Set Them Free, See Them Fly

India’s airlines are already over-regulated. They need more competition, not more regulation.

On November 24, Indigo Airlines tweeted that it has started charging for web check-ins. Folks on Twitter were understandably upset at having to pay for what was formerly a free facility. Two claims made by people stood out. First, that Indigo has too much market power. Second, that government regulation is the way to increase competition among airlines. Let us examine these assertions separately.

Does Indigo have market power? At first glance, it seems that it does. Its market share has risen from 15% in 2009 to more than 40% today. But an airline can capture market share by providing better and cheaper services than its competitors. In fact, ticket prices have declined over the last few years. Hardly a sign of market power.

A better measure of market power is the profit margin. Firms with market power can raise prices and make extraordinarily high profits. Indigo’s profits, however, have been declining to wafer thin margins. Even this indicates a lack of market power.

Globally, the aviation industry has experimented with different pricing models and it seems to be the case that customers are increasingly preferring “no-frills” low cost airlines over traditional airlines. In such a model, airline companies are able to offer tickets at very low prices by unbundling the flight ticket and other add-on services like meals, check in baggages, and web check-ins which are sold for an extra charge. Such unbundling should also be encouraged in India as it can lead to increased choice and lower ticket prices for consumers.

Of course, this does not mean that everything is perfect in the civil aviation market. It is always desirable to increase competition, which will increase consumer welfare. But is government regulation the best way to achieve that?

To answer that, we must examine the existing barriers to competition. For example, the most significant source of market power for airlines is the ability to monopolise gates at airports. Even the government admits this. One of us wrote an article for the Foundation for Economic Education describing this problem in the US, but the same applies to India as well.

Airports lease out gates to airlines for periods of six months. Additionally, airlines which have been using the gates in the previous allocation receive “grandfather rights”, meaning they automatically get the gates in subsequent allocations. This favours incumbents and keeps out new airlines since they can’t obtain gates at the airports.

Contrast this with Europe, where the airports are privately managed. In order to maximise profits, the airports efficiently lease gates by the hour, rather than months or years as in India.

Next, there are “Route Dispersal Guidelines” (RDGs), which force airlines to use 10% of their capacity along unprofitable remote routes. This is advertised as an egalitarian policy which seeks to make air travel accessible to all. Apart from the losses on remote routes, there is the cost of procuring a separate fleet of smaller aircraft to service those routes, since using jetliners would prove too costly. These costs can be absorbed by large airlines such as Indigo, but is too much for a small airline, which deters it from entering the market.

Similar to RDGs is the UDAN (Ude Desh ka Aam Nagrik) scheme. Airlines flying along UDAN routes have a price cap imposed on them for 50% of their seats (up to a maximum of 40 seats per aircraft). The remaining seats can be sold at any price. The problem is that the airlines flying along these routes are granted a 3 year monopoly by government, which allows them to charge very high prices for the remaining seats.

The cost of procuring smaller aircraft aside, there is also an opportunity cost, as an airport official explains. At crowded airports, such Mumbai airport, these schemes reduce the airport capacity. After all, if a smaller aircraft is using the runway at any given time, that’s a slot that could not be used by a larger aircraft for another route. This is compounded by the fact that smaller aircraft take longer to clear the runway.

Next, there are capital requirements if one wants a licence to operate flights. An operator must have a minimum of five aircraft to qualify as a scheduled operator. Furthermore, for aircraft with take-off weight of more than 40,000 kg, the company must have paid-up capital of Rs 50 crore for five aircraft, with each subsequent five aircraft requiring an additional capital of Rs 20 crore. For aircraft with take-off weight less than 40,000 kg, the company needs to have paid-up capital of Rs 20 crore for five aircraft, and a further Rs 10 crore for every additional five aircraft.

How does the government justify having these capital requirements? In an earlier version of these rules, the government said that these are kept so the company can demonstrate its “commitment, seriousness and genuineness”. And here we thought that only shareholders and loan officers needed to be convinced of those things.

If airlines wish to service international routes, they have another think coming. An airline needs to have at least 20 aircraft serving domestic routes before they can think of starting global operations. Since domestic routes are highly competitive (apart from the aforementioned monopoly routes), it is difficult for a smaller player to expand even if it manages to enter the domestic market with five aircraft. This again serves to effectively raise the capital requirements in a roundabout way, and creates a barrier to entry.

Another silly regulation which harms competition is not allowing foreign airlines to fly domestic routes. For example, there is no reason why Lufthansa should not be allowed to fly passengers from Mumbai to Bangalore.

Ludwig von Mises rightly said that capitalism is always blamed for the bad effects of government policy, which leads to calls for further government intervention. Clearly, this has been the same case with airlines in India. Further regulation will simply push up costs and worsen quality just as it has done so far.

The simplest, cheapest and most effective way to increase competition among airlines is to get rid of all these stifling regulations, rather than adding more, and allowing the market process to work.

About the author

Jairaj Devadiga

Jairaj Devadiga is an economist. His work mainly deals with public policy and economic history. His writings have been published by various think tanks such as the Foundation for Economic Education, the Centre for Policy Studies and the Institute of Economic Affairs.