The Government of Spain has started a rescue to save the Plus Ultra airline from the crisis. A Hispanic-American airline that could end up costing citizenship dearly in the country. Let’s see in this article what the Concorde fallacy is, and how it could help us in this situation.
Since COVID was imposed in our lives, many are the companies that had to close down and stop their activity in their tracks due to the restrictions applied to stop the virus. A standstill that has caused many of these companies today to be on the verge of bankruptcy. The impossibility of receiving income has caused many of these to be forced to close, and in some cases, permanently.
To avoid these closures, the different governments, in their objective of minimizing the damage derived from the pandemic, promoted containment plans to hibernate the economy and, in this way, avoid what we call “consolidation of losses”.
This hibernation, as well as the cost it has incurred in public coffers, has drawn praise from many economists. Economists who, confident of a speedy recovery, saw in this action a sensible decision and that would lead us to move away from the effects recorded during the Great Recession of 2008. However, in the same way, this aid has also aroused criticism from other economists. Which, based on objective criteria and based on economic and financial indicators, have expressed their dissatisfaction with some of these disbursements.
In Spain, one of the disbursements that has caused the most tension has been that of the Plus Ultra airline. An airline that connected the peninsula with the Latin American region, making flights to Ecuador, Venezuela, Peru, as well as other Latin American economies.
This airline, as reflected by various economists, was not eligible for financing from private entities due to the fact that the company was not profitable even in times of economic boom. The deficit that the company presented, taking into account its numbers, intends to continue to be present in the future, so it is an investment with many risks.
But to top it all, the latest decision by justice has reinforced the position of these economists so “ominous”, raising doubts about the rescue offered by the Government and the ways in which it has been carried out. A debate that, as we will see throughout this article, is not the first time that it occupies them.
Well, years ago, a European plane called the Concorde sparked a similar debate. Debate that ended up giving name to the fallacy that concerns us today in this article: the Concorde fallacy.
An unprofitable rescue
“The analysis carried out by numerous economists raised the need to evaluate this second installment. Well, the numbers said that the company was not profitable, while the Government tried to undertake the second installment of the granted capital. “
With the onset of the pandemic, one of the sectors that suffered the most from the effects of the crisis was the tourism sector. A situation that has led many economists to qualify this crisis, even, as a tourist crisis.
With a drop in activity of up to -84%, with the World Tourism Organization (UNWTO) putting the losses at 2.5 trillion dollars, many companies linked to this sector have been in the obligation to close, or, on the other hand, restructure its financial situation to continue operating.
To get around the situation, many of these airlines resorted to debt and mergers to get away with it. This is the case of Air Europa, which was acquired by IAG.
However, not all airlines presented sufficient guarantees to qualify for a rescue by private financial entities or to be acquired by another larger fish. This is the case of Plus Ultra, which had to be considered strategic by the Government in order to achieve a rescue that will allow it to continue operating; through an ordinary loan.
It is then that the debate arose as to whether an airline that does not account for even 0.06% of passenger transport in Spain can be considered a strategic company for the country. Its passenger volume in 2019 according to AENA was 156,139 in Spain. To use a comparison, an airline that no one would doubt is strategic, Iberia, transported 40 million passengers in Spain in the same period.
The Plus Ultra company adds losses of 13.29 million euros in the five years in which it has operated.
The rescue offered by the Government was divided into two sections: a first section, where the Government delivered 19 million euros to the company, and a second section, where the Government planned to deliver 34 million euros, culminating with this second delivery of the concession. of a loan that amounted to 53 million euros.
And up to here everything was correct.
The ASNEF analysis reflects that the company has an “adjusted” level of financial autonomy, since the entity’s own funds represent 11.6% of the total sources of financing.
However, the analysis carried out by numerous economists, including that of the renowned professor at the London School of Economics, Luis Garicano, and taking into account the finances of the company and in the case of an airline that has a fleet of three operational aircraft, raised the need to evaluate that second installment. Well, the numbers said that the company was not profitable, while the Government intended to undertake the second installment of the granted capital.
A situation that made even the Court of Auditors doubt itself.
And we are talking about a rescue of 53 million euros, of which 19 have already been delivered, and we do not know if we can recover. The weakened situation of this airline, as well as the fact that it was already in deficit before the rescue and intends to continue being so in the future, leads us to a scenario in which we must choose between giving up the 19 million euros or, for the On the contrary, deliver the 34 and trust that they will return the ransom in full.
The company has a long-term debt of 6,473 million euros and a short-term debt adds another 1,440 million.
A scenario in which, with the numbers in hand, the first option, as Warren Buffett and economic science would say, could be the most successful.
But let’s see!
Is it wise to keep investing ?: Sunk costs
“When you find yourself in a hole, the best thing to do is stop digging.”
This same debate that today occupies politicians in Spain, and that the press has extended to other sectors such as football, one day occupied many other leaders. In fact, the Concorde fallacy, serving as an example for economists, arises from a situation similar to the one we are experiencing today.
To get an idea, this fallacy, named after the famous Anglo-French passenger jet that was called to revolutionize interoceanic flights, refers to what in economics we know as “sunk costs”. A series of costs that have already been incurred and that cannot be recovered in the future. Sunk costs include, among others, time, money, and other resources that were spent on a project, investment, or other activity that cannot be recovered.
For economists, an important rule regarding sunk costs is that they should not be taken into account in economic investment decisions. Well, they correspond to the past and the relevant thing in these cases is to evaluate the opportunities to obtain future profits.
This is so because of its relationship to what we economists call “opportunity cost.” Well, the sunk costs are the costs that we have assumed when choosing an alternative. Therefore, if we still have time to choose the other alternative, it does not matter the (sunk) costs that we incurred when we chose the first, since they are already spent and it is convenient to analyze the situation for the future, the objective being not to incur in more and fatten losses.
And it is that, related to sunk costs, it is interesting to listen to the reflection on the matter of Warren Buffett, one of the most recognized investors in the world, in which he said: «When you find yourself in a hole, the best thing you can do is stop digging«.
Buffett himself, in this statement, was explaining the sunk costs. Costs that, as we have explained, should not be taken into account when continuing to invest in the project. Well, the reason for the Spanish Government to offer the second tranche of the rescue was the possibility of not losing the 19 million already delivered, but the risk assumed by the Spaniards, and that the economists warn through the sunk costs, could lead them to lose 53 million.
Much larger losses, which would worsen the starting situation notably.
The Concorde Fallacy: A Historical Lesson
“Although everyone knew it was a ruinous business, the expense was maintained because of how much it had cost to start it and because of the illusions that had been deposited in it.”
Thus, we arrive at the fallacy of the Concorde. A fallacy that, as we said, gets its name from what happened with the Concorde plane.
50 years ago, the Concorde made its first flight. For the first time, the world would see a supersonic plane, capable of crossing the Atlantic in less than three hours. It was a technological marvel ahead of its time, however, 35 years after its manufacture, it abruptly disappeared. But why?
The reason, although it seems pure chance, has to do with sunk costs.
Although everyone knew it was a ruinous business, the expense was maintained because of how much it had cost to start it and because of the illusions that had been deposited in it. Such an ambitious project, and in which so many countries had invested to make it a reality, could not be abandoned so lightly. Expenditure losses that had already been incurred held back the decision of some rulers who felt they had squandered a lot of public capital, but who faced the risk of continuing to squander it.
Finally it was decided to abandon and write off the money. The Concorde, pride of European technology, went into losses and it is history, currently serving to give name to this fallacy, the Concorde fallacy, used as a precedent by economists in scenarios like the current one.
Economic science told these leaders that, as the sunk costs and Buffett himself show in the previous paragraphs, it makes no sense to continue investing in a project taking into account that investment undertaken, because continuing to invest could lead to millionaire losses that, as we see, they would significantly aggravate the decision.
Ultimately, what a priori may seem like the most rational decision, taking into account that opportunity cost and those sunk costs, becomes the wrong decision. We can lose 19 million, but it would be better to lose 19 than to lose 53. And, in the same way, the actions that could be carried out with that money are not being taken into account, which in the opportunity cost would translate into a new calculation of losses of all that we lose, and that we stop gaining, with this ruinous rescue.
With that said, let’s listen to economics!