David Oks on the bad business economics of airlines

Airlines are a strange business. They seem to have huge numbers of passengers, and yet we routinely hear about airlines struggling financially, entering administration, or shutting down. For example, in 2024 in Australia, Bonza collapsed, while Rex withdrew from major intercity routes after entering vountary administration (see this post for more on those examples). The most recent example is Spirit Airlines in the US, which shut down this month, after its second bankruptcy process in less than two years.

I just discovered David Oks's Substack, which has overnight become one of my favourites. The post that first attracted me was this one titled 'Why airlines are always going bankrupt', inspired by the Spirit Airlines story. Another recent post titled 'Why ATMs didn’t kill bank teller jobs, but the iPhone did' is also excellent, as is 'How funerals keep Africa poor'.

Oks's airline post has a huge amount of depth, so is difficult to summarise without losing part of the story. However, I'm going to try (but I really recommend that you read his entire post, as it is truly excellent).

Oks first notes that airlines are not just badly managed, they are structurally vulnerable and often fail to earn a positive return on capital. He then turns to the game theory of airlines, noting that there is an 'empty core' problem, meaning that there isn't any subset of the airline industry that can form a stable coalition, because some part of the coalition would always be able to make themselves better off by breaking away from the coalition. In other words, no group of airlines and routes is stable for long, because whenever capacity is tight and fares are high, another airline has an incentive to add seats. However, once those seats are added, the market can quickly become unprofitable.

The 'empty core' arises because airlines have high fixed costs, low marginal costs, volatile demand, weak product differentiation, and large minimum efficient scale. All of that means that adding one extra airline on a route, or one extra aircraft, can swing a market from being undersupplied and profitable to being undersupplied and unprofitable. So, what happens in the airline industry is that when there are few airlines, they are profitable and happy, but that encourages new airlines to enter, after which profits decrease until one or more of the airlines shuts down. And then the cycle starts over.

As you can see, there is a lot to unpack from Oks's post. Again, I encourage you to read the whole post. But the key points are, first, that airlines are always going bankrupt because the nature of the airline industry lends itself to a boom-bust cycle when airlines compete with each other.

Second, from the perspective of airline consumers (and, probably, governments as well) there is an uncomfortable trade-off. We want low fares from competition between airlines, and we also want airlines to be financially stable, but it may be difficult to have both. The pursuit of low fares can set off the cycle described above, with competition pushing fares down, leading to falling profitability, and eventually one or more airlines exiting the market. Airline financial stability, on the other hand, probably requires some limit on competition between airlines. One way of achieving this is to regulate airlines more closely, closer to the equilibrium that existed before deregulation in the late 1970s and early 1980s, when regulators had much greater control over fares, routes, and market entry. Airlines segmented the market, flew fewer routes, and were profitable in part because they were not actively competing with each other. The other alternative is to recognise that airlines can diversify into other markets. Oks’s most striking example of this is Delta:

...the most profitable airline in the United States, which started a fruitful partnership with American Express in 1996 and launched a co-branded card with them in 2008. Annual spending on Delta-branded American Express cards comes out to about 1 percent of U.S. GDP. In 2025, this produced about $8 billion in revenue for Delta, accounting for more than the entirety of its profit. That means that without the American Express partnership, Delta would be operating at a substantial loss. In effect, Delta’s aviation business is a loss leader for a much more profitable credit card partnership. So to the extent that Delta is now a good business, it is because it escaped the basic instability of the airline industry by becoming less of an airline.

Allowing airlines to operate in a cartel-like equilibrium, as airlines effectively did prior to the 1980s, doesn't strike me as a very positive solution, especially from the perspective of consumers. Having airlines shut down at short notice, cancelling thousands of flights, is clearly not good for consumers either. Perhaps then we need to tolerate airlines that try to sell us financial services, or unbundling the airline package and separately selling seat selection, checked baggage, meals, and so on (see this post about Jetstar's business practices, or this one).

The economics of castles

When I'm in Britain or Ireland, one of my favourite sightseeing trips is to visit medieval castles. Even the ruined ones are fun to visit. Actually, maybe the ruined ones are more fun to visit, because you get to imagine what they would have looked like in their heyday. Britain and Ireland are full of castles, many of which were built by and housed local nobles. In fact, in relative terms there were very few royal castles, which the literature in history and economic history has interpreted as a sign that centralised states were weak.

However, this recent article by Desiree Desierto and Mark Koyama (both George Mason University), published in the journal European Economic Review (ungated earlier version here) challenges that view. They instead show that there was an economic logic to the proliferation of private castles.

Desierto and Koyama develop a game theoretic model of medieval states, which first recognises that the monarch cannot rule alone but must rely on a coalition of local lords or barons. Each lord agrees to join the coalition, and pledges resources to the monarch in exchange for a (however small) share of control of the kingdom. The monarch can renege on the agreement, taking the resources without offering a share to the lord. However, the lord would then rebel, leaving the coalition. What allows the lord to leave the coalition, and gives them bargaining power, is the presence of their own castles, since they can retreat to their castle when they rebel against the monarch. Without a private castle, the lord would have little bargaining power, and would anticipate the monarch reneging on any agreement, and so they would not join the coalition in the first place. In economic terms, the castle gives the lord an outside option. 

So, the monarch tolerates private castles held by the lords, because the presence of those castles gives the lords the feeling of security they need to join the kingdom. And, in turn, the presence of those castles disciplines the monarch. Rebellions are more costly to suppress when the lords can retreat to a well-defended private castle. The lords' outside option increases the feasibility of rebellion and ensures that the monarch mostly keeps to their agreement with the lords.

In short, the private castles induce an equilibrium where the kingdom is larger and more stable than it would be without them. Notice that this is the opposite of the conventional view that private castles represent a sign that a state was weak.

Desierto and Koyama support their argument with descriptive evidence, noting that:

In Norman England after the Conquest, castles were built across the country: by 1154 there were 225 baronial castles (compared to 49 royal castles) in England... Baronial castles allowed the Dukes of Normandy to extend their authority over the far larger territory of Anglo-Saxon England. Similarly, in the twelfth century Angevin rule expanded over much of France as semi-independent lords in Gascony accepted the lordship of Henry II.

Desierto and Koyama also note that powerful medieval monarchs did not act to systematically eliminate private castles, and in fact the monarchs often gave away their own castles to local lords. And the power of the lords did keep the monarchs in check - a lord's probability of rebelling against the monarch was positively correlated with the number of private castles in the lord's family network. That last point might sound contradictory, but since castles make rebellion by lords a more credible threat, this can deter monarchs from reneging and reduce the number of rebellions overall. However, when rebellion does occur, lords connected to more castles were more likely to participate in the rebellion.

So, if private castles were so important for the stability of medieval states, why did private castles eventually disappear? Desierto and Koyama note that:

The answer is military technology, not the rising power of the state. Technological changes and the associated ‘‘military revolution’’ that took place beginning in the late Middle Ages reduced the value of medieval fortifications. The main technological innovation was the introduction and improvement of gunpowder weapons, which began in the fourteenth century but only really began to have a serious impact in the fifteenth century with the introduction of iron cannonballs.

This is not a new insight, but it does align well with their model. However, it somewhat reverses the logic of the conventional view, which is that greater state power, along with military technology, reduced the prevalence of private castles. Instead, in Desierto and Koyama's model, the rise of gunpowder reduces the ability of lords to retreat to a well-defended castle in the event of a rebellion (because the castle could not be as well-defended against cannons). This reduced the lords' bargaining power, giving the monarch and the centralised state greater power. As a result, the state should become less stable. In support of this, Desierto and Koyama use the Wars of the Roses in England as an example:

England experienced a large number of rebellions and civil wars between 1450 and 1500. These conflicts are conventionally grouped under the label of the Wars of the Roses (1455–1485), but the period of weak state capacity and frequent rebellion extended from Jack Cade’s uprising in 1450 through Perkin Warbeck’s invasion and the Second Cornish Uprising in 1497. The causes of these rebellions were complex, multifaceted, and varied across cases. Nonetheless, the frequency of civil war during this period is consistent with our model’s prediction that a decline in the military value of castles would destabilize feudal realms.

And so, as gunpowder reduced the military value of castles, private castles became much less useful as a source of bargaining power for lords. That helps explain why the medieval pattern of widespread private castles gave way to state-controlled castles from the mid-15th Century onwards. Now, I'll be thinking more carefully about the vintage of the castles I visit on my next trip to Europe next month!

This week in research #125

Here's what caught my eye in research over the past week (which was clearly another quiet week):

• Sinclair et al. (open access) compile a dataset of monthly birth rates by maternal age and parity for the Australian state of Victoria over the period from 1983 to 2020, and apply a variety of different time series models to the data, finding that Australian family policy has mainly altered the timing of births rather than reversing the long-run fertility decline, and that the Australian 'Baby Bonus' led to only a short-lived impact, concentrated among second births

The Hamilton vs. Wellington population showdown

Some of my research was profiled on the front page of the Waikato Times today (paywalled):

Forget Wellington — Hamilton is on track to overtake the capital within 14 years.

New University of Waikato projections show the city’s population could climb to 242,716 by 2040, cementing its status as New Zealand’s fastest-growing city.

Hamilton’s population projection is under the “high variant” forecasts — the growth estimates council staff are recommending, and which the Government requires councils to use when planning their Long Term Plans.

If that is compared to Stats NZ's and the Wellington Regional Growth Framework estimates for Wellington for the same year, Hamilton's population will be larger by 2716 people.

Now, this Hamilton versus Wellington head-to-head population battle seems to be attractive to the media (see this post from 2019, talking about this 2019 Waikato Times article). However, they've got things wrong this time, for a couple of reasons.

First, they are comparing Hamilton City with Wellington City, which is a valid comparison of city council areas, but may not be the comparison many people have in mind. I'll come back to that point at the end of the post.

Second, and more importantly, you shouldn't compare a projection from one source, based on one set of assumptions, with a projection from a totally different source, based on a different set of assumptions. Especially when projections from the same source are available, using consistent assumptions. Otherwise, you are not comparing apples with apples.

So, let's make some consistent comparisons. Stats NZ's projections are available on Aotearoa Data Explorer, Stats NZ’s online data tool. Search for "subnational population projections", and then scroll down to "Subnational population projections, by age and sex, 2023(base)-2053". Stats NZ offers three variants (low, medium, and high) of 2023-base population projections. The difference between the variants is that low variant projections assume low fertility, high mortality, and low international migration, while high variant projections assume high fertility, low mortality, and high international migration (and the medium variant projection is, obviously, in-between the low and high). Here are the three variant Stats NZ projections for Wellington City and Hamilton City:

The bold lines are for Hamilton City. The dotted lines are for Wellington City. The low, medium, and high variants are coloured blue, green, and brown respectively. The key thing to notice is that the lines cross over. Where the lines of the same colour cross, that is the point in time when Hamilton catches up with Wellington under that projection variant. So, with Stats NZ's projections, Hamilton is projected to be larger than Wellington by 2038 under all three projections. If we do a linear interpolation (because Stats NZ only reports their projections for five-year intervals), then Hamilton is projected to be larger than Wellington by 2034 in the low and medium variant projections, and by 2035 in the high variant projections.

Turning to the University of Waikato (UoW) projections (which I produced), there are also three variants (low, medium, and high) that can be interpreted similarly to Stats NZ's projections. The methods and assumptions differ from those used by Stats NZ. These are the projections that Hamilton City Council uses in its planning (as do several other local councils). Here are the three variant UoW projections for Wellington City and Hamilton City:

In my projections, Hamilton is projected to be larger than Wellington by 2040 in the low variant projection, by 2048 in the medium variant projection, and by 2066 in the high variant projection (which is beyond the projection horizon for Stats NZ projections as they only project for 30 years).

Why the difference? The difference between the timing using Stats NZ projections and the timing using my projections is due to differences in assumptions and the underlying models. It would take a long post to unpack all the differences in detail. The differences between the low, medium, and high variants are easier to explain. Wellington has a head start - it was much larger in 2023 than Hamilton. However, Hamilton has both higher fertility and greater net migration than Wellington. That head start makes a bigger difference in the high variant projections than in the low variant projections, because the higher fertility and international migration in the high variant projections allow Wellington to maintain that lead for longer. In the low variant projections, Hamilton's higher fertility and net migration allow it to catch up much faster. In other words, because Wellington starts from a larger population base, assumptions that lift population growth across the whole country add more people to Wellington in absolute terms, delaying Hamilton's catchup, even though Hamilton’s underlying growth rate is higher.

What is interesting is that the differential effect between low-variant and high-variant projections doesn't seem to be anywhere near as prominent in the Stats NZ projections as it is in my (UoW) projections. In part that is because the uncertainty expressed in my projections (proxied by the difference between the low and high variant projections) is much higher than the projections by Stats NZ. I'm comfortable with that, given that international migration in particular is highly uncertain. So, we should expect a fairly high degree of uncertainty when we project future population.

One final thing to note is a point I made in my 2019 post on this topic. Wellington City is only one part of a larger urban area ('Greater Wellington') that also includes Porirua City, Upper Hutt City, and Lower Hutt City. There is no projection that has the Hamilton urban zone catching up in population to the broader Wellington urban zone any time soon. I suspect that many people would be flabbergasted by the suggestion that Hamilton might become larger than Wellington. Many of those people would be thinking about Greater Wellington, and they would be right.

So, Hamilton will eventually be New Zealand's number three city council area in terms of population. However, the celebrations could easily be put on hold by a council amalgamation process that the government has started, which could conceivably merge some Wellington councils together, putting their combined population out of reach of Hamilton for the foreseeable future.

[HT: The incomparable Emeritus Professor Jacques Poot]

Read more:

• Hamilton won't be our second largest city any time soon