In committing itself to providing a 30-year framework for air transport policy, the government recognised that the existing approach of ad hoc interventions, delayed decisions and the consequent congestion could not be allowed to continue indefinitely. A ten-year transport strategy had been set out for the railways (DETR, 2000); a new energy policy was eventually produced at the end of a lengthy consultation period (DTI, 2003); and a longer-term framework for water published too (Defra, 2002). The government recognised that markets and competition, though important, would not be sufficient for the development of core infrastructure.

Helm, Dieter

English

Research Papers in Economics

1 OXERA
1
Introduction
Dieter Helm, Fellow, New College, Oxford
Dieter Helm
In committing itself to providing a 30-year framework for air transport
policy, the government recognised that the existing approach of ad hoc
interventions, delayed decisions and the consequent congestion could not
be allowed to continue indefinitely. A ten-year transport strategy had
been set out for the railways (DETR, 2000); a new energy policy was
eventually produced at the end of a lengthy consultation period (DTI,
2003); and a longer-term framework for water published too (Defra, 2002).
The government recognised that markets and competition, though
important, would not be sufficient for the development of core
infrastructure.
But while the recognition that the current state of affairs is unsatisfactory
is a necessary step, finding a ‘solution’ is proving altogether more difficult,
and it is unlikely that the forthcoming Air Transport White Paper will
provide much more than a partial answer. The reason is that a ‘framework’
is not the same as a ‘decision’. Deciding whether to build more airports
and/or runways, and deciding where to put them, form part of an aviation
sectoral framework, but there are many other components. These include
the prices for aviation services, the interconnections with other
infrastructures, the environmental constraints, the design of the aviation
markets (including slots) and the regulatory framework.
As many commentators have recognised through the government’s
consultation process launched in 2002 (DfT, 2002), there are two ways of
going about constructing the logic of the White Paper. The first is to sort
out all the distortions in the market (including pricing and environmental
factors) and then allow the investment decisions to be taken against the
‘correct’ demand and supply parameters. The second is to decide what to
build and where, and then leave the distortions to be worked out
subsequently.
For very good reasons, the first approach is the right one. It still leaves
decisions to be reached which only government can make. But these
decisions are better informed, and the resulting economic benefits are
likely to be much greater. The second approach is inevitably one that
lends itself to politics and political pressures, and is a process which tends
to use analysis as an ex post rather than ex ante justification.2
Air Transport and Infrastructure: The Challenges Ahead
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The sheer scale of the distortions in aviation indicates how important it is
to try to address these first. Decisions based on a structure in which one of
the busiest airports in the world (Heathrow) has among the lowest prices,
where cross-subsidy is endemic, and where the environmental damage is
largely unpriced, are certain to be wrong by a very considerable degree.
Taking each of the major distortions in turn, the pricing of airport services
has grown up on the basis of cost recovery and cross-subsidy. A single till
combines revenues so that the economic costs of landing are greatly
influenced by how much shopping goes on at airports. While this might
be rational if the pricing function of an airport were shopping, it makes
little sense as an aviation policy.
The consequences are obvious: the lower the landing fees at Heathrow,
the higher the demand for slots (and therefore runways) and the greater
the substitution from other regional and South East airports to Heathrow.
These issues are not new, and have been raised at successive Monopolies
and Mergers Commission and Competition Commission reviews of BAA’s
fees, charges and price caps.
Relative pricing between aviation and other forms of transport—notably
railways, but also roads and ferries—is also distorted. The railways and
roads have no clear economic asset valuations on which to base capital
charges. There are no clear current-cost valuations of either to compare
with BAA’s accounts. For roads, there is also no link between the capital
costs and asset depreciation and road charges. Fuel taxes are high, but
unrelated to investment. For Network Rail, there is not as yet even a
proper asset register, and the track access charges were developed on the
back of a required return for the regulatory asset base, determined by
what the then Conservative government could sell the railways for. In
any event, the scale of capital subsidy in the railways is now the
overwhelming and dominant factor for investment.
The treatment of the environment and environmental impacts in aviation
and between aviation and other transport modes is very crude, and often
effectively ignored. Aviation does not remotely pay for its direct
environmental externalities—on land use, on CO
2 and other gas emissions,
and on noise. Furthermore, the indirect costs are ignored too. Large-scale
tourism and international travel brings great benefits to individuals and
tourist-based economies, but it has also destroyed key habitats,
contributed to biodiversity loss, and encouraged the transmission of
diseases.
The scale of these effects is understandably the subject of much debate.
Aside from the obvious lobby interests on both sides, the tools of
cost–benefit analysis provide an evaluation mechanism, but the outcome
is bound to be uncertain. Direct estimates of noise value and CO2 emissions
are relatively well developed. Those of land-use loss, habitat and
biodiversity are less so. As David Pearce points out (see chapter 13), the3 OXERA
aviation tax debate has had a chequered history, but the case for such a
market-based instrument is very strong.
In setting out a 30-year framework, the government has the opportunity
to adopt a more rational approach to aviation and transport resource
allocation. Auctioning slots, peak pricing, and environmental taxes are
part of a market-orientated policy framework, which helps to reveal the
underlying demand and supply conditions. And although the consultation
exercise has been accompanied by the attempt to estimate what the
consequent demand for aviation would be, the case for a market-based
approach is premised on the idea that such exercises are bound to fail. If
planners could make such estimates as well as markets, there would be
little point in using markets.
These considerations lead to an optimal strategy for government: first, fix
the distortions, then decide on capacity in light of the revealed demand.
Sadly, this luxury is not available—having failed to address the distortions
over the last couple of decades, the government now has to make decisions
on capacity. Policy is therefore second-best—focusing on how to decide
on capacity, but at least having the simultaneous option of adjusting the
distortions.
Recognition of the practicalities leads on to the inevitability of trying to
judge how much demand would fall if prices were corrected. Would, as
some claim, an appropriate environmental aviation tax reduce demand
sufficiently to negate the need for some, or all, of the additional capacity?
It is well beyond the scope of this chapter to adjudicate on this question,
except insofar as to provide some remarks on the environmental cost
estimates and the elasticities with respect to other transport modes. On
the externalities, the commitment in the Energy White Paper (DTI, 2003)
to addressing the Royal Commission on Environmental Pollution target
of reducing CO2 emissions by 50% by 2050 (RCEP, 2000) would indicate
that a substantial contribution is required from aviation. This is
particularly relevant given that emissions in the atmosphere are much
more damaging than emissions at ground level. Furthermore, as noted
above, since the wider externalities are typically ignored, we can assume
that the main estimates of environmental damage are underestimates. With
regard to the substitutes, these are capacity-constrained too, and
elasticities should be considered for different levels of investment in rail
and road, as well as for the existing system. If this is done, the elasticity
should rise (as, for example, with the completion of the Channel Tunnel
Rail Link, and other high-speed links to the Midlands, the North and
Scotland).
But such considerations are hypothetical: it matters whether the
environmental taxes are actually imposed, and whether new rail, road
and other substitute infrastructure is actually built. Suppose for a moment
that it is not. In such circumstances, the unconstrained demand for air4
Air Transport and Infrastructure: The Challenges Ahead
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travel is likely to grow very considerably, as a number of forecasts
indicate. More people will want to take cheap holidays abroad. Business
will take advantage of falling costs of international travel. Commuting
patterns will respond to the location effects of cheap flights. People will
own more widely dispersed second homes. With prices falling, demand
will outstrip supply, and queueing and congestion will result—as has
already happened on many of Britain’s roads.
These demands have a political context as well as an economic one.
Ministers will be loath to be responsible for raising the price of cheap
foreign holidays, for fear of voters’ reactions to having their new-found
lifestyles priced out of their reach. The larger the distortions appear, the
more entrenched this political effect becomes. Ministers in the past have
ducked the airports decisions for fear of the backlash in a geographical
electoral system. This time, the fear may be the other way around: not to
build risks the new cheap-holiday vote.
In bringing together the strands of the debate and in responding to the
consultation process, the government might be tempted to do the
minimum possible. This time that probably means choosing more
runways rather than a new airport, and to concentrate them around
Heathrow. That may be the right answer, and it would buy time to think
more about the further steps. If this is combined with a proper economic
framework that starts to reduce the distortions, it may not be a bad
outcome, and then a proper framework for aviation policy might begin to
be created and demand respond to the true resource costs.
If this is to be the outcome then, as many of the papers in this volume
indicate, much more research is needed to design appropriate economic
instruments and, where appropriate, new markets. The Air Transport
White Paper represents an opportunity to set out a framework within
which the policy instruments can be developed. It remains to be seen
whether the intention to avoid the dithering and evasions of the past is
carried through successfully.
References
Defra (2002), ‘Directing the Flow: Priorities for Future Water Policy’,
November, Department for Environment, Food and Rural Affairs.
DETR (2000), ‘Transport 2010: The Ten Year Plan’, July, Department of the
Environment, Transport and the Regions.
DfT (2002), ‘The Future Development of Air Transport in the UK: A National
Consultation’, July, Department for Transport.
DTI (2003), ‘Our Energy Future: Towards a Low Carbon Economy’,
February, Department of Trade and Industry.
RCEP (2000), ‘Energy—The Changing Climate’, 22nd Report, Royal
Commission on Environmental Pollution, June.

Directing the Flow: Priorities for Future Water Policy’, November, Department for Environment, Food and Rural Affairs.

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