By Merrill Goozner

The latest news about the deregulated airline industry leaves little hope that the American flying experience will rise above its sub -- Greyhound Bus standard any time soon. The steady march toward oligopoly continues. Service keeps deteriorating. American Airlines has taken over the bankrupt TWA. United Airlines may yet find a way to convince a Republican-run Justice Department that a merger with U.S. Airways isn't anti-competitive. And the Department of Transportation (DOT) has retreated from policing predatory pricing. Big airlines routinely offer targeted promotional fares just long enough to drive an upstart competitor from a route, or out of business entirely. Then fares rise back to their old level.

It wasn't supposed to be this way. Deregulation, which began in 1978, was expected to improve air travel through heightened competition. Removing entry and exit barriers and fare regulations would allow start-up airlines to flourish, proponents argued. These low-cost carriers would keep deregulated fares in check, provide competition on routes previously served by monopolistic carriers, and price air travel within the reach of average consumers. Industry officials and deregulation proponents claim that that's exactly what's happened. Deregulation advocates Clifford Winston of the Brookings Institution and Steven Morrison of Northeastern University have found that fares have fallen 27 percent on average because of deregulation, and that today's average route has 2.2 carriers, compared with 1.7 carriers before deregulation.

But other studies show that these cost savings are more the result of technology, and that fares, adjusted for fuel costs, actually declined at a faster rate before deregulation. Much of the so-called competition fostered by deregulation is a mirage: Smaller airlines are put out of commission in no time by the dominant carriers, who weather temporary price cuts and then jack up the rates again after they've outlasted their challengers. And quality of air travel has taken a major nosedive, with long delays, crowded planes, and an opaque fare structure that gouges travelers who have to book or change reservations on short notice, as well as anyone who happens to live in a monopolized urban hub or a small city.

A RATIONAL STRATEGY

One measure of the airlines' recent pricing power is their profit performance during the economic boom of the late 1990s. The industry used to have razor-thin margins that plunged into the red during economic slowdowns; yet it racked up $ 21 billion in net profit between 1995 and 1999 -- an amount that far exceeds the losses experienced during the first half of the decade, when economic growth was slow and a number of low-price carriers entered the field. Modest losses at five of the six largest carriers during the first quarter of this year suggest that the current economic lag will do far less damage to industry profitability than previous downturns did.

Like many old-economy industries, airlines' profitability has been enhanced by the computer revolution. Their proprietary reservation systems allow them to maximize fare revenue, especially from late-scheduling travelers. They also enable the airlines to turn up the price dials quickly whenever there is a sudden surge in demand for popular leisure travel destinations.

But the biggest reason major airlines' profits have soared since deregulation isn't computers; it's familiar corporate behavior that was made popular by John D. Rockefeller and outlawed in the 1914 Fair Trade Commission and Clayton Acts. According to a DOT study released in mid-January (conducted by Clinton V. Oster, Jr., of Indiana University and John S. Strong of the College of William and Mary), airlines that have near-monopoly status at hub airports have shown time after time that they can use their size to drive low-cost carriers from their markets. How? Predatory pricing and dumping of surplus capacity. Laments Alfred E. Kahn, economics professor emeritus at Cornell University and the architect of airline deregulation during Jimmy Carter's administration: "The reasons why we thought contestability would be high are the same reasons predation is so cheap." In other words, it's easy for an established carrier to match cut-rate fares selectively, for just long enough to drive a new competitor out.

When the big airlines also deploy special kickbacks to travel agents and offer additional miles in their frequent-flyer programs, the thinly capitalized low-cost carriers that are trying to break into a market have about as much chance to do so as Saddam Hussein's air force. All a major airline has to do is bring in its planes and slash prices until the upstart is driven from the field.

For example, in 1995 Spirit Airlines entered the Detroit-Philadelphia market, which was dominated by Northwest Airlines. Spirit started by offering one round-trip flight daily, with fares ranging from $ 49 to $ 139. It immediately garnered a quarter of the market. Early in 1996, the airline added a second flight and further increased its market share. Northwest struck back by matching Spirit's fare and flooding the market with discounted seats. The result: Northwest's revenue plunged, but the airline regained its entire market. In late 1996, Spirit quit the routes, unable to make money at its sub-par operating rates. A few months later, Northwest eliminated virtually all low-cost fares on the route, and its revenue returned to precompetition levels.

In all 12 cases cited by the Oster-Strong study, the upstart carrier offered initial fares at half the price of the market's dominant incumbent -- and the threatened major airline responded, like Northwest, with price cuts. Within two years, half the new carriers had exited the market because they were unable to make a profit. And in five of those six cases, the incumbent carrier's revenue two years later was higher than it was before the low-cost carrier entered the market. Indeed, it was high enough to make up for the money lost during the period of intense price competition. The study concludes that "predatory practices may be a rational strategy in the airline industry, in that short-term revenue losses may be recouped in the long term."

Rational isn't necessarily legal. In May 1999, the Department of Justice's antitrust division filed suit against American Airlines for predatory pricing at its Dallas -- Ft. Worth hub, where it carried 77 percent of all nonstop passengers at the time the suit was filed. During the 1990s, new airlines such as Vanguard, Sun Jet, and Western Pacific occasionally offered stiff competition on flights to second-tier cities like Wichita, Kansas City, and Colorado Springs. In each case, American responded by drastically cutting its fares until the fledgling was driven from the route. Then American raised fares and reduced service to accommodate the declining number of passengers.

Some legal observers have been banking on rigorous antitrust enforcement to curb the worst abuses by dominant airlines. "It increases the potential costs and makes [predation] a riskier strategy for the incumbent," according to William Kovacic, an antitrust scholar at George Washington University Law School. But in late April, U.S. District Judge Thomas Marten in Wichita dealt that hope a major blow when he dismissed the government's antitrust case against American before it could even go to trial. It's unlikely that the Bush administration will appeal. Bush's designated antitrust chief, Charles James, while at the D.C. power law firm of Jones Day Reavis and Pogue, represented Robert Johnson, the entrepreneur who plans to run DC Air, which will be spun off from the United -- U.S. Airways merger.

Tougher antitrust enforcement is an inadequate remedy for predatory airline pricing. For one thing, proving that airlines are engaging in predatory practices is virtually impossible under the rules set down by the conservative U.S. Supreme Court -- and even if the government had won in the lower courts, the verdict would have been easily challenged on appeal. In the past two decades, the Court has ruled twice against plaintiffs in predation cases. The first instance involved Japanese giant Matsushita Electronics, which in the mid-1980s was accused of a decade-long conspiracy to dump television sets in the U.S. market in order to drive domestic manufacturers from the field. (The other case, in the 1990s, involved a generic-cigarette manufacturer's challenge to Big Tobacco.) The Court claimed that it was implausible that a company would engage in economic activities with substantial profit losses [that] showed little likelihood of success. In a spirited dissent, Justice Byron R. White argued in the earlier case that the role of the courts is not to "engage in academic discussions about predation," but to inquire whether companies were actually making below-cost sales to drive out competitors. Unfortunately, like the deregulatory ideologues, the majority of the justices weren't about to let the facts stand in the way of a good theory.

It's true that the mere threat of antitrust enforcement can sometimes stymie airlines' anti-competitive mergers. (Northwest, for example, backed away from its attempted takeover of Continental Airlines after the Justice Department sued to block elements of the deal.) But as a remedy for predation, such enforcement often comes too long after the fact to have meaningful market impact. A low-cost start-up airline that has been driven out of business may hope for economic restitution, but any payback will occur only years after the company goes belly-up. That's hardly a business plan designed to draw new capital into the industry. Indeed, the number of new airlines dropped sharply in the late 1990s as evidence of widespread predation mounted. "Capital has dried up for start-ups because of their very poor record," said Edward Faberman, executive director of the Air Carrier Association of America, which represents low-cost carriers and small communities. "They sometimes fail because they make the wrong decisions; but they also fail because of what large carriers do to them."

THE DEPARTMENT OF PROCRASTINATION

A better solution would be for the DOT to go after predatory practices as they occur. It already has the authority to do so. But under three successive administrations -- and now likely a fourth, even with Democrat Norman Mineta as DOT secretary -- the department has largely ignored its responsibilities. More than two years ago, the agency proposed specific guidelines for when it would intervene to stop predatory behavior. It commissioned two studies, which were released this January, to justify its enhanced role.

But the industry mobilized its considerable political clout to stop the new rules. Since January 1999, it has contributed roughly $ 4.1 million in "soft money" -- almost double the amount given during the run-up to the 1996 presidential election -- according to the Center for Responsive Politics. Total industry contributions to congressional candidates grew to $ 6.5 million in 2000. Instead of enforcing its new rules, the DOT has agreed to continue evaluating predation and other anti-consumer practices on a case-by-case basis. In other words, there has been no change in policy.

The industry, meanwhile, has lobbied hard to kill a passenger bill of rights and has resisted all moves to enact rules that might eliminate some of the worst flying experiences. Today, one out of every four flights is delayed an hour or more. One out of 30 flights is canceled. Paul Hudson, who closely follows the airline industry for Ralph Nader's Aviation Consumer Action Project, points out that air travel in the 1990s has become slower than at any time since the 1940s for most flights under 1,000 miles. Between the delays and the plane changes in the airlines' hub-and-spoke system, flights that used to take an hour or two can now take up to five hours.

It is fashionable to attribute the industry's service woes to its customers: too many people trying to go too many places at the most popular times. "The problem is not that deregulation has failed but that it has been a smashing success," wrote Virginia Postrel, editor at large of the libertarian magazine Reason, in a New York Times column last fall. "Flying is no longer limited to an exclusive club." Proponents of deregulation say that the hub-and-spoke system allows airlines to fly more planes to more places with more frequent departures on the most popular routes. The free market has enabled travelers to trade timely arrival for improved frequency of service. But the exorbitant airline profits in the past five years suggest that prices are much higher than they need to be.

To solve the capacity problem, some observers -- such as Adam Bryant in his recent Newsweek article "7 Ways to Fix Air Travel" -- propose "congestion pricing": adopting higher landing fees at the busiest times instead of charging by weight, as is currently done. The idea is to force out small planes that hog valuable airspace during the rush hours. But it's not at all clear that this approach would drive away small private jets. Wealthy owners of such planes may not be sensitive to price hikes. Anyway, given the preferences of the many elected officials and corporate executives who have their own planes, this plan -- a form of regulation -- is unlikely to find much traction in Congress.

PRIVATIZE, PRIVATIZE

Deregulation proponents say the key to better service is more deregulation. They claim that privatizing the airports and air traffic control system will allow the market to allocate these scarce resources more efficiently and that it will provide the proper financial incentives to expand capacity.

But why would a private operator be any more successful than a public operator would in increasing the number of flights into an airport, when that requires either more runways or more hours of operation? A private operator would likely face the same economic constraints as the public authority. Airports have to negotiate long-term leases with the major carriers when they construct new gates or baggage handling and passenger facilities to accommodate increased traffic. The $ 1-billion reconstruction of Chicago's O'Hare International Airport in the 1980s is a case in point. The dominant airlines at O'Hare demanded control over the new gates as the price for guaranteeing repayment of the 30-year bonds sold to finance the project. Would a private operator have more flexibility because it financed its construction with corporate bonds instead of government bonds?

Allowing privatized auctions to determine allocation of airport space -- something the private operator ostensibly would be more inclined to do -- would be a recipe for further monopolization of the nation's air lanes. "If you open it up to an auction, the only ones who will get in are large companies," says Faberman of the Air Carrier Association of America. He cites the example of Delta Airlines paying huge fees for slots at New York City's LaGuardia Airport simply to limit the ability of a start-up gaining access to that busy facility. Adds the father of airline deregulation, Alfred Kahn: "Privatizing airports bothers me because you're talking about a monopoly. Airports, like transmission lines in electricity, are a natural monopoly."

The airline industry is now reaching the end of its second cycle of competition and concentration since the onset of deregulation. Even longtime friends of airline deregulation like Kahn have grown frustrated by the industry's seemingly inexorable march toward monopolization, which threatens to undermine the limited gains that consumers have registered over the past two decades.

Last fall Democratic Representative James Oberstar of Minnesota introduced legislation that would require the DOT to step in when the domestic market is reduced to three or fewer carriers that account for more than 70 percent of scheduled flight-miles. The agency would closely monitor air carrier pricing, anti-competitive responses to new entrants, and other predatory practices. In monopoly hubs, it could impose lower fares and limit the airline's slots and gates if the dominant carrier was charging unreasonably high prices compared with similar flights from non-monopoly airports. If a dominant carrier tried to undercut a new entrant with low prices, the bill would require that those low fares stay in effect for at least two years.

Oberstar's call for partial re-regulation is the beginning of sound policy. The airline industry has turned leisure travel into a gut-wrenching experience and business travel into a nightmare to be avoided at all costs. The time has come for the government to re-regulate the industry -- not with old-fashioned price-and-schedule setting, but in new ways that will preserve the benefits of competition while reducing bad customer service.

Start with the Oberstar bill. Then, let's create conditions that will allow real competition. Over the next decade, the nation will be investing in the air traffic control system and building new runways and airports to accommodate the needs of an expanding economy. A substantial share of the new capacity should be dedicated to new entrants and to flights to and from underserved communities.

Another way to increase capacity for start-ups would be to build an intercity rail system in the United States. Linking the major cities of the Northeast, the upper Midwest, California, Texas, and Florida with high-speed trains would give short-haul business travelers an alternative that's just as fast as plane service and leave them free to work while they travel. "It wouldn't pay," I already hear the deregulation ideologues screaming. Neither did the Erie Canal, the transcontinental railroad, airports and air traffic control systems, nor the interstate highways, all of whose initial construction entailed massive government subsidies.

When laying the basis for expanded competition, the government has to ensure that the new and the established carriers play by the same set of rules or it risks fomenting a race to the bottom in terms of service. A passenger bill of rights makes sense. Flights that are chronically late should be stricken from the schedule, and customers should have easy access to timely-performance records. The overselling of flights must be abolished, as should the practice of scheduling more flights at popular hours than airports can reasonably handle. Airlines could even be subjected to banklike reserve requirements that force them to maintain a small surplus of pilots and planes over current operations. Airlines are now operating so close to the bone during peak periods that any delay has huge ripple effects; some overworked pilots are even questioning the safety of the system.

But most important, the government has to get serious about policing unfair competition. In the past, the DOT has rarely exercised more limited powers than it does today, largely because it has become a captive of the industry. We need legislation to provide floors and caps in airline prices, so airlines can no longer charge in the thousands for a last-minute round-trip ticket from Detroit to Washington, D.C. Price floors would be low enough to allow start-ups to flourish yet high enough to prevent predation.

The monopolization of the airline industry is not inevitable. It is a consequence of the age of deregulation. In such circumstances, the government must step in -- not to set prices but to specify the terms of competition and mandate basic standards for the delivery of passenger service. This is, after all, the twenty-first century. Is it too much to ask that the planes run on time?

MERRILL GOOZNER, a professor of journalism at New York University, writes on a variety of business and economic topics.