“Economic airport regulation from a practitioner's perspective” by Cathal Guiomard
A plea for less rather than more government intervention in Europe
The economic regulation of airports is one of the most complex tasks of government economic supervision. Unlike in highly competitive industries, airport operators can set fees above their costs due to their often monopolistic position. This phenomenon of market power provides the theoretical justification for government price controls. However, practice reveals significant weaknesses in the system – and raises fundamental questions about the purpose and design of such interventions.
Theoretical foundations and practical realities
Economic theory identifies market power as a key potential motive for regulation: if a company can set prices significantly above its costs due to a lack of sufficient competition, welfare losses arise. Regulation is intended to bring prices closer to efficient costs, thereby relieving the burden on passengers and airlines.
However, because there may be net benefits in theory does not mean that there are benefits (or that there are large enough benefits) to justify regulation. A sound cost-benefit analysis must first clarify whether the benefits of lower airport charges exceed the direct and indirect costs of regulation. At an airport with 35 million passengers such as Dublin, a reduction in charges of just one euro would generate a total benefit of 35 million euros for passengers. However, this is offset not only by the operating costs of the regulatory authority, but also by the airport's and airlines’ compliance costs and distortion effects that are difficult to quantify.
The fundamental problem with any economic regulation lies in information asymmetry: the airport knows its actual costs and efficiency potential, but the regulator does not. The airport has a systematic incentive to present higher costs in order to justify higher price caps. The regulatory authority must therefore estimate efficient cost levels with considerable uncertainty—an inherently imperfect process.
Three regulatory models compared
Historically, three basic approaches to airport regulation have emerged, each creating different incentive structures.
Rate-of-return regulation: The traditional American model limits the airport's return on capital. Companies are allowed to earn a fixed percentage of profit on their invested capital. This approach seems plausible at first glance, but it produces systematic misalignments. Since higher assets enable higher absolute profits, airports tend to overinvest – a phenomenon known as gold-plating. A current example is the discussion about the budget for the third runway at Heathrow, where the airport would earn higher profits from costlier investments. This does not incentivise an efficient investment plan. Furthermore, low profitability does not automatically guarantee low prices for users. RoR regulation does not reward firms for operating cost reductions. RoR regulation (sometimes called ‘cost-plus’) is today much less used than in the past.
Price cap regulation: The dominant method in Europe focuses directly on prices. The regulatory authority sets a price cap (ceiling or maximum) per passenger, typically for a period of five years. Dublin Airport currently operates with a cap of around €10 per passenger, Heathrow with around €30. The key advantage of a price cap system is that if the airport operates more efficiently than assumed by the regulator, it can keep the additional profits. This creates an incentive to reduce costs. At the next price review, the regulator has better information on the efficient level of airport costs. However, over time, the system, which began in a quite simple form, has become increasingly detailed with very many and very lengthy regulatory decision documents, as both sides argue over every aspect of the calculation. Investment incentives can also be weak under a price cap and this too can lead to detailed scrutiny of an airport’s investment plans.
Light-handed regulation: Australia and New Zealand have been pursuing a radically different approach for 25 years. There are no ex-ante price controls. Airports set their fees completely freely for five years. At the end of this period, a competition authority analyzes the data retrospectively: Is there market power? Has it been exploited? If the answer to both questions is yes, price caps might be reintroduced. This threat disciplines airports without incurring the ongoing costs of detailed regulation. In its regular reports, the Australian Productivity Commission consistently concludes that market power exists and prices have risen, but not excessively. The Productivity Commission is also very slow to regulate. They have decided that, on balance, they should continue with light-handed regulation. For a place like Dublin, I think we should be thinking about a move to light-handed regulation after 25 years of a price cap.
The mechanics of price caps
The calculation of a regulated price cap follows a complex system that opens up considerable scope for assessment. The regulator must estimate five key components:
First, efficient operating costs: how much should a well-run airport spend on personnel, energy, maintenance, and other ongoing expenses? The regulator cannot simply rely on the accounting data provided. Financial reports are subject to strategic manipulation—airports save money in the early years of a regulatory period in order to increase costs toward the end and establish a higher cost base for the next period. This creates a characteristic U-shaped pattern.
Secondly, there are capital costs: airports tie up considerable capital in long-lived assets. Heathrow has an enormous asset base of historic investments totaling more than €20 billion. The regulator must allow an appropriate return on this capital, based on the returns earned by comparable companies in the economy. Returns that are too low jeopardize necessary investments, while returns that are too high place a burden on users.
Thirdly, depreciation: Infrastructure wears out and must be replaced. The regulatory depreciation period determines how quickly depreciation charges are refinanced through fees.
Fourthly, commercial revenues: airports generate significant revenues from retail, catering, parking, and other non-air traffic businesses. This is where the single till and dual till methodologies differ fundamentally. Single till offsets all revenues against costs, thereby reducing airport fees. Dual till separates the two areas – the airport retains commercial revenues, which increases the price cap but at the same time limits the scope of regulation. There is a noticeable trend towards dual till in order to grant airports entrepreneurial freedom in commercial activities.
Fifthly, the traffic forecast: the price cap is ultimately calculated as the ratio of expected costs to expected passengers. Airlines systematically forecast higher traffic growth (larger denominator, lower price), while airports forecast more modest growth (smaller denominator, higher price).
All five components are the subject of intense debate. Both sides submit detailed expert reports, often hundreds of pages long. The regulatory authority must develop its own analyses and cannot rely on the interested parties.
Structural weaknesses of the regulatory process
Practical regulatory experience reveals systematic challenges and drawbacks that go well beyond technical issues.
Focus on the regulator instead of direct dialogue: In a regulated industry, airports and airlines no longer negotiate directly with each other as they do in normal markets. Both sides address their arguments to the regulatory authority. This undermines compromise-building within the industry. Ideally, the regulator would like to see agreements between the parties that it then only has to approve – but the system incentivises exactly the opposite.
Strategic ‘gaming’: Each party has an incentive to complain loudly about every regulatory decision. The airport wants to achieve higher prices in the future and therefore cannot describe a current decision as appropriate – it must be portrayed as "very low." Airlines want lower prices and must brand every decision as "far too high, the highest we pay at any airport we use." Regardless of the actual outcome, a climate of permanent confrontation arises that has little to do with the objective quality of the regulatory decision.
Increasing complexity: Regulation becomes more and more detailed over time. What starts as a lean framework develops into a comprehensive set of rules as both sides bring new aspects into the process. Regulatory decisions become voluminous documents that are hardly comprehensible to outsiders.
Weak incentives for deregulation: Every regulation creates winners who defend their advantages. The regulatory authority itself also develops institutional interests. Abolishing a regulation is therefore much more difficult than introducing it. This explains the historical accumulation of regulatory provisions without a corresponding reduction in outdated rules.
The European context and future prospects
The discussion on airport regulation must be seen in the context of the broader European regulatory debate. The Draghi report on European competitiveness paints an alarming picture: Europe cannot finance its standard of living, its social system, increased defense spending, and decarbonization costs at the same time without significantly higher economic growth. The report identifies the incomplete single market and overregulation, particularly in the digital sector, as key obstacles to growth.
This diagnosis raises the question: how many government resources should Europe devote to regulating airport charges when there are more fundamental challenges to address? The opportunity costs are considerable—every euro and every hour of work spent on airport regulation is lost elsewhere.
There are specific implications for air transport: relatively few airports actually have strong competition between airports. London, Paris, New York—a handful of major cities have multiple airports. For the vast majority of airports, airlines have limited alternatives. But does this automatically mean excessive fees? Since the economy is full of sectors with an imperfect level of competition but without a policy response, would excessive airport charges justify a dedicated response? The Australian experience suggests that the mere threat of regulation is often sufficient to prevent abuse.
A more radical proposal concerns air traffic control: here, regulation could be replaced by competitive tendering. Europe operates with 30 separate airspaces, each with its own air traffic control and its own charges. A flight from Dublin to Athens crosses numerous of these zones. The vision of a Single European Sky remains unfulfilled. Instead of regulating each national air traffic control organization, specific airspaces could be put out to competitive tender. This would realize efficiency gains through competition without the expense of continuous regulation.
Methodological considerations: Regulation as an experiment
Given the uncertainties, regulation should be understood as an experimental process. There are no absolutely correct answers to complex regulatory questions. Europe has numerous airports and different national regulatory frameworks, which allows for systematic variation and evaluation.
In concrete terms, this could mean that some jurisdictions switch to light-handed regulation, others stick with price caps, and still others modify specific parameters. After five years, the results are compared: prices, costs, investments, service quality. This evidence-based approach would gradually reveal which forms of regulation actually achieve the set goals.
The same principle applies to other policy areas: digital regulation could be designed differently in different member states in order to study the effects. The European Union would thus become a laboratory for regulatory innovation.
Conclusion: Time for regulatory restraint
After a quarter of a century of intensive airport regulation in Europe, it seems appropriate to critically evaluate the instruments used. The costs of the system – direct administrative costs, compliance costs, distortion effects – are considerable. The benefits in the form of lower fees are often difficult to prove, as there is no comparison scenario without regulation.
For established regulated airports such as Dublin, a transition to light-handed regulation would be worth considering. Twenty-five years of price caps have lowered costs. The question now is: Should the airport be left to manage its affairs independently, with retrospective review instead of permanent control?
In principle, government authorities should be reluctant regulators – institutionally designed to intervene only when there is a clear and substantial need. The introduction of a "one in, one out" rule would ensure that the overall volume of regulation does not grow indefinitely: each new regulation requires the abolition of an old one.
Regular evaluations, say every five years, should examine each set of regulations: Do the benefits still outweigh the costs? Has the market developed in such a way that regulation has become obsolete? Many regulations outlive their original justification by decades because there is no systematic review.
The key insight: both markets and regulation are imperfect. Economic textbook discussions often contrast ideal-type regulation with a flawed market reality. But realistic regulation, with all its information problems, misguided incentives, and costs, must be weighed against realistic market solutions with all their imperfections. Against this backdrop, less regulation often appears to be the better option—not because markets are perfect, but because regulation often creates as many problems as it solves.
For European aviation, this means that resources should be prioritized for decarbonization, not for increasingly detailed price controls. Combating market power is not Europe's most pressing challenge in 21st-century aviation.
Cathal Guiomard
Cathal Guiomard was Ireland's aviation regulator from 2006 to 2014 and headed the Commission for Aviation Regulation. Until recently, he was Assistant Professor of Aviation Management at DCU Business School in Dublin and Program Director for the Bachelor of Science in Aviation Management. His research focuses on the economic regulation of aviation. He is a member of the Advisory Board of the European Aviation Conference.