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Flying the unfriendly skies Mar 22nd 2003 From The Economist Global Agenda

America’s big airlines say the war in Iraq could make their current dire predicament turn catastrophic. But this may not be enough to win them further state aid

COULD President George Bush be forced to order the nationalisation of America’s airline network to save it from total collapse? A report on the dire state of the airlines’ finances, published last week by the Air Transport Association (ATA), which represents them, insists that such a dramatic scenario is “not unrealistic”. Since the terrorist attacks in America on September 11th 2001, its airlines have lost a combined $18 billion, in spite of the big aid package that Mr Bush granted the industry shortly afterwards. Now, with a war being waged in Iraq, passenger bookings falling sharply and airlines making heavy cuts in their schedules, America’s main carriers predict that their losses this year, given a fairly short war, will be almost $11 billion. If the war drags on or there are more terrorist attacks in America, the losses could reach $13 billion.

United Airlines, the world’s second-largest carrier, which is already in bankruptcy proceedings (as is US Airways, another big carrier), added to the gloom on March 18th by saying that it was a “distinct possibility” that it may soon close altogether unless it achieves further cuts in wage costs. Though its staff unions have agreed to temporary pay cuts worth $840m annually, the airline is seeking long-term savings on labour costs of around $2.6 billion a year. New forecasts from the Federal Aviation Administration (FAA) on the same day were rather less doom-laden than the industry’s own predictions. Even so, they suggest that passenger traffic will not return to 2001’s levels until perhaps 2006 (see chart).

The FAA admits that its forecast of a gradual recovery in air traffic is at risk from the war and from any further terrorist attacks. A reminder that such risks are real came on March 19th, when home-made bombs were found, and three men arrested under Britain’s Terrorism Act, at an apartment near London’s Gatwick Airport. This follows an incident last month in which a grenade was found in the luggage of a passenger arriving from Venezuela.

America’s transport secretary, Norman Mineta, said the government would be “ready to move very quickly” to provide further aid on top of the $15 billion package announced after the September 11th attacks; and a bill to be introduced in the House of Representatives on March 19th by James Oberstar, a Minnesota Democrat, proposes that the government compensate the airlines for any losses due to the Iraq war and reimburse some of the extra security costs they have suffered since the 2001 terrorist attacks. However, there does not seem much prospect of getting extra subsidies past sceptical White House officials, who are more preoccupied with the likely heavy costs of pursuing the war.

The ATA’s report argues that America’s airlines have already taken significant “self-help” measures to cut their costs and rationalise their schedules. Around 100,000 airline jobs have been cut since September 2001. A further 70,000-100,000 are forecast to go. On March 21st, Northwest Airlines, the world’s fourth-largest carrier, added 4,900 to the redundancy count and said it was cutting 12% of its flights.

This is partly due to the downturn in bookings caused by the expectations of a war in Iraq, and the rise in the cost of fuel, which has doubled in the past six months. But the airlines have also been suffering from a fall in business travel due to the collapse of the dotcom boom. In all, the crisis in the industry goes beyond what might be expected from “normal” market forces, they argue, so there is a strong case for the government to come to the rescue. What the airlines want especially is reimbursement for the $4 billion of extra costs they claim to have suffered due to the extra security measures imposed on them by the government after the September 11th attacks. They also want cuts in taxes on air travel, which they reckon have risen by 180% since 1991, about six times the rate of inflation.

The 1991 Gulf war, triggered by Iraq’s invasion of Kuwait, caused years of losses for America’s airlines. After operating profits of $1.8 billion in 1989, they suffered more than $6 billion of losses in the following three years. Four firms (Pan Am, Eastern, Midway and Markair) went into liquidation. Despite enjoying a period of prosperity in 1995-2000, the industry enters the second Gulf war in an even worse state: the combined debt of America’s big “network” airlines is $100 billion, compared with their combined stockmarket valuation of just $3.2 billion in February.

Latin American airlines are also struggling. On March 21st, Colombia’s Avianca filed for bankruptcy protection in the American courts, as it sought to renegotiate debts of $130m. And Brazil’s heavily indebted flag-carrier, Varig, is seeking an operational merger with its local arch-rival, TAM.

Also on March 21st, KLM of the Netherlands became the latest European carrier to announce big cuts in continental and transatlantic flights. But in general Europe’s and Asia’s airlines are in a better position than America’s to withstand the slump in bookings caused by the war. Formerly troubled carriers like Lufthansa of Germany and Iberia of Spain are in better shape than they were, after making big cost cuts. Europe’s airlines are expected to share profits of $2.6 billion this year, reckons UBS, a bank, while Asia’s will make $3.2 billion.

Back in America, the FAA forecasts that, while the big network carriers will have a slow recovery, short-haul flights (dominated by leaner cut-price airlines) and air cargo will enjoy strong growth. United’s problems are partly the fault of its own staff, who got a stake in the airline in lieu of pay as part of a restructuring in 1994, and have used it to block painful but necessary cost cuts. The management’s threat to close the airline permanently is as much aimed at twisting its unions’ arms to make concessions as at pleading with the government for handouts.

The big airlines that are in bankruptcy proceedings are able to hold off their creditors and can thus try to grab market share by undercutting their rivals, forcing the whole industry to continue offering uneconomically low fares. Unless the government and the airline unions give in to the carriers’ demands, the industry’s crisis could well drag on until one or more of America’s main carriers is forced to close for good. In the meantime, hardy passengers who are prepared to brave the risks of air travel can enjoy fantastically cheap fares. The ATA reckons that tickets, before taxes, are cheaper in nominal terms than in the late 1980s, and therefore much cheaper in real terms. Enjoy it while it lasts.