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Aviation and Economic Performance

Peter Forsyth

Monash University

BTRE Transport Colloquium

Canberra June 2007

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Key Issues

How does aviation impact on economic performance- GDP, overall economic welfare- and what policy implications are there from these impacts?

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Outline

• Introduction- what are the issues?• How aviation can affect economic

performance• Assessing aviation’s impacts• Policy implications• Conclusions

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Issues

• Aviation is like other industries- it produces outputs which are valued by users

• This is counted as its contribution to performance- GDP, employment etc

• An extra $100m of productivity gains in aviation would add $100m to GDP

• But does aviation do more?

• Could an extra $100m of aviation services add $150m or $250m to GDP?

• Would increasing aviation share of GDP lead to a substantial increase in GDP?

• Some say yes

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What Changes are being Considered?

• Increase or decrease in aviation output• Due to liberalisation, productivity

increases, or shocks like SARS, imposition of carbon taxes

• Not considering complete removal of aviation

• These are policy relevant changes

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Transport and Performance

• Key role of transport is in reducing transactions costs, affecting scale economies, market integration, specialisation, agglomeration

• Link markets and increase competition

• Facilitate tourism

• Infrastructure debate- is investment in (transport) infrastructure extremely productive? Some evidence says yes

• Bottlenecks matter, but evidence in general is fragile• Are there big positive externalities created by (air)

transport?

• Does additional transport remove major distortions?

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Possible Aviation Externalities

• Negative- GGE, noise• To focus on positives:• Linking markets- scale economies,

specialisation, enhancing competition• Economies of density• Agglomeration economies• Tourism- additional economic benefits

from extra tourism

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Market Effects

• Mainly through freight, and perhaps, business travel• Lower transport costs bring markets closer together• Cheaper air freight enhances competition in electronics

goods markets• Scale economies- can locate at one place and transport

goods, to get greater scale economies• Cities can specialise• Are there major externalities here? Effects factored in by

decision makers, and benefits from transport are counted by them

• Producers pay transport costs to gain scale economies

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Economies of Density

• Well documented in air transport literature• Larger aircraft are cheaper per passenger or per tonne to

operate• Increased market size leads to lower air fares or greater

frequency (with lower generalised costs)• Externality is present- there is a tendency to undersupply• The effect is easy to measure, and robust, but it is not

large

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Agglomeration

• A big theme in transport/location/trade literature• More firms of a type producing at one location lowers the

cost of all the firms• An externality between the firms• Better air transport can facilitate agglomeration• Mainly freight and business travel• For example, financial services• The new hub of activity will gain- but what about the

periphery which loses activity?• Will Macquarie Bank move to London (and will Australia

lose from this)?

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Tourism

• Aviation facilitates tourism flows

• Additional inbound tourism- is this positive for the economy?

• Not necessarily, but it could be if

• (a) tourists pay more than the resource costs for the product they buy (taxes)

• (b) terms of trade effects

• (c)tourism stimulates economic activity and adds to employment

• (a) and (b) are quite possible for Australia- matter of measuring the effects

• (c) not very likely for Australia, with tight labour markets and skill shortages at the present

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Patterns of Tourism Flows

• Suppose that international air fares on a route come down- liberalisation, productivity increases

• This stimulates inbound and outbound travel- any net effect likely?

• Very likely that inbound traffic will grow more than outbound- that there will be a positive net effect on tourism

• The liberalisation paradox- when two countries liberalise their ASA, both experience an net gain in inbound tourism

• A consequence of trade diversion towards the liberalising countries

• Lowering aviation costs lead to net increase in inbound tourism, with consequent tourism benefits

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Aviation Impacts

• Lower cost aviation can impact on patterns of economic activity

• This can generate some positive externalities• These are not likely to be very large• Some effects (e.g. Agglomeration) are very difficult to

quantify• A $100m cost reduction in aviation could lead to a gain in

GDP a little above $100m

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Modelling Studies

• Can modelling studies help estimate the magnitude of these effects?

• Big numbers are now fashionable- may transport investments are claimed to have very large “economic benefit”

• Melbourne port deepening; expanding London Heathrow airport; liberalising aviation markets (and special events)

• Claimed net benefits some multiple of costs, revenues• How can you get such large numbers?

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Input Output Models

• Often used to estimate economic impacts (on output, GDP, employment) of a change

• Measure direct and indirect effects• But- inputs are assumed to be freely available at no cost• No negative impacts on other industries• Guaranteed large “economic benefits”• Should not be used to evaluate aviation investments or

policy changes

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Computable General Equilibrium (CGE) Models

• Complete model of all markets in the economy• Inputs have to come from somewhere- and have a cost• Additional economic activity here means less activity

elsewhere- crowding out• Can be used to estimate impacts• Widely used in Australia to study economic impacts of

policy changes

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Cautions

• Changes in GDP do not necessarily measure changes in economic welfare

• Employment assumptions: impacts on activity can be large if labour is assumed to be in excess supply- not appropriate for Australia now

• Other assumptions matter- savings, exchange rates• CGE models can be misused- can get big numbers under

certain assumptions

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Uses of CGE Models

• Can pick up effects of distortions (e.g.. taxes)• Can pick up terms of trade effects• Generally cannot pick up scale effects• Cannot pick up agglomeration effects• Can be used to measure tourism benefits

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Econometric Studies

• Can relate variable of interest (air passengers, business passengers) to performance (GDP, productivity)

• Estimate relation econometrically• Used in the infrastructure debate• No underlying economic model- no way of explaining the

results in a rigorous manner• What is driving the results? A question rarely answered

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Modelling Examples

• Oxford Economic Forecasting (econometric)

• 12 m extra passengers in UK leads to extra ₤2.5b GDP ($A500 per pax)

• Implausibly large

• ACI, ATAG, IATA/InterVistas The Economic Impact of Air Service Liberalization (I-O Multiplier)

• UK-UAE liberalisation- 1.1m extra pax, benefits of $US1.1 ($US 1000 per extra pax)

• Australia-NZ single market-1.7m extra pax, benefits of $US1.452m ($US854 per extra pax)

• Implausibly large

• Melbourne Airport Economic Impact Study 2003 (CGE)

• Plausible impacts

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Recommended Approach

• Use Cost Benefit Analysis to capture direct effects• Can measure economies of density, though not market

integration and agglomeration effects• Can capture distortions, terms of trade effects and any

impacts on economic activity using CGE • Can combine both in a CBA framework• Example, assess the benefits and costs of air service

liberalisation, including measuring tourism benefits with the help of CGE model

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Policy Issues

• How large are the benefits (costs)of changes which increase (decrease) aviation output?

• Relevant for:• Liberalisation of aviation policy• Investment in infrastructure (airports etc)• Investment in security to avoid costs of crises• Tax policy- passenger service charges, state stamp

duties on aviation• Airport regulation policy• Should aviation be included in a GGE Emissions Trading

Scheme?

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Implications

• If gains from aviation are as large as sometimes claimed, the policy implications are huge

• Liberalise everything• No taxes• Exempt aviation from GGE measures• Make security free• Subsidise aviation as much as feasible• Build airports before any congestion occurs

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Aviation and Economic Performance

• Efficient aviation is positive for good economic performance

• Aviation has some negative (GGE) and positive externalities

• Underlying economics suggests some small, though positive effects on economic performance from aviation

• No reliable evidence exists for large positive effects of aviation on economic performance (unless there are bottlenecks or poorly functioning economies)

• Worth exploring aviation’s effects more but should not expect a major shift in perspective

• Can use standard techniques (CBA and CGE Models) for evaluating aviation policy options

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Thank You!

peter.forsyth@buseco.monash.edu.au