Views from the Air Currents Conference of January 2004

International Air Transport Policy Issues for Canada: Views from the Air Currents Conference of January 2004

Janda, Richard

Abstract

In this paper, we describe several key international air policy issues discussed at the Air Currents: Building the Future of Canada’s Air Transport Policy conference, jointly organized by Concordia University, McGill University, and University of British Columbia, and supported by a majority of government agencies involved in air transportation in Canada. These key issues are: (a) completing an Open Skies North American air transport market in the context of the NAFTA region; (b) Canada’s approach to the proposed EU-U.S. Open Aviation Area; (c) foreign ownership limitations and a foreign airline’s rights of establishment in Canada; (d) air cargo liberalization; and (e) problems arising from government-imposed fees on passengers, airports, and other air transport infrastructure providers. For each of these topics, we present background to the policy issues requiring decision, conference presenters’ views, results of audience opinion polling, and our analysis and recommendations. Our most important recommendation is that Canada has reached the point where the focus of aviation policy, including its stance taken at bilateral and other international negotiations, should be shifted away from the protection of the air transport industry and carriers to the promotion of consumer welfare, business competitiveness, and the wider economic interests of the nation.

Résumé

Dans le présent article, nous examinons plusieurs questions de politique aérienne internationale abordées au cours du congrès Air Currents: Building thé Future of Canada’s Air Transport Policy. Le congrès était conjointement organisé par l’Université Concordia, l’Université McGill, et l’Université de Colombie-Britannique et bénéficiait du soutien de la plupart des organismes gouvernementaux impliqués dans le transport aérien au Canada. Les questions fondamentales abordées ont trait à: (a) l’achèvement du marché du transport aérien dans le contexte géographique de l’ALENA dans le cadre du traité « Ciel Ouvert »; (b) l’attitude du Canada vis-à-vis de la proposition américano-européenne d’un espace aérien ouvert; (c) les restrictions imposées aux propriétés étrangères et les droits d’établissement au Canada accordés aux compagnies aériennes étrangères; (d) la libéralisation du fret aérien; (e) les problèmes liés à l’imposition, par le gouvernement, des droits aux passagers, aux aéroports, et autres fournisseurs d’infrastructure de transport aérien. Pour chacun de ces problèmes, nous dressons un état des lieux actuel et présentons les questions de stratégie exigeant des décisions, des opinions exprimées par les congressistes, des résultats des sondages d’opinions; nous clôturons par une analysis et des recommandations. La recommandation la plus importante est que le Canada a atteint un niveau ou il doit passer de la protection de l’industrie et des compagnies aériennes à la promotion du bien-être du consommateur, à la compétitivité de l’entreprise, et à l’intérêt économique général de la nation.

The world’s air passenger traffic grew from 1.573 trillion revenue-passenger-kilometres (RPK) in 1985 to 3.394 trillion in 2000, a growth of 116% during the 15-year period. This represents an average compounded growth of 5.26% per year. Air freight traffic grew at a significantly faster rate than passenger traffic during the same period. Boeing’s 2004 current market outlook forecasts an average annual growth of 5.2% for passengers and 6.2% for air cargo volume in the next 20 years (2004-2023). Airbus (2003) forecasts 5.0% annual growth in RPK for the same 20-year period. Both Airbus and Boeing forecast that air traffic will grow faster in the first 10-year period than the second 10-year period. Since, in the long run, levels of per-capita income and GDP are the main factors determining air passenger and freight volumes, it is not surprising to see that the long-term growth outlook for the air transport industry is excellent. Even in North America, where the airline markets (especially the United States and Canada) are saturated, passenger traffic is forecast to grow on average 4.5% per year in the next 20 years.

In the short run, however, the world’s air transport industry is still recovering from a series of major challenges and catastrophic events since 2001. The dot-corn collapse and the subsequent slowdown of business travel beginning in 2001, the 9/11 terrorist attacks on the United States and the subsequent war on terrorism, the Afghanistan and Iraq wars, and the SARS outbreak are the key events that brought the world’s airlines and the associated air transport industries to their knees. Together these events completely wiped out more than three years’ worth of air traffic growth and produced a more than 15% reduction in air passenger volumes globally in the short run (see Figure 1). However, the International Air Transport Association’s (IATA) recent traffic statistics show promise that the air traffic volumes for 2004 are likely to reach or even surpass the levels enjoyed in 2000, the last normal year of airline operations. For example, Table 1 shows that the level of international scheduled passenger traffic (in terms of RPK) for January-June 2004 was 8.4% higher than the same six-month period in 2000 while the international cargo traffic measured by freight tonne kilometres (FTK) for January-June 2004 was 16.2% higher than that of 2000. Over the January-June 2004 period, international passenger traffic in Asia Pacific, Europe, and North America was 12.2%, 2.3%, and 4.4% higher, respectively, than it was over the same period of 2000. In the absence of another catastrophic event, and if the recent extraordinary rise in fuel price subsides, global and North American airline traffic volumes are expected to reach or surpass the 2000 levels either in 2004 or 2005.1

On the Canadian scene, as of October 1, 2004, Air Canada (ACE Aviation) emerged from 18 months of bankruptcy (CCAA) protection, and its third-quarter results show a clear improvement. WestJet has just initiated its transborder services to the United States. Both carriers report significantly increased passenger load factors in 2004 over 2003. These signal cautious optimism for Canada’s airline industry even in the short run.

At this juncture, it is important for Canada to examine its medium-term air transport policy options, taking into account the changed and changing industry environment domestically and internationally. With this objective in mind, the Air Currents conference held in Ottawa on January 27-28, 2004, was organized jointly by the International Centre for Aviation Management Education and Research of the John Molson School of Business at Concordia University, the Institute of Air and Space Law of McGill University, and the Centre for Transportation Studies at the Sauder School of Business of the University of British Columbia. It was designed to assemble leading industry, public sector, and academic experts on air transport in order to provide an opportunity to explore options and to forge a new consensus for future policy direction and the position of the Martin government. The 120 conference participants came from all sectors of the aviation industry and drew on a deep pool of experience. There was significant representation (42%) from government departments and agencies. In diminishing order, the other participants were 14% aviation consultants, 13% from carriers, 11% academics, 6% from union and employee groups, 5% industry suppliers, 4% airport and air navigation service suppliers, and 5% from other domains. The group of those who were relatively fresh to the industry (O to 5 years of experience: 25%) was balanced by the group of those with over 25 years of experience in the industry (26%), with an even distribution in between. Participation rates in responding to audience polling varied from a high of 107 to a low of 46. Therefore, it cannot be claimed that polling results are fully representative of the opinions of all conference participants. Nor can it be claimed that the participants constitute a statistically representative sample of the industry. Rather, polling results are intended to provide policy makers with some general guidance gathered from the opinions of experienced and informed industry observers. It should also be made clear that polling results were assembled on a confidential basis.

As Conference Chair Donald Carty put it,

Transportation has been a cornerstone of Canada’s national political and economic policy since before Confederation and continues to be vitally important to this country’s future. Given the global restructuring of the aviation industry that is well underway, it is critically important that Canada chart a clear course for Canada’s airlines and air service providers.

It was on the basis of collecting and synthesizing ideas expressed at the conference that a tangible and practical contribution to policy-making was envisaged.

This task has become all the more relevant in light of the mandate to review Canada’s economic regulatory regime as it affects the Canadian air industry, issued on November 5, 2004, by Transport Minister Jean Lapierre to the Standing Committee on Transport. The issues discussed at the Air Currents conference tie directly into this ongoing policy review. The 11 questions put by the Minister to the Standing Committee provide a useful backdrop to this paper and will be used to synthesize our conclusions at the end:

1. Should Canada increase the limit on foreign ownership of voting shares in Canadian air carriers from the current 25% to 49%?

2. Should Canada go further and remove constraints on who controls Canadian air carriers, such that foreign interests could establish, or acquire control of, air carriers in Canada, for the purposes of offering domestic services only (right of establishment)?

3. Should Canada permit foreign air carriers, as a matter of principle or on a case-by-case negotiated basis, to provide air services between points in Canada? If so, under what conditions?

4. Should Canada seek negotiations with the United States in an effort to further liberalize the current air agreement between the two countries?

5. Should Canada seek negotiations with the United States in an effort to achieve a U.S.-style open skies agreement?

6. Should Canada seek negotiations with the United States to address issues that go beyond open skies? If so, what issues specifically?

7. How should the Canadian government balance the often conflicting interests of Canadian airports and local governments on the one hand, and air carriers on the other hand, during bilateral air negotiations?

8. Should Canada further liberalize its charter policies to lessen or remove remaining restrictions on granting authority for charter flights between Canada and third countries?

9. Should different approaches be taken to the two questions above for passenger and all-cargo services?

10. Should Canada consider introducing domestic service, ownership and control, and market integration issues into its international negotiations, and, if so, under what conditions or with which bilateral partners?

11. Would Canada be better served by adopting a multilateral (many countries) or plurilateral (smaller group of like-minded countries) approach for further air liberalization? Would this be practical?

After discussing briefly the global trends in air transport policies, this paper attempts to summarize and analyze each of the key air transport policy issues discussed at the conference, presenting the conference participants’ opinions on the issue and making policy recommendations. The key policy issues treated at the conference were: (a) the future of North American Open Skies; (b) Canada’s approach to the EU-U.S. Open Aviation Area negotiations; (c) foreign ownership limitations and a right of establishment for foreign airlines for domestic services in Canada; (d) air cargo liberalization; and (e) government-imposed fees on passengers, airports, and other air transport infrastructure providers.

As a final preliminary note, we observe that the conference did not purport to raise all issues of significance to the future of air transportation. Thus, while airport fees and charges were discussed in general terms, the specifics of pricing for airport gate access, landing slots as well as peak/off peak pricing issues-which are of great significance in the EU and the U.S. at congested airports-were not directly canvassed. Labour-management issues, which were discussed at the conference, turned on the specifics of the Air Canada restructuring and are not discussed here since they have been overtaken by events. Guarantees of service for isolated and remote communities and the contribution of air transport policy to Canada’s emerging Cities Agenda, while raised in passing, did not generate sustained discussion or conclusions.

Global Trends in Air Transport Policies

Socio-political and economic trends have influenced air transport regulatory policy choices toward more liberalization and deregulation in both domestic and international markets.

For domestic markets, since the U.S. deregulation in 1978 there has been a major shift in focus of air transport policy of most OECD countries from one of protecting the interest of national air carriers to one of enhancing consumer benefits. Australia may be regarded as the most notable case of domestic deregulation, because in 1999 it allowed the right of establishment for Virgin Blue (then 100% owned by foreigners) to provide airline services in Australian domestic markets. The benefit of such deregulation and liberalization of the airline sector has been enhanced by privatizing and commercializing airports in many countries.

During the last decade or so, there has been a significant advance in liberalizing bilateral airline markets. The U.S. government has succeeded in signing open skies bilateral air services agreements (ASAs) with more than 60 countries, beginning with its first open skies agreement signed with the Netherlands in 1992. Many other countries are now pursuing similar bilateral liberalization strategies. There is a definite sign that many countries are now attempting to move away from “Bermuda”-style restrictive bilateral air services agreements towards a more liberalized ASA regime. For example, over 70% of the ASAs concluded or amended during the last 10 years contain some form of liberalized arrangement, such as unrestricted traffic rights, multiple designations of carriers, freeing capacity restrictions, a double disapproval of country-of-origin pricing, and broadened criteria of air carrier ownership and control (Wang, 2004). It is clear that Canada has not been at the forefront of the bilateral liberalization trend.

With regard to the liberalization of regional markets, the creation of a single aviation market in the European Union can be considered the single most successful case. However, as the list of agreements (below) shows, 10 of the new regional liberalization pacts have been signed in less than a decade. This illustrates that many countries in various regions are interested in the idea of open skies air transport markets. Despite this global trend, at the moment there is no formal negotiation underway in North America aimed at creating an open skies North American region. This issue has been treated formally in the Air Currents conference.

List of Regional Agreements Signed since 1995

By May 2004, 10 regional ASAs were signed around the world, seven of which include instant or phased-in liberalization leading to full market access in the future (Wang, 2004):2

1. The European Economic Area (EEA) agreement involving the EU together with Norway, Iceland, and liechtenstein as well as the 2002 bilateral agreement with Switzerland;

2. The Andean Pact (Cartagena Agreement) involving Bolivia, Colombia, Ecuador, Peru, and Venezuela;

3. CARICOM (Caribbean Community) Air Services Agreement of 1996 among 15 nations in the Association of Caribbean States;

4. The Fortaleza Agreement of 1997 among Argentina, Brazil, Bolivia, Chile, Paraguay, and Uruguay (1997);

5. The CLMV Agreement among Cambodia, Laos, Myanmar, and Viet Nam (1998);

6. Intra-Arab Freedoms of the Air Programme among 16 states of the Arab Civil Aviation Commission (ACAC) (1998);

7. CEMAC – an agreement among the six States of the Economic and Monetary Community of Central Africa (1999);

8. An agreement among the 20 States of the Common Market for Eastern and Southern Africa (COMESA) (1999);

9. The Banjul Accord among the six States in Western Africa (1997); and

10. The Yamoussoukro II Ministerial decision among 52 African Union States (1999).

On the multilateral front, the WTO, OECD, IATA, UNCTAD, APEC, and International Chamber of Commerce (ICC) all work towards liberalizing international air transport and related trade and commerce. However, there are two specific international liberalization projects that are especially noteworthy. First, in 2001, five APEC members (U.S., Brunei, Chile, New Zealand, and Singapore) signed the Multilateral Agreement on the Liberalization of International Air Transportation (MALIAT). Peru, Samoa, and Tonga subsequently joined them. The U.S. government touted it as the first plurilateral open skies agreement in the world. Second, the proposed EU-U.S. Open Aviation Area now being negotiated has the potential to become a multilateral framework agreement. It was one of the important topics treated at the Air Currents conference.

In summary, liberalization will continue to make progress at the national, bilateral, regional, and multilateral levels at varying speeds. This trend appears irreversible. Airlines, airports, and governments will need to face it and adapt their strategies to deal with it. First movers are likely to reap more benefits. Furthermore, it is important to reexamine priorities for air policies and regulations because air transport is not an end in itself, but rather a means to achieve economic wellbeing for a country, region, and indeed the world by serving populations and industries efficiently. The main lesson for the future is that policy priorities must change from protecting the air transport industry and carriers to serving users-consumers, the tourism industry, and trade and commerce generally.

The Future of North American Open Skies

Background

Chapter 12 of the North American Free Trade Agreement (NAFTA) on Cross-Border Trade in Services excludes from its ambit all air services except repair and maintenance services and specialty air services. In this respect, it is not quite coterminous with the Air Transport Services Annex of the General Agreement on Trade in Services, which currently extends only to aircraft repair and maintenance services, computer reservation services, and the selling and marketing of air transport services.

While the NAFTA framework remains unambitious, both Mexico and Canada have entered into liberal bilateral agreements with the United States.3 In the Canada-U.S. case, as of 1998, Canadian and U.S. passenger carriers are permitted to operate transborder scheduled services between any points in both countries. Large allcargo courier aircraft are not permitted to serve more than one point in the territory of the other party on a single flight. However, UPS northbound service from Louisville, Kentucky, to Hamilton and Toronto was grandfathered as a permanent co-terminalization right for scheduled and charter services. The agreement also prevents single-flight numbering in sixth freedom markets or undercutting prices on fifth and sixth freedom routes of carriers with third or fourth freedom bilateral rights (e.g., American Airlines cannot have a through-flight display on Toronto-Chicago-Mexico City or undercut any Canadian or Mexican carrier in the Toronto-Mexico City market). Fifth freedom rights are severely restricted. One Canadian carrier may be designated to operate services beyond Honolulu to Australasia and beyond with fifth freedom rights and one United States air carrier may be designated to operate beyond Gander to Europe and beyond with fifth freedom rights. Any number of Canadian carriers may be designated to serve Canada-San Juan-and beyond with fifth freedom rights.

The Canada Transportation Act Review Panel (CTAR, 2001) recommended that Canada should “enter into negotiations with the United States and Mexico to create a North American Common Aviation Area in which carriers from Canada, the U.S. and Mexico would compete freely” (pp. 123-124). Failing successful NAFTA negotiations, the panel recommended “that the government negotiate with other countries for the reciprocal granting of modified sixth freedom rights and of rights of establishment for foreign-owned domestic carriers.”

On December 13, 2001, Air Canada President and CEO Robert Milton proposed Open Skies Plus for Canada and the United States, designed to build further on the 40% growth in traffic between the two countries since the 1995 agreement. The core of the proposal was the exchange of “modified sixth freedom rights” and the removal of restrictions against all-cargo courier co-terminalization and third-country selling. Air Canada hopes to gain full anti-trust immunity in the U.S. upon conclusion of what the U.S. considers to be a true open skies arrangement. “Modified sixth freedom” would allow U.S. and Canadian carriers who have hubs located near the Canadian border to offer services via that hub between points in the other country (e.g., by allowing a U.S. carrier the combination of Montreal-Minneapolis with Minneapolis-Vancouver and allowing a Canadian carrier the combination of Seattle-Toronto with Toronto-Boston). There has also been speculation about “tagend” cabotage, which does not form part of the Air Canada proposal, and would allow service between points in the other country to be added on to the end of service from the carrier’s country (e.g., Montreal-Detroit-Denver or Detroit-Montreal-Quebec).

On January 26, 2004, U.S. Ambassador Paul Cellucci once again called for a reopening of the 1995 Canada-U.S. agreement to achieve further liberalization. Most recently, in a speech of October 29, 2004, Transport Minister Jean Lapierre indicated that the Government of Canada was prepared to review bilateral aviation relations with the United States including specifically the issues of coterminalization and cabotage and even the possibility of integrating the two markets under a single set of rules.

Conference Speakers’ Views

The Hon. Doug Young, now Chairman of Summa Strategies, was Minister of Transport in 1995 when the Canada-U.S. air services agreement was signed. He noted that traffic increases have helped both economies, raising the question as to whether Canadian travelers have accounted for most of the increase. Yves Dufresne, Senior Director, International and Industry Affairs, Air Canada, was subsequently able to confirm that this was the case. Mr. Young went on to note that the airline industry was not unique in being affected by problems that have hit the economy as a whole. He urged that Canada not beg for a seat at the negotiation table with the EU and the U.S. “unless someone has nothing to do for a long time.”

John Byerly, U.S. Deputy Assistant Secretary of State for Transportation Affairs, noted that the United States was very pleased with the results of the Canada-U.S. agreement and would like to do more. The air cargo market is where the greatest improvement was sought. UPS and Federal Express cannot serve multiple Canadian cities on one flight (co-terminalization). He argued that Canadians bear the cost of less efficient and more expensive cargo delivery systems. The U.S. wants full cargo liberalization. He expressed satisfaction that the new Canadian administration seemed open to further U.S.-Canada aviation liberalization, which he described as a win-win situation providing the benefit of economic expansion to both markets and to the consumers of both nations. Negotiations could proceed either bilaterally or trilaterally with Mexico. Mr. Byerly underscored the overriding importance of security issues in the current context and argued that common security concerns could and should be addressed without limiting common prosperity.

Yves Dufresne of Air Canada reviewed his company’s Open Skies Plus proposal. He noted that Air Canada had benefited immensely from the new opportunities afforded by the 1995 agreement and that it believed it could benefit still further from an expanded agreement. The air treaty should be updated to allow Canadian and U.S. carriers to exploit their networks fully within and beyond North America so as to compete against global network carriers more successfully.. This means lifting barriers that prevent Canadian carriers from competing effectively outside the North American market to the rest of the world. Carriers should be enabled to price freely in third-country markets and authorized to work closely with alliance partners in these same third-country markets. Without such flexibility, it will be difficult for Air Canada to sustain its international growth or to initiate new intercontinental services out of its main Canadian hubs.

Audience Polling Results

The audience polling results may be summarized as follows:

* A majority of the respondents (55%) felt that Canada should focus on bilateral liberalization with the U.S. rather than pursue a three-way negotiation including Mexico or indeed rather than becoming part of MALIAT.

* However, a majority (71%) believed that a North American Common Aviation Area under NAFTA should be a medium-term objective.

* The majority of participants (62%) believed that Canada should enter into Open Skies Plus negotiations with the United States as soon as possible, focusing on cargo, fifth freedom, and modified sixth freedom liberalization.

* There was, nevertheless, uncertainty as to whether modified sixth freedom rights would be viable given heightened customs and immigration screening requirements on both sides of the border; the audience was equally divided on the point.

* A clear majority felt that modified sixth freedom and tag-end cabotage would benefit travelers and airlines over time, with tag-end cabotage identified as more beneficial.

Discussion and Recommendations

The bilateral Canada-U.S. air transportation links are by far the most significant ones for our country. They are not only critical for Canada’s trade relationship, but in fact have also become an ordinary feature of life for many Canadians. Although post-9/11 security concerns add a new and complex dimension to the management of our air transport relationship, these concerns highlight the need for more rather than less integration of the two air transport regimes.

It would be appropriately ambitious for Canada to seek a fully integrated air transport regime with the United States analogous to the Common Aviation Area in the EU. This would ultimately involve common licensing rules and significant institutional coordination between partner transportation authorities. It is beyond the scope of this paper to outline how such integration could in practice be achieved in the absence of a transnational body like the European Commission. Suffice it to say that Canada would have to propose much closer coordination than exists currently with the FAA and DOT. Canada should also work toward a North American Common Aviation Area with the United States and Mexico; Mexico is our third most important bilateral aviation market (after the U.S. and the UK).

A less ambitious but nevertheless significant goal for Canada remains to pursue Open Skies Plus discussions with the United States, placing particular emphasis on adding modified sixth freedom and tag-end cabotage rights to the agreement. As further liberalization is negotiated, special attention should be paid to potential impacts upon levels of service to small and remote airports. In the current security environment, it is critical to ensure common and streamlined customs and immigration procedures at “smart borders” if the benefits of further market access liberalization are to be realized.

Canada’s Approach to the Proposed EU-U.S. Open Common Aviation Area

Background

On November 5, 2002, the European Court of Justice handed down a series of eight rulings-the so-called Open Skies Judgments-the effect of which was to propel the re-negotiation of bilateral air services agreements entered into by EU member states. In essence, the Court determined that existing ASA ownership and control clauses violate EU national treatment obligations, under Article 43 of the EC Treaty, by extending the benefit of ASAs only to airlines owned and effectively controlled by nationals of the individual member state. The upshot of these decisions is that the European Commission has sought to re-negotiate all of the EU’s bilateral agreements, targeting in particular its member states’ open skies bilateral ASAs with the U.S. The Commission’s goal is to substitute an EU-U.S. Open Aviation Area for the current web of EU-U.S. ASAs. The Commission has received an ambitious and comprehensive negotiating mandate from the EU, including the lifting of ownerships limits, convergence on the application of competition rules, broad market access, and unlimited traffic rights (including cabotage). The thorny issue of slot allocation, an item of great concern to the U.S.-notably at London’s Heathrow airport-is also on the table, as is liberalization of cargo traffic.

It now appears unlikely that the EU and the U.S. will quickly conclude an agreement since on February 26, 2004, the then EU Commission Vice President and Transport Commissioner Loyola de Palacio rejected a U.S. proposal that failed to include cabotage rights, describing cabotage as “something that must appear in the agreement.” She added that this would entail the inclusion, at the very least, of “consecutive cabotage”-the right for European carriers to fly on to additional points in the U.S. after the U.S. gateway. From the EU’s standpoint, fifth freedom flights within the EU by U.S. carriers (e.g., London to Frankfurt) are equivalent to flights within the U.S. by EU carriers. The absence of cabotage rights thus creates an asymmetry favouring U.S. carriers. Although U.S. carriers no longer make much use of their fifth freedom rights within the EU, tending to rely instead on alliance partner carriers from the EU, this asymmetry remains of concern in the event of trans-Atlantic market restructuring. If U.S. carriers in principle have better access to the EU than EU carriers have to the U.S., restructuring would tend to favour U.S. carriers, both as investment targets and as having more flexibility to pursue network growth on both sides of the Atlantic.

The implications of any possible agreement could be far-reaching for Canada, especially if the EU successfully holds out for an ambitious Open Aviation Area. Like the Bermuda bilateral of another era, an EU-U.S. agreement is likely to become the model for other bilateral or indeed multilateral arrangements. Already the Air France-KLM merger, which was given clearance by the European Commission on February 12, 2004, is premised upon foreign governments ultimately accepting an EU designation clause and upon the U.S. or other countries not acting in the interim to block flights by a French-controlled Dutch carrier. Canada’s trans-Atlantic markets will be affected by the consolidated EU airline industry this merger heralds. It also has been argued that if Canada wishes to have its carriers participate in the restructuring of the trans-Atlantic air services market, it will have to ensure that investment opportunities in and for Canadian carriers are at least as attractive as investment opportunities in and for U.S. carriers.

Conference Speakers’ Views

Michel Ayral, the European Commission’s Director of Air Transport and head of the EU negotiating team with the U.S. at the time of the Air Currents conference, reiterated the view that even if the 2002 European Court of Justice Open Skies decisions appeared to cast the Commission’s jurisdiction over bilateral ASAs narrowly, over time this jurisdiction would expand to cover the full range of issues addressed in these agreements. At the time, the Commission had received from the Council a mandate to negotiate a general agreement with the U.S. and to oversee the elimination of national ownership and control clauses in other bilaterals. The EU would soon adopt a regulation providing terms of reference for bilateral negotiations by individual Member States. As a general principle, the Commission favoured urgent reform of the regulatory environment for aviation so as to liberalize access to external markets and to promote competition. Airline consolidation in Europe could only proceed on the basis of increased competition from foreign airlines. It appeared that the ambitious Open Aviation Area agenda could not be achieved in a single step. As for the inclusion of other North American countries, the EU had pronounced itself in favour of regional cooperation and would be ready to consider the involvement of other countries, but only on the basis of a decision shared by the United States.

John Byerly, U.S. Deputy Assistant Secretary of State for Transportation Affairs and the one responsible for negotiations with the EU, underlined U.S. commitment to further liberalization of international aviation. Artificial constraints upon the planning of service networks force airlines to pursue suboptimal business strategies. The flexibility to adjust to global market demands is critical to the long-term health of the aviation sector. Civil aviation works best when markets, not governments, determine who flies where, how often, and at what price. The U.S. sought to build on the success of its negotiation of bilateral open skies agreements and favoured the emergence of a multilateral approach. The EU, on the other hand, sought to extend the success of its internal market to relations with the United States. The U.S. was willing to discuss with Canada the further liberalization of their bilateral air services agreement but believed that negotiations with the EU would be rendered more complex, and thus delayed, by the inclusion of additional parties.

Roland Dorsay of the Canadian Airports Council noted that EU-U.S. talks are critical to the future of international civil aviation because the bilateral system has reached a dead end; however, Canada has yet to take a position on the key issues under consideration in those talks and until Canada decides what it wants to achieve, it should not join them. Canadian policymakers should ask what approaches will maximize Canada’s global competitiveness and maximize consumer choice at the best possible prices. The answer to those questions is almost always more open markets and more open free trade. Aviation should be freed from as much economic regulation as possible.

Audience Polling Results

The audience polling results may be summarized as follows:

* A majority of the respondents (67%) felt that an EU-U.S. Open Aviation Area without Canada participating in it would have negative consequences for Canada.

* Of the respondents, 81% indicated that in the event that an Open Aviation Area is negotiated successfully, it should serve as a basis for multilateral air services regime.

* When asked which position Canada should adopt in response to the EU-U.S. bilateral negotiations, the respondents’ opinions are divided: for example, 30% in favour of waiting for the outcome of the negotiations and then seeking our own separate agreement with EU; 23% for seeking to become a partner in the current EU-U.S. negotiation; 20% in favour of waiting for the outcome and then seeking to become a partner to the trans-Atlantic agreement. In short, respondents felt that Canada should do something in response to the proposed EU-U.S. Open Aviation Area but were divided as to what to do.

* Of the respondents, 86% felt that Canadian carriers will be able survive through restructuring, alliance, and merger in a single North American and trans-Atlantic market.

Discussion and Recommendations

The proposed EU-U.S. Open Aviation Area would improve air services between the EU and U.S. as higher frequencies of services and a wide variety of fare-quality travel options become available, and as the global alliance carriers further strengthen their intercontinental passenger routing via U.S. mega hubs. These developments would put Canadian air carriers at a disadvantage in competing in the North Atlantic markets as more and more Canadian and European passengers would choose to route their travel to and from Canada via a U.S. point. For example, Dresner and Oum (1998) show clearly that an increasing proportion of international passengers to and from Canada route their travel via U.S. hubs as the U.S. government signs open skies agreements with an increasing number of countries. A similar negative effect on the Canada-Europe travel market is likely to occur if the proposed EU-U.S. Open Aviation Area becomes a reality without Canada participating in it. Furthermore, as travel to the U.S. becomes more convenient and cheaper, some European travelers who would travel to Canada may switch their destination to U.S. points.

Although it is quite clear that Canadian carriers and the Canadian economy would be negatively affected if the EU-U.S. Open Aviation Area does not include Canada as a party, at the moment Canada is not a participant in the Open Aviation Area negotiations. Furthermore, it appears that the Canadian government did not make a serious attempt to participate in the negotiation process. This happened despite the fact that the Report of the Canada Transportation Act Review Panel (2001) recommended, “the government should ensure that Canada participates in any negotiations to establish a Transatlantic Common Aviation Area (TCAA)” (p. 125). In our view, this is a major failure on the part of Canada’s federal government. This failure appears to stem in part from the uncertainty at the time concerning Air Canada’s future, as well as a tendency on the part of Transport Canada to adopt restrictive Bermuda II-style bilateral ASAs as its basic approach to protect Canadian carriers (especially Air Canada) from international competition. By now, we should have learned that such a restrictive approach to bilateral agreements actually harms our flag carriers by making them uncompetitive in the long run in addition to reducing consumer welfare and harming the broader economic interests of the nation.

Canada needs to be proactive in relation to the current EU-U.S. negotiations. Whereas at an early stage there may have been an opportunity for Canada to participate in the EU-U.S. negotiations, these talks opened officially on June 25, 2003, and both parties have now shown reluctance to include Canada as they feel that inclusion of a third party would make the negotiation process more complex and might slow it down.

Since resolution of this issue will take some time, perhaps the Canadian government should make a renewed effort to persuade the European Commission and the United States to change the current bilateral negotiations into the trilateral negotiations, much the same way Canada was finally included in NAFTA despite the fact that U.S. initially wanted to do two separate bilateral deals with Canada and Mexico. Since integration of Canada into the Open Aviation Area system with extensive fifth freedom rights is likely to benefit EU carriers, it may be possible for Canada to persuade the European Commission, which has heretofore resisted the addition of additional parties. Canada would have to persuade the EU, and ultimately the U.S., that adding it would help rather than hinder negotiations by providing fresh ideas on issues such as cabotage, which have deadlocked the talks. Furthermore, Canada would have to argue that unlike non-EU members of the EEA, which might also want to be included, Canada does not currently have a formal way of expressing its views on the negotiations and is at least equally affected by them.

If Canada fails in persuading the EU and the U.S. that it should be included in the Open Aviation Area talks, which is now the most likely outcome, then the next best alternative is clearly negotiating a separate bilateral open aviation agreement with the EU, perhaps even in advance of the U.S. agreement. Since the European Commission has indicated its willingness to enter into separate negotiations with countries that are prepared to negotiate a “fully liberalized” aviation environment, such an open skies agreement with EU may be possible. Given that the United States had signed separate open skies agreements with 67 countries as of October 2004, there is a real risk that international traffic to and from Canada will be routed increasingly via U.S. hub airports, especially as snags in implementing new Canada-U.S. border security procedures have eased. The only way to prevent such traffic diversion is to make direct air travel between Canada and foreign countries more convenient and inexpensive. This, of course, can be accomplished by signing open skies agreements with most of the countries with which the United States has open skies. It also entails a fundamental change in attitude on the part of Canada’s international air policy makers and executers. They need to abandon the notion that restrictive bilateral agreements (a foreign carrier is denied the opportunity to expand its services or launch new routes if a Canadian carrier cannot make money on the route) will somehow protect uncompetitive Canadian carriers’ interests in the long run. This protectionist policy prolonged the uncompetitive situation for Air Canada and, before its demise, of Canadian Airlines while inflicting major costs on the traveling public and harming Canada’s wider economic interests (tourism and related industries, corporate location choices, etc.). Such a policy did not protect either Canadian Airlines or Air Canada from becoming uncompetitive, allowing them to stare into the abyss of bankruptcy. We observe that Air Canada is fixing things fundamentally only after getting a real competitive assault from WestJet. WestJet seems to be the best medicine for Air Canada’s chronic disease.

Foreign Ownership and a Right of Establishment for Foreign Airlines in Canada

Background

Because the 1944 Chicago Convention enshrines state sovereignty over air space, states are left 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 almost universally permit deregulation of airlines only on the basis of “substantial ownership and effective control,” that is, they recognize national entities. Many states have historically pursued a “national champion” strategy with respect to airlines, occasionally investing in, retaining partial or full ownership of, and providing state aid to their flag carriers. Current Canadian air policy can be viewed as resting on four pillars: (a) substantial Canadian ownership, (b) reciprocal bilateral agreements for international scheduled service, (c) domestic deregulation, (d) and a shift to user-pay systems. This section of the paper focuses on the first pillar, dealing with ownership rules and providing background information on the state of Canadian airline ownership and control policy.

The Canada Transportation Act (1996) sets out the economic regulatory framework for transport in Canada. The Act establishes the Canadian Transportation Agency (CTA) as the economic licensing authority for publicly available air transport. Canadian and foreign airlines must hold an international scheduled or non-scheduled license issued by the CTA in order to operate services to and from Canada. International licenses are granted to airlines that hold route authorities (and that meet other Canadian regulatory requirements). Canadian carriers must obtain domestic licenses from the CTA to conduct operations within Canada. Non-Canadian carriers are ‘barred from operating domestic services within Canada.

More specifically, under the Canada Transportation Act, only a “Canadian” may receive a license to operate a domestic service, an international scheduled service, or an international non-scheduled service (unless, in the latter two cases, the airline is designated by a foreign country pursuant to a bilateral agreement). The 25% limit on foreign ownership is part of the definition of being a Canadian. The Air Canada Public Participation Act was amended in 2002 in such a way that Air Canada is now only required to meet the general requirements of the Canada Transportation Act, which provides that the federal cabinet can establish a higher percentage of foreign voting shares but cannot change the obligation to be controlled by Canadians. In addition, if the Minister considers that it is necessary or advisable in the public interest, an exemption from the obligation to be Canadian may be issued to a non-Canadian for the purpose of being licensed to operate domestic services. This exemption power does not extend to international services.

Canadian carriers face an obligation to monitor the level of foreign ownership of their voting shares and some, like Air Canada and WestJet, put in place mechanisms to provide a signal when the limit is being reached. For example WestJet, which over time has approached the 25% threshold and is currently reporting 22.6% non-Canadian ownership of voting shares, has put a special procedure in place for non-Canadian share transfers (www.westjet.com). Non-Canadians wanting to buy WestJet shares can reserve the right to obtain a transfer after completing a reservation application. WestJet’s policy is to permit reservations to stand for four business days when non-Canadian ownership levels exceed 21.0%.

Conference Speakers’ Views

Dr. Donald Bunker, President of Donald Bunker & Associates, questioned the rationale behind foreign ownership restrictions. For him, such restrictions are ultimately based on the mistaken conception that a foreigner will not promote one’s country. Would one really have less pride in a foreign-owned Canadian carrier carrying Canadian passengers? In the end, the government does more to generate employment by facilitating the best and most efficient infrastructure. If protection of the positions of a few Canadian senior managers, or even some Canadian flight crews, comes at the expense of poorer infrastructure, the trade-off is not worthwhile.

Dr. Michael Tretheway, Vice President and Chief Economist, InterVISTAS Consulting, cited IATA Director General Giovanni Bisignani’s observation that the airline industry is beset with three pillars of stagnation: (a) the traditional system of bilateral agreements; (b) national ownership restrictions; and (c) the dogmatic attitude of competition authorities. The world’s airlines are increasingly forceful in voicing the opinion that foreign ownership rules are an obstacle to industry development. The International Civil Aviation Organization (ICAO) has recently adopted the position that the substantial ownership and effective control clause standard to current bilateral agreements can give way to a principal place of business rule. The discussion of foreign ownership rules should be placed in the context of changing business models. It is highly likely that low-cost carriers will be serving 35-40% of the market within five years, and 10 years from now they may account for 50% of the market. Against this backdrop, full service airlines must be allowed to merge. Australia allows 100% foreign ownership for airlines operating domestic services. Qantas and Virgin Blue are both highly profitable, and fares are lower today than they were in the past. At one stage, Virgin Blue was 100% foreign owned. Canada’s foreign ownership rules are obsolete: they reduce access to equity capital, do not support the generation of jobs in Canada, constrain the return to Canadian investors, act as an entry barrier, and are an impediment to the needed consolidation and rationalization in the full segment sector of the industry. As a short-term measure, Canada should raise its ownership limit to 49% for carriers operating international services and move to 100% foreign ownership for domestic service carriers.

Audience Polling Results

The audience polling results may be summarized as follows:

* Sixty-four percent of those polled agreed with the option of not imposing any foreign ownership limits for purely domestic passenger carriers in Canada. Six percent were neutral, 22% disagreed, and 10% strongly disagreed.

* The majority of respondents (57%) indicated that awarding purely domestic passenger licenses (not to include transborder rights) will attract foreign investors to Canada.

* The overwhelming majority of the audience agreed with the statement that Canada should immediately raise foreign ownership limits for carriers offering international passenger service to 49%. Only 9% of those polled disagreed with this policy option.

* Sixty-five percent of the audience agreed that Canada will be assured of having adequate levels of service in all key markets if foreign ownership limits are raised to 100% for domestic passenger service and 49% for international passenger services. Nine percent were neutral and 26% disagreed.

* Furthermore, 64% agreed that, in its bilateral air negotiations, Canada should seek to substitute a “principal place of business” clause for “substantial ownership and effective control”; 16% remained neutral on this option and 28% disagreed.

Discussion and Recommendations

Is the existing 25% cap on foreign ownership of Canadian carriers a rational regulation? Restrictions on foreign ownership are usually justified on the basis that domestically owned companies provide high quality jobs, head offices, and businesses that have a good knowledge of, and a special interest in, the success of the Canadian market. The assumption is that Canadian-owned airlines offer a greater good for Canadians, and that foreign carriers or foreign ownership in airlines operating domestically in Canada would destabilize the Canadian-owned system, and, most importantly, leave Canada with an essential part of its transportation network in the hands of indifferent non-Canadians.

Those who advocate a restrictive ownership and control regime for the airline sector assume that Canadian carriers’ business practices and decisions somehow encompass broad national interests as well as their own self-motivated interests. However, in a deregulated environment, the government has little control or involvement in decisions made by airlines and cannot use the carriers as a tool of economic or social policy.

Canadian carriers under the current regulatory regime are not obliged to serve communities if they do not wish to do so after examining their own commercial interests. A restrictive foreign ownership regime suggests an outcome that is very difficult to attain, namely a societal benefit of sorts bestowed magnanimously by a private sector industry. Yet, when private carriers, especially Air Canada, do not deliver on Canadian goals, people feel betrayed. It is far from obvious that the relaxation or elimination of the foreign ownership limit on Canadian carriers would be to the detriment of Canadian service levels. If anything, the increased competition may encourage carriers to look for opportunities to serve marginal route markets in Canada.

The following policy recommendations emerged from the conference deliberations and our analysis:

* Canada should allow for foreign-owned domestic carriers as is the case in Australia.

* Canada should raise immediately the foreign ownership limit on air carriers to 49% for international passenger services.

* In its bilateral air negotiations and in cooperation with international organizations such as IATA and ICAO, Canada should seek proactively to substitute a “principal place of business” clause for the current “substantial ownership and effective control” clauses defining eligibility of carriers to benefit from the rights under the agreement. This could pave the way for lifting foreign ownership limits for international passenger services.

Issues in Air Cargo Liberalization

Background

A number of all-cargo airlines, including All-Canada Express, Cargojet Canada, ICC Canada, Kelowna Flightcraft, and Morningstar Air Express, provide jet service on behalf of Canada Post, courier companies, freight forwarders, consolidators, and shippers. Currently, there is no Canadian all-cargo carrier serving the international (non-transborder) market, although cargo is carried in the belly-hold of passenger aircraft, for example, by Air Canada as part of its scheduled passenger air services.

The upward trend line in Canada’s international air cargo trade that had characterized the late 1990s was reversed in 2001 and 2002. Perhaps even more disturbing was the fact that the market share gains air cargo services had been making as an overall proportion to Canada’s international cargo business were reversed during 2001 and 2002.

As the November 5, 2004, Transport Canada Discussion Paper points out, by volume,

air cargo accounts for one half of 1% of the total cargo carried in the Canadian transportation system-mainly for high-value, manufactured goods. While this is small, it gains in importance when its role in international trade is considered; for example, 24% of the values of goods imported from or exported to non-U.S. countries arrive by air.

Under the Canada Transportation Act, cargo service licensees, like passenger service licensees, are subject to the 25% limit on foreign holdings of voting shares. Canada’s bilateral agreement with the United States provides that large all-cargo courier aircraft are not permitted to serve more than one point in the territory of the other party on a single flight: the so-called no co-terminalization rule. Co-terminalization is the ability to serve more than a single Canadian city on one flight from the U.S. In substance, U.S. planes could land at the first point in Canada, unload packages destined for that area, and then continue to the next point in Canada with U.S. volume destined for that location. The argument for coterminalization on behalf of U.S. cargo carriers is that it would provide for a more efficient use of aircraft as several Canadian cities can be served by one aircraft.

The Canada Transportation Act Review Panel (2001) had pointed out that, “under the ‘scope clause’ in their contracts with pilots, Federal Express, UPS and other U.S. companies are bound to use their own aircraft and pilots on all jet category routes into their hubs and all routes where they have a right to fly” (p. 123). Coterminalization would thus decrease “demand for Canadian carriers to provide trans-Canada flights for U.S. cargo/courier companies.” The Review Panel did not recommend unilateral acceptance of co-terminalization.

Another bilateral restriction concerns seventh freedom rights, which allow an airline to carry passengers or cargo from a foreign country to another foreign country without a connection to the home country. Providing seventh freedom rights for cargo operations would enhance an integrator’s (e.g,. UPS or FedEx) ability to operate from Canadian hubs, yet it is questionable whether these operators would choose to do so.

In light of these considerations, the Transport Minister’s November 15, 2004, Discussion Paper identifies the following issues for reconsidering the Canada-U.S. bilateral air cargo regime:

* flying to more than one point in the other country on any transborder all-cargo courier flight;

* operating stand-alone services between the other country and third countries for all-cargo services.

Conference Speakers ‘ Views

Peter Wallis, President and CEO of the Van Home Institute, reviewed the case for a separate and a more liberal arrangement for cargo services as distinct from passenger services. He indicated there was strong support for unilateral open skies for all cargo services from U.S. carriers and from Canadian airports. He also noted that Canadian cargo carriers opposed liberalization of all cargo services.

Chris Mahoney, Senior VP and Chief Operating Officer of UPS, argued that the air cargo sector has a huge, positive impact on national economic growth and requires a liberal aviation regime to flourish. The original business of moving heavy freight from one airport to another has evolved into an integrated air express industry and the express share of the overall international air cargo market has tripled over the past decade. This industry is in the business of providing global logistics and supply chain services, and fast, reliable deliveries around the globe. Such services are necessary to support the growing trends of global production, global consumer demand, and distance-based commerce. Existing regulatory obstacles impose significant barriers to achieving efficient cargo transport operations, and these barriers ultimately affect all consumers. This is notably the case as regards restrictions against co-terminalization. After the 1995 Canada-U.S. bilateral was signed, Canadian carriers proved that they could compete with U.S. carriers. Mr. Mahoney argued that it is reasonable to assume that the same will happen in a further liberalized environment. Aside from the restrictions placed on formal cargo traffic rights by the bilateral agreement, some practical hurdles, including the following, can also impact express cargo operations: (a) customs and handling restrictions; (b) restrictions on intermodal operations; (c) constraints on night-time flight operations; and (d) post-9/11 security requirements.

Barry Lapointe, President of Kelowna Flight Services, took a diametrically opposed position. He argued that it was critical to separate cargo from passenger operations-and not to treat cargo as a liberalization test case-if change to the bilateral agreement with the U.S. was to be contemplated. He characterized co-terminalization as the “kiss of death for Canadian air freight,” notably 100% Canadian-owned Purolator. He predicted further consolidation among the big four in air cargo (UPS, Federal Express, DHL, and TNT) and argued that Canada should avoid turning over its market to a “quasimonopoly.” In his view, consumers in large centres might benefit for a while, but small centres would lose service. Eventually, price benefits would evaporate as market dominance set in.

Audience Polling Results

The audience polling results may be summarized as follows:

* Only 35% of those polled felt it would be significantly easier to achieve air cargo liberalization than to achieve passenger service liberalization (with the result that, if so, cargo liberalization should be pursued first). Fifty percent thought the two posed about the same level of difficulty with 15% of the audience holding a neutral view on this issue.

* With respect to trade in air cargo services, 34% of those polled thought the Canadian federal government should adopt a status quo policy, 28% felt that immediate full liberalization of foreign ownership rules and traffic rights should take place and 17% of the audience thought that Canada should pursue a policy of liberalization of foreign ownership rules and traffic rights only together with passenger services. The remaining 21% of the audience favoured an unspecified different policy option on this issue.

* In response to the question whether Canada should declare unilateral Open Skies for all comers for cargo traffic, 51% of the audience disagreed, 40% agreed, and 9% of the audience was neutral on this issue.

* Most members of the audience polled agreed (60%) that there should be no foreign ownership limits for Canadian cargo services; 33% disagreed and 7% were neutral to the idea.

* Imposing no limit as the appropriate Canadian foreign ownership rule for air cargo carriers was the most popular policy option for the audience with 43% advocating it. Five percent thought that raising the limit to 50% was appropriate and 29% thought that raising the limit to 49% was the best option. Twenty-one percent of the audience thought the status quo should remain.

* There was strong agreement (26% strongly agreed and 32% agreed) that Canada will maintain adequate levels of cargo service in all key markets if foreign ownership limits are removed. Seventeen percent of the audience disagreed and 13% strongly disagreed with 11 % being neutral.

* Most of the audience was undecided (24%) as to whether air cargo services should be brought within the Air Transport Services Annex of the General Agreement on Trade in Services (GATS). The rest of the audience was evenly split on the question, with 38% agreeing and 38% disagreeing.

Discussion and Recommendations

There will clearly be a major fight over extending co-terminalization rights to U.S. cargo carriers. Canadian cargo carriers believe that this would spell their doom. There is no doubt that the large, integrated global cargo carriers will have an enormous competitive advantage. No Canadian all-cargo carrier is currently positioned to take on UPS, FedEx, or DHL. This gives rise to the question whether Canadian carriers could at least become feeder carriers for the large express operators. Currently, U.S. cargo carriers operate under a “scope clause” in their collective agreements under which they are bound to use their own aircraft and pilots on all jet category routes into their hubs and all routes where they have a right to fly. This would effectively restrict the ability of Canadian carriers to act as subcontractors.

Canadians already rely on all-cargo express service for delivery throughout the world. The co-terminalization restriction acts as price protection for Canadian carriers at least in domestic markets, but it also represents an increased cost to Canadian businesses and individual consumers. The interest of consumers should prevail.

Therefore,

* Co-terminalization might be explored in negotiations with the U.S. on the basis that the scope clause would not apply to Canadian traffic. Canadian carriers would thus preserve the ability to compete on Canadian routes without being frozen out as service providers to the U.S. majors.

* Foreign ownership restrictions on cargo licensees should be lifted, perhaps completely.

* Canada should explore the possibility of including cargo services within the GATS Air Transport Services Annex.

Policy Towards Service Providers to Airlines: Airports, Air Navigation Services, Security and Insurance Underwriters

Background

Consistently, through the two days of conference discussion, participants identified airport fees and charges as one of the most important issues confronting Canadian air transport policy, with security and preclearance measures ranking high as well. In her keynote address, Nancy Hughes-Anthony, President of the Canadian Chamber of Commerce, focused considerable attention on the impact that the air travelers’ security charge, the federal fuel excise tax, and government-collected airport rents were having on the costs of air travel. She argued that it was time for the government to contribute to reducing the costs of air travel by cutting or eliminating these direct and indirect charges. As of March 1, 2003, the air travelers’ security charge was reduced from $12 to $7 for a one-way domestic flight, while the charge was maintained at $12 for a transborder flight, and $24 for any other international flight. The federal budget of March 23, 2004, further reduced these charges to $7 for a one-way domestic flight, $10 for a transborder flight, and $20 for any other international flight. By comparison, the charge in the U.S. is US$2.50 per flight segment, to a maximum of US$5. The Canadian government collects $400 million annually through this security charge. Ms. Hughes-Anthony argued that since “the expenditure on new capital equipment has largely been made, there should now be scope for the charge to be eliminated.” She pointed out that the Canadian fuel excise tax of 4 cents per litre (the U.S. rate is 1 cent per litre) was meant to reduce a federal deficit that has now disappeared. She argued that if it is not eliminated, the $90 million it collects should be put toward infrastructure improvements in the sector. The federal government now collects $250 million in airport rents, and this is expected to increase to $460 million by 2010. Rents translate into significant costs passed on to airlines and passengers. In line with the unanimous April 11, 2003, recommendations of the House of Commons Standing Committee on Transport, Ms. Hughes-Anthony proposed a number of measures with respect to airport rents: (a) the government should suspend rental payments by the airports for a two-year period and the airports should pass the rental savings on to the air carriers; (b) a more transparent process for determining airport rents should be established; (c) rents should be based on the real cost and expenses incurred by airport operators, leading to a substantial decrease in rents; (d) there should be a rent cap for total rents the government of Canada extracts from individual airports; and (e) all airport rents should be directed into an “airport reserve” rather than into the Consolidated Revenue Fund.

The new aviation security environment has given rise to two specific operational challenges: recovery of the insurance market and assuring a reasonable balance of convenience as passengers clear through stepped-up screening. As regards the first issue, on September 23, 2001, the government of Canada made a unilateral undertaking to extend war risk coverage to any airline, airport operator, NAV CANADA, Air Transport security Corporation, or any supplier of goods or services to an airport operator or an airline in Canada whose coverage had been cancelled after the events of September 11. Although this was conceived as a temporary program, the government has continued to renew the undertaking, most recently for a period of 90 days from September 22, 2004.

The downturn in the aviation sector has affected the revenues of NAV CANADA, the non-share capital private corporation that owns and operates Canada’s civil air navigation service. Despite the existence of a rate stabilization fund to address such downturns, the scope and length of the downturn led NAV CANADA to announce an average 6.9% fee increase for airlines effective August 1, 2003, to deal with a financial deficit that had grown to $116 million by August 31, 2003. As of November 30, 2003, the end of its first quarter, NAV CANADA had reduced this deficit to $72 million due to a combination of actions, including the service charge increase, the sale of its $45 million Air Canada debt for $15 million, and a successful financing transaction. On February 11, 2004, NAV CANADA announced a proposal to eliminate a temporary service charge at Lester B. Pearson International Airport that had been put in place on March 1, 2000, to recover the costs of installing new airport surface detection equipment. Those costs have now been recovered.

Finally, because federal government airport rents and passenger charges dominated the conference discussion, issues of airport governance and the level of user charges airports levy on airlines and passengers, including aircraft landing fees, received only passing attention. In our analysis section, we will take up these other issues briefly as they have important policy implications for Canada.

Conference Speakers’ Views

In the session on Canada-U.S. Open Skies, the Hon. Doug Young, who was the Minister of Transport when Transport Canada introduced its new National Airports Policy, took the occasion to comment on the current state of airport administration in Canada. All of the airports in the national airports system and many other smaller airports have been transferred to locally constituted Canadian Airport Authorities based on the policy announced by the Minister in 1994. The operating rights of virtually all of the major airports in Canada were transferred to the local airport authorities on a long-term lease basis, without retaining any authority to regulate airport user charges. Mr. Young criticized Canadian airport authorities for what he characterized as overspending and having driven up airport costs for the industry. Furthermore, he admitted that when he introduced the new Airports Policy he had not foreseen this problem because he was promised good behaviour by the overwhelming majority of local business interests.

Scott Clements, President and CEO of Edmonton Airports, took issue with Doug Young’s criticism of airport authorities. He noted that airport rents have sky-rocketed for no apparent reason and are a key driver of increasing costs and charges. Airport authorities want to run airports at least as well as did Transport Canada. The record to date is good and some tough decisions have been made at Canadian airports that were difficult to make under the previous regime. If airports are being overbuilt, it is only after consultation with the airlines. If there is a problem and if blame is to be cast, airport authorities are not alone on the receiving end.

Derek Devitt, Vice-President of Marsh Canada, addressed the current environment for risk management and insurance for the aviation industry. As a result of the events of September 11, 2001, aviation insurers were faced with paying compensation in excess of US$5 billion and are not likely to return to profitability soon. From an insurance perspective, there is in any event extreme volatility in the aviation marketplace, and the aviation insurance market is quite small in comparative terms. Thus, an event of the magnitude of 9/11 is utterly devastating to this market. The remaining limits to and inadequacies of war risk insurance coverage will probably require a joint effort of insurers and governments for some time to come.

John Crichton, President and CEO of NAV CANADA, outlined the mandate and operations of the company. He noted that it operates on a not-for-profit basis, funded totally through service charges paid by airlines and other owners and operators of aircraft. The company is accountable to its stakeholder board of directors: five of these directors are appointed by customers, three by the federal government and two by unions, with four independent directors and the President and CEO. The company is regulated by Transport Canada in respect of safety. NAV CANADA service charges must abide by the charging principles in the Civil Air Navigation Services Commercialization Act, and can be appealed to the Canadian Transportation Agency. Crichton underlined that the company had, from its origins, created a stabilization fund to cushion the effect of airline industry downturns, which helped significantly after the 9/11 terrorist attacks. The company reduced costs substantially through restructuring from 1997 to 2001; following the 9/11 attacks there were further cost reductions through comprehensive mitigation measures, which are still in place. The company has an excellent safety record, has reduced delays substantially, and has introduced world-leading technology, having invested $1 billion in system modernization since 1996. Service charges have increased by only 4% above the level at which they were introduced in March 1999, which is well below inflation, and are still 28% below the Air Transportation Tax they replaced.

Jacques Duscheneau, President and CEO, Canadian Air Transport Security Authority (CATSA), reviewed the structure, functioning, and recent initiatives of CATSA. He emphasized that CATSA did not have a role in setting the air travelers’ security charge and pointed to progress that had been made in monitoring and decreasing the time needed for effective security screening. Whereas CATSA’s exclusive priority was to strengthen security preparedness, it was nevertheless cognizant of the need to function in tandem with a customer service-oriented aviation industry.

Audience Polling Results

The audience polling results may be summarized as follows:

* As to the funding of airport facilities, 57% of respondents indicated that airlines and airports should equally share the burden while 35% said that airlines should share only a minimum burden or none at all.

* Of the respondents, 78% indicated that airports should be encouraged to provide common use facilities for all airlines including gates, kiosks, check-in counters, and so on.

* Of the respondents, 64% indicated that Canadian airport rents should be either “cut in size” or “set and equitable” while only 26% said they should be eliminated.

* The majority of respondents (57%) indicated that the new measures and expenditures on air security are either timely or overdue while only 24% indicated they are an over-reaction.

* Of the respondents, 56% indicated Canada’s security surcharges should be eliminated while 40% said that the security charges should be “cut in size” or “set at fair and equitable rates”.

* The majority of respondents (77%) indicated that the mandate for Canada’s civil air navigation system should be “safety comes first, but balanced with service and cost management” while only 22% said “safety should be the overriding priority, whatever the cost”.

* On the question of the need for the federal government’s contribution to a larger stabilization fund for NAV CANADA, the opinions were divided: 41% either disagreed or strongly disagreed while 37% either agreed or strongly agreed.

* On the question of who is best equipped to provide a long term insurance solution to war risk security threat for the Canadian transport system, 46% favoured the joint responsibility of Government of Canada and commercial insurers while 31% indicated only the Government of Canada.

* Of the respondents, 88% either agreed or strongly agreed that the Government of Canada should maintain its capital assistance program for small airports.

Discussion and Recommendations

Airport pricing and governance. Doug Young’s criticism of Canadian airport authorities certainly provided high drama for the conference. It should be noted that the former Minister did not direct his criticism to all Canadian local airport authorities, pointing out in particular that Vancouver International Airport has been conducting its business responsibly. Nevertheless, his general assessment suggests that it is time for Canada to review the current regulatory regime within which self-governing Canadian airport authorities operate as not-for-profit non-share commercial corporations. Although many of the Canadian airport authorities have done a very good job since commercialization, airport performance has depended greatly on the personality and commitment of the management teams.

The commercialization of Canadian airports initiated by the National Airports Policy of 1994 has improved both efficiency of Canadian airport operations and their responsiveness to local economies and communities. However, society cannot rely entirely on the goodwill of management teams for guaranteed responsive and cost-effective oversight of important public infrastructure. Currently, the local airport authorities are meant to be self-regulated through their Boards of Directors, which consist of members drawn from public bodies and private sector firms. The intent was that the Board of Directors would represent the interests of the wide spectrum of local businesses and communities. However, over the 100-year history of public utility management, including former monopoly electric utilities, telecommunications operators, and railroads, one can demonstrate that self-governing and self-regulating organizations invite inefficiencies, bureaucracies, and slow responses in the long run (see Heaver & Oum, 2000, for more detailed analysis of the governance and regulatory structure of Canadian airport authorities).

In our view, the current governing structure of Canadian airport authorities needs a fresh approach so as to ensure the long-term efficiency of our airport infrastructure services. In particular, most other countries that reformed their airport sectors avoided using airport authorities. For example, following the example of the successful privatization of major UK airports to BAA Plc in 1987, other countries such as Ireland, Denmark, Austria, Italy, and Australia have privatized their airports. Furthermore, most of these airports (with the exception of Australian airports) are currently under price-cap regulations.4 Recent evidence shows that, although the incentives for increasing commercial revenues (and other non-aviation service revenues) moderate airport management’s desire to raise airside user charges, including aircraft landing fees, an airport’s profit would be maximized by increasing landing fees very substantially from the current levels (Oum, Zhang, & Zhang, 2004) because the demand for landing and takeoff is extremely inelastic with respect to aircraft landing fees (Gillen, Oum, & Tretheway, 1988).

Government role in war risk insurance. Since the 9/11 terrorist attack on the U.S., governments’ role in war risk insurance to the air transport sector has become an urgent issue. In fact, most governments, including Canada’s, have decided to assist the industry temporarily. Debates among experts tend to converge on the following questions: (a) what is the degree of interdependence between the amount of governmental effort and expenditure and the incidence of terrorism; (b) what should be the long term adjustment process in war risk insurance premiums as the war on terrorism becomes more efficient and effective; and (c) what proportion of the war risk insurance premium should the public (government) bear and for how long?

Since all nations face essentially the same questions, it is our view that research on such questions can be addressed most effectively via international associations and organizations such as IATA and ICAO. Therefore, the Canadian government and the broader stakeholder community should participate actively in the on-going studies and reform efforts being led by ICAO.

Burden of charges, taxes, and rents. Since this issue has already been investigated in some detail by the House of Commons Standing Committee on Transport, the government should revisit the unanimous April 11, 2003, recommendations of that committee to see whether further progress can be made toward relieving the burden of charges, excise taxes, and rents faced by the air transport industry.

Secondly, the government should investigate whether it makes economic sense to offer such relief to the air transport sector on a permanent basis. Thirdly, before taking any permanent measures to relieve airport rents, it should examine carefully the long-term effects that reducing or eliminating them will have on airside user charges such as landing fees. Although Canadian airport authorities appear to promise that they will pass most of the rent savings on to the users of airport services (airlines, passengers, and shippers), the extremely low price elasticities of the demand for airport airside and passenger services (between -0.01 and -0.10 for commercial airliners according to Gillen et al., 1988) indicates that in the medium to long run, airport management would have the ability and incentive to retain most of the reduced rents without passing savings on to the airlines and other airport users. If we wish to help the airlines, it would be important to ensure that airport cost savings are passed along. If Canada were ultimately to move toward full-fledged airport privatization, a price cap regime ought to be considered.

Conclusions

In our opinion, the issue of Canada’s approach to the proposed EU-U.S. Open Aviation Area, and the issue of how to deal with Canada’s international traffic diversion to U.S. gateways as the U.S. signs open skies agreements with an increasing number of countries, should have been addressed more explicitly in the Minister’s reference to the Parliamentary Standing Committee on Transportation, although arguably the Committee is given scope to address these issues. We hope it will.

The results of the Air Currents conference and of the discussion presented here allow for some preliminary answers to most of the questions posed by the Minister of Transport to the Standing Committee on Transportation noted at the outset of this paper. We present these by way of conclusion:

* Canada should review foreign ownership rules with a view to eliminating restrictions for purely domestic passenger services and raising the limit to 49% for international passenger services.

* In its bilateral air negotiations, Canada should seek to substitute a “principal place of business” clause for the current “substantial ownership and effective control” clause defining eligibility of carriers to benefit from the rights under the agreement. This could pave the way for lifting foreign ownership limits for international passenger services.

* Canada should move toward an Australia-model domestic license regime for foreign carriers seeking to set up subsidiaries for service in Canada. This should be open to all foreign carriers that meet a test of being “fit, willing and able” to provide such services according to the existing Canadian licensing regime.

* Canada should pursue Open Skies Plus discussions with the United States, placing particular emphasis on adding modified sixth freedom and tag-end cabotage rights to the agreement. Canada should also explore the possibility of full integration of the two air transportation markets within a Common Aviation Area.

* Whereas all stakeholders, including airlines, airports, and municipalities, should be represented in bilateral air transport negotiations with the United States-and indeed any country-Canada’s overriding concern should be to further the interests of those who use the air transport system.

* Canada should open up the international charter market to the greatest degree possible consistent with safety and financial soundness.

* Co-terminalization should be explored in negotiations with the U.S. on the basis that the “scope clause,” under which U.S. cargo carriers are bound to use their own aircraft and pilots on all jet category routes into their hubs and all routes where they have a right to fly, would not apply to Canadian traffic. Canadian carriers would thus preserve the ability to compete on Canadian routes without being frozen out as service providers to the U.S. majors.

* Canada should consider lifting all foreign ownership restrictions on cargo licensees.

* In order to prevent the diversion of Canadian international traffic to U.S. hubs, Canada should initiate negotiations with a view to open skies agreements with the countries with which the U.S. has open skies agreements, and indeed countries with which the U.S. has yet to conclude such agreements.

* Canada should seek to become a leader in global aviation liberalization, along with countries like Singapore and Australia. It should pursue a re-invigoration of the GATS Annex on Air Transport Services. It should consider becoming a member of MALIAT, if MALIAT can be extended to cover the liberalization Canada seeks bilaterally with the U.S. In particular, MALIAT would have to re-open cabotage as well as ownership and control rules. If the EU-U.S. Open Aviation Area is ultimately more promising and ambitious than MALIAT, Canada should participate in building on that arrangement so that it becomes a global, multilateral agreement.

Finally, listed below are additional conclusions that emerged from the Air Currents conference and our discussions in this paper, which are worth noting (but do not relate directly to the Transport Minister’s questions):

* Canada should make an effort to be included in the currently stalled negotiation on the EU-U.S. Open Aviation Area. If it cannot become a party to EU-U.S. negotiations, Canada should find its own venue for negotiations with the EU and should consider a two-track approach in which it undertakes discussions with key member state partners, such as France, at the same time exploring a global relationship with the European Commission. In any event, Canada should seek to become part of an Open Aviation Area and should work to ensure that it is formulated so as to be open to additional parties.

* The government should conduct a review of the National Airports Policy with a view to ensuring the cost-effectiveness and accountability of airport operators.

* The government should revisit the unanimous April 11, 2003, recommendations of the House of Commons Standing Committee on Transport to see whether further progress can be made toward relieving the burden of charges, excise taxes, and rents faced by the air transport industry.

* Transport Canada should make a renewed effort to provide timely, carrier-specific electronic statistics.

As stated in the introductory section, the conference did not purport to raise all of the important air transport policy issues in Canada because it placed emphasis on some of the key questions in international air transport and related issues. Therefore, it is important for us to close this paper by pointing out some of the important current air transport issues and debates that require careful investigation but which neither the Air Currents conference nor this paper were able to address. Those topics include access and pricing issues of airport gates and landing slots, peak-load pricing issues at congested airports, the issue of guaranteeing services for isolated and remote communities, labour-management issues especially in the presence of intensifying competition between full service airlines (legacy carriers) and low-cost carriers, and the issue of contribution of air transport policy to communities and related businesses such as tourism. It is hoped that the Parliamentary Standing Committee on Transport will also review these issues carefully.

Notes

1 As this paper was being written, the crude oil price reached nearly US$55 per barrel in October 2004 as compared to about US$30 in June 2004. If this high oil price remains for an extended period, there is no doubt that the world’s airline industry will face an additional setback on its way to recovery.

2 Wang (2004) states that the following regional level proposals were under negotiation as of May 2004: (a) Pacific Islands Air Services Agreement (PIASA) among 16 States of the Pacific Islands Forum; (b) a Common Aviation Area within the Association of Caribbean States (ACS); (c) a common air transport program among eight States of the Economic and Monetary Union of West Africa (WAEM).

3 The United States Department of State does not classify the Mexico or Canada bilaterals as “open skies” agreements. The February 24, 1995, Canada-U.S. agreement is not classified as open skies because it does not grant unlimited fifth freedom rights, it restricts cargo co-terminalization, and it prevents single flight numbering in sixth freedom markets. Yet, interestingly, Canada appears in the U.S. Department of Transportation’s list of countries with which the U.S. signed open skies agreements.

4 The Commonwealth Government of Australia decided to have a five-year provisionary period of not regulating prices of privatized airports beginning July 1, 2002. At the end of this period, the government will review and decide whether or not it wants to go back to some sort of airport price regulation.

References

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Dresner, M. & Oum, T.H. (1998). The effect of liberalized air transport bilaterale on foreign visitor diversion: The case of Canada. Journal of Transport Economics and Policy, 32 (3), 317-330.

Gillen, D.W., Oum, T.H., & Tretheway, M.W. (with D.W. Gillen & M.W. Tretheway). (1988). Airport pricing principles: An application to Canadian airports. Proceedings of Transportation Research Forum, 29 (1), 28-34.

Heaver, T.D. & Oum, T.H. (2000). The commercialization of airports and air navigation systems: The Canadian experience. Journal of Aviation Management, 1 (1), 32-44.

Oum, T. H., Zhang, A., & Zhang, Y. (2004). Alternative forms of economic regulation and their efficiency implications for airports. Journal of Transport Economics and Policy, 38, 217-246.

Transport Canada (2004). Air liberalization: A review of Canada’s economic regulatory regime as it affects the Canadian air industry. A reference to the Standing Committee on Transport from the Minister of Transport. [On-line]. Available: www.tc.gc.ca/pol/en/Airpolicy/doc/AirLiberalization.htm

Wang, Y. (2004). Regulatory liberalization and its challenges: A global perspective. ICAO paper presented at the International Air Transport Symposium in Seoul, South Korea.

Richard Janda

McGill University

Triant Flouris

Concordia University

Tae H. Oum

University of British Columbia

The authors express sincere appreciation to the Air Currents conference organizers and speakers. We have attempted to convey the contents of the conference discussions and views expressed by the speakers as closely as possible in this paper; any unintentional mischaracterization of the speakers’ views is our error. Furthermore, the opinions expressed are entirely ours. We also thank the two anonymous referees for their timely and constructive suggestions. Tae Oum wishes to acknowledge gratefully the grant support of the Social Sciences and Humanities Research Council (SSHRC) of Canada for his part of the research in this paper.

Address correspondence to Tae Oum, Commerce & Business Administration, University of British Columbia, 2053 Main Mall, Vancouver, BC, Canada V6T 1Z2. E-mail: tae.oum@sauder.ubc.ca

Copyright Administrative Sciences Association of Canada Mar 2005

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