Member State of the European Community, andd on the scheduled transport of passengers. The analysis has answered the following key questions: : 1.. Which of the Bilateral and Community structures is more effective, 2.. Which of the two structures is more efficient in terms of transaction costs, and 3.. Given the present characteristics of the Community structure, what suggestions can be madee to improve the structure?

Soo far, the first two of these questions have been addressed using a model developed in Chapterr 0. This model focuses on the characteristics of the transaction and the transacting partiess and on the relationships between the states and the state and air transport industry to seee which of the Bilateral and Community structures contains features and mechanisms that enhancee goal attainment and transaction cost savings. The two governance structures have beenn described (Chapters HI and IV) and analysed (Chapter V) in terms of the effectiveness andd transaction cost efficiency criteria. The present chapter will summarise the conclusions drawnn from the analysis and will make some recommendations for the improvement of the Communityy structure from the perspective of the Netherlands. Some recommendations may alsoo be relevant outside the Dutch context. Sections 6.2 and 6.3, respectively, recapitulate the mainn aspects of the model and the main findings. Section 6.4 contains suggestions on how to improvee the Community structure and Section 6.5 makes some finalremarks . First,, a comment is made on the learning by doing approach, which was adopted in order to amendd the traditional structure governing exchanges of air transport rights and to develop the Communityy structure. Chapter II explained that the creation or modification of a governance structuree and the transfer of a transaction to a new structure invariably generate transaction 182 2 costs.. Even though these costs have been left out of the analysis, their level influences the speedd of change and the benefits that flow fromth e new structure. The costs of adaptation can bee reduced or even minimised when the general economic and social environment is conducive too investment, innovation and structural adaptation (OECD, 1997: 14). The internal market programmee described in Chapter IV created such an environment. There are different ways to effectt an amendment. In creating the Community structure, states chose a learning by doing approachh and gradually abolished existing Bilaterals between them (Button et al., 1998: 74- 75).. This method generally leads to lower uncertainty than a sudden one-off change. One reasonn is that there is often a programme describing the process of change and a time path, whichh reduces the complexity of the transaction and any uncertainty about the nature and timingg of proposals. In contrast, a 'Big Bang approach', offers the advantage that parties only needd to adjust to the new position once. Also, first-mover advantages which some airlines mightt enjoy in a phased change are removed. The disadvantages stem mainly from the possibilityy that the new institutional framework may be flawed and consequently cause serious damagee to the development of the sector. It also imposes heavy burdens on those in the sector whoo for a variety of reasons (e.g. relating to the existing institutional framework)star t from a moree disadvantaged position than others. In some cases, a gradual change is therefore preferable.. The phasing in of measures allows parties to plan their strategies. Phasing in can alsoo be developed in such a way as to address fears on the part of states or carriers arising from differentt initial market positions. Predetermined gradualism, however, has the disadvantage thatt it may not keep pace with market developments. It may also provide time for entrenched interestss to develop strategies to protect their positions in the new institutional environment. Ann important variation of the gradual approach is phased institutional change with no clearly pre-definedd sequence of change, i.e. the learning by doing method. Thee SEA incorporated a process and time path and also laid down explicit goals. The gradualismm of the learning by doing approach was not predetermined, however, because each phasee was designed on the basis of experience acquired in previous phases. To be sure, a learningg by doing method entails more negotiations, and thus generates higher ex ante transactionn costs. Renegotiations also open up the possibility of opportunistic behaviour. In the casee of the Community, a cautious stance on the part of the Member States, such as the protectionn of their flag carriers, has made it difficult to save costs through a restructuring of thee industry. A study by the European Commission on the outcome to date has shown that the industryy has yet to take full advantage of the new opportunities (Commission, 1996). Nevertheless,, gradualism and a simple abolition of existing Bilaterals have limited the transactionn costs associated with the move to the new system1.

11 Note, however, that the Member States chose a cautious strategy for political rather than efficiency reasons. Supra,, p. 94. 183 3 6.22 - Summary of the model Thiss thesis has developed a model to analyse governance structures in terms of their effectivenesss and transaction cost efficiency. Effectiveness has been defined as the ability of a governancee structure to attain the objectives of the transacting parties. Transaction cost efficiency,, on the other hand, has been defined in terms of the imrrimisation of the productive resourcess needed to effect the transaction in question. The two criteria are not unrelated. It mayy be that a structure can only be made more effective by incurring transaction costs. As an example,, the industry might not observe environmental regulations unless the state engages in somee monitoring. The model has been applied to a particular transaction in air transport, namelyy the exchange between states of air transport rights. The rights exchanged are the rights too cross foreign airspace, the right to transport people to and from a foreign territory and the rightright to capture the resulting benefits. Thee model has been used to evaluate a governance structure known as the 'State'. An essentiall property of the State is that the state (as an actor) holds the property rights to air transportt rights. The state's possession of these rights constitutes the main reason behind the state'ss participation in the exchange. The state's permission is needed before a foreign aircraft mayy use its airspace and it gives that permission through exchange with other states. Thee state as an economic decision-maker differs from other decision-makers in some crucial ways:: it imposes universal membership, it can claim sovereignty, it has the power of coercion andd it is a social welfare maximiser. These properties make the State a governance structure thatt differs substantially from the governance structures usually studied in the literature on transactionn costs. Two further properties make it difficult to measure the effectiveness of the State.. One property is that state-provided services are not well-defined. Secondly, as modelled inn this thesis, the state's objective of maximising social welfare is an aggregate of the goals it pursuess in the various sectors of the economy. Each of these sectoral goals is, in turn, an aggregatee of various subgoals. Some subgoals may be attainable only at the expense of others. AA measure of the effectiveness of the State then requires some difficult trade-ofis.

Withh respect to air transport, the Dutch state pursues a goal referred to as 'the selective networkk goal'. The goal is an aggregation of psychological, financial, social and political goals. Thee Dutch government has translated these further into specific requirements that must be includedd in interstate relations and that must be met by airlines and airports. Because states holdd the property rights to airspace, the Dutch state's ability to realise the selectivity goal dependss crucially on its relations with those states. The state does not execute the transaction itselff but leaves this task to the industry (in the Community structure more than in the Bilateral structure).. The state-industry relationships can therefore be regarded as agency relationships 184 4 withh the state as the principal and the industry as its agents. The problems usually associated withh agency, such as moral hazard and adverse selection, are a real risk in air transport because thee industry pursues the objective of continuity rather than the objective of a selective network. Althoughh there is overlap in that the industry depends on public support, there is considerable conflictt between the two objectives. Thee effectiveness of the State has been addressed indirectly in terms of the existence of mechanismss that motivate foreign states and the industry to pursue the goals of and meet the requirementss imposed by a given state. The transaction cost efficiency of the State has been evaluatedd in terms of those dimensions of the exchange that have implications for the transactionn costs generated by the exchange. TwoTwo variants of the State have been studied, namely the Bilateral and Community structures.. They have been analysed in terms of their distinguishing features, the nature of the transactionn process and the parties involved in the exchange. In the Bilateral structure, state ownershipp of the property rights to airspace, the equality among states and relational contractingg play an important role, whereas the Community structure is characterised by a delegationn of property rights, a proportional rather than equal allocation of power, and a high degreee of formality.

6.33 - Summary of findings Thee analysis shows mixed results on the effectiveness of the two structures: Bilateralism outperformss the Community in some respects and the Community performs better in other respects.. Chapter V showed that the Community enhances the harmonisation of state interests butt does not harmonise them completely. A Member State's greater knowledge about other Memberr States is outweighed by the loss of control over the transaction process. The Bilateral structuree outperforms the Community in one important area, namely the ability to discriminate betweenn transaction partners. This feature enables the state to create a selective transport networkk and pursue the main social goal of environmental protection. On the other hand, the Dutchh state's ability to attain its financial goal is limited by the Bilateral reciprocity requirementt and the Dutch lack of economic and political power, which restrict its ability to selectt and discriminate. Liberalisation as pursued through the Community structure means an absencee of the reciprocity requirement, which facilitates progress towards the financial goal. Thee Bilateral structure also falls short of the Community's performance in the area of good interstatee relations but performs better in terms of the psychological goal of prestige. A choice inn favour of one structure depends on the weights assigned to each of the selectivity subgoals. Fromm the perspective of transaction cost efficiency, the outcome is again mixed: the interstate relationshipp generates lower transaction costs in the Community, but the state-industry relationshipp performs better in the Bilateral structure.

185 5 Thee assignment of property rights plays a crucial role in the distribution of transaction costs withinn a given structure. The party that holds the property rights is confronted with high levels off uncertainty and is likely to behave opportunistically, generating high transaction costs in thesee problem areas. In the Bilateral structure the state has control over the property rights so thatt the claim on productive resources tends to be relatively high in the interstate relationship. Inn the Community structure, on the other hand, the state has more or less delegated the propertyy rights to the industry and the state-industry relationship shows a relatively high claim onn productive resources. State sovereignty makes it difficult to adjust interstate relations, closingg one avenue to a reduction in transaction costs. The power of coercion, however, enabless the state to exert influence on the behaviour of the industry. The Community structure mayy therefore be a better candidate for efficiency improvements than the Bilateral structure.

6.44 - Recommendations and suggestions for improvement Chapterr V concluded that the Community is weaker than the Bilateral structure in certain respects.. There are clearly some areas where change would improve the performance of the Communityy structure. The following sections suggest how the Community might be moulded intoo a structure that is more effective and more transaction cost efficient than the current version.. The suggestions in Section 6.4.1 target the interstate (i.e. Community) level, while the suggestionss in Section 6.4.2 address the state-industry level. In line with the overall thrust of thee thesis, the suggestions made focus on the Dutch point of view. It should be borne in mind thatt a different perspective may justify different recommendations. Furthermore, some suggestionss may be used in transactions not involving the Dutch state or industry.

6.4.11 - Suggestions for improvement from the perspective of the state as member of the Community y

6.4.1.1-- Effectiveness Onee of the problems confronting Dutch policymakers is that their air transport goal is not alwayss consistent with Community objectives. The Community, for instance, is moving towardss a common market based on a smaller set of harmonised rules. This is clearly in conflict withh the Dutch selective network goal, which requires a differentiation of air transport relations.. As a result, the Dutch are not always able to translate the goal into acceptable requirementss or apply the instruments needed to achieve the goal. The problem is not entirely duee to the conflict per se, however. A lack of appreciation on the part of the Community for thee exact nature of and motivation behind the selective network goal also explains some of the difficultiess experienced at the Community level. The Dutch state could generate more co- operationn at the Community level if it formulated the selective network goal within a

186 6 Communityy or global rather than a purely Dutch context. The current preference for KLM, for instance,, could be transformed into a preference for Community carriers. The Community mightt also be more favourably disposed towards the Dutch if the hierarchy of goals that constitutee the selective network goal were more transparent and if the trade-offs that the Dutch wouldd be witling to make were clearer. An example of one such trade-off is as follows. The Netherlandss favour liberalisation because h implies the abolition of strict requirements, for instancee on capacity allocation, which reduce the negotiation power of small states. One importantt consequence of liberalisation, however, is non-discrimination, which is inconsistent withh the Dutch desire to select and differentiate between trading partners. A trade-off thus needss to be made between selection and differentiation on the one hand and the effect of liberalisationn on the other. By clearly identifying the acceptable trade-offs, national negotiators shouldd be in a better position to find compromises with the Community or pursue policies at thee Community level. Att the same time, Dutch policymakers need to acknowledge that the transfer of power to thee Community is an ongoing and unstoppable process and is changing the role of domestic governmentss from policymakers to administrators. The ongoing social and economic integrationn of the world economy is also diminishing the state's control over domestic events. Thee formation of international airline alliances, for example, enables the airlines to manipulate trafficc flows more easily than the state. The state has fewer traditional instruments at its disposall to pursue a domestic policy and cannot always make adequate use of any remaining instruments.. If national policymakers want to attain the selective network goal, they need to movee away from a domestic focus and adapt their instruments to the common and global markets.. The above suggestion to change the focus fromdomesti c to Community carriers is a stepp in the right direction. Within the Community the Commission holds the right of initiative andd needs to be lobbied. Other organisations, such as the European Parliament and COREPER,, also need to be lobbied. The state further needs to realise that other domestic partiess - the industry, in particular - will lobby the same organisations and that it would benefit fromfrom better co-ordination with those parties. At the state level, the additional co-ordination responsibilitiess of the Ministries of Foreign Affairs (preparation) and Justice (execution) may bee combined in the State Secretariat for European Affairs, which is part of the Ministry of Foreignn Affairs. Groups such as the BNC, CoCo and COCOHAN could be merged into a singlee entity. Decisions as to what will be pursued at the Community level (the hierarchy) shouldd be taken in Cabinet. The minister responsible for the issue in hand (the Minister of Transportt in the case of air transport) should hold prime responsibility. The current allocation off responsibility for Community affairs between the Ministries of Foreign Affairs and Justice is noo longer appropriate, given that domestic law is becoming increasingly dominated by Communityy law. Community law should no longer be placed in the same category as

187 7 internationall law. At the industry level, the preparation of Community transactions in the area off air transport should include a consultative meeting between the Ministry of Transport and industryy players at the beginning of the transaction process (as in Bilateralism). Inn line with the previous suggestion, the Dutch state needs to become far more active in earlierr phases of the transaction process so that it can influence the content of Community policies.. Finally, explicit instructions to domestic representatives should be formulated much earlierr in the transaction process. In giving these instructions, the representatives should be givenn a clear and well-defined mandate and their performance should be monitored closely. Thee reward mechanism should be overhauled with performance tied more closely to factors thatt motivate public servants (WRR, 2000: 70, 84). This may include incentives to stimulate valuess as responsiveness, responsibility, integrity and helpfulness. Contrary to what was noted inn Section 2.7.3.3, traditional financial incentives may be used for this purpose, given that the state'ss problem in using financial incentives is simply one of information asymmetry (see Sectionn 5.9.4). If a transfer of powers occurs it will be important that the Netherlands should clarifyy any public interest aspects of the selective network goal. Clarity is particularly fruitful at thee interstate level, given the inability of the domestic state to use coercion and consequent needd to find other ways of engineering desired outcomes. Viewingg the size of the Community as an advantage rather than an obstacle could also benefitt the Netherlands. With decision-making powers placed in the hands of the Commission, thee small size of the Netherlands would cease to play a role in negotiations with third countries. . Itt may not be easy to implement these recommendations as the distribution of power at the Communityy level is by no means clear and is undergoing continual change. It is difficult to adaptt national processes to an ever-evolving Community. Uncertainty surrounding the precise operationn of the ERTA doctrine (see Section 4.5.6.1) in air transport is one problem afflicting thee change process. Eventually, the operation of the ERTA doctrine will require Member Statess to provide the Commission with a full mandate to negotiate air service agreements. The Commissionn tried to clarify the scope of its powers as early as 1994, among other things, by invokingg the ERTA doctrine but the Court rejected the Commission's claim2. What is clear is thatt as long as the impact of Community legislation remains obscure, any transfer of power and adaptationn of national structures should be managed carefully. To protect the state from unexpectedd adverse developments that may cause irreversible damage to the selective network, thee state should adopt a phase-wise approach to change. On the external policy front, for example,, the Dutch have been able to build a valuable package of rights, which must not be jeopardisedd by a poorly timed transfer of powers. The change process should also take into accountt the Dutch lack of size and hence the country's lack of influence on decisions taken.

188 8 Onee strategy would be to identify issues that should not yet be transferred to the Community levell and temporarily channel these through ECAC. This organisation is based on intergovernmentall co-operation and the principle of equality among states. Its procedures couldd play a vital role in getting the Member States to better appreciate national interests. This mayy help bridge the differences between national and Community goals. When the time is ripe issuess that have thus been resolved may be transferred to the Community. Thee Subsidiarity principle mentioned in Section 4.7.2 could also be used to manage a transferr of powers to the Community.

6.4.1.22 - Transaction cost efficiency Chapterr V showed that, in the Community, uncertainty is the main source of transaction cost inefficiencyy at the interstate level. The system lacks transparency at the Community level, wheree decision-making processes and ultimate responsibilities are not clear. The situation is aggravatedd by the domestic 'poldermodel' which has given rise to overlapping mandates and compromisess at the expense of clarity. The allocation of responsibility between the Ministers of Foreignn Affairs, Justice and Transport illustrates one such inefficiency. Similarly, civil servants mayy be confronted with conflicting goals, whose content can only be clarified through elaboratee information processing. A strategy geared towards lowering the degree of uncertaintyy should lead to considerable gains in transaction cost efficiency. Some of the suggestionss that would improve the effectiveness of the structure may also improve its efficiency.. These include the introduction of a hierarchy in decision-making, a clarification of areass of responsibility, a reduction in the number of people involved, as wetl as better co- ordinationn among policymakers and between policymakers and the industry. Each of these measuress would improve information processing capacities and simplify decision-making. A secondd source of inefficiency within the Community is opportunism on the part of Dutch policymakerss and representatives in Brussels. Well-designed incentives (see Section 6.4.1.1) directedd at these parties would lower the cost of supervision. Anyy room for efficiency gains at the interstate level is limited, however. Even though the Communityy has weakened the sovereign powers of Member States, each state continues to wieldd considerable powers enabling it to resist unacceptable changes to domestic systems. Moreover,, the state is not always the right target for effidency-enhancing measures as the air transportt rightshav e been delegated to the industry. The state's relationship with the industry iss addressed in the next sections.

22 Supra, pp. 106-107. 189 9 6.4.22 - Suggestions for improvement from a state-industry perspective AA state's ability to influence interstate relations in order to attain its own goals is restricted, especiallyy in the Community decision-making structure, where differences in power have been formalised.. An approach directed at the state-industry relationship is more likely to bear fruit.

6.4.2.11 -Effectiveness Ass liberalisation proceeds, the state increasingly relies on the industry to realise its air transport goal.. At the same time, the Community structure inhibits the Dutch state from building a selectivee network via the industry because some instruments are no longer allowed. Furthermore,, the incentives provided by other instruments or mechanisms have not been adaptedd to the new environment and may even be misused by parties with vested interests. The industryy would contribute more to the selective network goal if the state were to implement thee following recommendations. Inn the first place, a regulation introducing the compulsory disclosure of all commercial agreementss entered into by the industry would keep the state informed of the industry's actions.. This may help the state to co-ordinate competition policy and air transport agreements withh third countries and with Member States, which is increasingly important given the formationn of international airline alliances. Secondly,, the state should translate the selective network goal into requirementstha t are explicitt and ranked in terms of importance. Given the diminishing influence of domestic policy, thesee requirements should be formulated in ways that are consistent with the interests of the industryy and with the set of mechanisms permitted by the Community. The state should recognisee that it is up to the industry to meet the requirements. The industry should be allowed too conduct and optimise its operations without being hampered by state interference. The dynamicc air transport environment further implies a preference for framework rules. The industry'ss incentives could also be improved through slot differentiation based on environmentall criteria3. Thee state has traditionally relied on close relations and legislation as instruments to elicit appropriatee behaviour. Currently the state is switching towards the use of covenants with the industry.. This may be a more productive strategy than the strategy of domestic legislation, whichh runs a growing risk of conflict with Community law. In its use of covenants, however, thee state will have to refrain from obtaining promises from the industry at the expense of the publicc interest. Some interests may be so fundamental that they should be considered non- negotiable.. Environmental protection, healthcare as well as safety and security issues are gainingg in importance and may eventually constitute such interests. Furthermore, the demands flowingflowing from such principles as legal certainty and equality before the law may prohibit the

190 0 statee from replacing legislation with agreements, while competition law prohibits some forms off co-operation. In negotiating covenants, the state should also be aware that these covenants wouldd bind Dutch carriers, but not other Community and international carriers, placing the Dutchh industry at a competitive disadvantage. This would be one area where the power to coercee may still play a useful role. Because the state cannot directly regulate foreign carriers, coercionn would imply regulation of airline behaviour at the airport. The most likely target of regulationn would be the airport, given that its specific investments tie it to a fixedlocation . As liberalisationn and market regulation are potentially in conflict, and the scope for regulation is limited,, the state may resort to instruments like infrastructure investments (facilities), subsidies andd taxes. One area where the state can still exert an indirect influence is the location climate. Ass the KEPD, and the 1998 and 1999 Cabinet decisions (Ministry of Transport, 1998c, Ministryy of Transport 1999b) make clear, the state uses environmental planning instruments, fiscall measures and education to enhance the attractiveness of the Schiphol environment. The focuss of government attention may increasingly shift to these areas.

6.4.2.22 - Transaction cost efficiency Overr the past five years, the air transport industry has undergone more rapid change than the instrumentss used to steer the industry. As explained in the previous section, the current instrumentss and mechanisms are no longer optimal in the new environment. There is a lack of appropriatee incentives and hence a failure to limit opportunism on the part of the industry. The largee volume of legislation, the difficulty in monitoring industry behaviour and the increased riskrisk of opportunism lead to high costs of supervision. Uncertainty about the exact meaning of requirementss or the hierarchy of goals has led to substantial information gathering and processingg costs for both the industry and the state. The exposure to hold-ups resulting from transaction-specificc investment is no longer mutual, causing the parties to search for other guarantees. . Currentt incentives are ill-designed and not capable of eliciting the behaviour desired by the state.. Given the continuity objective of the industry, and the fact that financial incentives target ann important element of this objective, one solution may be to tighten the link between performancee and the financial rewards earned by the industry. The high costs of monitoring behaviourr suggest that, in eliciting appropriate actions, the focus should be on output rather thann on the underlying behaviour. Suggestions along these lines are already contained in the Optimisationn strategy and the 1998 and 1999 Cabinet decisions on the future of Schiphol airportt (Ministry of Transport, 1998c, Ministry of Transport 1999b). These decisions address thee airport directly; the airline is only affected indirectly, via the airport. The suggestions includee a change in the current airfield designation, splitting it up into an Airport Zoning

3Qim^opnionisa{^stuwdevelopmeMofsrc^ ^ 191 1 Regulationn ('Luchthavenbdelingsbeslurt'), dealing with the buildings surrounding the airport, safetyy zones and locational issues, and an Airport Traffic Regulation ('Luchthavenverkeersbeshut'),, dealing with flight routes and noise monitoring. The strict volumee caps will be removed, although a cap on noise and other emissions will be retained. Thee regulations aim to impose certain requirements on the industry, while leaving it free to choosee its own means. To realise the potential for improvement, the state will have to provide thee industry with a guarantee that investments will not be expropriated and that compliant behaviourr which violates noise regulations will not be punished. A further point worth noting is thatt the allocation of responsibility within the sector is not consistent with the fact that only the airportt designation is being changed. New requirements in airport regulation will lead the airportt to claim a greater say at the industry level and may give rise to new forms of opportunismm and thus new transaction cost inefficiencies. It may therefore be wise also to redesignn airline licences and bring them into line with the new allocation of responsibilities. Sectionss 4.5.6.1 and 4.5.7 observed that the Community structure still gives the state some powerss to tie a licence to factors that enhance goal attainment. An alternative strategy would bee to stimulate the industry players to sign covenants or service level agreements codifying theirr underlying relationships. These agreements should be consistent with EC law. Coercion mayy continue to be needed because the presence of international airline alliances reduces the effectt of any domestic measures targeting the airlines and because non-Dutch carriers may havee only a limited incentive to enter into covenants. Section 6.4.2.1 noted that any such regulationn would amount to airport regulation. Too reduce monitoring costs, the state could delegate monitoring activities to more independentt third parties. In 1999, in the context of the disentanglement process (see Section 3.3.1),, a suggestion was floated to set up a specialised airport institution. The Cabinet Decision off 17 December 1999 mentions a 'Handhavingsdienst', which would fall under the 'Inspectie Luchtvaart'' and would combine all available expertise and authority concerning airport matters intoo a single organisation. However, as part of the Ministry of Transport, it would not be independent. .

6.55 -Evaluation Sectionn 5.10 concluded that the Community has some strong features in certain respects but nott in other respects. It postulated that sovereignty at the interstate level and coercion at the domesticc level make the industry the more natural target for change than the foreign state. The suggestionss made in Section 6.4 confirm that it should indeed be easier to effect change directedd at the industry. Thiss conclusion and the analysis in the thesis may help policymakers as they try to influence thee future development of the Community and their own position in that development. If 192 2 transactionn cost minimisation and goal attainment remain appropriate criteria, the model may helpp policymakers identify where they should focus their attention as they devise and evaluate particularr policies. Onee example of how the model may be used is in the allocation of the property rights to the airspace.. There is some discussion about whether the state should retain the remaining propertyy rights or should delegate these to the industry. Chapter V showed that the assignment off property rights is an important factor in the distribution of transaction costs within a governancee structure. In the Community, the industry has acquired the bulk of these rights, whichh has shifted the problems of uncertainty and opportunism from the interstate to the state- industryy level. Coupled with the conclusion that there is more scope for improving the functioningg of the market at the industry level, the model provides a case for delegating the propertyy rightstha t remain with the state to the industry. A supporting argument may be found inn Section 5.2.4, which noted that the industry may be capable of generating an efficient outcome,, implying that the state cannot improve the performance of the industry without incurringg significant costs. There are of course other considerations not addressed by the model.. First, it is unlikely that the industry will generate an efficient outcome in the current environmentt because the industry's goals conflict with certain public interests. If the state completelyy withdraws fromth e market, the industry may not have sufficient incentives to act in linee with those interests. Second, Chapters IV and V observed that the position of the Netherlandss as a Member State of the Community restricts the powers of the state to unilaterallyy decide what to do with the property rights it possesses. Though the current structuree allows the delegation of these rights to the industry, the intent of the structure is clearlyy to effect exchange with non-EC countries at the state rather than the industry level. As aa result, the Netherlands may be accused of breaching its duties as a Member State if it were to effectt such a transfer at this time. Notwithstanding these caveats, the model provides one argumentt in favour of the suggested transfer. A second example concerns the conflict identified inn the analysis between greater freedom for the industry and the introduction of new legislation.. The analysis has shown that the industry cannot easily cope with the pressures of a freerr market and simultaneous regulation by the state. At present, Dutch society is placing a growingg emphasis on healthcare, safety and other social goals. If these are accepted by the statee in its current revision of air transport regulation, it would imply additional requirements andd hence regulation for the industry. A recognition of this conflict is one input into the decisionn of whether or not to incorporate those goals.

Itt is hoped that the model may provide similar guidance in other policy decisions.

193 3

Toepassingg van de transactiekostentheorie op de beheersstructuur van het geregelde internationaall vervoer van personen door de lucht f summary in Dutctri

Ditt proefschrift analyseert twee structuren die het internationale lijndienstvervoer van passagierss door de lucht beheersen. Onderzocht wordt hoe staten hun doelstellingen met betrekkingg tot de luchtvaart kunnen realiseren tegen zo laag mogelijke transactiekosten. Meer specifiekk wordt de problematiek bezien vanuit het oogpunt van de Nederlandse overheid. Dee transactie die in dit proefschrift centraal staat is de ruil tussen staten van de rechten die verbandd houden met het gebruik van eikaars luchtruim voor het vervoer van personen op commerciëlee grondslag. Deze rechten worden in het proefschrift aangeduid als 'luchtvaartrechten'.. Staten maken bij de voorbereiding, sluiting van de transactie en uitoefeningg van dee verworven rechten gebruik van luchtvaartmaatschappijen en luchthavens. Voorr de uitoefening van de rechten zijn de handeling van het vervoeren door de lucht, het biedenn van faciliteiten voor het landen en opstijgen, alsmede de afhandeling van de luchtvaartuigenn noodzakelijk. Vanwege de essentiële rol van ieder van de partijen worden zij inn het proefschrift aangeduid met de overkoepelende term 'luchtvaartindustrie'. De relatie tussenn luchtvaartindustrie en staat kan als een 'agency1- relatie worden geduid: de staat (principaal)) maakt gebruik van andere partijen (de 'agents') om bepaalde luchtvervoers- en luchthavendienstenn te laten verrichten. De staat verleent aan de industrie specifieke rechten omm de diensten te verrichten en formuleert expliciete eisen waaraan deze diensten moeten voldoen. . Hett transactie- of ruilproces omvat voorbereiding, sluiting en uitvoering van transacties. Deze activiteitenn leggen een beslag op schaarse middelen. Dit beslag wordt ook wel aangeduid met dee term 'transactiekosten'. De hoogte van deze transactiekosten is afhankelijk van de structuurr waarbinnen het ruilproces plaats vindt. De structuur bestaat uit het samenstel van regelss en instituties dat de transactie beheerst en wordt aangeduid als de 'beheersstructuur' (governancee structure). De ruil van luchtvaartrechten kan plaatsvinden via twee beheersstructuren:: de traditionele bilaterale structuur en de communautaire structuur zoals dezee geldt in de Europese gemeenschap. De transactiekostenanalyse wordt aangewend om een zoo efficiënt mogelijke combinatie van transactie en structuur te vinden. De meest efficiënte structuurr is dan die welke de transactiekosten minimaliseert. Dit wordt aangeduid als 'transactiekostenefficiëntie'.. Naast de transactiekostenefficiëntie behandelt dit proefschrift het vermogenn van de beheersstructuur om de doelstellingen van de partijen bij de transactie te verwezenlijken.. Dit wordt aangeduid als de 'effectiviteit' van de beheersstructuur.

Driee vragen staan centraal in het onderzoek: 11 Welk van de structuren is het meest effectief? 22 Welk van de structuren is het meest transactiekostenefficiënt en 33 Welke suggesties kunnen worden gedaan om de communautaire structuur te verbeteren? ?

Dezee vragen worden beantwoord vanuit het Nederlandse perspectief. Er is gekozen voor het perspectieff van een individuele staat omdat alle bestaande beheersstructuren in de luchtvaart uitgaann van een staat. De analyse is beperkt tot de Nederlandse situatie nu de auteur van dit proefschriftt slechts beschikt over een beperkte hoeveelheid kennis van de situatie in een anderee staat en begrensd is in het vermogen om relevante gegevens te duiden. Dit verschijnsel staatt bekend als 'begrensde rationaliteit'. Hierbij komt nog dat de auteur in de praktijk vertrouwdd is geraakt met het transactieproces zoals dat in Nederland plaats vindt. Ten slotte wordenn in dit proefschrift beleidsaanbevelingen gedaan voor de Nederlandse overheid. Dit

195 5 laatt evenwel onverlet dat de in het proefschrift ontwikkelde beschouwingswijze en sommige vann de bevindingen c.q. aanbevelingen kunnen worden gehanteerd bij de analyse van de transactiee tussen andere staten of groepen van staten.

Hoofdstukk I leidt het onderzoek in en geeft een korte uiteenzetting van de in het proefschrift gebezigdee beschouwingswijze en de begrenzingen aan de analyse. Hoofdstukk II behandelt allereerst de voorwaarden die moeten zijn vervuld voordat een ruil plaatss kan vinden. In dit proefschrift worden als zodanig genoemd: het bestaan van beschikkingsrechtenn met betrekking tot het goed dat wordt geruild, een geïdentificeerde ruilpartner,, de beschikking over informatie met betrekking tot de partijen en het goed zelve alsmedee een beheersstructuur. Vervolgens wordt ingegaan op het begrip 'transactiekosten'. Eenn belangrijke veronderstelling bij het onderzoek van transactiekosten is dat partijen zullen trachtenn om deze kosten te minimaliseren. Wanneer een bepaalde structuur tot te hoge kosten leidtt kunnen partijen voor een andere structuur kiezen of van de transactie afzien. Deze gedachtengangg is door Coase (1960) eveneens toegepast op de allocatie van beschikkingsrechten.. Daarbij wordt in eerste instantie aangenomen dat partijen bij een inefficiëntee allocatie door middel van transacties alsnog tot een efficiënte uitkomst zullen komen.. Ook hier is het bestaan van transactiekosten relevant. Zo kan een inefficiënte allocatie vann beschikkingsrechten tot onnodige transacties (en daarmee kosten) leiden. Ook kunnen dezee kosten ertoe leiden dat de bestaande allocatie in stand blijft. Dit maakt de toewijzing van beschikkingsrechtenn relevant. Dee in het proefschrift ontwikkelde beschouwingswijze is gebaseerd op Williamson (1971, 1985),, Noorderhaven (1990) en Van der Zaal (1997). Voor een analyse van de effectiviteit is allereerstt inzicht nodig in de doelstellingen van partijen. Indien er sprake is van meervoudige doelstellingen,, zoals bij de staat meestal het geval is, is het moeilijk de effectiviteit van een bepaaldee beheersstructuur direct te meten. Daarnaast is het welhaast onmogelijk veranderingenn in de omgeving toe te schrijven aan het beleid dat de overheid voert om haar doelstellingenn te realiseren. Om deze redenen is de aandacht gericht op de relaties tussen de bijj de transactie betrokken partijen. Onderzocht wordt of deze relaties tot een realisering van dee doelstellingen van de staat aanzetten, bijvoorbeeld omdat er beloningsstructuren zijn die eenn positieve bijdrage van een partij honoreren. Zowel de relatie tussen de ruilende staten als dee staat-industrie relaties worden beschouwd. Dee transactiekostenefficiëntie wordt geanalyseerd met behulp van een geïntegreerd raamwerk. Hierbijj wordt eerst de transactie gedifferentieerd aan de hand van de frequentie waarmee deze voorkomt,, de onzekerheid waarmee de transactie gepaard gaat en de mate waarin transactiespecifiekee investeringen nodig zijn. Verder worden de deelnemende partijen aan de handd van een tweetal aspecten gedifferentieerd. Het betreft hier de mate vann opportunisme en dee begrensde rationaliteit waarmee partijen te maken hebben. Deze vijf factoren - frequentie, onzekerheid,, transactiespecifieke investeringen, opportunisme en begrensde rationaliteit - wordenn in dit proefschrift aangeduid als 'kemdimensies'. Elk van de kerndimensies kent vier beïnvloedendee factoren, aangeduid als 'determinanten*. Beschreven wordt hoe een veranderingg in de onderscheiden determinanten uitwerkt op de kemdimensies en vervolgens hoee de kemdimensies de hoogte van de transactiekosten kunnen beïnvloeden. Zo zal, bijvoorbeeld,, een beter vermogen om informatie te vergaren (determinant van de kerndimensiee onzekerheid) de onzekerheid en daarmee de transactiekosten kunnen verlagen. Naastt de al eerder genoemde teheersstmctuur beïnvloedt ten slotte de omgeving van de industryiee (onder andere concurrentie en mogelijke schaalvoordelen) de effectiviteit en de hoogtee van de transactiekosten.

196 6 Err bestaan verschillende beheersstructuren, die worden onderscheiden naar flexibiliteit en belangg van het voortduren van de relatie. Na een bespreking van de gewoonlijk gemaakte hoofdindelingg van beheersstructuren (niet-specifiek, semi-specifiek en transactie-specifiek) wordtt dieper ingegaan op de transactie-specifieke beheersstructuur zelve. Een belangrijke transactie-specifiekee beheersstructuur is de structuur waarin de staat houder is van de beschikkingsrechtenn van net goed dat wordt geruild. Deze structuur wordt met 'Staat' aangeduid.. Belangrijke kenmerken van deze beheersstructuur zijn universeel lidmaatschap, meervoudigee doelstellingen, uitgebreide bevoegdheden en de hoogste graad van zeggenschap inn de samenleving. Dh laatste kenmerk wordt nationaal ingevuld met het rechtmatig gebruik vann dwang, waardoor transacties ook zonder het bereiken van wilsovereenstemming kunnen plaatsvinden.. In de interstatelijke relatie wordt het vertaald in soevereiniteit en fundamentele gelijkheidd van staten. Omdatt activiteiten van de staat veelal niet helder kunnen worden geïdentificeerd en omdat meervoudigee doelstellingen van de staat moeilijk in financiële termen vertaald kunnen worden zijnn uitspraken in dit proefschrift over effectiviteit en transactiekostenefficiëntie van structurenn uitsluitend in kwalitatieve termen gesteld.

Hoofdstukk ID beschrijft de bilaterale beheersstructuur waarin twee staten met elkaar een luchtvaartovereenkomstt sluiten. Eerst wordt ingegaan op totstandkoming van deze structuur, waarnaa de centrale elementen worden genoemd. Zo hebben staten onder meer de beschikking overr luchtvaartrechten, is toegang tot de markt strikt afhankelijk van voorafgaande toestemming,, is de interstatelijke relatie belangrijk, wordt het beginsel van gelijkheid van statenn toegepast op verdeling van vervoerscapaciteit over beide staten, is er sprake van informelee geschillenbeslechting en worden bepaalde aspecten van de transactie geheim gehouden.. Vervolgens wordt ingegaan op de motieven voor de staat om bij de luchtvaart betrokkenn te zijn. Het gaat om drie categorieën motieven: prestigegerelateerde, financiële en politiek-sociale.. De tweede categorie van motieven omvat onder meer belastinginkomsten en dividenden.. Tot de derde categorie worden onder meer gerekend het behartigen van de relatiess tussen staten en bescherming van het milieu. Het Nederlandse luchtvaartbeleid wordt gewoonlijkk aangeduid met de term 'selectiviteitsbeleid'. Hierbij wordt getracht de staten met wiee een luchtvaartovereenkomst wordt gesloten te selecteren en de relatie met deze staten op eenn zodanige wijze in te richten dat een vervoersnetwerk wordt gecreëerd waarmee een maximalee bijdrage aan de realisatie van de hierboven genoemde motieven wordt bewerkstelligd,, terwijl het beslag op schaarse milieu- en infrastructurele capaciteit wordt geminimaliseerd.. Dit beleidsoogmerk wordt vervolgens vertaald in concrete eisen en voorwaardenn die gelden tenn aanzien van de transactie. De realisatie van deze aspecten wordt zowell nagestreefd in de interstatelijke relaties als in de relaties tussen staat en luchtvaartindustrie.. Met het doel uiteindelijk de effectiviteit te kunnen analyseren worden daarnaa de relaties tussen staat en luchtvaartmaatschappijen en tussen staat en luchthavens behandeld.. Hierbij wordt onderzocht of er sprake is van convergentie van belangen. Voor zoverr er sprake is van divergentie van belangen wordt aangegeven hoe de staat anderszins kan bewerkstelligenn dat de luchtvaartindustrie een positieve bijdrage levert aan het selectiviteitsbeleid.. Verschillende instrumenten, zoals beloningsstructuren en belangenharmonisatiee worden behandeld. Vanwege de rol van internationale luchtvaaitorganisatiess worden daarna de belangrijkste organisaties kort besproken. Hiermee is hett overzicht van de belangrijkste partijen afgerond. Vervolgenss wordt het voorwerp van de transactie, zijnde 'luchtvaartrechten', behandeld. Conformm de gangbare literatuur worden de verschillende gebruiksrechten in acht vrijheidsrechtenn ingedeeld. Een aantal rechten is in de praktijk totstandgekomen. In het

197 7 bijzonderr Nederland heeft van deze laatste ontwikkeling geprofiteerd en daaraan ook bijgedragen.. Een belangrijke reden was het willen omzeilen van de restrictieve interpretatie vann het gelijkheidsbeginsel waarbij het recht op vervoer wordt verbonden aan het nationale vervoerspotentieel.. Hierna worden de verschillende fasen in het transactieproces beschreven. Opvallendd is het informele karakter van de onderhandelingen en de nauwe betrokkenheid van dee luchtvaartmaatschappijen. Een aantal kenmerken van de bilaterale structuur (onder meer enkelvoudigee aanwijzing) stimuleert een hechte band tussen staat en nationale luchtvaartmaatschappij.. Gezien de problemen die kunnen bestaan bij het voorkomen en oplossenn van conflicten tussen soevereine staten, wordt afzonderlijk aandacht besteed aan geschillenbeslechting.. Het blijkt dat conflicten voornamelijk door middel van consultatie wordenn opgelost. Ook in de relatie staatsluchtvaartmaatschappij wordt weinig gebruik gemaaktt van formele geschillenbeslechting. De wederzijdse afhankelijkheid is hiervoor de belangrijkstee reden. In de relatie staat-luchthaven wordt meer gebruik gemaakt van formele geschillenbeslechting,, onder andere vanwege de relatief omvangrijke hoeveelheid transactie- specifiekee investeringen die de luchthaven heeft gedaan. De bilaterale structuur kan worden beschouwdd als een variant van de transactie-specifieke structuur 'Staat', met een aantal kenmerkenn van de semi-specifieke structuur (regulering) in de relaties tussen staat en luchtvaartindustrie.. De bilaterale structuur staat in toenemende mate ter discussie. In meerdere jurisdictiess zijn pogingen gedaan om de structuur te wijzigen.

Inn hoofdstuk IV wordt ingegaan op de communautaire structuur. Voor een goed begrip van dezee structuur wordt eerst kort stilgestaan bij de Europese integratie en de rol van vervoer in hett EG Verdrag. Hierna worden de (fasegewijze) totstandkoming van de specifieke luchtvaartstructuurr en haar belangrijkste kenmerken besproken. Onder meer geldt dat institutionelee fectoren de ruimte beperken om nationale belangen te behartigen, er sprake is vann een meer-partijen overeenkomst en besluitvorming met gekwalificeerde meerderheid plaatss vindt. De lidstaten hebben hun bevoegdheden echter niet volledig afgestaan. Voorts zijnn luchtvaartmaatschappijen uit derde landen op de interne markt actief. Hierdoor kunnen in dee executiefase of bij het onderhandelen met derde landen problemen ontstaan. Het vereiste vann gelijkheid wordt gewoonlijk geïnterpreteerd als het recht op gelijke toegang tot de markt. Vervolgenss wordt ingegaan op wijzigingen in de onderscheiden relaties als gevolg van de communautairee structuur en wijzigingen in het vermogen van de staat om de nationale luchtvaartdoelstellingenn te verwezenlijken. Zo is bijvoorbeeld bij het verwezenlijken van de doelstellingenn van de staat de nadruk op de relatie staat-luchtvaartindustrie komen te liggen. Voorr wat betreft het voorwerp van de transactie wordt geconstateerd dat de aanvankelijke indelingg in afzonderlijke vrijheidsrechten inmiddels is geëlimineerd. Verder blijkt dat sprake iss van een grote mate van openheid van het transactieproces en van formalisering van dit proces.. Voorts zijn relatief veel partijen bij de transactie betrokken, waarbij het sluiten van compromissenn een grote rol speelt. Ten slotte wordt vastgesteld dat een supranationaal geschillenbeslechtingsmechanismee is gecreëerd en dat het belang van rechtspraak is toegenomen.. Onder meer vanwege het gelaagde karakter ervan kan ook de communautaire structuurr als een variant van de transactie-specifieke structuur 'Staat' worden beschouwd. Omdatt evenwel de transactie plaats vindt in de vorm van Europese regelgeving is er in dit geval,, in vergelijking met de bilaterale structuur, een groter aandeel van de semi-specifieke structuurr regulering.

Hoofdstukk V analyseert de bevindingen van de hoofdstukken in en IV, waarbij de kenmerken vann elk van de structuren en de kerndimensies van de transactie worden behandeld. Allereerst wordtt de structuur van de luchtvaartindustrie besproken. Het blijkt dat, ondanks het bestaan

198 8 vann externe effecten (zoals bijvoorbeeld luchtverontreiniging), een grotendeels geliberaliseerdee luchtvaartindustrie in staat kan worden geacht voor de staat aanvaardbare uitkomstenn te genereren. In de daaropvolgende analyse van de beheersstructuren op het punt vann effectiviteit wordt geconstateerd dat de bilaterale structuur beter presteert voor wat betreft hett vermogen te differentiëren. Verder draagt het gesloten karakter van deze structuur bij aan eenn hechte relatie tussen staat en luchtvaartindustrie. Met deze dementen kunnen prestigegerelateerdee en sociaal-politieke aspecten van het Nederlandse selectiviteitsbeieid goedd worden behartigd. Door de ruimere interpretatie van het gelijkheidsbeginsel presteert - voorr Nederland als relatief kleine staat - de communautaire structuur beter op het punt van de financiëlefinanciële motieven. Deze uitkomsten impliceren evenwel niet dat de bilaterale structuur effectieverr is dan de communautaire, of omgekeerd. Een dergelijke uitspraak zou een oordeel overr het relatieve belang van de motieven behelzen, hetgeen niet tot het domein van de economiee behoort. Voorr wat betreft de transactiekostenefficiëntie kan worden geconstateerd dat de prestatie van dee structuren verschilt naar gelang de relatie die wordt bezien. Door de grotere openheid, de integratiee en de mogelijkheid van supranationale geschillenbeslechting presteert de communautairee structuur beter in de interstatelijke relatie. Door het afnemen van bevoegdhedenn op het interstatelijke niveau is de Nederlandse staat genoodzaakt zijn doelstellingenn in toenemende mate via de luchtvaartindustrie te realiseren. Hier staat tegenoverr dat op communautair niveau de vrijheid voor deze industrie (in elk geval voor de luchtvaartmaatschappijen)) is toegenomen. Dit creëert een toenemende frictie in de relatie tussenn betrokken partijen. De staat moet daardoor meer inspanningen leveren om de luchtvaartindustriee te motiveren, terwijl deze laatste meer geneigd is tot opportunisme. Verder zijnn de eisen die aan de luchtvaartindustrie worden gesteld vaak conflicterend. Aangezien zowell overheid en industrie als transactiekosten maken (bijvoorbeeld om het gedrag van de industriee te controleren of overheidseisen te interpreteren) is de bilaterale structuur op het vlak vann de relatie tussen staat en bedrijfstak transactiekostenefficiënter dan de communautaire structuur.. Er kan derhalve geen eenduidig antwoord worden gegeven op de vraag naar de relatievee efficiëntie van beide beschouwde structuren. Wel kan worden geconstateerd dat de allocatiee van beschikkingsrechten een belangrijke rol speelt bij de verdeling van transactiekosten.. Om deze reden wordt besloten te bezien welke relatie de beste mogelijkheid biedtt voor een vergroting van de transactiekostenefficiëntie. Vanwege de soevereiniteit van staten,, respectievelijk de mogelijkheid voor de staat om dwang te hanteren richting luchtvaartindustrie,, lijkt de relatie tussen staat en bedrijfstak de meeste kansen te bieden. Nu beschikkingsrechtenn over gebruik van het luchtruim in de communautaire structuur grotendeelss aan de luchtvaartindustrie zelf zijn gedelegeerd biedt die structuur de beste mogelijkheidd voor verbetering.

Hoofdstukk VI vat de bevindingen uit de voorafgaande hoofdstukken samen en beziet de derde vraagg die centraal staat in dit proefschrift: de mogelijkheden voor verbetering van de communautairee structuur. Allereerst worden aanbevelingen gedaan voor de interstatelijke relatie.. Geconstateerd wordt onder andere dat Nederland er baat bij zou kunnen hebben wanneerr de selectivhettsdoelstelling met een Europese in plaats van een puur Nederlandse blikk wordt ingevuld. Dh kan betekenen dat de preferentie voor de KLM wordt gewijzigd in eenn preferentie voor een communautaire luchtvaartmaatschappij. Een volgende aanbeveling is omm de verschillende aspecten van het selectiviteitsbeieid transparanter te maken, een rangorde inn die aspecten aan te brengen en de onderhandelingsruimte te identificeren. Mede hierdoor zoudenn de Nederlandse onderhandelaars in een eerder stadium van de onderhandelingen actief kunnenn zijn en een grotere invloed op de uitkomst kunnen hebben. Overigens kan Nederland,

199 9 alss relatief kleine staat, baat hebben bij een verdere overdracht van bevoegdheden naar het communautairee niveau, bijvoorbeeld wanneer onderhandelingen met derde landen zouden plaatss vinden. Over gevoelige kwesties als bijvoorbeeld de herverdeling van verworven rechten,, zou via de European Civil Aviation Conference op een laagdrempelige wijze overeenstemmingg kunnen worden bereikt. Ook het subsidiariteitsbeginsel kan worden gehanteerdd bij een beheerste overdracht van bevoegdheden. Voor een vergroting van de transactiekostenefficiëntiee wordt er onder meer voor gepleit de helderheid van het besluitvormingsprocess en de verdeling van bevoegdheden te vergroten. De onzekerheid die aann de communautaire structuur verbonden is kan hiermee worden verminderd. Vervolgenss worden aanbevelingen gedaan voor de relatie tussen staat en bedrijfstak. Op het puntt van de effectiviteit wordt onder meer de suggestie geopperd de luchtvaartindustrie te verplichtenn commerciële afspraken openbaar te maken. Hiermee kan de staat enigszins zijn afgenomenn beinvloedingsmogelijkheden als gevolg van integratie en luchtvaartallianties ondervangen.. Voorts wordt geadviseerd om het selectivitehsbeleid te vertalen naar expliciete eisenn en daarin een ordening aan te brengen. Gelet op de afgenomen invloed van de staat op dee luchtvaartindustrie zouden deze eisen zoveel mogelijk moeten aansluiten bij de eigen doelstellingenn van de bedrijfstak. Ondanks het vermogen van de luchtvaartindustrie om een efficiëntee uitkomst te genereren zou interventie van de overheid nodig kunnen blijven ter zake van,, bijvoorbeeld, regulering van gezondheidseffecten die het gevolg zijn van luchtvaartactiviteiten.. Vanwege de locatiegebondenheid is de luchthaven een natuurlijk object voorr deze interventie. De transactiekostenefficiëntie zou kunnen worden verhoogd door meer doeltreffendee - bijvoorbeeld financiële - prikkels te creëren, terwijl voorts de nadruk op outputcontrolee zou moeten komen te liggen. Het toezicht op de bedrijfstak en de handhaving vann gestelde eisen zouden moeten worden opgedragen aan een onafhankelijke handhavingsdienst. .

Tenn slotte wordt vastgesteld dat de in het proefschrift gehanteerde beschouwingswijze elementenn bevat die kunnen worden gebruikt bij het opstellen van overheidsbeleid met betrekkingg tot de luchtvaartindustrie en in het bijzonder ook bij het bepalen van de prioriteiten inn dat beleid. Een mogelijke toepassing is de allocatie van beschikkingsrechten over het luchtruim.. Eerder in het proefschrift is geconstateerd dat deze allocatie een belangrijke rol speeltt in de verdeling van transactiekosten tussen staat en luchtvaartindustrie. Op basis van de bevindingenn in het proefschrift wordt er voor gepleit om beschikkingsrechten die nu nog bij dee staat berusten aan de luchtvaartindustrie over te dragen.

200 0

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215 5

Epilogue e

Sincee the dose of this research in January 2000, various developments have taken place in the air transportt industry that may have some bearing on what has been examined. This epilogue addresses a numberr of these developments.

Att the industry level, KLM's financial position has deteriora^ as the airiine has fbuiKi itself confronted withh high kerosene prices and overcapacity on intercontinental routes. The year 2000 began with the announcementt of a major internal reorganisation. In May 2000, KLM decided to terminate its alliance agreementt with Alitalia. Despite discussions on the position of Milan's airports, the legal situation surroundingg traffic shares remained unclear. Furthermore, the agreement between the two airlines stated thatt Alitalia would be privatised no later than 30 June 2000. Yet, the Italian government had indicated thatt such a scenario would not be attainable. KLM's initially strong position as a partner in a far- reachingg agreement with another European carrier thus took a turn for the worse. As a carrier with a smalll home market, but with great ambitions, the company still needs a European partner to guarantee itss long-term survival. KLM started negotiation with British Airways. The latter airline seems to have shiftedd its focus away from its QneWorld partner American Airlines due to the difficulties surrounding thee alliance negotiations resulting from a link widi the UK-US Open Sides agreement and a number of anti-trustt issues. The current negotiations between KLM and BA are die third such discussions since the earlyy 1990s. Once again, issues concerning international route rights, anti-trust, nationality requirementsrequirements and the position of the home airports are creating stumbling blocks. At this stage, it is not certainn whether these negotiations will lead to an agreement. The initial period of exclusive talks elapsed inn July but was extended in August by a period of several weeks. What has transpired so far is that, in thee current setting, the status of flag carrier is becommg less important. KLM needs a partner and, givenn its financialposition , is prepared to accept a mincflty share man alliance with BA. Anyy such alliance would need die approval of various competition authorities, in particular, the Europeann Commission and the US Federal Trade Commission. Both institutions may tie their approval too strict conditions, such as those governing US carrier access to Heathrow airport. The Commission, forfor its part, may sense an opportunity to increase its mandate to negotiate air services agreements with thee United States. The United Kingdom's CAA has already given the Commission some support in a recommendationrecommendation to the UK government.

Ass was me case with Alitalia, one important aspect in an alliance with BA is the position of the airports involved.. Schiphol airport's growth potential will be an asset to KLM, especially considering the constraintss facing BA at its London home airport. The Dutch Minister of Transport has sent a letter to thee Dutch parliament, as a follow-up to the December 1999 decision, laying out the industry's ability to groww at Schiphol and describing how future relations widi the air transport industry will be managed. Notwithstandingg the state's wish to overhaul its relationship with the industry, the letter mentions a numberr of new behavioural instruments. The state will find it difficult to refrain from regulating the industry'ss output and behaviour, thereby worsening the current situation. It will certainly not improve relationss between KLM and Schiphol. Thee privatisation of Schiphol will be discussed after parliament returns from its summer recess. In Mayy 2000 (WRR) and June 2000 (CPB), respectively, recommendations were issued supporting the claimm that the industry mvironment did not require a continuation of state ownership. Att the institutional level, there is now a Commission proposal on access to information, which would leadd to a significant reduction of access. Parliament has asked the government to protest against the proposal. . Finally,, with respect to environmental protection, some concrete measures may flow from the 1999 Commissionn Decision formulating an environmental action plan. This may remove some of the Dutch concernss and help shift the state's attention to other problem areas.

217 7 Thee above comments again illustrate the dynamic nature of the air transport industry. In the Netherlands,, the industry may well change its face completely in the coming period. New considerations mayy call for further discussion and research. However, this journey has come to an end.

Septemberr 2000

218 8

Index x

Aanwijzingenn voor de regelgeving 12i AAPomtsPomts 124-125,165 ACII 71,118 Acquiss communautaire \\\ Adversee selection 22 155 174 AEAA ' 73* 112 Agencyy relationship 3 22 Airr Services Agreement ' 45 Airr Services Transit Agreement 44 Airr Transport Agreement 44 Airr transport industry 2 Airr transport rights I Arbitrationn 47 82 Asjes-Saeedd regime \ ]4 Assett specificity 2.4 J, 5.6.3, SS3 BB points 124,165 Bermudaa I Treaty 45 Bermudaa II Treaty 32 {35 Bigg Bang approach ' 94 Bilaterall 45 Bilateralismm 3^2 BNCC j 22 187 Bondingg (mechanism) 26 63 Boundedd rationality 2^.4 Cabotagee 73 g* Characterr trust 24,156,172,173 Chicagoo Convention 44 Chicagoo School 85 Clearingg House 71 Coasee theorema 12 J;0000 123,187 Cocohann 123}187 Co-decisionn 99 1Q2 120 Comitéé des Sages ' ' \\(, Consultationn 47 82 Contactt phase 14,3.5.1,4J.1 Contractt phase 14,3.5 J, 4.72 Contractt Soaal 99 37 Contestabilityy 139-140 Co-ordinationn costs 14 Coree dimensions ic Coree theory 140 Councill phase 121 Courtt of First Instance 4^ 4 Deregulationn 85 5Jj Designationn 4g 79 Dutchh Civil Air Transport Division (CAA) * 50 Dynamicc referral 91 127 ECC Treaty ', tt7 ^A^^ 45,70,118,189 220 0 Economiess of scale 5.22 5.22 Economiess of scope 5.2.2 2 Economiess of density 5X2 5X2 Economiess of experience 5X1 5X1 EEA A 96 6 Effectiveness s 2.5 5 Encirclementt strategy 46,146 6 ERTAA doctrine 106,110,111 1 Europeann Commission 4.5.1 1 Europeann Community 1,89 9 Europeann Council 100 0 Europeann Court of Justice 4.5.4 4 Europeann parliament 4.5.3 3 EFTA A 95 5 Exx post facto review 47,80,148 8 Exchange e 9 9 Executionn phase 14,3.5.3,4.7.3 3 Fairr and equal opportunity 46 6 Ferreiraa doctrine 73 3 Fiche e 123 3 Flagg carrier 44 4 Flagg state 72 2 Foreignn Affairs, Ministry of 50 0 Freedomss of the air 42 2 Freedomm rights 72,119 9 Frequencyy (of the transaction) 2.4.1,5.6.1,55.1 1 GATS S 74 4 Governancee structure 11,2.7 7 Grantorr state 72-73 3 Hardd rights 49 9 Harmonisation n 89,171 1 Hub b 68 8 Hub-and-spokee system 68,115,136,139 9 IATA A 70-71,118 8 ICAO O 69-70,118 8 ICER R 124,187 7 Industryy environment 2.6 6 Interestt harmonisation 25-26 6 ITA A 88 8 JAA A 62,98 8 JARR OPS 62 2 JARS S 98 8 KEPDD (Key Environmental Planning Decision) 52-53 3 Liberalisation n 56,89,135,146,171 1 Learningg by doing 94,182-183 3 Lobbying g 19-20,167,168,171 1 Luxembourgg Compromise 125 5 Maastrichtt Treaty 1,99 9 Mainport t 53 3 Marshallplan n 57,62,109 9 Memorandum m 49,80,148,156 6

221 1 Mega-carrierr $g Morall hazard 22 35 38 Nationalityy requirement 4g go 97 Negativee integration ' ' g9 Non-aviationn quid pro quo 78> 145^152,167,176 Nouvelless frontières 93 Openn permit 6Q 1 ^ 149 Openn Skies Bilateral ' 45* 145 Cforxirtaimsmm 2.4.5,5.6.4,5.9.4 Optimisationn strategy 5g 59 117 PASOO ' ' 62 PKB(seeKEPD) ) Pariss convention 43 Peacee Conference (Paris, 1919) 43 Peacee Conference (the Hague, 1899) 43 Poldermodell 55 J^Q Positivee integration ' gg P*^^^ 3.3.1.1,161,177 Propertyy rights 9_10 Propertyy rights theory 13 Publicc service requirement 106 119 Quasii rent ' 21 Quidd pro quo 46 REIAA 123 Regulationn 33 Regulationn (EC) 90 Relationall contracting 34 83 130 145 156 Reputationn (effect) 17 23 Scale-relatedd economies 5J2 Schengenn acquis 9*g Securitell decision 122 127 Secondd memorandum

223 3

Stellingen,, behorende bij het proefschrift van M. Ravoo, te verdedigen op 25 oktober 2000 te Amsterdam m

1.. Bij een transactiekostenanalyse zou naast transactiekostenefficiëntie het aspect effectiviteit expliciett moeten worden meegewogen.

2.2. Als een transactie kenmerken heeft die vragen om het gebruik van dwang of universeel lidmaatschapp kan de Staat de preferente beheersstructuur zijn. De ruil van luchtvaaitrechten heeftt maar in zeer beperkte mate deze kenmerken. Ter voorkoming van onnodige transactiekostenn kunnen beschikkingsrechten over het luchtruim worden toegewezen aan de luchtvaartindustrie. .

3.. Jezelf ontstijgen heeft veel meer te maken met instelling dan met de inspanningen die men zichh getroost.

4.. Het Nederlandse luchtvaartbeleid staat op gespannen voet met de beheersstructuur voor de luchtvaartt die geldt in de Europese Gemeenschap.

5.. Dromen zijn bedrog, evenals de werkelijkheid.

6.. Verbetering van de relatie staat-luchtvaartindustrie vergt zowel aanpassing van de luchthavenvergunningg als aanpassing van de vergunningen van luchtvaartmaatschappijen. In dee huidige voorstellen van de Nederlandse overheid komt slechts het eerste aspect aan bod.

7.. Hij die liever z'n mond houdt weet niet wat hij over zich afroept.

8.. De beheersstructuur voor de luchtvaart die in de Europese gemeenschap geldt biedt, in vergelijkingg met de traditionele beheersstructuur voor de luchtvaart, de meeste kansen voor eenn verhoging van de txansactiekostenefficiêntie.

9.. Het effect van een hoge transactiefrequentie op de hoogte van transactiekosten is onbepaald.