Contestability Theory and the Deregulation of US Airlines

Abstract This essay discusses the development of the notion of contestable markets—the idea that optimal Pareto conditions can be induced by facilitating ultrafree entry into and exit from markets—set within the development of applied economics. The role of potential competition in influencing the behavior of incumbent suppliers had been discussed previously, but the work of William Baumol, Elizabeth Bailey, and others, they claimed, offered a more rigorous and internally consistent framework of analysis and a sounder basis for economic policymaking. This article outlines the history of the development of the theory and provides insights into the roles of key figures and institutions. It does this in the context of the role contestability played in influencing the deregulation of US airlines in the 1970s and in terms of the empirical findings of subsequent studies of the implications of this liberalization. Overall, it is also set against an intellectual background when applied and empirical research was becoming a more central part of political economy.