Regulating Alongside Competition - Issues Raised in the UK Airport Market

Airports have different characteristics to the network utilities, such as energy and water networks, and yet have historically been regulated using regulatory approaches originally designed for these natural monopoly businesses. However, airports can - and do - compete with each other and, following the recent decisions by the UK Competition Commission to require BAA to sell three of its airports, this inter-airport competition looks set to intensify. This paper explores the issues that should be considered when the regulation sits alongside competition. This paper describes how the investment incentives created by the application of 'RPI-X' style price cap regulation can be similar to the incentives typically associated with 'rate of return' regulation; namely the existence of 'gold plating' incentives. However, these distortions to incentives also affect non-regulated airports. A model is presented that illustrates the potential for perverse incentives on non-regulated airports and distortions to their investment decisions. Finally, this paper considers the case of the regulation of Stansted Airport, which illustrates that these incentive effects can occur in practice. This paper concludes that regulators should not assume that approaches designed for natural monopolies are suitable for airports markets or in other markets where there is a degree of competition between suppliers.