Reforming U.$. Airports
An economist makes the case for deregulating the marketplace
By Dr. Frederick R. Warren-Boulton, Economist
June 2001
Those who currently benefit from regulation
are usually well aware of those benefits, and thus defend the status quo.
In contrast, the costs that regulation imposes are usually recognized
by those who would benefit from deregulation only if and when those markets
are deregulated. This asymmetry has helped sustain inefficient and anticompetitive
regulation in a number of industries, including airports.
Prices based on marginal costs would benefit passengers in three ways ...
First, much of the increase in airport
revenue at congested airports would come from the reduction in the
sheer waste of resources and time due to congestion.
Second, to the extent that congestion
has been reduced by slot constraints, airlines get to charge passengers
higher prices precisely because they no longer impose the time and
aggravation costs on those passengers. Passengers escape the non-monetary
costs of congestion only by paying ransom to the airlines. Slot constraints
give airlines an incentive to block capacity expansions at airports
and the ability to block or hinder the entry of competing airlines.
Thus replacing slot allocations with higher landing fees would not
increase fares in the short run, and would lead to higher capacity
and lower fares in the long run.
Finally, as discussed above, any temporary
airport "profits" from marginal cost pricing should be (and
are likely to be) invested in capacity expansion, which can be expected
to rapidly bring down landing fees.
— R.W-B.
Airline monopoly power is not in the economic interest of airports. Thus
airports will not take actions that reduce airline competition unless
forced or induced to do so by dominant airlines. Looking at a parallel
with Microsoft, computer manufacturers as a group are harmed by Microsoft’s
monopoly over the operating system, but were induced by Microsoft to take
actions that helped Microsoft to preserve its monopoly power. The natural
economic incentive of airports, once free of control by the airlines,
would be to encourage as much competition as possible among airlines.
A major and largely unnoticed effect of
airport regulation has been to inhibit the development of vigorous competition
among airlines, at great cost to the American consumer and to the economy.
If deregulation would allow airports to price efficiently and use the
resulting revenue to expand capacity, the influence of dominant airlines
at each airport would be reduced, and airports could be expected to take
other actions that would increase competition.
Consider an economist’s perspective
on two major (often hidden) costs of airport regulation: facilitating
the ability of dominant airlines to use their influence over airports
to exclude entrants and rivals; and, forcing airports to finance their
capital and overhead costs with socially inefficient charges. Also consider
why the group that believes itself to be a major beneficiary of airport
regulation – airline passengers — is, instead, its major victim.
The most important example of such economic
regulation is the constraint on airports’ ability to raise landing
fees to "true" marginal cost levels because of price controls
— maximum prices based on "historic costs" which ignore
market values, opportunity costs, congestion, and scarcity rents. (It
should be made clear this discussion is aimed at only economic regulation,
not safety or environmental regulations.)
Cost of regulation 1.
Airlines use their influence or control over airports to exclude entrants
Until fairly recently, economists have regarded exclusionary and predatory behavior by dominant firms as rare and often simply irrational. Recent years, however, have seen a spate
of antitrust cases where it has become clear that dominant firms have
imposed or entered into arrangements with downstream (complementary) facilities
to exclude rivals. In antitrust economics, this has become recognized
as the ability of dominant firms to use exclusivity contracts, or pricing
mechanisms with exclusivity effects, to "raise rivals’ costs"
or "reduce rivals’ revenue".
With airlines, dominant carriers have allegedly
engaged in both traditional horizontal predatory pricing and in exclusionary
contracts (overrides with travel agents; gate arrangements with airports)
that either raise costs to smaller rivals or reduce the value of services
to passengers.
Current DOT and FAA regulation increases
the role dominant airlines play in the financing of airport capital development,
making it possible for those airlines to control or "capture"
airports, and to use that control to induce airports to exclude or hinder
smaller rivals in a number of ways. Airport regulation has also helped
dominant airlines maintain market power by reducing airports’ ability
to increase capacity, especially capacity that might be available to entrants.
Cost of regulation 2.
Socially Inefficient Financing Mechanisms
One of the longest standing issues in economics
has been how best to price the individual products of a multi-product
firm so as to recover fixed costs that are common to all those products
(i.e., overhead). The profession’s answer: an efficient set of prices
can be arrived at through a two-step process that might be called "adjusted
marginal cost pricing."
The first step is to determine the full
short-run marginal cost. The short-run marginal cost of an aircraft landing
at a particular time at a particular airport consists of several components.
The first is the incremental cost incurred by the airport, an amount that
is generally both relatively small and readily quantifiable. The second
is the increase in cost imposed on passengers on other flights or their
airlines, a cost that is positive only if the airport is "congested"
— that is, allowing an additional aircraft to land increases the
costs of those other flights or reduces their value to the passenger.
If allowing the flight to land does not actually result in another flight
not landing, then this component of marginal cost is the sum of all the
additional costs imposed on all the other flights affected.
If allowing the flight to land means that
some other flight cannot land (as when an airport is "slot controlled"),
then this second component of short-run marginal cost is the "opportunity
cost" of that flight (i.e., the amount the prevented flight would
be willing to pay to land).
No airport can choose both market-clearing
prices and quantities. Like any supplier, the airport can set prices (landing
fees), and allow its customers (the market) to determine quantity, or
it can set quantity, and use a market mechanism (like an auction) to determine
price. Which is preferable depends on the situation.
Short-run marginal costs, by definition,
take capacity (fixed assets) as a given. But the prices generated by efficient
short-run pricing (i.e., short run marginal cost) also give the correct
signals to airport managers with respect to increasing capacity. With
prices based on true short-run marginal costs, airport managers can value
any increase in capacity, and compare that value with the cost of increasing
capacity.
Efficient pricing also permits the financing
of that increase in capacity. If congestion is sufficient to warrant an
increase in capacity, efficient pricing will result in sufficient revenue
to finance that investment.
Moreover, the value of adding capacity depends
critically on whether the expanded capacity will itself be priced efficiently.
Expanding capacity by itself, without reforming pricing, is grossly inefficient.
As transportation planners have discovered, building or widening roads
to relieve congestion often just results in more drivers on those roads,
so that within a short time period congestion is almost as bad as before.
Airports need to plan capacity expansions long before congestion appears,
but implementing congestion pricing as soon as congestion rears its ugly
head is an essential complement to any capacity expansion strategy.
This problem cannot be dealt with by looking only at supply. Demand management is essential.
Instituting efficient congestion pricing
would not result in some huge permanent windfall to airports. While simply
instituting congestion pricing with no change in capacity could result
in a substantial increase in revenue to airports in the short run, little
of that windfall will be left after the subsequent capacity expansions.
The same characteristic that creates concern as to the distributional
effects of congestion pricing in the short run (that a low price for landings
would mean controlling congestion through landing fees and result in astronomic
fees) also means that efficient landing fees will also be very sensitive
on the downside to increases in capacity.
The "second step" of further adjusting
prices based on marginal costs becomes necessary only if, with efficient
(i.e., marginal cost) pricing, airport revenue is insufficient to cover
accounting costs, and some additional source of revenue must be found.
This is unlikely at major airports where congestion is significant or
where congestion has been only controlled in the past through slots.
But for airports that do not have outside
sources of funding and whose capacity is expected to exceed demand for
the foreseeable future, pricing at least some products above marginal
cost becomes necessary. Marginal-cost pricing would not allow them to
cover overhead or fixed costs.
Economists provide a prescription ("Ramsey
pricing") which is seldom acceptable to incumbent players: If the
goal is to raise revenue while minimizing the adverse effect on output,
raise that revenue by taxing (or taxing most heavily) those products for
which the demand is relatively insensitive to price. At the same time,
keep relatively low markups over marginal costs for those products whose
demand would fall the most as a result of pricing above marginal cost.
On its face, implementing this for uncongested
airports with excess capacity would probably imply that their fixed costs
should be covered by charging landing fees in excess of marginal cost,
rather than by taxing passenger services at the airport.
But my suspicion is that any inefficiencies
caused by failure to Ramsey price at uncongested airports are dwarfed
by the simple failure to price at marginal cost in congested airports.
An alternative solution would be the combined funding of congested and
uncongested airports. Particularly when capacity expansion is difficult
at congested airports, the revenues raised by efficient pricing could
be used to keep down prices to efficient levels at uncongested airports.
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 Econo-mics 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 .
