Britain’s rail policies defy economic logic

February 28, 2015

Britain could teach the world how not to run a railway. A combination of vast subsidies and overcrowded commuter trains means both taxpayers and passengers get a bad deal.

Privatisation should have delivered a dynamic free-market industry that improved services and cut costs. But the government wouldn’t give up control; it suffocated rail firms with regulation, choking off innovation. Worse still, an artificial structure was created that separated track from train, overturning almost two centuries of railway tradition and introducing layer upon layer of bureaucratic complexity.

Subsidies ballooned, more than doubling in real terms compared with the pre-privatisation era. Government support is now running at around £6 billion a year, meaning taxpayers now fund roughly 40 per cent of rail spending. Network Rail debt is forecast to hit £50 billion in 2020, a massive liability for future generations.

But the big winners from such largesse are not passengers. Armies of highly paid officials, lawyers and consultants have prospered as a result of the labyrinthine rules.

More positively, there has been a big rise in passenger traffic on the railways – and not just because anti-car policies have forced more travellers to use public transport. But with this growth in demand has come congestion.

Rush-hour commuter services into many major cities now suffer severe overcrowding. In the worst affected locations, the problem has gone beyond the problem of standing-room only. Passengers must often wait for the next train as they cannot physically fit into the carriages.

This is not how a market is supposed to operate. Businesses would normally take urgent steps to address such drastic declines in the quality of service. But the rail network is not a normal market, and train operators’ room for manoeuvre is severely limited.

The obvious solution to overcrowding is to vary fares in order to incentivise passengers to use less busy trains, thereby relieving the pressure in the peak hour. This is common practice in other sectors, such as airlines. However, on the most important commuter rail routes it is not permitted.

In the same way that Soviet apparatchiks determined the price of bread – creating shortages and long queues in the process – the government imposes price controls on the rail industry, and with similar results. In practice, someone travelling on a packed train at 8am typically pays the same as a passenger on a much quieter service at, say, 9am. Only later on, when off-peak tickets become available (usually at 9:30am) do prices drop.

This rigid regulated price structure has been disastrous. Not only has it produced sardine-like conditions for commuters; it has also created strong political pressure for the government to spend enormous sums increasing rail capacity to deal with the problem.

The amounts involved are astounding. The total cost of just two schemes in the South-East, Crossrail and Crossrail 2, is likely to reach £50 billion, enough to build roughly 1,000 miles of brand new six-lane motorway. In addition, overcrowding on the southern section of the West Coast Main Line has been used to justify the hugely expensive High Speed 2. As well as imposing a large burden on taxpayers, such London-focused, rail-centric spending is draining investment from better-value road schemes in the North of England.

Building new rail capacity is an expensive and complicated solution to a problem that in many cases could be solved relatively simply by allowing train operators more flexibility to smooth demand. It is far cheaper to make better use of existing infrastructure than to construct brand new lines.

The economic logic for deregulating fares is therefore compelling. Operators could then charge ‘super-peak’ prices on the very busiest services while offering cheaper tickets on quieter trains. This would not just benefit taxpayers by reducing the need for new infrastructure, it would also benefit many lower-paid workers such as cleaners and shop assistants, who often travel outside the peak hour but before current off-peak fares begin.

Flexible pricing could also encourage employers to alter their work patterns. For example, there are few good reasons why universities could not shift to a later schedule, allowing students and employees to benefit from lower travel costs.

Clearly, there would also be losers from deregulating fares. While many peak-hour commuters would rather pay more to avoid the crush, others might prefer overcrowded conditions to higher prices. The answer here is surely to offer more choice, for example by providing cut-price, standing-only carriages – effectively reintroducing third class.

A bigger obstacle to a change in policy is a far more powerful group of losers – the vested interests that profit from unnecessary public spending on new rail projects. Key beneficiaries include the bloated government agencies in charge of planning the schemes, and the firms winning the lucrative contracts to build the infrastructure and supply the trains.

Britain’s rail policies certainly defy economic logic, but they also allow various influential groups to make vast amounts of money at taxpayers’ expense. This means reform is unlikely.

YP February 2015

Unless otherwise indicated, all articles on this website are written in a personal capacity.

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Is privatisation to blame for high rail fares?

December 5, 2014

IEA Blog, December 2014

Rail fares per passenger-kilometre are on average around 30 per cent higher in Britain than in comparable Western European countries. In addition, annual regulated fare increases exceeded the Retail Prices Index, an official measure of inflation, by 1 percentage point per year from 2004 to 2013. This is widely held to be a consequence of privatisation: the necessity for private rail firms to make a profit and pay dividends to shareholders meaning that fares must be substantially higher than otherwise would be the case. It is therefore argued that the rail industry should be reformed to help tackle the cost-of-living crisis and secure a ‘better deal’ for passengers.

In May 2014 more than 30 Labour parliamentary candidates called for train operations to be taken over by the government as current franchise agreements ended – a form of gradual renationalisation. Official Labour Party policy does not go quite so far, but would allow publicly owned train operators to compete with private firms. This approach could lead to creeping renationalisation given political influence over the franchising process. There are also calls to introduce a freeze on rail fares or at very least a ‘tougher cap’ on increases.

Proposals to address the cost-of-living crisis by increasing state involvement in rail are based on a series of misconceptions. Indeed, the heavy focus on fares suggests fundamental ignorance of the economic importance of rail to the UK economy. While the average household spends approximately £64 per week on transport, only about £3.30 is spent on train and tube fares. The impact of any fare reductions on the cost of living would thus be trivial. By contrast, policies that reduced motoring costs (c. £56 per week per household), such as cuts to fuel duty and car tax, would offer substantial relief to household budgets.

Another problem for the re-nationalisers is the relatively modest profit margins of the train operating companies, estimated at around 3 per cent of turnover. This implies that the ‘savings’ from no longer paying out dividends to shareholders would simply not be large enough to fund a significant reduction in fares. This conclusion also holds when other privately owned elements of the rail industry are considered.

Additional state intervention in the rail market would also be poorly targeted if poverty alleviation were the aim. On average rail travellers are far better off than the general population. Almost 60 per cent of spending on rail fares is undertaken by the richest 20 per cent of households, who also spend a higher proportion of their incomes on rail fares than poorer groups.

The skewed distribution of rail ridership towards high-income groups severely limits the potential for enhanced price controls to reduce the living costs of those on modest incomes. Indeed, for the population as a whole, more stringent fare regulation is fundamentally flawed as a cost-reducing measure, since what is saved in fares must be paid in additional taxes. Worse still, price controls reduce the efficiency of the rail network by artificially stimulating demand and increasing industry costs. Lack of price flexibility also makes it much harder to make better use of existing capacity. The resulting overcrowding creates political pressure for state spending on uneconomic new rail infrastructure, at additional expense to taxpayers.

Even if they were successful then, the proposals for additional state intervention to moderate rail fares would be ineffective at addressing cost-of-living issues, and in the case of further price controls entirely counterproductive. However, the proposed interventions would almost certainly fail to achieve even their stated objectives because they reflect a flawed analysis of the problems facing the sector.

There are several reasons for the high costs of the rail industry, but ‘privatisation’ per se is not one of them. Firstly, the effects of the history and geography of Britain’s railways should not be neglected. For example, the high share of rail travel involving trips to and from London – a vast and expensive global city – raises costs compared to other countries, even if other factors are held constant.

Secondly, it is misleading to refer to the reforms of the 1990s as ‘privatisation’ without understanding the extent to which the state continued to regulate, fund and direct the industry. Nominal ownership was indeed transferred to the private sector, but key decisions remained with the government. Opportunities for entrepreneurship, innovation and cost-cutting were heavily restricted by regulation. Unsurprisingly, major productivity gains were not forthcoming.

To make matters worse, policymakers imposed a complex, artificial structure on the industry. Contrary to evolved practices, the sector was fragmented, with separate firms managing the infrastructure, owning the rolling stock and operating the trains. These arrangements required armies of highly paid lawyers, consultants and bureaucrats, and also created numerous other inefficiencies.

Under a genuine privatisation model, there would have been strong incentives to reduce these additional costs, for example by moving back to a structure of vertical integration. However, traditional railway industry structures and full private ownership are effectively banned under European Union law. The proposals for part-renationalisation will not address the fundamental flaws in the structure of the rail industry that push up costs. EU ‘open access’ rules limit the options for more radical reform.

Renationalisation policies also risk further undermining the limited opportunities for entrepreneurship and innovation on the railways. The shortcomings of state-owned enterprises are well documented, and include poor cost control, lack of entrepreneurship, susceptibility to political interference and endemic misallocation of resources. In the longer term, these inefficiencies would tend to lower productivity on the railways, resulting in some combination of higher fares, higher subsidies or reduced quality of service. A range of new problems would be added to an already suboptimal industry structure.

Finally, the high cost of Britain’s railways to a large extent reflects wasteful investment in uneconomic new infrastructure. Since the mid-1990s it has been government policy to encourage modal shift from private road transport to public transport. This contrasts with the previous post-war emphasis on the managed decline of rail.

In this context, subsidies and other interventions have artificially inflated passenger numbers, creating a rationale for new capacity. Moreover, government funding helped create a powerful rail lobby with a strong financial interest in extracting additional resources from taxpayers.

Several large rail projects have been undertaken during the ‘privatisation’ era, including High Speed 1 (HS1), the West Coast Main Line upgrade, Thameslink and Crossrail. The cost of these five schemes alone is approximately £50 billion in 2014 prices. While taxpayers have paid the lion’s share of the bill, there has also been a significant impact on fares in some areas. For example, passengers in Kent have seen steep increases following the commencement of HS1 commuter services.

More generally, wasteful spending has contributed to concerns about the taxpayer funding such a high proportion of industry spending, strengthening the case for regulated fares to be raised above the official rate of inflation. Importantly, rail infrastructure projects have typically been heavily loss-making in commercial terms and poor value compared with road schemes. They would not have been undertaken by a genuinely private rail industry that was not reliant on state subsidy. Wasteful investment, and its impact on fares, is the direct result of government policy and should not be blamed on privatisation.

Clearly there are strong grounds for criticising the privatisation model imposed on the rail industry. The productivity gains associated with private enterprise were largely suffocated by heavy-handed regulation; a complex and fragmented structure pushed up costs; and huge sums have been wasted on uneconomic projects. In this context, it is unsurprising that fares have not fallen. However, it is also the case that these problems are symptoms of government intervention rather than the result of privatisation per se. Indeed they would not have occurred had the railways been privatised on a fully commercial basis under a ‘light-touch’ regulatory framework which allowed the organisation of the industry to evolve according to market conditions.

 

A longer version of this article was published in Smoking out red herrings: The cost of living debate.

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