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At first, the bidding war that erupted recently for a stake in China Eastern Airlines, China's third largest carrier by revenue, was hailed as an example of capitalism invading the country's tightly controlled airspace. China Eastern was entertaining an offer by Singapore Airlines to buy 24% of the company for $920 million when a rival bidder, China National Aviation Corp. (CNAC), parent of flag carrier Air China, swooped in with a promise to beat that offer. In an uncharacteristic move, airline-industry regulators in Beijing said they would allow China Eastern's shareholders to settle the matter.

Shareholder's did what shareholders almost always do: they went for the highest bidder, on Jan. 8 voting to reject Singapore's overture. This cleared the way for CNAC to sweeten the pot. But while the vote may have seemed like the free market at work, the Chinese government isn't about to let the invisible hand shape its air travel industry. By green-lighting CNAC's $1.9 billion hostile bid, Beijing actually steered the proceedings toward what it really wants: by consolidating China's fledgling and fragmented airline industry, regulators aim to form a Chinese "supercarrier" capable of competing on international routes against the world's largest airlines. An alliance between Air China and China Eastern — the government is majority owner of both — is a first step toward this ambition. The two airlines ranked as the 13th and 14th largest in the world by number of scheduled passengers flown in 2006, according to the International Air Transport Association. Combined, they would be the fourth largest and the biggest outside the U.S.

The government's tacit approval of the CNAC-China Eastern alliance marks a potentially significant policy shift by the Civil Aviation Administration of China (CAAC), the country's aviation regulator. Just as Beijing has opened up its backward banking sector to overseas investment in order to tap the expertise of foreign financiers, in recent years the CAAC has been allowing foreign airlines to take small stakes in domestic carriers, hoping that outside partners could improve airline management. Air China, for example, has a cross-shareholding agreement with Hong Kong-based Cathay Pacific, and in 2005 American financier George Soros invested $25 million in Hainan Airlines, the country's fourth largest airline by revenue. But by freezing out Singapore Airlines, CAAC officials signaled that they have decided to close ranks around their domestic carriers — potentially shutting off the fast-growing China market to foreign carriers eager to expand their connections to the mainland. Says Richard Pinkham, an analyst at the Centre for Asia Pacific Aviation, a Singapore-based consultancy: "The regulators had clearly decided to go a different direction than the one the [Singapore] deal offered."

The man at the controls appears to be Li Jiaxiang, who in late December left his post as CEO of CNAC to take over as China's top airline regulator. Li has been a vocal opponent of allowing foreign carriers greater access to China's skies and has encouraged domestic airlines to raise their overseas market share by opening more long-haul routes. His appointment "set the stage for more consolidation and probably less foreign investment," Pinkham says. In early January, Li announced that the CAAC will not consider applications for new airlines before 2010. China's existing 22 carriers are also banned from importing new aircraft and from opening new routes if they have blemishes on their safety record.

The restrictions were imposed to relieve pressure on the overstretched industry, Li said on Jan. 10 when the changes were announced. "The speed of introducing new aircraft should go hand in hand with the recruitment of new staff and the improvement of safety standards," he said. China clearly needed to change course. Although the market has grown about 10% a year for the past five years, the top three players — China Southern, China Eastern and Air China — are filling less than three-quarters of their seats with paying customers. During a recent price war, tickets were discounted by as much as 70%, according to local media reports. Rising fuel costs and fare caps enforced by Beijing have sliced profit margins. Air China earned about $300 million in 2006, according to the most recent figures, but China Eastern lost $410 million that year.

The problems have become increasingly evident to customers. China's airports are infamous for flight delays and cancellations. The CAAC reports an 80% on-time-arrival rate countrywide, but frequent fliers traveling through clogged metropolitan airports beg to differ. On Nov. 20, for example, more than 50 flights to and from Guangzhou and Shanghai were delayed, keeping more than 6,000 passengers waiting as long as 10 hours for takeoff. Such delays are often caused by conflicts with the country's military. The People's Liberation Army confines commercial aircraft to narrow corridors of airspace, and carriers must hold or cancel flights due to sudden decisions by commanders. "It's so bad that you must fly a day ahead to get anywhere on time," says Jane Cheung, a Hong Kong accountant who flies regularly to Shanghai. "I avoid Chinese airlines at all costs."

The CAAC has not revealed how it plans to boost the performance of its carriers so they can compete in international markets, nor have plans for industry consolidation been made public. Opinions are divided as to whether shrinking the number of carriers — in effect, creating a more monopolistic market — will relieve the industry's growing pains. Adrian Lowe, airline analyst at stockbroker CLSA in Hong Kong, says consolidation will improve service and allow airlines to be smarter about how they route their flights, leading to fewer delays. "It can only improve things for the customer," he says.

Others are skeptical that travelers will gain much through mergers of domestic carriers such as Air China and China Eastern. Air China has little expertise to lend its potential new partner when compared with Singapore Airlines, which is known for top-flight service. "Bring in Singapore, and you can be confident service levels will go up," says Pinkham, the Centre for Asia Pacific Aviation analyst. "With Air China, the improvement is a lot less certain."

One thing is for sure — customers want something to be done, and soon. "It's illogical to spend billions of dollars on the Olympics while at the same time not solve the air-traffic problems," says Martin Craigs, president of the trade association Aerospace Forum Asia. "What happens at the airports are the face of China to travelers." If Beijing wants to be a world-class aviation player, saving face should be its first priority.

• Kathleen Kingsbury