Is there a free-market solution to overfishing?

Overfishing is often presented as a classic example of market failure. When individual fishing enterprises are competing, the benefits of winning the ‘race to fish’ accrue to the successful ones, while the costs of depletion are shared among all the fishermen in the fishery. There are therefore poor incentives for conservation – the so-called ‘tragedy of the commons’.

This is a simplistic interpretation, however. Market feedback mechanisms offer some protection to stocks. Declining yields will tend to force less efficient fishermen out of business, for example. Providing there is free trade in fish and substitutes are available in food markets, the combination of increasing costs and declining catches may not be offset by higher fish prices. The outcome will partly depend on the species in question. Its scarcity value, reproductive behaviour and migration patterns may affect the probability that overfishing leads to a collapse in stocks.

The history of the fishing industry shows overfishing has been hugely exacerbated by government intervention, in particular subsidies for uneconomic fishing businesses. These handouts have undermined the market mechanisms that would have helped to conserve stocks. The resulting overcapacity – too many vessels chasing too few fish – has strengthened the rationale for costly and bureaucratic regulation of the sector, as exemplified by the EU’s Common Fisheries Policy. As public choice theory would predict, such regulation has inevitably been subject to politicisation and lobbying by special interests, which has meant problems with overfishing have persisted. The creation of artificial property rights by governments, such as the Individual Transferable Quotas used in Iceland, has tended to deliver superior allocative efficiency compared with other forms of regulation, but has not been immune to special-interest influence or indeed discarding.

These problems raise the question of whether an unhampered market could solve the problem of overfishing. Clearly the removal of direct and indirect government subsidies would go a long way towards resolving the issue. However, it would not remove the tendency entirely and both yields and efficiency could still be suboptimal. While collapses would be less likely, they would not be impossible – and there are indeed examples that pre-date direct state subsidies to the industry.

There would therefore appear to be a trade-off between competition and efficiency. This is the case in many sectors, for example due to the ‘transaction costs’ resulting from competition, or because competition means economies of scale are lost (the rail industry is a classic example). Indeed it is a common misperception that unhampered markets inevitably produce a high level of competition. It depends on the characteristics of the sector concerned. One way markets can reduce transaction costs and capture economies of scale is through mergers and acquisitions.

In the fishing industry there are potentially major efficiency losses from competition in the form of the ‘race for fish’, both in terms of wasteful duplication of equipment, fishing effort and the depletion of stocks to suboptimal levels. There may therefore be strong incentives for fishing enterprises to merge or evolve into one large business (which could perhaps be some kind of cooperative) that held a near monopoly over fishing in a particular region. This dominant enterprise would then determine catch levels to maximise returns.

If fisheries remained ‘open access’, how could this structure be sustained? The market solution may be vertical integration. The dominant firm would merge with the harbours and/or the distribution operations in the region and perhaps even the fish processing industry, enabling it to exclude local competitors and to capture economies of scale that would act as a further market-based barrier to entry. Competitors from further afield would face much higher costs to reach the fishery. Nevertheless, initially the dominant firm might choose to deter them by deploying some of its vessels in a ‘race to fish’ in order to drive them elsewhere. Clearly there would be strong incentives to develop agreements between neighbouring firms not to stray into each other’s area of operation, to avoid the costs of such behaviour, and possibly also rules regarding migrating fish.

Subsidies from foreign governments to their own industries could upset this market outcome by artificially sustaining the ‘race for fish’, which raises issues regarding state protection of territorial boundaries within the current system of Exclusive Economic Areas. However, in principle there is no reason why these dominant firms or associations should not straddle existing national boundaries, with their geographical extent evolving according to market conditions.

This analysis also suggests that the state ownership/subsidy of fishing ports and associated distribution infrastructure (resulting again in substantial overcapacity) is likely to be a key factor in hindering a market solution to the problem of overfishing. In some countries there could also be problems with competition rules.

Finally it is important to consider the impact on consumers. The ‘market power’ of the vertically integrated firms would be severely limited. Under free trade they would be competing with fish suppliers from around the world, including produce from fish farms. Moreover, fish can be substituted for other foodstuffs and make up only a small percentage of the overall food supply. And the benefits would be substantial. A market solution to overfishing would deliver major benefits for consumers, with higher yields leading to lower prices and improved quality. At the same time, the inefficiencies, subsidies and special-interest influence associated with state-imposed fisheries policies would be avoided.

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.

 

Is privatisation to blame for high rail fares?

IEA Blog, December 2014

Rail fares per passenger-kilometre are on average around 30 per cent higher in Britain than in comparable Western European countries. In addition, annual regulated fare increases exceeded the Retail Prices Index, an official measure of inflation, by 1 percentage point per year from 2004 to 2013. This is widely held to be a consequence of privatisation: the necessity for private rail firms to make a profit and pay dividends to shareholders meaning that fares must be substantially higher than otherwise would be the case. It is therefore argued that the rail industry should be reformed to help tackle the cost-of-living crisis and secure a ‘better deal’ for passengers.

In May 2014 more than 30 Labour parliamentary candidates called for train operations to be taken over by the government as current franchise agreements ended – a form of gradual renationalisation. Official Labour Party policy does not go quite so far, but would allow publicly owned train operators to compete with private firms. This approach could lead to creeping renationalisation given political influence over the franchising process. There are also calls to introduce a freeze on rail fares or at very least a ‘tougher cap’ on increases.

Proposals to address the cost-of-living crisis by increasing state involvement in rail are based on a series of misconceptions. Indeed, the heavy focus on fares suggests fundamental ignorance of the economic importance of rail to the UK economy. While the average household spends approximately £64 per week on transport, only about £3.30 is spent on train and tube fares. The impact of any fare reductions on the cost of living would thus be trivial. By contrast, policies that reduced motoring costs (c. £56 per week per household), such as cuts to fuel duty and car tax, would offer substantial relief to household budgets.

Another problem for the re-nationalisers is the relatively modest profit margins of the train operating companies, estimated at around 3 per cent of turnover. This implies that the ‘savings’ from no longer paying out dividends to shareholders would simply not be large enough to fund a significant reduction in fares. This conclusion also holds when other privately owned elements of the rail industry are considered.

Additional state intervention in the rail market would also be poorly targeted if poverty alleviation were the aim. On average rail travellers are far better off than the general population. Almost 60 per cent of spending on rail fares is undertaken by the richest 20 per cent of households, who also spend a higher proportion of their incomes on rail fares than poorer groups.

The skewed distribution of rail ridership towards high-income groups severely limits the potential for enhanced price controls to reduce the living costs of those on modest incomes. Indeed, for the population as a whole, more stringent fare regulation is fundamentally flawed as a cost-reducing measure, since what is saved in fares must be paid in additional taxes. Worse still, price controls reduce the efficiency of the rail network by artificially stimulating demand and increasing industry costs. Lack of price flexibility also makes it much harder to make better use of existing capacity. The resulting overcrowding creates political pressure for state spending on uneconomic new rail infrastructure, at additional expense to taxpayers.

Even if they were successful then, the proposals for additional state intervention to moderate rail fares would be ineffective at addressing cost-of-living issues, and in the case of further price controls entirely counterproductive. However, the proposed interventions would almost certainly fail to achieve even their stated objectives because they reflect a flawed analysis of the problems facing the sector.

There are several reasons for the high costs of the rail industry, but ‘privatisation’ per se is not one of them. Firstly, the effects of the history and geography of Britain’s railways should not be neglected. For example, the high share of rail travel involving trips to and from London – a vast and expensive global city – raises costs compared to other countries, even if other factors are held constant.

Secondly, it is misleading to refer to the reforms of the 1990s as ‘privatisation’ without understanding the extent to which the state continued to regulate, fund and direct the industry. Nominal ownership was indeed transferred to the private sector, but key decisions remained with the government. Opportunities for entrepreneurship, innovation and cost-cutting were heavily restricted by regulation. Unsurprisingly, major productivity gains were not forthcoming.

To make matters worse, policymakers imposed a complex, artificial structure on the industry. Contrary to evolved practices, the sector was fragmented, with separate firms managing the infrastructure, owning the rolling stock and operating the trains. These arrangements required armies of highly paid lawyers, consultants and bureaucrats, and also created numerous other inefficiencies.

Under a genuine privatisation model, there would have been strong incentives to reduce these additional costs, for example by moving back to a structure of vertical integration. However, traditional railway industry structures and full private ownership are effectively banned under European Union law. The proposals for part-renationalisation will not address the fundamental flaws in the structure of the rail industry that push up costs. EU ‘open access’ rules limit the options for more radical reform.

Renationalisation policies also risk further undermining the limited opportunities for entrepreneurship and innovation on the railways. The shortcomings of state-owned enterprises are well documented, and include poor cost control, lack of entrepreneurship, susceptibility to political interference and endemic misallocation of resources. In the longer term, these inefficiencies would tend to lower productivity on the railways, resulting in some combination of higher fares, higher subsidies or reduced quality of service. A range of new problems would be added to an already suboptimal industry structure.

Finally, the high cost of Britain’s railways to a large extent reflects wasteful investment in uneconomic new infrastructure. Since the mid-1990s it has been government policy to encourage modal shift from private road transport to public transport. This contrasts with the previous post-war emphasis on the managed decline of rail.

In this context, subsidies and other interventions have artificially inflated passenger numbers, creating a rationale for new capacity. Moreover, government funding helped create a powerful rail lobby with a strong financial interest in extracting additional resources from taxpayers.

Several large rail projects have been undertaken during the ‘privatisation’ era, including High Speed 1 (HS1), the West Coast Main Line upgrade, Thameslink and Crossrail. The cost of these five schemes alone is approximately £50 billion in 2014 prices. While taxpayers have paid the lion’s share of the bill, there has also been a significant impact on fares in some areas. For example, passengers in Kent have seen steep increases following the commencement of HS1 commuter services.

More generally, wasteful spending has contributed to concerns about the taxpayer funding such a high proportion of industry spending, strengthening the case for regulated fares to be raised above the official rate of inflation. Importantly, rail infrastructure projects have typically been heavily loss-making in commercial terms and poor value compared with road schemes. They would not have been undertaken by a genuinely private rail industry that was not reliant on state subsidy. Wasteful investment, and its impact on fares, is the direct result of government policy and should not be blamed on privatisation.

Clearly there are strong grounds for criticising the privatisation model imposed on the rail industry. The productivity gains associated with private enterprise were largely suffocated by heavy-handed regulation; a complex and fragmented structure pushed up costs; and huge sums have been wasted on uneconomic projects. In this context, it is unsurprising that fares have not fallen. However, it is also the case that these problems are symptoms of government intervention rather than the result of privatisation per se. Indeed they would not have occurred had the railways been privatised on a fully commercial basis under a ‘light-touch’ regulatory framework which allowed the organisation of the industry to evolve according to market conditions.

 

A longer version of this article was published in Smoking out red herrings: The cost of living debate.

Why are rail subsidies so high? The lessons from transaction cost economics

Richard Wellings on The Influence of Coase on Economic Policy – The Next 50 Years from Institute of Economic Affairs on Vimeo.

Regulation, not privatisation, to blame for inefficient railways

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

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

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

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

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

24 May 2011, IEA Blog