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United Airlines recently had a passenger forcibly dragged off of an oversold flight. Video of the incident went viral and sparked a worldwide reaction, including Congressional hearings. Many people expressed shock that this could be legal in the U.S. It was, and the case actually highlights the limits of government regulation of business.
The incident occurred April 9 on a flight from Chicago to Louisville. Normally airlines handle oversold flights by asking for volunteers to take a later flight in exchange for compensation. If the airline fails to secure enough volunteers, passengers can be involuntarily denied boarding. Normally this occurs before boarding. If happens after boarding, as it did with the Louisville flight, unlucky passengers denied travel are supposed to deplane. The Louisville passenger, Dr. David Dao, refused to do so, leading to his forcible removal by airport security. Afterwards United officials euphemistically claimed that the airline had “reaccommodated” Dr. Dao, and has since reached a settlement with him and compensated the passengers who witnessed this traumatic event.
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, but that ultimately is a different question.) Commentators quickly noted mistakes that United made in this case, and United has subsequently announced changes in policy largely consistent with the critics. But my interest is not in second-guessing the airline.
Instead let’s consider overbooking, or the selling of more tickets than seats. Many people react very negatively to overbooking, since it appears to be fraud. Similar activities are surely considered fraud, like selling the same used car to two different buyers. And yet the U.S. Department of Transportation (DoT) lets airlines overbook and sets the rules for dealing with oversold flights.
To be certain, 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?
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 would probably be happy to accept a small risk of (voluntary or involuntary) bumping in exchange for lower prices. Nonetheless, DoT’s bumping rules are still troublesome, and specifically the compensation cap of $1,350, which arguably set in motion the commotion on the Louisville-bound plane. The cap, which is in essence a price ceiling, allows for bumping without adequate compensation. And yet the inconvenience from involuntary bumping is likely to differ across flights and be quite high for some passengers. On April 9, United was offering seats on a flight to Louisville at 2pm the next day. Dr. Dao had patients to see the next morning and wasn’t going to be adequately compensated. Also capping compensation makes involuntary bumping artificially cheap for airlines, discouraging other options. United has agreed to raise their limit for compensation to $10,000.
Our government’s failure to protect the interests of air travelers will come as no surprise to those familiar with the history of regulation in the U.S. 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 necessarily make consumers better off.
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, and 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.
Consumers collectively determine the success or failure of companies. The market billed United’s stockholders $1 billion for an action which government regulators permitted. Inevitably some businesses will engage in questionable practices. Before calling for regulation which may be captured to benefit businesses and thus harm consumers, we should consider whether the market has already punished the offender.