EAST-WEST CENTER EAST-WEST CENTER SPECIAL REPORTS Number 4 October 199 s THE ASIA-PACIFIC AIRLINE INDUSTRY: ECONOMIC BOOM AND POLITICAL CONFLICT SUMNER J. LA CROIX DAVID JONATHAN WOLFF The rapid growth of air traffic and related industries servicing Asia is straining existing facilities as well as threatening the framework of bilateral agreements that have governed Asia-Pacific aviation since the end of World War II. A U.S. call for free international trade in airline services is getting a wary reception from many Asian governments. East-West Center Special Reports are authored by scholars, journal• ists, and other commentators and examine issues of importance to the Asia-Pacific region and the United States. EAST-WEST CENTER fast-West Center Special Reports The contents of this paper may be present a thoughtful synthesis of reproduced lor personal use. 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Principal funding comes from and individuals with a broad interest Telephone: (808)944-7197 the U.S. government, with additional in Asia or the Pacific. Facsimile: (808) 944-7376 support provided by private agencies, E-mail: [email protected] The views expressed in this publica• individuals, corporations, and more tion are those of the authors and do than 20 Asian and Pacific govern- not necessarily reflect the views of the East-West Center. EAST-WEST CENTER SPECIAL REPORTS EAST-WEST CENTER Number 4 1777 East-West Road October 7995 Honolulu, Hawaii 96848 THE ASIA-PACIFIC AIRLINE INDUSTRY: ECONOMIC BOOM AND POLITICAL CONFLICT SUMNER ]. LA CROIX DAVID JONATHAN WOLFF CONTENTS Summary 2 The Ascent of Asian Airlines 4 Losses, Cost-Cutting, and Consolidation in the Global Industry 4 Entry, Expansion, and Profits in Asia 5 Summary 16 Bilateral Relations 17 Fifth Freedom Rights 17 Fifth Freedom Rights and the U.S.-Japan Aviation Treaty 19 The Future of Bilateral Agreements in Asia 24 Moving Beyond the Bilateral Regime 25 U.S. Views on Aviation Liberalization 25 Asian Views on Aviation Liberalization 26 Asia-Pacific Economic Cooperation (APEC) and Civil Aviation 28 From Restricted Bilateral to Open Skies Arrangements! 30 Asia-Pacific Aviation and the WTO 31 Conclusion 35 Endnotes 36. References 37 2 EAST-WEST CENTER Sumner f. La Croix is a senior fellow at the SUMMARY East-West Center and High rates of economic growth in Asia are spurring the rapid expansion of professor of economics at the University of commercial aviation industries serving Asia and the Pacific. The number of Hawaii. His primary passengers carried across the Pacific increased at an annual rate of 8.6 per• research interests are modern Asian indus• cent during 1982-92, compared with 5.4 percent on all other routes. And tries; property rights in with 16 of the world's 25 busiest air routes, Asia's major airports are already land, resources, and intellectual innova• near capacity. The region will soon account for the world's largest increase tions in the Asia-Pa• in aircraft purchasing, maintenance, and repair, generating tremendous cific region; and eco• nomic history. revenues for firms that service the industry. David fonathan Wolff, Although many Asia-Pacific nations are benefiting from the boom in air currently a consultant traffic, the continued expansion threatens the framework of bilateral agree• at the East-West Cen• ter, was recently ap• ments that have governed Asia-Pacific aviation since the end of World War pointed to the U.S. n. Growth in the number of passengers, airlines, and routes has stimulated Foreign Service. He formerly served as a competition and intensified aviation disputes, thereby increasing tensions foreign affairs aide in in the international relations of the region. Potentially, such tensions could the United States Sen• ate and has an M.A. fuel increased protectionism. from George Washing• The United States has been actively campaigning for countries in Asia to ton University adopt an "Open Skies" regime that would allow free international trade in airline services. Although liberalization would have positive effects, such as lower fares and more efficient airline management, some Asian govern• ments worry that it could also lead to predatory pricing, a retreat from low- demand routes, and a tendency toward oligopoly. And many Asian airlines, which owe their profitability in part to restrictive bilateral treaties, are partially government-owned; therefore, governments may be reluctant to adopt new competitive arrangements that eliminate or reduce these profits. Although free trade is usually superior to protected trade, it also gener• ates losers—countries whose national airlines would shrink or even disap• pear in a liberalized regime. Unless losing counties receive some compensa• tion, they are unlikely to support a free-trade regime. The Asia-Pacific Eco• nomic Cooperation (APECJ Working Group on Transportation could provide a forum for the formulation and discussion of new policies for international cooperation in aviation throughout the Asia-Pacific region. 3 EAST-WEST CENTER Asia's explosive economic growth has direct foreign investment flows to been accompanied by a rapid expan• Asia over the last 20 years.5 Finally, sion and transformation of the region's leisure travel has become the main airline industry. Between 1982 and source of demand on most interna• 1992, the number of passengers car• tional routes. Tourism is the primary ried across the Pacific increased at an industry for a number of the Pacific annual rate of 8.6 percent, and the Island nations and is growing in im• number of passengers traveling be• portance throughout the region. Be• tween Europe and the Asia-Pacific tween 1960 and 1992, the Asia-Pacific region increased at an annual rate of region's share of worldwide tourism 11.4 percent. On all other scheduled revenues grew from 3 percent to 16 international and domestic air routes, percent.* Rapidly rising per capita passenger traffic increased at an an• incomes in Asia hold promise for nual rate of only 5.4 percent.1 The dramatic increases in intra-Asian International Civil Aviation Organiza• tourism and air travel over the next - Expansion of air tion (ICAO} predicts that Asia-Pacific decade. transportation is air passenger growth rates will fall to This report provides a three-part critical to Asia's lower levels (6-8 percent) over the overview of this important and rapidly export-driven next 20 years but will continue to growing industry. First, we identify economies outstrip air passenger growth rates in and analyze major economic trends in 2 the rest of the world. the industry. Among these are in• For several reasons, air transporta• creased demand for new aircraft and tion is expected to play a larger role in ancillary services, growth in airport this booming and geographically far- infrastructure investment, privatiza• flung region than anywhere else in the tion of Asian flag carriers, relaxation world. First, the high population and of entry and price regulations, and income growth rates in many Asian increased intra- and interregional countries, will produce an astounding cooperation.* Next, we discuss.how increase in the demand for air trans• rapid expansion and transformation of portation services. The region already the region's aviation industry have led accounts for more than 50 percent of to increased political controversy. the world's population, and, by the Analysis of the bilateral system that end of the century, more than half of currently characterizes international the 25 most populous cities in the aviation services and of key bilateral world will be found in Asia. Second, disputes in the region illustrates this vast distances separate many Asia- increased level of international ten• Pacific countries (see map on pages sion. Finally, we consider the possibil- 20-21). About 60 percent of the air routes in the region are between cities * The report focuses on major trends in the Asia- that are at least 2,000 kilometers Pacific airline industry rather than the situation apart/ and a number of the countries within each country in the region. The analysis also focuses on the provision of air passenger in the region are islands or archipela• service, paying only passing attention to aircraft gos with few alternatives to air pas• manufacture and the air cargo industry. Thus, all senger travel. Third, expansion of air references to the "airline industry" pertain only transportation is critical to the region's to passenger air service. References to the "Asia- Pacific region" include the South Asian countries 4 export-driven economies. Business of India, Pakistan, Bangladesh, and Sri Lanka. demand for air travel has also been Service to the Pacific islands (with the exception enhanced by the rapid increase in of Hawaii| is excluded from the analysis. ity of improving the region's current ica, Europe, and Australia experienced international air service regime large cyclical losses in the early 1990s through the development of a multi• and have returned to profitability only lateral regime that would better unify since 1994. For example, in the early Asian markets.