Aviation Policy and Research Center

Airport Privatization and Deregulation

Theory and Some Empirical Evidence

14th December, 2004

Airport Privatization and Deregulation: Theory and Some

Empirical Evidence

Anming ZhangAnming ZhangSauder School of Business

  

BackgroundBackgroundAirports traditionally owned by governments: national or local governmentsRationale: Natural monopolyPrivate airports pursue profit maximizationGovernment ownership pursues social welfare maximization… is also an alternative to regulationIn addition, it creates right incentive for airport’s capacity investment

Problems of government department:

Inefficient management

Lack of clear objective: May serve employee interest rather than public

Lack of freedom for finance: difficult to raise fund Lack of freedom for finance: difficult to raise fund from capital marketfrom capital market

Set up public corporation (“Crown Corporation”):

Separate management from ownership

Commercialization: - Experience of YVR:- A recently (1992) commercialized public enterprise- Local airports authority- Not-for-profit, private corporation- Self-regulating Board of Directors- Long-term lease

The trend of privatization

Started in 1970s in Europe and North America

Privatize national railroad, airlines, oil companies, and public utilities

Government returns public enterprise to the private sector

sells shares to highest bidder or to highest bidder with ownership

limits government gives public shares

Mixed ownership:Minor private stake in equityMajority private

Airport privatization has become a growing trend: BAA of the UK, 1987Private airports pursue profit maximizationAirport’s monopoly powerMost privatized airports are regulatedPredominantly, regulation of airport chargesLanding fees (69%), aircraft parking (6%), terminal building charges (25%; passenger based)

Form of price regulation varies from country to country: Predominantly, Rate-of-return regulation, Price-cap regulationRecent studies on country-specific options and experiences: e.g. Forsyth (1997), Beesley (1999), Starkie and Yarrow (2000), Starkie (2001), Tretheway (2001), Gillen and Morrison (2001)Specific form of regulation may be inappropriateCritical to regulations: complex, unresponsive and expensive to administer costs of regulationRegulatory failure and deregulation

Starkie (2001) further concluded price regulation might be unnecessary:

Existence of a complementarity between demand for air-side and demand for “concession” activities This puts downward pressure on airport chargesA private airport sets charges close to social optimum The “concession effect”

Indeed, some countries are moving towards no formal price regulation: e.g. NZ, Australia

Airport as a multi-product firm: air-side and concession activities

Higher proportion of airport revenue from concessions:

75-80% in US; 40-80% for 50 major airports in the world (ATRS, 2002)

Concession operation has grown faster… and more profitable

ObjectivesObjectives1. Examine airport charges of a private airport

and a public airport (with break-even constraint)- Nature of concession effects?- Price regulation unnecessary?

2. Investigate impacts of different forms of price regulation on capital and productive efficiencies

3. Empirical examination of privatization and regulation using major airports around the world

Basic ModelBasic Model = P + D(Q,K) + x: full price perceived by passengers

P = airport charge for a flight

x = portion of ticket price excluding P; exogenous to the model

Q() = demand for airport facilities (# of flights)

K = airport capacity

D(Q,K) = flight delay costs

C(Q) = airport operating costs

r = cost of capital of the airport

Social welfare:

where u = price of concession servicesX(u) = demand for concession services per flight

c(X) = costs of providing concession services

- The objective of a public airport:

- Decision variables P, u, and K

u

XcuXduuXQKrQCPQdQSW )]()([)()(

0)]([)(..

)]()([)()(max,,

XcuXQKrQCPQts

XcuXduuXQKrQCPQdQu

KuP

(1)

Price comparisonPrice comparison

- For a public airport, FOCs lead to:

where

V = the consumer surplus from concession purchases, plus concession profits

1

)(1

'RV

Q

DQCPW (2)

)'

(1

'X

Xcu

(3)

rK

DQ

(8)

u

uXcuuXduuXV ))(()()( (4)

))(()( uXcuuXR (5)

- For a private airport, the objective is: (9)

- FOCs lead to:

- Result: Pπ > Pw Price regulation might be necessary

)]([)(max,,

XcuXQKrQCPQKuP

RQ

DQCP

)('

(10)

)'

('X

Xcu

(11)

rK

DQ

(12)

Alternative Forms of Price RegulationAlternative Forms of Price Regulation

Rate-of-return regulation (ROR)

- Firm’s prices are regulated in such a way that the firm can not make more than the allowed (fair) rate-of-return

Price-cap regulation

ROR and investment decision:

Consider the bus companies that are subject to the ROR regulation that bus fare should give the companies a return not exceeding 10%

Averch-Johnson (A-J) Effect:- Increase the “rate base”- this leads to overcapitalization (use too much capital input and too little non-capital inputs notably labour)- i.e., inefficient use of capital input

In addition,

1. regulatory proceedings costly- need regulatory oversight of costs (to ensure firm is efficient)- allowable ROR on the rate base (investment) is debatable- long history of regulatory battles over fair ROR

2. lack of incentives for the firm to minimize its costs:- gold plating and other cost inefficiency- concern about inefficiency being induced- call for new type of regulation

Price-cap regulation

In 1980s, economists designed a new form of regulation, the price-cap regulation

The regulated firm can set its price freely as long as it does not exceed a ceiling (the price cap)

The cap is subject to periodic review (e.g. every 5 years)

- Limit the maximum allowable average price increase to:(RPI - X) %RPI: retail price index, like our CPIX: expected decrease in cost due to productivity improvement

- Usually fix X at a given level for a period; so that firms have incentive to improve their productivity further than X% and keep the profit for several years; i.e., Price-Cap rewards firms who outperform the expected productivity growth

This is the reason, some times called as “incentive regulation”

Manchester Airport

The price cap is set as RPI – X

In October 1997, CAA made its ruling on the price cap for the third 5-year period (1998-2003):

Based on expected efficiency gain, the X was estimated to be 11.5% per year

However, with the integration of European Union, there was an estimated loss in duty-free sales, so the airport got a 6.5% rebate

Overall, airport charges are limited to RPI – 5% in each of the next 5 years

Main results:ROR tends to induce over-investment in capacity, whereas price-cap regulation under-investment

Dual-till price-cap has less severe distortional effects on investment than single-till price-cap

Empirical WorkEmpirical WorkAnalytical results imply:

1) Capital input productivity would be highest under single-till price cap, followed by dual-till price cap and ROR

2) TFP would be highest under the dual-till price cap, followed by the single-till price cap and then by the ROR

                                                                  

                                         

    

Table 1: Sample AirportsTable 1: Sample Airports

Name of Airport Regulation Structure

Ownership Region

1 Auckland International Airport (AKL) Single-till Price-cap Major Pri. Asia Pacific

2 Bangkok International Airport (BKK) Others Public Asia Pacific

3 Christchurch International Airport (CHC) Single-till Price-cap Private Asia Pacific

4 Hong Kong International Airport (HKG) Others Public Asia Pacific

5 Kansai International Airport (KIX) Others Major Pub. Asia Pacific

6* Melbourne International Airport (MEL) Dual-till Price-cap Private Asia Pacific

7 Tokyo Narita International Airport (NRT) Others Public Asia Pacific

8 Beijing Capital International Airport (PEK) Others Major Pub. Asia Pacific

9 Seoul Kimpo International Airport (SEL) Others Public Asia Pacific

10 Singapore Changi International Airport (SIN) Others Public Asia Pacific

11 Sydney Kingsford Smith Int’l Airport (SYD) ROR Public Asia Pacific

12 Amsterdam Int’l Airport Chisholm (AMS) Others Major Pub. Europe

13 Stockhold Arlanda International Airport (ARN) Single-till Price-cap Public Europe

14*

Barcelona El Prat International Airport (BCN) ROR Public Europe

15*

Paris Charles De Gaulle Int’l Airport (CDG) Others Public Europe

Regression variablesRegression variablesSINGLE: Single-till price-cap regulation or residual cost-plus

regulationDUAL: Dual-till price-cap regulation or compensatory cost-plus

regulationOTHER: Other than price-cap regulation and ROR regulationPAX: Volume of annual passenger traffic (in million)RATIO_CON: Percentage of concession revenue in total airport revenuePUBP: Dummy, equal to 1 for mixed ownership with majority

public ownershipPRIP: Dummy, equal to 1 for mixed ownership with majority

private ownership PRI: Dummy, equal to 1 if airport is 100% private ownedEUROPE: Dummy, equal to 1 if airport is in EuropeNA: Dummy, equal to 1 if airport is in North AmericaCONGSTON: Dummy, equal to 1 if airport is congestedHUB: Dummy, equal to 1 if airport is used as a hub by airlines

Table 2: Descriptive statisticsTable 2: Descriptive statisticsCapital Productivity

(1999) Capital Productivity

(1999 & 2000) TFP (1999)

Models Variables Mean Std Dev. Mean Std Dev. Mean Std Dev. PUBP .09 .29 .06 .25 .06 .24 PRIP .12 .33 .08 .28 .10 .30 PRI .09 .29 .06 .23 .02 .14 OTHER .28 .45 .22 .42 .22 .42 SINGLE .21 .41 .19 .40 .20 .40 DUAL .16 .37 .18 .38 .16 .37 PAX 26 16 27 16 26 14 RATIO_CON .50 .14 .50 .14 .49 .14 EUROPE .32 .47 .25 .44 .22 .42 NA .46 .50 .57 .50 .58 .50 CONGSTON .21 .41 .22 .42 .22 .42 HUB .38 .49 .36 .48 .44 .50

Table 3:Capital productivity and TFP regressionsTable 3:Capital productivity and TFP regressions

Independent variable

Capital productivity (1999)

Capital productivity (1999 &2000)

TFP (1999)

Model 1 2 3 1 2 3 1 2 3 PUBP -38.8**

(-2.07) -40.0** (-2.15)

- -27.6 (.90)

-29.2* (-1.75)

- .150 (.97)

.143 (.84)

-

PRIP -2.2 (0.13)

0.5 (0.03)

- -8.7 (-.59)

-6.6 (.47)

- .087 (.72)

.143 (1.09)

-

PRI -20.9 (-1.15)

-18.8 (-1.04)

- -14.6 (-.83)

-12.3 (-.70)

- -.416 (-1.60)

-.385 (-1.36)

-

OTHER 15.6 (1.00)

13.7 (0.89)

0.09 (0.01)

6.8 (.51)

5.1 (.39)

-2.6 (-0.22)

-.007 (-.06)

-.070 (-.51)

.011 (.10)

SINGLE 32.5** (2.33)

28.4** (2.16)

22.8* (1.80)

17.3

(1.63) 13.8

(1.34) 11.3

(1.13) .150

(1.65) .065 (.69)

.041 (.44)

DUAL 18.3 (1.28)

14.2 (1.05)

11.0 (0.84)

17.9 (1.54)

11.4 (1.08)

9.1 (0.89)

.306*** (3.07)

.194* (1.92)

.206** (2.05)

PAX 1.3*** (3.76)

1.2*** (3.75)

1.2*** (3.85)

1.4*** (5.15)

1.2*** (5.14)

1.3*** (5.37)

.012*** (4.50)

-.091*** (3.33)

.009*** (3.60)

RATIO_CON 111.7*** (3.15)

119.6*** (3.49)

102.4*** (3.01)

83.1*** (3.00)

88.7*** (3.23)

81.7*** (3.04)

1.179*** (4.39)

1.29*** (4.41)

1.32** (4.76)

EUROPE 46.5*** (3.50)

47.6*** (3.60)

38.5*** (3.01)

38.8*** (3.36)

38.6*** (3.32)

34.5*** (3.05)

-.299** (-2.49)

-.304** (-2.32)

-.215* (-1.84)

NA 21.5 (1.34)

18.2 (1.17)

16.6 (1.16)

12.9 (.95)

10.2 (.76)

11.7 (.98)

-.199 (-1.55)

-.292** (-2.14)

-.246** (-2.03)

CONGSTON 28.9** (2.52)

28.5** (2.50)

29.5*** (2.57)

26.1*** (2.8)

23.5*** (2.58)

24.4*** (2.70)

.208** (2.53)

.192** (2.14)

.193** (2.17)

HUB -11.3 (0.90)

-

- -14.0 (-1.29)

- - -.255*** (-2.93)

- -

(constant) 5.2 (-.21)

-7.0 (-.28)

4.7 (.20)

18.6 (0.90)

19.5 (0.94)

21.7 (1.12)

.060 (.27)

.076 (.31)

0.003 (.02)

# of obs. 68 68 68 108 108 108 50 50 50 R2 .555 .549 .502 .451 .441 .422 .691 .619 .577

Adjusted R2 .458 .460 .434 .381 .377 .375 .591 .509 .495 F- test 5.73*** 6.20*** 7.42*** 6.50*** 6.89*** 9.03*** 6.89*** 5.62*** 7.00***

Notes: t-value in parentheses; *** significant at 0.01 level ** significant at 0.05 level * significant at 0.10 level

ConclusionConclusionAirport charge of an unregulated profit-maximizing airport is higher than that of a public airport (subject to break-even constraint) even after taking into account concession effectsUnder a price-cap regulation, the airport tends to under-invest in capacity, and the problem is more severe for the single-till than for the dual-till Analytical results appear to be supported empirically

Privatization and productivity:

- No clear evidence on the positive link- UK airports- US airports: participation from the airlines- Experience of YVR

Commercial freedom given to management important; Not necessarily ownership type

Q & AQ & A