The lunatics take over the asylum

British Airways on Thursday announced that the British Office of Fair Trading (OFT) and the US Department of Justice (DOJ) are investigating the airline regarding passenger ticket pricing, in particular about the degree of ‘fuel surcharges’ that have been added to ticket prices in the current environment of high oil prices. For some reason airlines put up prices in such environments by adding this separate ‘surcharge’, rather than simply increasing prices the way they would in response to an increase in any other cost. It is believed that a number of other airlines have been involved in this investigation, (Virgin Atlantic, American Airlines and United Airlines) but probably in the context of providing information rather than being targets for investigation.

Accusations are that the airlines were behaving as a cartel. If the various airlines were found to have colluded in setting the level of these price increases, then theoretically the airlines could be subject to huge fines and the executives of the airlines to prison sentences. The severity of these potential punishments means that actual collusion is unlikely to have occurred, and that what the airlines are doing is responding to one another’s price increases, and are simply taking advantage of an oligopolistic market lacking in competition. I can hardly blame them for that.

Why do I think this? Well, the four airlines mentioned (BA, Virgin, AA, and UA) are the four ‘designated carriers’ under the Bermuda II agreement between the US and UK.

What does this mean? Well, I have explained this in detail before, but a quick summary. Between the end of World War 2 and about 1980, international aviation was a cartel, in a very explicit and literal sense. Only a very small number of airlines were allowed to operate on international routes (often only two airlines – the national airline of each country – were allowed to operate between country A and country B). Fares, routes, and frequencies were set by bureaucrats and governments, and airlines were often not allowed to compete with each other on price, at least not explicitly. (In reality they did, which led to a large grey market in international tickets where tickets were sold through third party ‘bucket shops’ and the customer paid a lot less than the price written on the ticket). Over the years this has broken down in some places and some parts of the aviation market (eg flights within the EU) are extremely competitive, but in certain areas of the market quite a lot of the old structure still exists. One of the worst areas in which this is so is on flights between Britain and the US. Flights between these two countries are still governed by a treaty called Bermuda II. People who watched the movie ‘The Aviator’ will recall Howard Hughes fighting for the right for his airline TWA to compete against Pan Am on flights between New York and London. The story told in the film is essentially true, and it led to what was an unusually competitive arrangement for the time being negotiated for flights between the US and the UK. The resulting treaty allowed two airlines from each country to fly between the US and the UK. Most similar treaties only allowed one. However, that was the late 1940s. Market sentiment is different today from what it was in the 1940s. The argument for free trade is, I think, a little better understood than in the 1940s. Aviation is certainly a bigger industry than it was in the 1940s. A treaty allowing a total of four airlines to travel between the US and UK may have been generous then, but it is ridiculous now. However, that is essentially what we still have. The treaty is still in force.

Actually, it is not quite that bad. The treaty today only applies to Heathrow airport, where the two designated US airlines are now United and American rather than Pan Am and TWA. Other US airlines are free to fly to other British (and London) airports pretty much as they please, and they do (US Airways, Delta, Continental, and Northwest all fly to London Gatwick). However, Heathrow is where Business Class passengers want to fly from, so it is therefore much more profitable to fly into Heathrow than other London airports and this is made worse by the bizarre way in which landing charges are regulated, making it often cheaper for airlines to fly to London’s busiest airport than to less busy airports. Only four airlines are allowed to fly from Heathrow to the US, and these are United, American, British Airways, and Virgin Atlantic.

There have been various attempts to renegotiate Bermuda II over the years. US negotiators want Heathrow airport to be opened up to more US airlines. British negotiators have been unwilling to allow this without giving British airlines some access to the US domestic market. American negotiators are completely unwilling to allow this, due to the need that they feel to protect US airlines from competition in their domestic market. Basically, though, negotiators on the British side have been negotiating on behalf of the interests of British airways, and US negotiators have been negotiating on the interests of more varied US airlines (or perhaps more on the interests of airline workers’ unions). It has been entirely about vested interests on both sides. The interests of consumers have been of no interest to anyone. Talks have always broken down in nasty recrimination a few days after starting.

Essentially, British negotiators have been protecting British Airways’ oligopoly position so that they will not have to face competition on Heathrow/US routes, and so that they can charge excessive prices.

And now, antitrust regulators are now investigating and punishing BA and other airlines for charging excessive prices on the US/UK route. One government agency is legally maintaining a cartel, and another is attacking the companies involved for behaving like a cartel. Forgive me for suggesting we have entered the bizarro world.

Now, what is actually happening here?

As a starting point, I think we should assume that it is obvious that the actual pro-competition action is to abolish Bermuda II and allow an US airline that wants to fly to Heathrow to do so (subject to the airline being able to obtain landing slots, which is another related but separate issue).

I can think of a number of possible explanations. The most generous would be that the people in the DTI understand the idiocy of Bermuda II, and are undertaking this action to make this obvious to everybody else in the hope that the anti-trust action causes the whole system to collapse. In truth, I rather doubt it, as discussion of Bermuda II ghas been absent from discussion of the anti-trust action despite its centrality to everything, and I don’t think government works like this. Even if this is the explanation, action for this reason is very rough on BA, the other airlines, and their shareholders, who have done nothing but operate their businesses in the current regulatory environment. (I am not generally a fan of BA’s culture or business practices, but they are being hard done by here).

A less generous explanation is that the DTI is blindly doing what the law tells it to do, without any great understanding of why they are doing it or why and how the aviation market is regulated. This I may believe. Seeing that a market is anti-competitive and then deciding that positive action (ie more bureaucracy and regulation) is necessary to fix it is pretty normal for ‘pro-competition’ regulators. Actually attempting to see why the market is anti-competitive (usually “it’s the government”) and then doing something to encourage genuine competition (usually ‘reduce regulation’) is not what they do.

The least generous explanation of all is that the DTI do understand what is going on and that they simply want to meddle, or they simply believe that they know best. If strong action is taken against BT here, then essentially the DTI are taking away the ability of BA and other airlines to set their own fares between Heathrow and the US, and we are back to a situation where government decides who can fly on the route and decides what the fares should be. In effect, we are back to the overregulated situation of the 1950s, with a new name. What is depressing is that this will have been done in the name of ‘competition’.