Deregulation Countdown Ptll

Rationale

The history of civil aviation in Australia has seen the evolution of a vast infrastructure of aviation facilities along with a reputation as the safest nation to fly in.

The justification for promoting aviation at the public’s expense was that the size and demographic spread of the continent required large resources beyond the capacity of private capital. It was considered that only governments were able to secure the large loans required for development of major public works such as airports. Thus regulation paralleled this financial responsibility to protect and foster government interests. The return on investment for the government was the economic development of the nation along with defence preparedness.

This section itemises the legislative structure of the Australian aviation industry under government regulation. The historical context is examined to show the forces which led to the creation of our unique Two Airline Policy.

Federation

Although aviation did not exist when the Australian Constitution was written, the states realised that it was in their best interests to allow the Commonwealth to legislate on transportation matters. Thus in 1921 many states passed their powers to the Commonwealth under section 51(xxvii) of the Constitution with uniform legislation titled the Commonwealth Powers (Air Navigation) Acts. Nowadays the only ones remaining are the Tasmanian and Queensland Acts which allow the federal Australian National Airlines Commission (Australian Airlines) to operate in those states. In 1987, New South Wales amended its Air Transport Act (1964) to also allow the Commission access to intrastate routes. · This is duly being taken up by an expanding Eastern Air Lines on behalf of Australian Airlines.

There was a Referendum held in 1937 to grant the Commonwealth power to legislate in aviation matters. This was defeated. Thus the power of the Federal Parliament to legislate on aviation matters has been based largely on the Constitutional power of the Commonwealth to deal with ·external affairs’ under section 51(xxix) and consequently with international treaties under section 75(i).

After some dispute with the states, the Sea and Submerged Lands Act (1973) extended the Commonwealth sovereignty to airspace above territorial seas and thus completed the federal control over aviation.

Air Navigation Act

The first federal legislation to reflect an international treaty followed from the 1919 Paris Convention which negotiated international rights for air navigation after the First World War. Although there was little problem in Australia (with few international borders that could concern aviators at the time)the Convention led directly to the Air Navigation Act 1920. The Air Navigation Act still provides for control over all aspects of air navigation, including: standards, rules of the air of aircraft and licensing of operators, aerodromes, flight crew and engineers.

This remains the basic enabling act of the Department of Transport and Communications (DoTC). Of note is that section 24 seeks to provide that DoTC is not liable to be prosecuted for a criminal offence under the act. The Air Navigation Legislation (Validation & Interpretation) Act (1982) also made provision for the exercise of additional powers and functions under the Air Navigation Act.

Delegation is thus via the Air Navigation Regulations which are under the direct control of Parliament. They are an extensive and comprehensive set of statutory rules which are constantly amended (as pilots well know) to reflect all the changing·aspects of aviation.

However, these Regulations anticipate further delegation of legislative power to the Secretary of the Department by allowing an Air Navigation Order to cover in detail all matters requiring special criteria or specifications. The power of the Department to impose these requirements is not nowadays in doubt – despite the Constitution.

Government Airlines

When the Chicago Conference met in 1944 to plan for civil aviation in peacetime, Australia and New Zealand jointly proposed outright international ownership and operation of civil air services on world trunk routes! Imagine: Air United Nations . . .

This incident shows the historical commitment in Australia to government owned air services. The loss of their proposal at the Chicago Convention however, didn’t stop the government from passing the Australian National Airlines Act 1945 which established the Australian National Airlines Commission (ANAC) to operate Trans Australia Airlines as a domestic carrier (now trading as Australian Airlines). This act is still administered by the Minister for Aviation.

In 1984 the Australian National Airlines Commission Retention Act was passed by the Hawke Labor government to repeal prior efforts of the Fraser Liberal government to privatise Australian Airlines. Now the Labor politicians are practising their touch and goes with the very same idea.

Likewise, the Qantas Empire Airways Act (1948) provided for the Commonwealth subscription of that airline’s capital. This act is also administered by the Minister. Although DoTC does not have a direct role in managing these government enterprises, one official function of the department is to assist in the formulation of policy “including the business undertaking of Qantas and Australian Airlines”.

This possible conflict between the regulation of aviation and the fostering of government enterprises has often generated debate. Note that Qantas dividends are paid directly into . the DoTC balance sheet to count as revenue. In the 1986/87 accounts the Qantas dividend was $14,961m.

The Two Airline Policy

The government ownership of both a domestic and an international airline has also led to other difficulties. The Airline Agreement Act (1981) updated the established Two Airline Policy. It formalised the agreement (between the Commonwealth, ANAC and ATI) that provides the basis for operation of the domestic Two Airline Policy until September 30, 1990. Note that the ‘policy’ is actually a negotiated contract. The Two Airline Policy is the unique feature of the Australian industry. Because the Commonwealth lacks Constitutional authority over air transport it must use this contractual agreement where it is only one among equals instead of being the controller of aviation. The Agreement Act regulates many facets of operation in the name of equal competition including curfews, fares control and sharing of the air mail service.

The Two Airline Policy also includes procedures where the two airlines consult and agree on fares, timetables, aircraft types, capacity and even load factors. Under the agreement, the federal government determines capacity provisions for both airlines for six monthly periods. In making these capacity determinations the government stipulates that each airline carry one half of the total estimated passenger traffic on trunk routes. It uses an average load factor of 65% in its calculations and the purpose of this is to ensure that neither airline can dominate the trunk network.

Because section 92 of the Constitution provides for free trade and commerce between the states, the Commonwealth cannot refuse operating licenses on economic grounds. Therefore it bases its regulation on issues of safety, regularity and efficiency.

However, the Two Airline Policy is implemented with the Airlines Equipment Act (1958) which restricts the import of aircraft. This device started with the Lockheed Electra (where TAA wanted to buy the jet Caravelle but were forced by the federal government to acquire Lockheed Electra Propjets due to Ansett- ANA’s preference for this aircraft) and saw the operation of identical aircraft by both airlines for a quarter of a century. Meanwhile, all other organisations were effectively stopped from importing aircraft.

Aircraft import restrictions also act as a barrier to entry because Australia does not produce commercial transport aircraft. For example, the restrictions proved most effective in controlling the expansion of East-West Airlines during recent years.

Loan Guarantees

The 1981 Act also stopped Qantas from operating domestic services. Ironically, the government was guarantor for six huge loans and was the actual borrower in four earlier loans that enabled Qantas to buy aircraft. The total amount outstanding for Qantas loans as at 30th June, 1987 was $US273,702m plus 8,795m yen. This totals approximately $A422m.

In addition to the Qantas loans and guarantees the government has three major loans outstanding for ANAC which amounted to $US66,567m as at 30th June, 1987. Under the Two Airline Policy the government assists with loan guarantees to both its own domestic airline as well as the private company ATI. There were, for instance, eight Airline Equipment (Loan Guarantee) Acts outstanding which totalled $US130,765m as at 30th June, 1987. This was double the amount guaranteed for the government’s own airline.

With these loans and guarantees the government is persevering with a previously necessary role of capital raising. The independent rise of East-West Airlines and the international expansion of ATI shows that this role may no longer be necessary to foster the domestic industry.

Independent Air Fares Committee

The Independent Air Fares Committee Act 1981 set up a committee consisting of 3 members with a supporting secretariat of 12 investigators. Their charter is to review and determine passenger fares on scheduled domestic services.

Previously, fare setting was a Department of Transport and Communication (DOTC) function. However, it was generally considered contentious as there were cross subsidies from political pressure to minimise long distance air fares to Western Australia and Tasmania. In fact subsidies of 10% were paid on Tasmanian services until 1985 at an annual cost of $5. 88m.

The Independent Air Fares Committee (IAFC) actually operates with 9 permanent staff and cost in 1986/87 $584,000 to run. Under its Act, the Committee allocates costs between the flagfall and distance components of the national fare formula. Thus, passengers must pay some approximation of average network cost instead of the actual cost of their service, while the process ensures that all flights of equal distance have compar. able fares.

The Independent Review of Economic Regulation of Domestic Aviation (May Report, refer p30 March 87 AA), comments that the IAFC procedures were complex and difficult to discern because of a lack of public documentation of the methodology. Further, the Report notes that the present regulation of air fares reveals a “considerable number of shortcomings that damage the public interest” and that the Act’s statement of economic criteria “Macks clarity” and “embodies some conflict between objectives”.

Changing Structure

There have also been a confusing string of name changes in the last few years. To summarise, the Department of Aviation became part of the super ministry called the Department of Transport and Communications. Within that portfolio they are now called the Air Transport Group. Then two authorities were detached to form the Federal Airports Corporation, which commenced operations on Jan 1, 1988 and the Civil Aviation Authority which became effective from July 1, 1988.

This report dealing with regulation is however concerned only with the Department of Transport and Communications and its Minister, the Independent Air Fares Committee, the Civil Aviation Authority and the Federal Airports Corporation. Qantas and the Australian National Airline Commission are minor government characters with Ansett Transport Industries involved as a contractual partner in the Two Airline Policy.

The recent hiving-off of responsibilities is a sign that government interest in aviation development is decreasing. DoTC has come under increasing criticism in recent years. This has even resulted in the establishment of the Aviation Committee of Review Proposal, a public body chartered to gain reform. There has been the Bosch Report with far reaching consequences and a Parliamentary Report by the House of Representatives Standing Committee on Expenditure. Finally, the Independent Review of Economic Regulation of Domestic Aviation (May Report) presented its scenarios for the future in December of 1986.

The changes may reflect the many suggestions in the Bosch Report that present DoTC policies are stifling the industry. The criticisms often revolve around comparisons with other countries. For example, Bosch showed that for every aircraft on the Australian register there are 1. 24 people regulating it. The equivalent figure in the USA is just 0. 21 people. These figures are often used to try to prove that there could be advantages with deregulation of the industry.

An internal malaise in airline regulation is evidenced by the recommendations of the Bosch Report which concluded that DoTC required a complete restructure of its functions. It is also noted that the department seems to have a conflict of interests by protecting two government airlines while still regulating the industry.

Another criticism levelled by Dick Smith in his book Two Years In the Aviation Hall of Doom is that the department is run by bureaucrats and not people with aviation backgrounds. The suggestion is that aviation is such a specialised industry that general administrators are not adequate for the task. Smith illustrates this problem with a telling organisational chart from 1984 where only one executive has any practical aviation experi- ence. After that book was published, the then Minister ironically took up flying lessons! The basic problem with the developmental ethos of the Australian regulations is that some sections of the industry are benefiting at the expense of others. DoTC is the arbiter of resources and it is thus locked into decisions of yesteryear by legislation such as the Airlines Agreement Act. This development momentum has been self generating; aviation in Australia is now oversupplied with facilities while the emergence of private investment has been stifled by current policies. Meanwhile, DoTC has been providing hidden subsidies to established aviation businesses long after it was necessary.

The US Congressional Declaration of Policy contained in their 1938 Federal Aviation Act (refer this series, last issue) reveals the similar economic role played by policy until 1978. The Civil Aeronautics Board had to look after the public interest by encouraging and developing a system adapted to the commercial, postal and defence needs of the US. Safety was a touchstone and economic conditions were to be met by coordinating the carriers. Service was to be “adequate, economical and efficient and without unfair or destructive competition. However, sound development was more important than competition.

Similar to the parallel US experience, the role and functions of the Air Transport Group are having to change. The three major themes of regulation, services and advice are a unique mix among government organisation and the introduction of new structures will break up these overlapping duties, but not remove them.

The everyday tasks of the Air Transport Group are to provide the Minister for Aviation with advice and research services. It develops national aviation policies, objectives and plans. It implements aircraft airworthiness standards, issues and checks licences and certificates and through the Bureau of Air Safety Investigation, investigates aircraft accidents and incidents.

Note that the Air Transport Group polices its own standards. There is an obvious contradiction between the regulatory role of the Department and its role as enforcer. The changing structure is shown by the hiving-off of the Federal Airports Corporation (FAC) to operate Commonwealth owned airports and ground facilities at a profit.

The dispersion of economic regulation between the Minister, the Department and the Independent Air Fares Committee leads to some confusion and delay. Therefore, this complex arrangement led to the May Report calling for a *. . . single, independent specialist Commonwealth regulatory agency. . . .

Thus in July 1988, the Civil Aviation Authority (CAA) took over the provision of airways facilities such as navigation aids and communication equipment along with services like air traffic control and Flight Service, to run them along commercial lines.

No single corporate objective exists for the remaining rump of the old Department of Aviation, except perhaps the general promotion of aviation safety. This by itself is too ethereal to focus DoTC plans for greater cost efficiency or user satisfaction. To satisfy its role and functions, the Air Transport Group (including FAC and CAA) has 9,624 staff at 110 locations in Australia. It costs $493m to run each year and when excise on aviation fuel is Included its revenue exceeds its costs. That is, it runs at a profit. This feature on deregulation of the Australian airline industry has presented the regulatory framework which has developed within the Australian aviation industry. It reflects the evolution of policy requirements over the last half century and gives a snapshot of the present situation including some of the factors which have led to the desire to reform aviation management in Australia.

State Of Play

In 1986/87 the two domestic airlines carried 12. 3m passengers with a load factor of 72. 6%. This margin over the 65% load factor used by the government in capacity determinations implies increased profits and reduced frequency. The average load factor today is even higher. Australian Airlines operated 30 aircraft while Qantas had 32 aircraft and Ansett Airlines operated 34. However, other ATI subsidiaries operated an additional 30 aircraft, not counting East-West.

The commuter and regional airlines carried 1. 1m passengers on routes outside the trunk network, but often feeding into it. There are over 50 of these commuter airlines in Australia but they account for only a minor portion of the total passenger market; Ansett Airlines and Australian Airlines dominate with approximately 85% of the total domestic market.

Yet, of the 309 centres which receive a regular public transport link, only 90 had full trunk airline service. Sixteen of the origin/ destination pairs accounted for 78% of the traffic of the two major airlines. The airline industry employs only 7% of total transport employees in Australia. For comparison, road and rail have 42% each.

Only 6 to 8% of total trips are taken by air, although this increases to 35% where the distance is over 1,000 kilometres. The private car accounts for a far greater proportion of all trips, other than those over 2,000 kilometres. The typical air passenger is a male between 25-44 in a professional or executive position. Over 65% of travellers do not pay for their own ticket, while the various levels of government pay for 14% of all trunk airfares.

Yet, when the May Report commissioned several surveys it found that 77% of respondents preferred a more flexible fare setting machinery, because the present policy works to the disadvantage of consumers.

Winds Of Change

The Two Airline policy is obviously unpopular, as early as 1979 the Australian Financial Review said that “there is little doubt the Two Airline Policy. . . is strongly inimical to competition, cheaper air fares, and cost efficiency. . . “. The President of the Australian Federation of Travel Agents has stated that the ‘undynamic duo’ of Ansett Airlines and Australian Airlines were “taking us for a ride”.

The Finance Minister, Senator Walsh, stated that the two government airlines had been a “case study in industrial relations management at the expense of the travelling public” because of wage and price flow-ons between the two and Ansett Airlines. One researcher concluded that the regulation of Qantas led to fares which were an average of 11% above the minimum.

The Two Airline Policy is more restrictive than the US regulatory framework because it goes beyond price control to also include capacity regulation. This capacity control is actually the primary means the Commonwealth uses to regulate the industry.

Meanwhile, the consultations between the airlines sanctioned by the policy has significantly muted competition, while any market gains must be shared with each other under the 50:50 market sharing arrangement.

As in the US, there is an example of unregulated air travel in Australia. Since 1979 South Australia has had no intrastate controls. Competition on four routes was thus strong with flexible scheduling and choice of aircraft type. Discount fares have meant that fares at the bottom end of the market have fallen in real terms since 1979. An academic study found that “the new freedom of entry has acted as a catalyst”. Even where there has been no competition on a route, the threat of entry has meant that the monopoly service is maintained at near competitive levels. Thus, by 1985, the federal Treasury was arguing that “. . . overall benefits would be maximised if the two airline policy were terminated from the earliest practicable date”. In the same year, the only submissions to the May Inquiry in favour of continuing the policy were from the two domestic airlines and their major unions! Therefore, in 1986 the May Report concluded that the Two Airline Policy was aimed as preserving the present industry structure instead of responding to the needs of consumers. The General Manager of Australian Airlines now believes that “the status quo is no longer an option” perhaps because the position of Australian Airlines was then deteriorating compared to Ansett. However, Australian Airlines is nowadays making improved profits which it sees as “as a very healthy opening in the countdown to deregulation”. The significant improvement is put down to stronger demand, improved yield, good capacity management and improved control over operating and overhead costs. Thus, it seems the threat of deregulation (and perhaps privatisation) is already bringing efficiencies.

Deregulation

This congruence of forces led to the announcement of the 7th October, 1987, when the government decided to end the Two Airline Policy in October of 1990 when the required period of three years notice runs out.

Capacity controls (which are responsible for parallel scheduling, few discount fares and minimal innovation in routes or marketing) will be removed. Import control over aircraft will also go. The Independent Air Fares Committee will be disbanded and the Commonwealth will withdraw from all fare determinations.

However, the Trade Practices Commission will ensure that predatory pricing is not introduced into the industry while the Prices Surveillance Authority will monitor fares and the use of cross subsidisation as a means of controlling unfair trading.

New airlines will be able to begin operations, provided they are not foreign airlines that currently have international services into Australia. However, the government will allow foreign airlines a 15% shareholding in domestic carriers, which will allow management systems and equipment to be immediately available to local operators. Whether Air New Zealand would be termed a ‘Foreign Airline’ under the terms of CEA is nowadays though, an interesting point of debate!

The right for Qantas to carry international passengers within Australia has also been restored. Before this change, Qantas was flying 17,000 empty seats around Australia each week. Thus, from July 1988, Qantas was able to offer fares to international travellers which are up to 55% lower than the standard fare of the two domestic airlines.

Unfortunately, the sudden takeover of East-West Airlines by Ansett Airlines in 1987 diminished the hopes for the success of deregulation. East-West had 8% of the market and were preparing to expand even before deregulation became effective. They wers the promise that deregulation would have immediate benefits to the consumer and they stood to be the main beneficiaries of the change.

The Trade Practices Commission consequently stepped in to force Ansett Airlines to withdraw from much of its ownership of East-West Airlines on the grounds that the takeover was contradictory to a competitive environment. Thus Ansett Airlines had to give up many of the routes where it would have enjoyed the irony of providing the only opposition to its own services. This intervention hints at how deregulation will operate in Australia (refer p. 111, Sept 87 AA).

The subsequent moves to bring Air New Zealand into the domestic market by a merger with Qantas appear to have arisen as a means to ensure that new competition has made deregulation effective. The government is obviously keen for deregulation to have an immediate and positive impact for consumers.

However, the poor returns in the aviation industry relative to other investment opportunities suggest there will be little change except in specialist markets such as linking the ten key regional ports with. Direct flights. This is because there has already a de facto hub and spoke network in Australia based on Sydney and Melbourne.

Time For Change

The May Report identified four substantive policy dimensions of regulation: aircraft capacity, route entry, fares and industry consultation and coordination. The first is unique to Australia because we do not manufacture our own aircraft, while the other three equate exactly with the regulatory devices used before 1978 in the US. That Australia administered them with an agreement called the Two Airline Policy is simply an anomaly of the Australian federal system. The decision by the government to deregulate the airline industry as of 1990 was the most radical option available to it. Like the US, it chose to withdraw from each of the areas of regulation.

However, it was even braver because it took the decision regardless of the impact on its own two airlines. Further, the previous policy history of the ruling Labor Party in Australia has been to protect the unions which support it and to favour government involvement in the marketplace.

The three factors which have combined to make change inevitable – comsumer pressure, internal problems in the system and a viable alternative in deregulation – are now present in the Australian airline industry, just as they were evident in the USA before they deregulated. Therefore, the next issue of Australian Aviation will examine how the Australian industry might develop after deregulation.