This paper specifies and estimates a production function for the airline industry, identifying firms? network characteristics and efficiency as the main determinants of their productivity. The application of this analysis to the European market shows that productivity differences among flag carriers could explain the governments? different views about deregulation at the beginning of the eighties. The introduction of liberal bilateral agreements by some European governments has given their flag carriers incentives to start adjusting their structure in anticipation of future liberalization in the European market while other European flag carriers have delayed this adjustment.