Reformaing U.S. Airports: Part II
If efficient, competitive airports is the goal, change is the answer
By Dr. Frederick R. Warren-Boulton, Economist
July 2001
One can readily think of four criteria that should be sufficient to ensure
that regulation of landing fees is unnecessary or undesirable.
First, at unconstrained "profit-maximizing"
levels, would revenue to the airport still be insufficient to cover costs,
so that some subsidy from the public is necessary for its existence? If
so, regulation can only distort the efficient financing of that deficit.
Second, and critically, passengers can only
benefit from allowing higher landing fees at slot-constrained or slot-controlled
airports. Allowing airlines to control slot allocation instead of using
landing fees to allocate excess demand benefits only airlines, and costs
passengers dearly. As long as slot constraints are binding, higher landing
fees only transfer revenue from the airlines to the airport, with no short-run
effect on ticket prices. In the longer run, shifting to higher landing
fees results in both the ability and incentive of all parties (now including
the airlines) to increase capacity, leading to reduced ticket prices without
congestion.
Third, does the airport face sufficient
effective competition from other airports to make regulation inefficient?
Note that an airport does not need to have a "perfect" substitute
available with excess capacity (indeed, given fixed costs, the availability
of a perfect substitute would probably indicate that one or the other
should be shut down). Rather, the question is whether there is sufficient
substitutability between airports to constrain an airport from pricing
significantly above its short-run marginal cost, or from not expanding
capacity when it would be desirable.
This can only be answered on an individual
airport basis, but it is not a difficult or unprecedented task. One precedent
is the Department of Justice’s proposal for deregulation of the vast
majority of oil pipelines. (An industry viewed as the classic example
of a "natural monopoly" needing regulation, and which thus,
on its face, would appear to be among the least viable candidates for
deregulation. However, a closer examination of individual pipeline markets
revealed far stronger competitive constraints than anyone had anticipated.)
A similar approach would require looking
at each airport on a case by case basis, using a common and accepted criteria
and methodology (e.g., the DOJ/FTC Merger Guide-lines). The goal: Determine
whether an airport has monopoly power in a relevant market that could
be expected to be exercised to the harm of consumers if regulation were
relaxed or eliminated.
It should be noted that airports face two
competitive constraints on the demand side:
• the ability of passengers to switch;
and
• the ability of airlines to switch
flights.
While related, each has a separate constraint
on the pricing of airport services. In many cases, the combined effect
may be enough to allay concerns that even a profit-maximizing airport
would raise prices above efficient levels.
Fourth, assume an analysis concludes that
certain airports have monopoly power. Public ownership of airports should
be sufficient to ensure non-monopoly behavior as long as the burden of
any supra-competitive pricing falls on the citizens of the political unit
that owns or controls the airport.
A high proportion of traffic by residents
should suffice to allay concerns, especially if the airport cannot discriminate
between residents and non-residents. And, even if "outsiders"
account for a high share of traffic, other airport stakeholders may bear
the burden of supra-competitive pricing.
For example, even though most of the passengers
traveling in and out of Las Vegas may not be residents and voters in Las
Vegas County, as long as Las Vegas competes with other destinations for
tourist traffic, any increase in ticket prices that resulted from higher
landing fees would ultimately be born by hotels or other providers of
the Las Vegas package that competes with similar packages available at
other destinations. In antitrust terms, that means that the city itself
needs to have monopoly power.
The combined set of airports that are either
revenue-inadequate, slot-constrained, in competitive markets, or are publicly
owned by competitive cities, should be quite large. Indeed, it is hard
to think of an airport that does not satisfy at least one of those criteria.
At the very least, a sizable share of airport capacity could be deregulated
without concern, and the experience from those changes used to induce
further reform.
THEORY OF THE SECOND BEST
Partial deregulation, on the other hand,
has generally been less successful. The best example was eliminating many
of the direct controls over the Savings & Loan industry while preserving
government insurance of deposits — a lethal recipe for what economists
call "moral hazard", and most people think of as massive fraud
and theft. Most recently, deregulation of electricity generation has resulted,
at least temporarily, in surprisingly high prices in California during
peak periods.
Both are examples of what economists call
the "theory of the second best" — that a policy change
which moves one aspect to its ideal level may not improve welfare if all
related variables are not also at their ideal levels.
While airlines have been deregulated since
1978, airport controls by the FAA/DOT remained in place. These include:
• rates and charges;
• policies on diversion of revenue
and privatization; and
• limited slot controls.
In addition, air traffic control is provided
by FAA and does not provide efficient pricing to encourage air traffic
control investments.
EFFICIENCY AND PRICING
Economists would argue that there are potentially
two considerations relevant in determining socially optimal prices: efficiency
and equity. The set of efficient prices would be the set that maximizes
the size of the pie (in economists’ terms, the set of prices that
maximizes social welfare). Once anyone knows what their economic role
is, of course, they are likely to prefer a set of prices that makes them
better off than the efficient set. A better test of equity or justice
would be what criteria we would choose before we knew what our role was
(i.e. ex ante rather than ex post). Asked under those conditions, many
of us might prefer a set of prices and incomes other than the set that
maximizes total income.
For example, many of us might have voted
for a tax system that redistributed some income from rich to poor before
we knew whether we would be rich or poor.
But any income redistribution that results
from "inefficient" pricing by airports (e.g., for landing fees
at slot-constrained airports, from city taxpayers to airline shareholders)
is not, I would assert, one that anyone would vote for ex ante, and thus
cannot be defended as "just" or "equitable". Rather,
those who favor deviations from efficient pricing do so because those
prices are in their realized interest — where they stand depends
on where they sit. One can conclude that the efficient set of prices is
also the most just and equitable.
Thus, while someone with a private plane
might greatly favor subsidies to general aviation, that same person would
probably have voted against such subsidies if asked before he knew he
was to become the owner of a private plane.
Persuading a large set of individuals to
accept change when each of them has veto power, however, requires what
economists call a "Pareto" standard: the change must make at
least some better off without making anyone worse off.
In principle, of course, every move to a
more efficient set of prices could be a Pareto improvement, since the
winners could compensate the losers and still be better off. But how to
compensate the losers?
THE BENEFIT’S THE THING
For congestion tolls, often the key is to
credibly assure those paying the fees that the revenue will benefit them
directly. It can easily be shown that a congestion toll will reduce the
welfare of users if they do not benefit from the toll revenue. (As can
be shown, the cost of the toll is always greater than the benefit from
the reduction in congestion). Users can thus be expected to oppose a congestion
toll unless they believe that the resulting revenue will be used to increase
capacity, which in turn will reduce congestion and subsequently the toll.
By "slot controlled" I mean that
someone has the right to determine usage — i.e., to allocate scarce
landing rights when there is excess demand. This includes the formally
slot-constrained airports (O’Hare, LaGuardia, Reagan National, and
JFK), and any airports where one or more airlines can effectively allocate
landing rights directly, rather than through a first-come-first-served
process where the value of those rights is dissipated through congestion.
SLOTS, ATC — TARGETS OF INEFFICIENCY
A critical component of any such plan is
the elimination of airline property rights in slots. Slot constraints,
with slots granted to airlines, are very much a second-best solution to
congestion problems. While better than allowing the value of landing rights
to be fully dissipated in congestion, granting slots to airlines deprives
airports of the funds to expand capacity. Slots also give the receiving
airlines a strong incentive to resist capacity expansions, which would
inevitably reduce the value of their slots. Given the influence of airlines
over airport decisions, it’s hard to imagine a more effective scheme
to prevent critical capacity expansions at airports.
As noted, the air traffic control system
is provided by FAA and does not provide efficient pricing to encourage
air traffic control investments. Efficient pricing of scarce air traffic
control resources and effective increases in air traffic control facilities
— both of which might be facilitated through privatization —
could greatly increase the effectiveness and productivity of airport investments
in additional capacity. As with airport capacity, efficient provision
of air traffic control services requires both demand and supply management.
* * *
Since capacity expansion tends to come in
lumps, efficient pricing will result in an accounting deficit in the earlier
years, and an accounting surplus in later years, as congestion rises before
the next capacity increase. Thus, the relevant questions for financing
are ...
• whether the present value of the
marginal-cost-based pricing revenues is at least equal to the present
value of the costs of capacity expansion; and
• whether the flow of revenues is sufficiently
secure (in terms of both economic projections and legal rights of the
airport) to allow outside financing of the expansion.
For any such rule, total costs should be
evaluated at their economic costs (i.e., incremental, forward-looking,
opportunity costs) rather than on the basis of historic or accounting
numbers.
About the Author
Dr. Frederick R. Warren-Boulton is a principal
of MiCRA (Micro-economic Consulting and Research Associates, Inc.), a
Washington-based economics consulting and research firm specializing in
antitrust litigation and regulatory matters. He holds a B.A. degree from
Yale University, a Master of Public Affairs from the Woodrow Wilson School
of Princeton University, and M.A. and Ph.D. degrees in Economics from
Princeton University. He has served as an expert witness on consultant
mergers and other anti-trust matters, starting in 1981 as an expert witness
for the DOJ in U.S. v. AT&T, and recently, for the States and the DOJ
in United States of America v. Microsoft .