American Consortium on European Union Studies (ACES)
Cases on Transatlantic Relations, No. 1
European Integration and Transatlantic Air Services Agreements:
Who Has the Authority?
by
Michael J. Harrison
This case was written for Prof. C. Randall Henning of the School of International Service at
American University and Editor of ACES Cases on Transatlantic Relations Nos. 1-3. Michael J.
Harrison is a graduate student at American University, one of the institutional members of the
ACES consortium. They wish to acknowledge Christopher Ross, Martin Staniland, Matthew
Finston and Jeffrey Saunders for extensive and helpful comments on drafts. Any errors or
omissions that might remain are the author’s alone. Copies of the case can be downloaded free
of charge, and information on other cases in this series can be found, at the ACES website:
www.american.edu/aces/pages/publications.html.
Copyright © 2003 American Consortium on European Union Studies
Editor’s Note
This case is one of a series on transatlantic relations developed by the American Consortium on
European Union Studies (ACES), a center organized by five universities in the Washington D.C.
area. Teaching essential concepts and principles concerning the politics and economics of
transatlantic relations is the central purpose of the case series. Each case explores its particular
topic as a specific instance of more general patterns of conflict and cooperation between the
European Union and the United States. European integration, EU and U.S. policymaking, and
their consequences for transatlantic conflict and negotiation are thus basic themes in the series.
The multiplicity of layers of policy authority on each side of the Atlantic, and shifts in the
location of that authority, also feature prominently in these cases. Each case thus conveys
information on specific problems in order to provide a factual foundation for students to discuss
broader principles as well as the particular policy dispute. These cases are written to assist
instructors of upper-level undergraduate and graduate courses in government, business and
economics in general and are configured for courses in International Relations, Foreign
Economic Policy and European studies in particular. We welcome your feedback on the
individual cases and the series as a whole.
C. Randall Henning
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1
Introduction
Disagreements over airline services have been a persistent source of transatlantic conflict
for several decades. Numerous bilateral agreements between EU member states, on the one
hand, and the United States, on the other, effectively segment the internal European airline
services market along national lines. Several powerful actors within Europe – including the
European Commission and some member states and airlines – are pressing for completion of the
single European market for airline services. In a landmark decision in 2002, the European Court
of Justice (ECJ) ruled that central aspects of the bilateral agreements with the United States
violated member states’ obligations under the European treaties. By requiring the renegotiation
of these agreements, yet leaving the institutional responsibility for conducting these negotiations
unspecified, the decision created great uncertainty in airline markets. Government authorities
and private airlines on both sides of the Atlantic were forced to reassess their strategies and
interests with respect to deregulation and European integration. At the same time, the ECJ
decision opened the door to the possibility of a truly free market in airline services across the
Atlantic.
Overview
From its inception through the creation of the monetary union, the European Union has
had the central goal of deepening integration among its members. One of the cornerstones of
this deeper integration, the 1986 Single European Act (SEA), sought to streamline rules and
standards among members in order to create a single market for goods and services, labor and
capital. While governments were generally successful in implementing the reforms mandated
under the SEA by 1992, their drive to remove barriers and harmonize policies in the airline
industry, among a few other sectors, was slower than their progress overall.
The European Commission sought to gradually harmonize rules regarding air travel in
three separate packages, the last of which was fully implemented in 1997. These packages
liberalized the market for intra-European air travel; but the European market remained
fragmented as a result of the rules regarding international air travel (i.e., travel outside Europe),
particularly travel to the United States, on which many European airlines depend for a large
portion of their revenue.
Under the rules of the 1944 Chicago Convention, states agreed to negotiate detailed rules
– such as which airlines are allowed to fly into which airports and how often – and codify these
rules through bilateral air services agreements (ASAs). The United States thus has bilateral
ASAs with nearly every European country, as do European governments with other countries
around the world. As the European Union grew from six members to 15 members, these
bilateral ASAs with the United States and other countries impeded the completion of the single
European market for air travel. Because ASAs recognize airlines on the basis of “substantial
ownership and effective control,” they are recognized as national – rather than European –
entities. Thus, for example, while Air France is allowed to fly to the United States from France
under its bilateral ASA, the German airline Lufthansa is not allowed to fly to the United States
from France even though EU rules would allow such a flight.
Many EU member states have historically pursued a “national champion” strategy with
respect to airlines, occasionally investing in, retaining partial or full ownership, and providing
2
state aid to their flag carriers. Such EU members, particularly smaller states, rely on their
bilateral ASAs with other countries to keep their national airlines flying and are thus reluctant to
allow the European Commission to negotiate an ASA with the United States on behalf of all EU
members. Such an agreement could mean smaller national airlines would be crowded out by
dominant airlines like British Airways and Lufthansa. In negotiating separate bilateral ASAs
with the United States, EU member states have, in effect, agreed to discriminate against airlines
from fellow member states, protecting their flag carriers from competition and preventing the
completion of the single European market for air travel.
Further complicating the issue is the number of EU members that have signed “open
skies” agreements with the United States that essentially liberalize all trade in airline services.
As of 2003, 11 EU members – all but Britain, Greece, Ireland and Spain – have open skies
agreements; the remaining four are much more restrictive agreements, the most egregious of
which is the Bermuda II agreement between Britain and the United States. Under Bermuda II,
for example, only four airlines – two American and two British – are allowed to fly between the
United States and London’s Heathrow Airport, one of the world’s biggest centers of international
air travel. While the European Commission would prefer to see a more liberalized aviation
regime – what has come to be called an "open aviation area" – between the European Union and
the United States, it must work to overcome the opposition of many member states.
In November 2002, the European Court of Justice (ECJ), the highest court in the
European Union, ruled that bilateral ASAs were illegal because they required EU member states
to discriminate against other member states’ airlines on the basis of nationality. The decision
precluded any further signing of bilateral ASAs by EU member states, with the United States or
with any other country. The European Commission is pushing for member countries to allow it
to negotiate on their behalf, in the interest of pooling negotiating leverage, particularly for talks
with the United States. The existing arrangement of bilateral ASAs, the Commission argues,
allowed the United States to “pick off” member states one at a time, concluding agreements that
may have been beneficial to the individual member states but were detrimental to the European
Union as a whole. The United States has not denied this “divide and rule” strategy of concluding
open skies agreements with smaller EU member states as a means for exerting pressure on larger
ones.
The ECJ decision presents the challenge of the untangling of a dense web of over 200
bilateral ASAs with 22 separate governments in such a way that satisfies not only all EU member
states, but also the United States, home of the most lucrative market for air travel in the world.1
This case lays out the dilemmas inherent in the system of bilateral ASAs in the European Union,
particularly the European Commission’s desire to complete the single European market for air
travel in the face of recalcitrant member states and a United States that is reluctant to overhaul
the transatlantic air travel regime at a time when many of its own airlines are struggling
financially.
The first section of this case explains the existing market and regulatory structure of the
airline industry. The second section discusses the contrasting approaches to airline deregulation
in the United States and the European Union. The third section looks specifically at the effect of
1
Dinan (1999), p. 362.
3
bilateral ASAs on the EU single market, details the recent ECJ decision and the European
Commission and U.S. viewpoints, and examines the steps that need to be taken to negotiate and
implement a new transatlantic regime. The final section considers the viewpoint of several
different airline alliances and national governments as a launching point for further discussion of
negotiating dynamics associated with transatlantic air travel.
Structure of the Market for Airline Services
Sir Adam Thomson, the late chairman of defunct British Caledonian Airways, once
remarked, “A recession is when you have to tighten your belt; depression is when you have no
belt to tighten. When you’ve lost your trousers – you’re in the airline business.” Making money
in the international air travel market is notoriously difficult. This is due to the complex set of
regulations by which airlines must abide, high costs of entry, and intense competition from other
airlines in more liberalized markets.
Cost and Revenue Structure of the Airline Industry
Airlines must take a number of variables into account in determining how to best serve
their markets. They must decide what type of aircraft would be most efficient in terms of costs
per passenger mile, how frequently to offer service, and whether demand is so high as to require
nonstop service or to connect two city pairs through a hub. Given an expected amount of
demand for travel between two points, airlines also face issues such as whether to offer a few
flights on high-capacity aircraft each day or several flights on smaller aircraft each day, based on
the aircraft available in the airline’s fleet.
Airlines have to focus on the load factor, or the percentage of seats that are filled on an
aircraft, and costs of operating a flight, including landing fees, fuel costs, labor (including flight
crew and ground crew) costs of leasing the aircraft, and costs for maintaining the aircraft. Since
these costs are spread among paying passengers and the distance traveled, costs are measured as
a function of revenue passenger miles (RPM). Airlines must decide what fares to charge
passengers, given higher per-mile costs on shorter flights and lower per-mile costs on longer
flights, and given the number of competitor airlines offering service and their fares. Airlines
achieve economies of scale by flying fuller aircraft (higher load factors) over longer distances. 2
Traffic, Revenue and Profit for selected U.S. and European airlines, 2001
Revenue Passenger
2
Fischer (1997), p. 70.
Revenue
Net Profit or Loss
4
Airline
Miles (million)
United (US)
187,686
American (US)
170,883
Delta (US)
163,683
Northwest (US)
117,658
British Airways (UK)
106,270
Continental (US)
98,374
Air France (France)
94,415
Lufthansa (Germany)
93,605
Southwest (US)
71,591
KLM (Netherlands)
57,848
Iberia (Spain)
41,297
Alitalia (Italy)
36,524
Swissair (Switzerland)*
32,981
Virgin Atlantic (UK)
30,198
SAS (Norway, Sweden, Denmark)
23,295
Sabena (Belgium)
15,320
Finnair (Finland)
12,800
TAP Air Portugal (Portugal)
10,457
Aer Lingus (Ireland)
9,554
Olympic (Greece)
8,428
Austrian (Austria)
8,140
Ryanair (Ireland)
9,844
Easyjet (UK)
5,126
Luxair (Luxembourg)
1,061
Source: Air Transport World, “2001 World Airline Report”
*Filed for bankruptcy; now known as Swiss International Air Lines
-- Data not available
(million $)
16,138
18,963
13,879
9,905
12,176
8,969
11,024
14,687
5,555
5,744
4,160
4,698
--4,989
-1,477
1,091
--1,911
543
525
264
(million $)
-3,771.0
-2,470.0
-1,117.0
-888.0
-161.0
144.0
206.8
-277.7
631.1
-82.0
4.3
6.2
---108.8
-11.7
18.1
---78.2
141.7
58.0
10.3
Considering all these variables, it is easy to see how, when airlines depend on a load
factor of 60 percent to 70 percent just to break even,3 even a slight downturn in passenger traffic
can have a devastating effect on an airline’s profits. In the competitive market environment
fostered by increasing deregulation and open skies bilateral ASAs, airlines have increasingly
turned to hub-and-spoke networks and code-sharing alliances to streamline operations, guarantee
sufficient passenger flow and maximize profits.
Hub-and-Spoke Networks
More than any other operational aspect, the system of flying passengers to hub airports in
order to efficiently move them to their destinations has become the definition of how the airline
system works. By routing flights between city pairs through a hub, an airline can leverage –
through permutation – the number of city pairs it can serve without being exposed to the risk of
operating less-profitable routes between two small cities.4 Prior to the increased use of hubs,
airlines tended to use smaller-capacity aircraft to serve more cities in point-to-point fashion, a
less efficient means of operation.
Consider an example in which an airline serves three airports in one area and three
airports in another area. Providing direct service between all six airports would require 18 flights
in all (nine each way). However, by routing the airports in each area through a hub airport, the
3
4
Fischer (1997), p. 69.
Hanlon (1996), p. 71.
5
same six airports can be served with only 12 total flights.5 The increased efficiency of hub-andspoke networks is multiplied when taking into consideration the massive multi-hub networks of
major international carriers such as American or United.
Hubs also make it possible for smaller airlines such as U.S. Airways to conduct
international operations out of nontraditional ports of entry – in U.S. Airways’ case, Pittsburgh,
Charlotte, N.C., and Philadelphia – by feeding passengers to the hub via spoke routes from, say,
Chicago, Detroit, and Washington. Thus, U.S. Airways is able to advertise service from
Washington to Frankfurt even though it actually operates the international segment of that flight
from Pittsburgh to Frankfurt.
Aside from the efficiency aspect of hub-and-spoke operations, the large costs inherent in
setting up hub airports create high barriers to entry for new airlines and lead to a snowball effect
by which hubs are exploited to their maximum at the expense of less lucrative routes between
smaller, non-hub airports.6 Airlines must pay for landing slots, defined by the International Air
Transport Association as “… the scheduled time of arrival or departure available, allocated to an
aircraft movement on a specific date at an airport.”7 These landing slots are among the most
precious assets of an airline, as they preserve market share by preventing other airlines from
usurping routes; the airports will not allow airlines to land or take off without a slot, except in an
emergency. As more airlines begin to adopt a hub-and-spoke strategy, many of the largest
airports are facing capacity pressures, forcing slots to be rationed in some cases. 8 In these cases,
protecting existing slots from competitor airlines becomes increasingly important as operations
are further concentrated at hub airports.
Code-Sharing Alliances
Hand in hand with the emergence of hub airports as the dominant strategy for airline
operations is the emergence of code-sharing alliances, particularly between U.S. and European
airlines. Code-sharing alliances allow one airline to offer tickets that connect to flights operated
by its code-sharing partners, giving European airlines access to their partners’ U.S. route
networks and vice-versa. The move toward code-sharing alliances has been seen as a next-best
alternative to industry consolidation, as mergers that would increase foreign ownership of a
merged airline to more than 25 percent remain illegal under U.S. laws.9 Approval of codesharing alliances can be sped up by U.S. authorities granting antitrust immunity, which is often
given as a quid pro quo for countries concluding open skies bilateral ASAs with the United
States. This was the case when the United States granted antitrust immunity to the alliance
between Northwest Airlines (NWA) and Dutch airline KLM after the Netherlands concluded an
open skies bilateral ASA with the United States in 1992.10
Nearly every major U.S. and EU airline is part of a code-sharing alliance. In addition to
the NWA-KLM alliance, major U.S.-EU code-sharing alliances include Skyteam (Delta Airlines,
Alitalia and Air France), Star Alliance (Austrian Airlines, Lufthansa, Scandinavian Airline
5
Fischer (1997), p. 43-44.
Staniland (1996), p. 5.
7
Kyrou (2000), p. 72.
8
Hanlon (1996), p. 133.
9
Staniland (2003), p. 9.
10
Staniland (2003), p. 15.
6
6
System and United Airlines), Qualiflyer (Swiss, Sabena of Belgium and TAP of Portugal), and
Oneworld (American Airlines, Aer Lingus of Ireland, British Airways, Finnair and Iberia of
Spain). Most of these alliances include other international partners, further expanding the global
networks of these five major alliances.
Through code-sharing alliances, European airlines gain access to their U.S. partner’s hubs
in the United States, while U.S. airlines gain access to European hubs. A U.S. airline is then able
to “feed” its hubs with its domestic network, fly passengers to Europe, and allow its partner to
fly those passengers to other European destinations beyond the European hub via spoke routes,
minimizing the need to offer point-to-point transatlantic service. The NWA-KLM alliance
demonstrates how airlines can exploit the extensive domestic networks of alliance partners.
NWA has hubs at the nontraditional ports of entry of Detroit, Minneapolis and Memphis, and
KLM has its hub at Schiphol Airport in Amsterdam. With 201 airports in the United States and
Canada feeding NWA’s hubs and 107 airports in Europe feeding Amsterdam, NWA/KLM needs
only three transatlantic routes – Detroit-Amsterdam, Minneapolis-Amsterdam and MemphisAmsterdam – to boast connecting service between 21,708 cities in the United States and
Europe.11
Coordinated marketing campaigns on both sides of the Atlantic and more efficient use of
resources creates synergistic effects, making code-sharing alliances highly profitable for
airlines.12 Code-sharing alliances also generate positive effects for consumers. A 2003 study
found that international fares on airlines that were part of alliances were 8 percent to 17 percent
lower than on non-code-sharing flights.13
Additionally, struggling airlines from European countries with small domestic markets
have increasingly seen code-sharing alliances as a strategy for preventing the loss of market
share to larger competitors. This strategy has been adopted by Finnair, SAS and Aer Lingus, all
of which have forged alliances with major European and U.S. code-sharing partners.14
Differences between U.S. and EU airlines
Two stark differences fundamentally define the strategies of European airlines vis-à-vis
U.S. airlines: First, European airlines are more dependent on long-haul international routes as a
portion of their total revenue, and second, the European market is segmented both geographically
and politically. The dependence of European airlines on international routes can be traced to the
historical evolution of airlines. In the United States, substantial domestic networks tend to
precede expansion into the international realm.15 In the EU, however, emphasis is first placed on
intercontinental routes, and airlines gradually branch into intra-European and domestic service.
In 1990, for example, 8.9 percent of the passengers on U.S. carriers were traveling
internationally, compared with 55 percent of passengers on European carriers, due in large part
11
Staniland (1996), p. 18.
Staniland (2003), p. 9.
13
Brueckner (2003), p. 105-118.
14
Staniland (2003), p. 22-23.
15
For many years, Pan Am dominated international travel to and from the United States. The demise of Pan Am was
brought on, by many accounts, by Pan Am’s lack of a system of hubs to feed its international flights from the United
States. See Staniland (1996), p. 8.
12
7
to the fact that Europe is comprised of many small countries relative to the United States.16 In
1993, four major European airlines (British Airways, Lufthansa, Air France and KLM) relied on
long-haul international routes for more than 80 percent of their total passenger traffic.17
Share of seats flown in November 2002 from the United States to selected countries
Airline
Total Seats
U.S. Airlines
American
United
Continental
Delta
US Airways
Northwest
European Airlines
British Airways
Virgin Atlantic
Lufthansa
Air France
KLM
U.S. Share
Source: ECLAT Consulting
--Data not available
Britain
908,563
Germany
354,743
France
279,818
Netherlands
229,089
14.3%
10.9%
5.1%
4.2%
3.3%
--
3.6%
16.2%
-11.5%
8.0%
--
11.1%
8.7%
6.7%
16.5%
---
-6.8%
5.6%
5.9%
-36.3%
38.1%
15.7%
---37.8%
--51.4%
--43.5%
---50.3%
-48.9%
----32.5%
57.3%
Higher levels of regulation on international routes provide greater opportunities for rentseeking behavior on the part of European carriers;18 European and domestic routes are less
profitable because there is greater competition, but also because Europe is geographically
smaller. While the average domestic flight in the United States covers 1300 km, the average
European flight covers only 750 km.19 Aside from facing shorter, less profitable flights on
European routes, national carriers have been slow to embrace the single market program, leading
to a geographic segmentation of the markets. Even a large national market such as Germany or
the United Kingdom pales by comparison to the sheer demand for air travel in the United States.
Furthermore, over shorter distances, European airlines must compete with rail and road transport;
Europe’s superb rail system provides a potent competitor within the EU travel market, while
Amtrak’s spotty service record and dismal national network provides Americans with greater
incentive to fly over short distances.20
As European carriers depend on international routes in order to remain financially
solvent, the rules governing international air travel become increasingly important to national
airlines. While U.S. airlines can depend on their domestic networks as a consistent source of
revenue, a negotiating misstep by an EU member state’s government can cost its national airline
dearly in the market for international air travel. With this in mind, the following section
examines how the rules governing air travel have affected the strategies of airlines in the United
States and the European Union.
16
Sinha (2001), p. 69.
Staniland (2003), p. 8.
18
Sinha (2001), p. 69.
19
Sinha (2001), p. 69.
20
See Staniland (1996), p. 8.
17
8
The Chicago Convention
The Chicago Convention represented a major push to codify international norms in the
nascent but booming air transport industry. As air travel became increasingly popular, and as
commercial aircraft increased in size and range, these fundamental changes in the industry
dictated a parallel change in international rules. This need was particularly acute in the United
States, which was prepared to shift from a more protectionist stance to accepting a more
liberalized, expansionist regime.21 Thus, an invitation went out in 1944 to members of the
United Nations to a conference that would “agree so far as possible upon principles of a
permanent international structure for civil aviation and air transport.”22
One of the more interesting aspects of the Chicago Convention is that the United States
was rebuffed – mainly by British opposition – in its pursuit of a wide-ranging multilateral
agreement to liberalize trade in airline services and subject fares, routes and capacity to
determination by market forces. The resulting agreement meant that trade in airline services
would be governed through a framework of bilateral ASAs.23 The new rules had the effect of
discouraging competition, and particularly led to the development of the single “national
champion” airline for European countries. The convention provided incentives for high degrees
of collusion among airlines, as agreements allowed fares to be regulated and split capacity on
given routes, rather than leaving operations and fares subject to market determination.24 In
addition to undermining competition and efficiency in the airline industry, the Chicago regime
contributed to the concentration of airlines at hub airports, where grandfather rights prevented
airport authorities from selling slots at market value. Particularly following U.S. deregulation,
this gave airlines incentives to build their operations around key airports where their slots were
guaranteed.25
Although the Americans failed in implementing a multilateral ASA, there were two
important outcomes of the Chicago Convention. First, it established the International Civil
Aviation Organization (ICAO), an arm of the United Nations that provides a forum for
discussing technical and safety aspects of air travel.26 Second, it established the concept of
freedoms, or privileges, of international air travel:
The Eight Freedoms
1. “Innocent passage” refers to the right to fly over another state, through that
state’s airspace, without landing.
2. The right to make a technical stop in another state, for the purposes of making
repairs or refueling.
3. The right to take passengers and cargo from an airline’s home state to a
destination in another state, as in a flight by American Airlines from New York to
London.
21
de Murias (1989), p. 43.
de Murias (1989), p. 45. The invitation also went to nations associated with the United Nations in World War II,
as well as certain European and Asiatic neutral nations.
23
Morrison and Winston (1995), p. 147.
24
Sinha (2001), p. 68.
25
Sinha (2001), p. 68.
26
Dobson (1995), p. 20.
22
9
4. The right to pick up passengers and cargo in another state and bring them to a
destination in an airline’s home state, as in a flight by American Airlines from
London to New York.
5. Also known as “beyond rights,” the right to pick up passengers and cargo in
another state and take them to a destination in a third state, other than the airline’s
home state, as in an American Airlines flight from New York to London that
picks up additional passengers in London before traveling on from London to
Frankfurt.
6. Also known as “behind feed,” the right to pick up passengers and cargo in
another state, bring them to the airline’s home state, then transfer them to flights
to a third state, as in an American Airlines flight from London to Mexico City by
way of New York.27
7. The right to carry passengers and cargo between two states, neither of which is
the airline’s home state, as in a direct flight by American Airlines from London to
Mexico City.
8. Also known as “cabotage,” refers to the right to carry passengers and cargo
between two points within a single state, especially in a state other than the
airline’s home state, as in a British Airways flight from New York to Los
Angeles. This is distinguished from “consecutive cabotage,” in which the
domestic leg of the trip is an extension of an international trip, as in a British
Airways flight from London to New York to Los Angeles.28
The signatories of the Chicago Convention readily accepted the first two freedoms,
innocent passage over a foreign country and the right to make a technical stop in a foreign
country, but third, fourth and fifth freedoms were left subject to bilateral ASAs.29 Sixth and
eighth freedoms were protected by national governments for their domestic carriers to prevent
foreign competition, while most states denied foreign airlines from making seventh freedom
flights. Even in 2003, very few bilateral ASAs with the United States allow sixth or seventh
freedom flights, and none allow cabotage.
Restrictive Bilateral ASAs – Bermuda II and Agreements With Greece, Ireland and Spain
The ECJ’s November 2002 ruling dates back to a case filed by the European Commission
in 1998, four years after Britain entered negotiations to liberalize aviation markets with the
United States. Although the talks broke down, the Commission was nonetheless enraged that a
member state would conduct negotiations that the Commission assumed were within its realm of
competency. At issue was the Bermuda II treaty, signed by Britain and the United States in
1977, which is widely regarded as one of the most restrictive bilateral ASAs in the world.
Bermuda II stands in stark contrast to open skies agreements between the United States and other
EU member states. While “open skies” agreements generally allow unfettered access by a
27
Some experts challenge the idea of sixth freedom flights, arguing it is actually a coordination of two flights under
third and fourth freedoms.
28
Adapted from Dobson (1995), p. x. The concept of “freedoms” predated the Chicago Convention, but at Chicago
signatories agreed to the “five freedoms of the air,” the third fourth and fifth of which would be subject to bilateral
ASAs.
29
Dobson (1995), p. 20.
10
national carrier of that member state to transatlantic routes to the United States, Bermuda II
strictly regulates access to Heathrow Airport in London, allowing only two British airlines – in
2003, British Airways and Virgin Atlantic – and two U.S. airlines – American and United – to
operate routes between the United States and London’s Heathrow Airport.30
Heathrow Airport is the last great frontier for U.S. carriers, the glittering jewel in the
crown of European aviation. As Thomas Petzinger puts it:
“Much more than an airport, Heathrow is a crossroads that links the Middle East
with North America, Africa with South America, Europe with Asia and every
other continent. Heathrow is to the planet Earth what Chicago, Dallas, or Denver
is to the United States. ... [T]he whole world changes planes at Heathrow.”31
Bermuda II came about after the British denounced the 1946 Bermuda I treaty, which
was considered by the UN’s International Civil Aviation Organization to be a model for bilateral
ASAs for the years to come. Bermuda II, conversely, can be seen as an example of what not to
do in negotiating bilateral ASAs.32 Faced with an eleventh-hour decision between suspending
U.S. airline service to Britain and agreeing to the rigid provisions of Bermuda II, the Carter
administration acquiesced. Quite simply, the United States had in fact gotten a raw deal: the
number of routes from the United States to Heathrow was cut from eight to two, capacity was too
rigidly controlled, and U.S. carriers were granted only minimal fifth freedom, or beyond rights,
to fly to other European destinations from Heathrow. These restrictions came from the U.S.
unwillingness to grant cabotage rights to British carriers to fly to other cities in the United States
after landing at a gateway airport. Fifth freedom rights are of little use to British carriers – and
indeed all EU carriers – due to the dearth of commercially viable destinations in other North and
South American countries.33
An outstanding bargaining instrument for the British, Bermuda II gave the British
effective control over the speed of air services liberalization on the eve of domestic U.S.
deregulation – and the United States has been trying to renegotiate ever since.34 This epic fight,
essentially over access to Heathrow Airport, spilled over into the 1990s as the United States and
Britain attempted – and failed – multiple times to devise a more liberalized bilateral ASA. By
preventing the United Kingdom from renegotiating Bermuda II, the European Commission
essentially retained the Heathrow trump card in any future negotiations with the United States.
The U.S. agreements with Greece, Ireland and Spain are less restrictive than the Bermuda
II agreement, and deal with a much smaller amount of air traffic. The U.S. agreement with
Greece, for example, places limits on fifth freedom flights, the number of airports served, the
number of carriers on certain routes, and sets price restrictions. The agreement with Ireland
30
Done (2002). Virgin Atlantic was designated following the demise of British Caledonian in 1987, while American
and United bought the rights formerly held by Pan Am and TWA in 1991.
31
Petzinger (1995), p. 377.
32
Dobson (1995), p. 140.
33
British Airways would be loath to offer, for example, service from Heathrow to Mexico City or Buenos Aires via
New York; much more lucrative would be an allowance to fly beyond New York to another destination within the
United States, say, Dallas or Los Angeles – what is referred to as consecutive cabotage. See Dobson (1995), p. 128.
34
Dobson (1995), p. 140.
11
requires a separate non-stop U.S. flight to or from Shannon for every U.S. flight to or from
Dublin, in effect forcing U.S. carriers to serve Shannon Airport with the same frequency as
Dublin Airport.35 These three agreements stand as additional examples of restrictive bilateral
ASAs, particularly when compared to open skies bilateral ASAs that have been signed by the
other 11 EU member states with the United States.
Open Skies Bilateral ASAs
Following airline deregulation in the United States in 1978, the United States embarked
on a series of “open market” ASAs with countries in Europe, Asia and Latin America. While
these agreements substantially liberalized transatlantic air travel, particularly with the
Netherlands, Belgium, Germany and Luxembourg, structural changes in the airline industry were
creating incentives for further liberalization. Between 1987 and 1993, passenger traffic between
the United States and foreign destinations increased 47 percent, while domestic U.S. traffic
increased only 6 percent.36 Industry consolidation in the United States had created a number of
carriers with large domestic networks, and these carriers began to look toward international
markets for expansion. By the early 1990s, a series of “open skies” bilateral ASAs between the
United States and EU member states marked the end of what few restrictions remained on
transatlantic air travel.37
Open skies agreements – signed with 11 EU member states, as well as Iceland, Norway
and Switzerland – effectively deregulated travel between the United States and those countries.
The agreements allowed for unlimited frequency of flights from any U.S. city to any point in the
other country, with no restrictions on fares. Additionally, the agreements allowed for unlimited
fifth freedom rights, or beyond rights, allowing airlines to pick up passengers in the other
country and fly to a third country.38 Finally, these agreements allowed for unlimited codesharing alliances and other commercial arrangements.39
Open skies ASAs still include a number of restrictions on unbridled open-market
competition. First, open skies agreements allow a state to reject flights by an airline that is not
“substantially owned and effectively controlled” by the state with which the agreement has been
signed. This “nationality clause” is the main issue at hand in preventing the coexistence of open
skies ASAs with the EU single market for air transport, but it serves a purpose similar to rules of
origin in other trade arrangements: it prevents a third country from receiving preferential
treatment to which it would not otherwise be entitled.40 Second, open skies agreements prohibit
seventh freedom flights between two countries, neither of which is the airline’s home country;
this is also an issue in the drive to complete the EU single market, as such rights would allow the
German airline Lufthansa to fly from Paris to New York, for example, as EU single market rules
would allow. Third, open skies agreements prohibit any type of cabotage, or flights between two
points within a foreign country. Finally, open skies agreements allow for “Fly America”
requirements, which dictate that U.S. government officials must fly on U.S. airlines; however,
35
Brattle Group (2002), p. 1-8.
Brattle Group (2002), p. 1-4.
37
Brattle Group (2002), p. 1-5.
38
The third country must also agree to allow fifth freedom flights, in addition to the two parties allowing fifth
freedoms in the bilateral ASA.
39
Brattle Group (2002), p. 1-5.
40
Brattle Group (2002), p. 1-6.
36
12
officials may still fly internationally on a foreign airline with which a U.S. carrier has a codesharing alliance.41
The results of open skies bilateral ASAs have been increased competition among U.S.
and foreign airlines, lower fares, increased transatlantic passenger traffic, further concentration
of airlines at hub airports, and increasing proliferation of multinational alliances such as codesharing alliances.42 Open skies agreements have eliminated most restrictions on international air
travel, but have maintained a number of rules that prevent the United States and the European
Union from negotiating an agreement that would complete the single European Market and move
toward an open aviation area with the United States.
Deregulating Airline Services
Once one of the most-regulated industries in the world, the airline industry has enjoyed
increasing levels of liberalization over the past 35 years, beginning in the United States. While
U.S. deregulation took a more “big bang” approach, eliminating all rules at once, EU
deregulation took place gradually in three phases, each meant to bring the industry one step
closer to the single market envisioned by the Single European Act. The United States and the
European Union also approach competition policy differently, with the EU necessarily taking a
harder stance on state aid to airlines, as national governments continue to hold substantial stakes
in their airlines and therefore take an interest in ensuring the viability of their national
champions. The United States has focused more on preventing foreign ownership of airlines,
largely to protect the domestic market from foreign competition.
Deregulation in the United States
In 1978, the United States passed the Airline Deregulation Act, which greatly enhanced
competition among airlines within the world’s largest air travel market. The three immediate
effects of deregulation in the United States were a sharp increase in the number of carriers, a
decrease in most fare prices and a decrease in the market share of major airlines. Seven years
after deregulation, the number of U.S. airlines had risen from 36 to over 120.43 Fare prices
dropped for 78 percent of U.S. passengers, particularly for those traveling 800 miles or more, as
regulations that subsidized short-haul fares at the expense of long-haul fares were discontinued.44
However, fare prices for trips less than 800 miles tended to increase – sharply for the shortest
flights – leading to some consumer dissatisfaction with deregulation.45 Finally, the market share
of the five largest U.S. carriers fell from 69 percent in 1978 to 57 percent in 1985. However,
industry consolidation brought the market share of the top five carriers back up to 70 percent by
1995, as airlines discovered methods for exploiting the deregulated U.S. system, one of which
was the concentration of operations at hub airports.46 Yet the deregulated U.S. airline regime has
also allowed a number of niche players, the best known of which is Southwest Airlines, to thrive
by serving regional markets and smaller airports at lower costs.
41
Brattle Group (2002), p. 1-7 and 1-8.
Brattle Group (2002), p. 1-5.
43
Hanlon (1996), p. 37.
44
Morrison and Winston (1995), p. 19.
45
Morrison and Winston (1995), p. 19.
46
Hanlon (1996), p. 38.
42
13
EU Deregulation and the European Single Market
Although the principle of the common European market was established as early as 1957
with the Treaty of Rome, substantial progress was lacking until the 1986 Single European Act,
with which the EU sought to “eliminate in their entirety ... internal frontier barriers and controls”
by the end of 1992.47 The underpinnings of exactly how internal barriers to trade would be
eliminated were laid down by the European Commission’s White Paper in 1985, a compilation
of over 280 directives to be adopted by EU member states. With regard to trade in airline
services, the Commission chose to tackle a highly regulated market in three stages; packages
adopted by the Council of Ministers in 1987, 1990 and 1992 gradually liberalized the EU internal
air travel market.48
Prior to the single market program, the EU air travel market was characterized by a
“national champion” ideology among member states, by which the national airline, if not
completely state-owned, was protected from competition through arrangements that regulated
market shares for each airline, fixed fares, limited capacity, and provided for state subsidies, all
of which contributed to widespread inefficiencies among EU carriers and high consumer costs.49
The Council packages increased competition on fares, increased access to routes for all EU
carriers, applied EU competition rules to airlines, and granted the right of cabotage within other
member states for any EU carrier.50 The third (1992) package was the most important, providing
the Commission the right to intervene to prevent predatory fare pricing, or to set maximum or
minimum fares; cabotage rights on domestic routes within EU member states were the last part
of the package to be implemented, effective April 1, 1997.51 Another key provision of the third
package was the transformation of all EU-owned airlines, regardless of their home member state,
into “Community air carriers” with equal rights and responsibilities under EU laws.52
As in the United States, deregulation in the European Union has resulted in lower fares
for consumers, and an increase in the number of – specifically low-cost – carriers. The European
Commission found several benefits of the deregulation packages in a 1999 analysis, including
improved productivity among EU airlines, an overall doubling of the number of airlines
operating flights in the European Union, overall increases in employment in the sector, increased
competition resulting in a 10 percent to 25 percent decrease in average fares, and an increase in
the overall number of routes flown.53 Contrasted with the more “big bang” approach to
deregulation in the United States, the gradual approach to airline deregulation in the EU has, by
many accounts, given an advantage to airlines at the expense of consumers, as airlines were able
to gradually adjust to different aspects of liberalization.54 One interesting aspect of airline
deregulation in the EU has been the increase in competition among airports. As low-cost carriers
begin to utilize under-used airports, these airports realize higher levels of passenger traffic,
increasing the market value of slots.55
47
Dinan (1999), p. 354.
Dinan (1999), p. 362.
49
Dinan (1999), p. 362.
50
Dinan (1999), p. 362.
51
Sinha (2001), p. 73-74.
52
Commission of the European Communities. (2002b), point 6.
53
Commission of the European Communities (2002b), point 8.
54
Sinha (2001), p. 77-78.
55
Sinha (2001), p. 76.
48
14
While the rest of the EU single market was completed in 1992, the single market for air
travel has taken much longer – while EU-wide cabotage went into effect in 1997, the single
market for international travel is still incomplete as a result of the bilateral ASA regime. A
partial explanation for the longer timeframe allotted to the airline industry lies in the substantial
state ownership of EU airlines. The two largest EU airlines, British Airways and Lufthansa,
were completely privately held by 2003. However, Lufthansa had been 37 percent owned by the
German government until 1997. Aer Lingus of Ireland, Olympic Airways of Greece, and TAP of
Portugal are 100 percent government-owned. The French government held a 94.2 percent stake
in Air France in 1996, but reduced that stake to 53 percent in 1999 and to about 20 percent in
2002.56 Finnair (60.7 percent), KLM (38.2 percent), Sabena of Belgium (33.8 percent), and
Austrian Airlines (51.9 percent) complete the picture of an industry in which national
governments had major incentives to intervene and protect as long as possible before EU-wide
competition policies came into effect.57
Competition Policy
EU competition policy aims to prevent market-distorting practices by dominant players;
applying competition policy to the airline industry was a key component of the EU deregulation
packages. While maintaining many of the features of U.S. antitrust policy, EU competition
policy also serves an important goal in moving toward a single market for air travel: by breaking
down barriers to increased competition among member states, the European Union takes on the
appearance less of 15 national markets and more of a single, integrated European market.58
Indeed, until the 1986 ECJ Nouvelles Frontières decision that applied competition rules to air
transport, national governments had actually been sanctioning the types of collusive practices
that would be outlawed in the single market.59
EU competition policy is defined by (re-numbered) Articles 81 and 82 of the Treaty of
Rome. Article 81 “prohibits agreements and concerted practices ... that prevent, restrict, or
distort competition and that affect trade between member states,” while Article 82 prohibits the
abuse of a dominant (monopoly) market position.60 Articles 87 and 88 deal specifically with
state subsidies and state-owned enterprises. Authority over competition policy is the realm of
European Commission Directorate General for Competition, who can issue decisions without
needing approval from the Council or being subjected to a qualified majority vote.
EU competition policy has been fractured as a result of the bilateral ASA regime, which
the European Commission argues creates legal uncertainty among EU airlines. Essentially, the
Commission does not wield the same authority with respect to international air transport as it
does with matters related to internal EU air transport, undermining the effectiveness of
competition policy.61
56
BBC News (2002).
Government ownership figures from Staniland (2003), p. 3.
58
Dinan (1999), p. 380.
59
Sochor (1991), p. 184. See also Kyrou (2000), p. 68-70.
60
Dinan (1999), p. 381.
61
Commission of the European Communities (2002b), point 26. Particularly with regard to code-sharing alliances,
the Commission has had to rely on the tenuous legal basis of Article 85; however, the Commission in February 2003
57
15
The European Commission also holds authority over the approval of mergers and
acquisitions. While U.S. regulations prevent cross-border mergers between U.S. and EU airlines
for the time being, any such merger would be subject to strict scrutiny by U.S. antitrust
authorities and DG Competition in Brussels to ensure that competition would be preserved. This
is especially important in the context of negotiating an EU-U.S. open aviation area, under which
the elimination of rules on foreign ownership in the United States could result in a flood of
applications for mergers between U.S. and EU carriers.
The “national champion” nature of EU carriers often leads to conflicts between member
states and the Commission over airline subsidies. Such was the case in 1994, when the French
government notified the commission that it intended to inject $3.42 billion into state-owned Air
France. Air France, in the wake of EU airline deregulation and as the conspicuous European
carrier without a U.S. alliance partner at the time, was losing money – $680 million in 1993
alone.62 Although the Commission approved the capital injection by the French government, it
set conditions on the injection to ensure that market distortions would not result, including
“rationalization” of Air France’s workforce and the stipulation that the government would be
prohibited from allocating additional state aid to its ailing airline.63 The Air France case was
controversial; six other member states, led by the United Kingdom, won an appeal against the
Commission over the Air France subsidies in the ECJ. However, Air France was not required to
repay the subsidy.64 The chances of the Commission approving state aid to another state-owned
airline in the future are thus highly unlikely – EU airlines must now face competition on their
own.
While the Commission and most member states have condemned the practice of offering
direct subsidies to airlines, EU officials are quick to point out that U.S. airlines received $2.3
billion in government aid in May 2003. The aid, given to airlines to help deal with reduced
demand coming as a result of the war in Iraq and Severe Acute Respiratory Syndrome (SARS),
significantly padded the 2003 second-quarter earnings of U.S. airlines. For example, Delta, the
third-biggest U.S. airline, reported earnings of $184 million, but received government aid of
$251 million. Government aid of $209 million contributed to the $227 million in profits for No.
4 Northwest, while No. 5 Continental posted profits of $79 million following $111 million in
aid.65
Ownership Regulations
Under U.S. regulations, any airline operating point-to-point service within the United
States must operate with a certificate issued by the U.S. Department of Transportation. One of
the requirements for obtaining a certificate is U.S. citizenship, defined by three separate statutes:
1. The company must be incorporated in the United States.
proposed changes that would address alliances with non-EU carriers. See Commission of the European
Communities (2003).
62
Dobson (1995), p. 228.
63
Dinan (1999), p. 387, and Dobson (1995), p. 229.
64
Dinan (1999), p. 387.
65
Bloomberg News (2003).
16
2. The company must have a president and two-thirds of the board of directors
who are U.S. citizens.
3. The company must ensure that no less than 75 percent of its voting stock is
owned by U.S. citizens.66
Ostensibly, the rule limiting foreign ownership of an airline operating within the United
States to 25 percent is necessary out of national security concerns. Currently, U.S. airlines
participate voluntarily in a program called the Civil Reserve Air Fleet (CRAF), under which U.S.
airlines provide a specific number of aircraft and crew to transport military personnel and
supplies in an emergency capacity. In return, the U.S. government procurement of air services
consists of the Fly America program, which gives U.S. carriers exclusive access to the peacetime
business of U.S. government officials. It maintains these programs in order to preserve legal
leverage over airlines – if an airline were to violate its terms under the CRAF program, the U.S.
government could revoke its operating license.67
In practice, however, the national security argument does not hold up, as a European
airline operating within the United States would be subject to the same regulations as a U.S.
airline, and the foreign-owned airline would remain subject to Exon-Florio provisions.68 Under
Exon-Florio, the U.S. Department of Treasury can block transactions or investments by foreign
entities that threaten national security.69 Thus, the limitation on foreign airline ownership can be
seen more as a means to protect U.S. airlines from foreign competition and prevent foreign
airlines from enjoying cabotage in the U.S. domestic market.
The rules regarding citizenship of airlines are also built into even the most liberal open
skies bilateral ASAs between the United States and EU members. The nationality clause present
in every bilateral ASA with the United States requires that an airline be “substantially owned and
effectively controlled” by the state signing the ASA. British Airways’ German subsidiary,
Deutsche BA, may operate cabotage flights within Germany or to any European airport; it may
not fly to the United States under the U.S.-Germany bilateral ASA because it is effectively
controlled by the parent, a British company. Under European law, a non-European entity may
own up to 49.5 percent of an airline operating within the European Union.70 However, in order
to be considered a European “Community carrier,” the airline must be 51 percent owned by EU
nationals.
The U.S. foreign ownership limitation on airlines is currently being challenged by DHL
Airways, a U.S. subsidiary of the German company Deutsche Post, which operates air cargo
services within the United States.71 DHL is under investigation by the U.S. Department of
Transportation at the behest of UPS and FedEx, U.S. air cargo companies that stand to lose a
substantial amount of market share should DHL be allowed to operate its services within the
66
Mead (2003), p. 2.
Brattle Group (2002), p. x.
68
Brattle Group (2002), p. xi.
69
U.S. Department of Treasury Office of International Affairs (2003).
70
Dombey and Done (2001).
71
Mead (2003), p. 2.
67
17
United States. Again, this tends toward the proposition that the U.S. regulation exists to limit
competition and protect domestic airlines, rather than to protect national security.
The nationality clause built into bilateral ASAs and the U.S. foreign ownership limitation
on airlines act as non-tariff barriers to the U.S. market for air services.72 These rules also stand
in the way of completing the single European market in air travel, by requiring European airlines
to operate flights to the United States from their home country only. Yet the EU members that
have signed bilateral ASAs with the United States are powerless to protest these rules; even a
powerful member state like France, Germany or Britain has little leverage against the United
States when negotiating on its own. Further, the current regime of bilateral ASAs provides
insulation to smaller EU member states that wish to protect their national champion airlines’
share of the transatlantic market, by preventing other airlines from operating out of their home
airports, as EU rules would allow. The European Commission contends that only a concerted
effort will apply sufficient pressure on the United States to make allowances that will complete
the single European market in air travel.
Bilateral ASAs and the EU Single Market
The implications of the European Court of Justice’s decision of November 5, 2002,
extend beyond the eight member states named in the case for signing bilateral ASAs with the
United States, to the bilateral ASA regime as a whole. More broadly, the ECJ decision speaks to
the need for a common external policy in the realm of air transport. The Commission views the
ECJ as an opportunity to redress the illegalities outlined by the decision, but also as a chance to
make changes in the interest of “creating additional opportunities for the European aviation
industry and giving European consumers a broader choice of service.”73
Why do Bilateral ASAs Violate the Single Market Principle?
Following three packages of reforms to create a single market for air transport in the
European Union, which were modestly successful in liberalizing intra-EU air travel, airlines in
the European Union remain fragmented along national lines. The resulting growth patterns
among EU airlines reflect growth in home markets only, rather than growth through investment
in other member states or through mergers and acquisitions.74 This is a violation of the right of
establishment, which allows any EU firm to establish operations in the territory of any EU
member state, under Article 43 of the EC Treaty.
The existence of nationality clauses in bilateral ASAs prevents EU carriers with
operations in the territory of a member state from operating to a third country in accordance with
the terms offered to a carrier that is a national of the member state in question.75 This violates
the principle of non-discrimination, which considers all EU firms to be recognized as
“community” firms, rather than being recognized as nationals of a particular member state.
The European Court of Justice Decision
72
The European Union, through its foreign ownership limitations, maintains a similar non-tariff barrier that prevents
U.S. airlines from being treated as “community carriers.”
73
Commission of the European Communities (2003), Point 25.
74
Commission of the European Communities (2002b), point 9.
75
Commission of the European Communities (2003), point 11.
18
Since attempts to complete the single European market for air transport began in earnest
between 1987 and 1992, the European Commission had taken issue with bilateral ASAs that
contained clauses that recognized European carriers only along national lines. In response to a
flurry of activity on bilateral ASAs between the United States and EU member states, the
Commission wrote a letter in November 1994 stating that such negotiations could only legally be
carried out at the EU level.76 In early 1995, during the run-up to the completion of the third
package of single-market reforms in 1997, the United States completed open skies bilateral
ASAs with Belgium, Austria, Luxembourg and Finland, and was working on two more with
Sweden and Denmark. Concurrently, the United States and Britain were also in negotiations to
find an alternative to the restrictive Bermuda II agreement.77
On July 17, 1995, the Commission sent a formal letter to the United Kingdom notifying
them that the amendment to the Bermuda II agreement reached on July 5, 1995 – which switched
the U.S. carriers allowed to fly into Heathrow Airport from Pan Am and TWA to United and
American – violated Article 43 of the EC Treaty. Article 43 provides for non-discrimination in
the treatment of firms from any EU member state, regardless of where that firm is established
and the nationality of the owners of the firm, and allows the right of any EU firm to establish
operations in any EU member state, subject to the same rules as any firm established in that
member state.78 The United Kingdom argued that because the nationality clause in Bermuda II
that was seen as a violation of Article 43 was actually an extension of the nationality clause built
into the Bermuda I agreement, which was concluded before the United Kingdom entered the
European Union in 1973, it could not be found in violation of Article 43.79
Unswayed by the British argument, the European Commission filed a complaint with the
European Court of Justice on December 18, 1998, against the United Kingdom, Denmark,
Sweden, Finland, Belgium, Luxembourg, Austria and Germany over bilateral ASAs they had
concluded with the United States. Although the other seven member states against which action
was brought, unlike the United Kingdom, had negotiated open skies bilateral ASAs rather than
more restrictive regimes, the Commission argued they were nonetheless in violation of Article 43
of the EC Treaty, by virtue of nationality clauses contained within those agreements.
In the interim between the Commission filing suit and the ECJ ruling on November 5,
2002, including talks that began as late as August 15, 2002, Britain and the United States
continued to attempt an open skies alternative to the Bermuda II agreement, further enraging the
Commission. While open skies talks broke down less than a month later, the British were still
pushing for a more limited liberalization of Bermuda II. The Commission issued a stern warning
to Britain and other countries in October that no agreements were to be reached while the legality
of such agreements was being deliberated by the ECJ.80
76
European Court of Justice (2002).
Reuters (1995).
78
European Court of Justice (2002).
79
European Court of Justice (2002). The United Kingdom based its line of argumentation on Article 307 of the EC
Treaty, which allows member states to uphold treaties concluded with outside states that were concluded prior to
entry into the European Union.
80
Dombey (2002a).
77
19
The ECJ found in favor of the European Commission, which argued – among other
things – that nationality clauses within the agreements violated the principles of the single
market. It was this line of argumentation that the ECJ found most convincing in its decision:
“... [B]y concluding and applying an Air Services Agreement signed on 23 July
1977 (the Bermuda II Agreement) with the United States of America which
allows that non-member country to revoke, suspend or limit traffic rights in cases
where air carriers designated by the United Kingdom of Great Britain and
Northern Ireland are not owned by it or its nationals, the United Kingdom of
Great Britain and Northern Ireland has failed to fulfill its obligations under ... the
EC Treaty.”81
The ECJ applied the “AETR” principle, under which the European Union acquires
external competence when it is able to exercise internal competence “where the international
commitments fall within the scope of the common rules.”82 Additional rules that have resulted in
changes to the transport section of the Acquis are also subject to EU competence, as the
Commission elaborates: “In subjects where Member States have agreed that it makes sense to
adopt common rules within the Community, they must draw the consequences and work through
its institutions when discussing such matters with foreign countries.”83 In short, member states
must cease and desist from negotiating any further agreements or amendments to existing
agreements, as such agreements are within EU competence.
The decision against the United Kingdom is consistent with the decisions against the
other seven countries that had signed bilateral ASAs, and covers all bilateral ASAs in place
between all EU member states and all third countries, so long as the agreements contain a
nationality clause or otherwise infringe “Community exclusive external competence.”84 Thus,
the Commission was victorious in preventing the further use of bilateral ASAs by member states,
but fell short of its greater goal of placing negotiating authority for the entire EU under the
Commission Directorate General for Transport and Energy, led by Loyola de Palacio. Under the
ECJ decision, neither EU member states nor the Commission has “free rein” to conclude bilateral
ASAs.85 Commissioner Palacio nonetheless heralded the ECJ’s decision the following day:
“This is a historic decision that is going to have some enormously positive consequences for the
consolidation of the European aviation industry.”86
The European Commission Viewpoint
In the context of the single European market for air services, the Commission had a valid
argument to deliver to the ECJ against bilateral ASAs with the United States. The Commission
feels that bilateral ASAs give an unfair advantage to non-EU carriers that are protected in their
home markets: “Nationality-based rules hamper competition between European Community
airlines and effectively prevent the European industry from consolidating into economically
81
Excerpted from European Court of Justice (2002).
Commission of the European Communities (2002b), point 29.
83
Commission of the European Communities (2002b), points 31 and 33.
84
Commission of the European Communities (2002b), point 38.
85
Commission of the European Communities (2002b), point 42.
86
Dombey (2002b).
82
20
stronger, international businesses.”87 The argument continues, “Such allocation of traffic rights
by nationality … effectively prevents any EU airlines with global ambitions from establishing
international operations in an EU member state other than its own.”88
The Commission sees bilateral ASAs as giving U.S. carriers operational advantages
within the EU market, without granting “rights of equivalent value” to EU carriers in the U.S.
market.89 One of these advantages is the right to fly fifth-freedom flights beyond the destination
country to a third country. “These fifth freedoms are of relatively little value on the American
side of the Atlantic, given that there are relatively few viable onward destinations. However, in
parts of the world where there are many international markets in close proximity, such as the EU,
they are more useful.” Fifth freedom rights effectively give U.S. carriers access to the intra-EU
market, while EU carriers have no such access to the U.S. domestic market, where such flights
would be considered cabotage.90
A strong argument can also be made that in the interest of gaining greater concessions
from the United States, the member states of the EU should pool their negotiating leverage –
rather than allowing the United States to “pick off” member states one at a time – by granting
negotiating authority to the European Commission.91 This “community approach” has additional
benefits. First, it prevents mixed signals from reaching third countries like the United States, as
the views of EU member states may diverge on certain aspects of reforming the bilateral ASA
regime.92 Second, such an approach prevents the possibility of the United States unilaterally
rebuffing an individual member state that carries little political weight in the eyes of U.S.
officials.93 Third, it prevents competition among member states in attempting to accentuate
certain aspects of reforms while downplaying others, to the advantage of individual member
states; this would result in “an incoherent patchwork of international market access
opportunities.” Further, the member state that was most successful in implementing measures
consistent with the EU single market would face the greatest competition from other EU airlines
without necessarily receiving additional market access in return.94 Finally, the community
approach would allow the Commission to undertake comprehensive negotiations on a number of
issues that prevent the smooth operation of the single market for air transport, rather than tackle
the issues one at a time.95
In late January 2003, Director General for Transport and Energy Francois Lamoureux
sent a sharply worded letter to EU member states threatening legal action “should any member
state decide to make unilateral amendments of their agreements with the U.S.”96 The letter
continued, “Our aim should first be to reach agreement among ourselves within Europe and then
to further our objectives vis-à-vis international trading partners and then begin a coordinated
87
Commission of the European Communities (2002a), point 6.
Commission of the European Communities (2002a), annex 5.
89
Commission of the European Communities (2002a), point 10.
90
Commission of the European Communities (2002b), point 14.
91
Commission of the European Communities (2002a), point 15.
92
Commission of the European Communities (2003), point 38.
93
Commission of the European Communities (2003), point 39.
94
Commission of the European Communities (2003), point 40.
95
Commission of the European Communities (2003), point 44.
96
Dombey (2003b).
88
21
community approach to the outside world.”97 The Commission followed that communiqué with
a proposal on February 26 that would strip negotiating power from member states in an attempt
to move forward with EU-wide negotiations with the United States. The proposal leaves the
existing bilateral ASAs in place until an EU-wide agreement has been negotiated by the
Commission, eliminating at least some of the legal uncertainty created by the ECJ decision.98
On June 5, 2003, the Council agreed to give the Commission a mandate to negotiate on
ASAs on behalf of all member states, a victory the Commission had been seeking for over a
decade.99 Convening the ministers of transportation of all of the member states, the Transport
Council passed a package consisting of three measures. First, the mandate gives the Commission
the authority to open negotiations with the United States, in the interest of working toward an
EU-U.S. open aviation area, to replace existing bilateral agreements agreed by member states.
Second, the Council authorized the Commission to open negotiations on EU-wide agreements
with third countries to replace existing bilateral agreements. Third, the Council drafted a
regulation to allow member states to continue to negotiate and implement bilateral ASAs with
third countries “with a view, inter alia, to reducing the vulnerability to legal challenge of their
existing bilateral agreements.”100 Reflecting a political compromise between the Commission
and member states over negotiating prerogatives, the third measure has the practical benefit of
providing for member states to assist the Commission in renegotiating the hundreds of bilateral
ASAs with third countries to bring them in line with the ECJ decision -- an “immense and
extraordinary task” for which the Commission lacks adequate resources.101
The mandate gives the Commission authority to establish a new framework for external
relations in the aviation sector, based on the principles outlined in the ECJ decision, “offering
pragmatic solutions to the many difficult political and legal questions raised by these
judgments.” On the mandate to open community-level negotiations with the United States, the
Council “envisages a comprehensive liberal agreement allowing carriers from both the European
Union and the United States to provide air services on a fair and equal basis.” Guidelines for
negotiations cover “market access, ownership and control, leasing, convergence on the
application of competition rules, safety, and institutional arrangements” but were not fully
disclosed.102
The U.S. Viewpoint
U.S. officials insisted immediately following the ECJ decision that the bilateral
agreements remained in effect, regarding the agreements as binding until nullified by both
parties.103 “The current agreements remain in force as the legal basis for air services between the
U.S. and individual member states,” said a U.S. official in the Financial Times.104 At the same
time, however, the ECJ decision sparked dialogue between U.S. officials in the State Department
and the European Commission.
97
Fuller (2003b).
Meller (2003).
99
Dombey (2003a).
100
Council of Ministers (2003).
101
European Union (2003).
102
Council of Ministers (2003).
103
Dombey (2002b).
104
Dombey and Done (2002).
98
22
The United States initially offered only to remove the nationality clauses that restrict the
agreements to national airlines, in order to eliminate parts of the agreements the ECJ ruled were
the responsibility of the European Union as a whole. “If Air France, for example, wishes to buy
KLM or Alitalia and operate under the Dutch or Italian open skies agreement with the United
States, this would allow them the right to do that,” said U.S. Deputy Assistant Secretary of State
for Transportation Affairs John Byerly. He called these concessions “a major move,” adding,
“This would open the door and remove a cited impediment to European consolidation of airlines
– if that’s what they want to do.”105 Director General Lamoureux referred to such concessions in
his letter to EU members as a “minimalist proposal that fails to recognize the fundamental
rights” of the EU treaty.106 In fact, the concessions offered by Byerly would not have resolved
the inconsistencies cited by the ECJ; the agreements would still have been in violation of Right
of Establishment rules outlined in the EC Treaty.
The United States has been seen by the European Union as a staunch defender of its own
airlines, similar to the national-champion mindset of many of its EU counterparts. Examples
abound, not the least of which is the more than $17 billion in aid and loan guarantees U.S.
airlines have received since Sept. 11. The biggest perceived threat to U.S. airlines arising from
the completion of the single European market for air travel would be consolidation among
European carriers that might result in a major new competitor such as a combined British-KLM
Airways, which were prevented from merging in 2000 over complications arising from bilateral
ASAs.107 U.S. airlines could, however, potentially reap benefits from airline industry
consolidation, particularly if cross-border mergers are allowed under a new air services regime
such as an EU-US open aviation area. Such consolidation could provide a much-needed capital
injection to ailing U.S. airlines. As an initial step in this direction, the U.S. Department of
Transportation in May 2003 proposed to raise the limit on foreign airline ownership from 25
percent to 49 percent, bringing the United States in line with EU ownership regulations.108
With its new authority to negotiate with the United States, the European Commission is
aiming to conclude an EU-wide agreement with the United States, which is likely to include
cabotage rights for EU carriers within the United States and the elimination or relaxation of the
foreign ownership limitations on both sides of the Atlantic. While the primary goal of talks on a
new aviation regime will be to bring bilateral ASAs into conformity with the ECJ decision, the
broader goal is the liberalization of trade in airline services between and within the EU and
United States under an EU-U.S. open aviation area.
While a liberalized aviation regime has its proponents in the United States, labor unions,
in particular, are loathe to open the U.S. market for air travel, arguing that foreign competition on
domestic routes would lead to widespread job losses. However, there is probably little reason to
believe European airlines would attempt to compete on already-saturated routes in the United
States. The Air Transport Association, the U.S. airline trade association, announced its support
for the Bush administration’s move to raise the foreign ownership limit to 49 percent, an initial
105
Fuller (2003b).
Dombey (2003a). See also Fuller (2003a).
107
Landler (2002).
108
Done (2003).
106
23
step toward liberalization. “This change has the potential to create greater access to the global
capital marketplace for U.S. airlines and could bring U.S. foreign-investment regulations in line
with those of other countries, including those of the European Union,” said Air Transport
Association President and CEO James C. May.109 United Airlines CEO Glenn Tilton has also
come out in support of liberalization: “The future of our industry is in multilateral ‘Open Skies’
agreements ….” He continued, “We must also break down barriers to consolidation and access
to global capital. That’s why we strongly support the [Bush] administration’s proposal to raise
the Cold War-era caps on foreign investment from 25 to 49 percent.”110
Airlines’ Perspectives
KLM
At other airports in Europe, congestion and capacity restrictions prevent one carrier from
dominating, but KLM has exploited Schiphol Airport, the only major airport in the Netherlands,
and set up perhaps the most efficient hub-and-spoke system in Europe.111 Given the miniscule
nature of demand for domestic travel in a small country like the Netherlands, KLM really had no
choice other than to capitalize on the central location of Schiphol Airport by seizing as much of
the European market for travel into Amsterdam as possible. Through its code-sharing alliance
concluded in 1989 with Northwest Airlines, KLM is able to serve nearly every U.S. destination
from over 100 European airports.
The government of the Netherlands has supported KLM in its attempt to corner the
market in travel to and from Amsterdam, both diplomatically and financially. The Netherlands
was the first EU member state to sign an open skies bilateral ASA with the United States in
1992; with the creation of the EU single market, it has prepared for additional competition by
intensifying efforts to build up a European network to feed Amsterdam for more profitable
transatlantic flights.112 Its dependence on its code-sharing partner in the United States produces
a conflict, however. While it would also prefer to cooperate with other European carriers to
exploit the single market, most European carriers have their own U.S. partners, forcing KLM to
remain loyal to NWA lest it lose market share in Europe or in Amsterdam to other EU carriers.113
It was thus not surprising that the Netherlands argued alongside other individual member states
before the ECJ to preserve the system of bilateral ASAs, rather than siding with the
Commission.114
British Airways
The United Kingdom has followed a much different tack in the bilateral ASA system.
Although it has attempted to renegotiate its bilateral ASA with the United States, the restrictive
Bermuda II agreement remains in force. The ECJ decision ensures the agreement will not be
renegotiated without participation by the Commission. As a result of Bermuda II, only two U.S.
carriers are allowed to fly to Heathrow Airport in London, while others must use Gatwick
109
Air Transport Association (2003).
Tilton (2003).
111
Graham (1995), p. 158.
112
Staniland (2003), p. 14.
113
Staniland (2003), p. 15.
114
European Court of Justice (2002).
110
24
Airport, perceived by many as less convenient. The U.S. share of transatlantic traffic to Britain
has decreased steadily, from 46.1 percent in 1994, to 41.9 percent in 1995, to 37.8 percent in
November 2002. The British government has thus fought to preserve the bilateral system in part
because of the protection it offers to the lucrative U.S.-UK market, a market that made up 34.9
percent of all transatlantic travel in 1995.115
British Airways also avoids the British domestic market, choosing instead to dominate in
transatlantic routes and in service to European airports to the east and south of the United
Kingdom, as well as routes to other worldwide destinations in Africa, the Middle East and
India.116 It is thus also dependent on its bilateral ASA with the United States, not because of the
access it allows, but because of the access it restricts. British Airways has in its code-sharing
partner, American Airlines, access to one of the two most extensive U.S. hub-and-spoke
networks – it even attempted, despite all the regulatory restrictions, a merger with American
Airlines as recently as 2002. While British Airways has supported the move toward a single
market in the EU, it has major concerns with handing negotiating authority to the European
Commission, partially because of the bargaining chip represented by Heathrow Airport. A
negotiated agreement between all of Europe and the United States would likely result in a loss of
British Airways’ market share at Heathrow, and the United Kingdom would not be able to
guarantee that additional access to the U.S. market would compensate for this loss.117
The Low-Cost Carriers – Southwest, Ryanair and Easyjet
Conspicuously absent from the transatlantic market for air travel are the low-cost carriers:
Southwest in the United States and Ryanair and Easyjet in Ireland and the United Kingdom,
respectively. Expanding to international travel would require a considerable capital outlay by
Southwest, which currently serves only the U.S. domestic market with shorter-range aircraft
unable to fly across the Atlantic. But Southwest’s strategy, shared by Ryanair and Easyjet, of
serving smaller airports with smaller, more efficient aircraft and relying substantially less on
expensive hub-and-spoke networks, offers an interesting opportunity. A liberalized ownership
regime might allow Southwest, the most profitable U.S. airline, to merge with a low-cost carrier
in the United Kingdom or elsewhere in Europe, and offer service to London’s Gatwick Airport
and other under-utilized European airports. While Southwest has established a more point-topoint network in the United States, it could still offer competitive international service through a
merger with Easyjet or Ryanair, much like the NWA-KLM alliance, with relatively few
transatlantic flights and with only a couple of long-haul aircraft. However, the track record for
low-cost international carriers, in the tradition of Freddie Laker’s Skytrain and the short-lived
People Express, may suggest that Southwest, Ryanair and Easyjet should maintain their current
structures.
Conclusion
The European Commission, in its desire to complete the single European market for air
travel, has succeeded in the initial step of gaining a mandate from member states to negotiate a
new air services agreement with the United States and third countries. The EU, while seeking
primarily to being the transatlantic aviation regime into accordance with the ECJ’s November 5,
115
Staniland (1996), p. 6.
Staniland (1996), p. 11.
117
Staniland (1996), p. 12.
116
25
2002, decision, will likely be pressing for the completion of a liberalized EU-U.S. open aviation
area, which would go beyond even existing open skies agreements. If past bilateral negotiations
are any indicator, talks between the United States and the European Union will be long and
arduous. Since most U.S. carriers can already operate fifth freedom flights between EU member
states, the Commission cannot consider intra-EU cabotage as a bargaining chip to offer the
United States. Short of playing hard-ball in negotiations with the United States, for example by
threatening to suspend these fifth freedom privileges, the Commission can offer little more than
liberalization of the restrictive bilateral ASAs with Britain, Greece, Ireland and Spain, which
would allow increased access by U.S. airlines to London’s Heathrow Airport, an avowed goal of
the United States.
The European Union may have to appeal to the precarious financial situation faced by
many U.S. airlines in 2003 – many have not yet recovered from the travel downturn that began
with the attacks of September 11, 2001. The relaxation of foreign ownership limitations would
open foreign capital markets to U.S. airlines. The Brattle Group estimates that an EU-U.S. open
aviation area would result in an additional 17 million passengers a year, increased employment
in the United States and Europe, and consumer benefits of $5 billion.118 The United States holds
its own bargaining chips, including an end to the “Fly America” government procurement
program and allowing forms of domestic U.S. cabotage, key objectives of the European Union.
Questions for Discussion
1. What interests and institutions are the driving forces behind centralizing authority over
air services agreements within Europe? What actors resist this centralization? What is
the scope and significance of the decision of the European Court of Justice?
2. Describe the central dilemma faced by governments and airlines in the wake of the ECJ
decision. What changes have to be made to the regime of bilateral ASAs to bring the
agreements into accordance with the decision? What were the central reasons the
Transport Council decided to delegate negotiating authority to the European
Commission?
3. As the chief executive officer of a European airline, what should be your strategy with
respect to European policy? What should be your business strategy? How does your
strategy differ depending on whether you are a high-cost, state-owned airline in one of
the smaller member states versus a large, lower-cost, private airline in a large member
state?
4. Identify the preferences of the United States with respect to transatlantic air services
agreements and further liberalization. Differentiate between airlines, consumers and
regulators. Which airlines would stand to gain and lose from an EU-U.S. open aviation
area? How would consumers gain or lose from such an agreement? What position
should the U.S. government adopt?
118
Brattle Group (2002).
26
5. Consider the negotiating arrangements for a new transatlantic accord. How does the
consolidation of negotiating authority under the Commission affect the negotiating
leverage of the United States? As the Transport Council will have to ratify any
agreement, how would voting procedures (consensus, unanimity, qualified majority)
probably affect the outcome?
6. Given the balance of concessions that each side could offer the other, what do you
believe is the most likely outcome from these negotiations? Is a full EU-U.S. open
aviation area possible or realistic?
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