Rail in a market economy

Richard Wellings

First published in The Railways, the Market and the Government (IEA, 2006)


This paper examines the economic impact of government intervention on the UK’s transport sector. The current situation is compared with what might be expected to occur under the conditions prevalent in a pure market economy, in terms of institutional structures, infrastructure provision and competition between modes. By this method it is hoped that insights can be gained into the endemic deficiencies of both the railway industry and British transport policy in general.

The importance of the exercise rests on the essential role transport plays in facilitating economic activity. In the 18th Century the development of an extensive and integrated network of toll roads was vital to the progress of the industrial revolution (Albert, 1983). In the 19th century railways came to predominate. In both cases, the new transport infrastructure lowered the cost of trade between individuals and firms in different geographical locations. A more specialised spatial division of labour was facilitated, creating new wealth through gains in productivity. However, by the 20th Century the political climate had changed. In the early 1920s several private consortia proposed a series of new profit-making toll motorways from London to the major cities, usually with the support of local authorities. Maybury, the Minister of Transport, objected on principle to “the placing of very important road traffic arteries in the hands of private capitalist enterprise, to be operated for profit” (Plowden, 1971, 193). The construction of the motorway network by the government would have to wait until the 1950s, decades behind Germany, Italy and the United States.

The 20th century was characterised by a gradual increase in the degree of state involvement in Britain’s transport sector. Despite the economic reforms of the 1980s, the trend seems to have continued into the early years of the 21st century. The first section of this chapter paper therefore examines theoretical objections to the centralised political control of the transport sector. Arguments in favour of government intervention are then discussed: in particular, the contention that since transport imposes economic and environmental costs on society as a whole government needs to act in order to limit these effects. The next section illustrates how government policies have affected the UK transport sector. Finally, different policy options are assessed.

Central planning and political control

In a pure market economy there is division of labour and private ownership of the means of production and there is market exchange of goods and services (Mises, 1949, 238). The operation of the market is not obstructed by institutional factors and the government abstains from hindering its functioning, while protecting it against encroachments on the part of other people. Accordingly there is no interference of factors foreign to the market (ibid, 239).

It is clear that the transport sector in the UK is very far removed from the kind of free market described above. There is direct political control of rates of fuel duty, road tax and infrastructure expenditure. In addition, numerous centrally decided regulations determine such matters as speed limits, safety provisions, service frequencies, train fares and vehicle sizes. This high degree of central planning and political control inevitably has a profound impact on both the transport sector and the economy as a whole.

According to Austrian economic theory central planning authorities are incapable of making efficient resource allocation decisions. The Misesian critique of socialism suggests that because government decision-makers do not personally own the capital they are allocating they have less incentive to act responsibly or show initiative (Mises, 1935). They lack the “commercial-mindedness” of private entrepreneurs, in part because the institutional incentive structures within government do not reward this ability. Thus the Victorian railway entrepreneur risked his own property and that of his shareholders when building a new line. In contrast the bureaucrat has little to gain or lose from involvement in a transport project, especially given the extended lines of responsibility typical of government institutions.

The central planners are further hampered because in some of their activities they may not have access to relevant market prices and therefore encounter difficulties in accurately calculating costs and outputs (see Mises, 1949, 696). Transport officials have faced this problem when planning new road schemes. In the absence of toll revenue from road users, the true value of the facility to users cannot be known and therefore the rate of return on the capital spent cannot be calculated and vital information about the best way of allocating capital resources is lost. Accordingly, it is unsurprising that transport planners have resorted to deploying extremely complex cost-benefit analyses to help them decide which road schemes are most worthwhile.

The importance of prices is also emphasised in the Hayekian critique of central planning. In his analysis of the use of knowledge in society, Hayek demonstrates how central planners are unable to achieve the most efficient use of resources since they cannot utilise the dispersed and subjective, time and place specific knowledge held by every individual (Hayek, 1945). In contrast, markets communicate such information via the price system and thus tend to allocate resources more efficiently and in a pattern that far more accurately reflects the different preferences of individuals.

It can be deduced from the above insights that the misallocation of resources is commonplace within the UK’s transport sector, given the high degree of government intervention and central planning. While it is impossible to quantify the impact on the British economy it should be borne in mind that the resulting economic effects could be of far greater magnitude than those simply relating to congestion and pollution. In focusing on the latter issues, writers have arguably neglected transport’s integral role in productivity increases and the resulting production of wealth.

The apparent misallocation of transport resources by government will be outlined, by way of illustration, below. However, given the negative economic impact of government intervention that can be deduced from Austrian economic theory, the next section examines the main justification for state involvement in the industry, namely that transport produces externalities, imposing social or environmental costs on the rest of society.

Transport and social cost

Although it can be agreed that in general “transport prices have been set on the basis of historical precedent or political expediency” (Glaister & Graham, 2005, 633), social cost arguments, taken from welfare economics, are sometimes deployed as a rationale for government intervention in the transport sector. For example, the findings of the Royal Commission on Environmental Pollution report, Transport and the Environment (1994), may have played a significant role in the decision to introduce the fuel duty escalator.

Adherents of the social cost approach suggest that, in the light of the external costs associated with transport, Pigouvian taxes might be justified. Additional taxes would be imposed in order to pay for associated economic, environmental and health costs, the rate of taxation being set at a level to maximise the welfare of society as a whole. Thus, transport prices would be partly determined by state enforced application of economic science rather than the voluntary decisions of individual participants in freely operating markets. Accordingly, Austrian economists and many market liberals in general, are quite critical of the social cost approach and its application. Indeed, it is suggested that the deficiencies of social cost arguments may be sufficient to undermine the case for deploying them in policy decisions. An alternative approach, based on enhanced property rights and deregulation, is discussed.

A government determined to set rates of transport taxation and subsidy according to social cost principles would be presented with a number of difficulties. Firstly, it is clear that accurately calculating the social cost of transport is extremely problematic. This is demonstrated by the large degrees of uncertainty observed in studies that attempt to quantify the external costs of road transport in the UK. For example, the influential Royal Commission on Environmental Pollution report estimated the figure at between £10bn and £18bn per year. The environmental component of this was between £4.6bn and £12.9bn (RCEP, 1994, 103). Other studies are characterised by similarly large ranges, if not of environmental costs then of other categories (e.g. Maddison & Pearce et al, 1996; Sansom et al, 2001). This high level of uncertainty would be problematic were governments to use such calculations to set tax rates, leaving room for significant political discretion in the decision whether to adopt high or low estimates.

Even if a cost estimate could be agreed on, further challenges would arise in the decision regarding which individuals to tax. The level of external costs arising from the transport sector is not simply the result of the actions of individual transport users, when they decide, for example, to take a journey by car. In reality, a complex web of factors is responsible for any given pattern of externalities. For example, the number of people suffering from road noise will depend on the location of the road and its relation to nearby housing. If government planning policies have prevented settlements from adapting to the environmental effects of road transport then they clearly bear part of the responsibility for subsequent negative effects experienced by residents. A significant proportion of new housing developments continue to be constructed on brown-field sites alongside busy roads and railways despite an abundance of ‘set-aside’ agricultural land. Yet town planning is just one of numerous factors influencing individuals’ experiences of externalities. Any given pattern of external costs from transport is the result of the complex interaction of different government policies and individual actions both current and historical. Thus it is extremely difficult to determine who should pay what to whom in order to remedy the situation. Certainly, it could be argued that a crude tax such as fuel duty is particularly unjust because it bears so little relationship to either the pattern of externalities or the complexity of causative factors.

Given the political pressures facing government decision-makers there is clearly significant potential for arbitrariness in the application of social cost theory to different modes and sectors. Whilst it might be deemed acceptable for road users to pay for accident, congestion and pollution costs the same principle might not be applied to public transport users. Indeed, currently public transport benefits from substantial taxpayer subsidies and the fares are Value Added Tax exempt, despite the presence of significant externalities. Notwithstanding environmental costs and accidents, buses, in particular, are responsible for significant spill over effects on other road users, for example, slowing down cars and cyclists.

Moreover, the principle of consistency would demand that social cost principles were applied in the same fashion to all other parts of the economy. From an environmental point of view the energy sector is of particular importance, yet domestic fuel is currently taxed at a very low rate compared with petrol. Although elements of cost-benefit analysis are applied in other sectors (for example, by the National Institute for Health and Clinical Excellence – NICE – in the health service), it can hardly be argued that the application is consistent, widespread and rigorous.

Thus one policy option would be to extend the scope of taxation based on the environmental/social costs of different activities by consistently applying the principle across all economic sectors. However, it is debatable to what extent this would be politically practical given that the policy would come into conflict with many egalitarian sensibilities. For example, in the transport sector, the mobility of the less wealthy and the disabled could be affected, whilst in the energy sector, there could be concerns over ‘fuel poverty’ if domestic energy consumers were paying similar tax rates to motorists.

Egalitarian concerns are also apparent in the estimation of accident costs. There has been a tendency to adopt willingness to pay (WTP) measures of the value of a statistical life (VOSL) in place of gross output measures (for example, by the Department of Transport (Maddison & Pearce et al, 127). A perceived problem with the earlier methodology was that the death of a disabled person or retiree could possibly be counted as a benefit since such individuals would tend to have a negative effect on economic output (see ibid, 125). Yet the very high VOSL values produced by willingness to pay methods (often in the region of £2 million) suggest that they should be treated with scepticism. Certainly, these figures bear no relation to individuals’ ability to pay, since only a tiny minority of the population have access to such financial resources. It should also be noted that if the government decided to adopt an unrealistically high VOSL figure, this would tend to exaggerate the social costs of less safe modes such as cars and motorcycles relative to those of trains and buses.

The Contingent Valuation Method (CVM) is the main technique for measuring people’s preferences for non-marketed goods and relies on survey data to reveal their willingness to pay for a hypothetical change in their circumstances (ibid, 34). Yet the CVM is characterised by significant methodological limitations. According to Graves, “…the results will inevitably be affected by the survey design, the scenario presented to the respondents and the possibility that Contingent Valuation responses reflect attitudes rather than real economic commitments.” (Graves, 1991, 216). Furthermore, Maddison and Pearce et al have noted that, “If respondents realise that the results of this survey will be used to determine the extent of government expenditure they have an incentive to overstate their WTP” (Maddison & Pearce et al, 1996, 35). Clearly, transport is one sector that people generally assume to be the responsibility of government. While techniques can be deployed to attempt to compensate for such biases, it is doubtful whether the CVM is capable of coming close to simulating the complexity and dynamism of real markets and thereby producing realistic valuations.

These difficulties would appear to make the controversial theoretical position of some Austrian economists relevant to the examination of social cost methodologies. For example, Mises states:

Prices are a market phenomenon. They are generated by the market process and are the pith of the market economy. There is no such thing as prices outside the market. Prices cannot be constructed synthetically, as it were. They are the resultant of a certain constellation of market data, of actions and reactions of the members of a market society. It is vain to meditate what prices would have been if some of their determinants had been different…It is no less vain to ponder on what prices ought to be. (Mises, 1949, 392)

Furthermore, there is the problem that social cost studies must translate inherently subjective costs into aggregate monetary terms. Accordingly, Cordato writes,

“… [T]he standard approach to environmental economics depends on being able to identify situations where the marginal private benefit of an activity exceeds the marginal social cost. This inherently involves making interpersonal utility comparisons and the summing of interpersonal evaluations across individuals. Neither of these can be held as methodologically valid.” (Cordato, 2004, 5)

Clearly, social cost methodologies attempt to measure individual valuations then aggregate them to arrive at a figure for large groups or society as a whole. Yet subjective individual valuations often exhibit significant variation. For example, one person might appreciate a beautiful landscape and another feel nothing. The social cost approach arguably submerges such diverse views and thus, if applied, produces tax rates and prices that fail to reflect the wide variations in individual preferences.

Having criticised the application of social cost methodologies to transport it is worth examining briefly how some of the negative effects associated with the sector might be dealt with in a pure market economy. In the absence of government intervention many environmental effects could be priced via land and property markets. Accordingly, different environmental options could be made available for individuals with different preferences3. For example, a developer of new housing settlements would have a strong incentive to provide a suitable transport infrastructure to provide access to the properties. If a new railway line was constructed as part of the scheme then residential properties alongside the route could be sold at a cheaper price than those further away, in order to reflect the additional noise and air pollution adjacent residents might expect to endure. Thus the external costs of the railway effectively would be given a market price arrived at through voluntary agreement.

There would also be strong incentives for any developer to invest in the environmental qualities of the new settlement according to the tastes of potential property buyers. Binding restrictions could be imposed by the developer to reduce the negative impacts of transport. For example, trains and lorries could be banned from entering the settlement for a period at night. Motorcycles could be prohibited completely. Older, noisier and more polluting cars could be excluded. The precise mix of measures would depend on the developer’s best estimate of the preferences of property buyers for different environmental goods. Clearly such market based solutions are dependent on deregulated land development, the private ownership of new transport links and the concomitant return of the close relationship between new transport infrastructure and property development.

In the absence of state intervention, markets are capable of pricing many external effects of transport and thereby providing incentives to reduce their magnitude. This is particularly clear in the case of congestion, which is estimated to cost the UK economy in excess of £21 billion per year, more than all the other road traffic externalities put together (Blythe, 2005, 572). Freely operating markets are capable of eliminating congestion through increased user charges at busy times, enhanced infrastructure capacity, the geographical dispersal of economic activity or some combination of the above and other measures. Accordingly, it is possible to contend that like environmental costs, current congestion levels are primarily the result of government policies that prevent the efficient operation of transport and land markets. Thus, even if one accepts their methodological validity, it can be argued that since social cost studies are situated in the context of the current highly regulated policy framework they actually provide very little information about the external costs of transport in an unhampered market economy.

Transport and poverty

The alleviation of relative poverty provides another important rationale for government involvement in the transport sector. For egalitarians, transport policy is about giving ‘access’ to all sections of the ‘community’, including women, pensioners on low incomes, those with young children, the disabled and members of ethnic minorities (Prescott, 1992; Torrance, 1992). A market based system is therefore rejected for its inherent inequalities.

Yet it is far from clear that government intervention benefits low income groups. Regulation and taxation may have inflated the costs of car ownership beyond the reach of many, through fuel duty, road tax, compulsory insurance, increasingly complex driving tests, vehicle design standards, import restrictions and MOT tests. At the same time, state regulation has prevented the development of the low cost forms of transport seen in the Third World, such as shared taxis and driver-owned minibuses. These options could significantly reduce any disadvantages faced by those unable to drive. Furthermore, it should be noted that expenditure on public transport has tended to be concentrated on the railways, subsidising, inter alia, commuters, business travellers and those who live in the countryside6: none of these groups is necessarily poor.

However, there are elements of British policy that are more clearly directed at addressing inequalities in transport. These include bus subsidies, free passes for the elderly, reduced fares for children, students and families, and mobility allowances for the disabled. But it is not clear that such measures are sufficient to ameliorate the negative effects of taxation and regulation mentioned above. Furthermore, as subsidies from taxpayers, these policies are economically damaging because resources are transferred from the productive parts of the economy to the non-productive thereby reducing the growth of the former. Moreover, incentive structures are altered such that it becomes more attractive for individuals to remain dependent on the state for their travel and other wants. Finally, if it is desired to transfer resources to such groups, it is much more efficient to transfer cash than to provide benefits in kind such as subsidised transport by certain modes.

The privatised railway

The economic problems associated with central planning and political control have been illustrated on Britain’s railways during the past decade. Although British Rail was ostensibly privatised in the mid-1990s the heavy degree of regulation and subsidy applied to the industry meant that the prevailing economic conditions were very far removed from those that would be expected in an unhampered market. Indeed, the privatisation of British Rail was perhaps analogous to what Hayek termed “constructivist rationalism” in the social sphere (Hayek, 1988). A complex web of contracts, institutions and regulations was artificially created that would never have evolved spontaneously through voluntary exchange under market conditions. Furthermore, the design of this structure cost the taxpayer £450m pounds in consultancy fees (Wolmar, 2001, 75). Unfortunately the perceived failures of the privatised railway have, rather unfairly, brought the whole process of privatisation, and even free markets themselves, into disrepute. Thus it becomes essential to examine the role of government intervention in the rail sector, and in particular in those areas where the results of privatisation have come under most criticism.

Before starting this analysis it is necessary to describe the main elements of the privatised railway. The traditional vertically integrated structure of the industry, in which the owner of the tracks also ran the trains, was discarded in favour of a system that deliberately segregated the different roles. Ownership of the tracks was given to Railtrack, a company that was floated on the stock market in 1996. The government sold the trains, the locomotives, carriages and wagons, to specially created rolling stock companies (ROSCOs). The vehicles were then leased to the Train Operating Companies (TOCs), who were given the responsibility for actually running the train services. The TOCs were awarded franchises for given routes by the government, initially through the Office for Passenger Railway Franchising (OPRAF). A rail regulator was appointed to oversee the industry.

Following the election of a Labour government in 1997 there were some structural changes to the industry. In 1999 the Strategic Rail Authority was created to coordinate future expenditure on the network and replace OPRAF as the agency responsible for the franchising process. In 2001 the government forced Railtrack into liquidation. It was replaced by Network Rail, a not for profit company, in a de facto re-nationalisation of the track and stations. The Strategic Rail Authority was earmarked for abolition in the 2004 Rail Review with its functions transferred to the Department for Transport (DfT).

The level of government subsidy for the industry has risen considerably since the mid-1990s despite initial hopes that efficiency savings would in the medium term reduce the demand for taxpayer support (ibid.). However, the responsibility for this outcome clearly lies with state interference. The 1993 Railways Bill made it virtually impossible to close loss-making lines even though these routes could potentially have been valuable if Railtrack had sold them as development property or converted them into toll roads (offering unimpeded access to town centres in many cases). According to one estimate, ‘marginal lines’ account for just 17% of rail travel but 64% of operating subsidy.

While this statistic suggests that line closures would substantially reduce the need for taxpayer funding, it is important to remember that in the absence of unhampered competition among different transport modes it is impossible to properly assess the market value of currently loss-making railways. Furthermore, in the absence of state regulation of safety it is likely that currently loss-making lines could reduce their costs significantly.

Indeed, high expenditure on rail safety is one reason why the rate of subsidy has risen. In 1999 the government decided to roll out a new Train Protection and Warning System across the network at the cost of £585m, or an estimated £15.4m per life saved (Commission for Integrated Transport, 2004). The Hatfield crash of 2000, which killed four people, less than half the daily average fatalities on Britain’s roads, led to even more expenditure on safety, including an emergency track renewal programme, speed restrictions (which led to large compensation payments from Railtrack to the train operating companies) and eventually promoted the adoption of the £3.7bn European Rail Traffic Management System, estimated to cost £99.2m per passenger life saved (ibid.)8.

In terms of government expenditure it would appear that such additional spending on passenger safety is particularly wasteful. Serious accidents on the railway are rare and the same money would save far more lives if spent elsewhere. Better still, if the rail safety subsidies were substituted for tax cuts then taxpayers could decide for themselves whether to spend their additional resources on improving their health and safety or alternatively on something else more important to them. Of course, in an unhampered market a private railway owner might wish to spend large amounts on safety in order to prevent his company’s reputation being damaged by a major accident. However, in the absence of taxpayer subsidy, safety expenditure would have to be carefully balanced against its impact on passenger fares in the context of free competition from other transport modes.

Still greater costs have resulted from the government’s desire for the railway to transport a greater share of passenger and freight traffic. The government’s Ten-Year Transport Plan aimed to increase passenger traffic by 80% and freight by 50% by 2010 (DETR, 2000). Meeting this ambition (now abandoned) entailed improving the quality and increasing the capacity of certain parts of the rail network, at enormous cost to the taxpayer. The cost of upgrading the West Coast Main Line (WCML), that links London, Birmingham, Manchester and Glasgow, will be £7.6bn, according to recent estimates (Hudson, 2004). Extrapolating from the cost of section one of the Channel Tunnel Rail Link (CTRL) it seems likely that a brand new high-speed railway could have been built at similar cost, at least as far as Lancashire9. Alternatively, the sum could have paid for the construction of approximately 500 miles of six-lane motorway. Once again, the WCML modernisation project appears to provide evidence of the wasteful allocation of resources. Although the scheme was started under Railtrack, it should be noted that the company was required by the Rail Regulator to spend a certain share of its turnover on infrastructure renewal.

Regulation also played a key role in reducing the income of the rail industry, and thereby increasing the need for subsidy, through the capping of fares. Season tickets, off-peak savers, and all fares within 50 miles of London, were regulated. Thus as demand rose in the late 1990s, these fares could not rise to choke it off, with chronic congestion, especially on peak time London commuter trains, the predictable result. This congestion led to demands for increased capacity on the worst affected routes. However, the state imposed structure created further problems. According to Wolmar:

[The system] is very unwieldy… with only 9 per cent of the charges being variable. In other words, Railtrack gets very little extra money (and in many cases none at all) when additional trains are run on its tracks, a situation which was to cause the company much grief when operators started putting on many new services in the late 1990s (Wolmar, 2001, 96).

Thus there was little economic incentive for Railtrack to earmark expenditure for increasing capacity. Furthermore, the increased traffic actually cost Railtrack money through increased wear and tear on the system. The transmission of passenger wants via the price mechanism was precluded by fare regulation and the artificial structure of the industry. In a pure market economy there would be many options open to railway owners faced with a substantial increase in passenger demand. They could increase fares, increase capacity, or apply a combination of the two, depending on which they thought would give them the highest return. The amount of congestion experienced by passengers would in part depend on their willingness to pay to avoid it (for example, if the market supported it, railway owners could introduce high density standing only carriages for those willing to sacrifice comfort for a cheaper journey).

If the price mechanism had been allowed to operate freely then Railtrack would have been able to raise track charges in response to the greater passenger demands on its infrastructure. Yet this ability to raise prices in an unregulated market provides a powerful argument against the degree of separation of ownership and function seen on Britain’s privatised railway. In an unhampered market the owner of the tracks would have the whip hand over the train operating companies. If the latter succeeded in increasing their profits by attracting more passengers then there would be nothing to stop the track owner from raising its prices in order to increase their profits. Given this possibility the owners of train operating companies would want the track owner’s charges and obligations set out in contract before investing their capital. However, given the potential costs associated with such a contract, such as transaction costs and a loss in operational flexibility, it is difficult to see why the track owner would wish enter into such an agreement, except where substantial efficiency gains would be achieved by the separation of track and train (for example, when long distance services made use of many different owners’ tracks). Railway owners would have to trade off the profit from allowing other companies to use their tracks with the resulting additional costs. They might also consider whether they could profit more by providing the proposed train services themselves. The main point is that, in contrast to Britain’s railway, in an unhampered market guided by prices, the degree of vertical integration could be adjusted according to the changing demands on the network.

Distorted competition

Given the very high degree of government intervention in the railway industry it is very difficult to determine whether different parts of the rail network are economically viable. The problem is compounded by government measures that impede free competition with other modes of transport. The high level of taxpayer subsidy has already been mentioned. On long distance routes, such as London to Paris and London to Glasgow, the trains are competing directly with the airlines, yet the railways are receiving capital grants from government to improve infrastructure: this situation hardly constitutes fair competition. At the same time, when the private sector attempts to increase capacity at airports it is faced with very great obstacles in the planning system as demonstrated by the long running and highly expensive public inquiry into Terminal Five at Heathrow.

On many other inter-city routes trains compete directly with coaches. However, unlike many train services, the latter do not receive an operating subsidy or the fuel duty rebate accorded to buses (Hibbs, 2000). Coaches are further disadvantaged by an EU imposed speed limit that restricts them to 62 mph, even on motorways, despite their inherent safety (ibid). Moreover, since motorways and trunk roads are free at the point of use and because the supply of road infrastructure has been determined by government diktat rather than the marginal demand for road space, coaches are slowed down by congestion. If coaches travelled at 80 mph on un-congested routes and perhaps used the edge of city terminals found in many developing countries, then they could provide very serious competition for the railways. Lower top speeds might be compensated by lower fares, increased service frequencies and a greater variety of routes, including direct journeys to smaller towns badly served by rail.

Despite the advantages of deregulated inter-city coaches compared with trains there can be no guarantee that either mode would be economically viable in an unhampered market system. Coaches, like trains, benefit from the VAT exemption on public transport fares. However, the main source of uncertainty as to the underlying competitive position of public transport is the high level of government involvement in the activities of private road users. Motorists, in particular, are very heavily taxed. In 2003 tax revenues from fuel duty and road tax exceeded government expenditure on the road network by £20bn, a sum large enough to construct about 1,000 miles of six-lane motorway (DfT, 2004). It is inconceivable that such a rate of construction, carried out, for example, over the last 20 years, wouldn’t have reduced congestion significantly, especially if a more liberal planning system had allowed economic activity to take full advantage of the available capacity by dispersing from cramped inner cities with their narrow Victorian streets. It is also difficult to deny that a far more specialised and productive geographical division of labour would have been achieved in Britain if the government had reserved its road user tax receipts for road expenditure.

The magnitude of fuel duty revenue suggests that motorists are prepared to pay significant sums for the use of road space. However, in the absence of market prices on the road network it is impossible to know the actual amount of road space that would have been provided in an unhampered market economy or what charges motorists would voluntarily pay for using it. Whether railways or other public transport modes could survive deregulation and the removal of differential taxes, subsidies and regulations, cannot be determined with absolute certainty in advance.

Towards free competition in transport

A key lesson that can be drawn from the recent history of Britain’s railways is that if government intervenes in market processes then many of the benefits expected from privatisation will be to some degree undermined. The current situation, in which general taxpayers, many of whom never use trains, subsidise rail passengers, is difficult to justify, even in egalitarian or environmental terms (see above). In addition, much of the expenditure on rail may be considered economically wasteful since a commercial return on the investment will never be achieved. Moreover, the central direction of rail expenditure by government officials means that, to a significant extent, it is detached from the wants of transport consumers and subject to the influence of special interest lobbies.

In order to end the requirement for subsidising the railways, it will be necessary to allow unprofitable lines and services to be closed. Furthermore, it should be possible for the market to determine the appropriate level of vertical integration on the network. Thus, if operating companies wish to take over the tracks and stations they use, the government should permit this providing subsidies are ended.

In order to encourage fair competition between modes, government should also seek to moderate the burden of safety regulations on the railways, enabling the industry to reduce costs significantly. The railway owners would be able to decide how much to spend on safety themselves according to their perception of its importance as indicated by consumer demand.

Wider reforms could also help the rail sector’s competitiveness. A liberalisation of employment law would help reduce the wage inflation that has hampered parts of the industry since privatisation. Similarly, an end to the special legal exemptions applying to trade unions would be beneficial (the rail industry remains heavily unionised compared with many competing transport modes).

Some railways could also benefit from the liberalisation of planning controls in Central London to allow the development of skyscrapers and high rise residential blocks, since it seems unlikely that such schemes could be served adequately by private motor vehicles. At the same time, increased private residential development in Inner London could actually harm the profitability of the commuter lines. A liberalised planning system is also an essential element in restoring the traditional link between transport infrastructure and property development. Without green belts and other restrictions, railway owners could fund infrastructure improvements and the maintenance of services by developing land along new routes and stations. This process would be particularly attractive around London since mass commuting by road into Central London is clearly impractical given current infrastructure provision and urban form. Under these conditions there seems every reason to believe that the London commuter railways would thrive in the absence of subsidies and government regulation.

Similarly, many of the inter-city rail routes from Central London might be viable since the distances involved are probably too short for air to compete on overall journey times. However, higher speed coach services on un-congested roads could present problems for the inter-city operators. The airlines might also drive the train companies out of business on the London-Scotland routes, although, in the absence of government intervention, the outcome would depend on passenger preferences.

Liberalisation and private ownership could also lead to greater integration between different modes. The cross-ownership of trains and buses is already very much in evidence with companies like Stagecoach and National Express. It would be in a rail firm’s interests to provide feeder bus services to their trunk routes in situations where branch lines had been closed to passenger traffic. Furthermore, depending on consumer demand, it might be beneficial for the railways to integrate their services more fully with the demands of the motor car, for example, by moving major stations out of town, perhaps to locations where railway lines and motorways intersected. Many potential rail users, particularly business travellers, no longer live in inner city areas. It is a deterrent to rail use that they must travel through congested urban streets to reach a major station and then pay expensive parking charges if they have decided to drive there. New out of town ‘parkway’ stations might enable many branch lines to be closed while actually improving overall travel times for many passengers. There would of course be extensive opportunities for property development at the new sites. New town centres would effectively be created that were purpose built to make efficient use of modern transport technology. Any disused railways could be converted into dedicated bus routes or toll roads, or the land could be developed, depending on which option offered the greatest commercial return. One of the great advantages of a proper market in transport infrastructure is that existing routes could be used far more efficiently, in many cases avoiding the high costs of developing brand new links.

In order to maximise the comparability of prices between different transport modes it is essential that any liberalisation of the railways is accompanied by a similar policy on the road network. Unfortunately, the privatisation of residential roads presents many difficulties around both charging methods and access rights to private property, and is therefore likely to be a piecemeal process that would take many decades. In contrast, the privatisation of the motorways and parts of the trunk road network appears to be relatively straight forward and achievable. However, the political control of the road privatisation process brings with it a number of dangers.

A national road charging system based on satellite tracking technology has been advocated as a possible stepping stone towards increasing the role of the private sector in the provision of road infrastructure. While this system would probably reduce congestion problems it would not respond to consumer demands for more road infrastructure. Indeed, it has been suggested that a possible benefit of a national charging system would be the reduced need for new road capacity (Glaister & Graham, 2004, 109). One can imagine the economic damage that would have occurred if such a system had been put in place in 1930. Instead of building trunk roads, and eventually motorways, prices would have been raised on the existing infrastructure to avoid congestion. The production of wealth through a greater geographical division of labour would have been seriously impeded by artificially high transport costs. There can be no guarantee that a national charging system would not have a similar negative economic effect in the future.

Notwithstanding the very grave implications for civil liberties, the political control of a national charging system would undoubtedly lead to calls for special exemptions for ‘key workers’ and ‘deprived areas’ or alternatively compensatory regeneration funding or potentially very large public transport subsidies. While the exact redistributive effects of a charging system are difficult to predict it seems likely that much of the economic benefit gained from reducing congestion would be absorbed by such payments.

A pure privatisation of motorways and trunk roads could avoid many of the problems discussed above since the level of tolls would be the concern of the road owners and therefore outside political control. Of course, it would be preferable if fuel duty was dramatically reduced, or the tax abolished, since otherwise drivers would be paying over the market rate for using the private roads. The continuation of high fuel taxes would seriously undermine the economics of new road construction since revenue that could be gained by the road owner through tolls would be diverted to the government.

Furthermore, it is preferable that the proceeds of privatisation are not absorbed by the Treasury but instead are distributed to road users (for example, holders of driving licences or registered vehicle owners could receive shares in the new road companies). If this were not done, the government would have a strong incentive to restrict the construction of new roads by competitors in order to inflate artificially the value of the existing road infrastructure and maximise its receipts from any flotation. Likewise, it is essential that potential private road builders can operate in a liberal planning environment such that the government cannot use the planning system to direct transport policy by the back door (for example, by banning or delaying road construction but allowing public transport schemes). In the absence of these regulatory and fiscal conditions it is likely that the benefits of road privatisation will be severely limited and may serve to bring free markets further undeserved criticism.


Britain’s railways were born in an era of entrepreneurship and individualism. However, like other industries, they gradually became subject to a greater degree of government intervention culminating in the nationalisation of 1947. Unfortunately, privatisation did not fully reverse this process. Instead the railways were so tightly regulated that many of the benefits deriving from markets were lost. Free markets were unfairly brought into disrepute and in consequence future withdrawals of state involvement in economic activities have been made more politically difficult.

In fact, the problems of the privatised railway have clearly illustrated the perils of centralised political control. The misallocation of resources has become endemic, as demonstrated by the high level of taxpayer subsidy. Only the liberalisation of the entire transport sector will reveal which parts of the railway will have a long-term future as profit making businesses. While such a policy would take a good deal of political courage, the proposed reductions in fuel duty and the wide distribution of road shares could help sway public opinion in its favour.


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