Why are rail subsidies so high?

Taxpayer subsidies to the rail sector have reached astronomical levels. At £6 billion per year (including Crossrail), they have roughly trebled in real terms over the last twenty years. But the high rate of subsidy has not led to a reduction in fares, which recently have risen above the official rate of inflation. There are two main reasons for the large increase in taxpayer support. The first, and probably most important, is wasteful investment in loss-making new infrastructure. This is the direct result of policies that have aimed to increase public transport ridership and reduce car use.

For much of the post-war period, rail was viewed as a declining industry. Despite previous government efforts to suppress private road transport, the step change in efficiency resulting from the door-to-door transit of passengers and freight led to rapid growth in car and lorry traffic. A policy of ‘managed decline’ was therefore applied to the railways. British Rail received subsidies to keep the system going and there was some modernisation of key inter-city routes, but there was little enthusiasm to attempt to reverse the long-term trend.

This changed with the ascendancy of environmentalism within government. With their perspective grounded in radical egalitarianism, environmentalists not only objected to the pollution produced by private road transport; they also resented its social aspects – for example, the way that cars had become symbols of wealth and individual expression. The environmentalist agenda gradually captured university departments, various government bureaucracies, elements of the media and eventually national policy. In the mid-late 1990s, the road construction programme was cut back dramatically and a new strategy introduced. Private road transport would be deliberately discouraged with travellers encouraged to use buses, trams and trains instead.

For the railways this represented a sea change. The new policy meant that rail now had prospects for growth. It did not, however, change the fundamental economics. Since rail involves at least a three-stage journey, compared to the door-to-door convenience of private road transport, it remained unattractive for the vast majority of journeys.

Following privatisation, however, the policy of encouraging more rail travel appeared to be successful. Usage rose by around 50 per cent between 1997 and 2012, to levels not seen in peacetime since the 1920s. This reflected not just the impact of various deliberate policies, but also other trends such as a booming central London economy for much of the period and demographic changes that led to a huge expansion of the ‘inner city’, pushing middle-class families out into the commuter belt to avoid poor schools, anti-social behaviour and fear of crime.

A combination of increased ridership and price controls produced severe peak-time overcrowding on several routes into London. Train operating companies have been constrained in their ability to smooth the peaks using the price mechanism, since season ticket fares on most London commuter journeys are regulated by the government. With a severely limited ability to deploy the price mechanism and other means to make more efficient use of existing rail capacity, the industry has increasingly focused on supplying new infrastructure to accommodate growth. This has proved hugely expensive, however. The final cost of the ongoing Thameslink 2000 upgrade, for example, is likely to be £6 billion. And the Crossrail scheme will cost £16 billion.

Since in commercial terms such projects are loss-making and would never be undertaken in their current form by the private sector, taxpayers have been forced to fund them. Accordingly, wasteful investment in new rail infrastructure is probably the largest single factor in the growth in taxpayer support in the post-privatisation era. Such investment has not been restricted to overcrowded routes in the South-East. The government also funds improvements for blatantly political reasons, in regions where there is little passenger demand. For example, it was recently announced that branch lines in South Wales would be electrified – at taxpayers’ expense, of course. The environmentalist agenda means that rail schemes get priority even though the government’s own cost-benefit analyses show that economic returns from road improvements are far higher.

The second major reason for the increased burden on taxpayers is the artificial structure imposed by the government on the post-privatisation rail industry. Historically, railways that developed in the private sector exhibited a high degree of vertical integration. This meant in practice that the same company owned the tracks and operated the trains, thereby avoiding the transaction costs associated with complex contractual arrangements between highly interdependent separate organisations.

Partly as a result of EU policy, Britain’s privatisation model has been very different, with one firm owning and maintaining the tracks, other firms operating the trains, and another set of firms leasing out the rolling stock. On top of all this complexity, the industry has been tightly regulated by various government agencies. The resulting fragmentation, combined with layers of bureaucracy, needlessly increased costs on the network. In addition, the high levels of regulation severely hindered entrepreneurship. As a result, the productivity-boosting innovations that have cut costs in other industries did not materialise on the railways. Indeed regulation is now so restrictive that private rail firms have effectively become subcontractors for the Department for Transport.

Structural reform would therefore be one of the best ways to reduce the burden on taxpayers. The government should stop prescribing the level of vertical integration and instead free the rail industry to become more efficient. This policy should be combined with a more rational approach to rail investment. A first step is to abolish price controls to remove artificial distortions to fare levels and consumer demand. The provision of new capacity should then be left to the private sector, without taxpayer support. It would make commercial sense to build new infrastructure in high demand locations where it could be funded by fare revenues or land development. Uneconomic projects driven by political motives and special-interest lobbying would no longer get built.

The economic case for phasing out subsidies is very strong. The taxes imposed on individuals and businesses to support the railways destroy jobs and hinder wealth creation in the wider economy. In addition, large parts of the rail industry could thrive without the bureaucratic micro-management that comes with government support. It may seem counter-intuitive, but removing rail subsidies could also end up benefiting passengers, by unleashing entrepreneurship and innovation on the railways that would drive down costs.

Originally published on the LSE Politics and Policy blog.

Indeed, this agenda has been supported by the environmentalist agenda applied to land use planning, which has severely constrained growth in housing supply, by imposing urban growth limits around London, meaning that villages served by rail for historic reasons had dramatic inflation in housing prices, supported by subsidised rail services that made them attractive for people seeking to commute to central London. This had the effect of pricing others in those towns out of housing even if they worked in the same town, because well-heeled central London workers in financial services, business services and the public sector priced them out of the market. These London workers would have probably chosen homes closer to London had the land been set free to allow it to develop. By contrast, the highway network has generated tens of billions of surplus pounds year after year, and much of it is left to crumble or have bottlenecks for the want of an extra lane, or a flyover/underpass. The political vagaries of all of this are appalling. Ken Livingstone had a policy of zero growth in highway capacity so as a result he: - Redeveloped land set aside decades ago adjacent to Savoy Circus on the A40 for grade separation at a notorious bottleneck for "affordable" housing, so that the highway scheme could never proceed, but leaving dozens of people living adjacent to a congested 6 lane highway and dangerous intersection; - Provided lukewarm support for the long standing proposal to fill the notorious bottleneck gap in the A406 at Bounds Green with a 6 lane highway, resulting in it being scrapped in favour of a cheap upgrade of the current road, with one extra lane, and a bikelane, which while halving traffic queues, still left a whole community living on top of a congested set of urban streets either side of a major 6 lane dual carriageway; - Supported a bridge replacement project on the A406 at Hangar Lane in Ealing where the 4-lane road narrows to 2-lanes with a 2-lane bridge, even though there is sufficient road corridor space on the southern side of the bridge to widen the road to 4 lanes through to Uxbridge Rd, relieving another bottleneck at relatively low expense. Time to end this policy obsession with technology over what the market wants.

@Libertyscott - Thank you for your insightful comments about planning policy. The 'stack'em and pack'em' policies of recent years have implicitly supported the rail industry, particularly since planners have effectively forced developers to build along public transport corridors.

I wonder if the British taxpayer would like to know that several millions of transport subsidies are being used to line other private company directors pockets
Excellent article. If the government was to step back resources would go to the most efficient areas of the railway industry such as the South East and inter-city lines which is where rail is a viable substitute to other forms of transport. Currently there are routes that are 50% subsidised by the taxpayer but utilised by just 2-3% of rail users. This current state of the industry just isn't allocatively efficient.
How can government be subsidising Crossrail? It isn't even built yet. Or maybe muddling investment in with day-to-day operations is your idea of economic literacy...
Unless Crossrail is fully privately financed and its capital costs are expected to be recovered from users, then it is subsidised. Heathrow Airport Ltd would happily fully fund a third runway entirely from airport charges and other revenue from airlines and airport customers. Crossrail is another transfer from non-rail users to rail users.
@Libertyscott But the article says "At £6 billion per year (including Crossrail)". You can only include Crossrail by (a) treating the capital being spent on construction as revenue or (b) rolling estimated future subsidies into what is stated as a current figure. Neither is logical ... or particularly honest.
Interesting points of view but sadly no less simplistic than the radical environmental and egalitarian lobbies you object to and conflate. The arguments for each lobby, and radical capitalism, are different. On the narrow argument about rail and infrastructure it is hard to imagine how everyone driving into London would make the city more efficient - or where the cars would be left while the people who drove them worked since every car would require at least as much space as every person does in an office. Equally it is hard to see how government investing in infrastructure is wrong - that is why we have governments as well as private enterprise. Governments are there to pay for things that private enterprise does not or can not pay for. People argued against building the first motorways for similar reason you use against railways. LibertyScott's argument that housing in the green and pleasant periphery of London is subsidised is excellent and, one would think, appeals to both the radical capitalists and radical egalitarian lobbies. The radical environmentalist would argue that the intangible qualities of the surrounding countryside outweigh any short term monetary value the capitalist developer sees in developing the land. The egalitarian will be torn between supporting the capitalist in expanding access to housing and supporting the environmentalist in arguing for universal access to the countryside. The local capitalist will be equally torn between the principals of the market and protecting or enhancing the value of their asset by supporting the environmentalist. Unfortunately life is a lot more complicated than radical protagonists are prepared to acknowledge.
In the last week I have had to catch the train 10 times, more than in the last decade combined, only two of those trains were on time. At the high cost I paid for a 20 min ride I found this unacceptable so wanted to look at how much the taxpayer subsidised the rail network and found this article interesting but in the interest of understanding I have a question or two. If the subsidies are dicontinued then the rail networks will need to recoup that money will they not? Which means higher costs to the user? Which means less users, which in turn would mean higher costs etc.... Is the rail network in such a disorganised mess that we are in a position that it would be easier to cancel all the contracts, bring everything back under the public umbrella and start from scratch with a view at looking at how other countries have privatised their networks? This may seem obvious to some and there is probably a valid reason why it can not be done but I am not an economanist or the most educated as my spelling and grammer will prove but I would like to get a little closer to understanding.
In reply to above... Regardless of any legal problems with nationalising the railways, it would simply be far too expensive to even consider buying out all the rail franchises. One aspect that means the UK would never have a rail system as good as other countries is that train tracks are hemmed in. To get more trains into London Bridge, for example, you need more train lines. To do this you need more train tracks. To do this you would have to bulldoze hundreds (thousands?) of offices and homes. Good luck getting that chief through Parliament! To get double decker trains in operation, you would need to raze or raise just about every tunnel and bridge that the trains go under or through. Again, lots of £. 100 years ago our train system was the best but now we're just living with a very, very old legacy. The best we can hope for is that there'll be sufficient deregulation of fossil fuels so that global warming increases and then the country floods enough that the train system can become a network of canal routes instead.

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