Govts need to monitor new developments

NOVEMBER  2009 ISSUE

 

Like every other industry, aviation has been undergoing economic reforms for the past one and half decades. I think, more than most industries, aviation as a trading activity has been granted very special status, both domestically and internationally.
To understand this clearly, we need to go back to the origin of the “Convention on International Civil Aviation”, quite often referred to as the Chicago Convention.
When it was established in 1944, governments were able to reach a consensus on the framework for the legal and technical oversights.
The convention, however, failed to achieve the multilateral exchange of traffic rights for scheduled international air services and it was left to states to exchange these rights by means of bilateral air service agreements.
Apart from the obvious reasons of national security, it is difficult to conceptualise how traffic rights would be exchanged on a multilateral basis, having regard for the enormous disparities in economic circumstances in the various countries. There is no indication the situation is any different today.
Since the US “deregulation” of its domestic aviation in the late 70s, there had been strong lobbying by some states to include aviation within the General Agreement on Trade in Services (GATS), which came into force in 1995.
Currently, the application of the GATS Annex on International Air Transportation is confined to:
• Repair and maintenance services
• Selling and marketing of air services; and
• Computer Reservations Systems.
The Council on Trade in Services (CTS) has met several times since January 2000 and discussed amongst other things, the review of this annex. To-date it has not been able to agree on the expansion of the annex beyond these three categories.
In its third session of the review, CTS noted the concerns and questions raised by members about the need for effective and sustained participation of developing states in international air transportation.
There was strong support for ICAO (International Civil Aviation Organisation) to play a primary role in dealing with air transport matters and that the constitutional role of ICAO should be maintained and strengthened.
In this context, the CTS considered the proposed memorandum of understanding to be developed between ICAO and the WTO would be an important approach to clarify the respective jurisdictional roles, particularly in regards to ICAO’s responsibilities with respect to safety, security and environmental protection.
Views were also expressed that any switch to GATS as an approach to liberalisation would need to ensure the current gains of liberalisation were not lost and that there would be added benefit to the aviation sector in its entirety.
Meanwhile, the fifth ICAO Worldwide Air Transport Conference held in March 2003, agreed that there was a need for the liberalisation of the Economic Regulations of International Air Transportation Systems.
However, recognising the different levels of development, it resolved that liberalisation should evolve by agreement between like minded states and not imposed.
Currently, there is no clear indication that an agreed global multilateral system will emerge in the near future, and which organisation this process will fall under. This resulted in the emergence of several regional groupings of like-minded states who have formed Multilateral Air Services Agreements amongst themselves.
Such regional groupings include:
• MALIAT (US, Singapore/Brunei/NZ/Chile/Samoa), Fortaleza (Argentina, Bolivia, Brazil, Chile, Paraguay & Uruguay;
• The Andean Pact (Colombia, Ecuador, Peru and Bolivia, Yamoussukro (several African States); and
• PIASA—The Pacific Islands Air Services Agreement.
Freer skies?
People hold different views whether the skies are more or less open.
The key point to note is whether the air services agreements being negotiated today are fundamentally different from those negotiated say before the US deregulation. If they differ, how are they different, and identify if possible, why they are different.
To answer this, I have selected four basic operational elements of an air service agreement for consideration:
• The number of carriers that may be designated.
• The means of allocating capacity.
• The method of setting tariffs.
• The number of gateway airports.
Carrier designation
According to ICAO statistics, the impact of liberal aviation policies on carrier designation is minimal. Between 1966 and 1975, before US deregulation, the number of negotiations reaching multiple and single designation was about equal: 51% and 49% respectively.
However, between 1986 and 2006 there was a slight shift to multiple designations: 56% to 43%. Such small changes are probably not statistically significant in themselves. Agreements that specify that each party could designate “one or more airlines” have rarely been clear as to whether the intent was for multiple carriers on the same route or only that different carriers could be designated for different routes.
There are probably valid reasons for states not to specify their exact intent. Needs change and neither party may wish to be boxed into one interpretation which might prove to be of limited value in the future.
It is interesting to note that the increase in the number of new entries in various markets including this region is not necessarily the result of multiple designations. The major impetus to the addition of new competition appears to be newer interpretations; not new bilateral.
In other words, there is a greater willingness by authorities to accept new carriers under existing agreement structures. This is important in the Pacific Islands context, because the existing bilateral provides better protection against unfair competition and predatory behaviour than, say the PIASA-type multilateral agreement.
Capacity regulation
There are three main types of capacity regulation in the Air Services Agreement.
These are the traditional Bermuda-type equal opportunity; Predetermination by mutual agreement; and Free Determination based on market demand. As early as 1988, ICAO began noticing agreements expressly excluding unilateral capacity controls. However, this restriction on unilateral controls has not reduced capacity regulation, but has shifted control from unilateral to a bilateral stage. As a result, the impact of liberalisation on capacity is vague.
The increase in percentage of free determination agreements is more than offset by a greater increase in percentage of predetermination agreements.
Simultaneously, ICAO noted there had been a dramatic decline in agreements relying on the relatively liberal Bermuda capacity formula so widely accepted up till the late 1970s. This is also the case in this region.
Tariffs
The impact of liberal policies on the issue of tariffs is greater than the impact of the previous two elements. Between 1966 and 1975, sovereignty reigned supreme and no agreement used a tariff article which limited either party’s right to disapprove a tariff; all required dual approval.
However, almost 60% of the agreements signed between 1986 and 2006 limit each party’s right to disapprove a tariff. The nature of this group, classified as limited disapproval, varies. Some cases specify the need for dual disapproval as opposed to dual approval. In other cases, tariffs have to be accepted within specified price zones. Still others limit disapproval to specific issues.
Most agree that the freedom to unilaterally set tariffs provides airlines with greater freedom to respond to market forces. This freedom also appears to have become an accepted means of increasing carrier efficiency.
Under such regimes, only efficient carriers survive. What is not yet demonstrated, however, is how unilaterally set tariffs breed innovation in the market and in service.
Today, tariff matching—not innovation—appears to be the key phrase.
Gateways
The impact of international deregulation and liberal policies on the issue of gateways is by far the most interesting. As in the case of tariff articles, the number of observations—or negotiations—has greatly increased. Here, several major changes are taking place. First, there is a proliferation of new and revised routes within established markets. Second, there has been not one, but two, shifts in route structure. In both cases, there has been a movement away from the traditional single gateway format “from my major city to your major city and vice versa”. Instead, more and more contracting are exchanging additional gateways.
Just as dramatic is the change in agreements which do not name their gateways. Here, the non-specific route format—“from points in my country to points in your country”—is twice as frequently selected as in the earlier decade (200 to 104).
Two other recent changes are notable. In the first, sixth freedom is being authorised, allowing “points behind our country, via our country, to your country”. In the second, codesharing services with third-country carriers are authorised.
Implications for Fiji & Pacific
I have highlighted these trends, brought about by liberalisation on the four important components of the Air Services Agreement to illustrate how important for governments of the region to fully understand these developments and how they might impact on their future air transport systems.
We are witnessing two opposing views on how liberalisation should proceed. One is promoted by the advanced economics who favour an open skies policy and the other by the developing countries who wish to stage their own pace of liberalisation.
The reality
Air transport in the region is characterised by small and widely spread populations across many islands. The limited potential for outbound travel and the seasonal changes associated with the peaks and troughs in inbound tourism present a major challenge to the economic viability of the region's air transport system.
Political and social tensions in some islands nations are also detrimental to the maintenance of a consistent strategy and policy for air services.
Achieving viable and sustainable structures for the provision of air services for passengers and freight have thus proved an illusive goal for many of the small islands countries in the region. There are certain routes within the region that will never be profitable and many of these routes are being cross-subsidised by other more profitable routes. This is a very important aspect in the Pacific Islands context that is worthy of continuous consideration.
Liberalisation
The policy challenge for Pacific Islands governments is to identify and prioritise reform objectives. Broadly, their objectives should aim at ensuring long-term, stable, and robust provision of air services at reasonable prices and frequencies.
 Development of the tourism sector should also be seriously addressed as in many cases tourism will drive air transport development. Governments therefore need to decide whether their tourism objectives can best be met through a total liberalised policy as proposed through “PIASA”, or through a more liberalised “Bilateral Agreement.”
Pacific open skies
Many of the PICs have signed and ratified PIASA—Pacific Islands Air Services Agreement—a multilateral open skies air services agreement that allows airlines to fly in between and through the participating member countries. The agreement is now effective but so far, we have not witnessed any new developments or benefits that have been promised under PIASA.
I suspect that those states which have signed the agreement were not even sure  PIASA would work the way the consultants say it would, but they had high hopes there would be new airlines flying into their shores and opening new routes, providing competition and lowering airfares and freight rates.
Apart from Pacific Blue which had entered the region before PIASA was in effect, we have not witnessed any new entrants to the region.
Fiji
Fiji is the only significant PIC that has not signed PIASA although cabinet was reported to have endorsed it. Fiji currently operates under the bilateral air services agreement but in a more liberalised approach, very similar to Australia. To my knowledge, Fiji has not unnecessarily blocked any efforts to genuinely open up routes that are not currently adequately served and has always welcomed competition where real benefits can accrue. The Australia-Fiji, NZ-Fiji and Honolulu-Fiji routes are good examples of Fiji’s Flexibility.
It is important to understand that all these can be achieved under the existing bilateral system, where you have some form of control if things don’t work out the way you have hoped it would.
Competition
Competition can be good for a country, particularly one that relies much on tourism, because cheap fares definitely will attract more people to want to fly. On the other hand, competition, if unchecked, can lead to the demise of airlines as we have witnessed all over the world, even in our region.
This is how it works. In the battle to capture customers, airlines use a wide range of tactics to ward off competitors. Increasingly, price is the weapon of choice and frequently the skirmishing degenerates into a price war. Creating low-price appeal is often the goal, but the result of one retaliatory price slashing after another is often a precipitous decline in industry profits.
Looking back at the price wars of 1991/92, when American Airlines, Northwest Airlines and other United States carriers went toe-to-toe in matching and exceeding one another’s reduced fares, the result was record volumes of air travellers—and record losses. Some estimates suggested the overall losses suffered by the United States' airline industry in those two years exceeded the combined profits for the entire industry from its inception.
In the Pacific islands region, there is often a conflict between the objectives of the tourism sector and those of the airlines. The national tourism offices, hotels and tour operators want as much airline capacity to be provided at the lowest cost. On the hand, the airlines would prefer as many people to travel at the highest possible yield.
Many Pacific Islands governments now believe that airline competition will generate more inbound tourism and is good for the region. Governments argue that competition will encourage the efficient provision of airline services at the lowest possible cost and price. But the competitive model relies on existing carriers challenging each other in an attempt to improve their position in the industry and on new entrants exploiting the opportunities and preventing established carriers from excessive profiteering in the market place.
Of course, there are a number of barriers to competition which hinder this process. Lack of sufficient tourism infrastructure is clearly a major problem. In many Pacific islands countries, there is a shortage of good quality hotels. There is also the clear seasonality where there are highs and lows in demand from our traditional source markets. In these situations, a price war is likely to lead to a fight for market share rather than increasing the number of inbound tourists.
Price wars
 Competition relies on the ability of the airlines to compete and to challenge one another continuously. Although passengers benefit in the short-run from lower fares and high frequencies while the battle is taking place, they will suffer from four possible harmful effects in the long-run.
First, if the loser is more efficient than the competitor but is forced out of the market for whatever reason, competition will jeopardise the tendency towards innovation and efficiency in the industry.
Secondly, if the price war leads to the demise of the competitor, this can lead to higher prices and lower frequencies in the medium to long-run as the survivor seeks to recoup the short-term losses incurred during the price war.
Thirdly, there will be the tendency for carriers to withdraw from routes that are essential but not profitable.
Lastly, if the loser happens to be the national carrier, which is so vital for the nation’s long-term goals and tourism objectives, then you are left at the mercies of foreign carriers.
It is important for policymakers to understand that price wars can create economically devastating situations that take an extraordinary toll on carriers and their viability. No matter who wins, the combatants will all end up worse off than before they joined the battle.
In the case of Fiji, Air Pacific has proven its reliability and commitment to the tourism industry over the years. Although competition has brought some benefits to the tourism industry since Pacific Blue entered the market, the additional competition when Jetstar and V-Australia enter the Australia-Fiji route will definitely have a tremendous negative impact on the economic viability of the national carrier.
The challenge for Fiji is whether the additional benefits resulting from the competition can more than offset the impact on the national airline, but more importantly on the future stability of the tourism industry.
A stable tourism industry requires a stable and viable air transport system. The government therefore needs to monitor these developments closely to ensure that Fiji does not suffer in the long run, by using the bilateral system to its advantage, a tactic often used by Australia to protect the “National Interest”.