Dr Rico Merkert asks: Why be secret about subsidies?

Based on study results that will be presented at the Seventh International Forum on Air Transport in Remoter Regions, to be held in Newquay, Corwall, UK, between April 5-7, 2011, this article calls for greater transparency and consistency about air route subsidies by European governments.  This is in the light of concerns from the low-cost airline sector.  Awards of Public Service Obligations (PSO) to airlines for flying subsidised routes are often veiled in bureaucratic secrecy.  These schemes are intended to support remoter and underdeveloped regions yet, somehow, a number of countries manage to apply them to what many would consider busy routes to popular holiday destinations.

In these current times of government austerity, PSO services are now being carefully scrutinised in many parts of Europe.  The Irish Government announced in December 2010 a cut of €5.5 million (US$7.6m) in support of regional air services from mid-2011.  It seems likely that the number of mainland Irish PSO services will be reduced from six routes to two.  However most European countries remain committed to regulated and often subsidised PSO air services for their remote regions (typically to peripheral areas such as the Outer and Inner Hebrides or the Orkney and Shetland Islands in Scotland).
Member states may impose PSOs on routes to their remote areas, if they feel that air services are vital for the economic and/or social development of these regions and that, without subsidies, and/or regulatory measures to protect them, scheduled air services to these regions could not be maintained.  Although the member states must respect the conditions and requirements set out in Article 16 of the Air Services Regulation (EC) No 1008/2008, the interpretation of the “air service adequacy” depends on the judgement of the Public Transport Authority imposing the PSO.  As a consequence, there is substantial heterogeneity and imbalance between different regions across Europe in terms of the provision of PSO operations.
One could argue that these differences are also a result of the varying geographical characteristics in the relevant member states.  Greece, for example, operates a large number of PSOs to remote islands and, in some countries such as Norway or France, the stage length is by definition longer than in Ireland or the UK.  However, the level of transparency and the terms under which the PSO provision is utilised vary materially.  This can be readily attributed to different interpretation of the current EC regulation and the way it is implemented, and because of this, inefficiencies in the operation of the mechanism can begin to arise.
The basic concept of subsidies and temporary regulative protection measures for PSO air services to remote or underdeveloped regions can have significant merit not only from a social perspective but also in terms of economic efficiency.  However, in order to achieve the desired cost efficiency (in addition to economic development, social inclusion and tourism benefits), the procurement, operation and enforcement of PSO contracts needs a clear and transparent framework that sets incentives for innovation and cost reduction.  Competition can be an important element of such a framework.
Although competition within the market will be limited for the period over which the PSO contract is awarded it is still fundamental to the efficiency of these services that there is competition for the market when the contract is tendered.  In a recent survey of all European PSO awarding authorities (undertaken in cooperation with Northpoint Aviation), we found that none of the authorities considered the number of bidders for their PSO contracts to be sufficient.  Based on a number of interviews with PSO carriers, we found in a further study that causes for this lack of competition (particularly cross-border) are often the non-transparency and uncertainty attached to the awarding process and operation of such air services.
In the absence of a transparent and consistent playing field covering all EU member states, it is perhaps not surprising that there are significant contrasts in the use of PSO contracts.  One striking aspect is the number of PSO routes in different countries.  France has 57 designated PSO routes of which 34 are currently served by an airline (including the international routes from Strasbourg and those linking Corsica to metropolitan France).  Greece, Portugal and Spain also have a substantial number of PSO routes.  The UK has 21 routes (mostly in the Scottish island archipelago) and Germany has two.
An even greater contrast is apparent, however, in the type of aircraft employed and with that the number of passengers carried on these routes.  Even experienced researchers cannot discover why services to places such as Corsica need to be subsidised or protected during the summer when large aircraft like the A320, or even the Boeing 777-300ER configured with 440 seats, fly on the routes between Paris and Ajaccio/Bastia.  These are not the kind of aircraft you would usually expect to see on a PSO route.  Meanwhile, many remote communities struggle to gain support for vital links using aircraft with less than 30 seats.  If the system was clear and equitable, such anomalies should not arise.  As a result, airlines like easyJet are going public with their concerns about the PSO system, which could inadvertently have the effect of endangering its availability where it is really needed.

Some Scottish Highland & Island routes have been subsidised for many years. (Both images: Eryl Crump)

Temporary subsidies and competition for the market (through European-wide tendering) are sensible for what local and national transport authorities are trying to achieve: the economic sustainability and development of remote regions, while ensuring the availability of lifeline services and the provision of access to domestic/international hubs and regional/national centres.  In order to make these services more efficient, it is our view that the level of subsidies should be more visible and the level of competition for the contracts (bids) should be substantially improved.  One innovation could be in developing more cross-border services, although this will result in difficulties in arbitrating the responsibility for funding of these services.  Incorporating stronger incentives for the operators to encourage growth in patronage in the PSO contracts might also encourage some routes to eventually emerge from PSO status and become freestanding open market routes.
If a fair, transparent and efficient PSO framework is to be implemented across all EU member states, there is one other vital component of the aviation system that needs to correctly incentivise (as well as transparently subsidise) for PSO services to work.  That component is the airports, both at the remote and hub (serving major cities) ends of the PSO.
A key issue for air services to remote regions is to secure access to congested airports that connect the peripheral or underdeveloped regions with the political/economic centre or domestic/international hubs of the relevant country.  As slots at congested airports are increasingly very valuable assets reflected in increased operating costs, as large airports seek to optimise revenues, in many countries it is very difficult to maintain services on thin-routes to these airports.  This is either because of the impact of such airport charges on fares, or because the opportunity cost of using scarce slots for larger aircraft carrying more passengers and paying more revenue is very difficult for many airports but also airlines– and perhaps also policy makers – to resist.
In the UK, for example, many regions lost their services to London Heathrow years ago, but there is now increasing evidence that getting into Gatwick or other convenient London airports is also becoming too expensive for some regional airlines (especially when they can sell prime slots on the ‘grey’ market for more than £3-4m).  In terms of economics and revenue management all of this makes sense from the airport operator’s and airline perspective.  By definition long-haul international flights with large aircraft will in any financial assessment get priority over, for example, a Dash 8 to Plymouth Airport.  Yet, somehow the French manage to slot in such flights at Paris-Orly (and not only A320 or B777 but also smaller aircraft) and to give a good non-EU example, the Australians do the same at Sydney Airport.  Whether this is desirable, is ultimately a political and socio-economic decision that goes beyond the congested airport’s pure business interests, and may often require some form of regulation if the airport is in private ownership.
Interestingly, the difficult issue of ownership also applies to strategically-important regional airports.  Commercial owners will always demand a commercial return: Plymouth is again a good example of privately-owned airports where the owners may get a greater commercial return from shutting down aviation operations and submitting planning applications for new homes, offices, retail, etc.  Plymouth City Council owns the freehold of the airport, but it is leased to Sutton Harbour Holdings (a property development company) that has already sold off a large portion to Cavanna Homes, and is now contemplating selling the rest for development.  Perhaps this kind of example does not apply to the same extent to very remote airports.  However, in the case of semi-remote airports (Plymouth is one of the remotest airports in England without access to London) or underdeveloped regions, the owners could simply view the airport as a huge capital asset, and not take into account its indirect and catalytic economic and transport value as it is difficult for the airport operator to capture them fully.
In summary, it will always be difficult to operate PSO services on a commercial basis, where both airlines and airports can make a commercial return.  In our view there may be nevertheless ways to improve the PSO mechanism.  For example, this could be by encouraging incentives in the PSO contracts, by increasing the level of competition (and hence efficiency), or by aligning the airport and airline strategies.  In addition it could be achieved by combining tourism, local business and residents’ interests, by government taking a view on regional access to international centres and not just leaving it to the markets, and perhaps by promoting appropriate cross-border PSO services.  All these aspects are of course areas where more research is needed, and April’s ‘Forum on Air Transport in Remoter Regions’ will bring together examples of how some of these issues have been tackled in other parts of the world.  Who knows, perhaps further research will teach us that more centralised control of regional air services as practised by some EU governments (for whatever reasons) may be a more effective way of fostering more broadly-based regional economic development.  The alternative more laissez faire approach to domestic air services may have some unintended consequences such as lack of regional access to the centre from the regions.  However, whilst it remains necessary to subsidise air services to remote regions in whatever form, the key finding of our current research is that this should be done as transparently and consistently as possible.  This would not only improve the economic efficiency of the mechanism but would also increase its acceptance and understanding amongst all stakeholders.
It is recognised that air services are vital in many remote regions (at least during some periods of the year) and they are highly valued by those communities.  They appreciate the invaluable importance of such services to the social and economic development of the remote regions in question.  Improving the operation and implementation of the mechanism can only increase the undoubted benefits delivered, whilst minimising the draw on central funds.
Dr Merkert
DR MERKERT will speak about this topic at the International Forum on Air Transport in Remoter Regions, along with international experts from Europe, the Pacific and the Americas, in Newquay, UK, between April 5 – 7, 2011.  For details see: www.catrr.eu.