Select Committee on European Communities Thirty Second Report

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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