Imrecon

The consultation period on the DfT's proposals for reform of airport regulation came to an end earlier this month.  The last few months have seen a raft of reviews: a review of the designation of Manchester and Stansted airports, price reviews for the three London airports, the Pilling review of the CAA and the Competition Commission's review of BAA's ownership of airports.  The DfT's proposals are at the tail end of a very active period for airport policy.

The proposals aim to tidy up a lot of anomalies in airport regulation such as automatic references to the Competition Commission and the lack of airport licences.  One of the more important is the proposal to replace the CAA's existing duties with a new, and sole, primary duty:

 "to promote the interests of existing and future consumers of passenger and freight services at UK airports, wherever appropriate by promoting effective competition"

The consumer interest is a worthy objective.   It is politically, intuitively, dogmatically correct, and the expert panel argued that it follows the practice in other sectors and "accurately reflects the proper purpose of regulation".  And yet this focus on the consumer interest troubles me. I don't think it stands up to analysis.   

Airlines and the economics of airports

The DfT makes it explicit that the word ‘consumers' does not include airlines. Even though the interests of airlines and consumers frequently coincide, the unique economics of airports mean they are not the same, especially at Heathrow.

Heathrow is potentially subject to competition, not least from a re-energised, separately owned Gatwick.  However, it benefits from strong network effects as the de facto hub airport for London and its physical capacity is constrained.  This means that market-clearing prices for airlines using Heathrow would be rather higher than cost.  But prices have to be kept close to cost because of international treaties - the regulator has no choice.  This reality, and thus the need for price control, is likely to continue for the foreseeable future.

This means that incumbent airlines get the benefit of any excess demand, reflected in high slot valuations (last year, pre-recession, peak time slots at Heathrow were said to be valued at up to £30 million per pair).  Whether this is right or wrong is moot - it is laid down in international treaties that airlines, not airports, can access the resulting economic rents.

The proper purpose of regulation

The ability of airlines to trade slots ensures the opportunity cost for an airline using a slot is close to its real economic value, thereby eliminating many of the potential distortions to their commercial decisions.   However, economic incentives for the airport itself are potentially severely distorted - and this has been a perennial complaint by airlines.  For the special case of airports, and especially Heathrow, the proper purpose of regulation, in my view, is to mitigate those distortions for the benefit of the economy overall, regardless of which class of stakeholder receives that benefit.  An inefficient outcome means we are generally worse off, whether as consumers of airport services or as are investors in airlines (directly or through our pension funds).

The main reason for there being a special airline interest is that end-users are partly insulated from the effect of investment and other decisions on airport costs.  Other things being equal, a change in airport costs translates into a change in airport charges at a price review.  But this does not necessarily or directly affect consumers.  As acknowledged by the Competition Commission (e.g. page 139 of its BAA airports market investigation report), increases in landing and parking charges, at least, are liable to result in lower slot values for airlines rather than higher fares for consumers.  

This means that airlines have a direct and immediate interest in the cost performance of an airport, qualitatively quite different to the interests of intermediate suppliers in other regulated sectors.  Consumer sensitivity to cost issues is thus artificially diluted and, logically, the CAA's focus on cost efficiency might also be dangerously compromised.

A potential source of tension?

By framing the duty so explicitly in consumers' interests, the CAA may find it difficult to give due weight to airline representations on issues where their interests are not perfectly aligned with those of consumers[1].  In some cases, a proposal could appear to be in the consumers' narrow interests but represent an inefficient outcome overall and to the detriment of airlines.

For example, how would the CAA assess an investment proposal that would appreciably improve the passenger experience but at a substantial cost if the cost would fall principally on the airlines (i.e. with limited impact on fares)?  The interests of consumers, as defined in the CAA's primary duty,  would be promoted but the overall outcome could be rather negative.  I doubt the proposed supplementary duty "to secure, so far as it is economical to meet them, that all reasonable demands for airport services are met efficiently" (the only one that refers to efficiency) would be enough to allow the CAA to depart from the logical consequence of its primary duty in such cases.

This would appear to create at the very least a perceived tension between the regulator and airlines.  In practice, the CAA may be able to steer an appropriate path through the issues, but it could make the relationship between the CAA and an important and powerful user group more difficult, and make it more difficult to engage airlines in the regulatory process.

I suspect the DfT will find enough support in consultation responses to confirm its proposals.  If so, I hope my concerns prove to be unfounded as well as unfashionable.

Ian Rowson
29 June 2009

[1] Airlines have argued that their and consumers' interests do not diverge.