Alfred E. Kahn
Whenever competition is feasible, it is, for all its imperfections, superior to regulation as a means of serving the public interest. ~ Alfred E. Kahn
American economist Alfred E. Kahn (1917–2010) was a staunch advocate of deregulating utilities and other industries that historically had been regulated, owing to their being a natural monopoly or necessarily using publicly shared (common) resources.
A natural monopoly is an industry where redundancy is wasteful, or otherwise a single entity providing a service or product is socioeconomically rational. Laying multiple electrical transmission cables for more than one electricity provider is exemplary. Likewise railways, where the redundancy of multiple systems is a waste of land, labor, and capital.
A positive network effect can be another example of natural monopoly efficiency. With a network effect, the value of a good or service is affected by how many consumers there are of it. Social networks of all sorts, including stock markets and dating services, have a positive network effect: the more people involved, the more opportunities exist.
Negative network effects also exist; most notably in the form of congestion, as with traffic or any shared resource that has limited throughput.
A commons is a natural or cultural resource that is accessible to all. Nature in its entirety is a commons: only the social artifice of private property creates uncommons.
Natural monopolies can also arise from commons. Wireless transmission relies upon the employment of a specific set of frequencies. Whoever obtains exclusive rights to bandwidths has the advantage of a monopoly for transceivers, such as cell phones.
Natural monopolies that provide infrastructure entangle the inexorable efficiencies of avoiding redundancy and excessive exploitation of commons. Allowing competition in a sector characterized by natural monopoly is a wasteful folly.
In The Economics of Regulation (1970), Kahn made his case for free-market choice. His lynchpin argument lay with marginal cost.
Marginal cost is the cost of producing one more unit; it can equally be envisaged as the cost that would be saved by producing one less unit. ~ Alfred E. Kahn
Kahn illogically interpreted marginal cost as providing the best valuation of whether more or less of something was worthwhile.
At any given time, every economy has a fixed bundle of productive resources, a finite total potential productive capacity. The basic economic problem, in short, is the problem of choice. The cost to society is ipso facto a decision to produce less of all other goods and services. “Cost” is opportunity cost – the alternatives that must be foregone. ~ Alfred E. Kahn
Kahn coupling marginal cost with “choice” is nothing more than a spurious association of orthogonal abstractions: economic theory as a vacuous semantic philosophy involving a fallacy of relevance.
A logical fallacy is of relevance when an argument relies upon premises not pertinent to the conclusion. Kahn’s observations about finite resources and economic choices (the premises) do not lead to the conclusion that marginal production cost – what it takes to produce an extra unit of output – is an opportunity cost. Trying to relate the 2 concepts is an apples-and-oranges comparison.
Kahn construed marginal production cost as an opportunity cost of an alternative foregone. Though the word cost is shared by both terms, the different concepts represented are not related. For instance, not making an extra unit of steel does not mean that you can have more strawberries.
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Despite lip service to the contrary, Kahn seemed heedless of the nature of natural monopolies, particularly with regard to the inevitable waste of competition in such industries. Kahn simply thought that an unfettered market could be a better regulator than bureaucrats. His thinking was confined to the logistical; not holistic in a socioeconomic sense of outcomes.
To Kahn, the root problem of regulation came in determining how valuable resources are. Based upon fallacious reasoning, Kahn imagined the market mechanism more adept.
The central policy prescription of microeconomics is the equation of price and marginal cost. ~ Alfred E. Kahn
Kahn got his chance to put his ideas into practice when he was appointed to head the US Civil Aeronautics Board in 1977 by President Jimmy Carter. Kahn knew little of the post, nor did he want it.
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From the 1930s, American airlines had been regulated to the hilt, as they were in other countries. Prices, routes, schedules, and profits were all fixed. Airlines could only compete on the number of flights and meals they served. Planes typically flew half full. But the airline business was still predictably profitable, as government regulators were sympathetic to their airlines out of national pride. Airlines were sufficiently flush to continually invest in more fuel-efficient aircraft, which allowed fares to drop over time. As it turned out, prices actually dropped at a faster rate in the decades before deregulation than afterward.
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Once installed, Kahn immediately went about deregulating the airline industry. Fearing a much different future, airline executives, pilots, and unions resisted removing the rules.
Kahn himself had no idea what would happen when he took off the leash, other than he expected prices to fall, as the country was experiencing severe inflation at the time. Kahn cavalierly cut it all loose anyway.
The wave of mergers, predations, and bankruptcies that followed in the wake shocked Kahn, demonstrating his ignorance of business. Blinded by boosterism, academic economists have hardly ever understood the cutthroat essence of capitalism. Kahn was no different.
The reconstitution of the industry into concentrated hub-and-spokes operations scandalized Kahn. (With a hub-and-spokes network, planes fly to a central airport (hub) to and from other airports (spokes), rather than flying directly point-to-point. Hub-and-spokes networks simplify routing for the airlines, and, for passengers, may facilitate changing airlines, and may make it more efficient to reach less-traveled destinations (smaller cities/airports).) For all his blather about marginal cost, perhaps Kahn never expected companies to figure out how to efficiently minimize their costs; certainly, Kahn hadn’t anticipated the hub-and-spokes strategy.
However ill-conceived airline deregulation was, it was the only the first in a landslide to come. Staunchly pro-business leaders arrived in the White House (Ronald Reagan) and Whitehall (Margaret Thatcher) shortly thereafter, both of whom took a cleaver to as many impediments to corporate profits as possible.
In airlines, low prices begat terrible service. Within a few decades of deregulation, all the major airlines had gone bankrupt through self-destructive competition.
After the bankruptcies and mergers, the US airline industry became an oligopoly. This owed in large part to the exclusiveness of limited parking slots at major airports (a negative network effect).
In 2017, the largest 4 American airline carriers controlled 80% of the market, compared to 48% in 2007. In Europe, the top 4 carriers have ~45% of the market.
Only a few major domestic carriers are left in the US, and prices have risen accordingly. Airlines do still compete on routes where they do not dominate the airports involved. So, while trying to give the appearance of low prices, airlines claw back revenue by nicking customers for every possible thing, such as baggage storage or food in-flight.
On one thing airlines all agree: an empty seat is an economic tragedy, so they routinely overbook flights, betting that some passengers won’t show. When their bet does not pay off, airlines simply bump people.
A seemingly paid reservation only means one thing to an airline: you’re not getting your money back. You can be dragged off a plane for insisting on getting what you paid for, despite a 1976 Supreme Court ruling that bumping passengers with confirmed tickets is a fraudulent act. (In a unanimous decision, the Supreme Court ruled in Nader v. Allegheny (1976) that a confirmed ticket meant getting a seat, and that not honoring the contractual commitment was fraud. To get around this, airlines instituted an auction system to bump passengers on overbooked flights. Buying an air ticket surreptitiously means signing on to being bumped when the airline wants, because what you are really buying is a lottery ticket, not a guaranteed seat.)
To observe that the flying public has been ill-served by deregulation is a gross understatement. But deregulation did not do the airlines any good either.