The policy questions around airlines

Business Standard, 27 November 2023

The airline industry has emerged as an important new feature of the Indian economy. The conceptual machinery of market failure and lowest cost intervention guides us on thinking about policy problems and solutions. By default, the state should do nothing. The actions of the state should be narrow and limited to addressing market failure when it seems that implementation of state intervention is feasible.

The problem: Underserved destinations

One piece of the airline industry is well understood: profit-maximising airlines may choose to not serve certain poor locations. The market failure here is "the positive externality". Air connectivity imposes gains upon the city, over and beyond the gains reaped by the traveller.

Positive externalities are well known in economics, with examples ranging from education to vaccines. The standard solution is public funding. A government should run a `viability gap funding' mechanism. An auction would take place where airlines would offer capacity of N seats a month on a given route and ask for payments from the exchequer. Multiple bids would be permissible (i.e. each airline would put up multiple price and quantity numbers). The lowest bids adding up to N would be chosen. Through this, the government would pay the airlines that are chosen through the auction.

The subsidiarity principle teaches us that every function of the state should be pushed down to the lowest level of government where it can feasibly be done. This function thus belongs at the city government. It should be the decision of (say) Nashik, to decide that it is a good use of public money to establish a VGF and bolster air connectivity. Given the failures of subnational finance in India, this may need to instead be at the state government level.

How hard is it to implement an auction for a VGF? It's an easy problem, because:

Number of transactions Low
Level of discretion Low
Stakes Low
Secrecy Low

The problem: Market power

The Indian airline industry is now an environment of one or two airlines with dominant market share. The market failure here is "market power".

One solution lies in going down the route of the CCI acting against the one or two dominant airlines. This runs into all kinds of implementation difficulties given the difficulties of the Indian state.

A good principle in the field of market power is that when there is full global competition, there is no domestic competition policy concern. The right solution for market power in the India airline industry thus lies in opening up access to all global airlines. Multiple global airlines will compete in India and remove any supernormal profit.

How hard is it to implement this removal of protectionism? It is a "first generation reform" (mere stroke of the pen, no complexities of building state capacity). No government organisation is required that operates this framework; the government just needs to get out of the way, end its protectionism, and let global players compete in the Indian market.

The problem: Consumer protection

Many actions of airlines are harmful to consumers. Consumers have a low understanding of what is going on and have low bargaining power. These include last minute changes of the time (which imposes costs upon users who have to perforce reschedule their activities), premature closing of the departure gate (which harms the interests of users who are told they were a no-show) and problems with refunds (all too often, users get very little money back for a flight cancellation).

One can imagine regulation of airlines that coerces airlines to behave differently. How hard is it to implement regulation of airlines? The regulatory organisation would require intricate knowledge about the working of the airline industry. And,

Number of transactions High
Level of discretion High
Stakes High
Secrecy Low

It is all too possible for the government, particularly in a fledgling democracy, to degenerate into central planning and corruption, when faced with such a challenge.

There are analogies with regulation in finance, where consumer protection is the central problem. In telecom, the problem of `quality of service' concerns telecom companies which sell plans to consumers but actually lack the implemetation to deliver sound services, which leads to problems such as calls dropped and poor bandwidth.

The least coercive state intervention is mandated release of information. As an example, the release of facts about on-time performance, about the percentage of pax who were no-show, will exert pressure upon airlines to do better. These require the coercive power of the state, to force data release and to police the correctness of the data. (A similar strategy belongs for airports).

John Maynard Keynes said, The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all. The government should stick to its lane, and find the best ways to convert coercive power into human welfare. Everything else is best done by private persons.

By this reasoning, state coercion for information release by airlines should be about:

  1. Establishing the content of information that must be released
  2. Enforcing API access for the public (without requiring any name/password/payment), and
  3. The mechanism for ensuring compliance.

After that, the private sector will do its magic of building websites, apps, alert services, insurance products, ratings, awards, etc. The government should not be in any of these activities; government should not do anything that private persons can do.

Finally, we come to the hardest problems of all, of regulation, of the rules which coerce airlines on how they behave so as to be fair to consumers, to achieve certain minimum levels of quality of service. These interventions are easy to describe but very hard to implement in practice. India now has a great deal of experience and knowledge on regulatory theory, on the understanding of how regulators work poorly in India. The path to state capacity lies in the strategy developed in the context of financial regulators, which is applicable to all regulators, of Financial Sector Legislative Reforms Commission (2011-2015) chaired by Justice Srikrishna. There is a draft law, research materials, and an expository video.


Modern public policy knowledge helps us in formulating the strategy, as broadly sketched above. This helps us rise above the conventional developing country diseases of welfarism, populism, and power play.

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