Subsidies in the Airline

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Table of Contents

Introduction
Birth of Subsidies for Commercial Airlines
Reason for Subsidies
Forms of Subsidies Given
Discussion and Conclusion
References

Introduction

Air travel has undergone dramatic changes since its humble beginning at the Wright Brothers’ garage. Today, air travel is the most fast and effective form of travelling and many nations boast of having an operational airline with commercial flights being prevalent. These commercial flights are encouraged by governments all over the world since it is understood that increasing movement and availability leads to the prosperity of the nation.

Many governments including the US are therefore in the habit of subsidizing the airline industry and while this habit is not as prevalent as it was in the early years of commercial airlines, it is still present today. Subsidies are seen as necessary to ensure that the industry is successful even in the face of uncertain economic realities. A significant occurrence in the history of US commercial airlines was the enactment of the deregulation Act which removed most of the federal government’s regulations imposed on the industry.

According to Bailey (1986), deregulation and “free sky” resulted in other flavors of government assistance to the industry. This paper will engage in an in-depth description of government assistance to the airline industry. The history of this assistance and why it is necessary will be discussed and any setbacks that can come from subsidizing articulated.

Birth of Subsidies for Commercial Airlines

Government subsidies to commercial airlines trace their root to the First World War. As a result of this war, businesses were destroyed, capital diminished and investors were unwilling to take great risks. The War also resulted in the military airplane being seen as a valuable weapon of war. Since hostilities between nations had ceased, some countries decided to develop commercial air transport so as to have a potential military weapon (Hiram, 1998).

Commercial air transport was then a new and experimental business and the private industry was unwilling to fully support it. Government therefore had to assume the lead in promoting the development of air services. Private companies were therefore offered grants to engage in aeronautical research and the government subsidized the purchase of aircraft parts for companies to assemble their aircrafts.

Reason for Subsidies

At the onset, airlines were pitted against well established forms of transport. Hiram (1998) states that commercial aviation had to compete with other older agencies of transportation such as railroad, automobile and ships. The general public was not keen on using air transport since its safety was not assured and the cost was significantly high (Warne, 1967).

In all kinds of transport, the safety element is key and the public demands for safety have to be fulfilled before public patronage can be assured. For this reason, key players in the airplane business were forced to assume large risks of loss before they could make any profits. The government therefore had to step in so as to popularize airlines with the public. Subsidies have been a common factor in the development of traditional forms of transport such as the railroad and the automobile.

The government has a vested interest in international aviation since it is regarded as a means of maintaining and extending the commercial or political influence and control (Hiram, 1998, p.199). Governments therefore seek to ensure that they have a well established airline in operation.

Historically, governments have encouraged the construction of railways and waterways from the realization that these infrastructures have military as well as commercial value. Hasbrouck (2006) notes that airlines are paid by the government in return for their agreement to avail their planes to the government in the event of a war. Commercial airlines therefore supplement the military aircrafts as “Reserve Air Fleet”.

Commercial airlines require investments of large amounts of capital before they can be started up. Traffic cannot be developed if the necessary equipment and facilities do not exist. Scott and Farris (1990, p.32) reveals that in air transport, it might take years and even decades before sufficient volume of traffic is attained by an airline to insure profitable performance.

It is unlikely that private investors will be willing to risk on airline ventures with the hope of making profits after many years. The government therefore has to step in to ensure that investors gain some return on their investments sooner than they would without subsidies.

International rivalry is another reason why government subsidies are necessary for commercial air travel. Without subsidizing aviation, a country faces the alternative of using foreign companies which will be allowed to crisscross its territory (Scott & Farris, 1990). Therefore, for the sake of national prestige, a nation may be forced to aid her domestic air services so as to ensure that the planes that operate on her airspace belong to the country.

At the onset, the subsidies were based on the assumption that the operating costs of air transport would move downwards. The government therefore took the position that private air transport companies needed to be supported through the difficult development period until they became an integral part of the nation’s transportation system (Hiram, 1998).

Today, air transport has matured and the operating cost is significantly lower than in was in the early years of development. However, government assistance is still a crucial component in commercial airlines.

While all businesses are exposed to certain risks in their operation, commercial airlines face even increased risks and if failure occurs, the losses would be catastrophic. Airlines are exposed to the volatilities of the market and in times of crises, the losses to be suffered are monumental (Balfour & Leandro, 2011). For this reason, state subsidies are used to rescue airlines in trouble and prevent them from collapsing.

Forms of Subsidies Given

Governments offer subsidies in the form of infrastructure for airline companies. Scott and Farris (1990) reveal that local governments generally own and operate the airports that fall within their location. The fees that airlines are charged for landing, office and operational space do not repay the operating costs of the airports and when they do, they still fall short of covering the capital costs. As such, the commercial airline is operating on a subsidy since it is the local government which will cover the balance for operating the airport.

Another form of subsidies offered by the Federal Aviation Administration (FAA) is grants which are given to the airline industry. These grants are provided for the building of infrastructure such as airports or increasing the capacity and efficiency of existing airports. In 2005, the FAA spent in excess of 3.4 billion making capital improvements of airport infrastructure through the Airport Improvement Program (AIP).

AIP ensures that all airports have the necessary infrastructure to support commercial airlines. The grant provides funds for activities such as runway construction and ensuring that the control towers are well equipped. Small airports are the major beneficiaries of grants and Warren (2008) reports that 60% of all grants go to small airports.

This is because large and medium sized airports are “mature financial enterprises that no longer need passenger entitlements to meet their capital needs” (Warren, 2008, p.61). While large airports have a great ability to finance their debts for capital projects with bonds, smaller airports lack this ability and can only survive from revenues obtained from federal grants.

Another form of assistance that the government gives US airlines is protection from foreign competition. Hasbrouck (2006) notes that foreign airlines are prohibited by Federal law from carrying passengers within the US. In addition to this, foreign entities are not allowed to own over 25% of the voting stock in US based companies.

The US government also gives US flag airlines an edge over their competitors by dictating that all travels that are funded by the US government (even if only in part) be on a US airline company. This demand is regardless of how much costlier the US company may be compared to a foreign commercial airline. Hasbrouck (2006) states that this de facto monopoly on government funded travels gives US commercial airlines consistent and big revenue

In addition to the direct subsidies, governments also offer indirect aid to commercial aviation. This includes meteorological services and weather maps which are necessary for safe navigation. Private enterprises are also aided substantially in research and scientific developments to come up with better aircrafts and increase efficiency. Another form of subsidies is in research and development of aviation technology.

Most of the technology utilized for the production of commercial aircrafts is obtained from military developments (Hasbrouck, 2006). This military aircrafts are funded primarily by the government and the manufacturers of civilian aircrafts often obtain the knowledge from military research for free.

Discussion and Conclusion

Commercial airlines have a vital peacetime commercial and wartime defense interest and for these two reasons, the government has and will continue to offer subsidies to the industry. Subsidies have resulted in the significant growth and development of the airline industry.

It has also led to people being so accustomed to the relatively low rates of air fare that it is unlikely that they will accept future increases should the subsidizing be removed. Thanks to subsidies, small communities that would otherwise lose services of air carriers can continue to enjoy these services. Warren (2008) documents that through the Essential Air Service (EAS) program, small communities are protected from being abandoned by airlines.

The program obligates airlines to give 3months notice before terminating service to allow the Department of Transportation time to find a replacement airline that will serve the small community. In the event that no airline is willing to serve the community, subsidies are offered to an airline to ensure service.

Nations including the US grant subsidies and spend millions of dollars to ensure the development of commercial air transport. This paper has attempted to explain this phenomenon which has been taking place since the advent of the commercial airlines industry.

While subsidy programs continue to draw criticism from people who deem them as a waste of tax payers money, this paper has shown that subsidies have historically helped to develop the airline industry to what it is today. They continue to ensure that the airline industry develops and is available for use by everyone.

References

Bailey, E. E. (1986). Deregulating the airlines. Cambridge, Massachusetts: MIT Press.

Balfour, J., & Leandro, S. (2011). State Aid in the Airline Sector: a Change in Focus. European State Aid Law Quarterly (2), 225-236.

Hasbrouck, E. (2006). Government subsidies to airlines. Web.

Hiram, J. L. (1998). Commercial air transport. Harvard Business Review, 6 (2), 198-217.

Scott, D. R., & Farris, T. M. (1990). Airline Subsidies in the United States. Transportation Journal, 34(3), 25-33.

Warne, C. (1967). Economic Factors Relating to the Impact of Routes and Schedules on Subsidy Needs of Local Service Airlines. Transportation Journal, 6(4), 5-14.

Warren, E. D. (2008). The regional economic effects of commercial passenger air service at small airports. NY: ProQuest.

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