Economic Regulation - IATA

05 - Economic Regulation 35
From the airport and ANSP regulatory systems that have
so far been implemented there is no evidence of any
convergence towards a favourite model. Various systems
have been used, reflecting differences in objectives
and in operational structures. The advantages and
disadvantages of each system are discussed below.
IATA believes that price-cap (CPI-X) regulation, or a variant
of it, is the most appropriate mechanism for incentivising
improvements in efficiency and service quality. However,
to ensure that a price-cap regulation system can deliver
both ongoing improvements in efficiency and sufficient
incentives for timely and cost-effective new investment
the system also needs to:
Ensure it does not revert to rate-of-return
regulation over time.
Price-cap regulation requires significant amounts of
information on cost levels and the potential for efficiency
gains. Asymmetries in available information mean
that the optimal cost level is often not revealed or is
too resource intensive to discover. As such, price-cap
regulation can be based on historic rather than potential
costs, effectively turning the system into a rate-of-return
regime. An appropriate balance is needed between the
risk of excessive administration costs in obtaining the
information and the risk of setting charges on the basis
of historic rather than achievable lower costs to ensure
that price-cap regulation remains effective over time.
Contain sufficient flexibility and incentives
to encourage new investment.
Major investment decisions need to be based on a
long-term strategic plan that involves the input of all
stakeholders, including airports, users and Governments.
However, regulation can have an impact on the timing
and cost of this investment. As the focus shifts at
capacity constrained airports or ANSPs towards the
need for timely and cost-effective new investment, the
price-cap system needs to be flexible. This may involve a
variety of supplemental measures, such as consultation
with users on investment plans and separate incentives
on the timing and available return for large, long-term
investments. However, an effective price-cap regime must
still remain on existing assets, to ensure that efficiency in
day-to-day operations is not neglected during a period of
new investment.
RATE-OF-RETURN REGULATION
A rate-of return regulation system, or weaker variants
of it, is the traditional model for determining the level
of revenues (and therefore user charges) for airports
and ANSPs, especially those within the public sector. It
is effectively a “cost-plus” system whereby airports and
ANSPs are remunerated on a full cost recovery basis, plus
an additional return as a profit or reserve component.
Rate-of-return regulation has largely fallen out of favour
as airports and ANSPs have become increasingly
commercialised and, in some cases, privatised.
Nevertheless, in some cases, such as Düsseldorf airport,
it has still been chosen as the main form of regulation for
an airport that has recently been privatised.
Supporters of the system highlight the benefits it provides
in terms of long-term consistency and incentives for
investment, as airports and ANSPs are assured sufficient
revenues. It also provides protection against external
shocks for airports and ANSPs (though not for their
airline users). However, these benefits are outweighed
by some significant disadvantages:
Little incentive for cost minimisation.
As airports and ANSPs receive a full cost recovery there
is little incentive for them to deliver those costs in the
most efficient way. As well as no additional reward for
further efficiency there is also no penalty in the case of
poor performance.
Too high an incentive for an over-expansion
of capacity.
As the additional return earned by an airport or ANSP
is related to the size of its capital base, there is a strong
incentive to increase this base through new capacity
regardless of whether demand for this capacity exists.
The incentive is not just for unnecessary new capacity but
also for the “gold-plating” of new investment, delivering
high-quality new facilities that have no practical or
commercial need.
Misallocation of resources.
Therefore, a rate-of-return system can lead to scarce
resources being misallocated to unnecessary or
excessive investment rather than improved efficiency for
existing assets. Moreover, it also leads to a misallocation
of risks and returns within the industry, with infrastructure
providers enjoying stable returns while airline users face
the full cost burden of any external shocks.