New Airline Market Rules Make No Sense

Among the talk about reforming the economy and opening up markets to competition, the recently adopted regulations on designation of Ukrainian carriers comes as a step in the wrong direction. Much has already been written on the entry barrier these regulations create. Any airline wishing to be designated to serve international routes out of Ukraine must first offer services on the domestic market. 

This, together with a number of other rules, clearly places Ukraine International Airlines (UIA) into a more advantageous position relative to other Ukrainian market players, and monopoly on this market is never a good thing for customers. Further, these rules have the potential to hurt UIA as well in its competition with foreign airlines. What annoys me the most, however, is that these regulations signal that Ukrainian government is not that interested in opening up the country’s economy to proper competition after all.

As Ukraine has officially declared its intention to move closer to the European Union, with the eventual goal of joining this organization, a quick description of the European airline market is in order. Since about 1995, the EU airline market has been completely open to competition: any EU airline can fly between any two airports within the EU, as long as it is able to do so safely. This has led to incredible growth of air travel within the community, with low-cost carriers such as Ryanair and easyJet making flying affordable to millions of people, while also putting pressure on the large network carriers (such as British Airways, Lufthansa and Air France) to become more competitive or die. When Eastern European countries joined the EU, their airline markets have immediately become an integral part of the wider EU market. Liberalization of this market segment led to what it was supposed to lead – survival of the fittest and demise of the firms that were not prepared to competition. On one hand, Malev Hungarian Airlines went bankrupt, and both LOT and Czech Airlines are struggling. On the other hand, a number of new carriers appeared in the Eastern Europe, with WIzzair (an airline registered in Hungary) establishing itself as one of Europe’s leading low-cost airlines.

Ukraine’s airline market has been developing slowly but steadily over the last decade, despite setbacks due to the financial crisis and Aerosvit bankruptcy. In fact, ICAO has recently placed Ukraine among the top 40 countries worldwide in terms of its air transport connectivity.

Kyiv Boryspil airport is developing as a (small size) transit hub on Europe-Asia and Europe-Middle East market. We are seeing some development of regional airports, which now are directly connected to some of the world’s largest hubs (such as Vienna, Munich, and Istanbul). I am afraid that these new regulations are an unfortunate step back from this positive trend.

As I noted above, the new regulations hurt Ukraine’s carriers on two fronts. First, they create an entry barrier for both new and existing airlines. New airlines have to operated domestically before they can be designated for international routes. Existing carriers wishing to expand their international network out of Ukraine may need to operate new domestic flights. This can lead to one of the following scenarios. First, the airlines may be forced into domestic routes which they will otherwise deem not profitable, and will then have to cross-subsidize their losses on the domestic routes from the profitable international markets. Second, the requirement to operate domestically might indeed pose an insurmountable entry barrier for Ukrainian carriers – and with little prohibiting foreign airlines from flying into Ukraine, we may end up seeing a foreign carrier entering where a domestic airline could have provided the service instead (for instance, I can easily see such situation arising on seasonal charter routes). The second way in which the new regulations can harm Ukrainian airlines comes from the fact that their competitors from other countries do not face such restrictions. Ukraine’s airlines compete with foreign carriers on many markets, competition in the aviation industry is known to be fierce, and by potentially increasing the Ukraine’s carriers operating cost the government is doing them a disservice.

I understand that Ukrainian government may be interested in developing the domestic airline industry. I further realize that the Russian aggression against Ukraine has led to closure of Kyiv-Simferopil and Kyiv-Donetsk routes, which were the largest and quite likely the most profitable domestic markets for Ukraine’s airlines. At the same time, forcing entry where it would otherwise have not been profitable for the airlines is never a good idea. Competition is a good thing only if the firms are allowed to freely choose which markets to enter and which to stay away from. Ukraine’s domestic airline market is bound to be relatively small at this stage, given the distances between the major cities, available surface transport infrastructure, and the generally low income levels. As the country develops, the domestic airline market in Ukraine will be bound to grow with it. However, government regulations cannot force or speed up this development. Governments do support some of the domestic airline services in Europe. Through the Public Service Obligations (PSO) programs, the governments subsidize flights to small and remote communities, which would otherwise be effectively cut off from the world. Yet, PSO programs typically fund flights to island or very remote cities – one would be hard pressed to justify such subsidies in Ukraine.

Overall, I find the new regulations on designation of Ukrainian carriers will limit competition on the international routes, distort domestic market, and may overall worsen competitive position of Ukraine’s airlines. Further, it sends a signal to the West that Ukrainian government is not willing to walk the walk of reform and market liberalization. My suggestion therefore is clear – these rules must be repealed. The government does have a noble and important role in the aviation industry – ensuring safety and security, as well as preventing abuse of market power. I suggest that Ukrainian government focus on these issues instead of trying to micromanage competition.