Expansion of Heathrow and Gatwick might not be necessary if a proper charging structure were in place claims influential senior economist.

In his evidence to the Competition Commission enquiry into BAA’s London Airports, published by the Institute of Economic Affairs, Professor Stephen Littlechild suggests that there is a serious problem of under pricing at Heathrow and Gatwick Airports, which artificially increases demand for the use of those airports and distorts investment decisions.

Professor Littlechild suggests that there is an urgent need to raise prices for take-off and landing as current prices are below those that would equate supply and demand. The level of prices that would “clear the market” is much higher than at that now charged, he claims. Furthermore the two main London airports are significantly under-priced relative to the cost of expanding capacity and by international standards. Charges at both are less than half the level reported for the two main New York airports.

Under-pricing leads to many problems including:

• Artificially stimulating the demand to fly rather than the use of other modes of transport


• Reducing the incentive for airlines to expand capacity by using larger planes


• Other airports find it more difficult to compete


• The scarce resources of Heathrow and Gatwick are not used efficiently


• Artificial signals are given to expand capacity at the two main London airports.The appropriate basis for setting airport charges is a matter for debate. If prices were set on the basis of long-run marginal cost, one advantage is that better information would be provided on the real economic benefits of building new terminals and runways at Heathrow and Gatwick. Demand would not be artificially inflated. Future investment decisions would then be better informed.
  
  If airport charges at the two main London airports were increased, there would be concerns expressed by airlines, passengers and no doubt politicians. There might also be political problems as the general public noted that increased charges in a regulated industry led to higher profits. One solution to that problem would be for part of the increased charge to be ring-fenced in a fund used to help finance the costs of expanding capacity.
  
  Littlechild also suggests that the three London airports covered by the enquiry should be treated separately, as stand-alone businesses, for the purpose of price control. Additionally, other commercial activities should be separated from the core business. This would lead to better investment decisions and more focused regulation. Such separation of activities for the purpose of regulation may lead to higher airport charges but this would, in fact, be beneficial. Littlechild suggests that there can be great benefits to regulation, from ring-fencing the core monopoly business (providing services to airlines in this case) and applying price control to that business as a stand-alone entity.
  
  Read the full paper here.