Global Forum on Transport and Environment in a Globalising World 10-12 November 2008, Guadalajara, Mexico

The Impacts of Globalisation on International Air Transport Activity
Past trends and future perspectives

Ken Button, School of George Mason University, USA

NOTE FROM THE SECRETARIAT

This paper was prepared by Prof. Ken Button of School of George Mason University, USA, as a contribution to the OECD/ITF Global Forum on Transport and Environment in a Globalising World that will be held 10-12 November 2008 in Guadalajara, Mexico. The paper discusses the impacts of increased globalisation on international air traffic activity – past trends and future perspectives.

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TABLE OF CONTENTS

NOTE FROM THE SECRETARIAT .............................................................................................................2 THE IMPACT OF GLOBALIZATION ON INTERNATIONAL AIR TRANSPORT ACTIVITY - PAST TRENDS AND FUTURE PERSPECTIVE ....................................................................................................5 1. 2. 3. Introduction ..........................................................................................................................................5 Globalization and internationalization ..................................................................................................5 The Basic Features of International Air Transportation .......................................................................6 3.1 Historical perspective ..................................................................................................................6 3.2 The modern industry....................................................................................................................8 4. The effect of globalization on airline markets ......................................................................................9 5. Implications of global air transport institutional changes in airline regulation ..................................11 5.1 Fares ..........................................................................................................................................11 5.2 Linkages between domestic and international air services ........................................................14 5.3 Airline profits ............................................................................................................................16 6. The Shifting Situation .........................................................................................................................24 6.1 The traffic forecasts that we have ..............................................................................................24 6.2 Globalized labor markets, migration and international air transport .........................................25 6.3 The business models of airlines .................................................................................................31 6.4 Changing industrial needs .........................................................................................................33 6.5 Developments in emerging markets ..........................................................................................34 7. Conclusions ........................................................................................................................................37 REFERENCES ..............................................................................................................................................38

Tables Table 1. Table 2. Table 3. Table 4. Table 5. Table 6. The ten largest international airlines by scheduled passenger-kilometres ...............................9 The 20 largest international airports by passengers .................................................................9 European low cost carriers that ceased to exist (2003 to 2005).............................................21 Strategic Airline Alliances.....................................................................................................22 Scheduled freight tonne-kilometres flown.............................................................................34 Selected indices of China's Civil Air Transport System ........................................................35

Figures Figure 1. Figure 2. Figure 3. Figure 4. Trends in World international trade, and airlines‟ revenue passenger kilometres .................10 Short-term links between World-trade in manufactures and air freight volumes ..................11 The simple economics of Open Skies policies ......................................................................12 The implications of globalization on the various air transport markets ................................14 3

Figure 5. Figure 6. Figure 7. Figure 8. Figure 9. Figure 10. Figure 11. Figure 12.

A „dog-bone‟ or „dumb-bell‟ international air transport network..........................................15 Operating margins of airlines ................................................................................................17 Airline profitability by global region.....................................................................................18 The alternative views of the implications of migration .........................................................27 The notion of gateways..........................................................................................................28 Impacts of opening more gateways on air transport networks and flows ..........................29 Air travel between the UK and selected transition economies ..........................................31 Throughput of freight at major Chinese cargo hub airports ..............................................36

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THE IMPACT OF GLOBALIZATION ON INTERNATIONAL AIR TRANSPORT ACTIVITY PAST TRENDS AND FUTURE PERSPECTIVE

1.

Introduction

1. Air transportation is a major industry in its own right and it also provides important inputs into wider economic, political, and social processes. The demand for its services, as with most transport, is a derived one that is driven by the needs and desires to attain some other, final objective. Air transport can facilitate, for example, in the economic development of a region or of a particular industry such as tourism, but there has to be a latent demand for the goods and services offered by a region or by an industry. Lack of air transport, as with any other input into the economic system, can stymie efficient growth, but equally inappropriateness or excesses in supply are wasteful. 2. Economies, and the interactions between them, are in a continual state of flux, and although economists‟ notions of equilibrium have some very useful intellectual content, and also validity in the very short-run, in reality the world is dynamic. This dynamism, of which the particular thrust of globalization is the concern here, has implications for industries such as air transport that service it. But there are also feedback loops, because, developments in air transport can shape the form and the speed at which globalization and related processes take place. In effect, while the demand for air transport is a derived, the institutional context in which air transport services are delivered have knock-on effects on the economic system. These feedback loops may entail direct economic, political, and social effects that, for example, accompany enhanced trade and personal mobility, but they may also be indirect, as for example through the impacts of air transport on the environment. 3. The analysis here is, by necessity, excessively simplistic given the multi-dimensional and dynamic nature of globalization, and focuses on one small sector, international commercial aviation, and on only one direction of causality, the implications of globalization for this sector. Some related considerations are embraced where particularly important. For example, there is an increasing blurring of international and domestic air transport as airlines form alliances and invest in each other to form global networks; indeed, the domestic and international air transport market within the European Union (EU) is de facto one market. Also, not all feedback loops are ignored, particularly when changes in air transport facilitate global trends that then, in turn, feed back on the air transport industries; migration of labor is one example of this. 2. Globalization and internationalization

4. Globalization, in its most literal sense, is the process of making, transformation of things or phenomena into global ones. It can be described abstractly as a process by which the people of the world are unified into a single society and function together. This process is a combination of economic, technological, socio-cultural, and political forces. The idea of globalization is, however, also often used to refer in the narrower sense of economic globalization involving integration of national economies into the 5

international economy through trade, foreign direct investment, capital flows, migration, and the spread of technology.1 Here much, but not all, of the focus is on the narrower perspective, although clearly the increase in mobility and personal interchanges that air transport facilitates has broader socio-cultural and political implications. 5. The reasons for the contemporary globalization processes from the latter part of the 20th century, and their larger implications, are much debated. Thomas Friedman (2005) for example, suggests the world is "flat" in the sense that globalization has leveled the competitive playing fields between industrial and emerging market countries. The globalization of trade, outsourcing, supply-chaining, and political forces have changed the world permanently, for both better and worse. He also argues that the pace of globalization is quickening and will continue to have a growing impact on business organization and practice. This flattening is seen as a product of a convergence of the emergence of the personal computer and the fiber-optic micro cable, combined with the rise of work-flow software. He calls this Globalization 3.0, which is different to Globalization 1.0 (when countries and governments were the main protagonists in globalization) and the Globalization 2.0 (in which multinational companies led the way in driving global integration). Cairncross (1997) looks at it from only a slightly different perspective. The growing ease and speed of communication is seen as creating a world where miles have little to do with abilities to work or interact together. Much work that can be done on a computer may be done from anywhere; workers can code software in one part of the world and pass it to a company thousands of miles away that will assemble the code for marketing. With workers able to earn a living anywhere, countries will find themselves competing for citizens as individuals relocate for reasons ranging from lower taxes to nicer weather. 6. Much of these processes have been technology-driven, although facilitated by broad political shifts, such as the demise of the Soviet system, the gradual emergence of international free trade bodies, such as the EU and World Trade Organization, and reductions in global political tensions. Many of these technical changes have been in transport. In particular, there have been massive developments in the technologies that we use to transport information. While traditional transport analysts often see the “telecommunications revolution” as somehow different and outside their field of study, it is, in fact, the first major transport-change since the widespread adoption of mechanized transport in mid-19th century. Air transport, although still a child of the mechanized age, has been closely linked with globalization and the telecommunications revolution. It has been important in the opening up of labor markets, along the lines indicated by Frances Cairncross, and in its role of role as a facilitator for the development of industry allowing the production and maintenance of cheap telecommunications hardware. It has also, in turn, benefited from the communications revolution in terms of air traffic control, navigation, and safety enhancement, but also in making possible the airline logistics of bringing the elements required in moving millions of people and tons of cargo across complex networks practical. 3. 3.1 The Basic Features of International Air Transportation Historical perspective

7. Air transport has always been seen to have an inherently strategic role. It has obvious direct military applications, but it is also highly visible and, for a period, and in some countries still, was seen as
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Strictly, there are differences between globalization and internationalization. Internationalization refers to the importance of international trade, relations, treaties etc.; it refers to actions between or among nations. Globalization means erasure of national boundaries for economic purposes; international trade (governed by comparative advantage) becomes inter-regional trade (governed by absolute advantage). In practical terms, internalization is technically what has largely been occurring in the World with the development of agencies such as the World Trade Organization. Perversely, globalization has been more narrowly geographically concentrated, for example within the EU area. We use the term „globalization‟ here in is broader sense.

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a “flag carrier”, a symbol of international commercial presence. From its earliest days, airlines were seen as having potential for providing high-speed mail services, and subsequently medium and long-term passenger transport. Technology now allows the carriage of much larger cargo pay-loads in a more reliable way. These strategic functions were used to pursue internal national policies of social, political, and economic integration within large countries such as Canada, the US, and Australia, but also took on international significance from the 1930s within the Imperial geopolitical systems centered mainly on the UK, France, Germany, and other European countries when technology allowed for intercontinental services to be developed. 8. Air transport was highly regulated and protected in this environment with the intention of it being used as a lever for larger political and economic objectives. But even in these roles, its importance, largely because of the technology until after World War II, was small. British Imperial Airways, for example, only carried about 50,000 passengers to the colonies in the 1930s; a figure hidden in the public media coverage given to the importance of colonial air networks. Technology shifts as an offshoot of military developments in World War II changed this with the introduction of planes with far longer ranges, faster speeds, enhanced lift, and the increasingly ability to cope with adverse weather conditions. Air traffic control, navigation, communications, and airport facilities have also improved considerably, and more recently the underlying management structure of the supplying industries has enhanced efficiency. 9. The Chicago Convention of 1944 confronted the new international potentials of civil aviation and initiated an institutional structure that laid common ground rules for bilateral air service agreements (ASAs) between nationals. The result, however, while providing a formal basis for negotiation, was essentially one of protectionism with pairs of countries agreeing on which airlines could offer services between them, the fares to be changed and, often, how the revenues could be shared. Added to this, with the major exception of the US, most international airlines were state owned flag-carriers that operated to fulfill, often vague, national objectives of prestige, as well as linking colonies. Internal markets within countries were regulated in similar fashions, and it was not uncommon for wealthier countries to have an airline to provide primarily domestic and short haul services, and one for long-haul, international markets. 10. The breakdown of the domestic regulatory structure within the US from the late 1970s (Morrison, and Winston, 1995) provided both a demonstration for other countries to follow in deregulating their own domestic regimes, but also the US‟s, initially unsuccessful, initiatives from 1979 to liberalize international services on a bilateral basis based on a common “Open Skies” recipe began to bring about pressures to wider reforms. This was coupled with more generic moves towards a withdrawal of government in marketoriented countries such as New Zealand and the UK that saw airports and air traffic control being privatized, or at least operated on a more commercial footing. The move to a Single European Market within the EU from 1992 represented a broader trend, both in terms of the sectors and the geography involved, towards market liberalization of air transport infrastructure, as did the collapse of the Soviet economic system. Not all countries moved completely in this direction, the US for example, rather perversely, continued with its traditional, strongly socialist policy of air traffic control being a state owned, tax financed monopoly and airports, with few exceptions, being owned by local governments (Button and McDougall, 2006). 11. Where there have been almost universal tightening of regulations that run counter to the market liberalizations, have been in what the US calls „social regulation” and Europe calls, “quality regulation”. This concerns such matters as the environment, safety, security, and consumer and labor protection. These are areas that have been traditionally dealt with at the international level by the International Civil Aviation Organisation (ICAO) set up under the Chicago Convention, and in accord with some peculiar international accords such as the Warsaw Convention that dates back to 1929 and deals with liabilities in the case of

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accidents2. More recently, regional or national actions have also taken international significance; e.g. the extension of carbon trading within the EU to embrace all air transport, and the US‟s introduction of stricter security measures, such as the provision on passenger information, for all flights into the country. 3.2 The modern industry

12. The modern air transport industry is thus one that increasingly operates within a liberal market context. While government controls over fares, market entry, and capacity continue in many smaller countries, they are gradually and almost universally being removed or relaxed. International controls under the bilateral ASA structure are increasingly moving towards broad Open Skies formulations, allowing free provision of services between the countries involved, although progress on open market, whereby nationality of ownership of airlines is unrestricted, is coming more slowly. The EU area3 has effectively been the largest international free market in air transport services in the world since 1997, and this has grown as the Union has expanded geographically. The supply and operation of air transport infrastructure is also becoming more market driven with on-going privatizations of airports and air traffic control systems, or the use of franchising mechanisms to involve private capital and expertise (Button, 2008). It is also becoming more coordinated.4 13. The air transport industry is now large – it accounts for about 1% of the GDP of both the EU and the US – and is vital in many industries such as tourism, exotics, and hi-technology5. It is an important transporter of high-value, low-bulk cargoes. International aviation moves about 40% of world trade by value, although far less in physical terms. The market is served by a diversity of carriers, some specializing in long-haul international routes and others in short-haul markets6. Table 1 offers some indication of the scale of larger airlines involved. To handle the interface between land and air transport the world‟s major airports have grown to handle millions of international passengers (Table 2) and tonnes of cargo7 each year, and many have been significant catalyst facilitating, in particular, the growth of modern hitechnology industries and tourism about them. In 2008, passenger air services globally link around 15,500 airports; with the fastest growth in air services over the past two decades being in the Europe-Asian Pacific markets.

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The air transport industry itself has established international bodies to both interact with national governments and institutions such as the ICAO; e.g. the International Air Transport Association (IATA) was established to assist airline companies to achieve lawful competition and uniformity in prices Norway and Switzerland are also included in most of these agreements. E.g. in October 2001, the European Commission also adopted proposals for a Single European Sky, to create a Community regulator for air traffic management within the EU, Norway and Switzerland One US survey has shown that hi-technology personnel fly about 60% more than their counterparts in traditional industries. A broader econometric analysis indicates that the location of a city with a hub airport in the US in the 1990s enjoyed some 12000 more high technology jobs than a comparable city without a hub (Button et al., 1999Source). Analysis of transatlantic routes shows that enhanced numbers of links and service frequencies lead, albeit at a declining rate, to more hi-technology employment (Button and Taylor, 2002). In terms of total passengers, because length of trips not included the ranking of airlines is somewhat different; e.g. according to IATA, Ryanair carried 40,532 thousand passengers in 2006; Lufthansa, 38,236; Air France, 30,417; British Airways, 29,498; and KLM, 22,322 For example, Airports Council International data shows Memphis International Airport handled 3,840,491 metric tonnes of cargo in 2007; Hong Kong International Airport New Territories, 3,773,964 tonnes; Ted Stevens Anchorage International Airport, Shanghai Pudong International Airport, 2,559,310 tonnes; Incheon International Airport, 2,555,580 tonnes.

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Table 1. The ten largest international airlines by scheduled passenger-kilometres Airline Scheduled passenger-kilometres (million) Air France 112,689 British Airways 111,336 Lufthansa 109,384 Singapore Airlines 87,646 American Airlines 81,129 United Airlines 74,578 Emirates Airline 74,578 KLM 71,761 Cathay Pacific 71,124 Japan Airlines 59,913 Source: International Air Transport Association Table 2. The 20 largest international airports by passengers Airport London Heathrow Airport Charles de Gaulle International Airport Amsterdam Airport Schiphol Frankfurt Airport Hong Kong International Airport Singapore Changi Airport Narita International Airport Dubai International Airport Suvarnabhumi Airport London Gatwick Airport Incheon International Airport Madrid Barajas International Airport Kuala Lumpur International Airport Chatrapati Shivaji International Airport Munich Airport Dublin Airport John F. Kennedy International Airport London Stansted Airport Taiwan Taoyuan International Airport Malpensa International Airport Source: Airports Council International International passengers 62,099,530 54,901,564 47,677,570 47,087,699 46,281,000 35,221,203 34,289,064 33,481,257 31,632,716 31,139,116 30,753,225 29,339,784 26,938,970 25,360,860 23,988,612 22,339,673 21,521,711 21,201,543 20,855,186 20,627,846

14. If one looks at the basic aggregate data there is clear general link, although causality is another matter, between the growth in global GDP and international trade and air transport. Figure 1 provides aggregate information on the trends in world trade, and international air transport from the mid-1990s. A similar picture emerges if one plots world GDP against air traffic. In each cases air volumes have risen albeit it slightly less rapidly than GDP. Figure 2 gives detail of the shorter-run tends in growth in world trade and air freight traffic volumes, and shows the common cyclical effects. While the ups and downs broadly coincide, little by way of a consistent lag structure emerges. 4. The effect of globalization on airline markets

15. The implications of globalization in its many manifestations have been profound for the international air transport industry, not just on the demand side, where the scale, nature, and geography of demand in global markets has led to significant shifts, but also on the supply side, where implicit and explicit international coordination of policies by governments (e.g. regarding safety, security, and the environment) and the private sector (e.g. the internationalization of airframe and aero-engine production) have affected the institutional and technological environment in which air transport services are delivered. We address some of most important of these interactions.

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Figure 1. Trends in World international trade, and airlines’ revenue passenger kilometres

Note: RPK are revenue passenger kilometres

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Figure 2. Short-term links between World-trade in manufactures and air freight volumes

Source: Boeing Commercial Airplane

5. 5.1

Implications of global air transport institutional changes in airline regulation Fares

16. The restrictive bilateral ASAs that typified the institutional structure of international airline markets before the advent of Open Skies manifestly had a number of adverse effects on the efficiency of supply and, specifically, on the levels of benefits society could reap from air travel. These effects are not easy to isolate and to completely quantify in a simple way, but Figure 3 offers a general representation of the issues that are involved. In particular, it highlights the potential fare- and output-implications of the various types of regulatory regimes that have been common in the past and are gradually emerging as globalization is taking place8. 17. The initial position of the demand curve for international services between two countries, A and B, under the pre-1980s regulatory regimes that typified international trade in air services is assumed linear and shown as D1 in the figure, and the average cost curve per passenger, which for simplicity is assumed to

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The treatments of elements in the figure are static in the sense that technology is held constant. Modern economic theory holds that at least part of technical change is endogenous and thus a function of market and institutional structures.

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rise more than linearly with quantity, as C1.9 Market forces, however, because of the institutional interventions in place, did not determine fares and capacity in these regulated markets. Capacity under this system was limited (seen as the “capacity constraint” in the figure) and fares were regulated. If we assume that the terms reached under the bilateral agreement between A and B regarding fares allowed for at least cost recovery by the partners‟ airlines, this implies a fare level up to F1.10 The removal of both this capacity constraint and of negotiated pricing, as happens under a typical Open Skies arrangement, results in competition for air services, and a move toward cost-recovery pricing strategies by the carriers. This would reduce fares to F*1.
Figure 3. The simple economics of Open Skies policies

18. Open Skies policies, coupled with the permitting of strategic alliances, not only remove the capacity constraint but also affects both the demand and supply curves for international air travel between
9 This particular approach to examining the implications of international deregulation of air transport markets was developed in the specific context of transatlantic routes, but the arguments are general (Button, 2009a). That paper also assesses the quantitative analysis that has been done on the implications of a US-EU Open Skies agreement. In practice, fares tended to reflect the bargaining power of the parties and the objectives of the countries‟ overall approaches to the airlines market. Continental European countries have had a long tradition of supporting their flag-carriers for a variety of reasons that are linked to their perceptions of their national interest. In some cases, the fares may have been below the level required for cost recovery, whilst in others it may have been higher if, for example, one partner sought to cross-subsidize domestic services.

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A and B. The ability of airlines to more effectively feed their transatlantic routes and coordinate their activities, through the restructuring of their business and networks, will reduce the average cost of carriage to C2 in the figure. The effect is often reinforced due to downward pressures on costs because, although not strictly part of the Open Skies framework, the wider competitive environment within Europe, and the privatization of many carriers, by heightening commercial pressures, reduces the amount of static and dynamic X-inefficiency in the airline industry. In other words, there is the combined pressure of both free airline markets across the Atlantic and within the two feeder markets at either end. 19. The Open Skies policy also has stimulation effects on the demand side. By allowing more effective feed to the long-haul stage of transatlantic services through the concentration of traffic at international hub airports, it increases the geographical market being serviced and also generates economies of scope and scale. The larger physical market demand, combined usually with the improved quality of the “product” that accompanies more integrated services, such as code sharing, interchangeable frequent flier programs, common lounges, and through baggage checking, pushes out the demand for international air services to D2 in Figure 3. 20. The outcome of the lowering of costs and the outward shift in demand is that the number of passengers traveling increases to Q2 and, because Open Skies allow price flexibility, the fare falls to F2 in the way our example is drawn. It should be noted that fares might not actually fall; indeed, they may rise as the result of the freer market conditions. The reason for this is that the outward shift in demand reflects a better “quality” of service – e.g., more convenient flights, transferability of frequent flier miles, and seamless ticketing – and that, on average, potential travelers are willing to pay more for this than the generic portfolio of features that were found under the old bilateral ASA structure. (In Figure 3, the shift out in demand may counteract the fall in costs resulting in F*1