Half a free market is better than none.

In case you were ever thinking about starting up an airline in the UK, presumably the first thing you'd do is get hold of the accounts for other UK airlines and look at the profit and loss account. Then you divide the profits you could make by the amount of money you'd have to invest in aeroplanes, and that gives you your return on capital. If that's more than, say, ten per cent, then you are on to a winner, yes?

Nope. There are two kinds of airlines in the UK - those who were granted take-off and landing slots for free when they were privatised in the 1980s (i.e. British Airways); and those who had to buy landing slots for their market value 'second hand' (most of the others). The accounts for the former will neither show the value of the landing slots (which is enormous, they are worth more than the aeroplanes) nor the associated amortisation*; the accounts for the latter will show the cost of the landing slots; the associated liability (or share capital) and the amortisation.

So before you can go into business, you need to buy some slots (and now might be a very good time to buy, the air travel industry being at rock bottom). How do you work out the value of the slots? Well, you work out your cash profit per flight and then deduct from that the required return on the money invested in aeroplanes; what is left over is a balancing figure - you then take a random figure as an "earnings multiple" and that's what you offer. Another airline with slots to spare does the same calculation, and provided your estimate is higher than theirs, they'll sell you it.

If you overestimate the value, then you are doomed, of course - you are committed to the corresponding loan and interest repayments for ever more, but the value of the slots can plummet (let's imagine that Eyeful o'yokel never stops erupting, for example). Or their value might rocket if the NIMBYs get their way and airports are never allowed to expand.

Anyways, getting back to the point in hand, Nick Drew looked at the Lib-Con Energy policy, and under "Good", he listed replacing Air Passenger Duty with per-flight duty. I commented thusly:

Per flight taxes are better than per passenger, but the best way of doing it is auctioning off the landing/take-off slots. The value of these is merely a balancing figure between revenues and costs; so however much the airlines voluntarily pay for the balancing figure does not change anything - it's a non-distortionary tax, because you cannot pass on a balancing figure.

In other words, instead of having to hand over a vast amount to another airline, every year or two, you would do your own calculations and turn up at the next auction and bid for the number of slots you think you need; and if yours is the winning bid, you buy an aeroplane or two to match (airlines who lose enough bids will no doubt have one or two spare), paint it in your colours and away you go. If you overbid for a slot for a year or two, you will go out of business, but at least the amount of money you have lost is much less than if you had overbid for buying up slots in perpetuity from another airline.

Nick D didn't seem to get the point, and replied:

I'd be cautious about price-setting distortions (market power) under your auction system, MW - auctions have been tried in many areas of the energy industry and have thrown up all manner of problems.

I specifically was not talking about auctions in the energy industry, which is all much trickier (because raw material costs fluctuate so wildly). Ah well. Here endeth today's.

* Applying normal accounting standards, BA only accounts for landing slots which is has acquired from third parties, which are stated as having cost £212 million in its 2009 accounts, the cost is amortised at £8m a year. Back in late 2008, BMI which owns 11% of Heathrow landing slots, valued them at £770 million (the value has fallen since), BA owns 41% of Heathrow landing slots (plus heck knows how many at Gatwick etc) so their total value a year or two ago must have been about £5 billion, about as much as all its aeroplanes put together.