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Saturday, 27 December 2014 00:00
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Price caps on airline tickets are a bad idea

With unfailing regularity, government after government in India has flirted with the idea of price caps in various sectors, quite oblivious of the impact this has, so it is not surprising the aviation ministry should be contemplating putting a R20,000 cap on economy class airfare. The move is ostensibly to ensure airlines don’t ‘exploit’ the SpiceJet situation by hiking the fare for customers who need to travel by air. In the past, when price caps were put on pharmaceuticals firms, the result was a slowing in production of various drugs and the industry becoming more export-focussed. When price caps were put on LPG and diesel—this was done by way of government subsidies on these products—the private industry reacted by simply shutting down its business. Interest rate caps have resulted in banks ceding space to informal lenders as they cannot lend to certain categories of borrowers unless the spreads are much higher; when the Andhra government put caps on what micro-finance firms charged, this resulted in them leaving Andhra’s citizens to the mercy of moneylenders who charged even higher rates. And, more recently, when price caps were put on gas prices, the private industry reacted by simply stopping exploration for new gas in high-cost areas.

Apart from there being no rationale for price caps since there is no obvious sign of any airline cartel operating—if there is, the Competition Commission should be looking into it—the aviation ministry’s draft proposal will result in overall costs rising. Right now, airlines charge lower rates on certain sectors and also according to the time of day, and the amount of traffic, among other variables. Which means airlines charge below cost on some sectors/time and above cost on others. A cap will mean the cut in profits on certain routes will have to be made up elsewhere. The ministry, in fact, wants airlines to fix prices keeping in mind their break-even cost and a certain profit margin —apart from the fact that fares will go up once this happens, does the government really want to get back to a situation in which it is fixing fares for each route and for different types of aircraft? And if it is doing it for airlines today, where else will this logic extend to?

The government’s job is really just three-fold, to ensure there is no monopolistic/oligopolistic pricing, that the industry is being fair to customers—not refunding full fare for flights that are late is a frequent complaint—and that government policy itself is not creating a problem. There are standard techniques for looking for oligopolistic pricing that most regulators are familiar with. Government policy, in the airline sector, is the worst and is responsible for most of the industry’s troubles. This ranges from extraordinarily high VAT rates on jet fuel which makes low-cost airline operations impossible, to hugely subsidising the loss-making Air India—had Air India shut down, there would be less seats available and, even if airline fares never went up, load factors would rise for the industry as a whole. In other words, the SpiceJet problem may never have taken place. If the government is serious about make-in-India, it needs to look at the distortions its policies are causing instead of going and increasing this further.

 

 

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