Don’t fear Air Canada’s market dominance

With Air Canada looking to acquire Air Transat, should air travellers fear higher prices as a result of an eventual consolidation? In a word, no.

The notion that companies with large market shares hurt consumers is based on the confusion of cause and effect. Companies with significant market shares may have managed to reach their position by being efficient, by increasing the quality of their products or services, and by reducing costs and thus prices.

When this is the case, high levels of concentration are not problematic for consumers – quite the contrary, as this entails access to cheaper goods of higher quality. More importantly, large market shares and the promise of substantial profits act as bait for innovators. Thus, large market shares are actually a sign of gains for consumers through innovation.

This is why economists have moved away from measuring competition merely through market shares or the number of companies in a given market. Instead, they tend to emphasize the “threat” of competition. A company that innovated faster than its competitors, allowing it to reduce prices and gain the loyalty of a vast majority of consumers, will continue to act in a competitive manner and pay attention to the needs of consumers if it fears entry by companies within the industry or by others that will invent new products and make its own products obsolete. If, on the other hand, a large incumbent company actually raises prices, it will end up encouraging market entry.

That’s what happened in the U.S. whisky industry in the late 19th century, for example. The incumbent companies waged a price war in an attempt to drive out competitors in order to then raise prices, but they failed spectacularly. There were few barriers to entry, which meant that once the big companies started increasing prices, new companies entered the market and won market shares from the financially strained incumbents.

It is thus the presence of barriers to entry in an industry that harms the interests of consumers, not the number of companies in a market.

The Worst Barriers Are Governmental

These barriers may be inherent to products themselves, but competition through the invention of new products limits their importance. More pernicious and persistent are barriers that stem from government policies.

This can be seen in the case of airline competition today. Indeed, the Canada Transportation Act explicitly limits foreign competition, prohibiting non-Canadian carriers from carrying passengers between Canadian cities. This means that a European carrier cannot take on passengers in Toronto, drop them off in Montreal, and pick up new passengers there before heading to Europe. This is a barrier to competition – one that does not stem from the market, but rather from government policies.

In fact, where cases of large companies abusing their consumers have been confirmed, it is frequently with the help of governments. For example, one of the best documented cases of abuse of dominant status is that of the sugar industry from the late 19th century to the early 20th century, in which the industry benefited heavily from trade tariffs that curtailed imports of refined sugars.

Similar evidence exists regarding the airline industry. For example, before the mid-1970s, the American industry was cartelized by government regulations explicitly designed to limit competition.

With lower threat of entry, air carriers were less compelled to reduce prices and satisfy consumers. It is only after the legal barriers to competition were removed in 1978 that prices began falling.

In sum, those who are concerned with consumer welfare, in the air-travel industry and in general, should concern themselves more with barriers to competition than with the size and the number of companies in a market. It is these obstacles, especially those erected by governments to protect incumbent companies, that really end up costing us.

Vincent Geloso is Associate Researcher at the Montreal Economic Institute and the author of “Consolidation in the Air Sector: Should We Be Worried?” The views reflected in this op-ed are his own.