The British air travel industry is arguably the freest it has been in its century-long history, with consumers, business and the Treasury all reaping the benefits of an inexpensive, safe and convenient mode of transportation. Yet despite the significant progress that has been made, there remain significant hurdles to the realisation of a truly efficient and competitive aviation industry in Britain, namely the way in which the government proceeds with the regulation of airports. This article identifies the major barriers to efficiency in the aviation industry and recommends that clear and strong property rights would resolve many of the problems currently faced.

Background

During the first half of the twentieth century, British airports were fully controlled by the Ministry of Defence. As commercial aviation became more popular and more complex, this inflexible form of administration was relaxed. However, instead of privatisation the British government opted to maintain ownership of most airports and created the state-run British Airports Authority (BAA), which assumed control over Heathrow, Gatwick, Stansted and Prestwick airports in 1966, and Edinburgh, Aberdeen and Glasgow airports in 1971. BAA was eventually privatised under the Airports Act 1986, and though this was an improvement on the previous system of state control, various regulations persist that inhibit the development of a competitive, efficient market in aviation.

The Airports Act 1986 included various regulations such as ‘traffic distribution rules’, which controlled the allocation of flights to various airports, and price controls, which determined how much certain airports could charge to airlines for the use of their facilities. These regulations were intended to be temporary measures that would ‘protect consumers “until competition arrived”’, and were targeted at airports owned by BAA; regulators believed that the company’s large presence in certain markets such as London would allow for monopolistic control and pricing that was unfair to consumers.¹  In addition to restrictions on landing, departure, and gate charges, airports were also prevented from selling landing and takeoff slots, which are instead allocated by a system of grandfather rights that permits airlines to use slots if their utilisation of the slot was 80% or higher during the previous year.

In the time since the Airport Act 1986 has been in effect, the commercial aviation industry has experienced explosive growth. The number of passengers using London airports, for example, doubled between 1987 and 2000.²  Both Heathrow and Gatwick airports have been operating close to capacity for years, and demand for landing slots at the airport has become very high. Yet some of the ‘temporary’ regulations that were enacted in 1986 continue to govern the industry today, and cause significant distortions.

Challenges

Price controls remain in place at Heathrow, Gatwick, and Stansted airports, because the Competition Commission believes these airports retain semi-monopoly power that could result in ‘unfair’ pricing. The Civil Aviation Authority establishes maximum charges that these airports may charge. The determination of such prices is not entirely objective and sometimes involves a great deal of subjectivity on the part of the regulator. Peter Scott of the University of Bath School of Management writes: ‘It is clear that the particular maximum price set by the regulator is not the result of the application of some clear economic rule but of informed judgment in the midst of great uncertainty.’³

Price controls strictly limit airport revenues from airlines, forcing airport owners and operators to look elsewhere to raise money. Heathrow, for example, has received substantial criticism in the past for placing too much emphasis on retail stores at the expense of passenger amenities. British Airways CEO Willie Walsh said that this was ‘typical of the English short-termism, lack of planning, lack of investment,’ while former London mayor Ken Livingstone called it ‘shameful’. But, instead of levelling criticism at BAA, Mr. Walsh and Mr. Livingstone should have focused on the activities of the CAA. The price controls explain why the airport concentrates more on retail than passenger comfort: The Economist noted in 2007 that landing fees at Heathrow are one-third lower than comparable airports in New York City, and that retail stores offer one way for the airport to make up for the government-imposed handicap.⁴  The only way BAA could devote more money and space to passenger amenities would be by raising the fees it charges to airlines. The government forbids this, so passengers suffer the consequences.

Similarly, the legal treatment of landing slots is a relic of the state-controlled system that creates perverse incentives for airlines and misallocates scarce space on runways and taxiways throughout Britain. By law, landing slots are allocated through a grandfather system where airlines that have utilised a slot in the past may continue to use it in the future so long as the airline has a utilisation rate of 80% or higher. If they do not meet this requirement, airlines will lose their slots. This system is a poor way of allocating a resource as scarce as landing slots, and is replete with unintended consequences.

When passenger loads are light, such as during economic downturns, airlines with valuable landing slots have an incentive to continue flying flights in order to preserve their landing slots for the future, even though their aircraft are nearly empty. Bmi, for example, flew ghost flights to Heathrow airport throughout 2008 in order to maintain their rights to landing slots valued at £770 million.⁵  This waste is a consequence of the general interference with normal market mechanisms that would allocate slots to the most profitable routes at peak times at airports where runway and gate space are scarce. Airports, meanwhile, are left with little say over which airlines use their runways, gates, and taxiways. Though there exists a market for secondary trading of slots, it continues to be hampered by regulation and is not widely used: SEO Economic Research reported that even as late as 2009, only 1% of landing slots at Heathrow were traded annually.⁶

The government’s purported efforts to enhance competition through regulation are undermined by restrictions on airport development, which complicate any private effort to build or expand new airports. Whereas in a competitive market, monopolistic activity is quickly eroded by the entry of new producers into the marketplace, strict regulations discourage the construction of new airports, making entry into the market more difficult. Further runway development at Heathrow, Gatwick, and Stansted airports was vetoed by the Coalition government earlier this year, and BAA’s effort to develop a fifth terminal at Heathrow to accommodate passenger numbers that substantially exceeded capacity was retarded by a lengthy eight-year approval process that involved the longest planning inquiry ever held in the United Kingdom.⁷  There are externalities associated with airport expansion and building, but these are best dealt with at the local planning level, not the national level where they are subject to posturing by politicians.

One of the main arguments used to support the current regulatory framework is that some airports, such as Heathrow, Gatwick, and Stansted, enjoy monopolistic power and if unregulated would be able to charge airlines and passengers ‘unfair’ prices for the use of their facilities. Though there are significant barriers to entry into the airport market due to government regulations themselves, the perception that airports are immune from competitive forces is a fallacy.

Airports have many different types of passengers that use their services for various reasons, and airports face significant competition for each type of passenger from various substitutes. Airports competing for a larger share of the market for domestic passengers or passengers flying between the United Kingdom and Continental Europe, for example, face competition from ferries, rail services, bus companies, and car rental agencies. Airports such as Heathrow, which host a substantial number of international transit passengers, must compete not only with such domestic alternatives, but also with other large international airports. Amsterdam Schiphol, Frankfurt Main, and Paris Charles de Gaulle, for example, provide Heathrow with strong competition for such passengers. If landing fees were raised by an inordinate amount at Heathrow, airlines and passengers would simply opt to fly to less expensive or otherwise more attractive airports elsewhere in the world.

Solutions

The current system of aviation regulation is anachronistic and has created significant distortions in the market. Airports do not have full control over revenue, scheduling or development, and airlines are subject to significant rigidities in route planning which increase the time and cost of travel for passengers and freight. Scarcity is artificially created in the system through strict planning regulations, and British law prohibits airports from efficiently managing this scarcity by raising prices. The result is overcrowding, poor service, and higher prices for consumers. Changes to the regulatory environment must be made in order to preserve the competitiveness of the United Kingdom’s aviation industry, which employs more than 500,000 Britons and contributes more than £11 billion directly to the economy. If the government is intent on discouraging future growth of airports to combat climate change, a market-based approach must be used to efficiently manage the scarcity of airport space in the country.

In order to accommodate higher demand and avoid shortages, airports must be able to set their own prices. These market prices will, in turn, allow British airports to improve their facilities and services, which they must do in order to compete with other airports and modes of transportation. Similarly, well-defined property rights must be created for landing slots, and these should belong to the owners of the airports to be distributed as they see fit, not distributed by arbitrary government rules.

The most logical way forward would be to give complete control over the ownership, pricing, and management of landing slots to the airports, which have the best knowledge of how to allocate their property. This would also incentivise future airport development and expansion where planning concerns allow for it. Alternatively, landing slots could be defined as the fully fungible property of the airlines, which would have the ability to sell their slots to any buyer, whether they were airports, airlines or investors. Either option, as long as the ability to sell the landing slot was included, would be an efficient market system that would allocate scarce landing slots to those who could make the most profitable use of them, and both would be an improvement on the current system. The legal status of landing slots is shrouded in a haze that must be cleared in order to better benefit passengers.

The aviation industry is vital to the United Kingdom’s economic and social wellbeing. Trade, business, tourism and the jobs of millions of Britons all depend upon the success of aviation. Nevertheless, the industry remains subject to a great number of state restrictions and regulations, which exacerbate the scarcity of airport facilities, harm their quality and misallocate routes to inefficient users. Even with the government’s desire to slow the growth of aviation in order to curb greenhouse gas emissions, the system can be managed in a more appropriate manner with the introduction of property rights and an end to price controls. It is time for regulators at the CAA and the Competition Commission to take a break, cut back on regulation, and give passengers, airports and airlines a breath of fresh air.

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1) Nienke Hendricks and Doug Andrew, “Airport Regulation in the UK,” In The Economic Regulation of Airports: Recent Developments in Australasia, North America, and Europe, Peter Forsyth, David Gillen, Andreas Knorr, Otto Mayer, Hans-Martin Niemeier, and David Starkie, eds. (Aldershot, United Kingdom: Ashgate Publishing Limited, 2004), 101.

2) “Passengers and Air Transport Movements,” Civil Aviation Authority, “www.caa.co.uk/docs/ 1/ADU%20Airport%20Stats%20Master.pdf” (accessed 6 August 2010).

3) Peter Scott, “Economic Regulation of Airports in the UK,” Centre for the Study of Regulated Industries, University of Bath School of Management, 2004.

4) “The Man Who Bought Trouble,” The Economist, 5 July 2007, http://www.economist.com/ node/9440733 (accessed 4 August 2010).

5) Helen Nugent, “Planes ‘fly empty’ to keep slots at Heathrow,” The Sunday Times, 16 July 2008. http://www.timesonline.co.uk/tol/travel/news/article4340518.ece (accessed 6 August 2010).

6) “How airlines play the aviation slot machine,” Reuters, 3 March 2009, “http://www.forbes.com /feeds/afx/2009/03/03/afx6119917.html” (accessed 9 August 2010).

7) Keith Boyfield, David Starkie, Tom Bass, and Barry Humphreys, “A Market in Airport Slots,” Institute of Economic Affairs, 2003.