Free Trade in Airline Services: Assessing the Proposals to Liberlize the Canada - U.S. Air Transport Bilateral David W. Gillen Mark Hansen Robson Ramos Working Paper UCTC No. 407 The University of California TransFortafion Center Urfiver~ity of California Berkeley, CA94720 The University of California Transportation Center The University of California Center activities. Researchers Transportation Center (UCTC) at other universities within the is one of ten reg/onal units region also have opportunities mandated by Congress and to collaborate with UCfacul~ established in Fall 1988 to on selected studies. support research, education, and training in surface trans- UCTC’seducational and portation. The UCCenter research programs are focused serves federal Region IX and on strategic planning for is supported by matching improving metropolitan grants from the U.S. Depart- accessibility, with emphasis ment of Transportation, the on the special conditions in California Department of Region IX. 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Universityof California TransportationCenter 108 NavalArchitecture Building Berkeley,California 94720 Tel: 510/643-7378 FAX:510/643o5456 Thecontents of this report reflect the viewsof the authorwho is responsible for the facts and accuracyof the data presentedherein. The contents do not necessarilyreflect the official viewsor policies of the State of Californiaor the U.S. Departmentof Transportation.This report doesnot constitute a standard, specification,or regulation. Free Trade in Airline Services: Assessing the Proposals to Liberalize the Canada - U.S. Air Transport Bilateral David W. Gillen Mark Hansen Robson Ramos Institute of Transportation Studies University of California Berkeley, CA 94720-1720 WorkingPaper Februao, 1990 UCTCNo. 407 TheUniversity of CaliforniaTransportation Center Universityof Californiaat Berkeley Abstract In tbAs paper we examinethe consequencesof changes to the bilateral agreement which regulates air transport betweenCanada and the United States. A hubbing competition modelbased on an n-player non-cooperativegame is used to simulate six alternative bilateral scenarios including the current positions of Canadaand the UoS.. Wefind that chan,gesto the biIateral does not havea significant effect on the total amountof traffic but it does effect the distribution of traffic betweencountries and amongcarriers and airports. For all scenarios up to cabotage both countries gain from the changein the bilateral. Two key results of the modellingeffort are the pronouncedasymmetry with respect to market shares attained by U.S. and Canadianairlh’aes in each others country under cabotage. Canadacan generally be expected to hub in smaller U.S. cities and therefore obtain less than 1%of the U.S. domestic market while U°S. carriers would gain 40%of the Canadian domestic market as major airports m Canadaare relatively more accessibleJ3ffferent bilateral policies have considerableand varying effects for different airports.Major capacity investments are planned for both Pearson and VancouverInternational and an assessment of these investmentsshould not be divorced from a decision regarding future bilateral poIicy.Canadamay wish to reevaluate their open skies position contained in the ’new ’bilateral’ proposal. The current U.S. proposal provides more benefits for Canadathan the current Canadianproposal Alternatively, CanaCamay wish to modify their open skies proposal with ’fences’ established restricting access to major Canadianhubs at Toronto and Vancouverjust as Canadianairlines are restricted at major Americanhubs. 1.0 Introduction In both the U.S. and Canadathe domestic airline industries have been deregulated in 1978 and 1988, respectively. The U.S. also movedto liberalize bilateral agreementsin 1978. These agreements, amongother things, allowed greater freedoms with respect to capacities, fares, routes, multiple desig-nations and competitionin scheduledmarkets. 1 This newtype of agreement was sig’ned by a numberof countries but no5 Canada. The primary agreement which regulated air ~xnsport (scheduled and non- scheduled, passenger and cargo) between Canadaand the U.S. was signed in 1966.2 It established route scheduleson specific routes3 (point to point) permitted to carriers in each country. U.S. carriers were permitted to operate on I6 routes and Canadiancarriers on 12. The agreementalso prevents one country from limiting the capacity, frequency or gauge of aircraft4 used. Fares, on the other hand, required approval by both governments. In 1984, as Canadamoved to significantly liberalize its domesticairIine industry, it signed a new agreementwith the U.S. governing regional, local and commuterair services. The agreementwas designed to reduce the time required for approval of applications and to encouragegreater transborder services at the local and regional level. 5 A step to further liberalize transborder air transport occurred in October of 1984 whenthe U.S. and Canada jointly agreed on an experimental programin which designated carriers were given automaticunrestricted access to Mirabel airport from any point(s) in the U.S. other than special international gateways.There were liberal pricing provisions and no limit on the numberof designated carriers. While ai1 the amendmentsto the 1966 Act and the agreementsresulting from the 1984liberalization policy movedin the direction of free trade in air services. Negotiations to revampthe Canadian-U.S.bilateral in a more fundamentedway are ongoing. In January of 1988, Canada and the U.S. signed a "Free Trade" agreement designedto gradually liberalize trade, across almost all goodsand services, betweenthe 1 SeeDresner, Hadro,Ac and Tretheway (1988) for a full discussion. 2 Thisagreement has beenamended on a numberof occasions.It is similarin structureand content to the BermudaI agreementbetween the U.S. and U.K.in 1946. 3 Thisis morerestrictive thana standardbilateml for air routeswhich would specify "points in CountryA" to specific"points in CountryB" for serviceby a carrier fromCountry A. 4 Chartertransport is governedby a separateagreement signed in 1976.It is moreliberal thanthe agreementgoverning scheduled traffic for capacity,fares andfrequency° The U.S. carriers currendydominate the scheduledmarket with 65% while Canadian carriers havethe bulkof the chafermarket (Dresner et al., 1988). 5 Routeapproval was automatic if 5 conditionswere met: aircraft capacity60 paxand payload 18,000 lbs; the city-pa/r wasnot in the 1966agreement; one city hadto be less than500,000 in Canadaor 1 millionin he U.S.; stage length400 mL in central Canadaand 600 mi. elsewhere;currendy not servedby carrier from applicationoriginating country. 2 two countries. A numberof products were specifically excluded from the agreement including transborder air transport. In 1985, Canadaand the U.S. exchanged’concept’ papers on the Bilateral Air Treatyas a prelude to future negotiations, and to maintainthe "spirit" of the free trade negotiations. The two concept papers were markedlydifferent. Canada, the bastion of conservatism in such matters, proposed essentially an open skies pohcy for North America. It advocatedcomplete freedom (in services and factors of production) incIuding cabotage but did not specifically address pricing and non-scheduledservices. 6 The U.S. concept paper was far less radical. It proposeda free trade marketin whichcarriers wouldbe permitted to serve any city-pair marketwhich crossed the border. This clearly ruled out cabotage. The Canadianposition was driven by the idea that "open sides" wouldallow CaJaachancarriers to competewith U.S. carriers on a moreequal footing. Withoutthis concept, U.S. carriers, it was argued, had a smacmraladvantage and could easily extend spokesinto Canadato collect traffic to U.S. hubs and distribute it over the rest of theft" system.7 Pre-clearance also provided Americancarriers with a competitive advantage. The U.S. was loath to adopt the Canadianconcept primarily because it would establish a precedent whichother carriers in other countries could demandand follow. In the case of both Canadaand the U.S., refusal to accept the other countries concept was based on the protection of the domesticairhne industry. Either proposal, it was hypothesized, would increase service and competition on transborder markets and would therefore benefit consumers.However, there is also someprobability that somesmaller markets mayhave service reductions while others wouldgain direct service to the U.S.. "Ibis latter outcomecould result in a serious shift of passengers awayfrom Canadian carriers.8 This research investigates the effects of changesin