Impact of international air service liberalization on Mongolia

Transcription

1 Economic Policy Reform and Competitiveness Project Impact of international air service liberalization on Mongolia March 2011 Ulaanbaatar, Mongolia This publication was produced for review by the United States Agency for International Development. The views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

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3 Project: Mongolia Economic Policy Reform and Competitiveness Project (EPRC) Report Title: Impact of international air service liberalization on Mongolia Main Author: InterVISTAS LLC Contract No. 438-C Submitted by: EPRC Project/Chemonics International Inc., Tavan Bogd Plaza, Second Floor, Eronhii Said Amar Street. Sukhbaatar District, Ulaanbaatar, Mongolia Telephone and fax: (976-11) Fax: (976-11) Contact: Fernando Bertoli, Chief of Party address:

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5 ABBREVIATIONS AND ACRONYMS Authorized points Bermuda agreement Bilateral Cabotage (rights) Catalytic impacts Chicago Convention The allowable routes that could be operated under an air service agreement. This could range from a general statement such as any point in Country A to any point in Country B to an exhaustively detailed specification of individual airports, and what points could or could not be combined on a particular flight and in what order. In 1946, the United States and the United Kingdom negotiated one of the first air service agreements under the Chicago Convention. The agreement, signed in Bermuda, included capacity and pricing controls. According to the standards of 2006, it is a restrictive structure. The so-called Bermuda I agreement has served as a prototype for many subsequent agreements. In 1977, the Bermuda II Agreement, again involving the United States and the United Kingdom, was similar to its predecessor in most respects, but included restrictions of multiple designation, and provisions for capacity and all-cargo services. Bermuda II has now been replaced by the U.S.-EU Open skies agreement which came into force in Bilateral air service agreement normally between two nation states, also known as an air service agreement. Cabotage is the transport of goods or passengers between two points in the same country (domestic transport). Specifically, the right of an air carrier from one country to operate domestic services within another country. Most countries do not permit cabotage by foreign airlines. Catalytic impacts capture the impact a particular economic activity has in facilitating growth and productivity in the general economy. The continued existence of the activity (in this case aviation) could cause long term changes in the society s expectations. Businesses and people observe the activity, assume its continued existence, and modify their behavior accordingly. They then pursue new interests which would not be possible in the absence of this activity. For example, the presence of an airport with commercial air services may make the community more attractive as a location for a branch plant. Potential exporters could be offered low air freight rates to overseas destinations, which would make them newly competitive. Neither the new businesses nor the exporters need have any apparent relationship to commercial aviation, except as customers. The Convention on International Civil Aviation (or Chicago Convention) was signed on December 7, 1944 by 52 nations at the International Civil Aviation Conference held in Chicago, USA. The Chicago Convention led to the creation of the International Civil Aviation Organization (ICAO), a United Nations agency coordinating and regulating international air travel. It also established a set of international rules regarding use of airspace, aircraft registration, safety, and the framework for bilateral air service agreements governing air travel between nations. Code-sharing An agreement whereby airlines permit the use of their flight code in the flight schedule of other airlines providing they have the underlying traffic rights. This allows two or more airlines to market their joint services as a single entity and each airline can sell tickets on its code-share partners either as a stand-alone flight or as a connecting service. For example, one airline may operate route A-B while another operates B-C. Under a code-

6 share, both airlines can sell through-tickets for travel between A and C. In addition, code-shares can allow Airline X to sell tickets on Airline Y flights even where they have no overlapping services the ticket will be branded as a service by Airline X even though the flight is in fact operated by Airline Y. Designation Direct impacts E/D Passengers EU Fare elasticity Freedoms of the air The number and name of airlines nominated by each country in an air service agreement to operate air services between the two countries. Direct Impacts arise immediately from the conduct of those entities performing the activity in question. For an airport, the direct impacts would include the activities of airlines, the airport itself, forwarders, ground handling agents and other firms whose principal business involves commercial aviation. Enplaned/deplaned passengers. A measure of passenger volume that counts each passenger that enplanes or deplanes an aircraft. European Union, an economic and political union of 27 member states, located in Europe. It was established by the Treaty of Maastricht in November 1993 replacing the previous European Economic Community, which dates back to Consumers sensitivity to fare price changes for a particular good or service. See Annex A. FTE Full-Time Equivalent Job, a standardized measure of employment where 1 FTE is equal to one person working a full-time job. GDP IATA Indirect impacts Low Cost Carrier (LCC) Gross Domestic Product, a measure of the total national output of an economy. International Air Transport Association. Indirect Impacts involve the supply chain of the businesses or entities conducting the primary activity (i.e., those included in the direct impact). The airlines at an airport may purchase goods or services, such as stationery and office supplies, from a local business. Catering companies at the airport buy food from wholesalers. The items purchased can be used for many purposes besides commercial aviation, and would usually occur off-site. The materials support the primary aviation activity, although they could be used for many purposes. Also known as a no-frills or budget carrier, these are airlines that typically offer low fares for an air service with lower levels of service than traditional network or legacy carriers. Although there is considerable variation in the business models, low cost carriers typically operate a single aircraft type (to reduce training and maintenance costs), do not offer first or business class travel, do not provide in-flight services such as meals and entertainment (or offer them at additional charge), and emphasize point-to-point travel offering limited connecting options. Examples include Southwest Airlines in the U.S., EasyJet and Ryanair in Europe, Air Asia based in Malaysia, Gol in South America and Virgin Blue in Australia.

7 MALIAT Multilateral Agreement on the Liberalization of International Air Transportation, originally signed by New Zealand, Brunei Darussalam, Chile, Singapore and the United States. Mongolia is now a signatory to this agreement for cargo services only. Member State MIAT MNT MOU O/D Traffic Open Skies A sovereign nation state of the European Union (EU). There are currently 27 member states of the EU: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, United Kingdom. MIAT Mongolian Airlines. Mongolian Togrog (or tugrik). Memorandum of Understanding: in the absence of a formal Air Service Agreement, two countries may conclude an MOU granting air traffic rights between the two countries. In addition, MOUs may be used to make modifications to an existing Air Service Agreement. Such changes could include allowing additional capacity, resolving an ongoing dispute, clarifying any ambiguities or definitions, or clarifying items that had been left to be agreed in the original negotiations. A total renegotiation of the agreement could be procedurally difficult for either party, or both nations might be satisfied with the overall framework. Under such circumstances, the countries would agree to retain the original agreement but amend it as necessary. The results of the negotiations would be summarized in a Memorandum of Understanding, Record of Consultations, Exchange of Notes or similar mechanisms. Although the parties agree to retain the original agreement, the negotiations can be very complicated and important. Origin/Destination traffic: in aviation this refers to the traffic between two cities or countries where the origin is the starting point of the air journey and the destination is the final destination of the air traveler. As such, it does not include connecting traffic at the origin or destination. For example, O/D traffic between the UK and Singapore would capture the total traffic that started in the UK and ended in Singapore (and vice versa in the other direction). It would not include passengers starting in the UK and connecting in Singapore enroute to other destinations (e.g., Australia). An Open Skies air service agreement creates a very liberal market between the two signatory nations. It allows any number of airlines from either nation unlimited rights to fly between any city-pair involving the two countries, without significant restrictions on capacity, frequency or price. It generally also includes the right to operate fifth and sixth freedom services.

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9 TABLE OF CONTENT ABBREVIATIONS AND ACRONYMS... i EXECUTIVE SUMMARY... i SECTION I: INTRODUCTION Report structure...1 SECTION II: OVERVIEW OF AIR SERVICE AGREEMENTS AND AIR SERVICE LIBERALIZATION History and characteristics of air service agreements The trend toward liberalization Impact of liberalization on air service Liberalization of air service bilaterals Air liberalization impacts in emerging economies Impact of liberalization on the wider economy Summary...14 SECTION III: OVERVIEW OF THE MONGOLIAN AVIATION MARKET Passenger traffic Air cargo traffic Major airlines and routes Origin and destination markets International air service agreements signed by Mongolia...19 SECTION IV: THE ECONOMY OF MONGOLIA Population Economic growth Major economic sectors Exports and imports Tourism...24 SECTION V: RECOMMENDATIONS FOR THE LIBERALIZATION OF MONGOLIA Issues and approaches for Mongolia Scenario for liberalization in Mongolia... Error! Bookmark not defined. SECTION VI: IMPACT OF LIBERALIZATION ON AIR TRAFFIC IN MONGOLIA Defining the scenario Modeling the impact of liberalization Traffic impacts of liberalization Impacts on passenger traffic Impacts on air cargo Impacts on pricing Secondary impacts on the domestic air services Overview of the investment requirements Airport infrastructure Air carrier equipment...40 SECTION VII: ECONOMIC IMPACT OF LIBERALIZATION Impact on tourism Sensitivity tests Impact on employment Employment impacts in the aviation sector Employment impacts in the tourism sector Catalytic impacts Total employment impact Impact on gross domestic product...45 ANNEX A: FREEDOM OF THE AIR...49 ANNEX B: DETAILED DESCRIPTION OF THE GRAVITY MODEL...55

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11 EXECUTIVE SUMMARY Mongolia presents a dynamic air service market with significant potential for growth as its national economy expands. Although the Government of Mongolia has executed bilateral air service agreements (bilaterals) with over 30 foreign states, there are only four major routes which regularly connect Ulaanbaatar to critical international hubs in Beijing, Moscow, Seoul and Tokyo. Most of Mongolia s bilaterals contain tightly controlled designations for carriers, routes, airports, capacity, frequency, and pricing. There is considerable empirical evidence confirming that the liberalization of air services provides benefits for consumers including lower fares and more air services. Furthermore, liberalization will contribute to the overall improvement of the Mongolian economy in terms of a growing gross domestic product (GDP) and increasing employment throughout Mongolia. The purpose of this study was to examine the potential impact of air service liberalization in Mongolia and to provide some insights as to how Mongolia might approach more liberalized air services. Evidence of the impacts of liberalization As documented in this report, there is considerable evidence that liberalization of international air markets has provided substantial benefits for air passengers and the wider economy. For example, liberalization of the EU aviation market (one of the most prominent and large-scale examples of liberalization), lead to a 34% decline in discount fares and a doubling in the rate of growth in air traffic in the EU. Liberalization has also benefited emerging economies: the liberalized UK-India bilateral resulted in a 108% increase in passenger traffic, an 8-17% decline in fare and the entry of new Indian carriers. Similarly, the liberalization of the Malaysia-Thailand bilateral resulted in a 37% increase in traffic volumes. Furthermore, other studies have demonstrated a link between increased air traffic and growth in employment and Gross Domestic Product (GDP). For example, a study estimated that each 10% increase in international air services led to a 0.07% increase in GDP, which can translate into millions (or even billions) of dollars of incremental GDP. 1 In summary, liberalization leads to increased air service levels and lower fares, which in turn stimulates additional traffic volumes and can bring about increased economic growth and employment, as illustrated below: Liberalization New air services / lower fares Traffic growth Economic growth Job growth Impact of liberalization in Mongolia Full liberalization (i.e., open skies ) will ultimately have the greatest positive economic impact on Mongolia and is forecast to produce the results discussed in this report. But, as discussed in the report, there are political and economic realities that will likely prevent full liberalization from being adopted immediately. Therefore, immediate adoption of full open 1 InterVISTAS Consulting Inc., Measuring the Economic Rate of Return on Investment in Aviation, December 2006.

12 skies may not be practicable. However, maintaining the status quo for air services would result in the withholding of significant economic benefits for the citizens of Mongolia. The impacts of further liberalization on the Mongolian international air market were estimated using a gravity model developed by InterVISTAS which forecasts traffic between any two countries (or groups of countries) based on the two countries economic characteristics, trade levels, geographic relationship and the characteristics of the air service bilateral between the two countries. By specifying changes to the terms of the bilateral, the model can be used to estimate the traffic impact resulting from liberalization. The long term estimated impacts of full international bilateral liberalization were: International traffic to/from Mongolia increases by 112% within 2-3 years of implementation. Traffic to/from Asia accounts for nearly two thirds (65%) of the total projected increase in traffic (China, South Korea and Other Asia). Many of these Asian markets (notably China) are projected to achieve high levels of economic growth in the next decade. Increased air services and air traffic to/from these countries will support Mongolia further leveraging its own growth through better ties with other emerging economies. At the same time, liberalization will also stimulate air service to large, established markets such as Europe and North America. It is projected that liberalization will reduce passenger air fares by an average of 42%. Assuming full liberalization and based on the traffic increases projected in the report, the total fare savings across all Mongolian air passengers on international flights is estimated to be US$ 121 Million (MNT Billion). Liberalization is also projected to increase international air cargo volumes by 62% and increase domestic air traffic (through onward connections) by 43% to 87%. Economic benefits to Mongolia Liberalization is also projected to generate significant economic benefits for Mongolia including: A total of 117,000 additional international visitors per annum are projected as a result of liberalization, representing a 21% increase over 2010 visitor levels. These visitors are estimated to spend a total of US$94 Million (MNT Billion) in the Mongolian economy. Air service liberalization is projected to generate 21,540 full-time jobs in the aviation, tourism and other sectors of the Mongolia economy. This represents an increase of approximately 2.1% in total employment in Mongolia. An additional US$ Million (MNT 253 Billion) in Gross Domestic Product (GDP) per annum. This equates to an increase of 2.5% in national GDP. Executive summary Page ii Impact of international air service liberalization on Mongolia

13 SECTION I: INTRODUCTION As Mongolia seeks to develop national transportation systems, there have been discussions regarding the negotiations of Open Skies Agreements with potential airline partners. These discussions focus on the impact of rapid economic development in the coming years, specifically, how the liberalization of civil aviation will promote increased business and tourism related travel. International visitors currently travel to/from Mongolia primarily by air. As Mongolia is a landlocked country, air travel is critical to Mongolia s trade, economy, and its ability to access overseas markets. Although the Government of Mongolia has executed bilateral air service agreements (bilaterals) with over 30 foreign states, there are only four major routes which regularly connect Ulaanbaatar to critical international hubs: Beijing (BJS), Moscow (SVO), Seoul (ICN) and Tokyo (NRT). Most of Mongolia s bilaterals are of the Bermuda I type, with tightly controlled designations for carriers, routes, airports, capacity, frequency, and pricing. There is considerable empirical evidence confirming that the liberalization of air services provides benefits for consumers including lower fares and more air services. Furthermore, liberalization will contribute to the overall improvement of the Mongolian economy in terms of a growing gross domestic product (GDP) and increasing employment throughout Mongolia. The Government of Mongolia has recently stated plans to conduct a comprehensive review of national civil aviation policies. Specifically, the Economic Policy and Competitiveness Research Center (EPCRC) aims to provide an assessment to help frame public dialogue and policy choices on achieving measurable benefits of liberalization of air services to consumers and the overall economy in Mongolia. The aim of the study was to assess the current status of the Mongolian aviation industry, air traffic levels and wider economy and examine the following impacts of air liberalization on Mongolia: Impact on international and domestic passenger traffic volumes and air fares Impact on air cargo traffic Impact on jobs in the air transport industry and the wider economy Impact on tourism Impact on Gross Domestic Product (GDP). In addition, this research also provides discussion and recommendations regarding the approach to liberalization that can be undertaken and the regulatory and infrastructure implication of any such liberalization. 1.1 Report structure This report documents the analysis undertaken to examine the impact of liberalization on Mongolia. The report is structured as follows: Section II provides a general discussion on structure and history of international air service agreements and the previous evidence on the impacts of liberalizing international air policy. Section III gives an overview of the Mongolian aviation market as well as the current state of its air service agreements. Section IV provides background on the economy of Mongolia, including its recent strong growth and tourism development.

14 Section V provides a discussion on the issues and approaches to liberalization and develops scenarios for air liberalization of Mongolia. Furthermore, the chapter examines and evaluates examples of liberalization approaches undertaken in other countries. Section VI analyses the traffic impacts (international passengers and air cargo and secondary impacts on domestic air services) of air liberalization on Mongolia. The analysis is based around a gravity model developed by InterVISTAS which forecasts traffic between two countries based on the countries economic characteristics, trade levels, geographic relationship and the characteristics of the air service bilateral. Chapter 5 also provides an overview of additional airline equipment and airport infrastructure required to meet the higher traffic levels stimulated by liberalization. Section VII examines the impact of liberalization in Mongolia on the wider economy, especially on employment, Gross Domestic Product and tourism. Additional details on air service agreements and the structure of the gravity model are provided in the appendices. Section I Page 2 Impact of international air service liberalization on Mongolia

15 SECTION II: OVERVIEW OF AIR SERVICE AGREEMENTS AND AIR SERVICE LIBERALIZATION 2.1 History and characteristics of air service agreements In most parts of the world, international air services between countries operate under the terms of a bilateral air service agreement (bilaterals) negotiated between the two countries. These agreements are generally of treaty status and are enforceable in international law (although some operate under, or are modified by, a less formal Memorandum of Understanding arrangement). The framework for these bilateral air service agreements was established towards the end of World War II in 1944, when 52 countries came together at the International Civil Aviation Conference held in Chicago, USA, which established the Chicago Convention. 2 The Chicago Convention stipulated that two nations seeking to be linked by commercial air services would negotiate the terms through concluding a bilateral air service agreement also known as a bilateral. This would specify the conditions under which the proposed services would operate in terms of the privileges granted by either signatory country to the airline or airlines of the other country. The agreement would cover such items as: Traffic rights. Also known as Freedoms of the Air, these are a standard set of nine distinct air rights over which the two countries will negotiate. For example, the first freedom of the air is the right to overfly the territory of a country without landing there, the second freedom is the right to stop in a country to refuel (or other technical reasons), the third freedom is the right to carry passengers (or cargo) from one s own country to the other country and the fourth freedom is the right to carry passengers (or cargo) from the other country to one s own. A summary of the freedoms of the air are provided in the box below and in more detail in Annex A. Virtually all bilaterals will allow freedoms one to four. 3 However, bilaterals differ in their treatment of fifth freedom rights the ability of a carrier from Country A to carry traffic from Country B to a third country as an extension of a service between Countries A and B. Some bilaterals do not permit this type of traffic while others do, or some variant of it. Authorized points. The allowable routes that could be operated. This could range from a general statement such as any point in Country A to any point in Country B to an exhaustively detailed specification of individual airports, and what points could or could not be combined on a particular flight and in what order. Capacity. The number of flights or seats that could be operated between the two countries. Pricing. The method for setting fares on the route. The agreement would specify the conditions necessary for a fare proposed by the airline of one country to become operative. Some agreements require airlines to submit ticket prices to aeronautical authorities for approval while others allow the airlines to set prices without restriction. Designation. The number of airlines the bilateral partners can nominate to operate services and the ownership criteria airlines must meet to be designated under the bilateral agreement (e.g., the airlines designated by Country A must be majority owned by residents of Country A). 2 The Chicago Convention framework clearly distinguishes between international and domestic services. Domestic services are considered strictly a matter for the respective national government. 3 For many countries, the first two freedoms (known as technical freedoms) are enshrined in a multilateral agreement known as the International Air Services Transit Agreement signed at the Chicago Conference.

16 Other clauses related to operative agreements (e.g., code-sharing) and various doing business issues such as repatriation of currencies, the ability to select handling agents at foreign airports and the use of computer reservations systems. Freedoms of the Air When countries negotiate air services bilaterals, they grant traffic rights to airlines that are referred to as "freedoms of the air." These rights are: First Freedom. The right to fly over another nation s territory without landing. Second Freedom. The right to land in a foreign country for non-traffic reasons, such as maintenance or refuelling, without picking up or setting down revenue traffic. Third Freedom. The right to carry people (or cargo) from the airline s own country to the other country. Fourth Freedom. The right to carry people (or cargo) from the other country to the airline s own country. Fifth Freedom. The right to carry traffic between two foreign countries with services starting or ending in the airline s own country (also known as beyond rights). Sixth Freedom. The right to carry traffic between two countries via the airline s own country. Seventh Freedom. The right to carry traffic between two foreign countries on a service that does not involve the airline s own country. Eighth Freedom. The right to carry traffic between two points within a foreign country (i.e., domestic traffic) as an extension of a service starting or ending in the airline s own country (also known as tag-on or fill-up cabotage). Ninth Freedom. The right to carry traffic between two points within a foreign country with no requirement to start or end the service in the airline s own country (also known as pure or standalone cabotage). Further details on the freedoms of the air can be found in Annex A. Historically, many of the bilaterals have been fairly restrictive. One of the earliest agreements was the Bermuda I agreement between the United States and the United Kingdom signed in This bilateral specified the limits on pricing, capacity, designated airlines and routes operated. This restrictive agreement has acted as a template for a great number of subsequent bilaterals between various countries. 4 As a result, the development of international air service has been as much a function of government policy as it has been a function of commercial considerations. 2.2 The trend toward liberalization The international framework of the Chicago Convention has proven to be durable and fairly flexible, allowing a wide range of market regimes, from highly restrictive agreements with rigidly defined descriptions of allowable city-pairs, capacity and pricing to more liberal agreements that allow free entry of airlines of either signatory nation to any route, unrestricted capacity and full pricing freedom. Nevertheless, a number of shortcomings have been identified with this form of regulation: 4 Bermuda I was replaced by a slightly less restrictive Bermuda II agreement in Bermuda II has now been replaced by the U.S.-EU Open skies agreement which came into force in Section II Page 4 Impact of international air service liberalization on Mongolia

17 The regulation is slow moving and unresponsive under restrictive bilaterals, changes in capacity, number of airlines, pricing, etc. would require negotiation by diplomats creating delays of several years in some cases before the changes can take place. The bilateral negotiations are often narrowly focused on the benefits to the airlines. The benefits to passengers, shippers, tourism and the wider economy are given less weight, often because they are more difficult to quantify. The industry has undergone considerable transformation which is not always reflected in the bilaterals. Technological improvements have allowed a great range of services at much lower cost and many countries have privatized previously state-owned air carriers. Recognizing these shortcomings and the potential economic benefits of a more liberal aviation sector, many governments have moved to deregulate various aspects of aviation. This has included the privatization of airlines and airports, deregulation of domestic markets and liberalization of international bilaterals. One of the earliest instances of liberalization was the deregulation of the U.S. domestic air market in Prior to deregulation, the pricing, routes and capacity operated on air services within the U.S. was tightly controlled by government. Deregulation removed all of these controls and allowed market forces to determine service and price levels. There has also been a trend towards the liberalization of international bilateral agreements. Since 1992, the U.S. has pursued open skies bilaterals with other countries. 5 The term open skies is somewhat loosely defined but the U.S. government defines it as allowing the carriers of the two nations to operate any route between the two countries without restrictions on capacity, frequency or price, and to have the right to operate fifth and sixth freedom services. 6 It also allows cooperative marketing arrangements such as code-sharing and liberal all-cargo operations (e.g., seventh freedom operations). The U.S. definition of open skies does not include seventh freedom passenger services, cabotage or liberalization of ownership and control restrictions, although other definitions of open skies do (e.g., the European Union considers cabotage to be part of open skies). To date, the U.S. has signed over 90 open skies agreements. Other countries, such as New Zealand, Chile and Morocco, have also pursued similar open skies arrangements. For example, in 1996 Australia and New Zealand signed a Single Aviation Market agreement which now allows carriers from the two countries to operate without restriction between the two countries (the Trans-Tasman market) and also allows fifth freedom and cabotage rights. A number of multilateral agreements have also developed, most notably the European Union (EU) single aviation market. Between 1987 and 1993, the EU introduced three packages of reforms that almost fully deregulated the EU air market. Carriers from within the EU are now free to operate any route within the EU without restriction on price or capacity, including cabotage (i.e., domestic air travel within a member state), which has been permitted since In addition, all restrictions on airline ownership have been removed for EU citizens (e.g., an air carrier operating from Italy can be 100% owned by investors from the UK; however, investment by non-eu citizens is restricted to 49%). The EU is also negotiating open skies bilateral agreements as a block with other countries, for example the EU-U.S. Open Skies agreement in Another less extensive example of a multilateral agreement is the 5 In fact, the U.S. had started pursuing more liberal bilaterals since the late 1970s, but the policy was only formalized as open skies in the 1990s. 6 Some controls on pricing remain through a double disapproval mechanism, i.e., if both governments concur to disallow the fare. Impact of international air service liberalization on Mongolia Section II Page 5

18 Multilateral Agreement on the Liberalization of International Air Transportation (MALIAT) originally signed by New Zealand, Brunei Darussalam, Chile, Singapore and the United States. 7 The MALIAT signatories have granted each other unlimited traffic rights between each other under third, fourth, fifth and sixth freedoms, as well as unlimited seventh freedom traffic rights for cargo-only flights. National majority ownership is not a requirement for being designated between MALIAT countries, only a principal place of business is required. New Zealand, Chile, Singapore and Brunei have gone even further and granted each other seventh and eighth freedom rights for passenger flights. In the area of ownership and control, there has been some liberalization but considerable restrictions still apply in most cases. Chile is one of the few examples of countries that do not place any restrictions on the foreign ownership and control of its domestic and international airlines. However, the airlines are required to have their principal place of business in Chile (i.e., the airline must be primarily based in Chile). In part, this is to ensure that the airline can reasonably be designated as a Chilean carrier under the terms of Chile s international bilateral. However, most countries apply some limit on ownership that typically ranges from 20% to 50% of voting shares (stocks). Some countries apply different restrictions on domestic and international carriers. For example, both Australia and New Zealand allow 100% foreign ownership of domestic carriers but only 49% ownership of international carriers. Despite the trend towards liberalization, there remain considerable government restrictions on airline operations and ownership. Many bilaterals still follow the constrictive Bermuda model established over 50 years ago and most governments still apply restrictions on the ownership and control of airlines. The next section describes the benefits that have arisen from liberalization and are likely to arise with further liberalization. 2.3 Impact of liberalization on air service In many ways, the liberalization of the aviation industry can be seen as part of a fairly global trend of market deregulation and privatization which has also been applied to the telecommunications, utilities, railway and other industries. It is generally accepted that this deregulation has been on the whole beneficial to these industries and, more importantly, to the consumers they serve. Indeed, empirical research has found deregulation/privatization of many industries has often led to lower prices for consumers, higher service quality, improved access to services (greater take-up by consumers, in part due to lower prices, and increased levels of investment). However, it is worth noting that many of the remaining restrictions placed on the operation of international air service and the ownership and control of airlines are fairly unique to the industry. Today, there are very few industries subject to such a large degree of government control. Major industries such as pharmaceuticals, energy and even parts of the defense industry have been allowed to merge across borders and have no restriction on their foreign ownership Liberalization of air service bilaterals As the examples below illustrate, liberalization of air service bilaterals have generally fostered greater competition, resulting in lower fares for travelers, greater numbers of people travelling, greater choice of airlines and routes and improved service levels (higher frequencies, etc.). A 7 The Cook Islands, Samoa and Tonga have joined MALIAT since its original signing. Mongolia joined in 2008 for cargo traffic only. Peru was also a signatory but has since withdrawn. Section II Page 6 Impact of international air service liberalization on Mongolia

19 2003 study by the European Union found that the liberalization of the EU air market (the single aviation market) had resulted in the following: 8 Changes to industry structure. The total number of scheduled airlines increased 6% between 1992 and 2000, increasing from 124 to 131 airlines. However, this understates the degree of change in the industry. The EU reports that just over half the airlines present at the start of 1993 were still operating by the end of Between 1992 and 2000, 144 new airlines entered the market, of which 64 were still operating in Increased routes and capacity. There was a strong rise in the number of city-pairs served and in overall capacity provided in the EU market. The total number of intra- EU city-pairs increased 74%, while the number of domestic city-pairs increased 12% between 1992 and Both the number of flights and seats operated increased by an even greater amount, indicating that overall capacity has increased substantially. Increased route competition. The number of carriers competing for traffic on European routes has increased substantially. The number of domestic city-pairs served by more than one carrier increased 88%, while the number of intra-eu citypairs served by three or more carriers increased 256%. Reduced fares. In real terms (i.e., after adjusting for inflation), average fares have declined substantially for most passengers. Discount economy fares, which represent the vast majority of tickets purchased, declined 34% in real terms between 1992 and Full economy fares declined somewhat (5%), while business fares actually increased by 26%. A 2006 study by InterVISTAS-ga 2 also found a substantial stimulation of traffic resulting from the liberalization of the EU air market. 9 It found that, as a result of liberalization, the rate of traffic growth doubled from an average of 4.8% per annum in to 9.0% per annum in The stimulatory effect on traffic of liberalizing individual bilaterals is illustrated in Figure 2-1. The table provides a comparison of traffic levels in the year immediately preceding inauguration of the new bilateral to volumes in the first full calendar year after inauguration. It also shows the new services initiated the year after liberalization. These examples result from changes in bilateral air service agreements, or from specific government decisions to relax the restrictive provisions of current agreements. The table shows that just one year after liberalization, traffic increased by as much as 174%. This may understate the stimulus impacts as traffic can take several years to fully mature. 8 European Experience of Air Transport Liberalisation, Joint Presentation by the European Union and the European Civil Aviation Conference to the 5 th Worldwide Air Transport Conference (ICAO), 24-29th March InterVISTAS-ga 2, The Economic Impact of Air Service Liberalization, June Impact of international air service liberalization on Mongolia Section II Page 7

20 Figure 2-1: Air service agreement liberalization and traffic growth City-Pair New Services Arising Liberalization Event Increase Vancouver-Phoenix America West Canada-U.S. Bilateral Toronto-Minneapolis Air Canada 1995, Northwest Toronto-New Orleans Ottawa-Chicago Air Canada 1998 Air Canada/ American Canada-U.S. Bilateral 1995 Canada-U.S. Bilateral 1995 Canada-U.S. Bilateral Montreal-Atlanta Delta Canada-U.S. Bilateral Atlanta-San Jose CR 146.4% 55.3% 41.2% 109.7% 55.5% Delta U.S.-Costa Rica 118.5% Chicago-Hong Kong United 1996 U.S.-Hong Kong Bilateral Chicago-London United 1995 U.S.-U.K Mini Deal, % 42.1% Chicago-Sao Paulo United 1997 U.S.-Brazil, % Houston-Sao Paulo Continental 1999 U.S.-Brazil, % Atlanta-Guadalajara Delta 1999 U.S.-Mexico, % Detroit-Beijing Northwest 1996 U.S.-China, % Houston-Tokyo Continental U.S.-Japan 116.6% Atlanta-Rome Delta U.S.-Italy 110.8% Dallas/Fort Worth- Zurich American Open Skies 115.3% Source: The Economic Impact of Air Service Liberalization, InterVISTAS-ga 2, June A study by the World Trade Organization (WTO) also examined the impact of liberalization on passenger traffic volumes using a gravity-type model calibrated on air passenger flows between 184 countries. 10 The analysis found that complete or near-complete liberalization resulted in traffic increases of 30%, on average, although some impacts were as high as +86% on some country pairs. While there has been substantial research into the impact of liberalization on passenger services, there exists very little research on the impacts to air freight. One research paper did examine the impact of air service liberalization on air freight rates. 11 The authors found that improvements in the quality of regulation (i.e., the level and structure of tariffs associated with aeronautical services, how they are set and the regulatory process to modify them), reduced air freight cost by up to 14%, while fully deregulating the air cargo market (i.e., open skies) resulted in a further 8% decline in freight rates. 10 Piermartini, R. and Rousová, L. (World Trade Organization), Liberalisation of Air Transport Services and Passenger Traffic, Staff Working Paper, December Micco, A. and Serebrisky, T. (2004), Infrastructure, Competition Regimes and Air Transport Costs: Cross Country Evidence, July Section II Page 8 Impact of international air service liberalization on Mongolia

21 2.3.2 Air liberalization impacts in emerging economies The following section provides brief descriptions of examples where emerging economies have liberalized their air services and discusses the impacts of this liberalized market. India-UK Bilateral The UK Civil Aviation Authority (CAA) examined the impact of the liberalization of the UK- India bilateral which took place in The study found that two years after liberalization, the number of direct services between the UK and India had increased from 34 (22 services operated by UK airlines and 12 by Indian airlines) to 112 services (63 services operated by UK airlines and 49 by Indian airlines) per week (an increase of 229%) as can be seen in Figure 2-2. While most of these new services were operated between the two countries main airports (Heathrow in the UK and Delhi and Mumbai in India), services connecting secondary points in the UK and India also arose. In addition, the number of carriers operating between the two countries increased from three to five (BMI and Jet Airways entered the market). This increased competition resulted in average fares declining by 17% for leisure passengers and by 8% for business passengers. The lower fares and increased service caused passenger traffic between the two countries to increase by 108%. Figure 2-2: Number of scheduled services between UK and India ( ) 120 Indian Airlines Prior to liberalization Post Liberalization UK Airlines Scheduled Services (UK-India) Summer 2003 Winter 2003/04 Summer 2004 Winter 2004/05 Summer 2005 Winter 2005/06 Summer 2006 Source: UK CAA, UK-India Air Services: A Case Study in Liberalisation, 22 November 2006 based on OAG data. Malaysia-Thailand The original agreement between Malaysia and Thailand was signed in This Bermuda I agreement allowed named points, carrier designations, frequencies and capacity to be added into the market based on government consultations. Following Memoranda of Understanding 12 UK CAA, UK-India Air Services: A Case Study in Liberalisation, 22 November Impact of international air service liberalization on Mongolia Section II Page 9

22 (MOUs) between Malaysia and Thailand have allowed services and frequencies to increase, thus driving an increase in overall traffic. Many attributes of a liberalized market can be found within the terms of the current agreement between the countries. They include no restrictions on points served, multiple designations, code sharing rights and open frequencies. Fifth freedom, intermediate or beyond, and seventh freedom cargo operations are included in the agreement. As in most other bilateral agreements, cabotage is not included. In 2004, AirAsia, a Malaysian low-cost carrier, entered the Malaysia-Thailand market triggering a sharp seat capacity increase in the market. AirAsia targeted third and fourth freedom markets, i.e., traffic between the two countries. The bilateral agreement between Malaysia and Thailand permitted AirAsia to expand in the market with new designations and frequencies. Figure 2-3 shows non-stop air services between Malaysia and Thailand in 1996 compared to Non-stop routes have increased mainly due to new low-cost carrier services provided by AirAsia. As AirAsia grew domestically it also developed an international network to destinations such as Kuala Lumpur-Bangkok/Phuket and Bangkok-Penang. While these routes were already served in 1996, the total capacity has grown due to AirAsia s low fare strategy. Figure 2-3: Malaysia-Thailand Non-stop services 1996 vs Source: InterVISTAS study: The Economic Impact of Air Service Liberalization, 2006 based on OAG data In 2005, 1.3 million passengers traveled between Thailand and Malaysia. Of this total, over 370,000 can be attributed to the combination of the liberalized regime and the entry of the new low cost carrier. The direct and indirect effects of liberalization have caused a market expansion of over 37%. The economic and tourism impacts of Thailand and Malaysia are near identical. It is estimated that each nation obtained more than 4,300 full-time equivalent positions and a stimulus of over $114 million to their respective GDPs. 13 Jamaica-U.S. Open Skies The U.S. is the only country with which Jamaica has concluded a truly liberalized agreement. Jamaica depends highly on tourism and the U.S. is a major tourist market for Jamaica. Thus, the tourism market is central to Jamaican aviation policy. In 2002, the conclusion of the Open Skies Agreement conceded to Jamaica the right to serve any point without restriction. At that time, Jamaica had already over 20 years experience in 13 InterVISTAS study: The Economic Impact of Air Service Liberalization, Section II Page 10 Impact of international air service liberalization on Mongolia

23 operating in a fairly liberalized regime with the U.S. Air Jamaica has increased the number of points served from four gateway points in 1979 to 12 gateways points across the U.S. During the period from 1979 to 2002, the U.S./Jamaican market also increased significantly from 450,000 to 1.2 million passenger arrivals, averaging an annual 12% increase. At the same time Air Jamaica has maintained its competitiveness. Jamaica s experience with code-sharing is limited to only one arrangement between Air Jamaica and Delta Airlines. This code sharing agreement has proved to be a positive experience as Jamaica was able to expand its market to points which it would not otherwise have been able to access. 14 Air Jamaica was beset by other financial and management problems, however. Caribbean Airlines acquired the airline's fleet and route rights on 1 May 2010, and will open a new hub at Kingston's Norman Manley International Airport. Liberalization in Chile Chile has pursued an aggressive policy of air service liberalization since Chile has a broad policy of allowing free entry into its domestic and international air markets with little restriction on pricing and operations (subject to safety regulations), provided it generally receives reciprocity from the other country and there are no conflicts with bilaterals related to a third country. 15 As a result, Chile has signed a relatively large number of open skies agreements, such as those with the U.S., UK, Uruguay, Paraguay, Singapore, Panama, New Zealand, Jamaica, and the Dominican Republic. In other cases, while an open skies agreement has not been achieved, a more liberal bilateral has still been signed (e.g., Brazil, Argentina, Spain). A 2008 study analyzed the impact of the Chilean air liberalization policy, especially, traffic growth, traffic concentration and economic benefits of five Chilean aviation markets that were liberalized. 16 The study examined the impact on traffic and economic growth as a result of liberal or open skies agreements with the U.S., Spain, Brazil and Argentina. The study found that, in general, with each liberalized agreement, passenger traffic flows grew steeper and generally exceeded previous projections of traffic growth. Using econometric analysis, the study s authors estimated that liberalization of the agreements with these four countries resulted in an additional US$ million in Gross Domestic Product. 2.4 Impact of liberalization on the wider economy The impacts of liberalization extend beyond those to passengers. The increase in air services and traffic volumes stimulated by liberalization has been found to increase employment and benefit the wider economy. This arises in a number of ways: Aviation sector: additional economic activity in the aviation sector is generated by the servicing, management, and maintenance of the additional air services. This includes activities at airlines, airports, air navigation, and other businesses that support the aviation sector. The impact can spin-off into the wider economy (called indirect or multiplier impacts) e.g., food wholesalers that supply food for catering on flights, trucking companies that move goods to and from the airport, refineries processing oil for jet fuel, etc. Tourism sector: air service facilitates the arrival of larger numbers of tourists to a region or country. This includes business as well as leisure tourists. The spending of 14 Jamaica s Experience with air transport liberalization, Regulatory Policy Seminar on Liberalization Policy and Implementation, in Port of Spain, Trinidad and Tobago, April The Policy of Open Skies in Chile, December 29 th, 2003, ICAO Document. 16 Villena, M.J., Harrison, R, and Villena, M.G., Impacto Economico de la Politica de Acuerdos de Cielos Abiertos en Chile, Revista de Analisis Economico, Vol. 23, No. 1, pp , June Impact of international air service liberalization on Mongolia Section II Page 11

24 these tourists can support a wide range of tourism related businesses: hotels, restaurants, theatres, car rentals, etc. Of course, air service also facilitates outbound tourism, which can be viewed as reducing the amount of money spent in an economy. However, even outbound tourism involves spending in the home economy, on travel agents, taxis, etc. In any case, it is not necessarily the case that money spent by tourists flying abroad would be spent on tourism at home if there were no air service. Catalytic impacts: also known as Wider Economic Benefits. Air transportation facilitates employment and economic development in the national and regional economy through increased trade, attracting new businesses to the region and encouraging investment. Industries and activities that would otherwise not exist in a region can be attracted by improved air transport connectivity. In particular, catalytic effects can include some or all of the following: Trade effects air transport liberalization opens new markets to many businesses as a result of new destinations, better flight connections and higher frequencies offered. This leads to a broader demand for existing products. Investment effects a key factor many companies take into account when taking decisions about location of office, manufacturing or warehouses is proximity of an international airport. Productivity effects air transportation offers access to new markets which in turn enables businesses to achieve greater economies of scale. Air access also enables companies to attract and retain high quality employees. A 2004 study by the UK CAA examined the impact of liberalization of the EU market on employment in the aviation sector. 17 It found that between 1991 and 2001 (i.e., before and after liberalization) employment in the aviation sector had increased by 38% in the UK. The study found similar results across Western Europe with employment increasing by 6-84%, except in a few countries where the national carrier had collapsed or been restructured as a result of government policy (e.g., Switzerland, Belgium, Greece). More broadly, a number of studies have examined the link between air service levels and general employment or economic growth (the catalytic impacts ): A study by Irwin and Kasarda (1991) examined the relationship between the structure of airline networks and employment growth at 104 metropolitan areas in the United States. 18 Using data for a 30-year period, the researchers conducted statistical analysis which found that expansion of the airline network serving a region had a significant positive impact on employment in that region, particularly in service sector employment. 19 A study by Button and Taylor (2000) examined the link between international air service and economic development. 20 Using data for 41 metropolitan areas in the U.S., the authors statistically analyzed the link between high-tech employment and the number of direct routes to Europe offered by airports in the region. The analysis found that there was a strong and significant relationship between employment and 17 UK CAA, The Effect of Liberalization of Employment, 16 March Irwin, M. and Kasarda, J. (1991), Air Passenger Linkages and Employment Growth in U.S. Metropolitan Areas, American Sociological Review, Vol. 56, No. 4, August The analysis was conducted using non-recursive models which confirmed that increases in the airline network were a cause rather than a consequence of this employment growth. 20 Button, K. and Taylor, S. (2000), International air transportation and economic development, Journal of Air Transport Management, Vol. 6, Issue 4, October Section II Page 12 Impact of international air service liberalization on Mongolia

25 air services to Europe, such that increasing the number of European routes served from three to four generated approximately 2,900 high-tech jobs. In a similar study, Brueckner (2002), also looked at the impact of air service on employment in the U.S. 21 The analysis found that a 10 percent increase in passenger enplanements in a metropolitan area leads to an approximately one percent increase in employment in service-related industries. Frequent service to a variety of destinations, reflected in the high levels of passenger enplanements, was found to both attract new firms to the metro area and stimulate employment at established enterprises. However, the analysis found that there was no impact on manufacturing and other goods-related employment suggesting that air travel is less important to these industries than it is to service-related industries. Cooper and Smith (2005) examined the contribution of air transportation to tourism, trade, location/investment decisions and productivity. 22 The study estimated that the net contribution of air transportation to trade (i.e., export minus imports) was 55.7 Billion in 2003 across the 25 current EU members, or approximately 0.6% of GDP. A 2006 study by InterVISTAS Consulting Inc. found that a 10% increase in a nation s air connectivity (a measure of international air service) increased GDP by 0.07%. 23 Bel and Fagenda (2008) analyzed the relationship between international air service and the location of large firm s headquarters across major European urban areas. 24 The authors found that supply of non-stop intercontinental flights was a significant factor in determining headquarter locations (along with other economic, business, labor and tax factors). Empirical research indicated that a 10% increase in supply of intercontinental air service was associated with a 4% increase in the number large firm headquarters located in the corresponding urban area. Ishutkina and Hansman (2009) analyzed the interaction between air transportation and economic activity on a worldwide basis. 25 The study uses a feedback model, literature reviews, aggregate data and case study analyses. The authors concluded that a feedback relationship between air transport and economic activity exists. Air transportation provides employment and supports economic activities which are dependent on the availability of air transportation services. In turn, economic activity drives the demand for air transportation services. Specifically, aggregate and individual country-level data were analyzed in terms of the relationship between air transportation passengers and GDP. A data analysis of 139 countries over a time period of 30 years (1975 and 2005) showed that in the majority of the countries with positive growth rates, significant changes were observed. On the air transportation supply side, changes in the regulatory framework and infrastructure capability, and on the air transportation demand side, changes such as economic liberalization reforms and supporting infrastructure investment lead to positive growth rates. 21 Brueckner, J. (2002), Airline Traffic and Urban Economic Development. 22 Cooper, A. and Smith, P. (2005), The Economic Catalytic Effects of Air Transport in Europe, EUROCONTROL. 23 InterVISTAS Consulting Inc., Measuring the Economic Rate of Return on Investment in Aviation, December Bel, G. and Fageda, X. (2008), Getting There Fast: Globalization, Intercontinental Flights and Location of Headquarters, Journal of Economic Geography, Vol. 8, No Ishutkina M.A. and Hasnman R.J. (2009), Analysis of the interaction between air transportation and economic activity: a worldwide perspective, PhD thesis, Department of Aeronautics and Astronautics, Massachusetts Institute of Technology. Impact of international air service liberalization on Mongolia Section II Page 13

26 Air liberalization can also impact the air cargo industry and an increase in air cargo services and air cargo volumes can also increase employment and further benefit the wider economy as the following studies demonstrate: Kasarda et al. (2006) examined the impact of the air cargo industry on the global economy. 26 The paper discussed potential impacts on the air cargo industry when air rights would be liberalized and other operational reforms in the air transport industry would occur. The authors conclude that with a liberalized air cargo market, the air cargo industry would be able to expand its geographic spread. Furthermore, liberalization would lead to a more efficient use of air carrier resources, expand product mix, and further increase economic development. Cech (2004) used a cross-section statistical comparison method to investigate how air cargo services affect local economies, including: 1) the attractiveness of an area for the creation of new jobs and retention of existing jobs (measured by employment), 2) the impact on economic growth (measured by earnings) and 3) the impact on added value created by employees and subsequent improvement of efficiency and competitiveness (measured by earnings per employee). 27 The author grouped 125 U.S. counties with similar population size into seven groups depending on the number of airports to which they connected, the volume of cargo handled and the frequency of flight service. The author concluded that there is a positive catalytic effect related to accessibility to air cargo services. More specifically, the catalytic effect can lead to an increase in the number of jobs as well as improve regional productivity and increase employee earning. The transportation sector is most influenced by the accessibility of air cargo services. However, construction, retail and wholesale trade industries are also positively influenced. A Booz Allen Hamilton study (2007) provides an analysis of the potential economic benefits from establishing an Open Aviation Area between the EU and the US. 28 Among other things, the study also examines the stimulation of the air cargo market through and Open Aviation Area. Results show that the air cargo market would increase between 100,000 (low scenario) and 170,000 (high scenario) tons of freight, which is equivalent to 1-2% of the existing market which would create between 5,000 and 9,000 new jobs. 2.5 Summary The research summarized in this chapter provides evidence of the way in which liberalization leads to increased air service levels and lower fares, which in turn stimulates additional traffic volumes, and can bring about increased economic growth and employment, as illustrated below: Liberalization New air services / lower fares Traffic growth Economic growth Job growth 26 Kasarda J.D., Appold S.J, and Mori, M. (2006), The impact of the air cargo industry on the global economy, paper for the International Air Cargo Association, Air Cargo Forum, Calgary, Canada, Sep Cech P. (2004), The Catalytic Effect of the Accessibility to Air Cargo Services, TIACA Graduate Research Paper Competition. 28 Booz Allen Hamilton (2007), The Economic Impact of an Open Aviation Area between the EU and the US, Prepared for the European Commission. Section II Page 14 Impact of international air service liberalization on Mongolia

27 SECTION III: OVERVIEW OF THE MONGOLIAN AVIATION MARKET 3.1 Passenger traffic In 2010, total annual air passenger traffic in Mongolia reached 665,803 passengers, as shown in Figure 3-1. International passenger traffic in Mongolia totaled 529,000 passengers (accounting for 79% of total passenger traffic), while domestic traffic totaled 137,000 passengers (accounting for 21% of total passenger traffic). Between 2001 and 2007, international passenger traffic has exhibited strong growth, averaging 17% per annum. In 2008 and 2009, international traffic declined due, in part, to the global economic recession. Traffic volumes recovered strongly in 2010 (up 18% from 2009). Domestic passenger traffic has been fluctuating over the last decade, reaching its peak in 2004 with 163,000 domestic passengers. Domestic traffic grew by 55% in 2010 relative to Figure 3-1: Domestic and international passenger volumes ( ) 700 International Passengers Domestic Passengers Air Passengers (Thousands) Source: Statistical Bulletin of the Mongolian Civil Aviation Authority. 3.2 Air cargo traffic Figure 3-2 illustrates the historical levels of air cargo traffic in Mongolia, split into international and domestic freight and mail. Air cargo increased by an average rate of 12% per annum between 2001 and Traffic declined 14% in 2009, with the global recession the likely major cause. International freight is the largest component of air cargo, accounting for 2,936 tons (77%) in Including international mail, international air cargo accounted for 3,342 tons (88%) of total air cargo.

28 Figure 3-2: Air freight carried ( ) 5,000 Domestic Mail Domestic Freight 4,500 International Mail International Freight 4,378 Air Cargo (Metric Tonnes) 4,000 3,500 3,000 2,500 2,000 1,500 1,000 1, ,567 2, ,696 2, , ,029 2, ,418 2,334 3, , , , , , , Source: Statistical Bulletin of the Mongolian Civil Aviation Authority. 3.3 Major airlines and routes Mongolia has 23 airports but only 14 have paved runways. Chinggis Khaan International Airport (ULN) is the largest airport in the country handling virtually all the country s international traffic and acting as a hub for MIAT Mongolian Airlines (MIAT), Aero Mongolia, and Eznis Airways. 29 ULN is located about 18 kilometers southwest of the capital Ulaanbaatar, and also accounts for the large majority of the country s domestic services (ULN acts as a hub for most domestic services to other points in Mongolia; there are a small number of services that connect other airports directly, bypassing ULN). Figure 3-3 shows the airline market shares in the domestic market in Three major Mongolian carriers operate in the domestic market: MIAT Mongolian Airlines is Mongolia s national airline, headquartered in Ulaanbaatar. MIAT Mongolian Airlines, founded in 1954, holds a code-share agreement with Korean Air and Aeroflot and operates domestic and international flights from and to ULN. International flights are operated to Moscow, Berlin, Beijing, Seoul, and Tokyo from ULN. 30 MIAT now accounts for very little of the domestic market operations, and has carried an increasingly small share of domestic passengers (in 2008, the carrier handled over 13,000 domestic passengers). Eznis Airways, founded in 2006, offers scheduled and charter flights and is the largest domestic airline in Mongolia. In summer 2009, the airline also started offering 29 The other airport with scheduled international service is Ölgii Airport with service to Kazakhstan. 30 MIAT-Mongolian Airlines website. A small number of seasonal services to Hong Kong, Osaka (Japan) and Irkutsk (Russia) are also operated. Section III Page 16 Impact of international air service liberalization on Mongolia

29 international flights to Hailar in China. A year later in summer 2010, Eznis Airways started international services to Ulan-Ude in Russia. 31 Aero Mongolia was founded in The airline offers domestic and international services to 12 domestic destinations and four international destinations (Altai and Irkutsk in Russia, and Urumqi and Hohhot in China). 32 Figure 3-3: Domestic market airline shares in Mongolia (2010) Airline 2010 Domestic Passengers Passengers Market Share Eznis Airways 77,274 56% Aero Mongolia 59,273 43% MIAT 281 1% Total 136, % Source: Statistical Bulletin of the Mongolian Civil Aviation Authority. Major domestic destinations served from ULN include Oyutolgoi, Dalanzadgad, Khovd, Tavantolgoi, Ovoot, Ulgii, Murun and Ulaangom. Figure 3-4 shows the airline market shares in the international market. National carrier MIAT accounts for 50% of all traffic. Mongolia s other carriers, Eznis Airways and Aero Mongolia, account for about 2% of international traffic. The remaining international traffic is carried by foreign carriers such as Korean Air, Air China, Aeroflot, SCAT (Kazakhstan). Figure 3-4: International market airline shares in Mongolia (2010) Airline 2010 International Passengers Passengers Market Share MIAT 266,040 50% Korean Air 112,073 21% Air China 82,373 16% Aeroflot 49,539 9% Aero Mongolia 8,802 2% Eznis Airways 5,672 1% Other 4,476 1% Total 528, % Source: Statistical Bulletin of the Mongolian Civil Aviation Authority. Figure 3-5 shows passenger traffic on international routes to/from Mongolia in Seoul (South Korea) is largest international route, operated by MIAT and Korea Air, accounting for nearly 210,000 passengers or 40% of all international traffic. Beijing is the second largest route, followed by Moscow and Narita. These top four routes accounted for 92% of all international traffic in Eznis Airways website. 32 Aero Mongolia website. Impact of international air service liberalization on Mongolia Section III Page 17

30 Figure 3-5: Traffic on international routes to/from Mongolia (2010) Route (and Airlines Operating Route) 2010 International Passengers Passengers Market Share Seoul (MIAT, Korea Air) 209,901 40% Beijing (MIAT, Air China) 193,261 37% Moscow (MIAT, Aeroflot) 56,841 11% Narita (MIAT) 26,167 5% Berlin (MIAT) 16,028 3% Other China (Eznis, TianJin Airlines) 14,443 Other Japan (MIAT) 3,019 1% Other Russia (Eznis, Ural Airlines) 1,230 0% Other 8,085 2% Total 528, % Source: Statistical Bulletin of the Mongolian Civil Aviation Authority. 3.4 Origin and destination markets The passenger traffic figures in Figure 3-5 show the volumes of traffic on direct services operated to/from Mongolia. This does not necessarily represent the final origin/destination of the passengers. For example, some passengers flying to Moscow may be making onward connections to Europe. Similarly, some passengers from Seoul may have connected there and actually originated their trip in North America. Figure 3-6 presents the traffic figures in terms of the final origin/destination (O/D) country of the passengers. The figures are based on travel booking data. On an O/D basis, the largest markets remain those with direct service: South Korea, China, Japan, Russia, and Germany. The O/D passenger volumes for most of these countries were lower than the route volumes, indicating a significant degree of connecting traffic. For example, route traffic to/from Moscow totaled nearly 57,000, while the number of passengers starting or ending their journey was only 26,000. This suggests that approximately 31,000 of the passengers to/from Moscow were connecting (e.g., some of passengers may have been travelling to/from Europe). One exception to this is Japan: O/D volumes exceeded route volumes, suggesting some passengers to/from Japan were connecting elsewhere (most likely Seoul). In total, it is estimated that approximately one third of passengers to/from Mongolia were travelling via a connecting point. A notable unserved market is the U.S., which was the fourth largest O/D market despite the lack of direct service. Other significant unserved markets were in Europe and Asia. The analysis of the booking data also revealed the directionality of travel. Exactly two thirds of passengers were Mongolian residents travelling to and from other countries while one third were foreign visitors to Mongolia. 3% Section III Page 18 Impact of international air service liberalization on Mongolia

31 Figure 3-6: Top 10 origin/destination markets for Mongolia (2009) Country Passengers (Thousands) % of Total Passengers South Korea % China % Japan 48 9% U.S. 43 8% Russia 26 5% Germany 22 4% France 14 3% Italy 9 2% Czech Republic 9 2% UK 8 1% Other 72 14% Total % Source: Travelport Bookings Data and Mongolian Civil Aviation Authority. Note: Traffic figures are based on the final origin or destination of the air passenger, not their immediate connecting point. Figures may not sum up to the totals due to rounding. 3.5 International air service agreements signed by Mongolia The Government of Mongolia has executed bilateral air service agreements with over 30 foreign states. Figure 3-7 provides summary information on nine of those bilaterals. Country Finland Germany Hong Kong India Japan Russia Singapore Sweden Figure 3-7: Key Characteristics of the air service agreements in Mongolia Authorized Points Any Unknown Named Unknown Unknown Unknown Any Unknown Capacity Predetermina tion Predetermina tion Predetermina tion Predetermina tion Predetermina tion Predetermina tion Predetermina tion Predetermina tion UK Any Bermuda Source: ICAO World Air Services Agreement Database. Pricing Airline Designation Single Disapproval Dual/Multiple No Country of Origin Dual/Multiple No Single Disapproval Dual/Multiple No Single Disapproval Dual/Multiple No Single Disapproval Dual/Multiple No Single Disapproval Dual/Multiple No Double Disapproval Dual/Multiple Yes Country of Origin Dual/Multiple No Double Disapproval Dual/Multiple No Fifth Freedom Impact of international air service liberalization on Mongolia Section III Page 19

32 In general, the bilaterals to which Mongolia is a signatory are fairly restrictive in nature, with controls on capacity, pricing, airline designation and fifth freedom operations. It should be noted that governments typically require reciprocity when negotiating the terms of a bilateral. Therefore, it is possible that restrictions within bilaterals are not due to the policies of the Mongolian government but due to the policies of the opposite country. Figure 3-8 provides additional information on the specific capacity limits on the air service agreements with three major markets: China, South Korea, and Japan. The number of allowed flights per week is restricted for all three markets. The Korean market has a flight frequency limit of six flights per week. Since South Korea is Mongolia s top O/D market in terms of passenger numbers, these frequencies are fairly restrictive and regularly violated by giving special permission for additional flights during the summer peak season. 33 Figure 3-8: Capacity limits under bilateral air service agreements for top 3 O/D markets in Mongolia Country Korea Capacity Allowed (Flights per Week) 6 (special permissions for additional flights during summer) Seat Limit None (since 2003) China 28 (14 for Beijing) None Japan 5 (3 for Tokyo, 2 for Osaka) None Source: Bayarsaikhan S.: Case of International Air Transport Market Since 2008, Mongolia is also a signatory to the MALIAT agreement with Brunei, New Zealand, Singapore, Samoa, Cook Islands, Tonga and the United States but for cargo operations only. In 2009, Mongolia has also signed a horizontal agreement with the EU which, while not open skies, allows carriers greater freedom to operate between points in Mongolia and the EU Source: Bayarsaikhan S., Case of International Air Transport Market 34 A horizontal agreement is an agreement negotiated by the Commission on behalf of the Member States, in order to bring all existing bilateral air services agreements between Member States and a given third country in line with Community law. Section III Page 20 Impact of international air service liberalization on Mongolia

33 SECTION IV: THE ECONOMY OF MONGOLIA Mongolia is the second largest land locked country (after Kazakhstan), bordering China on the south and Russia on the north. The following sections provide an overview of Mongolia s historical economic situation and provide an outlook of Mongolia s economy. 4.1 Population The population of Mongolia has grown at a fairly constant rate over the last 20 years, averaging 1.4% per annum growth from 1990 to 2010 and reaching nearly 2.8 Million by the end of In 2009, 28% of the total population was under 15, 68% between years and 4% over 65 years. 36 Approximately 38% of the population lives in the capital city of Ulaanbaatar. 37 Mongolia s population density is one of the lowest in the world with 1.7 persons per square kilometer. 38 The International Monetary Fund predicts a steady annual population growth of 1.5% over the next five years. 4.2 Economic growth Figure 4-1 shows Mongolia s real GDP growth rates for 2003 to The Mongolian economy has grown strongly since 2003, with growth rates reaching as high as 10.6%. The economy contracted by 1.3% in 2009 (due in part to global economic conditions) but recovered to 6.1% growth in Between 2003 and 2010, the economy averaged 7.5% per annum growth. The economic growth outlook for Mongolia is favorable. IMF economists also predict strong growth for Mongolia with an average annual growth rate of nearly 13% up to Solid and growing investments across the mining sector and other sectors, significant increases in government expenditures, positive outlook for commodity prices, growing export values driven by strong international demand and growth in personal income supported by domestic and foreign capital investment can be considered as primary economic growth drivers for Mongolia. The World Bank classifies Mongolia as a lower-middle-income economy. In 2010, its estimated GDP per capita was US$ 3,300 at Purchasing Power Parity (or PPP, which allows for cost of living differences). 40 This puts Mongolia at similar level to India, Vietnam and Uzbekistan but only 45% the income level of China and 7% that of the United States. 35 National Statistical Office of Mongolia ( and International Monetary Fund, World Economic Outlook Database, October WHO country health information profiles: Mongolia. 37 Transportation Statistics Report of Mongolia, March WHO Country Health Information Profiles: Mongolia Outlook, January International Monetary Fund, World Economic Outlook Database, October CIA World Factbook.

34 12% Figure 4-1: Mongolia annual real GDP growth rates ( ) 10% Real GDP Annual Growth Rate 8% 6% 4% 7.0% 10.6% 7.2% 8.6% 10.2% 8.9% 6.1% 2% 0% % (Estimate) -2% Source: National Statistical Office of Mongolia ( 4.3 Major economic sectors Figure 4-2 provides a breakdown of national GDP by major sector. As can be seen, the mining and quarrying sector is the largest in the Mongolia economy (accounting for 18% of GDP). The mining sector has also been a major engine of growth for the Mongolian economy, growing by 17% per annum, more than double the rate of the overall economy. The second largest sector is agriculture, forestry, and fishing, accounting for 16% of the economy. This sector share of the economy has been declining as the economy has developed: in 2004, this sector accounted for 25% of national GDP. The transportation and storage sector contributed approximately 12% to Mongolia s total GDP. Air liberalization will likely increase the GDP contribution of this sector. The accommodation and food service activities division, which currently accounts for less than 1% of GDP, will also benefit from liberalizing the Mongolian air market through increased tourism. Section IV Page 22 Impact of international air service liberalization on Mongolia

35 Figure 4-2: GDP contribution by division (2010) Electricity, gas, steam and air conditioning supply 3% Education 3% Information and communication 4% Financial and insurance activities 2% Other 8% Mining and quarrying 18% Real estate activities 5% Manufacturing 6% Agriculture, forestry and fishing 16% Wholesale and retail trade; repair of motor vehicles and motorcycles 8% Transportation and storage 12% Source: Mongolia Bulletin of Statistics, Dec 2010 Net taxes on products 15% 4.4 Exports and imports Figure 4-3 illustrates Mongolian exports and imports over the last ten years in terms of value. Both exports and imports have grown strongly over the last ten years, at annual average growth rates of 18.3% for imports and exports combined. However, the global economic recession in 2008/09 hit Mongolian trade hard with combined exports and imports declining by 30%. However, trade recovered by 54% in China is Mongolia s greatest export market, accounting for 85% of all exported products in Russia was Mongolia s greatest import market (38% of total imports), followed by China (27% of total imports). 41 China is Mongolia s largest overall trading partner, accounting for 44% of combined imports and exports, followed by Russia (27%), Japan (5%), Korea (4%), and the United States (3%). 42 Mineral products are the largest trade group, accounting for 60% of exports and 30% of imports. 41 National Statistical Office of Mongolia 42 Ibid. Impact of international air service liberalization on Mongolia Section IV Page 23

36 Figure 4-3: Exports and imports Mongolia ( ) 3.5 Export Imports 3.0 Exports and Imports ($US Millions) Source: Mongolia Bulletin of Statistics, Dec 2010 and National Statistical Office of Mongolia, Main Statistical Indicators 4.5 Tourism Tourism is a relatively new economic sector with potential to grow substantially. Figure 4-4 shows the total number of visitors to Mongolia since Over the last 10 years, international visitor traffic to Mongolia has increased by an average of 13.4% per annum, reaching 557,414 in These figures are for visitor arrivals by all modes (i.e., ground and air). Based on the O/D traffic data described in Section 3.4, it is estimated that 17% of visitors arrive by air. Section IV Page 24 Impact of international air service liberalization on Mongolia

37 Figure 4-4: Inbound visitors to Mongolia ( ) Total Visitors (Thousands) Source: Mongolian National Tourism Center 2010 and Mongolia Bulletin of Statistics, Dec 2010 Figure 4-5 provides a breakdown of visitors to Mongolia by source country. China accounted for over half (52%) of all visitors in 2010, while Russia accounted for 23%. These two neighboring countries accounted for three quarters of all visitors in South Korea is the third largest source market (8%), followed by Japan (3%) and the United States (2%). Figure 4-5: Proportion of inbound visitors by country (2010) France 1% Germany 1% USA 2% Japan 3% Other 10% South Korea 8% China 52% Russia 23% Source: Mongolia Bulletin of Statistics, Dec 2010 Impact of international air service liberalization on Mongolia Section IV Page 25

38

39 SECTION V: RECOMMENDATIONS FOR THE LIBERALIZATION OF MONGOLIA 5.1 Issues and approaches for Mongolia Section of this report outlines the impact of liberalization of air services in emerging economies and demonstrates the positive impacts of liberalization under almost all circumstances. InterVISTAS modeling and prior liberalization examples demonstrate that opening the Mongolian market would produce a rapid increase in passenger and cargo traffic. However, the current government policy in Mongolia must balance the need to stimulate additional traffic, with all the economic benefits that such stimulation entails, with a policy of improving the competitive position of MIAT, the national flag carrier, and its private national careers to prepare them for more open competition in a liberalized market. There is unmet demand for air services into Mongolia, particularly during the busy spring and summer seasons, but improving the competitive position of MIAT and other national carriers is also a critical factor. Liberalization of air markets has produced positive results for flag carriers in the past (e.g., Dubai, Singapore, and others). However, many of these examples represent strong national carriers with significant fleets and assets to engage in, and endure, strong competition. Other national flag carriers have failed (or suffered significant losses) when faced with opening of markets (e.g. Sabena, Alitalia, Olympic, Air Jamaica). If the survival and future development of MIAT remains a national priority, the government of Mongolia must adopt a stepped, measured approach to both strengthening MIAT as a viable entity, while still moving toward a liberalized air service policy that will provide economic benefits to the entire Mongolian economy. Mongolia represents a relatively unique situation, because of a number of factors: As a landlocked nation, Mongolia is particularly dependent upon air transportation, both domestically and internationally; Mongolia possesses a relatively small national population dispersed over a large geographic area; Dramatic economic growth has stimulated demand for air services to and from Mongolia Seasonal air service demand (summer) is particularly high, with dramatic drop in demand during the autumn and winter seasons; and Internal destinations, which are keys to growth, are remote, and many domestic airports will require major upgrades (ILS, paving runways, etc.) MIAT, the national flag carrier, could be in a precarious position with increased competition, as it is not presently structured to compete in an open environment against the major carriers from Mongolia s bilateral markets (particularly China, Korea, and Russia). The carriers flying into Mongolia have vast fleets, larger capacity aircraft, and significant economic resources (including broad air carrier networks and alliances) from which to draw. Although MIAT has announced plans for eventual fleet expansion, intending to double its fleet from three to six aircraft, this expansion could be four to six years in the future. It is also critical that the Government of Mongolia recognize the investments made and committed by the privately owned national carriers and support a policy to encourage them to expand their services internationally. While strengthening MIAT, a strong policy to support privately owned Mongolian carriers must be put in place to allow them to offer international route services and compete in a liberalized market along with MIAT.

40 Eznis and Aero Mongolia, the major privately owned domestic carriers, are poised for growth and have recently made major commitments to step up their capabilities with a plan of further investments into their operations. The potential for growth of domestic air services is high, particularly to the west and south of the country. Eznis is adding two Avro RJ85 aircraft to its fleet, while Aero Mongolia is planning to add either a B737 or A320 to its fleet of Fokker F50 aircraft. Both airlines are building maintenance facilities to increase their in-house maintenance and engineering capabilities in preparation for their fleet expansion. With this expansion of their fleets, both carriers will be ready to add additional international routes and will likely fully support liberalization. The government policy at this time appears to be somewhat cautious, keeping existing bilateral constraints in place, particularly with regard to Korea and China. Given its significant potential impact, the government is apparently willing to consider liberalization, but only on an incremental basis, as MIAT strengthens through fleet expansion, corporate restructuring and building up of cash reserves. The following section proposes one path toward liberalization that could, if implemented successfully, address both of these concerns. 5.2 Scenario for liberalization in Mongolia Ultimately, full liberalization (i.e., open skies ) will have the greatest positive economic impact on Mongolia. But, as discussed above, there are political and economic realities that will likely prevent full liberalization from being adopted immediately. Primarily, current government policy is focused on strengthening MIAT to be more competitive and to have an adequate fleet to supply the required capacity in a more competitive market. Therefore, immediate adoption of full liberalization ( open skies ) may not be either practical or desired. Nonetheless, maintaining the status quo for air services results in the withholding of significant economic benefits for the citizens of Mongolia. There is a middle road between the presently restricted markets and open skies, however. Capacity, frequency, and designation changes short of full open skies can be examined in selected markets to ease current bottlenecks and permit some growth of the market with positive impact on Mongolian economy and Mongolian aviation. In the long run, the government must find a method to strengthen MIAT in preparation for a broad opening of air service markets, while reaping the benefits of increased air traffic into and out of Mongolia. The following steps provide a potential outline for meeting important government objectives in the long-term, while furthering the growth of Mongolian air markets and national economy in both the short- and medium-term: 1. Establish target. The first step would be to evaluate the benefits of liberalization (using this study and others) and then to establish a target for a level of deregulation/liberalization, taking into account effects to tourism, the national economy, and the overall aviation industry. Thus, the government would set a goal for limited or full air service liberalization and establish an initial target date to implement the necessary policy changes to meet that target. 2. Establish conditions for liberalization. The second step would be to examine the policy and regulatory framework that governs international air services to ensure that there are no impediments to the liberalization of air services and then to establish the conditions necessary to achieve liberalization. An initial review of the legal and regulatory framework indicates that there are presently no major legal impediments to liberalization. Once a policy is established to move toward liberalization, the Section V Page 28 Impact of international air service liberalization on Mongolia

41 government must establish the required conditions for full deregulation, including ensuring a level of readiness and expectations from all parties, including the Ministry, MCAA and the air carriers. This will require a cooperative atmosphere among the parties and a willingness to commit to (at this stage) a broad timeline towards achieving the goal of air service liberalization. 3. Strengthening of MIAT. Although the specific circumstances of MIAT are beyond the scope of this study, it is readily apparent that MIAT must be strengthened to become a strong, economically viable international air carrier. Because of MIAT s size in relation to its competitors in international markets, there is justifiable trepidation regarding MIAT s capabilities at this time to withstand strong competition in some markets. In this step, the government would work to improve the ability of MIAT to compete in a more liberalized market. This would include a comprehensive review of potential marketing and strategic alliances, development of updated route and fleet optimization plans, completing a competitive service offering review and analysis of performance improvement options. 4. Strengthening of privately owned national carriers. While MIAT is being prepared for an increasingly competitive environment, particularly on Beijing and Seoul routes, the government must encourage domestic privately owned carriers to develop other international routes and augment Mongolia s capacity to compete with foreign carriers. This can be done by allowing the private carriers to serve destinations that are not of high priority for MIAT. Also, during peak seasons or when there is a capacity constraint on routes served by MIAT, the private carriers can be asked to provide services on those routes. In order to foster further investment and expansion of their capabilities, the government must consider reallocations of existing unused or underutilized designations based on private carriers willingness and technical capabilities to service those routes. 5. Development of liberalization strategy. This step involves the determination of interim steps for gradual liberalization, and the development of a clear negotiation strategy for discussions with Mongolian air service bilateral partners. In developing this strategy, the government must take a holistic approach, examining the impact of liberalization on the entire Mongolian economy and on its air carriers, including MIAT, Eznis and Aero Mongolia. Existing bilaterals should be examined for opportunities to explore limited or gradual increases in capacity and frequency and, where, appropriate, carrier designations. In addition, Mongolia should examine opportunities for new bilateral or multilateral relationships that could provide opportunities for its carriers and for potential positive impact on Mongolian air services and the economy as a whole. Upon agreement of a negotiation strategy, the government can make initial inquiries with its aviation partners regarding receptiveness to limited changes in bilaterals as it explores a path to more complete liberalization. 6. Implement limited liberalization. Once long-range targets and polices have been established and a plan for the strengthening of MIAT is developed, the government should examine the possibility of negotiating limited increases in frequency and capacity in particularly constrained markets such as South Korea and China. As noted above and throughout this report, liberalization will produce a significant positive impact on the Mongolian economy, creating additional jobs in multiple sectors and increasing travel options for Mongolian citizens and visitors from abroad. With a viable plan in place for ensuring the viability of the national flag carrier, the government should examine limited liberalization steps that could be taken to Impact of international air service liberalization on Mongolia Section V Page 29

42 immediately provide a positive impact on the Mongolian economy and to also permit the continued dynamic growth of private air carrier operations by Aero Mongolia, Eznis, and others. Options for increased frequencies, capacity or designations have the potential for immediate and significant impact on Mongolian tourism, the national economy, and job creation and can be undertaken in a way that is consistent with broad government policies and without harm to the national flag carrier. 7. Synchronization of market liberalization. The government should consider adopting a synchronized, measured approach to opening some markets with milestones or implementation schedules that coincide with positive developments in reorganizing MIAT and with the growing capabilities of other Mongolian carriers. Thus, the agreement of additional capacity or frequencies among bilateral partners could be implemented to ensure fairness on all sides, such as adding frequencies when Mongolian carriers add to their fleets and are capable of providing lift similar to that of the airlines of Mongolia s bilateral partners. 8. Examination of domestic market. At the same time the government begins to open the air service market to additional passengers and cargo, a study should be undertaken to review domestic lift capabilities with the goal of ensuring that Mongolian citizens in all geographic regions of the country have reasonable access to air services. Essential air service or other subsidization plans ensure both regular and emergency access to air transport. As the number of international passengers coming into Mongolia increases, it will be critical to strengthen and ensure the growth of domestic services during transition period to full liberalization. 9. Address aviation fuel price issues. One factor that keeps airfares at an expensive level is the cost of aviation fuel in Mongolia. While there may be reasons for high fuel prices in Mongolia (shipment expenses, lack of refinement nearby refinement capabilities, etc.), Mongolia has a reputation for having one of the highest costs for aviation fuel in the world. If Mongolian carriers are to be competitive with other carriers in the region, they need access to reasonably priced aviation fuel, at least at a price level similar to that enjoyed by their competitors. As part of a comprehensive strategy to develop air services throughout Mongolia, the issue of aviation fuel pricing must be addressed. While fuel costs may eventually decrease over time as the fuel distribution infrastructure in Mongolia matures, access to market-priced aviation fuel is critical to the competitiveness of Mongolian carriers and to increasing the access to air services for all Mongolian citizens that lower airfares will provide. It is recommended that the government undertake study of fuel costs and procurement systems to develop the necessary policies and tactics to reduce these costs to air carriers. 10. Adherence to the liberalization plan. The critical factor in the success of any plan to liberalize Mongolia s air services will be the adherence to the milestones, schedules and programs adopted under such a plan. While the basic elements of a program to move toward liberalization are highlighted here, the government will need to ensure that programs and plans remain on an agreed schedule so that Mongolia can begin to reap the benefits of liberalization, even on a limited basis, as quickly as possible. This will require initial agreement from all parties involved, including the affected air carriers, and consistent and continual oversight of the process. Section V Page 30 Impact of international air service liberalization on Mongolia

43 SECTION VI: IMPACT OF LIBERALIZATION ON AIR TRAFFIC IN MONGOLIA This chapter provides a summary of the estimated traffic impacts resulting from liberalization of Mongolia s bilaterals with other countries. These impacts were estimated using a gravity model described in Section 6.2 below. 6.1 Defining the scenario The analysis assumes that Mongolia moves to an open skies regimes for all of its significant bilateral agreements, so that the bilaterals allow airlines from either country to operate any route between the two countries without restriction on capacity, frequency or price and with the ability to operate fifth freedom services and enter into code share arrangements. It is assumed that in pursuing open skies bilaterals, Mongolia receives reciprocity with the other country to allow the open skies to operate freely in both directions. Furthermore, the analysis does not allow for any other potential constraints on air service development such as onerous visa requirements or infrastructure limitations (e.g., lack of airport or air navigation capacity). It should be recognized that this represents an extreme and idealized scenario. In reality, it may not be possible or desirable to convert all of Mongolia s bilaterals to an open skies format. Furthermore, any attempt at liberalization may occur gradually at a pace that minimizes disruption to the market. Nevertheless, the analysis in this chapter and chapter 7 provide an estimate of the full traffic and economic potential that could arise from liberalization. The impacts presented are the long term impacts manifesting 2-3 years after liberalization is enacted. The impacts are those arising purely from liberalization, and are in isolation to other factors that may impact traffic volumes, such as general economic growth or infrastructure development Modeling the impact of liberalization The impacts of liberalization of the Mongolian international air market were estimated using a gravity model which forecast traffic between any two countries based on the economic characteristics of the two countries, trade levels between the two countries, their geographic relationship and the characteristics of the bilateral between the two countries as illustrated below: Country i Mongolia Traffic i = F(GDP i, Trade i, Intervening i, BilateralFactors(0,1) i ) Where: 43 The impacts are provided relative to current (2010) traffic levels. The projections were generated under the assumption of ceteris paribus. In other words, the only difference between current traffic levels and the travel levels projected by the model is the impact of liberalization. GDP, trade and other factors are kept constant.

44 Traffic i is the total Origin/Destination (O/D) passenger traffic between Mongolia and country i in both directions. GDP i is the product of the GDP of Mongolia and the other country i, capturing their economic size (i.e., Mongolia is more likely to have higher air traffic volumes with larger countries economically, as else being equal). Trade i is an estimate of the total amount of trade between Mongolia and the other country (i.e., the higher the amount of trade with another country, the higher the potential air traffic volumes, all else being equal). Intervening i captures the intervening opportunities for closer travel than between Mongolia and the other country. Traffic between two countries was found to be less if there were opportunities for travel to closer countries. The intervening variable is calculated as an index of the sum of GDPs of every country that is 10% or less distant than the distance between Mongolia and country i. In other words, air traffic volumes are likely to be higher from nearby countries than from more distant ones, all else being equal. BilateralFactors(0,1) i are dummy variables capturing the presence or absence of a specific restrictions on the bilateral. For example, if the bilateral allows flights only to named points then the dummy variable takes the value 1 or else, if carriers are unrestricted in the airports/cities they can fly to, the dummy variable takes the value 0. The dummy variables also have modifiers to reflect the circumstances of the individual bilateral. For example, the named points dummy is multiplied by a variable derived from the product of the geographic area of the two countries. This captures the fact that liberalizing this term will have minimal impact on geographically small island nations with only one major airport than on large countries with multiple airports. The gravity model was developed and calibrated as part of a previous study by the InterVISTAS group. 44 Its parameters were estimated using traffic, economic and bilateral data from over 800 country pairs with varying degrees of liberalization. Further details on the model can be found in Annex B. The impacts of liberalization were estimated by specifying changes to the terms of the bilateral, e.g., the BilateralFactors(0,1) dummies were switched from one (1) to zero (0), where relevant, on each bilateral agreement. The gravity model then calculated the growth in international traffic stimulated by this change. In estimating the traffic, the model takes account of the fact that liberalization is a necessary but not a sufficient condition for traffic growth. No new services will result if there is no underlying demand to support them. The model therefore examines the air services already operating between each country-pair (the model contains up-to-date information on services to/from Mongolia from OAG schedule data). If any such flights already operate, it is assumed that capacity can expand to accommodate demand. If no such flights exist, the model algorithm determines the aircraft most appropriate for a route of that length. If the traffic available is insufficient to support a reasonable level of service, the model assumes that no direct service will arise. The model then examines the bilateral agreement to ascertain if fifth freedom rights are available. If so, it then allocates the traffic to an appropriate indirect service, reducing the estimated traffic due to the undesirability of the indirect service. If no fifth freedom rights are available, then the model assumes that there will be no increase in traffic level despite the liberalization of the bilateral. 44 The results of that study can be found in the report, The Economic Impact of Air Service Liberalization, InterVISTAS-ga 2, June Section VI Page 32 Impact of international air service liberalization on Mongolia

45 To undertake the analysis in this report, the model was fully updated using 2009 traffic and economic data (the most recent available on a global basis) Traffic impacts of liberalization The following subsections examine the impact of liberalization on passenger traffic level, air cargo volumes and fare (cost of service) Impacts on passenger traffic Based on the gravity model described above, the projected increase in international traffic resulting from liberalization is summarized in Figure 6-1 represents the long-term impact manifesting 2-3 years after liberalization is enacted. Liberalization of Mongolia s air service bilaterals is estimated to increase international traffic to/from Mongolia by 595,000 annual passengers, an increase of 112% relative to 2010 traffic levels of 528,975. Figure 6-2 shows the traffic increases stimulated by liberalization, broken down by market. The largest estimated increase is traffic to/from China, which is forecast to increase by 184,000 annual passengers, a 138% increase over 2010 levels. In part, this is driven by Mongolia s strong trade relationship with China: 44% of Mongolia s total trade is with China. 46 Traffic to/from Asia accounts for nearly two thirds (65%) of the total projected increase in traffic (China, South Korea, and Other Asia). Many of these Asian markets (notably China) are projected to achieve high levels of economic growth in the next decade. For example, the IMF Economic Outlook October 2010 forecast average economic growth for Developing Asia of 8.5% per annum up to 2015, compared with 2.6% per annum for the U.S. and 1.7% per annum for the Euro area. 47 Increase air services and air traffic to/from these countries will support Mongolia further leveraging its own growth through better ties with other emerging economies. At the same time, liberalization will also stimulate air service to large, established markets such as Europe and North America. 45 The economic data was sourced from the World Bank s World Development Indicators. The traffic (and fare) data was sourced from Travelport Bookings Data. 46 Source: National Statistical Office ( Figure based on 2008 import and export data Impact of international air service liberalization on Mongolia Section VI Page 33

46 Figure 6-1: Passenger traffic impact of liberalization 1,200 1,124 1,000 International Passenger Traffic (Thousands) (+112%) Current Traffic (2010) After Liberalization Figure 6-2: Traffic impact of liberalization by market Market Traffic Increase (Thousands) Percentage Increase Share of Total Increase China % 31% South Korea % 21% Other Asia % 14% Russia % 5% Europe/Middle East % 14% North America % 14% Other 7 +41% 1% Total % 100% Impacts on air cargo Liberalization can have significant implications for air cargo. Many bilateral agreements have liberalized provisions for all-cargo services, including seventh freedom rights. All-cargo services are sometimes used as a means to test the consequences of liberalization before extending the process to include passenger services. The characteristics of air freight differ greatly from passenger traffic: Section VI Page 34 Impact of international air service liberalization on Mongolia

47 Air freight is very heterogeneous: it can include documents, machinery, foodstuffs, live animals and literally anything else that people wish to ship. Air freight shipments range greatly in size, from single-page documents to huge movements requiring charter of several wide body all-cargo aircraft. Air cargo can exhibit severe directional imbalances. In general, air passenger flows tend to directionally balance nearly all passengers who fly from a country return back to that country (and most on the same route). By contrast, air cargo can exhibit strong flows in one direction (e.g., exports from one country to another) which are not necessarily matched in the opposite direction (e.g., there are limited imports from the same country). This imbalance has major implications for capacity management and pricing (e.g., freight rates for the weak directional flow can be very low). The means of transport can differ: some freight is carried on dedicated freighter aircraft while significant volumes of freight are also carried in the bellyhold of passenger aircraft (that remaining after luggage requirements). 48 In very direct way, development of air cargo services to/from Mongolia will play a key supporting role in developing Mongolia s trade and its overall economic development. Section 2.4 discusses a number of papers that have established air cargo s role in the development of trade and the economy. Air cargo is particularly important for Mongolia given that the country is landlocked and currently has limited rail and road infrastructure in the country. 49 Estimates of the cargo volumes to/from Mongolia stimulated by liberalization have been estimated using the following information: A calculation of the bellyhold capacity provided on the additional air services stimulated by liberalization of passenger services. 50 It is assumed that air carriers will price this bellyhold capacity to achieve a 60% average load factor. Section summarized a paper by Micco and Serebrisky (2004), which estimated that full liberalization (quality of regulation plus open skies) could reduce freight rates by up to 22%. An assumed air fare elasticity of -1.5 was used to estimate the consequent change in freight quantity. 51 The projected increase in air cargo volumes is provided in Figure 6-3. Air cargo volumes are projected to increase from 3,428 (metric) tons to 5,555 tons, an increase of 2,127 tons or 62% relative to 2009 volumes Combi aircraft can also be used, which allow a mixed use of passenger and cargo capacity, although use of these aircraft is on the decline due to safety and economic reasons. 49 Mongolia s main rail corridor is the Trans-Mongolian Railway running from Russia through Ulaanbaatar into China. In total, Mongolia has 1,908 kms of railway track, of which the Trans-Mongolian Railway accounts for 1,110 kms (Source: CIA World Factbook). In addition, Mongolia has 3,015 kms of paved roads and 46,234 kms of unpaved roads (Source: CIA World Factbook). 50 Based on the capacity available after allowing for passenger s luggage requirements. 51 Fare elasticity measure s consumers sensitivity to fare price changes for a particular good or service. As the fare increases, the quantity demanded (e.g., the volume of freight transported) is expected to decline and vice versa. Since the quantity demanded generally decreases when the fare increases, this ratio is usually expected to be negative. Air freight has been found to be particularly price sensitive (in this case, a 10% decline in price is expected to result in a 15% in freight demand). For example, see: D. Gillen, W.G. Morrison and Stewart, C. (2002), Air Travel Demand Elasticities: Concepts, Issues and Measurement, October The increase in freight volumes is shown relative to 2009 levels as 2010 data was not available. Impact of international air service liberalization on Mongolia Section VI Page 35

48 Figure 6-3: Impact of liberalization on air cargo 6,000 5,555 International Air Cargo Traffic (Metric Tonnes) 5,000 4,000 3,000 2,000 3,428 2,127 (+62%) 1,000 0 Current Traffic (2009) After Liberalization Impacts on pricing The fare reductions were estimated on the basis that much of the traffic stimulation is due to fare reductions. This assumption is supported by the research reviewed in Section 2.3 which found that liberalization generally results in significant reductions in air fares. In estimating the fare reduction, it was assumed that on country-pairs which already have direct service prior to liberalization, all of the traffic stimulation is attributable to the fare reductions; while on country pairs that did not currently have direct service, two thirds of the traffic increase is attributable to fare reductions (thus, one third is attributable to improved service levels direct service, increased frequency, etc.). As such, the fare reduction was calculated as follows: Country Pairs Already With Direct Service % Fare Reduction i = (1 + % Traffic Increase i ) ^ Fare Elasticity i - 1 Country Pairs With No Prior Direct Service % Fare Reduction i = (1 + 2/3 x % Traffic Increase i ) ^ Fare Elasticity i - 1 Information or data on fare elasticities specific to the Mongolian market were not available. Instead, the fare elasticities were taken from an IATA study which provides fare elasticities for different geographic markets. 53 For example, IATA elasticities were available for Asia- Europe, for Asia-North America traffic, and so on. The most applicable elasticity from IATA report was selected for each country pair. Typically, these elasticities ranged from -0.8 to The estimated impact on passenger fares is summarized in Figure 6-4. It is projected that liberalization will reduce passenger air fares by an average of 42%. This is in line with 53 Estimating Air Travel Elasticities, An InterVISTAS Consulting Inc. report for IATA, December Section VI Page 36 Impact of international air service liberalization on Mongolia

49 experiences elsewhere: a study on the liberalization of the EU aviation market found fare reductions averaging 34%. 54 Assuming full liberalization and based on the traffic increases described earlier, the total fare savings across all Mongolian air passengers on international flights is estimated to be US$ 121 Million (MNT Billion). 55 Figure 6-4: Passenger fare impact and total fare savings from liberalization % Reduction in Average Fare Total Fare Savings for Mongolians (MNT) Total Fare Savings for Mongolians (US$) Liberalization 42% Billion 121 Million Impact All financial figures are in 2010 prices. As noted in the previous section, previous research indicates that liberalization can result in air freight rates declining by up to 22%. It anticipated that freight rates to/from Mongolia will decline by a similar proportion if open skies liberalization is undertaken. 6.4 Secondary impacts on the domestic air services Domestic traffic totaled 136,828 passengers in 2010, with Eznis Airways and Aero Mongolia operating the vast majority of Mongolia s domestic services. While this study does not consider further liberalization of the domestic market, it is anticipated that liberalization of international service will have an impact on domestic traffic volumes. Some of the incremental passengers will likely connect with domestic services in order to start or complete their journey in areas of Mongolia away from Ulaanbaatar. 56 In particular, there is expected to be demand for service to/from mining regions in the South and tourist attractions around the country. Information was not available on the current proportion of international passengers connecting onto domestic services. Anecdotal information indicates that most tourists to Mongolia use local tour operators to make arrangements for travel within the country, including booking domestic flights as part of the tour package. As these passengers are in essence self-connecting (the domestic carriers do not have interline agreement with any of the international carriers), it is very difficult to track their connections. Instead, the impact on the domestic market has been assessed using scenario analysis. Based on experience in other markets and expert judgment, it is assumed that between 10% and 20% of the incremental international passengers would connect onto domestic services. Based on this assumption, it was possible to estimate the impact on the domestic market, as summarized in Figure 6-5. If 10% of international passengers connect on domestic services, this would produce a 43% increase in domestic traffic. If 20%, the growth in domestic traffic is 87%. It is 54 European Experience of Air Transport Liberalisation, Joint Presentation by the European Union and the European Civil Aviation Conference to the 5th Worldwide Air Transport Conference (ICAO), 24-29th March Parts of the EU market had already been liberalized by individual members states prior to the EU s full liberalization. For example, the UK and the Netherlands had already signed an open skies agreement. As a result, the impact of EU liberalization are lower than those of Mongolia. 55 The total fare savings are for Mongolian air passengers only and do not include the fare savings for foreign visitors to Mongolia. Foreign visitors are also expected to benefit from lower fare levels. 56 It is anticipated that virtually all the additional international services will be still utilize ULN. Impact of international air service liberalization on Mongolia Section VI Page 37

50 clear from this analysis that liberalization of the international air services could have major impacts for the Mongolian domestic market. Figure 6-5: Secondary impact on domestic passenger traffic Assumed % of Connecting International Passengers Additional Domestic Passenger Traffic Growth in Domestic Market* 10% 59, % 20% 119, % * Relative to 2010 traffic levels. 6.5 Overview of the investment requirements Figure 6-6: The Mongolian Airport Network Airport infrastructure Chinggis Khaan International Airport ( ULN ), 18 km southwest of the capital is the international airport serving Ulaanbaatar. ULN serves the main base of operations for MIAT Mongolian Airlines, Eznis Airways and Aero Mongolia and is the primary hub from which Aero Mongolia and Eznis serve the other airports in Mongolia. The airport was originally built in 1961, and the passenger terminal was upgraded in Between 1994 and 1997 a further major upgrade was undertaken with funding from the Asian Development Bank. Unfortunately, the airport possesses only one runway, with directional restrictions on takeoffs and landings. This makes the airport a unreliable facility during adverse wind and weather conditions. The terminal building is a modern and efficient design, but only has the capacity for approximately 600,000 passengers per year. Section VI Page 38 Impact of international air service liberalization on Mongolia

51 The construction of the new airport in Ulaanbaatar is a key priority for the government. It is also a critical element of a strategy to increase air services, as the present airport is limited in its capacity and weather conditions, as noted above. The new airport is listed in the National Development Strategy for , along with the further development of aviation infrastructure and developing the competitiveness of the Mongolian aviation subsector. The new airport, designed to completely replace, not supplement, ULN, will be located 54 km outside of Ulaanbaatar, in the Khoshigt Valley, and will be designed to accommodate up to 1.6 million passengers per year. Perhaps most importantly, the new airport will enable bidirectional landings and take-offs, which the existing airport cannot provide because of its topography. In addition to the main airport facility that will be designed with capacity for 1.6 million passengers per year, other components may include (i) multiple runways; (ii) improvements to the air navigation system to allow for improved airspace safety and overflights; and (iii) a newly constructed paved road linking Ulaanbaatar to the new airport location. If construction begins as planned in 2012, completion of the new facility is expected in This new Ulaanbaatar airport project is being partially financed by a US$280 million equivalent loan from the Japan Bank for International Cooperation. However, estimates of the total cost for construction of the airports, ancillary facilities and linking highway are closer to US$500 million. Because Ulaanbaatar will remain the focal point of all international traffic to and from Mongolia, the modernization and construction of facilities at the new Ulaanbaatar airport will be the critical component of an investment strategy to increase air capacity. However, economic growth is being driven by mining activities and tourist traffic to other parts of the country. For this reason, the domestic airport network must also be examined as an investment target. To facilitate both mining operations and tourism in the south, a new airport at Oyu Tolgoi in the South Gobi region is being completed, enabling operations of B737 and A320-sized aircraft. This will also permit an increase in flight frequency to the region of up to 20 daily flights, from the present 2 or 3. Modernization of the other airports will also be an important factor in increasing capacity of the domestic aviation system. Earlier EBRD and ADB studies have identified improvements to be made at the other airports in the system (see Figure 6-6), but cost figures for the required investments were not available. One figure given during interviews was that each domestic airport would require an average investment of US$8.5 million for runway improvements and the upgrading of radar and air navigation services, or a total of approximately US$145 million for basic upgrades. This figure will vary widely in application, however. Of the 18 airports in Mongolia with ICAO identifier codes, a majority do not have asphalt or concrete runways, with most consisting of grass or gravel airstrips, averaging about 1,800m in length. Only limited types of commercial aircraft can operate on unpaved runways, generally including smaller turboprop aircraft and the Avro RJ85 aircraft being acquired by Eznis Airways. The critical factor for investment in international traffic growth, which is the focus of this study, will be completion of the new airport for Ulaanbaatar. Enabling all-weather operations, the airport will eliminate another potential constricting factor in air service expansion, easily accommodate the forecast traffic growth and permit a broader range of scheduling options for Mongolian and international carriers. Impact of international air service liberalization on Mongolia Section VI Page 39

52 6.5.2 Air carrier equipment MIAT operates a fleet a one Airbus A series aircraft and two Boeing series planes. MIAT has indicated that it intends to double its fleet by 2017 with the addition of three additional aircraft. A specific timetable has not been determined, but is one of the factors that must be taken into consideration when examining a phased approach to liberalization that permits MIAT to compete with air carriers from, inter alia, China, Korea and Russia. From the traffic growth projected in this report, it appears that this schedule would not keep pace with projected growth and could be a limiting factor in a liberalization initiative. Eznis Airways presently operates four 34-seat Saab 340B aircraft on its route network, operating to 14 domestic scheduled and charter destinations as well as two short-haul international markets - Hailar (China) and Ulan-Ude (Russia). Eznis has signed a Letter of Intent (LOI) to purchase two Avro RJ 85 regional jets from BAE Systems. The aircraft, scheduled for delivery in May and June 2011, will each have a capacity of 93 seats and a range of approximately 2,900 km. The Avro RJ 85 is a four-engine aircraft and is the only jet engine aircraft approved for operation on gravel runways, which will provide the first jet services to Mongolian airfields that do not possess paved runways. Eznis has furthermore indicated a willingness to procure additional aircraft to meet demonstrated market demand. Aero Mongolia presently maintains a fleet of three Fokker F50 aircraft, a twin turboprop aircraft with a capacity of up to 58 passengers and a range of approximately 2,000 km and one Fokker 100, a twin turbofan aircraft with 100 seats and a range of approximately 2,400 km. It operates to seven destinations in Mongolia (including ULN) and to Altai and Irkutsk in Russia and Huh Hot and Urumqi in China. Aero Mongolia has demonstrated a willingness to meet market demand with the acquisition of additional aircraft and has recently discussed the addition of a 737 aircraft in Section VI Page 40 Impact of international air service liberalization on Mongolia

53 SECTION VII: ECONOMIC IMPACT OF LIBERALIZATION The increase in air service and traffic is forecast to stimulate employment and economic growth in a number of ways: Aviation Sector: additional economic activity in the aviation sector is generated by the servicing, management, and maintenance of the additional air services. Tourism Sector: air service facilitates the arrival of larger numbers of tourists to a country; this includes business as well as leisure tourists. The spending of these tourists can support a wide range of tourism related businesses: hotels, restaurants, theatres, car rentals, etc. Catalytic Impacts: includes the role of air transportation in facilitating growth and productivity in the general economy by increased trade, business activity and greater personal productivity. The following sections describe the potential economic impacts for Mongolia as a result of air service liberalization. 7.1 Impact on tourism In 2010, a total of 557,414 international visitors arrived in Mongolia. 57 In 2010, these visitors spent a total of US$ Million (MNT Billion), an average of US$ 399 (MNT 524,300) per visitor. 58 Based on previous booking patterns, it is estimated that approximately 39% of the incremental air traffic stimulated by liberalization will be visitors to Mongolia (the remainder will be Mongolian residents). It is anticipated that visitors by air will spend considerably more than the overall average rate of US$ 399, which is heavily skewed towards visitor by land. 59 Visitors arriving by air tend to stay for longer and have greater need for accommodation and ground transportation. Therefore it is assumed that the incremental visitors by air will have a spend rate double the average (US$ 798). Sensitivity analysis on this assumption is provided in the next section. Based on these assumptions, Figure 7-1 shows the incremental visits stimulated by liberalization. A total of 117,000 international visitors per annum are projected as a result of liberalization. This represents a 21% increase over 2010 visitor levels (557,414). 60 These visitors are estimated to spend a total of US$94 Million (MNT Billion) in the Mongolian economy. The employment impacts of this additional visitor and tourist spend is discussed in the next section. 57 Source: Mongolian National Tourism Center, 58 Ibid. 59 Based on the air traffic data described in Chapter 3, it is roughly estimated that only 13% of visitors to Mongolia arrive by air. 60 The increase in visitors (21%) is considerably less than the growth in passenger traffic (112%) due to the high proportion of visitors arriving by land.

54 Incremental Visits Figure 7-1: Additional visits stimulated by liberalization Additional Visits All financial figures are in 2010 prices Sensitivity tests Total Visitor Spend (MNT) Total Visitor Spend (US$) 117, Billion 94 Million As data on spending by visitors arriving by air was not available, the spending rate of these visitors was estimated assuming that they spent double the average of all visitors. This was a reasoned estimate based on typical spend rates in other parts of the world. However, as the spend rate was based on an assumption, sensitivity test were carried out to examine the impact of this assumption. Two tests were conducted assuming different levels of visitor spend: Low: visitors are assumed to spend at the average rate of all visitors to Mongolia (both air and land visitors): US$399 per visitor. High: visitors are assumed to spend at three times the current average (3 x 399 = US$1,197). This 50% higher than assumed spend rate used in the primary analysis. The estimate spend under these assumptions are provided in Figure 7-2, along with the results from the primary analysis. Note that the number of visitors is the same in all scenarios, only the spend rate changes. As can be seen, the total spend is US$ 47 Million in the low scenario and US$ 141 Million in the high scenario, a range of +/-50% relative the primary analysis. Figure 7-2: Sensitivity test on the visitor spend rates Primary Analysis (US$ 798 per visitor) Low Scenario (US$ 399 per visitor) High Scenario (US$ 1,1197 per visitor) Additional Visits Total Visitor Spend (MNT) Total Visitor Spend (US$) 117, Billion 94 Million 117, Billion 47 Million 117, Billion 141 Million 7.2 Impact on employment This section provides estimates of the employment generated in three areas: Aviation; Tourism; Catalytic impacts Employment impacts in the aviation sector Increases in air traffic will require additional resources to handle the additional passengers and aircraft. Employment in the aviation sector is related to the servicing, management and Section VII Page 42 Impact of international air service liberalization on Mongolia

55 maintenance of additional air services, which includes activities at airlines, airports, air navigation and other aviation-related businesses. Furthermore, this additional aviation activity has spin-off impacts into the wider economy known as indirect or multiplier impacts. For example, these include: food wholesalers that supply food for catering on flights, trucking companies that move goods to and from the airport, refineries processing oil for jet fuel, etc. These indirect impacts generate additional employment in a range of industries. The parameters and methodology used to estimate the employment impacts in the aviation sector are described in Annex B. The resulting estimates are provided in Figure 7-3. Liberalization is projected to generate an additional 2,010 (direct) full-time equivalent (FTE) jobs in the aviation sector. Including the indirect jobs, the total reaches 4,310 new full-time equivalent jobs. As with the traffic figures, these are the long term projections some 2-3 years after liberalization. Figure 7-3: Additional employment generated in and by the aviation sector Liberalization Impact Direct Employment (FTEs) Indirect Employment (FTEs) Total Employment (FTEs) 2,010 2,300 4, Employment impacts in the tourism sector Air service facilitates the arrival of tourists (both business and leisure) to a country or region. The spending of these tourists can support a wide range of tourism related businesses: hotels, restaurants, theatres, car rentals, etc. In addition, the tourism industry generates significant indirect impacts in businesses that supply and support tourism. For example, food wholesalers for hotels and restaurants, taxi firms, hotel laundering services, delivery trucks, etc. 61 In described in Section 7.1, liberalization is projected to result in an additional 117,000 visitors to Mongolia spending a total of US$ 114 Million in the national economy. Based on the methodology and parameters described in Annex B, the estimated incremental employment related to the tourism sector is summarized in Figure 7-4. The incremental tourism is projected to generate 5,600 FTE jobs within the tourism sector itself, plus 6,620 FTE jobs in indirect employment for a total of 12,220 FTE jobs. Figure 7-4: Additional employment generated in and by the tourism sector Liberalization Impact Direct Employment (FTEs) Indirect Employment (FTEs) Total Employment (FTEs) 5,600 6,620 12, Catalytic impacts As discussed in Section 2.3, air transportation has been linked to economic and productivity growth. Air transportation facilitates employment and economic development in the national and regional economy through increased trade, attracting new businesses to the region and 61 By this definition, air transport could be considered part of the indirect industries benefiting from tourism. The multipliers used in this analysis exclude air transport as part of the indirect impact of tourism, to avoid double counting. Impact of international air service liberalization on Mongolia Section VII Page 43

56 encouraging investment. In particular, catalytic effects can include some or all of the following: Trade effects air transport liberalization opens new markets to many businesses as a result of new destinations, better flight connections and higher frequencies offered. This leads to a broader demand for existing products. Investment effects a key factor many companies take into account when taking decisions about location of office, manufacturing or warehouses is proximity of an international airport. Productivity effects air transportation offers access to new markets which in term enables businesses to achieve greater economies of scale. Air access also enables companies to attract and retain high quality employees. These catalytic impacts can have significant implications for employment. For example a study by Button and Taylor (2000) found that as many as jobs are generated for each additional 10,000 E/D international passengers while the study by Brueckner (2002) found that 22 jobs were generated by each additional 10,000 E/D passengers. 62 The catalytic impacts in Mongolia have been estimated using parameters calibrated from international data from previous examples of expanded air service. The parameters have been then tailored to the Mongolian situation, reflecting local employment, economic and business conditions. Figure 7-5 shows the forecast employment stimulated in the wider economy (excluding air transport and tourism) by the catalytic impacts of increased air services. Liberalization is forecast to generate 5,010 FTE jobs in catalytic impacts. Figure 7-5: Additional employment generated by catalytic effects Catalytic Employment (FTEs) Liberalization Impact 5, Total employment impact The total employment stimulated by liberalization is provided in Figure 7-6. Air service liberalization is projected to generate 21,540 FTE jobs in the long term. This represents an increase of approximately 2.1% in total employment in Mongolia. 63 Figure 7-6: Total incremental employment stimulated by liberalization Employment (FTEs) Aviation Sector 4,310 Tourism Sector 12,220 Catalytic Impacts 5,010 Total 21, Button, K. and Taylor, S. (2000), International air transportation and economic development, Journal of Air Transport Management, Vol. 6, Issue 4, October Brueckner, J. (2002), Airline Traffic and Urban Economic Development. 63 The total employed population at the end of 2010 was 1,089,600. Source: Monthly Bulletin of Statistics, National Statistical Office of Mongolia, November Section VII Page 44 Impact of international air service liberalization on Mongolia

57 7.3 Impact on gross domestic product In addition to employment, another measure of economic impact is the contribution to Gross Domestic Product (GDP). GDP is a measure of the total national output of an economy - the total monetary value of all goods and services produced domestically. It includes income earned domestically by foreigners, but does not include income earned by domestic residents on foreign ground. The estimates of additional GDP generated by liberalization provided below includes the employment income associated with the jobs described in the previous sections as well as the profits of the benefiting businesses and any related taxes or subsidies. The total GDP generated by increased activity in the aviation and tourist sectors, as well as indirect and catalytic impacts, is presented in Figure 7-7. Air service liberalization is forecast to generate US$ Million (MNT 253 Billion) in GDP per annum. This equates to an increase of 2.5% in national GDP. 64 Figure 7-7: Additional gross domestic product generated by liberalization Incremental GDP (MNT) Incremental GDP (US$ at PPP) Liberalization Impact All financial figures are in 2010 prices. 253 Billion Million 64 Mongolia s GDP in 2010 is estimated to be US$ Billion (at PPP). Source: CIA World Factbook, Impact of international air service liberalization on Mongolia Section VII Page 45

58

59 ANNEX A: FREEDOMS OF THE AIR

60

61 ANNEX A: FREEDOM OF THE AIR The freedoms of the air were first established at the Chicago Conference in 1944 in order to provide a standardized basis for negotiation of bilateral air service agreements. In 1944 only the first five freedoms were identified, however, since that time another four definitions have been added. The nine freedoms of the air are: First Freedom Second Freedom The right to fly and carry traffic over the territory of another country without landing. For example, the right of a Russian air carrier to transit Mongolian airspace enroute to another country (or as part of a domestic flight). For many countries, this freedom (and the second freedom rights) is enshrined in a multilateral agreement known as the International Air Services Transit Agreement (IASTA) signed at the Chicago Conference. However, a number of countries are not party to this agreement, including Russia, Canada and Brazil, and have chosen to negotiate these rights as part of the individual bilaterals. Although these rights are fairly universal, airlines are generally required to give prior notice before entering a nation s airspace and are often charged a fee to cover air navigation costs. The right to land in another country for technical reasons such as refuelling or maintenance without boarding or deplaning passengers or cargo. For example, right of a Chinese carrier to refuel in Mongolia as part of an onward journey. The long range of modern aircraft means that this freedom is rarely used for passenger carriers. Historically under this right, locations such as Anchorage, Shannon and Gander became key refuelling points for early long haul aircraft. As with the first freedom, many countries provide this right under IASTA. The first two freedoms are known as technical freedoms. Third Freedom The right of an air carrier from a country to carry passengers or cargo from that country to another country. For example, the right of a Chinese carrier to transport passengers from China to Mongolia.

62 Fourth Freedom The right of an airline from one country to land in a different country and board passengers traveling to the airline s own country. For example, the right of a Chinese carrier to transport passengers from Mongolia to China. Third and fourth freedoms are granted in virtually all air service agreements and almost always together. Fifth Freedom Sixth Freedom This freedom is also sometimes referred to as beyond rights. It is the right of an airline from one country to land in a second country, to then pick up passengers and fly on to a third country where the passengers then deplane. For example, a Chinese carrier flies from China to Mongolia boards passengers at a Mongolian airport and flies those passengers to Russia. Two sub-categories exist: Beyond fifths which allow the carriage of passengers from the second country to the third country (e.g., a Chinese carrier flying China-Mongolia-Russia). Intermediate fifths which allows the carriage of passengers from the third to the second country (e.g., a Chinese carrier flying China-Russia-Mongolia Whereas third and fourth freedoms are standard in nearly all bilaterals, the granting of fifth freedoms varies from bilateral to bilateral. The right to carry traffic from one country through the home country to a third country. For example, a Chinese carrier transporting passengers from Mongolia to Japan via China. Sixth freedom clauses rarely appear in the bilateral agreements (it is essentially an airline using the third and fourth freedom rights of two separate agreements). However, in the past, some governments have attempted to restrict this traffic. For example, the UK government tried to restrict UK- Australia traffic via Malaysia by requiring a stopover of several days in Kuala Lumpur (or other connecting points). It also required Malaysia Airlines to pay $50 to British Airways for each sixth freedom passenger Annex A Page 50 Impact of international air service liberalization on Mongolia

63 carried. 65 Nowadays, governments rarely place restrictions on sixth freedom traffic. Seventh Freedom Eighth Freedom Ninth Freedom The right to carry traffic from one country to another state without going through the home country. For example, the right of a Chinese carrier to transport passengers from Mongolia to Russia as a stand-alone flight. Seventh freedom rights are fairly rare for passenger services. One example is the UK-Singapore bilateral signed in 2007 which allows Singapore air carriers to operate services from London and British carriers to operate services from Singapore. The granting of seventh freedom rights is far more common for allcargo flights. The right to carry traffic between two points within a foreign country (i.e., domestic traffic) as an extension of a service starting or ending in the airline s own country (also known as tag-on or fill-up cabotage). For example, the right of a Chinese carrier to transport passengers from Ulaanbaatar to Khovd as part of service that originated in China. This right is also rarely granted. One example is the Australia-New Zealand single aviation market which allows a carrier from each country to operate tag-on domestic services in the other country. Another is part of the MALIAT between New Zealand, Chile, Singapore and Brunei (although not the U.S., the other signatory). The right to carry traffic between two points within a foreign country with no requirement to start or end the service in the airline s own country (also known as pure cabotage). For example, a Chinese carrier operating a service between Ulaanbaatar to Khovd as a stand-alone service. It is rare for this right to be granted. The only major example is the EU single aviation market which allows EU carriers to operate domestic services within any of the EU member states. 65 Source: Rigas Doganis, Flying Off Course: The Economics of International Airlines, Third Edition, 2002, Routledge. Impact of international air service liberalization on Mongolia Annex A Page 51