Commentary

Will Midway Lease Re-Start U.S. Airport Privatization?

Like toll roads, other countries are far ahead of the U.S. in airport privatization

Two years ago this month, the City of Chicago received a check for $1.8 billion for the 99-year lease of the Chicago Skyway lease. Two years before that, most pundits would have considered the idea as some kind of libertarian pipe-dream. But today, not only has the high valuation been validated by subsequent leases of the Indiana Toll Road and the Pocahontas Parkway, but serious efforts are under way, with bipartisan support, to lease the Illinois State Toll Highway system, the New Jersey Turnpike, and the Pennsylvania Turnpike.

So Mayor Richard Daley’s current efforts to lease Midway Airport should be taken very seriously. To begin with, as with toll roads, the rest of the world has long since accepted airport privatization as a sensible policy. To be sure, when Margaret Thatcher sold what was then the British Airports Authority via an IPO in 1987, it was viewed as a one-off transaction, as radical as the Skyway privatization in 2005. But in the two decades since 1987, over a hundred airports have been privatized worldwide-in Europe (Belfast, Brussels, Budapest, Copenhagen, Dusseldorf, Frankfurt, Hamburg, Rome, among others), South Africa, Latin America (Argentina, Chile, Colombia, Mexico), and Asia-Pacific (Auckland, Brisbane, Melbourne, Sydney, and others, with Hong Kong and Tokyo in the pipeline). About a dozen global airport companies are on the prowl for acquisitions, and as it has done in toll roads, Macquarie has created a privatized airports mutual fund for global investors.

Why has the United States been virtually untouched by this phenomenon? As with highways, several uniquely American institutions have kept airports as an almost exclusively public-sector enterprise. First is a user tax/trust fund system analogous to the fuel tax and Highway Trust Fund system in highways. Second is the availability of low-cost capital via tax-exempt revenue bonds for airports. But third-unique to the U.S. airport sector-has been the joint-venture nature of airport governance.

In most countries, prior to the wave of airport privatizations, state-owned airports generally operated like shopping malls: the state-run airport company related to the airlines as landlord to tenant. Generally, this meant that the airport controlled all the space, including gates, assigning them dynamically to airlines as needed (common-use gates). Airlines paid landing fees and space rentals, at pre-set rates, based on how much of the facilities they used. This businesslike model has continued under privatization, meaning very little change for the airlines.

In sharp contrast, the typical U.S. model is one in which the anchor-tenant airlines signed long-term lease-and-use agreements, giving them exclusive control of entire terminals or concourses and the right to approve or veto capital spending plans. And under the common “residual cost” lease agreement, what such an airline paid each year in landing fees and space rentals was determined by the airport’s prior-year budget outcome. The difference between total (non-airline) revenue and total expenses was defined as the residual cost, and was to be recovered out of landing charges and space rentals in the following year.

This type of arrangement made the “signatory airlines” joint venturers with the airport. If times were good and passengers were abundant, the airport would take in lots of revenue from car rentals, parking, and retail sales, leaving a small amount to be divvied up among the airlines. But the airlines also took the risk that in bad years, precisely when their own revenue from fares fell short, the airport would also do poorly on non-airline revenues, and hence have to hit the airlines with higher landing fees and rental rates. However, in exchange for sharing in the risks, the airlines gained the very useful ability to veto what they considered extravagant capital spending-or terminal expansions that would make it easy for new competitor airlines to add a lot of service.

In the early 1990s, quite a few U.S. mayors saw what Margaret Thatcher had done and wanted to sell or lease their airports. But the airlines raised a hue and cry about potentially huge increases in airline charges, which they would have to pass through as higher air fares. And they also pointed to the very restrictive conditions attached to federal airport grants. Those grant agreements implied (though pro-privatization attorneys argued for different interpretations) that should an airport be privatized, the city in question would have to repay all previous federal airport grants. Moreover, the FAA interpreted a provision requiring that all “airport revenues” remain on the airport and be used solely for airport purposes to apply to lease or sale proceeds.

In the face of these arguments, privatization proponents went to Congress for relief, resulting in the 1996 Airport Privatization Pilot Program. It allowed exemptions from the most onerous provisions of the airport grant agreements for up to five airports. Cities whose airports were accepted for the pilot program would not have to repay previous grants. And they would be able to take the sale or lease proceeds downtown. But the airlines lobbied hard for what some described as a poison pill on the latter provision. In order to make use of lease or sale proceeds, a city has to get the approval of 65% of the airlines serving the airport-which the airlines assumed would never happen.

And that is pretty much the explanation for why not much happened in the 10 years since the pilot program law was passed. The only airport actually privatized under it-Stewart Airport in Newburgh, NY-did not get the airline approval. Therefore, New York State is required to use its lease revenues for improvements to Stewart and other state-owned airports.

So why does Mayor Daley think he can lease Midway? For one thing, there has been a sea change in the U.S. airline market since the mid-1990s. The major airlines (now called “legacy carriers”) have lost a fortune in recent years, as well as losing about one-third of the market to the new generation of low-cost carriers (LCCs). In their much weaker financial condition, today’s airlines are more risk-averse and more cost-conscious than ever before. The old risk-sharing residual-cost model of shared airport governance has lost a lot of its charms. Moreover, the legacy carriers (American, Delta, Northwest, United, etc.) have had another decade’s worth of experience working with privatized airports in Europe and elsewhere. Even Southwest-the archetypical LCC-sees merits in the idea of stable, predictable landing fees and space rental rates, as a Southwest official admitted to this newsletter last summer (PWF, July-August 2006).

So I find it plausible that Chicago and potential airport acquirers would be focused on coming up with a deal that Midway’s airlines could find attractive. But if they can’t, Mayor Daley could decide to go forward with the privatization anyway, like New York State did. Without airline approval, he’d be constrained in the use of the lease revenues, to be sure. They could only be used for airport purposes. But the City of Chicago just happens to have another airport, O’Hare, that’s embarked on a $15 billion expansion. If a good-size chunk of that could be funded by Midway privatization proceeds, the city and O’Hare’s airlines would both be better off. Since the only important Midway airline that does not serve O’Hare is Southwest, it will be under some pressure to strike a deal at Midway that gives it as good a deal as possible, rather than a deal done without its consent that helps its competitors at O’Hare.

Thus, assuming Mayor Daley is re-elected in February, I think the Midway lease is likely to go through. And if it does, we may well see a repeat in the airport sector of what has been happening in toll roads since the Chicago Skyway lease.

Robert Poole is director of transportation at Reason Foundation. An archive of Poole’s work is available here and Reason’s privatization research and commentary is here.

Robert Poole is director of transportation policy and Searle Freedom Trust Transportation Fellow at Reason Foundation. Poole, an MIT-trained engineer, has advised the Ronald Reagan, the George H.W. Bush, the Clinton, and the George W. Bush administrations.

Surface Transportation

In the field of surface transportation, Poole has advised the Federal Highway Administration, the Federal Transit Administration, the White House Office of Policy Development, National Economic Council, Government Accountability Office, and state DOTs in numerous states.

Poole's 1988 policy paper proposing privately financed toll lanes to relieve congestion directly inspired California's landmark private tollway law (AB 680), which authorized four pilot toll projects including the successful 91 Express Lanes in Orange County. More than 20 other states and the federal government have since enacted similar public-private partnership legislation. In 1993, Poole oversaw a study that coined the term HOT (high-occupancy toll) Lanes, a term which has become widely accepted since.

California Gov. Pete Wilson appointed Poole to the California's Commission on Transportation Investment and he also served on the Caltrans Privatization Advisory Steering Committee, where he helped oversee the implementation of AB 680.

From 2003 to 2005, he was a member of the Transportation Research Board's special committee on the long-term viability of the fuel tax for highway finance. In 2008 he served as a member of the Texas Study Committee on Private Participation in Toll Roads, appointed by Gov. Rick Perry. In 2009, he was a member of an Expert Review Panel for Washington State DOT, advising on a $1.5 billion toll mega-project. In 2010, he was a member of the transportation transition team for Florida's Governor-elect Rick Scott. He is a member of two TRB standing committees: Congestion Pricing and Managed Lanes.

Aviation

Poole is a member of the Government Accountability Office's National Aviation Studies Advisory Panel and he has testified before the House and Senate's aviation subcommittees on numerous occasions. Following the terrorist attacks of Sept. 11, 2001, Poole consulted the White House Domestic Policy Council and the leadership of the House Transportation & Infrastructure Committee.

He has also advised the Federal Aviation Administration, Office of the Secretary of Transportation, White House Office of Policy Development, National Performance Review, National Economic Council, and the National Civil Aviation Review Commission on aviation issues. Poole is a member of the Critical Infrastructure Council of the Los Angeles Economic Development Corporation and of the Air Traffic Control Association.

Poole was among the first to propose the commercialization of the U.S. air traffic control system, and his work in this field has helped shape proposals for a U.S. air traffic control corporation. A version of his corporation concept was implemented in Canada in 1996 and was more recently endorsed by several former top FAA administrators.

Poole's studies also launched a national debate on airport privatization in the United States. He advised both the FAA and local officials during the 1989-90 controversy over the proposed privatization of Albany (NY) Airport. His policy research on this issue helped inspire Congress' 1996 enactment of the Airport Privatization Pilot Program and the privatization of Indianapolis' airport management under Mayor Steve Goldsmith.

General Background

Robert Poole co-founded the Reason Foundation with Manny Klausner and Tibor Machan in 1978, and served as its president and CEO from then until the end of 2000. He was a member of the Bush-Cheney transition team in 2000. Over the years, he has advised the Reagan, George H.W. Bush, Clinton, and George W. Bush administrations on privatization and transportation policy.

Poole is credited as the first person to use the term "privatization" to refer to the contracting-out of public services and is the author of the first-ever book on privatization, Cutting Back City Hall, published by Universe Books in 1980. He is also editor of the books Instead of Regulation: Alternatives to Federal Regulatory Agencies (Lexington Books, 1981), Defending a Free Society (Lexington Books, 1984), and Unnatural Monopolies (Lexington Books, 1985). He also co-edited the book Free Minds & Free Markets: 25 Years of Reason (Pacific Research Institute, 1993).

Poole has written hundreds of articles, papers, and policy studies on privatization and transportation issues. His popular writings have appeared in national newspapers, including The New York Times, The Wall Street Journal, USA Today, Forbes, and numerous other publications. He has also been a guest on network television programs such as Good Morning America, NBC's Nightly News, ABC's World News Tonight, and the CBS Evening News. Poole writes a monthly column on transportation issues for Public Works Financing.

Poole earned his B.S. and M.S. in mechanical engineering at Massachusetts Institute of Technology (MIT) and did graduate work in operations research at New York University.