Granted a "cheapest-at-all-costs" demand from the public encourages airlines to strive for the lowest possible standard service. However, Govt through legislation can prevent this kind of 'market failure' by forcing the airlines which preach the most extreme 'cheapest' message to raise their standards - and thus the self-destructive striving ceases.
Yes, the compensation regime is a little blunt, but taxation by its nature is always blunt. That engine which has been knocked out by freak multiple bird strikes should not really be a cause of a big compensation bills, but tech has in the past been used as an excuse by some of the more cowboy-ish airlines rather too often. How does landside Joe Bloggs seeing 'Cancelled' on a monitor verify which carrier is being honest about tech, and which uses it as an excuse ? Wouldn't you become cynical eventually ?
Any 'fair' approach will inevitably be highly complex and quickly becomes subjective. The pilots know part of what's going on.... the dispatcher knows another bit, maintenance knows something else - must pax really call all these different people to a small claims court to get a decision as to whether compensation should be due ?
Any kind of scheme should coerce airlines into factoring a level of reliabilty into their operation and dissuade from just abandoning pax whenever convenient - so there has to be a painful part for airlines somewhere. Even when you've decided what is or isn't allowed - how severe should the financial penalties be ? Very subjective decision....
How do you set up a scheme with appropriate incentives, which is simple to understand, verifiable by all and easy to process ? Industry regulation can be a surprisingly complex part of microeconomics.... if you have any good ideas on this, I'd be genuinely interested to hear of them.