Foreign Policy

Aviation: The Politics and Economics of a Boom

By Ellis J. Juan

Getting stressed out about how to fly home for the winter holidays? Caught in the crossfire of the fare wars? Can't remember how many frequent flyer programs you've signed up with? Well, take some small consolation: air travel in the not-so-distant future may or may not get better, but it will become a lot simpler.

Within a decade, fewer than 10 "airline families"--groups of airlines linked by a variety of ties from ownership exchanges to marketing agreements and franchises² will dominate air transport markets. A handful of global operators will run the world's airports. Passenger and cargo aircraft will be assembled either in Seattle by Boeing or in Toulouse by Airbus.

A single, integrated air transport network serviced by supranational corporations will spur economic efficiency. That could be good news for air travelers who will see the average ticket price decline. But as this market forms, the ability of individual states to oversee and regulate air transport will erode, a development that raises troubling questions about the future of everything from air safety to airfares. Not only will nations be compelled to strengthen their respective regulatory capabilities, but they must find ways to integrate these disparate regulatory frameworks on an unprecedented scale.

In the past two decades, the aviation industry has undergone intense deregulation. While the state was the majority owner of most airlines in the 1950s and 1960s, private investors now control 75 percent of the airline industry--the remaining holdovers will likely be privatized within the next few years. Likewise, faced with the need to invest billions of dollars in airport infrastructure, 67 countries are privatizing their airport systems; air navigation services (air traffic control and communications--a subsector with national security implications) will most likely follow suit.

Deregulation has also brought about "Open Skies" agreements, which remove flight restrictions on air travel between and among nations. During the past five years, the United States has signed these agreements with 23 nations. Meanwhile, countries with relatively small air transport markets such as Guatemala and the United Arab Emirates are unilaterally declaring themselves Open Skies territories: any certified carrier interested in servicing their markets is free to do so. All told, if the United States succeeds in achieving Open Skies with Japan and the United Kingdom, approximately 60 percent of the worldwide air transport market will be deregulated and/or under an Open Skies regime.

Conventional wisdom holds that privatization and deregulation spur competition. But, in the long run, that will not be the case in the global aviation market. The concept of flag carriers (national airlines) will lose relevance as aviation markets allow all countries to offer whatever services they choose. The competition unleashed by this trend will force weak airlines to merge into a larger airline family or to disappear entirely from the market. Airlines, aircraft manufacturers, and airport operators will need to consolidate into efficient and large conglomerates to survive. Only then will they be able to muster the financial muscle, resilience, and know-how to meet the dictates of global competition.

Already in 1996, the 10 most profitable airlines accounted for almost 70 percent of the industry's net profits. Given this trend, airlines will seek to consolidate with other carriers through myriad partnerships ranging from ownership exchange (Royal Dutch Airlines and Northwest) to route integration (Delta, Singapore Airlines, and Swissair). Since 1996, European regulatory authorities have been analyzing the proposed merger of American Airlines and British Airways. If it is approved, the two carriers will control 65 percent of the lucrative North Atlantic market.

The rise of the aviation megacorporation will present nations with a broad array of regulatory challenges. Increased aircraft traffic will call for better harmonization of international safety and security standards and procedures. Control by one airline family over a dominant share of traffic in a key international air corridor raises questions about undue influence over pricing and servicing standards. New aircraft manufactured by different subcontractors in different countries will need to have reputable agencies certify their airworthiness. In short, the aviation sector will require state-led regulatory institutions on both national and transnational levels than can match wits with consolidated global corporations.

But any solution to these regulatory challenges must begin with those involved acknowledging that airline consolidation is inevitable. The evolution of air transport--like the evolution of telecommunications, energy, and finance--into a single global marketplace is an inescapable feature of today's world. And like its counterparts in other economic sectors, the globalization of aviation is not a pretext for declaring the death of the nation-state but an opportunity for modernizing the regulatory structures that nations must continue to rely on in decades to come.

Ellis J. Juan, an investment banker, is one of the worldÕs leading experts on the economics of the aviation industry.