Select Committee on European Communities Report


86.  AIRLINE COMPETITION (32ND REPORT, SESSION 1997-98)

Memorandum from the Department of the Environment, Transport and the Regions

INTRODUCTION

  1.  The House of Lords Select Committee on the European Communities published its report on airline competition on 11 December 1998. The Committee heard oral evidence between 4 June and 23 July 1998 from bodies including airlines, consumers and regulators. This document is the Government's response to the Committee's report.

  2.  The Committee's inquiry was prompted by the European Commission's proposals to amend Regulations 3975/87 and 3976/87 (as amended), which apply the Community's rules on competition (set out in Articles 85 and 86 of the EC Treaty) to intra-EEA air services, entirely between or within EEA States. The Commission's proposals would in effect extend the scope of the existing Regulations to cover extra-EEA air services. At present, both Member States (under Article 88) and the Commission (under Article 89) have powers to investigate the competition aspects of extra-EEA air services. Only Member States have powers to grant exemptions from the competition rules set out in Article 85. If the proposed Regulations were adopted, the Commission would have the sole right to investigate and to grant exemptions in future cases under EC competition law.

  3.  The Committee has produced a wide-ranging report setting out conclusions which not only deal directly with the Commission's proposal but which also comment on a number of other issues separate from but related to the application of competition rules, notably airline competition, the future development of the global aviation industry, the allocation of slots, and the ability of Member States to negotiate bilateral agreements with third countries.

  4.  There has been no progress on the Commission's proposals. They were not considered during the Luxembourg, UK or Austrian Presidencies and there is no indication that the German Presidency is likely to table them for discussion.

RESPONSE TO THE COMMITTEE'S RECOMMENDATIONS

Competition in the airline industry

1.  Airline competition should provide a good deal for the consumer. The aim of the Competition Rules governing the airline industry in the European Community, as in other industries, should be to offer the consumer lower prices, a better quality of service and greater choice. The airline industry is constantly evolving and we are concerned that the way in which it operates does not and will not achieve these goals.

  1.1.  The Government agrees that fair competition between airlines should provide the consumer with lower prices, better quality of service and greater choice. Securing user benefits continues to be a key objective in the Government's consistent support for greater liberalisation in the airline industry.

  1.2.  The UK has played a leading role in the establishment and development of the single European aviation market. In so doing, the Government has been mindful not only of the interests of consumers but also of the potential commercial opportunities for UK airlines. Last year, the Civil Aviation Authority published its analysis of the first five years of the single European aviation market[30]. Whilst acknowledging that the situation was not perfect, the CAA concluded that where competition has developed it has often led to substantial price reductions, for business as well as leisure travellers, and to increased choice for customers and better value for money. A number of major EU airlines have been privatised, and even among those which have not, there seems to be a growing recognition that a more commercial approach is needed. The rapid spread of low-cost, low frills operators, particularly in the UK, has been another striking development.

  1.3.  The aim of national and EC competition rules is to ensure fair competition. The Government believes that their proper application is in the interests both of consumers and efficient airlines.

  1.4.  As the Committee observes, the airline industry is rapidly evolving, and the Government recognises that there is concern about the possible effects on competition of the growth of global airline alliances. While the network benefits of airline alliances undoubtedly have potential to create user benefits, alliances may also cause detriment and thus may present a challenge to the application of competition law. Because, historically, the development of the industry has been rooted in the bilateral system, regulators have relatively little experience of applying competition law to international aviation, but the Government sees no reason to doubt that an appropriate competition framework can be established.

2.  The continuance of any immunity or block exemptions from the Competition Rules should be strictly justified in the interests of consumers and the promotion of competition.

  2.1.  Block exemptions within the Community are a matter for the European Commission. Article 85 prohibits anti-competitive agreements and concerted practices between undertakings which affect trade between Member States, but allows exemptions for agreements and practices which promote competition and the interests of consumers. The Commission may grant individual exemptions from Article 85 in particular cases and block exemptions for certain categories of agreements and practices.

  2.2  Block exemptions are an administrative convenience, negating the need to seek individual exemptions on each separate occasion. Regulation 3976/87 gives the Commission the powers to grant block exemptions for aviation services within the Community. Regulation 1617/93 (as amended), exempted the following categories of agreements: consultations on passenger tariffs which assist interlining on scheduled services between Community airports; slot allocation and airport scheduling in so far as they concern air services between airports in the Community; joint planning and co-ordination of the schedule of an air service between Community airports; and joint operation of a scheduled air service on a new or on a low density route between Community airports.

  2.3  Regulation 1617/93 expired on 30 June 1998. The Commission has proposed an amending Regulation, published for consultation on 28 November 1998, which would have retrospective effect from 1 July 1998 and partially extend Regulation 1617/93 until 30 June 1999. Following an earlier round of consultation, the Commission concluded that block exemptions were no longer needed for agreements on joint planning and co-ordination of schedules as well as agreements on joint operations. The amending Regulation would extend the block exemptions for passenger tariff consultations and for slot allocation at airports for a limited period only, to allow the continued need for these block exemptions to be properly reviewed.

  2.4  The Government fully agrees with the Commission that the continuance of any block exemptions from the EC competition rules should be strictly justified in the interests of consumers and the promotion of competition and therefore supports the Commission in its moves to withdraw block exemptions which are no longer justified.

  2.5  Paragraph 104 of the Committee's report refers to the equivalent mechanism in the US regulatory system, the granting of anti-trust immunity to approved agreements. Anti-trust immunity is used by the US authorities as an instrument of policy rather than exclusively as a competition measure, but the UK has no control over US Government action in this area.

3.  Introducing normal competitive conditions should be the clear objective for further regulation and development of the airline industry.

  3.1  As already indicated, the Government fully supports further liberalisation in aviation. The Government agrees with the Committee that the airline industry should, ultimately, be subject to the same competitive conditions as other industries. But, taking the EU and the US as an example, aviation is not directly comparable to other international industries in which enterprises operate on both sides of the Atlantic and are subject to two sets of competition rules. Unlike the generality of other industries, aviation (and shipping) services are produced and consumed between the EU and the US. Airlines cannot separate their activities between the two continents, or tailor their operational structures differently in different places, in the way firms in other sectors can. As a consequence, decisions by competition authorities at either end of the route have a more pervasive impact on the operations of the firms involved than might be the case in other industries.

  3.2  As the Committee rightly observes, the airline industry has received special treatment because of the system of bilteral agreements which has developed over many years and which continues to govern global aviation relations. The bilateral system will take time to dismantle. The single European aviation market is unique and has emerged from the strong political base of the European Union. Member States have a great deal in common, culturally, economically and geographically. This is significant. It will be harder to establish liberalisation more broadly with countries which have less in common and which have particular interests of national carriers to defend. The Government is prepared to support Community action towards this objective but it must be taken forward on the basis of clear political agreement, respecting the relative competences of the Community and Member States in external relations.

4.  We consider that the present system of airline regulation predominantly at the Member State level should not continue. Responsibility for regulation of airline competition should lie at the highest practical international level. In the case of these proposals, this means the European Commission.

  4.1  The Commission already has sole competence for applying the EC competition rules to airline services within the Community. Outside the Community, competence is shared between the Commission and Member States under the transitional arrangements provided in Articles 88 and 89 of the EC Treaty. Member States have the sole power to grant exemptions under Article 85(3), but the Commission has a power of investigation and it may authorise Member States to take measures to end any infringement of the competition rules it finds.

  4.2  The Government accepts that in the long term the Commission may assume sole responsibility for deciding competition cases affecting extra-Community routes as well as those affecting the internal market. But, as the Department of the Environment, Transport and the Regions (DETR) made clear in its evidence to the inquiry, the Government believes that competence for the application of the Community's competition rules should move in parallel with competence to negotiate traffic rights. Until now, Community legislation has followed this path, with the application of competition rules first to air services between Member States and then to services within Member States reflecting the gradual development of the single aviation market. The Government maintains its view that this is the correct way to proceed.

  4.3  The Government believes that the present legislative position properly reflects the respective competences of individual Member States and the Community in their aviation relations with third countries. The Committee concluded, in paragraph 130 of its report, that it would not support the Commission negotiating bilateral agreements on behalf of the European Community without a political mandate from the Council of Ministers. The Government entirely agrees. That is why we cannot accept that the Commission's proposals should be adopted before such agreement is forthcoming, as they would seriously restrict the ability of Member States to continue negotiating bilateral agreements effectively.

 5.  The Commission could apply the Competition Rules more efficiently and consistently than Member States have done to date.

  5.1  The Government accepts that if the Commission had exclusive competence to apply the Community's competition rules there might be gains in consistency, and it also recognises the attractions of a "one stop shop". However, the Commission already exerts a considerable influence in the application of the rules to extra-Community air services. The ongoing investigations into the proposed British Airways/American Airlines alliance, conducted by both the UK competition authorities and the Commission, demonstrate this point clearly. One advantage of the present system is that the Commission and Member States' competition authorities co-operate and may pool their experience, which can enhance the quality of decision-making of both.

  5.2  A number of witnesses expressed concern at the speed at which the Commission currently deals with competition cases. If the Commission does at some point assume sole responsibility for applying the rules, all parties will wish to be reassured that the Commission has the capacity to deal with cases effectively and in good time.

6.  We do not accept that the Commission would use competition policy as more of a political tool than Member State governments do. A political and commercial agreement on what should be contained in the block exemptions should minimise the ability of the Commission to exploit competition policy from a political motive.

  6.1  The Government is not clear who suggested that the Commission would use competition policy as a political tool, and would not support such a view. Further comments on this are expressed in our response to recommendation 26 below. As the response to recommendation 2 above makes clear, block exemptions are merely an administrative convenience to save airlines from having to apply for individual exemptions in areas where co-operation is clearly not anti-competitive. Block exemptions are set out in Community legislation which is subject to prior consultation with interested parties and Member States.

  6.2  As we have already made clear, the Government fully supports the regular review of the continued need for block exemptions which have already been granted. If Community competence is extended to application of EC competition rules on extra-Community air service, we would expect such an approach to continue.

7.  The proposed Regulations could achieve a greater degree of transparency in the application of competition policy to airlines.

  7.1  It is not clear how the proposed Regulations would, in themselves, achieve a greater degree of transparency, as they would merely affect who applies the rules rather than how the rules would be applied. As the DETR stated in its evidence, the Government believes there is scope for greater transparency surrounding the Commission's administrative procedures in applying the EC competition rules within the Community. This is particularly true when the Commission decides not to pursue a complaint as it is not always clear how the Commission arrived at its decision. It is acknowledged, however, that once the Commission has decided to open proceedings following an initial complaint, a fair balance is generally maintained between the conflicting claims of transparency and the need to protect commercial confidentiality.

 8.  The airline industry should, in the long run, be treated as any other industry in terms of the Competition Rules.

  8.1  The Government generally supports the principle that normal competition law should apply to international scheduled aviation. The Competition Act 1998 broadly achieves this aim by extending the newly-consolidated UK competition regime to international aviation. But aviation is by definition an international business, largely governed outside the Community by a system of bilateral agreements, and subject for historical reasons to a wide range of Government controls in different parts of the world. The transition from a regime in which competition is "managed" by means of tightly-drawn bilateral agreements to a regime in which airlines can freely offer services subject to the application of normal competition rules would be a substantial shift, both in policy and in practice. This is bound to be a gradual process as it would be subject to agreement from a wide range of third countries, many of whom would resist such change.

  8.2  Pargraph 111 of the Committee's report recommends that the Commission should, over time, limit the kinds of activity that would be permitted under block exemptions. As explained in the response to recommendation 2 above, block exemptions are an integral part of the way in which the EC competition rules are applied and the Government fully supports the systematic review of such exemptions to ensure that they continue to be justified.

9.  While we acknowledge the logic of the argument put forward for an independent European competition authority, we do not consider either that it is necessary or that it would be practical.

  9.1  The Government shares the Committee's scepticism about the potential benefits of an independent European competition authority.

Winners and losers

10.  We note concern that liberalising airline services with third countries might lead to a highly concentrated industry but we believe that, with the strict application of competition policy (in terms of controlling cartel activities, dominant positions, mergers and state aids), this can be avoided.

  10.1  The Government assumes that the underlying concern here is a fear that liberalisation with third countries will, if unchecked, lead to a concentration of the industry as ownership restrictions are relaxed, and that industry concentration will lead to a diminution of competition. The Government believes that industry concentration does not inevitably have to mean less competition at the route level if it results in a greater overlap of competing airline networks, but recognises that vigilance by the competition authorities is needed to check any undesirable behaviour that restricts competition.

11.  Airline carriers in the United Kingdom would be well placed to cope with increased competition under the proposals, given the advanced state of deregualtion of the industry in this country, and may do well in the longer term.

  11.1.  The Government agrees with the Committee's assessment.

The needs of the consumer

12.  The needs of the consumer should be paramount. Competition between airlines should ultimately be for the benefit of the consumer in terms of price and quality of service, and in this respect, the maintenance of "national" airlines is irrelevant.

  12.1  The Government agrees with the Committee in opposing the maintenance of inefficient airlines for reasons of national policy. Over recent years a number of state-owned, EC airlines have been in receipt of state aid. Such subsidies distort competition and are unfair to those airlines which do not receive any aid, including all UK airlines. Nor is it in the interests of airline passengers to provide financial support to inefficient airlines with higher operating costs. The UK Government has actively opposed the granting of state aid to airlines and welcomed the Commission's statement in its July 1997 decision approving state aid to Alitalia that it did not expect there to be any further cases of state aid to airlines in the future. We very much hope that is the case and that from now on all European airlines will compete on an equal commercial basis.

13.  We recognise that in certain circumstances, for instance when there is no competitive interest in serving a certain route, it would be necessary for essential services to be maintained by government subsidy. Consumers across the European Union could benefit from competition rules being applied at the European Union level.

  13.1  The Government is, as a matter of principle, opposed to state aid in the air transport sector but accepts that in certain limited circumstances there may be a need to provide financial support for uneconomic but socially necessary air services. Council Regulation 2408/92 allows a Member State to impose a public service obligation (PSO) to protect services which would otherwise not be provided on a purely commercial basis on routes serving airports in peripheral regions and thin routes to any regional airport which is vital to the economic development of the region. The Regulation allows for PSO routes to be restricted to a single carrier, subject to an open competitive tender, and for the remuneration of operating losses incurred by carriers selected to operate these routes. A PSO can only be imposed on a route involving a regional airport, subject to certain narrowly defined criteria. The UK has imposed PSOs on a number of lifeline air routes to, from and between the Scottish Highlands and Islands which are considered essential for the economic and social welfare of these remote communities.

  13.2  The more general issue of the application of the competition rules is dealt with in the response to recommendation 4 above.

Barriers to competition

14.  Action should be taken at the Community level to ensure airlines are able to compete in a normal competitive environment free from ownership restrictions, thereby making code-sharing alliances less prevalent in the longer term.

  14.1  The Government agrees that the traditional restrictions on ownership and control of airlines hinder the development of competition and are no longer appropriate. The UK's work to break down these restrictions is detailed in the response to recommendation 27 below. Within the Community, of course, national ownership restrictions have already been broken down as any airline majority owned by a Member State or its nationals may operate within or between any other Member States. It is clear, however, that at the wider international level the removal of ownership restrictions can be addressed only on a reciprocal basis.

Slots

15.  In our view, the current system of slot allocation, based on the retention of grandfather rights, is clearly anti-competitive.

  15.1  The preamble to EC Regulation 95/93, which governs the slot allocation procedure at airports within the EU, places it in the context of the Community policy of facilitating competition and encouraging entry into the market, with preferential treatment for carriers who intend to start operations on intra-Community routes. Analysis by the Civil Aviation Authority indicates that it has not been successful in enabling new entrants to become established at congested airports such as Heathrow and Gatwick. But the Government believes the principal reason for this to be capacity constraints at the two airports. In addition, it should not be overlooked that, in the London airport system as a whole, there has been a substantial growth in intra-Community scheduled services competing on the same routes from Stansted, Luton and London City airports.

16.  We believe that there is now a pressing need for a new Slot Regulation which radically alters the rules governing the allocation of slots at Community airports. This is fundamental to ensuring a competitive airline industry, both in the European Community and world-wide. The question of slot ownership should be clarified.

  16.1  Proposals for a revision of 95/93 are awaited from the Commission. They are overdue, and indications are that they may not be forthcoming in the near future. It is difficult to comment on possible changes without seeing an overall package of measures.

  16.2  The Government has made clear its view that slots are not the property of the airlines which occupy them. However, the concept of slot "ownership" is a legally complex one over which different views have been expressed, and where there is currently no relevant case law. It can be argued that, given the existence of grandfather rights within the current regime, occupancy rather than ownership is the key consideration relating to the use of slots.

17.  The system of grandfather rights is now increasingly anomalous and anti-competitive and this system combined with the flexibility afforded to airlines to switch slots between routes provides incumbent airlines with too powerful a tool against its current and potential competitors.

  17.1  By definition, historic or "grandfather" rights work to the advantage of incumbent airlines. They are an internationally recognised principle within the aviation industry. They enable airlines to plan on the assumption that they will be able to use the slots that they currently hold in future seasons, provided that they meet the conditions of minimum use set out in the EG Regulation, and hence to take a long-term view in developing routes and their wider network of services, and in planning investment. But the effect at congested airports is to make it considerably more difficult for new entrants to start up viable competing services. We understand that the Commission is considering the issue of grandfather rights in preparing proposals for revising the slot allocation Regulation. The Government will study these with interest when they appear.

 18.  We urge the Commission to use its existing powers to suppress anti-competitive practices and abuses of dominant positions by airlines at Community airports.

  18.1  The UK Government supports any moves that support the principle of open competition in a free internal market.

19.  We urge the Government to consider allocating a number of slots at major airports to maintain regional air services.

  19.1  The UK has already made proposals to the Commission that priority in the allocation of slots not claimed under historic precedence should be given to airlines that wish to use the slots for services to regional airports, rather than, as at present, to new entrants. And in A New Deal for Transport[31], the Government said that it would press for recognition in any revised EC regime for slot allocation of the case for maintaining access from regional airports into major hubs such as Heathrow and Gatwick.

20.  No airline should be allowed to dominate slots at any particular airport to the extent that they have unfair and anti-competitive access. The promotion of competition between airlines should be the aim of any new system of slot allocation. The objective in the long run should be an open and competitive slot allocation system.

  20.1  Both the European Commission and the Office of Fair Trading have powers to investigate abuse of a dominant position, and to consider the effect on competition of proposed alliances and take-overs. The Committee will have noted that the resultant increase in BA's share of slots at Gatwick was a contributory factor in the recent decision to refer the acquisition of CityFlyer Express by BA to the Monopolies and Mergers Commission.

  20.2  Congestion at hub airports, and the delays and difficulties that may be encountered in expanding capacity to meet growing demand, mean that the slot allocation regime must have regard to making the most efficient use of slots as well as to competition considerations.

21.  Linking slots to routes is a positive step towards regulating airline behaviour and one that could be extended to enhance competition.

  21.1  To tie slots to particular routes would tend to have the effect of causing the market to ossify, by preventing airlines from altering their service patterns and frequencies to meet market demands. As such, it would be likely to reduce rather than increase competition. It would also prevent airlines from swapping slots to enable timetabling changes that can benefit both carriers, and their passengers.

  22.1  The Government shares the view that there are ambiguities in the current Regulation that should be removed in any forthcoming revision. It agrees that promotion of the public interest should be paramount. On occasions, for instance in the treatment of regional services into congested hub airports, this may entail some constraints on competition.

23.  Whilst we recognise that there may be legal complexities to overcome, ultimately we believe that slots at each Member State's airports should be treated as national assets of that Member State. Airlines should bid for the use of slots within criteria set by the European Community.

  23.1  As indicated in the response to recommendation 16 above, the legal situation regarding slot ownership is complex, and the implications of any changes to existing arrangements would need careful consideration. The Government takes the view that as things stand, airlines do not have property rights in the slots that they occupy. Some parties have argued for the auctioning of slots on a time-limited basis as the best means of supporting competition. Others suggest that this could simply tend to favour the large carriers with the greateast financial clout. While the existing system of grandfather rights remains, only newly created slots or ones returned to the allocation pool could be auctioned, and this could have only a marginal effect on competition. Given the substantial excess of demand for slots at congested hubs over the available supply, any method of allocating slots, formerly the subject of grandfather rights, other than auction would be contentious with disappointed airlines. Allegations of favouritism might arise. This could work against the Commission's objective, supported by the UK Government, that slot allocation should be based on neutral, transparent and non-discriminatory rules.

Bilateral air services agreements

24.  The true negative effects on competition within the European Community come from distorted competition between the European Community and other large airline markets, notably the United States.

  24.1  As indicated in the response to recommendation 4 above, the Government believes that the extension of Community competence to implement the EC competition rules should proceed in parallel with the extension of competence to negotiate traffic rights. So, as the Commission has already been granted a mandate to negotiate with the 10 Central and Eastern European countries, we believe that it is entirely logical that it should assume sole responsibility for applying the EC competition rules on extra-Community air services to these countries, but not more generally. The Government accepts the Committee's assertion that concerns about potential market distortion are more significant on trans-Atlantic routes than in wider geographical Europe, but it does not change our view that competence for negotiating traffic rights and for applying competition rules should proceed in parellel.

Should airlines be treated differently?

25.  Airlines have been afforded special treatment in the European Community's competition policy for historical reasons. We believe that these reasons are just that—historic. While we fully recognise the importance of safety standards and controls in the airline industry we believe that these should not inhibit the creation of a more competitive airline industry world-wide.

  25.1  As already indicated, the Government fully agrees with the goal of creating a more competitive airline industry world-wide. This would bring clear benefits to consumers and we believe that UK airlines would be well placed to take advantage of new opportunities. The Government also accepts that the current competitive situation is the legacy of the development of the bilateral system since the 1940s. But as indicated earlier, just because a system is outmoded does not mean that it is easy to dismantle, particularly when many States outside the Community regard it as in their national interests to maintain restrictive agreements.

26.  Member States' governments are as culpable, if not more so, than the Commission for playing politics with airlines, because the Commission would have to balance the competitive needs of airlines from all 15 Member States in its decision-making. It should not, therefore, have a relationship with any particular airline.

  26.1  This Government does not "play politics" with airlines. We have a multi-airline industry in the UK and we want to see all our airlines thrive in a competitive environment. Our objectives in negotiations with third countries are to promote liberalisation and to secure benefits for UK consumers. These objectives can bring benefits to UK airlines too, through greater access to world markets. The Government does not believe in using airlines, whether UK or foreign, as pawns in wider political games.

27.  The real issue affecting airline competition world-wide is the continuing existence of ownership and control restrictions, particularly in the European Community and the United States. Removing these ownership and control restrictions is a vital step towards achieving a truly competitive global airline industry.

  27.1  The Government agrees that the traditional restrictions on ownership and control of airlines hinder the development of competition and are no longer appropriate. That is why it has already (in 1997) amended the United Kingdom's model Air Services Agreement (ASA) so that it no longer requires airlines to be majority owned and effectively controlled by nationals of the state designating the airline. In line with the recommendations of the ICAO Air Transport Regulation Panel, which stressed the need (to ensure effective safety oversight and prevent the emergence of flags of convenience) for a strong link between an airline and the designating state, we now require an airline to be established and have its principal place of business in the state of designation, and to hold an Air Operator's Certificate from that state. The nationality of the owners and managers of the airline is no longer material.

  27.2  Several bilateral agreements adopting this more liberal approach have already been concluded with other states. To stimulate a more widespread adoption of this policy, the United Kingdom has been working within ECAC (the European Civil Aviation Conference) with a view to agreeing a model article replacing traditional ownership and control restrictions by a focus on the strong link referred to above. The UK's approach has met with widespread support, and agreement on a final text is expected in March.




30   The Single European Aviation Market: The First Five Years-Civil Aviation Authority-ISBN 0 86039 736 X. Back

31   A New Deal for Transport: Better for Everyone-(Cm 3950)-ISBN 0 10 139502 7. 22. The new European Community Slot Regulation should set clear and effective criteria for the allocation of slots, and that promotion of competition and the public interest should be the most important elements. Back


 
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