1 Airport ownership in the UK: can the proposed divestiture be expected to have major effects on competition and performance? Professor George Yarrow Regulatory Policy Institute Oxford, UK

2 Major UK airports

3 Airport share of passengers (2007) BAA London Heathrow 28.2% London Gatwick14.6% London Stansted 9.9% Edinburgh 3.8% Glasgow 3.6% Aberdeen 1.4% Southampton 0.8% Total 62.3% Non-BAA Manchester 9.1% London Luton 4.1% Birmingham 3.8% East Midlands 2.2% London City 1.2%

4 Changes in pax, 12 months to Nov 08 BAA London Heathrow -1.0% London Gatwick-1.7% London Stansted -5.7% Edinburgh-0.1% Glasgow -6.4% Aberdeen -3.5% Southampton -0.5% Non-BAAManchester-3.2% London Luton +3.6% Birmingham +4.8% East Midlands +6.0% London City +13.1%

5 Privatization BAA privatized in July 1987 Arguments for retaining common ownership of major London airports given at the time: –Hub status would make Heathrow dominant whatever –London was an integrated system –Business prospects for separated airports would be unduly sensitive to government policy –Separation would delay privatization Note that: –Airline markets were considerably less competitive than now –Luton (and now City) serves London but is not part of an integrated system –Separation may have improved government policy

6 Airport regulation The regulatory regime differs in a number of respects from the standard UK model. For example: –There is no licensing system –The decision concerning whether or not to impose price controls at an airport lies with the ministry, not the regulator –There is an automatic reference of price control issues to the Competition Commission (in other sectors the Commission is only involved in the event that a regulatory decision is challenged) –No ring fencing: single till revenues are regulated On the other hand, there are also similarities: –RPI-X charge controls are imposed for five year periods

7 Why now? Enterprise Act 2002: wide ranging changes in competition law. UK institutional structure is a little unusual in having a Competition Commission as well as an Office of Fair Trading (the latter enforces Arts 81 and 82, and their domestic equivalents). There is also a UK tradition of sectoral investigations that are additional to enforcement of competition law relating to abuse of dominance, cartels and mergers. (cf EU sectoral inquiries) Formerly this was done via the concept of complex monopoly. Now done by Market Studies (OFT and sectoral regulators) and Market Investigations (the CC). The CC identifies whether there are features, or combinations of features, that give rise to adverse effects on competition (AECs). The Act gives the CC a duty to remedy any AECs identified, without ministerial involvement except in specified public interest cases (currently only national security).

8 The OFT, the CC and the CAA Initial market study by the OFT. Took up the issue of divestiture, and referred the matter to the CC for a Market Investigation. CAA broadly supportive of divestiture, although the regulator sees a rather more limited range of features that might be expected to give rise to AECs. The CC market investigation is still in progress, but provisional decisions point to required divestiture of: –London Gatwick, which BAA is already seeking to do –London Stansted, and –One of Edinburgh or Glasgow

9 Features identified by the CC These include the obvious fact of common ownership and the market power to which it gives rise. However, the CC has gone far beyond this in its provisional findings and decisions. Identified features (giving rise to AECs) include aspects of the regulatory regime itself, including not only the absence of a licensing system, but also things such as the weight given by the CAA to its better regulation duty (not to regulate more than necessary) and the nebulous notion of the regulatory culture. They also include the capacity position, the argument being that capacity constraints serve to restrict competition. Existing capacity constraints are said to be the consequence of underinvestment by BAA.

10 The CCs views of divestiture In fact, on the basis of its analysis, the CC is notably pessimistic about the prospects for enhanced inter-airport competition in the short- to medium-term. This raises an immediate question: if the CCs analysis is correct, what are the sources of the perceived benefits of divestiture? The answers appear to be that increased competition is expected to have longer-term benefits, and that, until these start to materialise, separate managements and an enhanced ability of the regulator to make performance comparisons will benefit airport users? But, if this is the case, is the remedy proportionate? The longer- term benefits are necessarily relatively speculative, particularly given the uncertainties facing the sector, and convincing evidence concerning performance comparisons has not been presented. Open to legal challenge?

11 Underinvestment There is a general debate about the implications of the planning system for infrastructure investment. However, if features of the planning system are the cause of underinvestment, why not identify those as the relevant features giving rise to AECs? More puzzling, because of the nature of the regulatory regime for airports, the CC regularly considers many of the relevant issues, on a five yearly basis. Past CC reports on the price controls for London and Manchester airports did not identify a specific problem of underinvestment. Question: what has changed? The CC seems concerned to ensure that airport expansion goes ahead, including in particular expansion at Stansted airport; whereas the usual arguments for competition tend to be based on the notion that competition leads to better discovery of what investment is and is not required to serve customers.

12 Capacity constraints Whilst capacity constraints are one of the factors that can be expected to influence competition in a market, they are not generally the principle determinant of the pressure of competition. The CC in its preliminary decision on remedies suggests that, because of capacity constraints at London airports (specifically Heathrow), divestiture will lead only to marginal increases in competition. The underlying model of competition appears to be one in which airports compete for passengers within catchment areas, and route patterns are relatively fixed. This may have been a reasonable approximation at the time of privatization, but there have been very substantial changes in airline markets since then, which have major implications for inter-airport substitutability. This wider substitutability can be expected to reduce the impact of localised capacity constraints on competition.

13 Competition and regulation? The standard argument in regulated sectors is that regulatory controls can be relaxed as competition develops. Because the CC is of the preliminary view that the increases in competition resulting from divestiture will, at least in the short- to medium-term, be marginal, and because it also thinks that regulation has been too lax, the provisional remedies call for more intrusive regulation, even with divestiture. For example: greater regulatory involvement in investment decisions; introduction of price controls at Aberdeen airport. Most significantly of all, there is contemplation of a regulatory regime that might re-introduce price controls on airports whenever the demand capacity balance became tight. This could be expected to discourage private investment. Why invest if, whenever the investment becomes profitable, it is likely that price control will be reintroduced?

14 Assessment CC analysis looks more appropriate for the 1980s when –Airlines markets had not been liberalized and LCCs were a much less significant force in those markets –Stansted development was in its infancy –The airports were publicly owned so that a decision to privatize them separately would have raised no major issues of interference with private property rights –The limitations of yardstick regulation and yardstick competition had been less clearly exposed by available evidence than now when –Airline liberalization has transformed the demand side of airport markets –Increased inter-airport substitutability has significantly reduced the significance of capacity constraints for competition, both in general and a fortiori in relation to localised constraints (eg at London Heathrow) In broad terms, the competition case for divestiture is relatively stronger, and the regulatory case (based on yardsticks) for divestiture is relatively weaker, than in the 1980s

15 In conclusion The CC has not yet reported. All conclusions to date are provisional, and potentially subject to change in response to reasoning and evidence. In my view, the competition case for divestiture is much stronger than the CC appears to believe. If that case is not made out, however, the conclusions may be vulnerable to legal challenge. The Enterprise Act gives the CC very considerable, delegated powers. Those powers must inevitably be accompanied by greater responsibilities in relation to the exercise of the CCs discretions. Will those responsibilities be met?