This chapter may not be as entertaining as the movie with a similar title (with automobiles at the end instead of trucks), but I will promise you this: It will demonstrate how extraordinary things can happen when regulators and legislators pay attention to some very simple economic insights that had long been promoted by many economists before policy makers actually acted on them.
The insights center on the role that competition, rather than regulation of prices and entry, can and should play in markets that do not display characteristics of natural monopoly. The extraordinary consequences are the new businesses and business models in the world of transportation, as well as substantially lower prices than would be the case if prices and entry into the transportation business were still regulated. Indeed, I will bet that many consumers of these businesses, and even many of their founders, may not appreciate the extent to which they owe their good fortune to the power of some simple economic ideas that led to transportation deregulation in the late 1970s and early 1980s.
How did all this happen? The answer differs by industry. The public choice theory of regulation only explains the deregulation of air cargo transportation and rail traffic (where affected industries wanted it), but it doesn’t explain passenger airline and trucking deregulation (industries in which firms liked the regulated life). In all these cases, however, economists from across the political spectrum were well ahead of the politicians and regulators in advocating deregulation.
Economists did not predict every outcome of deregulation, however. That is not surprising since markets have a way of developing and revealing behavior that few can anticipate.
The fact that each of the transportation industries reviewed in this chapter was deregulated, especially during a Democratic administration, was something of a miracle. I have already previewed the reasons why in the introduction to this section, but the circumstances that led to deregulation of each of the transportation modes are sufficiently different, as are the natures of the platforms that each created for business, that each deserves its own short discussion. Along the way, I highlight the role of economists in prodding the processes along. In the last part of the chapter I document the huge impact that transportation deregulation has had on the economy, and more relevant for readers of this book, on many businesses that would not exist in their present form, if at all, without deregulation.
Since the invention of railroads, and later the car and the airplane, America has been a nation on the move. By one estimate, in 2007, total spending on transportation services amounted to $2.4 trillion, or about 17 percent of GDP,1 roughly on a par with health-care spending as a percentage of the economy.
It’s easy to take transportation for granted, except when something bad happens, like airplane crashes (which are much less frequent and generally less deadly than in earlier eras) or train derailments. But the fact is that our lives, as consumers, workers, and entrepreneurs, and as businesses, depend on fast and reliable transportation.2 People use their cars to travel to and from work, to go on vacations, to visit friends, and to shop. We use mass transit—railroads, planes, buses, and subways—for business and pleasure. Businesses require transportation services to deliver their supplies and final goods to wholesalers and, increasingly (in the case of Internet sales), directly to consumers.
This is all true now, but it took roughly two centuries to reach this point, beginning with the invention of railroads in the early 1900s. Railroads began as steam engines, the technology that defined the Industrial Revolution, put on top of wheels on tracks. The tracks cost a lot of money and time to build. The process of laying them, beginning in the populated east coast, and later extending throughout the country, culminating with the cross-continental railroad track project after the Civil War, was an immense undertaking. It was made possible with the combination of foreign financing and lots of cheap unskilled labor. Those who want to know more about this amazing story can read any one of several classic books on the subject.3
Unlike the other modes of transportation to follow—airlines, and even more so, cars, trucks, and buses—railroads require substantial fixed investments to operate, which means there are significant economies of scale in operating them, and economies of scale limit the number of firms that can operate at a profit.
In other words, it makes little economic sense to build multiple tracks between the same locations. Unless the tracks can be shared, then only one railroad can operate on them, much like telephone, electricity, or cable lines in landline telecommunications. Each of these industries is liberated from the economies of scale problem when there are multiple methods or modes of transporting people, goods, or electrons from place to place. That is eventually what happened to railroads, which always had competition from barge traffic in rivers and lakes in some places (but not all), yet clearly found more competitors once airplanes and trucks were invented. As is discussed in Chapter 11, the same thing happened in communications once information was digitized and capable of being sent through the air as well as over wires.
But I am getting ahead of the story, if only to let you see where it eventually ends. At the beginning, when railroads made their debut, they quickly became the principal mode by which goods, the supplies that made them possible (like coal), and people were transported over long distances. After the Civil War, complaints arose from shippers who objected to the alleged monopoly prices that railroads were able to charge. More complaints followed after the discovery and later refinement of oil in the latter part of the nineteenth century, as large refiners (notably Standard Oil) were able to extract volume discounts at the expense of smaller shippers that had to payer higher rates.
In response, a number of states attempted to control railroad rates, but the Supreme Court overruled their efforts in 1886 as an unlawful encroachment on the Commerce Clause of the Constitution. Congress responded the following year by subjecting rail rates to price regulation overseen by one of the nation’s earliest regulatory agencies, the Interstate Commerce Commission (the Comptroller of the Currency preceded it in the early 1860s, as the overseer of national banks authorized by Congress).
Although academics have disputed the need for the ICC in the twentieth century, one thing is clear: The agency and its mission were not demanded by the rail industry to which it was subject. Instead, the ICC and the rail rate and entry regulation it administered were definitely seen to be in the public interest.
The ICC’s mandate was extended in the twentieth century with the invention of the car and truck—motorized competition for rail. This extension of regulation better fits the public choice model, but only halfway: While railroads later wanted trucks under a regulatory tent to contain competition with them, the same was not true of trucking firms until they and later their unionized workers, too, became accustomed to the comforts of regulation. As for rail, the ICC not only limited the prices trucks could charge, but also required approval of new routes. The agency subsequently added other rules, especially on what trucks could or could not carry on their return, to further limit competition between trucking firms and rail transport.
The airplane was the next major transport invention, proving its value initially in a military context during World War I. When the war ended, the postal service used airplanes to deliver mail, which prompted private operators to use them for carrying cargo. Rather than give the ICC regulatory control over the airlines, however, Congress in 1938 created an entirely new agency, the Civil Aeronautics Board (CAB), to oversee prices and entry into both the cargo and passenger airline traffic business. Since planes flew routes that took them over rail tracks, and yet could only operate with large fixed investments in airports, they looked to policy makers to bring them under regulatory protection, too. After all, were not airplanes simply railroads or trucks with wings (to paraphrase the economist Alfred Kahn’s quip that planes were “marginal costs with wings”)? Since flying over specific routes exhibited economies of scale in much the same way railroads did, wasn’t there also a good public interest rationale to regulate prices and entry into the air traffic business as well?
Whatever theory best explains the creation of the CAB and the regulatory system it was supposed to implement, the CAB quickly moved after its creation to authorize a limited number of airlines fit to fly major point-to-point routes. No others were later allowed to fly these routes, at least as long as the CAB was in business.4
Once established, the regulation of prices and entry into the major modes of mass transportation became something like the woodwork or plumbing in a house: just taken for granted. Incumbents that had their routes were happy with them, even though price controls limited their profits. In return, the authorized carriers were protected from competition with new firms in all of the different transportation modes.
There was one major loophole in this cozy system: Under the Constitution, which authorizes Congress to regulate interstate commerce, the CAB could only oversee travel between states. What the states did within their own borders was their own business.
For most states, this didn’t really matter, because they were either too small or too sparsely populated to support multiple carriers within any transportation segment. This was not true in airline or truck traffic, however, especially in the two largest states (by land area): California and Texas. Both served their roles as laboratories well, especially regarding airlines.
Michael Levine, one of the pioneers of what would eventually turn into full-scale airline deregulation, and later William Jordan, published studies of intrastate air traffic in California in 1965 and 1970, respectively, and compared its cost to interstate travel over comparable distances. Their startling conclusion: Intrastate fares were roughly half the comparable interstate fares.5 This finding reinforced the conclusion reached in an earlier, more academic study by one of America’s then-leading industrial organization and trade economists, Richard Caves, of Harvard University, that the airline industry displayed no evidence of economies of scale and therefore was not suited for price and entry regulation.6 A subsequent study in the 1970s by economists George Douglas and James Miller (who later went on to head the Federal Trade Commission and the Office of Management and Budget) found that regulation led airlines to schedule too many flights, explaining their low load factors, while denying consumers the ability to choose cheaper, unregulated flights.7
It is difficult to understate how remarkable these economic studies were. Airlines were regulated, so it was thought, in order to reduce airline prices, ostensibly on the theory that air flight exhibited economies of scale and would enable airlines to exercise market power, or charge prices well above marginal cost. In fact, regulation shielded the major airlines from competition, and by encouraging them to compete on the basis of flight frequency rather than cost, the airlines responded by flying their planes roughly half-full. This had the effect of keeping average costs high, and likewise for passenger fares, which were regulated to ensure the airlines could recover their average costs with a profit on top.
This crazy situation probably would have persisted for a long time—the airlines were happy with it, after all, and passengers didn’t know what the world would look like with lower fares—but for a totally unexpected turn of political events.8
The origins lie in the decision by Senator Edward Kennedy, who upon learning in 1974 that he would be assuming the chairmanship of the ostensibly minor Subcommittee on Administrative Practice and Procedure of the Senate Judiciary Committee, cold-called one of the leading administrative law professors in the country at the time, Professor Stephen Breyer of the Harvard Law School (20 years later, Breyer would be sitting on the Supreme Court). Kennedy asked Breyer for a list of hearing topics leading to possible legislative reforms, and to come to Washington to direct the subcommittee’s staff. Among the list of administrative law topics he provided, Breyer included the suggestion that Kennedy’s subcommittee hold hearings to examine the impact of CAB’s regulation of the airline industry. Breyer was steeped in the economics of the subject, which he taught his law students, but told Kennedy he could not take the staff director position fulltime given his tenured position at Harvard. Breyer suggested instead that he work on the subcommittee’s staff during the 1974–1975 academic year, which coincided with his sabbatical. Kennedy accepted the deal.
Once on the job, Breyer quickly went to work organizing hearings that were held in 1975 that showcased the economists and their research, especially the contrast in fares between intrastate and interstate routes. The hearings stretched out over seven days, and brought in consumer advocates, officials from the CAB, and airline executives. It turned out that the only witnesses who favored the status quo were those who benefited from it, the industry and its regulatory agency. That coincidence, coupled with consensus among the economists that regulation was misguided, convinced Senator Kennedy that something needed to be changed.
Initially, the aim of the hearings was quite modest: simply to have the Antitrust Division of the Justice Department, as the arm within the Executive branch charged with protecting consumers from excessive prices, weigh in on regulatory matters before the CAB. As the hearings went on and as Kennedy became more engaged, he realized that the entire system of airline regulation eventually had to be dismantled. This was evident from the massive evidence compiled by the Senate committee report of the perverse effect of CAB regulation on airline entry and fares.9
Kennedy and Breyer both were politically savvy and aware that any move toward deregulation could bring the risk of higher fares on routes to smaller communities, an especially sensitive issue with rural state senators. The legislation that eventually deregulated airline traffic met this concern by authorizing subsidies for these routes.
The Kennedy hearings clearly got the airline deregulation ball rolling, and helped provide political cover for the Ford Administration to begin taking administrative steps to undo airline regulation, acting through the chairmanship of the CAB by John Robson. Robson took his first crack at the lowest hanging fruit, the aspect of regulation that none of the certificated carriers liked, air cargo regulation. Dating from the 1940s through the mid-1970s, only four carriers had certificates to fly cargo independently of passenger airlines (cargo could be flown in the belly of passenger planes but this was an exception), and had rejected other applicants seeking to carry both domestic and international air cargo.10
In the 1970s, the CAB relented and allowed a new company, Federal Express, to enter air cargo transportation, but at first only by flying small aircraft. Moreover, under the rules of the Interstate Commerce Commission (ICC) at the time, airlines could not transport air cargo by truck beyond 20 miles of an airport. Federal Express was severely constrained by this rule, which of course, appears totally anachronistic today. Both Federal Express and UPS now operate full fleets of planes and trucks that deliver all kinds of packages and cargo throughout the United States and all over the world. But in the highly regulated world before the 1980s, none of this was yet possible.
In 1976, Robson proposed an air cargo deregulation bill to Congress, but Kennedy was not able to convene hearings on both air cargo and passenger deregulation combined until 1977, by which time a new president, Jimmy Carter, had assumed office. The timing could not have been better. Carter and his domestic policy advisers had a strong commitment to transportation deregulation that went far beyond airlines. Given the strong backing of the air cargo airlines themselves, including the then upstart new entrant, Federal Express, Congress was able to pass an all-cargo deregulation bill by the fall of 1977, which President Carter signed into law in November.
Deregulating air passenger regulation was a heavier lift, because all of the established trunk carriers, with the exception of United, didn’t want more rate freedom if it also was coupled with more entry. If deregulation of passenger traffic was going to be accomplished, it was going to take a combination of both administrative and legislative action.
President Carter saw this from the beginning, realizing he needed not just a CAB chairman who was committed to airline passenger deregulation, where it could be accomplished administratively, but other commissioners and staff who had the same objective. The administration’s domestic policy advisers on these issues, Mary Schuman (then a young former staffer for Senator Magnuson), and Simon Lazarus (former staffer at the Federal Communications Commission, and someone with whom I later practiced law and who has been a longtime friend), found that leader in Alfred Kahn. At the time, Kahn was the leading academic expert on regulation in the country (he is profiled in the following box). He was paired with another notable academic, Elizabeth “Betsy” Bailey (also profiled shortly), together with some high-powered economic staffers, Michael Levine and Darius Gaskins. Both Levine and Gaskins went on to have remarkable post-CAB careers (discussed in later profiles).
Whether deliberately or not, Kahn and Senator Kennedy proceeded to act like a tag team whose actions reinforced the case for air passenger deregulation, leading to ultimate success. Kahn and his fellow CAB commissioners would take administrative deregulatory steps, setting the stage for Senator Kennedy, Senator Cannon (who had initially opposed deregulation but later joined forces with Kennedy), and eventually the full Congress, to see the virtues of going all the way.
For example, because neither Kahn nor Kennedy would have wanted airlines to increase their fares on certain routes out of the box, the CAB moved quickly in 1977 to grant permission to the airlines to lower their fares without filing new rates (which otherwise could have been contested and thus delayed for months, if not years). Although the airlines might have objected to lower fares, certainly consumers would not, so this was a clever political strategy that also validated the earlier-cited academic studies documenting lower rates on intrastate routes than interstate routes of comparable distance. The Kahn-led CAB also liberalized entry for carriers serving certain underserved airports such as Newark, Baltimore, or Chicago’s Midway (all thriving airports today).
The CAB’s air passenger initiatives, coupled with the success of air cargo deregulation, and the activism of Senator Kennedy, combined to push the landmark airline passenger deregulation bill into law by the end of October 1978. The law phased in deregulation over a five-year period and eliminated the CAB as of January 1985. Airline safety regulation remained at the Federal Aviation Administration, while authority for international airline negotiations and antitrust oversight was shared between the Department of Transportation (a mistake in my view) and the Justice Department.
Airline deregulation had some predictable, beneficial consequences—lower fares in particular—but also led to an unexpected restructuring of routes in the United States. The effects of airline deregulation on business, in particular, are explored in greater detail later in this chapter.
Once the deregulation ball began rolling with airlines in the late 1970s, it turned out to be hard to stop. Thank goodness, because that ball led to one of the most important, but largely unrecognized, policy reforms of that era: the deregulation of prices and entry into interstate trucking, and to a lesser extent, of railroads.
If price and entry regulation were not suitable for airlines, they clearly couldn’t be for trucking, which had both major national firms and thousands of independents all competing against each other, but under the thumb of a command-and-control regulator, the ICC. Yet neither the trucking firms nor their unionized workers from the Teamsters wanted this system to change. Forget delivering services to shippers in the way they wanted. To those doing the driving, it was good to have the government approving routes, and thus effectively limiting competition, and allowing the truckers themselves to use effectively legalized cartels or rating bureaus to set shipping rates that the ICC routinely approved. The regulated system ensured that the firms would have profits from which they could meet union demands for high wages. Public choice theory cannot explain how this cozy system ever would have been eliminated.
But public choice does help explain how it all got started. It didn’t take long after the automobile was invented and successfully commercialized for some companies to realize that these vehicles could do a lot more than carry people. With some modification, autos could be (and were) turned into trucks that would carry freight and directly compete with railroads but in a far more flexible fashion. Railroads were limited to carrying their loads down tracks, and once having arrived at their destinations, had to have their goods unloaded and put into the distribution chain—to manufacturing plants (if raw materials, like coal or metals), or to warehouses (if finished goods). The horse and buggy did much of this work, until the truck came along. And when that happened, the railroads faced a new kind of competition they hadn’t seen, for trucks were not only useful for ferrying goods to and from railroad platforms, but they could also carry goods long haul instead of railroads themselves!
Dorothy Robyn’s classic history of trucking deregulation (and later deregulation overall) pithily describes the chain of events that led to the industry’s regulation, and although she doesn’t explicitly embrace public choice theory as the explanation, her recitation of the facts demonstrates, at least to this author, the usefulness of the public choice framework.13
As Robyn tells it, the growing competitive threat posed by trucks to rail was not clearly evident until after World War I, during which the railroads were temporarily nationalized to support the delivery of men and equipment to their points of ocean departure for Europe. By the time railroads were returned to private hands in the 1920s, trucks had rushed into the vacuum for transporting goods and they clearly were a competitive force to be reckoned with. Using a time-honored tactic of harnessing the power of government to thwart competition, railroads first lobbied the states (reflecting the relatively weak power of the federal government at that point in history) to restrict entry into trucking and to set both maximum and minimum rates they could charge. By 1925, 30 states had enacted such regulatory restrictions.
The Supreme Court intervened by restricting the power of states to control interstate trucking traffic—the most important competitive threat to railroads that routinely crossed state lines—as a direct intrusion on the power of the federal government to regulate interstate commerce. So the railroad industry switched tactics, supporting a federal bill drafted by the national body representing the state utility commissions that gave states primary power to regulate trucks, while allowing appeals to be made to the ICC that then regulated rail. Truckers and labor opposed the bill. Advocates of public choice theory can claim victory with both stances: The railroads were acting in their economic interest to limit competition from a new technology and so wanted regulation, and they were opposed by the firms and employees using the new technology (trucks). It all made sense, but it also made for a standoff. The railroad-backed utility commissioners’ bill went nowhere in Congress, until the Depression.
Then things changed, backed by President Roosevelt, who despite his reputation for being an antibusiness president, sided with the railroads, fearing that cutthroat competition between the railroads and the trucking industry would cause only more unemployment in the midst of the Depression. Even many truckers (but not the entire industry or the manufacturers that made trucks) switched sides and supported Roosevelt’s National Industry Recovery Act (NIRA), which put most of the economy under the thumb of the government, but not the previous bill giving regulatory authority over trucks to the ICC that was perceived to be too much in the pocket of the railroads. Only after the Supreme Court struck down the NIRA as unconstitutional did the trucking industry give its support to what became the Motor Carrier Act of 1935, which put trucks and rail under the regulatory control of the ICC. In 1948, Congress followed up by effectively delegating rate making authority for trucks to collective rating bureaus (analogous to similar arrangements in the insurance industry, which were sanctioned in the McCarran–Ferguson Act of 1944).
It is difficult for readers under the age of 40 or so, or those who never would have experienced the impacts of trucking regulation, to appreciate the complexity, indeed craziness, of what regulation of the trucking industry became. Imagine a world in which the nature of the cargo and prices for moving it were approved for every departure and destination. In such a world, trucks could carry goods one way, but had to return empty, or maybe half-full, because authority to carry full loads on that same return route would have been given to other firms. Imagine how such a world would or, more accurately, would not have accommodated the rise of Internet retailing and the transformative impact it has had on the U.S. economy. Hold that thought in your head until I resume discussing the impact of trucking deregulation on the American business landscape later in this chapter.
Even more so than with airlines, the obvious question is: How was it ever going to be possible to eliminate regulation of trucking? Unlike airlines, whose fares voters actually paid, the costs of truck shipments were (and still are) hidden in the price of goods that consumers pay. Only buyers of supplies and retailers pay trucking costs, and these can generally be passed on to the next purchasers. Moreover, to the extent deregulation of trucking would reduce shipping costs, the benefits to each buyer of trucking services would be small, as compared to the potentially large cut in wages, and possibly profits, earned by many truckers. Normally, such an imbalance in benefits and costs explains why status quos remain.
But the late 1970s were different and unique in several respects. First, once airline deregulation had been enacted, a precedent had been set for deregulating an even more diffuse industry, namely trucking, which clearly had no natural monopoly characteristics. Second, with Senator Kennedy again on board, the Carter White House took advantage of the momentum established by airline deregulation by helping to organize shippers and consumer groups to put pressure on Congress to take the next logical step and deregulate the trucking industry. Third, the ICC under the leadership of A. Daniel O’Neal in the early years of the Carter presidency took some initial administrative actions to loosen trucking rules, a process that his successor in 1980, Darius Gaskins, greatly accelerated. This was no surprise because Gaskins worked for Kahn at the CAB and, like Kahn, saw the virtues of a competitive, unregulated trucking market and persuaded his fellow commissioners of this view. Fourth, the general economic atmosphere at the time, another horrible episode of stagflation following the large increase in oil prices in 1979, had a silver lining for advocates of deregulation: It allowed them to claim that deregulation, which promised lower shipping rates, was needed to fight inflation. Alfred Kahn, by that time the administration’s inflation czar, and Charles Schultze, the chairman of Carter’s Council of Economic Advisers, were among those leading the charge for legislative deregulation using anti-inflation arguments.
It took all four of these factors to overcome decades of inertia, culminating in the passage of the Motor Carrier Act of 1980, signed into law by President Carter in July 1980. The Act eliminated government-sanctioned rating bureaus from setting interstate trucking rates (some states still maintained vestiges of intrastate controls after the 1980 Act), removed most restrictions on the commodities that specific truckers could carry, and got the government out of the business of approving routes and geographic territories for trucking firms. The Gaskins-led ICC moved aggressively after the Act to implement its key provisions.
The deregulation of the railroad industry, for both passengers and freight, was different and easier than for airlines and trucks, because in this case, the industry wanted to be out from under the government’s thumb. As we will see later, the industry, and the policy makers who listened to them, turned out to be right.
The introduction of regulation for rail differs from other industries, because it was motivated by a legitimate desire to curtail monopoly pricing by railroads in the late nineteenth century. As that monopoly eroded—due to stiff competition from autos for passengers and from trucks for freight—the case for having the ICC continue restricting entry while allowing the railroads themselves to set rates (a delegation of price regulation to the industry) also eventually fell apart. But it took an existential threat to rail for change to occur.
Given the rigidity of the collective rate making for railroad fares, railroads steadily lost traffic from the 1930s through the 1970s to other transportation modes, and for a number of railroads profits turned to losses. Deregulation was the only obvious answer to the industry’s problems and it happened in two stages.
In 1976, Congress gave railroads some pricing freedom in the Railroad Revitalization and Regulatory Reform Act (known as the 4R Act). But shippers wanted more flexibility to negotiate their own deals with railroads. This is what they got when the Staggers Rail Act of 1980 was shepherded through Congress by the chairman of the House Commerce Committee, Representative Harley Staggers. This Act effectively deregulated virtually all aspects of the rail industry, except for safety and a requirement that railroads with bottleneck tracks or facilities give access to connecting rail lines (similar interconnection requirements were later imposed on regional telecom carriers after the breakup of AT&T and by the Telecommunications Act of 1996, subjects discussed in Chapter 11).
The route to passage of the Staggers Act was facilitated not only by industry support, but also by the momentum generated by the deregulation of the airline and trucking industries. If these two industries, which competed with railroads, could operate freely, it was hard to argue that railroads shouldn’t be given the same treatment. Finally they were.
The deregulation of prices and entry in all sectors of the transportation industry has accomplished what the economists who supported it said would happen: It has lowered prices. One of the nation’s leading transportation economists, Clifford Winston of the Brookings Institution, by himself and with colleagues, has documented this result in multiple academic publications, using a methodology that is now recognized as the gold standard in the way to conduct such studies.15 Rather than simply look at prices or price trends before and after deregulation, Winston and his colleagues have constructed models to project what prices would have been in absence of deregulation and compare them to actual prices. Only by looking at these counterfactual examples can one know with any certainty whether deregulation has actually lowered prices. Nonetheless, it is still useful information to know that the pre- and post-deregulation data for airline prices, in particular, make clear the dramatic benefits deregulation delivered to consumers. Between 1978 and 2011, the real or inflation-adjusted passenger revenue yield (an average price measure commonly used in the industry) fell by almost one-half.16
Deregulation of transportation did have some unexpected results for the industries themselves, however, especially the airline industry, where at times the deregulation policy has been questioned (though it never has been reversed). The development of the hub and spoke system for airline routes was one unanticipated result, which on the whole has been a good thing by enabling travelers from non-hub locations to gain more frequent access to multiple destinations by flying to the nearest hub. Frequent flyer miles, a method airlines have used to ensure greater customer loyalty, was also an unanticipated result and a mixed blessing. Other things being equal, such customer loyalty arrangements can frustrate the ability of new entrants to entice customers away from established airlines, which diminishes competition. Nonetheless, even with these loyalty programs, the research shows that, on balance, average airfares are lower than they would have been under the old regulated system.17
A third development, which was entirely anticipated given the decline in fares, is much higher load factors, and thus less comfortable flights. Many readers may be too young to have experienced air travel when it was fashionable: People actually dressed up to fly. But because of its expense, air travel was limited to those with higher incomes and wealth. With deregulation, and the much lower fares it has brought, the panache has gone out of air travel—to put it mildly.
What is worse, at least from the passengers’ point of view, is that in their quest to become profitable, airlines have substituted smaller, more fuel efficient, but less comfortable regional jets for the older, larger jets that the airlines used to fly. This source of reduced comfort is not deregulation’s fault, however, since even in a regulated environment, airlines probably would have reacted pretty much the same way in response to higher fuel costs (unless the CAB would have approved passing on the higher costs to consumers).
Another result of deregulation that I do not believe was widely anticipated is the large variation in fares for essentially the same seats on the plane. This outcome was produced by yield management techniques that vary prices by when reservations are made. Airlines have also unbundled their services, generating another reason for fare variation. Passengers wanting a no-frills experience sitting at the back of the plane pay the least, while those wanting food, checking or carrying on baggage, entertainment, Internet service, and better seats, pay more for each of these items. Each of these developments—more fuel-efficient planes, unbundled pricing and service, and yield management—have led to much fuller planes, which has finally enabled many airlines to make money.18
It has taken a long time to get to this point, which many would say was unexpected. It is less surprising, however, if one considers the long time it has taken for the airlines to adjust their highly unionized workforces to a deregulated and more competitive environment. In this effort, the airlines ironically have been aided by multiple bankruptcies, which have afforded them leverage to gain concessions from unions, often repeatedly and by damaging employee morale. Another cost to the bankruptcies is that bankrupt airlines can keep flying while under judicial protection from their creditors. This has intensified competition, complicating efforts by all airlines to turn a profit. One response has been a rash of mergers, which airlines have sought in order to spread their fixed costs over larger route structures and passenger bases. The Department of Justice mostly accepted this consolidation until 2013, when the Department challenged the merger between US Airways and American Airlines. Like most challenged mergers in the past, this lawsuit was never tried because the parties worked out a plan of route divestitures (at this writing, the settlement had not yet been approved by the courts since some critics of the deal argue that DOJ gave too much to the merging parties).
Since airline deregulation was launched the industry has been in a constant state of upheaval. At first, a number of low-cost airlines entered the industry but, with the exception of Southwest, few have succeeded. Readers old enough may remember once popular upstarts like People Express and New York Air that have since disappeared, indicating that creditors are more apt to force liquidation of a new airline than a previously well-established carrier. A few newer airlines that offer better service, like Jet Blue, Alaska Air, and Virgin Air, nonetheless have survived, at least as of 2014 (Virgin’s rights to fly domestically are severely restricted because it is a foreign carrier and the United States still has not liberalized much foreign carrier entry into the domestic market).
Developments in the air cargo side of the industry following deregulation have been more predictable but also revolutionary. FedEx has grown into one of the largest transportation companies in the world, followed closely by UPS. Both established integrated air and truck transportation systems, so they could deliver packages directly to their destinations rather than having to hand them off to another mode. This kind of integration, and the efficiencies and customer conveniences it has brought, never would have happened without deregulation of both airline and interstate truck travel.
As for trucks, all of the predictions about deregulation in this industry—which was never a natural monopoly—came true for both segments of the industry, TL (trucks loaded full) and LTL (trucks that are less than full). With entry controls gone, the number of TL companies exploded, from about 20,000 in 1980 to 55,000 in 1995. LTL truckers, meanwhile, gained much more flexibility without the regulationera commodity traffic approval process. All in all, the industry became much more competitive and rates dropped, by at least 25 percent and perhaps more.19
Likewise, railroad deregulation also led to a major drop in freight rail rates, according to the Government Accountability Office, which also reported an increase in rail profitability.20 How could that be? Because the drop in rates induced a substantial increase in traffic, as rail became a more viable competitor to trucks for freight shipments.21
If the only outcomes of deregulating the transportation industry were lower prices, I would not have discussed the subject so extensively in this chapter. Rather I have done so because the deregulation of transportation has led to the formation of entirely new firms, while also fundamentally changing the way existing firms do business, or even stay alive. Indeed, it is hard to think how our modern economy would have developed over the past three decades, given the digital and Internet revolutions in particular, had the main transportation industries not been deregulated. In short, just as personal computing and mobile telephone operating systems have been platforms upon which entirely new apps firms were born, transportation deregulation has become one of the most important policy platforms for business in the late twentieth and early twenty-first centuries.
The key was not lower prices, although that helped. Instead, deregulation took the government out of the details of approving both prices and routes, and in the process turned firms that once offered services to customers on a highly rigid basis into flexible providers. And it was the flexibility created by deregulation—the ability of firms to get their goods from point A to point B using airplanes, trucks, or rail—that revolutionized the economy and the businesses operating within it.
With all modes of transportation deregulated, shippers could pit the various modes against each other for long-haul traffic. For short-distance traffic, where trucks were dominant, the multiplicity of firms offered much competition. The result is what we have today, which was not the norm during the age of regulation: Any individual or company can call or make arrangements for transportation anywhere in the United States, obtain multiple quotes and shipping times, and then make a decision about who to engage and at what price.
This total freedom of movement has been the lifeblood of both existing and new businesses in the age of the Internet, and even before. In the 1980s when Japanese manufacturing techniques seemed to threaten the viability of many American firms, one of the Japanese practices most singled out for praise (and worry) was just in time (JIT) delivery. Used heavily by Japanese auto companies, JIT cut down on the need for large inventories of parts, and relied on systems of tracking sales and production so that parts could be ordered just as they were needed, with time allowed for transporting them from their sources to the production line. With few or no spare parts hanging around, the companies didn’t need to spend cash to build stockpiles of parts to insert into the production line, but rather could rely on the parts being there as needed. To be sure, JIT systems were vulnerable to disruption (as the nuclear disaster at Fukushima in Japan proved in 2011) but, on the whole, they proved so successful that they were eventually adopted by U.S. manufacturing firms of all kinds. One of the early proponents was Michael Dell, who formed Dell Computer by using JIT to assemble the component parts of personal computers once they were ordered (that Dell later ran into trouble because PCs were being displaced by tablet devices in no way contradicts the importance of JIT, since tablet manufacturers also use JIT, as do many other manufacturers).
Now ask yourselves: Could JIT exist in a world where air, rail, and truck routes were tightly regulated? The question almost answers itself: of course not. If there is one word one associates with JIT it is flexibility, and no company relying on JIT to deliver parts and goods exactly when they are needed could compete successfully if it had to rely on transportation modes that were tightly controlled by an elaborate system of government approvals.
The other major force that has dramatically affected the U.S. economy over the past two decades, of course, is the Internet, and the rapid growth of web retailing. One company, Amazon, symbolizes the power of this phenomenon, but it is hardly the only one. Today, no retailing enterprise of any size can survive without an Internet presence, although the amount of “e-tailing” by conventional bricks-and-mortar companies has not picked up as rapidly as many may have thought.23
But just as there is a massive physical infrastructure that makes virtual reality possible on the jumble of wires, cables, and switches that constitute the Internet—there is a massive transportation network that enables Internet retailers of all kinds to deliver the goods that customers buy through third-party shippers, such as UPS or Federal Express. That is possible because these transportation networks can pick up ordered items virtually at any place, at any time, without the need to gain advance approval from a regulatory agency, as would have been the case before deregulation. Indeed, the only way companies like Amazon could have launched in a regulated era and promised multiple delivery options (other than the U.S. mail service) would have been to own their own transportation systems—trucks and planes—at the outset, something that few or any startups could have funded.
One huge irony is that the age of Internet commerce, seemingly untethered from the physical world, would never have developed as rapidly as it did without the fundamental policy reforms that transformed the physical transportation world in the late 1970s and early 1980s. Think about it: a world with far fewer retailers selling goods on the Internet than is the case now. Modern readers probably can’t imagine it—and a major reason is that a lot of transportation economists established that it was the right thing to do decades before the deregulation reforms were adopted.
Likewise, modern manufacturing would not be what it is today without JIT. But JIT would also not have been possible had the transportation industry been as tightly regulated as it was before 1980.
The importance of deregulation of transportation, in short, is easy to overlook. Hopefully, this chapter brings to life the extraordinary contributions of economists who helped make this policy change a reality.