Memorandum by The Economic Regulation
Group, Civil Aviation Authority
1. The Economic Regulation Group (ERG) regulates
airlines, airports and travel organisers. It also acts as expert
adviser to the Government on a number of economic matters concerning
airlines and on airports' needs and collects, analyses and publishes
economic and statistical information on them.
2. This submission addresses the questions set
out in the Clerk's letter of 28 May 1998.
Q1. In your opinion, what are the strengths and
weaknesses of the current regulatory regime governing airline
competition in the European Union (EU)?
3. In the CAA's view the principal strength
of the regulatory regime governing airline competition in the
EU is that European airlines are now very much freer than they
were under the old restrictive bilateral system to innovate and
to compete with each other throughout the Union. Civil aviation
within the EU has been substantially liberalised for more than
five years and the remaining economic regulatory restrictions
within Member States' domestic markets were removed in April last
year. Previous restrictions on the nationality of airlines' ownership
and control within the EU have also been removed. EU airlines
are therefore better able to access capital markets in other EU
states as well as to develop their networks through merger, takeover
or alliances, subject only to normal competition law and policy.
4. There has been criticism of some aspects
of the current regulatory regime in Europe. This has included
the way in which the Commission has dealt with grants of state
aid by some Member States to their national airlines. State aid
is of course one manifestation of the problem of the industry
in transition from a heavily regulated to a liberalised environment.
Nevertheless, the financial sums involved have been substantial
and the creation of the conditions in which inefficient companies
will exit, or at least reduce their activity to an economic level,
is as much a prerequisite of a truly competitive market as is
the removal of barriers to entry by new companies. The consequences
of any misuse of state aid in the liberalised EU internal market
thereby jeopardising the prospects for future competition. That
said, the guidelines published by the Commission in late 1994
have at least helped to improve the transparency of the process
and the conditions attached to approval of the aid have increasingly
sought to mitigate any adverse competitive implications.
5. Concerns have sometimes been expressed also
about the practical application of the Treaty's competition rules,
particularly Article 86. Since the introduction of the Third Package,
the Commission's role in dealing with abuse of dominance has been
central but its resources are clearly very limited and individual
cases can take a long time to resolve. In cases involving specific
allegations of predatory behaviour by one airline against another,
experience shows that speed is often of considerable importance.
However, drawing the line between vigorous but fair competition
and predatory behaviour raises difficult analytical and empirical
problems and there is arguably a need for greater clarity as to
how more general precedents, such as that from the judgment of
the European Court in the AKZO cases, would read across to the
airline industry. One case which might have helped to clarify
matters was that brought in October 1996 by EasyJet against KLM
alleging predatory fares behaviour on its Netherlands/London services.
However, this was withdrawn by EasyJet in November 1997 before
it was taken to a conclusion.
6. Ultimately the success or otherwise of EU
liberalisation and the new regulatory arrangements which accompanied
it must be judged by its results. The CAA has monitored developments
in airline competition within the EU closely over the last five
years, producing three reports over the period setting out its
findings. The most recent of these was published on 17 June 1998.[1]
This concluded that the effects of liberalisation in aviation
within the EU were broadly analogous to those in other markets.
It has brought steady growth to smaller and medium-sized airlines
and a consequent fall in the share of the national carriers. In
particular, there have been major advances in the domestic markets
of a number of larger EU states, including France, Germany, Italy
and Spain. On routes where significant new entry has occurred
air fares have normally fallen, often quite dramatically. This
however has not been true on routes where the national carriers
have kept their dominance.
7. Despite the substantial removal of previous
government-imposed economic regulatory restrictions, there are
still significant problems relating to airline entry and competition
in the EU, most notably the congestion which now exists at a number
of the EU's largest airports. For example, 70 per cent of the
30 or so densest international intra-EU routes with more than
half a million passengers a year have a seriously congested airport
at one or both ends. However, although it might be possible to
mitigate matters by suitable changes to the regulatory regime,
the problem is principally one of physical constraints in infrastructure
capacity, largely as a consequence of growing environmental pressures.
Q2. If, under the proposal, the Commission was
to negotiate bilateral agreements with third countries on behalf
of Member States, should this be done by: (a) a gradual, phased
process; or (b) a rapid transition?
8. In principle, phasing could be implemented
in a number of different ways. First, it could be done country-by-country,
beginning with the United States, by far the most important external
market for EU airlines, and then moving on progressively to less
important country-pair markets. Secondly, specific restrictions
of the type found within existing individual Member State bilaterals,
for example on the routes which could be operated, on the numbers
of airlines per route, on the permitted operational frequencies,
or on controls on air fares could be retained but progressively
loosened in much the same way as occurred through the three main
stages of liberalisation within the EU between 1988 and 1993.
Thirdly, it would be possible to envisage only certain aspects
of Member States' existing bilateral agreements being included
in an EU/third country agreement, with others to follow at a later
stage or stages.
9. Phasing of the first type would seem not
only desirable but would probably also be inevitable for there
to be any prospect of the Commission achieving its long term objectives.
Indeed, it seems unlikely that the Commission would wish, at least
in the foreseeable future, to extend its competence in this area
beyond a relatively small number of the most important aviation
countries. With its very limited resources it would be unable
to administer and enforce a large number of traditional style
aviation bilaterals in the way individual EU Member States do
today. Moreover, the bulk of world aviation is made up of a relatively
small number of markets with any future US/Europe common aviation
area—which would in principle encompass both the US domestic
and EU internal air markets as well as the north Atlantic routes
connecting them—alone accounting for about one half of the
total. It is largely on this basis that the Commission has set
itself the first goal of an EU/US aviation agreement. An EU/Japan
agreement seems a likely second target from the Commission's perspective
with possibly the aim of a multilateral accord between, say, the
EU and the ASEAN countries much further down the road.
10. Phasing of the second type would seem much
more problematic. Given that a number of EU states either doubt
the ability of their national carriers to compete in a liberalised
market or wish to continue to use them as instruments of wider
national policy, the acceptance in principle of such an approach
would risk the imposition in practice of a very lengthy period
of transition.
11. Moreover, the removal of nationality restrictions,
at least between EU carriers, thereby giving airlines owned and
controlled by nationals or governments of one member state the
freedom to serve routes linking other Member States with third
countries, would appear to be a sine qua non of any EU/third
country aviation agreement. But, if transitional restrictions
were to remain on airline numbers, operational frequencies and
capacities etc., there would then be a need to choose not only
which airline or airlines would be permitted to operate a route
but often also the exact manner in which they could do so.
12. It would be necessary, therefore, to put
in place the means for making such choices between airlines owned
and controlled in different member states. If these were to be
implemented by Member States for routes to and from their own
territory there would be considerable scope for allegations of
discrimination on grounds of nationality. However, it is unclear
whether Member States would accept the Commission taking on such
a role or whether it would have the resources to do so. This type
of problem did not arise during the phased liberalisation of the
internal EU air market as it was only with the introduction of
the virtually fully liberalised Third Aviation Package in January
1993 that Member States were required to grant operating licences
to carriers owned and controlled by nationals or governments of
other EU states.
13. The third type of phasing would probably
be the least easy to achieve. For example, although in discussions
so far between the EU and US, the EU has sought to focus first
on a possible regulatory framework (so called "soft"
rights), the US has been adamant that it would not be prepared
to consider any agreement with the EU which did not also include
"hard" market access rights.
Q3. If, under the proposal, the Commission was
to negotiate on behalf of Member States a single bilateral agreement
with each third country: (a) how should they do this; and (b)
how would this affect European airline competition?
14. So far as procedural aspects are concerned,
the essential framework for negotiating with third countries,
in aviation as in other sectors, is laid down in Article 228 of
the Treaty. The Commission is responsible for conducting aviation
consultations on behalf of the EU, and with the US in October
1996 and April 1997 did so in consultation with a "Special
Committee" appointed by the Council and including a representative
of each Member State. Ahead of the negotiations a structure of
technical and policy working groups was established to prepare
the detailed groundwork on the various aspects of the mandate.
These procedural arrangements appeared to work satisfactorily,
the real obstacle to progress laying principally with the differences
between the EU and US over the inclusion or otherwise in the discussions
of market access rights.
15. In the CAA's view, if the Commission were
to negotiate in the future on behalf of the EU a single bilateral
aviation agreement with the US or other third countries, the fully
liberalised EU internal aviation market would provide an appropriate
model. This would involve the removal of all constraints on route
access (including fifth freedom and cabotage), number of airlines
and operating frequency. It would also mean the elimination of
special nationality-based ownership and control restrictions and
the engagement of normal competition law.
16. Such full liberalisation would not only
allow UK and other European airlines to innovate more freely and
provide the services and products which they wish, but would permit
them also to build global networks through mergers, acquisitions
or alliances as they see fit. (The current focus on alliances
between airlines is largely explained by the nationality rules
which impede cross-border airline acquisitions and mergers because
of the risk that the parties would be unable subsequently to exploit
existing traffic rights to points outside the EU). Again, these
would of course be subject to normal competition policy, under
which conditions could where appropriate be applied to remedy
detriments to competition, for example airport slot transfers
to facilitate additional services by actual or potential competitors.
17. Arguably, therefore, a fully liberalised
market would provide a firmer base from which efficient European
airlines could exploit their strengths in the longer term. In
many cases, the control of, or merger with, non-EU airlines, and
the greater scope for in-depth integration of activities and effective
management control which that would allow, would be preferred
to potentially unstable alliances.
18. The main alternative model on offer is the
US version of "Open Skies". However, this does not include
the liberalisation of national ownership and control rules. If
all EU states were to agree open skies bilaterals with the US
this would mean that US carriers would have complete freedom to
serve any route they wished between the US and Europe but their
EU competitors would still be restricted to serving only their
own bilateral corridor between the US and their home state. Indeed,
if such open skies agreements were to be in strict accord with
the US model, this would also give US airlines widespread fifth
freedom access to routes within the EU, but without any guarantee,
or even probability, of equivalent access to the US domestic market
for EU carriers. (The US domestic market is larger than the EU
market as a whole and dwarfs the domestic market of any single
EU state.) The likelihood is that this would come only in the
context of a wider EU/US regime.
19. From a UK perspective, there seems no reason
to suppose that the establishment of a wider liberalised market,
first with the US and perhaps later with other major aviation
countries, need impact adversely on UK airlines. The UK airline
industry comprises strong and effective competitors, as is amply
demonstrated by their performance both within Europe and on the
North Atlantic. UK long haul airlines have a cost advantage over
their European counterparts and compare well in terms of value
for money with the major US carriers. There seems no reason to
suppose well-managed UK airlines would not be able to succeed
in a genuinely liberalised market.
Q4. What effect would the harmonisation of future
bilateral agreements between Member States and third countries
have on airline competition?
20. Much would depend on the form such harmonisation
took. In the worst case it might involve EU/third country agreements
which would retain the type of restrictive provisions occurring
in many of today's individual Member State bilaterals. These might
continue to restrict airlines' access to routes and to specific
airports, limit the number of airlines permitted to operate and/or
the specific airports, limit the number of airlines permitted
to operate and/or the frequencies or capacities they could mount
and prevent them from charging the prices they wished. This might
arise because some EU states wished to continue to protect their
national carriers believing that they would be unable to withstand
the level of competition which would follow the establishment
of, say, a fully liberalised EU/US common aviation area, or that
they would at least require a lengthy period to adjust.
21. In practice however it seems more likely
that the dynamic of EU level negotiations with third countries
would be towards liberal and not restrictive agreements. Further,
given its strictly limited resources and for the reasons already
touched on in paragraphs 10 and 11 above, it seems unlikely that
the Commission would be prepared to countenance agreements with
restrictive provisions of a type which would require policing.
Q5. How would the proposal resolve differences
in economic regulation and implementation of competition rules
for airline services operating between Member States and third
countries?
22. It is in the nature of existing bilateral
agreements between EU states and third countries that most, if
not all, contain restrictive provisions which limit competition
and conflict with the Treaty's competition rules. Thus, implementation
of the proposal without liberalisation of Member States' bilaterals
with third countries would not of itself resolve these differences.
However, it would put the Commission in a position to exert considerable
pressure on Member States to change such provisions, and would
give it a new power to call for direct consultations between itself
and a third country where such conflicts exist. Indeed, to the
extent that the removal of restrictive nationality of ownership
and control provisions would be required, this might often be
achievable only through the replacement of individual bilaterals
with EU/third country agreements.
18 June 1998
1 The Single European Aviation Market: The first five
years, Civil Aviation Authority, CAP 685, London. Back
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