Policy engagement at Queen’s

Expanding Heathrow: Bad for competition and bad for passengers

As the Airports Commission reports today on where to locate London's new runway, Edward Mills and Dr Chris Colvin explain why expanding Heathrow could be bad for its competitors, and bad for London’s air passengers.

Expanding Heathrow: Bad for competition and bad for passengers

Heathrow, London’s biggest airport, is full. Its two runways cannot accommodate any more flights, and its terminals and infrastructure can handle no more passengers. London’s second airport, Gatwick, has one runway which is now 95% full, while Stansted, the third-largest, has all its landing slots taken at peak times. These airports – along with the smaller Luton and London City – are forecast to be full to capacity by the year 2030.

While the need to provide additional capacity might seem urgent, building a new runway in the wrong place could be bad news for consumers. Indeed, our analysis of the sector’s history suggests that building London’s new runway at Heathrow rather than Gatwick could have real costs for the city’s air passengers. With Sir Howard Davies’s Airports Commission announcing its findings today, we urge policymakers to reflect on its recommendations and remember the recent record of changes to airport ownership in London alongside issues surrounding Heathrow’s “hub” status.

Competition and consumer choice

Until privatisation in the 1980s, London’s three largest airports were government owned under the British Airports Authority (BAA). Now a stock-listed company, BAA continued to own these three airports – as well as a number of others in England and Scotland – until 2008. Its near-total monopoly – 90% of London’s passengers – was allowed to exist under a regime where the prices they charged in fees to airlines at the London airports were capped, but encouraged to cross-subsidise the running costs of provincial airports which were often unprofitable.

The UK’s Competition Commission was called in to investigate BAA’s market power by the UK’s Civil Aviation Authority, and ruled in 2008 that the firm should not own more than one airport in London due to concerns that it was monopolising the market to the detriment of consumers. BAA agreed to sell Gatwick immediately, but resisted the ruling to sell Stansted – only complying after a lengthy court battle, five years later.

Did the Competition Commission’s intervention work? We analysed data on monthly passenger numbers published by the Civil Aviation Authority between 2005 and 2015 to measure how the market changed in response to the Competition Commission’s actions. We constructed an econometric model that controls for changing consumer preferences to air travel between specific destinations, as well as the effect of wider aviation policy and changes in total aviation demand. In particular, we needed to account for the EU-US Open Skies Agreement, which deregulated the transatlantic market in 2008, and for business cycle effects – passenger numbers fell as the recession began and recovered as the economy returned to growth.

With this model, we observe only a limited effect on relative passenger numbers between London’s airports; in fact, it appears that the smaller rivals lost passengers to Heathrow. This is a surprising result, as the splitting up of BAA was expected to reduce Heathrow’s market power. Instead, it seems that other factors led to Heathrow – now BAA’s sole airport – becoming more attractive.

One of these factors was the Open Skies Agreement. Previously only four airlines had been allowed to fly between Heathrow and America. Once this restriction was removed in 2008, all US airlines that had been using Gatwick shifted operations to Heathrow. As Heathrow’s runways were at capacity, the US airlines had to displace existing flights from Heathrow – routes for which the values of the landing slot was lower, which attracted less custom.

Meanwhile, our analysis reveals that Stansted did not solve the problem of lack of choice for London’s air passengers. Stansted had an 18% share of passengers in 2007, falling to 14% in 2015. This was despite it having the spare capacity to increase passenger numbers. Strangely, passenger share at Stansted fell most significantly prior to the airport’s eventual sale in 2013. This suggests that while BAA was contesting the decision in court, it was also reducing the potential for competition between its two airports – perhaps by encouraging the airlines to switch to Heathrow, or by pricing out routes at Stansted who were likely to compete directly for customers with Heathrow’s flights.

Perhaps the first instinct on reading these results is to conclude that the Competition Commission’s intervention was a failure. But this would be unfair, as it does seem that competition between Heathrow and Gatwick has spurred-on some material improvements, particularly in passenger provisions such as new terminals and retail opportunities. If the splitting up of BAA appears to have been ineffectual, it is because Heathrow may still be too powerful, with the 50% market share it has today remaining in a monopoly range.

To hub or not to hub

Much of the debate concerning the runway decision has been about whether London requires a dominant “hub” airport, with a wealth of connections for the benefit of connecting passengers. Those who advocate a hub are supportive of Heathrow’s bid, citing evidence that the number of destinations served by Heathrow has fallen in recent years. But this interpretation could be wrong, because our analysis suggests that destinations have been displaced by a more intense service on more popular routes.

Competition is clearly an important consideration for the government’s runway decision. There will be no point in providing additional capacity if prices will not be low enough to attract additional demand. Regulators observed that one indicator of BAA’s dominant position before 2008 was its failure to vigorously lobby for expansion prior to Heathrow’s sale. While Heathrow is now campaigning for a new runway, we suggest that its big concern is not expanding itself, but preventing its biggest competitor, Gatwick, from obtaining the means to increase passengers.

We contend that the concept of a hub airport has possibly passed its sell-by-date. What is the point in investing in a hub when increasing numbers of airlines and passengers now want to fly point-to-point? The government should build on the Competition Commission’s breakup of BAA, and allow the new runway to be built at Gatwick. Only by allowing the world’s busiest single-runway airport to expand will it gain the ability to compete effectively with Heathrow, to the benefit London’s air passengers.

Edward Mills graduates with a First Class Honours BSc in Economics from Queen’s University Belfast in July 2015. His undergraduate dissertation research, for which he will receive a prize, measured the impact of the breakup of BAA in 2008.

Dr Chris Colvin is a Lecturer in Economics at Queen’s University Belfast. He won the Economics Network’s Best New Lecturer Award in 2013, a national award ‘in recognition of exemplary teaching practice that encourages understanding of and inspires interest in economics’.

Disclosure statement: Edward Mills and Dr Chris Colvin do not work for, consult to, own shares in or receive funding from any company or organisation that would benefit from this article, and have no relevant affiliations.

The featured image has been published under a Creative Commons licence.

 

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