TCS Daily

Darwin Is My Co-Pilot

By John Baden - January 7, 2003 12:00 AM

Even the saints among us practice economics. Miracles aside, they must make choices among competing alternatives. Mother Teresa had to decide how, when, and where to allocate her time and other resources dedicated to the sick.

People deliberately or subconsciously weigh the benefits and costs of alternatives. Do we go to church or ski on Sunday mornings? Do we drive to Seattle or find a bargain airfare? We consider many margins, e.g., convenience, safety, timing, and price. Such decisions have large cumulative effects. Economics, the study of choice, helps us understand them.

Economics is best understood as a subset of evolutionary biology. Consider something that affects us all: the competition that drives the evolution - and extinction - of commercial airlines. This competition has predictable results.

Until the mid 1970s the Civil Aeronautics Board regulated airline ticket prices. According to Supreme Court Justice Stephen Breyer, 95 percent of the time the regulatory board acted to stop airlines from lowering their prices. Its goal was to stop competition.

Stopping competition, however, is akin to stopping any other natural force. According to Justice Breyer: "Now, if you take a group of competitors and make an artificial rule that prohibits them from competing on price then they'll still compete. They will compete on service." As a result, we had excellent service - and very high prices. The "great sandwich war" erupted and Continental established the "Aloha Pub" on flights to Hawaii. But, Breyer added, "The most important form of competition was simply putting on more flights and having ever more seats and having them ever emptier."

Flights within a state, however, were not regulated. Southwest Airlines flew within Texas - and reduced their weekend tickets to $15 across Texas. This situation, and a similar one in California, prompted airline deregulation. In 1976 only 15 percent of air travel was subject to discount fares. In 2001 96 percent was at discount.

Alfred Kahn was the intellectual and political leader of deregulation. He calculates that since deregulation, airline consumers save about $20 billion dollars a year with average fares down more than 40 percent. Under regulation, consumers had only one option, good service at high prices. Now the average consumer has lower prices but less service. Full fares have gone up 70 percent - but ever fewer people buy them.

The problems afflicting the major airlines derive from their protection under a regulated system. As such they had few incentives to control costs, especially labor costs. In 1992 Braniff went into bankruptcy, then Eastern, Pan American, and TWA. United is the latest to fail - but the Wall Street Journal reports senior 747 captains on United earn $290,400 per year, twice the salary of many university presidents.

Although United has more hubs than any other airline, and they are in the best sites, its market value is only $146 million. Meanwhile, Southwest is making a profit and is worth $10.6 billion. Competition works in a relentless, evolutionary process.

What's next? We can expect more airlines such as JetBlue to emulate Southwest's model. When long-established airlines compete with the leaner new ones, their fares fall short of operating costs and they abandon some destinations. For example, Southwest has displaced United from many western markets.

For frequent fliers, mainly business travelers who have logged a million-plus miles, flying is not a holiday adventure but rather a near necessity. They demand comfort and convenience, e.g., reserved seats and first-class amenities such as ample shoulder and legroom and upscale lounges such as Delta's Crown Rooms. With far less overhead than the established carriers, the new lean airlines compete to find the best mix of service and price.

In our less regulated environment, competition delivers products more finely calibrated to consumers' desires than did regulation. This evolutionary process punishes those who neglect consumers' preferences. The waves of creative destruction sweeping the airline industry are inherent to dynamic systems.

A niche for entrepreneurs to exploit is reduced hassle, now a huge cost of air travel. The first to offer "prescreened status" to approved passengers will be a winner. Eventually entrepreneurs will discover the means of implementing this improvement. We'll all be the beneficiaries.

John A. Baden, Ph.D., is Chairman of the Foundation for Research on Economics and the Environment (FREE) and Gallatin Writers, Inc. Both are based in Bozeman.

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