Economic Regulation - IATA

05 - Economic Regulation 37
has been set to reflect increases in the asset base as
major new investment is undertaken. An RPI+X profile
can also provide efficiency incentives though, of course,
it still relies on the correct value of X being set.
Price-cap regulation does have a strong track-record in
terms of improving the efficiency of infrastructure assets.
However, it does also encounter some practical problems
that need to be addressed:
Resource intensive.
Price-cap regulatory reviews involve significant amounts
of regulatory resource costs and time. In addition, the
degree of complexity has increased over time as the
objectives and practice of regulation have evolved. For
example, in the UK the first review of BAA airports in
1991 took 12 months, determining a simple value of X.
The review in 2002 took 32 months, setting a value of
X with six trigger points and a service quality scheme
covering 12 different parameters.
Regulatory game playing.
The regulated company has an incentive to take
advantage of asymmetrical information in order to provide
inflated expenditure and investment forecasts and to
convince the regulator of the need for higher returns and
a higher price cap. In particular, in the two years prior to
each review the regulated company can be more focused
on responding to the regulator rather than to the needs
of customers.
It can become based on actual rather than
efficient costs.
As discussed above, in light of asymmetric information
and the need to reset CPI-X on a periodic basis, pricecap
regulation can converge in practice towards a rateof-return
system if set on an actual rather than optimal
level of costs. If, over time, the price cap starts or tends to
resemble a cost-plus system, its ability to deliver ongoing
incentives is reduced.
An increase in volatility of profits
for the regulated company.
Setting price-caps across four to five year regulatory
periods can also expose the regulated companies to
volatility in profits, especially with regard to external
shocks. However, a large part of this potential volatility
should be welcomed, as it represents a more appropriate
sharing of risks within the industry. Airlines and their
users cannot be expected to face the full burden of any
external shocks. It should also incentivise the regulated
firm to improve its contingency planning and response.
Nevertheless, in extreme cases, force majeure clauses or
an interim review can be used. However, in order to protect
regulatory credibility it must remain the exception rather
than the expectation in the event of an external shock.
A potential, though unlikely, barrier to investment.
Price cap regulation and its periodic reviews are
sometimes argued to act as a barrier to new investment.
Regulated companies are argued to face uncertainty
over whether the regulator will “capture” future efficiency
gains from investment and are subsequently deterred.
However, experience does not provide any clear evidence
that this is the case in practice. Indeed, the information
asymmetries on capital expenditure plans may actually
encourage investment in order to boost returns, while
investment may also be undertaken as an entry-deterring
strategy against other airports 17 .
However, while these problems exist, as discussed above
and in other chapters, they are not insurmountable.
An effective and flexible price-cap regulation system
can still provide significant incentives to improve efficiency
and service quality, while also improving consultation with
airline customers on their operational and investment
needs.
There are costs involved in undertaking price-cap
regulation. For example, in 2003 the New Zealand
Commerce Minister found that “the direct costs of
control (including both the regulators’ and market
participants’ costs) for a single airport might be NZ$1.1-
$2.2 million (US$ 0.75-1.5 million) in a review year, and
NZ$0.5-$1.1 million (US$ 0.35-0.75 million) in other
years. Over a five year period, with one review, this
suggests an annual average of between NZ$0.62-$1.32
million (US$ 0.43-0.9 million) per year at each airport” 18 .
As such, it is not something to apply to every airport, but
only to those with clear market power and where the
potential benefits of regulation outweigh the costs of its
implementation.
17
See Starkie, D (2004), “Testing the Regulatory Model: The expansion of Stansted Airport, in Fiscal Studies, vol.25, no.4.
18
See: http://www.med.govt.nz/templates/MultipageDocumentPage_10435.aspx