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Report to Congressional Requesters: 

July 2004: 

TRANSATLANTIC AVIATION: 

Effects of Easing Restrictions on U.S.-European Markets: 

GAO-04-835: 

GAO Highlights: 

Highlights of GAO-04-835, a report to congressional requesters 

Why GAO Did This Study: 

Transatlantic airline operations between the United States and 
European Union (EU) nations are currently governed by bilateral 
agreements that are specific to the United States and each EU country. 
Since 1992, the United States has signed so-called “Open Skies” 
agreements with 15 of the 25 EU countries. A “nationality clause” in 
each agreement allows only those airlines designated by the signatory 
countries to participate in their transatlantic markets. 

In November 2002, the European Court of Justice ruled that existing 
Open Skies agreements were illegal under EU law, in part because their 
nationality clauses discriminated against airlines of other EU nations.
The United States and the EU have been negotiating revisions to these 
agreements. Experts agree that removing the nationality clause is 
central to any new agreement. GAO was asked to report on (1) how 
prevalent Open Skies agreements are and what their effects on airlines 
and consumers are, (2) what the key ways that commercial aviation 
between the United States and the EU could be changed by the Court of 
Justice decision are, and (3) how the elimination of nationality clause 
restrictions might affect airlines and consumers. GAO’s work included 
both analyzing data on transatlantic air service and evaluating 
information from and positions of industry officials, subject-matter 
experts, and stakeholder groups. GAO is making no recommendations.

What GAO Found: 

Open Skies agreements have benefited airlines and consumers. Airlines 
benefited by being able to create integrated alliances with foreign 
airlines. Through such alliances, airlines connected their networks 
with that of their partner’s (e.g., by code-sharing agreements), 
expanded the number of cities they could serve, and increased passenger 
traffic. Consumers benefited by being able to reach more destinations 
with this “on-line” service, and from additional competition and lower 
prices. GAO’s analysis found that travelers have a choice of 
competitors in the majority of the combinations of U.S.-EU destinations 
(such as Kansas City-Berlin).

The Court of Justice decision could alter commercial aviation in four 
key ways. First, it would essentially create one Open Skies agreement 
for the United States and EU, thereby extending U.S. airline access to 
markets that are now restricted under traditional bilateral agreements. 
Notably, more U.S. airlines would gain legal access to London’s 
Heathrow airport, which is restricted by the U.S. agreement with the 
United Kingdom. Second, it would also allow EU airlines to operate into 
the United States from airports outside their own countries. Third, for 
EU airlines, a revised agreement could alleviate some obstacles to 
merging with other EU carriers or creating subsidiary operations in 
other countries. Finally, the possibility that EU airlines might move 
some operations into other EU nations raises concerns about which EU 
nations’ regulatory and legal systems would govern.

U.S. airlines and consumers are likely to benefit from the elimination 
of the nationality clause, but the benefits may not be realized in the 
near term. Both U.S. consumers and airlines would benefit from gaining 
access to markets restricted under bilateral agreements, especially 
London’s Heathrow airport, though capacity considerations there are 
likely to postpone and limit such access. Consolidation within the EU 
aviation industry could occur, with the effect on U.S. consumers 
varying, depending on whether consolidation creates additional 
competition or reduces it in particular markets. EU airlines could 
begin new transatlantic service in countries other than the airline’s 
own, which would provide consumers with additional competitive choices 
(see graphic). However, those airlines would likely face difficulties 
in competing successfully at another airline’s hub. 

A new Open Skies agreement could result in more international routes: 

[See PDF for image]

[End of figure]

www.gao.gov/cgi-bin/getrpt?GAO-04-835.

To view the full product, including the scope and methodology, click 
on the link above. For more information, contact JayEtta Z. Hecker, 
(202) 512-2834, heckerj@gao.gov.

[End of section]

Contents: 

Letter: 

Results in Brief: 

Background: 

Open Skies Agreements Have Benefited Consumers and Airlines by Removing 
Restrictions on International Air Service: 

Addressing the European Court of Justice Decision Will Affect 
Commercial Aviation in Four Key Ways: 

U.S. Consumers, Airlines, and Labor Groups May All Benefit from Changes 
in Agreements, Although Extent of Benefits Is Uncertain and Gains May 
Not Be Realized Immediately: 

Concluding Observations: 

Agency Comments and Our Evaluation: 

Appendixes: 

Appendix I: Scope and Methodology: 

Appendix II: Air Freedoms: 

Appendix III: Cargo Carriers: 

U.S. Cargo Carriers Have Increased Their North Atlantic Operations 
Since Open Skies: 

Fifth Freedom Rights: 

Lack of EU Enforcement Ability on Noise Regulations May Affect U.S. 
Cargo Carriers: 

Appendix IV: Current International Airline Alliances: 

Appendix V: Air France-KLM Merger: 

Appendix VI: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

Acknowledgments: 

Tables: 

Table 1: Changes in Domestic U.S. and EU Aviation Markets and 
Employment: 

Table 2: Summary of Key Differences between Traditional Bilateral 
Agreements and Open Skies Agreements: 

Table 3: U.S.-EU Markets Served with Nonstop, Single-Connection or 
Double-Connection Flights: 

Table 4: Changes in Average Fares in Transatlantic Markets, 1996 versus 
1999: 

Table 5: Comparison of Dominant Carrier's Scheduled Seat Capacity With 
That of Next Largest Airline at Major EU Airports: 

Figures: 

Figure 1: Largest U.S. and EU Airlines, Based on Percentage of Total 
U.S. - EU Traffic Carried, 2002: 

Figure 2: EU member states with Open Skies agreements: 

Figure 3: Illustration of How Alliance Networks Link Markets: 

Figure 4: Customers in the Kansas City to Berlin Market Have Multiple 
Trip Options: 

Figure 5: Most US-EU Markets Served by Three or More Competitors: 

Figure 6: Comparison of Total Runway Capacity and Demand at Heathrow, 
Summer 2004 Demand for Arrivals: 

Figure 7: Potential effect on transatlantic service with the removal of 
the nationality clause restrictions: 

Figure 8: Top EU markets based on total percentage of U.S.-EU passenger 
traffic from 1990-2002: 

Figure 9: Change in Nonstop City Pairs and Average Aircraft Capacity 
Across the North Atlantic: 

Figure 10: Freighter Operations for All Carriers Flying Between the 
United States and the EU, 1990-2002: 

Abbreviations: 

EU: European Union: 

DOT: Department of Transportation: 

DOJ: Department of Justice: 

State: Department of State: 

UK: United Kingdom: 

Heathrow: London Heathrow Airport: 

KLM: KLM Royal Dutch Airlines: 

DG TREN: European Union Directorate General Transport and Energy: 

DG COMP: European Union Directorate General for Competition: 

BACK: BACK Aviation Solutions: 

FAA: Federal Aviation Administration: 

AEA: Association of European Airlines: 

UPS: United Parcel Service: 

Letter July 21, 2004: 

The Honorable John McCain: 
Chairman: 
The Honorable Ernest F. Hollings: 
Ranking Minority Member: 
Committee on Commerce, Science, and Transportation: 
United States Senate: 

The Honorable Trent Lott: 
Chairman: 
The Honorable John Rockefeller: 
Ranking Minority Member: 
Subcommittee on Aviation, Committee on Commerce, Science, and 
Transportation: 
United States Senate: 

Since the late 1970s, commercial aviation within the United States and 
the nations that form the European Union (EU)[Footnote 1] has become 
substantially deregulated, creating greater competition, lower fares, 
and significant increases in passenger traffic. Commercial aviation 
between the United States and the EU is not deregulated to the same 
degree. Since 1992, however, the United States has signed what are 
called "Open Skies" agreements with a number of EU nations. These 
bilateral agreements seek to create a more deregulated transatlantic 
environment between the two nations signing the agreement by reducing 
or eliminating operating restrictions on the airlines of either nation. 
This means that any airline licensed by either nation can offer service 
between the two nations. This same relaxation of restrictions does not 
extend, however, to airlines licensed by other nations. Under what is 
called the "nationality clause," the right to provide nonstop service 
between a point of origin in one nation and a destination in a second 
nation is limited to airlines that are owned and controlled by citizens 
of the two nations signing the agreement, thereby effectively excluding 
other EU airlines from providing competing service.[Footnote 2]

In November 2002, the European Court of Justice, the EU body 
responsible for interpreting European law, ruled that seven existing 
Open Skies agreements and the bilateral agreement between the United 
States and the United Kingdom violated EU law. In particular, the Court 
of Justice found that the nationality clause illegally discriminated 
against airlines from other EU nations because it excluded them from 
entering the transatlantic aviation market between the two nations that 
had signed the agreement. In June 2003, the European Council, composed 
of representatives from each member state, issued a mandate to the 
European Commission to negotiate with the United States on the creation 
of an Open Aviation Area, which provides for the liberalization of the 
U.S.-EU market, including the removal of restrictions on foreign 
investment in airlines between the EU and the United States.

In October 2003, the United States and the EU opened negotiations. 
Industry experts and stakeholders we spoke with agreed that resolving 
the nationality clause was the key issue. However, in June 2004, the 
European Council rejected a draft agreement being negotiated by the 
United States and the EU Commission. The European Council stated that 
further efforts should focus on "more balanced market access 
provisions" than were included in the draft agreement. U.S. officials 
interpreted that as referring to a desire by EU carriers to gain more 
direct access to the U.S. domestic aviation market. Further contacts 
are being considered. U.S. and EU officials stated that current 
agreements remain in effect. There is no set time frame for when the 
matter must be settled.

Changing the agreements to remove the nationality clause restrictions 
carries implications for U.S. and EU airlines, airline passengers, and 
other stakeholders within the airline industry. These negotiations thus 
represent an opportunity to examine the current agreements and their 
effect on the U.S. airline industry, as well as the implications of 
potential changes to those agreements. You asked us to report on the 
potential implications of changes in these agreements. We examined the 
following questions: 

* How prevalent are Open Skies agreements between the United States and 
EU nations, and what has been their effect on airlines and consumers?

* What are the key ways that commercial aviation between the United 
States and the EU could be changed by the Court of Justice decision?

* How might the elimination of nationality clause restrictions in any 
new U.S.-EU agreement affect airlines and consumers?

To examine the prevalence and effect of Open Skies agreements on 
airlines and consumers, we reviewed prior research from a variety of 
organizations, including the U.S. Department of Transportation (DOT), 
and we analyzed DOT data on passenger traffic from 1990 through 2002. 
To determine the key issues related to the European Court of Justice's 
decision, we interviewed officials from five major U.S. and eight major 
EU airlines; DOT; the U.S. Department of State (State); the European 
Commission Directorates General for Competition, Employment, and 
Transport; U.S. and EU labor unions and associations; and EU airports, 
as well as officials of EU aviation trade associations. To determine 
how the absence of the nationality clause restrictions might affect 
airlines and consumers, we interviewed industry experts about the 
likely outcome of removing the nationality clause restrictions, and 
used prior research to highlight any potential benefits or barriers 
that airlines and consumers would face. We also analyzed available data 
on capacity constraints at EU airports and the effect of opening 
transatlantic markets on labor. We assessed the reliability of the 
various data sets analyzed throughout the report and determined that 
they were sufficiently reliable for our purposes.

We recognize that other important factors must be carefully examined 
when analyzing international aviation. For example, issues relating to 
safety and security regulatory oversight are obviously critical to any 
comprehensive analysis of air transportation. Because of the magnitude 
of these issues, however, we agreed with your staff at the outset that 
they were beyond the scope of this report. In addition, while the EU 
mandate called for the creation of a more open aviation market 
(including issues such as foreign ownership restrictions and access to 
domestic markets), both U.S. and EU officials acknowledged that 
addressing the Court of Justice ruling and resolving the nationality 
clause issue were both priorities, and we therefore focused our report 
on the issues linked to the ruling only. We also agreed to exclude from 
this report several other related issues - such as requirements that 
U.S. government employees and others using U.S. government financed 
foreign air travel to use U.S. airlines.[Footnote 3] For additional 
information on our objectives, scope, and methodology, see appendix I. 
We conducted our work from October 2003 through July 2004 in accordance 
with generally accepted government auditing standards.

Results in Brief: 

Starting in 1992 with the signing of the first of 15 Open Skies 
agreements between the United States and EU nations, both consumers and 
airlines have benefited from the removal of government restrictions on 
international aviation. With one notable exception, the United States 
has Open Skies agreements with the EU countries to which most 
transatlantic passenger traffic flows. The exception is the nation that 
is the single largest transatlantic market in terms of passengers and 
flights--the United Kingdom (UK). Under the U.S.-UK agreement, only two 
U.S. airlines have access to London's Heathrow airport, the major 
gateway to the United Kingdom and the largest EU airport for 
transatlantic passengers. Available research indicates that U.S. 
airlines profited from Open Skies agreements by establishing more 
integrated alliances with EU airlines. Consumers benefited from Open 
Skies agreements because they allowed airlines and alliances to provide 
on-line service to more locations at cheaper fares. Our analysis of 
scheduled service for May 2004 showed that the majority of possible 
U.S.-EU markets were served with no worse than two-stop flights. 
Moreover, travelers had a choice of competitors, with the majority of 
markets being served by three or more airlines (or alliances).[Footnote 
4]

Addressing the findings of the Court of Justice decision could change 
commercial aviation between the United States and the EU in at least 
four key ways. They are as follows: 

* Extension of U.S. airlines' Open Skies traffic rights to the entire 
EU. If the rights available to both U.S. and EU airlines under the 15 
current Open Skies agreements were extended to the entire EU, U.S. 
airlines would gain equal legal access to and between EU nations that 
still have restrictive bilateral agreements. However, significant 
capacity constraints and restrictions at a number of airports in these 
nations are likely to limit the airlines' ability to make use of this 
new access, at least in the near term. Some of those rights may have 
greater implications for cargo carriers than passenger airlines. (Cargo 
issues are discussed in greater detail in appendix III.)

* Extension of traffic rights for EU airlines. Removal of the 
nationality clause restrictions would mean that the United States would 
recognize all EU airlines as "European Community" airlines. With this 
recognition, all EU airlines would gain the right to operate into the 
United States from EU airports outside of their home countries. For 
example, Air France, which currently can operate direct nonstop service 
only between U.S. and French cities, could legally provide nonstop 
service to the United States from any city within the EU.[Footnote 5] 
EU airlines from countries with restrictive bilateral agreements, such 
as Spain, Greece and the United Kingdom, would also gain further access 
to U.S. markets.

* Internationalization of airline operations within the EU. To the 
extent that nationality-based restrictions would be removed, EU-based 
airlines would be able to move their operations to other EU member 
states and still provide service to the United States--for example, by 
merging with or acquiring another airline, creating a subsidiary, or 
moving an existing base of operations.

* Continued regulatory oversight. The possibility that EU airlines 
might relocate into other EU nations raises issues about which nation's 
legal and regulatory system would apply, particularly regarding safety, 
security, and labor law. U.S. and EU labor groups have questioned 
whether EU airlines, in attempting to reduce costs to improve their 
overall competitiveness, would relocate operations to nations with 
lower wages or labor standards.

Based on past experience with the U.S. aviation market, the opinion of 
industry experts, and our analysis of available data, U.S. consumers 
and airlines are likely to benefit if nationality clause restrictions 
are eliminated between the United States and the EU, but the benefits 
may not be realized for some years and will depend in part on the 
business strategies that U.S. and EU airlines choose.

* U.S. airlines and consumers could gain additional access to London's 
Heathrow Airport. Experts and officials expect that more U.S. airlines 
would seek to provide nonstop service from their hub airports into 
London's Heathrow Airport. Both consumers and "new entrant" airlines 
(those that would gain access to the airport) could benefit from the 
new service. Access to Heathrow by other U.S. airlines would provide 
consumers with greater choice, service from more U.S. destinations, and 
possible competitive pressures on price. New entrant airlines would 
benefit from being able to carry passengers into a valued destination. 
However, because of capacity constraints at Heathrow, it may be some 
time before these potential benefits for U.S. airlines and passengers 
emerge.

* EU airlines could launch competitive transatlantic service from an 
airport now dominated by another EU airline. For example, Lufthansa 
Airlines might decide to initiate nonstop passenger service between 
Paris and Miami--a market now generally divided between Air France 
(with its alliance partner Delta Air Lines) and American Airlines. 
Airline officials said that they would be unlikely to establish a 
significant presence at another airline's hub, however, because of 
operating and marketing barriers to establishing competitive service 
there.

* Consolidation within the EU aviation industry could increase. Ending 
nationality clause restrictions would remove a barrier to consolidation 
of the EU aviation industry, because airlines would no longer have to 
be concerned about whether a merger would jeopardize traffic rights 
that are granted under current agreements. Mergers could potentially 
affect U.S. consumers in a positive way if such consolidation would 
create an additional competitor or provide access to new "on-line" 
service. However, mergers can also have negative effects if, by 
combining into one airline, the number of competitors in a market 
falls. Although industry experts and officials anticipate that EU 
airlines will merge, they did not agree on the timing and nature of any 
additional consolidation.

* EU airlines could relocate to other EU nations with lower wage costs. 
While increased competition is likely to force airlines to become more 
cost-efficient, we did not find substantial evidence to indicate that 
airlines would consider such relocations in the near term. Airlines 
would still need to locate operations based on where passenger demand 
exists, rather than on where the lowest wages could be paid. However, 
the 10 newest EU nations, which joined the EU in May 2004, have an 
average gross domestic product that is 40 percent of the average for 
the 15 other EU countries, so the possibility for such actions cannot 
be dismissed.[Footnote 6] Because transnational unions do not currently 
exist within the EU, organized labor has raised concerns about how 
employee rights could be protected were companies to relocate to or 
form subsidiary operations in other EU countries.

Background: 

U.S. and EU Domestic Airline Markets Are Largely Deregulated: 

A dominant theme of the commercial airline industry in the United 
States and the EU in the past 2 decades has been one of decreased 
government economic regulation. This development began in the United 
States with passage of the Airline Deregulation Act of 1978, phasing 
out federal regulation of rates, routes, and services for domestic 
airlines. EU aviation deregulation began in 1987 and led to the 
creation of a single European aviation market.[Footnote 7] In 1993, the 
EU efforts mirrored U.S. deregulation by removing all government 
restrictions on routes, fares, and capacity, as well as barriers to 
cross-border investment of European airlines. By 1997, the EU removed 
the final operating restriction by allowing cabotage within the EU. 
Deregulation has allowed substantial growth in both U.S. and EU airline 
operations and passenger traffic, with consumers on both sides of the 
Atlantic benefiting from decreased fares and increased service. As 
airline operations and passenger traffic grew, U.S. and EU aviation 
industry employment increased as well (see table 1).

Table 1: Changes in Domestic U.S. and EU Aviation Markets and 
Employment: 

Type of change: Annual average percentage change in revenue passengers 
enplaned; 
U.S. since deregulation (1978-2002): 3.3%; 
EU since deregulation: (1993-2002): 6.1%[A].

Type of change: Annual average percentage change in number of pilots; 
U.S. since deregulation (1978-2002): 3.9%; 
EU since deregulation: (1993-2002): 3.7%[B].

Type of change: Annual average percentage change in pilot 
compensation/expenses[C]; 
U.S. since deregulation (1978-2002): 3.4%; 
EU since deregulation: (1993-2002): 3.1%[B].

Type of change: Annual average percentage change in real (or inflation 
adjusted) airline yields[D]; 
U.S. since deregulation (1978-2002): - 2.7%; 
EU since deregulation: (1993-2002): N/A[E]. 

Source: GAO analysis of data from DOT, Air Transportation Association, 
and Association of European Airlines.

[A] Based on data from 25 Association of European Airline members.

[B] Based on data from 15 Association of European Airline members.

[C] Pilot compensation percentage changes do not reflect possible 
changes in negotiated work rules. According to Air Inc.'s 2004 U.S. 
Airlines Salary Survey, work rules include, among other things, the 
maximum number of hours worked per month, payment for hours above the 
maximum, and number of vacation days.

[D] Yield is an industry term denoting the price (in cents) a revenue 
passenger pays to fly one mile. Yield does not include aviation taxes, 
which are remitted directly to the taxing authority and never recorded 
in carrier financial statements.

[E] Comprehensive yield data for all EU carriers is not available.

[End of table]

Open Skies Agreements Extend Partial Deregulation to Transatlantic 
Routes: 

For many decades, international air service has been governed by 
aviation agreements that are based on the principle that nations have 
sovereignty over their airspace. This sovereignty is defined by nine 
"freedoms of the air" that have developed over time to outline possible 
aviation rights between countries.[Footnote 8] During a 1944 
international civil aviation convention in Chicago, the participating 
countries decided that international aviation would be governed by 
negotiated bilateral aviation agreements that specify "traffic rights," 
such as the number of airlines that can operate between markets, the 
airports from and to which they operate, the number of flights that can 
be provided, and the fares that airlines could charge. These aviation 
rights, including the right to prevent foreign airlines from cabotage 
operations, have been the basis for international aviation.

Under traditional bilateral agreements, air services can only be 
offered by airlines that are licensed and designated by the two 
countries that sign the agreement. To be licensed to provide commercial 
air services, an airline must meet various legal and regulatory 
requirements. Among these requirements are citizenship and control 
tests, which require that an airline be majority-owned and effectively 
controlled by citizens of the licensing country.[Footnote 9] In the 
United States, the airline must also meet economic fitness and safety 
requirements. EU law establishes a framework for the granting of 
airline licenses and air operators certificates,[Footnote 10] but all 
Community airlines licensed by EU member states in accordance with EU 
law are permitted to provide transport throughout the EU. The process 
by which countries indicate which airlines are authorized to provides 
service under the agreements is called "designation." Designation has 
traditionally indicated that the country making the designations will 
ensure appropriate regulatory oversight. This responsibility extends to 
ensuring that the airline complies with international civil aviation 
safety and maintenance standards.[Footnote 11]

Open Skies agreements are a particular kind of bilateral agreement. 
They remove the vast majority of restrictions on how airlines of the 
two countries signing the agreement (signatory countries) may operate 
between their respective territories. For example, they remove 
prohibitions on the routes that airlines of the signatory countries can 
fly, or the number of airlines that can fly them.[Footnote 12] These 
expanded operational rights represent significant alterations to the 
traditionally more restrictive bilateral agreements that specified 
service frequency, capacity, routing, and pricing.

While they granted more rights to airlines of the signatory countries, 
Open Skies agreements, through the nationality clause, allow the U.S. 
government to block airlines of other countries from these rights. For 
example, while both Germany and France have Open Skies agreements with 
the United States, the German-based carrier Lufthansa is not permitted 
by either France or the United States to operate flights between France 
and the United States, without it being a continuation of a flight that 
originates in Germany.[Footnote 13] Yet according to DOT officials, if 
it is deemed "not inimical" to U.S. interests, DOT can waive the 
ownership and control requirements. For example, DOT officials stated 
that, under the multilateral Open Skies agreement signed with Brunei, 
Chile, New Zealand, and Singapore, it applied a more flexible 
definition of the nationality clause for nations covered by the 
agreement and focused on ensuring that the airlines covered by that 
agreement are "effectively controlled" by nations that signed the 
agreement.[Footnote 14] Table 2 summarizes some of the key differences 
between traditional bilateral agreements and Open Skies agreements.

Table 2: Summary of Key Differences between Traditional Bilateral 
Agreements and Open Skies Agreements: 

Type of agreement: Traditional bilateral agreements; 
Service capacity: Restrictions on which airlines can operate; 
Service frequency[A]: Restrictions on what markets airlines may serve 
and the number of flights that can be flown; 
Fares: Restrictions on pricing; 
Extended traffic rights: Restrictions on operations to and from 
additional countries.

Type of agreement: Open Skies agreements; 
Service capacity: No restrictions on the number of airlines that may 
operate; No restrictions on what markets airlines may serve; 
Service frequency[A]: No restrictions; 
Fares: No restrictions on pricing; 
Extended traffic rights: Allowance for open rights to and from 
additional countries. 

Source: GAO analysis of U.S. Department of State and U.S. Department of 
Transportation data.

[A] Governments are allowed to restrict operations at airports due to 
environmental regulations. For example, 44 EU airports reported having 
night flight restrictions.

[End of table]

The U.S.-EU market grew from 28 million annual passengers in 1990 to 
over 51 million passengers by 2000, representing the most important 
international market for U.S. airlines. British Airways is the largest 
carrier in the U.S.-EU market, followed by American, Delta, and United 
Airlines (see fig. 1). Neither U.S. nor EU low-cost carriers currently 
offer transatlantic services.[Footnote 15]

Figure 1: Largest U.S. and EU Airlines Based on Percentage of Total 
U.S. - EU Traffic Carried, 2002: 

[See PDF for image]

[End of figure]

Open Skies Agreements Have Benefited Consumers and Airlines by Removing 
Restrictions on International Air Service: 

Consumers and airlines have benefited from Open Skies agreements that 
the United States has signed with 15 individual EU member nations. The 
number of such agreements has grown over time, although 10 EU member 
nations, including the largest U.S. aviation partner, the United 
Kingdom, still have more restrictive bilateral agreements or no 
agreement at all. Open Skies facilitated the formation of more 
integrated international alliances between U.S. and EU airlines, which 
allowed the airlines to expand their networks and provide competitive 
service for more passengers to more locations at cheaper fares. As a 
result, U.S. passengers have been able to pay less to reach most EU 
destinations, significantly increasing passenger traffic.

The United States Has Open Skies Agreements with the Majority of EU 
Nations: 

Since signing the first Open Skies agreement with the Netherlands in 
1992, the United States has entered into agreements with 15 of the 25 
EU nations (see fig. 2). The United States signed nine of these 
agreements by 1996. Since then, the United States has signed Open Skies 
agreements with six EU member states: Italy, Malta, Poland, Slovakia, 
Portugal, and France.[Footnote 16]

Figure 2: EU Member States with Open Skies Agreements: 

[See PDF for image]

[End of figure]

While the majority of EU member states have signed Open Skies 
agreements, 10 EU member states maintain bilateral agreements that are 
more restrictive than Open Skies agreements or have no aviation 
agreement with the United States. The United States does not have any 
aviation agreement with Cyprus, Estonia, Latvia, Lithuania, and 
Slovenia. EU member states that have traditional bilateral agreements 
include Greece, Ireland, Spain, Hungary, and the United Kingdom. For 
the five countries with bilateral agreements but without Open Skies, 
the types of restrictions vary from agreement to agreement. For 
example: 

* The U.S.-Spain agreement does not permit U.S. airlines to code-
share[Footnote 17] with any of their EU partners from intermediate 
points elsewhere in Europe. For example, United Airlines cannot place 
its code on any Lufthansa flight from Germany to Spain. The resulting 
"interline" service tends to be both more expensive and more 
inconvenient than code-shared routes, placing them at a competitive 
disadvantage.[Footnote 18]

* The agreement with the United Kingdom, commonly referred to as 
Bermuda 2, restricts service between the United States and London's 
Heathrow airport to two airlines from each country--at present, 
American and United from the United States, and British Airways and 
Virgin Atlantic from the United Kingdom. In addition, the agreement 
limits nonstop service into Heathrow by U.S. airlines to 12 specified 
U.S. cities. UK airlines can operate from Heathrow to 11 specific 
cities, plus other cities where there is no U.S. airline competitor. 
Despite these restrictions, London's Heathrow airport (Heathrow) 
accounted for the highest percentage (over 20 percent) of U.S.-EU 
passengers of any European airport between 1990 and 2002.

Open Skies Agreements Enhanced Creation of Airline Alliances and 
Subsequent Expansion of Airline Networks: 

Open Skies agreements greatly changed how U.S. and EU airlines provide 
international service. The change centers on the alliances that various 
U.S. and EU airlines have formed with each other.[Footnote 19] 
Operating in an alliance allows an airline to greatly expand its 
service network, without having to increase the number of routes it 
flies using its own aircraft. In the simplest case, an international 
code-sharing alliance links the route network of one airline with the 
route network of another, forming an end-to-end alliance with little 
overlap (see fig. 3). In this way, alliances have allowed airlines to 
expand the number of markets that received "on-line" service between 
the U.S. and EU.[Footnote 20] Airline passengers prefer this type of 
"seamless" service, compared to interline service, because it allows 
the convenience of single ticketing and check-in, among other things.

Figure 3: Illustration of How Alliance Networks Link Markets: 

[See PDF for image]

[End of figure]

Alliances greatly increase the number of markets that can be served on-
line because they connect locations that were otherwise served only by 
one of the alliance airlines. This concept, illustrated in figure 3, 
allows networks to serve "behind-and-beyond" markets. Transatlantic 
flight occurs between what are called "gateway" airports, such as 
Atlanta and Paris. A "behind" point is a location that feeds passenger 
traffic into the gateway airport on one side of the Atlantic, while 
"beyond" points are those destinations that can be reached once a 
passenger has traveled to the gateway airport on the other side of the 
Atlantic. For example, Kansas City, Missouri, and Berlin, Germany, 
constitute a "behind-and-beyond" market. Neither city has nonstop 
transatlantic service, so passengers from either destination must first 
fly to a gateway airport. A passenger originating a trip in Kansas City 
would have to take a flight into a gateway airport (such as Atlanta), 
connect to a transatlantic flight to an EU gateway (such as Paris), and 
then connect onto a flight to Berlin.

Most major U.S. airlines that provide transatlantic service (American, 
Delta, United, Northwest, US Airways, and Continental) belong to 
international alliances with other airlines, including many from the 
EU. To more closely integrate scheduling and pricing, alliance partners 
may request that they be given immunity from national antitrust laws, 
which would otherwise prohibit potential competitors (i.e., the 
alliance partners) from coordinating pricing and services.[Footnote 21] 
DOT has granted antitrust immunity to most of the alliances that U.S. 
airlines have with EU airlines. Beginning with Northwest and KLM Royal 
Dutch Airline (KLM) in 1993, DOT approved antitrust immunity for U.S. 
airlines with 18 international alliance partners. Yet not all alliances 
have received antitrust immunity. U.S. policy stipulates that only 
airlines from countries that have signed Open Skies agreements with the 
United States can receive antitrust immunity.[Footnote 22] The efforts 
to obtain antitrust immunity for an alliance between American and 
British Airways has twice failed, in part because the United States was 
unable to obtain an Open Skies agreement with the United Kingdom and 
the airlines were not willing to cede Heathrow slots as required by 
competition authorities. American and British Airways are limited in 
the number of markets in which they can code-share, and are not 
permitted to coordinate market scheduling and pricing in the same way 
as other airlines that do have antitrust immunity. (See appendix IV for 
summary information of the major international alliances.)

Consumer Benefits Have Resulted from Expanded Alliances and Networks: 

Various studies have found that the alliances and expanded networks 
created since the first Open Skies agreements have produced significant 
benefits for consumers. Two studies conducted by DOT found that the 
development of alliances in transatlantic markets led to consumer 
benefits in the form of more competitive service and more extensive 
networks.[Footnote 23]

We found that international network airlines serve the majority of 
U.S.-EU city-pair markets with no worse than double-connection (i.e., 
two-stop) on-line service. Based on scheduled flights for May 2004, 83 
percent of the possible U.S.-EU markets (5,165 of 6,210) were scheduled 
to receive on-line service with nonstop, single-connection or double-
connection service.[Footnote 24] More than half of those markets were 
served by nonstop or single-connection flights. Table 3 summarizes the 
connectivity of major U.S.-EU markets. (Additional markets may also 
have received on-line service, but the service would have required more 
than two connections and would thus be excluded from our analysis.)

Table 3: U.S.-EU Markets Served with Nonstop, Single-Connection or 
Double-Connection Flights: 

Best level of service scheduled: Nonstop; 
Number of markets: 174; 
Percentage of markets: 3.4%; 
Example of market served: New York-London (Heathrow).

Best level of service scheduled: Single connection; 
Number of markets: 2,640; 
Percentage of markets: 51.1%; 
Example of market served: Kansas City-Atlanta-Paris.

Best level of service scheduled: Double connection; 
Number of markets: 2,351; 
Percentage of markets: 45.5%; 
Example of market served: Oklahoma City-Chicago- Copenhagen-Helsinki.

Total; 
Number of markets: 5,165; 
Percentage of markets: 100.0%. 

Source: GAO analysis of Sabre, Inc., May 2004 airline schedule data.

[A] We categorized markets based on the best level of service, which 
generally refers to the fastest possible service (i.e., having the 
least number of connections). Markets were placed in a single category. 
For example, although several airlines offer connecting service between 
Chicago and London, because other airlines serve that market with 
nonstop flights, we categorize it as a nonstop market.

[End of table]

In addition, consumers in most U.S.-EU markets have a choice of service 
from more than one competing airline or alliance. Figure 4 illustrates 
that consumers flying between Kansas City and Berlin have four 
different competitive alternatives. In the 174 nonstop markets, 71 
percent have at least three airlines providing either nonstop service 
or competitive single-stop service.[Footnote 25] In markets where the 
best level of service is one-stop or on-line single connections, over 
85 percent have at least three competitors, and in markets where the 
best level of service involves two connections, 60 percent have three 
or more competitors (see fig. 5).

Figure 4: Customers in the Kansas City to Berlin Market Have Multiple 
Trip Options: 

[See PDF for image]

[End of figure]

Figure 5: Most U.S.-EU Markets Served by Three or More Competitors: 

[See PDF for image]

[End of figure]

Between 1996 and 1999, according to DOT, within Open Skies countries, 
fares dropped an average of 20 percent, compared to a 10 percent fare 
decrease in non-Open Skies markets (see table 4). These differences are 
consistent across the various categories of markets, such as gateway-
to-gateway markets and behind-beyond markets. Much of the decrease has 
been attributed to the incentive for alliances to offer lower-priced 
on-line service rather than the higher-priced interline connecting 
service.[Footnote 26] DOT officials noted, however, that little if any 
analysis of changes in airfares and service has been completed that 
would examine any changes in the market since September 2001.

Table 4: Changes in Average Fares in Transatlantic Markets, 1996 versus 
1999: 

Type of market: Open Skies markets; 
Behind-beyond markets: -23.9%; 
Behind-gateway markets: -19.9%; 
Gateway-beyond markets: -24.8%; 
Gateway-gateway markets: -17.0%; 
Average for all market categories: - 20.1%.

Type of market: Non-Open Skies markets; 
Behind-beyond markets: -13.2%; 
Behind-gateway markets: -14.6%; 
Gateway-beyond markets: -15.8%; 
Gateway-gateway markets: -5.1%; 
Average for all market categories: - 10.3%. 

Source: DOT.

Note: Fares are not adjusted for inflation.

[End of table]

Addressing the European Court of Justice Decision Will Affect 
Commercial Aviation in Four Key Ways: 

Industry and government officials with whom we spoke generally said 
that the Court of Justice decision-particularly as it relates to likely 
changes in the existing nationality clause in the Open Skies agreements 
and the bilateral agreement with the United Kingdom-will affect 
commercial aviation in at least four key ways, depending on the 
eventual outcome of negotiations between the United States and 
EU.[Footnote 27] These experts agree that complying with the Court of 
Justice decision will require that nationality-based restrictions be 
eliminated. The four key areas raised by potential changes to the 
nationality clause are closely intertwined and are as follows: 

* A new U.S.-EU agreement that would address the nationality clause 
issue would likely supersede the five existing restricted bilateral 
agreements and also would become effective in the five EU nations where 
no agreement currently exists. It would thus provide U.S. airlines with 
expanded legal traffic rights (i.e., rights to operate between two 
destinations) into what are now restricted markets. However, capacity 
limitations at certain key airports might restrict U.S. airlines' 
ability to exercise this new right.

* Eliminating the nationality clause restrictions means that the United 
States would recognize all EU airlines as "European Community" 
airlines. These airlines, which currently can provide transatlantic 
passenger service only between the United States and airports in their 
own country, would have the ability to provide service between the 
United States and any EU country.

* Because nationality-based restrictions would no longer apply, one 
major barrier to European transnational mergers would no longer exist. 
EU-based airlines could more freely consolidate, create subsidiary 
operations, or relocate their businesses to any location within the EU 
without jeopardizing their rights to fly to the United States.

* The increased operating flexibility that EU airlines would receive 
raises questions as to which EU member state's regulatory oversight and 
labor laws should apply in particular situations. If an EU airline 
moved its operations to (or established a subsidiary carrier in) 
another EU country--perhaps to take advantage of lower wages or other 
cost savings--questions are likely to arise as to which member state's 
regulatory framework and labor laws would apply.

U.S. and EU officials agree that both sides must eventually reach some 
agreement on resolving the nationality clause issue in order to comply 
with EU law. However, there is no set time frame for when the matter 
must be settled. In November 2002, the EU called for member nations to 
renounce their Open Skies agreements with the United States, but did 
not pursue the request in response to receiving a negotiating mandate. 
It is uncertain how a prolonged inability to remedy the nationality 
clause issue might affect U.S. and EU commercial aviation, in part 
because such issues have never arisen before.

Extension of Open Skies Model Would Provide U.S. Airlines with 
Additional Traffic Rights: 

U.S. airlines would gain expanded legal traffic rights under a new 
U.S.-EU agreement. According to U.S. and EU industry and government 
officials, a new agreement would supersede and be binding on all EU 
member states, thereby removing most remaining traffic right 
restrictions.[Footnote 28] Because the Open Skies agreements between 
United States and 15 member states have already effectively eliminated 
traffic restrictions in those markets, there would be no significant 
gains in traffic rights for U.S. airlines, although EU airlines would 
gain expanded traffic rights or operations to and from those countries. 
However, U.S. airlines would gain rights to serve markets, from which 
they had been previously restricted, with the other 10 EU countries.

Extending the Open Skies framework and rights to all EU member states 
would be necessary in order to prevent a critical imbalance of economic 
rights from developing that would place U.S. airlines at a potential 
competitive disadvantage. Unless Open Skies rights were extended to all 
EU nations, any country with which the United States now has a more 
restrictive bilateral agreement would be able to benefit from rights 
negotiated by other countries without itself having to negotiate for 
those rights. In other words, those countries (and their passengers and 
airlines) would benefit from the actions of others without "paying" for 
them-an outcome known as "free riding." A free-rider scenario would 
occur between the United States and EU if an airline from a non-Open 
Skies country were able to operate from an Open Skies country to 
circumvent restrictions in the home country's bilateral agreement. For 
example, a UK airline could originate a flight in France with a 
commuter aircraft, change to a wide body aircraft at London's Heathrow 
airport, and then continue on to the United States to a point not 
designated under Bermuda 2 with hundreds of additional passengers. This 
would put U.S. airlines at a competitive disadvantage because the 
current bilateral agreement with the United Kingdom prevents any U.S. 
airline from flying similar routes.

U.S. Airlines Would Gain Access to Restricted Markets: 

One key operational right that U.S. airlines would gain is full legal 
nonstop access to all markets in the 10 countries with which the United 
States still has more restrictive bilateral agreements or no 
agreements. The most noteworthy of these 10 is the United Kingdom, 
because of the amount and value of passenger traffic that moves between 
the two countries. Bermuda 2's limits on competition disproportionately 
affect U.S. airlines because the United Kingdom successfully negotiated 
for additional traffic rights in the early 1990s. Partly as a result, 
between 1992 and 1996, the UK airlines' share of the U.S.-UK market 
rose from 49 percent to 59 percent.[Footnote 29] Today, UK airlines 
still provide more service in the U.S.-UK market, especially into 
Heathrow. As of May 2004, British Airways and Virgin Atlantic scheduled 
a total of 43 daily nonstops from Heathrow to the United States, 
compared to 28 daily nonstops offered by American and United.

While a new U.S.-EU agreement could eliminate the legal restrictions on 
the number of U.S. airlines permitted to operate into Heathrow, 
capacity limitations would affect the extent to which U.S. airlines 
would be able to operate there. Heathrow is essentially operating at 
full capacity, especially at times that are commercially viable for 
transatlantic operations. According to airline and industry officials, 
the commercially-preferred times for transatlantic arrivals into 
Heathrow are between 6 a.m. and 10 a.m., and the commercially-preferred 
times for transatlantic departures from Heathrow are between 10 a.m. 
and 2 p.m. These times are based on airlines being able to coordinate 
their transatlantic flights with feeder flights from their spoke 
airports. However, as figure 6 shows, the demand for arrival (and 
departure) slots during these times generally exceeded the available 
supply.[Footnote 30]

Figure 6: Comparison of Total Runway Capacity and Demand at Heathrow, 
Summer 2004 Demand for Arrivals: 

[See PDF for image]

Note: The demand for slots is calculated from requests from individual 
airlines for the right to operate at particular times. Demand is 
calculated as a 7-day average. Capacity and demand for departures are 
similar to capacity and demand for arrivals.

[End of figure]

U.S. Airlines Would Gain Fifth Freedom Rights: 

If the U.S. Open Skies framework were extended to all EU countries 
following the removal of the nationality clause restrictions, U.S. 
airlines would gain full "fifth freedom rights," including to and from 
EU member states with restrictive bilateral agreements. These fifth 
freedom rights would allow U.S. airlines to operate flights from the 
United States to any EU country and then beyond to another EU country. 
However, traffic rights to countries beyond the EU would be limited to 
those the United States already has under its Open Skies agreements; 
the EU has no current mandate to grant new "beyond rights." Open Skies 
agreements, by definition, grant airlines the unrestricted right to 
operate fifth freedom flights, which are otherwise limited under the 
more restrictive bilateral agreements, such as the agreement with the 
United Kingdom.

Airline officials and industry experts maintain that over time, 
however, fifth freedom rights available from countries that have Open 
Skies agreements have proven to be of limited commercial value to 
passenger airlines. (Cargo airlines, on the other hand, greatly value 
fifth freedom rights. See appendix III for additional information on 
cargo carriers.) United, for example, attempted to exercise fifth 
freedom rights for operations with Open Skies countries in Europe, but 
abandoned those operations after determining that they were not 
profitable. United officials explained that, with the development of 
alliances, it is more cost efficient to use alliance partners to 
provide connecting service into "beyond" markets. Of the U.S. passenger 
airlines that have fifth freedom rights with EU countries, only two 
airlines exercise these rights. Northwest operates fifth freedom 
flights from Minneapolis that stop in Amsterdam and continue to Bombay, 
India. Delta flies from Atlanta to Bombay using fifth freedom rights 
over Paris.[Footnote 31]

U.S. Airlines Would Gain Code-Sharing Rights: 

Under the terms of the more restrictive bilateral agreements with Spain 
and Greece, U.S. airlines are prohibited from serving those markets by 
way of code-share flights. This effectively prohibits, for example, 
passengers using a United ticket from traveling from Albuquerque to 
Madrid by connecting at Frankfurt, Germany, to a United code-share 
flight operated by its Star alliance partner Lufthansa. If the Open 
Skies framework were extended throughout the EU, such prohibitions 
would be eliminated. Airlines would be able to offer new routings to 
passengers, and passengers would be free to choose among new options 
for travel into those countries.

EU Airlines Would Be Able to Establish Transatlantic Routes between the 
United States and Other EU Countries: 

Like U.S. airlines, EU airlines would have greater access to 
international markets. Eliminating nationality clause restrictions 
included in existing agreements effectively means that, in any new 
agreement, the United States could recognize the concept of a "European 
Community" airline.[Footnote 32] This could mean, for example, that 
rights originally restricted to designated airlines of the signatory 
countries would be available to all European Community airlines. In 
other words, Lufthansa, British Airways, and LOT Polish Airlines would 
be European Community airlines in addition to being German, British, 
and Polish airlines. If the United States recognized a European 
Community airline, it would have the right to operate transatlantic 
flights directly to and from more EU destinations. Under current Open 
Skies agreements, the right to establish transatlantic routes between 
destinations in the signing countries is limited to airlines licensed 
in and designated by those two countries and is under the ownership and 
control of the country's citizens. For example, Air France--an airline 
licensed and designated by France--is not allowed under existing Open 
Skies agreements to provide nonstop transatlantic service between 
cities in the United States and Italy; it can fly only between U.S. and 
French cities.[Footnote 33] Under an Open Skies agreement that included 
an EU nationality clause, Air France would have the right to fly 
between any EU city and any city in the United States. In theory, Air 
France could also decide to establish a mini-hub in a city outside of 
France, where it could potentially begin providing nonstop service into 
additional U.S. cities. This same flexibility would extend to all EU 
airlines and to all U.S.-EU markets. In this way, EU airlines, 
regardless of the EU country in which they were licensed, would have 
the ability to provide flights into the United States from throughout 
the EU (see fig. 7).

Figure 7: Potential Effect on Transatlantic Service of the Removal of 
the Nationality Clause Restrictions: 

[See PDF for image]

[End of figure]

EU Airlines Will Have Greater Ability To Restructure and Operate 
Transatlantic Service: 

Eliminating nationality-based restrictions would remove a major barrier 
that has prevented EU airlines from restructuring their operations by 
merging with another airline or creating significant commercial 
operations in locations outside their home countries, without 
sacrificing traffic rights across the north Atlantic. Because 
international traffic rights are granted by two signatory nations and 
are tied to national ownership and control, an airline operating an 
international service cannot merge with a carrier from another EU 
member state without risking the loss of these U.S. traffic rights. 
Similarly, because the traffic rights are tied by designation and 
nationality clause to airlines from particular countries, airlines also 
cannot move operations into another country and exercise those rights.

Eliminating nationality-based restrictions would allow citizens of any 
EU nation to exercise what is called the "right of establishment." 
Under the Treaty of Rome, any EU citizen has the right to establish a 
business in another EU state. Removing nationality-based restrictions 
would allow EU airlines to restructure operations, such as merging with 
another EU airline or relocating in another EU member state, to gain 
economic efficiencies without losing traffic rights into the United 
States.[Footnote 34] For example, EU airlines could relocate operations 
to or establish subsidiaries in EU member states that have lower 
average wages and (from a business perspective) more lenient labor 
laws. Controlling costs associated with labor (i.e., "social costs," 
which include wages, benefits, and pensions, and which also define the 
number of hours in the work week) is important to an airline's ability 
to compete with lower-cost or more efficient airlines, because those 
costs can represent a major portion of an airline's operating costs.

Under an agreement in which the United States would recognize a 
European Community airline, EU airlines could take the following 
actions.

* Acquisitions or mergers--EU airlines could engage in cross-border 
airline mergers and acquisitions without jeopardizing traffic rights to 
the United States.[Footnote 35] Some observers of EU aviation have long 
believed that the large number of relatively small state-supported 
airlines created a fragmented, inefficient system burdened with excess 
capacity. The suggested remedy was consolidation of the European 
industry.

* Moving operations to another country--EU airlines could move some or 
all of their operations to other EU countries without risking the loss 
of traffic rights. For example, an existing airline, such as Austrian 
Airlines, hypothetically would be able to move its operations into and 
establish itself in Poland and still be able to provide service into 
the United States from anywhere in the EU.

* Creating subsidiary operations--EU airlines could set up subsidiary 
operations outside of their home countries that could provide 
transatlantic service.[Footnote 36] Because these subsidiaries could be 
established anywhere in the EU, they could potentially take advantage 
of lower costs that might be available in some EU countries.

* Establishing new entrant airlines--EU citizens in one country could 
establish an airline in another country and provide service into the 
United States, provided they met licensing and certification 
requirements. Citizens from Spain, for example, could establish a new 
airline in Poland and provide service from anywhere in the EU to the 
United States.[Footnote 37]

Moving Airlines or Operations between EU Countries Raises the Issue of 
Which Country Would Have Regulatory Authority: 

While eliminating the nationality clause restrictions may mean that 
traffic rights are no longer limited, the concept of an airline's being 
licensed by a particular EU country remains important for regulatory 
oversight. For issues concerning safety and security oversight of 
airlines, all governments maintain an interest in having assurance as 
to which other government remains responsible for assuring the safe and 
secure operation of airlines that may fly to or from any given 
location.

While operating a safe, secure carrier is of course important for 
maintaining consumer confidence in the carrier, ensuring the safe and 
secure operation of commercial aviation is a fundamental responsibility 
that is shared by governments and airlines. Under the existing EU 
framework, this oversight responsibility resides with each country, 
subject to a framework of European level cooperation and legislation. 
Thus, one issue that will need to be resolved, if airlines are 
permitted to shift their operations from one EU country to another, is 
which country exercises the oversight responsibility.[Footnote 38]

A number of criteria have been suggested for determining which 
country's legal and regulatory system should apply. Traditionally, the 
country that issued the airline's operating license has been 
responsible. However, ensuring safety and security would become 
problematic if an airline relocated its major hub activities to a 
location possibly hundreds of miles outside the licensing state's 
borders. Another possible criteria proposed to determine which state's 
systems apply is based on the location of the carrier's "principal 
place of business." But in an industry in which the assets and 
employees are mobile, what constitutes an airline's principal place of 
business is uncertain. While not providing a definition per se, the 
ICAO Air Transport Regulation Panel and the Organization for Economic 
Co-operation and Development have suggested a set of guidelines that 
governments could use in determining an airline's "principal place of 
business."[Footnote 39] These guidelines propose that a "principal 
place of business" means the country in which an air carrier does the 
following: 

* maintains its primary corporate headquarters;

* regularly provides air transportation service;

* maintains substantial capital investment in physical facilities;

* pays income tax and registers its aircraft; and: 

* employs a significant number of nationals in managerial, technical, 
and operational positions.

However, questions arise regarding how to measure the extent to which 
an airline might meet each of these criteria (e.g., defining and 
measuring "substantial capital investment").

Officials with major airline unions generally support these criteria. 
The concern of labor groups is that, unless a relatively stringent 
standard is applied, airlines will move operations to countries 
specifically to take advantage of lower costs of doing business 
(particularly with regard to wage rates and labor laws). Doing so is 
sometimes referred to as adopting a "flag of convenience," a pejorative 
term adopted from the maritime industry.

The question of which member state's labor law should apply to a 
situation is the subject of a current legal challenge brought by 
employees of the EU low-fare carrier Ryanair at the Charleroi Airport 
in Belgium. Ryanair is headquartered in Ireland and has bases located 
in Stansted, United Kingdom; Frankfurt/Hahn, Germany; Stockholm, 
Sweden; and Charleroi, Belgium. It employs nonunionized pilots. All of 
Ryanair's pilots, regardless of where they are based, are employed 
under Irish labor law and pay Irish taxes. In May 2002, Ryanair did not 
retain three employees after these employees had completed Ryanair's 1-
year probationary period. The employees at Charleroi charge they were 
wrongfully terminated under Belgian law. The question for the EU courts 
is whether Ireland or Belgium's labor laws would apply in this 
instance.

U.S. Consumers, Airlines, and Labor Groups May All Benefit from Changes 
in Agreements, Although Extent of Benefits Is Uncertain and Gains May 
Not Be Realized Immediately: 

Eliminating the nationality clause restrictions from the new U.S.-EU 
agreement would likely provide new benefits to consumers, airlines, and 
labor groups. By eliminating the nationality clause restrictions, a new 
agreement would in effect extend the Open Skies framework to the 10 EU 
member countries without Open Skies agreements. This could potentially 
provide the same benefits that consumers, airlines, and labor groups 
realized after the signing of the current Open Skies agreements. 
However, because of mitigating circumstances, these benefits will take 
some time to develop, and they will be contingent on resolving a number 
of related issues (e.g., de facto access to restricted airports). 
Experts and industry officials with whom we spoke generally agreed that 
eliminating the nationality clause restrictions would mainly increase 
the potential for the following: 

* More U.S. airlines might attempt to provide nonstop service from 
their hub airports into London's Heathrow Airport.

* EU airlines might use their new ability to establish transatlantic 
routes between U.S. cities and EU destinations outside of their 
homeland.

* More transnational mergers might occur between EU airlines.

* An EU airline might attempt to establish a "flag of convenience" 
operation--that is, the airline might move some or all of its 
operations to another EU country with lower wage or other costs.

Each of these actions would allow airlines to more freely respond to 
market forces and consumer demand. As in other instances where 
government removed restrictions on airlines, such as domestic 
deregulation and Open Skies agreements, consumers could potentially 
benefit from increased competition and therefore better service and 
lower fares.

New Entry by U.S. Airlines Into Restricted Markets Would Benefit 
Consumers, but Access to London's Heathrow Airport May Be Limited by 
Current Slot Allocation Process: 

Officials at some U.S. airlines said a major potential benefit of a new 
agreement would be the opportunity for access to markets restricted by 
the existing bilateral agreements. Similar to the experience of current 
Open Skies agreements, U.S. consumers and airlines would benefit from 
gaining access to the 10 restricted markets, such as the United 
Kingdom, Spain, Ireland, and Greece. The likely source of the greatest 
benefit would be London's Heathrow Airport, since it is the largest 
destination for U.S. travelers (see fig. 8). If a new agreement 
extended the U.S. Open Skies framework to all EU member states, it 
would remove the restrictions of the Bermuda 2 agreement. U.S. airlines 
with no current access to Heathrow would gain the right to operate 
there. For example, Continental Airlines, which currently has no 
Heathrow access with its own aircraft, would be able to begin service 
into Heathrow from any U.S. airport, including its hubs at Newark, 
Houston, and Cleveland. (Continental now operates flights from those 
hubs into London's Gatwick Airport and code-shares with Virgin Atlantic 
into Heathrow.) Because Heathrow is the major U.S.-EU gateway, many 
U.S. airlines view the opportunity to gain access to this market as a 
positive benefit.

Figure 8: Top EU Markets Based on Total Percentage of U.S.-EU Passenger 
Traffic from 1990-2002: 

[See PDF for image]

[End of figure]

Access to Heathrow by additional U.S. airlines represents potentially 
positive benefits to consumers and airlines. Consumers would benefit 
from gaining greater choice of airlines, service from more U.S. 
destinations, and possible competitive pressures on price. For example, 
if all U.S. airlines now serving London by flying into Gatwick switched 
their operations to Heathrow, London-bound consumers would benefit 
because access to central London is faster and easier from Heathrow. In 
addition, consumers in Denver and Detroit, who now have flights into 
Heathrow only on British Airways, would likely benefit from the 
additional competitive presence on those particular routes. Airlines 
that do not now have access to Heathrow would benefit from being able 
to carry passengers into a valued destination. Even though these 
airlines operate to London's Gatwick Airport, they have reported losing 
high-yield business passengers and corporate accounts to competitors 
because of their inability to provide service to Heathrow.

For consumers and airlines to realize such benefits, however, airlines 
would first need to gain de facto access to airport slots, gates, and 
terminal space. Because Heathrow is already operating essentially at 
full capacity, a new entrant airline would have to gain access through 
the existing slot allocation process, which provides limited 
opportunities for new entrants--airlines with no more than four slots 
per day (the equivalent of two daily takeoffs and landings). Each year, 
the number of slots that become available through the normal slot 
allocation process is equivalent to about five daily takeoffs and 
landings.[Footnote 40] Existing EU slot allocation regulation requires 
the slot coordinator[Footnote 41] to set aside 50 percent of any slots 
that become available for distribution to new entrants.[Footnote 42] 
Before those slots are made available, however, incumbent airlines have 
limited rights to acquire any open slot and substitute another they 
already hold. Incumbent airlines can use this process to "trade up" 
slots they hold at less desirable times for newly available slots that 
might be for more commercially advantageous times. This effectively 
relegates the slots available to new entrants to commercially less 
desirable times. However, once a new entrant does obtain slots, it can 
gain slots at more commercially viable times through a grey market, 
which is used by airlines to trade slots. These trades are allowed 
during any point of the year and are often done so for payment. The EU 
does not officially condone this grey market, although a 1999 decision 
by a UK court found this system to be acceptable within European 
law.[Footnote 43] The EU has recently initiated proceedings against 
this system.

While some officials have pointed out that the slot allocation process 
does give priority to allocating slots to new entrant airlines, there 
is disagreement regarding the effectiveness of this process in 
assisting new entrants. Once a new entrant airline acquires five or 
more daily slots, it is no longer considered a new entrant and then 
must compete for any available slot as an incumbent airline. To gain 
additional slots for transatlantic operations, a new incumbent airline 
with five slots would have to compete against British Airways, with 
over 500 daily slots, and Virgin Atlantic, with just over 30 daily 
slots (in the Summer 2004 scheduling season).

Another option for U.S. airlines to gain slots is based on the 
reallocation of slot resources between alliance partner airlines. Some 
airline officials said that, once the legal restrictions are removed, 
international alliances with substantial numbers of Heathrow slots 
could reallocate these slots between alliance members, thereby 
providing U.S. airlines with some access to Heathrow slots. Some 
European airlines have stated that this option would be discussed 
within the alliance; others maintained that alliance partners would be 
hesitant to trade or sell slots to other alliance members, because the 
Heathrow operations likely add considerable revenue to their own 
network. Alliance partners may also be hesitant to trade or sell slots 
because, although the alliances are established through legal 
contracts, past experience has shown that airlines can and do move out 
of alliances. Thus, a slot sold or traded might be permanently lost or 
used against the airline in the future. Finally, even if an alliance 
partner may have a slot that theoretically could be put to more 
productive commercial use by trading or selling it to another alliance 
partner, other capacity constraints at Heathrow could prevent its use 
for transatlantic operations. For example, a slot (with its associated 
Jetway and terminal facilities) used for 40-passenger turboprop 
operations could not readily be transformed for use by a 400 passenger 
Boeing 747.

Given the limits imposed by these slot allocation options, it may be 
some time before the potential benefits for U.S. airlines and 
passengers emerge. Some European airline officials have pointed out 
that gaining access to slots, gates, and terminal space at Heathrow can 
be done over time. They cite Virgin Atlantic as an example of an 
airline that originally obtained slots at less preferable times and, 
over time, acquired additional slots and traded them with other 
airlines. Through trading, Virgin Atlantic gained a number of slots at 
prime times. In Virgin Atlantic's case, it applied for and obtained six 
daily slots once the UK government designated it as one of the two 
British airlines allowed to provide transatlantic service from Heathrow 
in 1991.[Footnote 44] By 1996, it had obtained approximately 15 daily 
slots, which rose to 28 daily slots by 2001. Airline officials reported 
that between 1996 and 2001, the airline gained an additional five pairs 
of daily slots to the United States. As of the 2004 summer schedule, 
Virgin Atlantic will have just over 30 daily slots. That total includes 
four pairs of slots that Virgin Atlantic was able to acquire this year 
for about 20 million British pounds (approximately $36 million).

Airlines may also gain access if capacity at Heathrow expands. 
Heathrow's capacity may increase over time through capital improvements 
and changes in operations.

* The first phase of a new terminal at Heathrow, Terminal 5, is 
expected to be operational in 2008 and could ease terminal and aircraft 
parking capacity constraints related to passenger holding areas and 
aircraft gates. With the completion of the second phase in 2011/2012, 
this new terminal is expected to handle 30 million annual passengers 
and will include 45 aircraft parking stands.[Footnote 45] British 
Airways is expected to be the principal tenant at the new terminal, and 
its relocation there will allow other airlines (possibly new entrants) 
to gain access to facilities in other terminals. However, the new 
terminal will have no direct impact on the number of available runway 
slots.

* BAA, plc,[Footnote 46] is examining the potential to implement a 
"mixed mode" runway operation, which would allow both runways to be 
used for landings and takeoffs rather than assigning one runway for 
landings only and one runway for takeoffs only.[Footnote 47] The 
examination will need to take account of potential noise and air 
quality implications. There are no official estimates of the impact on 
runway capacity of a change to "mixed mode," but BAA, plc, has 
suggested that this change could increase slot capacity by 10 per hour. 
However, it is unclear if the UK government will approve this change 
due to opposition by local communities related to the expected increase 
in noise.

* The UK government's 2003 report on the future of air transport 
supported further development of Heathrow, including a new runway and 
additional terminal capacity, but only after a new runway at London's 
Stansted Airport was finished and only if stringent environmental 
limits could be met.[Footnote 48] The report indicated that any 
additional future enhancements to Heathrow's capacity would be 
completed within the 2015-2020 period.

A report commissioned by the EU on the effects of different slot 
allocation approaches concluded that current EU slot regulation 
provides incumbent airlines an advantage and makes it difficult for new 
airlines to obtain slots to introduce new or more frequent 
service.[Footnote 49] It also concluded that if the EU adopted various 
market mechanisms (such as secondary trading, increased slot prices, or 
slot auctions), higher passenger volumes would occur. The report did 
not recommend that the EU commission require divestiture of slots as a 
condition of airline mergers. However, in its approval of the Air 
France-KLM merger, to ensure that new entrant airlines could provide 
new competitive service on certain markets, the EU commission sought 
the surrender of 94 daily slots from Air France and KLM.[Footnote 50] 
Generally, incumbent airlines object to such events, arguing that they 
own the slots and would have to be compensated for them.[Footnote 51] 
BAA, plc, officials also voiced the concern that forcing incumbents to 
surrender slots each time a new entrant wanted to gain access to the 
airport was not permitted in the EU slot regulation and would create an 
undesirable precedent, in part because of the instability it would 
create for incumbent airlines' operations.

While a new U.S.-EU agreement would provide U.S. airlines with legal 
access to markets that are now restricted, airline officials stated 
that, without actual physical access, these new legal rights would be 
meaningless. This is especially true for access to Heathrow. The 
current slot allocation process at Heathrow gives incumbent airlines an 
advantage to help maintain and improve their position, making it 
difficult for new entrants to gain effective commercial access. 
Therefore, it may take an indeterminate amount of time before consumers 
and airlines derive significant benefits from a more open Heathrow.

EU Airlines' New Ability to Provide Service in More Markets Could 
Increase Competition, but Entry May Be Limited: 

Absent the nationality clause restrictions, EU and U.S. airlines could 
begin offering new transatlantic service between more cities. New 
competition has the potential for generating various benefits for 
consumers: transatlantic service to and from more cities, increased 
choices--and possibly pressure on prices--on existing routes, and 
pressure on airlines to provide higher quality service. Some officials 
said that increased consumer demand for nonstop point-to-point service 
could spur airlines to develop new city-pair markets. For example, a 
carrier could start nonstop service from Berlin to Kansas City, neither 
of which, as of May 2004, had direct transatlantic service.

The Boeing Company expects that consumer preference for nonstop 
flights, congestion at major airports, and new technology will push 
airlines to develop new nonstop city pairs. According to Boeing 
officials, between 1980 and August 2001, as the transatlantic market 
has developed, the total number of city pairs served with nonstop 
flights more than doubled, in part because airlines were able to 
connect those markets using aircraft with smaller capacities (see fig. 
9). Boeing projects that, between the United States and EU, an 
additional 114 city pairs could support nonstop service with 250-seat 
aircraft. It cites San Francisco-Milan, Houston-Madrid, and Seattle-
Frankfurt as possible examples.

Figure 9: Change in Nonstop City Pairs and Average Aircraft Capacity 
across the North Atlantic: 

[See PDF for image]

Note: Data were drawn for the month of August in each year.

[End of figure]

The development of new nonstop service or new competition in existing 
markets would offer consumer benefits. Clearly, consumers would benefit 
from having nonstop service on new city-pair markets rather than 
connecting service. If airlines chose to compete on other airlines' 
existing routes, the presence of additional airlines on a route could 
not only provide consumers with more choices of flight times during the 
day, but also could act as a competitive force on service quality and 
price. In the United States, consumers at dominated airports experience 
higher average airfares than do those at more competitive 
airports.[Footnote 52]

Although removal of the nationality clause restrictions would 
theoretically open the door for new competition in various markets, 
airlines will likely face significant operating barriers in those 
markets, particularly at dominated hub airports. In the past, we 
reported that new competition at key domestic airports was inhibited by 
a lack of access to slots and airport facilities.[Footnote 53] In 2004, 
an EU report noted that competition at certain key airports continued 
to be inhibited by lack of available slots at attractive times. The 
report listed Heathrow, Frankfurt, Madrid, and Paris's Charles de 
Gaulle airports as having more demand for slots than available 
capacity, either throughout the day or at peak times of the day.

As in the United States, major European gateway airports also tend to 
be dominated by a single carrier or alliance.[Footnote 54] As table 6 
shows, each of the EU's major airports has one airline that controls a 
much larger percentage of scheduled seat capacity than its next largest 
competitor. Transatlantic flights to and from these airports are 
generally dominated by one alliance. For example, Delta and Air France, 
both members of the Sky Team Alliance, fly 100 percent of the nonstop 
flights between Atlanta and Paris's Charles De Gaulle airport. United 
and Lufthansa, both part of the Star Alliance, operate 100 percent of 
the nonstop flights between Frankfurt and Washington Dulles and 73 
percent of the nonstop flights between Frankfurt and Chicago.

Table 5: Comparison of Dominant Carrier's Scheduled Seat Capacity with 
That of Next Largest Airline at Major EU Airports: 

EU airport: Madrid, Spain; 
Dominant airline: Iberia; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 59.3%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
9.3%.

EU airport: Frankfurt; 
Dominant airline: Lufthansa; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 58.8%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
2.6%.

EU airport: Paris Charles De Gaulle; 
Dominant airline: Air France; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 57.2%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
4.1%.

EU airport: Barcelona; 
Dominant airline: Iberia; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 52.7%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
7.7%.

EU airport: Amsterdam; 
Dominant airline: KLM; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 52.5%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
5.6%.

EU airport: London Gatwick; 
Dominant airline: British Airways; 
Dominant airline's percentage total scheduled seat capacity for airport (2002): 51.3%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 8.6%.

EU airport: Munich, Germany; 
Dominant airline: Lufthansa; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 49.4%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
8.8%.

EU airport: Rome Fiumicino; 
Dominant airline: Alitalia; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 46.8%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
8.9%.

EU airport: London Heathrow; 
Dominant airline: British Airways; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 40.5%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
9.6%.

EU airport: Manchester, United Kingdom; 
Dominant airline: British Airways; 
Dominant airline's percentage total scheduled seat capacity for airport 
(2002): 35.5%; 
Percentage of scheduled seat capacity for next largest carrier (2002): 
10.7%. 

Source: Citigroup Smith Barney, 2003 Hub Factbook.

[End of table]

Sales and marketing practices--which include frequent flier programs 
and corporate incentive programs--may also impede competition. They do 
so by reinforcing market dominance at hubs and impeding successful 
entry by new carriers and existing carriers into new markets. Practices 
such as frequent flier programs encourage travelers to choose one 
airline over another on the basis of factors other than obtaining the 
best fare.

Such factors have a tempering effect on the extent to which EU airlines 
may seek to launch competitive transatlantic service at these EU 
gateways. EU airline officials with whom we spoke said they have no 
plans to establish a significant presence in the hub airports of other 
airlines. Officials said it would be difficult to successfully compete 
in a hub against an incumbent airline because of the inherent 
advantages airlines maintain in their own hub airport. More recent 
experience has shown however that it is precisely the existence of high 
premium routes that have attracted low-cost carriers to introduce new 
competition at or near those high-fare markets, although they often use 
secondary airports. Experience in both the United States and Europe has 
shown that low-cost carriers have increased their presence in major hub 
airports or secondary airports in major hub markets (i.e., Southwest 
and ATA at Chicago's Midway airport and easyJet at Gatwick).

Consolidation among EU Airlines Could Affect Consumers Both Positively 
and Negatively: 

Consolidation among EU airlines may be more likely if nationality 
clause restrictions were eliminated, and could lead to a more efficient 
EU industry structure. Generally, removal of regulatory barriers to 
industry structure, when accompanied by appropriate competition-
preserving antitrust policies, is expected to improve operating 
efficiencies and promote innovation. The U.S. Department of Justice's 
Horizontal Merger Guidelines[Footnote 55] recognize that competition 
usually encourages firms to become more efficient. Mergers can also 
generate significant efficiencies by permitting a better utilization of 
existing assets, enabling the combined firm to achieve lower costs than 
either firm could have achieved without the merger. In turn, that may 
result in lower prices, improved quality, enhanced service, or new 
products. At the same time, however, because the motivation behind 
mergers is the prospect of financial gain, mergers are restricted under 
both U.S. and EU antitrust laws in their ability to create or enhance 
market power or to facilitate its exercise. Market power in this 
instance is the ability of a firm to profitably maintain prices above 
competitive levels for a significant period of time. Thus, while 
consolidation in an industry through mergers can produce efficiencies 
and potential consumer benefits, it remains important for antitrust or 
competition authorities to guard against market abuses.

Analyses we have previously conducted of actual or proposed mergers in 
the U.S. domestic market suggest that mergers often have both positive 
and negative effects.[Footnote 56] Mergers have the potential for 
creating positive benefits to consumers in such ways as the following: 

* In markets where each of the merging airlines had a relatively 
limited presence, combining their limited shares can create an 
additional effective competitor.

* Consumers in some markets would benefit from having access to new 
"on-line" service. For example, when the European Commission recently 
approved the merger of Air France and KLM, it reported that KLM 
consumers would gain access to more than 90 new destinations and Air 
France customers would be offered 40 new routes.

* Members of the frequent-flyer programs of the merged airlines would 
be able to use their miles to reach an expanded number of destinations.

Some industry officials and experts said a U.S.-EU agreement removing 
nationality restrictions would facilitate the opportunity for more 
cross-border mergers in the EU aviation industry, because EU airlines 
would not lose important traffic routes into the United States as a 
result of merger. However, other officials said that restrictive 
bilateral agreements still held with three other major aviation nations 
would limit the extent to which airlines would seek to consolidate. The 
three nations most frequently mentioned were Japan (because of the size 
and value of the existing market), China (because of the size and value 
of the potential market), and Russia (because of the implications of 
overflight rights). For example, Russia and Germany currently have a 
bilateral agreement that restricts routes and overflight rights to 
Russian and German airlines. If Lufthansa Airlines were to merge with 
another EU carrier, it is not clear that Russia would extend these 
rights to the merged airline. If an EU carrier did not have overflight 
rights from Russia, its flight times and costs for operations to other 
Asian countries would increase significantly. These officials said 
airlines that had received traffic rights and other operating 
considerations through such agreements might be unwilling to risk 
losing them through a merger.

A merger can have negative effects on consumers in those markets where 
the merger reduces the number of effective competitors. This negative 
effect is increased if the two airlines that merge have significant 
overlapping markets or if the merger creates an airline that dominates 
a particular market. Industry experts generally agree that, with 
dominance in a market, airlines can wield market power and make entry 
into those markets by would-be competitors more difficult. Therefore, 
an airline that can wield this market power has the ability to raise 
fares when unconstrained by competition. Consolidation also raises the 
possibility that competition in key markets will be reduced, thereby 
potentially affecting fares and service. The current merger between Air 
France and KLM illustrates this point. The European Commission noted 
that the merger would also eliminate or significantly reduce 
competition on 14 routes, including 3 transatlantic routes (Amsterdam-
New York, Amsterdam-Atlanta, and Paris-Detroit). Air France and KLM 
have agreed to surrender slots at Amsterdam and Paris, but it is 
unclear if other airlines will provide effective competition in those 
markets.

In the absence of specific merger proposals, it is not possible to 
project the extent to which such positive and negative effects would be 
present. Some aviation experts maintain that the likely outcome of 
consolidation is the solidification of three "mega" alliances. These 
"mega" alliances would provide the vast majority of international 
aviation service and would be solidified around the Star, SkyTeam, and 
oneworld alliances, with the major U.S. and EU airlines providing the 
vast majority of transatlantic service. Some experts question the long-
term viability of the existing structure of smaller EU national 
airlines, such as Austrian Airlines or TAP Airlines. These experts 
project that such smaller airlines may become regional or niche 
airlines serving limited markets.

Major Obstacles Likely Would Limit EU Airlines from Moving Operations 
to Other Countries, at Least in the Near Term: 

While labor groups and some other stakeholders are concerned that EU 
airlines may attempt to achieve lower costs by relocating operations or 
establishing subsidiaries in EU member states that have lower social 
costs and labor standards, a number of major obstacles could limit 
airlines from establishing such "flag of convenience" operations. 
Increased competitive pressure resulting from any new U.S.-EU agreement 
may lead airlines to seek reductions in operating costs. Because labor 
represents the single largest portion of these costs, labor groups have 
expressed concern that EU airlines might consider relocating to EU 
countries with--from an operating standpoint--more favorable labor 
laws.

Differences in labor costs and labor law among EU member states 
certainly exist. According to a 2003 EU study, the newest 10 member 
states had an average gross domestic product that is 40 percent of the 
average for the 15 other member states.[Footnote 57] The EU has adopted 
a common set of rules with regard to certain labor policies, such as 
gender equality, nondiscrimination, and health and safety. Even so, 
specific regulations and enforcement authority remain with the member 
states. Additionally, EU member states still maintain their own 
national labor laws, some of which may provide airlines with more 
favorable labor environments. Differences remain, for example, in how 
EU member states regulate collective bargaining. For instance, an EU 
report stated that the new EU member nations had generally very weak 
collective bargaining regulations when compared to the other EU member 
nations.

According to labor representatives, the ability of airlines to relocate 
to or establish subsidiary operations in other member states would 
enable airline management to replace the existing workforce with lower-
wage workers. Additionally, EU officials stated that there is no EU law 
regulating the representation, in collective bargaining, by a single 
employee organization. As a result, workers in the same "craft" (i.e., 
pilots or flight attendants) employed by a single company but located 
in different EU member states cannot be represented by a single 
employee organization. There are, however, common rules concerning the 
right to information and consultation of employees in Community-scale 
undertakings and Community-scale groups of undertakings. According to 
labor representatives, employee representation rights are critical to 
preventing downward pressure on wages. These rights include single 
representation for all members of an employee group, including those of 
subsidiaries and holding companies; the ability to negotiate an 
agreement; and effective enforcement of a negotiated agreement. Unless 
labor gains some of those rights, airlines will be able to establish 
subsidiaries and then substitute lower-wage labor for the existing 
workforce. A study prepared for the European Cockpit Association, the 
association of each member state's pilots unions, argues, that with the 
increase in inter-company and cross-national alliances, trade unions 
and employee associations based in single countries and without inter-
union networks could be left without an effective voice in the future 
restructuring of the industry, such as determining where work will be 
located and under what conditions.

While many aspects of this issue remain unsettled, we did not find 
substantial evidence to indicate that airlines would relocate 
operations or establish "flag of convenience" subsidiaries in lower-
wage EU countries, at least in the short term.

* None of the EU airline officials we interviewed indicated a desire to 
relocate to a low-wage country, citing company branding and markets as 
being more important in driving business decisions than low-wage labor. 
Airline officials said that commercial aviation differs from other 
industries because the product (air travel) must be produced close to 
the customer base (population and economic centers). Consequently, 
airlines need to maintain their major operations at key economic 
centers, none of which are located within the lower-cost countries. 
Another example that suggests factors other than low-wage labor drive 
an airline's business decisions is that EU regional airlines, not bound 
by international bilateral agreements, have not pursued movement to 
countries with lower wages and social costs over the last 11 years, 
despite the fact that such movements were possible after the creation 
of a single European aviation market.

* Despite the fact that pilots and flight attendants are inherently 
mobile and could theoretically travel from lower-cost areas to do their 
work, airlines said it was preferable to locate flight personnel close 
to the base of operations. Therefore, airlines will have to provide a 
competitive, market-based compensation package to retain qualified 
employees. For example, an airline that chose to have a major base of 
operations in Paris would need to hire employees paid at "market" 
salaries. To run its daily operation from Paris to Hong Kong, Cathay 
Pacific Airways, for example, employs 70 French citizens at its Paris 
offices and Charles De Gaulle Airport. To compete in the labor market 
for qualified employees, Cathay officials said that it must offer a 
compensation package that is competitive with that offered by other 
airlines.[Footnote 58]

* If an airline decided to move its operations to another EU country or 
import low-wage labor from there, it appears unlikely they would have 
access to a sufficient supply of appropriately trained personnel. For 
example, according to EU and airline officials, the number of pilots 
available in these countries who are trained on aircraft used by the 
airlines is relatively small.

* Finally, airline and government officials noted that both U.S. and EU 
pilots have negotiated scope clauses[Footnote 59] that limit the 
airline's ability to substitute workers from lower-wage subsidiaries 
for its current workforce (i.e., engage in "labor substitution"). 
Moreover, available evidence suggests that the creation of the EU's 
single market has not led to labor substitution.[Footnote 60] A report 
by the UK Civil Aviation Authority stated that, since EU aviation 
deregulation and the creation of a single market, the United Kingdom 
had not had any airlines reflagging to a more lax regulatory regime or 
workers displaced by cheaper workers from other countries in the EU, 
nor had any UK airlines lost any market share to airlines from lower-
wage EU countries, despite the fact that the United Kingdom is one of 
the higher-wage EU countries.

While there currently appears to be little evidence of serious 
consideration of relocation or establishment of subsidiaries for access 
to low-wage labor, the removal of the nationality clause restrictions 
and the accession of 10 lower-wage member states into the EU does 
change the market dynamic. EU labor groups said that the benefits of 
relocating business operations among the 15 countries that comprised 
the EU prior to May 2004 were limited, since there was not a large wage 
and social cost disparity between them. Now, the disparities are 
greater. In addition, one U.S. labor representative said that, while 
there initially may be little economic incentive for established 
transatlantic EU airlines to move their operations to countries with 
lower costs and labor standards, new entrants could use the change in 
regulatory structure to gain a competitive advantage. Furthermore, over 
time, there may be economic incentives for established EU airlines to 
move their principal places of business or to establish subsidiaries in 
countries with lower labor standards. Some airline officials cite low-
cost carrier Ryanair as an example of a carrier that is taking 
advantage of the fact that the EU's single market is still governed by 
individual member states' labor laws, and that pay and working 
conditions are not subject to collective labor agreements at the 
European level.

Because of this concern, U.S. labor representatives have proposed that 
certain protections be included in any draft U.S.-EU agreement that 
would reduce the incentive for airlines to take advantage of "flags of 
convenience." One proposal would be to include a definition of 
"principal place of business" in the draft to help clarify which set of 
laws would be applied to a given carrier. Including this definition 
would make it harder for major EU airlines to establish subsidiaries in 
lower labor standard countries and have those laws applied to them. 
Setting this standard would also clarify which country would be 
responsible for overseeing and enforcing safety and security 
requirements for the airlines.

The success of low-cost carriers like Ryanair and Southwest raises the 
question of whether existing low-cost carriers could successfully 
compete in the transatlantic market. Typically, low-cost carriers have 
succeeded in the domestic market by providing point-to-point service, 
often at less congested airports. These airlines achieve their 
comparative cost advantages through lower operational costs (often 
gained through using a single aircraft type), and greater productivity. 
Recently, low-cost carriers have begun to compete with network airlines 
by offering long-haul (transcontinental) service. Under current Open 
Skies agreements, both U.S. and EU low-cost carriers can provide 
nonstop flights between the U.S. and the home countries of the EU low-
cost airlines. However, it is unclear how low-cost carriers would 
compete on transatlantic routes. Key aspects of the low-cost carrier 
business model, notably the higher relative productivity of labor and 
aircraft and the use of a single fleet type, are more difficult to 
achieve on transatlantic routes.

Concluding Observations: 

A new aviation agreement without nationality-based restrictions between 
the United States and the EU could create additional benefits for 
consumers and airlines, but would require oversight from antitrust 
authorities to ensure that the benefits of more open markets in the EU 
accrue to the traveling public. The existing bilateral aviation 
agreements between the United States and individual EU countries would 
need to be modified to resolve legal concerns within the EU, namely the 
nationality clause. Depending on the outcome of negotiations between 
the United States and the EU, the changes could be relatively minor or 
could result in a comprehensive opening of the U.S. and EU markets. 
With a new agreement that removed the nationality clause restrictions 
and expanded the Open Skies framework, U.S. consumers and airlines 
could benefit from increased access to new destinations within the EU, 
lower fares from more efficient route networks, and potentially more 
competitive routes. As discussed in this report, such benefits may be 
limited because the current alliance structure and bilateral agreements 
already provide many benefits, and because congestion and limited 
access to key airports may mitigate or delay the potential benefits. 
Resolving the EU legal concern over the nationality clause could lead 
to continued consolidation among airlines within the EU and potentially 
stronger ties between U.S. and EU airlines. However, mergers such as 
that between Air France and KLM raise questions about their impact on 
U.S. consumers because of their antitrust-immune alliance partnerships 
with U.S. airlines. For example, how might the Air France-KLM merger 
affect the international operations of their U.S. partners, Delta, 
Continental and Northwest? In evaluating the potential effects of such 
a scenario, how would regulators separate the effects or influences of 
airlines' international operations from their domestic operations? 
Since other major U.S. airlines participate in alliances with EU 
airlines, further European industry consolidation would continue to 
raise such questions.

In the absence of any significant competitive pressure from low-cost 
carriers flying between the United States and the EU, there is a risk 
that beneficial elements of potential restructuring could be offset by 
a reduction in competition between alliances. Antitrust authorities in 
the United States and EU will need to be vigilant to safeguard the 
benefits that could accrue from the changing market structure.

The net effect on airlines and consumers will depend on (1) when and to 
what extent U.S. airlines might gain access to markets that are now 
restricted, and (2) the business strategies that U.S. and EU airlines 
adopt. Obviously, the outcomes of any of these developments cannot be 
predicted. For example, low-cost airlines-which have often been a 
source of innovation-may find ways to alter their traditional business 
plans in ways that would make them a competitive alternative to major 
network carriers in transatlantic service. Past experience has shown 
that removing government restrictions on aviation (e.g., through 
domestic deregulation or Open Skies agreements) provided benefits to 
consumers, airlines, and the industry's workforce. Because those 
significant benefits have already been realized, the benefits 
associated with additional liberalization of the U.S.-EU markets should 
be similar in nature but incremental in scope. It appears that the 
greatest source of likely benefits to both U.S. airlines and consumers 
lies in gaining de facto access to London's Heathrow Airport. How the 
benefits from access to such restricted markets may compare to those 
already realized from the other 15 Open Skies agreements ultimately 
depends on the extent of the increase in competition and changes in 
airline operations and passenger traffic.

Agency Comments and Our Evaluation: 

We provided a draft of this report to DOT and State for their review 
and comment. Neither DOT nor State offered written comments, but did 
provide technical corrections, which we incorporated as appropriate. In 
oral comments, DOT's Deputy Assistant Secretary, Office of the 
Assistant Secretary for Aviation and International Affairs, noted that 
concluding a new agreement with the EU that would further liberalize 
transatlantic aviation would provide significant benefits to consumers, 
airlines, communities, and labor interests on both sides of the 
Atlantic. DOT believes that establishing a regional air transport 
agreement between the United States and the 25 members of the EU would 
establish a template for a more competitive aviation regime on a 
worldwide basis. Finally, DOT noted that it remains committed to 
achieving that goal and securing the benefits that it could bring. We 
also provided selected portions of a draft of this report to the 
European Commission; airlines; BAA, plc; the Airline Pilots 
Association; and other groups cited to verify the presentation of 
factual material. We incorporated their technical clarifications as 
appropriate.

Unless you publicly announce the contents of this report earlier, we 
plan no further distribution of this report until 30 days from the date 
of this letter. At that time, we will provide copies to relevant 
congressional committees; the Honorable Norman Y. Mineta, Secretary of 
Transportation; the Honorable Colin L. Powell, Secretary of State; and 
other interested parties, and will make copies available to others upon 
request. In addition, this report will be available at no charge on the 
GAO Web site at [Hyperlink, http://www.gao.gov]. If you have any 
questions about this report, please contact me or Steve Martin at 202-
512-2834. Other major contributors are listed in appendix VI.

Signed by: 

JayEtta Z. Hecker, 
Director, Physical Infrastructure Issues: 

[End of section]

Appendixes: 

Appendix I: Scope and Methodology: 

At the request of the Chairman and Ranking Minority Member of the 
Senate Committee on Commerce, Science, and Transportation, and the 
Chairman and Ranking Minority Member of that Committee's Subcommittee 
on Aviation, we examined three issues relating to potential changes to 
existing Open Skies aviation agreements with European Union member 
states. Specifically, our objectives were to answer the following 
questions: (1) how prevalent are Open Skies agreements between the 
United States and EU nations, and what has been their effect on 
airlines and consumers; (2) what are the key ways that commercial 
aviation between the United States and EU could be changed by the Court 
of Justice decision; and (3) how might the elimination of nationality 
clause restrictions in any new U.S.-EU agreement affect airlines and 
consumers?

To determine how prevalent Open Skies agreements are and what their 
effect on airlines and consumers has been, we reviewed prior research 
from Department of Transportation (DOT), the UK Civil Aviation 
Authority, the EU Directorate General Transport and Energy (DG TREN), 
and other aviation research organizations. We reviewed documents from 
the Department of State (State) to identify the EU member nations with 
Open Skies agreements and reviewed the five bilateral agreements the 
United States has with 5 of the 10 non-Open Skies EU member nations. 
(The United States does not have any relevant aviation agreements with 
Cyprus, Slovenia, Estonia, Latvia, or Lithuania.) We interviewed 
officials from these agencies to confirm that the information in these 
documents and reports were correct.

To determine the effect of Open Skies, we looked at the growth of 
transatlantic passenger and freight traffic, and we analyzed historical 
data on airline passenger and freight traffic. We used DOT's T-100 on-
flight data to determine the total number of passengers and the total 
weight of freight and mail volumes that flew between the United States 
and the EU from 1990 to 2002. U.S. and foreign airlines are required to 
report all nonstop segments in which at least one point is in a U.S. 
state or territory.[Footnote 61] To facilitate analysis of the T-100 
data, we contracted with BACK Aviation Solutions (BACK), an aviation-
consulting firm. BACK obtains the DOT data and makes certain 
adjustments to these data, such as correcting recognized deficiencies 
in the airlines' data submissions, when these submissions have not met 
DOT's standard of 95-percent accuracy.

To determine the reliability of DOT's T-100 data and BACK's product, we 
(1) reviewed existing documentation from DOT and BACK about the data 
and the systems that produced them, (2) interviewed knowledgeable 
agency and company officials, and (3) performed electronic tests of the 
data. We concluded that the data were sufficiently reliable for the 
purposes of this report.

To determine the amount of nonstop or connecting service available 
between selected U.S.-EU markets,[Footnote 62] we analyzed airline 
flight schedule information submitted to Innovata by U.S. and EU 
airlines for May 2004. Innovata, whose clients include all major North 
American airlines, maintains comprehensive airline schedule data files 
based on information they collect, verify, and aggregate from the 
airlines. We purchased and accessed Innovata data through Sabre's 
FlightBase airline scheduling software. To determine the reliability of 
the Innovata data and Sabre's product, we (1) reviewed existing 
documentation from Innovata and Sabre about the data and the systems 
that produced them, (2) interviewed knowledgeable company officials, 
and (3) performed electronic tests of the data. We concluded that the 
data were sufficiently reliable for the purposes of this report.

When analyzing the scheduled service in markets, we selected the 
largest U.S. and EU airports in terms of passenger traffic, based on 
airport categorization by the Federal Aviation Administration (FAA) and 
the Airports Council International.[Footnote 63] While this does not 
include all airports within the United States or EU, the U.S. airports 
selected accounted for 96.6 percent of the total U.S. passenger traffic 
in 2002, and EU airport officials stated the EU airports selected 
comprised the major European airports. We also used the May 2004 
schedule data to examine the number of competitors within a given 
airline market. DOT has in the past defined a "competitor" as an 
airline or alliance that has a market share of at least 10 percent of 
available flights. As in prior reports on the effects of changes in 
competition of proposed mergers or alliances, we adopted that 10 
percent threshold. To determine the number of competitors within each 
market, we identified the best level of service provided and the 
competitive alternative.[Footnote 64] For example, if a market has 
nonstop service, that would be considered the best level of service. 
However, one stop/single on-line connecting service may be a valid 
competitive alternative to nonstop in some markets (e.g., among the 
subset of passengers who are not time-sensitive or may be more 
sensitive to prices).[Footnote 65] Therefore, when the best level of 
service is nonstop, to determine the number of competitors, we counted 
all airlines that provided either nonstop service or one stop/on-line 
single connecting service. For markets where the best level of service 
is one stop/on-line single connecting service, we counted airlines that 
provided two stop/on-line double connecting service as additional 
competitors.

To determine what the key ways are that commercial aviation between the 
United States and EU could be changed by the Court of Justice decision, 
we interviewed officials from DOT, State, DG TREN, the European Union 
Directorate General for Competition (DG COMP), France, Germany, the 
Netherlands, and the United Kingdom, as well as from U.S. and EU 
airlines, EU airports, and EU aviation trade associations. We discussed 
the implications for European airlines of changes to the nationality 
clause in existing Open Skies agreements. We also discussed congested 
airport facility access and environmental regulations to better 
understand carrier access to EU airports. We reviewed reports 
recommended by aviation authorities from the European Commission, 
Germany, Britain and the Netherlands. Finally, we also discussed with 
EU officials the EU process for airline certification, establishment, 
and operations.

To analyze the potential effect of removing the nationality clause 
restrictions on consumers and airlines, we interviewed officials from 
DOT, State, DG TREN, DG COMP, France, Germany, the Netherlands, and the 
United Kingdom, as well as from U.S. and EU airlines, U.S. and EU 
airports, and EU aviation trade associations. We also conducted a 
review of existing research and analyzed airport capacity and demand 
data from Airport Coordination Limited. These data contain the number 
of slots available at London's Heathrow airport and the demand for 
these slots by airlines. Based on logical tests for obvious errors of 
completeness and accuracy, we determined that the data were 
sufficiently reliable for our purposes. To analyze the potential labor 
effects, we interviewed officials from major U.S. and EU airlines, U.S. 
and EU labor unions, the EU Directorate General for Employment, labor 
research organizations, and U.S. and EU agencies.

We also conducted a review of existing research and analyzed data from 
DOT's "Form 41" database. This database contains financial information 
that large air carriers are required by regulation to submit to DOT 
(see 49 C.F.R. Sec. 241). Airlines submit financial data monthly, 
quarterly, semiannually, and annually to DOT with financial and 
operating statistics. To facilitate analysis of these data, we 
contracted with BACK, an aviation-consulting firm. BACK obtains the DOT 
data and makes any necessary adjustments to these data to improve their 
accuracy. To determine the reliability of DOT's Form 41 data and BACK, 
we (1) reviewed existing documentation from DOT and BACK about the data 
and the systems that produced them, (2) interviewed knowledgeable 
agency and company officials, and (3) performed electronic tests of the 
data. We concluded that the data were sufficiently reliable for the 
purposes of this report.

We also reviewed an industry survey of pilot contracts that included 
wages and benefits for pilots and pilots of different seniority levels, 
by airline. The Association of European Airlines (AEA) provided 
employment information for 15 member airlines. Based on interviews with 
knowledgeable AEA officials and logical tests for obvious errors of 
completeness and accuracy, we determined that the data were 
sufficiently reliable for our purposes.

We conducted our work from October 2003 through July 2004 in accordance 
with generally accepted government auditing standards.

[End of section]

Appendix II: Air Freedoms: 

[See PDF for image]

[End of figure]

[End of section]

Appendix III: Cargo Carriers: 

While U.S. cargo carriers have also benefited from the 15 Open Skies 
agreements the United States has signed with EU member nations, the 
European Court of Justice ruling also affects these carriers. Since 
1990, U.S. cargo carriers have experienced a significant increase in 
volume and operations with the development of a large hub-and-spoke 
network. With a new agreement that extended the Open Skies framework, 
U.S. cargo carriers would also likely gain additional traffic rights 
into markets that are currently restricted. There are unique cargo 
carrier issues that are not directly linked to the nationality clause, 
however, and these issues do present concerns to U.S. cargo carriers. 
Because U.S. cargo carriers rely heavily on night operations, attempts 
by local communities in EU member states to impose additional 
restrictions on night flight operations could have an effect on U.S. 
cargo carriers.

U.S. Cargo Carriers Have Increased Their North Atlantic Operations 
Since Open Skies: 

Similar to the increase in passenger service, cargo service also 
experienced a significant increase in volume and operations since the 
inception of Open Skies agreements. Freighter operations for all 
carriers flying between the United States and EU increased more then 75 
percent from 1990 levels to over 20,000 flights in 2002 (see fig. 
12).[Footnote 66] Using "fifth freedom" rights provided by Open Skies, 
FedEx and United Parcel Service (UPS)--the largest U.S. all-cargo 
carriers--expanded operations through hub-and-spoke networks in Paris 
and Cologne. FedEx currently operates three daily flights from the 
United States to Paris, one to Frankfurt, and one to London (Stanstead 
Airport); UPS operates five daily flights from the United States into 
its European hubs (Cologne, Germany; East Midland, United Kingdom; and 
Paris, France). These increased freighter operations carried more than 
double the 1990 freight and mail volumes, so that by 2002 freighters 
carried over 2.5 billion pounds between the United States and the EU.

Figure 10: Freighter Operations for All Carriers Flying between the 
United States and the EU, 1990-2002: 

[See PDF for image]

[End of figure]

Fifth Freedom Rights: 

With the removal of the nationality clause restrictions, U.S. airlines 
would gain "fifth freedom rights" (i.e., the right to operate flights 
from the United States to an EU country and then beyond to another 
country) in EU member states with restrictive bilateral agreements. For 
example, under "fifth freedom rights," FedEx is able to transport cargo 
from Memphis to Paris, deposit some or all of it in Paris, and then 
pick up new cargo and fly it to Frankfurt. While all U.S. cargo 
carriers have fifth freedom rights under current Open Skies agreements, 
under the more restrictive bilateral agreements, such as the agreement 
with the United Kingdom, these rights are limited.

UPS and FedEx make extensive use of fifth freedom rights in many of the 
EU countries where they have such rights. Under the Bermuda 2 
agreement, when U.S. cargo carriers operate a flight from the United 
States that stops both in the United Kingdom and an airport in 
continental Europe, that flight is restricted from using some fifth 
freedom rights to pick up cargo in the United Kingdom and transport it 
on to the continental destination. For example, FedEx schedules a daily 
flight from its hub in Newark to its hub in the United Kingdom, and 
this flight then continues on to Paris. Under the current agreement, 
FedEx is allowed to drop off cargo in the United Kingdom, but it is not 
allowed to pick up cargo in the United Kingdom and transport it to 
Paris. Instead, the plane must travel to France only partly loaded 
(that is, with the Paris-bound cargo that originated in the United 
States). Cargo that FedEx receives in the United Kingdom for shipment 
to Europe must be shipped using a separate charter service. This 
increases FedEx's operating costs. A new agreement would remove these 
restrictions and allow FedEx to utilize its network more efficiently.

Lack of EU Enforcement Ability on Noise Regulations May Affect U.S. 
Cargo Carriers: 

Increased restrictions on night flight operations could potentially 
adversely affect the ability of U.S. cargo carriers to operate. At a 
number of EU airports, local communities are seeking, for environmental 
reasons, to restrict the extent of night operations. At Frankfurt, for 
example, German officials are in the process of attempting to ban all 
nighttime operations at the Frankfurt airport and have cargo carriers 
move their operations to the Hahn airport--about 80 miles away. 
Restrictions on these nighttime operations would compromise U.S. cargo 
carriers' operations.

If cargo carriers need to limit their nighttime operations or move them 
to other locations, the impact on U.S. cargo carriers could be 
significant, since they have invested substantial financial resources 
to develop their distribution networks and airport facilities. For 
example, FedEx has invested over $200 million to develop its operations 
at the Charles de Gaulle, Stansted, and Frankfurt airports. UPS also 
has invested significant sums in its facilities at Cologne, Germany. 
Therefore, changes in night flight regulations could effectively 
devalue these investments by reducing the ability of these companies to 
fully utilize their networks and facilities. In particular, if FedEx 
were forced to relocate its Frankfurt operations to Hahn, the value of 
its Frankfurt facilities would be diminished. FedEx officials indicated 
that if a night ban was enacted, it would limit them with regards to 
expanding future operations. In addition, if an airport restricted 
aircraft from landing after midnight, it would force U.S. cargo 
carriers to eliminate either late pickups or early deliveries. Both 
FedEx and UPS highlighted this as a huge competitive disadvantage.

The EU has little direct influence in local attempts to invoke such 
restrictions, as such actions remain a local-and country-specific 
matter. Although the EU issued a directive in 2002 on the establishment 
of rules and procedures with regard to noise-related operational 
restrictions at EU airports, all actual regulations are established and 
implemented by the individual member states.[Footnote 67] The EU 
directive supports the ICAO "balanced approach," which outlines a 
standard set of procedures for establishing aircraft noise 
regulations.[Footnote 68] This approach and the EU directive attempt to 
harmonize the procedures used by individual member states. However, 
since the pressure to restrict night operations usually originates with 
local communities surrounding airports, local governments have enacted 
night flight restrictions in compliance with local citizen demands or 
local government regulations. Therefore, noise restrictions can greatly 
vary between member states. If aviation stakeholders feel that member 
states have not followed the procedures established under the ICAO 
"balanced approach," they can appeal to the EU. If the EU rules in 
favor of the aviation stakeholder, the member state is required to 
amend the regulation. However, according to EU officials, under EU law, 
during the infringement proceedings, there is no requirement for the EU 
member states to stop or delay these noise regulations. Officials 
stated that, while the EU does not have any enforcement mechanisms and 
the infringement procedure is more of a political pressure tool, the EU 
treaty does provide for accelerated procedures once the procedure is 
placed on the Court of Justice agenda.

[End of section]

Appendix IV: Current International Airline Alliances: 

Global alliance: oneworld; 
Alliance airlines: Aer Lingus, American, British Airways, Cathay 
Pacific, Finnair, Iberia, LanChile, Qantas; 
Annual passengers (millions): 218.4; 
Number of cities served: 573; 
Airlines with antitrust immunity: American, Finnair; 
EU Open Skies countries: Finland.

Global alliance: SkyTeam; 
Alliance airlines: Aero Mexico, Air France, Alitalia, CSA Czech 
Airlines, Delta, Korean Air; 
Annual passengers (millions): 212; 
Number of cities served: 500; 
Airlines with antitrust immunity: Delta, Air France, Alitalia, CSA 
Czech Airlines, Korean Air; 
EU Open Skies countries: France, Italy, Czech Republic.

Global alliance: Northwest - KLM; 
Alliance airlines: Northwest, KLM; 
Annual passengers (millions): N/A; 
Number of cities served: N/A; 
Airlines with antitrust immunity: Northwest, KLM; 
EU Open Skies countries: Netherlands.

Global alliance: Star; 
Alliance airlines: Air Canada, Air New Zealand, ANA, Asiana Airlines, 
Austrian, bmi, LOT Polish Airlines, Lufthansa, Mexicana, SAS, Singapore 
Airlines, Spanair, Thai Airlines, United, US Airways, Varig; 
Annual passengers (millions): 360; 
Number of cities served: 680; 
Airlines with antitrust immunity: United, Lufthansa, Austrian, SAS, 
Air Canada, Air New Zealand, Asiana; 
EU Open Skies countries: Germany, Denmark, Sweden, Austria. 

Source: U.S. Department of Transportation, U.S. Department of State, 
oneworld alliance, Star alliance, Northwest Airlines, and SkyTeam 
alliance.

[End of table]

[End of section]

Appendix V: Air France-KLM Merger: 

A major consolidation event--the recently approved Air France-KLM 
merger--is already occurring within the framework of existing Open 
Skies agreements. This merger involves two airlines owned and 
controlled by national citizens from countries that had both signed 
Open Skies agreements with the United States. It has been structured in 
such a way as to protect the traffic rights granted under bilateral 
agreement for each airline.[Footnote 69] This meant that the merger 
needed to include a series of corporate governance and ownership 
adjustments not normally found in a traditional merger. For example, 
the actual merger includes a 3-year transitional shareholding structure 
that will ensure that majority ownership of Air France is with French 
citizens and that the majority ownership of KLM is under Dutch 
citizens. The basic structure attempts to preserve the brands and 
identity of each airline by establishing a French holding company, Air 
France-KLM, which will own 100 percent of the economic rights for both 
Air France and KLM.[Footnote 70] To protect KLM's traffic rights, Air 
France-KLM will only control 49 percent of the voting rights, with 51 
percent being held by Dutch foundations and the Dutch government. After 
3 years, the Air France-KLM holding company will own 100 percent of 
both airlines. European officials believe that the EU's February 2004 
approval of the Air France-KLM merger signals the start of 
consolidation of the European aviation industry. If a new U.S.-EU 
agreement eliminates the nationality clause restrictions, the need to 
structure mergers to protect traffic rights across the north Atlantic 
will likely be eliminated.

Mergers among major European airlines will inevitably raise questions 
about how existing global alliances will be affected. Because of the 
alliance with U.S. partners, mergers will exert effects on U.S. 
airlines and consumers. Air France and KLM are in separate alliances 
with different major U.S. airlines (Delta and Northwest, respectively), 
and DOT has granted antitrust immunity to both of these alliances. In 
addition, Delta, Northwest, and Continental agreed to a major domestic 
code-sharing partnership in 2002, which was permitted with certain 
conditions by DOT.

[End of section]

Appendix VI: GAO Contacts and Staff Acknowledgments: 

GAO Contacts: 

JayEtta Z. Hecker (202) 512-2834 Steven C. Martin (202) 512-2834: 

Acknowledgments: 

In addition to those named above, Amy Anderson, David Hooper, Jason 
Kelly, Joseph Kile, Grant Mallie, Sara Ann Moessbauer, Tim Schindler, 
Stan Stenersen, John Trubey, and Matt Zisman made key contributions to 
this report.

(544082): 

FOOTNOTES

[1] The European Union was initially established with 6 countries under 
the Treaty of Paris (1951) and the Treaty of Rome (1957), which set the 
ground rules for the European Union. These founding treaties have since 
been amended by the Single European Act (1986), the Treaty of the 
European Union (Maastricht 1992), the Treaty of Amsterdam (1997), and 
the Treaty of Nice (2001). The EU now has 25 member countries. EU 
countries have reached EU-wide agreement in certain policy areas and 
operate as a single economic market. 

[2] Under current Open Skies agreements, airlines are allowed to 
provide service from other "Open Skies" nations into the United States; 
however, such flights must be continuations of flights that originate 
in the airline's home country.

[3] The Fly America Act, 49 U.S.C. App. 40118, as implemented in 
General Services Administration regulation 41C.F.R. section 301-10.131 
et seq., requires federal employees and their dependents, consultants, 
contractors, grantees, and others performing U.S. government financed 
foreign air travel to travel by U.S. airlines.

[4] In the airline industry, a market has been defined as scheduled 
airline service between a point of origin and a point of destination. 

[5] Under current Open Skies agreements, Air France is allowed to 
provide service from other "Open Skies" nations into the United States; 
however, this service must be a continuation of a flight that 
originates in a French city, flies to a city in another EU nation, and 
then continues on to a destination in the United States. (The right to 
conduct such connecting flights are included within the Open Skies 
agreements.) The same is true for other airlines that are owned and 
controlled by citizens of Open Skies nations.

[6] European University Institute, Enlarging the European Union: 
Achievements and Challenges (Mar. 26, 2003).

[7] Prior to the establishment of a single EU internal market, European 
aviation was governed by individual bilateral agreements between pairs 
of European nations. These bilateral agreements normally restricted the 
airlines that could provide service, the number that could provide 
service, the level of service, and the fares airlines could charge. 
European deregulation included eventual "cabotage rights" that allowed 
any EU airline to provide domestic service within any EU member state. 
(Cabotage refers to operations in which an airline of one country 
operates flights and carries traffic solely between two points in a 
foreign country.) The EU has international agreements with three other 
European countries. It has a bilateral air services agreement with 
Switzerland providing for comprehensive liberalization of air services, 
except cabotage, and through the European Economic Area Agreement, 
Iceland and Norway are fully included in the EU air transport market, 
including cabotage. 

[8] These traffic rights and nine freedoms are shown in appendix II. 

[9] The U.S. permits up to 25 percent foreign ownership of voting stock 
in U.S. airlines (49 USC 40102); the EU permits up to 49 percent 
foreign ownership of its airlines. The administration has proposed 
raising the existing U.S. limits to match the EU's. 

[10] Under these common rules, all air carriers licensed in the EU are 
considered to be "Community carriers" and have equal rights. Through 
their agreements with the EU, Switzerland, Norway, and Iceland have 
aligned their licensing systems with Community law.

[11] In the United States, once licensed and designated, an airline 
still must receive authorization from DOT to operate in specified 
international markets before it can provide the service. A foreign air 
carrier of a sovereign state desiring to conduct foreign air 
transportation operations into the United States files an application 
with the DOT for a foreign air carrier permit. Consistent with 
international law, bilateral agreements normally provide that a partner 
country must meet International Civil Aviation Organization (ICAO) 
safety oversight standards as a condition for service by its designated 
airline. FAA is also responsible for safety oversight of U.S. airlines 
and for ensuring that foreign countries comply with the ICAO standards. 
To assess a country's ability to meet this standard, the FAA 
established the International Aviation Safety Assessment (IASA) program 
in 1992. This program focuses on ensuring that a foreign country 
adheres to international standards and recommended practices for 
aircraft operations and maintenance established by the ICAO. 

[12] While Open Skies provides expanded traffic rights, airlines may be 
limited in exercising these rights due to restrictive bilateral 
agreements with other nations. For example, Russia might not allow a 
U.S. carrier to pick up passengers in Frankfurt and carry them on to 
Moscow, even though the U.S. Open Skies agreement with Germany would 
permit such operations to points beyond Germany.

[13] In addition to these nationality restrictions, both Open Skies 
agreements and traditional bilateral agreements permit one country to 
deny permission to operate to airlines designated by the other country 
if those airlines are not substantially owned and effectively 
controlled by its citizens. However, some Open Skies agreements do 
allow cargo carriers to operate seventh freedom rights.

[14] The Multilateral Agreement on the Liberalization of International 
Air Transportation was signed in 2001. Since then, Peru, Tonga and 
Samoa have also acceded to the agreement.

[15] For additional information on the operations and recent financial 
success of low-cost airlines, see U.S. General Accounting Office, 
Commercial Aviation: Despite Industry Turmoil, Low-Cost Airlines Are 
Growing and Profitable, GAO-04-837T (Washington, D.C.: June 3, 2004).

[16] In May 2004, 10 European nations were accepted into the EU: 
Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, 
Poland, Slovakia, and Slovenia. Czech Republic, Malta, Poland, and 
Slovakia had already signed Open Skies agreements with the United 
States prior to their entry into the EU.

[17] "Code-sharing" refers to the practice of airlines applying their 
names--and selling tickets via reservations systems--to flights 
operated by other carriers.

[18] Interline fares are most frequently the sum of the fares charged 
by each airline for its segment of the itinerary. Even when tickets are 
purchased well in advance to take advantage of possible airline 
discounting, such fares tend to be considerably higher than on-line 
fares from the same origin to the same destination. 

[19] Many industry experts consider alliances as a second-best option 
to full mergers, because alliances do not allow the airlines to achieve 
the full range of cost savings through operational efficiencies that 
could be possible through a merger. Current restrictions on foreign 
ownership and control limit the extent to which airlines can pursue 
international mergers.

[20] On-line service provides passengers with connecting flights 
without requiring them to change airlines. Similar conveniences can be 
obtained between two airlines that have "interline" agreements. 
Although interline agreements do not incorporate fare coordination, 
they may provide for the mutual acceptance by the participating 
airlines of passenger tickets, baggage checks, and cargo waybills, as 
well as establish uniform procedures in these areas.

[21] U.S. law gives the Secretary of Transportation the authority to 
grant immunity from U.S. antitrust laws to agreements in foreign air 
transportation. In general, the antitrust laws are designed to protect 
consumers by prohibiting competitors from colluding and engaging in 
such anticompetitive behavior as jointly setting prices (commonly 
referred to as "price fixing"). The Secretary may grant immunity if an 
agreement is in the public interest and is necessary to permit 
implementation of an approved cooperative agreement. The Department of 
Justice (DOJ) role is advisory, and its analysis is performed pursuant 
to the Sherman Antitrust Act and the Clayton Act, which set forth 
antitrust prohibitions against restraints of trade. For the European 
Union, the Directorate General Competition (DG Comp) is responsible for 
enforcing Articles 81 and 82 of the EC Treaty, which prohibit 
activities that fix prices, limit production, or exercise market 
dominance to distort competition.

[22] While the signing of an Open Skies agreement does not guarantee 
that airlines from signatory nations will be granted antitrust 
immunity, Open Skies is now a requirement for antitrust immunity. For 
example, DOT approved antitrust immunity for the alliance between Delta 
Air Lines and Air France after France signed an Open Skies agreement 
with the United States in 2002.

[23] DOT, International Aviation Developments: Global Deregulation 
Takes Off (Washington, D.C.: Dec. 1999) and Transatlantic Deregulation: 
the Alliance Network Affect (Washington, D.C.: Oct. 2000).

[24] We limited our analysis of scheduled service to airports serving 
larger communities in both the United States and EU. In the United 
States, we included only airports defined as Large, Medium, or Small 
hubs. Large hubs are statutorily defined as having 1 percent or more of 
all annual passenger boardings at primary U.S. airports, medium hub 
airports as having between 0.25 percent and 0.99 percent of boardings, 
and small hubs as having between 0.05 percent and 0.249 percent of 
boardings. In the EU, we included only airports defined as Category 1, 
2, or 3 hubs. The Airports Council International defines Category 1 
airports as having more than 2 million boardings per month, Category 2 
as having between 1 million and 2 million boardings per month, and 
Category 3 as less than 1 million boardings per month. For additional 
information on this analysis, see appendix I.

[25] In our analysis of the number of competitors serving particular 
markets, we first determined the best level of service available in 
each market and then calculated the number of competitors in each 
market. For example, in any given market, competing airlines may offer 
nonstop, single-connection, or double-connection flights. The double-
connection would not be considered a truly competitive alternative to 
the nonstop flight. However, single-stop service may be considered a 
viable competitive alternative. Thus, Continental, American, and Delta, 
which all offer single on-line connections between San Francisco and 
Frankfurt, would all be considered competitors to United, which offers 
nonstop service. In this case, we categorize the San Francisco-
Frankfurt market among the nonstop markets, and count it as having four 
competitors. Similar to definitions used in the past by DOT and the 
Department of Justice, we defined an airline as being "competitive" in 
a market if it provided at least 10 percent of scheduled capacity. If 
alliance partners with antitrust immunity both served a market, we 
combined their capacity and identified the alliance (not individual 
airlines) as being one competitor. (For additional information, see 
app. I.)

[26] Prior to alliances, passengers could travel between two smaller 
markets using two different airlines that did not offer any 
coordination of schedules or pricing. Each airline priced its own 
segment of the trip, to maximize its own profits without considering 
the opportunities for both carriers to jointly profit. The lack of 
coordination also required separate ticketing and baggage processing. 
As airlines began code-sharing, they offered coordinated on-line 
services with conveniences preferred by passengers. 

[27] As indicated by the European Council's rejection of the June 2004 
draft agreement, additional issues can be linked to the new accord, 
such as changes in limits of allowable foreign ownership of U.S. 
airlines or providing EU carriers with cabotage rights within the 
United States. 

[28] The EU mandate does not include negotiating new route rights 
beyond the EU.

[29] U.S. General Accounting Office, International Aviation: 
Competition Issues in the U.S.-U.K. Market, GAO/T-RCED-97-103 
(Washington, D.C.: June 4, 1997).

[30] A slot is a specific time when airlines are allowed to take-off 
and/or land. 

[31] Several officials from the EU, EU members states, and EU airlines 
suggested that, to balance the fifth freedom rights within the EU that 
U.S. airlines would gain, they should be allowed to operate 
continuation flights within the United States. For example, after 
deplaning passengers at Washington Dulles International Airport, a 
British Airways flight arriving from Heathrow should be allowed to 
continue to St. Louis. The return flight to London would thus originate 
in St. Louis and stop in Washington. On such flights, British Airways 
could carry local St. Louis-Washington passenger traffic. U.S. 
officials note, among other things, that such operations would 
constitute "consecutive or fill-up cabotage" (so-called "eighth 
freedoms") not equal to the fifth freedoms already negotiated with EU 
member states. Such operations would require a change in U.S. law. We 
excluded analyses of the potential effects of such cabotage from this 
report.

[32] EU airlines would still need to obtain formal DOT approval to 
operate into the United States.

[33] Air France can use its fifth freedom rights to provide service 
between Italy and the United States only if that flight originates in a 
French city, stops in Italy, and then continues to the United States.

[34] The EU recently approved the merger of Air France and KLM under 
the current Open Skies agreements. For details on this merger see 
appendix V. 

[35] Several officials noted, however, that because EU member states 
continue to have restrictive bilateral agreements with other important 
airline markets (i.e., Japan and China) that continue to include 
nationality clauses, consolidation would still jeopardize those traffic 
rights.

[36] Since the liberalization of air transport inside the EU in 1993, a 
number of European airlines have established or purchased subsidiaries 
in countries other than their own, including British Airways (in France 
and Germany), KLM (in the United Kingdom), Ryanair (in the United 
Kingdom), and SAS (in Spain and Finland). 

[37] Moving operations, creating subsidiary airlines, or establishing 
new airlines would be subject to satisfying the licensing and safety 
authorities in their home country and the receiving country that such a 
change would not compromise safety standards and other regulatory 
requirements. 

[38] Issues relating to safety and security regulatory oversight are 
obviously critical to any comprehensive analysis of aviation. Because 
of the magnitude of these issues, however, we agreed at the outset to 
leave them beyond the scope of this report. For additional information 
on limitations to the scope of this work, see appendix I.

[39] Organization for Economic Co-operation and Development, 
Liberalization of Air Cargo Transport (May 2, 2002).

[40] Slots generally become available in three ways. First, airlines 
can lose any slot they do not use at least 80 percent of the time. 
Second, if an airline fails, it must surrender its slots. Third, slots 
can be created based on technical improvements in operations, either on 
the ground or in air traffic control. Examples of such improvements 
include shortening the time aircraft spend on the runway or smoothing 
the peaking of demand within an hour. 

[41] Each EU nation's slot coordinator is responsible for managing the 
slot allocation process for operations at one or more of the country's 
airports.

[42] EU regulations also generally grant priority consideration for 
slots to airlines meeting certain conditions. For example, an airline 
would receive priority consideration for slots if it holds less than 5 
percent of the slots at an airport and is seeking to use those slots to 
provide service to an EU market in which two or fewer other airlines 
compete. Incumbent airlines already having relatively large slot 
holdings are not allowed to qualify for such priority consideration.

[43] 25 March 1999, in R v Airport Co-ordination Limited ex parte. The 
States of Guernsey Board of Transport.

[44] Prior to 1991, Virgin Atlantic was not allowed to use Heathrow, 
but instead was required to use Gatwick. As part of the revision of the 
bilateral agreement in 1991 between the United States and United 
Kingdom, Virgin Atlantic was allowed to transfer much of its service 
from Gatwick to Heathrow.

[45] Some of the 45 parking stands will be "remote" stands rather than 
stands accessed via a pier and Jetway.

[46] BAA, plc, is a private airport company that owns seven UK 
airports, including Heathrow, Gatwick, and Stansted, and has interests 
at 13 airports overseas.

[47] Heathrow currently limits the use of its two runways so that one 
is used only for takeoffs and the other is used only for landings. 

[48] United Kingdom Department of Transport, The Future of Air 
Transport (Dec. 2003).

[49] National Economic Research Associates, Study to Assess the Effects 
of Different Slot Allocation Schemes: A Final Report for the European 
Commission, DG TREN (Jan. 2004).

[50] Slots are to be made available at Amsterdam, Paris, Lyon, Milan, 
or Rome. The EU stated that the surrendering of slots would enable 
rival airlines to start a service where competition would have been 
eliminated or significantly reduced, therefore preserving choice of 
airlines and competitive prices for European travelers. Air France and 
KLM have committed to surrender these slots. 

[51] In the "explanatory memorandum" to the proposal presented on 20 
June 2001 to revise the slot allocation rules, the European Commission 
stated that slots should be considered as "public goods" allocated to 
airlines to be used under certain conditions. Slots are created by 
decision of the State and exist only as long as "capacity is not 
sufficient to meet actual or planned operations." While EU regulation 
95/93 defines a slot as "the scheduled time of arrival or departure 
available or allocated to an aircraft movement on a specific date at an 
airport coordinated under the terms of this regulation," it did not 
create any ownership rights. The Phase I revision (Regulation 793/2004 
of 21 April 2004), which will be enacted on July 30, 2004, redefines 
slots to mean "the permission given by a coordinator in accordance with 
this Regulation to use the full range of airport infrastructure 
necessary to operate an air service at a coordinated airport on a 
specific date and time for the purpose of landing or takeoff as 
allocated by a coordinator in accordance with the Regulation."

[52] Dominance at an airport, in and of itself, is not anticompetitive. 
Nevertheless, research has consistently shown that dominated airports 
tend to have higher airfares than airports that have more competition 
from other airlines. An airline's dominance of an airport alone, 
however, does not demonstrate its market power. One important indicator 
of the possible exercise of market power is what is known as a "hub 
premium," which represents the extent to which fares to and from hub 
cities are higher than average fares on similar routes throughout the 
domestic route system. Dominated airports tend to have markets with 
higher airfares than airports that have more competition from other 
airlines. In 1999, the Transportation Research Board confirmed that 
dominated hub markets (i.e., markets where either the origin or the 
destination is a dominated hub) tend to have higher airfares than other 
markets. This is especially true in short-haul markets. Transportation 
Research Board, Entry and Competition in the U.S. Airline Industry: 
Issues and Opportunities, Special Report 255 (July 1999).

[53] See, for example, U.S. General Accounting Office, Airline 
Deregulation: Changes in Airfares, Service Quality, and Barriers to 
Entry, GAO/RCED-99-92 (Washington D.C.: Mar. 4, 1999).

[54] The Commission's 2002 industry report demonstrates that, at each 
major EU airport, there was a single alliance that dominated that 
airport.

[55] U.S. Department of Justice and Federal Trade Commission Revision 
to the Horizontal Merger Guidelines (Apr. 8, 1997).

[56] See, for example, U.S. General Accounting Office, Aviation 
Competition: Issues Related to the Proposed United Airlines-US Airways 
Merger, GAO 01-212 (Washington, D.C.: Dec. 15, 2000).

[57] Wim Kok, Enlarging the European Union: Achievement and 
Challenges," Report of Wim Kok to the European Commission (Mar. 2003). 
By comparison, Spain and Portugal had an average GDP per capita of 70 
percent of the existing EU.

[58] Ryanair also stations its personnel close to their European base 
of operations; however, all employees are contracted under Irish labor 
laws, regardless of where they are located. Additionally, according to 
a 2001 International Labor Organization study, there were at least 10 
other EU member states with higher nonwage costs than Ireland.

[59] Scope clauses are found in some union contracts that limit the 
company's ability to use code-sharing regional or international 
airlines for its flying.

[60] We did not conduct a direct wage or compensation comparison 
between U.S. and EU airline employees. While the compensation data for 
U.S. airline employees were relatively complete, the data for European 
airlines were frequently incomplete or not available. The social costs 
between the U.S. and EU also vary, and several officials told us that 
any comparison of wages or compensation between U.S. and EU airlines 
would not completely account for those differences.

[61] 14 C.F.R. Sec. 241 prescribes the collection of scheduled and 
nonscheduled service traffic data from the domestic and international 
operations of U.S. air carriers, while 14 C.F.R. Sec. 217 prescribes 
the collection of data from foreign air carriers. The schedules 
submitted by the air carriers to DOT under this requirement collect 
nonstop segment data and on-flight market information by equipment type 
and by service class. This report is known as the T-100 report. 

[62] In the airline industry, markets are generally defined in terms of 
service between a point of origin and a point of destination. Thus, a 
market is often, but not always, defined as a city pair. 

[63] U.S. airports are defined at 49 USC 47102 as large hub airports, 
medium hub airports, and small hub airports. Airports Council 
International defines the largest EU airports as having more than 2 
million passengers per month for Category 1 airports, between 1 million 
and 2 million boardings per month for Category 2 airports, and less 
than 1 million boardings per month for Category 3 airports. 

[64] Coding by best level of service meant that once a market was 
identified, it could not be recounted. For example, while the San 
Francisco to Frankfurt market has nonstop, single-connection and 
double-connection service, the market would be counted once as a 
nonstop market.

[65] For example, DOT's approval of the United-Lufthansa antitrust 
agreement (docket number OST-1996-1116) states, "for a significant 
number of travelers in long-haul markets not constrained by strict 
time-sensitivity, one-stop and connecting service can provide a 
reasonable substitute for nonstop service and should be considered as a 
competitive option for purposes of antitrust analysis."

[66] Freighters are airplanes that provide only cargo service.

[67] Directive 2002/30/EC of the European Parliament and of the Council 
of 26 March 2002 on the establishment of rules and procedures with 
regard to the introduction of noise-related operating restrictions at 
Community airports.

[68] ICAO Resolution A33/7 introduced the concept of a "balanced 
approach" to noise management. The "balanced approach" concept of 
aircraft noise management is composed of four principal elements and 
requires careful assessment of all different options to mitigate noise, 
including reduction of airplane noise at the source, land-use planning 
and management measures, noise abatement operational procedures, and 
operating restrictions, without prejudice to relevant legal 
obligations, existing agreements, current laws, and established 
policies.

[69] The Dutch government has an option allowing it to obtain 50.1 
percent of KLM's voting rights if its traffic rights are challenged as 
a consequence of the nationality of KLM's shareholders.

[70] Economic rights are defined as the right to collect dividends.

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