Those desperate men in their flying machines

BA and American Airlines stand accused of creating a superpower in the skies. But it is fright, not might, that drives this unholy alliance

HG Wells is responsible for the state of the world's airline industry, according to Hugh Welburn, an economic adviser to Virgin. In his book, The Shape of Things to Come, Wells predicted both the Second World War and a subsequent government run by aviators. The first prediction came true, and the unprecedented

power unleashed by the Luftwaffe, RAF and USAF made the second a threat to consider.

At the 1944 Chicago Convention, where the allies created a new order for the skies, America's free-market principles were overruled by demands for a heavily regulated civil aviation industry. The preamble of the convention's communique made it clear that the delegates saw passenger planes as potential bombers. Ironically, only a few years later, their designs diverged so radically that the threat evaporated.

But the legacy of Wells lives on today in the bilateral agreements that rule who flies where, and the hefty subsidies some countries give to their flag carriers. The results are higher fares for passengers, and bitter recriminations over deals such as the one between British Airways and American Airlines last week.

The deal will see a joint management team co-ordinating the airlines' passenger and cargo activity between Europe and America. Flight codes will be shared, so passengers buying BA tickets could find themselves on an American plane. There will be profit sharing but no exchange of equity. The reach of the deal is astounding. In the words of Virgin Atlantic boss, Richard Branson: "In no other industry in the capitalist world would the creation of such a monopolistic alliance be tolerated. The two governments will have presided over the creation of the Aeroflot of the capitalist West." Virgin plans an ad campaign next week featuring extracts from evidence in US courts about American's anti-competitive activity.

Mr Branson has an obvious interest in opposing the move, but there is truth behind his alarm. The not-quite-merger - to take effect next spring - will see BA/American carrying some 70 per cent of the passengers flying between Heathrow and Kennedy Airport, more than 60 per cent of the traffic between the US and Britain, and over a quarter of the total flights across the North Atlantic. Despite rapid growth in Far Eastern markets, this remains the busiest and, arguably, the most important international air corridor.

Yet neither the Office of Fair Trading nor the Monopolies and Mergers Commission has the automatic power to investigate it. When BA was privatised, the MMC was barred from probing into anything other than mergers and acquisitions worth more than 300m ecus (pounds 370m). The OFT has to determine that there has been a merger before it can take any other action. Only the US Department of Justice and the EU Commission stand firmly in the way, and the carriers have asked the former for immunity from prosecution under America's anti-trust laws.

The traffic-sharing deal illustrates not only the past of the industry, but the present state of the companies involved and the future of international air travel. For BA - the world's biggest international carrier - the deal gives a much better chance to gain a toe-hold in the lucrative US domestic market than does its 24.6 per cent investment in the troubled US Air. To American - the world's second largest airline overall - it is a chance to prise open the gates of Heathrow - which have been virtually locked to newcomers for years.

Which is not to say that other outsiders will be welcomed; neither BA nor American plans to release any of its precious Heath-row landing slots. American and United only got permission to land at Heathrow when TWA and PanAm sold theirs' off. Like their predecessors they are

fiercely

defending

their so-called grandfather rights.

The question perplexing observers is what the deal means for the future of airlines. On the one hand, the alliance creates a massive duopoly; on the other, it is the type of deal typically used by the US government for further deregulation. But both the mega carriers and Washington's heavy-handed approach could be brushed aside by a new trend - the return of point-to-point carriers.

On the surface, the BA/American deal is all about amalgamation. The International Air Transport Association says there are some 800 airlines around the world, ranging from household names to bush pilots in remote regions flying single planes on erratic schedules. Some of the deals already completed have been less than inspiring. KLM, the Dutch flag carrier and Northwest, one of the second-tier US carriers, are in court over their interlocking shareholdings. The two have also disagreed over price and quality.

According to some commentators the type of alliance envisaged by BA and American could help promote open skies. In the past, the US government has traded immunity from its anti-trust legislation for access to foreign markets. At the very least, Washington is expected to demand that Heathrow be opened up to other US airlines in return for letting the BA deal go through. Jeffrey Erickson, chief executive of TWA, cautioned that this may not be enough. When, he wondered aloud, "Does the growth of such a combine exert a chilling influence on other airlines?"

Until recently it was thought that deregulation and mega airlines were inextricably linked. Liberalising markets allowed large players to emerge. As they grew bigger they could be used by policy makers to batter down the doors of other markets, leading to more growth. This is no longer the dogma it once was.

Southwest Airlines is perhaps the most successful carrier

to emerge as a result of America's deregulation in the late 1970s. While the big airlines focused on hub-and-spoke configurations - feeding passengers into one huge airport from which long-haul flights could take them to other hubs - Southwest has re-introduced point-to-point flying. In doing so it is furthering deregulation, by providing lower fares and stiff competition for the majors. Given enough financial strength, the flexible point-to-point airlines could be best placed to take advantage of future liberalisation.

The argument for point-to-point links makes a lot of sense for passengers, though perhaps less for airline accountants. From a passenger's perspective, it is far better to fly direct from New Orleans to Houston than to detour through a hub - in this case, Dallas. It would be a bit like driving from Glasgow to Edinburgh via Manchester. The main disadvantage is that fewer destinations can be offered. Aaron Gellman, director of the transportation centre and professor of management and strategy at Northwest University in Evanston, Illinois, says that it lacks "the economy of scope".

Southwest has compensated in other ways. It operates only one family of planes - Boeing 737s - so any of its pilots can get into any of its cockpits. When it agreed to be the launch customer for a new version, Southwest insisted that controls be old-fashioned dials, rather than digital displays. Boeing compromised by making its screens look like analogue controls. Common equipment cuts maintenance bills and reduces turnaround time. Southwest also runs a turn-up-and-go system, so passengers do not have to book in advance. The combination of lower costs, more direct flights and easier boarding has proven to be a winner.

Europe has always operated a hub-and-spoke system, although it was not necessarily recognised as such. But even here, deregulation is likely to create point-to-point carriers. The latest phase will allow airlines to hop from city to city across the Continent without having to return to their home base after each leg. Mr Branson has now launched Virgin Express to do just that.

Niche carriers are perhaps a more natural result of deregulation than the mega-airlines

built, often, on old state monopolies. The BA/ American alliance is a sign of their weakness, not their strength. But the nimble newcomers are more dependent on continuing liberalisation than the mega carriers, which have proven in the past they can survive quite nicely in a world carved up by political fiat.

The problem for the upstarts is that deregulation is not a sure thing. While many countries, notably the US and UK, espouse open skies policies, they could easily change course if their own operators were under threat. Winston Churchill, when Secretary of State for Air in 1921, said: "Air transport must stand on its own feet. The Government can't hold it up in the air." France took a less sanguine view. Within six months, all six of Britain's fledgling airlines had gone belly up, so that when the first London airport opened at Croydon it had no domestic carriers. The policy was changed.

Even in the US today, open skies can be pushed back to make room for vested interests. Mr Erickson complained on Wednesday that his plans to fly from St Louis to Japan had been stopped by a "skilful and thus far successful lobby effort" by United and Northwest, which are already present in Japan. "I do not fault them one bit for vigorously defending their commercial interests," Mr Erickson said tellingly. "I would do the same thing."

Despite the vested interests arrayed against making sense of the industry, deregulation is likely to proceed in sputters and jerks. The US example has been decried by opponents using anecdotal evidence. But the statistics are convincing. The Brooking Institution, a US think-tank, calculated that the first 10 years of deregulation saved consumers $100bn.

But new airlines such as Southwest and Virgin, with their relatively weaker brand names, are vulnerable to other dangers - notably public concern about safety. Public opinion in the US was whipped into a frenzy when ValuJet Flight 592 crashed in the Florida Everglades last month. Both discount carriers and the contracting out of heavy maintenance came under fire. Southwest, which qualifies on both points, has one of the best safety records in the business. Professor Gellman worries that the biggest threat to the industry, barring a catastrophic war, would be the discovery of a serious fault that grounded much of the global fleet and destroyed public confidence.

Safety in general is likely to become more of a problem as the airline industry grows. At present, the average rate of growth is around 6 per cent, which sounds small but would mean a doubling of traffic volumes by the middle of the next decade. Air freight is growing even faster than passenger traffic, and the Far East faster than America's domestic market, but Europe is expected to grow at exactly 6 per cent, though Branson is rather more bullish.

National interests extend beyond aircraft operators to air traffic controllers, who are at the centre of most safety issues. Each country in Europe, even those so small a jet can pass over them in a matter of minutes, insists on defending its aerial sovereignty. The result is a confusion of air traffic control centres, each with its own computer system. One, possibly apocryphal, tale has it that some controllers had to use a pay phone in their lobby to tell a neighbouring centre when they were passing over control. Moves are afoot to consolidate the various systems, but imagine the tabloid headlines if flights into Gatwick were to be orchestrated from Brussels or Frankfurt.

The wisdom of America's chosen tactic of using alliances to force deregulation elsewhere is a tougher issue to judge. The BA/American deal in particular highlights the dangers of accepting one cartel in the interests of breaking another. Perhaps the best choice for the UK Government would be to block the transAtlantic alliance while moving swiftly to open up British aviation to all comers. British Airways, which last year made a profit of pounds 585m, is in as little danger of following in the footsteps of Mr Churchill's ill-fated half dozen, as world governments are of falling prey to HG Wells's flying technocrats.