Public interest or regulatory capture: Theory and evidence from China’s airfare deregulation

The study is motivated by two seemingly contradictory patterns observed in China’s airline industry with prevalent airfare caps. On the one hand, airfares tend to be higher and thus airfare caps are more likely to be binding in routes operated by fewer airlines; but on the other hand, it is in these same routes where airfare caps are more likely to be deregulated. To explain this apparent paradox, we build a simple theoretical model, which derives distinctive predictions from the public interest theory versus the capture theory of regulation. When empirically testing the model, we find more support for the public interest theory. In particular, Chinese regulators seem to genuinely care about public interests when making deregulation decisions, and their concern with market exit and the consequent failure to serve certain markets is the main reason for removing airfare caps in routes served by fewer airlines. In contrast to most studies that investigate consequences of deregulation in the airline industry, we explore the motivation for deregulation. We also contribute to the literature by emphasizing the role of universal service obligations in understanding regulatory reforms in developing countries.