Friday, September 23, 2005

Actually, it's old-fashioned oligopoly theory 

David Downing continues to work some economics into DowningWorld. Today he looks at Ed Lotterman's explanation of oligopoly theory as it regards the airline industry and the stadium issue. I pose the questions a little differently than David (and Ed, for that matter), though I think we end up in the same place.

Regarding Northwest, we know the industry consists of a few large players. It's worth remembering that not very long ago airlines were considered the prime example of a contestable market -- a market where the mere threat of competition would force firms that have otherwise natural monopolies to control their prices. Northwest operates a route between St. Cloud and MSP on which they currently charge $35 each way when the hop is appended to a NWA ticket from MSP onward. There are six flights a day. This is a great deal -- given parking is free at the local airport, I seldom drive to MSP. What makes it so? There is an agreement between NWA and the local transportation authority, but why does NWA agree to it? Simply because there is the possibility of another airline that would fly St. Cloud to Chicago. While that link is to a recent letter, the possibility has existed for quite some time, particularly since the runway was lengthened.

Now consider: NWA has a number of legacy costs from pension plans agreed at an earlier time when the ability to compete was lower. The ability compete requires largely three things: planes, gates, and employees. Given that travel has diminished after 9/11 and that financing plane leases is easier, it is easier to get planes and gates. Competition is fiercer. And the potential competitors have none of the pension costs involved. So the airlines figures it has to declare bankruptcy and move out from under those costs to meet the contestants for their markets.

The union is not necessarily engaged in a prisoner's dilemma with NWA, however. It represents other mechanics at other airlines, and it may invest in its reputation by staging a strike to deter lowball wage offers from other airlines. It may also want NWA to cut back its routes, allow competitors into the market, then negotiate better deals with them. It may well have known that taking NWA into a strike would mean bankruptcy, but that isn't necessarily an act of someone "aghast" or "insulted". It may be a rational calculation. There was no assurance that, had they settled, NWA wouldn't have declared bankruptcy anyway. The pension costs were still there to be shifted.

I'll save the stadium issue David addresses for another time, perhaps tomorrow on NARN, or in another radio appearance on Sunday. But it isn't a prisoner's dilemma with the Gophers (who can't go), and it actually isn't with the Twins (who have no place to credibly threaten to go) or the Vikings (unless someone convinces the other NFL owners that the Vikings should follow the Lakers to LA, at the cost of millions of expansion revenue. Bloody unlikely.)