John R. Byerly: Turbulent Times in Airline Ind.

Turbulent Times: Regulation, Security and Profitability in the Airline Industry

John R. Byerly, Deputy Assistant Secretary for Transportation Affairs
Chatham House Conference, London, 5-6 March 2007; Session Three: Regulatory Open Skies
London, England
March 5, 2007

As prepared for delivery; revision of 3 March 2007

Introduction

*Let me begin by thanking Chatham House, Airline Weekly, and co-sponsors Norton Rose and Virgin Atlantic for the opportunity to participate in this timely conference. I am honored to be here.

*“Timely” doesn’t capture the extraordinary turning point at which we find ourselves. By the end of this month—indeed, on March 22 to be precise—we will know whether Europe and the United States will seize the opportunity to make aviation history and change the world for the better…or dither, debate, and fail to do so.

*As you know, on Friday, European and American negotiators initialed the text of a comprehensive, first-step EU-U.S Air Transport Agreement.

*European Commission Vice-President Jacques Barrot—whom we had the honor of hearing this morning—said that he would submit the draft agreement to the Council of EU transport ministers on March 22, terming it an “unprecedented agreement” and “step change” in transatlantic relations.

*The agreement initialed on Friday consists of the Air Transport Agreement negotiated in November 2005 and a package of substantial enhancements negotiated over the course of three rounds of further talks this year.

*The 27 EU transport ministers will decide whether or not to approve the Agreement as supplemented. If they approve, we can look forward to signature of the Agreement—arguably the most important air transport agreement in modern history—at the U.S.-EU Summit in Washington on April 30.

*If, however, EU ministers do not approve, the almost four-year-old negotiations between the United States and the European Union will have reached a dead end, with no prospect of early resumption.

*It’s worth reflecting on what’s at stake: what signing the Agreement will mean, and contrasting that with what one can expect from failure. It’s a stark contrast, a troubling one for those who believe that, sixty years after the legal framework for international civil aviation was established in the Chicago Convention, it’s time to begin dismantling the shackles of economic regulation inherent in the thousands of bilateral aviation agreements between countries across the globe.

The Benefits of Concluding the EU-U.S. Air Transport Agreement

*Let me summarize some of the principal advantages of the EU-U.S. Air Transport Agreement that was negotiated in November 2005 and then turn to the provisions added in Brussels last week.

*I’ll address the broader transatlantic market but also touch on UK-U.S. aviation relations.

*What would the November 2005 Agreement change for the better?

*It would allow every EU airline, for the first time in history, to operate to the U.S. from every city in the EU, not just from cities in that airline ’s home country.

+ Today, British carriers are limited to air services to the United States that originate in or otherwise connect to air service in the UK. And even carriers from America’s Open Skies partners—for example, Air France and Lufthansa—may offer passenger service only if it connects to the territory of France or Germany.
+ Under the November 2005 Agreement, however, BA or Virgin or bmi or silverjet or any British carrier—existing today or created tomorrow—could fly to the United States—to any city in the U.S.—from Stockholm, from Athens, from Lisbon, from Valletta or Vilnius. Airlines could decide for themselves…without the heavy hand of government blocking innovative ideas or insisting upon some bureaucrat’s concept of the perfect, ever-so-finely balanced bilateral market.
+ This expansive grant of new traffic rights to EU carriers, moreover, would open the door to cross-border airline mergers and acquisitions within the EU—something that is possible today only if airlines are prepared to place their international operating rights in legal jeopardy.
+ BA, for example, could acquire Iberia, or Virgin could establish direct subsidiaries in other EU member states, and those British-controlled airlines could operate wholly outside the UK to the United States. Perhaps easyjet will initiate low-cost, no-frills, point-to-point service across the Atlantic from a new set of European gateways. It could do so under the November 2005 Agreement. The decision belongs to the airline, not to government regulators.
+ By effectively abolishing the traditional “nationality clause& rdquo; for EU airlines, the November 2005 agreement would also cure& mdash;immediately, fully, and permanently—the legal defects that the European Court of Justice found in existing bilateral agreements, including the U.S.-UK Bermuda 2 agreement.
+ In short:

o We would establish legal certainty where legal jeopardy reigns today; o We would increase opportunities for competition and innovation in the transatlantic market with a sweeping grant of new rights for EU airlines to enter previously limited markets; and o We would enable the consolidation of EU airlines that so many Europeans have argued is essential.

*And what would U.S. airlines obtain in return for this grant of “ European carrier rights” to each and every EU airline?

+ U.S. carriers would receive no additional traffic rights in the German, the French, the Italian markets—indeed, no additional traffic rights whatsoever for service to the 16 out of 27 EU member states with which we today have Open Skies bilateral agreements.
+ With the remaining eleven states, including the United Kingdom, the web of restrictions in existing bilateral agreements would be replaced by equal and reciprocal market access across the Atlantic for European and American airlines.
+ And lest one think that, in actual practice, this grant of equal and reciprocal access would redound only to America’s benefit, look at Spain and Ireland. These two EU member states lack Open Skies agreements with the United States, see themselves disadvantaged as a result, and are among the strongest advocates for concluding the EU-U.S. accord.

*There are many other provisions in the November 2005 Agreement that improve significantly upon current bilateral agreements. Time won’t permit me to cover these in detail, but let me mention that the Agreement:

+ Lets carriers establish prices according to market demand, not the dictates of government bureaucracies;
+ Requires the United States to permit its airlines, for the first time, to lease foreign aircraft with crew;
+ Commits both sides to a robust program of cooperation on competition law, government subsidies, the environment, consumer protection, and security, creating a Joint Committee to lead such efforts; and
+ Contains a binding commitment to pursue further liberalization in a second round of negotiations to begin only 60 days after the first-step Agreement is applied.

The Status of the Negotiations

*So why didn’t we sign the Agreement last year?

*On the surface, at least, the question has revolved around the issue of & ldquo;balance” in one relatively narrow aspect of the November 2005 texts.

*From an American perspective, the November 2005 Agreement was balanced.

+ For us, balance is properly measured by looking at all the new rights in the Agreement and assessing their relative value to the two sides.
+ For the reasons I’ve mentioned, we believe that the Agreement offered EU airlines arguably greater new rights than would be made available to U.S. carriers.
+ What mattered most, however, was that the Agreement offered huge benefits to both sides: to airlines, to consumers, to shippers, to local communities, to workers, to the collective transatlantic economy.

*European transport ministers, however, took a different position in late 2005. Their position was based on the fact that U.S. carriers would receive additional so-called “intra-EU fifth freedom rights”—in other words, additional rights to fly between the sovereign member states of the European Union —whereas EU carriers would not be granted rights to carry passengers and cargo within the U.S. domestic market— the right of “cabotage.”

*I’d note that U.S. carriers already have unlimited “intra-EU fifth freedom rights” with respect to the 16 member states with which we have Open Skies agreements.

*Agreements with other EU countries—including Bermuda 2 with the United Kingdom—contain further intra-EU fifths on a more limited basis.

*From a legal perspective, the EU analogy of fifth freedom rights to cabotage is incorrect. Under international law, the right to operate within the territory of another sovereign state is considered quite different from the authority to operate between separate sovereign countries.

*The unique status of cabotage is reflected in EU practice. For example, cabotage rights are not granted in the EU’s air services agreement with Switzerland. And it was only in the third and final package of liberalization creating the common EU aviation market that cabotage was included.

*Let’s put the law to the side, however, and look at the commercial situation.

*The value to the United States of fifth freedom rights from the 11 of 27 member states with which we do not have Open Skies is modest.

+ Experts agree that the value to U.S. passenger carriers is decimal dust. For years, no U.S. carrier has operated passenger service between any cities in the EU, notwithstanding broad legal rights to do so in existing bilateral agreements. They rely, instead, on codeshare arrangements with European partner airlines. And no expert believes that this situation will change.
+ U.S. all-cargo airlines do utilize some of the existing fifth freedom rights to operate a relatively small number of flights between points in Europe, primarily UPS from its hub in Cologne and Fedex from its hub in Paris.
+ There’s no doubt that Fedex would use new rights in the U.S.-EU Agreement to start service from Stansted to Paris.
+ But it’s most unlikely that U.S. cargo carriers will make extensive use of these new rights: operating from Slovenia to Estonia or starting a route from Latvia to Cyprus doesn’t have much commercial appeal.

*But apart from the legal and commercial perspectives, there’s a much more important point.

*Namely, that focusing on “balance” in one corner of the November 2005 Agreement is to focus on at most five percent of its total value.

*Our hope had been that the rulemaking begun by the U.S. Department of Transportation in late 2005—a rulemaking undertaken not to secure the EU-U.S. Agreement but rather on its own merits as good for the U.S. aviation industry—would have been a solution to our disagreement over “balance.”

*The DOT rulemaking was aimed at encouraging foreign investment in U.S. airlines by expanding the permissible scope of foreign citizens’ participation in the commercial management of those airlines while protecting legitimate interests in security, safety, and national defense.

*As you know, DOT’s carefully drawn proposal was swept up in the typhoon of xenophobia that pummeled the United States last spring in the so-called Dubai Ports controversy. Despite valiant efforts to salvage the rulemaking, it proved impossible to build the sort of broad consensus with Congress that was needed to sustain a final rule. For this reason, Secretary of Transportation Peters terminated the rulemaking in early December.

*I appreciate—indeed, I share—the deep disappointment that many in Europe felt when the rulemaking was ended. From my personal perspective, America missed an opportunity to strengthen its own airlines through greater investment and cross-border airline cooperation.

*But neither America nor Europe should allow the termination of the rulemaking to rob us of the opportunity to achieve a comprehensive EU-U.S. Air Transport Agreement.

*Indeed, there is no better way to encourage the sort of broader liberalization of international aviation and the eventual creation of global airlines appropriate for a global economy than to take this first huge step forward now—a step that will massively liberalize the world ’s largest international aviation market, laying the foundation for the emergence of airlines with truly global scope.

The 2007 Package of Enhancements

*Precisely because the debate over balance obscured the 95% of the EU-U.S. Agreement that is pure win/win for both sides, the United States put its views on balance in the remaining five percent to one side and negotiated enhancements to the Agreement to secure European support.

*Among the items we negotiated last week—some of them unreciprocated, unilateral enrichments of the agreement to the benefit solely of EU airlines and investors—are enhancements that would:

+ Establish “safe harbors” for EU investment in U.S. airlines, stipulating that specified levels of EU stock ownership under 50% will not, of themselves, be deemed “control” and making clear that ownership of 50% or more of total equity is not automatically presumed to constitute control but will, instead, be considered on a case-by-case basis;
+ Permit EU nationals, including EU airlines, to own and control air carriers from almost 30 countries outside the European Union without putting at risk those carriers’ rights to continue flying to the U.S.;
+ Offer EU carriers unprecedented rights to fly passengers between the U.S. and the nine non-EU members of the European Common Aviation Area without a connection to EU territory—so-called “passenger seventh-freedom rights”;
+ Grant EU carriers, for the first time, the right to carry U.S. civilian-agency-funded passengers and cargo, a major exception to the decades-old Fly America Act;
+ Clarify, with great specificity, that “franchising” is permitted as long as the franchise arrangements do not establish foreign control over U.S. airlines;
+ Strengthen the role of the Joint Committee overseeing the Agreement; and
+ Bolster the commitment to second-stage negotiations.

*Had EU negotiators insisted on measures that the U.S. cannot at this time offer—for example, statutory changes in our laws on “control& rdquo; of U.S. airlines or on cabotage—the negotiations would have ended, rendering existing bilateral agreements subject to further legal challenge, jeopardizing transatlantic airline alliances, leaving barriers to EU airline consolidation unchanged, and slowing (not speeding) progress toward greater liberalization in the future.

*Similarly, had EU negotiators insisted that a “balanced” agreement be achieved by reducing the rights of market access contained in the November 2005 agreement, the United States would not have agreed: a diluted, “Open Skies Lite” accord is not one either side should accept.

Benefits in the UK-U.S. Market

*Let me say a word about the UK-U.S. market. Thirty years after Great Britain and the United States committed one of the greatest crimes in the history of aviation—the signing in 1977 of the Bermuda 2 air services agreement—we can now put an end to this abomination.

+ Gone will be the legally sanctioned oligopoly at Heathrow that limits operations to only two airlines from each side—BA and Virgin, American and United. Consumers in the UK and the U.S. would welcome new entrants in the Heathrow market. Leading the pack will be bmi, which Bermuda 2 has long denied the ability to operate to the United States from its principal hub.
+ Gone will be the temptation that a government-imposed oligopoly creates for airlines that benefit from that oligopoly to venture into the illegality of price-fixing or other cartel-like behavior.
+ Gone, too, will be the warren of senseless airline and airport restrictions that say, in effect, to a businessman or -woman in London: “No, you’re not allowed to fly non-stop from Heathrow to Atlanta, or Dallas, or Houston—get yourself out to Gatwick instead.”
+ Gone will be the bizarre ritual that British and American officials engage in every six months to “set capacity” on the various city-pairs in our two markets, handing out, trading, or holding back new frequencies as if we were schoolboys playing Old Maid or Pokey Man. It would be funny if it weren’t so sad.
+ Gone, also, will be the craziness of barring Federal Express from flying small packages from Stansted to its continental hub in Paris: as if the enhanced service that FedEx could provide to British customers is a vice, not a virtue. Perhaps if we dig a little harder into Bermuda 2 we’ll discover that those FedEx packages must be sealed with wax and stamped with signet rings to pass muster.

The Choice Between Failure and Success

*When he spoke earlier this month before Washington’s International Aviation Club, Commission Vice-President Jacques Barrot stated that a failure of the EU-U.S. negotiations would entail consequences “too terrible to contemplate.” He was right:

+ Failure would trigger further litigation before the European Court of Justice, quite possibly leading to the termination of existing bilateral agreements and destabilization of the market.
+ Failure could lead to the termination of antitrust immunity and the airline alliances as we know them.
+ Failure would jeopardize the consolidation of EU airlines.
+ Failure would leave intact the disparities in access to the U.S. market among European carriers—disparities that work today to the disadvantage of airlines such as bmi, Iberia, and Aer Lingus.
+ Failure would also leave us with Bermuda 2.
+ In summary, failure would mean we had thrown our lot with legal chaos and protected markets rather than with legal stability and market growth.

Encouraging Future Liberalization

*There will be some who argue that the EU should nevertheless reject the enhanced agreement.

+ Some are motivated by a desire to maintain protected markets, to guard oligopoly profits, and to thwart new competition. They mask their arguments behind the high-minded rhetoric of insisting on a “ better deal” or a “truly” open agreement. “ Holding out” for the supposedly “better deal” is, for these parties, a code for “holding out” for more years in which to pick the pockets of consumers.
+ But there are others who worry that if the EU does not hold back traffic rights from the United States—whether it’s Heathrow access or intra-EU fifth freedoms—the U.S. will not seriously negotiate further liberalization.
+ “Got to keep the Yanks hungry,” in other words.
+ I do not question the bona fides of those who raise this concern.
+ The validity of the argument, however, turns on whether holding back such rights would, in fact, lead the United States to change its statutes to permit, for example, foreign control of U.S. airlines, a right of establishment in the U.S. for EU carriers, or outright transatlantic airline mergers.
+ The answer to this question, I am convinced, is a clear “no.& rdquo;
+ Such arguments have proved wrong, repeatedly, over the course of U.S.-UK air services negotiation. The UK insisted on such changes as the price for getting rid of Bermuda 2; the U.S. refused; and the talks stalemated. An outcome, I regret to say, that some in the industry applauded.
+ Such arguments also proved wholly ineffectual in persuading the U.S. Congress to endorse DOT’s proposed rulemaking on “control.& rdquo;

o Faced with the possibility that the U.S.-EU talks would break down if the rulemaking did not proceed, the answer from our Congress was “too bad.”

*From my perspective—as one who would like nothing more that to see my country reexamine its airline investment rules and lay the foundation for U.S. airlines to participate in (not be excluded from) an emerging world of global airlines—the only way forward is to proceed on a step-by-step basis.

*Achieving significant liberalization with like-minded parties, such as the European Community and its member states, would lead us to assess the real benefits of taking further steps and tearing down additional walls that hem in our aviation industry.

*I’m biased, of course, having poured so much heart, soul, family time, elbow grease, and shoe leather into achieving an agreement.

*But I hope that the ministers of all 27 EU member states will recognize the immediate and enormous benefits that the Agreement would deliver to our consumers and economies.

*Successful conclusion of the Agreement would also set an example for the rest of world where, so often, protectionism remains deeply imbedded.

*And, I believe, success in this first-step Agreement would lead to further liberalization in the transatlantic market as the value of a more global, more “normal” aviation market becomes evident.

*The opposite of success—failure—does indeed entail what Vice President Barrot said: consequences “too terrible to contemplate.& rdquo;

*The choice between success or failure now rests with the 27 member states of European Union.

*Thank you for the opportunity to be here today. I look forward to your comments and questions.

Released on March 5, 2007

ENDS

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