The Persistent Financial Losses of U.S. Airlines

Two factors seem to be the major drivers of the [airline] industry's poor profit performance:  the severe demand downturn after 9/11, [and] the large cost differential between legacy airlines and the low-cost carriers.

The dismal financial record of the domestic airline market, more than 30 years after deregulation, is somewhat puzzling. In 2008 and 2009, U.S. passenger airlines reported aggregate net losses before extraordinary income and charges of $14 billion on revenues of $270 billion. About 76 percent of the losses were on domestic U.S. operations, which have been deregulated since the fall of 1978. From 1979 through 2009, U.S. airlines lost $59 billion (in 2009 dollars) on domestic operations.

In On the Persistent Financial Losses of U.S. Airlines: A Preliminary Exploration (NBER Working Paper No. 16744), author Severin Borenstein examines some of the most common explanations for this dismal performance, including high taxes and fuel costs, weak demand, and competition from lower-cost airlines. His analysis suggests that high taxes have been, at most, a minor factor. Fuel cost shocks have played a role only in the last few years.

Two factors seem to be the major drivers of the industry's poor profit performance. The first is the severe demand downturn after 9/11, a reduction that left demand much weaker in 2009 than it was in 2000. The second is the large cost differential between legacy airlines and the low-cost carriers (LCC), which has persisted even as their price differentials have greatly declined. Adjusted for average flight distance, legacy carrier costs have remained 30-to-60 percent higher than the LCCs' costs for nearly all of the deregulation era, averaging about 40 percent higher in the last decade.

Borenstein points out that the airlines' financial performance improved substantially in 2010 and that the industry seems likely to be close to break-even on domestic operations for the year. Still, the experience of the last decade suggests that until legacy carriers can either close the cost gap with LCCs or increase the price premium they maintain, they will likely have difficulty earning consistent profits through the typical cycles in the airline business environment.

--Lester Picker