Regulation, not privatisation, to blame for inefficient railways

The recent history of Britain’s railways has undoubtedly brought the whole concept of privatisation into disrepute. But this is unfair. Rail privatisation was a pastiche of genuine privatisation – in many ways it actually increased the level of state control.

Last week’s McNulty Review estimated that costs are about 40% higher on Britain’s railways than comparable European networks. Taxpayer subsidies, adjusted for inflation, have probably more than tripled since the British Rail era – reaching around £7 billion per annum. As McNulty explained, higher costs are to a large extent the result of the fragmentation of the industry. A vertically integrated industry was split up, with different firms managing the infrastructure, running the trains and leasing the rolling stock. As a result, transaction costs mushroomed.

It is a myth, however, that fragmentation was the result of privatisation per se. The government imposed an artificial structure on the industry from above. Indeed, when train operators subsequently approached the government with a view to taking ownership of the track, they were rebuffed. Moreover, the regulations imposed on the ‘private’ rail industry made it virtually impossible to close loss-making lines, while franchise agreements with train operators effectively forced them to continue running uneconomic services.

By contrast, the structure of a rail industry under genuine private control would be determined by market forces. Historical experience suggests that vertical integration would predominate. This may be explained both by the desire to minimise transaction costs and the relatively high degree of asset specificity on the railways (for example, rolling stock is often designed for use on particular routes). Moreover, genuine private owners would be free to close uneconomic lines and cancel loss-making services. Freed from government price controls, they could set fares to address overcrowding. Expensive new capacity would be funded by fares and land development rather than taxpayers (many of whom never use the railways).

A truly private railway would be efficient, innovative, responsive to consumer preferences and would not require taxpayer support. It is time the critics (such as Will Hutton) stopped blaming privatisation for problems caused by government intervention.

And the coalition is just about to repeat the same type of mistake in their NHS reform (if it goes through at all). There would be notional competition but within a centrally imposed industry structure - commissioning of healthcare services by GP consortia, an artificial creature. If it goes wrong, I'd bet my right arm that the papers will be full of articles saying "market forces in healthcare have harmed patients".
David Tyrall put this very well in an article in Economic Affairs. Two simultaneous experiments were carried out (1) a move to private ownership of train operating companies (and Railtrack at first) and (2) the imposition of a structure on the industry. It is not possible merely by observing that this has not succeeded as well as we hoped to conclude that the first experiment failed. There is pretty good prior evidence to believe that the second experiment failed: 1. rail traffic (the responsbility of the operating companies) has mushroomed 2. the extra costs seem to result from the transactions costs of the fragmented system 3. railways have never evolved this way naturally 4. Competition between tocs on tracks owned by another party has not materialised (suggesting that the creation of tocs to separate the natural monopoly element from the rest was not necessary) I think Will Hutton is either being quite disengenuous or he is simply not very reflective when deliberating about such matters.

"Moreover, genuine private owners would be free to close uneconomic lines and cancel loss-making services."

So, you think that if a line is "uneconomic" it should close, do you? And if a service on a line at a given time is "uneconomic" it should also be cancelled?

This reductionist free-market ideology can only have one long term outcome: the destruction of the entire rail network, or the vast majority of it.

People do not generally travel from A to B on the railway. They travel from A to B to C. So what happens if A to B is profitable but B to C isn't? If you close B to C then you reduce the likelihood that the traveller will use the rail network to go from A to B. Thus, closing or cancelling services makes it more likely that the profitability of otherwise profitable services will be compromised as well.

If we extend this line of reasoning more fully: suppose we have road pricing in the future. Are you advocating closing all loss-making roads as well? Should those who live in isolated communities be disconnected from the rest of society?

The lesson to be learned here is that the viability of one part of the network depends on the very existence of the rest of the network. A single and comprehensive rail provider might appreciate this and plan accordingly. They would be more likely to cross subsidise the worst performing parts from profits from the most popular routes knowing that the increased traffic would benefit the whole network. The problem with franchises is that they reduce this scope for cross-subsidisation. Thus the problem of fragmentation arises from different operators controlling different routes, not just a separation of TOCs from the ownership of the track. It may well be true, as you claim (though I personally doubt it) that:

”A truly private railway would be efficient, innovative, responsive to consumer preferences and would not require taxpayer support.”

But as I have outlined above, even if the above statement were true, the price that would be paid would be a massive pruning of the existing network to the extent that it would no longer be a functioning network. You only have to look at the disaster that was bus deregulation in the 1980s to see a portent for the future under such a plan.

Moreover, you talk about market prices and inefficiency but fail to mention the most heavily subsidised users of the railway - commuters!

The cost of a season ticket from Reading to London Paddington is £3,584.00 per annum. That equates to about £14.34 per working day. Yet the cheapest standard off-peak day return is £16.00, so why the disparity?

In a properly functioning market, in order to attract greater custom, the cost of off-peak tickets when the trains are virtually empty should be much less than the cost when they are full. After all, many of the one-off costs (such as rolling stock, line rental and maintenance) are already covered by the lucrative commuter fares.

True, the costs per commuter is less for the TOCs so they could charge less, but they are in the business of profit maximisation, and commuters are a captive market. So rail operators should be able to charge them a premium. Instead the Government caps their fares thereby subsidising their costs. This cost is then passed on the wider public in two ways: (i) via taxes through the state subsidy; (ii) through higher house prices in the south east. In addition, it is the infrequent traveller who is expected to pick up part of the cost. The McNulty report specifically points to the failure to manage commuter rush-hour demand as being one of the key drivers of poor train utilization and excessive costs.

As a result of this market failure we end up with the worst of all worlds. An overheated economy and housing market in the south, a lack of financial incentive for companies to relocate their workers away from London, overcrowded peak services, inefficient off-peak services, and poor levels of rail investment in the regions.

"People do not generally travel from A to B on the railway. They travel from A to B to C. So what happens if A to B is profitable but B to C isn't? If you close B to C then you reduce the likelihood that the traveller will use the rail network to go from A to B." Cantab, why do you think Greek restaurants offer you a free Ouzo after the main course? Selling something for £0 is by definition unprofitable. The answer is: They know that the Ouzo, even if unprofitable on its own, contributes to the profitability of the PACKAGE they sell. Don't you think before closing the connection from B to C, railway companies might want to look at whether their customers use it as a complement to another connection, like A to B, such that the package is profitable? Do you think you have discovered the economic concept of the complementary good? Maybe you should become a railway consultant and tell them about your great discovery.

Reply to Kris (on Mon, 06/06/2011 - 15:00)

And what happens if the different courses of a meal are served in different Greek restaurants? Then there is no PACKAGE. So there can be no cross-subsidy between courses. That is how it will be with the railway network when you have different rail companies (TOCs) owning and running the different lines and no state subsidy. Result: no free Ouzo!

Two options: -If the two train companies' services are so complementary, why would they not merge, or one taking over the other? That is one of the main functions of the market discovery process: Find out where the boundaries between different organisations should be. -Alternatively, they could work out some kind of deal, which would effectively amount to a cross-subsidy if that is in both parties' interest. Cross-subsidies can occur across companies as well. Example: Easybus, the airport shuttle of Easyjet, also transports Ryanair passengers. Presumably, Ryanair pays them for this. Free Ouzo is back on the menu. Jamas!
It was indeed private railway companies that developed through ticketing and also standardised time.

Reply to Kris (on Tue, 07/06/2011 - 11:20)

So, your two solutions appear to be:

(i) Merge the different rail franchises into a single monopoly.

(ii) Allow the different rail franchises to operate as a cartel - a quasi-monopoly.

How very free-market! Since when did advocating the formation of private monopolies become an integral part of free-market economic thinking? I thought that competition was one of the central tenets of free-market orthodoxy? Perhaps I shouldn't be surprised though. After all, laissez-faire 'free-market' capitalism always results in the creation of monopolies and oligopolies eventually. That is why mergers and takeovers should be outlawed, or at the very least heavily restricted, and why markets need to be regulated. It is also one reason why there is no such thing as a totally 'free-market', and why there never can be. Free-markets cannot stay free indefinitely without regulation, but with regulation they are therefore not free. Therefore they cannot exist. QED!

As for the private railway companies of the past, they thrived precisely because they had local monopolies in an era before the advent of the motor car.

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