US airlines should focus on service, not subsidies

At some point, a failing airline will just have to fail, writes Bashar Malkawi.

The Air Transport Agreement between the United States and UAE signed in 2002 addressed several issues such as user charges and fair competition.

The Air Transport Agreement allows a fair and equal opportunity for the countries’ airlines based on commercial considerations in the marketplace. Intervention by the US or UAE is limited to protecting airlines from prices that are artificially low because of direct or indirect governmental subsidies and support.

The US-UAE Air Transport Agreement has had a positive impact on the number of passengers between the countries. However, several major US airlines are calling to re-evaluate the bilateral agreement because they are facing economic hardships.

US airlines accuse Emirates and Etihad Airways of not behaving in accordance with rational business principles, resulting in a markedly unbalanced playing field. The focal point is not whether UAE airlines are government-owned, but whether they benefit from unfair government subsidies. The UAE government, to the extent it retains ownership stakes in Emirates and Etihad Airways, acts as a commercial shareholder and not as a guarantor of last resort.

The spat between US airlines on the one hand and Emirates and Etihad on the other reflects several internal and external factors. The US government has a long history of providing state aid to the airline industry, whether to airline manufacturers such as Boeing or airlines themselves. The US government has provided massive subsidies and bailouts to industries when they faced financial trouble. This applies equally to the country’s auto and airline industries.

The indirect subsidies given by the US government take the form of low-interest loans, grants, tax waivers and guarantees. The guarantees, for instance, require no immediate expenditure of funds – they are not loans in themselves – but rather provide the security necessary for airlines to obtain commercial loans they could not have otherwise obtained. Because of the high costs associated with the airline industry, some level of government support is necessary.

The US airline industry has itself to blame for its historically poor performance. There is a need for US airlines to adjust in the face of overcapacity of domestic airlines and stiff competition in the coming era of UAE airlines’ dominance. To compete with many foreign airlines, US airlines need more routes, more modern planes and lower prices.

It is an already overcrowded market. Competition puts immense financial pressure on airlines and forces them to cut fares to compete. The presence from low-cost carriers such as Southwest is cutting into the profits of Delta, American Airlines and United Airlines.

One way to alleviate the airline overcapacity problem would be for some US airlines to merge. Another way would be to lean more heavily on their hub-and-spoke systems to take advantage of the average cost decreases experienced when flights are full. Additional profits can be captured as airlines add new cities to their established hub-and-spoke networks. In addition, US airlines will have to reduce their labour costs and make their fleets more fuel-efficient.

The US bankruptcy code functions to some extent as a safety net for failing airlines. The law is lenient while trying to help financially distressed businesses in Chapter 11 bankruptcy. At present, courts do not have the power to challenge airlines’ reorganisation plans when they file for bankruptcy. Courts should allow an airline to emerge from Chapter 11 bankruptcy only if the airline has a real chance of surviving upon exit.

Turning to the issue of oil price, it is obvious that the record-low oil price is forcing airlines to change their operation and marketing practices. Low oil prices will have a significant impact on market outcomes if they remain low in the long run.

The airline industry worldwide is becoming increasingly market-based. As more countries, including the US, have deregulated their aviation industries, state subsidies and their effects on competition have become less of an issue. Concerns of the US airlines over foreign government subsidies are increasingly less relevant. At some point, it is necessary to allow a failing airline to fail. It is the time of laissez-faire in which airlines must operate efficiently and profitably or face going out of business.

Bashar Malkawi is the dean and a professor of law at the University of Sharjah’s college of law