Aviation and Economic Performance

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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?

3
Outline

• Introduction- what are the issues?
• How aviation can affect economic performance
• Assessing aviations 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 aviations 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_at_buseco.monash.edu.au