Air India has got itself into serious trouble, and private airlines are also doing badly. The CMIE report on air transport for August 2009 shows a bad picture for the airline industry: from the quarter ended June 2007 onwards, in each quarter, the PAT margin was negative.

There are three interesting aspects to the present situation. The first is about the role of the State. Flying by plane is a private good and not a public good. Seats in a plane are rival and excludable. I fly in a plane, I benefit. There is, hence, no role for government to be in this area. Governments in good countries do not run airlines. The right thing to do is to privatise Air India as soon as possible, without trying to engage in a government-led restructuring. In an auction, if the highest bid is a negative number, government should pay this to get the company out of public ownership.

The next point is the cost of a bailout. NHAI highways cost roughly Rs.5 crore per kilometre. Hence, if government puts Rs.5,000 crore into Air India, this comes at the opportunity cost of 1000 km of four-lane highways.

The most interesting dimension, and one that has not been widely noticed in India, is the impact of Air India upon the woes of the aviation industry. Air India today is a `zombie airline’: a firm which should be dead but isn’t only because it is artificially propped up by the government. (The phrase `zombie firms’ or `zombie banks’ originates in the experience of Japan in the late 1980s).

If market forces were allowed to work, then Air India would go into liquidation. This would lead to somewhat higher prices for air travel since competition would be reduced. In addition, it would lead to somewhat lower prices for staff (since erstwhile Air India staff would be looking for jobs) and somewhat lower prices for planes (since erstwhile Air India aircraft would be available for purchase or lease).

Other firms in the industry would thus obtain somewhat higher revenues and face somewhat lower costs.

Conversely, when a government steps in to create a zombie firm in an industry, it damages profitability and investment amongst the healthy firms of that industry. If this process goes on for a while, then otherwise healthy firms in an industry will become sick. This was the experience in Japan, when the `zombie firms’ supported by the government led to sickness spreading amongst other firms and led to a extended period of reduced private corporate investment.

In summary, one reason why the private airline industry as a whole is in the doldrums is that Air India is being artificially kept alive.