Memorandum by the Civil Aviation Authority,
Economic Regulation Group (AS 05)
AIR SERVICES AGREEMENTS BETWEEN THE UNITED
KINGDOM AND THE UNITED STATES
SUMMARY
1. The UK-US market is the UK's largest international
aviation market outside the EU, comprising over 18 million passengers
in 1999, and is by far the largest aviation market between the
US and Europe. While relatively competitive by the standards of
international aviation generally, the market is far from fully
competitive. This is because the bilateral air services agreement
between the UK and the US, known as "Bermuda 2", contains
a host of restrictions including those covering routes, frequencies,
pricing and the ownership and control of airlines. The CAA believes
that the long term interests of air travellers will be best served
by a full liberalisation of international aviation markets. This
would involve the removal of all bilateral restrictions so that
the airline industry can compete on the same footing as other
industries.
2. This submission addresses the Committee's
specific terms of reference below. The principal points the CAA
makes are as follows:
— Full global liberalisation of international
aviation markets should deliver substantial benefits for the UK
economy, UK air travellers and the UK airline industry;
— The US Government's policy of "open
skies" falls substantially short of full liberalisation and
is designed permanently to benefit its own industry over that
of the UK and other major aviation nations;
— If the UK is to achieve full liberalisation,
it must consider the impact of any interim deal on the prospects
of securing the longer term objective. Increased access to Heathrow
for US airlines constitutes the major source of negotiating leverage
for the UK. In the CAA's view the UK should make significant concessions
in this regard only as part of an agreement which would deliver
full liberalisation;
— In the context of aviation negotiations
between the UK and the US, policy towards the grant of fifth freedom
rights should take account of the UK's negotiating position in
the round;
— Secondary trading in take-off and
landing slots at airports should be formally recognised and made
overt and transparent, thereby helping to ensure that slots are
put to the use of highest value;
— EU legislation requires that EU licensed
carriers be majority owned and effectively controlled by EU nationals
or governments. The UK is not free to negotiate bilaterally changes
to these rules. Consequently the UK is unable to secure full liberalisation
of the UK/US market on its own through bilateral negotiations
with the US;
— The only practicable means of achieving
a full liberalisation of the North Atlantic aviation market is
through EU/US negotiations. If it chooses to do so, the UK could
have a major influence on the shape of a future liberalised EU/US
aviation area, just as it did on the internal EU aviation market.
INTRODUCTION
The CAA's role
3. The Economic Regulation Group (ERG) regulates
UK airports and airlines and provides advice to the Government
on aviation policy from an economic standpoint. Its general duties
with respect to the regulation of airlines are set out in the
Civil Aviation Act 1982[18].
4. The CAA's policies towards the licensing
and regulation of UK airlines are set out in its Statement of
Policies[19].
Its long standing policy has been to promote competition between
airlines as the best available means of ensuring that users have
the widest possible choice of products, services and airports,
that quality of service is maintained and that fares are set at
reasonable levels in relation to the cost of providing them. Competition
also provides a powerful incentive to efficient operation and
the sound allocation of resources.
5. Responsibility for the UK's external
aviation relations, including the regulation of foreign airlines
serving the UK, lies with the Department of the Environment, Transport
and the Regions (DETR). As the licensing body for UK airlines,
the CAA liaises closely with the DETR on international matters
and participates in the most important bilateral and multilateral
consultations and negotiations. It has participated as part of
the UK delegation in most UK/US bilateral consultations since
the renegotiation of the Bermuda Agreement in 1977.
International Air Services Policy
6. International scheduled air transport
has been governed since the Second World War by a complex web
of bilateral air services agreements. These agreements have in
practice been used to severely restrict the degree of competition
in international air services markets, for example by limiting
the number of carriers each side may designate, the routes which
may be served, the frequency which may be operated and by constraining
airlines' ability to charge the prices they choose. Underlying
these restrictions has been the central principle that in order
to exercise rights under a country's bilateral air services agreements,
an airline must be majority owned and effectively controlled by
nationals of that country. The effect of this in general has been
to limit substantially, both in terms of numbers and variety,
the pool of possible competitors in any given international scheduled
aviation market. Airlines have been able to compete in international
markets between two countries other than their own only through
the exercise of specifically negotiated fifth freedom rights or
by carrying traffic via their own country (sixth freedom services).
7. The UK has for many years pursued a broad
policy of liberalising its bilateral air services arrangements
in order that both UK and foreign airlines should be free to serve
markets according to their own commercial judgement. The UK was
at the forefront of moves which resulted in the establishment
in 1993 of a single aviation market within Europe and the CAA
played a full part in these negotiations.
8. In advising the DETR in its bilateral
air services negotiations outside the EU, the CAA has advocated
that the UK's long term objective should be full liberalisation,
thereby placing aviation on the same footing as other industries.
Such full liberalisation would involve not only the elimination
of bilateral restrictions on numbers of airlines, route frequency
and capacity and fares, but also free access to cabotage markets,
the removal of special ownership and control rules and the engagement
of normal competition law and policy. It would result in a framework
within which UK airlines would be free to build global networks
through alliances, mergers or take-overs subject only to the application
of competition policy and without becoming entangled in the bilateral
negotiating process.
9. Such a long term objective of full liberalisation
will not of course be achieved overnight. However, it will be
important to establish a clear long term objective so that the
decisions which must be taken in the short term can be judged
against this.
BACKGROUND: THE
UK/US MARKET
10. The United States is the UK's largest
aviation market outside the single European market by a considerable
margin. In 1999, some 18.3 million passengers travelled by air
between the UK and US, over 17 million of whom used scheduled
services. For the UK industry, the US market accounts for a substantial
proportion of total output—some 11 per cent of total passengers
carried or 28 per cent of output measured in terms of revenue
passenger kilometres (RPKs). For the two UK scheduled airlines
operating to the US, Virgin Atlantic and British Airways, the
US market is even more important. Virgin's US routes contribute
around 80 per cent of its passengers and RPKs and are therefore
likely to account for a similarly high proportion of its turnover.
For BA the US represents 17 per cent of its total passengers,
36 per cent of its total RPKs and an estimated 29 per cent of
its total revenue. Virgin has for some years now been building
its position as the only UK scheduled airline currently providing
competition to British Airways on long haul routes. It currently
serves eight US cities (New York/Newark, Boston, Washington, Miami,
Orlando, Chicago, Los Angeles and San Francisco) and plans to
commence services to Las Vegas this summer. It also operates to
Tokyo, Hong Kong, Shanghai, Johannesburg, Cape Town, the Caribbean
and Athens, although some of these routes are served less than
daily. The North Atlantic is likely to continue to be critical
to the airline's overall profitability for some time to come.
11. Detailed statistics for the UK-US market
are given in Tables 1 and 2. Table 1 shows that in 1999, UK airlines
accounted for 58 per cent of the total scheduled market and 91
per cent of the charter market. US airlines' share of the scheduled
market has declined steadily since the 1991 "Heathrow access"
deal under which American and United replaced Pan-Am and TWA as
the two US carriers entitled to serve Heathrow. It is notable,
however, that the UK and US airlines' respective shares of the
market have closely reflected their respective capacity shares
as Table 3 shows, while in terms of frequencies the market remains
split almost exactly 50:50. In other words, it would appear that
the decline in the US share of the market may be closely associated
with US airlines' choice of using relatively smaller aircraft,
such as the B767, than their UK counterparts who use predominantly
B747 equipment.
12. The UK is by far the largest market
between the US and Europe. The latest figures available from the
European Civil Aviation Conference (ECAC) show that in the year
ending May 1998 total EU-US traffic amounted to some 39.3 million
passengers, of whom 37.6 million travelled on scheduled services
and 1.7 million on charters. During the same 12 month period the
UK accounted for 41 per cent of the total EU-US market. Table
4 shows how this traffic was distributed between the fifteen EU
Member States, and how these markets have grown since 1990. The
UK's share of the EU-US market has increased slightly over this
period. Annual average growth in the UK market of 6.5 per cent
has exceeded that of all of the other major markets with the exception
of the Netherlands, which has grown at an average rate of 13.5
per cent per annum. Germany is the second largest market but remains
well under half the size of the UK market. Indeed the UK market
alone is larger than the next three largest markets combined—Germany,
France and the Netherlands.
THE INQUIRY'S
TERMS OF
REFERENCE
(a) The impact of a continued failure to resolve
the negotiations over the bilateral air services agreement between
the United Kingdom and the United States on the economy of the
United Kingdom, on the position of the United Kingdom as the leading
gateway for air passengers between Europe and the United States,
and on the passenger and freight air transport industry
13. Compared with a fully liberalised North Atlantic
aviation market, the presence of government-imposed restrictions
on air services such as those in the existing Bermuda 2 agreement
inevitably imposes a cost on users and on the UK economy. However,
the impact on the UK economy of not achieving negotiated changes
to the current agreement will depend on what assumptions are made
about the terms of any new agreement. Any liberalisation of the
current agreement is likely to produce user benefits in the short
run. Whether or not these are translated into longer term benefits
and are maximised is likely to depend upon the degree and nature
of such liberalisation. The impact upon the UK economy will also
depend in part upon whether the UK-based industry continues to
be able to compete effectively with its US counterparts.
14. At the heart of this question lies a
key strategic issue. It seems to the CAA that the greatest economic
benefits in the long term can be secured only by means of a full
and genuine liberalisation of the global aviation market. There
would be a number of benefits from a global aviation liberalisation:
(a) The complete removal of ownership and
control rules would permit UK airlines to build global networks
through mergers, acquisitions or alliances as they saw fit, subject
only to normal competition policy. A fully liberalised market
would thus provide a more secure base from which to exploit their
strengths in the longer term. Ultimately, it is likely that control
of foreign airlines, and the greater scope for in-depth integration
of activities and effective management control which that would
allow, would be better than potentially unstable alliances.
(b) The UK airline industry comprises strong
and effective competitors, as is demonstrated by their performance
both within Europe and on the North Atlantic. There seems little
reason to suppose that they would not be able to succeed in a
genuinely liberalised market.
(c ) Global liberalisation would give UK
airlines wider access to capital markets and should result in
their being able to obtain capital more cheaply.
(d) Aviation investment, activity, and thus
employment, in the UK is much more likely to increase than decrease
as a result of genuine liberalisation.
15. The US Government has been energetically
pursuing its own "open skies" policy for international
aviation. It has now concluded some 45 "open skies"
agreements with countries around the world, including 10 of the
15 EU Member States. The five countries yet to sign a full "open
skies" agreement are the UK, France, Greece, Spain and Ireland.
In the case of the larger EU markets, the US has used the grant
of antitrust immunity for airline alliances (such as those between
Lufthansa and United, and KLM and Northwest) as leverage to secure
its bilateral objectives. However, the US "open skies"
model falls substantially short of full liberalisation. For example,
if all EU states agreed "open skies" bilaterals with
the US, this would give US carriers complete freedom to serve
any route they wished between the US and Europe. Their EU competitors,
on the other hand, would remain restricted to serving only their
own bilateral corridor between their home country and the US.
British Airways and Virgin, for example, would be unable to serve
the US from Paris or Frankfurt, while Air France would be unable
to do so from London.
16. Indeed, it such "open skies"
agreements were to be in strict accord with the US model, US airlines
would also be given the ability to develop networks within Europe
using widespread intra-EU fifth freedom rights. But there would
be no guarantee, or even probability, of equivalent access to
the US domestic market for EU carriers.
17. If negotiations between the UK and US
were to be resolved by the UK signing a US-style "open skies"
agreement, there would undoubtedly be some short term economic
benefits. However, the risk is that it would also make it significantly
more difficult, if not impossible, to secure the full liberalisation
which is necessary if the industry's contribution to the UK economy
is to be maximised and resources are to be allocated most efficiently.
Crucially, signing a US-style "open skies" agreement
would involve the removal of the bilateral restrictions on access
by US carriers to Heathrow without securing the removal of a host
of other bilateral restrictions, including those on ownership
and control or cabotage services. Such a deal would deliver all
of the US' bilateral objectives while leaving fundamental UK needs
unmet. Without the ability to use Heathrow access as negotiating
leverage, it is difficult to see how the US would be persuaded
to make future concessions.
18. There is no doubt that the restrictions
in Bermuda 2 are currently constraining the development of the
UK-US market. For example, British Midland is prevented from commencing
transatlantic services from Heathrow by virtue of the rule which
limits each side to two carriers at that airport. Bermuda 2's
capacity rules have from time to time been used to prevent airlines
on both sides from adding all of the frequencies they planned
in particular markets. In particular, United and American have
both been prevented from increasing significantly the number of
flights they operate from Chicago to Heathrow. The restrictions
on the number of gateways which each side's airlines may serve
from London have also occasionally prevented new services from
starting. In 1997, because only one unused gateway opportunity
was available to the UK at the time, the CAA had to choose between
BA's proposed service to Denver and Virgin's proposed service
to Las Vegas. More recently we have seen US Airways unable to
mount a service from Pittsburgh to Gatwick following BA's withdrawal
from the route (although this matter has now been resolved).
19. As described earlier, Table 4 shows
that the UK is by far the largest market between Europe and the
US. Other things being equal, one might expect the UK's share
of the EU-US aviation market to decline over time given that the
UK market could be regarded as relatively mature compared to continental
European markets. For example, as the size of the EU/US market
grows, increasing numbers of routes will become dense enough to
support direct non-stop air services of their own. However, the
evidence is that, if anything, the UK's position seems to be strengthening
rather than weakening. Table 4 shows that the UK's share of EU-US
air services was increasing, at least up to 1998, despite the
fact that many other EU countries had signed "open skies"
agreements with the US. Given the way in which Bermuda 2 is currently
constraining UK-US air services, liberalisation seems likely to
help the UK's share grow further, due fundamentally to the strength
of the underlying market.
20. That being said, there are clearly a
number of factors which are likely to affect the UK's position
as the leading market between the EU and the US, of which the
bilateral agreement is only one. US carriers may in future expand
services to continental points at a faster rate than their services
to London for reasons wholly unrelated to the bilateral position.
For example, the development of close-knit airline alliances enjoying
immunity from US antitrust laws has undoubtedly led some US airlines
to focus their transatlantic operations increasingly on the European
hub of their alliance partner. This applies both to Northwest,
in alliance with KLM, and to United, in alliance with Lufthansa.
It is also possible that an inability to secure slots at Heathrow
or Gatwick due to the constraints on capacity at those airports
will lead US carriers to add services or capacity to other European
points in preference to London. Indeed it seems likely that factors
of this sort will play a rather greater part in the decisions
of US carriers about how to develop their networks to Europe than
the constraints imposed by Bermuda 2.
21. A failure to negotiate liberalised arrangements
with the US is likely to hinder the development of the UK market
relative to others in Europe. But given the strength of the UK
market relative to those of other European countries, there appears
little risk that the UK's position as the leading gateway will
be threatened in the short to medium term. That being so, it will
be important to ensure that the framework which succeeds Bermuda
2 is that which will best enable the UK to fully exploit its inherent
advantages of market size and geographical position in the long
term.
(b) in particular, the benefits and disadvantages
for regions of the United Kingdom and for the nation as a whole
of granting increased numbers of Fifth Freedom Rights both in
the United States and Europe
22. There are a number of aspects relating
to the question of fifth freedom rights in the UK-US context.
The US "open skies" template demands the grant of open
fifth freedom rights as a key element. Full liberalisation as
advocated by the CAA would also include the removal of all restrictions
on fifth freedom rights, but would go further by removing not
only ownership and control restrictions but also those on cabotage
services.
23. While fifth freedom rights beyond the
UK would allow US airlines access to dense international routes
which provide a significant proportion of feed traffic for transatlantic
services, the same would not be true for UK airlines at the US
end. Table 5 shows for routes between London and the US the proportions
of traffic connecting at either end of the route in 1998. 34 per
cent of the total traffic on these routes made a connection at
London, of which 28 per cent, or over 4 million passengers, was
connecting to/from points outside the UK. At the US end of these
routes, on the other hand, of the 23 per cent of total traffic
which made a connection at the US gateway, only 3 per cent, or
less than 450,000 passengers, connected to/from points outside
the US. It follows that the reverse is true in terms of passengers
making domestic connections at each end of these routes. While
only 6 per cent of the market made a UK domestic connection at
the London end in 1998, some 20 per cent of passengers connected
to/from a US domestic point.
24. These figures illustrate first that
"beyond" fifth freedom rights are likely to be of significantly
greater value to US airlines than to UK airlines. Second, they
highlight the much greater importance to transatlantic services
of feed traffic from the domestic market in the US than from the
domestic market in the UK. This is why the UK has argued in the
past that any liberalisation of Bermuda 2 must deliver effective
access to the US domestic market for UK airlines. One means by
which this might be secured would be through the exercise of cabotage
rights, while removing the restrictions on foreign ownership and
control of US airlines would be another. UK airlines might also
be able to gain effective access through entering alliances with
US carriers. However, a solution based around the formation of
particular airline alliances would be very much second-best compared
to a full liberalisation which would establish a level playing
field for all airlines, irrespective of whether they chose to
enter into alliances with other airlines or not.
25. Putting aside these issues of fair competition,
the economic impact of granting fifth freedom rights from the
UK will depend on how and where the rights will be exercised,
and what impact they have on existing third and fourth freedom
air services. The CAA has in the past carried out a number of
economic analyses aimed at estimating the potential economic impact
of granting particular foreign carriers fifth freedom rights between
the UK and the US. These have attempted to quantify the wider
economic benefits to be derived from the additional air services,
not just any potential negative impact on UK airlines. In general,
granting fifth freedom rights at regional UK airports will tend
to have greater net economic benefits than granting fifth freedom
rights at Heathrow or Gatwick. This is in part because congestion
at the latter two airports means that additional air services
are likely to be possible only at the expense of existing air
services.
26. The CAA has responded to two consultations
by the DETR over the last year which have considered questions
relating to the grant of fifth freedom rights. The first was the
DETR's consultation on the application by Federal Express for
all-cargo fifth freedom rights from Prestwick and Stansted. The
second was its consultation on the Government's policy towards
international access to regional airports following the recommendations
of ETRAC. The underlying approach adopted by the CAA was essentially
the same in both cases. If in a particular market there was a
realistic prospect of securing a wider liberalisation, and of
doing to within a reasonable timescale, then the UK should consider
how such prospects might risk being diminished by the immediate
grant of requests for additional rights from airlines of the other
side. This implies the need in such circumstances to make explicit
the trade-off between short term and long term UK economic interests.
27. In the current context, the governments
of the UK and the US are engaged in a process of exploring the
prospects for a major liberalisation of the existing air services
arrangements. While there have been few, if any, demands in recent
years from US passenger carriers for fifth freedom rights beyond
the UK, the same is not true of the US all-cargo carriers. In
these circumstances, and in order to maximise the benefits which
any such deal might deliver, it seems important that the UK should
consider its negotiating position in the round and avoid doing
anything at this time which might prejudice it significantly.
(c ) the steps which might be taken now and
in the future, including for example changes to infrastructure
and to arrangements for granting slots to air transport providers,
to resolve the impasse in negotiations between the United States
and the United Kingdom, as well as the role of the European Union
in future negotiations with the United States over air service
agreements
28. A UK objective of full liberalisation
of the North Atlantic market is unlikely to be secured through
bilateral negotiations. The EU regulation on the licensing of
air carriers[20]
requires that EU licensed carriers be majority owned and effectively
controlled by EU nationals or governments. Ultimately, therefore
the UK is not free to negotiate in its bilaterals changes to the
rules governing ownership and control of airlines established
in the UK. It seems inconceivable that, without reciprocal rights,
the US Government would seek the changes to US law which would
be required to allow UK airlines to own and control airlines established
in the US.
29. The only practicable means of achieving
a full liberalisation of the North Atlantic aviation market is
through EU/US negotiations. If it chooses to do so, the UK could
have a major influence on the shape of a future liberalised EU/US
aviation area, just as it did on the internal EU aviation market.
Achieving this outcome will first require Member States to agree
an extension of the Commission's existing negotiating mandate
in order to include so-called hard rights (route and traffic rights,
pricing etc). Much of the groundwork for this has already been
completed. Indeed, if the UK were actively to support a mandate
for the Commission, it could well be agreed within a year or so.
While the EU/US negotiations would then undoubtedly take some
time, there is no reason to believe that a full liberalisation
of the EU/US market could not be achieved over a period of, say,
two to three years. The model which such an outcome would establish
would then provide the basis for global liberalisation.
30. It is difficult to see how, within any
reasonable time frame, changes to infrastructure would be feasible
on a scale that could relieve significantly the problems which
airport congestion poses for market entry. Indeed, even if it
were possible, for example, to expand Heathrow's capacity it is
doubtful whether this would have any impact on the US approach
to issues such as ownership and control or cabotage. The relevance
of infrastructure constraints to the liberalisation debate is
primarily that they are likely to prevent the full potential economic
benefits of liberalisation from being realised. The CAA believes
that creating the right incentives for infrastructure providers
to expand capacity to meet demand in a sustainable manner should
be a priority objective, but this is independent of the international
liberalisation debate. Realistically, however, given the time
it takes for investment in infrastructure to come to fruition,
there seems to be little prospect of a major expansion of aviation
infrastructure in the short to medium term.
31. The process of allocating take-off and
landing slots at congested airports such as Heathrow and Gatwick
is governed by an EU Regulation. The central principle enshrined
in the legislation is that an airline which uses a slot in one
traffic season is entitled to claim the same slot in the next
corresponding traffic season. This system, based on historical
precedence, combined with the effects of airport congestion, already
work to limit competition in a substantial proportion of markets
to and from London. To avoid this becoming an increasing bottleneck
to the further development of competition the methods of allocating
capacity must be improved. It has to be recognised that the supply
of slots at airports such as Heathrow, while not static, remains
strictly limited and may never be enough to satisfy demand. Changing
the way in which slot allocation is carried out would be likely
to produce as many losers as winners and therefore should be done
only in pursuit of clearly defined objectives. In the long term
it will be important that the incentive structure for aviation
infrastructure development facilitates projects where the benefits
to the UK exceed the full costs, including environmental costs.
32. The CAA's view for some time now has
been that secondary trading in slots should be formally recognised
and thereby made more transparent. At a practical level, this
would at the very least help maintain and improve the flexibility
of the system: while historical precedence remains at the heart
of the slot allocation system, airlines, large or small, charter
or scheduled will need to exchange slots and money payments will
be an inevitable part of the system if, as will often be the case,
exchanges involve slots of significantly differing values. In
a network-based industry with the unusually concentrated structure
of aviation, it may be necessary to consider very carefully the
precise way in which such a market-orientated approach should
be introduced. But as well as recognising an existing reality,
secondary trading would make explicit the economic principle that
where a resource is scarce it should be put to the use of highest
value.
33. In the bilateral context, in seeking
to liberalise its aviation markets, the UK is increasingly facing
the problem of countries demanding guaranteed slots at Heathrow
before they are prepared to agree to even modest increases in
third/fourth freedom capacity, let alone full liberalisation.
Under the EU slot Regulation, it would be illegal for the UK Government
to intervene directly in the slot allocation process. But a system
which allowed overt and transparent slot trading should make it
easier for foreign carriers to acquire the slots they need to
exploit the opportunities created by liberalisation. The US has
also in the past expressed the need for its airlines to gain "viable
access" to Heathrow if liberalisation is to produce real
benefits. While formalising secondary trading in slots will not
provide a complete solution to the problems of congestion, it
would nevertheless introduce a greater degree of flexibility to
the system which should make it easier for US carriers to obtain
the slots they require to take advantage of a liberalised market.
To this extent, changing the slot Regulation to allow trading
should go some way towards solving one of the issues which has
been a source of difficulty between the two sides.
CONCLUSIONS
34. The US Government's policy is to seek
a new international order for aviation which would fall substantially
short of full liberalisation while permanently benefiting its
own airline industry over those of the UK and other major aviation
nations. Given the importance of the UK-US market in global aviation
terms, the UK is in a uniquely strong position to give the international
lead needed before this US template becomes too firmly embedded
to dislodge. The UK's aim should be to secure the long term interests
of consumers through a full and genuine liberalisation of international
aviation markets. This alternative to the US model would involve
the removal of all bilateral restrictions, including those relating
to cabotage and to the ownership and control of airlines, accompanied
by the engagement of normal competition law. The UK is unable,
because of EU law, to secure this objective on its own through
bilateral negotiations with the US. This suggests a central role
for the EU in achieving the suggested UK aim.
Civil Aviation Authority
13 April 2000
18 Civil Aviation Act 1982, Section 4. Back
19
Statement of Policies on Route and Air Transport Licensing, May
1993 (CAP 620). Back
20
Council Regulation (EEC) No 2407/92. Back
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