"I have come to bury Caesar, not to praise him"
The debate about the pros and cons of privatization have been
raging for some while, and, as is usually in debates where politics,
economics and special interests all clash much heat has resulted, and
little light Rather than rehearse the whole debate, this paper presents
some of the key issues relevant to the question of privatization of
airports in Australia. In doing so, it first considers the general
arguments for privatization, before concentrating on the specific
arguments for airports. In discussing the privatization of airports
within the context of the current Australian debate the arguments for
network versus individual ownership need to be evaluated, as this is an
important issue within the policy suggestions, as well as the economic
and political arguments on privatization.
Privatization: The General Case
In recent years, microeconomic reform has become the buzz word for
'fixing' the problems of the Australian economy. Although
there is no agreement as to exactly what this may entail, the one aspect
of microeconomic reform which appears to have gained wide approval is
that of privatization of much of the public sector. There seems to be a
mystical belief that by moving operations into the private sectors, the
efficiency of markets will infect these bodies. Implicit in this is the
belief that it is primarily the ownership of an asset which influences
its efficiency. While it may be true that in some case efficiency can be
improved by such transfers, it is by no means apparent that this it true
In evaluating this position, it is important to realize that
economic policy follows fashion. After the second world war, fashion
dictated that any market failure was met by nationalization, and
economists oversold the efficacy of government intervention. In the
1970s, there was an overreaction in discarding of these ideals, with
economists now overselling the efficacy of markets. The state came to be
seen as a liability, with the general rule becoming the less state
intervention, and the smaller the role of the public sector, the better.
This has come to be the creed for much policy throughout the OECD, with
Australia being no exception. In other words, privatization seems to be
pursued for its own sake, rather than in order to achieve specific aims.
At this stage it is important to note that there is no evidence,
theoretical or empirical, to back the view that privatization will
guarantee enhanced economic performance. (1) Quite the opposite. When
the economic performance of all countries is examined we see that there
is no definitive relation between the size of a country's public
sector and its performance. (2) The Asian tigers provide a perfect
example, with some relying on heavy government intervention to promote
growth, while others have relied equally on markets.
Similar arguments are relevant to the question of privatization.
Certainly there are no conclusive theoretical or empirical arguments
which consistently show privatization as improving the allocation of
To understand why this may be the case, it is important to examine
the reasons why certain activities have come into the public sector.
There have been two main types of enterprises which economists have
argued should be considered for public ownership, those involving
monopolies and those where community/social services may lead to
benefits accruing to the community if alternatives to private sector
profit maximizing principles are adhered to.
In the case of monopolies, which is of particular relevance in the
discussion of airports, the argument for privatization rests on
extremely shaky foundations, since the benefits are supposed to flow
from increased competitiveness. Since, due to the nature of the beast,
competition can not be encouraged, problems arise. Economic theory
maintains that there are conflicts between monopolies and economic
efficiency. As a result, privatization of monopolies is usually
associated with a regulatory body. This means that resources are being
wasted monitoring and regulating an activity that previously did not
need this. (3) The position seems to require a contradictory assumption,
namely that although governments are not good at managing these
enterprises they are good at regulating them.
In any case, this looses sight of the main point, which is that it
is not ownership, per se, that is important, but the state of
competitiveness in the market. Competitiveness can be encouraged within
public sector enterprise, as has been shown in the fact (discussed
below) that many have experienced increased efficiency and profits just
prior to privatisation!.
The supposed benefits of privatization are dubious. If markets are
efficient, then the government should not make any profit on the sale.
All it is doing is selling future income streams at their current price,
to improve the current budgetary position. This is assuming that the
price of the asset has been correctly determined, so that it is not
undervalued (as was the case with much of the privatization in both the
UK and in New Zealand). (4) In fact there is strong evidence of bias
towards selling public assets for less than their market value due
firstly to the 'political imperative associated with privatisation,
and because of moral hazard problems associated with the sale of a
regulated monopoly'. (5) This later refers to the perception that
the higher profits associated with the private sector monopoly may lead
the government to tighten regulations. In addition, the transaction
costs associated with the transfer of the asset from the public to the
private sector, may be substantial, (6) reducing the realized value of
the sale. In other words, there are costs associated with privatization,
these are the transaction costs involved in the whole process of the
sale, coupled with the costs of regulation. Additional problems
associated with the impact of privatization include the negative impact
on financial markets and the resultant fall in private sector savings
available to finance private sector investment (7) These are two effects
which the Australian economy can ill afford.
In any case, the government is often unclear about what benefits it
expects to flow form privatization. In many cases, it is the one off
revenue gain, rather than any long run improvements to efficiency. This
has been compared to selling the family jewels, which leads to the
question of why privatize unless there is some gain to the economy as a
whole from the sale?
When pushed, supporters of privatization will answer in terms of an
improvement in efficiency from privatization. However, this is far from
clear. While it is true that many public sector enterprises have not
been run at maximum efficiency, this is a problem with management
practices rather than with ownership. Experience has shown that, prior
to privatization, in order to make sale attractive, these same
enterprises have been made profitable while still in the public sector.
(8) In other words, it is not the question of who own the enterprise
which determines efficiency, but rather how they are run.
The public sector has also been important in the provision of
infrastructure and of certain services which benefit the whole
community. In these cases economics has shown that the private sector is
bad at allocating these efficiently.
Problems with private sector allocation have been reinforced by
recent developments associated with deregulation of the financial
sector, which have meant that private sector enterprises in general, and
the financial sector in particular, have become much more myopic. As a
result, there is a lack of desire to undertake and fund long term
projects within the private sector. However, it is precisely these
projects which have spillover effects on efficiency and growth and which
must form the basis of any macroeconomic reform.
What we are arguing is that there are no general rules. Just as
there are some activities which produce a socially optimal outcome in
the private sector, so there will be others which will do so within the
public sector. Rather than espouse a naive belief in general rules, it
is much more appropriate to consider the arguments for privatization or
nationalization in each individual case, evaluating the likely costs and
benefits. The important question, then, is whether privatization of the
airports represents a net benefit to society.
Why Privatize Airports?
There are two related areas which need to be discussed when
considering the question of privatization of airports. (9) The first is
the question of whether they should be privatized at all. The second,
and related question, is the form such privatization should take.
Clearly these questions are related, as the form of privatization will
vitally influence any potential gains. In the next section, the nature
of airport interrelations will be considered, and it will be argued that
it is socially desirable to keep them together as a network. This result
will be used to throw some light on the desirability of privatization.
Airports As Networks
Elsewhere it has been argued that pricing and investment decisions
of aeronautical services by airports can only be made efficiently when
the individual airports do not act as separate optimizing agents; but
rather act as elements within a network. (10)
Relationships between airports are extremely complex, they are both
'complements of and substitutes for each other' [Woods, 1971:
298]. As (almost) all flights involve flying from one airport to
another, individual airports must be considered to act as compliments to
each other. On the other hand, to the extent that the purpose of a
flight can be achieved via a choice of airports, then they the potential
competitors are substitutes. Clearly though, the relationship between
airports is more often that of compliments. The related question of
whether the correct unit of analysis for the purposes of investment
decisions is the individual airport or the network depends, to a large
part, on the exact nature of the product. In other words, is what is
being analyzed air transport as a whole, or is it flights to a
particular airport? To answer this question, it is helpful to
differentiate domestic and international flights. In doing so we can
introduce the distinction between open and closed aviation systems. An
open system is one where either flights originating from outside the
system arrive into the system or where flights originating from within
the system have a destination outside it. Within a closed system all
flights both depart from and arrive to destinations within that system.
With respect to the Australian airline system, international flights
represent an open system while domestic flights represent a closed one.
With respect to international flights, to a large extent the
product being sold is travel to or from Australia. As it is an open
system, the international airports act as gateways for entry or exit to
the country. In Australia's case, the fear of competition from
outside the system, from other international airports, is not a concern,
as it would be, for example, for a European country. Although this has
important implications for both pricing and investment decisions, I will
concentrate on the latter. With respect to investment, taking this into
consideration, and given the earlier argument that the demand for
international air travel is exogenous, allowing investment decisions to
be taken on the basis of individual airports will lead to
over investment. If each airport acts as an isolated individual in
making their investment decisions, then they will tend to expand
facilities in order to attract demand, as a form of strategic behavior.
However, as total demand is fixed, the airports are involved in a zero
sum game, so that any airports gain will be at the expense of another
airport. Consider the following example:
If we assume that investment decisions are now taken by individual
airports and that Melbourne International Airport wishes to expand its
facilities in order to reduce costs and capture a larger share of
international travel. If other international airports believe that such
an expansion will give Melbourne a relative advantage, then they are
likely to follow suite. Each airport in attempting to expand or maintain
their share of international flights will increase their investment.
However, not withstanding this total increase in investment there will
be no resultant increase in total flights. So, the increased investment
will not generate any increased revenue for the system as a whole.
This example allows consideration of the essence of the problem.
Individual airports are concerned both with the total number of
international flights but also, importantly, with their share of that
total. It is in their interest to try to maximize both of these,
although they can really only influence share. As it is a zero sum game,
attempts by individual airports to increase their share will lead to
over investment. Such investment will not increase overall usage, but,
rather will lead to switch effects between airports. Total international
traffic will, however, remain unchanged. From the social viewpoint, the
resultant over investment is inefficient.
In addition, there are clear welfare advantages from investment
decisions for overseas services being taken on the basis of a network
rather than individual airports. With networks, peak loads can be
spread, therefore reducing the total capacity (and, therefore,
investment) requirements. (11) As well, there are clear informational
advantages from the size and resources of a network unavailable to
We can contrast this discussion of international flights, with
domestic flights. As noted above, domestic flights form a closed system.
Any such flight will be from one airport within the system to another
one, also within it. As a result, neither the demand for nor the supply
of flights or airport facilities within one airport can be independent
of the whole system. The implications of this is that it will not be
rational for investment decisions with respect to airport capacity to be
made at the level of the individual airports. Without the pooling of
information implicit in network decisions, individual airports may reach
incompatible investment decisions on the basis of less perfect
information. If decisions were made at the level of individual airports,
then, for example, one airport could decide to expand, even though no
other airport within the system expected any expansion in the demand for
their services. Clearly this indicates incompatible expectations as any
increase in the demand for the services of any one airport must be
matched by an equal increase in demand for services over the rest of the
system. In other words, because the demand for the services of any one
domestic airport is linked to the demand for services of other airports
within the system, it is not rational for investment decisions to be
made at the level of individual airports, thereby ignoring the
interdependent nature of those demands. Rationality would require
investment decisions to be made on the basis of network considerations.
To measure values of individual airport improvements within the
framework of a general aviation airport system, benefits must be
quantified in such a manner that incremental improvements at individual
airports can be evaluated with respect to the contribution they make to
the entire system [Wood, 1971: 295, emphasis in original]
In addition, there is the possibility, as with the case of
international facilities, that individual airports will expand in order
to increase their attractiveness in terms of both cost and noncost
factors. As such expansions are unlikely to change the total volume of
air transport, the only likely effect is to induce switching behavior:
On the one hand, it is quite often alleged that variations in the
landing fee will have little or no effect on the demand for runway
capacity, since the landing fee is but a small fraction--perhaps about
2% or at most 1% - of the total cost of the trip. On the other hand, one
hears, often in the same speech and sometimes in the same sentence,
that, if landing fees are increased too much at Heathrow, London will
lose much valuable traffic to Paris .... Thus, while it is quite
sensible to conclude that if all the competing airports in a region
raised landing fees there would be little effect on air transport
movements, it is misleading to suppose that there would be no effect on
the demand for a particular airport's operation if it, and it
alone, put up its fees. [Walters, 1978:133,emphasis in original]
This indicates that the only likely effect of changes in airport
charges come from switching behavior. In other words, an individual
airport may generate increased air traffic by a reduction in fees but
only at the expense of air traffic to other airports. (12) In this case,
other airports will also expand their facilities as defensive measures.
The net result of this will be a bias within the system for the
generation of inefficient excess capacity as a result of the competition
So far we have considered both domestic and international travel,
but not the link between them. The argument for network considerations
to dominate investment decisions is reinforced by the interrelation of
these types of travel. To a large extent domestic and international
travel are interrelated. The international airports serve as gateways to
the domestic system. Residents in order to partake of international
travel must first get to an international airport. Non-residents rarely
stay the full length of their visit in their initial city of arrival
In other words, there are important interdependencies in all types
of air travel. These may be the interdependencies where one type of
flight acts as a service link to others, or they may be more direct,
where routes involve many airports:
Th[e] viewpoint of airports and air transport as an ever-widening
circle of inter-acting consequences is compounded by the need for
compatibility of airports and airplane schedules. The planning unit in
airline economics is the route. Airports on the route must satisfy
minimum requirements in terms of runway length, navigation aids, etc.
Hence there is a powerful motive to 'keep up with the Joneses
' so that a country or city is retained on the route. If a route is
fixed, then upgrading one airport on the route will usually mean that
all the others should be considered for upgrading also. Piecemeal
investment is likely to be inefficient; and this applies a fortiori to
navigation systems. [Walters, 1978:127, emphasis added]
The above analysis suggests that the interrelations and linkages
between airports within a country like Australia are so strong that
airport investment decisions are unlikely to be efficient if they are
taken in isolation of the rest of the network. The strong links indicate
that the capacity decision of any individual airport will have important
implications for the other airports in the network. Economic efficiency
would require that investment decisions be made on a network basis.
To Privatize Or Not To Privatize, That Is The Question
I should note at the outset that the evidence suggests that
airports in Australia in general, and the FAC in particular, are
extremely efficient. One report concludes that:
The FAC is a highly efficient enterprise, both compared with other
airports and airport systems, and relative to its past performance.
There is little scope for gains in operational efficiency. (Paddon and
Carman, 1992: 3). (13)
The economic main argument in favour of privatization of economic
assets is that an increase in efficiency will result. An important
requirement for this is that there be an increase in the level of
competition, particularly when the government asset was run as a
monopoly. Monopolies result from barriers to entry in the market. Where
the barriers to entry are not caused by government license or
regulation, serious doubts exist as to the possibility of competitive
gains. In such cases, privatization will simply be associated with the
monopoly moving from the public sector to the private sector. In the
case of airports, the large capital expense of setting up and
maintaining them means that they are virtually natural monopolies. The
lumpy and indivisible nature of the investment decision, alluded to
above, implies high fixed costs with relatively low marginal costs. The
net result of these are decreasing costs per unit, so that the output
can most efficiently be delivered (that is, at least cost) by a single
producer. This is reinforced by the fact that airports do not compete,
rather it is destinations which do. This has been reinforced by the
Department of Prime Minister and Cabinet who, in a leaked Cabinet
submission, admitted that there is 'little scope for effective
competition between airports, even those as close as Brisbane and
Due to the nature of demand for aeronautical services, which is
extremely price inelastic, economic theory tells us that a profit
maximizing private sector airport will radically increase price and,
therefore profits. The higher price will enable excess investment, which
will result in a tendency for excess capacity. The net result will be a
substantial reduction in welfare and efficiency. In other words, due to
the monopolistic nature of airports, public sector ownership has served
as a way of preventing them from reaping the excess profits that the
noncompetitive nature of the market would otherwise allow.
Privatization [of airports] is unlikely to achieve much; it would
enhance the incentive to abuse monopoly power and while it would also
enhance the incentive to produce efficiently, there is no evidence that
productive efficiency is much of a problem (Dwyer and Forsyth, 1992:235)
To overcome the increased inefficiencies associated with this would
require the formation of a regulatory body. The problems and ironies
associated with this have been discussed above.
In addition to these considerations is the problem associated with
externalities. Airports create both positive and negative externalities.
Although at present most concern is on the negative externalities,
especially given the problems with noise pollution associated with
Sydney's third runway, there are also positive externalities
related to the benefits of transport and communications systems at the
local, regional and nation levels. (15) Where such externalities exist,
private sector decisions, which operate on the basis of private benefits
and costs cannot provide socially effective outcomes, as they do not
deal with the social content of required for efficient decision making.
As a final consideration, it is important to note that the sale of
airports will reduce the net worth of government assets. As was noted
above, assets tend to be undervalued during the privatization process
due both to the political imperative and to moral hazard. (16) In the
case of airports this under valuation is likely to be more significant
for two additional reasons. Firstly the valuation of the large capital
assets associated with airports is extremely difficult to calculate.
Given the traditional problems associated with valuing such assets,
reinforced by the fact that their value outside the aviation industry is
likely to be low, it is likely that it will be undervalued. Secondly,
the value of the airports as a network is much greater than the sum of
the value of the airports sold individually. Given the Federal
government's commitment to sell them as separate units, this will
result in their sale value being lower than the market value of the
The Political Argument
One of the important arguments raised, both in the economic
literature and the media for privatization is that it will reduce the
incidence of 'pork barreling'. The argument is best summarized
Airports .... seem to breed effective lobby groups, which succeed
in blocking good proposals and getting poor proposals accepted. Building
or expansion of airports involves gains and losses to geographically
concentrated groups (who could be voters in marginal electorates).... In
some areas, airports for which economic justification has been dubious
.... have been constructed. (Dwyer and Forsyth, 1992: 226)
In other words, the argument seems to be that political
considerations may sometimes overcome economic ones. There are two
responses to this charge. The first is that this sort of decision making
is part of the democratic process, and that the alternative is that the
decision is made by a private corporation, and there is no guarantee
that they will choose more appropriately. The second, and related
response, point to the fact that privatization will not remove the role
of noneconomic factors, merely change the nature of them. In the USA,
for example, where airports are not run by the Federal government,
municipal governments compete, in terms of tax subsidies, cheap energy,
and so on, to attempt to attract airports. The impact of a major airport
to a particular region may be very great, and, as a result, local
communities, local government, business and other regional interests
will intervene in order to attract the investment. The important
question is the degree to which the effects and costs of this differs
from the situation where it is a government agency which is making the
When examining the arguments for privatization of airports, the
potential benefits are unclear. There is unlikely to be any gain in
efficiency resulting from increased competition. If the aim is to
improve the Federal budgetary position, then privatization will have the
exact opposite effect. As the sale value is likely to be significantly
lower than the market value, the impact will be to impoverish the
government, by adding to current income an amount less than the current
value of the asset.
This paper asks the question: why privatize airports? The answer is
that there is no good reason for doing so.
Dwyer, L and Forsyth, P. (1992) 'The reform of air transport
and its impact on tourism' in Forsyth, P. (ed), Microeconomic
Reform in Australia, Allen and Unwin: Sydney.
Favotto, I., Kearney, C, Kriesler, P. and Stegman, T. (1994)
'Network pricing versus location specific pricing of aeronautical
services' with Economic Papers, June, Vol. 13 pp. 38-52.
Industry Commission (1992) Aviation Report, AGPS.
Johnson, M. (1992) 'Evaluating the privatisation ofthe English
and Welsh water industry*, The Economics and Labour Relations Review,
Vol. 3 No. 2.
Kriesler, P. (1994) 'Some issues in the analysis of investment
in aeronautical services' CAER Working Paper: 994/2, UNSW.
Paddon, M. and Carman, M. (1994) Paying the price of privatization:
The Federal Government's FAC privatization proposal in 1994, Public
Sector Research Centre, UNSW.
Quiggin, J. (1994) Does privatisation pay?, Discussion Paper No. 2,
Australian Institute, ACT.
Rowthorn, B. (1989) 'The Thatcher revolution' Economic
Papers, Vol. 8 No. 2.
Rowthorn, B. and Chang, H.(1992) 'The political economy of
privatisation' The Economics and Labour Relations Review, Vol. 3
Saunders, P. (1993) 'Recent trends in size and growth of
government in OECD countries' in Gemmill, N. (ed), Public Sector
Growth: Theories and Evidence, Edward Elgar: Aldershot.
Stegman, T. (1994) 'The pricing of aeronautical services by
the Federal Airports Corporation, Australia: an assessment of the costs
and benefits of a shift from network pricing strategies to location
specific cost recovery CAER Working Paper 1994/3, UNSW.
Walters, A. A. (1978) 'Airports- an economic survey'
Journal of Transport Economics and Policy, Vol. 12 No. 2.
Williams, M. (1992) 'Privatisation (asset sales) in New
Zealand', The Economics and Labour Relations Review, Vol. 3 No. 2.
Woods, D.F. (1971) 'Determining general aviation airport
system benefits' Journal of Transport Economics and Policy, Vol. 5
Peter Kriesler, School of Economics, The University of New South
(1.) cf. Rowthorn and Chang (1992) and Williams (1992).
(2.) Saunders (1993).
(3.) Williams (1992). For a discussion of the English example of
privatisation and ineffective regulation of water, see Johnson (1992).
(4.) See Rowthorn (1989) and Williams (1992).
(5.) See Quigin (1994).
(6.) It has been estimated that the total costs associated with the
privatisation of British Airways and the British Airports Authority was
158 million [pounds sterling] [Paddon and Carman (1994) p. 12].
(7.) See Williams (1992), Quiggin (1994) and Paddon & Carman
(8.) See Rowthorn (1989) and Rowthorn & Chang (1992).
(9.) There is the further question of the impact of the manner in
which airports are to be privatized on the effect of privatization. Time
prevents me from dealing with this, but interested readers are referred
to Paddon and Carman (1994).
(10.) See, for example, Favotto, Kearney, Kriesler & Stegman
(1994), Kriesler (1994), Paddon & Carman (1994) and Stegman (1994).
(11.) Similar comments on the benefits of 'pooling' with
respect to energy generation is made in Industry Commission (1991)
(12.) In the Australian case, with large distances between
airports, it is unlikely that small differences in prices will lead to
any switching effects.
(13.) See also Dwyer and Forsyth (1992).
(14.) Cited in Paddon and Carman (1992) p. 22.
(15.) See Stegman (1994).
(16.) See Quiggin (1994).