The future of the railways

This debate marked the launch of my new paper on rail privatisation, Without Delay: Getting Britain’s Railways Moving. The study is heavily critical of the 1990s privatisation model, in which politicians and officials imposed a complex and fragmented structure on the industry, ignoring the lessons of both transaction cost economics and railway history.

 

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HS2: subsidies breeding more subsidies

The rail industry depends on a very high level of state support. Much of the sector would not be viable without vast taxpayer subsidies and other special privileges.

The government supports the railways in several ways, including:

  • Providing direct subsidies from the taxpayer of about £6 billion a year (not including London Underground or light rail). This is equivalent to approximately 70% of fare revenue and represents a major distortion of the transport market.
  • Guaranteeing Network Rail debt, which has now reached an astounding £38 billion, larger than the national debt of Nigeria, a country of 180 million people. Big increases in such borrowing have enabled the government to hide the true level of taxpayer support by passing some of the costs on to future generations.
  • Imposing price controls on many rail fares, thereby increasing overcrowding, particularly on peak-time commuter services into London from satellite towns such as Milton Keynes.
  • Exempting rail fares from VAT. By contrast, tax is charged on road fuel at a rate of approximately 150%.
  • Adopting planning policies that push new development into areas adjacent to railway stations (for example, Stratford City), while restricting more spatially dispersed car-friendly growth. Also locating large public sector employers around rail hubs, including much of the civil service.
  • Funding ‘business’ rail travel by public sector workers and government contractors.
  • Suppressing competing modes such as road and air transport through high taxes, heavy regulation and restrictions on new capacity.

The artificial nature of the rail market raises uncomfortable questions for advocates of new rail infrastructure such as High Speed 2. Massive taxpayer support, regulated fares, discriminatory tax treatment and distortionary planning policies mean that the case for HS2 is grounded on levels of demand that have been hugely inflated by state intervention.

Existing subsidies are breeding future subsidies, with the UK’s transport sector and economic geography becoming ever more maladapted and distorted in the process.

Why taxpayers should be angry about rail policy

Taxpayers have far more reason to be angry about rail policy than passengers. They pay about £6 billion a year to support the railways, even though most of them rarely use trains. And it makes little economic or environmental sense to subsidise long-distance commuting, which encourages inefficient travel patterns and energy intensive lifestyles.

The argument for subsidies on grounds of fairness is also weak, as rail commuters are on average far richer than the general population. Measures that froze rail fares or limited increases to the Consumer Price Index would benefit this affluent minority at the expense of taxpayers and the wider economy.

Moreover, stricter price controls would exacerbate overcrowding problems, putting pressure on the government to fund hugely expensive infrastructure projects to increase capacity.

Regulating fares is therefore not a sensible way to cut travel costs. Instead the government should reverse current policy and give train operators more flexibility to vary fares to address congestion problems, for example by introducing ‘super-peak’ pricing and offering large discounts to passengers who avoid travelling at the very busiest times.

 

A shorter version of this letter was published in the London Evening Standard on 8 December 2014.

The railways are a classic example of a politically distorted market

In September 2012 I was invited to discuss rail policy with the Transport Select Committee. The session can be viewed here (@39 min). Some excerpts from the (uncorrected) transcript are provided below:

Chair: Do you support the Government’s overall strategy in HLOS [the government’s rail plan]? Have they got the right priorities?

Dr Wellings: I would say no. The Government has not dealt with the fundamental problem that the rail industry is hugely distorted by subsidies and other distortions such as the planning system. Basically, the central planners in the DfT are groping about in the dark. They don’t have an idea of genuine levels of demand or genuine prices because we also have price controls. Before embarking on these absolutely huge investments at taxpayers’ expense, they ought to get the fundamentals right and remove these distortions and, in particular, the subsidy regime.

Chair: What would you like to see change?

Dr Wellings: I would like to see the subsidies phased out and a change in the planning laws that force developers into corridors around railway stations, for example. There needs to be a change in the tax regime as well so that there is a level playing field with other transport modes.

Mr Leech: Dr Wellings, you argue that there is no economic case for the improvements because of the cost to the taxpayer. You suggest that taxpayers are already paying about £5 billion a year in subsidy. As far as you are concerned, that is an unacceptable level of subsidy. What would be an acceptable level of subsidy?

Dr Wellings: Zero. I would like to see it phased out over a period of, say, 10 years to zero.

Mr Leech: What impact do you think that would have on fare prices on trains and the number of passengers who could afford to use them?

Dr Wellings: It would vary. I don’t think it would have much impact on, say, the London commuter market, which I think is probably fundamentally economically viable, particularly if we also liberalise the planning system so that rail companies could make money from property development as they do in Japan. At the other extreme, you have railways in places like rural Wales that are very poorly used. I think they should definitely close down. There is no economic case whatsoever to keep them going and there is also no social case.

Mr Leech: On the basis that there is a subsidy taking people out of cars and reducing carbon emissions, in your studies what impact would there be on carbon emissions and on the cost to congestion as far as the economy is concerned? Have you done any of that work?

Dr Wellings: It is a myth about carbon emissions. If you closed the entire rail network down overnight, the impact on carbon emissions would be barely measurable. There are two reasons for that. One is that it is quite a small share of overall transport use. The second reason, of course, is that we are talking about a different market from cars. A high proportion of journeys are into central London, for example. These would probably hypothetically go on to coaches and buses, which are more efficient than trains. It would actually be barely measurable.

There is also the effect of subsidising people to move further and further away from where they work through cheaper train fares. You end up, for example, with long-distance commuters through the season ticket system. Although the rail journey might be relatively efficient from an environmental perspective, in terms of the whole lifestyle they probably emit more than if they lived in inner London or close to work.

Steve Baker: Dr Wellings, in your article for City AM in July you were highly critical of the Government. You said that “cynical political calculation seems to be the driving force of policy”. You talked about the railways as a classic example of a politically distorted market. You have also said, without reading the whole article, that many of the projects are motivated by politics rather than economics. Could you give us some examples of where these things can be seen?

Dr Wellings: Yes. The most telling example from the recent plans was the plan to electrify the branch lines in south Wales. Of course the Welsh railways already have perhaps the highest operating subsidies per passenger mile in the whole network. We already have a false market, a rigged market, and yet we are going to invest good money after bad in this already hugely subsidised market. It seemed that the Government was allocating new schemes across the country to pay off various special interests. Few of them made any economic sense. For example, if you wanted a fast train up to Sheffield, it can already be done by the East Coast Main Line in an hour and three quarters. There just isn’t the demand for that kind of service. The idea to spend this money electrifying the Midland Mainline to make some very tiny time savings didn’t make any business sense to me.

Of course the worst example of all is High Speed 2, which has a very low benefit-cost ratio. We saw road schemes being cancelled in the Comprehensive Spending Review that had a benefit-cost ratio over three times High Speed 2. There is no economic logic at all behind current transport policies.

Chair: We are on rail today, though.

Steve Baker: I would follow it up by asking this question. Isn’t it true that all Government investment decisions, including right across transport, are influenced by politics to some degree?

Dr Wellings: What we have is basically a thinly veiled version of Soviet-style central planning here. It is hugely centralised with the DfT and politicians making the big decisions. This is in a morass of economic distortions from price controls, subsidies and distortionary tax treatments as well. These people just can’t make sensible investment decisions because, first, it is hugely politicised, and, secondly, because we don’t have genuine prices or genuine levels of demand.

Renationalise the railways?

The West Coast franchising debacle has highlighted serious shortcomings in the structure of the railways – but it should not be used to justify renationalisation.

Indeed, the role of the Department for Transport in the scandal shows the railways were never properly privatised in the first place. Politicians and officials retain tight control over the industry, deciding service levels, fares and investment priorities.

Such interventions explain why privatisation hasn’t worked as well as initially hoped. While there have been successes – including a large increase in ridership and better safety – the level of taxpayer subsidies has risen to unacceptable levels (about £5 billion a year).

High subsidies reflect the complex, artificial structure imposed on the industry. Layers of bureaucracy mean costs are far higher than on comparable networks abroad.

Another factor is wasteful investment. Economic objectives have tended to be outweighed by politics and the desire to please powerful special-interest lobbies. The recent decision to electrify loss-making branch lines in Wales is a recent example of this tendency.

Renationalisation would only make these problems worse. It would inevitably lead to even more bureaucracy and political interference. The historical record bears this out. Nationalisation was tried before and outcomes were poor.

Rather than going back to the 1970s, the government should restructure the railways along genuinely private lines. The entrepreneurship and innovation of the private sector should be unleashed to deliver lower subsidies, cheaper fares and better customer service.

November 2012, Director

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.

22 January 2013, LSE

West Coast Main Line row: should railways be renationalised?

In many ways the railways have been successful over the last fifteen years, with significant growth in passenger numbers and freight. Several routes have been upgraded, ageing trains have been replaced and safety has continued to improve.

Taxpayer subsidies have, however, reached unacceptable levels, at around £5 billion a year. And costs are much higher than on comparable networks abroad.

In reality, the railways were not privatised properly. Politicians and officials retained tight control. As the current West Coast debacle shows, the government decides who runs the trains. It also decides levels of service, controls prices and determines the priorities for investment.

This is not genuine privatisation. Rail firms are essentially subcontractors for the state. And the high costs of the railways flow directly from these high levels of government involvement.

In particular, the government has imposed a complex artificial structure on the industry. The railways are suffocated by unnecessary bureaucracy. Highly paid lawyers, accountants, consultants and civil servants have benefited at the expense of taxpayers and passengers.

A further shift toward nationalisation would only make this worse. Nationalised industries are hugely inefficient and quickly become a drain on the economy, as we know from bitter experience in the 1960s and 1970s. Politicians would exert even more control over the railways, squandering money to buy off special interests and wasting yet more billions on uneconomic vanity projects.

In the 19th century private firms built and operated a vast network without massive handouts from taxpayers. A similarly innovative and entrepreneurial private rail industry is the best way to improve outcomes and reduce costs. In particular, the same firms should be free to own the tracks and run the trains, as happened in the past. This is the best way of removing the political interference that is holding the industry back.

4 October 2012, BBC