Aviation / Current / Economics

Modern Indentured Servitude

A friend of mine, the aviation expert for this blog, began screaming at me last night that economists have no clue what they are talking about. This friend is wrong, of course, yet the ire triggered by this entry by Paul Krugman…    

My soon-to-be-colleague Branko Milanovic writes forcefully against the term “human capital”; Elizabeth Bruenig notes an especially unpleasant use of the term by reformicons trying to sell child tax credits to their conservative allies.

I’m in agreement with both. It’s actually shocking how readily we have fallen into rhetoric that treats human beings as assets; it’s closely related to the remarkable, equally shocking way that we now talk about medical patients as health care “consumers”.

But I think there’s a bit more to add.

Branko says that the essential difference between skills and physical capital is that the former aren’t worth anything unless you work, and that is certainly an essential difference. I would, however, also emphasize the flip side: if you think of capital as something that rentiers can own, which is surely one of the important things we connote when we use the c-word, then labor force skills are not capital in that sense. Children of the wealthy can inherit or buy factories and buildings; absent indentured servitude or the coming of androids, they can’t buy worker skills.

…offers the opportunity for a teachable moment. Maybe not my colleague–not much I can say to an infuriated pilot, so I leave out his off-color language to describe Mr. Krugman’s piece. But aviation is a perfect example how economics does not recognize how deranged large business can become.

Man-Made Mission to Miss by a Mile

Every country on this planet is experiencing a severe pilot shortage, a primer on this problem available here courtesy of my angry colleague. The problem revolves around a conundrum:

The pilot shortage dates from the 2008 financial crisis, masked by the phase in (from December 2007 to 2012) of the age 65 rule over the age 60 rule. The industry relies on the hope that students will resume taking out loans for $100,000 to $250,000 for flight training for the prospect of taking a job that pays less than $50,000 a year.

A little background is useful. Any aircraft that carries more than 7,500lbs of payload or the equivalent number of passengers must be operated under 14 CFR 121 to engage in revenue operations (the FAA can make exceptions, of course). Most air carrier jets cross this threshold, which generally is in the range of 37 seats and above. Considering 50-seat regional jets are rapidly losing their luster and 70-76 seat RJs are all the rage, regional airlines are and will continue to operate under 121 for the most part.

Airline pilots are limited to flying 1,000 hours per year for operations covered under 14 CFR 121.471. This is important to note when considering wages for entry-level pilots–$22 an hour is a $22,000 annually. If a person were to peruse airline pilot salary schedules, one would hard-pressed to find a first officer whose wages at a regional airline would cross the $50 an hour threshold (i.e.: a $50,000 annual salary) ever. Now consider this:

New Jersey native Christopher Machado, 20, a junior at Embry-Riddle Aeronautical University in Daytona Beach, Fla., has wanted to be a pilot since he was a boy, watching the planes overhead at Newark airport, not far from his home.

At 17, he had a private pilot’s license – before he drove a car alone. Machado said the cost of his education and flight training will be about $250,000 before he can sit in the first officer’s seat of a regional airline, where commercial pilots usually start to build experience.

Machado said he’s lucky that his parents in Colonia, Woodbridge Township, support his dream, and are paying for it. “I know a lot of people who would be pilots, but for the money.”

The quarter-million figure is due to the ATP (Airline Transport Pilot Certificate) requirement newly imposed for all 121 operations, a license than requires 1,500 hours of flight time amongst other requirements. To be fair, $250,000 is a worst-case scenario where someone holding a commercial pilot’s certificate (250 hour requirement) is not able to find any sort of employment after spending a mere…$41,667 at the ratio mentioned above. To be unfair, $167 a flight hour is far below the going rate for most training aircraft, let alone factoring in the cost of a college degree. But even if we take the ratio as a given, $40,000 isn’t the full cost of admission:

Pilots planning for a career that requires certification to airline transport pilot (ATP) standards will need to set aside thousands of dollars to pay for additional training mandated by new FAR 61.156. The training is required before the candidate can take the ATP written and practical tests (beginning August 1 next year), and the portion that will cost the most is 10 hours of simulator training, including at least six hours in a full-flight simulator (FFS) meeting Level C standards and replicating a multiengine turbine-powered airplane weighing at least 40,000 pounds. This requirement applies no matter what type of airplane the ATP candidate will be flying, whether it’s a Seneca piston twin or a four-engine A380 weighing more than a million pounds.

Before conservatives start screaming about regulation, realize these requirements are a give-away to the flight-training industry. This isn’t safety-related, it is rent-seeking. Flight schools had been turning themselves inside and out to claim training will cost each student less than six figures, and now…this (the ATP written was once free, then became a $100-150 test, and now is a $4,500 test).

This storm has produced a severe shortage of candidates willing (and more importantly, able to afford) high-cost training which is chasing low-wage employment. A solution is nowhere in sight:

Even with an expected 0.4% decrease in the regional jet fleet of 2,200 by 2023, a figure computed by the FAA, the pool of regional pilots will in theory have to be completely replaced in seven years due to retirements. While some could see that as a promising sign, given the normal career path from regional to major, the pilot pipeline into the regionals from schools is not running at rates high enough to keep the seats filled, in part due to the average $50,000 per year cost of a four-year education including flight training, compounded by a flagging interest in the profession.

The result is a situation that could force the industry to park aircraft or defer deliveries as the pilot ranks decrease and opportunities abound for those that remain in the business. Some regional airlines are reporting that pilot candidates are not showing up for interviews or training classes, presumably because they are able to choose the best of several options without notifying the others. And, some say the airlines’ weak position could lead unions to demand better collective bargaining conditions given that there are no other options for replacing the pilots.

Pilot hiring will have to climb to cover retirements, a daunting issue with fewer applicants entering the training pipeline.

Cohen says the regionals are doing as much as they can. “Our members are doing everything within their control to manage the pilot supply issue, but many of the issues that are causing it, and the solutions, are out of our control.”

Hardly. The regionals have exacerbated their disastrous descent.

The Last Bastion of Indentured Servitude

To pilot any specific turbofan or turbojet aircraft, or if the aircraft has a maximum takeoff weight of 12,500lbs or more, that pilot must hold what is known as a type rating. Training costs tens of thousands USD and typically takes two months before a pilot sets foot into the aircraft he or she will fly operationally (and yes, there will be passengers or cargo aboard during the very first flight).

Aviation employment is rife with abuse in the form of the training contract. Republic Airways, the target of my aviation colleague’s Christmas rant, forces their new pilots to sign a two year, $20,000 contract. If the pilot quits less than 24 months after he or she begins “flying the line” (the two months spent training to fly isn’t included) he or she will be liable to pay back the contract. Sounds fair, right? Two years of guaranteed employment?

There isn’t a guarantee at all. Republic furloughed (airline-speak for laid off) over 100 pilots in September 2008, the senior-most having been hired six months prior. The contract obligated each furloughed pilot to return to work regardless how long he or she was unemployed—the time spent on furlough would be forfeit (toward the contractual 24 months) if the pilot elected not to return to work. The risk is all on the side of the employee—no obligation on the part of the employer whatsoever.

Moreover, Republic is not alone in requiring training contracts. Currently Compass Airlines, Great Lakes Airlines, Republic Airways and formerly Silver Airways have set the standard which Cathay Pacific, Emirates, Qatar, Singapore Airlines and their subsidiary Scoot followed in requiring onerous financial risk on the part of pilots upon an offer of employment. Perhaps this isn’t quite modern indentured servitude, but could one argue training contracts aren’t in the ballpark?

Macroeconomic Evolutionary Cul-De-Sac

The flailing of the regional airline industry indicates the coming collapse of an entire sector in the world economy.   At its heart, the regional industry has sown the seeds of its destruction with a contradiction—how can contracting something a business specializes in save the entity money?

A for-profit business has a profit margin. If the entity “contracts out,” as airlines do with gusto, the profit margin for the contractor will come from…the larger entity’s profit margin. How could it not? Both businesses are sipping from the same revenue stream. Worse, major airlines (American, Delta and United in this instance) typically have four or more regional airlines that provide contracted services. For these airlines, another basic economic concept comes into play—economies of scale. Airlines measure cost per available seat-mile or tonnage-mile (passenger versus cargo aircraft). Regional jets typically have ASM costs two to three times greater than mainline aircraft. Unsurprisingly, the cost of operating an airliner is less per capita the more seats it holds. Economy of scale—it also works as a physics concept.

There are massive costs associated with inappropriate contracting. The regional airline industry boomed between 2002 and 2008. Between 2001 and 2011, the U.S. airline industry lost $51 billion. At its conclusion, the lost decade accounted for 155% of the industry’s total losses since the 1920s (the percentage has risen in the last four years since the airline industry returned to the black). The “logic” of contracting as led to this:

[T]he situation of pilots in the regional airline industry is deteriorating. Regional airlines compete on price for contracts with the major airlines, and much of the burden of that competition falls on employees.

Swing and a miss. Contracting to “save money” can be based on only one paradigm—wages can never rise. The deck is stacked so deep against the contractor he has to bring something to the table; his only card is lower labor costs. But the concept is completely false—wages represent at most 5% of the cost of operating an airplane (generating enough energy to actually fly is expensive).

The coming contractor crash is downright hilarious to peruse from afar. The regional dog-and-pony show is so demented that airline managers are demanding concessions to offset the incentives, primarily signing bonuses, to attract more staff. But what about the androids Krugman mentions?

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