By Chris Lyle of Air Transport Economics in Montreal
How long do airlines have to wait before they can be given a stable regulatory environment in which they can do business?
Much has been made of the potential impact of the open aviation area agreement between the European Union (EU) and the USA, finally negotiated late last year, but presently bogged down in a regulatory quagmire in the USA over interpretation of what constitutes "actual control" over a national carrier.
Assuming the current draft finally sees the light of day, what advantages will it offer?
- A single, fully harmonised, agreement to replace the 20 present bilateral agreements between the USA and EU states, at the liberal end of the spectrum, and including the other five EU states
- acceptance by the USA of EU community rather than national designation of air carriers
- convergence of US and EU policy on safety and security, plus co-operation regarding the application of US or EU competition rules.
This would be a significant step forward for the air transport industry, for consumers and for the economies concerned. A study by the Brattle Group in 2002 suggested that a fully liberalised common EU-US aviation market would generate benefits of €5 billion ($6.2 billion) a year in consumer surplus alone.
However, the agreement would fall well short of a common aviation market. There would be no right of establishment of a carrier by US parties in the EU or vice versa, and air carrier ownership and control would be required to remain in the hands of US or EU entities for designation by one or the other party. Cabotage, that is carriage of traffic within an EU state by a US carrier, or within the USA by an EU carrier, would also be excluded.
The draft agreement is silent on issues such as the "Fly America" programme, the US Chapter 11 bankruptcy protection provisions, public service obligations, infrastructure constraints and slot allocation (London Heathrow remaining a prime problem). Nor is there any hint as to the implications for antitrust immunity for airline groupings.
While a EU-US agreement would reflect 12% of air carrier revenues worldwide, in terms of international passenger traffic numbers it represents only 6%. What about liberalisation for the other 94%?
The ICAO Air Transport Conference in 2003 was successful in developing a comprehensive range of material on how to liberalise international air transport. But this almost certainly represents the culmination, after 60 years and five Air Transport Conferences, of what can be achieved through ICAO, which has a focal mandate of safety and security and which in the field of air transport can offer only guidance.
Nearly four years after the conference, there is little practical impact. True, a handful of more liberal bilateral air services agreements have been negotiated and the EU has pursued its own liberalisation agenda. But there has been no progress on the key issue of national air carrier ownership and control. Plus the conference confined itself to providing guidance on the content of regulation and was unable to give any advice on the process.
Apart from the EU context and some other intraregional initiatives discussed later, air carrier traffic essentially remains regulated by a bilateral process dating from the US-UK "Bermuda" agreement in 1946. ICAO estimates that over 3,500 bilateral air services agreements remain on the books today.
Some liberalisation can be achieved through the bilateral process. ICAO reports that 122 "open skies" bilaterals are now in place, providing for full market access regarding (national) carrier designation, route rights, capacity, frequencies, codesharing and tariffs. The USA is one of the partners in 75 cases however, while a few of these cases involve significant traffic partners, the majority concern very small markets for which there is still no direct air service.
In the case of developing countries many bilaterals have not been amended since they were agreed by their colonial masters. In practice the vast majority of bilaterals worldwide are still very restrictive - ICAO classifies well over 90% of the 2,000 bilaterals filed with it as "traditional".
With very few exceptions, bilaterals suffer from three intrinsic weaknesses: an inflexible basis of reciprocity air carrier designation based on national ownership and control and a lack of transparency.
The principle of reciprocity in the trading of air services is unique in international trade. In air transport terms reciprocity often means matching frequencies and capacity, leading among other things to unused authority because of the inability of a small or weak national carrier to match capacity or prices.
The designation restriction has major implications. The financial markets of the vast majority of the world's countries are simply not large enough to accommodate readily the capitalisation required by an air carrier of any significant size. The designation restriction also requires tortuous arrangements between at least three parties to allow market access beyond third and fourth freedom traffic. Reciprocity and designation restrictions inhibit benefits from combining small national markets.
Lack of transparency
As for transparency, many agreements are not filed with ICAO as required and specifics are frequently governed by confidential memoranda rather than the agreement itself. This can severely hamper competition and enables states with strong carriers to hold other states to ransom.
International air transport is by its nature multilateral, but it is shackled by bilateral regulation. Airlines continue increasingly to find ways round many of the economic provisions, through alliances, codesharing and so on. But this is an unsatisfactory compromise for the airlines involved, creates barriers to participation and market access by other carriers, and does not resolve the key issue of transborder access to capital.
Some governments have complemented the bilateral process by developing multilateral intraregional agreements. The table (see page 61) lists a number of such agreements or arrangements. Those related to the EU are substantive in effect, as are the CLMV, MALIAT and the three current intra-ASEAN agreements. However, the others are each only partly functional. One reason for this is that there is no strong underlying economic authority for the regions concerned.
There are three worldwide agreements, only one of which (the Transit Agreement) has any substantive impact at present.
This aside, none of the multilateral agreements can as yet be regarded as truly inter-regional or inter-continental, which is one reason why a EU-US agreement has generated speculation as a possible model for global expansion. Once the agreement is fully operational it would undoubtedly have an impact on neighbouring states. However, a EU-US agreement, a (bloc to bloc arrangement or a bloc to single small state agreement is unlikely to be applicable much beyond that region, for the following reasons:
- in most regions there are few blocs and the blocs are relatively weak, lacking the backing of a powerful institutional authority such as the EU
- the EU multistate commonality gives an unacceptable one-sided advantage, particularly where a single state is expected to be the partner
- competition law needed to back up a liberalised arrangement would be asymmetrical at best (many countries do not even have applicable competition law, or consumer protection provisions).
The table (see right) illustrates the increasing complexity, inconsistency and fragmentation in the process of international air transport regulation. The entanglement has reached a stage where it actually inhibits liberalisation. One problem is that consensus on amendments to regional or plurilateral agreements can become virtually impossible to obtain, thereby permanently locking in any barriers to market access or restrictions on ownership and control. Non-founding members, especially those with limited negotiating advantages, are unlikely to be able to influence the construction of the core arrangements, including the terms on which they can become members.
The need for global air transport liberalisation is widely recognised by governments and the industry is increasingly expressing its frustration with lack of action. The elements have been identified and their benefits widely espoused and acknowledged. Why, therefore, has there not been greater movement? One challenge is that of institution. Air transport regulation tends to be based on narrow sectoral interests, often still focused on protecting national carriers, rather then on trade, tourism, economic development and competition considerations. The regulation of air transport is uniquely isolated and outdated in a globalised marketplace.
What is GATS?
The General Agreement on Trade in Services accord, in force since 1995, is a set of multilateral rules on international trade, complementing long-standing agreements of the World Trade Organisation. Negotiated by governments, it has two parts: the framework agreement containing the general rules and national schedules where the 149 members list those services they want to offer access to for foreign suppliers.
Air transport was not originally included substantively. However, the GATS Annex on Air Transport Services instructs the Council for Trade in Services to "review periodically...developments in the air transport sector and operation of the Annex with a view to considering the possible further application of the Agreement in this sector". The current review commenced in September 2006.
Given the wide range of policy positions, the most promising, perhaps the only, way to achieve a global regulatory framework is through the GATS. The World Trade Organization (WTO) has had a bad rap in recent years, leading to the failure of the Doha Round, which aimed to lower trade barriers around the world. The contentious issues, however, are not applicable or relevant to air transport services, and the exclusion of "traffic rights, however granted or services directly related to the exercise of traffic rights" from the GATS may in part be attributed to: a lack of enterprise (living with an existing comfort zone) preservation of institutional fiefdoms (eg transport versus trade and tourism departments in government, ICAO versus WTO at the global level) and a lack of open analysis and education on the merits of the GATS option.
Work on the GATS tends to be under the radar, but a mandatory periodic (five-year) review of the Annex on Air Transport Services is just under way with a view to expansion of the coverage. So the time is ripe to take a serious look at the GATS option.
Some of the fictions that are used perpetrate negativism towards the GATS are:
- The objective of the GATS is not to deregulate services, many of which are regulated for very good reasons, but to liberalise services trade. The right to regulate is one of the fundamental premises of the GATS
- concern regarding inflexible application of the multilateral "most favoured nation" and "national treatment" rules is misplaced. Negotiations reflecting these principles are first and foremost bilateral, and exemptions to most favoured nation may be taken for 10 years, or possibly even more
- there would be no "big bang" deregulation on transferring air services regulation to the GATS the system of commitments and exemptions means that the concept of "progressive liberalisation" articulated by ICAO applies equally, and indeed more equitably, under the GATS. Countries would only be required to open air transport access to their markets to the extent that they make commitments in the sector. Furthermore, GATS commitments are not irreversible
- arguments regarding an impact on safety and security are not compelling. ICAO has adopted provisions to avoid the issue of "flags of convenience" in the shipping industry by defining clearly the state with responsibility for safety and security regulation of an air carrier, and these provisions could be accommodated in the GATS. ICAO could be defined as the responsible worldwide executing agency for aviation safety and security (as well as environmental protection if desired)
- dispute resolution is slow and laborious. There is truth in this. However, there is nothing to prevent invocation of the "first resort" dispute mediation mechanism which ICAO has maintained since 1998, with only the most intransigent issues being referred to the formal WTO process.
On the positive side for the GATS:
- The process is a true "progressive plurilateral" with an eventual worldwide rules-based system a viable goal
- the process is flexible, both regarding entry and regarding the pace and elements of liberalisation
- the process of liberalisation accords due respect for the level of development by members. There is provision for developing countries for "liberalising fewer types of transactions, [and] progressively extending market access in line with their development situation"
- transparency - offers, subsequent commitments and exemptions are publicly available.
As for the key ownership and control issue, the GATS would be an ideal vehicle for gradual implementation of designation of air carriers based on effective control by or within any grouping of so committing states. Small market countries should be open to commitment because it provides their airlines with a more level playing field compared with airlines designated by countries with large domestic capital markets. All countries should benefit from the extended capability to access foreign capital and increased competition among investors. At the same time, the designation issue would almost certainly be treated separately from other market access issues. A state's decisions regarding the Air Transport Annex need not stand or fall solely on the designation issue, or vice-versa.
While the USA would be extremely unlikely to sign on to significant liberalisation of ownership and control, it has long accepted community designation by developing countries and is poised to accept community designation by EU states, which has already been accepted by over 60 other states. Thus potential conflict between application of GATS provisions and traditional air services agreements seems limited.
Gathering support for GATS
A number of countries from all world regions, as well as the European Commission (which speaks for all EU states in the Council on Trade in Services) are known to support in principle the inclusion of air transport "hard rights" in the GATS. Critical mass for substantive amendment to the Air Transport Annex is unlikely to be achieved during the current review, but progress should be made. The opportunity could also be taken to explore the concept of a core group (a mooted "open club") to move forward fairly quickly to a new regime, applying the GATS provisions but semi-independent from the GATS until such time as critical mass is judged to be achieved. It would be important to include membership from developing countries, to accommodate industry submissions, and to draw on the wealth of knowledge and experience from ICAO and the GATS secretariat as well as states.
At the same time a proposed successor to the Think Tank on Multilateral Aviation Liberalisation, which produced a "Free Trade in the Air" report in the early 1990s, could engender public scrutiny and debate. With confidence built, the next periodic review of the GATS Air Transport Annex (within five years at most) could be a watershed.
The greatest challenge to extensive liberalisation of air transport is the need for a liberalised mindset. Sixty years after the Bermuda Agreement air transport is still constrained by the Bermuda process, albeit with a regional flavour. How long do international airlines have to wait before they can be given a stable regulatory environment in which they can invest with confidence and make a reasonable return on a continuing basis? And how long do passengers and shippers have to wait before they are given a wide and reliable choice of airline service and price worldwide?
About the author
Chris Lyle's career spans British Airways, the Economic Commission for Africa and ICAO. Currently he heads up his consultancy, Air Transport Economics, and acts as representative of the World Tourism Organization to ICAO. Website: www.airtransporteconomics.ca and email: email@example.com.
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Source: Airline Business