Government can’t regulate everything

Published 3:00 am Thursday, April 27, 2017

United Airlines recently had a passenger forcibly dragged off of a flight, and the video went viral.  Many people expressed shock that this could be legal.  The case highlights an important limitation of government regulation of business.

The incident occurred on an oversold United flight from Chicago to Louisville.  Normally airlines ask for and get volunteers to take a later flight for compensation before boarding.  If enough volunteers are not forthcoming, passengers can be involuntarily denied boarding.  If this occurs after boarding, unlucky passengers must deplane, which the Louisville passenger refused to do.  Afterwards United officials euphemistically claimed that the airline had “reaccommodated” the passenger. United’s ordering the passenger off the plane was legal, as industry experts quickly noted.  (Airport security may have used excessive force in carrying out the removal.)  Overbooking, or the selling of more tickets than seats, appears to be fraud.  Similar activities are surely considered fraud, like selling the same used car to two different buyers.  The U.S. Department of Transportation (DoT) lets airlines overbook and sets the rules for dealing with oversold flights.

Overbooking offers an economic advantage.  Not everyone who buys a ticket will be on the flight, for a variety of reasons.  Every unoccupied seat represents lost revenue for airlines.  Overselling can help keep prices low, and not just pad profits.  How so?

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Suppose an airline flies a 100 seat plane on a route and wants $30,000 in revenue from a typically full flight.  To earn $30,000 by selling 100 tickets, the airline must charge $300.  If 150 tickets can be sold, because usually only 100 ticketholders show up, they only need to charge $200.  Competition for passengers should drive the price down to $200.

Although occasional voluntary and involuntary bumping will be inevitable, with care the frequency will be low.  According to DoT statistics, involuntary denial of boarding occurs quite infrequently.  United involuntarily bumped 3,765 passengers in 2016; nationally this happens to less than one out of 10,000 passengers.

Many fliers will accept a small risk of (voluntary or involuntary) bumping in exchange for lower prices.  Nonetheless, DoT’s bumping rules are still troublesome.  Specifically, DoT caps compensation at $1,350, meaning that some passengers will not be adequately compensated (the man removed from the United flight was reportedly a doctor).

It still might offend Americans to think that our government fails to more adequately protect consumer interests.  Yet history provides many instances of such government failure.  Historian Gabriel Kolko proposed a “capture” theory of regulation.  Regulation, say of railroads or utilities, begins with legislation proclaiming consumer protection.  After the initial fanfare, businesses start lobbying, cajoling, and hiring former regulators for high salaries.  Before long, regulation favors businesses, not consumers.

Economists have found numerous instances where businesses lobbied to establish regulation, which can be used to control competition and raise prices.  Whether regulatory capture was by design or not, it demonstrates that a law or regulation protecting consumers will not enforce itself.

Is there any hope for us little people?  Consumers routinely discipline businesses, through the power of the market.  Most airlines thank passengers at the end of flights, because we have travel options.  This announcement reflects recognition of the power of the market.  No airline can force any passenger to purchase tickets.

Many fliers on social media announced that they would boycott United.  Stock prices summarize how investors expect current events to impact a business’s earnings.  After the “reaccommodation” video went viral, United’s stock price tumbled from $72 a share to less than $68.50, a 5 percent decline.  United’s market capitalization (the value of all of its stock) is just over $20 billion, and so the event plausibly cost United $1 billion.  (A statistical analysis is necessary to confirm attribution to the video.) Consumers collectively determine the success or failure of companies.  The market billed United’s stockholders $1 billion for an action government regulators allow.  Inevitably some businesses will engage in questionable practices.  Before calling for regulation which may be captured to benefit businesses, we should consider whether the market has already punished the offender.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.  The opinions expressed in this column are the author’s and do not necessarily reflect the views of Troy University.