How the FAC Plays Monopoly

User Pays

As a result of this pressure, the concept of “user pays” is being applied to many government services which support the private sector. The idea is that any given industry must pay the full cost of all inputs, including those provided by the government. If the government is providing services which are not being fully paid for, it means there is an implicit subsidy involved.

For many industries this is something of a shock to say the least, and some may not survive at all without the government assistance they previously ertjoyed. But the hard line being taken is that despite unemployment and displacement which may be caused, the fact that a business or even an entire industry would fail without government protection or assistance is no longer considered a valid rationale for propping it up.

The Australian aviation industry has found itself in the unenviable position of being one of the first “cabs off the rank” for wholesale application of the user pays principle.

In the case of the Federal AirPorts Corporation, the goal has been set that it must fully recover the costs of the services it provides to the industry, from the industry. The idea is that if this raises the industry’s costs, then these increased costs can be passed on to its customers through higher prices. If the customers choose not to pay these higher prices, it may mean that they didn’t really need the service that much in the first place, andonly usedtheservice becausethey didn’t haveto pay the full cost.

Corporatisation

Once the concept of user pays is adopted, the next logical step is the corporatisation of the agency providing the service. The essence of this concept is that a Government Business Enterprise (GBE) should operate in every sense, exactly like a corporation. Ideally, this means that it must organise itself to run efficiently so that it not only covers its costs, but makes a profit and earns an appropriate rate of return on its assets. It must also pay taxes as well as all the other government taxes and charges that any commercial operation is subject to. To make sure there are no hidden subsidies, if the GBE is exempt from any particular charges, then the value of this exemption should be determined and it should pay an equivalent amount to the Government as though it was subject to those charges.

The only difference between a fully corporatised GBE and a private company should be that the shareholder is the Government. Supposedly, if the GBE were privatised there would be no apparent change in its behaviour.

Theoretically, the advantage of corporatisation is that the agency becomes removed from the annual budget process and its associated political manoeuvrings. In exchange for fully funding its own activities, the GBE has greater autonomy to conduct its own affairs in amanner which is more sensitive and responsive to its industry customers.

In addition to the efficiency which resultsfrom thediscipline of being required to earn a rate of return, paying taxes and other Government charges, and returning dividends to the shareholders, the GBE can be subject to competition, which forces upon it the need for greater efficiency if it is to survive. And since it is subject to all the same costs as a private company, the fullycorporatisedGBE shouldnot have an unfair advantage over private sector competitors. So much for the theory.

Meanwhile, back in the real world, there is an awful lot of fear and loathing being directed at the FAC by its customers, who believe it is a prime example of government bureaucracy gone mad.

The FAC’s opinion of itself, on the other hand, is that it is doing just fine. It appears to truly believe that it is a well meaning, hard working organisationwhich is doing agreat job. It’s just a little misunderstood, that’s all.

In view of this difference of opinion, what is really going on?

To understand the situation better, we need to look at some of the common problems which can affect GBEs in general, and then see how they apply in the FAC’s case.

Monopoly Power

The problem with the FAC’s line of business – the provision and operation of airfields – is that it is a “natural monopoly. ” This means it is a business where it does not make economic sense for there to be any more than one provider of the service in a given area. In this sense, its situation is similar to other Federal and State GBEs such as the providers of electricity, water, roads and railways.

The usual problem with any monopoly is that it has, by definition, no competitors. This means that it is not under the samepressure to improve its products or to lower its prices as a business operating in a competitive market. Sinceits customers must buy the services they want from the one monopoly supplier, the firm does not need to worry as much about keeping its customers happy and satisfied. The customers have no choice, except to decide how much of a service they want to use. Sometimes, even this choice is limited (like if you’re a 7 4 7 and you want to land at Sydney. Not many options there).

Because the customers are locked in, the firm is free to adjust prices and service quality in order to maximise its own welfare, rather than that of its customers. This will invariably leave some customers worse off. This is the social cost of monopoly power.

As well as the issues of price and service quality, a monopoly may exploit its position in other ways. For instance, it may spend large amounts of money on unproductive purposes for its own benefit, or for the benefit of its employees, rather than its customers.

Indeed, it seems to be just about inevitable that a monopoly firm, left to manage its own affairs, will charge higher prices and offer a lower quality of service than if it were operating in a competitive market. This is generally the case even if the monopoly firm is sincerely trying its best to be efficient and responsive to its customers. Despite a monopoly firm’s best intentions, without the threat of a competitor to spur it on it never becomes as efficient as it would otherwise be.

Within the aviation industry, the suggestion that the FAC places its customers a clear second to its own interests has the

status of an obvious statement of fact. Anecdotal evidence abounds.

Tony Wilkinson of the Aircraft Owners and Pilots’ Association (AOPA) says that the biggest single problem with the FAC as far as he and his organisation is concerned is with its lack of industry consultation. FAC management says it recognises the importance of consultation but to date its rhetoric is not matched by its action. The FAC does meet frequently with the industry but such meetings serve only to inform the industry of decisions that have already been made. As Tony Wilkinson puts it, “the difference between the CAA and the FAC is that the CAAconsults with industry, the CAA listens to the industryand reacts to its concerns, whereas the FAC appears to make its decisions in isolation with a complete disregard for industry concerns. ”

This general lack of consultation, and the general unwillingness to discuss issues has generally led to a climate of antagonism, dislike and distrust of the FAC by the industry.

The General Aviation Infrastructure Tariff (GAIT) charges are not in themselves a major issue, and are generally supported in their present form by groups like AOPA and the Royal FederationofAeroClubs ofAustralia. ThecombinationofCAA and FAC charges, when originally introduced, approximated the previous Air Navigation Charges, and the GAIT has only been increased by CPI during the past several years. A true “user pays” system would have required an army of bureaucrats with clipboards recording aircraft callsigns every time an aircraft landed, took off, or indeed taxied from one place to another. Since this would have been rather impractical the idea of the GAIT charge was to average out airfield usean’iong all GA aircraft owners, and then charge them equally. If you ran a flying school, you were probably being undercharged. If you flew once a year you might consider yourself overcharged, but at least you could assess whether you are getting your money’s worth or not.

The problem that aircraft owners have with the charge is not the idea of the charge itself, but the way in which the FAC administers it. Too many errors are made and, although the FAC readily corrects them, it is extremely aggravating for the aircraft owner whose time and money is wasted in correcting someone else’s error.

There are numerous individual disputes quietly corroding away any residual goodwill towards the FAC at various airfields around the country. Each one adds support to the claim that the FAC is more interested in taking the money and running than in building relationships with its customers. These vary from disputes about GAIT charges and leasing arrangements at airports, to who should pay for security services.

The issue of Peak Period Surcharges at Sydney continues to fester. Allegedly introduced to reducecongestion at peak times (and introduced at the same time as the CAA introduced a number of air traffic control innovations which generally ren dered it unnecessary), it has since become a nice little earner and the FAC is now very reluctant to remove it.

Indeed, almost every aircraft owner or operator has a story to tell about a particular gripe with the FAC and the manner in which it conducts itself. While many of these disputes on their own may seem small, when put together they form a clear picture of a large, insensitive Government monopoly which is out of touch with its customers.

Community Service Obligations and Cross Subsidies

A special problem which often applies in the case of government owned monopolies is the confusion which occurs between the GBE’s requirement to maximise its financial performance and its obligation to provide serviceswhich meet a government’s social (or political) agenda.

Such services are defined as “Community Service Obligations” (CSOs). A common example of a CSO is found in public transport, where unprofitable bus routes are often maintained for reasons of a government’s social policy agenda.

Traditionally, what occurred in government agencies was that CSOs were financed through cross subsidisation by other profitable activities. But now that bodies like the FAC have been corporatised, and rate of return requirements have been laid down, there is a conflict between maximising financial performance and continuing to divert funds to finance CSOs which make a loss.

One way in which a GBE may try to deal with this is by increasing prices in profitable areas where it can exploit its monopoly power, in order to finance loss making operations while maintaining an acceptable overall financial performance.

It has in fact been suggested that this is precisely what the FAC is doing at airports like Sydney, Melbourne and Brisbane where it is extracting monopoly profits from its activities (duty free franchises and the like) in order to subsidise its airside activities.

This form of cross subsidisation may be tricky to unwind.

The problem is that the FAC, whose core business is to provide runways, taxiways, and other airside facilities, earns only 400/4 of its revenue from this source. The remainder is derived from its non aeronautical activities.

It is analogous to a shopping centre which leases out shops, but must also finance a car park for thecustomers. It’s just that in the case of the FAC, they are in business to maintain the car park, and they use the shops to pay for it.

The issue of whether this cross subsidy actually exists, and whether it results from an abuse of monopoly power by the FAC, has yet to be established. No doubt the Prices Surveillance Authority will be looking at it closely.

But there are at least two more levels of cross subsidisation within the FAC.

One is that which exists between airports of similar type, say between Sydney, Melbourne and Brisbane, and their smaller counterparts such as Adelaide, Perth and Hobart. The charges at these airports are the same, although their operating costs and underlying asset values are clearly different. This means there is an implicit cross-subsidy built into the pricing structure. This may be solved by setting different charges at different airports, as the Industry Commission has recommended.

A bigger worryfor GA, however, is that all the GAAP airfields like Bankstown, Moorabbin and Archerfield operate at a loss, and only stay open because they are being cross-subsidised by the major international airports.

Indeed, the entire financial structure of the FAC is a tangled web of cross subsidisation.

Within the aviation industry, opinions on cross subsidies depend on which area of the industry you belong to. The airlines take a narrow view and see no reason why they should continue to cross subsidise GAAP airports which they never use. GA, on the other hand, is fighting tooth and nail to keep things the way they are.

If the concept of “user pays” is properly applied, then all airfields will be required to pay their own way, through prices which are set according to their individual operating costs, and with margins that provide the required rate of return on their asset values. Of course, this outcome would be very good for users oflarge, busy airports like Sydney who are propping up the rest of the network, but it would be very bad for smaller airports and especially GAAP airports which are the ones being propped up.

GA pays its GAIT charges, but GAAP airfields like Bankstown and Moorabbin are still operating at a loss, despite being at near full capacity. This most likely means that the charge is too low, but GA says it cannot afford to pay more.

This is where the dilemma occurs for the FAC, if it is faced with airports like Bankstown and Moorabbin, which it must keep open, but which cannot afford to pay their own way. These airports are therefore, strictly speaking, CSOs.

A solution to eliminate the support of CSOs (Community Service Obligations) through cross-subsidies has been proposed by the NSW Treasury, in relation to its own (more correctly named) Government Trading Enterprises (GTEs). The essence of the NSW Treasury’s draft policy is that any CSOs should be clearly identified, and then funded directly from the budget. This would then leave the GTE free to concentrate on the one aim of maximising financial performance, without the need to take cash from profitable business units in order to fund unprofitable areas, dragging down its overall performance.

Indeed a similar suggestion has been made by the Industry Commission in relation tothe FAC. It has recognisedthat every so often “Commonwealth policy” (ie political pork barrelling) dictates that certain new airports or improvements be built, or that oldones be kept open despite being unprofitable. The FAC is then stuckwith earning a returnon these new assets whether J. t wants them or not. As in the case ofthe NSW Treasury’s draft policy, the Industry Commission recommended that the FAC should be paid directly by the Government for anything it is required to do “in accordance with Commonwealth policy”.

In the case of the GAAP airfields, this means that if it were not possible for the FAC to operate them at a profit, then they would need to be closed down or sold off unless the Government chose to directly subsidise their continued operation as a CSO. And given the pressures on the budget, and the small size ofthe GA industry, it is not at all certain that the Commonwealth would choose to do this. The Industry Commission has recommended that some smaller FAC airports, ifthey cannot pay their own way, should be leased or sold off to State governments or private interests. They will then cease to be a problem to the FAC, and it will be forStategovernments andlocalcommunities todecidewhether or not they want these airports to keep operating.

The Prices Surveillance Authority is looking into the whole issue of cross subsidies, and we will see what it has to say in the coming months.

Valuation of Assets

A second major problem which can occur in government-owned monopolies, and perhaps the largest area of contention concerning the FAC, is the valuation of its assets.

Although a GBE is required to make a profit, the fact that it remains government suggests that there is some underlying social benefit that it is intended to serve. Therefore, although governments may like the dividends they extract from such agencies, they usually recognise that it is morally wrong for such agencies to openly exploit their monopoly power to the detriment of the public they are meant to serve.

This is one of the main reasons why a rate of return target is set. It must not be too low, since this leads to over investment in underperforming assets. But at the same time, it must not be too high, since this would require abuse of monopoly power.

But for GBEs, there is a way around this, and it is by “gold plating” its assets. Put simply, if you look like being embarrassed at earning unseemingly large profits, you spend your spare cash on gold plating your bathroom fittings, buying expensive office furniture, building unnecessary, large new buildings for your staff, etc. etc. Your assets are now worth more. Therefore, to fulfil your obligation to the Government you must now raise your prices to earn the required rate of return on your new assets.

Could this be what the FAC is up to?

Well, this is an extremely difficult question to answer. The valuation of assets, especially those which were originally provided by the Government many years ago, or those which cannotreadily besoldtoanotherowner, orthose which cannot readily be converted to an alternative use, is fraught with difficulty. After all, as everyone knows, something is only worth what the market is willing to pay for it at the time of sale.

But, for want of a definitive answer, we can only look for evidence.

Certainly it is true that the FAC has been very busy with its capital expenditure -some $250 million last year, out ofa total of $2. 8 billion ofplanned capital expenditure. Despite many of the items having been questioned by the industry, who will eventually be paying the bill, the FAC appears determined to plunge ahead with this capital investment program, whether the new assets are wanted or not.

There are two possible explanations for this seemingly lavish outlay. One is that it is absolutely necessary to build these facilities, which are urgently required by the industry. Indeed, it may well be said that the FAC is trying to put right the legacy of years of Federal Government neglect and underinvestment.

The other explanation is that if the FAC doesn’t quickly increase its assets, it would have to do something about its efficiency. It might have to cut costs, reduce prices, even reduce staff. Maybe even become more responsive to the industry. Perhaps they find it easier to build up their assets, so they can relax a bit.

But there is more to worry about.

Actually building new assets is one way to increase their value. The other way is tojust declare that they are worth more than they were last year. Ifyour assets double in value, then if you are to continue earning your rate of return, you must double your prices. Sounds simple, doesn’t it?

In this context, it is interesting to learn that the FAC has increasedthe value ofits assets by 100%over the last five years. Now, as mentioned earlier, the valuation of assets of the type owned by the FAC is notoriously difficult, and indeed the increase may even be justified. Nevertheless, an increase of 100% in five years, during a period of relatively low inflation, does tend to raise the eyebrows somewhat.

Indeed, this may be the key to the whole problem. We may have found the method by which the FAC is able to make little or no improvements in its efficiency or cost effectiveness, while keeping the Government happy that it appears to be doing a good job by earning its target rate of return.

So long as it is able to either build or, by a stroke of the pen, bump up its asset values at will, it can continue to exploit its monopoly power and the industry has no choice but to pay. Assessing the FAC’s Performance There is at least prima facie evidence that the FACIS pushing up its asset values in order to avoid improving its efficiency and cut its operating costs. But how efficient is the organisation? The answer at this stage is that it is difficult to say.

Since no FAC airport has a direct, non FAC competitor with whom it can be compared, it is very difficult to observe whether it is being efficient or not. Furthermore, it is difficult to compare one airport with another, since they have different weather, geography, facilities and air traffic characteristics.

Apparently, the FAC does have some thirty performance indicators which are used for internal management purposes, so how are they doing? Unfortunately for us, they’re not telling. The Industry Commission recommended that: “To help as- sess the FAC’s performance, a range of performance indica- tors for each of the airports should be introduced and made publicly available. ” In the absence of any benchmarks or performance indica- tors which allow us to objectively assess the efficiency of the organisation as a whole, what else can we do? One thing we can do is to look for examples of behaviour by the FAC which indicate that it is operating to maximise its own welfare at the expense of its customers, and there are certainly a few such indications around.

For instance, it is true that the FAC did reduce its staff by 20% when it was first established. However, it is also the case that it increased its numbers by 20% during the next three years. This is during a period in which total aircraft movements have decreased by over 20%) which does not paint a picture of an organisation pressing ahead with increasing the productivity of its workforce.

There could be two explanations for this. One is that the organisation is already so highly efficient that there is no room for further staff reductions. The other is that the FAC is rather comfortable with its current, paunchy state and so is not really interested in getting on with increasing its productivity. There are other clues which may be trivial in themselves, but may also be indicative of a more pervasive attitude within the FAC that its own welfare and the welfare of its own employees are ranked above that of its customers.

For instance, there is the FAC’s new national newspaper. To be sure, a fairly harmless idea, but does it really need to be printedin full tabloidsizeon glossy paperwith four pagesin full colour? Even BHP’s newsletter is a fairly modest, monochrome affair.

Needless to say, the main theme of the FAC’s magnificent newspaper is the great job it is doing on behalf of its customers. – we are sure they are impressed!.

On the cover of the FAC publication is a nice colour photo of several general managers who won a golf tournament held to coincide with an FAC management conference in Brisbane. We can only speculate as to how important this conference really was.

We also read about the booklet produced for the new Sydney international terminal extension, which has won a printing award. The booklet is certainly a lavish one, printed on expen- sive, heavy paper and full of beautiful, glossy full colour photographs. But why did it need to be printed at all? The customers have no choice about using or paying for the facili- ties. So why go to so much trouble and expense to advertise facilities that customers must use whether they want to or not? To be sure, this kind of anecdotal evidence does not in itself prove anything. It does however, add to the growing pool of evidence in support of the propositionthatthe FAC is not really that concerned about cutting its costs and improving its effi- ciency. A higher priority appears to be making the staff feel good about themselves and making the FAC a really nice place to work.

It does appear, then, that in many ways the FAC is indeed a very typical Government monopoly – quite comfortable the way it is, perhaps honestly believing it is doing the right thing by its customers, butin reality nottoo concernedabout whether they are really satisfied or not.

In such a context, the outrage of some sectors of the aviation industry at its apparent insensitivity is understandable.

The FAC certainly talks about how important its customers are, but talk is cheap. What its customers would really like to see is acti orin the form of lower prices, rather than words.

In Summary

There is certainly no shortage of evidence that the FAC has a number of serious problems.

The FAC, despite its rhetoric, has acquired for itself a repu- tation for consistently failing to consult with its industry cus- tomers. How efficient it really is, in international terms, is unknown. The FAC does have performance indicators but they are secret.

There is at least prima facie evidence that it is involved in the murky business of bumping up asset values, or busily building new ones, so that it can avoid looking at its own costs. Internally, the major problem yet to be resolved is the tangled web of cross-subsidies which holds the whole organisation together.

In view of this, what is to be done?

The Solution

It is not enough for the FAC to reassure everyone that it is doing a good job, even if this is what it sincerely believes. If it is to remain in Government ownership, and since it is in any case, anatural monopoly, it is necessary for the Government to act in some way to impose pressure on its costs and pricing structure in order to simulate the stimulus of competition which applies to most of the “real” world.

The use of a rate of return target alone can lead (and in the FAC’s case, most likely does) to “gold plating” of assets in order to justify high prices.

Since customers have little bargaining power, it will be necessary for the Government to artificially apply pressure to the FAC to keep its prices down.

The FAC must not be left to its own devices to determine what it thinks is good for the industry. A mechanism must be set up to ensure that it does not have the ability to keep building new assets and revaluing old ones in order to justify its high prices.

Construction of capital works and new facilities must be based solely on industry requirements. Pricing mechanisms and performance indicators must be transparent and public. One example of how this can be done is the NSW Govern- ment Pricing Tribunal. This body, independent of the political process, has the power to determine what the maximumprices of GBES should be. It does so through a process of receiving written submissions and conducting open, public hearings.

The Federal Government is presently running a National Inquiry into Competition Policy which has been set up to examine whether all GBEs should be subject to the provisions of the Trade Practices Act, to prevent abuse of monopoly power.

Both the Trade Practices Commission and the Prices Sur- veillance Authority are lobbying for the role of national GBE watchdog. Alternatively, the Inquiry may recommend that a completelynew body such as a “National Competition Author- ity” be set up.

In the meantime, the Prices Surveillance Authority is cur- rently conducting an inquiry into the FAC, and is expected to report by August 17 1993.

Certainly, the FAC should be feeling the heat. If it behaves true to form, we can expect to see more expensive, glossy brochures in the next few months claiming that everything is just fine, but don’t expect to see any movement on productivity or efficiency.

Stay tuned for further developments.

Other Complaints about the FAC

Most complaints about the FAC can be divided into three categories. These are: 1. That the aviation industry is a special case, of extraordinary national importance, and is not being given the special consid- eration it requires; 2. That the requirements for financial performance being im- posed on the FAC are unfair and immoral; and 3. That the FAC is abusing its monopoly power.

The third category is where the real problems lie, and this formed the basis of the above article. However, since com- plaints in the first two categories are routinely bandied about, they are also worthy of close examination.

Aviation is a Special Case

This argument runs along the lines that the aviation industry does not operate purely for its own benefit. It generates employment, earns revenue, and creates many other benefits which flow through to the wider community. The FAC’s air- fields facilitate the arrival of tourists and business people who spend their money throughout the communities where they are located.

Because of these wide ranging community benefits which extend well beyond the airfield boundary, many in the aviation industry consider themselves entitled to ongoing subsidy and support by the wider community of the airports they use.

However, the Industry Commission put things in perspec- tive in its report on Intrastate Aviation last year, when it said that: “Airports clearly provide benefits to sectors of the com- munity other than airport users. However, such linkages are common to many, if not all, economic activities. For example, coal mines, pulp mills and chemical factories are all significant employers in regional economies. They attract other indus- tries to the area and support an array of local suppliers of inputs. On a smaller scale, shopping complexes provide locational advantages for nearby residents which are reflected in house prices. Because of the proliferation of such linkages, it is generally not possible for governments to support all industries which claim “special needs,” merely because they support other areas of economic activity. To support the case for continued airport subsidisation, there would need to be evidence to show that airports generate “exceptional” benefits – benefits beyond those to which other forms of economic activity can lay claim. ” The reality is that the aviation industry, despite its high profile, is small. The total air transport industry accounts for 1% of Australia’s GDP and less than half a percent of Australia’s workforce. And if air transport as a whole is small, then GA is microscopic when viewed from a national perspective.

At a time when government assistance and subsidies in all their various forms are being wound back, it is highly unlikely that the aviation industry will make much headway by continu- ing along the lines that aviation is so important that it deserves special treatment.

Requirements for Financial Performance

There are many other objections about the corporatisation of the FAC which in reality stem from a rather naive or inadequate understanding of financial or economic principles. The most common misconceptions are listed below, together with an explanation of why they are in fact invalid.

Rate of Return There are various measures of rate of return – the most common being return on assets and return on equity. Return on Assets (ROA) is usually the best measure of the efficiency ofan organisation, since it is independent of the firm’s financial structure.

The FAC has been set a target ROA of 7. 5% Many people see it as totally immoral that a government agency should be required to earn a set rate of return on its assets. It is, however, fundamental to an agency’s efficient functioning.

In the past, government agencies were not required to earn a target rate of return on their assets, since the requirement to make a profit was seen as being incompatible with their operating for the public good. It was considered more correct that they should operate to a very low rate of return (if it was ever calculated)-say 1%, or nothing at all. But as it turned out, in the long term the public lost out for this very reason. What this low ROA resulted in was overinvestment in underperforming assets. This pattern was repeated in govern- ment agencies around the country, and indeed throughout the world, in government owned banks, railways, utilities, and so on.

Very large amounts of money were wasted because these organisations were allowed to underperform. After the money was spent, more money continued to be spent, overinvesting more equipment which in turn was also underutilised, and the whole system continued to run down. The same applied to employment of human capital. Government organisations typi- cally became bloated and overstaffed with underperforming employees.

Precisely because there was no requirement to earn a rate of return, government bureaucracies remained ineffective and inefficient.

This is why corporatisation was introduced in the first place, and this is why establishing a rate of return is so important. It allows us to measure whether or not a corporation is running its assets efficiently or not – whether it’s getting full perform. ance out of them – whether they are pulling their weight and paying their way.

Opportunity cost This is an important concept in finance and economics, but it is also one which can provoke outrage among those who do not understand it properly, particularly when it is applied to Government activities.

A basic definition is “the cost incurred by not investing in the highest return available (at the same risk level). ” Suppose you have a bank account in which you are earning interest at 5%. Each year your account shows that you have made a profit. Are you ahead? Not necessarily. If there is another bank next door which pays 10% for the samerisk level then you have, in financial terms, made a loss. You have paid the opportunity cost of not investing at 100/4. Thesameappliestogovernmentswheninvestingtheirmoney, and it is opportunity cost which is used to set the required rate of return from its GBEs such as the FAC. The FAC’s required rate of return of 7. 5% is determined in this way. It is based on theGovernment’s best alternative way of earning a return on its investment, ie through the selling of Treasury bonds. The Treasury bond rate is adjusted upwards to account for the greater risk involved in running airports (although at the moment 7. 5% approximately equals the 10 year bond rate). Let’s apply the concept of opportunity cost to a facility such as Bankstown airport. What it means is that if the Government thought it would be better off by selling it off for industrial or residential land, then that is what it would be obliged to do. Of course the Government would need to carefully consider the full range of social benefits that are generated by the airport. But if the Government became convinced that an alternative use of the land would create more jobs, more exports, and more other social benefits then it would be obliged to use the land for that purpose. The airport would then be moved to a new site, probably more remote from Sydney, where the next best use of the land (eg farming) would produce a lower return than using it for an airport.

Of course, this reasoning is not purely hypothetical. It is already happening.

Dividends This is perhapsthe area of greatest ongoing indignation from the industry, and indeed within the FAC itself. The common view is that if the Government did not claim a dividendfromits GBEs then it could lower its prices, so that its customers and the public in general would benefit. Indeed a recent newspaper article expressed the view from within the FAC that unless the Government backed off on its dividend claims, then it would have to raise its prices to raise the money required. However, this viewpoint is not quite right. The reason isthat we are talking about two different things. The first is the requirement to earn a target rate of return on assets. The second is the dividend paid to the Government as the owner, out of the profits earned. They are different issues and the decision made about the second should not affect the first. Remember that it is important that the FAC and other GBEs earn an appropriate rate of return in order to ensure that their assets are being used efficiently – that there is not overinvestment in underperforming assets. This requirement does not change as a result of how the profits are divided up after they are earned. After revenue is earned, and expenses, tax, interest and other charges are paid, then comes the decision of what to do with the profit. And, like any other corporation, it is usually a good idea to retainsomeprofits, and itis also normal that an agreed amount then be returned to the shareholder(s), who are entitled to some return on their investment, which can then be used for other purposes. Indeed, it is a necessary principle of corporatisation that this be done in order toensure the GBE is

not in a privileged position in comparison to the private sector. In the case of the FAC, the issue of dividends needs to be put in perspective. Last year the FAC paid a dividend of $5,100,000 to the Government, after earning profits after interest and taxes of $34,957,000. That represents a payout ratio of 14. 6%. This should be compared to last year’s ratio for National Australia Bank (70. 4%), TNT (average of 40% when it used to make a profit) or Lend Lease (70%)-three companies picked at random. Clearly in this respect, the FAC has in fact been getting something of a free ride from its owner. If the principle of corporatisation is properly applied, it should be expected to provide much higher dividend payouts in the future. It should also be pointed out, though, that profit is only the tip of the iceberg of the total revenue earned by the corporation. In the case of the FAC, last year’s dividend amounted to just over 1 % of total revenue. Hence a doubling or triplingofthe dividend should have negligible effect on industry charges and is therefore something of a red herring in any discussion of the alleged plight of the FAC or the industry it services. What would the FAC want with all that money anyway? It might be nice to be sitting on this big pot of cash to dispense however it saw fit – funding capital expenditure for instance, but thatisnothow corporate finance works. to managethe amount ofcash it needs and thenfinancethe rest through the normal methods-usually the issue of debt, as it is doing. The rest should be paid out to the shareholder so it can go about discharging its other responsibilities. “The Industry has to pay twice to use FAGfacilities” This argument runs as follows: The FAC has to borrow money to pay for the construction of the third runway at Sydney, which is paid for by the industry. Once it is completed, it will go on the asset register of the FAC, andthe industry will again have to payso that theFAC can earn a rate of return on its new asset. Therefore, the industry must pay twice. Sounds OK at first glance, but it is also wrong. When a tenant pays rent to the landlord,it is neversuggested that the landlord’s financial situation – ie whether the flat is fullypaidforor not-should betaken intoaccountwhensetting therental, norshould it be. The landlord has titletoanasset,for which a charge is levied in order to earn a rate of return. Most people would recognise that it would be nonsense to suggest that after a landlord has paid off a property, the tenants should be allowed to live in it for free. In the case of building a new runway, the same thing applies. The decision has been made that a new runway will be built. The initial costs the FAC will incur will be the finance for the construction phase. Thereafter, it will incur lower, ongoing

costs for the maintenance of the new facility. Throughout th total life of the runway, which starts at the decision to proceed and build it, it must recover the cost from the customers and earn the required rate of return. There is no double charge involved. The same applies to old assets which were built before the FAC was formed, and transferred to the FAC upon formation. If an airportis worth having(froma national perspective), then it must earn the required rate of return and if not, then it should be sold off and used for a more productive activity. The question of who built it, and when, and how it was financed is immaterial. It should also be remembered, of course, that in Sydney’s case the industry will derive benefits from the operation of the third runway. They will be able to schedule more flights into Sydney, to take advantage of its increased capacity. Existing users will have their holding times and delays reduced. More people will fly. Eventually, the larger number of flights may generate economies of scale which reduce the costs to all. The industry is not being asked to pay something for nothing.

Paul Couvret spentsixyear:s in theRoyalAustralianNavy as an aeronautical engineer and subsequently worked for three years as a commercial pilot and flight instructor which included the training of Qantas cadet pilots. Since completing a Masters Degree in Business Administration at the Australian Graduate School of Management he has been doing economic policy analysis for the NSW Government.