Double Marginalization and the Counter-Revolution Against Liberal Airline Competition

Abstract

In the last decade, the Department of Transportation has abandoned its previously liberal, market-oriented policies towards international airline competition. While the policies of the 1980s and 90s were designed to maximize industry competitive dynamics so that consumers could benefit from ongoing improvements in price and efficiency levels, recent DOT policies have sought to reduce competition and entrench the position of the largest carriers. These policies have already led to the consolidation of 26 previously independent transatlantic airlines into three collusive alliances that would be virtually immune from future competitive challenges, and in 2009 the DOT has initiated a process that could see 23 previously independent transpacific airlines consolidated into those three same collusive alliances. While the DOT proactively used "Open Skies" treaty negotiations in the 1990s to undermine the ability of governments to reduce consumer welfare through artificial competitive barriers, recent "Open Skies" negotiations with the EU and Japan reestablished that private, bilateral discussions between large legacy airlines and government officials could dramatically restructure international airline competition in favor of those established legacy carriers. While the DOT used antitrust immunity in the 90s as a tool that allowed small competitors such as KLM and Northwest to offer consumers improved schedules and lower prices in previously underserved niche markets, since 2003 the DOT has used antitrust immunity to enhance the market power of the largest incumbents, leading to pricing shifts that appear to have created multi-billion dollar annual consumer welfare losses.

The abandonment of consumer welfare-based airline antitrust policies and the sudden shift to unprecedented levels of international airline concentration was made possible by the DOT’s evisceration of traditional antitrust immunity evidentiary standards. The DOT’s recent immunity grants to members of the Star, Skyteam and Oneworld alliances were based on willful non-enforcement of the Clayton Act market power test and the Horizontal Merger Guidelines’ requirement that applicants present verifiable, case-specific evidence of public benefits in order to meet the section 41308 test that immunity is required by the public interest. The DOT has supplanted the need for verifiable, case-specific evidence with a series of arbitrary “rules” that ensure that almost any antitrust immunity proposal will be found to automatically produce public benefits without any risks of creating market power. The most important of these is “double marginalization”, a rule which asserts that every time an immunity grant reduces international competition, consumer prices in certain connecting markets automatically fall 15-25%, regardless of actual market or competitive conditions.

This paper describes the process by which the DOT has used rules such as "double marginalization" to eviscerate traditional antitrust evidentiary standards, and argues that none of the post-2003 consolidation of international aviation would have been possible if the traditional public benefits or market power tests and the traditional evidentiary standards had been enforced. The dispute over evidentiary standards surfaced in late 2009 when the Department of Justice’s Antitrust Division objected when the DOT rubber-stamped the Star/Continental applicants’ unsubstantiated benefit claims. The DOT emphatically rejected the DOJ’s objections as an inappropriate interference with the DOT’s aviation policy and bilateral negotiation prerogatives, a position that was more fully articulated in a recent Dean and Shane Air and Space Lawyer commentary, which claimed that all recent DOT decisions were fully consistent with longstanding pro-consumer, pro-competitive policies, and attacked the DOJ and Congressional critics of the DOT’s antitrust approach as hostile to the interests of the US airline industry. This paper argues that the policies favoring extreme concentration and the effort to render the public benefits and Clayton Act tests meaningless reflect a major policy shift towards more active governmental management of airline industry structure, and represent a counter-revolution against the liberal airline competition policies of the 90s.

Keywords: antitrust, antitrust immunity, aviation, airlines, DOT, Open Skies, deregulation, mergers, consolidation, American Airlines, British Airways, alliances

JEL Classification: D43, K21, L43, L51, L93