AFA - Aerospace Forum Asia

Speech by Mr. Karan K. Bhatia,
Assistant Secretary for Aviation and International Affairs,
U.S. Department of Transportation
at the AAPA 48th Assembly of Presidents,
26 November 2004, Taipei, Taiwan

The Effects of Civil Air Transport on World Economies and Politics

Let me start by conveying greetings from President Bush and from Secretary of Transportation Norm Mineta and Under Secretary Jeff Shane. As you may know, both Secretary Mineta and Under Secretary Shane have deep personal interests in aviation in the Asia Pacific region, and both were delighted when I told them that you had invited me to participate in your assembly today.

Let me also express my personal appreciation for your invitation. As some of you may know, this is the Thanksgiving holiday weekend in the United States, which is generally celebrated by gathering inside with one’s family, eating excessive quantities of turkey, and watching American football on television. Alright ?I’ll admit it’s a somewhat quirky tradition, but we like it, and I can tell you that one misses Thanksgiving –especially, when one is married to my wife ?only at some personal cost. (And, given the “make-up?shopping list that she handed me as I left, apparently some financial cost as well.) There are very few events that could even tempt me to incur those costs. But this gathering was one.

Over the past year, we at the Department of Transportation have been focusing intensely on our international relationships ?evaluating them, and looking to broaden and deepen those that we believe are of the greatest importance. It is our view that the growth and dynamism that we see in the Asia Pacific region will be among the most important drivers of change in global transportation ?and, indeed, in the global economy ?in the next quarter century. Simply stated, we believe that there is no region of greater importance to global economic growth than the Asia-Pacific region, and that the airline industry represented by you all here today will be instrumental in facilitating that growth. And so, I am delighted to be with you all today.

What’s Going on In Washington. Now I have been asked to provide the “view from Washington.?I can report that it is a fascinating view right now ?in the period between the recent election and the start of President Bush’s second term. There is a palpable sense of excitement in the Administration as we review priorities, anticipate challenges, and seek to define our agenda for the next four years. Working with the White House, State Department and other agencies, my staff and I are doing that with specific reference to aviation.

Let me share a few very fundamental beliefs that inform our thinking as we approach that task:

?First, we believe that efficient, safe, and secure aviation is critical to the achievement of broader domestic, regional, and global economic and political objectives. In short, aviation is important because it is a facilitator of domestic and international economic growth and of mobility, freedom and democracy. The policies we adopt must recognize and help it to fulfill those functions.

?Second, stated simply: we have a strong predisposition to market-based solutions to aviation problems where possible. We recognize that, in certain cases and with certain issues (and I will touch more on these cases later), there is a role that government must continue to play. But, it is our view that, over the course of history, with certain rare exceptions, government has been an impediment to the effective functioning of the aviation system, not the solution.

?Third, we believe that aviation must ?more than ever before ?be viewed in a global context. Lest there was any doubt, it is now clear that the airline industry is an international network ?or, rather, an international network of networks. While ?in a world of sovereign states ?such networks cannot work free of national governmental control, those constraints should be minimized where possible.

?Finally, our aviation policymaking must be informed by the current state of the airline industry, both domestically and abroad. And I would like to spend a bit of time on this subject this morning, because I would submit that it is this topic ?the state of the airline industry ?that most immediately affects the Department’s aviation outlook and agenda, both domestically and internationally.

What’s currently going on in the industry. It is probably news to no one here that the U.S. airline industry is in the midst of a fundamental restructuring. Earlier this year, Secretary Mineta used the phrase “paradigm shift?to describe what we see occurring in the industry. The current financial state of the industry ?with two major passenger carriers in bankruptcy and the others all actively reorganizing to avoid it ?is evidence that this is an industry in a fundamental process of redefinition.

In the United States, the shift reflects, I believe, the ongoing evolution of a deregulated industry. The financial challenges facing our so-called “legacy?passenger carriers have been in the making for some time. The combination of spiraling costs that began in the 1990s and the rise of a new generation of stronger, better-capitalized low-fare airlines have contributed to the cost pressures currently confronting many of our legacy carriers, as has the increased price transparency faced by all airlines as a result of growing airline Internet ticket sales.

For years, our large network carriers were able to transcend cost-side pressures with revenue-focused strategies ?largely centered on the high-yield business traveler. With innovations like sophisticated global distribution systems, revenue management, and frequent flyer programs, airlines were able to segment demand and achieve yields capable of covering relatively high costs. The strategy generally worked because the business traveler grew accustomed to paying high fares and didn’t have any really attractive alternatives, and because the airlines enjoyed a greater ability to control the number of seats available to discretionary travelers. Those conditions appear to exist no longer. Yields have declined substantially since 1999 and ?notwithstanding the broader economic rebound ?remain low. Business travelers are increasingly turning to the growing variety of attractive low-fare options available (including options offered by the legacy carriers themselves) and the expansion of LCCs has diminished the legacy carriers?ability to control supply.

As the executives of a number of U.S. legacy carriers have recently said, they no longer have any choice. To be able to serve the huge pool of price-sensitive travelers profitably, their costs must come down dramatically. Whether the U.S. legacy carriers are going to remain an industry force will, accordingly, depend in large part on how successful they are in achieving lower costs. They are leaving no stone unturned in that cause. While most legacy carriers have already achieved cost reductions that border on the heroic, recent developments suggest that still more will be needed.

International Effects of the Paradigm Shift. While this restructuring process is going on –indeed, as part of the restructuring process ?we see the U.S. airlines again beginning to look outward. We have recently seen U.S. legacy carriers announce plans to start new international services. In our limited entry markets, such as China and Mexico, interest is at an all-time high, with highly contested proceedings ongoing before the Department for allocation of limited route rights. U.S. carriers are seeking to expand both with their own aircraft and in combination with code share partners. And it is not just the U.S. majors that are doing this. We have seen U.S. LCCs, such as Jet Blue, Spirit and Frontier, enter international markets ?admittedly in a limited form, but enter nonetheless. We suspect that this is a sign of more to come. And our expectation is that new entry or reentry into these markets will stimulate traffic that heretofore has not been able to afford to travel abroad.

From an international perspective, what is fascinating is that the paradigm shift we see occurring in the United States also appears to be happening in other parts of the world –even in places that have historically been perceived as far more “regulated?than the U.S. In Europe and here in Asia ?rapidly changing, dynamic marketplaces, with robust demand for air travel ?legacy passenger network carriers are being challenged by LCCs like Ryanair, EasyJet, and Air Asia. Established carriers around the world are responding in similar ways. Some, like America West and Aer Lingus, have transformed themselves into low-cost carriers. Others, like United, SAS, and Qantas have formed low-fare airline brands. Yet others, such as Lufthansa with Germanwings and Singapore Airlines with Tiger Airways, have invested in independent low-fare carriers. All, however, are focusing on costs to an extent heretofore unknown.

In short, I would submit that the paradigm shift we currently see ongoing in the global airline industry is inexorable. And it is inexorable because it is being compelled by the marketplace ?by the enormous untapped demand for transportation worldwide.

The Impact on Policymakers and Policy. The principal beneficiaries of this dynamic, highly competitive marketplace are, of course, the consumers ?both in the United States and abroad ?who have available to them more transportation options at lower prices. But, of course, the benefits go beyond consumers. They encompass the entire economy –the small businessman who can now afford to conduct the client meeting; the university able to attract the student from a distant point; the city whose restaurants, hotels, and businesses are supported by the traffic generated by the new, low fare environment. Increasingly ?and this goes back to one of the core principles I mentioned above ?air transportation is being seen by policymakers at home and abroad not just as an end unto itself, but as a generator of economic growth.

What does all this mean for policymakers? Policymakers ?and here, I mean policymakers both in Washington and in capitals around the world ?have two choices: to seek to stand in the way of this onrushing tide or to try to harness its power and ride the wave. Increasingly you see policymakers choosing the second option. Increasingly we see governments ?in countries ranging from Ireland to Thailand to India ?realize the enormous broader economic and political benefits to be derived from allowing the paradigmatic change to happen.

Moreover, you see those who originally sought to resist the change by putting up barriers ?refusing, for example, to allow new carriers to challenge the incumbents ?changing tack. Whatever the viability of that strategy thirty years ago, we believe it is simply no longer viable in today’s globalized economy. Other economic pressures ?the pressures to attract business ?will make the protected airline an unaffordable luxury. A country’s refusal to liberalize ?and with it, the effective imposition of higher fares on passengers, and the consequent deterrence of air travel ?is simply no longer politically or economically affordable in today’s economy where capital will move seamlessly from where artificial barriers to entry (such as unnaturally high air fares) exist to where they do not.

The Aviation Policy Agenda. So let me turn finally to what roles we do see for government in this period of enormous change, and what areas we at the Department of Transportation are focusing on. Let me touch on five areas: (i) ensuring aviation safety; (ii) supplying certain public goods necessary to the efficient functioning of the aviation system; (iii) ongoing efforts to liberalize international markets; (iv) streamlining of regulation governing carrier activities; and (v) security.

First, government will and must continue to be involved in ensuring the safety of air transportation. The role played by aviation safety organizations, such as the FAA, are critically important to the vitality of our industry. I should note in this regard that the U.S. is actively committed to improving aviation safety, not just in the United States, but internationally as well. In the Asia Pacific region, for example, the FAA has recently concluded bilateral aviation safety agreements with Singapore, Taiwan, and New Zealand, and are close to concluding an agreement with Australia. We have been working very closely in APEC fora with Korea, Japan, Indonesia, Malaysia, Singapore, and Thailand to improve air navigation and aviation safety. And we have provided incountry training and technical assistance this year to China, Korea, Taiwan and Thailand, some in cooperation with AAPA. We are committed to and have been working actively with and through international institutions such as ICAO and APEC to help promote common approaches to aviation safety and to strengthen compliance with those practices.

And let me here recognize someone who has been critical to our efforts in the area of safety in the Asia Pacific region ?Beth Erickson. As the FAA’s director for the region, based in Singapore, Beth has made major contributions to building the United States?relationships with the region in the area of aviation safety for the past four years, and we will sorely miss her when she retires from the FAA next year.

Second, there will be certain “public goods?necessary to the efficient functioning of the aviation system that government must continue to supply. The global aviation infrastructure ?runways, airports, ATC ?comes to mind. Let me note briefly note two recent U.S. developments in this area. First, last year, the Congress passed legislation, at the Administration’s urging, significantly streamlining the environmental regulatory review process necessary for the creation of new airport infrastructure. This change will yield substantial benefits in cost and time savings for building new aviation infrastructure. Second, the Administration has launched The Next Generation Air Transportation Initiative ?an initiative that, for the first time, brings all the relevant federal agencies ?the Departments of Transportation, Defense, Homeland Security and Commerce, and NASA ?into one room to develop a common approach to the U.S.’s air transportation future. This process has already yielded significant benefits by improving the way different agencies tie research and implementation plans together, and we believe that it can ultimately deliver a system that by 2025 will handle approximately three times the capacity of the current one.

Third, government must seek to permit carriers to compete as freely as possible ?to minimize the regulatory burden on them, and where such burden is necessary, to apply the burden as evenhandedly as possible. Internationally, this involves working bilaterally with our likeminded partners to open currently restricted markets. The Open Skies agreement remains our template and our first preference with all our bilateral partners, although we have been willing to work incrementally to deregulate our international markets. Let me note a couple of specific areas that may be of interest to you all.

We have had a banner year and a half in terms of liberalization of U.S.-Asia Pacific markets. Last summer, we concluded a landmark air services agreement with China that will more than double the number of U.S. carriers that can operate in the market and increase the number of frequencies by fivefold. We have also recently concluded a full Open Skies agreement with Indonesia, an all-cargo Open Skies agreement with Thailand, a trade-expanding agreement with Hong Kong, and our first bilateral air services agreement with Vietnam, which will soon result in the reintroduction of direct service between the United States and Ho Chi Minh City. These developments were not happenstance. They were the product of a concerted effort on our part to focus our resources on the Asia Pacific region and to focus on significant actual or potential markets. We look to build on those successes in the coming year, as we seek to engage other trading partners in the region as well as in the Asian subcontinent and the Middle East.

Looking to Europe, we continue our discussions with the European Union, with the goal of a complete bilateral opening of the transatlantic markets with all 25 EU member states. The failure of the EU Council of Ministers to approve a very progressive first phase agreement that we had reached with the European Commission was unquestionably a disappointment. We nonetheless remain committed to trying to work with our European colleagues to secure the complete liberalization of the transatlantic market.

Fourth, we will work to minimize the regulatory burden on carriers domestically to allow them to structure their businesses in the ways they believe best. Let me single out three areas in specific:

Operation of alliances/code sharing. In a world where bilateral and legal limitations on carrier ownership remain, code sharing alliances have been resorted to by many carriers seeking to capture efficiencies of scale and scope. It remains the Department’s view that alliances and code sharing generally benefit carriers and consumers, and it is generally our policy (absent some other compelling reason) to approve code shares. In this regard, let me point out to you an order that we recently issued proposing to allow a carrier alliance ?in this case, the TACA group ?to collectively utilize a common trade name and to use a common designator code to sell all of its flights. While a final decision has not been issued and I accordingly cannot discuss the merits of the case, I can tell you that our tentative decision concluded that there are public benefits that will be realized from the implementation of a proposed common name, and that, subject to certain conditions being met, there is no reason for the government to preclude the carriers from enhancing their alliance as they see fit.

CRS systems. At the end of last year, the Department terminated decades of regulation of Computer Regulation Systems. Finding that the basis for the CRS regulations no longer existed, the Department has freed airlines and CRS systems to enter into arrangements as they see fit. We will continue to look to ensure that government regulation does not needlessly hamper airlines or distribution companies as they seek to explore creative means of marketing their services. Equity structures. Finally, the Department continues to consider how most effectively to ensure that airlines?need for capital is not stymied by laws prescribing ownership. We in the Bush Administration advanced a proposal last year to increase foreign investment up to 49 percent ?a proposal never acted upon by Congress. Certain prominent figures in U.S. industry have recently argued that the U.S. law needs to be amended to further liberalize in the area of ownership –even to permit foreign citizens and carriers a right of establishment. Clearly, this is one area that requires careful consideration in the weeks and months to come. Fifth, let me turn finally to the subject of security. I will confess that I approach the subject somewhat gingerly ?not only because it can be a controversial topic, but because transportation security is no longer within the purview of the Department of Transportation. As of March 2003, responsibility for U.S. transportation security has resided in the new Department of Homeland Security. But to briefly offer a perspective on what has happened and what the future may hold, from the perspective of someone who has been in on some of the intra-governmental meetings on security issues:

September 11 revealed that there was a leg of transportation infrastructure ?security –that was sorely underdeveloped, and that needed to be developed both for the viability of the industry and because it constituted, more generally, a national security risk. While significant steps have been taken, the creation of that infrastructure necessarily remains a work in progress, as we fight a global war against terrorism. I would suspect that you may see more Security Directives and more Emergency Amendments if vulnerabilities in the transportation system are uncovered or new intelligence comes in. As President Bush has made clear, the Administration will take whatever actions are needed to protect the security of the American people. And clearly, addressing these vulnerabilities is in all of our best interests. The challenge, of course, is doing so as efficiently and in as coordinated a fashion as possible. Here, I truly believe that you have seen and will continue to see, improvements in how government coordinates with industry and how governments coordinate among themselves. Over the past year, DHS has become an eager participant in international fora, such as ICAO and APEC, and has engaged in numerous bilateral consultations with trading partners on security issues. I am strongly convinced that you will see that continue. And I should note that many of the governments represented by your carriers have been among the strongest partners as we collectively seek to ensure the security of our industry’s future.

Let me conclude by returning to where I began ?how pleased I am to be here. The carriers you represent constitute the major suppliers of air transportation in a region of the world ?the APEC region ?that represents over one-third of the world’s population, sixty percent of global GDP, and nearly 70 percent of global economic growth over the past decade. We recognize and appreciate the enormous contribution that you have made and continue to make to that record of success. We recognize that the industry is going through a period of substantial change. We are highly sensitive to ensuring that government ?the U.S. government and other governments ?afford carriers the freedom to go through that process of change and to apply your creative energies to ensure that this industry will be able to continue to support the enormously bright future that we see for the region as a whole.