Britain’s rail policies defy economic logic

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.

The dangers of hyperinflation in Ukraine

?????????????????????????????????????????????????????????????????????????????????????????????????????????The Cato Institute’s Steve Hanke has estimated that Ukraine’s inflation rate is now running at 64.5% per month – well above the 50% per month that is usually used as the definition of hyperinflation. If this continues, the political and economic consequences are likely to be horrific.

Worryingly, an analysis of current conditions in Ukraine and a comparison with previous episodes of hyperinflation suggest the country is highly vulnerable to such a scenario.

 

The hyperinflation process

While the political economy of hyperinflation is often complex (see below), in simple terms it is caused by governments creating large amounts of money. Instead of funding public spending through borrowing from investors or collecting taxes, governments print money or create it electronically.

Expectations then come into play. As governments rapidly debase the currency, individuals lose confidence in the money. More and more people expect its purchasing power to decline. They try to reduce their cash holdings to limit their losses from its depreciation.

Money then becomes like a hot potato. People try to pass it on as quickly as possible. The velocity of money explodes as it circulates far more rapidly through the economy.

There is a ‘flight to real goods’ as money is exchanged for items expected to more reliably hold their value, such as cigarettes and tinned food. This results in what Mises termed a crack-up boom.

Eventually, the transaction costs of using the money rise to such an extent that it is rendered useless and new forms of money, such as gold, foreign currency – or even cigarettes – are used instead, along with barter.

In the meantime, high rates of inflation have made economic calculation almost impossible, and huge malinvestments have taken place. The later stages of hyperinflation and any subsequent stabilisation, are generally marked by a painful adjustment process as these malinvestments are liquidated, and governments slash spending and/or raise taxes.

The Weimar Republic

Only by looking at the detail of particular episodes of hyperinflation does one begin to appreciate its horrors.

The first sign of trouble in Germany was when it went off the gold standard in 1914. The government then borrowed and printed money rather than raising taxes to pay for the war.

By 1917, the amount of money in circulation had risen five fold. The main surge in prices came after the war ended, however. The people had been hoarding cash during the conflict, for security, and because many goods were unavailable.

Then, in 1919, this money came flooding back into the economy – prices rose by around 300% that year.

It was then that people lost confidence in the currency – this mindset not helped by the Treaty of Versailles and the hefty reparation payments imposed on Germany. The flight to real goods began, and the hyperinflationary process accelerated.

There was also a problem for a government committed to maintain, as far as possible, its spending levels, in that high inflation made it in some ways even harder to collect tax to balance the budget. Eventually they ended up adjusting taxes by the month. But another problem was that companies would deal in foreign currencies using foreign bank accounts, to avoid holding Marks, making tax avoidance easy. The increased use of barter also didn’t help the collection process.

Germany also faced enormous instability, and this perhaps partly explains politicians’ unwillingness to exact big public spending cuts and their preference to use the ‘hidden tax’ of inflation to fund expenditure. There were hundreds of political assassinations and both the communists and national socialists threatened the nascent democracy, while the French were trying to break the country up by establishing a Rhenish republic.

Indeed it was after the French invaded the Ruhr in January 1923 – Germany’s industrial heartland – in retaliation to default on war reparations – that inflation accelerated to the level that has become the stuff of legend.

The German government lost a major source of revenue, but insisted on funding the Ruhrkampf, the struggle against the French occupation, and kept paying out dole for unemployed workers in the Ruhr.

Even at the end of 1922, the cost of living had risen by 1500 times since the war, while wages had gone up around 200 times.

But the worst was yet to come. The cost of living index, fixed at 1 in 1914, had risen to an average 15 million by September 1923, 3,657 million in October and 218,000 million in November – when the Mark was finally abandoned.

By this stage, only 1% of the government’s budget was funded from tax receipts, the rest through printing money.

In the last months of the Mark, people would queue outside banks with buckets and wheelbarrows because so much currency was required to buy basic goods. Local authorities and large firms were allowed to issue their own notes in lieu of Marks, to address the shortage. Around 300 factories were employed to print notes.

In the worst period, a cup of coffee that had cost 5000 Marks would cost 8000 Marks by the time it had been drunk. Diners’ restaurant bills would rise as they ate. Newspapers would list new prices for tram and taxi fares every morning.

Thieves would steal baskets and suitcases full of money, but leave the money and keep the containers.

It played hell with economic calculation and many businesses shut down in the last months.

Wider social effects

Another result was widespread famine in the large cities. Malnutrition was endemic and disease rife, particularly TB among children.

Although the harvest had been good, farmers were unwilling to exchange food for worthless currency. So the cities starved and the inhabitants ate rats and dogs to stay alive.

In contrast, farmers were doing rather well. Their fixed rate mortgages had dwindled to nothing. They could barter food for luxury goods from the urban middle classes, so farms would boast cars, expensive jewellery, fine furniture, grand pianos etc.

Of course, the urban middle classes saw their wealth destroyed by the inflation, and ended up selling valuables for essentials. Those relying on savings income were in a particularly poor position, and often ended up in the soup kitchens.

As an aside, it was very difficult to protect one’s wealth. There was a mania to invest in shares, and companies did well initially in the ‘crack-up’ boom, but by 1923 most shares were trading at a tiny fraction of their 1914 values, measured in pounds, and dividends had declined even more. In terms of purchasing power, shareholders were looking at a loss of 90% plus, much better than cash or government bonds, but still an absolute disaster. Rental property was also a disaster since rent controls stopped landlords raising rents in line with inflation. By 1923, foreign students with dollars were able to buy rows of houses in Berlin using their allowances.

Gold and foreign currency were far better inflation hedges, and both were in high demand during the hyperinflation, though even with these you would tend to lose significantly in terms of purchasing basic goods. Possession of such goods, such as coffee, sugar and fuel, not to mention food-producing land, was perhaps the surest insurance policy.

In the initial stages, the working classes did a bit better than the middle classes.

They received more frequent wage increases thanks to the political power of the unions, but eventually they lost out as factories and coal mines closed down, and millions ended up unemployed on a pittance of dole money.

Entrepreneurs, particularly currency speculators often did well, and those who could obtain foreign currency could pick up assets at bargain prices in the later stages of the inflation. There was great resentment at their success, while most people were borderline starving.

Urban unrest

Given this boiling cauldron of suffering and resentment, it is unsurprising that there was significant urban unrest. Linz in Austria, which was also affected by hyperinflation, was plundered by a raging mob, with shops looted. They didn’t just steal, they also smashed up fittings and furniture. Food shops were looted in Berlin and there were numerous riots in just about every city in Germany. Parties of workers raided farms, slaughtering animals and tearing the meat from their bones, before torching the buildings.

State of emergency

Predictably all this unrest led to a government crackdown, and in September 1923, seven articles of the constitution were suspended and a state of emergency introduced.

There could now be restrictions on personal liberty, freedom of expression, freedom of the press and freedom of association. The army and the police could interfere at will with postal, telegraph and telephone services, indulge in house searches, and confiscate property.

Incitement to disobedience could be punished with imprisonment or a fine of up to 15,000 gold marks. If lives were endangered the punishment would be penal servitude. Death would be the penalty for the ring-leading of armed mobs, treason, arson or damage to the railways.

The parallels with Ukraine

Unfortunately, these are the kind of developments that could afflict Ukraine if hyperinflation continues to take hold. Worryingly there are striking parallels with the situation in 1920s Germany.

In particular, the Ukrainian government faces an existential crisis combined with a collapse in tax revenues, meaning there are strong incentives for policymakers to attempt to maintain some semblance of political stability by printing money to buy-off various interest groups – in the short term at least.

The strong presence of potentially destabilising far-right groups in both the government and the military is an especially disturbing aspect of the current situation. And as in Germany, there are also some groups that could potentially profit from a hyperinflation episode.

Ukraine’s corrupt oligarchs, several of them holding political office, own vast assets abroad, and, unlike ordinary Ukrainians, are to a large extent insulated from the currency collapse. Along with overseas investors with hard currency, they may find opportunities to buy valuable Ukrainian assets at bargain prices during the crisis. Of course, this assumes that hyperinflation does not result in the nightmare scenario of some form of totalitarian regime coming to power.

Given the obvious risks, it is absolutely vital that the Ukrainian government changes course quickly before hyperinflation becomes entrenched. This perhaps means enacting spending cuts and doing as much as possible to de-escalate the political crisis and restore confidence.

Further reading:

When Money Dies by Adam Fergusson

Human Action by Ludwig von Mises

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

New rail links can’t solve London’s transport crisis

Busway 205London’s population is forecast to hit 10 million in 2030 and it’s difficult to see how the transport system will cope. Already a high proportion of commuters endure severe overcrowding, standing in jam-packed carriages or even struggling to find enough space to get on trains.

The government sees additional rail capacity as the best way to address rising demand. But this is unrealistic. With further spending cuts needed to reduce government debt, there is no way the Treasury will be able to fund the scale of investment required.

Part of the problem is that rail schemes in London are hugely expensive. The proposed Crossrail 2 scheme, which will add relatively little to the capital’s transport capacity, is predicted to cost an astounding £27 billion. Many more big projects would be needed for the network to accommodate the projected additional numbers of passengers. This is simply unaffordable. Public transport subsidies already cost taxpayers £12 billion a year, with roughly half of this spent in London.

An alternative strategy would be to manage demand by raising fares. Yet despite the economic logic, fare hikes have become politically toxic. Even rises of just 1 per cent above inflation are now deemed unacceptable.

Future governments will therefore face a difficult predicament. They won’t be able to afford to increase rail capacity to cope with growing demand and they will struggle to manage congestion with fare increases due to political constraints. But fortunately there is a potential solution if policymakers are prepared to think outside the box and take a more flexible approach to the use of transport infrastructure.

The rapidly growing cities of Latin America and Asia have faced similar issues: rising demand but severe budgetary constraints. But rather than investing in hyper-expensive rail infrastructure, local governments have often decided to build much cheaper high-capacity busways instead. From Istanbul to Mexico City, these busways carry vast numbers of commuters while offering cheap and affordable fares.

So, why not do this in London? One apparent reason is the lack of space, the city lacking the wide boulevards used for busways elsewhere. But London does have an extensive rail network with often vast corridors reaching right into the centre. This raises the question, would some of these routes deliver better value for money if they were converted into busways?

There is certainly strong evidence that this would bring a major increase in capacity. A single bus lane in New York’s Lincoln Tunnel carries up to 30,000 commuters in the peak hour, compared with a figure closer to 10,000 for a typical railway track entering Central London. And on former railway routes managed to avoid congestion, the potential capacity of busways would be much higher.

There could also be a big reduction in fares. Operating costs are likely to be much lower than on comparable rail routes. Busways are far simpler to manage and maintain.

Concerns about journey times can also be dismissed. On the shorter commuter routes where busways would be most appropriate, a combination of more direct services and increased frequency would deliver faster door-to-door travel times for the vast majority of passengers.

While busways may not be the best option in every location, the next government should not set transport infrastructure in stone. A more flexible approach may be the only way to avoid a severe capacity crunch.

For more details see Paving Over the Tracks…a better use of railways?

An earlier version of this article was published in City AM, February 2015

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