Competition regimes and air transport costs: The effects of open skies agreements

Abstract

The relevance of transport costs has increased as liberalization continues to reduce artificial barriers to trade. Is it worthwhile to implement policies designed to increase competition in transport markets? Focusing on air transport, this paper quantifies the effects of liberalization of air cargo markets on transport costs. Between 1990 and 2003, the United States implemented a series of Open Skies Agreements, providing a unique opportunity to assess the effect that a change in the competition regime has on prices. In our sample, Open Skies Agreements reduce air transport costs by 9% and increase by 7% the share of imports arriving by air. Those results hold for developed and upper-middle-income developing countries but for lower-middle-income and low-income developing countries Open Skies Agreements do not reduce air transport costs.

Introduction

A close relationship exists between trade costs and the capacity of a country to increase its exports and to integrate in the world economy. The relevance of transport costs, as a component of trade costs, has been increasing as liberalization continues to reduce artificial barriers to trade. In many cases, the effective rate of protection provided by transport costs is higher than the one provided by tariffs (Clark et al., 2004, Hummels, 1999).

One of the most important and evident components of transport costs is distance. In its simplest formulation, the gravity model for trade, introduced by Linnemmann (1966), states that bilateral trade flows depend positively on the product of the gross domestic products (GDPs) of both economies and negatively on the distance between them, which stands for bilateral transport costs. The effect of distance on countries' volume of trade is significant: recent estimates of the elasticity of trade volumes with respect to distance indicate that when distance increases by 10%, the volume of trade is reduced between 9% and 15% (Overman et al., 2003).²

In addition to distance, many other elements influence transport costs. As Limão and Venables (2001) explain, transport costs and trade volumes depend on many complex details of geography, infrastructure, and administrative barriers, and on the state of competition in the transport industry. Given that distance and infrastructure-related costs are major determinants of the success of a country's export sector, immediate questions arise: What can governments do to “get closer” to markets with high import demand? Can improvements in infrastructure and regulation reduce transport costs? Is it worthwhile to implement policies designed to increase competition in transport markets? Do those policies have a quantifiable effect on transport costs and trade volume?

Not many papers have tried to estimate the effect on transport costs of policies that improve the quality of regulation and infrastructure or that implement new competition regimes. Focusing on infrastructure and using data from maritime shipping companies, Limão and Venables (2001) show that poor infrastructure accounts for more than 40% of predicted transport costs. In a study specific to the port sector, Clark et al. (2004) show that an improvement in port efficiency from the 25th to the 75th percentile reduces shipping costs by more than 12%. Fink et al. (2002) argue that both public policies, such as restrictions on the provision of port services, and private practices, such as collusive carrier arrangements, significantly influence maritime transport costs. Their argument implies a policy need to pursue attempts to break up international cartels in the maritime transport market. However, because their data do not include a change in the intensity of competition in the market (that is, from cartel to noncollusive behavior), they cannot estimate the effects on transport costs of a change in the competition regime.

The aim of this paper is to close this gap in the literature by estimating the effect of a change in the competition regime on air transport costs. We focus exclusively on air transport costs because of the increasing importance of the air transport mode, the availability of detailed microdata for U.S. imports, and the recent change in competition regimes introduced by Open Skies Agreements (OSAs).

The advent of wide-body aircraft in the 1970s made available large volumes of aircraft space. With the increased ability to accept palletized or containerized freight, airlines began addressing the air cargo market more aggressively. As the evolution and design of aircrafts made it possible to carry more cargo in an efficient manner, dedicated cargo airlines entered this market.

The size of the air freight and express market worldwide is approximately US$75 billions; during the 1990s, this market grew at an average rate of 6% per year.³ The United States explains almost 40% of total worldwide revenue. In the United States, as indicated by Fig. 1, the value of air shipments relative to the aggregate value of air and vessel shipments increased from 24% in 1990 to 36% in 2000. The drastic drop in air shipments in 2001 may have been caused by the restrictions that the United States applied to air traffic after September 11, 2001. In 2003, the relative value of air shipments was 32%, a fall of four percentage points from the peak in 2000.

In 1992 the United States signed the first OSA with the Netherlands. Since then, the United States has signed more than 55 OSAs with developed and developing countries in all continents (see Appendix B, Table B1). Those agreements give us a special opportunity to estimate the effect that a liberalized air cargo market has on transport costs. Given the literature's lack of estimation of the effects of OSAs–or any other change in competition regime–on cargo rates, this paper adds a new dimension to the literature that estimates the determinants of transport costs.

The results obtained have important policy implications. We find strong evidence that a more competitive air transport market–through OSAs–reduces air transport costs by about 9% and increases by 7% the share of imports arriving by air within 3 years after an OSA is signed.⁴ The results are driven by high- and medium-high-income countries. For low-income countries, we do not find a positive effect (that is, reductions in air transport costs) of OSAs. We interpret this result as evidence that in low-income countries other overriding barriers to competition prevent those countries from taking advantage of OSAs.

Improvements in infrastructure and in the quality of regulation also influence the level of transport costs significantly. For instance, our results suggest that for countries like Uzbekistan and Honduras, moving from their level of infrastructure availability (p25 in our sample) to that of France (p75) would reduce their transport costs by 10%. For the quality of regulation, our results suggest that for countries like Ecuador and India (p25), improving their regulations to the level prevailing in Greece (p75) would reduce transport costs by 14%.

The paper is organized as follows. Section 2 briefly summarizes the economics of air cargo. Section 3 presents the empirical framework, and Section 4 shows the results for the cross-section, the panel data estimations, and the change in the shares of imports arriving by air induced by Open Skies Agreements. Finally, Section 5 presents our conclusions.