Coffee, tea or … bankruptcy?

Delta

and Northwest Airlines’ bankruptcy filings are the latest consequences of the troubles afflicting the long-established, or “legacy,” airlines. Inflexible work rules, above-market wage rates, under-funded fixed benefit pension plans, huge debt burdens, outdated business practices and high fuel costs burden the legacy carriers with enormous disadvantages relative to newer carriers who are flying by different rules.

To deal with these burdens, the legacy carriers have made dramatic changes. During the four years ending last December, they collectively reduced capital spending by 62% while simultaneously taking on $16-billion of new debt to cover losses; they cut annual labour costs by more than $6-billion and total annual expenses by more than $20-billion, and they eliminated more than 125,000 jobs. Despite these efforts, the industry recorded losses of more than $30-billion, is losing billions more in 2005, and seems poised for still more losses in 2006. Sisyphus wouldn’t trade places with today’s airline managers!

Sky-high fuel prices have recently made things worse, but lower fuel prices will not solve the industry’s problems. In most industries, producers are able to pass on raw material price increases to their customers, as they are doing today. For a variety of reasons, including very intense competition that limits any one carrier’s pricing power, the airline industry has consistently failed to earn adequate profits; cumulatively, the industry has lost money since its inception.

While analysts are closely focused on fuel prices — and occasionally note the major cost differences between low-lost carriers and their legacy competitors — little is said about the many unique burdens imposed on airlines by inappropriate laws and regulations. These include taxes and fees representing more than 25% of a typical ticket’s purchase price; labour laws enabling unions to drive compensation far above the amounts paid in other industries for similar work; and continuing underinvestment in the operation and construction of the air traffic control system and aviation infrastructure.

Among the most egregious of these burdens are those imposed by the nation’s bankruptcy statutes, which allow a failed carrier to use Chapter 11 to dramatically reduce its costs. In bankruptcy, airlines renegotiate aircraft and facility leases, disavow selected contractual obligations, revise or abrogate labour contracts, and even repudiate pension obligations — all the while continuing to operate. Airlines often remain in bankruptcy for extended periods of time.

Chapter 11 also protects inefficient, unprofitable capacity, since aircraft are always worth more in the air than on the ground. Without Chapter 11, failed airlines might have to liquidate, selling off their physical and operating assets. This would remove capacity from the system and restore some measure of pricing power to the industry’s remaining participants.

Chapter 11 also undermines responsible managements. In an intensely competitive industry providing a commodity product, the “dumbest competitor” — unrestrained by fear of failure — sets the standard. Thus, when irresponsible union demands are granted, or an improvident management adds unrewarding capacity or uneconomic service features, other managements are compelled to choose between matching the new “industry standard” and tolerating labour unrest and lost revenue. Since experience has established that matching irresponsibility is the better long-term business strategy, few managements have been able to resist the perpetual game of “follow the leader.”

While few in either management or labour aspire to bankruptcy, the knowledge that liquidation is unlikely has unquestionably been a factor in encouraging excessive demands by labour and imprudent actions by management. But the probability of liquidation rather than reorganization would likely provide substantial incentives for more responsible labour-management relationships, more cost-effective labour contracts, and more carefully reasoned business plans.

Revising the bankruptcy laws would certainly cause hardship for the communities and employees most involved with failed airlines. On the other hand, revising the rules would offer expanded opportunities for new competitors and for legacy carriers whose managements, unions and employees are most willing to adapt to new realities. Since the United States badly needs a vibrant, growing and successful aviation industry, new policies are clearly in order.

To build a better airline industry, we need bankruptcy laws designed to reward success and penalize failure. We need labour laws that better balance the power of unions and management. We need to recognize that travel drives economic activity of many kinds and benefits every community— and should revise the currently onerous structure of fees and taxes, which seems premised on the notion that only the airlines and their passengers benefit from the airline system. Finally, we need administration and congressional support for legislation to provide the FAA with the resources to build and operate an aviation infrastructure consistent with both U.S. aviation leadership and growing consumer demand.