Aviation and Economic Performance

1. Aviation and Economic Performance Peter Forsyth Monash University BTRE Transport Colloquium Canberra June 2007

2. 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 aviation’s impacts • Policy implications • Conclusions

4. 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

5. 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

6. 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?

7. 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

8. 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

9. 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

10. 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)?

11. 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

12. 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

13. 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

14. 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?

15. 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

16. 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

17. 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

18. 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

19. 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

20. 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

21. 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

22. 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?

23. 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

24. 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

25. Thank You! peter.forsyth@buseco.monash.edu.au