China's "Bermuda Triangle" for Private Airlines

In 2005 China's first private airline, Okay Airlines (奥凯航空) began flying. Subsequently, another four private (民营) airlines also began flying in China.

On 06 December 2008, Okay took its final flight. It has since been trying to reorganize itself, but to no avail. This article asks whether the policy of permitting private airlines is being reversed.

Today, another article appeared announcing that Air China, the flagship SOE airline, will be buying 100 percent of private airline "East Star" (东星航空).

Naturally, the blame for the disappearance or absorption of these private airlines is blamed on the financial crisis, which has apparently dampened demand for flying in China. Even two of China's big three SOE airlines (China Southern and China Eastern) recently were the beneficiaries of three billion RMB in government money.

However, if Singapore's Temasek Fund had been allowed to take a stake in China Eastern in 2007, the government bailout probably would not have been necessary. Apparently, the impending takeover was blocked in a political maneuver by the former head of Air China who had just been promoted China's Civil Aviation Administration. China Air reportedly wanted China Eastern for itself. (This article by Barry Naugton in China Leadership monitor details some of the maneuverings.)

Economic theory tells us that state owned firms tend to drive private investment out of industries in which they compete, and China's civil aviation industry is a prime example. When times are tough, the government is always ready to step in and rescue its most important SOEs, if for no other reason than to prevent the unemployment that would be generated by a liquidation.

Private airlines, on the other hand, are generally left to fend for themselves. The market wisely decides not provide more capital to a business that has fallen on hard times. Barring a government bailout (such as Air China's purchase of East Star), there is no other choice but for private airlines to disappear.

All of which raises what I think is the most important question: Why do private investors even bother in the first place?

Also, why do we see this phenomenon more prominently in some of China's industries and not in others? For example, why do state-owned and private firms seem to compete so well together in the auto industry and not in the airline industry? Is it all a matter of industrial policy -- of governments picking and choosing exactly where private firms will, and will not, be allowed to compete? And if that's the case, then why even allow Okay Airlines to get launched in the first place?