Economics of the U.S. Commercial Airline Industry: Productivity, Technology and Deregulation

Since the beginning of World War II the U.S. Air Force and Navy have been the largest customers for the U.S. aircraft industry. Government policies toward the commercial aircraft and air transportation industries have been partly responsible for their records of innovation and productivity growth through the policy impact on demand for aircraft both military and civilian, through regulation and through the direct support of research.¹ The diffusion of scientific and manufacturing technology for airframes, jet engines and avionics, from military contractors to commercial manufacturers, the so-called dual use of technology or swing technology greatly benefited the U.S. commercial airline industry.

Shortly after the end of World War II, the airline industry was able to use civilian versions of wartime transport aircraft to meet a rapidly expanding market for air travel. The war itself was partly responsible for the broader interest in air travel. The advance in aircraft technology, particularly, the gas turbine engine, revolutionized the industry, and set the stage for a tradition of steady technological change in the decade that followed. Thus, entering the post World War II period, new technologies were available, and an extensive skill base of aeronautical engineers and flying personnel existed. Major production facilities were in place and a base of public acceptance for air travel had been created.¹ The development of the jet aircraft, commercial as well as military, overlaps the period of the piston-engined planes. Design of the Boeing B-47 began in late 1943. Douglas began design of the XB-43, essentially a modification of the XB-42, in 1944. Convair’s XB-46 design was also initiated in 1944. There had been interest in jets before, but no commercial firms in the United States had had sufficient interest and resources to take the lead in jet engine development. Thus, it is quite clear that so far as the United States manufacture of either military or commercial planes were concerned, jet development had to wait until the development of technology overcame the early obstacles. It is not clear when research on the specific commercial transports by United States manufacturers began. Boeing quite certainly was studying alternative models to the C-97 as early as 1950.

Regulation¹ of the airline industry began in the 1920’s when the U.S government began to award contracts to the airlines for the carriage of mail. Airmail was the major source of revenues in the early days of the airline industry. The U.S. Post Office and the Interstate Commerce Commission played decisive roles in the evolution of the airline industry structure. However, the failure of existing regulatory schemes, coupled with increasing passenger demand for air transportation led congress to establish the Civil Aeronautics Board (CAB) in 1938. The CAB was granted extensive regulatory authority over airlines providing interstate airline service, along with the authority to award routes, regulate fares and assure safe airline operations.²

The U.S Commercial Aircraft Industry experienced its initial period of rapid growth after the passage of the Kelly Act of 1925 and the Air Commerce Act of 1926. The Air Commerce Act provided, among other things, for the certification of aircraft types in order to promote greater safety. The first Approved Type Certificate (ATC) given under the Air Commerce Act was issued for the Buhl Airster C-3Am, a three-seat, open cockpit biplane, in 1927. By the end of 1931, more than 450 ATCs had been issued to 79 differently named aircraft manufacturers. Of these, 104 aircraft types were land planes with four or more seats intended for use as commercial transports.¹ Most of the manufacturers were unable to produce an economically successful aircraft in sufficient quantities to permit them to stay in business, and thus many existed from the aircraft manufacturing market. Among the early causalities were now unfamiliar aircraft manufacturers: Buhl, Alexander, American, Kreutzer, Hamilton, Bach, Ogden, Emsco, and Cunnigham-hall.² By 1932 there were 23 different types of planes representing nine different manufacturers in use by the then principal carriers in the U.S., among them were some legendary manufacturers such as Fokker, Ford, Boeing, Douglas, Fairchild, Stinson, Lockheed, Curtis and Northrop. In 1933, only five manufacturers supplied new aircraft to the airline industry.

Earlier studies of technological change in the semiconductor, computer and telecommunication industries¹ and in the aircraft engine and aircraft industries² provide evidence that the physical characteristics of technology can add substantially to the realization of econometric models of production. This chapter outlines the translog variable cost function will be applied to the airlines and the results analyzed in Chapter 7.

The translog variable cost function (equation 6.2) in our study is specified with one output (Y) revenue passenger miles, one quasi-fixed factor, the capital stock (K) of flight equipment that has been quality adjusted with technological parameters — payload, SFC, range, thrust and passenger capacity — and five variable inputs, labor (L), energy (E), materials (M), business services (S) and other expenses (O). A full description of the model can be found in Chapter 6. Efficient estimates of The Restricted Variable Cost Function (RVCF) over the period 1970-1992 (161 observations) for the seven major carriers were obtained using the Generalized Method of Moments (GMM)¹ estimation algorithm in the TSP (Time Series Processor) econometric software program.² All of the parameters in the RVCF model are identified by estimating a pooled time series cross-sectional translog variable cost function jointly with a revenue equation, and five input demand equations, instead of the value shares of inputs. The input demand equations are subject to the same linear homogeneity and symmetry restrictions as the share equations. Our regression coefficients are therefore in quantity terms rather than input value shares. The techniques of estimating translog cost functions with input demand quantities are described by McElroy (1987)³ and Norsworthy and Jang (1992)⁴. The fitted variable cost function satisfies at every sample point the regularity conditions that it be non-decreasing and concave in input prices.

We have presented and applied what we regard as the empirical framework for analyzing productivity, technological change and investment in commercial airline industry. The approach consists, first, of describing and understanding the major characteristics that distinguish the industry: its key institutions, technologies and practices, and only then engaging in a program of econometric estimation and inference. We believe that this approach represents a vast improvement over either shotgun econometrics or pure description that rhapsodizes about the peculiarities of an industry’s culture. The institution-based econometrics also is more fruitful than the use of simple linear regression models to analyze productivity, or the use of questionnaire-based information (typically ignoring such performance measures as profits, productivity, and costs) to analyzing business and economic phenomena. It is only from an institutionally conformal econometric specification, that we can analyze and describe quantitatively the effects of regulatory changes and provide strategic planners in the aircraft engine and aircraft industries with the technology-related information required for decision making. The information developed in this book is the empirical foundation for such decision making.