THE UNIVERSITY OF WESTERN AUSTRALIA€¦ · Western Australia and to Professor Warren Pengilley, Sparke Helmore Professor of Commercial Law, The University of Newcastle. I have been

THE UNIVERSITY OF WESTERN AUSTRALIA

FACULTY OF LAW

GEOFFREY CLIVE BALDOCK B.E., LLM

SOME LEGAL ASPECTS OF AN “OPEN SKIES” AVIATION POLICY FOR AUSTRALIA

This Thesis is Presented in Partial Fulfilment of the Requirements for

the Degree of Doctor of Juridical Science

30 OCTOBER 2003

© The University of Western Australia. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright owner

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SUMMARY

“Open Skies” is the term given to a relatively recent (1992) policy initiative of the

United States in its pursuit of the deregulation of international air transportation1. It

represents the latest in a long line of similar initiatives which the U.S. has been pursuing

almost since the inception of the aviation industry.

Essentially “Open Skies” is little more than a specific type of bilateral aviation

agreement between two nations (and often between more than two nations) which

typically provides for open entry on routes, unrestricted capacity and frequency on

routes, and unrestricted air traffic rights2 The significance of Open Skies agreements is

that they appear to encapsulate general world-wide trends towards open economies

characterised by a minimum of government interference and a maximum reliance on

market forces to allocate scarce resources.

The pattern of trade in international air transport services does not follow the usual

principle of allocating resources in favour of producers who can show comparative

advantage, because the bilateral regulatory framework within which international

aviation operates prevents comparative advantage from influencing the pattern of trade.

This is because nation states are largely reluctant to treat the trade in aviation services as

the same as other goods and services, so there are few if any opportunities to trade-off

with other sectors of the economy.

1 The words “liberalisation” and “deregulation” are used frequently throughout this thesis

where they are used interchangeably. They are however defined as follows:- Liberalisation is “the reduction of constraints upon…the incumbent national airlines” Reports of Conferences, 12 Air L. 303,306 (1987). Deregulation goes one step further. In principle it means the removal of government control over the free play of market forces within the industry, with the retention of only those laws which prevent monopoly and ensure safety. See Mark Zylicz, International Air Transport Law, Dordecht (1992), p 36 – 7. In another sense it means “survival of the fittest”, but it is actually defined as “the abolition of all restrictions dominating the air traffic marketplace, thus providing free access to international air transport.” Id. See also H.A. Wassenbergh, New Aspects of National Aviation Policies and the Future of Air Transport Regulation, 13 Air L. 18,20 (1988)

2 Air traffic rights are generally defined by reference to the Five Freedoms, see page 14 below. The exact nature of Open Skies agreements is discussed in more detail in 2.1 infra.

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Because of this, reforming the international air transport regime by the Open Skies

bilateral route instead of on a multilateral basis creates advantages for those who move

first or furthest in relation to neighbouring States. In this way, the development of Open

Skies agreements between two nations often brings pressure to bear on neighbouring

countries that have not yet signed such an agreement to either do so or face the

possibility of missing out in sharing in the growth of air traffic services which often

results from Open Skies agreements. Australia is to some degree now in this position,

with several of its neighbours, such as Singapore and New Zealand, having already

entered into Open Skies agreements with the U.S.

Open Skies is a worldwide phenomenon which has been remarkably successful in its

relatively short life. Sixty countries worldwide3, including some of Australia’s

neighbours4, are currently signatories to Open Sky agreements, usually but not always

with the United States. Many more are being negotiated5, some with other neighbours of

Australia.

Australia however is not one of the nations seeking to become a party to such an

agreement with the U.S. despite attempts by that nation to persuade Australia to do so

and the question is: Can or should Australia resist attempts by the United States to bring

it within the expanding umbrella of Open Skies, or are there other practical alternatives

open to Australia?

After examining the history of the development of Open Skies agreements and their

international legal foundation, this thesis argues that there are strong considerations of

policy and economics why Australia should embrace Open Skies initially at least on a

regional basis centred in the Asia Pacific region, rather than with the United States.

Implicit in that proposal is the fact that in terms of its constitutional and legal system,

Australia has the legal capacity to enter into Open Skies agreements. The parties to such

a regional Open Skies agreement might at a later date choose to enter into a multilateral

3 As at 30 September 2003. See U.S. Dept. of Transportation website,

www.dot.gov/affairs. 4 E.g. Singapore, Malaysia and New Zealand. 5 E.g. Hong Kong, Philippines, Indonesia.

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Open Skies agreement with the United States, if economic and political conditions are

suitable for them to do so.

On the assumption that a form of Open Skies policy will eventually be adopted by

Australia this thesis examines the constitutional and domestic legal regulatory

framework for aviation within Australia, and the changes if any which would be

required to it, if Australia was to embrace such a policy.

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TABLE OF CONTENTS

CHAPTER TITLE PAGE

Summary 2

Acknowledgements 8

1.0 THE EVOLUTION OF OPEN SKIES : FROM 10

TAKEOFF TO FINAL APPROACH (1919 – 1992)

1.1 The Early Years of International Aviation 10

1.2 The Paris Convention of 1919 11

1.3 The Chicago Convention of 1944 13

1.4 Bilateral Agreements 17

1.5 Opposition to the Chicago Regime: 20

The Genesis of Deregulation.

1.6 International Deregulation Efforts: The 24

United States’ Experience

1.7 Some Factors Affecting Deregulation 30

1.7.1 Slots 30

1.7.2 Airport Leases 37

1.7.3 Cabotage 40

1.8 Conclusion 43

2.0 THE ELEMENTS OF OPEN SKIES: FROM FINAL 47

APPROACH TO LANDING (1992 – 2002)

2.1 Formulation 47

2.2 The U.S. Open Skies Strategy 50

2.3 Impediments to Open Skies 53

2.4 The U.S. – Canada Experience 56

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CHAPTER TITLE PAGE

2.5 Open Skies and the European Union 58

2.6 The U.K. – U.S. Open Skies Negotiations 66

2.7 Open Skies and the Asia Pacific Region 70

2.8 Australia and Open Skies 74

3.0 THE REGULATION OF AUSTRALIAN AVIATION

3.1 Introduction 81

3.2 Constitutional Issues 82

3.2.1 The External Affairs Power 83

3.2.2 Implied Incidental Powers 92

3.2.3 The Trade and Commerce Power 94

3.2.4 The Corporations Power 97

3.2.5 Interstate Trade and Commerce 99

3.2.6 Executive Actions 101

3.2.7 Summary: Aviation and the Constitution

(i) Safety 104

(ii) Provision of Infrastructure 105

(iii) Competition 105

(iv) Environment 107

3.2.8 Conclusion 107

3.3 The Federal Legislative Regime 108

3.3.1 Pre-World War II 109

3.3.2 Post World War II 109

3.3.3 The Deregulatory Era: 1990 – Present 116

3.4 Australian Competition Law

3.4.1 General 122

3.4.2 Competition and the Aviation Industry 124

3.4.3 Key Features of the Australian Aviation Industry

• Concentration 132

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Chapter Title Page

• Market Structure 134

• Australian Duopoly 137

• Mobility 140

• High Fixed Costs 142

• Product and Pricing 143

• Vertical Integration 145

• Barriers to entry 150

3.4.4 The Market for Aviation Services

• General 161

• Definition 161

• Product Substitution 164

• The Geographic and Product Markets 167

• Judicial Determinations 176

3.4.5 Some Aspects of Market Behaviour

• Predatory Pricing 181

• Computer Reservation Systems 192

• Airline Ownership / Mergers 200

- Qantas / Air New Zealand Merger 206

4.0 CONCLUSION 211

Bibliography 215

ACKNOWLEDGEMENTS

…… without you I might still be planespotting.

The work for this thesis began in 2001. Over the course of the previous two years,

I have received invaluable guidance and kindness in abundance from a list of

people too numerous to mention individually, including from the Australian

Competition and Consumer Commission, and the Civil Aviation Safety Authority.

I owe them a considerable debt of gratitude.

Of the many people who helped me to a better understanding of the issues which

formed the complex subject matter of this thesis, special thanks must go to my co-

supervisors, Mr Peter Johnston, Senior Lecturer, Faculty of Law, University of

Western Australia and to Professor Warren Pengilley, Sparke Helmore Professor

of Commercial Law, The University of Newcastle. I have been the fortunate

beneficiary of their goodwill, their immense knowledge and experience, their

sense of perspective and the many hours of their valuable time spent reading draft

after draft of this thesis.

I would also especially like to acknowledge the contribution of Mr Colin

Lochhart, Senior Lecturer, Faculty of Law, University of Western Australia, who

suggested the topic to me. Without him I might indeed still be planespotting!

“Open Skies” proved to be highly topical – scarcely a day would pass without

newspapers reporting on the subject in one form or another. Particularly towards

the final stages of the thesis, part of each day was spent updating the previous

day’s writing to take account of new developments.

Thanks to Dr Peter Handford, Associate Professor and Director of Postgraduate

Studies, Faculty of Law, University of Western Australia, for guidance and

assistance in dealing with the administrative side of things.

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To Mr Simon Young, PhD candidate, Faculty of Law, UWA, and to Dr Steven

Emery, PhD candidate in the Department of Marketing, UWA, and to many others

who I met during the course of the degree, my sincere thanks. I will remember for

a long time the stimulating conversations on a variety of topics.

Finally, and by no means least, a special note of thanks to Audrey and latterly to

Julie for their endless patience, understanding and support during different stages

of the degree. I am truly grateful and indebted to them both.

Chapter 1: The Evolution of Open Skies

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CHAPTER 1: THE EVOLUTION OF OPEN SKIES:

FROM TAKEOFF TO FINAL APPROACH (1919 – 1992)

I will not speak to you about yesterday because I was not the same person

(Alice in Wonderland)

1.1 THE EARLY YEARS OF INTERNATIONAL AVIATION

The years immediately following World War I saw the rapid development of the

domestic aviation industry in many countries. Many countries were alerted to its

possibilities following the aviation exploits of such intrepid aviators as Mannock,

Fonck, Robert Little, Edgar Johnston and Count von Richthofen (“The Red Baron”)

during World War I which had demonstrated to the world the “lethal and invasive role”6

of aviation in the affairs of nations and therefore the vital importance, for defence

purposes at least, of controlling a nation’s air space7.

From the beginning, the fledgling aviation industries of all countries were carefully

protected from the vagaries of the market place and the “chill-winds of creative

destruction”8. Rarely if ever has an industry been so protected by home States as their

aviation industries. It is small wonder that its deregulation has been and still is being so

hard-fought.

Even in the U.S. where the airline industry has never been state-owned, there was at one

time a strongly perceived need to protect its aviation industry from outside competition

6 D.C.Hedlund, Toward Open Skies: Liberalising Trade in International Airline Services,

Minnesota Journal of International Trade, Vol 3, 1994, page 259 7 The question of the vertical extent of a state’s airspace remains undetermined, although

it is definitely limited (See Baron Bernstein of Leigh v Skyviews and General Ltd (1978) QB 479, and see the Outer Space Treaty, 1967, 610 UNTS 205, art 2). One view is that the airspace above a nation’s geographic boundaries extends to a height equal to the world altitude record at any time for a naturally aspirated aircraft. Others are the maximum height at which air is to be found; the height at which aerodynamic lift ceases and centrifugal force takes over; the lowest possible perigee of an artificial satellite in orbit, or the lowest height at which it is possible to place a satellite in orbit. See Shawcross & Beaumont, Air Law, vol 2, 4th ed, Butterworths, London, 1977, pIV/1

8 Baron and Sweezy, Monopoly Capital, page 17, Pan Books (1965)


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– an attitude that prevailed in fact until the mid 1970’s. Because the “outside”

competition was often state-owned or subsidised, it is somewhat ironic that the early

years of aviation saw the privately-owned U.S. aviation industry even more heavily

protected than that of many other nations.

For most of the 20th century, the diplomacy of the aviation industry was, for many

nations, the diplomacy of the regulation of their national carriers for its protection

against competition or foreign takeover9. Furthermore, States were free to impose

market regulation under both international and national law because air law, virtually

since its inception, has largely been the product of international treaty10, and such

treaties sanctioned this type of response.

1.2 THE PARIS CONVENTION OF 1919

The first significant development in the regulation of the emerging international air

transport industry was the Paris Convention of 191911, which pitted the promoters of a

“freedom of the skies” philosophy against those promoting the inherent right of a State

to control its airspace. The conflict was firmly resolved by the Convention in favour of

“cuius solum” i.e. each state has full and exclusive sovereignty over its territory’s air

space. The practical effect of this meant complete equality in terms of negotiating power

between large and small aviation nations, and between efficient and inefficient airlines.

It lead directly to the international air transport industry being one of the most

politicised industries of the 20th century, by forcing the aviation industry “into a

maddening web of national regulations and international compromises”12.

9 Thomas D. Grant, Foreign Takeovers of United States Airlines: Free Trade Process,

Problems and Process, 31 Harvard Journal On Legislation, 77 10 But see J.Z. Gertler, Custom in International Air Relations, 10 Annals Air & Space L.

63 (1985), (discussing the development of international air relations from custom) 11 The “Convention Relating to the Regulation of Aerial Navigation”, Oct 13, 1919, 11

L.N.T.S. 173, hereinafter “Paris Convention”, originally signed by thirty-two nations. 12 Benoit Swinnen, An Opportunity for Trans-Atlantic Civil Aviation: From Open Skies to

Open Markets?, Vol 63 19 J. Air L. & Com., 249 (1997), quoting Andras Vamos-Goldman, The Stagnation of Economic Regulation Under Public International Air Law : Examining its Contribution to the Woeful State of the Airline Industry, 23 Transp. L.J. 425, 443-46 that the system of bilateral agreements and the trade in air rights eventually lead to the signing of over 4000 bilateral agreements. Note however that Hedlund, supra note 6, at footnote 2, describes the international air traffic system as consisting of “1200


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During the twenty-five years following the Paris Convention of 1919, international air

transport developed within a regulatory regime based on air sovereignty and

characterised by endless horse-trading over air rights. Agreements were negotiated

strictly on the basis of granting reciprocal ad hoc bilateral air rights between States13

and sometimes even on the basis of unilateral agreement between them14, each State

dealing with each other on an equal footing irrespective of the size or nature of its

aviation industry.

Only within the U.S. did air transport develop along commercial rather than political

lines. Being a single national market helped this but even so, its domestic aviation

industry in its early stages at least, was carefully protected from outside competition.

The commercial success of the industry was assured when it was able to demonstrate

that it could halve the travel time between many American cities. The industry therefore

devoted itself to passengers and profits in an atmosphere of commercially regulated

domestic competition. Trunk carriers like American Airlines, United Airlines, Eastern

Airlines and Trans World Airways became established and expanded steadily to such an

extent that by 1930, U.S. airlines were carrying as many passengers as the rest of the

world put together15.

The rapid growth of air traffic and aviation technology in the years following the Paris

Conference demanded a much greater degree of international co-ordination and aviation

different bilateral agreements…negotiated ….over the past 50 years” – and that was 10 years ago.

13 Canada and the US for example signed a broad agreement in 1929 and a more restrictive agreement in 1938. See Peter Haanappel, Pricing and Capacity Determination in International Air Transport 18-24 (1984)

14 Pan American Airways for example was granted exclusive operating rights by several Latin American countries which sought the provision of international aviation services for their citizens but which were at the time technically or financially unable to establish their own national airlines at the time. See Anthony Sampson, Empires of the Sky: The Politics, Contests, and Cartels of World Airlines 44-46, (1984).

15 Peter W. Brooks, The Development of Air Transport, Journal of Transport Economics and Policy, 1, 2, 167 (1967). Even today, domestic air transport makes up about 70% of the total operations in the U.S. There is less reliance on international operations, in contrast to EU airlines whose operations are about 70% extra-European Community and 30% intra-Community. European Commission, Air Transport Relations with Third Countries, COM (92) 434, para 4. In Australia, approximately 40% of all air operations are domestic. See Productivity Commission 1998, infra note 27 at p XXII


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diplomacy than the Paris Conference could achieve. These requirements eventually

gave rise to the second multilateral attempt to codify international air traffic, which took

place in Chicago in 1944, as World War II was ending.

1.3 THE CHICAGO CONVENTION OF 1944

Sponsored by the United States, this conference was called by it to promote “the

privilege of friendly passage of aircraft accorded to nations”. If this principle had been

adopted by the Convention, it would have opened the airspace of the world to those

powers with the ability to establish a global network of air routes. This would have

applied particularly to the US. After a slow start in aviation - despite having pioneered

the world’s first flight – the U.S. had emerged from World War II as the strongest

aviation power in the world. With a huge air fleet largely intact after the war, and

leading the world in aviation technology and production capacity, the U.S. was in a

position to strongly advocate a laissez-faire system of aviation free-enterprise in which

market forces would determine capacity, frequency and fares on transcontinental routes,

much like any other tradeable commodity. Under such a system, all airlines would have

relatively unrestricted operating rights on international routes16

However, many delegates at the Convention opposed the idea of unrestricted passage

between nations and ultimately it was defeated. The dilemma, which continues to this

day, was thus posed: How does a State balance on the one hand the need to prevent its

aviation industry from being dominated by another State, against the need on the other

hand to provide the cheapest and most reliable air services for its citizens.

Three separate treaties emerged from the Chicago Convention17. They attempted to

provide an acceptable solution to the dilemma posed above. Only two of them were

ratified. The third - the International Air Transport Agreement - was not ratified. It was

16 Paul S Dempsey, Turbulence in the “Open Skies”: The Deregulation of International

Air Transport, 15 Trans. L. J. 305, 315 (1987) 17 The Convention on International Civil Aviation, Dec.7, 1944,61 Stat. 1180, 15 U.N.T.S.

296; The Treaty on the Transit of International Air Services and The Treaty on International Air Transportation. The last was not supported. It dealt with the carriage of traffic between the State of registration of the aircraft and another Contracting State, and embodied the five freedoms of the air.


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however the very one needed to tip the scales in favour of eschewing protectionism by

securing multilateral agreement on international flights.

One of the common themes at the Conference was the desire of most participants to

moderate the principle of unrestricted air sovereignty so that international aviation could

no longer be held to ransom by small states whose territory lay astride the main

international air routes, some of which had already been seeking to exploit the resource

of their air space, rather than to develop air transport itself18. To achieve this the

Conference attempted to transform the dogma of unrestricted air sovereignty into a

more specific set of “five freedoms of the air”, which purportedly guaranteed access to

foreign air space on a scale of increasing commercial value19. These freedoms were: -

(i) First Freedom: The right of one state to fly over the sovereign

territory of another state without landing, in order to

arrive at a third state.

(ii) Second Freedom: The right to land in another state for technical or

non-commercial reasons like refuelling or

maintenance.

(iii) Third Freedom: The right to discharge passengers or cargo from the

carrier’s home state in another state

(iv) Fourth Freedom: The reciprocal right to pick up and carry traffic from

another country to its home state.

18 The Italians for example refused to allow the British airline Imperial Airways to overfly

their territory en route to Egypt unless revenue was shared with an Italian airline which never carried a single passenger; while the Greeks insisted that the British pay duty on fuel, wherever it was loaded, if it was used on flights over Greek territory. Even the British exercised their sovereign rights in Canada and Bermuda and held up the start of Pan Am’s transatlantic service in the mid-1930’s by several years. See J.C. Cooper, The Right to Fly, New York (1947) pp17-35, 107-111.

19 Peter Lyth, Experiencing Turbulence: Regulation and Deregulation in the International Air Transport Industry 1930 - 1990, in Transport Regulation Matters, J. McConville (ed), Pinter (1997) at page 157


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(v) Fifth Freedom: The right of a state’s carrier to pick up passengers

and goods in another state in order to carry them

into a third state as long as the flight originates or

terminates in its home state.

The above freedoms are what are euphemistically referred to as “the five freedoms of

the air”. In reality they achieve the dead opposite.

Most of them created little controversy, although the fifth freedom has sometimes been

used in a way which virtually amounts to cabotage20. For example, Qantas, using fifth

freedom rights can fly into the UK, pick up traffic and continue its route to (say) Rome.

If the European Union for example is considered to be a single cohesive market, this

effectively creates a right to carry traffic from one inland point to another in the same

state.

In addition to the five freedoms, there is sometimes reference to three other “Freedoms

of the Air” 21 which have since been added after the Chicago Convention was signed.

Of these, only the eighth freedom was even discussed at the Convention and none of the

three was recognised by it. These additional three freedoms are as follows: -

(vi) Sixth Freedom: This is the right of a state’s air carrier to pick up

cargo and passengers in one state, transport them on

a route through the air carrier’s flag state, and

eventually bring the cargo and passengers to a third

state22.

20 Cabotage is a contentious issue between States. It is the right of a foreign-owned airline

to pick up traffic from one inland point in another state and carry it to another inland point in that same state. All States jealously guard cabotage which they regard as “the jewel in the crown”. See Jeffrey Goh, The Single Aviation Market of Australia and New Zealand, (Cavendish Publishing, 2001), page 6.

21 The sixth, seventh and eighth freedoms have been described as representing “only minor variations of the first five”, I.H.PH Diederiks-Verschoor, An Introduction to Air Law 2 (Kluwer, the Netherlands 1988) p. 12

22 Christer Jonsson, International Aviation and the Politics of Regime Change 32 (1987)


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(vii) Seventh Freedom: This Freedom is the right of an airline of one state to

carry passengers on free-standing or stand-alone

services between two other states without any stop

in the territory of the State in which that airline is

registered

(viii) Eighth Freedom: This freedom is the right of a foreign-owned airline

to pick up traffic from one inland point in another

state and carry it to another inland point in that state.

This is cabotage, which the Convention specifically

prohibits23, unless expressly granted by the State.

Note that the combination of fifth freedom rights

and sixth freedom rights greatly expands the

opportunities for cabotage since the carrier can fly

into the state granting sixth freedom rights as part of

a route that is otherwise not connected to the

carrier’s home state)

Of the above eight freedoms, only the first two (dealing with overflight and technical

stops) were actually adopted by the Convention and became established as fundamental

privileges for a nation’s air carriers with respect to the sovereign airspace rights of

another. The commercially significant third, fourth, and fifth freedoms” became terms

to be negotiated separately, and on an equal footing, between nations in the creation of

bilateral air transport agreements. They serve as the basic “working rules” for all

bilateral air transport services agreements between states24.

The Convention’s goal of formulating a comprehensive economic policy for

international civil aviation was to a large extent achieved, albeit indirectly, through the

23 Article 7 24 Bilateral agreements are essentially reciprocal exchanges of “permissions” or

“authorisations” between two contracting parties. Governments negotiate them and they become effective after both nations ratify them. They are made by executive agreements, treaties or an exchange of diplomatic notes. See Haanappel, supra note 13 at 47. In the U.S. they are executive agreements signed by the President. In Australia bilateral agreements are negotiated by the Commonwealth government under the executive power of the Commonwealth. See Commonwealth Constitution, section 61.


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creation of the International Civil Aviation Organisation (“ICAO”)25. Other than the

recognition, if not the acceptance, of the five freedoms, the ICAO is considered to be

the Chicago Convention’s most enduring contribution to the regulation of international

civil aviation although in reality its role in preventing economic waste has been

overtaken by the inherent inefficiencies of the bilateral system of aviation regulation, in

which governments themselves play the major role and the ICAO’s influence has been

restricted to that of a “standard-bearer for air safety”26.

In 1994, the ICAO Secretariat published proposals to liberalise the ownership and

control requirements that are invariably imposed by nations on the carriers of other

nations before those carriers can be granted air rights as part of the bilateral regulatory

system. Although these proposals were not accepted, it is the requirement that national

flag carriers be locally owned and controlled which the Australian Productivity

Commission described as the ‘most fundamental’ constraint on efficiency and

competition which the bilateral system imposes’ and which it urged the Australian

government to adopt27.

Since the Chicago Convention, several other international conferences attempted to

approve all the five freedoms as the basis of regulating air transport on a multilateral

reciprocal-rights basis, as distinct from the essentially bilateral basis of the Chicago

Convention. All these attempts took as their starting point the Chicago Convention28 but

none was able to substantially alter the Chicago bilateral approach.

1.4 BILATERAL AGREEMENTS

The vast majority of international scheduled flights today are regulated by such

agreements. They establish the regulatory mechanism for the performance of

25 While ICAO survives today as one of the the Chicago Convention’s major contributions

to the field of civil aviation law, its creation was not the Convention’s sole intent. 26 S.A. Stanleigh, Excess Baggage at the FAA: Analysing the Tension Between “Open

Skies” and Safety Policy in the U.S. International Civil Aviation Policy 23 Brook. J. Int’l L. 965 at 968 (1998)

27 Australian Productivity Commission 1998, International Air Services, report No. 2, AusInfo, Canberra, p XXX


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commercial air services between the participating countries.29 Bilateral agreements

place direct limitations on carriers from each of the contracting states, permitting air

service only to those cities specified in the bilateral agreement30, and regulate almost

every aspect of the service, sometimes to the point of absurdity31.

Basically each bilateral agreement is based on three broad principles: (1) the bilateral

exchange of traffic rights, (2) such rights are only granted on a reciprocal basis, and (3)

there are fair and equal opportunities for each contracting party.

It is an important general requirement of bilateral agreements that only carriers that are

designated as such by the respective contracting states can exercise the traffic rights

granted in the bilateral agreement between them. In this way the nationality of the air

carrier guarantees that each state obtains, or at least has the possibility of obtaining, its

own share of the market. No third parties are allowed to benefit from the bilateral

exchange of traffic rights32. As a result of this restriction, many airlines try to

circumvent it by alliances or mergers in various forms. Conversely, most nations have

strict airline ownership rules aimed at regulating such arrangements, rendering it almost

impossible for an air carrier under the currently prevailing bilateral regime to sell a

majority of its shares to a foreign carrier and still qualify as a designated air carrier of its

state; or to buy a majority share of a foreign air carrier and to exploit the traffic rights of

the acquired carrier.

28 B. Stockfish, Opening Closed Skies: The Prospects for Further Liberalisation of Trade

in International Air Services, J. of Air L. & Comm, Vol 57, 1992, p 599, at note 24 therein, and generally see Haanappel, supra note 13 at 18-24 .

29 Dempsey, supra note 16 at 13,14 30 Id. 31 For example, when Scandinavian Airline Service decided in 1974 to go “up-market”

and introduce Danish salmon and caviar sandwiches on flights between Finland and Germany, it found itself in breach of a multilateral agreement on in-flight catering, and was quickly forced to discontinue the practice!

32 H. Wasserbergh, The Regulation of State-Aid in International Air Transport, 22 Air & Space L. 158,160 (1997). Note however that a recent trend has been to multi-designate carriers, so that virtually all the carriers of each participating nation can fly the approved routes. For example, all but 8 of Australia’s 51 bilateral agreements are now multi-designated.


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To illustrate how a simple bilateral agreement is concluded, consider the factors

involved in the development of a bilateral agreement between Argentina and Australia

which occurred in 1988.

Both countries designated their national flag carriers33 for the agreement. Aerolineas

Argentinas believed that a market existed which would initially support a weekly

service between the two countries. It also aspired to use Australia as a stepping-stone

into the lucrative Asian market. On the other side, Qantas viewed the route as the only

gap in its worldwide route structure. It already operated extensive services into Asia,

Europe, and North America and although it recognized South America as a small

market at the outset, it saw significant strategic potential in the long term.

With no bilateral agreement in place, travelers coming from Australia and the South

Pacific region ordinarily traveled north to Los Angeles or San Francisco, then south to

Argentina. The most direct route at the time from Sydney to Buenos Aires, Argentina

required a journey of some fifty-five hours (elapsed time). Aerolineas Argentinas

proposed a new route which traversed the South Pole and reduced the elapsed travel

time to approximately twenty-five hours.

With no one to oppose the agreement and strong mutual goals, the respective

governments quickly reached a bilateral agreement providing for the operation of one

weekly Boeing 747 service for each carrier. The bilateral agreement designated the

precise type of aircraft that could be flown or substituted, the number of seats allotted,

the exclusive names of the carriers that could operate, and specified that the origin and

destination would be the two primary cities, Sydney and Buenos Aires. It also stipulated

that, subject to a separate commercial agreement between the two national carriers, one

carrier could choose not to operate, but could instead negotiate a separate seat- purchase

agreement with the operating carrier.

In that seat-purchase agreement, Qantas agreed not to operate its own flights in

exchange for the ability to sell in its own right, an allocation of fifty seats per flight on

Aerolineas Argentinas flights. In exchange, Aerolineas Argentinas received the right to

33 Aerolineas Argentinas and Qantas respectively


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exercise Qantas's weekly flight allocation, which it only exercised during the peak travel

months of December to February each year. In the period since the bilateral was signed

in 1988, Qantas has never operated its own aircraft on the route.

Even a relatively simple bilateral agreement such as this contained some of the

complexities that exist in nearly all bilateral agreements. The bilateral agreement

granted “beyond traffic” rights to the designated Australian carrier, permitting it to carry

passengers beyond Argentina to two additional points in South America, in exchange

for the Argentine carrier's right to travel to one point in New Zealand and one additional

point in Australia. However, if for example, Qantas chose to exercise its right to fly its

aircraft to Buenos Aires, then on to Rio de Janeiro, Brazil, it still could not do so

without first negotiating a separate bilateral agreement between Australia and Brazil

which granted it that same right.

Australia has negotiated 51 bilateral agreements with other nations, basically using the

Form of Standard Agreement for Provisional Air Routes34 (“the Standard Chicago

Agreement”) which had been endorsed by the Convention as being a suitable model

form for future bilateral agreements.

1.5 OPPOSITION TO THE CHICAGO REGIME: THE GENESIS OF DEREGULATION

The U.S. was even more restrictive of its domestic aviation industry than many other

nations during its early years. This was because its aviation industry was and always has

been privately owned and therefore considered even more in need of protection than the

state-owned and state-backed competing airlines of many other nations. Thus in the US,

there were from the outset strict domestic controls on market entry, pricing, and

capacity in order to protect its fledgling national airlines from excessive competition.

34 Approved in outline form only, leaving the members to negotiate details such as

capacities and rate-making separately amongst themselves. Agreements were entered into by the U.S. with Canada, Denmark, Ireland, Ireland, Norway, Portugal, Spain, Sweden, and Switzerland. Apart from the US/Canadian agreement, these agreements were particularly liberal in that they freely exchanged all five freedoms with few if any restrictions on pricing or capacity. See generally Paul S Dempsey, Law & Foreign Policy in International Aviation, 52 (1987)


21

The United States began tackling the deregulation of its domestic aviation industry in

earnest in the mid-1970s. By then its airline industry had expanded and matured to

become a “$100 billion industry”35 and it no longer needed the degree of protective

regulation and government financial guarantees which had carried over from an earlier

age. In addition there was pressure on the industry from the travelling public, with

widespread allegations of unduly high fares, excessive profits and route inefficiencies36.

Congress began with the passage of the Airline Deregulation Act 1978, the object of

which was to “encourage, develop and attain an air transportation system which relies

on competitive market forces to determine the quality and price of air services”37. It

eased domestic restrictions on pricing, market entry and routes in order to promote

competition and replaced the previous criteria of “public convenience and necessity”

which had served to restrict entry by new airlines since 1938 in favour of the essentially

pro-forma requirement of being “fit, willing and able” to provide aviation services38.

The passing of the Airline Deregulation Act has been described as a “landmark

decision” 39 which revolutionised commercial aviation in the U.S. It placed maximum

reliance on competitive market forces, with new entry guaranteed unless it was clearly

against the public interest, and regulated fares only within a wide ‘zone of

reasonableness’ 40. After 1983, even this form of fare control was abolished, and in

1984 the U.S. Department of Transportation (“DOT”) was made responsible for the

enforcement of the Act.

The U.S. experience regarding domestic deregulation has been well documented 41.

Initially it caused chaos. With the ability to lower their fares at will, airlines encouraged

the non-flying public to fill seats which would otherwise have flown empty. This they

did by wild fare discounting in 1979 – 80, which occurred at the same time as escalating

oil prices and economic recession. As a result almost every airline lost money. With

35 M. Cohen, Regulatory Report 1559 – 1566 (1975). 36 See Swinnen, supra note 12 p 280 37 Publication No 95 – 504, 92 Stat. 1705 (1978) 38 Airline Deregulation Act, Section 27. 39 Lyth, supra note 50 at 165. 40 Elizabeth Bailey et al, Deregulating the Airlines, Cambridge, MA (1986), at p 36 41 See generally D. Kaspar, Deregulation and Globilisation: Liberalising Trade in

International Air Services, (Cambridge,MA: Ballinger), (1988), p 27- 42


22

entry restrictions dismantled, competition became intense with an initial burst of new

entrants. In the absence of route restrictions, airlines sought to maximise efficiency by

developing extensive hub-and-spoke operations at key cities throughout the U.S. The

result was an increased concentration of operations by a single airline at a particular

airport hub with, ironically, a corresponding reduction in competition. A rash of

subsequent mergers, acquisitions and bankruptcies (e.g. Braniff) resulted in a highly

concentrated domestic industry, now dominated by three mega-carriers: American

Airlines, United Airlines and Delta. By 1990, the eight largest American airlines had 94

per cent of the American domestic passenger market and controlled almost all the major

hubs42. Not surprisingly, new carriers now find entry to the U.S. domestic market a

daunting proposition43.

With the development of hub-and-spoke route structures, airfares became complicated,

even incomprehensible, as airlines sought to cater for the widely differing demands of

the travelling public. To handle this complexity, sophisticated computer reservation

systems (“CRSs”) were developed in the early 1980s, owned by the large incumbent

airlines and used in ruthless fashion to shut out competition from smaller new rivals. As

more routes and fares became available under deregulation, computers were vital to

keep everyone moving in and out of the new hub-and-spoke network systems. In

addition they became powerful weapons with which to fight price wars, using

sophisticated software to juggle fares and seats on every flight to maximise revenue.44

Many other countries have now also substantially deregulated their own domestic

aviation industries. An example of how they have gone about the process is the

European Community (“EC”) where, together with New Zealand, the most significant

efforts to liberalise air transportation outside the U.S. have occurred.

The U.K., in a report from its Civil Aviation Authority in 198445, recognised that the EC

offered it the best chance for a national policy of liberalisation. The report argued that if

42 Stockfish, supra note 28 at p 383 43 Id 44 See R.Katz, The Impact of Computer Reservation Systems on Air Transport

Competition, Deregulation and Airline Competition, Paris, OECD, 1988, pp 85-102. The process of maximising the revenue from each flight is known as ‘yield management’


23

the countries of the Community could be deregulated to form a common air transport

market providing cabotage rights to every Member State, then Britain’s domestic

aviation base would be enormously enlarged. Furthermore, the EC could be used as a

lever to negotiate with the Americans for better access to the vast pool of American

passengers currently not available to U.K. carriers

Another impetus to EC deregulation occurred in 1986 when the Court of Justice of the

European Communities held in the Nouvelles Frontieres case46 that the EC’s antitrust

laws applied to civil aviation matters, including cartel-like activities of the Member

States in those matters. This significant decision opened the way for the EC to intervene

in the civil aviation policies of Member States. Within a year of the decision, the EC

passed the Single European Act 47. The Act was a very important pieces of legislation

for the liberalisation of air transport in the EC because it replaced the unanimous voting

requirement under the EEC Treaty, allowing the EC to act on competition matters

without facing the veto power of any single Member State.

In December 1987 the EC approved the first of a series of three “Liberalisation

Packages” dealing with aviation between EU Member States48. The packages included

procedures for applying the EC’s antitrust rules to the air transport industry, and

provided that governments must approve airfares proposed by airlines if the fares were

reasonably related to the air carrier’s costs. It also included provisions for capacity

sharing, market access, and the assignment of multiple airlines to single interstate

routes.

The second phase of liberalisation in September 1989 further prepared the way for a

unified air transportation market in the EC by January 1, 1993 by further relaxing

market access and capacity sharing. This process was helped by the Ahmed Saheed

45 Civil Aviation Authority, (1984), Airline Competition Policy, CAP 500, London 46 Joined Cases 209 & 1384, Ministere Pub. v Lucas Asjes, 4 E.C.R. 1457, 3 C.M.L.R.

173 (1986) (analysing whether a French travel agency had the right to sell airline tickets below levels agreed to in airline tariff agreement approved by member states)

47 Single European Act, 1987 O.J. (L 169) 1-29 (stating that the Act would come into effect July 1, 1987 and that signatories to the Act were committed to establishing a European internal market by Dec 31, 1992)

48 Stage 1 was of limited value to Britain since it had already signed as many liberal bilateral agreements as it could, without needing any Commission encouragement


24

case49 which also held that the competition provisions of the EEC Treaty applied to air

transport.

In 1990 the EC approved regulations to take effect in 1993 that granted freedom to

airlines to fly routes between community states and the need for double disapproval to

prevent adoption of fares negotiated between two airlines. Most importantly, the

regulations also assured new airlines access to airport landing and takeoff slots and

computer reservation systems – factors not provided for by the U.S. in its deregulation

efforts, but without which competition in the aviation industry cannot occur.

In June 1992, the EC adopted the third phase of airline liberalisation which effectively

created a single EC airline market, in which any European airline could fly on any

European route with full cabotage rights. This meant that provided an air carrier met

certain financial and safety standards, it could establish an airline in other EC countries

with full fifth freedom access to each other’s markets within the EU. Furthermore, and

all bilateral agreements, capacity limitations and national ownership rules for air carriers

were abrogated. Airfares and rates could be set by a carrier subject only to review by a

state if that state could determine that the fares were either too high or too low. The

third stage was completed by 1 July 1997.

In summary, the EC has achieved a liberalised and single air transport market for the

European Community by threatening EC legal and economic action against the anti-

competitive conduct of any of the Member States. It is arguable that it created a

competitive market more successfully than the U.S. because it was implemented with

more regard to the marketplace and political realities of the region.

Australian and New Zealand have also deregulated their aviation industries. The process

by which this occurred is set out in Chapter 3 of this thesis.

1.6 INTERNATIONAL DEREGULATION: THE UNITED STATES EXPERIENCE

49 Case 66/86, Ahmed Saeed Flugreism & Silver Line Reiseburo v Zentrale Zur

Bekampfung Unlauteren Wettbewerbs (1990) 4 CMLR 102


25

The US began the process of international deregulation in the late 1970s. By then it had

become obvious that the bilateral (or “tit-for-tat”50) approach to the negotiation of third,

fourth and fifth freedom rights, upon which the entire international air transportation

system depended, was under immense commercial pressure.

As Professor Pengilley puts it, “…it is not surprising that the “tit for tat” arrangements

(were) breaking down and will continue to do so. That the economic reality was

overtaking the legal negotiating framework is evidenced by the pressures put by the

former on the latter. In particular, the legal “tit for tat” negotiating framework is under

stress when (for example) a first country carrier wishes to pick up traffic in a second

country and on carry such traffic to a third country. The final destination third country

and the intermediate second country may well have lucrative traffic between each other,

which they seek to protect. The first country carrier will seek to invoke fifth freedom

rights of carriage whilst the second and third countries will seek to exclude such carrier,

arguing that third and fourth freedom rights are at stake” 51

Another problem with the tit-for-tat approach occurs when there is a “tit” but no

corresponding “tat”. A recent example of this occurred in the provision of a direct

service from Kuala Lumpur to Vancouver. There was only sufficient demand for the

service by one airline but not one from each country. Whose airline should it be? What

could the successful airline provide to the other by way of a “tat” 52.

A subtle variation on this theme occurs when the “tat’ for the corresponding “tit” exists

only in theory. For example, the U.S. may offer country “X” access, even generous

50 Warren Pengilley, Airline Snacks, Staff Seminar University of Newcastle, 1995, at p 17 51 Id at 21. An example of this type of dispute occurred in 1993 between Australia and the

U.S. The dispute was in relation to the “fifth freedom rights” of Northwest Airlines, an American airline, to fly from America to Australia via Japan and uplift passengers in Japan destined for Australia, a right granted to it as a result of American - Japanese treaty arrangements negotiated after the war. The United States claimed that Northwest was permitted to fly from America to Australia via Japan pursuant to American fifth freedom rights to pick up passengers in Japan. The Australian government however restricted Northwest’s ability to carry Japanese passengers from Japan to Australia in order to protect its rights under its own bilateral agreement with Japan. The U.S. reacted by withdrawing permission for Qantas to operate three direct services per week to Los Angeles. The dispute was eventually settled on the basis of a reallocation of services, with Qantas obtaining some additional services to the U.S. See generally Pengilley, id at 21, 22


26

access, to its domestic market in exchange for access to the domestic market of country

“X”. Country “X” however may not realistically be able to compete in the intensely

competitive U.S. market because its cost structure is simply too high or its resources

insufficient to properly service that market. By comparison the efficient, resource rich

U.S. airline is more than able to capture market share in country “X”, within the limits

of its air traffic rights. The benefits therefore are really only one-way.

As a result of restrictions on operating flexibility caused by the bilateral system (such as

route allocations, pricing and frequency of services), the airlines of several of the larger

airline nations in particular responded in several ways to avoid these restrictions. These

responses were to a large extent initiated independently of their governments (although

some of the airlines were of course owned wholly or partly by those governments) but

the involvement of an airline carrier’s government was usually required at some stage of

the response, either for ratification or for treaty agreement.

One form of response was to become more commercially involved in the fortunes of

competing airlines, for example by forming alliances or joint ventures with each other 53 or by holding shares in one another (or combinations of these).

Another response was to do “deals” with each other which were outside the legal

negotiating framework of the Chicago Convention’s reciprocity (or “tit for tat”) rules.

For example, as Pengilley has pointed out54, “if a United States airline can privately “do

a deal” with a European government or airline which will permit the US airline to offer

special discount flights into the European country in question it will not be possible for

other European countries to stand aloof and attempt to impose restrictive conditions on

flights by that airline into their own territory, which they may otherwise wish to impose

on the U.S. airline. The U.S. carrier will simply fly to the European destination offering

the most favourable flight conditions. Passengers may then be transferred from that

destination to other destinations by the US airline’s European co-partner or they may be

trans-shipped by the very efficient European rail system”.

52 Id at 19, 20 53 For particulars of alliances see 3.4.5 below 54 Pengilley, supra note 50, p.20


27

If by “doing such a deal” a United States carrier can “pierce the armour” of any

particular nation’s airline protection system, it has effectively pierced them all. As

Pengilley puts it: “The attraction of any one particular country to doing a special deal

with a US carrier may well be that the US carrier offers all its on-going European

passengers to the carrier of the European country involved”55. In other words, if such a

deal was done, other European countries could not simply ignore it.

This was one of the strategies pursued privately by US airlines to circumvent the

restrictions of the bilateral system of regulating international air services56. When

successful, the arrangements often amounted to avoiding cabotage57 restrictions of other

European states without at the same time allowing the airlines of those states access to

cabotage in the U.S. The reason for this is that even though the U.S. may appear prima

facie to be generous in granting a European carriers a wide choice of landing in the U.S.

in exchange for a geographically unequal choice of landing in a smaller European

country, the scale tips in favour of the American carrier if fifth freedom rights allow

them to build and control a network of routes based on “hub and spoke”58 operations in

the E.U. For example, Frankfurt became a hub for U.S. spoke traffic to Eastern Europe

following the end of the cold war.

The U.S. on the other hand, being a single market, does not offer the opportunity for

European carriers to derive, from fifth freedom rights, the ability to build “hub and

spoke” operations in the U.S. That can only occur by means of merger or takeover or

part ownership.

55 Id 56 It first bore fruit in 1978 with the “doing of such a deal” between the U.S. and the

Netherlands which was quickly ratified by the respective governments. This was “the essential piercing of the armour”, as Pengilley puts it. From then on all other European regimes had to engage in similar arrangements, and most did so.

57 For the meaning of cabotage see Paul S. Dempsey, The Disintegration of the U.S. Airline Industry, 20 Transp. L.J. 9, 29 (1991)

58 The “hub and spoke” system brings passengers from smaller cities along “spokes” to a central (“hub”) airport where an airline’s operations are concentrated and where the airline aggregates passengers with the same destination. Since deregulation, hub and spoke systems have become the almost universal route structure of choice for deregulated airlines. See U.S. Dept of Transp., Secretary’s ‘Task Force on Competition in the U.S. Domestic Airline Industry, Industry and Route Structure’ 1 (1990)


28

With ownership of domestic carriers in the U.S. restricted by law, foreign carriers have

therefore been forced to develop code-sharing arrangements, co-operation agreements,

alliances and franchise arrangements in an attempt to simulate “hub and spoke” systems

in the U.S.

While its private carriers were engaged in strategies such as those referred to above, the

United States government began its own campaign for international “open skies” by

calling, in the mid 1970’s, for “open” bilateral agreements based on a prohibition of

government intervention with fares except by mutual agreement59.

The tactic that the U.S. used was to sign liberal bilateral agreements with other States

such as the Netherlands and Belgium that aspired to be hubs for transatlantic traffic and

then to pressure other states like Britain and Germany to also accept some liberalisation

of their existing agreements or face the prospect of losing business. In other words, the

policy was an attempt to expand deregulation internationally through the multiplying

effect of liberal bilateral agreements.

The initiative was mainly successful in Northern Europe where widespread competition

in air services and fares already existed, meaning that there were several like-minded

states that were prepared to co-operate with the U.S. and to enter into liberal agreements

with it. It was rather less successful in other parts of the world. This was not only

because there were few other like-minded partners with whom the U.S. could negotiate

such agreements, but also because of mounting international resistance to the unilateral

liberalisation policies of the U.S.60.

An example of this is that as recently as the early 1990s, the U.S. offered France,

Germany and the United Kingdom “open skies” agreements which contained virtually

no restrictions, including the right of access to all and any cities in the US and

permission to determine fares and schedules without government approval. In exchange,

these countries were asked to grant American carriers increased access to their own

59 Diederiks-Verschoor, supra note 21 at 50 60 Dempsey supra note 57, p 31


29

markets61. Even these initiatives were unsuccessful, with France and Germany rejecting

them outright62 while the UK was simply unable to conclude its own Open Skies

agreement with the U.S.63

In summary, although some international liberalisation was achieved as a result of the

international policy initiatives of the U.S. between the mid 1970s and the early 1990s, it

did so both at a much slower pace than the U.S. wished, and occurred mainly in a piece-

meal fashion by means of limited (though liberal) bilateral agreements as distinct from

the preferred U.S. model of multilateral agreements.

It is alleged that part of the reason for this was that the U.S. failed to sufficiently

appreciate that there are fundamental differences between the domestic and international

aviation markets of all nations. In reality there is no single aviation market64. Each

separate state is different in terms of the stage of development of its aviation industry,

the size and number of airlines operating within it, the degree of state ownership and

control and the condition of those airlines as well as the degree to which they have been

deregulated at any time. Moreover this mix is dynamic rather than static. It is not

surprising therefore that an international approach which failed to take into account this

wide diversity met with almost universal rejection.

For example, when the U.S. started its international deregulation initiatives, it had no

less than eleven domestic trunk air carriers and an additional eight local service carriers.

None of these carriers embodied the “ego” of the U.S. presence in the world airline

community. Therefore, culturally speaking, it was quite acceptable for the U.S. to let

one or even several of those carriers go out of business if that was the price to be paid

for deregulation. Such was not the case in Europe and other parts of the world. Many

61 E.Tazewell Ellett, International and US Legal and Policy Impediments to the Growth of

the Airline Industry: Time for a Change in the World Order?, Air & Space L., Winter 1991, 3 at 8-9

62 France has always opposed the relinquishment of control over its national carrier, Air France which is 54% owned by the French government. Other Mediterranean airlines, such as Iberia, Alitalia and Olympic have the same attitude.

63 Negotiations finally ceased in November 2002, ten years after their initiation in 1992. They will not be restarted. Instead, the EC will conduct negotiations on behalf of all Member States. The parties believe that an Open Skies agreement will take some years. See ‘Open Skies long way off’, The Australian, 3 October 2003; and see The Economist, ‘Open Skies and flights of fancy’, 4 October 2003


30

other countries had a single national airline that was the “flag carrier”, embodying the

entire ego of each of those countries in the world airline community. It was not

acceptable for these flag carriers to fail65.

1.7 SOME FACTORS LIMITING DEREGULATION

1.7.1 Slots

Slots, and slot allocation, are the terms given to the times designated to airlines for take-

offs and landings at airports. In the allocation of slots, consideration must be given to

such factors as air traffic control capacity, runway capacity and airport building

capacity. Airports are typically congested and the slots available are restricted. Slots are

often, but not always66, allocated on the basis of historical precedent, a method

sometimes described as the “grandfather doctrine”67. This means that takeoff and

landing spots, once they are assigned to an airline, remain the “property” of that airline

as long as they wish to renew their application for possession.

Even though slots may not have an intrinsic value of their own, they do have a

substantial market value because they facilitate air travel to and from high-density

airports68. The market value of slots is of course not homogeneous, being determined by

64 Stockfish, supra note 28 at 624 65 M. Tretheway, European Air Transport in the 1990s, pp 61-62 66 In Central American countries for example they are allocated by governments – which

of course leaves them open to political influence. Kries supra note 254 p 323 67 A system described by Sir Richard Branson, head of Virgin Atlantic, as “absurd”. See

Arthur Reed, Grandfather is Alive and Well in Europe, Air Transp. World, May 1, 1992, at 65-67

68 Report to Congress: A Study of the High Density Rule, Technical Supplement No 2 and Trend Analysis, U.S. Dept of Transportation, May 1995, page 22. For example, United Airlines in the U.S. has estimated that each of its peak hour slots at Chicago’s O’Hare Airport generated annual receipts to it in 1990 to the value of five million U.S. dollars. On this basis the current price for such a slot is over two million U.S. dollars. See Dario Maffeo, Slot Trading in the Reform of Council Regulation (EEC) No 95/93: A Comparative Analysis with the United States, 66 J. Air L & Com, Fall 2001at 1579. Even larger figures are said to apply in Europe. In May 2000, two slots at Gatwick Airport belonging to AB Airlines were sold to Virgin Atlantic for two million British pounds, and a study claimed that the value of all slots at London Heathrow Airport is over one billion British pounds. See John Balfour, Who Really Owns the Slots? A Legal View, Presentation at the London Strategy for Overcoming Slots Limitation Congress (June 27, 2000).


31

a range of market forces69. Nevertheless slot trading between airline carriers has given

rise to some significant transactions in recent years70 although in reality, major air

companies avoid selling slots whatever the price71. Furthermore the trend towards major

and long-established carriers retaining their slots in order to keep new competitors out

of the market may be increasing72

Although frequently described as “property”, slots may not in fact be the subject of

property rights. In the U.S., the FAA has claimed that “slots do not represent a property

right but represent an operating privilege, subject to absolute FAA control”73. The 5th

Circuit Court in the U.S. has supported this view, holding that slots are not property

themselves and that even if a limited proprietary interest arose from the allocation of

slots, the transfer and disposal of such slots nevertheless required the approval of the

FAA74. The views of the 5th Circuit Court of Appeals are not however unanimous75.

69 Such as the particular airport, the time allocated, the range of operators able to use the

slot, operative limitations (e.g. noise abatement requirements), and the availability of gates. The market, when it exists at all, is clearly very restricted and therefore dysfunctional, comprising at best a very small number of sellers and an excess of buyers.

70 In 1991, USAir bought ten slots at Washington National Airport and twelve slots at La Guardia for US$16.8 million ($760,000 per slot). Continental bought 35 slots at La Guardia from Eastern Airlines for $54 million ($1.5 million per slot). See infra note 293. In 1996, a new entrant in the market was forced to pay approx $2 million for a single slot at La Guardia airport. See Gleimer, infra note 72.

71 See Airport Mobilisation: Barriers to Entry & Impediments to Competition, Hearings on the State of Competition in the Airline Industry Before the House Committee on the Judiciary, Cong. 76-330 (2000). Of 3100 slots for domestic carriers at four high-density airports in the U.S. only 45 are held by airline companies that began to operate after deregulation in 1978. Id at 25

72 Sales of slots between unrelated carriers decreased from 110 per quarter in 1986 to 28 per quarter in 1987 to 12 per quarter in 1988. Eileen Gleimer, Slot Regulation at High Density Airports: How Did We Get Here and Where Are We Going? 61 J. Air L. & Com 877 (1996) at 896

73 14 C.F.R. pt. 93.223(a) (2000). See also Haanappel, Airport Slots and Market Access: Some Basic Notions and Solutions, Air & Space Law 202 (1993)

74 See In Re Braniff Airways Inc v Braniff Airways Inc, 700 F. 2nd 935, 942 (5th Cir. 1983)

75 For example, bankruptcy courts have questioned this ruling. In In Re McClain Airlines Inc, 80 B.R. 175, 179 (Bankr. D. Ariz. 1987), the court stated that slots are the property of the debtor’s estate, notwithstanding the Federal Aviation Act which, the CAB alleged, prohibited the creation of property rights in air transportation slots. The court held that such a position must be assessed according to current administrative arrangements which permitted carriers to purchase or to sell slots. The bankruptcy court also noted that the enactment of rules by the CAB to provide for the “maximum reliance on market forces to determine slot distribution…” was difficult to reconcile with the FAA’s claim that such free market items do not constitute property rights. The FAA’s


32

Various ad-hoc measures have been proposed to overcome the slot problem in the U.S.

In the late 1960s the FAA proposed the so-called “High Density Rule”76 to limit the

number of hourly takeoffs and landings at several major “high density” airports,

requiring that a slot support each operation. Although not intended to be a permanent

solution (its original life was in fact limited to just 12 months), the rule has been

extended indefinitely, basically because the airlines have refused to voluntarily reduce

their schedules to the level required by the high-density rule. The airlines in fact

responded by reaching agreements amongst themselves on scheduling which they did

through so-called “Scheduling Committees” which they established with the support of

the CAB. The agreements themselves were granted immunity from antitrust laws77.

The Airline Deregulation Act 1978 put this ad-hoc system of scheduling under further

pressure because new airlines then began offering low prices and new flight connections

and demanded slots to be able to do so. In 1980 the Committee system broke down

when a new entrant (the New York Air Company) was refused twenty slots to operate a

shuttle service between Washington National Airport and La Guardia airport. The FAA,

having finally recognised that a voluntary system for scheduling was impossible, then

proposition that slots were not property was further undermined in the Gull Airlines bankruptcy, the court in that case holding that because of the existence of a market for slots, carriers possess a proprietary right in their slots even if that right is encumbered by conditions imposed by FAA regulations. Applying this principle, the court also determined that any proprietary interest held by the airline in the slots terminated automatically when the airline failed to use the slots for the requisite period of time specified in its agreement with the airport operator, and that the withdrawal of the slots by the FAA did not violate the automatic stay contained in the U.S. Bankruptcy Code whereby a bankrupt’s assets are preserved for a statutory period of time to allow their orderly disposal. See In Re Gull Air Inc., 890 F.2d 1255, 1259-60 (1st Cir. 1989). As a result of this case, the FAA was forced to recognise that in the light of the buy-sell rule, slots are in fact rights of property that have to be defended in bankruptcy, creating a further complication to their rational allocation.( But only in bankruptcy, according to the FAA which claims that the principle of slots as property rights upheld by the Bankruptcy Courts “has not been found in any other context”. See In re United Airlines Inc., No 27151, B.R. (May 3, 1993)

76 High Density Rule, 33 Fed. Reg. 17,896 (1968), which became effective on 27 April 1969.

77 See 14 C.F.R. pt. 93 (K),(S). A similar position exists in Australia where the ACCC has granted authorisation under the Trade Practices Act to scheduling committees, particularly for Sydney Airport, where a scheduling committee in the mid 1990s allocated slots firstly on the basis of existing schedules, after which any remaining slots were split 50/50 between new entrants and existing operators. Whether this is still the current practice following the privatisation of the airport is unknown.


33

confiscated some slots from major carriers which, together with several other slots

which had been voluntarily given up, enabled New York Air to begin operations.

Although the FAA’s actions were contested, it was held on appeal that its actions were

legitimate and fully compatible with the competition policy set down in the Airline

Deregulation Act78. This decision therefore put in question the validity of the private

slot agreements between carriers, reached through their scheduling committees.

In 1985, as a response to worsening congestion, the FAA introduced the “Buy-Sell” rule

that allowed scheduled air carriers and commuter airlines for the first time to sell slots

in four high-density airports. Slot allocation itself was based on the grandfather method.

The FAA argued that using this method was in effect a recognition of the investment

and commitment which the large carriers had made in the industry in the past79.

The market in slots that subsequently developed as a result of the Buy-Sell rule failed to

achieve its objective of stimulating competition and acted instead to actually depress it,

to increase airfares and to minimise the effects of liberalisation80. “Good” slots became

increasingly difficult for new entrants to obtain because those who had slots tended to

protect and keep their share of the market to avoid favouring any potential competitors.

As already stated, most major air carriers avoid selling their slots, whatever the price81.

As a result, the Authorisation Act 1994 was passed authorising the Department of

Transport to allow slot exemptions whenever public interest was involved and if

exceptional circumstances permit it, in order to allow new entrants82 to provide services

at many high density airports. Despite this, very few exemptions or “exceptional

78 See Northwest Airlines Inc v Goldschmidt, 645 F.2d 1309, 1318 (8th Cir. 1981) 79 In Australia, similar arguments were put by both Ansett Airlines and Australian Airlines

to justify the long term leases granted to them in 1987 at Sydney and Melbourne airports. See Part 3 of this thesis.

80 The General Accounting Office (GAO) found that airports where entry is limited by slot control have airfares which are about seven percent higher than airports where entry is not so controlled. See infra note 83 at 12

81 The major American airlines control over 90% of the slots at Washington National Airport and the remaining 10% are almost all controlled by commuter companies that are in most cases their affiliates. See note 83 supra at 10

82 A new entrant is defined as a carrier or commuter that holds and operates (as from December 16, 1985 onwards) less than 12 slots at the airports in question, not including international slots. See 49 U.S.C. para 41714 (h) (3) (1994).


34

circumstances” were ever recognised by the DOT, so much so that as late as October

1996, the U.S. General Accounting Office found that “control of slots by a few airlines.

(still) greatly deters entry at key airports in Chicago, New York and Washington”83

It is clear that the anticompetitive market caused by slot control does not provide the

consumer with many advantages. Despite this vested interests continue to oppose

abolition of the slot rules. Even environmentalists oppose its abolition, fearing that it

may cause increased noise pollution.

The most recent development in the U.S. has been the enactment of the Wendell H.

Ford Aviation Investment Reform Act for the 21st Century (“FAIR 21”) which provides

amongst other things for the gradual elimination of all restrictions linked to slots at

certain key high density airports, and their elimination by July 1, 2002 (O’Hare) and

January 1, 2007 (at New York Airports). FAIR 21 gives DOT stronger powers to grant

slot exemptions and to break the slot monopoly enjoyed by the major airlines. However,

based on past experience when measures taken to regulate the anticompetitive effects of

slots often resulted in the actual strengthening the position of the major carriers, it is

unlikely that FAIR 21 will achieve its goal of eliminating the anti-competitive effects of

slot control.

In Europe the position regarding slots is much the same as in the U.S. if not worse with

up to 80% of slots in many of Europe’s most congested airports, such as Heathrow

(London) or Charles de Gaulle (Paris) awarded on the grandfather principle.

As in the U.S. the obvious barriers to entry of the grandfather system of slot allocation

have lead to calls for its reform. The EC however, after initially assessing the effects of

the “grandfather rule” in the mid 1980s, decided that although the system undoubtedly

restricted free market access and entrance and was therefore illegal, it was nevertheless

functioning and should be preserved until something better replaced it. A temporary

group exemption was therefore granted by the EC 84.

83 Report to Congress, Airline Deregulation: Barriers to Entry Continue in Several Key

Domestic Markets 84 Proposal for a Council Decision on Aviation between Member States Relating to Air

Transport (1984) O.J. (C 182) 1


35

To deal with the problem on a more permanent basis, the EC requested its Member

States to create a code of conduct for slot allocation predicated on the principle of non-

discrimination based on nationality. This was incorporated into EU law in 199385. This

was a system for slot allocation which “avoids situations where, owing to a lack of

available slots, the benefits of liberalisation are unevenly spread, and competition is

distorted”86. It did not however achieve the desired results, with dominant carriers

continuing to be treated favourably at congested airports and able to benefit from their

“grandfather rights” for unlimited periods into the future.

In 1995 the EC therefore commissioned the international accounting firm, Coopers and

Lybrand, to report on how Regulation 95/93 was being applied and to propose changes.

Although Coopers and Lybrand reported to the EC on October 17, 199587 suggesting a

variety of measures to deal with the problem of slots, the EC has to this day been unable

to reach a consensus on the issue amongst its members. This is an indication of how

contentious the issue of slot allocation is in the EU.

Since 1995, congestion in European skies has worsened dramatically88 and amongst

other things generated a “hidden” market in the trading of slots89. Despite the fact that

the large airline companies obtained slots at high-density airports without paying any

cost or without renting them, their slots have a high economic value because of their

demand from other carriers who have insufficient slots to service their operations.

85 Regulation n.95/93 dated 18 January 1993 stating common rules regarding slot

allocation in EC airports. 86 Id 87 See Coopers & Lybrand, The Application and Possible Modification of Council

Regulation 95/93 on Common Rules for the allocation of Slots at Community Airports, Oct 17, 1995

88 A recent study evaluates the economic consequences of air traffic congestion in Europe at six billion U.S. dollars in 2000 and estimated that traffic lost to congestion in 2000 was 27 million passengers. British Airways alone estimated that congestion linked to air traffic control problems caused it to consume 50,000 tons of extra fuel in that year.

89 Cooper & Lybrand discovered numerous sales of slots in this “hidden” market, supra note 87


36

On July 26, 2000, The European Commissioner for Transport commissioned a thorough

review of Regulation 95/93 including a procedure for the orderly and fair sale of slots. It

remains to be seen what will be the outcome of that review.

In summary, it is clear that the high-density rule, by which slots were first introduced

into the U.S. fifteen years ago, has totally failed to achieve its goal of relieving airport

congestion. Not only has congestion worsened since the rule was introduced, but the

rule has impeded competition in the airline industry by enabling large incumbent

carriers to hoard a good part of the market for slots. This has made it difficult for new

entrants to gain entry, thus forcing consumers to pay higher fares for correspondingly

less services.

Furthermore, the buy-sell rule has allowed the carriers to sell public resources that were

freely allocated to them in the first place, for many hundreds of millions of dollars

without any economic return to taxpayers. Slots are rare goods and carriers are prepared

to pay high sums of money for them. A flight linked to good slots is almost a guarantee

of commercial success, and is a strong barrier to competition.

The progressive phasing out of both the High Density and Buy-Sell rules in the U.S.

may see the use of slots in that country normalised in the future, while in Europe the

modification of Regulation 95/93 is designed to achieve the same result.

However the indirectness if not timidity with which both the U.S. and the European

Union have dealt with the core reason for the existence of the slot problem in the first

place – namely the grandfather rule – is hard to reconcile with the stated goal of reform

of the aviation industry, which is efficient competition amongst air carriers.

It maybe that the eventual solution to the slot allocation problem will come about less

through government intervention as has happened in the past and instead through a

more pro-active role by (private) airport managing bodies who regard a slot as nothing

more than a carrier’s right to use the infrastructure and services of an airport for a

certain period of time whenever it lands or takes off, rather than as an inalienable piece

of airline property. The former view should enable slot allocation amongst competing


37

users to be rationalised according to market forces rather than dealt with on the basis of

arbitrary rules such as the Grandfather rule.

Viewed in this way, i.e. as an asset of the airport managing body to be managed like any

other asset, slots may come to be managed on the basis that, being strongly linked to

airport infrastructure, they have the capacity to greatly increase the return on the airport

managing bodies investment in the airport. At present this asset management approach

to slots is largely absent from the analysis of the problem.

A starting place would be for airport managing bodies to insist on being involved in slot

allocation and transfer procedures in the first place.

In Australia, hubs may not be as significant a problem as they are in the U.S. or the EU,

although Sydney Airport may be an exception to the rule90. It appears that new entrant

airlines in Australia such as Compass (1990) and Virgin Blue (2000) were both able to

obtain the necessary slots and other airport facilities, although in both cases it was not

without difficulty. In Virgin’s case, that may have had more to do with the demise of

Ansett Airlines which freed up many slots at Australian airports including Sydney

Airport just at the time when Virgin needed them to expand91.

1.7.2 Airport Leases

A somewhat related issue to slot allocation is the equally vexed question of airport

leases and their effect on competition and deregulation. As with the control of slots,

restrictive airport lease agreements act as a barrier to entry and exacerbate concentration

in the airline industry but have generally received less attention than other barriers to

entry such as slots, ownership restrictions and computer reservation systems.

In the U.S. the issue is complicated by the fact that airlines either own many airports or

are substantial investors in them, the majority of airports in the U.S. being funded

privately. The airlines therefore typically have leases which run for long terms and

90 See Brett Johnson, Industry Perspective on International Regulatory Developments in

the Airline Industry, (2002) 14 DePaul Bus. L.J 257. 91 See Part 3 of this thesis.


38

contain exclusive-use clauses and other clauses92 which allow airlines to veto expansion

at a particular airport93 which might for example enable more slots to become available.

It is claimed that such restrictive leases are the benefits the airlines receive from the

airports for their investment94 in the construction of airport facilities.

Although restrictive leases in the U.S. predated the start of deregulation in 1978,

deregulation aggravated their harmful effects by insulating incumbent airlines from

competition without the restraints imposed by regulation of routes and fares. Although

this was recognised by the CAB as early as 1983, and the elimination of all majority-in-

interest clauses recommended95, little has happened in the interim to change anything.

In addition, deregulation facilitated development of the hub-and-spoke systems that

airlines contend requires them to control a substantial number of gates and other

facilities at airports in order to operate properly. This frequently causes inefficient use

of airport facilities96 and has lead to the development of “airline-specific”

concentrations at particular airports, sometimes to the extent of having only one carrier

per airport. Combined with restrictive lease provisions, the growth of the hub system

has therefore resulted in single airline control over access to existing gates, and

therefore control over the very process of expansion at many airports that would see the

number of gates increased.

92 So-called “majority-in-interest” (“MII”) clauses 93 The Adequacy of Competition in the Airline Industry: Hearings before the Subcomm. on

Aviation, 101st Cong., 1st Sess. 128-129 (1989). American Airlines’ lease with Dallas-Fort Worth Airport provides that: “The Airport may be further improved , developed or expanded through the use of the Capital Improvement Fund, the issuance of Bonds, or through the use of proceeds of Bonds, the debt service of which is payable from Gross Revenues of the Airport….only when and as mutually agreed between the Board (of the airport) and a majority-in-interest of Airlines”. See CAB Report, infra note 95 at footnote 17

94 There are two basic ways in which airport construction is funded in the U.S., the residual cost and the compensatory methods. Airlines generally cannot insert MII clauses into a lease agreement with the airport financed under the compensatory method because the airport bears the risk of excessive costs. Under the residual financing method however the airlines take more risk. In return for their agreement to pay all costs not covered by non-airline sources, they extract valuable MII clauses. See U.S. Dept of Transport Task Force, “Impact on Entry”, 3-5 (1990) at 3-8

95 CAB, Report and Recommendations of the Airport Access Task Force 61 (1983) 96 Supra note 95, at 53. Many ‘spoke’ flights converge on the ‘hub’ at about the same time

in order to catch connecting flights and thus aggravate congestion.


39

In 1990, majority-in-interest (“MII”) clauses were in effect at fifty-five airports in the

U.S. including fifteen of the twenty-seven largest97, with most of the leases being for

terms of twenty to thirty years, on an exclusive basis98.

It has been argued99 that “exclusive-use” and “MII” clauses are in breach of the anti-

trust provisions of the United States’ Sherman Act and as such should be declared void

and unenforceable, thus freeing up airport expansion without having to first secure the

approval of the dominant incumbent airline. It is further argued that U.S. courts could

force airports and incumbent airlines to make gates available on non-discriminatory

terms, and Congress should amend the Federal Aviation Act 1958 to assist this100.

As yet however, nothing has been done in the U.S.

In Australia, airports are constructed and owned by the federal government, which over

recent years has been selling several of them to private owners101. Australian airlines

enter into lease agreements with the owners of airport facilities which give the lessee

exclusive use of parts of the terminal buildings including “gates”. The leases are

typically long term arrangements. For example, Ansett Airlines was 13 years into a 30-

year lease with (then government-owned) Federal Airports Corporation Ltd for part of

the terminal at Sydney Airport when it went into liquidation102.

Ansett’s liquidator is currently trying to expedite the sale of the balance of Ansett’s

lease facilities at Australian airports, after selling some of the facilities to Virgin Blue,

which had been trying without success to acquire terminal space on sub-lease from both

Ansett and Qantas since it began its operations in Australia103.

97 Harvard Law Review Association, The Antitrust Implications of Airport Lease

Restrictions, 104 Harv. L. Rev. 548 at 551(Dec 1990) 98 Id 99 Id at 564 100 Id at 569 101 For example, Perth International Airport is now owned by the Westralia Airports

Corporation. 102 Sydney Airport is now owned by Sydney Airports Corporation. 103 See Weekend Australian Financial Review, 23/24 March 2002.


40

1.7.3 Cabotage

Cabotage, in aviation parlance, amounts to a prohibition on foreign carriers from

carrying domestic traffic of any kind within a State, thereby preserving the State’s

sovereignty.

Consider the following hypothetical example: Australia has negotiated a bilateral

agreement with the United States whereby Qantas has been granted reciprocal traffic

rights to operate from Sydney to New York, Chicago, and Atlanta. Because of the

prohibition on cabotage within the U.S., Qantas cannot compete with U.S. carriers by

operating its flights between (say) New York and Chicago, by carrying cargo or

passengers that are traveling only between those cities. Unless there is sufficient

demand to independently operate services to each of those cities from Sydney on some

regular basis, Qantas is prohibited from competing.

Qantas may be interested in flying from Sydney to New York where it would discharge

New York passengers, and then continue on to Chicago with the balance of the

passengers and cargo. But again it would only be allowed to carry passengers and cargo

to Chicago that originated in Sydney. In all probability the economics of operating such

a separate service to each city would be prohibitive. But even if Qantas decided to

operate such a service it would be forced to deny carriage to an American traveler

standing at its gate in New York wishing to purchase a ticket from it to fly from New

York to Chicago. Under cabotage laws, Qantas cannot make any exceptions, except

under emergency-type conditions. The prohibition is, for practical purposes, absolute.

The interpretation of Article 7 of the Chicago Convention (dealing with cabotage) can

be interpreted either restrictively (so as to only allow the granting of cabotage rights on

a non-exclusive basis i.e. that a nation which grants cabotage rights to one country

would be obliged to grant cabotage rights to other nations demanding similar rights) or

liberally, according to which Article 7 permits the exclusive grant of cabotage rights if

the grant does not specifically indicate that the cabotage rights are exclusive104.

104 Institut Du Transport Aerien, Cabotage in International Air Transport: Historical and

Present Day Aspects 9 (7-E/1969) at 9, noting that the liberal interpretation allows ”State A to grant cabotage privileges to State B provided it is not stipulated that they are


41

According to this view, two nations may agree to grant cabotage rights to each other

provided that the agreement allows for the possibility that other nations may receive

similar cabotage rights105. This interpretation however appears to fly in the face of the

sovereignty principle. In practice the restrictive interpretation is almost always used106.

Different governments may however grant exceptions to the cabotage rule for limited

periods of time during emergency situations. For example, when a U.S. carrier

suspended operations without warning, live camels en route to Los Angeles were

stranded in Honolulu. Qantas operated between Los Angeles and Honolulu with an

aircraft capable of transporting camels. In order to get the business, Qantas was required

to serve notice on all U.S. carriers that had an appropriate cargo configuration and

service to Hawaii from the U.S. mainland. After no U.S. carrier expressed interest in

providing an aircraft, DOT granted the exemption to Qantas because the situation

“clearly constituted an emergency created by unusual circumstances not arising in the

normal course of business” 107.

Similarly, when Ansett Airlines collapsed on 14 September 2001, the Australian

government allowed U.S. carrier United Airlines to carry domestic passengers between

some Australian cities for a limited period of time until Qantas and Virgin Blue could

increase their carrying capacity.

On the other hand, requests for cabotage exemptions are usually denied when

alternative transportation is an option108 and the U.S. DOT has even allowed passengers

to become stranded when American scheduled carriers needed a weekend to service a

passenger backlog caused by unscheduled maintenance problems109.

exclusive…without third States having the right to demand the same privileges”. See also Bin Cheng, supra note 51 (opining that granting and receiving cabotage rights on a nonexclusive basis is clearly permitted according to Article 7)

105 Douglas R. Lewis, Air Cabotage: Historical and Modern Day Perspectives, 45 J. Air L. & Com. 1059, 1063-65 (1980)

106 For example, see Federal Aviation Act of 1958, Section 1108(b). 107 Application of Qantas Airways Ltd for Emergency Exemption made pursuant to FAA

para 416(b)(7), DOT Order 91 –10-10 (Oct. 4, 1991) 108 For example, Application of Heavylift Cargo Airlines Ltd for Emergency Exemption,

denied. DOT Order 85-12-78 (Dec 27, 1985) 109 Application by Qantas Airways Ltd for Emergency Exemption made pursuant to FAA

parag 416(b)(7) denied. DOT Order 85-6-20. In denying a request to transport the


42

The example illustrates the extreme reluctance for governments of all persuasions to

grant cabotage rights to non-citizens.

Cabotage of course provides the “bread and butter” income of any national airline and

most nations protect their domestic cabotage rights the same as the U.S. The sheer size

of the U.S. domestic aviation market however makes it prima facie attractive to outside

carriers as a means of expanding their businesses, so U.S. carriers have been particularly

vigilant in advocating the continuing denial of cabotage rights to foreign carriers. They

have argued110 that granting cabotage rights may impair national security, cause U.S.

airlines to lose their competitive advantage in the U.S. market, cause bankruptcy and the

loss of American jobs to foreigners.

So far these arguments have found sympathetic support from the U.S. government.

It has been argued111 that there are no longer legitimate reasons for limiting cabotage

rights to U.S. carriers. They are not required, so it is said, for national security reasons,

and in any event such rights can be suspended in times of emergency or war.

Furthermore, the U.S. domestic air transport market is well established and highly

competitive as a result of deregulation (particularly the development of highly efficient

hub and spoke networks) and the grant of cabotage rights to foreign carriers would

therefore probably not cause significant economic injury to U.S. carriers112.

If grants of cabotage rights were reciprocal, as one would expect them to be, it is highly

conceivable that efficient U.S. airlines would gain more business from having access to

stranded passengers, DOT stated that there were sufficient non-certified air carriers (i.e. air taxis) which could provide extra flights.

110 Robert Kuttner, Flying in the Face of Reason: Why the Skies Need Re-regulating, Bus. Wk., May 3, 1993, at 18

111 Seth M. Warner, Liberalise Open Skies: Foreign Investment and Cabotage Restrictions Keep Non-citizens in Second Class, 43 Am. U.L. Rev. 277 at 317 (1993)

112 National Commission to Ensure a Strong Competitive Airline Industry (1993), 3, noting that U.S. airlines have lower costs and are more efficient than most foreign airlines.


43

overseas domestic markets, than it would lose from opening its own domestic market to

less efficient foreign carriers113.

In the light of the events of September 11 2001 in the U.S., it and many other nations

are however very likely to re-examine the security aspects of allowing foreign airlines

to overfly their skies at will, even “friendly” airlines.

1.8 CONCLUSION

Regulation’s longevity is a quintessentially political fact. Accordingly, it is through the

processes and institutions of international politics that deregulation of international

aviation must ultimately come about. As states have progressively shed their flag-

carrier’s associations of patriotism and prestige in favour of a better recognition of the

needs of consumers, so has come an increased willingness to explore the options for

deregulation.

For liberalisation to occur on a broad scale through the bilateral process, two factors

must be present114. Firstly, the bargaining states must have a similar philosophy towards

aviation, which in the case of bilaterals involving the U.S. means matching its free-

market philosophy. If one state persists in viewing its airline as an essential public

service deserving of Government protection, then broad scale liberalisation of

international air transport services with that state is essentially a non-starter. Secondly,

there needs to exist rough parity in bargaining strength between the two states both in

terms of what benefits they can offer when trade barriers are removed and in the

strength of their airlines.

Both these requirements are difficult to match, and as a result, many countries tend to

limit the relaxation of restrictions in their bilateral agreements with the U.S. The

113 In 1992, it cost Lufthansa 21.2 cents to carry a passenger one mile, and it costs British

Airways about 13.6 cents. For U.S. airlines, the figure was 9.3 cents. See Gibson and Goldstein, The Plane Truth, Washington Post, Oct 10, 1993 at C5. Although subsequent liberalisation in Europe may have reduced the costs of European carriers, it is likely that U.S. carriers still enjoy competitive cost advantages over their European counterparts.

114 Stockfish, supra note 28 at 635


44

majority, including Australia, are still not prepared to liberalise to the extent of an Open

Skies agreement although over 50 nations have done so.

It is however evident that a complex network of bilateral agreements and associated

implementation problems is simply too unwieldy to cater to the demands of the modern

aviation industry. Few argue that the bilateral system is the most efficient means to give

effect to the worldwide deregulation of air transport. With their emphasis on capacity

and fare structures between two nations and even two cities, bilateral agreements simply

do not allow a broad enough application of liberalisation principles on a multi-state or

preferably global basis. The lack of international success by the U.S. in its efforts to

deregulate through the bilateral process is evidence of this.

While bilaterally authorized operations continue to be routinely negotiated, they are

invariably subject to restrictions of cabotage and control and to a host of discriminatory

practices and charges by host governments. These restrictions persist today in varying

degrees and evidence a formidable conceptual barrier to the further liberalization of

international air transport.

Perhaps a more fruitful avenue towards international liberalisation lies in a combination

of bilateralism and multilateralism. Multilateralism in the sense of a universal regime

encompassing all nations of the world is probably no more achievable now than it was

at Chicago in 1944. Any form of global or even regional multilateralism under the

auspices of the Chicago Convention suffers the inherent limitation of being a “lowest-

common-denominator” approach, meaning that to achieve universality, it cannot go

beyond the level of liberalisation allowed by the most protectionist state within the

region. As such, and for so long as states continue to pursue their national interests

(which the sovereignty principle not only permits them to do but more or less requires

them to do so), multilateralism is unlikely to be a realistic avenue to further

liberalisation.

Multilateralism on a club basis however may well prove to be a much more realistic

goal to achieving liberalisation in the current world air transport environment. By

focussing on a small group of countries having relatively open, unregulated air transport

markets, the problems of bilateralism and regional multilateralism can be avoided or at


45

least substantially mitigated. If such clubs target their membership towards states having

similar intent, it could well provide the basis for the development of other “trading

blocks”

Although clubs are not a new idea115, their time may be nigh because there are a

number of such developments occurring in various parts of the world. The EC may be

the most prominent example because it conducts itself along club principles to a

considerable degree. New members for example are only admitted if they agree to the

EC’s goals. In the march toward a single market, considerable progress has been made

in the removal of intra-Community restrictions in respect of market entry, pricing, and

capacity116, and Member States have now achieved the establishment of a single EC

civil aviation regulatory authority according to harmonized civil aviation standards.

Other club-type regional developments have also been occurring. For example, the

Andean Pact countries and the Mercosur117 regional agreement (comprising Argentina,

Brazil, Paraguay, Uruguay, Chile and Bolivia), has now been concluded118. Closer to

home, Australia and New Zealand concluded their own regional agreement in 2000, and

the possibility of extending it to other countries of the South Pacific is still open119.

Furthermore, airlines from countries belonging to the Association of South East Asian

Nations (ASEAN) have for some years been exploring the prospects for a multilateral

regional air transport agreement for some years120. Although progress has been slow,

the recent creation of a co-operative framework for air transport services between the

East Asia Growth Area as a sub-regional economic zone has as one of its objectives a

common airline for the area.

115 This was the approach recommended by the Productivity Commission Report in 1998

on International Air Services See footnote 27 supra at p XXXIV 116 But see Carol A. Shifrin, Liberalised European Air Transport Market Will Not Yield

Benefits of U.S. Deregulation, Av. Wk. & Space Technology, Dec 24, 1990 at 63 (stating that the European single market is unlikely to produce the same benefits and opportunities for consumers and entrepreneurs that U.S. deregulation produced)

117 Meaning “Southern common market” 118 Robert C. Booth, Open Skies Over the Andes, Airline Bus. Sept. 1991 at 80 119 Peter Forsyth, The Regulation and Deregulation of Australia’s Domestic Airline

Industry, in Airline Deregulation: International Experiences, (Kenneth J. Button ed., 1991) at 73.

120 Asian Carriers Consider Forming Group to Protect Access to European Routes, Av. Wk. & Space Technology, Oct. 22, 1990, at 31


46

It is not inconceivable that, as these club "trading blocs" begin to grow and then link up,

a truly universal multilateral regime will emerge121, but such a development is

realistically still a long way off. Doubts surrounding for example the competence in

international law terms of a club or even a common market to negotiate effectively for

its members remain and are unlikely to instill confidence in third parties to negotiate

valuable air traffic rights. Multilateralism in international air transport probably remains

some years away.

Limitations such as airline ownership restrictions, cabotage restrictions, anti-

competitive practices such as slot control, airport leases and computer reservation

systems however remain, and it is likely to be many years before there is truly

competitive trade in air transport services.

121 But see Louis Uchitelle, Blocs Seen Imperilling Free Trade, N.Y. Times, Aug. 26, 1991

at D1

CHAPTER 2: THE ELEMENTS OF OPEN SKIES - FROM FINAL APPROACH

TO LANDING (1992 – 2003)

“Geography has already made a decision for us”

2.1 FORMULATION

The most recent attempt to deregulate international air transport, and the current policy

of the United States concerning international aviation, is to pursue an initiative known

as “Open Skies”1. This policy was first announced in March 19922. It represents a

further championing of the “five freedoms” concepts promoted by the U.S. at the

Chicago Convention some fifty years earlier, and is an attempt by the U.S. to restart the

process of deregulating international air transport, which by the mid 1980s was

generally recognized as having stalled3.

"Open Skies", in one sense, is little more than a special form of bilateral agreement

which the U.S. now officially uses in negotiating bilateral agreements with other

nations4. More particularly, an Open Skies agreement contains a set of provisions which

“at the minimum includes open entry on routes, unrestricted capacity and frequency on

routes, and unrestricted traffic rights”5.

1 The precise definition and origin of the phrase is unclear. In one sense it is an antonym

of the principle of a state’s national sovereignty. Whatever its precise definition, “Open Skies” has practically become a slogan for current U.S. aviation policy

2 By the then U.S. Secretary of Transportation, Andrew H. Card Jnr 3 Between 1978 and 1982, the U.S. successfully entered into no less than 23 liberal

bilateral air service agreements, mainly with smaller nations such as Singapore, Israel, Belgium and Thailand. These agreements were the forerunner to its formal Open Skies policy. None of the agreements granted cabotage rights or varied U.S. ownership requirements. The fact that no further such agreements were entered into after 1982 was said to be because there were no more ‘like-minded’ nations available or willing to enter into such liberal agreements with the U.S. See Thomas Grant, Foreign Takeovers of United States Airlines: Free Trade Process, Problems and Progress, (1994) 31 Harvard Journal of Legislation, 63 at 89,90.

4 Defining “Open Skies”, D.O.T. Order No. 92 – 8 – 13 at 1 (1992) 5 Daniel C Hedlund, Toward Open Skies: Liberalising trade in International Airline

Services, 3 Minn. J. Global Trade 259, 263 n.22 (1994)

Chapter 2: The Elements of Open Skies

48

In 1995, the U.S. Department of Transport (“DOT”) published a “Model Bilateral Air

Transport Agreement” to standardize Open Skies agreements6. The model agreement

incorporated eleven basic elements, which the DOT considered to comprise the essence

of Open Skies. They were:

(1) Open entry on all routes7;

(2) Unrestricted capacity and frequency on all routes;

(3) Unrestricted route and traffic rights, that is, the right to operate services between

any point in the United States and any point in the European country, including no

restrictions as to intermediate and beyond points, change of gauge, routing

flexibility, co-terminalisation, i.e. the right to carry fifth freedom traffic8;

(4) Double-disapproval pricing9 in Third and Fourth Freedom markets, and price

leadership in third country markets, but only to the extent that the Third and

Fourth Freedom carriers in those markets have such price leadership;

(5) Liberal charter arrangements (the least restrictive charter regulations of the two

governments would apply, regardless of the origin of the flight);

(6) Liberal cargo regime (criteria as comprehensive as those defined for the

combination carriers);

6 U.S. Department of Transportation: Model Bilateral Air Transport Agreement (1995),

reprinted in 35 International Legal Materials 1479 (1996). 7 In Open Skies agreements, route access is not restricted to a limited list of officially

designated carriers 8 Prior to Open Skies, bilateral aviation agreements typically disallowed service beyond

the signatories’ territories, except to destinations expressly designated in the agreement. Where such rights are granted they are termed “Fifth Freedom” rights, i.e. the “privilege to fly into the territory of the grantor state for the purpose of picking up, or putting down, traffic destined for, or coming from, third states” See Eugene Sochor, The Politics of International Aviation 221 (1991) at 265

9 “Double-disapproval” pricing means that in order for a fare to be struck down as anti-competitive, both signatories must reject it.


49

(7) Conversion and remittance arrangements (carriers would be able to convert

earnings and remit in hard currency promptly and without restriction);

(8) Open code-sharing opportunities10

(9) Self-handling provisions (right of a carrier to perform/control its airport functions

going to support its operations);

(10) Pro-competitive provisions on commercial opportunities, user charges, fair

competition and inter-modal rights; and

(11) Explicit commitment for non-discriminatory operation of and access to computer

reservation systems11.

These elements broadly encompass the rights covered by the first five of the eight

“freedoms of the air” referred to in Chapter 1 of this thesis12. It is for this reason that

any bilateral aviation agreement that includes these five rights is generally designated an

Open Skies agreement13.

Most of the above elements closely reflect the free trade and liberalism goals originally

set out in the Federal Aviation Act 1958, although provisions for liberalising both

airline ownership and control, and cabotage rights were conspicuously missing. Before

finalizing the form and content of the model Open Skies agreement, the DOT sought

and obtained wide industry and interest group input to the document14 following which

it issued its “Final Order Defining Open Skies”15. The final Open Skies formulation

was virtually identical to the original one, although the Final Order did, by way of

comment, specifically address some of the suggestions, which had been made by

respondent interest groups.

10 See Chapter 3.4.5 of this thesis. 11 Id 12 See Chapter 1, pages 14,15. 13 Rarely however do Open Skies agreements go beyond the fifth freedom rights. Indeed,

it is the fifth freedom right that typically is the deadlock issue in Open Skies negotiations.

14 Including the Airline Pilots Association International and foreign airlines.


50

A number of these suggestions argued for the inclusion of both ownership/control and

cabotage provisions in the final definition of Open Skies because they are key, if not

crucial, factors to true competition in the air. The DOT however claimed that it was

forced to exclude them because, according to it, to do so would require changes to the

Federal Aviation Act 1958, which were outside the realm of the Open Skies initiative16.

The DOT’s claim that changes to the ownership and cabotage laws would require

legislative amendment has been challenged17 on the basis that the Federal Aviation Act

appears, on one interpretation, to actually recommend them18 and the case law which

has developed in the U.S. on the subject of the DOT’s supervisory powers over foreign

ownership transactions in the U.S. aviation industry, demonstrates that the courts take a

rather less restrictive view of the DOT’s discretionary powers under the Act than does

the DOT itself19.

The exclusion of cabotage and ownership issues from the current formulation of Open

Skies identifies them as unresolved issues for the future deregulation of international

aviation. However, the open-ended nature of the current Open Skies formulation,

combined with the reasons the DOT gave in its Final Order for excluding ownership and

cabotage, left little doubt that it viewed itself as retaining substantial discretion over

those issues, particularly on the ownership issues, and that it reserved for the future, on

a case-by case basis, what it may or may not offer at the Open Skies negotiating table.

2.2 U.S. OPEN SKIES STRATEGY

The strategy adopted by the U.S. was to firstly negotiate Open Skies agreements with as

many European governments as possible, following which the strategy would be

15 “Open Skies”; Final Order, DOT Order 92 – 8 – 13, Docket No. 48,130, at 12 16 Id at 4 17 See Thomas D Grant, Foreign Takeovers of United States Airlines: Free Trade Process,

Problems and Progress, 31 Harvard Journal on Legislation, Winter 1994, 63 at 89, 90 18 Subparts (2) through (7) of section 1502(b) support the Act’s ten declared goals for

American international aviation policy, each of which reflect a strong theoretical commitment to free trade and economic liberalism.

19 U.S. courts have not yet considered the specific issue of the DOT’s powers over airline ownership and cabotage.


51

exported to other regions of the world which were willing to grant U.S. carriers

essentially free access to their markets20. In the first three years of its operation the U.S.

entered into Open Sky agreements with no less than eleven European nations21.

The strategy has been remarkably successful during its 10 or so years of operation. To

30 September 2003, sixty nations had entered into Open Sky agreements with the

U.S.22. It is likely that, on the trans-Atlantic route at least, a majority of Europe – U.S.

air traffic now flies under Open Skies agreements23.

Most such agreements involve the U.S. as one of the parties, but on occasion they are

entered into between two or more countries other than the U.S24. On yet other

occasions, more than two States have entered into multilateral Open Sky agreements,

again usually including the U.S., but not always25.

The success of the policy is partly because its implementation by the U.S. has been

carried out somewhat aggressively. The strategy has increasingly been to require that an

Open Skies agreement first be concluded before the U.S. will approve proposed mergers

or alliances between its carriers and those of another country26. Although officially, it

remains the long-standing position of the U.S. not to link ownership considerations with

the liberalising of its aviation treaties the practice is otherwise27. In fact the U.S.

actively discriminates against countries that refuse to enter into Open Skies agreements

20 See DOT, supra note 15 21 Austria, Belgium, Czech Republic, Denmark, Finland, Iceland, Luxembourg, the

Netherlands, Norway, Sweden and Switzerland. Of these, eight were also European Union (EU) Member States, these being Austria, Belgium, Denmark, Finland, Luxembourg, Sweden, the Netherlands and Switzerland.

22 See Chapter 1, fn 3 23 It was estimated that, by the end of 1998 (when only twenty seven nations had signed

Open Sky agreements), approximately 40% of Europe – US air traffic flew under Open Skies. See L. Hill, Bilateral Ballistics, Air Transport World, February 1997, 53-61. That figure would undoubtedly be much higher today and would be approaching 100% if the U.S. and the U.K. had been able to secure an Open Skies agreement.

24 For example, Australia and New Zealand signed an Open Skies bilateral agreement in November 2000

25 For example, in 2001, the U.S. together with New Zealand, Brunei, Chile, Malaysia, (four countries with which the U.S. already had entered into Open Skies agreements), went the next step and entered into a multilateral Open Skies agreement in which any of the five members have free access to the skies of all the other members.

26 M. Kayal, “European Airlines Flying in Open Skies”, Journal of Commerce, 31 March 1997, 1B


52

with it. Those countries risk a loss of air traffic because of the diversion of travellers to

routes that are more competitive, where frequencies are higher and where service is

better28. This incentive gives the Open Skies strategy the ‘teeth’ it needs for successful

implementation.

One of the earliest countries to recognise this was the Netherlands, with which the U.S.

signed its first ever Open Skies agreement in October 199229. It is no coincidence that

the Netherlands government had decided only months beforehand that its national

carrier “KLM” would no longer be subsidised by the government, so KLM was ‘on its

own’30. The resulting agreement gave U.S. and Dutch airlines open entry into each

other’s markets, unrestricted capacity and frequency on all routes and the greatest

possible freedom in setting fares. It was the first ever aviation agreement which allowed

each country’s airlines access to “a point or points” in the other country without

limitation31. This is similar in effect to granting (limited) cabotage rights to each other.

The Netherlands agreement was part and parcel of a package that included U.S.

approval for a strategic alliance between KLM and Northwest Airlines. Similarly in

1996, U.S. approval for a proposed alliance between Germany’s national carrier

Lufthansa and United Air Lines was made conditional on the conclusion of an Open

27 Grant, supra note 17 28 For example, the competitive position of Seoul as a regional hub was greatly

strengthened in 1998 when South Korea and the U.S. entered into an Open Sky agreement. This agreement was even more liberal than the new Japan – United States accord signed in April 1998, which although more liberal than the original U.S. – Japan bilateral agreement, stopped well short of being an Open Skies agreement. The Korean Open Skies agreement had the effect of diverting travellers from Japan to Korea, where service was better. It is an illustration of the way in which the conclusion of an Open Sky agreement between two nations brings pressure on those who have not already signed to join up. See generally Tae Hoon Oum, Overview of regulatory changes in international air transport and Asian strategies towards the US open skies initiatives, Journal of Air Transport Management 4, (1998), 127.

29 Agreement to Amend the Air Transport Agreement, Apr. 3, 1957, U.S. – Neth., 12 U.S.T. 837, as amended, and the Protocol Relating to the United States – Netherlands Air Transport Agreement of 1957, Mar. 31, 1978, 29 U.S.T. 3088, as amended, Oct. 14, 1992, U.S. – Netherlands., T.I.A.S. No 11976

30 Because the existing 1957 bilateral agreement between the U.S. and the Netherlands was itself very liberal, the parties simply amended that agreement to incorporate the special provisions of Open Skies agreements

31 Id, para. 12


53

Sky agreement between the U.S. and Germany32. Similarly, an Open Skies agreement

between the U.K. and the U.S. was made a prerequisite for U.S. approval of the

proposed British Airways / American Airlines alliance33.

The insistence of the U.S. to tie Open Sky agreements with other matters such as

ownership of its airlines, despite official denial34, is clearly a reason for the success of

the Open Skies policy. The airlines of many nations see an alliance with a major U.S.

carrier as essential if they are to grow. This means in turn, an Open Skies agreement

between the respective countries.

2.3 IMPEDIMENTS TO OPEN SKIES

For air transport to become truly global and for the skies to be cleared of market

impediments, restrictions such as refusing full cabotage rights, the expansion of foreign

ownership rights, and less restricted access to many airports still need to be addressed in

many countries35.

For this reason, simply negotiating more and more Open Sky agreements, although

desirable in itself, does not provide the full long term solution to freeing-up trade in air

services. This is because Open Sky agreements, while prima facie open and reciprocal,

are essentially ‘hub and spoke’- type agreements and as a result do not necessarily

achieve an adequate level of ‘openness’. For example they do not cover domestic

32 Id 33 Note that negotiations for this Open Skies agreement were terminated without

conclusion in September 2002, just prior to a decision of the EU Court in November 2002 which ceded power to the European Commission to negotiate Open Skies agreements with other countries on behalf of individual Member States. The decision also declared that any existing Open Skies agreements with the U.S. entered into by individual EU Member States were invalid.

34 Grant, supra note 17 35 For example, congestion at Tokyo’s Narita Airport (Japan’s main international airport)

prevents US carriers from taking advantage of their more favourable terms access to Japanese markets which they enjoy under the US / Japan bilateral agreement of 1952. To illustrate, in 1999 there were no slots at all available at Narita, and new entrants were forced to either fly to Osaka, or wait until 2001 when limited new capacity was expected to became available as a result of airport expansion. See A. Elek et al., Open Skies or Open Clubs? New Issues for Asia Pacific Economic Cooperation, Journal of Air Transport Management, 5 (1999) 143 - 151


54

operations, so U.S. carriers in particular have the advantage of being able to draw on

their extensive domestic networks in the United States to which foreign carriers would

not have direct access, even if their governments negotiate Open Skies agreement with

the U.S. For example, even if as a result of an Open Skies agreement, Australian

carriers were offered cabotage in the U.S., they would first need to build their own ‘hub

and spoke’ networks in that country before they could take advantage of this right

At the same time, a series of Open Sky agreements within a particular region would by

themselves give U.S. carriers much more liberal access to routes within that region. To

see why this is, suppose the US were to sign an Open Skies agreement with each of

Australia and Japan36. This would allow US carriers and those of both Japan and

Australia to have free access – in terms of capacity and also points served – on all routes

between the U.S. and both the other countries. Significantly, because each Open Skies

agreement would typically provide each party with automatic “beyond” rights, the US

airlines would have the right to pick up traffic in either Australia or Japan and carry

them to other destinations (subject of course to the (bilateral) agreement of the countries

of those destinations).

It is apparent that several Open Skies agreements involving the U.S. within a particular

region which for example included Australia and Japan, would give its airlines

unrestricted rights to operate anywhere within the region covered by those agreements

but they would not create regional open skies for either the Australian or Japanese

airlines, tending therefore to confer much greater benefits on the United States hub. In

other words, US carriers would have unrestricted access to all routes between Australia

and Japan, but the airlines of both Australia and Japan would only have free access on

their direct routes to the United States, and not necessarily between themselves.

36 Neither Australia nor Japan presently has an Open Skies agreement with the U.S.

Although the US and Japan signed a liberal agreement in April 1998 allowing inter alia two airlines from each country to fly from any city in their home country to any city in the other’s country and beyond without restriction on capacity, code sharing between airlines and multiple designation, the agreement did not encompass full fifth freedom rights, and therefore fell short of being an Open Skies agreement. The signing of an Open Skies agreement with Japan remains a key objective of U.S. aviation policy in Asia. See G Fisher, 1998 Amendment to the U.S.–Japan Civil Air Transport Agreement: The Battle May be Won, but the War for ‘Open Skies’ is Far From Over, 9 Minn. J. Global Trade 327, offering the opinion that ‘the (1998) agreement fails as a whole


55

Several other conditions would also need to be met for Australian and Japanese carriers

to gain the right to the same access as US carriers would have from these ‘hub-and-

spoke’ agreements. Firstly, they would need to sign an Open Skies agreement between

themselves. Secondly, they would need to ensure that their own agreements with the US

do not contain undue restrictions on their ability to exercise their beyond rights to carry

passengers or cargo to the United States37.

In fact some States have already begun to co-operate among themselves in similar terms

as with the U.S. ‘hub’ to ensure that these conditions are met, rather than allow

themselves to continue to be individually “picked off” by the U.S. For example, a

number of regional air transport agreements are either actually emerging or may

emerge, with the ICAO having identified no less than fifty different groupings of states

that are or which could become involved in the regulation of their region’s aviation38.

A proliferation of regional Open Skies agreements raises the question whether they will

lead to greater integration or to further fragmentation of the global air transport market.

While one possible outcome is that the formation of aviation ‘blocs’ could result in

greater competition within the blocs, it is also possible that barriers could rise for

airlines from outside the region. This latter outcome is much enhanced in the absence of

some overall limit on discrimination such as would be imposed, for example, if the

World Trade Organisation were to become involved in the regulation of the

international trade in aviation services39.

because it essentially gives Japan everything it could gain from an Open Skies agreement’, so there is no incentive on it to do so in the future.

37 Most bilateral aviation agreements place strict limits on the exercise of beyond rights, for example by insisting that a minimum share of passengers are from the point of origin, rather than from intermediate ports.

38 These include the European Union (370 million potential passengers), the Mercosur bloc in South America, BIMP-EAGA in SE Asia, (with a potential 250 million passengers), several blocs involving combinations of SE Asian States and China or parts of China, and the single aviation market between Australia and New Zealand. See Findlay et al., Asian Pacific Air Transport: Challenges and Policy Reforms, Institute of Southeast Asian Studies, Singapore, 1997


56

2.4 THE U.S. – CANADA EXPERIENCE

It is constructive to examine the United States – Canada Open Skies agreement because

of the potentially useful lessons for Australia which can be learned from Canada’s

attempt to create a ‘level playing field’ as part of its Open Skies agreement, when the

flag carriers of the two nations were not equally competitive. This situation might well

apply to Australia

Prior to 1995, the US and Canada had one of the most restrictive bilateral air services

agreements in the world, even though they shared the largest bilateral air services

market in the world. With Canadian carriers expected to be structurally disadvantaged

in an Open Skies agreement compared to the major US carriers, at issue in Open Skies

negotiations was how Canada’s fear of domination by U.S. carriers could be allayed.

This fear was based on the following three factors that both sides accepted40.

Firstly, US carriers had a well-developed continental services network supported by a

large population and strong defensible hubs. Secondly, because the majority of trans-

border travelers originate from or are destined to eight major cities in Canada, the US

carriers would be able to cost-effectively reach over 80% of the Canadian trans-border

market by extending their spokes to these Canadian cities from their US hubs. Thirdly,

Canadian carriers would not be able to access landing slots, gates and counters at some

congested US airports, so they may not be able to initiate new services or provide high

frequency services.

To balance the situation, it was agreed firstly that US carriers’ entry into major

Canadian markets (Toronto, Montreal and Vancouver) would be relaxed gradually over

a three year phase-in period while at the same time allowing Canadian carriers full

access to the US market from the outset without any limitation. Secondly, the US

guaranteed a certain number of slots at congested US airports such as Chicago and

LaGuardia Airports41.

39 T. Ballantyne, New Group on the Block, Airline Business 12 (9), 10, 1996 40 Oum, supra note 28 at p 130 41 Id


57

Several other factors also helped to bring about the conclusion of the Open Sky

agreement between the two countries42. Firstly, each of the two major Canadian carriers

(Air Canada and Canadian Airlines International) was in an alliance relationship with at

least one major U.S. carrier. Air Canada and United Airlines had an equity alliance,

while Canadian also had an equity alliance with American Airlines43. These alliance

relationships reduced some of the fear of domination of Canadian carriers.

Another factor was that the negotiations were conducted at a high level of political

involvement so that economic and political factors were taken into account in the

decision, as distinct from the decision being based on narrow, purely aviation-based

matters.

The U.S. - Canada agreement led to a significant increase in trans-border air traffic

between the two nations, which increased by 10% in the first year of its operation. Seat

capacity rise by 30%. Consumers benefited from the establishment of 102 new trans-

border routes that offered many cities their first non-stop trans-border services. The

agreement also enabled U.S. and Canadian airlines to develop integrated networks

across the border, such as those established by American Airlines and Canadian

International44.

The important lesson to be learnt from the US - Canadian Open Sky agreement, and one

that may well be relevant to Australia, is that it would appear to be possible to create by

negotiation a level playing field even if the flag carriers of the two countries are not

equal, competitively speaking. For example, if airlines in Australia feel insecure about

an Open Skies agreement with the U.S.45, it ought to be possible, based on the Canadian

42 Strictly speaking, the 1995 agreement between Canada and the US was not an Open

Skies agreement (although it is generally described as such) because it did not follow the standard format or contain the standard Open Sky clauses. It is more correctly described as a very liberal variation of the original (restrictive) bilateral agreement between the two countries, which in a staged manner opened up trade in air services between them. See K. Button and S. Taylor, International Air Transportation and Economic Development, Journal of Air Transport Management, 6, (2000), 209 at 211

43 Air Canada also had an alliance relationship with Continental Airlines in which it held a 28.5% shareholding, and American Airlines owned 33.35% of the equity shares in Canadian Airlines. See Oum, supra note 28 at footnote11

44 Button and Taylor, supra note 42 at 211 45 Virgin Atlantic, the owner of Virgin Blue in Australia, is strongly supportive of Open

Skies agreements. See Swinnen, infra note 52 at 266.


58

experience, to negotiate significant concessions from the U.S. in terms of (say) staged

access and such other factors as code-sharing with American flag carriers, via which

they can pool traffic and revenue46. The anti-competitive effects of such measures

would need to be balanced against the increased competition that an Open Skies

agreement would bring to the Australian aviation market.

2.5 OPEN SKIES AND THE EUROPEAN UNION

European Union Member States have, independently of the U.S., moved substantially

towards creating and achieving their own multilateral open skies agreement amongst

themselves via the three stages of “Liberalisations” referred to earlier47. These

liberalisations covered most of the elements of the U.S. Open Skies definition, and in

several important respects, such as ownership, control and cabotage48, went

substantially further than the United States Open Skies framework49.

The conclusion of the Third Liberalisation Package in April 1997 created a single

aviation market for Member States of the EU, with more than 370 million potential

passengers. Within this market, Member State carriers enjoy more of the aviation

46 In fact, the U.S. has made Open Skies a condition for approving even code-share

alliances. See Oum, supra note 28 at footnote 8 47 See Chapter 1, page 24, and see Marin, P.L., Competition in European Aviation:

Pricing Policy and Market Structure, The Journal of Industrial Economics XLIII (2), June 1995, 141 – 159; and see Trethaway, M.W., European Air Transport in the 1990s: Deregulating the Internal Market and Changing Relationships with the Rest of the World, Working Paper # 91-TRA-003, Faculty of Commerce and Business Administration, The University of British Columbia, Vancouver, Canada.

48 The EC implemented full cabotage amongst its members in phases which began on 1 Jan, 1993 and which were completed in April 1997. A four-year transition period was then begun to soften the impact of cabotage on less competitive European carriers. See Grant, supra note 17 at 84

49 The arguments for removing cabotage and ownership controls extend beyond those of stimulating local economic development through greater freedom of international air transportation markets. See K.J. Button, Infrastructure investment, endogenous growth and economic convergence, Annals of Regional Science 32, 145 – 163. However, the ability of non-Member State airlines to operate in member States is still severely constrained. The same holds true for owning foreign airlines and also on the degree of control that foreign investors can exercise over an airline. Australia for example currently restricts aggregate foreign ownership of an Australian airline to 49%, a figure which Qantas has recently argued (unsuccessfully) should be increased, on the basis that it would help to reduce its cost of capital. See Australian Financial Review, 10 August 2002, page 47.


59

freedoms than any US carrier enjoys as a result of the individual Open Skies agreements

that the US currently has with eight of the Member States50.

Despite undoubted progress, the European deregulation process has not yet produced

the far-reaching effects that the deregulation of the U.S. domestic aviation industry

achieved, even though that was its stated goal51. As a result, the structure of the US and

European aviation markets is still notably different, partly because of the EU’s different

commitment to the application of the EU competition rules52

The Open Skies agreement between the U.S. and the Netherlands, referred to earlier,

and the one with Sweden, each grants cabotage to U.S. carriers. The U.S. however does

not reciprocate. As already stated, that is the most prized and jealously guarded

privilege in aviation. Because of the reciprocal nature of Open skies agreements, the

question must be asked: What has the U.S. given to Sweden and the Netherlands in

exchange for being granted cabotage rights to those countries?

Before answering that question, a closer examination of the two agreements shows that

cabotage does not in fact amount to much of a prize inside the Netherlands – a country

50 For example, every EU-registered carrier has the right to run domestic services within

any of the EU’s fifteen member countries, as well as in Norway and Iceland. This means that EU carriers have full third, fourth, fifth, sixth, seventh and eighth freedom air rights on all intra-Community routes. National ownership rules have been replaced with EU ownership criteria, and airlines have been given freedom to set fares, with safeguards against predatory pricing through competition rules. See Oum, supra note 28 at129.

51 J. Basedow, Airline Deregulation in the European Community – Its Background, Its Flaws, Its Consequences for E.C. – U.S. Relations, 13 J. L. & Com., 247, 248-50 (1994)

52 Set out in Articles 85 through 94 of the EC Treaty. Although these competition rules are fundamental and complement the overriding principle of undistorted competition within the EU, the Commission nevertheless has extensive powers of exemption that it has frequently been forced to exercise in the interests of political compromise. These exemptions have been both agreement-specific (See Benoit Swinnen, An Opportunity for Trans-Atlantic Civil Aviation: From Open Skies to Open Markets?, Journal of Air Law and Commerce, 63 (1997) 251 at 265) and in the form of industry-wide block exemptions (Swinnen, id at 260). Block exemptions have for example included computer reservation systems, and airline co-operation agreements. See Raffaele Cavani, Computer Reservation Systems for Air Transport: Remarks on the EC Legislation, 17 Fordham Int’l L.J. 441, 454-56 (1994). As a result of the granting of block exemptions, the EU Commission itself has effectively become involved in anti-competitive practices. The resulting conflict of interest has resulted in the Commission being described as having “changed from the watchdog of competition to the shepherd of anti-competitive market participants” (Swinnen, id at 265).


60

barely one-third of the size of the U.S. state of Ohio. Similarly, while cabotage within

Sweden – a state with a population of approximately nine million people and roughly

the geographic size of California - may be more appreciable, it is also seen to be not

much of a prize when Swedish aviation is compared with that of California, let alone the

whole of the United States53

On the other hand, access by U.S. carriers to flight routes, landing slots, code-sharing

and airport resources in each of those countries constitute a particularly valuable asset to

these carriers, especially if the bulk of the aviation services of both Sweden and the

Netherlands consist of terminating or departing international flights. Slots for example

have long been the traditional bottleneck of civil aviation at most European airports.

Crowded European conditions therefore provide a bonus to this asset of access54. Thus

although cabotage rights may be the biggest prize of all within the U.S., that does not

necessarily apply to other countries such as the Netherlands and Sweden, whose

primary reciprocal rewards to the U.S. are liberal access rights for international flights.

Similar considerations would apply to an Asian country such as Singapore where

cabotage privileges to U.S. carriers would also be largely symbolic55, but where other

rewards such as sweeping access to landing slots and routing would also be very

valuable for the U.S. in the Asian market56.

So despite the principle of reciprocity, the American reward to Sweden and The

Netherlands emphatically does not extend to an offer of cabotage within the U.S.57 but

53 For example, in 1991 available seat kilometres in Sweden (including domestic legs of

international flights) amounted to 4,861,907, while the figure for the U.S. (excluding domestic legs of international flights) was 36,162,840 (all figures in thousands). Source: ICAO, Digest of Statistics No 358 (1991)

54 Airports are even more crowded in Europe than the U.S. and the cost of expansion is generally higher in Europe. With the supply of landing slots more or less inelastic, winning access to them carries great rewards. See Grant, supra note 17 at note 71 therein.

55 Singapore was the first Asian country to sign an Open Skies agreement with the U.S. in January 1997.

56 Note however that slots are less of a problem at Changi Airport than at most other major airports because the Singapore government constructs airport extensions ahead of demand. See Li, Air Transport in ASEAN: Recent developments and implications J. of Air Transp. Mgt., 4, (1998) 135 at 142.

57 The U.S. has never put cabotage on the bargaining table in any of its bilateral negotiations and the picture is unlikely to change in the near future. Such diverse groups


61

it arises less directly, in the form of liberal interpretations by the DOT of matters to do

with the foreign ownership of U.S. carriers. For example, contemporaneously with the

conclusion of the Open Skies agreement with Sweden, the U.S. allowed SAS, the

Swedish flag carrier, to become the first major European airline to purchase a large

stake in a U.S. carrier when it bought 16.8% of the non-voting shares of Continental

Airlines in 1990. Similarly, the Dutch carrier KLM was granted permission to purchase

a sizeable 25% stake in Northwest Airlines in June 1993 following the conclusion of the

Netherlands – U.S. Open Skies agreement58.

Many EU Member States have been pursuing Open Skies agreements with the non-EU

states, particularly the U.S.59. The EC’s view is that the cumulative effect of these

individual Open Skies agreements “endangers the whole process of deregulation of

Europe’s civil aviation market.”60. The U.S. on the other hand, being a single large

market does not offer European carriers any opportunity to build corresponding hub and

spoke operations in the U.S. from their fifth freedom rights61.

There are other differences between Europe and the U.S. which give rise to further

inequality in the effects of Open Skies agreements. Antitrust policy in Europe goes well

beyond the “rule of reason” approach of U.S. antitrust enforcement to include attempts

as the carriers themselves and trade unions have always strongly opposed granting cabotage right to foreign airlines. There is little chance of this changing in the future.

58 See Grant, supra note 17 at pages 96, 97. 59 Button K., The Effects of Open Skies in the European Union. A paper presented at the

First Asia Pacific Transport Conference: International Transport Liberalisation, 5-6 December 1997, Seoul, Korea

60 Neil Kinnock, Speech to the Association of European Airlines, Luxembourg (April 28, 1995) Lexis, Europe Library, Alleur File. This is because, as it now stands, although a carrier of an Open Skies signatory state can nominate any international airport in the U.S. as its port of entry, under Para 1508(b) of the U.S. Civil Aviation Act of 1992 it does not have access to cabotage within the U.S. Therefore, even though the U.S. may appear to be generous in granting foreign carriers a wide choice of landing rights, in exchange for what may appear to be a geographically unequal choice of landing in a (small) European country, the scale tips in favour of American carriers if fifth freedom rights allow those carriers to build and control a network of routes based on hub and spoke operations in the E.U. For example, Frankfurt became a major hub for U.S. traffic to the Eastern European bloc in 1996/1997 simply as a result of the Open Skies agreement negotiated between it and Germany in 1996.

61 Because ownership of U.S. domestic carriers is also restricted by U.S. law, in an effort to simulate hub and spoke systems, European (and other) carriers have been forced to resort to the development of code-sharing arrangements and other cooperation


62

at “social engineering”, as part of the European integration process62. This puts

European airlines at a substantial disadvantage in the U.S. market because many of

these exemptions are essentially anti-competitive in their nature and would therefore be

reviewable under U.S. antitrust standards63 if the European airlines were to operate

there. Because the E.C. Commission itself is sometimes a party to cartel-like activity by

European carriers through its exemption policy, it is conceivable that it might have to

seek U.S. immunity for itself before European carriers could enter the U.S. market.

It is evident that from a structural, economic or legal point of view, it is easier for

American carriers to penetrate the European market than for European carriers to gain a

foothold in the U.S. market.

In order to balance the bargaining powers of the two parties in Open Skies negotiations,

and to prevent the U.S. from “picking off” individual EU Member States one-by-one by

means of a policy of “conquer and divide”64 through Open Skies agreements, the

European Commission initiated court action to oppose the independent negotiation of

such agreements by individual Member States seeking the right to negotiate all such

treaties involving them, on their behalf65. The essence of the Commission argument was

that the separate Open Skies agreements with non-member countries such as the U.S.

agreements and alliances. See J. Morroco and C. Shifrin, Airlines Duel as Talks Resume, Aviation Wk. & Space Tech., 9 Dec, 1996 at 38.

62 Basedow, supra note 51 at 249-51 63 Swinnen, supra note 52 at 273 64 See Kinnock supra note 61, referring to a statement made by US Secretary of

Transportation Pena in 1994 in response to the EU’s inability or unwillingness to pursue negotiations with the US toward a multilateral Open Skies agreement.

65 Although the EU created a deregulated single aviation market in 1992, the effect of the individual open skies agreements was, according to EC chief spokesman Jonathon Faull, to “treat the individual territories of our member states as separate markets”. The final implementation of free cabotage amongst the EU Member States in 1997, and the consequential inability of Member States’ to continue to legally subsidise their national carriers as a result of EU deregulation laws, had the unintended effect of actually encouraging the smaller Member States to enter into their own Open Skies agreement with the U.S. The separate Open Skies agreements between the U.S. on the one hand and Belgium, Luxembourg, Sweden, Finland, Denmark and Austria on the other, all of which were concluded in 1995, illustrate this motivation brought about unintentionally by EC policy. See Andras Vamos-Goldman, The Stagnation of Economic Regulation Under Public International Law: Examining Its Contribution to the Woeful State of the Airline Industry, 23 Transp. L. J. (1996) 425 at 443-46. The alternative was to see their national carriers simply unable to compete in the newly competitive intra-European


63

were trade agreements and as such were properly within its jurisdiction66. It regarded

those agreements as anti-competitive because they benefited home-country carriers at

the expense of the carriers of other Member States.

What was at stake was the very nature of the Open Skies agreements which had been

struck with the U.S.67 because entering into an Open Skies agreement with the U.S. had

increasingly been seen as a “quid pro quo” for the grant of immunity against the

operation of U.S. anti-trust laws to any alliance which the foreign government’s air

carriers may wish to enter into with a U.S. carrier. In other words, the Open Skies treaty

“disciplines” the proposed alliance, which can only be fully achieved with anti-trust

immunity68. This has had the effect of granting those national flag carriers which have

entered into alliances with U.S. carriers, unfair competitive advantages over other

carriers operating on the nominated Open Skies routes69. Especially on the trans-

Atlantic routes, this has had a considerable adverse impact on competition, resulting in

prices which, for business travellers at least, are said to be “notoriously high”70.

aviation environment and to quietly disappear, as in fact happened to Belgium’s Sabena Airlines in November 2001.

66 ‘Leaders: Unfinished Business’, The Economist, May 26, 2001 67 Increasingly, they were being seen not only as unduly favouring American airlines by

allowing them access to all of the internal European market - while not allowing European carriers to do the same in America - but also, and perhaps more importantly, as acting as a brake on further competition in aviation between Europe and the U.S., rather than stimulating that competition as Open Skies agreements are theoretically supposed to do (See The Economist, supra note 66). It is claimed for example that Open Skies have delivered a “false” liberalisation that actually raises rather than lowers barriers to entry (id). This is because in theory, Open Skies agreements are competitive in their nature because they lift all controls over who flies where, when and at what prices between any destinations at either end of the nominated routes. In this way, Open Skies are said to be a check on potential abuse of market power by dominant carriers, by expediting the ability and right of other carriers to enter the “dominated” market and inject competition.

68 The U.S. emphatically denies that anti-trust immunity for a proposed alliance is used as a “carrot” in Open Skies bargaining (See The Economist, supra note 66), insisting that foreign government pressure for it to “guarantee” immunity in return for an Open Skies agreement has consistently been refused in favour of a case-by-case evaluation by DOT based on statutory criteria and the effect of such immunity on “the public interest” (supra note 66).

69 The Economist, supra note 66. 70 The Economist, supra note 66. For example, the German - U.S. Open Skies agreement

of 1996 accompanied an alliance between United Airlines and Lufthansa, allowing those two airlines to pool many of their services across the Atlantic. The same applies to both the Franco-American Open Skies agreement of October 2001 and the Air France / Delta Airlines alliance which resulted from it (giving Air France the right to sell tickets


64

To preserve the key role which it had planned for BA to reverse this adverse impact71,

the EC initiated legal action against Austria, Belgium, Denmark, Finland, Germany,

Luxembourg and Sweden in the European Court of Justice in 1998 alleging that the

nationality provisions of Open Skies agreements, to the extent that they exclude

nationals of other Member States violated Article 6 of the EC Treaty which prohibits

“within the scope of the application of this Treaty, and without prejudice to any special

provisions contained herein, any discrimination based on grounds of nationality72.

Although the U.K. did not have an Open Skies agreement with the U.S., it was also

joined in the same action on the grounds that its Bermuda II agreement of 1977 also

breached EU competition rules. The Netherlands voluntarily joined the action in 1999.

The European Court of Justice decided in November 2002 to adopt the EC position and

to treat Europe as a single aviation market. The decision has been described as an

‘astonishing’ step ‘with far-reaching consequences’ for Asia-Pacific aviation73. The

decision means that any European airline could fly on bilaterally agreed routes, and that

any EU country that granted rights to a non-EU state must allow any other EU airline

access to the same rights. It also means that for EU airlines, ownership and control

provisions in bilaterals no longer mean national ownership, but ownership in any

country or countries of the EU74.

It also means, for example that ‘lucrative transatlantic slots at Heathrow (can) no longer

be reserved solely for British carriers’75 because the Bermuda II agreement under which

only four airlines (BA, Virgin, American and United) were allowed to fly between

Heathrow and the U.S. was “a case of discrimination, excluding air carriers of other

member states from the benefit of national treatment in the host member state which is

to more than 100 U.S. cities, compared to the seven cities prior to the alliance); and to the Netherlands agreement of 1992 and the KLM / Northwest alliance.

71 The Economist, supra note 66. 72 EC Treaty, Article 6. 73 See ‘Europe decision blow to Pacific’, ‘The Australian’, quoting Peter Harbison of the

Centre for Asia-Pacific Aviation, 8 November 2002, page 25 74 Id 75 ‘Open skies deals shot down’, Guardian Unlimited, 8 February 2003.


65

forbidden by the community rules on the right of establishment”76. An EC spokesman

has said that EU carriers seeking to run transatlantic flights from Heathrow would be

able to sue the U.K. government for the right to do so77

Initial indications are that some Member States at least are not going to acquiesce to this

transfer of power to the EC without resistance. The U.K. for example has already

insisted that it will continue to go it alone on the issue of negotiating future treaties,

claiming that it can continue to insist on airlines being “established’ in Britain, even if it

could not continue to demand British ownership78

In response, the U.S. has written to each of the eleven countries with which it has

bilateral agreements, offering to renegotiate them by ‘wiping out’ the provisions which

the Court found objectionable, including current restrictions on ownership79. Describing

this step as “a major move by us”, the U.S. spokesman said that it would for example

enable Air France to buy KLM or Alitalia and operate under the Dutch or Italian open

skies agreement, thereby ‘removing a cited impediment to European consolidation of

airlines – if that is what they want to do’80. In fact, that is exactly what they want to do,

and talks have recently been initiated between Air France and KLM to that end81. Their

success depends on the successful conclusion of an E.U. – U.S. Open skies agreement.

It is submitted that before any such negotiations could be fruitful, both sides would need

to review their positions regarding the application of their competition rules to alliances

between American and European carriers. For the EU such a policy would amongst

other things need to be non-discriminatory while for the Americans there needs to be

more transparency between the grant of anti-trust immunity and its relationship (if any)

to Open Skies. U.S. policy favours the development of international aviation alliances82

because they foster competition. But for those alliances that do not involve a dominant

76 Id. 77 Supra note 75. 78 Id 79 John Byerly, Deputy Assistant Secretary for transportation Affairs, quoted in ‘EU

threatens action over “open skies” deal’, Herald Tribune, 30 January 2003 80 Id 81 See The Economist, Open skies and flights of fancy, 4 October 2003. 82 ‘Antitrust Immunity, Open Skies and First Principles’, Washington, Aviation Daily, 20

March 2002 at 7


66

foreign carrier, it is contrary to this policy for the U.S. to demand an Open Skies

agreement as a condition of alliance immunity. At present there is a widespread view

that open markets are merely the U.S. “price” of antitrust immunity.

The matter is relevant to Australia’s approach to Open Skies because the U.S. Open

Skies strategy in Asia parallels that in Europe (see 2.7 below, pages 70 on)

The EU’s response to the U.S. attempt to renegotiate individual Open Skies agreements

has been to threaten to take Member State governments to court yet again if they do

so83.

The latest development is that the U.S. and the E.C. met on 2 October 2003 to discuss

an EC-U.S. Open Skies agreement. No doubt due partly at least to the current poor

shape of U.S. carriers in particular, U.S. officials were said to be in no rush, saying that

an agreement “could take years to achieve”84.

2.6 THE U.K. – U.S. OPEN SKIES NEGOTIATIONS

The reason why the United States’ insisted on the successful conclusion of an Open

Skies agreement between it and the U.K. as a condition for the grant of antitrust

immunity, was that the proposed alliance between AA and BA would control

approximately sixty percent of UK-US air traffic85. For this reason the US believed that

the proposed alliance raised major competition issues for trans-Atlantic aviation and

needed to be carefully regulated. The EC also agreed with this view86. Furthermore,

because of the sheer size of the proposed alliance, the United States saw fit to impose

further conditions on the grant of anti-trust immunity. In particular it required the

83 John Byerly, supra note 79 84 ‘Open skies long way off’, The Australian, 3 October 2003. 85 Aviation Week & Space Tech, U.S. – U.K. Open Skies Stymied as AA, BA Balk, Feb 4,

2002. Rival airlines that oppose the alliance say that AA and BA have market shares exceeding 50 percent on seven U.S. – Heathrow routes that account for two-thirds of all U.S. – Heathrow traffic.

86 Swinnen, supra note 52 at 279.


67

alliance to divest itself of nine slots at Heathrow Airport87. The two carriers however

rejected this condition88.

In theory, an Open Skies agreement between the Britain and the U.S. would open the

transatlantic routes to any airline which wished to compete on those routes89 Prima

facie, it would therefore seem to be a strategically backward step for BA and AA to

voluntarily surrender their dominance at Heathrow Airport by supporting an Open Skies

agreement between the U.S. and the U.K. in exchange for alliance immunity. Similarly,

if Australia were to negotiate an Open Skies agreement with the U.S. perhaps as part of

a merger between Qantas and American Airlines (AA) - the two are already leading

members of the ‘Oneworld’ alliance - it would open the trans-Pacific routes, on which

Qantas currently enjoys a monopoly, to any U.S airline which wished to fly the route.

87 To make up for the loss of existing competition between AA and BA in those markets,

the US Justice Department recommended that AA and BA each be required to divest themselves of slots for nine daily round trips, seven from New York and two from Boston, plus an unspecified number of additional slots so that new U.S. entrants could serve Heathrow from their own hubs. See Aviation Week and Space Technology, Dec 24, 2001 at 47. Opponents of the AA – BA alliance had demanded much more than this. Northwest Airlines for example called for 32 daily round trips for competitors, while Delta Airlines called for 36. The U.K. Merger Commission raised this figure to 168, but the EC described even this number as “completely inadequate”. See S Murray, Turbulence hits BA-AA alliance, Wall St. J., Eur., Jan 14, 1997 at 6. In 1998, in an earlier AA – BA immunity bid, the U.S. Justice Dept had recommended the divestiture of 24 slots. A related issue was whether the proposed alliance could sell these slots or whether it would be required to surrender them without compensation. The issue was never resolved. EU Regulations on slot allocation are unclear. The 168 slots were “valued” at US $180 million in 1997 (although there is no official slot market against which this value can be tested). See Murray, id.

88 See Aviation Week & Space Technology, supra note 85. The reason why this condition was imposed is that BA and AA were two of only four airlines - the so-called “club of four” which also includes Virgin Atlantic and United Airlines - which are permitted under the Bermuda II agreement to use Heathrow Airport for transatlantic routes, described as “the most lucrative airline market in the world”(See ‘Can ‘Open Skies’ really take off’, www.cnn.com/2001/World, 23 October 2001 (“CNN”)). While several other airlines such as British Midland Airways (“BMI”) also own slots at Heathrow, they are not permitted to use them for transatlantic routes. As might be expected, BMI and the other airlines strongly object to this, claiming (with apparent justification) that it is discriminatory and therefore contrary to EU competition rules. BMI has threatened to sue the British government for damages caused by the government’s “continued support for anti-consumer regulation” on flights between London’s Heathrow Airport and US cities. See “Open up US air routes – or we’ll sue”, The Australian, February 1, 2002 p 67.

89 As Joanna Walters puts it: Open Skies “will bring a herd of buffalo-sized U.S. airlines stampeding into BA’s heavily protected back yard”, The Observer, 25 August 2001


68

As with BA, the attraction to Qantas would be its right to operate its AA merger in the

U.S. with anti-trust immunity, giving it access to that country’s aviation market.

But for other airlines to compete in fact as well as in theory, they would need access to

Heathrow slots and facilities (and at Sydney Airport if a U.S. – Australia Open Skies

deal was done). At Heathrow, these are simply not available, particularly slots most

suited to trans-Atlantic operations - i.e. early morning arrivals, and late-morning or

early afternoon departures - and are unlikely to become available at any time in the

future. New entrants would therefore not be able to mount major challenges90. As

Swinnen puts it: “…without slots, there can be no meaningful access to air rights”91

On the other hand, the much-coveted prize for BA, for which it was more than prepared

to pay the price of increased competition via an Open Skies agreement92 was antitrust

immunity in the U.S. market. That would have permitted AA and BA to act like a single

merged airline, setting fares and schedules jointly, and code sharing, as well as sharing

revenues, costs and profits.

In rejecting the DOT’s conditions for immunity93, AA and BA closed what they had

earlier described as a diminishing “window of opportunity” for the U.S. and the U.K. to

negotiate an Open Skies agreement. This was because the EC’s legal bid to take over

negotiations for all Open Skies agreements involving its Member States, including the

90 Joanna Walters: “Fortunately for BA there will not be enough spare capacity at one of

the world’s most crowded airports for all the buffaloes to get to the trough at once”. Id 91 Swinnen, supra note 52 at 285. Delta Airlines, Continental Airlines and Northwest

Airlines, three possible new entrants on transatlantic routes from the U.S., appear to accept that they would not be able to compete effectively on these routes due to the unavailability of slots because in June 2001, they warned the U.S. Transportation Secretary of a collapse of transatlantic competition if the BA – AA alliance went ahead, describing it as “the most powerful and anti-competitive alliance in aviation history”(CNN, supra note 88). (Author’s note: It is possible that even the very appearance at Heathrow of major U.S. carriers like Continental, Delta and Northwest, would constitute a major change to the existing competition picture at the airport. Once they have their ‘foot in the door’, those airlines will ‘beg, bargain and borrow’ slots and facilities year by year until they have grown into a formidable competitive force, much the same as Virgin Atlantic did after it was first allowed a toehold at Heathrow in 1991, despite draconian restrictions on its ability to grow).

92 It was not however prepared to pay the price of losing its Heathrow slots, as already seen.


69

one between the U.K. and the U.S., was by then expected to be approved by the

European Court of Justice later in the year, leaving insufficient time for the U.S. and the

U.K. to conclude their own agreement in view of the many still outstanding issues

between them94.

By mid 2002 there already were signs that BA had reached the conclusion that the

alliance with AA would never be approved. It was said to be “moving on”, having

apparently decided that closer links with American Airlines were “not as strategically

valuable as retaining its slots on transatlantic routes”95.

The problem for BA, and indeed for all European carriers, is that EC plans for the

further deregulation of European aviation may well include a determined attack on the

problem of slot allocation. Only the EC can legislate to create an official market for

slots at EU Member State airports. So far, for political reasons, it has chosen not to do

this, but the attitude of Member States towards deregulation is changing. If the EC

perceives that the climate is suitable for it to legislate for slot control, BA and all other

slot holders at Heathrow and elsewhere, may find that “their” slots, if they retain them

at all, no longer give them the strategic advantages that they currently do.

93 Industry observers claimed that AA and BA were surprised by the conditions, and that

the DOT was equally surprised by their rejection, claiming that the conditions were fair. See Aviation Week, supra note 85 at 43

94 Apart from the “alliance plus Open Skies” standoff, there were also fundamental differences between the U.K. and the U.S. as to what actually constitutes “Open Skies”. America’s definition of Open Skies, according to one commentator (Rod Learmount, Operations Editor of Britain’s (‘Flight International’), effectively amounts to “…. we can come in and do what we like, we want access via Britain to the rest of the EU – you can’t have access to the U.S. internal market”. Or as John Prescott, Britain’s then Deputy Prime Minister puts it: “The Americans are very happy to see open skies over here (in Britain). They are less keen to see them over their own country” See Birmingham Post, 8 March 2000. Britain’s definition of Open Skies on the other hand is rather wider. For the British Government, it means opening up airports and slots with no restrictions on access or airline ownership. Id. The U.S. does not accept this and there is little prospect of it happening. On ownership and cabotage matters, as has already been stated, the U.S. government consistently refuses to budge, saying that domestic legislation would be required, and Congress would be unwilling to surrender American commercial advantage.

95 Aviation Week, supra note 85 at 44


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2.7 OPEN SKIES AND THE ASIA PACIFIC REGION

The United States began the Asia Pacific96 phase of its Open Skies initiative in mid

1996. The region is of particular interest to the U.S. and its carriers because of the

anticipated high growth rates for aviation services in the region97.

Up to 1996, U.S. carriers operated in Asia under numerous bilateral agreements with

Asian nations most of which were negotiated shortly after World War II when those

nations had very little aviation bargaining power. As a result, the agreements are all

very one sided, in favour of the U.S.98. This has resulted in its carriers traditionally

enjoying healthy shares of the Asia Pacific aviation market. Apart from this imbalance

stultifying the development of Asian aviation, such development of the industry as there

has been has resulted in a very fragmented and inefficient industry when compared to

either the North America or European aviation markets. A major reason for this, quite

apart from the dominating role of the U.S. in the region, is that most Asian countries

generally have highly restrictive bilateral agreements between themselves, which have

prevented the development of rational integrated intra-Asian networks99. As a result,

each Asian airline has an extensive network to and from its own capital city but few

have developed hubs in other parts of Asia.

Despite these differences with the European market, the U.S. strategic approach to

Asian open skies closely paralleled the way it dealt with Europe in the early 1990s. In

Europe, the strategy of the U.S., as we have already seen, was to negotiate a series of

open skies treaties with “soft targets” such as The Netherlands and Sweden which

96 The term “Asia Pacific” is hard to define but for the purposes of this thesis means the

Asian Pacific coast countries and their neighbours, including Australia and New Zealand.

97 IATA forecast an average growth rate of 7.4% per annum for the Asia Pacific region between 1995 and 2010. Source: IATA Asia Pacific Air Transport Forecast 1980-2010, January 1997.

98 This applied especially to the U.S.-Japanese Civil Air Transport Agreement of 1952, which it was forced to negotiate as a defeated country following World War II. Japan has consistently threatened to repeal it because of its “unbalance”. See Oum, supra note 28 at 132

99 T.H. Oum and Y.K.Lee, The northeast Asian air transport network: is there a possibility of creating Open Skies in the region? Journal of Air Transport Management, 2020, 279 at 281


71

eventually lead other “hard targets” like Germany and France into signing their own

Open Skies agreements.

Similarly, this strategy towards Asia has seen the U.S. shift its initial focus from Japan

to other Asian countries, on the basis that successes with these other countries,

particularly Korea, would pressure Japan into signing its own Open Skies bilateral100.

Just as experience in Europe proved to be the case, such a “divide and conquer” strategy

was considered to be effective in theory because countries like Japan which refused to

enter into such agreements with the U.S., risked losing aviation trade because of the

diversion of travellers and cargo to routes which were more competitive and where

service was better because of the Open Skies conditions101.

Nevertheless, the policy has not been very successful in Asia. The reason for the

hesitation of Asian nations to embrace Open Skies, despite many years of insistence by

Asian nations that air traffic rights between them and the U.S. be more balanced, is that

they fear domination of their flag carriers by large and aggressive U.S. (and European

carriers to a lesser extent), resulting in the loss of the lucrative Pacific Rim air transport

market to those carriers102. Few Asian carriers are considered to be up to the task of

competing with U.S. or even some of the better European carriers in an unrestricted

market environment. For many Asian nations, Open Skies arrangements are suspect

because of their belief that only U.S. carriers can fully benefit from such an

arrangement103.

100 Unrestricted access to the Japanese market has long been the goal of the U.S. The

strategy has already been partly successful. In 1998, Japan signed a liberalised four year bilateral agreement with the U.S. which recognised unlimited beyond rights and increased third and fourth freedom rights to three U.S. carriers, while at the same time allowing All Nippon Airways increased access to a number of U.S. cities. Japan however regards even the 1998 agreement as still being “unfair and unbalanced”. See Oum, supra note 28 at footnote 16.

101 The U.S. has denied that “divide and conquer” was the basis of its Asian strategy, designed to pressure the toughest target of all, Japan, into US liberalisation demands. See record of interview with Mark Gerchick, Deputy Assistant Secretary of State for Transportation, Orient Aviation (June / July 1997 issue).

102 Garrick Goo, Deregulation and Liberalisation of Air Transport in the Pacific Rim: Are They Ready for America’s Open Skies, University of Hawaii Law Review, Vol 18, 1996 at 543.

103 Id at 569


72

Nevertheless, some have taken the “plunge”. In January 1997, Singapore became the

first country in Asia to sign an Open Skies agreement with the U.S. but since then the

U.S. government has concluded Open Skies agreements with only four other Asian

countries104. It has also concluded an Open Skies agreement with New Zealand105 and

several Pacific Island nations106.

Although the current number of Open Skies agreements with Asian countries is

currently low, more are expected in the future107. If this does eventuate, US carriers will

then be in a position to set up an efficient intra-Asian network of services, more freely

than individual Asian carriers could because of the restrictive bilateral agreements

which Asian nations have between themselves. This poses a major potential threat to

Asian carriers because most of those agreements contain restrictive third and fourth

freedom traffic rights that limit or prevent what each can do in the aviation market with

their neighbours. For example, most intra-Asian bilateral agreements apply an “equal

benefits” principle for determining capacity, frequency and pricing of services, which

restricts the ability of either party to independently determine capacity and

frequency108.

No such restrictions of course apply to U.S. carriers. Asian carriers would therefore

need to persuade their governments to dismantle these restrictive bilateral agreements

before they are able to compete effectively with U.S. carriers in their own continent. If

done piece-meal, this would take an indefinite period of time, and could result in the

104 To November 2001. The other countries are: Brunei (February 1997), Taiwan (March

1997), Malaysia (June 1997), and Korea (April 1998). In March 2000, the U.S. signed a code-sharing agreement with Vietnam. It has also signed various other liberalizing agreements with Asian countries that stop short of being Open Skies agreements. In December 1999, the U.S. signed an “All-cargo” Open Skies agreement with Australia, but this does not include passengers.

105 In May 1997. 106 Most of these agreements allow airlines from both countries to fly between any point in

the U.S. and any point in that country with no restrictions on capacity or frequency. They also provide unlimited “beyond traffic” (fifth freedom) rights to both countries’ carriers. Some include seventh freedom rights on cargo (i.e. “hubbing” rights in foreign territory). These latter rights were included to enable Federal Express and UPS to set up mini-hubs in Asia. See Oum 28 at 131.

107 The U.S. is currently negotiating with Hong Kong, Thailand, Indonesia, the Philippines, and Vietnam.

108 Oum, supra note 28 at 131.


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possible closure of many Asian carriers who would simply not be able to compete with

U.S. carriers.

It has been suggested109 that liberalisation should be negotiated first among like-minded

Asian nations in order to demonstrate the benefits and illustrate the threat of traffic

diversion from protective countries. Liberalisation, it is further suggested, could begin

with relatively “soft” issues such as ownership restrictions on second level carriers, and

progress through charter and freight services to the relaxation of third and fourth

freedom services and finally to the multiple designation of carriers110.

When Australia deals with Asian nations on Open Skies agreements in the future, the

issue of the differing standards of competitiveness of different Asian carriers111 might

be able to be addressed by adopting safeguards for their protection for a suitable period,

similar to the US - Canada Open Skies agreement referred to earlier under which US

carriers were allowed into the three major Canadian airports on a three-year phase-in

basis, while Canadian carriers were allowed into the U.S. market without restriction

from day one.

This very issue has lead to the view that Open Skies should first occur among Asian

countries, creating their own Open Skies “bloc”, and then to negotiate regionally with

countries outside Asia112. It may not be too late for this to happen in view of the

relatively small number of Open Skies agreements with the U.S. currently in existence

in Asia. On a regional or sub-regional basis, particularly the north-east Asian region,

this possibility may be strong because neither Japan, Hong Kong nor China have yet

signed an Open Skies agreement with the U.S. and there may be merit in them delaying

doing so individually for as long as possible.

The signing of the U.S. - Korea Open Skies agreement in April 1998 was however a key

victory for the U.S. in its plans to force Japan to the bargaining table through its

(unofficial) strategy of ‘divide and conquer’. In fragmenting the important northeast

109 Id at 131,132 110 Id 111 Chinese airlines are not currently considered to be cost competitive in Asia. See id at

132


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Asian region in this way113, it much increased the likelihood that the U.S. would need to

be included in any regional Open Skies agreement for northeast Asia that would involve

China and Japan.

To avoid the possibility of such fragmentation occurring again, several Asian

commentators have suggested the adoption of a “club” approach to initiating the

removal of restrictions on capacity on all routes among a group of like-minded

economies114, in which club members would exchange unrestricted air traffic access

rights, while non-members would be excluded. What makes the open club approach

different from existing preferential trading arrangements is that club rules would specify

the terms under which new members could join? These rules would include such

matters as non-discrimination between members, accession by new members being

limited to those states with demonstrated ability to follow policies consistent with club

rules, transparency of co-operative arrangements between members, and a process of

review to ensure that the rules are being applied consistently115.

The Open Skies club arrangement is seen to somewhat analogous to a “private” Asian

version of the European Union, falling well short of a formal treaty arrangement

between nations which may not be currently feasible in the fragmented Asian market116,

but which would nevertheless have some of the same benefits in terms of presenting a

unified negotiating approach to the U.S. on Open Skies matters.

3.5 AUSTRALIA AND OPEN SKIES

Australia has traditionally regarded itself as being at the forefront of trade liberalisation

matters, and in nearly all trade matters, Australia has traditionally been in the vanguard

of moves to deregulate trade.

112 Id at 131 113 Comprising Japan, China, Hong Kong and Korea 114 For example, Elek et al, supra note 35 at 146 – 149. 115 Id 116 Id


75

In aviation matters, its approach, up to a certain point at least, has been no different. The

Productivity Commission117 described Australia’s airline industry as having been

“transformed” during the decade ending 1998118. This has enabled Australia’s

international aviation industry to become the sixth largest in the world, based on 1996

revenue-passenger kilometres figures119. At the same time the Commission noted that

recent domestic and international annual growth rates of the industry120, impressive

though they were, were still ‘marginally lower than the global average of the rates

achieved by airlines of North America and the Asia-Pacific’ region121.

Australia has been actively involved in some moves to liberalise international aviation

trade. For example it played an important role in international negotiations for the

liberalisation of the international air services framework known as the Cairns Group122.

But despite these achievements, it has been conspicuously luke-warm in its interest in

signing an Open Skies treaty with the U.S.123 or indeed any other countries124, seeming

to be content with liberalising the bilateral system of regulation125.

117 Productivity Commission 1998, International Air Services, Report No 2, AusInfo,

Canberra 118 The Commission cited such developments as the termination of the two airline policy,

the merger and privatisation of Qantas and Australian Airlines, the ‘internationalisation’ of Ansett, the multiple designation of Australia’s airlines in all but seven of Australia’s 51 bilateral agreements with other nations, relaxing restrictions on equity investments in Australian airlines, increased competition from Asian competitors resulting in reduced fares, and the creation of the Single Aviation Market between Australia and New Zealand (with no restrictions on trans-Tasman flights or cabotage) – all without compromising safety. See id, page XXIV

119 Productivity Commission, supra note 117 at XXII 120 An average of 8.1% and 7.8% per annum respectively for international passenger and

freight cargo for the period 1986 - 1996 121 Productivity Commission, supra note 117 at XXII 122 Id 123 Australia signed an “all-cargo” Open Skies agreement with the U.S. in December 1999. 124 As recently as September 2003, Australia rejected an Open Skies agreement with

Singapore, despite the latter’s clear preference for one. Instead Australia opted for a slight relaxation of its existing bilateral agreement. See ‘A little sunshine, but Singapore wants more’ The Australian, 24 September 2003, quoting the Minister for transport as saying that the time was ‘not right’ for an Open Skies agreement with Singapore.

125 This is in marked contrast to some of Australia’s close neighbours such as Singapore, Malaysia and New Zealand (As at September 1998, New Zealand had signed no less than 6 Open Skies agreements), all of who have signed such agreements with the U.S. without apparent adverse effects on their flag carriers. It is true that both Air New Zealand and Malaysian Airlines have recently been through major structural dislocation, but neither airline has blamed its Open Skies agreement with the U.S. for these upheavals. Instead they were caused by regional downturns in the economy or poor management decisions. By contrast, Ansett Airlines Ltd went into liquidation in


76

The Productivity Commission cautiously recommended the adoption of a reciprocal

open skies policy, but it did so in the face of opposition from Qantas and Ansett. In the

four years since its report, Singapore has frequently expressed its interest in entering

into an Open Skies agreement with Australia, and Australia has in fact signed its first

Open Skies agreement with New Zealand in November 2000.

Because Open Skies has never been promoted to the Australian public, it is unlikely that

the concept currently enjoys the support of the Australian public126. Such progress as

there is seems to occur at a snail’s pace compared to the speed at which other countries

negotiate their Open Skies agreements. It is true that the aviation industry in Australia

and its immediate region has been in a state of flux for some time. Such factors as the

demise of Ansett, the emergence of Virgin Blue, financial instability in Air New

Zealand following the demise of Ansett necessitating a government bailout, United

Airlines of the U.S. filing for Chapter 11 bankruptcy protection in January 2003 and its

subsequent withdrawal from the Australia – U.S. market leaving Qantas and Air New

Zealand as the only carriers serving the two countries, continuing suggestions that

Singapore Airlines will purchase an interest in Air New Zealand or purchase British

Airways’ 21% interest in Qantas, the general downturn in the world aviation industry

following September 11, and a host of other factors, are all reasons which could be

advanced for Australia’s lethargy. The attitude seems to be: “Lets wait for it all to settle

down and then have a look at implementing a program of reforms such as Open Skies

agreements”127.

The danger with this approach is that it is essentially reactive in nature and there is the

danger that Australia will get left behind in aviation developments in the region, forcing

September 2001 without being involved in or affected by an Open Skies agreement of any kind.

126 The author can offer no empirical evidence of this but the letter from John Douglas to the editor of The Australian newspaper on 8 April 1999 entitled ‘Open skies…..and closed hangers’, opining that the adoption of an Open Skies policy as recommended by the Productivity Commission would see the demise of Qantas and the decline of the aviation industry in general in Australia, may well represent a widely held view

127 See the comments of Transport Minister Anderson, supra note 124


77

it to react even more. It does not seem prepared to adopt a pro-active Open Skies policy

or indeed to have any strategic policy or goals in the area of international aviation128.

A notable exception however has been the considerable progress over the past decade

regarding Australia’s aviation involvement with New Zealand in the trans-Tasman

market. This began with the signing of an air services agreement with New Zealand in

1992. Although described as being regional in nature, the agreement was in fact simply

a memorandum of understanding between the two nations that substantially amended

the existing bilateral agreement between them which had operated since 1961. More

importantly though, it created the framework for a single aviation market between them,

known as the Australia New Zealand Single Aviation Market (“SAM”), in which each

country would have the right to overfly the air space of the other without restriction129.

More specifically, the MOU allowed the national carriers of both Australia and New

Zealand to have free access to the other country for flights to and from the U.S. and

Canada, as well as the rest of Asia130. Other provisions deal with the multiple

designation of airlines so that from 1 November 1992 either party could designate the

phasing out (in stages) of route regulation, double disapproval fare setting, and (most

importantly) cabotage. Fifth freedom, or beyond rights, other than to the U.S. or Canada

would continue to be regulated by the 1961 bilateral agreement.

Although the MOU providing for the creation of the SAM was signed in 1992, it was

not until 1996 that the SAM was actually signed. This is because just prior to 1

November 1994 when the SAM was due to be signed, the MOU was abrogated by the

Australian government when it withdrew the cabotage and beyond rights to New

Zealand carriers in the MOU, which the parties had agreed to implement. The reason

given by the Australian Federal Minister of Transport was that the 1992 MOU was

“clearly an arrangement that, in the absence of any rationalisation of the airline

128 Author’s note: To a considerable extent this must be due to the implacable opposition of

Qantas to Open Skies. If its criteria for Open Skies continue to be adopted by the government of the day (namely, that the aviation industry is in a state of ‘equilibrium’ before such a move is contemplated), Open Skies might never occur in Australia.

129 C. Findlay and C. Kissing, ‘Flying towards a single aviation market across the Tasman’, in: Findlay, Chia and Singh (Eds), Asia Pacific air transport: challenges and policy reforms. Institute of South East Studies, Singapore, (1997), 181-191.

130 Goh J., The Single Aviation Market of Australia and New Zealand, (Cavendish Publishing, 2001), p 33.


78

structures competing with each other, was in New Zealand’s favour to the tune of many

millions of dollars”131.

Although the SAM was finally signed on 1 November 1996, some restrictions on

beyond-rights between the two countries remain132, which interfere with the true nature

of a single aviation market. These restrictions also add to the costs of carriers in the

SAM, including Qantas. Take the example of a service from Auckland to Sydney to

Tokyo133. A SAM airline would be able to operate between Auckland and Sydney, but

not automatically on the Sydney-Tokyo sector which would be regulated by the 1992

MOU and the 1961 bilateral agreement. By comparison, a Japanese carrier would be

entitled to operate a more attractive round-trip service between Tokyo, Sydney and

Auckland134, and in fact may be the only airline able to do so because no SAM carrier

could operate the Tokyo-Sydney sector. The cost to SAM carriers of this lost business

could be considerable.

The SAM is undoubtedly Australia’s most liberal bilateral agreement135 and in many

respects approaches the definition of an Open Skies agreement, dealing as it does with

most of the five freedoms. In some matters it even goes further than an Open Skies

agreement. For example, in its relaxed ownership and control requirements for SAM

airlines136, it deals far more generously with an issue which is either not usually

contained at all in Open Skies agreements, or if it is dealt with, is usually dealt with on a

much more restrictive basis.

The SAM is the only arrangement (other than an old agreement with India) in which

Australia grants (reciprocal) cabotage rights to a foreign carrier. It is interesting to note

131 The Australian Financial Review, 11 November 1994 132 Beyond rights would continue to be governed by the 1961 agreement and the 1992

MOU 133 See Goh, supra note 130 at p 57 134 Assuming of course that the Australia-Japan and New Zealand-Japan air service

agreements permit this to happen. 135 The SAM did not terminate the 1961 bilateral agreement between Australia and New

Zealand that continues to regulate such matters as beyond rights. The SAM did contain a commitment for the parties to conclude a new bilateral on the same terms and conditions as the SAM.

136 At least 50% of the common voting stock and effective board control must belong to the nationals from either country and two third majority of the board must be nationals from either country.


79

that despite the world-wide ‘clamour’ for cabotage rights as being the ultimate solution

to the deregulation of the world’s international aviation industry137, New Zealand

carriers have not taken advantage of these rights to cabotage in Australia, choosing

instead to access the Australian domestic market through an equity investment in Ansett

Airlines and by tried-and-true means of an extensive alliance and code-sharing

agreement with Ansett.

Although the provision of cabotage services is often said to be most relevant in the U.S.

because of its size138, and that conversely there is often little interest in providing

cabotage services in a small country, that argument cannot explain New Zealand’s lack

of interest in cabotage in Australia because the Australian domestic market is large

compared to New Zealand’s and should in theory offer its carriers much scope for

expansion. It is hard to escape the conclusion that New Zealand’s carriers would be

unable to generate enough business from cabotage in the Australian domestic market to

justify what would undoubtedly be the substantial investment required to service that

business. In other words, that they are not competitive enough with Australian airlines.

The final step in formalising the SAM arrangements between Australia and New

Zealand took place on 20 November 2000 when the two countries signed an Open Skies

agreement which provisionally took effect immediately. It was Australia’s first Open

Skies agreement, and New Zealand’s seventh, allowing both countries’ international

carriers to operate across the Tasman and then beyond to third countries without

restriction. Previously, restrictions referred to above meant that beyond services were

limited to twelve Boeing 747s per week to a maximum of eleven countries139.

The agreement also provided that the international carriers of both countries could each

operate dedicated freight services using seventh freedom rights. This would enable them

to operate freight services from any international airport in Australia and New Zealand

to third countries. They agreed to examine the possibility of extending seventh freedom

rights to passenger services140.

137 E.g. see Goh, supra note 130 at p 21. 138 Id 139 Id at 37 140 Id


80

The parties also agreed to recognise each other’s safety approvals by December 2003.

Assuming that occurs, and particularly if seventh freedom rights are extended to

passengers, the airline industries of the two nations would be amongst the most highly

integrated in the world, and their Open Skies agreements one of the most liberal.

In September 1998 the Australian Productivity Commission reported to the Australian

parliament on the suitability of an Open Skies aviation policy for Australia141. The

Commission noted that Open Skies agreements were spreading rapidly throughout the

world142 and that there was a risk that if Australia did not move rapidly in the area of

liberalising its aviation industry, ‘the rest of the world could liberalise around it’. The

Commission also commented that Australia’s aviation objectives were not at all clear

and that it had been ‘difficult’ even for the Commission to ascertain what those

objectives were. One of its recommendations was that the Australian Government

should publish and keep up to date a statement of its aviation policy143.

The Commission also considered the subject of Australia’s membership of an open

aviation ‘club’ of ‘like minded’ countries, based on common agreement, which would

allow all carriers within the club to have the same rights. It considered that the club

concept was a positive means of extending the scope of liberal bilateral aviation

agreements to a plurilateral context, with the benefits to members growing in proportion

to the size of the network. At the same time, the opportunity costs to non-members

would also increase as they became increasingly excluded from their region’s aviation

mainstream, thus bringing pressure on them to join the club.

In common with other commentators144, the Commission considered that non-members

would probably find membership of the club to be more acceptable than negotiating an

‘Open Skies’ agreement with the U.S.

141 Productivity Commission, supra note 117 142 When the Commission reported in September of 1998, there were approx 40 Open

Skies agreements in existence. In the four years since then, some 12 further Open Skies agreements have been concluded.

143 Productivity Commission, supra note 117, ‘Recommendation 5.1’ 144 E.g. Oum and Lee, supra note 99.

CHAPTER 3: THE REGULATION OF AUSTRALIAN AVIATION

“We thought an aeroplane was nothing more than a marginal cost with a wing”

(Alfred Kahn)

3.1 INTRODUCTION

Aviation in Australia is subject to regulation from a wide variety of laws, ranging from

the Australian Constitution, to Commonwealth, State and Territory statutes and

regulations, as well as the common law. There is even a possible, although uncertain,

involvement of customary international law1.

Because this thesis is concerned with Open Skies aviation agreements between

Australia and other sovereign nations, it will confine itself only to a consideration of

those Constitutional issues and Commonwealth laws which could affect, or be affected

by, Open Skies agreements. It will not therefore examine the aviation laws of the

individual States or Territories of Australia. It should however be borne in mind that in

some relatively limited but nevertheless important intra-state aviation areas, the

Commonwealth Parliament either does not have legislative competence, or there is

doubt about the scope of its competence. Where this occurs, the States may chose to

pass their own legislation, either independently of the Commonwealth (for example, in

order to regulate the granting of intra-state route licences, as occurred in the Airlines of

NSW (No 2) case2), or to complement existing Commonwealth legislation. On yet other

occasions, although the Commonwealth has the necessary legislative power, it may

nevertheless invite the States to regulate a particular aviation activity themselves, for

reasons of administrative convenience. This has occurred in the past whenever the

Commonwealth and the States have agreed that to do so is in the interests of all

concerned.

1 For a discussion on this, see the majority decision in Commonwealth v Tasmania (1983)

158 CLR 1 ( the ‘Tasmanian Dam’ case), at 647 (Stephen J.); id at 653 (Mason J.); id at 656 (Murphy J.)

Chapter 3: The Regulation of Australian Aviation

82

3.2 CONSTITUTIONAL ISSUES

Under the Australian Constitution, there is no express Commonwealth grant of

legislative power in respect of air navigation or civil aviation. This is hardly surprising.

The first flight by the Wright brothers did not occur until five years after the

Constitution was adopted. Legislative power for intrastate civil aviation therefore

essentially belongs to the States3. The Federal Parliament legislates in the area of air

navigation by virtue of other express heads of legislative power including the external

affairs power,4 the trade and commerce power,5 the corporations power6 and the

incidental power7. Several other Commonwealth powers, such as the naval and military

defence powers of the Commonwealth, and the prohibition contained in s. 92 of the

Constitution preventing the Commonwealth from regulating trade and commerce

between the States of Australia, also have the potential to impact on aviation, albeit less

directly.

Recent decisions by the High Court of Australia have to a very considerable extent

clarified the scope of the Commonwealth’s powers in the field of aviation and

elsewhere, including in particular the scope of its external affairs and corporations

powers. These decisions have largely been in favour of the Commonwealth, with the

result that today the Commonwealth, in the exercise of the above two powers in

particular has (with one or two important but relatively easily satisfied provisos),

adequate power to regulate virtually all aspects of interstate aviation and even most

aspects of intrastate aviation, particularly those matters to do with safety and

competition. Add to this the Commonwealth’s implied incidental power attaching to

each head of power, together with the Commonwealth’s trade and commerce power,

and the field of aviation is virtually unrestricted for the Commonwealth.

2 Infra, note 44 3 In the Commonwealth Constitution, residual powers belong to the States. Compare the

situation in Canada for example, where residual powers are reserved to the Federal Government.

4 Commonwealth Constitution s 51 (xxix). 5 Id, s 51 (i) 6 Id, s 51 (xx)


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3.2.1 The External Affairs Power (Section 51(xxix))

Aviation law in Australia encompasses both international law8 and domestic law. Its

domestic law frequently derives from international law through the adoption of treaties

and conventions to which Australia is a party9. Because there is no express treaty-

making power in the Australian Constitution, the implementation of conventions into

Australian domestic law - including those relating to aviation - have been the source of

much contention between the Commonwealth and the States, particularly in recent years

following the Tasmanian Dams decision10. Australia’s conventions and treaties

(aviation or otherwise) are initially negotiated and signed by the Executive arm of the

government of the day, but those actions have no effect at law until the enactment by

the Federal Parliament of an Act of the Parliament which incorporates the provisions of

the Treaty or Convention into that Act. For example, the “Convention on International

Civil Aviation” (i.e. the Chicago Convention) forms Schedule 1 to the Air Navigation

Act 1920 (Cth).

Aviation is a good example of a matter which, in Australia, is constitutionally within the

plenary powers of the States, but which became a matter of international significance

early in the twentieth century. Because the Commonwealth unquestionably had power

to legislate with respect to international flights, disputes between the Commonwealth

and the States over international and non-international jurisdiction in aviation matters

featured prominently in the development of Australia’s Constitutional law ever since

7 Id, S 51 (xxxxix) - which operates in conjunction with an implied incidental power that

attaches to every other head of Commonwealth power. See 3.2.2 infra. 8 International law includes both international convention law and international

customary law which deals with such matters as sovereignty and jurisdiction. The sovereignty of a state refers to the right to exercise the functions of a state in regard to a portion of the globe to the exclusion of any other state. It is not clear whether or to what extent a rule of customary international law would be applied in Australian courts. See supra note 1 and see Koowarta, infra note 27 at 203-204.

9 Although the terms ‘treaty’ and ‘convention’ are often used interchangeably, strictly speaking a treaty is a bilateral agreement between two States, while a convention is a multilateral agreement between three or more States.

10 Tasmanian Dams case, see infra note 27. In June 1996, the Council of Australian Governments set up a Treaties Council in which the Commonwealth agreed inter alia to take into account the views of States and Territories before signing a convention, ‘wherever practicable’.


84

federation11. To some extent this was to be expected because of the status bestowed by

many nations, including Australia, on the development of their aviation industries, and

particularly their flag carriers, during much of the twentieth century – a status which is

only recently showing signs of waning.

The first constitutional matter in Australia involving an aviation-related dispute, and the

‘foundation case on treaty implementation’ in Australia occurred in 1936 in the case of

R v Burgess; ex parte Henry12 (“Burgess’ case”). This dispute arose when the

Commonwealth Parliament attempted to implement the provisions of the Paris

Convention for the Regulation of Aerial Navigation of 191913 by enacting regulations14

under the Air Navigation Act 1920 (Cth)15 which attempted to regulate both interstate

and intrastate aviation. The intrastate aspects of the legislation were challenged as being

an infringement of the jurisdiction of the State of New South Wales.

The High Court held in Burgess that the Commonwealth Parliament had no general

power over civil aviation pursuant to either its external affairs power or its trade and

commerce power, both of which powers (together with their respective implied

incidental powers) were considered by the Court. The Court further held that the

particular regulation which was the subject of the case was invalid because, not only did

it go beyond the stipulations of the Paris Convention, it was actually in conflict with

them in several areas.

On the vital question of the general power of the Commonwealth to negotiate and sign

treaties, the High Court was however in no doubt. The external affairs power gave the

Commonwealth authority to ratify international treaties, and the Commonwealth clearly

had the power to enter into the Paris Convention. 11 Were it not for the undoubted co-operation between the Commonwealth and the States

in this area, aviation-related disputes would no doubt have featured even more prominently than they have in the development of Australia’s Constitutional law. For example, there have been no aviation-related cases specifically dealing with the reach of the Commonwealth’s treaty powers despite the significance of treaties in aviation law. Nor have there been any aviation-based cases on the scope of the Commonwealth’s corporations power, even though this power is today an important source of power for much Commonwealth legislation relating to air navigation and civil aviation generally.

12 (1936) 55 CLR 608 13 11 LNTS 174. See also Chapter 1 of this thesis, page 11 14 Air Navigation Regulations, 1920


85

For nearly half a century, Burgess’ case was authority for the proposition that the

federal parliament possessed power to enact legislation under its external affairs power

on matters which implemented international obligations even if the matters were not

otherwise explicitly assigned to it, provided the provisions of the enabling Act were

necessary to implement the principles of the convention or treaty upon which it was

based, and further provided that the legislation did not go beyond the convention or

treaty.

In R v Poole; Ex parte Henry (No 2)16, the question again before the Court was

whether the (amended) Act could be said to merely give effect to the requirements of

the Paris Convention, or did it also go beyond them. A differently constituted High

Court this time stated that the regulations did not have to be an ‘exact reproduction of

the rules contained in…..the Convention’, in order for them to be valid17, before ruling

this time in their favour. Even allowing for the fact that this case dealt more specifically

with the question of conformity (which is dealt with below in more detail) than the

question of the scope of the external affairs power, it is not easy to reconcile the

decision with the Burgess’ decision. Nevertheless it represented, in terms of later

developments in interpreting the scope of the external affairs power, a slight but

significant broadening of the hitherto narrow scope of the power.

The Air Navigation Act 1920 was further amended on 11 December 1947 to give

domestic effect to the far-reaching provisions of the Chicago Convention of 1944, to

which Australia was a signatory. That Convention was incorporated into the Act as

Schedule 1. The Chicago Convention required the Commonwealth to attend to a wide

range of technical and navigational matters, without regard to whether they involved

interstate or intrastate matters. The Commonwealth therefore carried out the Convention

stipulations more or less to the letter for interstate and international aviation as well as

those aspects of intrastate aviation which were also necessary in order to give effect to

the Convention. The States, at the invitation of the Commonwealth, regulated all other

aspects of intrastate air navigation which were also considered to be necessary for

15 Air Navigation Act 1920 (Cth), Section 26 16 (1939) 61 CLR 634 17 Id at 644, per Rich J.


86

Australian aviation, but which were not specifically dealt with by the Chicago

Convention.

The Commonwealth’s role in the domestic regulation of civil aviation was thus

restricted to:

• Interstate aviation; and

• All safety matters, whether interstate or intrastate (including the

licensing of personnel, airworthiness certificates and registration of

aircraft)

The States were responsible for almost everything else.

This arrangement continued, more or less without challenge, until 1964. In that year, the

Commonwealth’s role in relation to interstate aviation regulation again came before the

courts18.

In Airlines of NSW Pty Ltd v New South Wales (No1)19, East-West Airlines argued that

the Commonwealth’s regulations exclusively controlled the issue of aircraft licences

even for intrastate aviation and that the NSW regulations under the State Transport (Co-

ordination) Act 1931 (NSW) were therefore invalid.

A majority of the High Court disagreed, noting that the NSW Act did not involve itself

with Commonwealth aerodromes (or various other forms of Commonwealth controlled

air space, such as military bases), nor did it attempt to interfere with the issuing of

aircraft licences to regulate airworthiness or safety matters, which the Commonwealth

regulations confined themselves to. For this reason, the NSW Act and the

Commonwealth Air Navigation Regulations could co-exist without inconsistency, and

the NSW Act was therefore valid.

Importantly, the majority said: 18 Strictly speaking, these matters were also considered by the High Court in the ANA case

in 1945 (see note 65 infra), but because they were peripheral to the main issues in that case, they were only considered indirectly.


87

“….In carrying out an (international) obligation, measures that at one time

might have been unnecessary may, with changing circumstances, become

necessary. It is not that the nature of the power changes. What changes are the

conditions and circumstances within which the power is exercisable, and in

consequence the particular aspects of the subject matter that can be

regulated”20.

The majority also said:

“The proper regulation in the interests of safety of the operations of interstate

and overseas airlines and the due execution by Australia of the international

obligations which it has accepted, may well make it desirable that the one

authority should exercise sole control of all movement of aircraft in the air and

of matters connected with such movement, that is to say of all matters

connected with how aircraft may be used” 21

The decision clearly suggested that although the States had extensive residual powers in

the field of civil aviation, the Commonwealth also possessed powers that would enable

it to move into many of the areas then occupied by the States, if and when technological

and other changes in the industry necessitated.

The Commonwealth seized the opportunities offered by the Airlines of NSW Case (No1)

decision and amended its Air Navigation Regulations to again re-entered the field of

intrastate aviation. This seizure of power at the expense of the States was predictably

challenged. In Airlines of NSW (No 2)22, the facts of which were the same as for the

Airlines of NSW (No 1) case, the High Court unanimously held that the Commonwealth

did not depend on the voluntary secession of power to it by the States to enforce air

safety regulations on intrastate operations, but possessed wide powers to do so23, either

19 (1964) 113 CLR 1 (Airlines of NSW Case (No 1)) 20 Windeyer J. at 51 21 Id 22 Airlines of NSW v New South Wales (No 2) (1965) 113 CLR 54 23 But not plenary powers, which, according to Barwick C.J. was “demonstrably unsupp- ortable” (at 77)


88

under its external affairs power or its interstate trade and commerce power, or even

under both powers according to several Justices24.

Barwick C.J. pointed out that: “….there are occasions - and…safety procedures….are a

ready instance…- where it can be no objection to the validity of the Commonwealth

law that it operates to include in its sweep intra-state activities…”25

With the aviation industry standing at that time on the threshold of the jet age, Barwick

CJ in particular was sensitive to the profound technological and other changes which

had either already overtaken the aviation industry in Australia and overseas, or which

were about to overtake it. He said :-

“The speeds at which aircraft move in the air, the narrow, and narrowing,

margins of time in which consequences of error or malfunction may be avoided

or reduced, the increasing density of air traffic, the interdependence of safety of

one aircraft upon the performance of other aircraft, the hazards of weather and

the variable performance of aircraft, leading to diversion and re-routing of

aircraft in flight, the need for use of common facilities…..all combine to

demonstrate that all air operations irrespective of destination or of their

particular nature must be subject to the same control if the air is to be safe”26

Despite the Commonwealth’s potentially unlimited power in the field of aviation which

was offered by this decision, there remains even today extensive agreement between the

Commonwealth and the States on a wide variety of aviation matters, epitomised by the

adoption by the States of the Commonwealth’s navigation regulations for licensing and

safety standards for intrastate aviation activities, in which the States continue to play a

vital role. This is done mainly for reasons of efficiency and administrative convenience.

This arrangement has more or less remained the state of balance between the

Commonwealth and the States regarding the Commonwealth’s constitutional powers

over intrastate aviation ever since Airlines of NSW Case (No 2). Indeed, it is difficult to

24 Barwick C.J, Menzies and Owen J.J 25 Id at 78 26 Id at 92


89

foresee any substantial changes to the existing balance in the future, apart perhaps from

the possible future impact of a much-increased role for the Commonwealth in aviation

security-related matters. Although related to safety, security may well evolve as a

distinct and separate area of aviation activity. The scope of such an expansion, if it were

to eventuate, could conceivably prove to be every bit as far reaching as the

Commonwealth’s central role in aviation safety matters. If security- related matters

became inextricably intertwined with the day-to-day running of an airline, it is even

possible that the State’s role in the “commercial” aspects of intrastate aviation may be

eroded or even disappear in favour of the Commonwealth.

In 1982 and 1983 the High Court delivered two decisions27 which finally upheld the

broad view of the Commonwealth’s external affairs power, thereby enabling the

Commonwealth Parliament to legislatively implement an internationally assumed

obligation even without there being any intrinsic external or foreign element present.

This authority extends to matters normally regarded as falling entirely within the

domain of State Parliaments. In fact, in both these cases the treaties were concerned

entirely with subject matters over which the Federal Government had no explicit

legislative power under the Constitution28.

The Tasmanian Dams case arose out of a major political dispute between the

Commonwealth and Tasmanian governments over the construction of a dam on the

Gordon and Franklin Rivers in southwestern Tasmania. In 1982, the area had been

placed on the World Heritage List pursuant to the UNESCO Convention for the

Protection of the World cultural and Natural Heritage 197229, to which Australia was a

party. The Commonwealth government enacted the World Heritage Properties

Conservation Act 1983 that effectively prevented construction of the dam by prohibiting

certain activities such as trucking operations within various areas including the Franklin

River valley.

27 Koowarta v Bjelke-Petersen, 56 Aust L. J. R. 625 (1982); Commonwealth v Tasmania

(1983) 158 CLR 1 (“Tasmanian Dam case”) 28 The areas involved were respectively racial discrimination and the environment. 29 27 UST 37, TIAS No 8226, 1037 UNTS 151. Australia ratified the Convention on 22

August 1974, and it entered into force on 17 Dec. 1975.


90

Because the Commonwealth had no express power over the environment or heritage

matters, it sought to justify the legislation by reference to a variety of powers including

the corporations power, but mostly to the external affairs power and its “special laws”

powers (arguing that the protection of aboriginal archaeological sites within the

protection areas was such a law). The Court30, by a four to three majority on the issue of

the scope of the external affairs power, validated sufficient of the legislation to prevent

the Tasmanian government from proceeding with construction of the dam.

The majority held that, subject always to overriding constitutional prohibitions, the

external affairs power extended to the implementation of treaty obligations, whatever

their subject matter.

The Tasmanian Dam case finally brought Australian jurisprudence in the area of treaty

making into line with developments in other modern countries such as the U.S., U.K.

and Canada. The most recent High Court decision on the scope of the external affairs

power31 also endorsed the wide view taken in the Tasmanian Dam decision, and the

doctrine is now firmly established in Australian Constitutional law.

It is clear that the Commonwealth’s external affairs power has grown from being a

relatively minor head of power to now being one of its most conspicuous and far

reaching. At times, its use by the Commonwealth parliament to expand the power has

also proven to be controversial32. However, as far as aviation is concerned, it can be

stated with (relative) certainty that there is now no constitutional impediment to the

Federal Government’s power to enact legislation under its external affairs power in

order to implement any aviation treaty into which it might choose to enter.

This power is subject only to overriding Constitutional prohibitions. It is also subject to

another limitation on the Commonwealth’s external affairs power which emerged from

the Tasmanian Dams case, namely the requirement that the enabling Act must 30 The composition of the Court had changed in the intervening year. Justices Aicken and

Stephen had been replaced, (for reasons of death and retirement respectively), by Justices Dawson and Deane.

31 Victoria v The Commonwealth (1996) 187 CLR 416 (‘the Industrial Relations Act case’)


91

reasonably conform to the objectives of the convention or treaty upon which it is based,

and be ‘proportional’33.

Even for the requirement of conformity however the modern High Court has taken a

much more benign and ‘forgiving’ attitude compared to the strict approach which it

displayed for example in Burgess34, only requiring that the legislation not in effect

subvert or oust the broad intent of the Convention, before it is acceptable. The current

authoritative version of conformity is that:

The law must be reasonably capable of being considered appropriate and adopted

to implementing the treaty. Thus it is for the legislature to choose the means by

which it carries into or gives effect to the treaty provided that the means chosen

are reasonably capable of being considered appropriate and adapted to that end35.

Clearly the Court is now prepared to concede a wide range of discretion to the

Parliament in carrying out Convention obligations36. This gives the Commonwealth

Parliament very wide latitude indeed in drafting legislation to implement a treaty.

In the light of current worldwide security concerns particularly in the aviation industry,

it is relevant that the High Court in the Tasmanian Dams case said that even matters of

‘international concern’ might be sufficient to trigger the valid use of the

Commonwealth’s external affairs power37. This may even apply in the absence of a

32 The history of its development has been set out by Michael Coper in Chapter 1 of his

book “Encounters with the Australian Constitution” 33 Tasmanian Dams case, supra note 1 per Deane J at 260, Brennan J at 232 and Mason J

at 138, for example. 34 See for example Burgess at page 654 where Latham CJ compared the Regulations and

the Convention stipulations in great detail, such as the different time periods set out in each for the medical re-examination of licensed pilots. Compare this with the Tasmanian Dam case where the Wilderness Regulations which were under attack implemented the supporting Convention only in part, but were nevertheless upheld.

35 Victoria v Commonwealth, supra note 31 at 146, per Brennan CJ, Toohey, Gaudron, McHugh and Gummow JJ .

36 See for example Richardson v Forestry Commission (1988) 164 CLR 261, per Mason CJ and Brennan J at 295-6; Wilson J at 304 and Dawson J at 327

37 Tasmanian Dams, supra note 27 at 171-2 per Murphy J. Several other justices expressed similar views e.g. Mason, Deane and Gaudron JJ


92

treaty38. Although this suggestion has yet to be confirmed39, it may provide yet another

avenue of expansion of the Commonwealth’s powers via the external affairs power,

particularly in the light of current international concerns about terrorism, especially in

aviation. It is however beyond the scope of this thesis to examine this possibility

further.

3.2.2 Implied Incidental Powers

In addition to an express incidental power contained in section 51(xxxix) of the

Australian Constitution, the High Court has consistently held that each separate head of

Commonwealth power in s 51 is accompanied by an “implied incidental power”, being

in the nature of a rule of construction applicable to all grants of power40. The effect of

each implied incidental power, express or implied, is to expand the potential ambit of

each express head of Commonwealth power.

The nature and subject of a head of power has been held to be critical in determining

what is incidental to that head of power41 and how the test of incidental validity shall be

applied. The current formulation of the test is to determine if the (incidental) law

“….is appropriate to effectuate the exercise of the power; one is not confined to

what is necessary for the effective exercise of the power” 42.

To minimise the large degree of subjectivity inherent in considering the validity of the

use of an implied incidental power, the High Court has developed several tools to assist

it, such as the tests of ‘sufficient connexion’ and ‘proportionality’. By use of the

38 The central proposition in Tasmanian Dams was that the external affairs power would

support Commonwealth legislation to discharge a treaty obligation on Australia, irrespective of the subject matter of that obligation. Although it left open the question of whether a treaty is required at all, the central proposition was broad enough to encompass that view.

39 It did however receive limited endorsement in Polyukhovic v Commonwealth (1991) 172 CLR 501

40 The difference between s 51(xxxix) and the implied incidental powers which attach to each specific head of power is not clear, at least as regards the legislative powers of the federal Parliament. PH Lane for example has suggested that there may be no difference at all. See The Australian Federal System, (Law Book Co, 2nd ed 1979), page 347.

41 See Victoria v The Commonwealth (1957) 99 CLR 575 at 614 per Dixon C.J. 42 Nationwide News v Wills (1992) 177 CLR 1 at 27 per Mason CJ (emphasis added)


93

proportionality test for example, the Court seeks to establish “….a reasonable

relationship or balance between an end and a means to establish that end”43.

The implied incidental power may have a particularly wide potential application to

aviation-related matters, as illustrated by the comment of one of the High Court Justices

that: ‘It is probably true that there is no head of federal power to which the flying of

aircraft may not be incidental’44. The use of incidental powers to validate

Commonwealth aviation laws has been specifically considered by the High Court in the

following aviation-based cases:

• Burgess case45 (1936) The High Court held that the

incidental power under s 51(i)

could not validate Commonwealth

regulations that extended to

intrastate aviation.

• The ANA case46 (1946) The High Court held that interstate

transportation could not be

regarded as something which falls

within the (trade and commerce)

power only because it

is…incidental …to the essential

object of the power.

• Airlines of NSW (No 2) case47(1965) The High Court held that the

incidental trade and commerce

power enabled the Commonwealth

to regulate the safety aspects of 43 J Kirk, Constitutional Guarantees, Characterisation and the Concept of

Proportionality, (1997) 21 MULR 1, 2. See also the comments by the High Court in Leask v Commonwealth (1996) 140 ALR 1.

44 See Airlines of NSW (No2), supra note 22, per Kitto J at 116 45 Burgess, supra note 12. 46 ANA case, infra note 65.


94

intrastate aviation, due to the

commingling of interstate and

intrastate aviation

• West Australian Airlines case48(1976) Several Justices held that the

incidental power under s 51(i)

could not validate the

Commonwealth’s attempts to

combine interstate and intrastate

flights for economic reasons.

3.2.3 The Trade and Commerce Power (Section 51 (i))

The subject matter of the trade and commerce power is trade or commerce between two

or more states, or between Australia and at least one other nation. Because the trade and

commerce power does not directly concern intrastate trade and commerce, the only way

that the Commonwealth can become directly involved in intrastate trade and commerce

is by use of the implied incidental power to the trade and commerce power. The

possible applications of the incidental power to the trade and commerce power are

virtually limitless. A number of them have involved aviation-related activities.

Apart from the already clear distinction referred to above between the integration of

physical and economic activities under the trade and commerce power, the Court has

also distinguished between the ‘vertical integration’ of interstate / international trade

and intrastate activities on the one hand (i.e. where intrastate activities are part of an

overall scheme or process which almost invariably leads to interstate or international

trade) – sometimes permitted under the incidental power to s 51(i) because they are seen

as essential links in an economic chain49; and the ‘horizontal integration’ of intrastate

and international/interstate trading activities on the other hand. The latter is usually not

47 Supra note 22. 48 West Australian Airlines case, infra note 53 49 See for example O’Sullivan v Noarlunga Meats (1954) 92 CLR 565; and Crowe v

Commonwealth (1935) 54 CLR 69


95

permitted by the Court50, although because of the wide range of possible situations to

which a concept as broad as ‘horizontal integration’ could apply, the High Court has

said that it will examine each case on its merits, so the possibility of horizontal

integration being permitted has not been categorically denied51.

This distinction between horizontal and vertical integration may have particular

relevance to the organisation of aviation in Australia, such as the development of cross-

border ‘hub and spoke’ aviation networks which is the much-favoured current form of

modern airline organisation. Such networks may well amount to the kind of vertical

integration to which the high Court referred. It could also amount to horizontal

integration, depending on the factual situation. The distinction may also be relevant to

the development of aviation alliances involving Australian carriers because the

existence of hub-and-spoke networks is often the rationale for the formation of

alliances. Many alliances are horizontal in nature, but could also be vertical, depending

on the exact form of the alliance. The merits of the High Court’s decision to examine

each case on its merits is apparent.

In Airlines of NSW (No 2)52 the distinction inherent in s 51(i) between what the

Commonwealth could and could not do as regards intrastate aviation trade and

commerce was clearly drawn for the first time along the lines of a physical versus

economic distinction. In Airlines of NSW (No2) the High Court, in deciding whether or

not the issuing of Commonwealth licences for intrastate air services was valid or not,

also considered whether the Commonwealth could, by use of its trade and commerce

power, extend the Air Navigation Regulations (Cth) to cover the safety, regularity and

efficiency of both intrastate and interstate aviation.

The Court held that the particular regulations concerned with the granting by the

Commonwealth of intrastate licences were valid. Kitto J stated that intrastate flights

could be regulated under s 51(i) where ‘the law, by what it does in relation to intrastate

activities, protects against danger of physical interference the very activity itself which

is within Federal power’. In other words, where the physical commingling of interstate 50 Perhaps because of its clear potential for Constitutional abuse. 51 See P Hanks and D Cass, Australian Constitutional Law: Materials and Commentary

(6th ed, Butterworths, 1999), p 749


96

and intrastate aviation was such that they couldn’t realistically be separated in the

interests of maintaining safety, then Commonwealth laws may be valid under the

incidental power to s 51(i).

By comparison with the validity of those particular Regulations dealing with the issuing

of Commonwealth licences for safety reasons, the Court in Airlines of NSW (No2) also

found that another of the new regulations (namely Regulation 200B) was invalid. This

regulation authorised a Commonwealth licensee under the regulations to conduct air

transport operations within NSW (or any other State) without regard to contrary State

laws. The purpose behind this regulation was to enable a Commonwealth license holder

to augment or supplement interstate and international aviation by ‘feeding’ them with

intrastate passengers from the (State) licensed airline. This of course is the very concept

behind the hub-and-spoke networks by which much modern day aviation activity is

organised, including in Australia. For example, a Kalgoorlie – Perth ‘spoke’ ensures

that a Kalgoorlie passenger feeds the Perth ‘hub’ in time to connect with interstate or

international flights, thus assisting the economic viability of those flights.

The narrow meaning which this decision gave to the scope of the trade and commerce

power caused considerable inconvenience at the time, but it was nevertheless strongly

endorsed by the Court’s subsequent decision in Attorney-General (WA), ex rel Ansett

Transport Industries (Operations) Pty Ltd v Australian National Airlines Commission53

(‘the Western Australian Airlines Case’). This case also involved an attempt by the

Commonwealth to protect an economic aspect of interstate aviation by attempting to

regulate intrastate aviation.

52 Airlines of NSW (No 2), supra note 22 53 (1976) 138 CLR 492


97

The relatively rigid distinction between intrastate and other forms of trade and

commerce which has been maintained under the trade and commerce power has today

been considerably undermined by other heads of Commonwealth commercial powers,

most notably the Corporations Power. The latter has enabled the Commonwealth to

regulate wide aspects of intrastate trading activities which it would not be able to

regulate under its trade and commerce power. In this way, the Commonwealth has been

able to ‘sidestep’ its difficulties in using s 51(i) to regulate intrastate trade.

Indeed, as Joseph and Castan remark, there have been no significant cases involving s

51(i) since the 1970s, when the High Court’s broad interpretation of the Corporations

Power began to emerge beginning with its Concrete Pipe’s decision in 197154.

3.2.4 The Corporations Power (Section 51(xx))

Because so much modern commercial activity, including virtually all aviation-related

commerce, is carried on by corporations, and because of the comparatively narrow

interpretation given by the High Court to the trade and commerce power, the

Commonwealth now relies heavily on the corporations power to regulate a wide range

of commercial activity which it would otherwise be unable to regulate. Included within

the scope of the power is the right to regulate the trading practices of ‘trading, financial

and foreign’ corporations55. This power is particularly important because of the

(alleged) prevalence of restrictive practices in the aviation industry worldwide56.

Nor is the Commonwealth restricted under the corporations power only to interstate

commerce. Its powers over corporations extend even to their purely intrastate trading

activities57. Indeed the power is so broad that it has been described as a ‘plenary’

power58, extending to any ‘business functions, activities or relationships of

constitutional corporations’59, including ‘the persons by or through whom trading,

54 Joseph and Castan, Federal Constitutional Law-A Contemporary View, (Lawbook Co,

2001) at p 53 55 See Strickland v Concrete Pipes Ltd (1971) 124 CLR 468 56 See for example Dempsey infra note 150. 57 See Strickland v Concrete Pipes Ltd, supra note 55 58 Re Dingjan; Ex parte Wagner (1995) 183 CLR 323, per McHugh, Gaudron and Toohey

JJ at 368, 352-53 and 364 respectively. 59 Id, per Gaudron J (with whom Mason CJ and Deane J agreed), at 364


98

financial or foreign corporations carried out their functions and activities and with

whom they entered into relationships’60. It follows that, subject only to tests of

remoteness and connection, any law imposing an obligation on a trading corporation by

regulating conduct that promotes or protects the activities, functions or business of s

51(xx) corporations, will be supported by s 51(xx), either directly or through its

incidental power.

The Commonwealth’s powers under s 51(xx) extend only to ‘Foreign corporations, and

trading or financial corporations…’61. There has been much litigation as to the precise

meaning of these terms62, and although the limits to the scope of the power (together

with its associated incidental power) are still somewhat open ended and uncertain, the

strong trend in the decisions of the High Court seems to be to give the power a wider

scope than a narrower one63.

There can be little doubt that companies engaged in the aviation industry, either directly

(such as airline carriers) or indirectly (such as the owners of airports) are included

within the ambit of the Commonwealth’s corporations powers either as ‘trading

corporations’ (if incorporated locally) or as ‘foreign corporations’ (if incorporated

overseas). This would apply even if those companies were not exclusively engaged in

aviation, provided only that a substantial or sufficiently significant proportion of their

activities constituted ‘trade’ in aviation64.

60 Id 61 Section 51(xx) of the Australian Constitution. 62 Apart from Re Dingjan, supra note 58, see also, R v Judges of Federal Court and

Adamson; Ex Parte Western Australian National Football League and West Perth Football Club (1979) 143 CLR 190; Tasmanian Dams, supra note 27.

63 See for example Re Dingjan, supra note 58, in which the majority supported the broad view of the power, namely that the Commonwealth may regulate all of the activities of a s 51(xx) corporation.

64 Id. An example of this would be stevedoring company Patrick Corporation, which has a 50% shareholding in Virgin Blue.


99

3.2.5 Interstate Trade and Commerce (Sec 92)

The convoluted history of the law relating to this section of the Australian Constitution

has involved at least two aviation-related cases65, one of which66 is perhaps more

important in terms of its political effect than the other, and also because it involved a

(relatively) rare attempt by the Commonwealth to pass laws which fell foul of s 92.

The problem with s 92 was that until the decision in Cole v Whitfield67, the High Court’s

decisions on it were so inconsistent that the ability to predict the validity or otherwise of

a Commonwealth initiative to introduce laws genuinely needed for the regulation of

interstate and intrastate trade and commerce was unnecessarily difficult, even when the

proposed laws were generally considered desirable.

Although Cole did not specifically involve an aviation-related matter, it is relevant to

aviation not only because the case represents the current ‘high-water mark’ for s 92, but

because aviation is a trading and commercial activity which is essentially interstate in

nature and which has been historically prone to interference from state and federal

governments.

In deciding that s 92 only prevents those discriminatory laws that are of a protectionist

kind, the High Court enunciated the triumph of the ‘free-trade’ (or the elimination of

protection) view of s 92, as being the original intent of s 92. This means that any

measure which has the effect of conferring protection on interstate trade and commerce,

or conversely of imposing discriminatory burdens on States, is prohibited. In other

words, a State’s laws will only infringe s 92 if they favour that State’s producers at the

expense of those of other States.

65 Australian National Airways Pty Ltd v Commonwealth (1945) 71 CLR 29 (“ANA

case”) which saw the High Court invoke s 92 to reject Commonwealth attempts to (in effect) monopolise interstate aviation in Australia by ‘squeezing out’ private operators; R v Anderson; Ex parte Ipec - Air Pty Ltd (1965) 113 CLR 117, (“IPEC”) in which the High Court refused to invoke s 92 against the Commonwealth to invalidate customs laws controlling the importation of aircraft, needed for interstate air services, arguing that the importation process preceded trade and commerce and was not part of it

66 ANA case, id. 67 (1988) 165 CLR 360.


100

Thus: ‘A law which has as its real object the prescription of a standard for a product or a

service or a norm of commercial conduct will not ordinarily be grounded in

protectionism and will not be prohibited by s 92’68. On the basis of this test it is

submitted that the IPEC case69, because it was based on the federal government’s two-

airline aviation policy at that time, which was non-discriminatory as between intrastate

an interstate trade and commerce, and was also non-discriminatory as between the

States, would be decided similarly today. Similarly with the ANA case70. Because it was

fundamentally protectionist of the Commonwealth as distinct from prescribing a

standard or norm for the aviation industry, it probably would also be decided similarly.

Cole v Whitfield is no doubt a good decision for aviation in an Open Skies era of

deregulation, because it means that genuine attempts by the Federal government to

further open Australia’s skies to deregulate interstate and international aviation are now

even less likely to be derailed by discriminatory actions of State or Federal

governments. For example, an attempt by (say) the West Australian government to

protect its regional airlines from competition from other airlines entering the Australian

market under an Open Skies policy, are likely to fail the Cole test. On the other hand,

the setting of non-discriminatory regulatory standards for such matters as safety,

maintenance, training and licensing for example, are now less likely to fail s 92.

Although the prohibition on interference in trade and commerce between the States is a

matter which is essentially internal to Australia, it clearly has the potential to impact on

Open Skies aviation policies, even though they are essentially international in character,

because such a policy will offer foreign carriers the right to fly to any points in

Australia and in so doing cross State borders. Conversely, in so far as s 92 constrains

the Commonwealth, it operates so as to prevent it from interfering with trade and

commerce between the States by prohibiting it from favouring one State over another in

the promotion of the trade and commerce between them, rather than granting to the

Commonwealth a specific head of power.

68 Id, at 408 69 IPEC case, supra note 65. 70 ANA case, supra note 65


101

In the Cole case, the Court commented at page 407 that under its new doctrine, breaches

of s 92 by the Commonwealth, though possible, were likely to be rare. An example

(probably unlikely) might occur if the Commonwealth sought to promote the use of

(say) Sydney Airport over the airports of the other States, in order to promote Sydney as

the main entry ‘hub’ into Australia. Alternatively it might choose to give Qantas, one of

its designated carriers under an Open Skies policy, a competitive advantage over the

designated carriers of the other Open Skies nation, by subsidising Qantas’ landing or

other fees incurred by it when it uses Sydney airport, but not other at other airports.

Alternatively, the pressure for such a measure could even come from the other Open

Skies state or from its flag carrier (which might conceivably even have a financial

interest in Sydney Airport, now that it has been privatised) in exchange for a concession

of some kind under the Open Skies agreement with it.

Note that the Commonwealth could legally single out Sydney Airport for preferential

treatment so long as there was a legitimate rational basis to justify that choice. The

rational basis need not be the sole basis, but it must be a basis for the decision. For

example, if for some reason all overseas passengers into Australia wished to enter the

country through Sydney Airport, the Commonwealth could justify its decision to give it

preferential treatment of some sort. In the absence of such a basis however, if the

Commonwealth were to agree to the type of discriminatory conduct in the examples

above, it may find itself in breach of s 92 under the Cole test71. However, throughout

federation the Commonwealth has rarely if ever adopted a protectionist position in

favour of one State in Australia over the others, so the illustration merely serves to

demonstrate how unlikely it is that it would occur in the future.

While on the subject of airports, it would be possible for the Commonwealth to

compulsorily acquire any airport in Australia under its powers of compulsory

acquisition in s 51(xxxi) of the Constitution. While the acquisition would of course need

to be on ‘just terms’, if it were done for reasons of (say) safety, or any other

Commonwealth purpose such as facilitating interstate and overseas trade and

commerce, the acquisition would be constitutional. See Airservices Australia v

Canadian Airlines International Ltd (1999) HCA 62.

71 Cole, supra note 67. See also


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3.2.6. Executive Actions of the Federal Government (Sec 61)

Executive power being the power to implement and to carry into effect the legislative

power of the Federal parliament 72. When applied to the Commonwealth’s aviation

treaty-making powers, s 61 enables the executive to negotiate and make such treaties or

agreements, following which the Commonwealth implements the treaty into Australia’s

domestic laws. Until this occurs, (and subject possibly to the Teoh doctrine73 which is

considered below) a signature on a treaty has no effect at law in Australia. There are no

practical limits on the power of the executive to negotiate and to enter into international

agreements, such as bilateral aviation agreements, including Open Skies agreements74.

If necessary, such agreements are ratified by the government. Ratification, if required,

signifies to the international community that Australia intends to be bound by the

provisions of the particular treaty or agreement. It also empowers the Commonwealth

Parliament to initiate proceedings to legislate the treaty into Australian law75.

For bilateral agreements such as Open Skies agreements, legislative ratification would

only required if the treaty was politically sensitive or if it required legislative

implementation76, which Open Skies agreements and other ASAs generally do not.

Ratification would also occur if the constitution of the other nation to an Open Skies

agreement, for example the U.S., specifically prevents its executive from assuming a

treaty obligation without the prior ratification by its legislature. Where this is the case,

the practice is for Australia to also ratify the treaty77.

72 Barton v Commonwealth (1974) 131 CLR 477, per Mason J at 498. 73 Minister for Immigration and Ethnic Affairs v Teoh (1995) 183 CLR 273 74 No member of the High Court has ever suggested such a constraint, although there has

been disagreement as to whether a wide use of the treaty making power produces a corresponding expansion of the external affairs power. See Tasmanian Dams case, supra note 27 per Dawson J at 303.

75 Campbell, ‘Australian Treaty Practice and Procedure’, in International Law in Australia (ed Ryan, 2nd ed, Law Book Co, Sydney, 1984), p 64

76 Id 77 Id


103

Because ratification is an executive act of the Federal government, it has no effect at

law. This at least was the position until the High Court decided in Teoh’s case78 that

ratification of an international treaty, such as an Open Skies agreement if for some

reason that was necessary, could create a ‘legitimate expectation’ in administrative law

that the executive and its agencies will act in accordance with the terms of the treaty,

prior to incorporated into Australian law, and even if the treaty never will be so

incorporated. This means that government agencies and decision makers, particularly

when exercising discretionary powers, must make procedural allowance for the

provisions of an unincorporated treaty in their decision making processes. The careful

wording of the Teoh decision means that it cannot be used as a ‘back-door’ method of

giving substantive effect to the provisions of a treaty in the absence of enabling

legislation, but, although its future remains somewhat uncertain, the present status of

Teoh is that it remains a valid procedural law for Australia.

By 1998, Australia had signed a total of 51 bilateral aviation agreements, or air services

arrangements (‘ASAs’), with other nations79. Generally these arrangements comprise

an Air Service Agreement and/or an exchange of letters80. Being essentially

international in their nature, ASAs only indirectly affect the Australian domestic

aviation regulatory regime. Nevertheless, as a result of them, the carriers of fifty-one

other nations either land aircraft at various Australian airports and / or overfly

Australian airspace. Those carriers are therefore subject to Australian safety,

airworthiness, security, maintenance and refuelling regulations and the like, as well as

being subject to Australian airport slot regulation policies and airport lease agreements.

In turn, these carriers contribute, albeit indirectly, to the regulation of Australian

domestic aviation and changes to that regime by bringing with them the regulatory

procedures and practices, both good and bad, from their home states.

78 Teoh, supra note 73. Note that the Teoh decision is likely to come up for

reconsideration by the High Court in the future. See the comments of McHugh J in Re Minister For Immigration and Multicultural Affairs; ex parte Lam, (2003) 77 ALJR 699.

79 See Productivity Commission 1998, International Air Services, Report No 2, AusInfo, Canberra, page 281


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3.2.7 Summary: Aviation and the Australian Constitution

Through various heads of power, most notably the external affairs power, the

corporations power and to a lesser extent the trade and commerce power, together with

their implied incidental powers, it is clear that the Commonwealth has very wide

powers indeed to regulate most aspects of aviation in Australia. These powers

encompass the international, interstate and intrastate aspects of the aviation industry.

The States however, because of federal constitutional limitations, retain authority to

regulate certain intrastate services by the granting of specific route licences.

There are four main areas of concern in the regulation of aviation in Australia81. They

are:

• Safety / security issues

• The provision of aviation services and infrastructure

• The regulation of competition in the aviation industry

• Environmental issues

(i) Safety

On all matters to do with the vital subject of aviation safety, including a likely much-

increased future significance for security-related matters, the Commonwealth

undoubtedly has adequate powers at its disposal. Interpretations of the trade and

commerce power for example show that the High Court has consistently invited the

Commonwealth to regulate on safety matters to the maximum extent that it deems

necessary or is obliged to do under international obligations. This more or less open

invitation to the Commonwealth to regulate virtually all of the so-called physical

aspects of aviation, also extends without restriction to the provision of infrastructure

80 Id at p 37 81 See Bartsch, Aviation Law in Australia, (Law Book Co, 1996) at p 178


105

facilities and services for aviation navigational purposes82. This means that the

Commonwealth can regulate the safety aspects of even private leisure aircraft, at least to

the extent that such aircraft might conceivably affect the safety of international or

interstate flights. The fact that the Commonwealth might choose to delegate such power

to the States for reasons of administrative convenience does not of course alter the fact

that the Commonwealth has the power at its disposal.

In addition to its powers under the trade and commerce power, the wide interpretation

given to the Commonwealth’s external affairs power in the Tasmanian Dams decision83

and in subsequent decisions, together with the latitude which the High Court is now

prepared to allow the Commonwealth in drafting legislation to implement international

treaties and conventions84, means that the safety aspects of international aviation can

also be adequately catered for by the Commonwealth under this power. The

Commonwealth’s power in this area also extends to the regulation of intrastate aviation

to the extent that it could impinge on safety concerns.

(ii) The Provision of Aviation Services and Infrastructure

The Commonwealth has always provided aviation infrastructure facilities and services

without challenge from the States. Many of these facilities and services are provided

pursuant to international convention, such as the Chicago Convention and its numerous

subsequent Protocols, for which the Commonwealth derives its primary authority from

its external affairs power. Until 1996, the Commonwealth was the owner and operator

of many of these facilities via the Federal Airports Corporation. In 1996, pursuant to the

Airports Act 1996 (Cth), it divested itself of all of the major airports in Australia (called

“core regulated airports”), except Sydney Airport which it subsequently sold in 2000.

Under the Act, the Commonwealth, via various heads of power such as its corporations

power or the external affairs power, retains control over the new airport owners for such

matters as the provision of airport safety and infrastructure. Under Division 3 of the 82 See for example Airlines of NSW (No 2), supra note 22; and see the ANA Commission

case, supra note 65. 83 Tasmanian Dams case, supra note 27 84 A law will only be held to be held invalid if it is so defective in implementing a

Convention, or so substantially inconsistent with it, that it amounts in effect to mala


106

Airports Act, foreign ownership of any airport is restricted to 49 per cent, with airlines

being permitted to own a maximum of 5 per cent. In this way, many of the U.S. aviation

industries’ competition problems which arise because airports there are often owned or

controlled by airlines, are avoided.

The Commonwealth’s two main agencies for providing aviation services are the Civil

Aviation Safety Authority (CASA) and AirServices Australia (ASA). These will be

considered in more detail below.

(iii) Competition

Although safety issues are always likely to remain paramount to air travellers, the level

of airfares is also of serious concern to the Australian public. In this area too, the

Commonwealth now has extensive powers to regulate the trading practices of airlines

via its corporations power85, including in particular the competitive practices of those

airlines. This is so even though the airline may be an overseas registered operator86 or

even if the airline operator may confine itself to purely intrastate aviation87.

According to classic economic theory, a free and competitive market is the ultimate

determinative of lowest prices. The generally accepted prevalence of restrictive trade

practices in the aviation industry worldwide makes the Commonwealth’s powers in this

field particularly important.

In addition, the Commonwealth can, if it wishes, establish its own aviation operator to

provide competition where appropriate, and has done so in the past, although it would

probably be inhibited by s 92 from monopolising the industry88. Indeed s 92 acts to

prevent interference with free market forces, either by the Commonwealth or the

States89.

fides on the part of the Commonwealth. See Richardson v Forestry Commission, (1988) 164 CLR 261 at 327 per Dawson J.

85 Commonwealth Constitution, sec 51(xx) 86 Id. Sec 51(xx) extends to ‘Foreign, trading and financial corporations’ 87 See Strickland v Concrete Pipes, supra note 55 88 See ANA Case, supra note 65


107

Most commercial aviation operations in Australia and overseas are carried out by

corporations which range in size from private companies to publicly listed companies.

These companies operate in all areas of the aviation industry, from general aviation90

(engaged in such diverse activities as crop dusting, flight training schools, flying doctor

services, air ambulance operators and police aerial surveillance) to fully-fledged

international scheduled operations in which they provide a full range of passenger and

cargo services. Provided these operations are carried out by a corporation91, and

provided that the corporation ‘trades’92, the Commonwealth has wide ranging power to

regulate them via its corporations power, wherever they operate.

With globalisation, competition matters are also increasingly becoming the subject

matter of international consideration93. If this was to develop to the stage of

international agreement, the Commonwealth could also regulate competition in

Australia via the external affairs power.

(iv) Environment

The aviation industry is finding itself increasingly at the forefront of environmental

matters. These include greenhouse gas heating caused allegedly by the world’s 12,000

jet airliners94 emitting exhaust gases and water vapour in the fragile upper atmosphere.

It is believed that the latter form ice clouds and trap heat in the atmosphere by reflecting

infra red radiation emitted from the earth’s surface95. One proposed solution is, subject

to international agreements, to fly planes at a lower altitude, particularly between

24,000 feet and 31,000 feet, but this might be counterproductive because it would

increase carbon-dioxide emissions from the increased fuel consumption caused by

greater drag in the thicker atmosphere.

89 Cole v Whitfield, supra note 67 90 The term ‘general aviation’ covers virtually all aviation activities other than military or

scheduled civil aviation activities. 91 Specifically a ‘Foreign, trading or financial corporation’ as defined. See note 62 supra. 92 See Adamson, supra note 62. 93 See M.G Egge, ‘The Harmonisation of Competition Laws Worldwide’, 2 Rich. J. Global

Law & Bus. 93 (Winter / Spring 2001) 94 See New Scientist, October 2002, p 4, a figure expected to double within 15 years.


108

Another long-standing and well publicised environmental issue has been aircraft noise,

particularly near airports in densely populated areas.

Because these matters are increasingly becoming the subject matter of international

convention, and because most aviation activities are carried out by corporations, the

position is that the Commonwealth has adequate powers at its disposal to regulate most

aviation environmental matters via its external affairs or corporations powers. Its

external affairs power has in fact already been specifically held to extend to

environmental protection96.

3.2.8 CONCLUSION

The only aviation activities in Australia over which the Commonwealth may not

currently have legislative power might be those activities confined to unincorporated

aviation operators (e.g. sole proprietors, such as private leisure flyers), engaged in non-

commercial functions, who confine their activities to intrastate flights without any

proximity to Commonwealth-controlled airspace. Even these operators, once they enter

controlled airspace, are immediately subject to Commonwealth regulation. Even

activities outside controlled airspace would come under Commonwealth control if there

was even a remote (but realistic) possibility that they could interfere with the safety of

Commonwealth-controlled flights, whether those flights were international, interstate or

only intrastate. While it is true that the States currently issue licences for intrastate

flights, which they are permitted to do so long as the States do not attempt to interfere

with interstate or international flight navigation97, the States do so more or less with the

consent of the Commonwealth, pending any future Commonwealth legislation on the

same subject under its corporations power which might render the State legislation

invalid for inconsistency98.

In addition to the powers specifically considered above, the Commonwealth also has at

its disposal a wide range of other powers which may directly or indirectly impinge on

95 Id. 96 See Tasmanian Dams case, supra note 1 97 See West Australian Commission case, supra note 53. 98 Commonwealth Constitution, sec 109.


109

civil aviation. For example, by means of its customs power99, it was able to prevent the

importation of jet aircraft into Australia in order to give effect to its aviation policies at

that time100.

3.3 THE FEDERAL LEGISLATIVE REGIME FOR AUSTRALIAN AVIATION

There are numerous Acts of the Commonwealth Parliament regulating air operations in

Australia. Several of the more important of them are set out in Pengilley and McPhee101,

and in Bartsch102. There have been numerous legislative changes since those

publications in 1994 and 1996 respectively, many of them resulting from a complete

review of civil aviation legislation which the Civil Aviation Safety Authority (CASA)

initiated in July 1996 under a program known as the CASA Regulatory Reform

Programme. Perhaps the principal change is that the Civil Aviation Regulations 1988

are being progressively replaced by the Civil Aviation Regulations 1998, which

designate CASA as having primary responsibility for the regulation of all aviation

matters in Australia, safety or otherwise. The new regulations are fashioned on the U.S.

Federal Aviation Authority’s regulatory structure which, together with the European

Joint Aviation Requirements, are specifically referred to in Parts 21 through 35 of the

1998 Regulations.

The review programme is currently due for completion by the end of 2003. The process

is said to be on course to achieve this target date103.

3.3.1 Pre - World War II

Federal regulation of aviation in Australia began with the passage of the Air Navigation

Act 1920 (Cth) which implemented the Paris Convention of 1919. The Act dominated

99 Commonwealth Constitution, section 90. 100 See IPEC case, supra note 65 101 W. Pengilley and J. McPhee, Law for Aviators, (Legal Books 1994) pages 349 – 469. 102 Bartsch, supra note 81, p 176-178 103 Per a telephone conversation with a CASA official and the author on 8 September 2003.

Of course, as Oscar Wilde once said: ‘Never believe anything until it has been officially denied’, so the claim that the programme was on track for a December 2003 completion, may be evidence that such will not be the case. Only time will tell.


110

Federal regulation of aviation up to World War II. It was the first Act of the Australian

Federal Parliament providing for aviation services and infrastructure, and for regulating

air transportation.

The Air Navigation Act 1920 also provided for the general regulation of air navigation

in Australia, including such matters as the provision of air navigation facilities, the

rights of aircraft in relation to air navigation (e.g. aviation standards and rules of air),

the registration of aircraft and the licensing of operators, aerodromes, flights crew and

engineers.

3.3.2 Post World War II - 1990

With the rapid expansion of the world’s aviation industry after World War II came a

corresponding expansion of regulatory activity. Following the Chicago Convention of

1944, the Air Navigation Act 1920 was further amended in December 1947104 to ratify

the provisions of that Convention. The Air Navigation Act has frequently been amended

subsequently to incorporate various new protocols to the Chicago Convention, or to take

account of technological developments in aviation. For example it was amended in 1988

to incorporate the 1984 Montreal Protocol to the Chicago Convention, dealing inter alia

with the interception of civil aircraft in flight105, and also in 1992 to provide for the

admissibility into evidence of cockpit voice recorders106. Most recently it was amended

in 2002 to accommodate the specialised Aviation Security Regulations 2002 dealing

with aviation security. Further amendments are more or less continuously in the

pipeline.

Before examining the development of aviation regulation in Australia to the present

day, it may be said at the outset that the development of aviation regulation in Australia

closely paralleled that of the U.S., albeit with a delay of approximately a decade. Thus

in the U.S., regulation of air transportation began in 1938 with the passage of the Civil

Aeronautics Act (CAA) and ended forty years later with the passing of the Airline

Deregulation Act 1978. The CAA created the Civil Aeronautics Board (CAB) and gave

104 Air Navigation Act (No 2) 1947 105 The 1984 Montreal Protocol is Schedule 10 to the Air Navigation Act 1920 as amended. 106 Transport and Communications Legislation Amendment Act 82 of 1992.


111

it responsibility for the economic regulation of airlines, including entry and exit

restrictions, the control of fares, and the assignment of routes. In the forty-year period

between 1938 and 1978, not a single new trunk carrier was certified by the CAB, even

though air traffic grew by 4000 per cent between 1938 and 1956 alone107.

In Australia, at about the same time as it formally adopted the Chicago Convention, the

Commonwealth Government inaugurated its ‘two-airline policy’. This policy was to

dominate Australia’s domestic aviation industry for the following forty or so years, until

the reforms of the late 1980s and early 1990s finally brought it to an end. The policy

was created by the Civil Aviation Agreement Act 1952 which gave legislative

authorisation to an agreement whereby the government-owned Trans-Australian

Airlines (‘TAA’), and an existing private airline, Australian National Airways (‘ANA’)

operated side-by-side on Australia’s interstate routes.

Qantas, Australia’s international carrier, was specifically precluded from operating

domestically, a situation which continued until 1994. The fact that it did not use its

political influence to gain a role in the protected domestic market when it was

supposedly facing the ‘chill winds’ of international competition108 is probably a good

measure of how equally restrictive and ‘feather-bedded’ the international market for

aviation services also was until the early 1980s.

To even further enforce the two-airlines policy, the Airlines Equipment Act was passed

in 1958 to regulate the size and composition of the fleets of the two airlines so as to

restrict each fleet to sufficient capacity for each to be able to cater for little more 50

percent of the market on competitive routes. It did this by the simple but indirect

expedient of controlling the importation of aircraft under its Customs power109 by a

strict licensing system, under the Customs (Prohibited Imports) Regulations. Without

107 W. Pengilley, ‘Deregulation or Re-Regulation? in ‘Competition Policy in

Telecommunications and Aviation’, S.G. Corones (ed) (Federation Press 1992) at p 116, fn 4.

108 The winds were not too chilly because the international ASAs into which the Australian government entered, with Qantas as its nominated carrier, ensured capacity, routes and fares were also strictly regulated and fares set at artificially high levels.

109 Section 90 of the Commonwealth Constitution.


112

permission to import aircraft, it was impossible for new entrants to establish competing

services110.

Although not specifically part of the two-airlines policy, 1958 saw the passage of the

Civil Aviation (Damage By Aircraft) Act 1958 (Cth). This Act incorporated the Rome

Convention on Damage Caused by Foreign Aircraft to Third Parties on the Surface,

dated 7 October 1952, which regulated the amount of compensation payable by a

foreign carrier for surface damage caused by the carrier in Australia. Pengilley and

McPhee point out that there must also be an “international” aspect to the journey before

the provisions of the Act will apply, even though s 16(2) of the Act purports to extend

its application to include Australian registered aircraft111.

Concerning liability, the Civil Aviation (Carriers Liability) Act 1959 (Cth), provided in

section 11 that the 1929 Warsaw Convention and the 1955 Hague Protocol “have … the

force of law in Australia in relation to any carriage by air to which the Convention

applies irrespective of the nationality of the aircraft performing the carriage”. The

Convention and the Protocol are set out in Schedules 1 and 2 respectively in the Act.

This Act imposed strict liability on carriers in exchange for limited liability112. Because

the Civil Aviation (Carriers Liability) Act only applies within Australia to passengers

and owners of cargo on international charter flights and interstate commercial

operations, each of the Australian States has enacted complimentary legislation for

purely intrastate commercial air carriage113.

The two-airlines policy was not all smooth sailing from a legal point of view. It was in

fact challenged (albeit indirectly) in the High Court in 1965 in the IPEC case114, the

facts of which were that IPEC was refused permission to import five Douglas DC-4

aircraft for the purpose of interstate air freight services. IPEC challenged the refusal,

alleging that the Import (Prohibited Goods) Regulations were being used to monopolise

110 J. Goh, The Single Aviation Market of Australia and New Zealand, (Cavendish 2001) p

67 111 Pengilley and McPhee, supra note 101 at page 248. 112 Currently a maximum of $500,000 for death or injury. 113 For example, Civil Aviation (Carriers Liability) Act 1961 (WA) 114 IPEC case, supra note 65.


113

trunk air services, similar to the way that the ANA case in 1945 had amounted to a

breach of s 92 of the Constitution.

The High Court disagreed, arguing that what happened at the importation stage of

bringing in an item of plant and equipment had nothing to do with what uses the plant or

equipment was subsequently put to, following importation. The importation process was

not therefore part of interstate trade, so in this case there was no interference with the

freedom of interstate trade guaranteed by s 92.

While it is hard to argue with the logic of this decision, there may be some room for

doubting that the same decision would be made today, following the case of Cole v

Whitfield115 with its policy emphasis on preventing any impediment to the free flow of

trade between the States. If the process of importation is for the sole purpose of

engaging in interstate trade and commerce (as indeed it was in the IPEC case), surely

importation is part and parcel of that commerce. In an age of e-commerce, for example,

the importation of relevant software, without which the electronic commerce cannot

take place, is usually an indistinguishable stage of the commerce itself, and is an

integral ‘part and parcel’ of it, without which the commerce itself often cannot take

place.

The IPEC case probably represents the high-water mark of the two-airlines policy,

because by 1978 when the case of Ansett Transport Industries (Operations) Pty Ltd v

Commonwealth116 (“the Ansett case”) came before the High Court, the policy had

already been watered down to the extent that IPEC (and another carrier, ‘Air Express’)

had both been granted the necessary rights to import large ‘airline-type’ aircraft for

operation between Tasmania and the Australian mainland. These were the same rights

which had been refused in 1965. Ansett, refusing to read the writing on the wall,

challenged the importation permits as breaching the 1952 Civil Aviation Agreement Act,

(as amended in 1961 and 1972), to which it was obviously still wedded.

A majority of the High Court held, on a construction of Clause 10 of the (fourth)

Airlines Agreement Act 1972, that there was scope for the issue of import permits to

115 Cole v Whitfield, supra note 67. 116 (1978) 139 CLR 54


114

other carriers where in the opinion of the Minister, neither TAA nor Ansett were

providing an adequate level of service. The Minister’s decision had not been shown to

have been invalidly made from an administrative point of view, and the Court declined

to overturn it.

The beginning of the end for the two-airline policy came in 1981 with the appointment

of the first of two major inquiries into the domestic aviation industry 117. The first of

these, the Holcraft Inquiry in 1981118 reported that whichever way it turned, it found

itself to be completely constrained by the two-airline policy in any of its

recommendations. The inquiry stated119:

Almost anywhere the Inquiry has attempted to do this (i.e. frame practical

recommendations on air-fare pricing) it has run into the virtually impenetrable

barrier of the provisions of the Two Airlines Agreement, existing or proposed

(italics added)

The recommendations of the Holcraft Inquiry were however politically popular,

particularly amongst Australians who had travelled to the U.S. after the passage of its

Airline Deregulation Act in 1978 and who complained strongly about the higher airfares

at home when compared to those in the U.S. This prompted the Commonwealth

government to adopt several of the Holcraft Inquiry’s recommendations to do with

liberalising fare structures in Australia, an issue which by then was becoming intensely

political. In particular, the government agreed that discount fares should be made

generally available for the first time in Australia. The changes however were more

cosmetic than real.

The Airline Equipment Act 1981 allowed aircraft imports to be available to regional and

commuter airlines, provided that they did not use the aircraft to undermine the two-

airline policy. Some regional and commuter airlines responded accordingly, particularly

those airlines that served Queensland because of its developing importance as a

destination of interstate and international tourists in Australia. In this way, several

117 The other was the May Review in 1986. 118 ‘The Inquiry’ (Holcraft Committee, 1981) 119 See Id, Vol 1, p 14


115

commuter operators grew rapidly and were in a position to take advantage of further

liberalisation in the Australian aviation industry. This was the beginning of a

Queensland ‘hub’ for aviation in Australia, ‘fed’ by regional tourist airline operators,

including several from interstate.

This possibility of commuter airlines being able to develop to the point where they

could take advantage of hoped-for later opportunities which would be presented by

deregulation was more theoretical than real. By 1991, a study by the Australian

Department of Transport and Communications found that all of the top ten commuter

airlines in Australia, which accounted for approximately ninety percent of total

commuter traffic in Australia, were linked by ownership either to Ansett or to

Australian Airlines120

In 1986, in the face of ever increasing public dissatisfaction with continuing high

airfares, as well as a lack of variety in fares and other aspects of airline services, the

Commonwealth gave Ansett and Australian Airlines the requisite three years notice that

the two airlines agreement would end on 30 October 1990, and that competition would

thereafter be permitted on all interstate routes. This meant that the domestic aviation

market would thereafter operate within the constraints of established competition policy

controls including in particular the Trade Practices Act 1974 (Cth), requiring airlines in

Australia to act competitively in all their operations.

The government formally achieved its objective of deregulating the aviation industry by

passing the Airlines Agreement (Termination) Act 1990, which repealed existing two-

airline legislation. By legislating in this way, the Australian government did not follow

the earlier successful examples of the U.S. and Canada both of which had passed

detailed legislation for the process of deregulation. Nor did it adopt the staged process

chosen by the E.U. and the U.S. Nor did it establish any specialist agency to deal with

deregulation. It did not pass industry-specific legislation nor even strengthen the Trade

Practices Act for this purpose (although both were considered). Instead, Australia

simply allowed deregulation to happen – a market forces strategy which not even the

U.S. had been prepared to follow in 1978.

120 Dept of Transport and Communications, 1990-1991 Annual Report, Australian

Government Publishing Service, Canberra, (1991)


116

Immediately after the 1987 announcement of the termination of the two-airline policy,

the Government granted long-term terminal leases to both Ansett and Australian

Airlines as well as development controls over land adjoining the terminals of the two

existing airlines. Through this seemingly perverse act, the government entrenched the

commercial advantage of its wholly owned ‘Australian Airlines’ which was ear-marked

for privatisation, but whose market value might be much reduced in a deregulated free-

for-all environment.

The Australian Competition and Consumer Commission’s predecessor, the Trade

Practices Tribunal, saw potential difficulties in the lease terms, and believed that

twenty-year leases were longer than would be consistent with its own authorisation

decisions. It saw the potential for the two incumbents, through their effective control of

the airport gates, to create an artificial shortage of landing capacity121.

To usher in the new deregulated era, 1988 the Commonwealth passed the Civil Aviation

Act 1988 making it the prime aviation regulatory legislation in Australia. The Civil

Aviation Act now covers most if not all of the functions previously covered by the Air

Navigation Act 1920, including aircraft and aircrew licensing, provision of aviation

facilities, search and rescue, collecting and disseminating aviation-related information,

safety and investigation.

To carry out the new Civil Aviation Act’s regulatory functions, the Commonwealth

created the Civil Aviation Authority (“CAA”) as the supreme regulatory and

administrative authority for air safety and aviation industry development matters in

Australia. The inauguration of the CAA as Australia’s aviation safety and other

regulatory authority, which came into effect on 1 July 1988, was not without concern on

the part of a number of influential commentators in the Australian aviation industry.

Their criticisms, which continued until 1995122, centred around what the critics believed

were inherent conflicts of interest faced by the CAA in administering both air safety

matters and matters to do with ensuring the commercial viability of the industry, and

that this conflict of interest would compromise its safety role.

121 See TPC Bulletin No 52, Jan – Feb 1990. 122 See “The CAA and air safety”, ‘The Australian’ newspaper, 12 October 1994.


117

3.3.3 The Deregulatory Era: 1990 - Present

Developments in the Australian aviation industry moved rapidly after 30 October 1990,

when the two-airline policy ended. Barely one month later, Compass Airlines entered

the Australian domestic aviation market123. This was the first new competitor in the

industry for nearly forty years. The immediate effect of the entry of Compass was to

drive down prices on those routes on which it flew in competition with Ansett and

Australian Airlines, as it strove to gain a share of the domestic market and the

incumbents, (Ansett and Australian Airlines), reacted to protect their existing market

shares. The lower fares boosted air travellers within Australia to record highs. Compass

however failed to sustain the heavy losses which it had incurred as a result of the airfare

‘war’124 and it ceased operations in 20 December 1991. Another entrant, also named

Compass Airlines (“Compass MKII”) entered the market in 1992 but lasted only six

months before it too went into (voluntary) liquidation.

In its report on the reasons for the demise of Compass, the Commission stated that one

of the factors contributing to the demise of the airline was the poor standard of terminal

facilities available to Compass125. This was despite the obligation on both incumbent

terminal lessees (Ansett and Australian) to ‘reasonably negotiate’ on such access. For a

more detailed account of some of the commercial problems that Compass faced as a

result of the conduct of Ansett and Australian Airlines, see Pengilley and McPhee126.

Nineteen ninety one also saw the passage of the Crimes (Aviation) Act 1991 (Cth),

dealing with criminal offences on board or affecting aircraft, or relating to aerodromes

or air navigation facilities, as well as hijacking and sabotage. In addition to adopting the

aviation-related offences contained within the Crimes Act 1914 (Cth) and repealing a

number of earlier statutes concerned with air safety in Australia127, the new Act also

adopted several international conventions dealing with aviation crimes to which 123 It began business on 1 December 1990. 124 So also of course did Ansett and Australian Airlines, but they had greater financial

resources to absorb their losses. 125 Report of Inquiry into the Demise of Compass Airlines, Trade Practices Commission,

1992. 126 Pengilley and McPhee, supra note 101 at p 236, 237


118

Australia was a signatory, such as the Hague Convention 1970, the Montreal

Convention 1971, the Montreal Protocol 1984 and the Tokyo Convention 1963. The

Crimes (Aviation) Act applies differently in different circumstances, and there are

limitations on the extent to which the Conventions apply. NSW has therefore enacted its

own legislation128 to compliment the Commonwealth Act in areas where its powers may

be lacking, even though it does not on its face purport to actually do this.

In 1992, Australia agreed to establish a Single Aviation Market (‘SAM’) with New

Zealand. Although international in nature, this agreement also directly affected

Australia’s domestic aviation market because it granted Air New Zealand cabotage

rights to the Australian domestic market (and of course, vice versa). Apart from one

other (older) arrangement with India, the SAM is the only arrangement under which

Australia allows cabotage by foreign carriers.

Despite the granting of these mutual rights, Air New Zealand and other New Zealand

carriers have to date not chosen to exercise them. Nor has Qantas in the New Zealand

market. Instead, Air New Zealand chose to gain access to the Australian domestic

market through an equity investment in Ansett Australia and an extensive alliance and

code-sharing agreement with Ansett. The granting of cabotage rights to New Zealand

carriers has however had no direct effect on competition within the Australian domestic

market. It is clear that the dynamics of the market place make it difficult to predict what

the results of a grant of cabotage to a foreign carrier in Australia would be, especially if

the grant of cabotage would lead for example to the possible loss of certain exemptions,

such as exemptions from excise taxes on fuel, which the foreign carrier would otherwise

enjoy.

Furthermore, despite the SAM, neither Australian nor New Zealand carriers are

currently able to operate their national registered aircraft in the other’s country without

first obtaining the necessary certificates of airworthiness etc for those aircraft. This is a

major administrative and financial burden for the carriers. Legislation currently before

127 E.g. the Crimes (Hijacking of Aircraft) Act 1972 (Cth) 128 See Crimes Act 1900 (NSW), as amended, particularly sections 204 – 210 inclusive,

353C and 357A. In WA, offences relating to aircraft are primarily dealt with under its Criminal Code, particularly sections 1(2), 258, 294A, 296A, 318A, 378(4a), 390B, 451A, 451B, 565A, and 711A


119

the Federal Parliaments of both Australia and New Zealand, which is expected to be

passed before the end of 2003, will for the first time grant ‘mutual recognition’ to each

others aircraft hereby enabling certified aircraft in each country to fly in the other129.

In 1992, the Federal government decided to allow multiple designation in Australia’s 51

air services agreements (ASAs)130. The objective was to facilitate new entrants into the

Australian aviation market. This in turn required a method of allocating capacity to

enable new schedule carriers to operate on particular routes. Accordingly, the

International Air Services Act 1992 (Cth) established the International Air Services

Commission (IASC) as a statutory body responsible for allocating bilaterally agreed

international aviation capacity negotiated under Australia’s 51 air services agreements.

Capacity is allocated by issuing specific international route licences for Australian

carriers, which the Air Navigation Act 1920 requires them to hold131.

Despite the proactive role of the IASC, its functions appear to overlap with those of the

ACCC in some areas, despite the latter’s often essentially reactive role in regulating

competition. This is particularly so for example in their respective assessments of

applications for code sharing. The IASC’s ‘public interest’ criteria include competition

factors and are arguably wider than the ACCC’s criteria, but other than that, there seems

little point in having the two separate organisations. In recognition of the potential for

overlapping functions and inconsistent decisions, the IASC and the ACCC entered into

a Memorandum of Understanding in 1997 seeking to limit the scope for overlapping

jurisdiction, but Qantas, in its submission to the Productivity Commission in 1998

argued that the ACCC should be the primary body responsible for assessing the

competition policy effects of service proposals132.

In March 1993, Qantas was partially privatised with the sale of 25 percent of its shares

to British Airways133, enabling the development of an alliance between the two airlines

129 See ‘Flying the Open Skies’, The Australian, 25 August 2003, quoting P Harbison as

describing the change as ‘an important thing commercially’. 130 All except nine of Australia’s 51 ASAs are now multi-designated. See Productivity

Commission Report, supra note 79, p 145 131 Air Navigation Regulations 191-197 132 Submission No 67, at p 24 133 Currently British Airways Plc holds 19% of the shares in Qantas Airways Ltd.


120

in 1995134. In order to operate in Australia, the alliance required the permission of the

(then) TPC because its price fixing effects would otherwise breach the TPA. The

alliance’s initial eight-year approval expired in July 2003, and has since been extended

by the ACCC on a temporary basis, pending a detailed review by the ACCC. The

ACCC has said that the extension did not mean that it would not automatically approve

the agreement, forcing BA’s chief executive to warn that if the exemption is not

continued, BA will ‘take a long, hard look at (its) ability to profitably serve Australia,

absent the joint service agreement’135.

Following the passage of the Qantas Sale Act 1992 (Cth), Qantas was fully privatised in

July 1995 by a public float of the remaining 75 percent of its shares. There are however

restrictions on who can own Qantas shares, in keeping with similar restrictions on

nearly all national airlines elsewhere in the world. These restrictions are set out in the

Qantas Sale Act 1992136. They require that the aggregate equity held by all foreign

persons in Qantas does not exceed 49 percent, with the aggregate equity held by all

foreign airlines limited to 35 percent. A single foreign person or airline is prohibited

from holding more than 25 percent137.

The policy of maintaining a strict separation between Australia’s international and

domestic aviation operations formally ended with the passage of the Airlines Agreement

(Termination) Act 1990. This, together with the announcement of the Federal

Government in February 1992 that restrictions on equity investments between

Australian domestic and international operators would be lifted, saw the government-

owned ‘Australian Airlines’ became a wholly owned subsidiary of Qantas in 1994. The

addition of domestic traffic to Qantas’ operating results for 1995 resulting from the

134 See M. S. Simons, ‘Aviation Alliances: Implications for the Qantas – BA Alliance in the

Asia Pacific Region’, 62 J. Air L. & Com. 841 135 See The Australian newspaper, 11 August 2003. 136 Section 7 137 Somewhat similar provisions apply to other Australian domestic and international

carriers, although in the case of the former, the Commonwealth Government is prepared to consider foreign equity proposals in excess of these guidelines, even up to 100% foreign ownership, provided the proposal is ‘not contrary to the national interest’, and provided that the aggregate shareholding held by foreign airlines does not exceed 40%, with no single foreign carrier/person holding more than 25% of the shares. See Air Navigation Act 1920, sec 11A.


121

Qantas – Australian Airlines merger, saw Qantas move from the 43rd to 21st position

amongst world airlines in terms of total passenger boardings138.

The crash of a Seaview Airways charter flight in October 1994, as well as a number of

other accidents which had occurred in an approximately two year period prior to then139,

saw no less than six separate enquiries into air safety being conducted by the end of

1994. It was clear that the Federal Government’s regulatory policies were not working

and that the concerns of the critics of the CAA’s dual incompatible roles were valid.

On 30 March 1995, the Federal government responded to this situation by initiating

moves which fundamentally changed the aviation regulatory regime in Australia. It

abolished the CAA and separated responsibility for the competing and incompatible

functions of air safety and the promotion and development of aviation by creating two

new and independent statutory bodies. These were the Civil Aviation Safety Authority

(‘CASA”) and Airservices Australia (‘AsA’), which were respectively given these

responsibilities.

CASA was created by a series of amendments to the Civil Aviation Act 1988, contained

in the Civil Aviation Legislation Amendment Act 1995. The effect of these amendments

was to remove from the Civil Aviation Act 1988 all the development and operational

aspects of that Act, which were thereafter to be administered independently by AsA. By

divesting the safety and the operational functions of aviation in this way, the existing

Civil Aviation Regulations and other subordinate legislation thereunder were able to

remain in force. Unlike AsA, CASA is not a Government Business Enterprise but is

funded each year by the Federal government. In 2002, CASA made a statutory

authority, reporting directly to the Minister for Transport and not an independent board.

This political control makes CASA vulnerable to adequate funding by the Federal

government, but such is the public sensitivity to aviation safety issues that it would be a

138 Jaggi, G. and Morgan, G. ‘Recent civil aviation experience’, in Hufbauer G. C. and

Findlay, C (eds), Flying High: Liberalising Civil Aviation in the Asia Pacific, (Institute for International Economics, Australia-Japan Research Centre, Canberra).

139 Including the Monarch Airlines crash in 1993 while on a scheduled ‘low capacity’ flight (i.e. 38 seats or less) in central New South Wales, which resulted in the deaths of seven people.


122

‘courageous’ government indeed which starved CASA of the necessary funds to carry

out its functions.

By comparison, AsA was created as a Government Business Enterprise by the passing

of the Air Services Act 1995 (Cth)140. AsA is charged with the responsibility for

developing and maintaining Australia’s aviation system in the broad sense of the term

by taking over responsibility for all the non-safety matters which were previously

carried out by the CAA. Its functions are specifically delineated in the Act so in theory

there is no room for uncertainty as to what constitutes a non-safety issue. In April 2003,

amendments to the Civil Aviation Regulations 1998 saw AsA itself came under the

regulatory control of CASA. Pursuant to these regulations, AsA is issued with a

certificate delineating its specific functions and its performance will be audited by

CASA, the same as any other certificate holder such as Qantas. An obvious future

development under such a regime might be the privatisation of AsA, although there are

currently said to be no plans for this to happen.

The advantage of such a system is that there is now little room for doubt as to whether

or not a function is within AsA’s responsibilities or CASA’s. If the function does not

appear on AsA’s certificate, it is not therefore its responsibility and must be dealt with

by CASA. In this way, in theory at least, there should be no safety-related or other

issues which are left unattended because of confusion as to whose responsibility it is.

3.4 AUSTRALIAN COMPETITION LAW

3.4.1 GENERAL

It is not the purpose of this thesis to examine the general state of competition law in

Australia. Instead it will look at certain specific aspects of competitive behaviour in the

aviation industry, such as predatory pricing, information (CRSs), mergers and

ownership issues. Before doing so however, some key features of the airline industry

will be briefly examined, including the concept of ‘the aviation market’ in Australia.


123

In addition, the operation of competition law principles in the Australian aviation

industry will be limited in this thesis to a consideration of certain aspects of the conduct

of domestic trunk carriers only. While the distinction may be somewhat artificial in the

modern aviation age, where regional, interstate and international networks are so

integrated as to form a continuum of services, it is nevertheless beyond the scope of the

thesis scope to consider competition between state (or ‘regional’) airlines. In addition,

most regional aviation services usually feed capital city airports (‘gateways’), which in

turn are integrated into the national networks of the trunk carriers. In this way, regional

airlines impact indirectly on competition between the major trunk carriers. Previous

studies141 have shown that most regional airlines in Australia tend to be owned or

controlled by one or other of the trunk carriers, for the strategic purpose of ensuring that

regional passengers on-fly with the same trunk carrier (group or alliance) which

transported them to the gateway in the first place. Regional Express (‘Rex’) is the

largest independent full service operator which currently competes with Qantas and

Virgin on a number of routes.

The view has been expressed that both regulation and vigorous competition-law

enforcement is ‘schizophrenic’ in the sense that vigorous competition enforcement is

simply a form of re-regulation142. It is submitted that such views result from the

mistaken view that the regulation of industry is a dichotomous choice between

regulation and no regulation. If instead regulation is viewed as a continuum of options,

to a large extent this resolves the ‘schizophrenia’. For the aviation industry, this

amounts to recognising that some airline regulations have been eliminated while others,

such as safety regulations, remain. Carstensen argues that a harmful false dichotomy is

established by treating “regulation” and “deregulation” as mutually exclusive

categories143.

In general terms, the purpose of competition law is to ensure that the potential benefits

and freedoms of deregulation are not lost by market behaviour which causes the

breakdown of the competitive mechanism. Competition law in the Australian aviation 140 This Act came into effect on 7 July 1995 141 See supra note 120. 142 Alfred E. Kahn, Deregulatory Schizophrenia, 75 Cal. L. Rev. 1059 (1987)


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industry for example is not (or at least should not be) concerned with how airlines

operating in Australia run their business, only that they act competitively in those

operations and not anti-competitively so as to unfairly eliminate competition. Nor

should competition policy be concerned with protecting competitors, only competition.

The law therefore proscribes or regulates conduct that may, actually or potentially, be

anti-competitive. The ‘trick’, as always, is to draw the line so that competitors, having

been urged to compete, are not then ‘turned on’ when they successfully do just that. Too

much government involvement can stifle innovation and competition, but too little can

have exactly the same effect. Drawing the line often requires fine judgement and is

seldom easy.

In the course of understanding how competition law works in the Australian aviation

industry, it will be necessary to examine what is meant by ‘the aviation market’ in

Australia. Determining the relevant market for the product or services in issue is the

starting point for virtually all competition issues. Having done this, consideration can

then be given to how competition operates within that market and in particular how

some barriers to entry, such as slots, CRS, airport leases, hub-and-spokes, alliances and

others, prevent or distort competition within the market.

3.4.2 COMPETITION LAW AND THE AVIATION INDUSTRY

Although competition law has been characterised as “humbug based on economic

ignorance and incompetence”144, nevertheless when the Australian airline industry was

deregulated on 30 October 1990 with the abandonment of the two-airlines policy145, the

Trade Practices Act 1974 (Cth) (“TPA”) became the primary means of regulating and

preventing anticompetitive structure and conduct in the industry. Until then, the TPA

was generally considered not even to apply to the aviation industry146. The Government,

143 Peter C. Carstensen, Evaluating “Deregulation” of Commercial Air Travel: False

Dichotomisation, Untenable Theories, and Unimplemented Premises, 46 Wash. & Lee L. Rev. 109, 115 – 116 (1989)

144 Mark D Howe, 1 Holmes – Pollock Letters 163 (Howe ed. 1941) 145 See page 114 – 116 above 146 By virtue of s 51(1) TPA and the plethora of specific legislation supporting the two

airlines policy. See however the 1981 Independent Public Inquiry into Domestic Air Fares which drew attention to the possible limits of the exemption, suggesting that care


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having decided that the airline industry did not warrant any further special

considerations from a competition point of view, either by way of amendments to the

TPA or by the introduction of industry-specific legislation147, opened the airlines to the

full force of competition.

The wheel had clearly turned a full circle in a period of some forty years. The very issue

of promoting competition which had been the genesis of the two-airlines policy in 1952,

was also the reason for its termination on 31 October 1990. The critical difference was

‘the range of mechanisms available to the Government in 1990 which were simply not

in existence in 1952’148.

The main sections of the TPA which are considered to have particular impact on the

aviation industry in Australia are sections 45 (prohibiting price fixing, collective

boycotts and anti-competitive arrangements), 46 (prohibiting misuse of market power),

and 50 (regulating mergers and the development of monopoly situations), together with

Parts VII (sections 88-95) and IX (sections 101-110), which deal with authorisations of

otherwise illegal mergers, price fixing, boycotting and anti-competitive arrangements on

the grounds of “public benefit”149. In this thesis we will examine only a limited number

of behaviours in the industry which are affected by some of these sections, in particular

predatory pricing, mergers, and the use of CRSs and other information systems to

unfairly compete against new entrant airlines.

Much has been written on the subject of competition in the aviation industry, especially

in the U.S., because of the alleged historic prevalence of anti-competitive conduct in the

be exercised by the Minister (as administering authority) in distinguishing those airline practices that were exempt and those that may not be.

147 This was very different to the U.S. and Canada which both passed aviation-specific deregulation legislation. In 2000, Canada introduced even more aviation-specific legislation to regulate competition in its airline industry. Although the ACCC has also suggested that aviation-specific legislation might be of benefit to Australia, no steps have been taken in this direction. See McCallister, infra note 197 at 234.

148 D Campbell, ‘Competition Policy in Domestic Aviation or The Rise and Fall of the Two Airlines Policy’, p 24, in Competition Policy in Telecommunications and Aviation, S. G. Cornes (ed), (Federation Press, 1992).

149 See W Pengilley, supra note 107 at pp 121-122, and pages 121- 178 for an analysis of how these sections relate specifically to the aviation industry in Australia.


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industry throughout the world150. The motives for such practices abound, although it is

typically the desire to gain additional market share that drives them. The practices

which have attracted the attention of the Regulators include anti-competitive practices

such as collusion on prices, abuses of dominant position such as predatory practices

aimed at driving out other competitors, and mergers between entities which jeopardise

competition through substantially enlarged market shares. One of the key tasks of

regulation, identified by Prosser, is the prevention of such practices151.

The problem is complicated in aviation because of its international character and

because much anti-competitive conduct was (and to some extent still is), officially

sanctioned by governments, even in some so-called leading countries of the world152.

One of the key assumptions behind the rationale for using competition law to prevent

practices which have an adverse effect on competition, is that conditions of sustainable

competition can be established either through the natural process of the marketplace or

through deliberate regulatory actions. A major difficulty in aviation however is to define

the conditions of economically sustainable competition and to identify when this state

of competition has been achieved. This is partly because of the unique problems of

structural imbalance in the industry, such as the scarcity of airport slots for landing and

takeoff for example, which, together with numerous other inherent characteristics of the

air transport industry, inhibit the cultivation of competition on a major scale. It is also

partly because the airline industry, in nearly all countries, is almost never in a state of

equilibrium, so it can rarely be said whether or not a condition of sustainable

competition has been reached or not.

The British government, in a policy White Paper on competition in its aviation

industry153, recognised that the level of competition in the industry was heavily

dependent on market capacity that could not always produce sufficient demand to attract

competitors and new services because of these inherent structural problems. The report 150 See for example: Paul S Dempsey, Predation, Competition & Antitrust Law:

Turbulence in the Airline Industry, 67 J. Air L. & Com. 685 (2002) 151 T Prosser, Law and the Regulators (Clarendon, Oxford, 1997), p 5. 152 E.g Japan. See G Fisher, ‘1998 Amendment to the U.S. - Japan Civil Air Transport

Agreement: The Battle May Be Won, but the War for Open Skies is far From Over’, 9 Minn.J. Global Trade 327


127

concluded that fares and route patterns should preferably be determined by market

forces, while at the same time ensuring that airlines are continuously open to challenge

by new competitors. The problem is how to ensure that this happens.

It was clear that the authors of the White Paper intended competition law not to play a

role in the regulation of the industry until the conditions of sustainable economic

competition had been achieved. This was considered to occur only when, in general

terms, economic regulation had reached the stage of critical market contestability, as

conceived by Baumol et al154. Boumol et al argued that optimal price and output

conditions could and would be achieved even with very few competitors (or even only

one competitor) provided the market had certain special characteristics which made it

‘perfectly contestable’. Airline markets, which, even when unregulated, appeared to

involve the presence of relatively few airlines in any given city-pair market, seemed

naturally to invite analysis using contestability theory rather than orthodox competition

theory. Unlike perfect competition theory, the theory of market contestability did not

require that a large number of firms compete in any given market in order to achieve

efficient performance. The theory assumed instead that non-participating producers can

be such perfect potential entrants that they can offer a supply when response when

monopolists charge higher than competitive prices and produce lower than competitive

output. It was this potential supply response which would force monopolists to produce

the optimal output and price characteristics of competitive markets.

Although it was quickly demonstrated that contestability theory requires costless entry

and exit on the part of competitors155 (which clearly does not exist in the airline industry

which, to the contrary, is characterised by unusually high start-up costs), contestability

was nevertheless considered to be more realistic for aviation analysis than the theory of

perfect competition, even though it was upon the latter that the U.S. Airline

Deregulation Act 1978 had been firmly based. Contestability predictions are however

easily testable and the theory has in fact turned out to be almost as inadequate as a

153 Airline Competition Policy (Cmnd. 9366, 1984) 154 W. Baumol, J.Panzar and R.Willig, Contestable Markets and the Theory of Industry

Structure (Harcourt Brace Jovanovich, New York: 1982) 155 Spence, Contestable Markets and the Theory of Industry Structure: A Review Article, 21 J. Econ Lit 981 at 987 (1983)


128

predictor of the behaviour of deregulated airline markets as perfect competition has

proven to be156.

For example, following deregulation, it was predicted that incumbents, with their

regulatory-era ‘hangovers’, including suboptimal route and pricing policies as well poor

technology (e.g. inefficient wide-bodied aircraft), would be at a competitive

disadvantage compared to new entrants and would quickly disappear from the scene

unless they adapted themselves to a low-cost structure. Many of the incumbents did just

that. In fact they adapted so quickly and so well that in many deregulated aviation

markets today, they are virtually the only survivors. This is the case even though it has

been shown that in the U.S., with the single exception of Continental Airlines (which

transformed its cost structure using bankruptcy laws to do so), no holdover carrier in the

U.S. has been able to lower its unit costs to new entrant levels in comparable markets.

For example, in 1986, eight years after deregulation, average holdover operating costs

in the U.S. for the incumbents were 7.2 cents per available seat mile (ASM), while for

new entrant airlines the figure was 6.2 cents – a cost advantage to the low cost new

entrants of approx 15%157. Ten years later, by the mid-1990s, the margin was probably

even wider. One of the leading new entrants, ValueJet, prior to its permanent grounding

in 1996 when one of its planes crashed into the Florida Everglades, still had operating

costs of only 6.5 cents per available seat mile (i.e. almost unchanged in 10 years), while

American and United Airlines had costs nearly double that on 500 mile stage lengths158.

In the long haul wide-bodied aircraft category, another new entrant, American Trans

Air, had ASM costs of only 4.1 cents, compared to American and United’s 8.5 cents per

ASM159.

Despite this substantial cost advantage, American Trans Air no longer operates. On the

other hand, United still does. Although it went into bankruptcy in 2002, this was only

156 S. Morrison & C. Winston, The Economic Effects of Airline Deregulation (1986) at 60,

finding that perfect contestability is not present in the airline industry because carriers must absorb sunk costs and require time to obtain gate space and establish patronage.

157 DOT Form 41 Returns, 1986. Analysis by I.P. Sharp Associates, New York. 158 Roberts Roach and Associates, Scorecard: Airline Industry Cost Management, 2Q 1995

12 (3rd ed. 1996) 159 Id


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because of a major downturn in the U.S. aviation industry following the events of

September 2001, and not because of competition from the lower cost new entrants.

Although the cost margin in favour of the new start airlines is believed to be only of the

order of 5% today as a result of drastic cost cutting by the incumbents160, even that

margin is significant in such a competitive industry as aviation, and should in theory

spell the end of the higher cost operators. Yet many of them still survive, and even

continue to dominate the industry.

It is likely that similar results would be revealed in Australia.

Economic theory is highly relevant to competition law because the latter is often based

on the former, both in Australia and overseas. For example, in the U.S., the Airline

Deregulation Act 1978 was unashamedly based on a perfect competition model of

business behaviour as it was then understood, while in Australia, a reading of the TPA

also gives the clear impression that some at least of its regulatory provisions, especially

those in Part IV of the Act, appear to have been lifted directly out of the economics

textbooks on perfect competition theory. This is not necessarily to say that the

assumptions behind the TPA are inapplicable in any given situation simply because of

the existence of market imperfections which may qualify the relevance of the theory.

Price fixing for example restricts competition whether the theory says so or not. But it is

to recognise that the assumptions behind the competition legislation of a number of

countries, including Australia’s TPA, simply do not conform to many modern market

realities.

This is particularly so in the aviation industry, and results in competition case decisions

often illustrating a certain ‘tension’ and inconsistency as the courts strain to

accommodate actual market behaviour with the often highly theoretical assumptions

about the marketplace, upon which the legislation which they are interpreting is

based161.

160 See Lanik, infra note 175 at 513. 161 For example, the High Court in the Boral case (infra note 363) disagreed strongly with

the Full Federal Court’s decision (infra note 262) in a detailed analysis of predatory pricing allegations under the TPA. While it is not of course unusual for an Appeal Court


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For example, the notion of ‘competition’ as defined in s4E TPA includes goods or

services that are ‘substitutable or otherwise competitive with’ other relevant goods and

services162. Similarly s 50(3) reflects a prominent economic influence in dealing with

the always controversial issue of airline mergers. Yet with even Boumol’s contestability

model of business behaviour having been shown to be sadly lacking as a predictor of the

actual behaviour of deregulated airlines, one is entitled to wonder how an Act such as

the TPA, based, apparently, on perfect competition concepts, could possibly be relevant

to the regulation of an industry such as aviation whose conduct, at least since

deregulation if not before, has defied prediction in so many areas for so long.

Furthermore, airline regulators are frequently accused of using perfect competition

concepts as their primary point of reference when analysing allegedly anticompetitive

conduct in the aviation industry, instead of aiming for effective long-term sustainable

competition in the industry. Too much regulatory response, it is alleged, is based on a

short-term view of market behaviour, instead of taking the longer tern view163.

Yet another reason why competition issues continue to be of major importance in the

aviation industry is that aviation carriers have found that the complexity of the modern

aviation marketplace is such that there are almost inexorable pressures on them to form

alliances or other forms of interconnection, in order to provide the necessary range and

flexibility in their products which consumers of aviation services now demand. Carriers

realise that they simply cannot serve all markets or sub-markets in the aviation industry.

Since aviation merger and takeover is almost universally regulated, if not prohibited,

airlines have resorted to many different forms of ‘interconnection’ between themselves

to provide a complete range of services to consumers, such as CRSs, frequent-flyer

schemes, slot and gate exchange arrangements, code-sharing and other forms of

information sharing. While these interconnections may allow an airline to provide a

wider range of services than would otherwise be possible, they all have one thing in

to overturn a lower court decision, the wide extent of the High Court’s disagreement with the Federal Court in Boral is somewhat unusual.

162 N R Norman, Economics and Competition Law: How Far Have We Come?, in ’25 Years of Australian Competition Law’, R Steinwall (ed), (Butterworths, 2000) at p 87

163 See for example Nicotra, infra note 166


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common: they lessen competition, either potentially or actually. Sometimes, they also

amount to, or are used as, instruments for predatory conduct.

Another major problem with applying competition law to the aviation industry is the

time factor. In re Tooth & Co Ltd164, the Australian Competition Tribunal, in its early

form as the Trade Practices Tribunal, said that “……in our judgement, given the policy

objectives of the legislation, it provides no useful purpose to focus attention upon a

short-run, transition situation. We consider we should be basically concerned with

substitution possibilities in the longer run”165. The trouble is that the aviation industry

in Australia and elsewhere is in such a constant state of flux that it can be argued that

regulatory authorities world-wide are nearly always observing a state of disequilibrium

in their local industries, caused either by regulatory change, exit and entry of

competitors, major industry disruption, and innovation and technology, all or several of

which are more or less constantly present.

As a leading Australian lawyer on the subject of aviation competition law put it: “If

regulators assess the legality of conduct within too short a period of time, there is a

serious risk that the observed “power” is overestimated. Intervention on the basis of this

overestimation may seriously distort the competitive process by distorting market

signals. It is interesting to note that in early 2001, from the ACCC’s perspective, Ansett

possessed too much power, so that it could be used to lessen competition A requirement

was imposed upon Ansett that it relinquish valuable airport terminal slots, but within

months it had moved to failing and exiting the market”166.

It may well be the case that much of the tension which seems to exist between

regulators and airline operators word-wide has as its genesis the different treatment of

time. The industry alleges that the regulators too often take a short-term view of market

behaviour and respond in such a way that longer term objectives are jeopardised167. The

trouble is that usually airline operators are also forced to operate with a limited time

164 (1979) ATPR 40-113 165 Id at 18,197 166 Aldo Nicotra, Practitioner’s Perspective on International Regulatory Developments in

the Airline Industry, 14 DePaul Bus. L.J. (Spring 2002), 263 at 265. 167 Id


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horizon because the industry is so fundamentally unprofitable that every short-term

profit opportunity must be taken.

3.4.3 KEY FEATURES OF THE AUSTRALIAN AVIATION INDUSTRY

Before examining the market for aviation services in Australia, some understanding is

required as to the nature and key characteristics of the aviation industry in Australia.

Some of these characteristics will of course be in common with the aviation industries

of many other nations as well.

• Concentration

The first factor to consider is market concentration. In the U.S., the primary device for

the measurement of market concentration in an industry is an index known as the

Herfindahl-Hirschman Index (HHI)168. This measure is arrived at by squaring and

summing the relative market shares of competing firms. The problem is that there are a

number of competing measures of market share ranging from the size of the fleet to

number of routes served. Probably the most common measure is revenue passenger

kilometre, computed by multiplying the number of paying passengers by the number of

kilometres flown for a given sector.

For the U.S. aviation industry, the HHI index measured approx 800 for the decade 1977

– 1987 on a national market basis, signifying low concentration, but measured an

average of approximately 2500 on a local market basis for the same decade, equating to

a high market concentration169. Extensive merger activity and liquidations in the U.S.

aviation industry since then would result in the comparable figures being significantly

higher today. Obviously, the degree of concentration in an industry depends on how its

markets are defined.

Because of the entirely different structure of the U.S. economy to the Australian

economy, including their respective aviation industries, these measures (and perhaps 168 R.Klingaman, Predatory Pricing and Other Exclusionary Conduct in the Airline

Industry: Is Antitrust Law the Solution?, (1992) 4 DePaul Bus. L. J. 281 at 290.


133

the HHI index generally) may not be appropriate measures of concentration for the

Australian aviation industry. Assuming however that they do apply, and assuming that

the market for aviation in Australia is the whole of the domestic passenger market, the

index for the current industry structure, in which Qantas holds about 70% of the

Australian city-pair domestic market and Virgin Blue holds the remainder, would be of

the order of approximately 5,800, which on the HHI index would equate to a very high

measure of concentration indeed. Even during the short period from June 1999 to

September 2001 when competition reached an historical peak in the Australian industry

with Qantas, Ansett, Virgin and Impulse all competing vigorously for the city-pair

market with percentage market shares of approximately 50, 30, 10 and 10 respectively,

the HHI would have measured approx 3700, also indicating very high concentration

even in that market.

A highly concentrated market would indicate the likelihood of market dominance,

which of course is the market reality in Australia as a direct result of Qantas’ historical

endowment170. Market dominance in turn has a direct bearing on the conditions of

competition, such as creating higher barriers to entry. For example, in considering the

Lufthansa / SAS alliance, the EU Commission commented that the greater frequency of

operation of the two airlines on all routes increased the economic power of the merging

airlines. It also said that the two airlines will “have an economic strength which will act

as a substantial barrier to entry on all routes between (the two countries)”171. If the

Commission referred to size alone as a potential barrier to entry, it is submitted that it

mistakenly did so. Size by itself cannot be an entry barrier, since it is a factor which is

reproducible by an entrant, given conditions of unrestricted entry and competition. Only

economies of scale together with sunk costs can constitute an entry barrier.

In any event, market dominance does not appear to have hurt Qantas. Although the

Australian air transport industry has been privatised since 1990, Qantas continues to

169 P Flint, Too Many Mergers, Too Little Competition?, Air Transport World, Jan 1988, at

81, 131 170 It is also the case in the U.K. where, despite it having the largest and most diverse

airline industry in Europe, British Airways still accounted for 83% of the total scheduled ‘revenue-passenger-kilometres’ in 1992. See ‘Airline Competition in the Single European Market’, CAP 623 (1993), para 7.

171 Commission Decision 96 / 180 / EC [1996] O.J. L54/28


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enjoy a relatively stable market share172 compared to other Australian operators by

virtue of its established network of routes, fleet size, publicity and slots, particularly in

Sydney and Melbourne Airports where slots are particularly scarce.

The level of concentration in a market is only one of nine (non-exclusive) factors set out

in s 50(3) of the TPA, which “must be taken into account” by the ACCC in assessing

whether or not an acquisition or merger is likely to substantially lessen competition in

the market in question. The other eight of these nine factors help to shift the emphasis

away from an industry’s structural features and more towards the conduct or behaviour

of the firms within the industry, which is consistent with trends in the U.S. and

Canada.173.

• Market Structure

It has been said that in the past, a misguided emphasis on industry structure, together

with use of inconsistent and unpredictable models of economic theory, resulted in

competition laws becoming nearly unenforceable174. Nevertheless, industry structure is

still a vital component of determining competitive behaviour, so it is to the structure of

the Australian aviation industry that attention is now directed.

A feature of aviation industries is that, at least in the two most important aviation

countries where the market is sufficiently large and diverse175, their structure tends more

or less naturally towards that of an oligopoly comprising a relatively small number of

operators selling a more or less identical product, namely air transportation from point

A to point B176. There have been several studies of this tendency and a number of

reasons offered for the phenomenon177. On the other hand, in some other potentially

172 Ignoring one-off disruptions such as the collapse of Ansett on 14 September 2001. 173 See Rowley and Baker, International Mergers – the Antitrust Process (2nd ed, Sweet &

Maxwell, 1996). 174 L.E. Gessel and M.T. Farris, Antitrust Irrelevance in Air Transportation and the Re-

Defining of Price Discrimination, 57 J. Air L. & Com. 173 at 193 (1991) 175 E.g, the U.S. and the E.U. aviation markets. See for example James C Lanik, Stopping

the Tailspin: Use of Oligopolistic and Ooligopsonistic Power To Produce Profits in the Airline Industry, 22 Transp. L.J. 509 at 515 (Spring 1995), re the U.S. airline industry.

176 Typically, an oligopoly consists of one or a few dominant players who supply most of the market, and several smaller players who share the rest.

177 See e.g. E.A. Friedman, ‘Airline Antitrust: Getting Past the Oligopoly Problem’, 9 U. Miami Bus. L. Rev. 121 (Winter 2001); and see J.C. Lanik, supra note 175.


135

large aviation markets178, any tendency towards oligopoly may be actively discouraged

or even prevented in favour of monopoly or a controlled structure, either as a result of

government regulation or because the industry has not yet developed sufficiently in

those markets.

According to classic economic theory, one of the characteristic features of oligopolies is

that competitors make their price and output decisions in anticipation of the reactions of

their rivals rather than consumers179, instead of pricing their services based upon their

marginal cost. Such pricing is invariably not in the best interests of consumers. It

means that oligopolistic firms will not reduce prices to increase sales because, since

others will match the price, such action is fruitless. Instead, oligopolistic competitors

tend to compete with each other through advertising, product differentiation and service

rather than price competition, which in oligopolistic industries at least, are largely

viewed as self-destructive180. The lack of price competition in oligopolies is exacerbated

where, as in the airline industry, there are high barriers to entry, created either by

government or by the airline industry itself, which largely nullifies the threat of start-up

competition as a deterrent to oligopolistic pricing.

It is clear however that in the airline industry, price wars amongst airlines frequently do

occur, despite the industry’s oligopolistic structure181. This is especially true in the U.S.

and (to a lesser extent) the E.U. It has in fact been suggested182 that the reason why the

airline industries of both the U.S. and the E.U. have not earned oligopolistic ‘rents’ for

most of their history has been the prevalence and intensity of the price wars within

them183. The same would no doubt also apply to Australia, where price wars have also

178 For example, the Russian, Japanese, Chinese and Indian aviation markets are heavily

government regulated. 179 F Scherer, Industrial Market Structure and Economic Performance, 134 - 135 (1970) 180 R L Heilbroner & L C Thurow, Understanding Microeconomics, 175 (1975). Price

competition is only considered to be rational (in theory) if the price competitor is later able to recoup the revenue lost as a result of reducing his prices. This requires some degree of market power.

181 Described as ‘schizophrenic’ price behaviour. See Dempsey, infra note 213 at 3-7 182 Lanik, supra note 175 at 529 183 Far from earning oligopolistic rents, the U.S. aviation industry as a whole is reported to

be currently on the brink of ruin and close to bankruptcy. Its debt has been reduced to ‘junk’ status, debt-to-equity ratios of airline companies within the industry exceed those in any other industry, the U.S. Air Transport Association expects the net loss for 2001-2003 to nearly equal the net profit for 1995-2000 with a net loss of US$18 billion for 2001-2002 and a projected loss of US$5.5 billion for the 2003 FY. Insurance costs have


136

occurred. For example, during the period 31 August 2000 and 14 May 2001, when no

less than four carriers (i.e. Qantas, Ansett, Virgin and Impulse) were competing on

many trunk routes in Australia, fares as low as $33 for the Brisbane – Sydney route and

$66 for the Melbourne – Sydney route were offered by Impulse Airlines in an attempt to

gain market share.

It is another characteristic of oligopolies that a price leadership role is often undertaken

by one of the industry’s relatively smaller players, a role which the smaller player

usually takes very seriously and which the dominant firms are more than happy to allow

- if for no other reason that it shifts the spotlight away from the possibility of their own

price-fixing activities, thereby removing them from accusations of misuse of market

power or monopoly pricing. Instead, any price-fixing considerations by the regulatory

authorities must necessarily focus on the (non-dominant) industry price setter who,

without necessarily any collusion, simply “signals” price changes to the industry which

all other competitors either accept or decline (but usually accept). This practice, known

as “conscious parallelism”184, occurs because large competitors in nearly all industries

are notoriously reluctant to compete on price if they can avoid it185. Usually therefore,

“signals” are accepted, especially if they reflect market conditions at the time they are

announced (and the price signaller invariably goes to considerable trouble to ensure that

this is indeed the case), so market shares remain largely undisturbed186.

tripled since the first quarter of 2001. See R.I.R. Abeyratne, The Sustainability of Air Carriers and Assurance of Services, (2003) 68 J. Air L. & Com. 3. See also ‘Conflict may send airlines bankrupt’, The Australian Financial Review, March 13 2003, stating that nearly all U.S. carriers are in serious financial trouble and that the industry could lose US$10.7 billion in 2003.

184 See, e.g. Reserve Supply Corp. v Owens-Corning Fibreglass Corp., 971 F. 2nd 37, 41 (7th Cir. 1992) where parallel behaviour in an oligopoly, without other factors, failed to establish a ‘contract, combination or conspiracy’, which is a prerequisite to invoking section 1 of the Sherman Act in the U.S. See also W. Pengilley, ‘The Nature of a “Contract, Arrangement or Understanding”’, supra note 107 at pp 126.

185 It only makes rational sense if a competitor has sufficient market power to be able to recover the costs of engaging in price competition, at a later time. Having said that, it needs to be repeated that most aviation markets, including Australia, have witnessed fierce price ‘wars’ on frequent occasions.

186 See Kahn, supra note 142


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This for example has been the traditional role played by Bethlehem Steel in the U.S.

steel industry, even though it had only about 10% of the market for steel in the U.S.187.

At the same time, because of its (relatively small) size, Bethlehem was more or less

immune from monopoly price-fixing accusations188.

A variation of this behaviour can also occur on the cost side of an oligopolistic industry.

Thus for example on 10 February 1995, Delta Airlines in the U.S. announced to the

industry its decision to cap the commission it was willing to pay to travel agents at

US$50 per round ticket and US$25 per one way ticket189. It did this because, in an effort

to buy more and more traffic, airlines had bid up the cost of travel agent commissions

from 3.4% of total operating expenses in 1980, to 10% in 1990 – a 300% increase.

Within three days, all other U.S. carriers had announced that they too intended to follow

Delta’s lead. Industry-wide savings the following year were estimated to amount to

US$400 million190. It was a risky decision to take. Had the industry not followed Delta,

travel agents would likely have skipped over Delta’s listings on their CRS screens.

This example of Delta Airlines has been offered as proof of the oligopolistic nature of

the U.S. airline industry, the argument being that because travel agents did not have the

power to shift bookings away from Delta, the industry is ‘truly’ oligopolistic191.

• Australian Duopoly

In Australia, a duopolistic aviation industry structure tends to prevail and nearly always

has done so, although on occasion, more than two have competed192. Appearances

187 This was its approximate market share at the time it filed for bankruptcy in 2001. It was

subsequently taken over by the International Steel Group. 188 At its peak, Bethlehem was the second largest steel producer in the U.S. behind United

States Steel, but its market position declined after World War II allegedly because it failed to modernise and thus became uncompetitive with modern electric-arc steel making technology.

189 J S Hirsch, ‘Airlines’ Move to Trim Commissions to Agencies May Boost Ticket Prices’, Wall St J., 13 Feb 1995 at B3.

190 Id 191 Lanik, supra note 175 at p 531 192 For example, between 1 June 1999 and 14 September 2001, the demand for Australian

airline services was met by the following airlines, in competition with each other: • Qantas and its subsidiaries Airlink, Eastern Australia Airlines, Southern

Australia Airlines, and Sunstate Airlines


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contrary to a duopoly can be misleading because many ‘second tier’ airlines in Australia

are in fact owned by one or other of the major airlines. A genuine oligopoly has rarely

existed in Australia which, like Canada, has often struggled to support even a duopoly

of two long-term domestic trunk carriers193. In fact, whenever there have been more

than two operators in the Australian aviation industry194, it has been plagued with

instability and heavy price discounting.

It is claimed that there is in fact no example in the world of a country of Australia’s

population size supporting more than a single viable major airline, let alone two195.

Canada for example, despite having nearly twice the domestic market of Australia and

with an Open Skies agreement with its U.S. neighbour, recently lost its second largest

airline (Canadian Airlines) to merger with Air Canada in December 1999, creating a

very dominant carrier in that country. Despite its dominance, Air Canada lost Can$1.25

billion in 2002196 despite controlling approximately 90% of the aviation market

revenues in eastern Canada197.

• Ansett and its subsidiaries Aeropelican Air services, Hazelton Airlines, Kendell

Airlines and Skywest Airlines • Impulse Airlines (until 14 May 2001, when it leased all its aircraft to Qantas) • Virgin Blue (from 31 August 2000) • Various regional airlines that do not primarily or substantially operate between

capital cities in Australia. Source: ACCC Statement of Claim, ACCC v Qantas Airways Limited, Federal Court action, Sydney Registry, filed 2002.

193 In fact, following the demise of Ansett Airlines on 14 September 2001 the Australian aviation market was in effect a monopoly. Although Virgin began operations on 31 August 2000, it operated only a restricted service at the time of the collapse. Qantas had in excess of 90% of the domestic market for a short time.

194 E.g. between 1952 and 1957 when TAA, ANA and Ansett were operating. Also in 1992 when Compass joined Qantas and Ansett for just over 12 months, and for a period in 2001 when no less than four trunk operators were competing (See supra note 192). Ansett’s liquidators have suggested that the seeds of Ansett’s subsequent demise in 2001 were sown during the discount war during 92-93 with Compass.

195 P Harbison, National Competition Policy and Corporate Failures: The Ansett Storey, Centre for Asia Pacific Aviation, March 2002, p 5. Published in www.aph.gov.au. Note however that because of the relatively large distances which each flight in Australia typically travels, compared (say) to the E.U., measured on an available-seat- kilometre (ASK) basis, the Australian aviation industry is significantly larger in world terms than if measured simply in terms of population served.

196 Id 197 D. McAllister, An International Perspective on Anti-Competitive Pricing Practices by

Dominant Carriers and Regulatory Rules to Facilitate Competitive Entry – Canada, 14 DePaul Bus. L.J. 231 (2002) at 233.


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Assuming that it is realistic to try and maintain two airlines in Australia198, pricing and

other competition issues therefore need to be considered in the context of a duopoly,

rather than an oligopoly. No other structure is considered feasible for Australia, or

perhaps even desirable199. This raises the question of whether or not the plethora of U.S.

competition literature on the subject of its aviation industry is applicable, with suitable

modification, to the Australian aviation industry with its essentially duopolistic industry

structure.

The weight of academic opinion is that oligopoly market theory is in fact applicable to

duopolies200. This means that despite the difference in structure between the Australian

(duopoly) and U.S. (oligopoly) trunk aviation industries, much of the airline

competition literature emanating from the U.S. does have direct application to the

Australian aviation industry, with of course appropriate modification201. An example of

such modification is that certain market behaviour in the U.S., such as the issuing of

“recommended prices” and the joint acquisition of goods or services, is illegal per se in

that country, which is not the case in Australia202. This is in recognition of the smaller

number of competitors in most Australian markets and the frequent need for small

businesses in Australia to band together to offer what may be the only effective

competition in a market.

Another difference, already stated, is that U.S. courts tend to approach predatory pricing

issues by comparing the cost of the services offered to the price being charged for those

services and then drawing inferences from the comparison203. Australian courts have

198 Harbison supra note 195 p 5. Harbison argues that it is realistic to do so - indeed,

incumbent to do so - but only if the correct Government policies are in place, which he considers is currently not the case.

199 Id 200 See for example Leonard F. Herk, Consumer Choice and Cournot Behaviour in

Capacity Strained Duopoly Competition, 24 Rand J. Econ. 399 (1993). 201 See for example Lanik supra note 175 at p 521 who asserts that a duopoly is merely a

specific type of oligopoly, in much the ‘same way that a square is a specific type of rectangle’ and that the theories of one hold true for the other. This widely accepted view appears to derive its authority from game theory. See Herk, id. Note however that no single theory can yet explain all oligopolistic behaviour in the aviation or any other industry, and should not be allowed to stand in the way of market realities.

202 See TPA s 45A. A number of small business price recommendation agreements have been authorised by the ACCC.

203 See Dempsey, supra note 150 at 806; and see Klingaman, supra note 168 at 299.


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expressly rejected such an approach204, but at the same time recognise that cost / price

comparisons may be relevant.

It has been suggested that Australia’s current duopolistic aviation industry structure,

comprising Qantas (offering a ‘full service’) and Virgin Blue (offering a cut-price

service) on trunk routes is ‘ideal’, at least for present market conditions following the

downturn in the world aviation market after September 11, 2001205. It is true that the

Australian aviation industry has remained profitable during this period206, when nearly

all other airlines, particularly those in the U.S. and Europe, have incurred heavy losses.

Harbison however suggests that rather than describing the present structure as ‘ideal’, it

is more in the nature of a (lucky) ‘bonus’ which is ‘unlikely to be repeated without

strong and realistic government policy input into the industry’, which he claims is

lacking207.

• Mobility

One of the unique features of the aviation industry is that its major item of ‘plant and

equipment’, namely a jet aircraft, is not only very expensive208 but it is also highly

mobile – in fact there are probably no more mobile pieces of tangible plant or

equipment in any other industry comparable to the mobility of a jet aircraft, which

could, in theory at least, redeploy itself virtually anywhere in the world within 24 hours

and be immediately ready to provide aviation services at its new location.

204 See Eastern Express infra note 223 at 72 205 See Terry McCrann, ‘Airline plans wouldn’t be make believe if you believed in me’,

The Australian, 2002. 206 Qantas declared an annual profit for 2002/2003 of $343.5 million, while Virgin Blue

announced a corresponding net profit of $158 million, pre-tax. Note however that Qantas reported to have lost $34 million in the six months to 30 June 2003. See ‘Qantas dives into the red’, The West Australian, July 17, p 37

207 Harbison, supra note 195 p 6 208 For example the cost of a Boeing 737-700, one of the most popular medium sized

commercial aircraft in the world (approx 150 seats), is approximately Aust $80 million, while the cost of a large sized carrier such as a Boeing 747 is approx Aust$300 million, depending in each case on configurations and options.


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Once in service, a single jet aircraft has the potential to earn considerable revenues for

its operator. For example, a 200 seat jet aircraft costing (say) about Aust$180 million209,

landing and taking off six times per day (i.e. 12 ‘movements’), on a $200 per seat (one

way) city-pair route, for 350 days of the year (approx one day per month downtime for

maintenance), with an average load factor of fifty percent210, will generate annual

revenues of approximately Aust$42 million dollars for its operator.

In the above example, for every one percent increase in the load factor (which is

perhaps the only variable on the demand side which is totally under the control of the

operator), the annual revenue generated by the aircraft increases by $840,000, often for

very little cost increase other than the cost of a meal. It is clear why airlines spend so

much of their resources on advertising and promotion, such as frequent flyer and other

loyalty schemes, in order to increase their load factors. At an 85% average load

factor211, in the hypothetical example set out above, the annual revenues for the aircraft

total Aust$71.4 million.

At one time it was thought (erroneously) that this feature of aircraft mobility was the

key to ease of entry into an aviation market. If surplus capacity arose in an aviation

market in some part of the world, so the argument ran, those surplus aircraft could be

moved literally overnight to another part of the world where demand was exceeding

supply. Only later was it appreciated that other structural and government imbalances in

the aviation industry worldwide provided formidable barriers to entry which mobility

could not overcome212.

209 E.g. a Boeing 757-200. Depending on options, such an aircraft could be leased today for

approx Aus$750,000 per month. 210 Load factor is a ratio measured as traffic (revenue-passenger kilometres, or RPK)

divided by capacity (available-seat kilometres, or ASK), i.e. Load factor = RPK/ASK. 211 This figure is not unrealistically high. According to AEA, average load factors for its

member airlines in July 2003 - in the midst of a severe economic downturn - averaged 77.8%. See ‘Airline traffic on rise but profits won’t follow yet’, The Wall Street Journal, quoted in The Australian Financial Review, 9 September 2003. Similarly, Qantas’ load factor figures for August 2003 were 82.1% for international flights, although its yield was slightly down. See ‘Airport growth flies higher’, The Australian newspaper, 23 September 2003.


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• High Fixed Costs

The above example also illustrates the high fixed-cost structure of the aviation industry.

With the industry’s major items of plant and equipment capable of earning such

potentially high revenues, why is it that most airlines worldwide earn such a low rate of

return on those assets213, even when times are good and load factors average 80% and

more. The answer is the industry’s high fixed costs, which means that airlines are very

sensitive to changes in demand, and therefore changes in load factors, such as occurred

recently with the outbreak of the severe acute respiratory syndrome virus (SARS).

High input costs present a formidable barrier to entry into the industry. They are the

establishment costs that must be ‘sunk’ before an airline can begin operating. Entry

costs are higher for a new entrant when compared to an incumbent that merely wishes to

expand. For example, unless a new entrant can point to an operating ‘track record’

elsewhere, its up-front insurance costs would be expected to be higher than for an

incumbent. Aviation insurance costs, now a major component of an airline’s costs, have

tripled since 2001 following the events of September 11 of that year.

New entrant airlines typically structure their operations to be low-cost. This is where the

expected growth in the market is due to occur, because full-service airlines are simply

unable to match the costs of low-cost competitors and are therefore losing market share.

However, the operating costs214 of low-cost airlines such as Virgin Blue are estimated

to be only about 5% lower than a (relatively) high cost operator such as Qantas215. It is

clear however that even a 5% cost advantage may well be crucial in an industry such as

aviation that often appears to be operating at the margin of profitability.

Airlines’ sensitivity to demand fluctuations due to their high input cost levels explains

why so many incumbent airlines around the world are either restructuring themselves as 212 See pp159 - 161 below. 213 It has been calculated that in the fifteen years following deregulation in the U.S. in

1978, the net profit of the airline industry worldwide equalled only 0.6% of revenue. Gross revenues equalled $2 trillion and operating expenses equalled $1.96 trillion. Operating profit was just 2% of revenue. See Paul S Dempsey, The Prospects for Survival & Growth in Commercial Aviation, 23 Transp. L.J. 1 (1995)

214 Operating costs are defined as expenses ($) divided by capacity (i.e. ASK). Cost units are calculated as $/ASK.


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low-cost operations, or alternatively, they are establishing low-cost subsidiaries as a

competitive weapon against low-cost competitors (the concept of an ‘airline-within-an-

airline’)216. It has become common for new start-ups or restructurings to model

themselves along the lines of Texas-based ‘SouthWest’ airlines in the U.S. which

industry commentators currently consider to be the winning model217.

• Product and Pricing

Another feature of the aviation industry is the extremely perishable nature of its main

product, namely the ‘available seat kilometre flown’ (or by whatever other measure the

product may be specified)218. Unless this product is sold prior to takeoff, it immediately

‘perishes’ and becomes worthless in the sense that it cannot be sold after takeoff. This

means that any discount pricing policy for an airline seat which does more than cover

the direct variable costs of flying the passenger to his or her destination (also described

as the carrier’s incremental or marginal costs), is ‘rational’ in the sense that a price set at

this level contributes positively to the profitability of the carrier.

In other words, the airline is better off financially by flying a passenger who pays

anything more than marginal cost for his or her seat. This is because the amount paid in

excess of direct variable costs makes a positive contribution towards payment of the

airline’s overheads. Such a pricing policy may therefore be arguably justified as being

‘economically rational’. A scheduled airline’s incremental cost is however likely to be

extremely low on any discrete flight219, comprising perhaps no more than the per-

passenger cost of airline food (which may, both literally and figuratively, be “peanuts”),

215 Dempsey, supra note 213 at 23 216 For example, Qantas’ is planning to launch a low-cost subsidiary, ‘Australian Airlines’

towards the end of 2003. 217 Virgin Blue is said to be based on the Southwest model. Qantas’ planned new

subsidiary, ‘Australian Airlines’, is also said to be based on the Southwest model. See ‘Dixon splits Qantas to recoup $1b’, The West Australian newspaper, 16 August 2003.

218 “Available seat kilometre” (ASK) is a common measure used to determine comparative costs in the airline industry, being the cost of moving one aircraft seat over a distance of one kilometre.

219 This comment will be true for all passengers except one – that passenger whose transport needs require another plane to be supplied in order to transport him or her. That passenger’s incremental cost will be huge. All subsequent passengers on that plane however will have very low incremental costs.


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plus the small, if measurable, cost of the amount of extra fuel consumed as a result of

having that passenger on board.

Even more rational and economically justifiable (but still nowhere near what would be

necessary to attain break-even) would be to price an airline seat at the airline’s average

variable cost, or (even better), average total cost (only this latter cost would be

sustainable in the long term). The contribution of such a pricing policy to an airline’s

profitability is significantly larger than for an incremental cost basis for pricing.

Average variable cost has in fact sometimes been suggested as the minimum price

which competition law should allow, particularly in the U.S. where it has been

suggested that prices are illegal per se if they are below average variable costs220.

Consumers see airlines’ products as basically fungible and inevitably choose the

cheapest and / or most convenient fare between two points. There is little brand loyalty

despite attempts by airlines to develop loyalty, for example by offering frequent flyer

programs and other devices221. This behaviour makes airlines reluctant to raise prices

above the market rate, due to the loss of business that will surely result222. Obviously,

excluding new entrants, particularly low-cost entrants able to charge low prices, is a

sensible strategy for a high-cost incumbent.

In Australia, an exclusively cost-based methodology for analysing predatory pricing

allegations has been rejected by the Courts as not being finally determinative of the

issue. Australian Courts have said that although costs may well be relevant, each case is

to be decided on its facts223. This contrasts with the U.S. where in a number of District

Circuit Courts, various measures of cost have been used as the basis for deeming that

airline prices below those costs are predatory per se224. However, the U.S. Supreme

Court has yet to rule on which if any of the various cost measures put forward it

220 See for example Caller-Times Publishing Co v Triad Communications 1990 -1 Trade

Cases 69,004. 221 See Dempsey, supra note 150 at 703 222 See Robert E Cooper, Communication and Cooperation Among Competitors: The Case

of the Airline Industry, 61 Antitrust L.J. 549 (1993) 223 See Eastern Express Pty Ltd v General Newspapers Pty Ltd (1992) 35 FCR 43 at 72 per

Lockhart and Gummow JJ 224 See Demsey supra note 150 at pp 804-805 for a summary of the present U.S. position

on the approach of its courts to using costs as the basis for determining predatory behaviour in its airline industry.


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supports. Its position remains that predatory pricing is rare, and if does occur, is rarely

successful225.

• Vertical Integration

From a competition law point of view, vertical integration is somewhat analogous to a

secondary level of concentration in a market. In other words if the aviation industry is

already concentrated from a structural point of view, vertical integration amongst the

individual competitors reinforces that structural imbalance and has the effect of making

the industry even more concentrated.

Deregulated airline markets exhibit a large degree of vertical, as well as horizontal,

integration. There are inexorable pressures within the aviation industry to integrate, by

consolidation or contract, across all the various segments of the industry, including the

international and domestic long haul, domestic short and medium haul, and local feeder

segments. Where possible this integration takes the form of ownership shares, but it

may also come about through contractual agreements between major carriers and

regional airlines that involve code-sharing226, coordinated scheduling and shared market

identities, some of which may be quite informal. Where this occurs, sometimes the

result is that the regional airlines virtually cease to market their output independently.

Possibly the ultimate form of vertical integration occurs when an airline controls a

major hub airport from which it operates a hub-and-spoke network system. An even

higher degree of vertical integration occurs if the airline controls some (preferably all)

of the ‘spokes’ which feed that hub. The hub and spoke system of airline organisation is

extremely efficient227, and serves as a formidable barrier to entry to a new entrant unless

it can join the hub network, perhaps via an alliance of some sort. Airline control of

airports occurs frequently in the U.S. whereas it is prohibited by the Airports Act 1996

225 Liggert & Myers v Brown & Williamson Corp 509 U.S. 209 (1993) (Brooke Group

case) 226 Code sharing allows flight operated by a regional airline to be identified by a national

airline’s two-letter code in the “Official Airline Guide” published by IATA. 227 Henricks, Piccione and Tan, ‘The Economics of Hubs: The Case of Monopoly’, Review

of Economic Studies (1995), found that the hub-and-spoke system is the optimum network structure for an unregulated airline in the presence of economies of density, and symmetric costs and demand.


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in Australia, and has been discussed in the literature228. In addition, hub-and-spoke

networks do not exist in Australia to anything like the same extent as in the U.S. where

they are more or less universal. The market power of a major hub airline, combined

with airport congestion (from which the major hub airline is largely free because it

controls many of the slots) present significant barriers to entry at U.S. hub229. Studies

have shown that particularly at a strong hub - where one or two airlines account for a

large proportion of departures – any new entry in the U.S. competes only on services to

and from other airlines’ strong hubs, and not on the hubbing airline’s spoke segments to

other non-hub cities230.

Hub and spoke systems have been described as concentrating most of an airline’s

operations at one or a very few ‘hub’ cities, serving other cities on the system from the

hub and providing predominantly one-stop or connecting service through the hub

between cities on the ‘spokes’231. If an inherent requirement of such a system is a

reasonably large collection of routes for viable operations, it raises the question as to

whether or not the Australian domestic aviation market could properly be described as

organised along ‘hub-and-spoke’ lines. Because these requirements are not present it is

unlikely that Australia’s domestic aviation would be a suitable candidate for a hub-and-

spoke system given its particular characteristics, having many thin routes and the

dominance of one city, Sydney, and one airline, Qantas.

Of course this domestic situation does not invalidate the possibility of developing such a

system for international services.

If in fact the hub concept does apply to the Australian domestic scene, two alternatives

views seem possible. On one view, Sydney Airport is the only true ‘hub’ in Australia,

from which the remainder of Australia is served. The other view is that each State

228 Id. 229 It is also true, as Brueckner et al have pointed out, that ‘hub-and-spokes’ may actually

assist competition at the city-pair level by lowering the cost of entry into individual city pairs. By simply adding a new spoke to their network, an airline can then serve a host of new markets. See Brueckner and Spiller, Economies of Traffic Density in the Deregulated Airline Industry, J. of L. and Econ., 1994, pp 379-415. The new entrant still however needs slot access to the hub.

230 M E Levine, Airline Competition in Deregulated Markets: Theory, Firm Strategy, and Public Policy, 4 Yale J. on Reg. 393 at 412 (1987).

231 Id at footnote 83


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capital city, and perhaps the regional centres of Canberra, Darwin, and Alice Springs,

comprises a total of some nine individual hubs that are the feeder points for regional

services. If the first view is taken, the airports of each capital and the above regional

centres might better be described as ‘gateways’ to their respective regions. It is

arguable that other airports such as Coolangatta and Cairns might also be added to the

list.

The question is not without its policy implications. Mike Merline, then General

Manager (Australia) of United Airlines argued in an address to a conference on airline

deregulation in 1990 that Canberra should be adopted as a national hub as one solution

to the problems of airport congestion at Sydney Airport232. The owner / operator of

Canberra Airport raised it again as recently as August 2003 as Sydney’s congestion

problems worsened and plans for a second Sydney airport at Bagery Creek appeared to

receding. On this scenario, the only flights into Sydney Airport would be international

and interstate city-to-city flights, together with a regular shuttle service between Sydney

and Canberra, ferrying all regional or intrastate passengers and cargo, who would

otherwise be barred from landing directly at Sydney. Thus a passenger from (say)

Albury-Wodonga, bound for Sydney, would land at the Canberra ‘hub’ and from there

be ferried to Sydney Airport together with all other passengers from other parts of

regional Australia. The idea is not without merit, although a number of other regional

cities close to Sydney could also be considered as well as Canberra (which suffers the

disadvantage of frequently being closed in winter due to fog), such as Newcastle or

Goldburn.

The hub-and-spoke form of organisation arose in the U.S. as a competitive response by

incumbent airlines to low-cost entrants following deregulation. These pressures never

existed to the same degree in Australia when it deregulated, so the development of

aviation networks in Australia has been motivated as much by convenience as cost

pressures. The author is therefore inclined to favour the view that Sydney is the only

airport in Australia which approaches the concept of a true hub airport, and that other

city airports merely serve as gateways for their respective states. In other words, flights

between each of the other capital cities and Sydney constitute the ‘spokes’, with Sydney

232 See Pengilley, supra note 107, at p 133, footnote 33.


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Airport being the ‘hub’. Within any hub and spoke system, stops at cities along any

particular spoke have always been permissible, as are flights between cities on any

particular spoke. So the fact that a flight might originate in Perth and terminate in

Adelaide merely constitutes a flight along part of a spoke or perhaps the addition of

another spoke in the system.

If the Single Aviation Market (SAM) with New Zealand develops as originally planned,

there would likely be two hubs in the combined region, namely Sydney and Auckland.

The original concept of the SAM, and the benefits of the Open Skies agreement

between Australia and New Zealand which stemmed from it and was signed in

November 2000, finally look like coming to fruition with a number of airlines now

competing or planing to compete on the Trans-Tasman route233, including Virgin Blue

which announced that it will begin offering Trans-Tasman services from February

2004234, based in Christchurch.

Regional airlines within Australia tend to be owned by Qantas or, prior to its demise,

Ansett235. Those that are not so owned, including some of Ansett’s subsidiaries which

have not yet found a new owner, may remain independent and therefore without a high

degree of vertical integration, but most find it necessary to at least enter into a code-

sharing agreement with Qantas or other major. For example, West Australian regional

airline Skywest Airlines, a former subsidiary of Ansett airlines, is currently developing

a strategic network alliance with Qantas in the wake of Ansett’s collapse which will

allow passenger feeds between airlines, seamless baggage and ticketing services and

access to frequent flyer points and airport lounges for passengers. Alliances are however

ephemeral arrangements at the best of times, and ‘mismatched’ alliances such as that

between Qantas and Skywest rarely last too long because of the different modus

233 Including Qantas, Virgin, Air NZ, Emirates, Singapore, United and BA (in code-share

with Qantas). 234 See ‘Virgin move a fillip for Qantas, Air NZ’, The West Australian, 18 September

2003. Virgin will operate under the name ‘Pacific Blue Airlines’ because an agreement with Singapore Airlines, which owns 49% of Virgin Blue’s parent, Virgin Atlantic, precludes the use of the word ‘Virgin’ in its name outside of Australia. Even the use of the name ‘Pacific Blue Airlines’ was not without difficulty for Virgin because Air NZ operates a company called ‘Pacific Blue Tours’ and claimed copyright in the phrase ‘Pacific Blue’. That difficulty has apparently been cleaned up. See ‘Fares slashed 30pc in NZ price war’, The Australian Financial Review, 17 September 2003.

235 See footnote 120, supra


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operandis of the partners. The Skywest alliance with Qantas is reportedly already under

strain because Skywest is allegedly poaching Qantas business passengers from some of

its regional routes within Western Australia.

Qantas itself is also vertically integrated to a relatively high degree. The corporation’s

divisions (or wholly-owned or controlled subsidiaries) provide a range of aviation

services solely for Qantas which are consumed by its principle flying operations. The

provision of these services range across most market segments from economy to

business and first class, to leisure, domestic and international and, via wholly-owned

subsidiaries (such as QantasLink) to regional airlines and its freight operations.

Qantas has recently announced that it intends to restructure itself into three broad stand-

alone business units in an attempt to increase profits236. Whether this will extend to

allowing its flying operations for example to source catering or other services from

outside the group if it can obtain better prices, remains to be seen. These restructuring

move of course do not affect its large degree of vertical integration. Qantas has also

announced that it will sell its domestic terminals in Sydney and Melbourne237, a move

which if completed will reduce the extent of its vertical integration.

Airlines in Australia are not permitted to own their own airports, unlike the position in

the U.S. where major airlines are also the major investors in many airports. This means

that most existing gates at U.S. airports are tied up with long-term leases for the

exclusive use of the leasing airline. This is invariably the investing airline. Airline

ownership of airports also enables the development of hub-and-spoke systems in the

U.S. to an extent not seen in Australia. Finally, “majority-in-interest” clauses in favour

of the investor airline at major U.S. airports, enable those airlines to veto airport-

operator plans to expand gate capacity.

As shall be seen in the next topic, access to airport facilities is a major barrier to entry

for new-start airlines. Although non-airline ownership of airports in Australia does not

236 See ‘Dixon Splits Qantas to recoup $1b’, The West Australian, 16 August 2003 237 See ‘Qantas eyes $500m terminals exit’, The Australian Financial Review, 25 August

2003


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automatically remove the barriers facing new start airlines in the U.S., it does alleviate

the worst effects of the problem in that country.

The nature and extent of vertical integration in a market is one of the specific factors

which must be taken into account by the ACCC in assessing if there would be a

substantial lessening of competition in a market as a result of a proposed merger or

acquisition238. In its Merger Guideline (June 1999), the ACCC elaborated on this by

stating that it would concentrate on the nature and extent of vertical integration caused

by long-term contracts and licensing arrangements between suppliers and carriers.

• Barriers to Entry

The final competition law factor considered in this thesis in assessing the key features

of the aviation industry in Australia are barriers to entry to the industry.

At the outset, it can be said that there are formidable barriers to entry in the Australian

aviation industry, as there are in all aviations industries worldwide. The significance of

such barriers is that they inhibit actual or threatened start-up competition, and thereby

cause higher prices and restriction of output, than would otherwise be the case. In the

absence of barriers to entry, sellers appraise the conditions of entry, and, anticipating

that entry may occur if price exceeds a given level, will regulate their prices

accordingly.

Barriers to entry have been defined as:

“…obstacles which inhibit the ability of firms outside the market to enter and

compete with established insiders…”239

The High Court of Australia has confirmed that barriers to entry are the prime

determinate of the long-term nature of the competitive process and the participants in an

industry240, and conversely that ease of market entry into an industry is the prime factor

238 s 50(3) TPA 239 P Geroski et al, Entry and Market Contestability; An International Comparison (1991),

quoted with approval by Finkelstein J in ACCC v Boral, on appeal, (2001) FCA 30 240 QMCA v Defiance Holdings (1976) ATPR 40 - 012


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in assessing competition factors and competitive effects241. The Court has also said that

barriers to entry are frequently the source of market power, and can occur for example

because of technological factors or government controls, or institutional barriers242 that

create or perpetuate monopolies243.

Barriers to entry are of two kinds:

(i) Government-created barriers (and other infrastructure-type

barriers); and

(ii) Airline-created barriers.

(i) Government-created barriers and other infrastructure-type barriers to

entry

The primary government-created barrier to entry is undoubtedly the prohibition on

cabotage244 because it completely eliminates even the possibility of foreign competition

in the domestic market. This absolute barrier to entry applies in most aviation industries

throughout the world, including Australia. The main exceptions are the EU Member

States who permit cabotage amongst themselves, and the Australia / New Zealand

aviation market where both Australia and New Zealand offer cabotage rights to the

other because of the historic close relationship between the two, but neither offers

cabotage to any other nations. In fact, no other nations in the world offer cabotage

rights, even to their close neighbours.

The U.S. for example does not even consider granting cabotage to any other country,

even as part of its otherwise extremely liberal Open Skies programs245. It is however

241 See Queensland Wire Industries Pty Ltd v The Broken Hill Proprietary Company

Limited (1989) ATPR 40 - 925 242 Such as bilateral agreements in international aviation, resulting from the Chicago

Convention 243 Melway Publishing Pty Ltd v Robert Hicks Pty Ltd (2001) HCA 13 244 See Friedman, supra note 177 at 122. Cabotage is more properly described as being in

the nature of a restriction or prohibition, but is often spoken of as being the grant of a right.

245 See Chapter 2, page 50. It is generally accepted, although not without dispute, that to do so would require an amendment to the U.S. Federal Aviation Act 1958.


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prepared to tie Open Skies with alliance approvals, but not cabotage. Because cabotage

rights in the U.S. are generally regarded as being particularly valuable due to the sheer

size of the U.S. domestic market, the presumption is that those rights would eagerly be

used by non-U.S. carriers if offered to them and the domestic market would therefore be

flooded with foreign owned airlines seeking to take advantage of U.S. cabotage rights.

The presumption that cabotage would necessarily open the floodgates to overseas

competition in the U.S. domestic market is not necessarily valid. The reason for this is

that the barriers to entry into the U.S. domestic aviation industry are perhaps higher than

elsewhere in the world due to the need for a new entrant to establish its own hub-and-

spoke system of operation there. Conversely, because many airports in the U.S. are

controlled by one or more of the existing carriers, the establishment of competing hub-

and-spoke systems is more difficult and expensive than normal. For these and other

reasons, the costs of setting up in the U.S. are perhaps higher then elsewhere in the

world. In addition, few non-U.S. airlines have a cost structure that would be competitive

with those of most U.S. carriers246, so few foreign-owned airlines could hope to

compete in the U.S. domestic market, even if they were given the opportunity.

Given the start-up obstacles to establishing a viable aviation operation in any country,

quite apart from the U.S. (but particularly so in the dynamic competitive situation in the

U.S.), it is therefore open to question whether or not foreign carriers would really want

to use cabotage rights in that country, even if they were offered. The temptation to tap

into the U.S. market if offered the chance might however be so high that it might entice

a few overseas airlines to try. Even if the attempt was ultimately unsuccessful, perhaps

the very threat of entry would be enough to deter anti-competitive conduct by

incumbent U.S. airlines, and so would help achieve U.S. competition goals.

The same sort of reasoning applies in Australia, where cabotage restrictions have been

relaxed for New Zealand since 1996. Air NZ however has chosen not to take advantage

of them, perhaps because it is regarded as a relatively high cost airline, and therefore

unlikely to be able to compete with Qantas or Virgin on the Australian domestic market.

But the very possibility of Air NZ entering that market, either as a result of it becoming

246 See Chapter 2, page 71.


153

more efficient or because Qantas becoming less so, may have the effect (or may already

have had the effect) of curbing anti-competitive practices by Qantas arising from its

market power, which might otherwise have occurred.

It would do well for U.S. aviation authorities to look closely at the precedent set by

Australia and New Zealand regarding the elimination of cabotage between themselves

as an example of what might (or might not) happen if the U.S. were to relax its own

cabotage rules. It may cause the U.S. to question the assumption that foreign carriers

would actually use cabotage rights if they were offered. This may lead to cabotage

being offered by the U.S. as a bargaining ‘chip’ in its Open Skies negotiations with

other nations.

Another government-created barrier, and one of the most pressing barriers to entry in

modern air transport is access to congested airports, especially the securing of suitable

slots for take-offs and landings, or in securing gate access for the embarkation or

disembarkation of passengers. Although Australia airports are now privately owned,

this barrier is appropriately classified as a government created barrier because the

government either retains a measure of control over the privatised airports via the

Airports Act 1996. It certainly had the power to act on the problem when it owned the

airports but largely chose not to. A related barrier, perhaps less important in Australia

than in the EU and the U.S., but one with major safety ramifications, is securing air

space to approach the airport.

In Australia, the airport access problem has been unnecessarily exacerbated by the

misallocation of airport and gate usage. This occurred with the creation of long term

airport leases, which the Australian government offered both Ansett and (then)

Australian Airlines in 1987247. This highly criticised decision still has repercussions in

Australia, and can be expected to do so until the leases expire in 2017. The leases cause

further pressure on new entrants to form alliances of otherwise ‘co-operate’ in one way

or another with the dominant incumbent to obtain access to airport facilities.

247 See page 115 above.


154

For example, in August 2002, Virgin Blue was forced to sue Sydney Airports

Corporation Ltd (SACL) to resolve a dispute over its access to available terminal space

previously used by Ansett (known as ‘T2’). Virgin claimed that an oral agreement made

on April 18, 2002, under which it was to take over up to nine gates for a period of 17

years at an annual licence fee of between $15 million to $18 million per year, was

breached by SACL which then offered Virgin a five year lease at an annual fee in

excess of $4 per passenger248. With passenger numbers passing through Sydney Airport

expected to grow substantially in the future249, the motive for such a basis for charging

was obvious. As part of the same dispute, Virgin Blue accused SACL of ‘behaving like

a monopoly’250.

In addition to Virgin’s private dispute with SACL, the Australian Competition and

Consumer Commission (ACCC)251 entered the arena, saying that “..an arrangement

which saw the (Sydney) terminal divided between Qantas and Virgin Blue on a long

term basis would not meet competition policy objectives”, adding that ‘It would

increase barriers to entry for any potential market entrant’252. Instead, the ACCC wants

the former Ansett terminal converted into common-user facilities rather than be divided

between dedicated users already established in the Australian aviation market253.

Whether as a result of this involvement of the ACCC (or perhaps despite it), Qantas’s

leisure aviation division, including its proposed new low-cost airline, Australian

Airlines, seems to have gained ready access to Ansett’s terminals at Sydney Airport -

about the same time as Virgin was beginning legal action against SACL - without

experiencing anything like the same problems which Virgin Blue experienced254.

Virgin’s dispute with SACL was settled in November 2002, with Virgin taking over six

dedicated gates in T2 and having shared access to six more. It agreed to pay a fee per

passenger on a scale that reduces from $6.50 per passenger to 80cents per passenger

248 See ‘Fels joins airport terminal row’, The Australian Financial Review, 1 August 2002,

p 1 249 ‘Airport shrugs off turbulence’, The Australian 21 October 2003. 250 Supra note 248 251 In November 1995, the Trade Practices Commission and the Prices Surveillance

Authority merged and were replaced by the Australian Competition and Consumer Commission (‘ACCC’) and the National Competition Council (NCC).

252 Supra note 248 253 Id 254 See ‘Dixon’s fight plan’, The Weekend Australian, 24-25 August 2002.


155

above an annual volume of 4 million passengers. The formula clearly encourages Virgin

to grow its business.

Although Sydney Airport is Australia’s largest airport, its problems are more or less

typical of the barriers which airport leases at most major Australian airports present to

new entrants in the airline industry. This is particularly so with a hub-and-spoke

structure centred on Sydney Airport (see above), where timely access to the hub,

especially at peak times, is essential if a new competitor is to have any hope of

matching the economies of scale of incumbents such as Qantas.

Finally, while on the subject of Sydney Airport, Virgin Blue applied to the National

Competition Council on 1 October 2002 for the airports runways, taxi-ways and parking

aprons to be ‘declared services’ under the TPA255, thereby allowing the ACCC to

arbitrate disputes over access and charges. Virgin alleged that without such regulation,

SACL would be able to raise charges for ‘airside’ services above competitive levels and

change the structure of those charges. A number of international airlines backed

Virgin’s application256. The application was not without precedent. In 2000, in Re

Sydney Airport257, the Trade Practices Tribunal declared that the freight aprons, hard

stands and areas where equipment may be stored were essential services at Sydney

Airport. On the basis of this precedent, and because Virgin’s application met all the

criteria set out in s 44G(2) of the TPA, the Council’s draft recommendation was that the

Airside Services should be declared essential services, as requested by Virgin.

Submissions on the Council’s draft ruling closed on 12 September 2003. A final ruling

is expected before the end of 2003.

Another infrastructure barrier in Australia as well as at many airports across the world is

the lack of slots for take-offs and landings. Limited airport terminal capacity or apron

capacity at an airport hinders the introduction of additional or competing services either

by incumbents or new entrants. Capacity constraints and slot allocation are a pre-

requisite of air transport safety because overloading either is a potential safety hazard.

255 Part IIIA Trade Practices Act 1974 256 See ‘Airlines bid to curb Sydney Airport’s pricing power’, The Australian Financial

Review, 19 March, 2003 257 (2000) ATPR 41-754


156

The allocation of scarce slots at Sydney Airport is co-ordinated by a Scheduling

Committee. The ACCC has expressed concern in relation to the processes used by the

Committee for airport runway space in peak hours258, but nevertheless authorised them

under Part VII of the TPA in order to avoid them constituting possible arrangements

between competitors in breach of s 45 TPA. Authorisation was conditional on new

entrant airlines being able to attend Committee meetings, and minutes of the meetings

are provided to the ACCC. Despite the obvious safety implications, CASA is not

involved in this slot allocation process. The Scheduling Committee is comprised of

representatives from the airlines, the airports and the ACCC.

The detailed procedures by which slots are allocated are complex depending on such

variables as peak or off-peak times, the size of aircraft used - which affect the time per

aircraft movement (i.e. the bigger the aircraft, the more time it will need for taking off),

and others. These factors are weighted according to the IATA Scheduling Procedures

Guide that incorporates a number of principles including historical precedent, new

entrants and emergencies. Slots held by an airline do not necessarily have to be used.

This may be due to a short-term lack of demand for services or to other extraneous

circumstances such as international embargoes, hostilities, industrial action or

worldwide health scares. Slots may also be traded between airlines, or indeed by the

airline itself within its pool to achieve a better allocation of resources.

The problems of allocating scarce airport resources involve ‘complex assessments and

not inconsiderable difficulties’259 for which no obvious solutions have been found

anywhere in the world. In the U.S., where the problems of slot and gate allocations are

much aggravated by airport lease clauses which give incumbent airlines de facto

management of the airport, including the right to veto airport improvements, the

Aviation Competition Enhancement Act 1997 260 mandates slot allocation to new

entrants and to a limited number of incumbent carriers where the capacity exists. Where

capacity does not exist, the Act phases in a gradual withdrawal of grandfathered slots to

the major airlines. It is too early yet to assess the effects of the Act, to which incumbent

airlines are strongly opposed.

258 See TPC, Bulletin No 52, Jan- Feb 1990. 259 Pengilley, supra note 107 at p 135 260 Aviation Competition Enhancement Act 1997, S. 1331, 105th Cong. (1997)


157

(ii) Airline-created Barriers to Entry

Barriers to entry have in general been held by an Australian Court to arise from such

diverse non-government factors as customer loyalty, availability of resources,

availability of land, availability of commercial information, levels of capital investment

required261, as well trade marks or patents, and by the ‘dynamic behaviour by incumbent

firms to exclude rivals by a variety of uncompetitive practices’, described as being as

much a barrier to entry as any structural condition in the market262.

Although the decision referred to above was not related specifically to aviation, many of

the barriers referred to are directly applicable to the aviation industry. In addition,

barriers-to-entry in aviation also take many other forms, some of which (apart from

cabotage) are unique to aviation. For example, because safety is such an important issue

in aviation, the time and cost for a new entrant to build a reputation for safe, punctual,

reliable and continuous service is particularly important in aviation. Conveying this

information to the market means that a new entrant will usually need to invest a

substantial period of large-scale operations at low load factors. Associated with this

barrier is the fact that most ticket sales are made through travel agents, whose loyalty to

an incumbent for paying their (unregulated) commission rates in the past, is another

barrier facing a new-start airline.

Related to this is the general issue of dominant firm control of information about

customers and competitors through computerised reservation services (CRSs). This is a

unique and significant barrier faced by a new entrant in the aviation industry, because it

means that the incumbent can know about the new start’s competitive strategies in

advance of their implementation, and can act to pre-empt them. CRSs are discussed in

more detail below.

In the face of these and other barriers, coming on top of the slot and gate access

problems discussed earlier, there is a strong tendency on the part of a new entrant airline 261 ACCC v Boral Ltd (1999) FCA 1318, at first instance


158

to form alliances of some form263 with one or more of the incumbents, particularly

where there is structural imbalance in the industry giving rise to a dominant position,

such as that enjoyed by Qantas as a result of historical endowment. This occurred for

example in Australia when Impulse Airlines effectively merged with Qantas on 14 May

2001 by leasing all its aircraft to Qantas after just eleven months of operation, much of

it in an environment of heavy price competition264.

The urge to merge is strong in aviation because economies of scale of operation or

network are considerably higher in air transport than for most other industries265,

particularly other transport industries such as road haulage. This fact contradicts the

findings of many academic theorists who have examined production costs in the airline

industry and have not found significant economies of scale266. Yet mergers persist in the

industry, particularly post deregulation. Part of the reason for this is that mergers and

consolidations since then find their genesis, not only as offensive or defensive responses

to predatory possibilities, but in the economies of scale which they offer in conveying

information to consumers. Further, the complex relationship between production costs

in city-pair markets and the control of discount pricing, make mergers attractive from a

risk management point of view, rather than for the sheer sake of size267. These factors

combine to raise the costs which new entrant face. Equally important is access to

infrastructure such as air space and airports. For small carriers, the temptation to merge

or form an alliance with an industry-dominant operator must seem overwhelming.

An alliance or merger between two airlines, being in the nature of as an investment in

capacity, can have the effect of itself creating a barrier to entry268. This why the EU

262 ACCC v Boral Ltd, on appeal. (2001) FCA 30. Although the High Court of Australia

overturned the Full Federal Court in 2003, the latter’s comments on barriers to entry were not overruled.

263 For example, BA took a 25% equity holding in Qantas (now reduced to 19%). 264 It was Impulse which introduced the now famous $33 one-way fare between Brisbane

and Sydney in August.2000. 265 See P Crocioni, The Lufthansa / SAS Case: Did the Commission Get the Economics

Right, Eur. Comp. L.R. 1998, 19(2), 116 at 119. 266 R Caves, Air Transport and its Regulators: An Industry Study, (1962) 267 See Levine, supra note 230 at 425 268 A Dixit, ‘The Role of Investment in Entry Deterrence’, American Economic Review, pp

47 – 57, (1980)


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Commission, in approving Lufthansa / SAS co-operative alliance in 1996269, imposed a

condition that the merged firm must freeze its daily frequencies should another firm

decide to enter the market, which was defined for the purposes of that case to be limited

to non-stop routes between Scandinavia and Germany (One-stop routes were however

excluded from the market). The imposition of carefully designed conditions of approval

by the EC in this case might offer some lessons for the ACCC in any future requests for

merger approval in the trans-Tasman region which structurally bears some analogies to

the German – Scandinavian region. A recent opportunity to do this with the Qantas / Air

New Zealand proposed merger to eliminate the worst features of that merger while at

the same time preserving its good points, was however regrettably lost.

Even the prevention or termination of alliances can create a barrier to a new airline. For

example, in the British Midland / Aer Lingus case in 1992, the EU Commission was of

the view that the termination by Aer Lingus of an interlining agreement between the

two created a barrier to British Midland when it decided to operate independently of Aer

Lingus. The Commission was of the view that without an interlining agreement with an

incumbent airline such as Aer Lingus, travel agents and the travelling public would be

likely to consider a new start airline as second-rate, thereby raising a barrier to entry 270.

Clearly, the possible range of airline-created barriers to entry is almost unlimited.

For an alternative point of view, namely that barriers to entry in the Australian aviation

industry are low, the comments of Qantas’ General Counsel, Brett Johnson, should be

noted. According to him, there are “low, real barriers to entry. There are significant

numbers of aircraft available. There are slots and terminals available. There are no

foreign ownership limitations in Australia…which means that anybody can commence

operating domestically. Capital is available…”271. These comments cannot, of course,

be dismissed lightly. They are persuasive and appear to accord with market realities.

The case of Virgin is a good example of how a new entrant can become established in 269 Deutsche Lufthansa AG / Scandinavian Airlines System (Case No. IV/M545) 1996 O.J.

L54/28 (CEC) 270 Interlining or code-sharing is the means whereby an airline accepts passengers holding

tickets issued in another airline’s name


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the Australian market relatively easily, although the fact of the collapse of Ansett soon

after Virgin’s start up undoubtedly created special circumstances that contributed to its

success. But even if entry itself may be relatively easy as Mr Johnson claims, the degree

to which a new entrant is subsequently allowed to compete fairly with incumbents is

always an issue for the regulatory authorities, particularly in the aviation industry.

The effect of the various barriers to entry is that when a new low-cost entrant does

establish services, it is often between a particular hub and a spoke where there is a

perceived opportunity to gain market share by charging lower fares. In response to the

new competition, large carriers typically respond by lowering their prices and

expanding capacity in order to become competitive with the low cost entrant.

Sometimes, due to hub and spoke efficiencies, large carriers continue to make a profit

even at prices below the new entrant’s prices. They may even be prepared to run at a

loss on the particular spoke on which they are competing with the new entrant, relying

on profits on other spokes on which there is no competition to subsidise the carrier’s

loss-making operations on the competitive spoke. The new entrant is unlikely to have

this luxury, and frequently exits the market, being unable to bear the losses of servicing

the particular route. After the new entrant exits the market, the large carrier then returns

to reduced capacity and raises fares on the route, hopefully reaping oligopoly level

profits.

The barriers created by the dominance of incumbents also apply to both domestic and

international air transport. The latter is further complicated by the fact of government

intervention in negotiations for air service agreements, which introduces further

uncertainty into the manner and extent of international competition. Nevertheless,

global alliances amongst airlines are also very common, either as an effort to rationalise

resources or simply to avoid competition. Such alliances even have a certain degree of

inevitability about them as a consequence of carriers recognising that they are not able

to service to all markets which their customers require. At the same time, it is submitted

that arguments by Qantas for example that it can only compete with other international

airlines if it is permitted to grow through merger with Air NZ or through an equity

271 See Brett Johnson, Industry Perspective on International Regulatory Developments in

the Airline Industry, (2002) 14 DePaul Bus. L.J. 257 at 259. Johnson is General Counsel at Qantas.


161

alliance with BA for example should be treated by the regulatory authorities with an

appropriate degree of caution, even scepticism, because the end result of nearly all

mergers is that market barriers to new entrants are raised even higher.

3.4.4 THE MARKET FOR AVIATION SERVICES

• General

Before considering how competition law impacts on certain aspects of the Australian

aviation industry, both currently and in an Open Skies environment, it is first necessary

to examine what is meant by the ‘aviation market’ in Australia. Market definition is not

an end in itself but is an important tool of analysis, being the starting point for virtually

all competition issues272. For example, the offence of misuse of market power under s

46 of the TPA has always been viewed by the ACCC as being particularly important in

the deregulation of the aviation sector in Australia (as well as all other sectors)273. This

is especially since the 1989 Queensland Wire Industries case274, in which the High

Court provided its (controversial275) interpretation of what misuse of market power

means. Crucial to s 46 is the determination of ‘the market’ in which the alleged

anticompetitive behaviour occurred. Whether the Queensland Wire case will have any

future relevance to the possible misuse of market power by an incumbent airline in

Australia remains to be seen, but crucial to that question in any event will be the

determination of the market in which the alleged anticompetitive behaviour will be

alleged to have occurred.

• Definition

If a market is defined too narrowly, the market conduct proposed or complained of will

be exaggerated. Conversely, if it is defined too widely, then virtually any market

conduct will be acceptable because there will always be competitors and substitute

products or services, and no one competitor will be able to dominate a market. For

272 See United States v Aluminium Co of America, 148 F. 2d 416, 424 (2d Cir. 1960) 273 See TPC, Annual Report 1989 – 90, pp 25-26. Trade Practices Commission, Misuse of

Market Power, Guidelines on Section 46 of the Trade Practices Act, 1989. 274 Queensland Wire case, infra note 372 275 See for example, Pengilley, supra note 107 at pp 137 – 142.


162

example, because of the highly mobile nature of aircraft and the cross-border nature of

air transportation generally, it could be argued that the market for the Australian trunk

aviation industry is the whole world. On this type of analysis, the aviation market is

global rather than local, with numerous competitors. However, while this might be true

in theory, it ignores the practical realities of the immediate marketplace with only a few

competitors, so is therefore not very helpful in analysing competitive conduct.

Having determined the market for aviation services, only then will it be possible to

consider how an Open Skies aviation policy might effect competition within that

market. Specifically, consideration can be given to the possible effects of Open Skies on

aspects of airline behaviour such as predatory practicing, information misuse, alliances,

slot control, airport leases, or whatever, which prevent or distort competition within the

market

The TPA does not attempt to define the term “market”. Instead section 4E merely

provides that a market includes goods and services substitutable for, or otherwise

competitive with, the goods and services under consideration. It has been left to the

courts, ‘applying principles of economics’276, to define the concept. This has proved

difficult to do. Furthermore, despite the importance of the concept of the ‘market’ in

competition analysis, there has not been any judicial consideration by the Federal or

High Courts in Australia as to what specifically constitutes ‘the market for aviation

services’ in Australia277. However the courts have given general consideration to the

subject in the context of industries other than aviation. The Queensland Milling

Association case278 is often cited to explain how markets are defined:

“ A market is the area of close competition between firms or,…..the field of

rivalry between them. ……So a market is the field of actual and potential

transactions between buyers and sellers amongst whom there can be strong

substitution, at least in the long run, if given a sufficient price

276 Miller’s Annotated Trade Practices Act 1974, (Thompson Lawbook Co, 24th ed, 2003),

p 94 277 See Taprobane infra note 291 for an analysis on an aviation market outside Australia. 278 Re Queensland Co-op Milling Association Ltd & Defiance Holdings Ltd (1976) ATPR

40-012, at 17,246 – 17,247


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incentive….Whether such substitution is feasible or likely depends ultimately

on customer attitudes, technology, distance and cost and price incentives.

It is the possibilities of such substitution which set the limits upon a firm’s

ability to ‘give less and charge more’. Accordingly, in determining the outer

boundaries of the market we ask a quite simple but fundamental question: If

the firm were to ‘give less and charge more’ would there be……much of a

reaction?”

The ACCC, with responsibility for enforcing the TPA, has applied the Queensland

Milling Association dictum (above) in identifying relevant markets in any particular

case:

“….by determining the smallest area over which a profit maximising

monopolist would impose a “small but significant and non-transitory increase

in price”, or equivalent exercise of market power. By including all substitution

possibilities, the process of market definition identifies all the sources of

competition that effectively constrain price and output decisions of the relevant

entities…..The market must be defined only to the extent necessary to

determine the effect of the proposed arrangements on competition”279

In other words, the ACCC ‘seeks to include all those sources of closely substitutable

products, to which consumers would turn in the event that the firm attempted to exercise

market power’280.

The process of defining a market for a particular range of goods or services by

considering its possible or likely substitutes is clearly not an exact one281, especially

when applying contestability theory to the marketplace with its emphasis on potential

rather than actual competition. Substitution is often a question of degree. Furthermore,

even if it is potentially possible, substitution may not be practically feasible, depending

279 ACCC Draft Determination, Qantas / Air New Zealand Merger Application, (A30220,

A30221, A30222, A90862, A90863), at footnote 32, p 44 280 Id at p 44. 281 “…[the word ‘market’] is not susceptible of precise comprehensive definition….”.

Queensland Wire case, supra note 241 per Deane J at 195.


164

as it does on a number of ex poste facto matters such as consumer attitudes to the

substitute product or service if it were to be offered to them. For example it has already

been argued that, in some situations, suppliers of aviation cargo services and / or air

charter services, could be considered as potential substitutes for scheduled airline

services in the same geographic market, even though, for reasons of consumer attitude

towards them, cargo and charter services might in fact not be effective substitutes.

In the face of these inherent difficulties in defining a market such as for aviation

passenger services, it is understandable that regulatory authorities in Australia and

elsewhere tend to err on the side of caution and define markets narrower than wider. In

this way, anti-competitive conduct is overstated rather than understated.

• Product Substitution

Substitute products are one of the factors specifically referred to in s 4E and s 50(3)(f)

of the TPA282 which the ACCC is required to take into account when determining a

market for a particular product or service. Despite this, when it comes to determining

markets in aviation services, the ACCC appears to exclude the possibility of many

potential substitutes existing. In this regard, it is similar to other regulators overseas

who routinely appear to discount or eliminate potential substitutes such as charter

passenger operators or even cargo operators from being possible substitute providers of

aviation services. It is true that before such operators could provide an effective

substitute service they would need to convert their aircraft to passenger configurations

and would also face and need to overcome the usual (and formidable) barriers to entry

faced by other new entrants. However, they all possess the main ingredient for

providing alternative supply, namely jet aircraft, and the possibility of their competition

should be recognised, at least in the medium term. Perhaps it is true that charter and

cargo operators represent potential competitors more than substitute products, but their

possible influence on the commercial passenger aviation market should be taken into

account in assessing the market.

282 Note that section 4E of the TPA states that a market for goods or services includes other

goods or services that are substitutable for, or otherwise competitive with, the first goods or services.


165

The temptation to ignore or eliminate these possible substitutes in the airline industry

arises because, although it is probably true to say that every product or service is

ultimately substitutable, in a practical sense this is not so for the aviation industry’s

major product. A feature of the industry is that there is in fact often very little scope on

the supply side of aviation services for the substitution of competing transportation

products. The speed, safety and comfort of plane travel are simply unrivalled283. This is

clearly the position in Australia and the U.S. and indeed most countries284, although the

position might not be quite so clear-cut in Europe for example, where fast and efficient

train services between relatively close cities, even where those cities are located in

different nations, mean that train services can sometimes be a viable substitute to plane

travel. This is especially so if the times taken to travel to and from airports to the city of

departure and destination are taken into account in calculating the comparable times for

the complete journey285.

Because substitution of products or services from outside the aviation industry is not

practically feasible, the distinction between substitution and competition becomes

somewhat blurred. Nevertheless, whether it be described as competition or substitution,

or perhaps both, as between the commercial passenger and the charter / cargo aviation

markets there is the possibility of substitution of competing services286, certainly in the

longer term and even perhaps with some modification of the service offered. Although

the very different aircraft configurations for both markets may make competition or

substitution on a day-to-day basis impossible, an aircraft configured for cargo could be

reconfigured in a relatively short time to take passengers, and vice versa. Before an

aircraft could actually carry passengers however, it would of course need to obtain the

necessary certificates of air worthiness as well as CASA (and other government)

permits which would be expected to take considerably longer than a mere technical

reconfiguration of the aircraft. The cargo or charter carrier would also face the usual

283 This point was not challenged by Qantas in seeking to strike out the ACCC’s Statement

of Claim in its action against Qantas alleging predatory pricing. See infra note 351. 284 Due for example to distances and natural geographical barriers to land transportation. 285 In Australia, the ‘Very Fast Train Project’ between Sydney and Melbourne was at one

time considered to offer a potentially attractive alternative to air travel between the two cities, even for business travellers, but the project is currently shelved and is now considered unlikely to ever see the light of day. See The Australian, 17-18 June 1991, p 11.

286 Although it may not be ‘politically correct’ to say so, passengers are after all a form of ‘cargo’, albeit a special form.


166

other barriers to entry before it could effectively compete in the scheduled passenger

market.

In its submission to the ACCC regarding the proposed Qantas / Air New Zealand

merger, Virgin Blue endorsed the arguments of Frontier Economics in its submission to

the ACCC that passenger and freight services are most usefully incorporated into one

market definition. Frontier Economics noted that most aviation cargo is in fact carried

in the ‘belly holds’ of passenger aircraft (as against in dedicated freighters) and that

there is synergy between freight and passenger carriage. It further suggested that when

an airline decides to increase capacity on a particular route, it does so on the basis of

total revenue expectations regardless of whether it is sourced from passengers or cargo.

Although there is currently excess passenger capacity in the world’s airlines,

particularly in Europe, there are no known examples of an air cargo operator switching

to passenger services or vice versa, either in Australia or overseas. This may be because

of the synergy between the two markets referred to above which would mean that

shortages or excesses of capacity in one sector may correspond more or less with

shortages or excesses in the other so that spare or surplus capacities occur in both

sectors more or less together, inhibiting switching. The possibility of relatively simple

substitution between the two products must however exist and ought to be a factor in

determining what is the aviation market at any time in any given location.

For reasons which are not clear, the regulatory authorities in many countries, including

Australia, tend to take a relatively narrow and somewhat simplistic view of the

scheduled passenger aviation market by generally excluding the possibility of product

substitution such as charter operators and, to a lesser extent, cargo operators. For

example, in the EU case of Deutsche Lufthansa AG / Scandinavian Airlines System287,

the EU Commission simply ignored charter operators as being a part of the relevant

market when considering an application for approval of a joint venture between

Lufthansa and SAS, even though there was evidence that charter operators were active

between Germany and Scandinavia. Similarly in the Australian case of Taprobane v

Singapore Airlines288, the possibility of charter operators competing with Singapore

287 Case No. IV / M545, 1996, O. J. L54 / 28 (CEC) 288 (1990) ATPR 41-054(First instance)


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Airlines in the packaged tour holiday business to the Maldives does not even seem to

have been considered, at least at first instance.

This matter will be considered further when the Australian market for aviation services

is considered below.

• The Geographic and Product Dimensions to the Market

For aviation markets, previous determinations by the ACCC289 state that, as regards the

scheduled passenger air transport market (as distinct from the charter passenger and

freight transport markets which will not be considered in this thesis), the aviation

market’s most important dimensions are its geographic dimension, and its product

dimension290.

The following statement from authors P. Areeda and L. Kaplow was quoted with

approval by French J in the Full Federal Court in Singapore Airlines Ltd v Taprobane

Tours WA Pty Ltd 291:

“a vast number of firms might have some actual or potential effect on a

defendant’s behaviour. Many of them however will not have a significant

effect and we attempt to exclude them from the relevant market in which

we appraise the defendant’s power. We try to include in the relevant

market only those suppliers – of the same or related product in the same

or related geographic area – whose existence significantly restrains the

defendant’s power. This process of inclusion and exclusion is spoken of

as market definition”.292

289 See Determination A90565 (Qantas and BA, 12 May 1995); A90649 and A90655

(Ansett Australia, Ansett International Air NZ and Singapore Airlines, 22 July 1998); A30202 (Qantas and BA, 10 May 2000) and A90408 (IATA Passenger Agency Program, 13 November 2002)

290 ACCC Draft Determination re Qantas / Air NZ, supra note 410. 291 Taprobane, (1991) 33 FCR 158 at 178 292 Antitrust Analysis (4th ed 1988) p 572


168

Further light is thrown on the concept of the geographic market by the following

passage from Von Kalinowski, Antitrust Laws and Trade Regulation293 that was quoted

with approval by the Federal Court in Australia Meat Holdings Pty Ltd v TPC294:

“Any geographic market…. must be one which corresponds to the

commercial realities of the industry and represents an economically

significant trade area. Because a geographic market determination looks

to actual trade patterns, it is not required that geographical boundaries be

drawn with exactitude….”

Thus the relevant geographic market is an area where a dominant firm for example

cannot increase its price without large numbers of consumers turning to alternative

sources outside the area, or where producers outside the area can quickly supply the

area with substitute products. The problem with this formulation for aviation is the

severe barriers to entry which prevent outside producers taking advantage of high prices

by moving into the market. Nevertheless, for domestic commercial aviation at least, the

relevant geographic market within Australia would certainly appear to include city-

pairs.

The associated concept of a product market referred to above requires amongst other

things an assessment of the products which are sufficiently close substitutes to compete

effectively in each other’s markets295. In the air transportation industry, the product

market serves to define the geographic market. Scheduled passenger air transportation is

probably the relevant product market in commercial aviation. Competing alternatives in

Australia such as rail, bus, and automobile transport can likely be ignored. In Australia,

relevant product sub-markets in scheduled commercial aviation might be non-stop

passenger air transportation to and from a hub (or gateway) airport, and connecting

service to and from other cities via the hub. Qantas for example calls this special service

its ‘City-Flyer’ service. Another product sub-market might be connecting services to

and from other hubs or gateways, for example, Sydney to Adelaide via Melbourne.

Connecting service is a separate market because it is viewed by most consumers as an 293 (Matthew Bender, New York, 1981), Vol 3, para 18-96 294 (1989) ATPR 40-932 at 50,092


169

inferior product to non-stop service, and has only a marginal competitive impact on

non-stop service296

ACCC determinations of the aviation product market consistently argue that separate

markets exist for economy and premium services exist, on the basis that they show

‘differences in demand characteristics and service requirements.., and the extent to

which substitute services that are acceptable to premium class passengers can be

provided by airlines in competitive markets’297. While it may be technically true that

two separate product markets exist, it is submitted that, at least on domestic flights, the

distinction between them is much less significant than it once was, even for corporate

passengers. Even though many corporations may be contractually tied to one particular

airline or another, many corporate passengers in Australia today fly economy class on

most flights, with the exception perhaps on long overseas flights. This trend is

worldwide, with American Airlines reporting in October 2003 that although business

travellers were (slowly) returning to the market, they were largely purchasing cheaper

and less flexible economy fares. (See ‘U.S. airlines see signs of improvement on

horizon’, The Australian Financial Review, 24 October 2003)

Within Australia, only Qantas offers a premium (first) class product and the number of

such passengers on most of its flights is now relatively insignificant. The service

remains on offer by the airline partly as a form of public service, and because of its

disproportionate profitability to the airline. Virgin by comparison does not offer a

premium class, but its corporate business, using its business-friendly fully flexible fare

which is 40 per cent cheaper than the Qantas full economy fare, is nevertheless said to

be popular with business travellers and is growing rapidly298. It is apparent that the

differences between the economy and premium markets is diminishing, and the

premium market may well now be simply a sub-market of the economy market, rather

than a separate market in its own right. Clearly corporate flyers are purchasing on the

basis of price and appear to have ceased to purchase the premium product no doubt

because, in an era of cost cutting and efficiency drives, premium class is no longer

295 Robert Pitofsky, New Definitions of Relevant Market and the Assault of Antitrust, 90

Colum. L. Rev. 1805 (1990) 296 Id 297 ACCC Draft Determination, supra note 279 298 ‘Qantas fares give business the blues’, The Australian Financial Review, 30 May 2003.


170

considered to be value for money. The first class market in Australia has been declining

for some time as corporate and government travellers find more value for money in

business class299.

Because of this, and also because corporate passengers are better able to ‘look after’

themselves in terms of bargaining power with airlines, one wonders at the merits of the

ACCC continuing to maintain the distinction between the two product markets for

competition law purposes, at least for domestic aviation. For the purposes of this thesis,

it is therefore proposed to discard the distinction as no longer reflecting the actual state

of the product market, and to regard the product market for aviation services in

Australia as solely comprising the economy product market, with the premium traveller

being but a segment or sub-market of the main market.

The ACCC also maintains that the domestic and international geographic markets

should be distinguished because of the very different regulatory environments under

which the two markets operate. This distinction appears to be based on firmer ground

than the distinction between economy and premium products, because the two

geographic markets have very different regulatory regimes. The distinction exists

principally because of cabotage, which restricts the carriage of passengers and cargo

between points in Australia to Australian domestic airlines only. Although a foreign

carrier can operate a wholly owned subsidiary airline within the Australian domestic

market300, cabotage nevertheless prevents it from carrying purely domestic passengers

or cargo within Australia.

But while foreign international carriers may themselves be prevented from operating in

the Australian domestic market, they are nevertheless able to maintain a virtual if not an

actual presence in that market by means of code sharing with Australian domestic

airlines. This the Federal Government permits to all points in Australia. Although the

policy is currently restricted to international passengers continuing their international

voyages beyond their entry point into Australia, it nevertheless results in international

299 See ‘Business seat in a class of its own’, The Australian, 26 September 2003. 300 A domestic carrier in Australia can be 100% owned by ‘foreign persons’ (unless

contrary to the national interest), of which no more than 40% may be held by foreign airlines (also subject to a national interest test). See Air Navigation Act 1920 (Cth), section 11A


171

and domestic passengers travelling together on Australian domestic flights under the

same regulatory regime. In this way, code-sharing alliances permit the international

market to impact on the Australian domestic market.

Furthermore, because code-sharing is invariably reciprocal, the practice frequently

results in substantially lower domestic fares being paid by international passengers, and

will therefore affect the yield rates of Australian domestic airlines. In this way code

sharing may at least have an indirect effect on the competitive performance of the

Australian domestic market301.

However, although the geographic distinction between the Australian international and

domestic aviation markets may have become somewhat blurred as a result of code

sharing, too much should not be made of it. International and domestic aviation markets

behave very differently. For example, a much greater degree of ‘sovereign risk’ and

uncertainty exists in the international market because of the continuing role of national

governments in the operation of their flag carriers. Until a regional (e.g. Asia-Pacific

Rim) Open Skies pact is entered into by Pacific rim nations, including Australia,

whereby all the region members will have unrestricted first five freedom rights (at least)

to provide aviation services to the other Open Skies members, it would probably be a

mistake to consider the domestic and international markets as merged into the one, even

within a close region such as the Pacific rim region, simply as a result of code-sharing.

The one current exception to this is the very important trans-Tasman route on which the

governments of both Australia and New Zealand have entered into an exceedingly

liberal Open Skies agreement. As already stated, this agreement goes well beyond most

Open Skies agreements elsewhere in the world in that it offers multi-designated

cabotage rights to the carriers of each other. The agreement exists only because of the

special historical relationship that exists between Australia and New Zealand, and

should not to be taken as an indication of the possible nature of other Open Skies

agreements into which either nation might enter, either independently or in conjunction.

301 Although discounted code-sharing prices for international passengers may not

necessarily translate into discounted domestic fares, the probability of this happening


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Cabotage rights mean that Air NZ for example is, in its own right, able to collect

Australian passengers and cargo at any airport in Australia, and transport those

passengers or cargo to any other point in Australia. Similarly any Australian carrier is

able to do the same in New Zealand. The fact that no airlines, including Qantas and Air

NZ, have chosen to do this at this point in time, does not alter the fact that both the

international and domestic aviation markets of Australia and New Zealand are

inextricably linked by their potential ability to do this. Possibly the only distinction

between Australia and New Zealand which air carriers in the two countries currently

face is that the aviation regulatory authorities in the two countries are different302.

For these reasons, and because of the extremely close links between the Australian and

New Zealand aviation industries, exemplified by the Single Aviation Market (SAM)303

between the two, it seems artificial to distinguish between the two, either domestically

or internationally. The two are as integrated as two aviation markets are ever going to

get. It is therefore submitted that the geographic distinction between Australia and New

Zealand should, in terms of aviation markets, be discarded, and that the whole of

Australia and New Zealand be considered as the one domestic geographic market

having probably two hubs, one at Sydney and the other at Auckland, between which the

majority of city-pairs operate. The existence of other city-pairs between the two

countries fragments the hub concept somewhat304, but essentially it remains intact

although not as highly developed as in the U.S.

When examining international air transport markets, the ACCC has consistently stated

that, after taking into account opportunities for indirect travel, a regional approach to

will be increased if there are other alliances between the two airlines, over and above code-sharing.

302 Harbison, supra note 195 describes as ‘unbelievable’ the fact that Australia and New Zealand have two separate competition authorities, including two totally separate aviation regulatory authorities (CASA and CAA) which have quite distinct regulatory and licensing provisions, making it difficult for a NZ aircraft to operate in Australia and vice versa, but which otherwise perform nearly identical functions.

303 The intention of the SAM was to create a ‘seamless commercial aviation environment’. Id. For a variety of reasons, it has not moved much beyond its early stages, although that may now be changing.

304 For example, Pacific Blue, Virgin Blue’s Trans-Tasman carrier, will initially offer direct flights between Christchurch and Brisbane, with services to other Australian cities to follow.


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market definition is generally the most appropriate305. The question is: Which region is

appropriate for the Australian international aviation market? Should it be limited for

example to the trans-Tasman region, or should it be wider. For the reasons set out

below, the author submits that the international geographic market for Australian

aviation should be the region comprising the Trans-Tasman area, together with

Singapore and the west coast of the U.S.

On 23 September 2003, Australia signed a liberalised bilateral aviation agreement with

Singapore. Although the agreement is not a full Open Skies agreement306, and certainly

not as extensive or far-reaching as the Australia / New Zealand Open Skies agreement,

it is nevertheless an improvement over the old agreement307. Singapore Airlines (SAL)

actively sought an Open Skies agreement with Australia to give effect to its long-

standing plans to fly directly between Sydney and Los Angeles, in competition with

Qantas. If an Open Skies agreement had been concluded on 23 September 2003, it

stated that it would have immediately launched those flights on a daily basis, increasing

to twice daily by June 2004. It is true that SAL is able to conduct such flights now by

virtue of its ‘beyond rights’ under the current bilateral agreement between Australia and

New Zealand, those right do not allow it to pick up passengers or cargo in Sydney and

fly them to the U.S., which an Open Skies agreement would do.

Australia has said that the issue of a full Open Skies agreement with Singapore will be

revisited ‘once the aviation industry has stabilised’308. Even though ‘stability’, in any

strict sense of the word may never occur, such an agreement seems inevitable, with or

without Qantas’ support. When concluded, it no doubt will as usual offer reciprocal

first-five freedoms of the air to multi-designated carriers from each nation. Although

New Zealand and Singapore already have an Open Skies agreement, it would make

much sense if that were incorporated into a single Open Skies agreement entered into

between Australia and New Zealand as a regional entity, and Singapore. But even

305 See supra note 279. 306 Singapore was reported to be keen to conclude an Open Skies agreement with Australia,

but Qantas apparently was opposed to the idea. See ‘Open sky call to Europe’, The Australian, 25 September 2003.

307 Note however that Peter Harbison describes the agreement as leaving ‘Australian aviation policy stuck in the 20th century’. See ‘A little more sunshine but Singapore wants more’, The Australian, 24 September 2003

308 Id, per Transport Minister Anderson


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without this, the combined effect of separate Open Skies agreements, together with the

SAM agreement, would mean that Singapore would have virtually unrestricted access to

the trans-Tasman region.

The large majority of international travellers to and from Asia and Europe and the

Australia / New Zealand geographic market pass through Singapore. With increasingly

liberal bilateral agreements between Australia / New Zealand and Singapore likely in

the future, and because Singapore has in the past, and is likely to be in the future, an

important investor in aviation in the trans-Tasman region, it is submitted that Singapore

should be considered part of the international geographic market for Australian aviation.

The international operations of Qantas and Air NZ are so closely tied to the Singapore

hub, that to exclude it seems irrational.

Somewhat similar arguments apply to the trans-Pacific route between Australia / New

Zealand and the west coast of the U.S. Qantas currently flies the route between Sydney

and Auckland to Los Angeles, while Air NZ flies the route between Auckland and Los

Angeles. United Airlines also flies the route from its U.S. bases, but it is currently

operating under U.S. bankruptcy protection laws, and is limited in its competitive

responses to market demands. All three airlines are high-cost, full service airlines. There

is therefore little real competition on the Sydney – Los Angeles route, and if the Qantas

/ Air NZ alliance goes ahead, there will be a virtual monopoly for the merged airline on

the Auckland – Los Angeles route. It is somewhat surprising that various other U.S.

carriers have not applied to replace or supplement United’s services on the Los Angeles

– Sydney route. Perhaps the only reason why this has not happened is that the U.S.

aviation industry is reported to be on the brink of insolvency, but with surplus capacity

available the lack of interest in the route is surprising.

By virtue of its Open Skies agreement with New Zealand, SAL is also able to fly the

Auckland / Los Angeles route and it is from that source that competition may come.

The market for the trans-Pacific route is large and is integral to the operations of both

Qantas and Air NZ.

It is therefore submitted that the final aspect to the international geographic market

should include the Los Angeles hub.


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The interconnection of the geographic markets of Australia and New Zealand becomes

even more evident in light of the fact that Singapore Airlines, which currently operates

68 flights a week to Australian capital cities, is reportedly interested in taking an equity

position in Qantas.309. It currently holds a small equity position in Air NZ. If an

Australian equity alliance with SAL occurs (either in Qantas or Virgin (Singapore

Airlines holds a 50% interest in Virgin Blue’s parent, Virgin Atlantic)), then SAL

would have access to both the Australian and New Zealand domestic markets, by virtue

first of its equity interest in one or the other airline and second by virtue of the Open

Skies agreement between Australia and New Zealand.

Assuming an SAL equity alliance in Qantas or Virgin would be approved by the ACCC,

SAL’s operations out of Singapore to the trans-Tasman region, and vice-versa, would

be largely indistinguishable from any other Australian or New Zealand carrier in that

region.

By comparison, a U.S. carrier flying into Australia directly or via Singapore would only

do so by virtue of restrictive bilateral agreements between the U.S. and each of

Singapore and Australia. Without more, these agreements would not entitle the U.S.

carrier access to the Australian domestic market. It is interesting to note that although

the U.S. and New Zealand concluded an Open Skies agreement in 1997, no U.S. carrier

currently flies the U.S.-Auckland route to take advantage of this agreement.

Viewed in this way, the international geographic aviation market comprising a

Singapore hub, the trans-Tasman region, and a Los Angeles hub would satisfy many of

the factors which the ACCC requires to enable it to define a market. Within this market,

different types of passengers destined for different parts of the region, may properly be

regarded as representing different market segments or sub-markets within the overall

product market. 309 SAL tried to buy a 25% interest in Qantas in 1994, but was beaten to it by British

Airways. BA has already sold part of that interest may sell all or parts of it in the future. SAL were prevented from purchasing TNT’s 50% share in Ansett Australia by Air NZ which exercised a pre-emptive right to do so. Qantas is potentially also interested in purchasing a share of SAL. See ‘Singapore keeps its options open’, The Australian


176

• Judicial Determinations of ‘The Market’

Generally speaking, it seems that Australian courts may be more inclined to listen to the

views of industry participants on issues such as the scope of the market, than is the

ACCC. For example, in Taprobane, French J, on appeal, gave considerable weight to

the evidence of the former Marketing Development Manager of Singapore Airlines in

relation to a ‘general tourist market’310. There are numerous other examples of the

Courts doing this311. By comparison, the ACCC seems to largely disregard or deprecate

the views of industry participants and economic and other experts in reaching its

conclusions.

For example, the views of both Qantas and Air NZ that there was a single geographic

Australasian market for air passengers, were rejected by the ACCC in its Draft

Determination of the Qantas / Air NZ proposed merger, even though those views were

also supported by Virgin Blue and others (although Virgin Blue went one step further

and argued for a single (combined) market for both passengers and freight)312.

It is interesting to note that in its current legal action against Qantas alleging breach of

section 46 TPA313, the ACCC’s Statement of Claim alleges that:

“(a) there is a market for Australian airline services (‘the Australian airline

market’), the geographic extent of which is Australia; or alternatively

(b) there is a market for Adelaide – Brisbane services (‘the Adelaide –

Brisbane market’), the geographic extent of which is Australia or

alternatively, Adelaide and Brisbane”314.

Financial Review, 4 October 2002; see also ‘Qantas ponders alliance options’, The West Australian, 31 October 2003.

310 [1992] ATPR 41-159 at 40,167 311 See Caron Beaton-Wells, Proof of a market for the purposes of the Trade Practices Act

1974 (Cth): A critical examination of the role played by industry evidence – Part Two, (2003) 31 ABLR 171 at 188.

312 Supra note 279 at p 52. 313 ACCC v Qantas, infra note 351


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The Commission did not however agree that the domestic market should be subsumed

under a larger trans-Tasman regional market for the purposes of the Qantas / Air NZ

proposed merger.

This is not to say of course that the courts will always regard the evidence of industry

operators as having considerable weight, but they seem to treat the evidence of such

persons in a manner ‘akin to expert opinion evidence’315, apparently in most cases

without legal objection, even though the evidence is often directed towards the ultimate

issue316.

There appears to be an aviation industry view, particularly within Qantas, that the

ACCC lacks aviation expertise which causes it to take a too narrow, short term and

artificial view of competition matters for such a complex industry317. Qantas believes

this is particularly so since the collapse of Ansett, which thrust Qantas, through no fault

of its own, into a position of almost complete market domination. Although Qantas’

market dominance was obviously transitory, that fact did not stop the ACCC launching

no less than fifteen enquiries into Qantas’ market behaviour during the six or so months

following Ansett’s collapse318, none of which resulted in any prosecutions.

On the other hand there is an emerging body of evidence that Qantas did not abuse its

dominant position in the post Ansett collapse, at least to anything like the degree to

which it could have319. Harbison for example argues that but for Qantas’ sense of duty

to the Australian public, it would have been easy for it to have driven the ‘thinly

funded’ Virgin from the Australian market following the Ansett collapse320.

314 Id at para 8 of the Statement of Claim 315 Beaton-Wells, supra note 311 at 189. 316 Which at common law usually renders such evidence inadmissible, although s 80(a) of

the Evidence Act 1995 (Cth) abrogates this rule in Federal Court proceedings. 317 See The West Australian supra note 309; and see also Harbison, supra note 195. 318 See Brett Johnson, Industry Perspective on International Regulatory Developments in

the Airline Industry, (2002) 14 DePaul Bus. L.J. 257 at 259. Johnson is General Counsel at Qantas.

319 Id. 320 See Harbison, supra note 195 at 7


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Qantas’ view of the naivety of the ACCC on aviation matters may well be valid. Similar

views are often held by the U.S. airline industry of its regulators321, even though those

regulators have much more opportunity to gain the necessary expertise than does the

ACCC in Australia. There would appear to be scope for both parties to seconde staff to

the other to gain a better understanding of how each operates.

Judicial determinations in Australia of what is meant by ‘the aviation market’ have

invariably been directed to the specific circumstances of the case. For example,

Taprobane Tours WA Pty Ltd v Singapore Airlines Limited322 (Taprobane) involved an

alleged breach of s 46 of the TPA (i.e. misuse of market power) by Singapore Airlines

when it decided to change the terms of its dealership arrangements with the plaintiff and

enter the market for packaged tours to the Maldives itself, rather than operate solely

through Taprobane. The Federal Court decided at first instance that there was a “clearly

defined area of competition for the supply of wholesale tour packages to the

Maldives”323. In other words, a market existed (apparently in isolation), for wholesale

airline tour services to that island alone, over which Singapore Airlines possessed

substantial market power.

On appeal, French J, speaking for the Court, was more circumspect in his treatment of

evidence that showed the promotion of holiday packages to the Maldives to be a

distinctive holiday experience. For the purpose of determining whether or not these

packages should be defined as a single market or whether packages to other island

destinations should be included in the market, he concluded that “the promotional

emphasis on the distinctive features is more convincingly characterised as an attempt to

differentiate one product from potential substitutes, than as an indication of a distinct

market”324. He concluded, with the unanimous support of the other members of the

Court, that “in the end, the relevant substitutions are not between airlines but between

destinations”325, and considered that what the trial judge had described as the market

was in fact a ‘sub-market in which the airline had [the relevant] power’. He therefore

321 See for example Pleatsikas, infra note 356 regarding the carriage of the U.S. Dept of

Justice case against AMR, infra note 477. 322 (1990) ATPR 41-054 323 Id at 51,704 324 (1992) ATPR 41-159 at 40,177 325 Id


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extended the product market to include the whole market for packaged holiday tours, at

least to other island holiday destinations. In this broader market, Singapore Airlines did

not possess substantial market power and had not breached s 46 of the TPA.

On the subject of the nature of a ‘market’ for competition law purposes, the Appeal

Court in Taprobane said:

“….it involves fact finding together with evaluative and purposive selection. In

any given application it describes a range of economic activities defined by

reference to particular economic functions (e.g. manufacturing, wholesale or

retail sales), the class or classes of products, be they goods or services, which

are the subject of those activities and the geographic areas in which they occur.

In its statutory setting, the market designation imposes on the activities which

it encompasses limits set by the law for the protection of competition. It

involves a choice of relevant range of activity by reference to economic and

commercial realities and the policy of the statute. To the extent that it must

serve statutory policy, the identification will be evaluative and purposive as

well as descriptive”326.

In reaching its decision, the court placed considerable weight on the substitutability of a

product as a way of delineating the relevant market, and referred to the process of

product substitution described by the United States Supreme Court in United States v

E.I. du Pont de Nemours and Co327. This reasoning led the Taprobane court to reject the

argument that a sub-market (for example, a market in a particular brand name where

there are a particular number of brand names available) was the relevant market.

However it recognised that ‘power may be located in a sub-market and according to the

circumstances, may be substantial in the sense used in section 46 in a market which

embraces the sub-market’.

The court then went on to say:

326 Id at 40,169 327 351 U.S. 37 (1956)


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“It may be the case that a successful campaign of product differentiation will

give rise to phenomena which resemble, even if they do not strictly constitute,

a sub-market. But product differentiation itself may have only transitory effects

or effects which are subject to short run contingencies”.

In Taprobane328, the Appeal Court found that the ‘primary product class’ was airline

services from Australia to destinations offshore and extended to other countries and

islands of Australia. The ‘secondary product class’ was found to have been constituted

by packaged holiday tours to such destinations. It was found that although Singapore

Airlines dominated the market for supply of airline flights to the Maldives, the relevant

substitutions were not between airlines but between destinations, as a wide range of

similar destinations existed. In this wider market, Singapore Airlines was found not to

have infringed section 46 of the TPA.

In a different context, the Trade Practices Commission (“TPC”) allowed the takeover of

East-West Airlines by Ansett in 1987. Because it was the only significant competitor to

Ansett and Australian Airlines at the time in the Australian domestic market, the

takeover was subject to the divestiture of some of East-West’s routes in NSW, as well

as the divestiture of Skywest (East-West’s operation in WA). The TPC imposed this

condition because it considered that separate aviation markets existed in each State for

passenger air services as distinct from an Australian domestic market, which now seems

to be its preferred view329.

In the U.S., aviation rivals tend to each sell their products in a limited geographic area,

where their customers often have no ready access to other sources. The general rule is to

confine the geographic market to that particular area of operation and to include only

those sales which are made within that area330. Occasionally courts are also willing to

identify sub-markets as part of the analysis. In Case-Swayne v Sunkist Growers331 for

example, the court held that market definitions should correspond to the commercial

realities of the industry and reflect the structure of supplier-customer relations. Using

328 Taprobane, supra note 291 329 See Pengilley, supra note 107 at p 202 330 See e.g. Union Leader Corp. v Newspapers of New England Inc., 284 F. 2d 582 (1st

Cir. 1960) 331 369 F. 2d 449 (9th Cir. 1966)


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this approach, it is possible to find regional sub-markets in the air transportation

industry because firstly, the commercial reality of the industry is that it is based on a

regional concentration of services through hubs, and secondly, customers purchasing

tickets at a hub tend live in the vicinity of a hub. Thus in general terms, the geographic

area for the purposes of a competition law analysis of a fare war in the U.S., should be

the city-pairs where the two airlines compete head-to-head332. This type of analysis may

be easier in the U.S. than Australia, where the markets are less structured and more

fragmented, and where the hub-and-spoke system is not nearly as highly developed as

in the U.S.

3.4.5 SOME ASPECTS OF MARKET BEHAVIOUR IN THE AUSTRALIAN AIRLINE INDUSTRY

• PREDATORY PRICING BEHAVIOUR

In the context of the provision of air transport services, predatory behaviour designed to

suppress competition comes in many forms of which predatory pricing is only one,

although it is a particularly significant form of such behaviour which most competition

jurisdictions recognise needs to be controlled333. Together with the restriction of access

to information, it is the only form of predatory behaviour that will be examined in this

thesis.

Predation in any form has as its primary purpose the reduction of the target

undertaking’s profitability so that it has no choice but to exit the market or, in the case

of predatory behaviour designed to deter entry in the first place, to ensure that the target

undertaking knows that entry would be so expensive and painful that it is not

worthwhile investing in market entry at all. The problem, with which courts world-wide

still grapple, is to distinguish legitimate but aggressive pro-competitive pricing, which is

often done in order to match competition, from anticompetitive pricing whose purpose 332 See Note, The Antitrust Implications of Airport Lease Restrictions, 104 Harv. L. Rev.

548, 554-55 (1990) 333 Other for example are capacity predation (i.e. dumping capacity, which is closely

related to predatory pricing, other than the fact that capacity predation usually includes simultaneous price reductions and capacity additions), refusal of access to information networks (or discriminatory access vis e.g. biased CRS), travel agent commission overrides, exclusive dealing, restricting access to essential facilities such as slots, or offering discriminatory access.


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is to discourage other carriers from entering a market, or to eliminate those which have

already done so. The difficulties in making the distinction, and the consequences of the

wrong decision have long been recognised in the U.S.334

According to classic economic theory, predation is considered to be rational behaviour

by the incumbent only if it believes that it can at least recover the costs of its anti-

competitive behaviour once the competitive threat has been removed. It is for this

reason that predatory pricing is often defined as the setting of artificially low prices in

the expectation of being able to raise them once the preyed-upon competitor has left the

market, or dropped plans to enter the market. However, since most segments of the

aviation market are considered to exhibit a demand which is strongly price elastic335,

any attempt to increase prices at a later time in order to recover revenue which was lost

during the alleged predation period will only succeed if there are only a few other

competitors remaining in the industry (or preferably none). This is an unlikely scenario,

so the practical relevance of a definition of predatory pricing which is based on a theory

of economic analysis that is somewhat divorced from reality, is open to question from

the outset.

In the context of air transport, it was once argued that because of the mobile nature of

aircraft, predatory conduct could never in fact be rational conduct. If faced with

predatory behaviour by a dominant carrier, a smaller carrier could simply withdraw

from the route in question and redeploy its aircraft on other routes, only to re-enter the

original route at a later date once the dominant airline had increased its tariffs to a

super-normal level. This argument takes no account of a number of highly relevant

factors, including first, the substantial investment (sunk costs) an air carrier has to make

before it can enter a route and the fact that such investment would be irretrievably lost

following withdrawal. Secondly, there is the bad publicity that would be suffered by an

airline that abandons a route, which would jeopardise the possibility of advance

bookings in the event of later re-entry on that route. Third, if a carrier had been the

victim of predatory behaviour once, there would be an added incentive for the dominant

carrier to repeat that behaviour in the knowledge that it had been successful at least once

in the past. This is sometimes called ‘signalling’. Finally, information impediments to

334 Cargill Inc v Montfort of Colo Inc, 651 F 2d 76 at 88 (2d Cir. 1981) 335 See Lanik, supra note 175 at fn 76.


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an airline contacting its customers to give them information, frequent flyer programs,

travel agent incentives, complex fare structures with capacity controls, and hub-and-

spoke systems all serve to complicate airline operations and impose non-recoverable

costs on airline operations.

Another problem with predatory pricing in the aviation industry is that it is especially

difficult to distinguish between ‘aggressive pricing’ on the one hand, and prices which

simply match a low cost competitor’s fares. Even if the price is below cost for the

incumbent, its behaviour may well be indistinguishable from a genuine commercial

response to a threat, and is therefore difficult to characterise as predation in the sense of

intending to hurt the competitor. The fact that consumers tend to prefer large airlines

with hub and spoke systems and information advantages at equivalent prices, means that

simple price matching often works to the advantage of the incumbent in terms of market

share if not profits.

Nevertheless, if predation means anything, it means deep, pinpointed, discriminatory

price cuts by established competitors aimed at driving price-cutters from the market. It

is analogous to an incumbent “posting prominent no-trespassing signs at the boundaries

of all its markets”336. Alfred Kahn, for example, recognised in the late 1980s that

antitrust laws in the U.S. as then administered and interpreted were inadequately

drawing distinctions between predation and vigorous competition.

It is the loss-recovery aspect of the standard definition of predation that often causes

problems, especially in the aviation industry because the power to control prices to the

extent required to recover the losses which result from predatory conduct is only present

if the predator has substantial market power. Recoupment is considered to be an

essential element of predatory pricing in most jurisdictions, including the U.S.337, the

EU338 and Australia339. The necessary market power to do this may exist at (say) a

dominant hub controlled by the predator, but is unlikely to exist generally, in other

336 Alfred Kahn, The Macroeconomic Consequences of Sensible Microeconomic Policies,

Society of Government Economists Newsletter, May 1985, p 2 337 Brooke Group case, supra note 225. 338 Notice on the Application of the Competition Rules to Anticompetitive Practices in Air

Transport, EU Commission Report, September 1992, unpublished 339 See Boral case, infra note 363.


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aviation markets not so dominated. This has led some legislators340 and also courts to

minimise the importance of predatory pricing. In the U.S. for example, the Supreme

Court has said that in industry generally, predatory pricing is rarely tried and if it is

tried, it is rarely successful because the predator is unlikely to be able to recover its

losses341. Even when it last considered predatory pricing behaviour in 1993342, the U.S.

Supreme Court was still in denial mode, dismissing a $149 million jury damages award

because the plaintiff had failed to show the Court how it could be possible for the

defendant, with only a 12% market share, to recover its investment in below-cost

predatory sales.

Despite the views of the U.S Supreme Court as to the unlikely prevalence of predatory

pricing, it seems to be generally accepted that there is in fact wide scope for predatory

pricing in the airline industry, particularly where a small low-cost airline faces a major

incumbent airline, such as occurred for example when Compass took on Qantas and

Ansett in 1993, or when Virgin squared off against the same two airlines in 2000.

Numerous similar examples have also occurred in the U.S.343 and Canada344. It is

particularly in the ‘large incumbent(s) versus the small new start-up airline’ situation

that predatory conduct seems to take its most common (and often vicious) form. In fact,

its existence in such situations (and indeed its success) is taken more or less as a

forgone conclusion345.

At one stage it was difficult to say if the airline industry was an exception to the

Supreme Court’s view that predatory pricing is rare, because until relatively recently

there was surprisingly little legal or economic scholarship on the question, even in the

U.S. It should be noted that despite increasingly numerous accusations of predatory

340 See for example, statement of Senator Percy, 124 Cong. Rec. 10,654 (daily ed. Apr. 19,

1978), speaking to the Airline Deregulation Bill. 341 See Matsushita Elec. Indus. v Zenith Radio Corp., 475 U.S. 574, 589 (1986) 342 Brooke Group case, supra note 225 343 See for example Dempsey, supra note 150 at pp 722 – 735. 344 See McAllister, supra note 197 at 236, commenting that “all the complaints we (i.e. the

Canadian Industry Bureau) received (up to 2002), have been predatory pricing and there is virtually nothing on the other side of these types of practices”

345 See for example V F Zonna, Insults fly in the Battle over Transatlantic Routes, L.A. Times, Feb. 14, 1991, reporting that British Airways proposed a “predatory fare cut” in an effort to “finish off haemorrhaging Pan Am, and perhaps TWA as well”.


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pricing in the U.S. commercial passenger airline industry346, it is remarkable that it was

not until May 1999 that the U.S. Department of Justice filed its first (and unsuccessful)

antitrust lawsuit against a major commercial airline in that country347. That suit alleged

that American Airlines had engaged in predatory conduct against three new entrants,

(Sun Jet, Vanguard, and Western Pacific) with the intent of forcing them to withdraw

from American’s Dallas / Fort Worth hub in Texas. The case was lost on summary

judgement in 2002, but is currently under appeal348.

Similarly in Australia. Despite frequent accusations of predatory pricing349 by new

entrant airlines350, there has never been an aviation case on predatory pricing or

predatory conduct of any sort in Australia’s aviation history351. This is despite the fact

that both Ansett and Australian Airlines may well have engaged in uncompetitive

conduct contrary to s 46 of the TPA in responding to the challenge of Compass in 1990.

Compass certainly believed so, but the Trade Practices Commission, (the predecessor to

the National Competition Council), for reasons which are not entirely clear, declined to

346 For example, between 1996 and 2000, 32 complaints were received by the U.S. Dept of

Justice objecting to the predatory behaviour of incumbent carriers. 347 United States v AMR Corp., No 99-1180-JTM (D. Kan. filed May 13, 1999), an

ongoing case alleging predatory pricing by AMR Corp, the parent of American Airlines, against a low cost entrant. The U.S. Department of Justice lost the case in a summary judgement ruling, with the court highly critical both of the DOJ’s use of average total cost instead of a more relevant measure of cost to prove predation, and because it had failed to show that a likelihood and method of recoupment existed.

348 Note that in the early 1980s, Laker Airways sued British Airways and five other airlines for $1.7 billion for alleged predatory pricing but the matter was settled out of court for $60 million; and Northwest Airlines was fined $2.4million for predatory pricing against a tour operator in 1991. Continental Airlines sued United Airlines for predatory conduct, receiving $77 million in an out-of-court settlement in 1990. There were however no actual court decisions involving a commercial carrier engaging in predatory pricing.

349 The 1991 comments of Bryan Grey, Chairman of Compass Airlines, notwithstanding. See Pengilley, supra note 107 at page 157

350 As in the U.S. and the E.U., deregulation exposed incumbent carriers in Australia to price competition from low cost start-up carriers, unleashing price competition to a much greater degree than was previously the case, including ‘price wars’. From there it was but a short step for the incumbent to engage in predatory pricing in order to ‘discipline’ or eliminate new entrants.

351 That may change soon. A case launched by the ACCC against Qantas, alleging predatory pricing by Qantas against Virgin Blue may be heard in the near future. See ACCC v Qantas Airways Limited (2002) FCA 1354 for a report on an interlocutory decision in this matter.


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become involved in regulating such conduct, even though Compass claimed that it

formally complained to the Commission that such conduct was occurring352.

Following recent investigations into the practice of predation in the U.S. aviation

industry, the emerging body of opinion is that predatory behaviour in the industry,

particularly price predation, is very common indeed353. Results suggest that the very

nature of the air transportation industry is such that it allows unfair exclusionary

practices to occur, and that, compared to other industries, a major air carrier can price-

discriminate to a much greater extent than incumbents in other industries, adjust prices

much faster and shift resources between markets much more readily. These

characteristics not only allow a carrier to drive a new entrant from the market, but,

having observed this predatory response by the incumbent on at least one occasion,

other potential new entrants also refrain from entering the market354.

Price predation is often considered in the context of a comparison between the alleged

predatory prices for the goods or services, and the cost of providing those goods or

services. This is so in Canada and particularly in the U.S. where the latter’s Circuit

Courts for example have used a variety of cost measures when dealing with allegations

of predatory pricing, although they have been unable to agree on a uniform approach355.

352 The Council disputes that a formal complaint was ever lodged with it, but in any event

the Council can act independently and does not need a formal complaint before it can act. After Compass’ demise, Ansett Chairman Ables said: “If they had had an extra $150 m on top of the $60m they had, we could not have afforded to chase them”.

353 See Dempsey, supra note 150 for a summary of current views in the U.S. 354 Dempsey, id at 736, commenting that “predatory behaviour can have a chilling effect on

new entrants”, giving as an example a hunter who walks past a field with a no trespassing sign. He may ignore it, unless the field is littered with the bodies of previous trespassers. Similarly Mark Atwood concludes, “Fear of predation shrinks the available pool of investment capital for upstart airlines and channels their entry away from the very (monopoly) markets where their competitive presence would be most valuable”. M Atwood, Refining Predatory policy: The Fear Factor and Reduced Funding for Low-Fare Airlines, Antitrust L. & Econ. Rev. 89 (1999). These factors have been collated in the U.S. to form the basis of the so-called ‘reputation’ and ‘signalling’ models of predatory pricing. See Pleatsikas, note 356 at15.

355 See Klingaman, supra note 168 at 299


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There are however a number of inherent problems with a cost-based approach to the

aviation industry. Firstly, there are so many different measures of costs356 and pricing

strategies357 to suit different stages of growth and competition in any particular market

that it is almost impossible to distinguish aggressive competitive pricing from (illegal)

predatory pricing at any point in time. Secondly, a cost-based analysis of predation

depends heavily on information which is difficult to collect and evaluate, requiring a

‘sophisticated enquiry into costs, economic conditions and strategic considerations’358,

so proving predatory behaviour will inevitably be difficult. Thirdly, even if a cost

standard by which to measure predation could be agreed, there also needs to be

agreement as to how the test should be applied, because depending on how the test is

applied produces different results. For example, if it is agreed that the appropriate

measure of cost is ‘avoidable cost’359 (below which cost, prices will be considered

predatory per se), the questions then become: What costs are avoidable, when do they

become avoidable, what is the relevant unit of capacity to consider and what is the

appropriate time period to consider, and so on.

The relationship between cost and pricing in any given situation apply irrespective of

whether the market has numerous competitors, or just a single operator - although of

course the ability to price as high as average cost may be much reduced if there are

other competitors in the market. Thus accusations of predatory pricing on the part of an

airline need to be carefully considered in the context of the perishable nature of its

product and the airline’s cost structure, as well as the whole matrix of aviation market

dynamics. This is particularly so in Australia where the test of ‘predation’ may not be as

high nor as clear-cut as in the U.S.360.

356 Id at pp 296 – 302; and see C.J.Pleatsikas, An economic interpretation of recent

American and Australian judicial decisions on predatory pricing, (2003) 11 TPLJ 12 at p 16,17

357 See Beaton-Wells, supra note 311 at 177 358 Pleatsikas, supra note 356 at p19, commenting that this requirement can be inferred

from the High Court’s decision in the Boral case, infra note 363. 359 Avoidable cost for example is the cost standard which has been selected in Canada for

its airline-specific competition law. See McAllister, supra note 197 at 237 360 See Explanatory Memorandum to the Trade Practices Amendment Act 1986


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Although the U.S. Supreme Court has yet to rule on which, if any, of the various cost-

based approaches to predatory pricing it agrees with361, it is submitted that the emphasis

in the U.S. on cost measures and on the recovery of predatory losses is too simplistic an

approach. This is especially so for an industry as complex as commercial aviation,

where that pricing will be but a single component of an overall predatory strategy,

where most costs are shared, where fixed costs comprise a large percentage of total

costs, where fare structures are so complex that computers are needed to handle them,

where joint costs are spread over a wide array of origins and destinations for connecting

passengers and freight, and where variable costs, including average variable costs, can

be very low, even to vanishing point. Furthermore, variable costs may well vary at

differing rates of output.

Australian courts by comparison have approached the problem of predatory pricing in a

somewhat more flexible way, in which costs play an important but not determinative

role and in which intent plays a greater role than it does in the U.S. In Australia,

predatory pricing has been defined as a pricing policy that is aimed at damaging or

destroying a competitor, or preventing a new competitor from entering a market.

Intention is therefore an element of predatory pricing in Australia362. This was further

developed by the recent High Court decision in Boral Besser Masonry Ltd (now Boral

Masonry Ltd) v ACCC363 (the Boral High Court decision) where the Court found that

Boral had not engaged in predatory pricing because, although there was evidence that

Boral intended to (illegally) eliminate a competitor, it did not possess substantial market

power to do so and, even if it did, it did not in fact use that power.

In endorsing the trial judge’s finding that selling below avoidable cost, even for a

prolonged period of time, could well be a rational business decision in a competitive

market, the Court recognised that while costs are a relevant factor in determining

predatory pricing, this should not be done on the basis of applying a simplistic formula

to them to arrive at one or another measures of cost. It also affirmed that intent and the

361 In the Brooke Group case (supra note 225), the U.S. Supreme Court did however

endorse the general concept of a cost based approach to predatory pricing by stating that the plaintiff must prove that “the prices complained of are below an appropriate measure of its rival’s costs”.

362 TPC v CSBP & Farmers Ltd (1980) 53 FLR 135 at 147 363 (2003) HCA 5 (7 February 2003)


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recoupment of a predator’s investment in predatory losses were essential elements of the

offence, and in the case of recoupment, the Court insisted that the plaintiff must be able

to show that it would occur only at supra-competitive prices and not at ‘normal’

monopoly prices364. As a result of the Boral and AMR decisions, it is said that the

Australian and U.S. treatment of predatory pricing have ‘largely converged’365

There are however a number of features specific to air transport which, it is submitted,

make the application of the Boral decision problematic, not only in Australia but also

elsewhere. Firstly, because recoupment is an essential element, it will need to be proven

that prices are being set at such a relationship to costs that recoupment will in fact need

to occur. This gives rise to all the problems associated with measuring costs. For

example, by definition, variable costs are those which vary with output. There is

however a variety of measures of output, ranging from seats on an aircraft that would

otherwise travel empty to the introduction of supplementary flights. Very few costs vary

directly in relation to the number of passengers carried on particular flights. Indeed, as

already stated, the marginal cost of filling remaining seats might well approach zero.

Other costs, such as some labour costs and landing charges, vary in relation to the

number of flights and to the type and size of aircraft used. For these reasons, it is

submitted that the relevant variable cost of filling an extra seat, when that seat would

have been offered in any event, should not be considered, and the relevant cost variation

should only relate to changes in the frequency of the service and in the choice of

aircraft.

Secondly, it is submitted that it is unrealistic to consider whether any individual fare is

predatory. The entire fare mix must be considered. Any particular seat can be sold at

various different fares and the sequence with which seats are sold at different fares

varies from flight to flight. Many of these fares are sufficiently low that if the carrier

tried to fill all seats at that fare, the total revenue would be less than costs. Other fares,

for example business class, are such that if all seats were sold at that fare, the carriers

would earn above normal profits. It is only realistic to consider average revenue per

364 The High Court agreed with U.S. practice that monopoly does not necessarily mean a

sole competitor. Substantial market power is enough, meaning that the effect of s 46 TPA was closely similar to the monopoly provisions of the U.S. Sherman Act.

365 Pleatsikas, supra note 356 at 12


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flight. This can be determined accurately on an historic basis and involves consideration

of both fare levels and the capacity offered at each fare level.

Thirdly, it is submitted that the classification of costs as fixed or variable is more

difficult in the aviation sector than in manufacturing industries, for which cost-based

tests may be more appropriate. Many significant costs, which in other industries would

be regarded as fixed, vary in air transport both in relation to age and frequency of use.

For example, depreciation is spread over the life of an aircraft that is often calculated in

terms of the number of take-offs and landings. In the ultimate, virtually all air transport

costs could, with the exception of administration and costs of sales, be deemed to be

variable costs. Furthermore, some fixed costs may become variable at a later time, and

vice versa. For example, six months prior to the commencement of a relevant season,

many costs are variable, (the whole flight could be cancelled for example) but as the

departure date approaches, the amount of variable cost reduces until one hour before

departure, the variable costs of flying an additional passenger are close to zero.

Clearly, the adoption of a test requiring the calculation of variable costs would make it

difficult to evaluate whether fares set in mid-season or those set close to departure are

predatory, due to the high and changing proportion of fixed to variable costs at those

times. Such a rest would lead to the application of two very different measures of

variable costs, depending on when the test was carried out.

In addition, because seats are sold over a considerable period of time, the proper

application of a cost-based test would require a comparison of fares against those costs

that were variable at the time of sale. The situation is even further complicated by

sophisticated yield management systems that are aimed at maximising the total revenue

from a given flight. Such systems segregate passengers into separate markets or sub-

markets for which the yield systems constantly adjust the mix and levels of fares to be

offered based on predicted and (later) actual demand patterns for each sub-market for

each flight. This means that a comparison of different fare revenues at one point in time

will be different to a similar comparison made at a later date. The complexity of the

calculations required may make the application of cost tests extremely difficult, and

may render the making of interim measures impossible.


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Because of these difficulties, it is submitted that an alternative and more appropriate test

for air transport might be to simply compare fare levels and revenue to the carrier’s total

costs allocated to the route in question on an ex post facto basis. Thus the carrier’s

direct operating costs on a particular route would be added to its administration, ground

handling and sales costs (allocated on an appropriate cost accounting basis such as pro

rata to the number of seats offered on that route). These costs can then be compared to

the total calculated operating revenue for the route. It is suggested, for the reasons

enunciated in Boral, that not all prices would be predatory where current revenue is

below 100 per cent of operating costs calculated in this manner. It would however

enable a percentage figure lower than 100 to be more realistically considered in the

context of the necessary later recoupment. Because airlines set their general non-

predatory fares on the basis of the costs allocated to the particular route, it might be

legitimate to presume an intention to eliminate competitors on the basis of fares set

below fully allocated costs, which could then be rebutted by the predator in the context

of market dynamics at the time the alleged predatory fares were set.

This was the approach taken by the U.S. Ninth Circuit Court of Appeals in William

Inglis and Sons Baking Co. v ITT Continental Baking Co366 where it placed the burden

on the dominant undertaking to show a valid business justification for fares set at such

levels in order to prove that they were not predatory367. Conversely, if the fares were

found to be higher than the carrier’s fully allocated costs, then the burden of proving

intent to eliminate rivals would pass to the complainant.

This test may better reflect the operating realities of the air transport industry and would

also enable interim measures to be put into place more practically.

Experience in the U.S. has shown that short-haul routes into hubs or gateways are where

most allegations of predatory pricing are likely to occur, with the new entrant being able

366 Inglis, 668 F.2d 1014 (9th Cir. 1981) 367 In Inglis, the court stated: “Although pricing below average total cost and above

average variable cost is not inherently predatory, it does not follow however that such prices are not predatory. Predation exists when the justification of these prices is based, not on their effectiveness in minimising losses but on their tendency to eliminate rivals and create a market structure enabling the seller to recoup his losses. This is the ultimate standard and not rigid adherence to a particular cost-based rule that must govern our analysis of alleged predatory pricing”


192

to offer lower fares than the full service carriers with their large overheads and ground

presence. Full service carriers use these routes to service point-to-point traffic and as

feeder services for their long-haul flights departing from that airport. The added benefit

to the full service airline of even a few additional passengers from the feeder services,

may justify it operating the feeder at a considerable loss. In other words, the feeder

routes are loss makers and are cross subsidised through the long haul routes. If a full

service carrier sought to justify its below-cost feeder fares on the basis that it is

profitable for the carrier as a whole, it is submitted that this should be resisted because

such a fare structure would make new entry virtually impossible and thus further

weaken the possibility of competition on the route.

It is clear that more so than in most other industries, special consideration needs to be

given to predatory pricing in the aviation industry to cope with its specific

circumstances, especially the unusual nature of its cost structure. The rules for aviation

need to be able to respond swiftly to predatory conduct in order to prevent new entrants

being forced to leave the market before a regulatory response can be determined.

Perhaps something in the nature of cease-and-desist orders might be appropriate to deal

with interlocutory situations pending a final determination. Appropriate cost orders

might also compensate for any abuse of the procedure.

• COMPUTER RESERVATION SYSTEMS

BACKGROUND

Although computer reservation systems (CRSs) existed for internal use in the 1960s and

1970's, airlines enhanced them dramatically after deregulation to meet their

substantially increased information requirements, particularly following their

development of hub-and-spoke networks. These networks caused the replacement of

simple distance-based two-tiered fare systems with complex multi-layered fare

structures designed to serve the wide range of destinations and fare products that

became available after deregulation.

CRSs could store and process information on destinations, flight schedules, prices and a

host of other options, all of which were subject to frequent, if not daily, change. In this


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way, customers through their travel agents, could access a complicated inventory of fare

possibilities, destinations and connecting possibilities. For the carriers themselves, their

sophisticated yield management techniques by means of which they achieve maximum

revenue per flight, would have been inoperable without the data support which CRSs

provide.

CRS’s exhibit economies of scale. For those airlines that did not posses those

economies, either because of their size or simplicity of route structure, it became

common for them to buy access to the CRSs of other airlines. Clearly, where the CRS

owner or operator is also one of the competing airlines, as most CRS owners are, the

potential for anti-competitive practices by the owner/operator is obvious368.

Today there are four CRSs which are wholly or partially owned by U.S. airlines. They

are:

• ‘SABRE’, which is wholly owned by American Airlines and is installed in

approximately 22,000 travel agencies. ‘SABRE’ contains schedules for more

than 650 airlines and projects more than 12 months into the future;

• (2) ‘Apollo’, in which United Airlines holds a majority ownership position and

several other carriers hold minority positions, is located in approximately 25,000

agency locations;

• (3) ‘SystemOne’, originally developed by now defunct Eastern Airlines and later

acquired by Continental Airlines, is installed in about 7,500 locations; and

• (4) ‘Worldspan’, which resulted from a merger of the TWA ‘PARS’ system and

Delta’s ‘DATAS II’ system, is installed in over 10,000 travel agency sites369

In Europe, two CRS systems were established, these being:

368 In fact, in the U.S., it was found that most CRSs were inherently and deliberately biased

in their presentation of schedules and fares (see Dempsey, supra note 150 at 814), thus influencing traveller choices by making it much easier for a travel agent to find and use the services of the system-owning airline, than those of its competitors. In the U.S., eighty five percent of flights are sold by travel agents off the first page of the CRS screen (Dempsey, id at 755). There is a clear incentive to be on the first page!


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• ‘Galileo’ to which Covair (the legal owner of the Apollo System), British

Airways, KLM ,Sabena, TAP-Air Portugal, Swissair, Alitalia, Olympic and

several others belong; and

• (2) ‘Amadeus’, to which Air France, Lufthansa, Finnair, SAS, JAT and a

number of others belong. On 12 December 2002, Qantas announced that it too

was joining Amadeus, and abandoning its old QUBE ticketing system, as part of

its ‘Triton’ e-commerce project.

Finally, ‘Abacus’, an Asian CRS established by a number of Asian carriers is based in

Singapore.

It is clear that as a result of their ownership of CRSs, airlines possess significant control

over travel agencies’ booking practices, especially for United Airlines and American

Airlines which have “dominated the CRS market with a combined share of [as much as]

77 percent of U.S. CRS rentals”370. It also provides airlines whose CRS systems are

used by travel agents access to a very accurate “real-time” picture of both its own and of

its rivals’ business patterns. It can for example track the effect of price changes and

marketing programs, or see how its full-fare business compares with that of its rivals at

any time. If a CRS owner detects travel agents making bookings on a rival airline’s

flights, it can intervene with targeted incentive commission programs in an attempt to

switch the business.

COMPETITION LAW ASPECTS OF CRSS CRSs are of particular interest to competition regulators for a number of reasons.

Firstly, ever since Levine first identified the prime role of information in the

understanding of airline predation371, the role of CRSs in airline competition has been

better understood. In an oligopolistic industry such as aviation, the high pricing which

is a characteristic of such industries is, in practical terms, much assisted when

competitors are able to share information. By means of CRSs, pricing information can 369 M.P.Leaming, Note, Enlightened Regulation of Computerised Reservation Systems

Requires a Conscious Balance Between Consumer Protection and Profitable Airline Marketing, 21 Transp. L.J. (1993) 469 at 473 – 74.

370 J. Brodley & Ching-to Albert Ma, Contract Penalties, Monopolising Strategies, and Antitrust Policy, 45 Stan. L. Rev. 1161, 1189 (1993)


195

be instantly shared - which almost seems tantamount to price setting372. In addition, by

means of a CRS, an airline may almost perfectly price discriminate consumers in order

to manage its yield. Finally, where one competitor is a CRS owner and another is not,

the ownership of a CRS can be considered as a barrier to entry373. Thus what at first

sight appears to be a competitive industry, suddenly looks a bit less so as a result of

CRSs.

As a result of these factors and the practices referred to above, and others such as

conspiring to publish fares well in advance of effective date or denying new competitors

access to CRSs374, the U.S. ‘Civil Aeronautics Board’ ruled in 1984 that each CRS

operator must charge its other airline customers a uniform rate375. Similar regulations

are in place in the EU376.

These Rules reduced or eliminated some of the more obvious distortions of marketplace

information by ruling inter alia that flight information had to be displayed on the basis

of various non-biased parameters, such as departure times, travel times and whether the

service was by direct flight or an interconnection. However they have not completely

eliminated either bias or the preferential access to information that CRSs provide.

CRS lease contracts in the U.S. and E.U. have resulted in substantial litigation over the

years. Contracts often contain minimum-use provisions that require the travel agent to

371 Levine, supra note 230 372 In Re Domestic Air Transportation Antitrust Litigation 1993 – 1 trade cases 70,165, a

class action against all U.S. airlines, the plaintiffs (unsuccessfully) alleged price fixing on the basis of CRS price sharing. In both Australia and the U.S., the announcement of future prices is not illegal unless there is agreement to charge the prices as announced. See Pengilley, Chapter 1, note 50 at 71 – 75.

373 Note that the highly successful SouthWest Airlines in the U.S. is something of a maverick in this area. Not only does it not subscribe to any CRS, but neither does it operate a hub-and-spoke system. It claims that by avoiding the substantial costs associated with both of these facilities, it attracts more customers as a result of its lower fare structure, than would be the case if it subscribed to a CRS and operated a hub. See Dempsey, supra note 150 at 693.

374 Another problem, in terms of its difficulty of detection and enforcement, is the temptation by the host airline to misuse the information received from its competitor. This led to a bitter controversy between Braniff Airways and American Airlines.

375 14 C.F.R., para 255.5(a). 376 (1993) OJ L278/1. See J. Goh, European Air Transport Law and Competition, (John

Wiley, Chichester, 1997), ch. 11 for a detailed examination of the EU Regulation. Note that in both countries, the possible expansion of the definition of CRS to include Internet reservations is being considered.


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book at least half of its flights on that specific CRS and typically contain strict

liquidated damages clauses that discourage travel agents from switching to a competing

system before the expiration of the contract. A travel agent wishing to terminate the

lease often faces stipulated damages amounting to several years of lease rentals.

In the U.S., there have been two basic types of legal challenge against CRS owners for

the alleged anticompetitive effects of CRSs. First, a number of challenges have been

brought by non-CRS owning airlines against CRS owners377. Second, suits have been

brought by travel agents alleging anticompetitive conduct within the CRS market

itself.378. It is worth noting that few of them have succeeded379.

In Australia there have been similar challengers to the CRS system380. Australian CRS

connections are primarily through the Sabre and Galileo systems381. Originally this was

done via an Australian company called Travel Industry Automated Systems Pty Ltd

(“TIAS”) that operated more or less as a switching mechanism between the airlines and

the systems. It did not provide any data to the system382. TIAS operated under TPC

authorisation on the grounds that although it was monopolistic in its nature, it

nevertheless provided public benefits in terms of increased efficiency and viability. The

authorization expired in 1996 and has not been renewed.

377 See Dempsey, supra note 150 at 715 – 768 for an analysis of a number of cases

involving various forms of predation, including CRSs. 378 E.g United Airlines v. Austin Travel Corp 867 F.2d 737, 739 (2d Cir. 1989), where the

‘SystemOne’ operator persuaded the Long Island Travel Agency to convert from APOLLO to its system. The court dismissed SystemOne’s suite alleging restraint of trade and monopoly, awarding United Airlines damages in excess of $400,000. It "found United innocent of monopolization because Apollo accounted for only 8% of revenues generated by CRS bookings in the Long Island area."

379 See for example Air Passenger Computer Reservations Sys Antitrust Litig., 694 F. Supp. 1443, 1451 (C.D. Cal. 1988); Alaska Airlines Inc. v United Airlines Inc., 948 F.2d 536 (9th Cir. 19910, certiorari denied, 503 U.S. 977 (1992).

380 See Warren Pengilley, Airline Snacks, footnote 50 of Chapter 1 at 67. 381 SystemOne, Fantasia (based on Sabre) and Abacus were also available in Australia. 382 Prior to the advent of TIAS, Australia’s two domestic and one international airlines

operated separate CRS systems through two wholly-owned subsidiary companies which, like TIAS, simply acted as a switching mechanism, relaying the CRS signals from the parent companies overseas. Neither of these companies was responsible for the CRS listings themselves or for the content of the signals. In addition neither was economically viable in its own right


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As Pengilley points out, at no stage of the process did TIAS (or its predecessors) have

any control over what was contained in the CRS signals distributed in Australia. TIAS

was compelled to distribute the signals that weer provided to it as part of its

arrangements with the overseas suppliers. The result of this is that an “antitrust attack in

Australia on the grounds of discriminatory listing or refusal to list is not relevant”383.

The fact remains however that both Ansett and Australian Airlines biased their CRS

information in their favour in the early 1990s, and were investigated by the TPC as a

possible breach of s 46 of the TPA384, but no action was taken385.

New entrant airlines in Australia have apparently been able to obtain access to a CRS if

they wished, and although screen bias may be another thing, with the demise of Ansett,

the author’s impression, based on conversations with industry representatives and the

ACCC, is that CRSs are not currently a major problem in the Australian airline industry.

Part of the reason for this may be that Virgin does not operate through travel agents. In

any event, the relevant questions involving CRSs in the Australian aviation industry, are

or have been most probably decided overseas, and this is likely to continue.

Related to CRSs is the issue of code-sharing386 which is the term given to the use of an

airline’s two letter designation on a partner-airline’s flights. The result is the equivalent

of an on-line (carrier X to carrier X) connection, rather than an interline (carrier X to

383 Id at 69 384 R Baxt, Policing the Airline Industry: the Role of the Trade Practices Commission, in

Corones ed ‘Competition Policy in Telecommunications and Aviation’, (The Federation Press, 1994) at p 48

385 Part of the reason for this may have been the uncertain application of an essential facilities doctrine in Australia, similar to that in the U.S.

386 Code-sharing “refers to the CRS code which allows airlines to display each other’s flights in computer reservation systems”. Strictly speaking the term is a misnomer because it is not the airline’s IATA-assigned designator code that is shared, but the flight (i.e. the carrier’s capacity). See J.E. deGroot, Code-Sharing, 19 Air & Space Law, 62, (1994), at 63. Code-sharing enables passage under the name of a single airline through the ticketing and airfare arrangements of that airline, even though the passenger must switch airlines en-route. In other words, “code sharing” refers to the practice of providing passage under the name of a single airline through the ticketing and airfare arrangements of that airline, even though passengers must switch airlines en route. Without code-sharing a passenger who needed to switch airlines to go from point A to point C through point B would require separate ticketing, billing, scheduling, and baggage check in. Open code sharing makes it easier for airlines to form strategic operating alliances. In fact code-sharing is said to be a pre-condition for an alliance. See deGroot, id. For example, if Qantas and BA wish to appear as if they are a single airline, they must code share for this to happen.


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carrier Y) connection and therefore a more favourable computer display when

consumers look to purchase their tickets. Code-share flights for example are commonly

listed twice on CRS systems, which results in superior listings on travel agent computer

screens387.

The possibilities for consumer deception are obvious. For example, in 1994 United

Airlines (UA) had code sharing agreements with several U.S. mid-west regional

airlines operating out of its hub at Denver. UA’s connections with these airlines were

falsely (perhaps fraudulently) displayed on CRSs as on-line connections between UA

and “United Express”. By comparison, Frontier Airlines had no such code-share

agreement, so its UA-Frontier connection was shown on CRS screens as what it truly

was – an interline connection between UA and Frontier, which was further penalized by

being not shown on the first page of the screen. As a result, Frontier’s connecting flight

tickets were rarely sold. As a result of this and other predatory or discriminatory

behaviour by UA, Frontier went into liquidation in 1986388.

CRSs and code sharing may enable foreign carriers to achieve “limited” or “tag-end”

cabotage in the U.S.389. For example, Scandinavian Airlines System (SAS) and

Continental Airlines have a code-sharing agreement390 that has enabled SAS to tap into

Continental’s established hub-and-spoke network, gain a better position in airline CRS

systems, and benefit from Continental’s marketing. Thus SAS and Continental have

387 An example of how this works is as follows. In November 1995, American Airlines

announced that it would place its ‘AA’ computer reservations system designator on four weekly Qantas flights between Los Angeles and both Auckland and Melbourne, thereby providing American with code shares on 24 weekly Qantas flights between Sydney and Los Angeles. Qantas in turn puts its ‘QF’ code on American flights between Los Angeles and Boston, Chicago, New York and Washington. See, ‘American Airlines and Qantas to Expand Their Cooperative Services’, World Airline News, Nov. 6, 1995. In other words when travel agents look for flight availability on their CRSs, they can offer consumers one of American Airlines’ twenty four weekly “flights” from the U.S. to Australia, even though no American Airlines plane ever touches down on the Australian continent.

388 For an account of this, see Dempsey, supra note 150, pp 24-26. 389 Limited or “tag-end” cabotage describes a situation where a foreign carrier flies

between two points in a country as a continuation of an international flight. See De Leon, Cabotage in Air Transport Regulation (1992) at 103. This type of cabotage has recently begun within the European Community, although there are limitations on the number of seats which a carrier may sell. See, Air France to Use Cabotage Rights, Travel Weekly, 24 Dec, 1992.

390 DOT Order 88-12-46 (Dec 23, 1988)


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achieved the air carrier’s goal of “seamless” service, which allows a passenger to check-

in at her local airport and claim his or her baggage at the final destination, as if he or she

was on a single airline for the entire trip391.

Despite U.S. concerns about the anti-competitive aspects of code sharing, the DOT

appears to regard it as the next best way, after an Open Skies agreement, to gain access

abroad for U.S. airlines. It has in fact created a policy that requires a foreign carrier who

wishes to form an alliance (including one in the form of a code share agreement) with a

U.S. airline, to first have underlying rights to the proposed U.S. routes. As a result, it

now negotiates with the foreign carriers to accommodate extensions of services beyond

U.S. gateways. Other nations have followed suite, complicating matters greatly392.

A recent development has been the role of the Internet on the sale of airline tickets and

the possible elimination of traditional travel agent services. There is a concern that

online travel services may engage in anticompetitive practices, such as forming

exclusive contracts with airlines. The Orbitz travel site, which went on-line in 2001, has

generated the most concern because it is owned by the five major U.S. airlines, which

account for the vast majority of domestic U.S. traffic393.

Future regulation of CRSs may come about via the GATS Agreement ‘Annex on Air

Transport Services’. Although limited in its application at present, it nevertheless

already expressly encompasses CRSs394 and may in the future provide an alternative

avenue for their regulation.

• AIRLINE OWNERSHIP / MERGERS 391 James S. Hirsch, Code Sharing Leaves Fliers up in the Air, Wall St. J., March 11, 1993,

at B1 392 Joan M. Feldman, Alliances: Are We Making Money Yet?, Air Transp. World, Oct 1,

1995 at 31 393 The converse is also possible: namely that airline-direct reservations, which by-pass

travel agents, will reduce the influence of CRSs. reduce the influence of CRSs. Many airlines, including Australian airlines, now offer the choice of booking a ticket over the internet or via a travel agent.


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Airlines are not able to conduct their businesses in the same way as other global

transnational industries in that they cannot usually acquire or merge with carriers from

other countries because of protectionist ownership rules contained in nearly all bilateral

Air Service Agreements395. For aviation, the important thing is who provides the

service, that is: Who owns the airline. Bilateral agreements recognize the designated

airlines of other countries as long as those airlines are substantially owned and

effectively controlled by the citizens of those other countries. Some of the machinations

which the U.S. government in particular has employed to determine whether or not a

U.S. carrier is truly ‘controlled’ by citizens of the U.S. are set out in footnote 400

below.

The paradox for aviation is that while it is by its nature one of the most global of

industries, as a result of its ownership rules, it is also one of the most parochial.

To overcome the commercial disadvantages arising from ownership restrictions, carriers

have resorted to various forms of collaboration, including code sharing, franchising,

partnering arrangements and strategic alliances 396. Airlines do this primarily to gain

access to foreign markets. For example, Singapore Airlines’ acquisition of a 49% stake

in Virgin Atlantic gave it immediate access to the trans-Atlantic market. Other reasons

are that collaborative arrangements between airlines feed increased traffic to their home

bases, or allow them to effectively acquire slots (for example, Lufthansa’s acquisition of

20% in British Midland gave it access to Midland’s slots at Heathrow), and to gain 394 See GATS Annex on Air Services, para. 3(a) –(c) 395 When absolute sovereignty was first incorporated into international air law to govern

relations between States concerning the use of their airspace, citizenship requirements were imposed on airlines such that only national "flag" carriers could operate domestically within a state. To back this up, States also used their bilateral agreements with other States to ensure that those other states designate only those (international) airlines whose "substantial ownership" and "effective control" is in the hands of nationals of those other States, to participate in the bilateral agreement. For example, the Philippines Government cannot designate Singapore Airline to fly the Philippines – Australia route because of the nationality clause in the ASA between the two. The rationale behind these requirements was to prevent a situation in which an airline, deprived of legitimate ties to a state, could still benefit from bilateral aviation rights obtained by that state. In so doing, they limit the strategies available to governments whose carriers are in difficulty. An ownership clause was included in the Chicago Convention’s Transit Agreement (adopted) and the Transport Agreement (rejected).


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quick access to economies of scale and scope. However, while these provide greater

flexibility, they have their limitations and there is growing pressure from airlines for

governments to ease ownership rules that in some countries are even stricter now than

they were fifty years ago397. Some airlines even claim that Open Skies are a sham and a

delusion without freedom of ownership and control398.

Cabotage is closely connected to the issue of foreign ownership and control because

foreign airlines see ownership of the airlines of other countries as the shortest route to

cabotage in that country. Because the U.S. restricts cabotage unbendingly, foreign

airlines wishing to gain access to its domestic aviation market, try to sidestep cabotage

restrictions by purchasing stakes in U.S. airlines in order to gain “backdoor” access to

that market399.

In so doing however they run foul of another set of U.S. aviation restrictions – the 25%

ownership and control limits embodied in the Federal Aviation Act of 1958400, which,

396 Also IATA’s Director General, ‘57th AGM and World Air Transport Summit’, Madrid,

28 May 2001. 397 OECD, The future of international air transport policy- responding to change, 1997 398 Orient Aviation, June 1999. 399 Apart from its size, the U.S. market is legally homogeneous compared to Europe, where

legal heterogeneity greatly complicates the aviation business. Furthermore in Europe, lavishly subsidised rail dominates inter-city transport, so aviation growth is limited.

400 Section 1108. The DOT enforces the 25% limit of voting equity merely as a threshold issue. It then concentrates on the question whether the foreign investor can actually exercise control in any given form, not only through voting. See Page Avjet Corp, Citizenship, DOT Order 83 7 – 5, 102 CAB 488 at 490 (1983); Intera Arctic Services Inc., DOT Order No 87-8-43, at 3 (1987); and Transpacific Enterprises and America West Airlines Inc., DOT Order No 87-8-31 (1987). These decisions seem somewhat arbitrary and do not allow an objective determination of under what circumstances a carrier is able to maintain its U.S. citizenship. For example, For example, in the 1989 buyout of the then-failing Northwest Airlines, KLM Royal Dutch Airlines (KLM), through its subsidiary Wings Holding, contributed $400 million of the $705 million in equity involved in that transaction. According to the terms of the agreement, KLM would, together with all other foreign shareholders, hold less than 25% of the voting stock, but would have the right both to block any amendments to the certificate of incorporation and to appoint one of the airline holding company's twelve directors. Furthermore, KLM would be able to name a three-person financial advisory committee to advise Northwest on management and financial affairs. See Wing Holdings Inc., DOT Order 89-9-51 (1989). Despite the fact that KLM would own far less than 25% of the voting stock, the DOT found that KLM would in fact be in a position to exercise control over Northwest through KLM's subsidiary Wings, Northwest's holding company, and prohibited the buyout from proceeding under its original terms. In its consent order, the DOT stated that in order to determine whether a U.S. carrier could maintain its U.S. citizenship status, it would consider "whether a foreign interest may be


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although only a partial barrier (unlike cabotage which is complete) nevertheless presents

an insurmountable obstacle to foreign airlines endeavouring to compete in the U.S.

market401.

In addition to limiting the amount of capital that airlines can obtain from other

countries, restrictive ownership rules also prevent lower fares and improved services

from being offered. For example, a few years ago, Britain’s Virgin Atlantic proposed

running low-fare services from twenty U.S. cities to feed into its international routes

operating out of New York and Washington DC, but was unable to get around the 25%

ownership rule. Another example occurred when Philippines Airlines halted all services

between Australia and the Philippines in 1998 as a result of the Asian economic

downturn at the time, leaving Qantas as the sole supplier of air services on the route.

The Philippines could not nominate Singapore Airlines for example to step into its

shoes and provide competition, without first obtaining the consent of the Australian

government under the bilateral agreement between Australia and the Philippines. If

another carrier or any foreign company came to the rescue of Philippine Airlines and

acquired a majority shareholding, the problem would still remain unless the Australian

government was willing to amend the bilateral agreement

Parts of the Asia Pacific region have lead the world in liberalising ownership

restrictions. In particular, in June 1986, New Zealand became the first country in the

world to remove foreign ownership restrictions entirely on domestic carriers. By

contrast, in 1996, New Zealand could only relax its international shareholding rights in

order to harmonise with those of Australia as required by the SAM agreement402. This

was done to provide access to additional capital resources403. Ansett Australia

in a position to exercise actual control over the airline, i.e., whether it will have a substantial ability to influence the carrier's activities. Id at 5.

401 A closely linked but distinct aim of foreign ownership, in addition to sidestepping the cabotage ban, is that takeovers allow foreign carriers to co-ordinate their schedules with U.S. carriers. For example, by purchasing a controlling interest in Northwest Airlines, KLM positioned itself not only to profit from internal U.S. aviation by circumventing cabotage restrictions, but also to enhance its own international routes by co-ordinating them to connect with domestic Northwest flights. See Northwest Plans Amsterdam Service in Deal With KLM, Wall St. J., Mar. 18, 1991 at B3

402 This meant that Air New Zealand’s ‘B’ shares – those that could be owned by foreign nationals – rose from 35% to 49%.

403 New Zealand Ministry of Transport, International air transport policy, February 1998.


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immediately purchased Newmans Air in NZ and began operating there in 1987, thereby

breaking Air NZ’s long-standing monopoly.

Numerous other beneficial changes have occurred in NZ since. In September 1996, Air

NZ purchased a half share in Ansett Australia from TNT. Because Ansett was at that

stage an international carrier, and therefore subject to bilateral restrictions on

ownership, Ansett International was separated from Ansett Australia to overcome the

problem of foreign ownership restrictions. In February 2000, Air NZ exercised its right

to buy News Corporation’s shares in Ansett. As a result, Air NZ owned 100% of Ansett

and 49% of Ansett International. This arrangement was approved in June 2000 by

Australia’s Foreign Investment Review Board404.

New Zealand has continued to surpass other Asia Pacific nations ever since in the area

of aviation deregulation, including Australia. For example, of New Zealand’s 45

bilateral ASAs, nationality clauses have been replaced by place of incorporation,

principal place of business, or place of effective control in 20 of them.

For its part, Australia has largely followed New Zealand’s lead405. For example, it now

allows up to 49% foreign investment in its international carriers in total, with a single

carrier holding limited to 25%, and total foreign carriers limited to 35%406. With 19%

of Qantas already owned by BA, only 30% is available for other foreign institutions. As

with NZ, Australia also now allows up to 100% ownership for domestic carriers.

Despite these examples, experience elsewhere shows that when ownership restrictions

are lifted, relatively few airlines acquire majority shareholdings in other carriers. For

example, in the EU only BA and the Swissair group have been keen to buy

shareholdings in several other airlines, and not all those ventures have been successful.

It is not easy to operate an airline in another country. BA and KLM explored a merger 404 Subject to several conditions. See Kaduck R.J. and Hooper P. (2001). ‘Airline domestic

ownership requirements: the cases of Canada and Australia, in 9th WCTR Conference, Seoul, 23 July 2001, p 13.

405 But not to the extent of entering into Open Skies agreements with any countries other than New Zealand.

406 Recently, Qantas Airways’ chairperson, Margaret Jackson, called for the Australian Government to ease these ownership regulations to allow it to have more international


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in 2000 but negotiations were complicated by the U.S.- Netherlands Open Skies

agreement which meant that “if KLM came under the effective control of BA while

Bermuda II still governs U.S. – U.K. air services, KLM will immediately lose the

benefits of the U.S. – Netherlands Open Skies agreement”407. As a result, merger talks

were terminated in September 2000.

With much of the world’s airlines ageing, and the consequent need for fleet renewals

and other investments looming large in the near future, it seems likely that foreign

investment will play a more significant future role in the airline industry. Some

countries such as Korea, Malaysia and China have already changed ownership limits to

attract foreign investors. In Australia, the competition benefits of the lifting of

Australia’s foreign ownership cap for domestic airlines to 100% in 1996 are already

being felt, with the resulting emergence of Virgin Blue, originally a subsidiary of the

U.K. Virgin Group.

The experiences of Australia and New Zealand, who have lead the world in the area of

liberalizing their domestic aviation industries from ownership restrictions, have shown

that foreign investment has the potential to stimulate competition within the airline

industry, and provide greater access to capital. There does not appear to have been any

significant downside to the move. Foreigners investing in airlines in the two countries

have all faced strong competition from the respective national flag carriers, so much so

in fact that, apart from Virgin Blue, none is yet profitable. Both countries appear to be

more comfortable with structural solutions than with regulating conduct, with

Australia’s Transport Minister saying that passengers not the government should

determine an airline’s market share408.

For international airline services however, no country is entirely free to move

independently of others. If foreign ownership goes beyond a certain point it raises

complicated questions because of its ASAs. Both Australia and New Zealand, and many

other countries continue to limit the foreign ownership of their international carriers to a

maximum of 25% for any single airline. It is in this context that the flexibility of Open

investors. With 19% of Qantas owned by BA, only 30% is currently available to other foreign institutions.

407 ATI News, ‘KLM would lose U.S. open skies under BA control’, 20 July 2000.


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Skies agreements offers governments some scope around the problem of relaxing airline

ownership restrictions. For example, a variation of the usual Open Skies agreement is

contained in the 1996 amendment of the U.S. - German bilateral agreement (the "1996

Protocol")409 amends the traditional nationality clause. Article 3 (3) waives the right to

withhold or revoke operating permission of a third country's carrier, under the

applicable article of the relevant bilateral air services arrangement between the

contracting party, (i.e., the U.S. or Germany), and the third country, "[w] here nationals

of either contracting party hold an ownership interest of less than 50 percent in an

airline incorporated and having its principal place of business in a third state.... solely

on the basis that ownership interest ... constitutes control or effective control"410.

The provision also requires that "the third state permits airlines of both contracting

parties to invest in airlines incorporated and having the principal place of business in

that third state on an equal basis, and ... that the relevant bilateral air services

arrangements between each contracting party and that third state are 'Open Skies'

agreements."411. This may avoid the problems which caused the collapse of the BA /

KLM merger talks.

In May 2001 a multilateral Open Skies agreement was reached between the U.S. Brunei,

Chile, New Zealand and Singapore in which a key differentiating feature was that the

traditional ownership requirement was substantially liberalized. It was the first time that

the U.S. had signed such an agreement and if it were to adopt this approach to all its

Open Skies partners, it would represent the most effective way of bringing about change

in airline ownership rules. The relevant article concerning designation and authorization

states that:

“(a) effective control of that airline is vested in the designating Party, its

nationals, or both;

408 The Australian, ‘Open sky call to Europe’, 25 September 2003 409 Bartkowski and Byerly, Forty Years of United States / German Aviation Relations, 46

ZLW 3, at 33 410 Id at 35 411 Id


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(b) the airline is incorporated in and has its principal place of business in

the territory of the Party designating the airlines.”

Three objectives are contained in the new agreement:

• To provide a competition-enhancing model for future agreements.

• To expand carrier access to equity financing.

• To streamline international aviation relations.

Furthermore, a protocol to the agreement signed by New Zealand would enable a New

Zealand airline to set up in Singapore and from there operate passenger services to third

countries which had exchanged the same rights with New Zealand. There is no

requirement that flights originate in or are destined for New Zealand.

It appears unlikely that the U.S. will unilaterally change its own foreign investment

restrictions in the foreseeable future. But, as a result of this multilateral Open Skies

agreement, it appears to be even more likely that the U.S. might suspend those

restrictions, although this would probably only be through bilateral or multilateral

agreements in which the other side(s) grants equal rights, and then probably only as part

of a formal Open Skies agreement.

QANTAS / AIR NEW ZEALAND MERGER

The most recent local development in aviation mergers in the trans-Tasman aviation

market was the proposed alliance between Qantas and Air New Zealand announced on

25 November 2002. The proposed alliance was in the form of a merger, whereby Qantas

proposed to purchase a 22.5% equity in the other for Aus$488.3 million. Fiji’s airline,

“Air Pacific” also sought permission to join the alliance412.

412 It would be part of the alliance anyway by virtue of the fact that Qantas owns 46% of

Air Pacific’s common shares and code-shares with it on flights between Australia and Fiji.


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The effect of the proposed merger on trans-Tasman competition is obvious413, with Air

NZ managing both airlines’ flights to, from and within New Zealand. If nothing else,

the proposed merger tested the harmonisation of the competition laws of the two

countries with the merger subject to regulatory approval by both the ACCC and its

equivalent, the New Zealand Commerce Commission.

Although some form of merger between the two airlines might ultimately be inevitable,

the current mix of variables in the Australian aviation industry made it an ideal

opportunity for the Australian (and New Zealand) governments to pro-actively

restructure their aviation industries and the whole trans-Tasman market, to ensure its

long-term viability. The key variables in the regional aviation ‘equation’ are:

• Firstly Qantas seeks by means of the merger to fulfil its strategic objective of

forming an Asian aviation hub involving itself and Singapore Airlines (SIA) as

the major players, possibly with SIA purchasing British Airway’s 19%

shareholding in Qantas414.

• Secondly, SIA seeks to expand its links to Australia through an Open Skies

agreement with Australia. That possibility was rejected on 23 September 2003,

when the Australian government opted, no doubt under pressure from Qantas, to

reject an Open Skies agreement in favour of the slight liberalisation of the

existing bilateral agreement.

• Thirdly, Air New Zealand was (and no doubt still is) considered by some as

unlikely to survive in the long term unless it can merge with a larger airline such

as Qantas, and

• Virgin Blue, now profitable and established as the region’s discount operator,

wishes to expand into the trans-Tasman market.

In rejecting the proposed merger, the above aspirations, all of which are pro-competitive

in their nature, have been denied. The ACCC considered that the merger failed the test

413 Virgin Blue has described it as ‘stitching up the competition’. See Chris Daniels,

Airlines alliance extends the net, ‘The Australian’, 7 December 2002. However Virgin later supported the merger, on condition that it was allowed to compete effectively.

414 See ‘Qantas closer to Asian dream’, The Australian Financial Review, 26 November 2002, p 72


208

of “substantially lessening competition”415 without at the same time offering sufficient

benefits to the trans-Tasman market to warrant an authorisation under s 88 TPA. The

New Zealand Commerce Commission reached a similar conclusion, the tests being

similar in both regulatory regimes.

In rejecting the proposed merger, both countries missed an ideal opportunity to pro-

actively restructure the trans-Tasman aviation market, rather than simply respond to

industry-initiated changes. If the proposed merger had been approved subject to

appropriate stringent conditions, both governments could have set the stage for the long

term growth of their respective aviation industries resulting in sustainable competition

in the trans-Tasman market for the long term benefit of all, including consumers.

For example, if the merger had been approved subject, inter alia, to:

• an Open Skies agreement being finalised between the Australian and Singapore

governments

• adequate slots and other facilities being made available by both airlines at key

trans-Tasman airports in Australia and New Zealand, for the use of Virgin Blue

and any other trans-Tasman competitor, including Emirates, SIA, or U.S.

carriers who may wish to fly the route either immediately or in the future,

then there might well be effective long-term competition on the trans-Tasman route, and

many of the pieces of the aviation jigsaw puzzle would have come together for both

Australia and New Zealand. The legitimate wishes of the regions airlines could also

have been realised, with the necessary and appropriate controls in place.

Both ACCC and the NZCC seemed to have viewed the merger, even with conditions

attached, as simply reinforcing the dominance of the two incumbent flag-carriers. This

is certainly the traditional view to take where, as here, the merger is between two large

flag carriers operating networks that substantially overlap.

415 S 50 TPA.


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The decision was predictably criticised as being more theoretical than practical,

reinforcing industry views that the regulatory authorities in both countries lack aviation

expertise416. To overcome this perception, one approach might be to reverse the onus of

proof by requiring the regulatory body to establish a case against the presumed

beneficial effects of a merger, rather than vice versa. But because the regulation of

mergers is a highly politicised process, it is doubtful that this approach would be

adopted.

The preferable approach would have been to approve the merger, conditioned in a way

that would have substantially eradicated its negative impact on competition. It is

recognised however that in the absence of clearly defined long term aviation policies in

both Australia and New Zealand, the decision of the Regulators to disapprove of the

Qantas / Air New Zealand merger is understandable. That does not mean it is correct. In

a sense, the Regulators currently operate in a vacuum. A White Paper on the subject of

long-term aviation goals for Australia is needed.

Irrespective of this, as a result of the refusal of the regulatory authorities in both

countries to approve the merger, such an ideal opportunity to restructure the trans-

Tasman market, and with it the airline industries of both Australia and New Zealand,

may not present itself in the near or immediate future.

416 ‘Kiwis kill Qantas, Air NZ merger’, The Australian, 24 October 2003 in which Air NZ

CEO Ralph Norris describes claims by the NZCC that airfares could rise by up to 19%


210

.

as a result of the merger as ‘”making no sense” in the light of market practicalities. See also The West Australian, supra note 309.

CHAPTER 4: CONCLUSION

The Paris and Chicago Conventions established the principle that each State has

absolute sovereignty over the airspace above its territory. Chapter 1 of this thesis

examined the historical development of the consequences stemming from this principle.

It led directly to the bilateral system of international airline regulation, from which

stemmed, amongst other things, the establishment of national carriers which were

protected from foreign competition by subsidies handed out by their governments, to

international cartels, to highly restrictive airline ownership rules and to cabotage. These

restrictions led to a ‘lowest common denominator’ effect in the international aviation

industry, where the governments of the least efficient airlines were able to insulate them

from competition from more efficient airlines. There is little incentive in such an

environment for any airline to become more efficient.

To avoid these restrictions, and at the same time maximising their revenues by

providing the ever widening range of aviation services demanded by their customers,

carriers are more or less forced into a bewildering range of co-operative agreements

with other airlines, ranging from informal marketing arrangements, to code-sharing, to

alliances and to equity mergers to the extent allowed by the ownership rules of each

airline’s home state. The inevitable consequences of such co-operative agreements are a

lessening of competition and the rise of anticompetitive practices in the markets affected

by the arrangements. The scope for such practices in the aviation industry is perhaps

wider than in any other. At one time these practices were condoned or even supported

by governments which exempted their national carriers from the reach of their

competition laws. Australia for example did this during the period of the two-airlines

policy. Some governments, even in developed economies such as Japan, still do so.

Although the restrictions described above still apply to much of the international

aviation industry, globalisation of the world’s economy has forced a rethink by many

governments of the costs versus the benefits of subsidising their national airlines. This

has opened the door to the first vestiges of true competition in the aviation industry and

to its deregulation.

Chapter 4: Conclusion

211

Open Skies agreements are at the forefront of this trend. The United States government

continues to lead the process of international deregulation under the banner of Open

Skies which it initiated in 1992, following the successful deregulation of its domestic

aviation industry in the mid 1970s. Parallels between the two abound and the undoubted

success of its domestic deregulation in terms of lowering prices has been used by the

U.S. as a reason why other governments should adopt Open Skies. Increasingly, other

governments are either less sure of the benefits, or suspect that Open Skies favour U.S.

carriers at the expense of their own.

Chapter 2 of the thesis examined the nature of Open Skies agreements, and the

widespread acceptance of the phenomena1. In particular, Chapter 2 examined the

strategies pursued by the U.S. in the implementation of Open Skies in different parts of

the world, including the Asia Pacific region of which Australia is a part.

It is in that region where the most rapid growth in aviation is expected to occur in the

first quarter of the 21st Century. The acceptance of Open Skies in the region has

however been particularly slow there, much less so than in Europe for example. One

reason for this is that many Asia Pacific governments still see the need to protect their

aviation industries and are aware that not all airlines win under Open Skies. Some

developing Asian airline industries, including those in such major markets as China,

Japan and India, are generally considered to be not as cost competitive as U.S. airlines2,

and continue to need protection. Those governments, and many other Asia Pacific

governments, have to date resisted attempts by the U.S. for them to enter Open Skies

agreements with it, because they believe it is not in the best interests of their aviation

industries.

The reason for Asian suspicion is that a sequence of Open Skies agreements with

smaller States give U.S. carriers much more liberal access to Asia Pacific routes than

vice versa. Australia (and its national carrier Qantas) also appears to take this view

because it currently shows no interest whatever in an Open Skies agreement with the

1 As at 30 September 2003, sixty Open Skies agreements have been signed by the U.S. A

number of others have also been signed which do not involve the U.S. 2 See Garrick Goo, referred to in Chapter 2, footnote 102, at 560


212

U.S., despite that fact that a number of its near neighbours, such as Singapore, Malaysia

and New Zealand have done so, apparently without damage to their aviation industries.

At the same time, it does not appear that many benefits have flowed to the national

airlines of these countries as a result of their governments having done so.

It appears in fact that Open Skies offers the most advantages to the non-U.S. partner to

such an agreement, only when it is coupled to an alliance between it and a U.S. carrier.

Indeed Chapter 2 showed that the strategy of the U.S. is to positively tie Open Skies

agreements to the granting of antitrust immunity for an alliance with one of its carriers.

In fragmented aviation markets such as Asia Pacific and the Europe, such a ‘divide and

conquer’ strategy makes much sense from the point of view of U.S. economic interests.

But Chapter 2 also showed that even where it makes economic sense for the non-U.S.

partner to agree to tie Open Skies to a grant of antitrust immunity, the fifth freedom

benefits which flow to the U.S. carrier almost always far exceeds the benefits that flow

to the other. Neither New Zealand, Singapore nor Malaysia for example has extended

their Open Skies agreements with the U.S. by doing this, so the benefits to them remain

muted. In fact it is hard to see what the specific benefits to them are.

Australia’s reluctance to sign an Open Skies agreement with the U.S., at least in the

absence of an alliance between its carriers and those of the U.S., may therefore be

understandable. What is harder to understand is why Australia shows no interest in

initiating Open Skies with any of its neighbours apart from New Zealand (to which

special considerations apply). For example, as recently as September 20033, Australia

rejected the opportunity to enter into an Open Skies agreement with Singapore, despite

the latter’s long-standing interest in doing so. To the best of the author’s knowledge,

there are no Open Skies negotiations being conducted by Australia anywhere in the Asia

Pacific region or indeed anywhere else.

Chapter 2 promoted the idea that Australia should take the lead in the Asia Pacific

region in promoting Open Skies on a regional basis as part of its general policy of

promoting trade in the region. There are strong considerations of policy and economics

why Australia should do this, rather than taking a ‘back seat’ and doing nothing as it is

3 See Chapter 3, footnotes 306,307 at p 173


213

currently doing. However before such an initiative could realistically happen, Australia

needs to have long-term aviation goals in place to which it can direct its strategic

initiatives in the region, and those goals need to be regionally based.

Once in place, either through a ‘club’ approach or however, the parties to such a

regional Open Skies agreement might at a later date use their combined negotiating

power to enter into a multilateral Open Skies agreement with the United States, similar

to the manner in which the EU is currently negotiating an Open Skies agreement with

the U.S. on behalf of all EU Member States.

Implicit in this proposal is the fact that in terms of its constitutional and legal system,

Australia is well able to progress to adopting Open Skies. It certainly has the legal

capacity to enter into Open Skies agreements with other nations. Whilst there are no

significant or insurmountable legal inhibitions constitutionally or in domestic law to

prevent that course

Chapter 3 of this thesis considered Australia’s constitutional framework in the light of

aviation generally, and Open Skies in particular. It found that the Australian

government has adequate powers under the Australian Constitution not only to enter

into Open Skies agreements, but also to regulate virtually all aspects of Open Skies that

might eventuate from its adoption. In particular aviation safety and navigation, the

development of aviation infrastructure such as airports, the domestic and international

competition aspects of Open Skies and any environmental consequences of Open Skies

can all be adequately controlled by the Australian government.

While it is true that in the short term, there may be some practical problems with the

implementation of Open Skies in Australia, such as airport capacity and cabotage, these

can all be accommodated in the longer term and are not of such a nature as to prevent

the implementation of Open Skies.

Some specific forms of anti-competitive behaviour in the airline industry, including

predatory pricing and merger activity, were examined in Chapter 3. Such conduct has

the potential to destroy many of the potential benefits of Open Skies. Anti-competitive

behaviour is however subject at virtually all times and circumstances to the control of


214

the Australian government, which has adequate powers at its disposal to regulate such

behaviour with a view to obtaining the maximum benefits of Open Skies. The only

possible caveat is that the regulatory authorities, in implementing these regulatory

powers need to assess the market behaviour of airlines in the context of long-term

aviation goals, rather than short-term objectives.

While not a panacea for all the aviation industry’s woes, an Open Skies policy is a step

in the right direction of freeing its aviation industry from the shackles of the Chicago

regime. However, for Open Skies to succeed in deregulating the international aviation

industry, the conditions of sustainable competition must exist a priori. Regrettably,

these conditions rarely do exist, as a result of structural imbalance in the aviation

industry and the persistence of bilateral agreements. Furthermore, competition is always

vulnerable to the anti-competitive behaviour of incumbent airlines, as distinct from

government itself. As a result, the potential competition-enhancing effects of Open

Skies policies are seldom fully achieved, even in countries such as New Zealand which

has been particularly active in supporting them.

This thesis set out to show that a carefully designed Open Skies aviation policy for

Australia and the Southeast Asia region has the potential to offer many benefits to

region and to Australia in particular. Because of the relatively slow acceptance of Open

Skies by governments in the region, the time is opportune Australia to promote the

concept, perhaps on a ‘club’ basis which might find better acceptance amongst Asian

nations. Countries such as Singapore, Malaysia and New Zealand might be expected to

become early members of the ‘club’. Nations who subsequently join the ‘club’ can then

see for themselves if Open Skies is beneficial or otherwise. Assuming it is, the ‘club’

can then be the basis for multilateralising United States-initiated Open Skies agreements

in the region.

Provided the Australian government now adopts longer term policies to implement its

own strategic aviation goals, the way will be open for it to promote the concept of Open

Skies in the region and initiate progress towards deregulated aviation. Without such a

clear strategy in place, it will not have the credentials to do so.

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Documents

THE UNIVERSITY OF WESTERN AUSTRALIA€¦ · Western Australia and to Professor Warren Pengilley, Sparke Helmore Professor of Commercial Law, The University of Newcastle. I have been