Could the Pandemic End Air Transport Liberalization?
The aftermath of the Covid-19 pandemic could usher in a new era of airline industry growth and innovation, provided governments don’t stand in the way of the trend towards liberalization and consolidation that were gaining in strength before the industry ground to a halt.
Or at least that’s what Brian Pearce, IATA’s chief economist since 2004, thinks. He spoke to Airline Weekly recently on the cusp of his retirement from the airline group.
The airline industry is no stranger to exogenous shocks. In just the past 20 years, war, economic collapse, and more regional pandemics like SARS and MERS delivered blows to the industry. But the scale and breadth of Covid-19 was unprecedented, leaving no airline in the world unscathed. The conventional wisdom was that airlines were on an upswing, finally delivering value to shareholders and consistently boasting profits before the pandemic spread and stopped that growth in its tracks.
But this isn’t the full picture, Pearce notes. “The five years before Covid were the best investors ever had,” he said. “But a closer examination of those five years of success shows that airlines in the U.S. and the a few others generated those profits.” Most other airlines continued to destroy shareholder value. Indeed, IATA’s 2020 forecast, issued at the end of 2019, forecast strong profits in North America and Europe, slightly weaker profits in Asia and the Middle East, and significant losses in Latin America and Africa. “The contribution of the top 30 [airlines] is absolutely disproportionate,” then-IATA Director General Alexandre de Juniac said in December 2019. “There are many airlines struggling to keep revenues ahead of costs.”
“Covid has delivered a massive demand shock to the industry, and the normal reaction would be the more inefficient players will go,” Pearce said. “This would lead to a stronger industry and would lead to some consolidation.” The industry outside the U.S. and the North Atlantic remains very fragmented, especially when compared to other industries, he added.
But governments have stood in the way of needed consolidation. “We are still governed by ownership and control rules from the 1940s, which limit foreign investment,” Pearce said. Airlines took on large amounts of debt during the pandemic and will need to raise equity, but their ability to raise that equity is limited to a pool of investors who won’t fall afoul of ownership and control rules. “That’s a real problem today,” Pearce said.
In fact, the Covid pandemic may have set the cause of liberalization back even further. Governments around the world poured money to prop up their airlines during the crisis. Taxpayers are likely to object if that investment is seen to accrue to foreign investors, or if a national carrier merges with a foreign airline. That backlash is something no airline leader or transport minister would want to endure.
A corollary to this is that Covid has made many governments more inward-looking. This trend began before the pandemic, with trade rows raging between China and the U.S,. and economies everywhere becoming more protectionist. Airlines, to succeed, depend on globalization and the willingness of people to travel, but in many parts of the world “globalism” became an epithet. “Globalization has stuttered a bit with trade wars,” Pearce said. “We have seen the political environment change: It has become more explicitly protectionist.” At least in the near term, governments will turn their focus toward national priorities to shore up economic growth. “This is not the environment that is conducive to the liberalization we saw in the U.S. and Europe or through open skies [agreements],” Pearce said.
In the more collared airline industry of the 1950s, fares were eight times more expensive in real terms than they were before the pandemic, a 90 percent drop in the cost of air travel, a reduction in fares made possible by liberalization in the U.S. in the 1980s and Europe in the 1990s. Technology, too, played a role, both on the aircraft — the jet engine — and in the airport. Innovation in business models — like the rise of the low-cost and ultra-low-cost carriers and the superconnectors — has further driven down fares. Liberalization has been good for both consumers and businesses, Pearce argued, and consolidation has led to stronger airlines.
So how does Pearce think the industry will climb out of this crisis? “Covid was a demand shock. Consumers can’t spend the money they ordinarily would have on travel. Savings rates are growing in many of the world’s largest economies. “We will see an almost complete rebound,” he said. “Covid will not stop people from traveling.”
Business travel could take longer to come back, Pearce predicts. Teleconferencing (the so-called “Zoom Effect”) could take out as much as 10-20 percent of all business travel. Business travel will grow again, but from a much lower base than before the pandemic. “The value of business travel hasn’t disappeared, because there is strong evidence that people will need to meet face-to-face,” he said. When that might be is unclear. Delta CEO Ed Bastian at an industry conference last week forecast a surge in U.S. domestic business travel beginning July 1 and then picking up dramatically after Labor Day in September, when children return to school. On the other hand, Southwest CEO Gary Kelly has said it could take anywhere between 5-10 years to return to 2019 levels. IATA itself believes the airline industry as a whole won’t match 2019 levels until 2023.
Another development that is likely to outlast the pandemic is the strength of cargo. Before the pandemic, cargo was an important, if secondary, revenue stream for airlines, comprising 10-15 percent of an airline’s bottom line. During the pandemic, several airlines, particularly in Asia, turned profits on the strength of cargo demand, and cargo on average has been about one-third of airline revenues. “Airlines are looking seriously at cargo in a way they haven’t before, and this will have lasting effects,” Pearce said. Cargo yields have been high during the crisis as supply, in the form of belly-hold space, has been constrained. That will change as airlines add more widebody international flights. Revenues next year won’t be as strong as a result. But still, the pandemic shone a light on an oft-ignored part of the business. “This year and last year were a trigger for cargo to be taken more seriously by airlines,” Pearce said.