Transport economics Why is transport important?1

Transport is something we all take for granted. Try to imagine a world where transport was difficult.

Say the average speed of passenger transport was 6 miles an hour and freight 3 miles an hour. How would the world be different?

The situation above was the case in the UK less than 200 years ago. Today we complain if we can’t do 90 mph on the motorway because there are other cars in the way.

Look at the following questions and try to find out the answers from published statistics. (Try the DETR web site at www.dft.gov.uk for statistics.)

How many people work in the transport industry?

How far do people travel each year and for what purpose?

How much freight is moved each year.

Where is the freight moved to and from and how is it moved?

What is the relationship between the demand for transport and the level of national income?

What are the main trends in transport use at present?

Why is transport economics important?

In 1975 there were fewer than ten academic economists specialising in transport. Today there is an A level course in it. Why has the focus changed so much?

One answer is that people have realised that transport is essential to the smooth running of the economy:

If goods cannot reach their markets then people cannot specialise and so overall output and so income would be lower.

If transport is expensive then the price of goods will rise and demand will be less. This will imply lower standards of living. If people cannot move freely around the country their choices are restricted and the quality of their life will be lower.1 Reading - DETR web site, Transport statistics, www.dft.gov.uk, Bamford Ch. 1 & 2

1

These are all reasons why we need a good transport system, but there is another way to look at it. People gave little thought to transport during the period when rising demand for transport was simply met by raising the capacity of the system. Today the system is finding it difficult to cope and the negative effects of transport are evident. Economists only took an interest in transport when it became a problem:

˙ Transport causes negative externalities. Loss of land, noise, pollution, global warming, accidents and blight are all examples.

˙ Congestion is also a negative externality and leds to higher stress levels as journey times take longer.

˙ Demand for transport is rising as more and more people demand their own independent means of transport. The system of roads cannot cope and public transport is seen as an expensive, dirty and awkward alternative.

Transport, like any other sector of the economy, demands scarce resources to use. The question is what is the efficient allocation of resources to transport? If we leave it to the market we are likely to see a misallocation due to the many negative externalities. People want to travel more, however, and so the problem is acute as we reach the limit of the transport system to cope and global warming becomes a more immediate problem.

The nature of transport

Two elements of transport

There are two areas of concern;1. Transport infrastructure2. Transport type.

Transport infrastructure

This refers to the physical and immovable transport routes such as roads, railways and canals. It also includes airports and sea ports as the terminals of air routes and sea routes.The ability of households, firms or government to consume transport services depends on the available infrastructure.

Transport type

This refers to the mode of transport such as walking, bicycles, motor cars, trains, aeroplanes, boats and ships.

2

Together these two factors meet the demand for transport services in the economy. The availability of one does not mean that the transport service can be provided efficiently, e.g. having a car does not help a lot when there are no roads.

In most cases the provision of infrastructure is left to the government because of the problem of public goods and the externalities that transport systems cause, e.g. noise and pollution. The private provision of transport infrastructure is becoming more common, e.g. the channel tunnel, but usually involves government consent.

Trends in transport use

The main modes of transport are;Road, Rail, Water and Air.In each case there are various alternative ways of using the modes and over the last forty years there have been changes in the way these modes have been utilized, and the intensity of their use.

Road transportIn 1996 total motor traffic was estimated at 438,300 million vehicle-km (i.e. total km driven by all vehicles on UK roads.) This represents a large increase since 1950, mainly due to a rise in the use of cars. Road traffic in the UK has grown by 87% since 1980, although it has grown at a slower rate since 1990 than before. In 2007 motor traffic had reached over 110,000 million (110 billion) vehicle-km.

The bulk of road transport use is private cars. In fact motorcycles and pedal cycles have declined in numbers absolutely and bus and coach traffic has declined relatively since 1990. In 1996 68.8% of households had the regular use of a cars, with 23% having the use of two or more cars. At the end of 1992 24.8 million vehicles were licensed for use in Great Britain, by 2007 this number had risen to 34 million, of these 28.2 million were cars.

3

A major change has been the number of cars per household. The data below shows this and explains the rapid rise in car numbers (and so congestion).

These vehicles used 386,631 km of roads of which 3,270 km are trunk motorways. Motorways represent less than 1% of total road length, but carry 15% of all traffic.

The demand for the use of roads is expected to rise rapidly. The traffic forecasts published in 1997 (remarkably the last ones!) suggest that there will be between a 36% and 84% increase in traffic over 1996 levels by 2031. The central forecast suggests a 28% increase in the period to 2010, this was raised to 35% after the scrapping of the automatic Fuel Duty escalator. The largest proportional increase is expected in goods vehicles, but the biggest impact will be made by cars, rising between 30% and 75%, which constituted 82.7% by vehicle km’s. The largest increase in traffic is expected on motorways.

By 2031 93% of motorways and 38% of trunk and principal roads are expected to be at capacity during the morning peak. This implies a 69% rise in journey times on urban motorways, 20% on rural motorways and around 6 - 7% on other major routes. For 2010 the central estimate implies a 65% increase in congestion on 1996 levels.

Transport was until around 1990 a luxury good. Private transport mileage rose faster than GDP, reflecting an income elasticity of demand of more than 1 (1.6 for car traffic and 1.7 for all traffic between 1984 and 1994). As the first chart above shows transport now has a slower growth rate than GDP, implying it is a normal good with an income elasticity of around 0.8. However by 2031 it is estimated that car ownership per head will have risen by 41% over the 1996 level.

Rail Transport

4

In 1825 the worlds first commercial railway service was opened in Britain, the Stockton and Darlington railway. From 1950 to 1991 there was a continuous decline in the use of railways by both passengers and freight, most of it transferring to road transport. Since 1991 demand has been stable, but the market share of rail has fallen to 5%.

In 1843 there were nearly 10,000 miles of track, this rose to 23,000 miles in 1910. Under nationalized control the amount of track and stations was greatly reduced, reducing to 15,000 miles by 1960 and the service is now based on main line, major routes with just 10,000 miles of track once again.

The freight carried by the railways is dominated by bulk commodities, such as coal, coke, iron and steel, building materials and petroleum. Bulk commodities account for 90% of rail freight. The government offers subsidies to encourage firms to move commodities by rail rather than road.

There has been a move back to the railways since privatization where the number of passengers has risen by 50%. The system has struggled to cope with the increased demands, a blow to those who saw greater rail use as a solution to road congestion.

WaterInland waterways are almost all only used for recreation in the UK, but in the EU they are used extensively for freight. The rivers Thames, Forth, Humber and Mersey and the Manchester Ship Canal are the only ones to carry significant amounts of freight.

Sea transport is very important for the UK. 94% by weight and 76% by value of Britain's overseas trade is carried out by sea. The rise in the general level of trade as a percentage of GDP means that ports and sea transport will become increasingly important to the UK economy.

You will see that water transport has increased significantly in the UK since the early 1970’s. This is accounted for by North Sea Oil and does not reflect a general change in transport use patterns generally.

The demand for transport

“Transport is not an end in itself. Its purpose is to move people or goods from place to place.” The demand for transport is derived from the demand to transfer passengers and freight from one place to another. This is like the demand for labour in the sense that labour is derived from the demand for the goods and services it produces.

The concept of derived demand is an important one. A person going to work demands transport because they wish to earn a wage, not because they enjoy the bus ride or drive. A firm of hauliers moves a fridge from Methyr Tydfill to Milton Keynes because someone in Milton Keynes demands a fridge, not because the fridge wanted a ride in a lorry.

5

Transport is an intermediate good in most cases as it is part of the productive process, rather than demanded for its own sake. As such the demand for transport will vary with the level of national income. As employment rises the demand for travel to work will increase, the demand for goods will increase and the demand for leisure activities will also rise (most of which entail travel). The exceptions to this are to be found in areas such as the demand for rail services from train spotters.

The demand for transport takes place over space and time, it is for journeys between two points over a particular distance and take a particular amount of time. However this demand is not evenly spread over the network or time and the result is peaking. Often expectations of time are false.

Factors determining the demand for transport2

Each mode of transport has its own characteristics that make it suitable for particular uses. The table below sets out the main ones for both passengers and freight.It is possible to identify a number of factors that determine the demand for the mode of transport used.

Physical characteristics

2 Ref: Cole. Ch 16

For commodities the choice of mode depends largely on the physical characteristics of the goods. High cost, low volume goods are usually moved by air. Electronic component parts for expensive machines, fashion clothing and food will often be air freighted. (The air courier business is a fast growing sector in the UK.) Low value, high volume goods, such as coal and iron ore are best moved by rail or ship, although road freight is often chosen.

PriceThe demand curve for transport modes will be downward sloping. The lower the cost of transport the more journeys will be taken. Proof of this proposition can be found in the rapid rise in demand for airline journeys when prices fall on a route due to the introduction of competition. For example – Ryanair and easyjet together with other low cost airlines have allowed massive rises in air travel including on routes that failed to be profitable previously and Virgin Atlantic in 1984 raised the number of trips taken from the UK to the USA.

Relative prices charged by different modes or different operatorsRelative prices are very important to decisions on which mode to use. For example when working in London and commuting to work a person has the choice of private car, bus, taxi or train. The relative costs of these will be one factor in making the mode decision.

Passenger incomeThe demand for traveling is income elastic for both business and leisure travel. Business travel has grown a great deal in recent decades, especially due to the growth of international trade. However new technology may reduce the need to travel in the future.

Speed of serviceSpeed is of importance to all travelers, but it is more important to some than others. Thus few holiday makers were prepared to pay the extra costs of flying on Concorde, but some business travelers did. Higher speeds also imply greater efficiency and so if freight can be moved faster by one route than another then the capital employed to move it (the lorry or train) can do more work (make more trips).

Quality of serviceQuality covers a number of different aspects of travel;

frequencystandard of servicecomfortreliabilitysafetyflexibility

Users will make decisions based upon their individual needs. The last characteristic on the list appears to be very important to people when deciding to use their own private

7

transport. Even if a public transport service meets high standards in all of the other categories people will opt to use their own car. (In addition to going when you like you get your own music and don’t have to run the risk of sitting next to the nutter.)

The consumer has to make a choice based on all of these factors. Inevitably it is a trade off between the different factors. Differences in some aspects of competing services can be striking.

For example take a commuter who travels from Milton Keynes to central London to work each day. The commuter has the choice of driving a car, taking a coach or taking a train.

The car requires fuel and parking. The latter is difficult and expensive in central London and now also attracts the London congestion charge. The commuter must also take into account that they will be more tired when arriving at work than on either of the two alternatives.

The coach costs £2000 a year. It takes between 2 and 4 hours to complete the journey ‘door to door’ depending on the traffic. It must be booked in advance. In addition the coach is the least comfortable of the three alternatives.

The train costs £6000 a year. It takes 1.25 hours to complete the journey ‘door to door’ and is subject to the least variation in journey time. There is no need to book.

Which alternative does the commuter pick? Actually different commuters make different decisions depending on how they balance the factors identified above.

Demand patterns not influenced by operators

Peak demandPeak demand in transport operating terms is the period of maximum demand. It affects both freight and passenger services, but more data is available for passenger services. The problem of peak demand is that transport as a service must be supplied when required, it cannot be stored, unlike goods.

Time of dayMorning journey to work 7.30 am to 9.30 am (factories, schools and shops).

8

Day of the weekThere is a summer weekend leisure peak on roads and public transport. Fares reflect this, for example a ‘white’ saver return on Great Western Railways from London to Bath cost £36 on a Friday in 1997, not £27, the cost during the rest of the week. This fare was not available between 4 pm and 6pm when the full fare of £57 is payable.

Seasonal peakSummer holiday traffic. Airlines operate their fleets much more during the summer to cope with demand. School holidays have the biggest effect on peak flows.

All of these factors mean that off-peak travel is offered at much lower cost. Marginal cost of carrying one more passenger at these times is very much lower than average cost. One reason for this is that there is an indivisibility of supply, one a bus, train or aircraft is provided the cost of taking one more passenger is negligible, or the ‘vehicle’ is unable to remain at its destination and must make the return journey.

Changes in social habitsLeisure time has increased as a result of shorter working hours, higher unemployment and early retirement. As a result more leisure journeys are being made.

Foreign holidays have replaced holidays in the UK. Greater car ownership has increased the frequency of short visits, especially to places not well served by public transport.

Out of town shopping centres have had a particularly large effect on transport demand. The improvement in the quality and range of entertainment available in the home has reduced the demand for evening transport.

9

Changes in competitors services or pricesImprovements in services can lead to passengers switching from one service to another. For example the advent of no frills airlines such as easyJet has led to passengers switching away from traditional scheduled airlines and to BA introducing Go, their own no frills service.

Changes in population distributionThe design of urban areas has changed in recent decades. Living patterns are becoming more dispersed, with people moving to suburbs, shopping in out of town centres and leaving the inner cities. With lower population densities it is more difficult for public transport to operate and car ownership becomes even more attractive.

Elasticity of demand3

Elasticity concepts can be applied widely in transport economics. This is not rocket science, just the application of price, cross price and income elasticity to transport issues. It is often so simple that it is missed by students.

Price elasticity of demand

Examples can be seen in situations where the cost of transport falls and more journeys are undertaken. The best examples are seen where operators charge different prices at different times. For example traveling on railways costs less after the morning rush than before, reflecting the downward sloping nature of the demand curve.

Factors that will influence the elasticity of demand are: How essential the journey is. The elasticity of demand for rail travel into London arriving between 8 am and 9.30 is highly inelastic as demand is mainly to get to work. Alternative practical modes. The more alternatives the more elastic is demand for a particular mode of transport, again travel to work in London. Availability of an alternative supplier. Sometimes routes are dominated or controlled by one supplier, thus it is not possible to shop around for a fare and changes in fares have less impact on demand. E.g. Transatlantic air routes were dominated by three carriers until the late 1970’s. Proportion of income transport accounts for. Where transport is a major item of expenditure we would expect the elasticity of demand to be more elastic than when it only accounts for a small proportion. As with other goods many of the factors are interdependent or may conflict.

In fact it is often difficult to find good straightforward examples of price elasticity of demand because of the strong relationship between transport modes as complements.

One example is recent estimates of rail travel PED. These are given below and are probably not a surprise to anyone. However the studies on which these are based found 3 Ref: Cole Ch. 2

10

that quality of service was much more elastic except for commuting. (an increase in quality is expected to lead to a rise in demand so the usual range of PED figures applies.)

Category Inner London Major Regional Quality-city area conurbations services

Non-commuting -0.8 -0.7 -0.7 -1.0 -3.5 to -1,5Commuting -0.3 -0.2 -0.4 -0.5 -0.5 to +0.5Leisure -1.1 -1.0 -0.9 -1.1Source TOC’s 2004

Cross-price elasticity

This can be seen in relationships between operators of the same mode of transport, or between modes of transport. Different airlines are competitors, providing services that are substitutes for each other. Cars are substitutes for buses and trains. Thus a change in the price of one will affect the demand for another. Of course transport has complements too, such as oil the main fuel source,

Estimates of elasticities show that the responses are typically small, i.e. changes in own and related prices do not have very large effects on demand. For example the table shows the own and cross price elasticities for the bus and underground services in London with respect to their own prices and the prices of their competition, underground, rail and buses as appropriate.

1979-85 1991-95Bus Own price elasticity -0.4 -0.62XPED with respect to underground +0.1 +0.13XPED with respect to Rail +0.05 +0.16

UndergroundOwn price elasticity -0.54 -0.49XPED with respect to bus +0.21 +0.2XPED with respect to Rail +0.17 +0.08Source: London Transport

Recent figures for the period 1971 to 2000 showed very similar results.

Income elasticity

This measures the response of demand for transport to changes in real income. In the UK the demand for transport has increased since 1950 as measured by both passenger kilometers and number of trips taken. Demand for freight transport has risen in a similar fashion.

11

Until recently the income elasticity of demand for transport was greater than one, showing transport to be a luxury good. This is no longer the case for transport as a whole, but not all modes have shown the same income elasticity characteristics, with public transport sometimes recording negative income elasticities.

The diagram on page 3 shows how income and transport demand have been related. Up to 1990 an income elasticity of demand for transport overall looks to be around 1, since then it has been positive, but less than 1. Prior to 1970 YED was seen to be greater than 1.

Public transport income elasticity varies by mode and location. London bus YED was recently estimated at -0.54 making it an inferior good and London Underground YED at +0.4. Due to other factors (such as the congestion charge London busses have sen increased use despite this.

Forecasting transport needs4

By using the characteristics of each transport mode, and the tools of economic analysis above it is possible to predict the future transport needs of society.

This was very important in the past when the policy in the UK was ‘Predict and provide’. During this period growing transport demand was met by increased provision, the forecasts telling government how much capacity to build. Today the forecasts show us how transport demand will change if there is no alteration in policy - which will lead to road gridlock - and so how much effect policies must have to prevent this by reducing road demand and moving passengers and freight to other modes.

Forecasting is an inexact science. However without them policy decisions are blind and so we need them to make sense of what we should do. Below is considerable detail of the last major road traffic forecast. The Eddington report published in December 2006 made use of these forecasts, although did update them.

The 1997 road traffic forecasts

The DETR published forecasts in 1997 (the previous ones having bee published in 1989). These forecasts are based on present transport policies including the real increase in fuel duty of 6% per annum until 2002. They are nevertheless restricted to the capacity of the 1996 road network (but with additional access roads to serve net additional urbanisation), with road users reacting to increasing congestion, where that emerges, by changing their travel behaviour. They are, therefore, the result of the interaction of demand with a largely fixed supply of road space.

The forecasts can serve several purposes:

4 Ref: DETR national road traffic forecasts 1997 on DETR web site. Cole Chapter 8.12

they are used as a background for estimating future traffic levels in the design and appraisal of road improvement schemes, and of traffic policies and initiatives aimed at changing the use of the network. Local forecasts specific to the areas concerned are developed for detailed consideration of such schemes and initiatives. Such local forecasts are related to these national forecasts and reflect specific local factors.

the forecasts thereby provide a basis for predicting many of the environmental impacts of road traffic both at the national and local levels;

the forecasts also help to inform the many individuals and interest groups who wish to know by how much road traffic can be expected to grow under present policies and give an indication of the effect of measures that they might propose to influence this growth. (The traffic database and various elasticities underlying these forecasts can be used to analyse the effect of alternative policies which could lead to different rates of traffic growth.)

The forecasts are subject to uncertainty. They are trying to predict the individual decisions of millions. It is possible to make forecasts only because the patterns of car ownership and vehicle use are well determined. There remains a range of uncertainty in the forecasts but, because the underlying relationships have been well determined and stable over long periods. Against this there is the particular difficulty of much transport demand being leisure based and so competition from non-traveling leisure based activities should be considered, but is very difficult to model.

The DfT use a two stage approach to forecasting. They look at factors that are not in their control, namely:

*GDP or Employment* Population

* Car Ownership * Car Fuel Costs * Car Journey Time * Bus Cost * Bus Journey Time * Bus Headway * Air Cost * Air Headway * Underground Cost

They then apply the influence of factors that are within policy control:* Fares* Generalised Journey Time (GJT) incorporating in-vehicle time, frequency and

interchange * Performance

* Non-timetable related service quality (focusing mainly on crowding, station facilities and new/refurbished rolling stock)

13

The system does therefore try to look at the effect of overcrowding on trains for example. Of course many of these assumptions will prove to be false, but represent a ‘best guess’ at the time. The forecasts are updated as and when a better estimate can be made.

The Consequences of the Forecasts

Some consequences of the 1997 forecast growth in traffic is an increasing proportion of urban traffic traveling in a busy direction encounters roads working at capacity or near capacity, and this forms a large proportion of traffic on urban motorways, even during the inter-peak on weekdays. Journey times are predicted to increase considerably, especially on urban motorways, where they are predicted to increase in the peaks by 70% by 2016 and to double in 2031. Average journey times on rural motorways are also predicted to increase substantially, especially in the peaks. The proportion of travel not undertaken on account of the effects of increasing journey times, or cut off by lack of capacity, taken over the week, is not great; the proportion is greatest in the conurbation's. It is to be noted that these consequences are all subject to wide ranges of uncertainty.

Reasons for Traffic Growth

Traffic is forecast to increase mostly because people are expected to become richer, and to enjoy longer lives, because economic activity increases, and because households are forecast to become more numerous. The main single factor leading to traffic growth is increasing car ownership.

Other modes

The forecasts referred to here are for road traffic, the dominant mode of travel for both passengers and freight. The principles of forecasting can be applied to any mode of transport. It is largely a matter of good past data to determine elasticities and forecasts of GDP growth. Assumptions are then made about policy options and capacity.

There seems to be two key lessonsUse the forecasts to monitor predictions against actual figures. This can then inform policy and future predictions.Monitor changes in key assumptions to avoid major policy mistakes (this can apply to private firms as well as governments).

This is an area frequently asked in the exam. Candidates seem to try to avoid it because they feel that their knowledge is too insubstantial. The key is to remember that there is a lot of basic economics here and it also tests knowledge of the nature of transport and transport trends. Be happy to answer the question!

14

Note there is a bigger question that relies on more knowledge, but is based here. Should traffic forecasts be the basis of transport policy decisions. Add ‘discuss’ and the phrase ‘alone’ and there is a major essay question here.

15

Theories of market structure

UK Industry

In the UK most firms are small, and since the 1970’s small firms have become more important to the economy.

Small firms typically have very little market power. There are two types of small firm:

1. Those which simply accept market prices.2. Those who try to give themselves some ‘unique selling point’ and so can have

some influence over price.The first type of small firm can be represented in a model of “Perfect competition”,

the second in a model of “monopolistic competition.”

Perfect competition5

This is a model of how firms which are price takers behave.To draw sensible conclusions about how these firms will behave we must make some

assumptions.1. All firms are profit maximisers.2. There are many buyers and many sellers, none of which can influence the market

by their actions.3. All firms produce an identical product.4. All firms and customers have perfect information.5. There is free entry and exit from the market.

A closer examination of the assumptions

Assumption 1 implies the firm will produce an output where MC = MR.Assumption 2 means that if a firm doubles output there is no effect on market price.

The firm is not large enough to cause a significant effect on the market supply curve and so all firms sell their output at the market price - they are price takers simply accepting the price as given.

Assumption 3 means customers cannot distinguish between the products made by each firm in the industry. (Each firms product is a perfect substitute for all of the others.) There can be no brand loyalty in this market. This condition is often stated as the firms are producing a ‘homogeneous product’.

Assumption 4 means that each firm is fully aware of the actions of its competitors, of changes in technology and of price. Customers also know what each firm is doing and will immediately be aware of any changes.

5 Sloman 6.1 and 6.2 16

Assumption 5 means a firm may enter or leave the market at will and at no significant cost. This requires all factors of production to be ‘perfectly mobile’ as they must be able to switch from producing one good to another as the firm makes a decision.

Market equilibrium

As the firms in this industry are price takers they face a perfectly elastic demand curve. i.e. they can sell all they want at the market price.

In the diagram below the firm will produce the output where MR = MC (q*) and sell that output at the market determined price of 0P*.

Profit under perfect competitionThe firm will generally earn only normal profit. Normal profit is the amount of profit

a firm requires as a minimum to stay in a market. Because it is the minimum requirement it is included in average cost as it represents the opportunity cost to the entrepreneur of being in the industry. If the firm does not earn normal profit then it could move to another market and earn at least normal profit there.

Normal profit: The profit that the firm could make by using its resources in their next best use. Thus normal profit is an economic cost.

The firm maximises profit by producing 0q* and charging 0P*. The average cost of producing 0q* is 0P*. The firm is exactly covering the average cost of production at this price and so earning normal profit.

17

Excess profit

Excess profit (often called ‘supernormal’ profit) is any profit greater than normal profit. It is often referred to as abnormal profit or supernormal profit.

Excess profit: Any profit earned over and above normal profit. It is any return over that necessary to keep the firm in the industry.

Excess profits are competed away in perfect competition as new firms enter the industry to get a share of the excess profits. This is possible because there are no barriers to entry or exit to the market and firms have perfect knowledge and are able to transfer resources without cost.

Returning to normal profit

Suppose that the market price is high enough to allow firms in a perfectly competitive industry to earn excess profits.

The initial market price is 0P1 as this is where the initial supply curve S1 crosses the market demand curve. All the firms in the industry will maximise profits by producing where MC = MR and they will, therefore, earn excess profits. In the diagram the representative firm initially produces 0q1 units of output and earns excess profits equal to the shaded area P1ABC.

18

The excess profits will attract firms into the industry (as they will be presently earning only normal profits elsewhere). This will cause the market supply curve to shift to the right and this will continue until the market price has fallen to 0P* and only normal profits are being earned by firms in this industry.

This process is possible because: There is perfect knowledge on the part of firms. Entry into the market is costless. Factors of production are perfectly mobile. There is no brand loyalty and new firms can find customers at the market price.

In more modern jargon the perfectly competitive market is perfectly contestable. Whenever excess profits are earned the existing firms are unable to prevent competitors from entering the market.

When the price in the market has reached 0P* and all firms are earning normal profit there is no incentive for firms to leave or enter the market. Under perfect competition any excess profits are competed away and any losses will be short lived as some firms leave the market (there is costless exit) to earn normal profits elsewhere (the supply curve shifts to the left raising price back to 0P*).

Monopolistic competition6

It is relatively easy for a firm to step from perfect competition to monopolistic competition. Most of the conditions of perfect competition apply.

1. All firms are profit maximisers.2. There are many buyers and many sellers, none of which can influence the market

by their actions.3. All firms and customers have perfect information.

6 Sloman 7.119

4. There is free entry and exit from the market.

The main difference to perfect competition is that the firms do not all sell an identical product, they are all in some way different from each other.

It may be that the firms all sell an identical good, but they locate in different places. For example many shops sell baked beans. If a customer can buy the beans in a shop in their own road they will not go to a shop two miles away. Thus the two shops are not in perfect competition as the near shop could sell the beans at a higher price but still get the persons custom.

It may be that the firms sell slightly different products, known as differentiated products. The consumer will be able to develop a ‘brand’ preference. In effect each firm is a monopoly supplier of its individual product, but is in competition with suppliers of similar goods which are close substitutes for its product.

Examples of monopolistic competition:Garages, Cinemas, Grocery shops, Newsagents, Garden centres.

Because of the distinct difference between the products each firm faces a downward sloping demand curve. Unlike in perfect competition where a firm will lose all its customers if it raises price brand preference or location allows a monopolistic competitor to keep some of them. When a firm is making excess profits in this market because of free entry and exit they will be competed away. The diagram below shows a monopolistically competitive firm earning short run excess profits (P*ABC).

As there is perfect knowledge, free entry and exit and mobile factors of production new firms will enter the market. Each new firm will take part of the market supplied by existing firms. This results in the shifting of the individual firms demand curve to the left. New firms will continue to enter the market until only normal profits are earned (price = average total cost).

The firm is earning excess profits and finds that new firms enter the market pushing its demand curve to the left. The process continues until only normal profit is earned by

20

the firm at price 0P2 while producing quantity 0Q2. Note that the firm is producing less than in perfect competition and at a higher price. (The perfectly competitive firm would produce at the price and quantity where the average cost curve was at its minimum.) For this reason monopolistic competition is said to be inefficient when compared to perfect competition as consumers pay more and production costs are higher than necessary.

Monopoly7

A monopoly is a market supplied by a single firm. There are no close substitutes for the firms product and there are barriers to entry to new firms entering the market.

Few markets comply with this definition of monopoly. Often the Post Office letter delivery service is quoted, however a fax is a substitute to a letter. Electricity and gas supply were often used examples, but today there is competition in these markets (an important point, a monopoly situation need not last forever).

The Competition Commission can investigate a firm with more than 25% of a market, such firms do have market power, but are not pure monopolies.

As in a pure monopoly; there is only one supplier of the good. there are no close substitutes. there are barriers to entry. the firm is a profit maximiser.

They can earn excess profits in both the short and long run. The firm will operate where MC = MR. At this output they will charge as high a price as the market will allow (i.e. as dictated by the demand curve). Thus it is often said that the monopolist can choose the price or quantity but not both as when one is decided the other is dictated by the demand curve.7 Sloman 6.3,

21

As the only supplier the monopolist faces the market demand curve.

The diagram shows a monopoly supplier in short and long run equilibrium. The monopolist charges price 0Pm and produces quantity 0qm, earning excess profits equal to the shaded area. Because there are barriers to entry in a monopoly no other firms can enter the industry to share in the excess profits and so the monopolist continues to earn excess profits in the long run.

Barriers to entry

Anything which prevents a firm from moving into an industry which is earning excess profits is a barrier to entry. We can identify three types of barrier (the descriptions are mine, not necessarily industry standard terms).

1. Legal barriersPatents or copyrights: These prevent any other firm from copying another’s ideas.E.g. The copyright on ‘Modern Economics’ means nobody else can publish the

material in it until 50 years after the death of myself and David Heathfield.A patent is a right granted in law to have exclusive control over a new invention for a

certain period of time. No one can produce the good or use the technology without payment. For example Polaroid successfully sued Kodak when they produced an instant camera in the late 1970’s.

Nationalised industries: Government owned they are often state monopolies. The law prevents any other firm from entering the industry.

Regulated industries: The law allows private firms to operate in the industry, but only under certain rules or with a licence. Many nationalised industries were privatised and became regulated industries between 1983 and the present. E.g. British Telecom, British Gas.

22

2. Technical barriersThis would include the scale of production necessary to compete in the market. A

high minimum efficient scale implies a high capital outlay which many firms cannot afford. (They may feel that they cannot afford to leave the industry if they did enter as the high capital outlay could not be recovered, known as ‘sunk costs’.)

Established firms have several advantages in a market:Brand loyalty Enhanced by advertising and product differentiation. A

new firm has no following and must match the existing firms advertising to gain even a foothold.

Lower costs A new firm will have to ‘learn’ how to produce a good. They will not achieve ‘best practice’ for some time.

Control over suppliers A new firm may find it difficult to convince suppliers to deal with them if this would mean losing the custom of an existing firm upon which they can rely for a certain volume of trade.

Take over threat A monopoly usually has large resources that would allow it to take over potential competitors.

3. Natural barriersSome industries are described as natural monopolies. The nature of the industry is

such that having more than one firm would be wasteful.The best known examples occur where economies of scale are realised at all levels of

potential output for the market (i.e. no matter what the price the industry never demands enough to allow the supplier to reach even constant returns to scale). Such a situation arises in the railway industry.

If two tracks are laid between two cities fixed costs are doubled, yet the tracks are idle most of the time. The more trains that run the lower average total cost becomes.

23

A monopolist can earn excess profits at any output between a and b. If there were two firms each supplying half the market neither would be able to cover their costs.

Other examples of natural monopolies are gas, electricity and water. In each case it is wasteful to have more than one distribution network.

Oligopoly8

Most industries operate in a state of imperfect competition, the vast majority of which would be characterised as oligopolistic. For a market to be considered an oligopoly it must possess the following characteristics:

Supply must be concentrated into the hands of a relatively few firms. For example 4 or 5 firms control 80% of the market with the remaining 20% shared between many.

There must be significant barriers to entry that prevent new firms joining the market to share excess profits which oligopolists usually earn.

Firms must be interdependent. the actions of one firm in the industry affects the others. For example, if a firm cuts price they will gain market share and so prompt a response from their competitors.

Firms recognise their interdependence and will act accordingly. However there is no single outcome because it depends on how the firms view each other and their likely reactions.

A number of features characterise oligopolies:

Non-price competition. As a change in price downwards will often lead to retaliation by competitors this is avoided. If all firms cut price they will gain no market share (although they may all sell more) and lower profit margins. Therefore competing on advertising, special offers and building brand loyalty is safer. Such measures are likely to bring a response from competitors, such as advertising more themselves, but this may lead to an overall rise in the size of the market to the benefit of all.

Firms collude. Recognising that price wars achieve nothing and preventing new firms entering they market is more beneficial than competing among themselves may lead to firms co-operating on pricing and output decisions. Formal agreements are called cartels but are generally illegal as they eliminate the benefits of competition. Informal agreements (tacit collusion) can also exist and are very hard to prove.

Price leadership. This can be a form of tacit collusion, or a habit that firms simply follow. The largest firm may simply be followed by the rest of the industry (dominant firm price leadership) or one firm is seen as the best indicator of market conditions and followed by the rest (barometric firm price leadership). This type of behaviour eliminates the need to cut throat competition and is a very cosy arrangement. 8 Sloman 7.2,

24

Competition authorities will try to eliminate it by opening up markets to new competition, they can rarely prove collusion.

Overall these features lead to remarkable price stability. Often price rises can be traced directly to rises in average costs rather than changing competitive positions. However this may not be due to deliberate policy by the firms in the industry as the following model shows.

The Kinked Demand Curve Theory

Interdependence is the key feature of oligopoly markets. The actions of one firm will affect their competitors and will prompt a reaction. Because of this firms might act in a way that avoids conflict.

Suppose that each Oligopolist believes that if the firm raises its price in order to raise profits none of the rival firms will follow and will keep their prices the same. This will lead to some customers switching to their rivals as they are now relatively cheaper. In other words the firm believes that the PED of a price rise will be elastic.

However the firm also believes that if they reduce their price in order to gain market share then rival firms will react aggressively to protect their own market share and lower prices as well. While the total sales in the market will rise, due to the law of demand, each firm will only gain a small number of extra sales. PED for a price fall is inelastic.

25

In the diagram the Oligopolist charges price 0P1 and sells quantity 0Q1. It believes that the demand curve is kinked at price 0P1, being more elastic at higher prices than lower prices. This is essentially the combination of two demand curves which meet at 0Q1. However the marginal revenue curves for those two demand curves don’t meet anywhere near 0Q1 and so there is a gap or discontinuity in the MR curve of ab.

As we know maximum profit occurs where MC = MR. The Oligopolist is a profit maximiser. However there are a range of marginal costs that allows MC to equal MR and so the firms in oligopoly will absorb rises in costs and still be profit maximizing in this model. As a result the price in the market is stable for two reasons – tolerance to cost changes and fear of competitors reactions.

Game Theory

The most difficult aspect of oligopoly is that no two markets are the same. The kinked demand curve model describes a market where there is little price competition, but there may be fierce non-price competition (but there may not be). In other markets there may be price competition.

Game theory has been used to model oligopolists behaviour. When there are two firms in the market they have to consider how their price changes will affect the other. This is a ‘game’ in the sense that the outcome is uncertain, but the aim of the game is to maximize profit. Usually we show game theory by using a two firm example.

Here both firms are initially charging £2, each making £10m profit. Firm A considers lowering price to £1.80.

There are two potential reactions from firm B. They can keep price at £2 and suffer a fall in profits to £5 million, while Firm A makes £12m Or they can match the price change, leading to each firm making only £8m as they fail to gain market share, but sell at a lower price.

26

In this example Firm B can also initiate the price drop with the same possible reactions from A. There is no reason in reality why there is such symmetry. For example where there are two bus companies and one has 80% market share they may have much less sensitivity to the price change of the rival firm. Also there are often more than one firm (difficult to represent in this format). For example easyjet and Ryanair can change prices and affect the market more significantly than BMI.

The essential point comes back to interdependence of firms. Game theory is an excellent way to represent this and can be extended to more complex situations.

Collusion

Collusion can occur in oligopoly markets. This is where firms try to act in a way that jointly maximizes profit.

This can take many forms, but examples include agreeing on prices so that all firms make a profit and there are no price wars and agreeing on which firm can operate certain routes without competition from other firms. Such agreements are illegal when they are formal.

Sometimes collusion is tacit, or unwritten. Here firms agree, perhaps in a bar at a trade conference, that they will act in particular ways. This is still illegal and the Competition Commission has taken action against firms who even share cost and pricing information.

It is very difficult to distinguish between tacit collusion and a Nash equilibrium. A Nash equilibrium may arise as each firm realises that if it acts to maximise the return to the group - the firms in its industry - and all the others do the same then they will collectively maximise their return. If they simply pursue their own maximum profit they may be competed out of the market, or at the least end up in a damaging price war. Hence firms may appear to be colluding, but they are just smart enough to realize their own best interest.

Transport markets have a number of examples of oligopoly. In air transport there are a number of large players on short haul, and in long haul there are now three major ‘groups’ which includes the ‘Oneworld Alliance’ that includes British Airways. The local bus market contains five large groups, three of them controlling 57.4% of the market.

Concentration ratios

The concentration ratio is the measure of how much of a market is controlled by the biggest firms. Oligopolies of course have a high concentration ratio.

27

The most common way to represent concentration ratios is a 3, 4 or 5 firm concentration ratio. A 3-firm concentration ratio tells us what percentage of the market the biggest three firms account for, a 4-firm ratio the top four and so on.

Consider the bus market.Firm Market share 2007 Concentration ratioFirst Group 23%Stagecoach Group 17.8%Arriva 16.5% 3 firm 57.4%Go-Ahead Group 9.3% 4 firm 66.7%National Express 5.1% 5 firm 71.8%

Concentration ratios need to be used carefully. Here the top three firms dominate and so the 3–firm ratio gives a clearer picture. The 5-firm ratio fails to show that National Express, the 5th player, is quite a small player. Also the ratio tells us nothing about market size, just share and also fails to tell us if the market is growing or if one firm is becoming more dominant.

Contestable markets9

The theory of contestable markets was introduced to try to explain firms behaviour without the need to characterise markets as one of a range of theoretical models that were not exactly appropriate. One of the reasons for this was that there were monopolies and oligopolies that did not earn excess profits and restrict output as the models suggested. Indeed they kept prices low and provided good service to customers.

The theory argues that the behaviour of firms in a market depends upon whether there is a real threat of competition. A market is said to be contestable if there is the potential to enter the market. For example in the rail industry a ‘Train Operating Company’ is awarded the franchise to run a line. That TOC is the only supplier of rail services on that line - a monopoly. They could raise prices and provide an infrequent and dirty service. However the next time the franchise is awarded they may lose it to another company, thus despite being a monopoly they offer reasonable prices and a good service.

For a perfectly contestable market the costs of entry and exit must be zero. If there are no barriers to entry then any excess profits will be competed away by new entrants. Thus the threat of new entrants means existing firms will operate at or close to normal profits.

Why are the markets with low barriers to entry that are dominated by large firms? The answer here usually lies in the cost of exiting the market. If a firm can enter the market and, if unsuccessful, leave taking all of its capital with it to use elsewhere then there is only a small penalty for trying to compete in the market. Consider a firm that must purchase specialised capital equipment to enter the market and that capital is 9 Sloman 6.4

28

useless in another market. All of this capital expenditure will be lost if the firm leave the market and the cost to the firm is considerable. Costs such as these are called sunk costs and are defined as costs that cannot be recouped.

Where high sunk costs exist firms will be deterred from entering. Thus the behaviour of a firm in an industry will depend no upon how many firms are presently in the industry but on the potential for new entrants and the size of sunk costs. A monopolist may fear that the potential for entry is high and decide to deter entry. They could advertise heavily, reinforcing brand loyalty or promote the public image of the company by sponsoring sports events etc. for the same reason. They may even charge lower prices to limit entry.

Contestability in transport

The air travel industry is often quoted as an example of a contestable market. It is dominated by large firms, but they can divert their resources to new routes at little cost, thus entering another market. If the route is unprofitable or another route becomes more profitable they can switch the aircraft to that route. It is possible that airlines will just make normal profits in this market structure without being in perfect competition. The example is flawed because in reality certain routes are too congested to enter and landing slots are strictly controlled at airports so new firms find it difficult to enter.

The privatisation programme in transport was designed to make these markets more contestable. The railways, for example, were broken up so that TOC’s did not have to buy expensive rolling stock (they hire it from specialist companies) or invest in track or stations (they hire these from Network Rail). Therefore a TOC can leave the industry quite easily and must beware rival firms bidding for and obtaining their franchise when it is up for renewal. The UK railway system is not perfectly contestable, but is much more contestable than it was under nationalised BR, a state monopoly, and more contestable that a system of regional railways where the firm had to own and run the track and rolling stock too.

Below is a summary of UK transport and contestability. It is debatable and so we must be careful when using it. For example barriers to entry are not so high in air transport that Ryanair could not become the largest European airline (overtaking established BA and Leufthansa) in terms of passengers carried from foundation in 1985 with a single route. However barriers in air travel are high compared to taxis.

Barriers to Entry High Low Rail passenger services Contract logistics Road haulage Rail freight

Franchised bus services Taxi services Air transport

Bus services in urban areas Coach services Ferry services Rural bus services

29

Low contestability High contestability

Monopoly as a market failure10

A perfect market is both allocatively and technically efficient in the short run and the long run. As such perfect markets are the ‘ideal state’ against which other market forms can be compared.

Monopolies are sole suppliers of a good, and so face the market demand curve. They try to maximise profit (producing at the level of output where MC = MR). If we compare long run equilibrium's of monopoly and perfect competition we find a loss of consumer surplus under monopoly and that monopolies are not efficient in an economic sense.

The loss of consumer surplusAssume that in the relevant range of output costs are constant, i.e. LRMC = LRAC.The monopolist produces where MC = MR, the perfectly competitive industry

produces where market supply (MC curve) = market demand (AR curve).

Monopolist Perfect competitionPrice 0Pm 0PcOutput 0Qm 0QcConsumer surplus ABPm ACPc

Under monopoly there is a “welfare loss” of consumer surplus of PmBCPc (the red and green shaded areas). The lost surplus is partly transferred to the monopolist in the form of excess profits (red box), the rest is lost to everyone as output Qc - Qm is not produced. This complete loss is known as dead weight loss (DWL) (green shaded triangle).10 Sloman p304-5

30

Productive and allocative inefficiency under monopoly

The diagram used for consumer surplus was simplified. A more complex one is needed here.

Monopoly Perfect CompetitionPrice 0Pm 0PcQuantity 0Qm 0QcProductive efficiency? No. AC > min AC Yes. AC = min ACAllocative efficiency? No. Pm > MC Yes. P = MC

Monopoly is productively inefficient because it produces output 0Qm at an average cost higher than the lowest possible (ACmin at point B).

Monopoly is allocatively inefficient because it sells its output at 0Pm which is greater than marginal cost. The marginal cost of 0Qm is at point C, perfect competition operates where P = MC and AC = min AC (point B).

Knowledge of productive and allocative efficiency is required. However they are simple concepts to apply.

Productive efficiency: Operating at the lowest point on the lowest possible average costs curve.

Allocative efficiency: Operating where marginal cost equals price (MC = P).

How bad are monopolies?If the welfare loss due to monopolies is very great then governments could take action

to prevent them, or reduce their power. But there is also a case to be made for monopolies.

31

Consumer surplus

Economists have tried to estimate the dead weight loss due to monopoly power. As all but perfectly competitive firms face downward sloping demand curves the DWL triangle appears in all markets.

Harberger (1954) estimated the loss at 0.1% of national income. Subsequent refinements of his method suggest the figure for his data was much higher. However this still represents a very small loss.

Cowling and Mueller (1978) estimated the loss at 4% to 13% of Gross Corporate Product, depending on how the loss is estimated. If they are correct the loss is significant.

Many claim that even if DWL is high the cost if intervening in the market to correct this would be as high or higher.

A monopolist with no economies of scale charges more and produces less than a perfectly competitive industry. A monopolist that gains economies of scale may produce more and charge less however. If supply under perfect competition is given by Spc, while the monopolist faces the marginal cost curve MC’ then consumers gain consumer surplus PcABPm’. Even though the monopolists price is greater than marginal cost the consumer is better off.

Thus technical and allocative efficiency may not result in the best possible outcome for consumers.

Contestability and efficiency

32

One of the arguments for making markets more contestable is to encourage allocative and productive efficiency. Fear of competition will cause a firm to cut out waste and also price efficiently as they try to meet consumer needs. A pure monopoly that does not have any contestability will therefore have larger welfare losses than one that is contestable.

Monopolistic competition and oligopolies

Both these market forms result in an inefficient allocation of resources because P = MC is not achieved and the firms do not operate at the bottom of their average cost curves.

The loss of welfare due to monopolistic competition will not be as great due to the larger number of firms and ease of entry into the market. Under oligopoly the result in a profit maximising industry with barriers to entry can be just as bad as monopoly. If the oligopoly market is highly contestable then losses may not ba as bad as theory suggests.

Dynamic efficiency

It has been argued (by Schumpeter) that monopolies and oligopolies are good for an economy because their large profits can be used to finance research and development (R&D) and so growth and innovation proceed at a faster pace. These dynamic gains outweigh the static losses, according to Schumpeter, especially as most industries are oligopolies and so wish to keep one step ahead of their rivals.

The truth of this argument may rely on how contestable the market is. The more contestable the greater the dynamic gains.

Natural monopolies

A natural monopoly occurs when it is only economical for one firm to operate in the market. In such cases it is not possible to apply the Price = MC rule. E.g. industries with large infrastructures such as railways or electricity distribution.

33

Whenever price = MC the firm makes a loss. Given the position of the demand curve there is no single price where the monopolist can even cover costs.

There are several possible solutions.1. Nationalise the industry.The state runs the industry in line with social objectives (e.g. greatest output) and

covers the loss from taxes.2. Allow the firm to operate by regulating prices. For example it may charge a certain

price to customers and receive a ‘public service’ grant.3. Allow the monopolist to charge different customers different prices. This is known

as a discriminating monopoly. It is a matter of contention if such practice is good or bad.

Price discriminaion

Price discrimination in transport can be very useful. In the case of natural monopoly this allows the firm to make a profit where none could be made otherwise. This is applicable I the rail industry where fixed costs are very high if operated as a single firm. So by charging different prices the firm maximizes revenue.

Perfect discrimination involves separating out each consumer and finding out what they are willing to pay for the product

In this way – consumer surplus can be extracted and turned into revenue

34

Here the firm charges three different prices to different consumers. Total revenue is equal to the area of the three rectangles (0P3 x 0Q3 + 0P1 x Q1-Q3 etc). Any single price reduces revenue and in natural monopoly means a loss.

35

The key element here is that each consumer, or group of consumers, must not only be prepared to pay different prices, but they must not be able to trade with each other. Thus the person paying price 0P2 must not be able to resell their ticket to someone prepared to pay 0P3.

Transport applications of price discrimination

One of the most important features of transport is peaked-demand. For trains and busses there are times of day when demand peaks, for airlines there are times of year when demand is much higher than normal.

It is possible to price higher during times of peaked demand. This is both profit maximizing and, in the case of rail and busses, a way of smoothing the peaks in demand by persuading people to travel at different times.

The problem transport industries face is a strict limit on supply. The firms have so many busses and aircraft and so much capacity on a railway line. Once demand exceeds this capacity there is nothing they can do in the short-run (and that can be a long time!).

However there is spare capacity at off-peak times. If the firm charged just one price they would find demand was very low in off-peak times. Therefore they charge less then, whilst still equating MC to MR, maximizing profits in both periods.

The real transport situation is more complex than the diagram suggests. Airlines charge many prices on the same flight making it essential you never ask the person next to you how much they paid – someone will be upset and it ruins the movie.

The discrimination works because there are strict times when tickets are valid, or in the case of airlines named, non-transferrable, tickets. Technically to discriminate there must also be different PED’s in each market ‘segment’.

36

Price discrimination in this sense is almost unavoidable in transport. Capacity constraints demand it. However some people would be concerned if transport was entirely profit driven and unregulated when contestability was weak as consumer surplus will be eroded considerably.

Examples of price discriminationBritish Rail: Young persons railcard, senior citizens railcard. Peak tickets for travel

before 9am, weekend and ‘supersaver’ tickets.British Airways: Up to 60 different fares charged on the same flight.

Transport costs and pricing11

Transport costs

As with all goods the possibility exists for two type of costs to occur;Private costs - the direct costs of using transport to the person consuming the service e.g. the fare on the bus or the fuel and running costs of a car.External costs - the costs imposed on others by the private consumption of transport, e.g. noise, pollution and accidents.Together private costs and external costs yield the total social cost of transport.

Costs in transport are very unusual because of the nature of transport. The non-storable nature of transport services and the different methods of providing and financing infrastructure and moving units in each mode of transport make it a more complicated matter than for most industries.

A transport service provider faces very different types of costs to the user of private transport, leading to very different decisions. Further the costs faced by users are not always the total costs of transport.

The optimal allocation of resources occurs where marginal social cost is equal to marginal social benefit. This is shown in the diagram below.

Price£

Marginal private cost

MPB = MSB0 Q

*Q1 Quantity

Marginal social cost =MPC + Marginal external cost

External cost of last unit produced

11 Ref: Bamford Ch. 337

If there are no external costs then the market will clear at quantity 0Q1 and this will represent an optimal (allocatively efficient) allocation of resources. In the case of transport this optimum does not occur in free markets because external costs do exist.In the diagram, assuming that the private marginal benefit is the same as marginal social benefit, the market would provide output 0Q1, but marginal social cost would exceed marginal social benefit. The optimal allocation of resources occurs at 0Q* where MSC = MSB.This suggests that there is a case for government intervention in transport markets.

Classifying private costs

Private costs can be subdivided into;Fixed costs, Variable costs and terminal costs.

Fixed costs - Paid in the short run in transport these usually consist of the costs of making transport vehicles available for use. In the case of railways and airports there are also capital costs such as track and airports.

Variable costs - these depend directly on how the transport vehicles are used and the level of service available.

Terminal costs - Costs at the end of journeys or service or when passengers or more usually freight moves from one mode of transport to another or move vehicles. Usually accounted for in fixed costs as far as firms are concerned.

The table below shows the main costs for each mode of transport.

The ability to identify and allocate costs between these categories has assumed a new significance since the privatisation process began in the UK. Companies wishing to bid to run bus or train services have to be able to find ways of controlling and reducing

38

costs if they are to be successful. Failure to manage costs properly or failing to understand the breakdown of costs may lead to lost franchises or losses.

Marginal costs are usually the most difficult to measure. Marginal costs are by definition made up of variable costs, as output (miles traveled or passengers carried) rises then so do variable costs. The marginal cost of transport is the addition to total costs of the extra mile traveled or the extra passenger carried or the extra tonne of freight carried. (The best way to measure this would be tonne km or passenger km.)

The problem is that as there are external costs involved measuring marginal costs is difficult. For example every extra road user imposes a cost on all other users because their journey takes a little longer (lost time) and leads to extra private costs (more fuel).

Economies of scaleThe breakdown of costs between these categories is important. Where fixed costs are high a natural monopoly can be the only solution. For example fixed costs make up a significant proportion of the cost of railways. The operation of railways demonstrate significant economies of scale, the more trains that are run over the tracks the lower average total cost becomes.

The table below gives an example of economies of scale in lorries.

The sources of economies of scale in transport can be complicated. There are essentially two sources:

Larger fleets e.g. Savings on purchases of equipment, fuel etc.Savings on maintenance.

More passengers e.g. More efficient use of vehicles.Fewer employees per passenger/tonne freight.

39

In addition a higher market share will allow a transport service provider to rationalise the use of its fleet and cut administrative overheads.

Economies of scale can be measured in various ways, for example:Cost per vehicle kmCost per passenger kmCost per tonne kmPassengers per employeeTonnes per employeeCost per vehicle

Load factors become important in passenger and freight transport. The load factor is the proportion of seats/volume actually taken up. In the airline industry fixed costs are again very high (the cost of hiring the aircraft) and so it is important to fill the aircraft even if the contribution of the marginal passenger is only a little over the marginal cost of taking them. This often leads to price discrimination and is examined later.

External costs of transport12

It is possible to identify numerous external costs;Air pollution - particularly from road transport. CO2, lead etc.

Noise - particularly a local problem, from nearby roads, railways or airports.

Human health effects - from reduced exercise as well as above.

Damage to buildings - by traffic vibration.

Traffic congestion - this delays travelers and raises the costs of business by longer hours and higher fuel costs.

Scenic degradation - transport systems can ruin the natural beauty of an area, also they can reduce the earning potential of an area. Linked to this destruction of wildlife.

Loss of sites of scientific interest or historic sites - to ease traffic flow or provide infrastructure routes are often chosen that include the cost of the loss of such sites, e.g. Twyford down, and the Newbury bypass.

Accidents - loss of life, costs of medical care and damage to property.

Breakdown of communal values - through separation of people into private transport and possibly by busy roads e.g. Bentley.

Environmental damage from fossil fuel - Transport accidents e.g. Amoco Cadiz and effect of oil exploration.12 The Road from Inequity, Mumford sections 1 and 2

40

Global warming.

Such problems have led to calls for a change in policy on the part of the government.

The economic argument behind the Commission recommendations is the existence of negative externalities. The estimated value of such external costs due to transport in the UK has been put at between £9.9 and £18.3bn. Estimates for the EU have been put at 2% of GDP due to traffic congestion, accidents a further 1.5% and air pollution 0.6% - a total of 4.1% of EU GDP. This is over 320 billion Euro’s. A similar figure has been estimated for the US. These estimates look increasingly optimistic.Certainly transport accounts for a significant proportion of CO2 emissions.

The value of external costs of road use

Valuing external costs is very difficult. In cost-benefit analysis it is usual to set the value at what people are prepared to pay to avoid the external cost. This tends to reflect the ‘ability to pay’ rather than a ‘willingness to pay’ (so high income areas will suggest higher costs in surveys) and is subject to great inaccuracy due to measurement difficulties.

We can measure the ‘ex-post’ costs of externalities - the actual costs to society of the externalities much more easily. The table below gives Mumford’s estimates for 1999.

41

Congestion costs dominate and refer to higher delivery costs and lost time. Most of the costs in the table occur in urban areas and so while the value of £25bn implies a cost of 5.6p per vehicle km the distribution of these costs is not at all uniform.

The next two tables show how widely the differences in external costs vary between locations and use. These are only estimates and they are subject to significant estimation error. Even taking this into account they show that driving in built up areas at peak times imposes significantly (50 times) more costs than driving on motorways or in rural areas for cars with an even bigger differential for HGV’s.

Taxation of road users

The solution to the problem of externalities is often the imposition of an indirect tax. This is shown below

42

Price£

MPC

MPB = MSB0 Q* Q1

Quantity

MSC MPC + tax

TaxP1P*

C

The tax imposed raises the market price of transport to 0P* from 0P1 the price charged without intervention. As MSC = MSB at this new level of output (0Q*) the allocation of resources is allocatively efficient. This is known as internalizing the externality - the full social cost is now reflected in the price paid by the consumer.

There are two main problem: Estimating the social costs and benefits involved. Differentiating between the road users that cause externalities.

In 1999 road users paid £26bn more in tax than was spent on roads. This represents a cost, as stated earlier, of 5.4p per vehicle km. According to Mumford’s figures an HGV driving through an urban centre at peak times imposes 87p of external costs on society for each km traveled, but a private car traveling in rural areas imposes just 0.8p of external costs. Thus a single tax policy will fail to reduce the demand sufficiently in urban areas and will penalise those who live in rural areas.

Who pays for the infrastructure?

This is known as the track costs argument. Confusingly it is applied to roads not rail, but is concerned with who pays for and who benefits from the provision of roads. In the case of railways it is fairly easy to see who should pay for the provision of track, but who should pay for the roads and their maintenance.

The track costs are;Construction costsMaintenance costs

The payments made are in the form of;Fuel taxCar tax (on new cars)Vehicle excise duty (the Road fund licence)

43

Value added tax

Originally the road fund licence was seen as a fund from which road network improvements could be financed. In the technical jargon it was hypothecated for road building and ongoing maintenance. The link is no longer made.

Cars and light vehicles paid 3.7 times more in tax than the track costs associated with them in 1994/95. Heavy goods vehicles paid only 1.4 times more than the costs due to them.

Due to externalities it is argued than private cars should pay more (even more) to use the roads, but that as heavy goods vehicles are production related they should pay less, i.e. just their track costs.Public transport reduces the level of negative externality and so should be encouraged with lower taxes or even subsidies.

The recent rise in the excise duty on fuel has led to widespread objections from the road haulage industry which has included protests on the roads around London. This reflects how difficult it is politically to deal with the problems of transport. As Table 9 in Bamford shows HGV’s pay a proportionately lower amount in tax than private cars compared to track costs.

Pricing transport servicesAs we have seen there are a considerable number of sources of external costs in transport. This makes the pricing of all transport services difficult.

The main problem is that the user has no idea of the full social costs of a journey. However for private transport the private cost of a journey is often not apparent either.

Consider the following situation:A couple are going from London to Birmingham for the weekend, a journey of 115 miles. In 1992 the train fare (cheapest possible) is £23 each (£46 in total) while the cost of taking the car is £11 of petrol (remember 1992 prices).

The train fare includes a contribution to the fixed costs of the railway while the petrol cost is only the variable cost of the car journey. When the cost of car servicing, depreciation and a contribution towards insurance are included the cost of the journey based on average mileage and a Peugeot 205 is £41.

The user of the car will be unlikely to look at the cost of the journey in this way. To them the annual running costs of the car are given, even though they do vary with milage. A rise in the cost of petrol to £16 would make it just as expensive to drive, but it is very unlikely that many drivers would decide to take the train as it is much more difficult to do so (fixed departure times and getting to and from stations rather than going door to door).

44

Price discrimination

In the area of public transport there are considerable economies of scale to be gained. This is largely due to the existence of constantly falling cost curves in the rail industry. Efficient pricing in the sense of allocative efficiency (Marginal cost = price) is, therefore, impossible. In the bus and rail industry there are many empty seats at off peak times and filling these seats, increasing the load factor, will lead to lower costs per passenger km. In freight the same argument applies, raise the load factor and reap economies of scale by reducing the cost per tonne km.

Price discrimination has been used to solve this problem. This is a situation where a firm charges different prices to different groups of consumers for identical units of supply. It is based on a principle of charging ‘what the market will bear’ and relates to differing levels of elasticity.

Constantly falling cost curves

The diagram shows the difficulty faced by an industry with a natural monopoly. If more than one firm operates in the market then the demand curve shifts to the left of ATC, making it impossible to charge a price that covers costs. If the demand curve lies to the right of ATC for any distance then it is possible to price to make a profit, but not where Price = marginal cost. At the output 0Q1 if price is set at marginal cost a loss of C1C2ab is made.

Price/costs

0MC

ATCD = AR

C1C2

P1

Quantity0Q1

a

b

A monopolist could charge 0P1 for output 0Q1 and make a profit.

The transport market is not always that simple. British Rail find that due to competition on some routes and in some markets they face widely different elasticities of demand for train use. Also covering costs is not as simple as in the diagram above (i.e. the demand curve lies closer to the ATC curve).

45

The solution to the problem is to discriminate between customers to allow the overall service to make a profit when charging one price would not.

The price elasticity of demand for some rail services is highly inelastic, for example business travel to London and commuting to major cities. This is because there is little competition from other forms of transport (such as cars). It is possible to charge high prices on these routes.

The market for travel for holidays and visits is much more competitive. Time of travel is not so important and so cars and coaches provide stronger competition. The price elasticity of demand in these market segments is elastic. It is necessary to offer lower fares in these markets, and so raise the capacity utilization of the service.

Due to the nature of the cost curves any contribution above marginal cost adds to profit. Thus given the high revenues form business passengers the railways can offer other travelers lower fares and still add to profits.

Rail companies adopt a twin approach. Discounted fares for everyone who was prepared to travel at off peak times and with certain restrictions (sometimes offering only a limited number of seats at the discount price) and discounts to certain groups, such as OAP’s and young people. These groups were believed to have high price elasticities of demand for rail travel due to low budgets and high competition.Table 10 in Bamford illustrates a typical BR pricing policy on one route.

In addition to the discrimination within the standard class carriages of trains there is a first class section. While this offers a better service it is another use of different elasticities of demand between customers. The table below shows the volume and revenue percentages on the rail network in 1992. It shows that if the lower priced tickets were withdrawn there would probably be a significant drop in volume. As the trains will probably just run with fewer passengers this suggests only a small corresponding reduction in costs.

The transport market is not always that simple. British Rail find that due to competition on some routes and in some markets they face widely different elasticities of demand for train use. Also covering costs is not as simple as in the diagram above (i.e. the demand curve lies closer to the ATC curve).

The solution to the problem is to discriminate between customers to allow the overall service to make a profit when charging one price would not.

Subsidizing transport

Many passenger services are unable to bring the operator a commercial rate of return whatever pricing strategy is used, e.g. rural bus services.

46

Subsidizing the service can reduce the fares paid by passengers and raise the numbers using the service. Subsidies can bring social benefits by;

reducing traffic congestion, limiting harmful emissions, reducing journey times and improving the mobility of low income groups.

Price£

MPB 0 Q*Q1

Quantity

MPC = MSC

MSB = MPB + MEB

A B

CD

Pm

The total subsidy necessary to move the market to the socially optimal output of 0Q* is equal to ABCD. This allows the market price to fall from Pm to 0D at which consumers are prepared to purchase 0Q* units. Effectively the supply curve has been moved to the right, passing through point C.

As private transport imposes external costs and public transport has social benefits and reduces the negative externalities of private transport an economic policy that taxed private transport to subsidize public transport would move the economy towards a more efficient allocation of resources.

An alternative way of showing a subsidy is shown below.

47

Price£

MPB 0 Q*Q1 Quantity

MPC = MSC

MSB = MPB + MEB

A B

CD

Pm

Subsidies are little used in the UK, but transport is an exception. Transport subsidies are either targeted at certain groups. e.g. pensioners or the rural bus subsidy, or are swallowed up within national costs and not reflected greatly in lower fares, e.g. the subsidy paid to the rail franchise operators.Local subsidies can have an effect, e.g. West Yorkshire where the Passenger Transport Authority subsidized the local rail network. In 1995 the average fare per passenger mile for journeys wholly within the West Yorkshire metropolitan area was 12.2p, for journeys not wholly within the area it was 16.7p.

Arguments for subsidies in passenger transport are:

Social equity - groups who could not otherwise afford to travel are able to do so.Promote positive externalities - greater use of public transport in urban areas reduces traffic congestion.Urban regeneration - Establishing a cheap, efficient public transport service to a run down area promotes growth, e.g. Manchester Metrolink, London Docklands.Environmental protection - reduce pollution or damage in an area such as the world heritage city of Bath, where pollution from cars attacks the limestone buildings. This could be achieved by subsidizing ‘Park and Ride’ schemes.

Arguments against subsidies in passenger transport are: Blanket subsidies are indiscriminate - a general subsidy benefits all passengers

regardless of income. Subsidies breed inefficiency - if subsidies are offered managers come to rely on them and operating costs are higher than they need be.

The inefficiency argument has had significant impact on UK policy towards bus and railway subsidy.

How much subsidy?

48

A private firm will assess a transport service according to the financial viability of the service, what might be called a ‘cost revenue analysis’. As we have established the external costs and benefits of transport services means that this is not always going to lead to an optimal allocation of resources. However knowing this does not tell us which services to subsidise or by how much.

A cost-benefit analysis would allow us to judge if it was worth subsidising a service.The reason for using CBA is because;

CBA takes a long view and a wide view.

The long view is needed because the infrastructure is in use for so long and the wide view because of the externalities.

Elements of CBA Identification of all costs and benefits Valuation of all costs and benefits Assessment of risk and uncertainty in forecasting costs and benefits Discounting future costs and benefits to find net present value Compare alternative projects

An illustration of CBA to assess subsidy

Suppose a railway service is privately run and the owners are considering closing the loss making service. A cost revenue analysis would consider the following:

Private benefits of closure Private costs of closureCapital replacement cost savings; Loss of train service revenue.(Stations, track, bridges, signaling, Cost of alternative bus service.rolling stock.)Operating cost savings;(Labour, fuel, maintenance.)Resources transferred to other services.Revenue from alternative bus service.

However the closure of the service will affect both users and non-users of the train service and a CBA must consider the effects on:

The existing users of buses and trains. The existing users of other modes of transport, e.g. private car users and pedestrians. The transport operators and the authorities providing roads. The rest of the economy.

The following issues will arise:

49

Time savings on trains - the alternative trip will take longer. The effect on feeder services - the loss of one service may reduce traffic on the rest of the network making it less viable. Accident savings on roads - the closure of the railway implies higher road traffic volumes and so more accidents. Overcrowding - on roads (congestion) and buses. More congestion means that existing road users have longer journey times and this implies a loss of welfare for them. Time savings on road - the alternative trip may be shorter. Journeys not made - some people will simply not undertake the journey anymore. This will mean a deadweight loss of welfare for those who used to use the service. Employment impact - the loss of the service will lower railway employment, but may raise employment elsewhere. A local multiplier effect may be involved. Environmental effects - e.g. more road use implies higher pollution.

We can add the following costs and benefits to the cost revenue sum to produce the full cost benefit analysis.Social benefits of closure Social costs of closureBenefits in journey times. Replacement costs on non-passenger (For former rail customers that spend services. less time traveling and existing bus (Freight and parcels taken by road users who get an improved service.) transport.)Connecting services. Journey time increases.(Cost savings due to fewer connecting (Former rail users journeys taking longer.)passengers.)

Journeys not made.Environmental effects. (Loss of mobility by individuals)(Lower noise, pollution for those living Increased car operating costs.near railway.) (From journeys transferred to cars.)

Increased congestion costs.(From increased passenger and freight traffic.)Increased accident costs.(From increased traffic flows.)Additional road maintenance costs.(Avoided by the retention of the rail service.)Additional public transport resource costs.(This cost relates to additional vehicles.)Loss of employment in local area.(Multiplier effects.)Environmental effects.(Higher noise, pollution etc. from roads.)

The amount of subsidy a scheme receives should not exceed the net benefit of retaining the scheme. This ensures that society as a whole gains.

The main problem is that the funding of subsidies will often be limited by available cash and may be subject to political decision making also. There are probably more

50

public transport services in need of subsidy than there are funds on the basis of performing a CBA.

Valuing time

One of the factors that has a great deal of impact on CBA’s of transport projects is the value of time. In the example of the bus and train routes above the value of time lost or gained by users was included. Often it is the value of time that is decisive.

There is an accepted formula for valuing time. Where time is gained the passengers gain consumer surplus. This is evaluated by the use of Department of Transport Manual which gives values for ‘in-vehicle time in non-working hours’. The DoT data is based on survey and behavioural study data that considered mainly journey-to-work trips and choices made by people between, for example, lengthy trips at a lower cost rather than shorter more expensive journeys. This is a form of shadow-pricing, putting a value on something where there is not an actual market, but it is priced as if there was.In the case of journeys undertaken during working hours the value of travel time is based on the price paid for a persons labour.

Thus the value of time lost or gained is given by the appropriate value multiplied by the time lost or gained.

The table shows the values of in-work time for 1998.

£ per person per hour (1998) Working time

Car driver 17.44Car passenger 13.69Bus passenger 11.09Rail passenger 25.17Underground passenger 21.15Bus driver 6.68All workers 11.57

Non-working time 4.52(Source:Transport economic Note, DETR.)

The values here are ‘before the fact’ and reflect an estimate of the willingness to pay of the groups identified to avoid the time delay. Therefore the difference between, for example, a bus passenger and a train passenger, reflects income levels and the value they put on their time.

Another way to do this is to value the vehicle journey per hour. This is less accurate, but useful where data is not of sufficient quality to value as above. Examples of 2006 values were:

51

Type of vehicle Value of time per vehicleand journey purpose (£ per hour)

Car – being used for work 24.99Car – commuting 4.75Car – other (i.e. leisure, shopping) 6.81Goods vehicle 8.42Bus/coach 59.16Average all vehicles 9.30

Investment in transport13

The nature of transport investment

There are two types of transport investment1. Infrastructure investment - new motorways, bypasses, light railways.2. Purchase of vehicles.

Most infrastructure decisions are taken by government agencies (although many more are now taken by the private sector).

The private sector uses methods of investment appraisal that look at the rate of return on the investment. Because much of public sector infrastructure investment is in public goods where market prices do not exist special methods of appraisal must be used. (Private road investment is only 2% of total expenditure on road infrastructure.)

Recall that public goods have two special features; Non-excludability - providing the good for one person means it is available for everyone else too. Non-rivalry - the consumption of the good by one person does not prevent others from enjoying it also.Some goods exhibit qualities of non-rivalry up to a point, e.g. a road, but when they reach capacity usage there is rivalry. Also some goods are restricted to certain groups, e.g. roads - only over 17’s with current licences may drive cars on them.

13 Bamford Ch. 452

Classification of transport goods

Excludable Non - Excludable

Rival

Non - rival

1. Private goodsPrivate cars, airline tickets,airports, Channel Tunnel

2. Quasi-public goodsCheap off-peak travel for pensioners

3. Quasi-public goodsRoads?

4. Public goodsPavements

Bamford lists lighthouses as public goods. This is a well known example due to Samuelson, but as Mankiw pointed out that there used to be many privately owned lighthouses.

Investment in transport infrastructure has particular features.

1. It is long term in nature - usually lasting in excess of 30 years.2. It involves a high capital outlay.3. It generates both positive and negative externalities.4. It represents an important part of local or central government capital spending.

Despite these features most transport infrastructure expenditure is made without direct charge to the user.Thus the government must decide how much it spends on infrastructure and which projects it funds and which it does not. All projects are cash limited and there has not been a period when the budget of the department of transport has been sufficient to undertake more than a few of the possible capital projects. There is, therefore, a need to prioritize infrastructure projects.

Cost-benefit analysis (CBA) is used to decide the answers to these questions.

COBA method of appraising roads14

The Department of Transport use a computer based form of CBA known as COBA to evaluate new inter-urban road schemes (those between towns or cities). It compares the

14 DETR New Appraisal Scheme - Photocopies in classroom resources.53

costs of a new road scheme to the benefits that will be derived by road users. In this sense it is more limited in scope than a full CBA.

Three types of benefit are recognized: Journey time savings - based on the ‘time is money’ principle these usually turn out as the most important benefit. A monetary value is put on the aggregate time saved by users of the new network. The value depends upon the purpose of the trip e.g. work or leisure as shown on page 40. The method assumes that any time saved would be put to good use and that the value of output must at least be equal to earnings.

Vehicle operating cost savings - the new network will affect fuel consumption (usually higher) and wear and tear (usually lower). Such savings are particularly significant for commercial vehicle operators. Potentially fewer vehicles are required for the same amount of work.

Accident cost savings - motorways and trunk roads are safer than normal roads. The reduction in accidents is given a value based on the direct costs to individuals, their vehicles, the emergency services, lost output and an allowance for pain and grief following death or injury.

User cost onexisting road network A1

User cost onnew road network A2

User benefitsB = A1 - A2

Construction cost of new network C

Net present value B - C

The COBA system

Two main costs are recognized: Capital costs - land purchase, construction costs, admin and design. Maintenance costs - street lighting, repairs and resurfacing.

54

All costs used are resource costs. This is because opportunity cost is the relevant economic cost for CBA. Although market prices largely reflect resource cost taxes and subsidies must be eliminated.

The standard period considered is 30 years into the future. The discount rate currently used by the DoT is 6%.

The NPV of the road tells us if it is of net benefit to society (a positive NPV). The ratio of benefits to costs is worked out. Thus if the Present Value of Benefits (PVB) is £40m and the Present Value of Costs (PVC) is £20m the NPV is £20 and the Benefit-Cost rato (BCR) is 2 (or 2:1). This ratio helps in prioritising schemes.

It is claimed that COBA has three practical purposes. It establishes the need for a particular scheme. It allows priorities to be established. It provides the basis for wider discussion.

The choice is not always between the existing situation and the new road as the analysis above suggests. For example a traffic management scheme might be a possibility on the existing road network. If so then the comparison between the new road and the result of implementing the traffic management scheme is relevant. It is more complicated to do this, but if this does not happen it is possible the benefits attributed to the new road may in fact be really due to a cheaper alternative.

It is not possible to perform a full COBA on all possible projects. To avoid undue cost a ‘first sift’ of projects is done based on criteria such as work flows or number of residents on a particular road.

Given the limited funds available demands for new roads exceed the resources available, therefore some method of appraisal is essential. COBA is not perfect however.

Complications of COBA method

Much of the data for COBA estimates are forecasts. While most of the expenditure takes place within a three year period the other costs and benefits are spread over a very long term. As we have seen thirty years makes a large difference to traffic flows, household behaviour and income and the mode of transport used.

Taking the M40 extension from Oxford to Birmingham as an example we can illustrate the problem. A general forecast of the vehicles per day between, say, Oxford and Warwick is inadequate. There is also a need to know:• The traffic split on existing roads (A41, A429 and A34 in this case).• The modal split of cars, LGV’s, HGV’s, buses and coaches.• The peak demand periods, how long they last and where they occur.

55

The forecasts then have to take into account:• Type of journeys made (work, education, weather) and the number of trips made of each type.• The modal split of passenger and freight journeys.• Trips expected to be made along each route.• Effect of new road on existing roads, transfers to new route and new traffic generated.

Forecasts in traffic planning and COBA

The problem of forecasts is that they are only well informed guesses and can’t anticipate policy changes. The classic example is the M25 where the forecasts suggested that the road would have sufficient capacity for 30 years, it was full the day after it opened because they failed to predict the diversion of local traffic on to the new road and because of increased leisure traffic from south-west London to north London. The forecast flows were 80,000 pcu’s (passenger car units) per day, the current figure is 190,000.

Transport is a derived demand and so traffic forecasts must also take in to account macroeconomic factors. Household income, GDP growth, changing trade patterns, manufacturing output, and changes in land use (such as out of town shopping and entertainment) are all examples of variables determined outside of the transport industry that affect it. The forecasting of transport demands and costs and a realistic appraisal of transport projects therefore requires a wide understanding of trends and developments in the whole economy.

Criticisms of COBA It is not a comprehensive CBA - COBA only considers the benefits to users of the new road. It therefore ignores the effects on other groups - externalities. Environmental issues are ignored - there is a loss of land when new roads are built. The environmental effects are; + Traffic noise + Visual intrusion + Pollution + Loss of amenities The Department of Transport now incorporates an assessment of environmental damage (the Environmental Statement) into the appraisal process, but no monetary value is placed on this. This is required by EU law.

Value judgements are involved - the valuation of saved time at particular wage rates for example.

Indirect effects of new projects are not accounted for - for example the effect of building a new motorway to a depressed region will encourage firms to move to the area.

56

Not all projects get as far as COBA evaluation - to achieve the desired results the list of projects assessed must be comprehensive. However many schemes never make it to the top of the priority list to gain assessment. Important projects may be missed.

COBA cannot be applied to urban schemes - COBA cannot cope with inconsistencies which may arise for peak and off-peak data, nor with the interaction between functions such as blocking back. The lower minimum speeds and longer maximum delays of urban areas are also not allowed for in COBA.

The COBA approach is shown by the case study of the M4 near Newbury on the next page.

The ‘new approach to appraisal’

The dissatisfaction with COBA has been recognised by the introduction of the Appraisal Summary Table (AST) by the ‘Roads Review. The DETR unit responsible for COBA have yet to work out a way of performing a complete CBA (for example valuing loss of countryside), but the table tries to take this sort of thing into account and balance the strict economic costs of COBA.

To achieve this objective the Government has developed a new approach to appraisal which is broadly based and takes account of five criteria:

environmental impact; safety; economy; accessibility; and integration.

The AST tries to:

understand the problem and ask what priority it deserves; identify a range of options; appraise options to determine the extent to which they meet the Government's

objectives as cost effectively as possible, given the need for benefits to outweigh costs and to achieve value for money.

The criteria have been divided into a number of sub-criteria, reflecting the wide variety of impacts arising from schemes.

Sub-Criteria

Environmental Impact

57

Noise Local Air Quality Landscape Biodiversity Heritage Water

Economy

Journey times and Vehicle Operating Costs Journey Time Reliability Scheme Costs Regeneration

Accessibility

Access to Public Transport Community Severance Pedestrians and Others

Integration

* NoneFor each of these, the impacts of a road scheme are expressed in the following ways:

qualitatively - using words to describe the main impacts; quantitatively - using numbers to measure the scale of the impacts; and as a summary assessment - using either a monetary value, a quantitative

indicator or a textual ranking.

The next page shows the AST for the congestion relief scheme for the A3 at Hindhead. Where monetary values cannot be estimated the following seven point scale is used.

large negative; moderate negative; slight negative; neutral; slight positive; moderate positive; large positive.

An additional ranking, very large negative, has been used where environmental impacts were deemed to be exceptionally severe. A scale in words rather than numbers has been used to avoid implying a direct comparison between types of impact which are not directly comparable.

58

Eddington and beyond

The Eddington Report shows that more work is going on to improve on AST. Ultimately all social costs and benefits should be monetized and included. Presently there is not enough data to do this. (To get monetary values there must be clear evidence from schemes actually enacted to judge these monetary values. Especially when valuing environmental effects this evidence simply does not exists.)

The section below gives the various measures used by the Eddington Report. Some extend beyond AST.

Government policy59

There has been a major change of emphasis in government roads policy. This can be broadly split in to three.

Up to 1994, 1994 to 2000 and 2000 onwards.

1945 to 1994

This was the era of ‘predict and provide’. The government used forecasts to look at the trends in the growth of road transport and provide the road space to accommodate it. The road network expanded and the public transport services were allowed to decline in both absolute and relative terms.

In 1989 the Roads for Prosperity programme announced a £12 billion road building package. This was to cope with the forecast rise in traffic volume of between 83% and 142% between 1988 and 2025 and reflected the ‘predict and build’ mentality.

Rising demand for transport was seen as a sign of desirable economic growth and rising private car ownership as an example of growing personal freedom. Hence expanding road traffic was seen as a sign of success.

1994 to 2000

In December 1994 it was announced that after the programme was complete there would be no significant major new schemes in the foreseeable future.

In 1994 this was due to the very serious financial position of the government which had been borrowing heavily since the recession of 1990. However the New Roads by New Means paper suggests that private enterprise may be allowed to invest in roads, the so called Private Finance Initiative (PFI)15. (Also referred to as PPP – Public Private Partnership.) Proposals have covered both road and rail schemes. For example: Schemes that are entirely private ventures with transfer of assets at the termination of the concession.Channel TunnelDartford - Thurrock bridge Second Severn crossingBirmingham North Relief RoadHeathrow ExpressWest coast and East coast Main Line

Schemes that are predominantly private sector with some government investment. Croydon Tramlink Channel Tunnel Rail Link Manchester Metro15 For up to date news stories and links to resources on PFI visit www.legalday.co.uk/current/pfi.htm

60

While some PFI schemes are financially free standing and others are joint ventures others are services sold to the public sector by the private sector, for example the Northern Line trains or the Birmingham Northern Relief Road. In this case a rental or shadow toll is paid by the government to the private sector provider. The advantages of PFI schemes are: Alternative sources of funding where there are constraints on public spending. Private sector skills are brought into planning and management of projects. Better value for money through economies of scale. Risk is transferred to the private sector. (e.g. The first Severn Bridge never recovered its costs through tolls.) Close links between market demands and construction.

Criticisms of PFI: Scheme is simply a substitute for, not addition to needed schemes. Scheme represents no real risk to private firm. In the case of the payment of a shadow toll the higher the risk the higher the shadow toll the commercial firm will require, thus there is little or no net gain to the public purse. Increased value for money is only likely when the lower construction and maintenance costs outweigh the cost of borrowing the finance through private sources (government always borrows at cheapest rate).

PFI can be seen as a way of deferring expenditure (some might say hiding). If the government builds a road it appears in current expenditure. If a PFI scheme builds it the costs appear years later maybe as a ‘shadow toll’ paid by the government based on vehicle numbers.

The government imposed a PFI scheme for London Underground. This was opposed on the basis of safety and that splitting the network up would lead to the same sort of problems as on the railways. The new London Crossrail scheme is also a PFI scheme, but is currently struggling to find backers in the private sector.

The Labour Government elected in 1997 had another agenda that also called for less road building. In July 1998 the government announced a number of schemes would not proceed, having already cancelled and postponed schemes in July 1997. This reflected the widely held view that simply building more roads increases road use and adds to the congestion problem and their proclaimed need for an ‘Integrated transport policy’.

What constitutes an integrated transport policy is difficult to pin down, although today it is often described as ‘one that encompassws all modes of passenger and freight transport’. We might call this the ‘weak’ definition of integrated transport as a strong definition would take account of environmental concerns for example.

Integrated transport policy would certainly mean the ability to switch between transport modes easily. For example riding your bike to a railway station, taking the train and

61

then a bus to work. To make this work there must be safe bicycle routes, adequate secure bike racks at stations, and sufficient timetabled buses leaving from the railway station. The aim of such a policy is to reduce private road transport demand. (As such this is just one small example and overall such a policy covers all transport use).

Suprisingly then in 2000 there was a Transport White Paper that presented a 10 year vision. It reintroduced many road schemes that had been cancelled or put on hold.

2000 onwards

The year 2000 is possibly an arbitrary date but it was the first year that the government published a long term plan that tried to address integrated transport policy. As time went on the plans became wider in scope and included explicit attempts to improve the environmental sustainability of transport with, for example, carbon reduction targets included by 2007.

Transport 2010 The 10 Year Plan16

The government announced a ten year plan for transport as part of the Comprehensive Spending Review in July 2000.

Key details of the Government's 10 Year Plan for Transport, Transport 2010 are as follows:a significant increase in spending in real terms compared with previous ten years total public spending and private investment will be £180bn. capital investment (public and private) will be £121bn. Almost 75% real increase

on previous ten years

The £180bn is made up of:£60bn for rail £59bn for local transport £25bn for London £21bn for strategic roads £15bn for future projects and other transport areas

Total roads spending (including local roads and London roads): £59bn

The government suggests that the £180bn investment means: reduction in road congestion below current levels 100 new by-passes widening of 360 miles of strategic roads elimination of local road maintenance backlog 50% increase in rail use (measured by passenger kilometres)

16 ‘A New Deal for Transport’ White paper 2000 62

80% increase in rail freight modernisation and upgrading of East Coast, West Coast and other Main Lines improved services on the London Underground and London buses up to 25 new tram lines in major cities and conurbations 10% increase in bus passenger journeys better rural transport a safe and secure transport system 

We shall return to the ‘Integrated transport policy’ later. However it is already clear that the financial resources the plan requires will not be forthcoming and in 2004 there was a revision and a new ‘ten year’ vision that involved a reform of the way the railways were organised. The Transport Select Committee was highly critical of the original plan and to a large extent it failed as they predicted. Subsequently there has been a railway long term plan and a sustainable transport plan based on the Stern Report and Eddington Report.

Privatisation and transport in the UK

The position in 1979The Conservative government faced particular problems; Rising levels of public subsidy Long term decline in use of public road and rail transport Road transport dominating rail in freight traffic Growing environmental concerns over transport Social concerns over public transport provision for the poor A transport network that was struggling to cope with rising demand

Unlike previous governments the Thatcher administration was committed to reintroducing market forces in as many areas of the economy as possible.

Their guiding principles were;

A belief that market forces were the best way to ensure an efficient allocation of resources. To achieve this is was necessary to replace local and national monopolies with contestable markets. Public services needed to be accountable and provide ‘value for money’ - nationalized industries would no longer be bailed out Public expenditure needed to be reduced in order to reduce inflation, reduce the burden on the productive economy and limit the deficit on the current account of the balance of payments

Privatization

Privatization refers to three different actions only one of which is strictly ‘privatization’;

63

Privatization - a change of ownership from the public to the private sector e.g. bus services. Deregulation - the removal of barriers to entry which protect most nationalized industries and allow them monopoly power. Franchising - the right to operate a particular service with or without public sector assistance.

The types of nationalized industry privatized in the public sector fall into various categories; 1. Transport services - such as the National Freight Company (NFC),Sealink, Inter-city coach services, local buses and passenger train services. 2. Transport infrastructure - such as Associated British Ports, British Airports Authority and the railway infrastructure.

There have been three main methods of privatization; 1. Management Buy Out (MBO) - here the present managers and employees buy the company from the government having raised the money from banks, often secured against their personal assets. e.g. NFC. 2. Public offering - where shares in the company are sold to the public and financial institutions. e.g. British Airways.

3. Franchising - this method was used in privatization of British Rail’s passenger services.

Privatization vs. nationalization

Until the mid 1970’s nationalization was accepted as the best way to cope with public utility provision and transport services. The following benefits were identified:

Transport services such as railways were natural monopolies and so nationalization allowed consumers to benefit from economies of scale. The negative externalities generated by transport services would not be regulated by private firms and the external benefits of public transport would not be considered either.Transport is an essential service and when in public ownership a meaningful transport policy can be developed and delivered. The subsidised public sector allowed a redistribution of income towards the less well off. Workers preferred working in state industries - less confrontation etc.

Against these arguments the case for privatization was that the nationalised industries were inefficient and expensive. Specifically the points made for privatization were:

64

Private firms make more efficient use of resources, often but not always because of competition (contestable markets). The consumer benefits from a wider choice, higher quality of service and lower prices. Wider share ownership is achieved - this is a political point. The revenue raised from the sale of nationalized industries reduces the PSNCR and benefits taxpayers.

Deregulation

The traditional approach

The transport market was heavily regulated, by both central and local government. There were two basic types of regulation:

Enforcement of minimum standards - such as safety. Commercial regulation - a licence system was used to limit competition, determine fares and service frequency.

Deregulation (the removal of barriers to entry) aims to create a more competitive or contestable market. While quality licences have been strengthened to maintain safety standards - and this in itself is a form of barrier to entry - coach and bus markets have been opened to competition. The air travel market and rail has seen some deregulation. Road haulage was deregulated in 1969, but the privatization of NFC in 1982 meant there were no public sector companies operating in that market.

Recall that a contestable market is one where there is freedom of entry and exit. Thus excess profits attract new competitors and losses mean firms leave. As a result of perfect contestability excess profits are competed away as in the perfect competition model. An important question is; are the deregulated transport markets more or less contestable than before? Also have the attempts to deregulate these markets improved the allocation of resources in terms of efficiency and equity?

Subsidies and Cross-subsidization

A consequence of deregulation has been the loss of subsidy paid to passenger transport. We shall take buses as an example.

The argument for paying subsidy to bus companies are well known. It provides lower fares for the less well off and otherwise unprofitable routes are operated providing a social service to less populated areas (such as rural areas).

Publicly owned bus companies also engaged in cross - subsidization of routes. They allowed revenue from well used, profitable, urban routes to subsidize unprofitable

65

routes. The combination of public subsidy and cross - subsidization allowed a network of services rather than a few profitable ‘trunk routes’ that a completely private service would be able to operate.

Cross - subsidization, which is internal to the business, was attacked on the grounds of efficiency. Some fares must be higher than they need be to allow the unprofitable routes to operate. Potential cost savings are not, therefore, passed on to the customer. It is a form of implicit taxation i.e. users of popular routes are being ‘taxed’ by the bus company in order to redistribute income towards those who use unprofitable routes.

Cross - subsidization can also be wasteful. Some marginal routes are supported too generously. It is unusual for a thorough cost - benefit analysis to be carried out on each route.

Subsidies are external to the business. Privatisation aimed to reduce the sums paid in subsidy, seeking ‘value for money’ in public spending.

Coach and bus deregulation

The bus market was deregulated because of the perceived success of the deregulation of the express bus service. This had led to reduced fares, higher quality services and more passengers using long distance coaches. The 1984 White Paper on buses argued: Co-ordination and planning on the pre-1986 scale was unnecessary and wasteful when a significant proportion of bus services could be provided commercially. The old form of network subsidy blunted competition and acted as a disincentive to operators to find new ideas and cut costs. There was little incentive to develop new markets as a new operator had to ‘prove’ the need for a new service to the traffic commissioners.

The evidence from express bus deregulation

In fact the success of express bus deregulation was not due to the greater contestability of the market, but to the National Bus Company (NBC) and its subsidiaries which dominated the market after the initial period of deregulation and the essentially local operators who ventured into the market withdrew.

The private sector reacted in one of three ways to express bus deregulation. No action - because of the risk and small size of each firm. Entered the market and failed. Most of these services were from their home base to London. The main reason for failure was the competition from a large company (NBC), poor terminal facilities and poor management and marketing. Entered the market and were successful. These represented 2% of firms in the industry.

66

The response of the large operators to competition was to lower fares and concentrate on major routes at the expense of cross country routes. There was clear evidence of a high cross elasticity of demand with BR and commuter buses have become popular.

The benefits accrued to commuters and travellers to London especially (even those travelling on BR as fares fell). The losers have been those using less popular routes and BR actually lost revenue.

The evidence of coach deregulation was, surprisingly, used to justify bus deregulation.

Bus deregulation

The deregulation of buses was intended to lead to more services and lower fares. Also councils would be better able to judge the costs and benefits of supporting a service by a tendering system. Operators would tender a price for the operation of a route that provided a social service. The lowest tender got the right to operate the route with the subsidy requested. Value for money in public expenditure was then assured.

Various trials were held to test deregulation, one of the areas being Hereford. The results of this experiment were; Dramatically increased services. Lower fares. Lower public subsidy

But also Reduced passenger information. Demand was not sufficient to support all the operators. Lower wages agreements Timetables which ran from 8 am to 6.30 pm. Bunching of departures leading to congestion. Fewer services as operators withdrew. Rural routes only saw competition for contracts.

The main aim of the trial was to halt the decline in rural bus services. In this sense it failed as part of the rural network was lost. However there was a competitive market for the contracts and subsidies fell and the quality of the service was reduced.

Subsidy levels in Hereford Oct1981 - Mar1982 Oct1982 - Mar1983 Oct1983 - Mar1984Subsidy at Oct 1982 prices £80,797 £52,592 £44,292

Remember that these figures are old! £80,000 represents £2 a person for Hereford at the time, around £10 to £12 in current purchasing power terms.

Details of local bus deregulation67

The previous system saw operators being given ‘Road service licences’ by Local Transport Commissioners. Outside of London this system was replaced by a system of registration where any PSV (Public Service Vehicle) operator’s licence holder could run a bus service.

Those wishing to operate a bus service simply register with the ‘Traffic Commissioners’. No time limit or commitment is required, although 56 days notice is required to cease service. The local authority can only object on the grounds of:

Road safety. Congestion.

District or county councils decide on the level of subsidy available. There are two possible systems:

1. Full cost - the council pays all the costs of the service and receives all of the revenue.2. Subsidy - the operator gets the revenue and receives an agreed sum from the council.

The first method allows the council to vary fare levels, the second tends to lead to pessimistic forecasts of revenue from operators who therefore seek higher subsidies. Both require a check on quality of service and reliability, the first requires a check on revenue. The subsidy method is used by all but one council.

In London almost all services are operated on the basis of a London Transport bus agreement. This is a tendered franchise from London Transport Buses to operate one of their services. It is a valid point to ask which system works better. One where the competition is between operators ‘on the road’ (i.e. outside London) or where the competition is between operators for franchises (in London). We shall return to this.

The theoretical benefits of contestability 

By increasing the level of competition in the bus sector and moving towards a contestable market it was hoped that there would be: 

a fall in average operating costs (improved productive efficiency)  lower fares  a reversal in the decline of bus use  a reduction in state subsidies  the end of cross-subsidisation  improvements in the quality of service as the sector became more responsive

to the needs of the consumer (dynamic efficiency)  improvements in the quality of the bus stock  greater supply of bus routes  new services

Results of bus deregulation68

The picture is mixed. Coach deregulation - long haul bus journeys - has been relatively successful. Fares are low and passenger numbers are strong as compared to railways the cost is low.

Outside of London bus deregulation on more local routes - the old local bus companies previous market - has not produced the expected result. The market for local bus services have not been contested very strongly.

The established bus companies, now in private hands, have maintained a dominant position and many privatized operators have merged or taken over each other to form several large companies. The market structure is closer to oligopoly with three major players and in the areas where they operate significant barriers to entry.

The following observations have been made about the deregulated bus market:

Fare levels are set too high. There has been a wasteful duplication of services on many main routes. There has been a misallocation of resources between busier and quieter routes. Network facilities have been neglected - such as reduced ticket co-ordination,

poor timetable information and poor linking of connecting services. Reduced vehicle quality (although there was significant investment at first).

Concerns about deregulation policy

Instability - Firms can enter and leave the industry relatively quickly - known as ‘hit and run’ tactics. While a notice period is required the service level may be minimal when losses are being made. As market testing is a reasonable course for firms there may be considerable instability in the initial period.

Co-ordination of services - Under the old system County Councils were responsible for the co-ordination of services, but this lapses for commercial services. This may lead to the loss of co-ordinated timetables, irregular services, inability to purchase through tickets, lost connections and poor publicity.Poor co-ordination would be particularly serious in tourist areas.

Competition between subsidised and commercial routes - In urban areas a subsidised rural route may be undercut by a commercial firm, making the subsidy a waste, or the commercial firm may be undercut by the subsidized operator which is anti-competitve. (The subsidy was intended for rural not urban travellers.)

Cross-subsidy was seen as undesirable in the government white paper because it was assumed to be the subsidization of loss making routes by profitable routes. In fact routes can subsidize themselves, i.e. peak time surpluses allow the running of off peak services and urban portions of routes allow the subsidization of rural portions.

69

Eliminating all cross subsidies could lead to the requirement for more council support for services.

Many existing bus operators have withdrawn from established routes due to the low returns. While other operators could enter the market in practice few have the suitable vehicles or capital to do so. There could therefore be a shortage of operators on the marginal routes.

Specific effects of bus deregulation

Operating CostsOperating costs the introduction of competitive pressure has forced firms to cut costs and raise productivity. Outside of London over the period 1994/5 and 2002/3, the operating cost per vehicle kilometre has fallen from £1.03 to 97p at 2004/5 prices. However in the year 04/05 they rose to £1.03, mainly due to fuel, staff and insurance costs. A similar trend is observed inside London (but higher costs due to local factors including slower journeys.)

Rising FaresDespite falls in operating costs fares continued to rise in real terms. Over the last decade real fares have increased by around 20% for local bus services outside London. During the same period, private motoring costs have decreased by 4%. Deregulation has not had the desired impact on the level of fares.

In London, Transport for London, have maintained fares meaning a fall of 3% in real terms, due to various fare concessions and saver cards, including the Oyster Card which has proved very popular. Overall bus prices in London have risen by 15% in real terms in the last decade.

70

Passenger NumbersBus use continues to decline. Rising fares have contributed to the decline in bus use. Over the last decade bus use has declined by over 18%. There are, however, signs that the decline in passenger journeys are levelling off. Clearly deregulation has been unable to reverse the long term decline in passenger numbers. Bus miles are, by contrast up. This means that more buses are running but with fewer passengers.

The obvious difference between London and the rest of the country is striking. It is most likely that the rise in bus use in London is due to the combination of policy measures, including the congestion charge and increased provision of services.

However privatisation has reversed the decline in the provision of bus services. Despite falling passenger journeys, buses are driving further. This reflects the provision of more frequent, but smaller buses.

Bus Operating SubsidiesSubsidies initially declined - Subsidies for local buses declined in real terms from £513m in 1988 to £222m in 1998. The introduction of competitive tendering for unprofitable routes has reduced the cost for the state and has freed money to be spent in other areas. Part of the rise in fares can be explained by the decline in subsidies.

In 2002 82% of bus services outside London were run commercially. However there has been greater subsidy in recent years.

71

Transport for London have raised total spending on busses by 511% between 1997/8 and 2006/7. The Rural Bus Subsidy Grant was introduced in 1998. The table below shows the latest available figures for bus subsidies.

The end of implicit taxationPrior to deregulation many loss making rural bus services were cross-subsidised by profits from urban routes. This was seen as a form of implicit taxation on the urban bus users and economically inefficient. Many argued that the benefits gained from the provision of rural routes were less than the cost of providing these services. Since deregulation this distortion in the market has been removed. However, the number of rural bus services has declined. The decline in rural services has a huge impact on low income families in rural areas and could be socially divisive.

Quality of passenger serviceInitially there was some evidence that the bus sector has become more responsive to passenger needs. The supply of local bus services increased by 12% between 1997 and 2007. This means that new routes have been developed. 

The nature of the bus stock has changed to allow more regular, but smaller, buses on popular routes. In 1998, 32% of buses are were mini/midi buses. There has also been an increase in the number of low floor and kneeling buses.

On the negative side, there has been a decline in the number of off-peak services as firms concentrate on busy routes. The quality of the bus stock has declined as the bus stock has been allowed to age (as new investment is deemed unworthwhile). Also, with so many different companies, it has become impossible to co-ordinate timetables and allow through ticketing.

Employment and safety 72

The number of workers employed in the bus sector has declined by 12 % over the last decade. This has been driven by the need to reduce costs in a competitive market. While operating costs have been reduced, some commentators believe that this has been at the expense of passenger service and safety.

Conclusion - Has bus deregulation worked?  

Some of the theoretical benefits predicted by economists have materialised. Deregulation has, however, failed to reduce passenger fares and the long term decline in bus use. Without an increase in bus use the future for congested urban areas looks bleak.

In 2006 the House of Commons Transport Committee concluded that the bus industry could ‘not be made to work’ without overhaul. The committee thought that bus service overall was poor quality and unreliable (although statistics don’t show that) and there were too many old inaccessible vehicles.

Is the bus market really contestable? 

Some economists have argued that the bus sector was never truly contestable and, as a result, many areas of the country have seen their services dominated by large bus companies who face no competition. Many of the larger companies forced smaller operators out of the market using unfair tactics and predatory pricing. This effectively gave them a local monopoly. 

It is very difficult for a new firm to start to run services in areas dominated by one of the big players. New firms would find great inertia among passengers who would be unwilling to switch providers if their journey needed more than one bus. Therefore entering the market on ‘single routes’ would be difficult, but so to would trying to compete on all routes as the capital required would be significant.

The frenzied competition seen on routes post-deregulation has now disappeared. Many routes are now being provided by a single company with monopoly power. This may explain why the fruits of deregulation have not been fully realised.

The table below shows how the structure of the bus market has changed. Note that mergers mean that the situation is complicated, however the concentration ratio has risen and the market has become more oligoplistic in nature.

Market share of bus operators (%)Operator 1989 1992 1995 1999 2006Stagecoach 3.9 4.9 13.4 16.4 17.8

Badgerline 3.1 5.0

73

First Group (Badgerline & GRT merger) 12.6 23.0 23.0GRT 0.6 1.2

British Bus/Arriva 2.8 3.4 8.8 13.6 16.6

National Express Group 0 5.9 7.7 6.2 5.1

Go-Ahead Group 1.7 1.7 4.3 6.5 9.3

There is some evidence to support the view that there is contestability in areas where subsidy is available. The new Rural Bus Subsidy Grant (see below) attracted a variety of tenders for new services as the graph below shows with more than 5 tenders being offered in 8% of cases and 78% of services attracting more than one. However the fact remains that there is little contestability in many areas of the bus industry now it is established.

New policies to reverse the decline17  

In March 1999, the Government announced new proposals to improve bus services in its document 'From workhorse to thoroughbred'. These included: 

a new framework for local authority influence over buses statutory backing to ensure quality standards 

greater powers to ensure that buses follow their timetable  new technology to improve bus information  more joint ticketing

The key element of the programme is the Rural Bus Subsidy Grant (RBSG) which is available to support new bus services and enhance existing ones. For a relatively modest sum, initially, £32.5m a year, now £48.5m, many more services have been provided in rural areas, often evening and weekend services. Half the contracts awarded cost local authorities less than £1.20 a mile.

London vs The rest of the country

It would seems relevant to consider why busses in London are doing so well compared to the rest of the country. There are a few obvious differences.

In London bus companies compete for franchises. They bid to run a route with the highest bidder getting the right to run the route for a period of time. In the rest of the country bus firms compete with each other for passengers on the road.

London has a large daily influx of commuters who find it inappropriate to drive to work.

17 The Rural Thoroughbred - summary report, Transport 2000/CPRE74

London has an integrated transport policy (run through Transport for London) under the auspices of the Mayor. This includes the implementation of the Congestion Charge.

It is ironic that the franchise system in London produces such good results, yet on rail it seems less successful. The Office of Fair Trading does not allow the franchise system to operate outside London (maybe because the law set out how busses were meant to work), but it could improve the system and reduce waste/increase efficiency.

However London is different to other areas and it might well be that transplanting the London system to other areas might not work.

British Rail Privatization18

The railway network has a long history of being commercially unviable. The figure below shows how the railway industry was organised over its history. The reverse of policy is striking.

The problem faced by BR in the 1980’s were considerable. It did have strengths in that it was a single network, had good management and was moving towards a more commercial attitude.

It had huge problems however. These were:

People were leaving rail as a means of both passenger and freight transport. Road was taking most of this traffic. See charts on next page.

Investment in the network was determined by the Treasury. In the 1950’s and 60’s this was a real problem due to the ‘stop-go’ nature of fiscal policy which halted projects without warning. (For example the modernisation of the West coast line was not completed due to this.) In the 1980’s much needed investment was denied due to political decisions. See chart on next page.

Something had to be done and privatisation was proposed. It had the potential to solve the industries problems if properly constructed.

18 Useful websites Rail Regulator www.rail-reg.gov.uk75

Features of BR operation

BR lost money overall. BR was heavily dependent on external subsidies, especially for provincial services. Safety is an important consideration and an area of great public concern. Unlike other forms of transport rail must have its own dedicated infrastructure.

The economic issues that had to be addressed before privatization could proceed were;

How to allocate costs for the operation of trains on particular lines. How to determine network fares.

The solution the government implemented was to split the infrastructure from the operation of trains and to split up the network into regions, each with its franchised operator. Freight was also split up, but on a different basis and the ownership of the rolling stock was separated from the service operators.

The services that needed financial support would continue to get it, but companies would have to bid for the right to run each service (franchise) and asking for less subsidy would be an important, probably the determining factor in the process (as service levels were laid down). As we shall see saving money for the government was a very important factor.

BR Privatization

The structure of the industry post-privatisation was:

Passenger services franchised to private operators. (Train operating companies or TOC’s). Any organization can bid to run trains over the infrastructure in 25 franchise areas (now reduced to 21). The Office of Passenger Rail Franchising (OPRAF) oversaw this. The Franchisers of routes are shown on page 66 of Bamford. The OPRAF set minimum standards of service and monitored franchise operations.

Freight and parcel services to be sold off. Only two companies operate freight services over the whole network.

The Red Star Parcel operation was so unprofitable that a price of £1 was asked for a buy out by the existing management.

76

The rolling stock was split between three companies (ROSCOS) who would lease it to the operating companies. The new operators were able to buy their own new stock, but most wished to run the existing stock. The separating of the companies from the rolling stock reduced the capital cost of entering the market, the existence of three leasing companies ensured competition, however Stagecoach now own Porterbrook one of the ROSCOS. A track authority, Railtrack, was responsible for the infrastructure, track, signaling, stations and other property assets. It was originally to be publicly owned and be responsible for maintenance, timetables, and determine charges for train operating companies. However Railtrack was sold off in 1996. Railtrack did not have their own maintenance department, they hired private subcontractors, some of which are former BR organisations.

This arrangement did not work at all and maintenance was poor and in many cases dangerous. Network Rail took over when Railtrack was forced to close down by the government. They have taken back a great deal of the maintenance inhouse.

A regulator, The Office of Rail Regulator (ORR), to safeguard the interests of passengers. As with other regulators, such as OFWAT and OFFER the regulator will aim to ensure fair competition and protect consumer interests.

Following the initial years of operation the Strategic Rail Authority (SRA) took over the role of the OPRAF as well as the ‘leadership’ of the industry. This was prompted by a number of rail disaster and a realisation that there was nobody with an overall vision for the industry.

Railtrack collapsed due to the impossible task of raising the required finance to invest in the network. The main problem was the track access charges for the TOC’s was set before the decision on what level of investment in infrastructure was required. Following several well publicised problems the government demanded more and more investment from Railtrack. The only ways Railtrack could do this was to borrow or get government subsidy. Subsidy did not come in the required amounts and Railtrack was effectively bankrupted by the Transport Secretary (Stephen Byers). Network Rail was put in its place - a ‘not for profit’ company.

Regulation of privatised industries is usual. The regulator is there to safeguard the public interest and in this case the issue is the promotion of public service and safety over profit. The resulting, rather complicated, industry structure is shown on the next page.

Quite amazingly the government reorganized the rail industry again in summer 2004. This is dealt with at the end of this section.

Benefits from privatization

77

The government view was that privatization would bring the following benefits;

Increased efficiency due to reduced waste. Greater concern for customer needs. Management will be free to operate a market led service. Increased employee motivation. Lower subsidy expenditure by central and local government. There would be an increased level of investment.

The first was based on the belief that competition would force firms to reduce costs. In the case of the TOC’s the competition came from trying to win the franchise. Getting the franchise meant accepting the lowest subsidy, to reduce the need for subsidy costs must be kept down. (Notice that this does not mean prices are low or quality maintained, a crucial point when customer service is considered.)

Private firms would, they argued, give better service as they tried to gain more customers. The managers would be able to innovate to keep costs down and customers happy in a way that BR was not allowed to do due to Treasury constraints.

Employees were not really better motivated as, on the whole, they opposed privatisation (or their unions told them to). In fact industrial relations are reported to be ‘better’ than before despite various disputes on working practices.

For a government committed to reducing state expenditure lowering subsidy was an end in itself. The money raised from the sale of the network (Railtrack raised over £4bn) could be used to finance expenditure in other areas or reduce taxes (being politically more popular taxes were kept lower).

The effect of privatisation

The tables show up to date (2007/8) data on the current state of the rail network. The long run of data shows how passenger km’s have risen significantly to an all time high. The number of journeys has also risen. Note that the change in trend occurs around the time of privatisation. This supports the view that one of the reasons for rails trouble is the success of privatisation.

78

Freight has seen a recovery since privatization, indeed there has been a 45% increase in freight carried between 1995 and 2004, but recent problems have disturbed the trend again. (Hatfield was a major contributor to this as it led to restrictions on the network that slowed all trains. Delivery times are often crucial to firms.) Recently (2003) Royal Mail stopped using rail altogether.

Freight moved by rail 1995 to 2006

Perhaps the most impressive figures are for investment in the network. Since privatisation There is, however, little doubt that investment had been well short of that required, but Railtrack and privatisation did have the desired effect.

79

Fare levels have generally risen faster than the RPI (see graph in bus deregulation section). This is because, with reduced subsidy to train operators, they must finance their investment in new rolling stock somehow.

Around half of rail fares are regulated, currently at RPI + 1% on the July figure. In 2009 that meant a price fall of 0.4%.

Market structures in rail80

Railtrack and now Network Rail is a natural monopoly.

The TOC’s are monopoly suppliers on their franchise routes generally, but face significant competition from road transport making the exploitation of this position difficult. In some cases different TOC’s operate trains over the same routes where their franchises overlap. There is no evidence to show that fares are lower in these cases.The TOC’s do price discriminate. This is because they are, in most cases, the monopoly supplier of rail transport and so can charge commuters and people who must travel at certain times more than the customer who can make a choice. By doing this they also reduce the problem of ‘peaking’.

However not all passenger rail operators hold franchises. When fares have become high new operators have emerged on particular routes. These are shown below:

Company Commenced ServiceHull Trains September 2000 Hull - London Grand Central March 2008 Sunderland – LondonWrexham & Shropshire April 2008 Wrexham – LondonHeathrow Express and Heathrow Connect are also non-franchise services.Hull Trains and Heathrow Connect are both owned by First group who operate four franchises, and so face lower barriers to entry than other firms.

Where there is a competition concern is where the same firm owns more than one form of public transport. Stagecoach own both South West Trains and local bus services. It would be possible for them to close parts of the rail network and replace it with buses, although there has been no instance of this to date.

There are substantial barriers to entry in the passenger market. j There are substantial entry costs. j Existing TOC’s have the experience to allow them a much more realistic assessment of the worth of a franchise. j There is a shortage of available rolling stock.j Trained staff are in short supplyj There are limited ‘slots’ to run services to London stations.j Restrictions are imposed on where trains can stop.

Grand Central trains took four years to be able to start operations due to legal challenges, rolling stock and staff difficulties and they cannot stop south of York.

A major concern arose with the acquisition by Stagecoach of one of the rolling stock companies. This means the separation between service provider and rolling stock owner has been broken and Stagecoach now lease rolling stock to rival operators. The recent government review of the rail industry has stated that the rolling stock leasing market is not operating as it was envisaged. Indeed there is a worry that as TOC’s replace old rolling stock with new trains the market for ROSCOs may disappear.

81

Subsidies will continue to be required on some routes (17 of the 20 franchises) until the end of the franchise period. Some, mainly intercity services, will break even or even repay subsidy. This assumes that the franchisers can meet their financial targets and one operator, National Express, handed back the East Coast mainline franchise in mid 2009 because they were unable to pay the agreed fee to the government.

Overall barriers to entry in rail passenger transport are high. The individual route operators indicate that entry is possible, but extremely difficult.

Freight

Freight has been a success so far, with 50% growth (tonne km) between 1998 and 2008 and there has been £1.5bn of investment.

Initially English Welsh & Scottish Railway (EWS) controlled around 80% of the market with Freightliner controlling most of the rest. Since privatization five new companies have entered the market. This seems to suggest that the market is contestable due to the fact that the track is accessible, with firms bidding for ‘train ‘paths’. The firms need to get the rolling stock, which they may lease, and then the business.

After years of declining use they are winning back business from road haulage due to substantial capital investment and, of course, competition. New locomotives and wagons have been introduced as well as new branch lines constructed to the sites of customers located near existing lines. Customer service has improved markedly.

An oligopoly still best describes this market, but the significant changes to market structure (2 to 7 firms) means that the barriers to entry and exit are not too high. However the larger firms are still in a stronger position to bid for train ‘paths’ than the smaller firms and also can offer more comprehensive services.

The effect of the growth of rail freight has been to take lorries off the road. Currently rail moves around 5.8 million lorry journey’s worth of material.

Arguments against rail privatisation

The natural monopoly argument

A natural monopoly cannot produce at the optimal level of output (MC = Price) 0Q* profitably. A subsidy is required to allow them to operate at this level of output. A profit maximizing monopolist produces at 0Qm, making profits of PmABC, but leading to a deadweight loss of ADE.

In 1993/94 the Public Service Obligation payment to BR was £800 million, representing 32% of total revenue. This had risen to £1669m in 1995/96, 39% of total passenger receipts, although this does include a special grant for the transition period

82

between private and public ownership which will diminish over time. Many argued that cutting the level of subsidy would inevitably mean losing part of the network and/or reduced train frequencies, especially to rural areas.

Price/costs

0MCATC

D = AR

C

APm

Quantity0Qm

B

Q*MR

DE

The level of subsidy paid to BR in 1985 was £988m, this had risen to £1741m in 1994. By 2006 it was over £5000m. The government insisted that it be brought down from this level.

The network argument

Many argue that the rail network only makes sense as a single entity. People wanting to travel from, say, Basingstoke to York simply want to get on to the train having bought a single ticket. In fact under the old system they had to use London Transport’s underground trains, but a through ticketing arrangement allowed this.

Today the passenger travels on three operators trains, South West Trains, London Transport and GNER. Each firm receives its share of the revenue.

There are, however, no attempts to co-ordinate timetables and no facilities to take ‘unusual routes’, such as breaking a journey.

Suppose the person wanted to go to Nottingham on the way to York and then return to Basingstoke. The old system allowed ‘any reasonable route’ and so charged the same fare. Today the traveler would be charged a single to Nottingham, a single from Nottingham to York and a single from York to Basingstoke. As the difference between return and single fares is small the traveler would pay around 3 times as much!

Through ticketing and comprehensive timetables are in force. The worst effects of this problem is avoided. However the allocation of resources is not efficient. For example when a Great Western Train broke down in Devon it took over four hours for Virgin Cross Country to agree to loan one of its locomotives to move the stricken train. This

83

was despite the fact that a Virgin train could not depart until the line was cleared. In the days of BR the decision to use the Virgin locomotive would have been made at local level, not over fax machines between a station and two company head offices.

The co-ordination argument

The fact that there are 125 firms trying to run their own part of the railway is going to create problems. Each company focuses on its core business. There is no overall body directing industry strategy. (Note the SRA were created to fill this role, but subsequently found that the Government kept interfering and making it change direction. Eventually that was scrapped too!)

The TOC’s want to carry more passengers, but for this they need more rolling stock and track capacity. The ROSCOS own the rolling stock and have limited investment funds. The TOC’s have short franchises and could not possibly get a return on the new trains before the franchise ends. This has resulted in little new rolling stock.

Railtrack was responsible for the infrastructure. It wants to expand capacity, but could not possibly invest fast enough. This is due to both a lack of resources and the physical ability to expand the network as fast as the TOC’s want to raise passenger numbers.

The economies of scale argument

Buying in bulk, for example new trains, offers potential savings. Railtrack used a number of different maintenance firms and this may have diluted economies of scale. Overall, however, these losses may be overcome by the savings due to competition for contracts.

There is a clear loss in the area of financial economies of scale. If the government ran the network and borrowed to invest they could do so at a lower rate of interest than any commercial borrower. Railtrack had to borrow at commercial rates. Network Rail now obtains funds from the government and may benefit from being able to borrow at lower rates than Railtrack, although this is unclear.

Railtrack (and all firms in the industry) had to pay dividends to shareholders. Many argue that all of the profit would be better re-invested in the industry. This argument is countered by the fact that Railtrack could borrow against future profits and invest several times their annual profit each year. While using all their profit to service borrowing might increase potential investment under BR the Treasury constantly blocked investment plans and might do so again. The argument is, therefore, not clear cut.

Recent events

84

During 2003 most of rail maintenance was taken out of the hands of contractors and the workers transferred to the employment of Network Rail. This can be seen as the second step (the first being Railtrack’s demise) towards renationalisation of the railway.

The Strategic Rail Authority and the regulator

The arrival of the SRA served to confuse as much as help. In 2003 the SRA cut the number of trains to help ease congestion. This seems odd, surely more trains means more passengers moved. However the SRA felt that if they took some trains off the network it would cause less holdups.

The position of the regulator became unclear. He made decisions that the SRA contradicted.

In theory the SRA should have had a vision of how the railway would be run. As Network Rail take more control of the infrastructure and strategy this may become a reality. At the moment, however, they change their minds so often a direction is difficult to discern.

The 2004 review19

The SRA is to be wound up. The key features of the review are:

The ‘Public Private Partnership principle continues.The government will take charge of setting the strategy for the railways. This includes the government deciding on the level of public expenditure and what it will buy. The Rail regulator and TOC’s continue.Network Rail will be given responsibility for operating the Network and for its performance. This is to try to overcome the lack of progress in improvement caused by the many players in the industry. Although it may be a forlorn hope it is intended that the new arrangement will prevent poor performance being blamed on others.Track and Train companies will work more closely. There will be a bringing together of track and train company responsibilities. There are to be fewer franchises, those remaining being more in line with rails regional structure. Regional government will, where appropriate, be given a greater role. The Office of the Rail Regulator will cover safety, performance and cost. There will be a single public regulator to reduce bureaucracy and ensure issues are looked at as a whole. Responsibility for safety passes from the HSE to the Rail Regulator, which is independent of Government.

Rail privatisation assessed

The way to assess a privatization is by comparing the outcome to the aims.

19 “The Future of Rail” DoT July 200485

Aims:k To see better use made of railwaysk To provide greater responsiveness to customer needsk To achieve a higher quality of servicek Provide better value for money for rail usersk Increase investment in railk Reduce government expenditure

The facts are:

Investment is up.Passengers are up.Freight is up.Subsidy was declining.Performance has been improving since 2002.

But:

Complaints are at an all time high.Fares are rising ahead of inflation.There have been high profile accidents.Years of neglect have not been remedied and the network is in a poor state of repair.The Public Performance Measures show that there has been little progress in raising quality.One franchise has already failed to be able to make payments promised.

Railtrack failed because the government subsidy paid was insufficient to meet the long term needs of the network. This was not recognised at the time of privatisation. Railtrack had debts of £3.3bn and made an operating loss of £534m in 2000/01.

The passenger market is not contestable in any meaningful sense. As such the hoped for efficiency gains are going to be achieved by the will of the regulator, not competition.

Part of the problem of rail is that it is now carrying more people and freight. In other words part of the problem is the success of privatization and part of the problem is how it was privatized. Given the clear weaknesses of privatization in the rail industry the 2004 reforms should help.

The diagram below is a summary of the views of one railway professional, His view is that much good has come out of privatisation, but the strengths of BR have been lost.

The fact that ‘Railway professionals’ have been replaced by businessmen appears to be more than sour grapes. Rail is a complicated and specialised industry that former supermarket executives cannot easily grasp.

86

Everybody has a view on what should happen next. The views range from re-nationalisation under one system to a rationalization with fewer companies. There is a consensus that TOC’s, ROSCOS and maintenance contractors can operate more closely. However put two railway experts in a room and get three opinions.

Airlines

In recent years there have been two clear trends in the airline market.The growth of low cost airlines on short-haul routesThe formation of airline alliances between long-haul carriers.

Low cost airlines

These have been able to come about due to deregulation of the industry. It is now possible to run an airline if you can meet safety standards (enforced by the Civil Aviation Authority in the UK) and can secure take-off and landing slots at airports.

The real change came with the deregulation of EU airspace. This was introduced in April 1997. The essential features of the policy are:Open access – an airline can establish themselves in any member state.Airlines can fix their own fares and cargo ratesCommon criteria must be applied for granting operators’ licencesAir transport is included in EU Competition Policy to prevent anti-competative behaviour.

Although airlines such as BA still dominate the major airports by control of landing slots (Heathrow and Gatwick for example) the increased use of less used airports and their subsequent growth has allowed low costs airlines to grow rapidly.

87

Of course there are still significant barriers to entry including the cost of aircraft and the establishment of a brand name consumers trust. However easyjet and Ryanair have done this quite quickly and are being followed by many other airlines.

Low cost airlines are able to compete by offering a different quality of service (no meals/reserved seats etc) and keep costs down by operating a uniform fleet (easyjet will move to only Airbus A318/319/320 in a few years, Ryanair only Boeing 737) so gaining scale economies.

It is possible to see the market moving from a highly contestable one to a more oligopolistic one as easyjet and Ryanair gain more market share. However airlines such as bmi continue to grow and new ones are established so the market does look really quite contestable.

The acid test is that prices have fallen and supply increased. Exactly what a consumer driven, contestable market would achieve. Thus the deregulation of airlines has benefitted the consumer considerably. But this is not necessarily the best result environmentally. Air travel has yet to be included in carbon trading and is a major source of growing carbon emmisssions.

Long-haul airline alliances

An airline alliance is an agreement between two or more airlines to co-operate for the foreseeable future on a substantial level. The degree of cooperation differs between alliances. The three largest alliances are the Star Alliance, SkyTeam and oneworld. A more recent development is the formation of alliances between cargo airlines, such as that of WOW Alliance between Lufthansa Cargo, Singapore Airlines Cargo, SAS Cargo Group and Japan Airlines Cargo.

Benefits and costs

Benefits can consist of:

An extended and optimised network: This is often realised through code-sharing agreements. Many alliances started as only a code-sharing network.

Cost reduction: This can include sharing of Sales offices Maintenance facilities Operational facilities, e.g. catering or computer systems. Operational staff, e.g. ground handling personnel, at check-in and boarding

desks. Investments and purchases, e.g. in order to negotiate extra volume discounts.

Traveler benefits: Benefits for the traveler can be:

88

Lower prices due to lowered operational costs for a given route. More departure times to choose from on a given route. More destinations within easy reach. Shorter travel times as a result of optimised transfers. Faster mileage rewards by earning miles for a single account on several different

carriers. Round-the-world tickets, enabling travelers to fly over the world for a relatively

low price.

Airline alliances may also create disadvantages for the traveler, such as:

Higher prices when all competition is erased on a certain route. Less frequent flights, for instance when two airlines fly each three times a day on

a given route, the alliance might fly only four times on the same route.

The abilities for airlines to form an alliance are often restricted by laws and regulations or subject to approval by authorities. Antitrust laws play a large role. Sometimes political quid pro quo between governments is at hand.

Also landing rights may not be owned by the airlines themselves but by the nation in which their head office resides. If an airline loses its national identity by merging to a large extent with a foreign company, existing agreements may be declared void by a country which objects to the merger.

The three largest alliances are:

Star Alliance oneworld SkyTeamPassengers per year 499.9 million 320 million 428 millionNumber of Destinations 912 692 841

Market share 29.3% 14.9% 20.8%Participants

Adria Airways (JP) Aeroflot (SU)Air Canada (AC) American Airlines (AA) Aeroméxico (AM)Air New Zealand (NZ) British Airways (BA) Air France-KLM Air China (CA) (AF/KL)ANA (NH) Cathay Pacific (CX) Alitalia (AZ)Asiana Airlines (OZ) Finnair (AY) Continental (CO)*Austrian Airlines (OS) Iberia (IB) Czech Airlines (OK)Blue1 (KF) LAN (LA) Delta (DL)bmi (BD) Qantas (QF) Korean Air (KE)Croatia Airlines (OU) Japan Airlines (JL) Northwest (NW)LOT Polish Airlines (LO) Malév (MA) Air Europa (UX)Lufthansa (LH) Royal Jordanian (RJ) Copa Airlines (CM)SAS (SK) To Join China Southern (CZ)Singapore Airlines (SQ) Mexicana 2009 Kenya Airways (KE)South African Airways (SA) S7 Airlines 2010 NEW SINCE Jan Spanair (JK) 2008

89

Swiss International Air Lines (LX) Air Europa (UX)TAP Portugal (TP) Vietnam Airlines Thai Airways International (TG) (VN) To join 2010United (UA) *Contiental switchingUS Airways (US) to Star AllianceNEW SINCE Jan 2008Eygpt Air (MS)Shanghai Airlines (FM)Turkish Airlines (TK)

Membership correct as of 31/12/08

The Star Alliance is going to increase its dominance (during 2008 Star’s market share rose from 23% to 29%) with the addition of Continental from Sky, Air India, Brussels Airlines and TAM Airlines (the Brazilian national carrier). Note some major airlines are not present – particularly middle eastern airlines, but they do operate code shares.

The economics of traffic congestion

Congestion

Congestion occurs whenever a journey has taken longer than the transport user expected (based on reasonable assumptions). As a consequence the transport system is inefficient and costly to users.

In 1989 the CBI estimated the costs of congestion to industry at £15 billion a year (1989 prices). London and the south east accounted for 2/3 of this cost. This represented an average of £10 per week per household on the average budget as the higher costs of transport are passed on in the form of higher prices. Since this estimate was made costs have risen, but the figure you get depends upon how you estimate costs.20

Congestion applies to all forms of transport and is increasing as the demand for transport use grows faster than supply. The average speed of traffic in cities is falling, the chart shows average speeds in London.

20 See Mumford again90

The costs of traffic congestion

Traffic congestion is a market failure. External costs are imposed on society by transport users. This implies that the marginal social benefit of using cars, for example, is less than the marginal private benefit.

0

Price per mile

Vehicle miles

D = MPB

MSB

P

Q* Q1

The demand curve represents the marginal private benefit of using cars. 0Q1 miles are driven when price is 0P. At price 0P the social optimum is where price equals MSB or 0Q* miles.

The cost of using a road has three elements: The users own costs of using the uncongested road. Congestion costs faced by the marginal road user.

91

Congestion costs imposed by the marginal user on everyone else.

The first two costs are internal the third external. The problem of congestion is that joining the traffic on a congested road costs the marginal user far less than it costs society.

Take the Severn Bridge as an example. The exodus from Wales means that the bridge is very busy and the average speed out of Wales is 5 mph. Suppose 10,000 cars are trying to use the bridge and with the toll the average cost of each journey is £4. Another car joins the traffic causing all cars to move slightly more slowly and this raises the cost per journey to £4.05.

The marginal private cost of this extra journey is £4.05, but the marginal social cost is 10,000 x 5p, £500, as all the other cars already on making the journey are slowed down. The market is unable to adequately pass this extra cost on to the marginal user and so congestion becomes common.

(Oddly the traffic moves freely on the road into Wales.)21

In reality the costs of congestion are difficult to compute, but they include:

The additional cost of journey times - these are costed more highly for worktime. Increased fuel and other running costs. Reduced vehicle productivity. Additional costs to users and operators of public transport. Higher stock levels due to less frequent and efficient delivery. The negative externalities caused by congestion, e.g. more pollution.

The problem of higher distribution costs are seen as particularly serious. Slow journey times means that more delivery vehicles and staff are required to distribute goods to retail and wholesale outlets. In the case of London the CBI estimates that around twice as many delivery vehicles operate than are necessary due to congestion. These extra costs are inevitably passed on to the consumer.

Policy solutions?

Any policy must address a central problem as identified by Pearce et al., in Blueprint 5 22

. “To relieve traffic congestion it must become possible to exclude certain sorts of road users from the road network - specifically those for whom the value of the journey is less than the value of the delays they would inflict on other road users.”

This is a very market oriented view, but one that draws great support. Basically Pearce is saying that consumers that only use the roads at low prices (who join the market at 21 This is a joke. It is much funnier when there is a Welshman in the class. (You must trust me on this.)22 The true costs of road transport, Blueprint 5. Copies in classroom.

92

the bottom of the demand curve) are the ones who should be excluded. A policy that rations road use by a means other than price will not do this.

Some people find this notion unacceptable. ‘Equality’ often confuses the issue. Those who can afford the highest price can pay more because they earn more. But they earn more because their value added is greatest. In other words they contribute most to the economy.

Possible solutions have been proposed (not all of which meet Pearce’s criteria);

Make better use of existing roads - the engineers solution. Reduce parking on busy roads, use bus lanes, park and ride schemes, etc. Build more roads - the option taken often in the past. The problem is how to fund the new infrastructure And to build it without further serious loss of other resources. Improve public transport - used extensively in some areas of Europe where they have tried to integrate their public transport network and supported this with greater public subsidy. Increase the cost of urban travel to private motorists - there are various methods of charging for road use that are possible. These can be either direct (i.e. placed directly on the road user), or indirect (i.e. paid within another charge like VAT).

Indirect methods On vehicle ownership On vehicle usage

Licence fee Fuel tax Tyre tax Area licence Distance licence Shadow tolls

Direct methods Recorded off vehicles Recorded on vehicles

Tolls Smart cards Automatic scanning

It is very difficult to discriminate among different road users with respect to the value of their trips. Goods whose delivery is urgent or people whose time is valuable are delayed by drivers on relatively unimportant trips. A real challenge is to find a method that prioritises the important users.

Road pricing

93

The principle of road pricing is that external costs should be internalized. That is users should pay the costs they impose on others. It is effectively a tax on road users, but can be varied according to the time of day and the level of congestion.

The advantage of road pricing is that it is possible to set the tax to the socially efficient level of road use. The most obvious problem is deciding on the appropriate level of charges on each mode of road transport so that the most efficient mix is achieved.

An important point to make is that road pricing is not a measure to be used in isolation, but as part of an overall strategy that allows everybody to use the transport infrastructure, but reduces the large costs of congestion.

Price of road space£

MPC

0 Q* Q1 Quantity of road space

MSC MPC + road tax

TaxP1P*

MSB = D

A

B Gain to societyC

The diagram shows how the imposition of a tax on road use will move the market to the social optimum. This does depend on the right level of tax being imposed. The ideal level of tax is where the marginal user is charged the cost of the additional congestion caused. In this case society gains the shaded area in avoided dead weight loss. In addition the government gains a tax revenue of P*ABC which is transferred to other members of society (although road users could benefit if the money is used to improve public transport for example).

The optimal tax is, however, not always the same on a particular route. The demand curve at peak times moves to the right, implying a higher level of tax is optimal than at low demand periods.

Sometimes the MSC curve is shows as not diverging from the MPC curve at low levels of road use. As it is difficult to imagine a situation where there are no externalities from road use this is certainly a simplification. In rural areas, however, the additional costs imposed by one more road user are very small. This diagram also shows how congestion on a road such as the M25 affects users. At certain times there are no

94

problems, but as traffic levels rise the external costs rise and become more and more significant.

Optimal tax, peak demand

D Peak demand

Price of road space£

MPC

0 Quantity of road space

MSC

Optimal tax, moderate demand

D Low demand

D Moderate demand

It is important to consider the price elasticity of demand when setting road pricing levels. As most congestion occurs in urban areas or busy motorway sections during the ‘rush hour’ it is reasonable to assume that the journeys being made are important. PED is likely to be inelastic at these times and so a small rise in marginal private cost will have little effect. This means that:The toll level must be set very high to have a significant effect.The toll must be used in conjunction with other methods to make PED more elastic.

Park and ride schemes, Raising parking charges, Reducing parking spaces and Improved public transport These are all possible strategies to implement at the same time. If the revenue form the road pricing scheme is hypothecated to other traffic reduction schemes then there is no cost to the general tax payer (non-road users).

It has been suggested that tolls on the Severn Bridge should be varied according to the time of day according to demand. As the example above shows the optimal tax may be a significant amount at peak times.

Advantages of road pricing

It is a market based solution, as it takes account of consumer preferences (demand). As it is not possible to see which journeys are the most important by observation road

95

pricing reveals this by the willingness of people to pay. Legislation would fail to achieve this. It will result in less traffic and higher speeds (unlike all the other policy options which lead to more traffic.) Revenue generated from road pricing can be used to fund improvements in public transport.

Disadvantages of road pricing

They are socially divisive and regressive. Road users carry all the costs, pay the same regardless of income and may not see a fall in travel times sufficient to compensate them for higher costs. Estimating external costs of congestion is too difficult to allow accurate road pricing. The technology available to implement road pricing by electronic reading is unreliable and lanes and booths would create delays not reduce them. The level of charge must be fixed carefully to take account of the price elasticity of demand if congestion is to be reduced.

Singapore - road pricing in practise

Road pricing was introduced in 1974 in the central district of the city. The problem identified then was excess demand at peak times (the morning ‘rush hour’ and evening ‘rush hour’).

The scheme tried to discourage use of the limited road space at peak times and also discourage use of private cars generally. A number of measures were taken.

Introduction of bus lanes - this reduced the supply of road space available to private cars, but reduced bus journey times. Payment of a licence fee if a car was to be used in a certain area at peak times. The raising of car parking charges generally.

Initially commercial vehicles and public transport vehicles were exempt. Also cars with four occupants could travel in the restricted area without a licence. This was to encourage car sharing, which effectively reduced demand for road space. The exemption for car sharing was withdrawn in 1989 as demand for road space grew further.

The time period when a licence is required is from 7.15 am to 10.15 am (originally 9.30 am was used, but traffic merely peaked then). This has been found to smooth out traffic flows, reducing the peak traffic flow in the morning and allowing faster journey times. There is no evening restriction as it is argued that if people go into work earlier or later this automatically adjusts the time they leave.

96

The rise in parking fees was reflected in both publicly owned car parks and private ones by the introduction of a levy. Of course car parking fees do not affect through traffic, but did help shift the demand curve for road space further to the left.

The result of the scheme was to reduce traffic flows by about 40%. This was achieved by a Singapore $60 per month (or $3 a day) licence fee and the increased car parking charges.

The Singapore government anticipated that the demand for road space would continue to rise as real incomes rose. This has led to the introduction of further measures.

The extension of the licence fee to all vehicles except public buses and emergency service vehicles. An import duty of 45% on new cars. A registration fee of $1000 for private cars and $5000 for company cars. An additional registration fee of 150% of the market value of the vehicle. An annual road tax based on engine capacity averaging $2000 for a private car and $4000 for a company car. Higher licence fees for company cars in the restricted area. The introduction of a Certificate of Entitlement Scheme (COE) to limit new car purchases (1990).

There are a limited number of COE’s and they are auctioned, each successful bidder being able to buy at the lowest successful bid price. This further restricts the number of cars in Singapore. It has been argued that this is an inefficient way to reduce congestion as it is not ownership but when and where cars are used that is the issue.

Recently the Land Transport Authority in Singapore have introduced variable tolls. Not only can tolls change according to the time of day, but they are also reviewed every three months and adjusted to account for traffic flow.23

The advent of ‘ERP’ ‘Electronic Road Pricing’ has allowed this. Electronic readers can charge cars as they pass through the barriers meaning there is no need to purchase an area licence in advance. This technology means that ERP will be easier to introduce elsewhere.

The success of the Singapore scheme is impressive, but has failed to reduce the number of cars on the road. In 1982 there were 179,635 cars in Singapore, by 1992 this had risen to 285,500. Perhaps the encouraging news is that the number of buses rose from 7,585 to 9,658 in the same period.

One of the lessons of Singapore is that a co-ordinated policy is required to solve the congestion problem.

Practical problems in the UK23 There is a great deal of material on the LTA website. www.lta.gov.sg

97

The application of road pricing to Britain is not as simple as in Singapore. Singapore is a city state (and an island) which makes the scheme more like pricing in central London only. Individual cities can adopt the scheme, but it may not work on a national scale.

There are essentially two different types of road pricing. Cordon schemes - appropriate for city centres. Mileage schemes - appropriate for trunk roads.

In a cordon scheme it is necessary to decide if vehicles must pass through the outer cordon (e.g. through a toll booth) where those within the cordon escape payment, or if everyone pays (e.g. an area licence scheme).

Crucially the effect on demand depends upon the elasticity of demand. These are expected to be quite inelastic for most city centres.

The political problems of introducing widespread charges may mean it is never introduced at a high enough charge level, although there is no strong evidence either way on public opinion they have reacted unfavorably to higher fuel prices.

A further consideration is the equity concerns over the destination of revenues. These are transfers from road users to someone else. Should we be concerned about this transfer?

There are three possible ways to road price: Toll booths. Electronic tags. Camera schemes

If toll booths are used they will cause tail backs at peak times. Also on a road like the M25 some 30 booths would be needed in each direction, requiring a great deal of land.

Electronic tags have implications for personal privacy. A tag is activated by a roadside beacon which charges according to the time of day. Such information could be regarded as an invasion of privacy as it implies that the location of individuals at certain times could be revealed to others.

A system where a road user remains anonymous unless a vehicle has contravened the rules (i.e. the number plate is photographed) gets around this. This was the system adopted in London. It avoids queues on the boundaries and allows drivers to remain anonymous unless they don’t pay. Unfortunately it is susceptible to false number plates and refusal to pay.

A further problem is the diversion to traffic. If ERP was introduced on motorways traffic would move to A roads. This may cause local problems and greater danger to pedestrians. When the London congestion charge was introduced there was also great

98

concern that roads just outside the charging zone would become overloaded as people ‘skirted around’ the zone. This did not happen.

Central London Congestion Charge

The Mayor of London has authority over the city’s transport network. According to Transport for London

Politically this is very difficult and runs the risk of unpopularity, Livingstone’s re-election may encourage others. London introduced a scheme to charge £5 a day to enter central London, later raising this to £8 in July 2005. This seems to have general support, but with many specific objections (such as the exact boundaries).

The area is very small and it was feared that it would encourage congestion immediately outside the chosen area. However so far this has proved an unfounded fear.

Initially many found it difficult to see how in an area where parking costs £6 and hour £5 a day extra will deter entry. The initial impact was a fall of between 20 and 25%. At the end of the first year this had settled down to a 18% fall in traffic during charging hours and a 15% fall in traffic overall.24 Average traffic speeds rose from 8.5mph before the charge was imposed to 10mph in 2006.

The improvement of public transport is crucial for the scheme to work and at present there is controversy over the future of the tube. Other methods, such as trams and improved buses are being considered.25

What follows is considerable detail of the scheme which some of you may find useful.

Why a charging scheme was needed

* Every weekday morning in Central London too many vehicles were trying to use too few roads* There is no possibility of building more roads in the centre of London

24 See Congestion Charging, Update on scheme impacts and operations. Feb 2004 TfL.25 See ‘Mayor of London, proposals for congestion charging’ is document boxes and Clift’s article from November 2003 Economic Review.

99

* Drivers spent up to 50% of their time crawling in jammed traffic* Congestion in London was costing business about £2 million a week* Static and slow traffic generates more air pollution and produces more carbon dioxide, the greenhouse gas. This has resulted in a general loss of amenity for Londoners in terms of quality of life on the streets* No one would deny that congestion in London was causing frustration and raising stress levels

Aims of the charging scheme

* Reduce traffic where it is most congested by between 10-15% year-round, ie to school summer-holiday levels* Reduce delays by 20-30%* Shorten journey time* Make delivery times more reliable* Save 2-3 million hours of journey time annually inside the zone and a further 4-7 million hours in the area between the zone and the North and South Circular roads* Raise £1.3 billion over the first 10 years for re-investment in all forms of transport in London, including roads, buses, local streets and railways* Increase public transport use in the central area by 1-2%* Pay for itself within 18 months of starting

Charging times

Charges were initially made between 7am and 6.30pm, Monday to Friday - excluding Public Holidays. This was changed to 6pm with the extension of the scheme.

Charging costs

The charge is £8 a day for which vehicles can enter and leave the zone any number times on the same day.

100

Exemptions

A discount of 90% is available to residents living in the zone.There is complete exemption for:

* Disabled persons with a Blue Badge* Vehicles used by certain NHS staff and patients.* Emergency service vehicles* Motorbikes and mopeds* Hackney carriages (black cabs) and London licensed mini-cabs * Buses and coaches with nine or more seats * The cleanest alternative fuel vehicles (band 4 as defined by the Powershift Register, www.powershift.org.uk) and electrically propelled vehicles* Breakdown vehicles in use to provide roadside assistance or recovery services operated by independently accredited organisations (eg AA, RAC, Green Flag)

An assessment of the impact of the London Congestion Charge

Despite concerns beforehand the scheme has been a success. Some people oppose it, but this is confined to those who simply do not want to pay the charge and those who must work either side of the boundary.

101

After one year the following can be concluded:

Traffic patterns are now settled.Traffic delays within the zone average 30% lower than before the charge was introduced.During the charging period traffic entering the zone are 18% down.Nitrogen Oxide emissions from traffic down 12%, carbon dioxide by 19%.Traffic diverting outside the zone has not caused problems.Public transport is coping well with ex-car drivers (principally the extra bus capacity)Buses have benefited from less congestion within the zone with up to a 60% reduction in disruption caused by traffic delays.60% of businesses surveyed supported the continuation of congestion charging (given continued investment in public transport) only 20% opposed it.There is only minimal impact on retailers.An average of 165,000 penalty charge notices are issued each month!

Of the 65,000 to 70,000 fewer car trips made each day between 50% and 60% have transferred to public transport, 20 to 30% divert around the zone and 15 to 25% have made other arrangements such as changing the time of trips. Bus passengers arriving in the zone is up 37%.The Institute for Public Policy Research published ‘In the fast lane’26 in July 2004. This basically covers similar ground to the CfiT view on a national charging scheme. It did include a CBA of the London Congestion Charge which is reproduced below.Preliminary estimates of costs and benefits of central London congestion charging £m per year

Annual costs Transport for London administrative and other costs 5 Scheme operation 90 Additional bus costs 20 Charge payer compliance costs 15 Cost to car occupants transferring to public transport, etc. 20 Total 150

Annual benefits Time savings to car and taxi occupants, business use 75 Time savings to car and taxi occupants, private use 40 Time savings to commercial vehicle occupants 20 Time savings to bus passengers 20 Reliability benefits to car, taxi and commercial vehicle occupants 10 Reliability benefits to bus passengers 10 Vehicle and fuel operating savings 10 Accident savings 15 Total 20026 See IPPR website www.ippr.org

102

Notice that this table excludes net revenue from the scheme, which was a little less than £80m in the first year. This surplus is earmarked for transport improvements. Effectively this gives a net annual benefit of £130m in the first year.

2006/7

The latest report by Transport for London states:Traffic patterns remain broadly stable. The July 2005 rise in price to £8 was effective in reducing traffic flow.Congestion levels are on average 26% lower than before charging was introduced. Given that without charging congestion would have increased this represents an underestimate of the effect of the charge.There appears to be no net impact on London’s economy.Accidents and pollution have declined.In 2005/6 there were net revenues of £122m.

Traffic Speeds

Traffic speeds have increased in the charging zone, but are falling again. This shows the ongoing problem of rising incomes and GDP will require more intervention in the future – see Singapore!

103

Commission for Integrated Transport

The CfIT has suggested a radical system that would lead to countrywide charging. Their aim is to manage the flow of traffic throughout the country, rather than in a few places. By using GPS they believe that it is possible to track and charge every vehicle.

104

They do not propose a rise in overall charges. Rather they suggest reducing fuel duty and vehicle excise tax and charging for use of roads when they are busiest. Thus someone driving on city centre roads at peak times pays a great deal, while someone driving along a country road pays little or nothing.

CONGESTION CHARGINGThe need to tackle congestion

Why traffic congestion is getting worse

Great Britain is a small and densely populated island Our towns and cities were built long before the car was invented and there is no room to provide more roads or parking spaces within them Car ownership continues to grow rapidly: 71% of households have access to a car; ownership of two or more cars rose from one in six households in 1986 to one in four in 1999 The relative cost of owning and driving a car is getting cheaper - and the government forecasts that costs will fall a further 20% over the next 10 years Meanwhile, public transport fares are rising and continue to attract less subsidy than elsewhere in Europe We are using our cars more and driving them further than motorists in the rest of Europe. The UK has seen the fifth highest growth in car modal share - increasing by 6.8 % between 1980 and 1998, compared to the European average of 5.3, even though there has been a lower than average increase in car ownership We now spend an average of 216 hours a year in our cars - in 1976 it was 92 hours We are commuting further to work We are driving our children to school more and ‘school run’ traffic adds a fifth to the total number of cars on the road at peak times We all want to use the busiest roads at the same time of day - and there is no incentive or penalty, other than congestion, to do anything else An RAC Foundation study has shown that just to keep traffic congestion at current levels would require a five-fold increase in what we spend now on road building, or a rise in fuel duty to five times the current level Large road building programmes are unpopular with the public on environmental grounds - there were widespread protests and demonstrations during the last Conservative government’s road building programme As new roads are built traffic levels quickly grow to fill the extra capacity - the M25 is a classic example No growing economy has yet managed to cut congestion Roads are almost the only public utility that is free at the point of use

Managing demand

There are a range of opportunities by which authorities across the UK can manage the demand for travel. Options:

105

Allocating space by people flow rather than the more traditional traffic flow. For example, a bus can carry up to 80 people and takes up less than three cars. On busy roads it might be a better use of road space to give a bus its own lane. In some busy town centre roads you can see cars parked on both sides with one slow-moving traffic lane in between, and pedestrians squeezed on to narrow pavements. Hardly a fair or effective use of road space ‘No parking’ areas to ease the flow of traffic ‘Resident parking only’ zones to discourage traffic in quieter areas Price - Introducing parking meters and paying car parks where drivers are charged by the time in a zone. Prices can be raised to a level that influences travel behaviour Congestion charging - where drivers are charged for entering a charging zone Workplace parking levy - where companies and organisations are charged for each parking space at their premises. Currently, up to 90% of people driving to work park freely when they get there. As a result there is no incentive to consider alternative forms of travel Effective penalties and adequate enforcement to ensure drivers stick to the rules Park-and-ride - where motorists are encouraged to park out of town centres and use cheap or free dedicated bus services - running on bus lanes - to get into the centre Cycle lanes - to give people more confidence to travel by bicycle Extra, secure parking facilities for bicycles and motorcycles Traffic calming - creating zones where road humps, visual obstructions and zigzag routes discourage fast driving and encourage motorists to consider alternative routes Speed restrictions - introducing, for example, lower speed restrictions outside schools and other areas Pedestrianised areas - separating traffic from pedestrians completely, particularly in parts of city centres Gated areas - which allow buses through to the centre of a city but exclude cars Green travel plans - which encourage employers to incentivise staff to come to work by other forms of transport. This might mean extra money for people who car share, negotiating bulk discounts with transport operators for season tickets, or providing special facilities like showers and secure bike parking for cyclists. The incentive for companies is that it can reduce their need for parking spaces which can reduce their costs and the space which then be put to better use

Microwave technologyThe illustration below shows how microwave technology operates. Cameras fitted on gantries read number plates as vehicles pass by. (The need for a smartcard to automatically deduct payment is optional.) Automatic number plate recognition (ANPR) technology detects non-tagged vehicles. Of the two electronic methods, microwave technology is by far the simplest. Its main disadvantage is that it requires gantries on every road at regular intervals, something that would soon become unmanageable on any large geographic scale or complex urban area. The use of lampposts has been ruled out as camera angles would not allow detection of every vehicle.

106

Global Positioning Satellite technology (GPS)The illustration below shows how the technology operates. Unlike microwave technology, GPS requires no overhead gantries and the necessary satellites are already in orbit. However, there is still a need for fixed or portable enforcement cameras, although these do not need to be as regularly spaced. Even though this technology is far more complicated than using microwaves, it is the only realistic option for any large scale implementation of electronic charging. Again, the use of a smartcard to automatically deduct payment is optional

107

The unit in the vehicle works like a car radio - it ‘listens’ for to broadcasts from GPS satellites but does not send any signal back to them. Communication is one-way and private. The in-car receiver matches its position with an electronic map of charged areas and a list of charge rates. The appropriate data is then ‘radioed’ to a processing office for the user’s bill to be produced.

GPS is already used for navigation in the road haulage, shipping and aircraft industries and, increasingly with in-car navigation systems.“Assisted GPS” will feature in coming generations of mobile phones. It will incorporate new levels of accuracy in locating the phone’s exact position and will allow retailers, for example, to call potential customers as they pass their doors. In the USA it is expected that all new mobile phones will have this facility by 2005.

Payment systems

There are four basic methods by which drivers can be charged, each with a number of variations:

Pre-paymentDrivers pay in advance for a permit to enter or drive in the charging zone for a specified period.

Payment on entry/exit

Drivers pay on entry or exit to the charged zone, or for using a specific section of road or infrastructure, such as a bridge or tunnel.

108

Pay as you go

In principle this operates in much the same way as mobile phone technology. Each vehicle carries a unique tag and is fitted with an onboard charging unit with a smartcard to enable charges to be deducted during the times they apply. Drivers need to recharge their smartcards or purchase a new card once the credits have been used

Regular invoicing

Similar to ‘pay as you go’ (above) except that instead of paying through an on board unit with smartcard, drivers receive regular invoices through the post (weekly, monthly, quarterly, etc) in the same way as users of a contract-based mobile phone

‘Pay as you go’ and ‘regular invoicing’ are most likely to be used with any widespread charging system and are familiar to people who use mobile phones. These payment methods are able to overcome concerns over civil liberties associated with GPS and so-called ‘spy in the sky’ systems.

Eddington’s contribution

In January 2007 Sir Rod Eddington produced a report on Transport policy. The introduction to this report is given on the next two pages.

We can summarise Eddington as:Congestion will continue to get worse unless something is done to reduce it.There will be severe environmental and economic costs of failing to act.The way forward is a national road pricing scheme and sustained investment in the existing transport network.Investment in transport should be concentrated on the existing network and especially the ‘small’ projects such as bypasses and relieving bottlenecks rather than on grand schemes. (The BCR are significantly higher for these.)Getting the economics right is important, that means:1. Road pricing2. Higher fares for peak-time trains3. Higher taxes on air passenger travelEddington justified his views on the basis of benefits for business, not reducing negative externalities.Thus special attention should be paid to1. The international ‘gateways’ for UK trade – airports and ports.2. Heavily congested urban areas3. Main inter-urban corridors.However he concludes that most of the transport system works well – which was a bit of a surprise all things considered.

Eddington went out of his way to support the conclusions of the Stern Report and emphasized that pro-environment and pro-growth are compatible.

109

Reading the summary of the Eddington Report (the full report is 350 pages) is about as good a revision activity as you could do.

Sustainability and transport

Much greater emphasis has been placed on the sustainable nature of transport systems in the last few years. The Labour government has suggested that it wishes to develop a transport policy that is more environmentally friendly and issued a discussion document in 1997 Developing an Integrated Transport Policy. The aims of the government were expressed as:

A strong economy. A sustainable environment.

An inclusive society.

The paper recognised that good communications are ‘central to the improved and lasting quality of life’ and that they were committed to facilitating the mobility of the British people in ‘an economically and environmentally sustainable framework’.

The projected rise in road use and the decisions made on new road projects show that to simply allow the situation to develop unchecked would be neither economically viable or sustainable.

Integration

What is an ‘integrated’ transport policy?

A policy which simply addresses to needs of motor car and lorry users could not be considered integrated. An integrated policy looks at all modes and means of transport and ‘concerns the ways or processes by which the individual parts of transport policy are deliberately linked into a policy covering all modes, for both passengers and freight.’. It is possible to improve the overall situation by this wide approach and attempting to move passengers and freight from one mode to another.

The 1997 discussion paper pointed out that many people have no real choice in transport modes, for example there is no local bus service to the shops. Further many people will not walk or cycle because it is too dangerous (traffic) or unpleasant (pollution) to do so due to excessive vehicle use.

The complaints made about much public transport is that it is unco-ordinated. Timetables mean difficult transfers between services, for example waiting for hours for a connection. Bus and train services operate independently and the train stations are frequently far from bus stations. Public transport is also expensive for the marginal user

110

and when combined with the inconvenience (or great convenience of the car) all this combines to discourage the use of public transport.

A frequently cited example is the difficulty of using a bike to get to a train or bus station. What do you do with the bike when you get there? In Europe there is excellent provision for safe storage or transport of the bike. In the UK you are lucky to see the bike again. This means driving to the station is our best option and if you have driven that far why not the rest of the way?27

The fragmentation of the public transport system between providers is an issue here. Bus and train companies are (usually) different and a single journey might involve three or four different providers. The government is concerned to allow users access to information and so have implemented national information services. Through ticketing is also something that would be desirable, i.e. buying a ticket on the bus that gets you to your final destination, three buses and a train ride away. The Dutch public transport system certainly provides for this, but trams, buses and local trains are operated by the same organisation.

Thus an integrated policy aims to use all modes efficiently. In the view of economists this means a more efficient use of resources and implies greater use of public transport to avoid wasteful duplication of journeys and to reduce negative externalities that cause allocative inefficiency.

Sustainability

Difficulties always arise over what is meant by sustainability. For our purposes we shall use the most widely publicised definition due to the World Commission on Environment and Development.

‘Development that meets the needs of the present without compromising the ability of future generations to meet their own needs.’

Thus not only must society concern itself with issues of equity in the present, but of equity over time - so called intergenerational equity.

A sustainable transport policy

It is clear that transport contributes greatly to the emission of harmful gases and substances (see next section). Further the demand for transport continues to grow, at the very least as fast as GDP, while supply lags behind leading to worsening congestion. A sustainable transport policy must, therefore, be based on three principles:

To reduce the rate of growth of future demand for transport. To reduce the future demand for road transport.

27 See ‘Destination Passenger: Towards a door to door Railway. Transport 2000111

To promote the increased use of more sustainable modes of transport such as rail, bus, cycling and walking.

The type of measures that are likely to be employed in such a policy are those which:

Make greater use of rail for passengers and freight. Encourage more people to use other forms of public transport. Promote cycling and walking. Increase car occupancy.

The future policy will reflect the need to make a difference in the medium and long term. There is little that can be done in the short term. The report of the Royal Commission on Environmental Pollution issued in September 1997 gave a clue to likely future measures. (See page 106 of Bamford for details.) There has been some dilution of these recommendations in recent times as we shall see later.

Pearce again

According to Pearce having a sustainable road transport system means, “making each road user pay at least the full marginal cost of his or her journey.” He and his co-authors in Blueprint 5 argue that there is no need for an abrupt change in lifestyles to achieve such a policy, merely the correct choice of policy instruments.

For them the correct policy is one that focuses on emissions not road use itself. In doing this, rather than focusing on motoring itself, an incentive is given to avoid the financial consequences of the tax by a range of responses including reducing the pollution per mile driven, reducing total mileage, switching to other forms of transport and encouraging the development of low-cost pollution control devices. This is a ‘dynamic’ rather than static solution to the problem. The main problem with this is the inability to monitor many emissions at present.

Currently the main two taxes imposed on road transport (fuel excise duty and Vehicle Excise Duty) fail to address the problems of noise, accidents, urban air pollution and congestion costs.

Blueprint 5 suggested the following policies to achieve a sustainable transport policy.

A uniform tax on carbon emissions throughout the economy.

Fuel taxes should be based on the environmental damage each causes. (To encourage the use of cleaner fuels.)

More research into valuing the effects of various fuels, including their long-term impact so that appropriate tax levels can be determined.

112

Purchase and ownership taxes to reflect the emission characteristics of the vehicles. (i.e. large dirty vehicles pay more than small clean ones.)

Road side spot checks to catch high polluting vehicles. (The MOT test is foreseeable.)

Displays of current pollution levels to allow people to see current air quality. This assists those with breathing difficulties and raises public awareness of the problem. In the long term it would make remedial action politically more acceptable.

Similar measures to reduce noise pollution as to reduce air pollution.

Loss of open access to urban central road network. Area licences or ERP to be introduced.

Charges for road damage and accidents to be related to distance. A kilometer tax based on the tachograph in HGV’s, for example. for cars odometer readings or ERP can be used.

Speed restrictions to be lowered to reduce accidents and congestion. (Slower speeds reduce accidents and, as the M25 variable speed limits show, can reduce “phantom” traffic jams.) There is a trade off between time saving and accidents/fuel consumption on non-congested roads.

We can add to this list policies to encourage a more efficient movement of freight. This would include:

Transferring freight from road to rail and water.

Reducing the number of lorries running empty or below capacity (raising load factors).

Better tracking of vehicles to allow their more efficient use (e.g. directing an empty lorry to a nearby waiting load rather than having it return to base). this can be further enhanced by co-operation between carriers or their customers to share vehicles.

There is great public concern about transport, but little consensus. Pressure groups on oth sides push their case with the ‘road lobby’ commanding most votes. Alternative policy suggestions see Commission for Integrated Transport and Transport 200028 for examples.

Current government policy

There are four policy issues for government.

28 CiT www.cfit.gov.uk, Transport 2000 ‘Alternatives to Traffic Growth, Gleeve and www.transport2000.org.uk113

T How best to forecast future transport demandT How best to organize the UK’s transport systemT How best to deal with congestion and other negative externalitiesT How much to allocate from the government budget to transport

At national level the government have tried to develop a transport policy that addresses all the concerns we have looked at in the course. Integration and sustainability are clearly important as they cut back the road building programme and encouraged the transfer of freight from road to rail. The numerous policy papers do attempt to look at integrated transport as they look at all modes of passenger and freight transport.

However the overall process of resource allocation lacks the cohesion and completeness that a true integrated policy would have. This is due to the fact that:

1. No direct charge is made for most road use.2. Ownership is fragmented across and within transport modes and industries.

An integrated policy requires all decision makers to follow the policy. This seems something very difficult to achieve in UK transport.

Eddington has provided a framework for future policy. This has been embraced by government.

In October 2007 the government published ‘Towards a sustainable Transport System – Supporting Economic Growth in a Low Carbon World’. The title says it all! Eddington was clear that economic growth was important and he highlighted the need to accept Stern’s view that global warming can be reduced without too much impact on GDP. The government is planning to act on this advice.

StrategyPlease be clear that the requirement is for an overall strategy. Many commentators in the semi-technical press have totally failed to grasp that a sustainable policy does not mean reducing carbon emissions in every sector. When plans to discuss the further expansion of Heathrow were announced in 2008 the press attacked the government. The government ministers tried to explain that carbon trading meant that if people wanted to spend their carbon emissions on air travel that was fine, the reduction in carbon emissions would come elsewhere as the ETS is a ‘cap and trade’ scheme. The ministers wasted their breath (which is a shame because they actually got this one spot on) but hopefully this idea of overall strategy will not be lost on you.

The government therefore aims to promote economic growth and reduce CO2 emmissions. There are five broad goals in the paper.

Maximise the competitiveness and productivity of the economy.Congestion raises firms costs and so reduces competitiveness. The challenge is to improve the existing transport network, making journey times more predictable.

114

Policies: Better traffic management, getting ‘prices right’ and some infrastructure development.

Address climate change by reducing CO2 and other greenhouse emissions.Putting a price on carbon is essential, internalizing the externalities.Policies: Indirect taxation, trading mechanisms, provide greener alternatives (public transport etc).

Promote people’s safety, security and healthNot much to say on this one – maybe they think its self-explanatory

Improve quality of life through reducing transport’s negative impactsPolicies: Standard internalizing externalities, providing green alternatives.

Promote greater equality of opportunity, in particular through the provision of effective access.Policies: Old persons free use of public transport. Improved services to rural/deprived areas.

Resources are to be concentrated on the most congested parts of the transport system, with additional emphasis on public transport. Eddington’s advice that smaller local schemes provide better returns is supported in the strategy. Thus measures to improve traffic flow, park-and-rides etc will receive more funding.

Urban congestion will get more attention, but there will be no road pricing scheme until a fuller evaluation (political talk for ‘not before the next election’?).

On freight the policy of continuing to encourage more use of rail is the main policy. So far the move to rail has been driven by competition post-privatisation. Containerisation certainly makes rail use easier for firms.

The increase in maximum lorry size from 41 to 44 tonnes (on 6 axles) in 2002 was designed to allow more efficient carrying of road freight. Larger vehicles with high load factors means fewer vehicle movements and lower CO2 emissions. There will be consideration of allowing even larger lorries (83 feet long and up to 60 tonnes). These will not be popular with those who live near the roads that will be used.

Another measure is to tax the more polluting freight vehicles more heavily. A similar scheme applies to road tax.

Reducing ‘food miles’ has also become a popular policy measure. Various examples exist of food travelling thousands of miles (such as chicken from Thailand). In addition we have become used to out of season fruit and vegitables. This is a very modern trend and will almost certainly be reversed in the next decade – so no strawberries in December! Certainly bottled water from outside the UK should become a thing of the past.

115

116