90157 July 2014 – Number 130 X1` Open Skies over the Middle East Anca Cristea, Russell Hillberry, Aaditya Mattoo1 Introduction: The dynamism of air traffic markets in the Middle East obscures the persistence of restrictions on international competition. But how important are such restrictions for passenger traffic? This longer paper by the same title that this Quick Note is based on uses detailed data on worldwide passenger aviation to estimate the effect of air transport policy on international air traffic 2. The policy variable is a quantitative measure of the commitments under international agreements. The paper analyzes, and for the first time, not only bilateral agreements, but also plurilateral agreements such as the one between Arab states. The analysis finds that more liberal policy is associated with greater passenger traffic between countries. Higher traffic levels appear to be driven primarily by larger numbers of city pairs being served, rather than by more passengers traveling Photo: World Bank Air Transport Annual Report 2013 along given routes. To demonstrate the quantitative implication of the estimates, two liberalization Deepening Arab Plurilateral Agreements and scenarios in the Middle East are evaluated. Including Turkey: Turkey, long a fulcrum between the West and the East, has deepened its economic links with the European Union and is now turning to the Middle East. In this sometimes turbulent neighborhood, it is beginning to create dynamic 1 trade links which echo past relationships albeit in a Anca Cristea is at the Department of Economics at Oregon University. Aaditya Mattoo is research Manager at the Trade and new international context. Even in the age of the International Integration Group (DECTI) at the Development internet, where geographic location seems perhaps Economics Group (DECVP) at the World Bank. Russell Hillberry less relevant, physical connectivity matters. Goods is a Senior Economist at DECTI. must be delivered, businesspersons must meet, and 2 people must travel to forge bonds and catalyze World Bank, 2014 ”Open Skies over the Middle East” Policy Research Working Paper #6937. Washington DC. The paper also trade. In facilitating each of these links, air transport served as an input into the recently released report: World Bank. is critical, especially in a region where overland 2014. Over the Horizon: A New Levant. World Bank. Washington travel is fraught with difficulty. D.C. Turkey’s Arab neighbors are already party to the has signed. Another branch of the literature has Intra-Arab Freedom of the Air Program of the Arab used cross-sectional variation in the level of policy Civil Aviation Commission (henceforth referred to commitments in agreements world-wide4.This as the “ACAC”). This Program has in principle literature offers an understanding of the effects created conditions for more liberalized air transport, outside the US, but there is no evidence yet on but more could be done to create fully open particular outcomes such as growth in the number conditions (Schlumberger, 2010). By comparison, the of city pairs served by direct flights. bilateral air service agreements (BASAs) between Turkey and its Arab neighbors are quite restrictive. We extend the analysis and add to the existing Looking ahead, policy makers must make choices: literature in four different ways. First, we employ a whether to deepen a plurilateral agreement like the rich cross-sectional dataset on origin-destination ACAC, or to negotiate more liberal bilateral pairs worldwide that combines the extensive agreements with partners such as Turkey. This country coverage observed in prior studies with the study attempts to inform such decisions with city-pair level detail that has only been exploited in quantitative estimates. In particular, the benefits of a studies of the United States. This improved dataset more meaningful open skies agreement in the acquired from the International Civil Aviation Middle East which would deepen the ACAC and Organization (ICAO) allows us to expand our include Turkey as a full-fledged member is assessed. investigation beyond country-level gravity The focus here is on the Middle East but these issues regressions. Second, our econometric analysis have global relevance, as regions from ASEAN to focuses not only on bilateral aviation agreements but Africa pursue the integration of their air transport also on plurilateral agreements. Third, we go markets. beyond understanding the impact of aviation policy on air passenger flows and explore how The Analysis and Conclusions: The study begins by liberalization affects the extensive margin of global estimating a gravity model of bilateral air traffic, aviation through the introduction of new direct which helps us relate passenger flows to measures services at city-pair level. Finally, we use the results of openness in air services agreements, while of our model to derive counterfactual calculations controlling for other determinants of international and policy predictions. travel. In this respect, the study builds upon prior work. The paper contributes to a small but growing The results of the paper suggest that more liberal literature that examines the implications of bilateral air service agreements are associated with liberalization in international aviation markets. One more passenger traffic, and with more city-pairs branch of the literature has exploited the high served by direct flights. There appears to be no quality data available for air travel involving US statistically significant difference between the effects airports, and variation in the timing of US bilateral of bilateral and plurilateral agreements once we take agreements3. This literature gives a fairly nuanced into account the respective policy content. We use understanding of the effects of US agreements, our empirical results in a counterfactual analysis in including estimates of the effect of an agreement on two steps5. First, we quantify the impact of the number of city pairs with direct flights. But the insights of this literature are restricted to the US 4 Gonenc and Nicoletti (2001) and Doove et al. (2001) use factor market, and to the specifics of the agreements the US analysis and information on a wide array of industry characteristics to construct aviation restrictiveness indexes. Piermartini and Rousova (2012), use information on 2300 bilateral 3 Brueckner and Whalen (2000), Brueckner (2003), Whalen (2007), Air Service Agreement (ASA) in force in 2005 among 184 and Bilotkach (2007) employ US international data on true origin- countries to estimate the impact of air service liberalization on destination city-pair air traffic to investigate the price effects of bilateral passenger flows. They find that increasing the degree of inter-airline strategic alliances and market competition following liberalization between two countries from the 25th to 75th the signing of OSAs. Cristea et al. (2012) and Jia and Winston percentile observed in the sample increases total passenger traffic (2012) consolidate the various market responses associated with by approximately 18 percent. the liberalization of air passenger traffic into a welfare calculation. Micco and Serebrisky (2006) find that OSAs reduce air cargo 5 The counterfactual analysis we conduct relies solely on freight rates by 9 percent and increase the share of US imports parameters we estimate in the reduced form econometric models, arriving by air by 5 percent after 5 years or more after the and not on a fully specified model of the behavior of market agreements enter into force. participants. As such we only calculate first order effects of liberalization, assuming that the coefficients remain constant and July 2014 · Number 130 2 deepening the ACAC agreement by assessing how Conclusion: While these results may seem much more traffic there would be among ACAC optimistic, there are three reasons to suggest they members if the policy commitments were extended are not unrealistic. First, current air passenger traffic to match those of the most liberal international levels in the region are low, and fast growth is agreements (e.g. UK-Singapore). Using country-level plausible off a small base. Second, much faster data we find that traffic flows would grow by growth rates have been observed in recent years in approximately 30%. The city-pair estimates suggest selected regional markets. Finally, the policy that traffic along given routes would grow modestly changes we consider are large, with the Turkey- (by 5 to 8%), but that there would be a significant ACAC policies changing quite substantially in our increase in the number of city pairs served by direct second scenario. The results should nonetheless be international flights within the ACAC. understood as preliminary work that scopes out the possibilities associated with further reform in the In the second step, we estimate the implications of region. Turkey’s accession to the ACAC agreement, assuming the more liberal commitments. This Contact MNA K&L: implies very large changes in the openness of the Gerard A. Byam, Director, Strategy and Operations. policy commitments, because Turkey’s existing MENA Region, The World Bank. agreements with countries in the region are quite Preeti Ahuja, Manager, MNADE Regional Quick Notes Team: restrictive, when such agreements exist at all. The Omer Karasapan, and Mark Volk country level analysis of Turkey’s accession to the Tel #: (202) 473 8177 ACAC at increased levels of policy commitments The MNA Quick Notes are intended to summarize lessons learned from MNA and other Bank Knowledge and Learning suggests that passenger traffic between Turkey and activities. The Notes do not necessarily reflect the views of the ACAC countries would more than double 6. City World Bank, its board or its member countries. level analysis suggests that the increase in traffic would occur both through the growth of traffic on given routes and substantial increases in the number of city pairs served7. In the full liberalization policy scenario we consider, passenger growth along existing routes is modest, but the likelihood that a direct flight would occur between a given pairing of a Turkish and an ACAC city would nearly triple. These large increases reflect both the significant changes in policy that we contemplate and the low probability that such city pairs are currently served by direct flights. that other right hand side variables do not change in response to our policy shock. We are potentially missing secondary effects that might operate, for example, through binding capacity constraints, or through spillovers to other markets. But these effects are difficult to estimate without substantially more data and a richer model structure, so we employ transparent calculations that rely on the reduced form estimates. 6 A policy scenario in which Turkey enters at the existing level of ACAC commitments generates a rough doubling of passenger traffic between Turkey and the ACAC member states. 7 An increase in the number of cities served by international travel reflects an improvement in the overall quality of air transport services because more people have the ability to take a direct flight. 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