The airline merger

Commentary this morning on the DOJ's challenge to the US Air-American Airlines merger has been economically illiterate. The assumption journalists make is that if airline mergers were approved before, this one should be too. But conditions are not the same.

The airline industry faces strongly pro-cyclical demand. The price elasticity of demand is quite high for the industry as well as for individual firms. Fixed costs are high, and marginal costs are low. There are substantial entry barriers, mostly in the form of limited airport capacity. For the last 30 years or so, these conditions have meant that when the economy was weak, airlines would get into very severe price wars, and most of the firms would lose money. Bankruptcies and mergers were very common. The industry was in serious trouble, and the government was hard-pressed to come up with a solution. From the 1930s until the early 1980s the industry was regulated like a public utility, but nobody wanted to go back to that situation. Industry executives tried to engineer a system of coordinated prices, but when this became public, there was too much outrage to sustain the effort.

In the last few years, the situation has changed. The number of competitors in the industry has been reduced. The industry culture has changed, away from rivalry and price wars. New ways have been found to extract revenue from the customers, using sophisticated price discrimination and piling up ancillary fees. Capacity has been systematically reduced. The new situation has meant that the industry has remained profitable even in the weak economy of the last few years.

Under these conditions, a further concentration of the industry is unnecessary, and indeed is likely to prove harmful to the interests of customers. (And remember, most of the customers are businesses, not consumers traveling for leisure.) DOJ is clearly justified in asking that this merger be rejected.