Last week, I blogged about the Labour Debt Myth and illustrated how it can be tackled with economic evidence. Today I thought I’d unleash the economics of industry on the debate surrounding the nationalisation of the railway. If you want to know the answer now, then basically, the economics supports it in my view. This post is a biggie and could easily become a dissertation, so I’ve just covered the main points as I see it. If you don’t want to read, then my arguments are summarised by:

Franchising the network does not produce competition, and has resulted in Train Operating Companies (TOCs, e.g. London Midland, Virgin) exploiting monopoly power. No other network in Europe runs it’s network based on this model. It is by far in a way the main over riding problem. Franchising has resulted in undesirable outcomes such as price rises and lower investment from TOCs, leading to a poor network overall.

Government intervention through regulation in order to deal with this problem has not been effective. As a result, the burden to the taxpayer has increased, but the performance of the network has not changed, and in many cases has become worse.

Take any picking of performance metric you like, and they indicate either a declining quality of service or no improvement. Overcrowding has increased, prices have risen sharply, and punctuality is no better than when nationalised.

The whole nationalisation debate is fascinating to the ears of an economist. Economists believe that politicians, being rational economic agents, design policies that maximise the number of votes they receive. Meanwhile, a conflict of interest occurs because policies that win votes may not be ones that maximise economic welfare. Some economists would argue that the programme of austerity is a classic example – it wins votes, as evidenced by the latest election, but economic welfare is optimised by spending now and saving later.

Why is this interesting? Well according to Down’s (1957) theory of voting, two party democracies converge to the middle ground and become homogenous; or in other words, they look and sound the same, and have similar policies. This is a criticism made by many in the press, but politicians would be irrational to do otherwise. The median (most frequent) amount of votes lies with the party in power, or else they wouldn’t of won of the election. Hence, an opposition party must sound reasonably similar to the winning party in order to attract these median votes. The median voter is very important in economic models of political behaviour.

Interestingly, rail nationalisation is a policy that would, according to polling, be popular with the median voter, despite the demonisation of any such policy by many in the press in an attempt to move this median voter position away from support of it. In a recent YouGov poll, 58% supported the policy. Not only that, but it’s one that is economically justified – as I will now explore.

Argument One – Franchising is pants. The railway isn’t a McDonalds restaurant.

The argument for privatisation is well-known. When privatisation of the network was completed in 1996, it was believed that free market forces and the desire to maximise profits in the presence of effective competition would breed lower prices, in order to attract customers, and better more effective use of resources in order to keep costs low. It should also breed innovation, as a way of making your rail product more desirable.

We can therefore deduce from this that a broad rule of privatisation is that it is only as effective as the competition you introduce. Unfortunately, competition is very tricky to produce on a rail network – unless you have several firms providing the same route then there is no competition. The supposed track (good pun) around this dilemma was to introduce franchising. Several firms bid for a franchise to provide a particular route – but this isn’t competition. It introduces monopolies on routes – and there are two problems with this.

First, how long should the franchise be – 10 years, or 20, etc? If the franchise length is too long, firms will take advantage of their safe monopoly power because the franchise is protected from new entrants – they can’t make bids because a lengthy contract is already signed. On the other hand, if the franchise is too short, firms will be discouraged from investing in their services because the returns from doing so are shorter. There is no optimal balance between the two – any length will produce either issue and therefore lead to a less effective rail network than if in public hands.

Second, because rail franchises are a monopoly power, they need to be regulated. Even the Dept. for Transport admitted back in 1992 that the “potential for monopoly abuse” is evident. Regulation is never as good as effective competition. So the way TOCs are regulated is by controlling the prices they can charge. Essentially, the regulator asks a rail firm if it needs to put up its prices above inflation and assesses their case for doing so. But what rational profit maximising firm would ever say prices do not need to rise? Further to this dilemma, the regulator does not have full information about the evidence and arguments the rail franchisee provides – meaning the regulator can end up making bad decisions, by allowing these firms to raise prices in order to increase profits, rather than to invest in the services they provide. Indeed, rail firms have an incentive to argue that investment isn’t needed when it may be optimal to do so for customers – in order to profit maximise. Even when taking into account inflation, the rate of private investment from franchisees is falling sharply. In 2006 it was £939 million, declining by over half to £434 million in 2013.

Who picks up the rest? You – the taxpayer, explored in argument three. Essentially, the government has created a ‘moral hazard’ problem. Franchisees know that if they invest less in rail, then the government picks up the tab anyway, so why bother? But if the network was nationalised, this problem would not exist – because the regulator would have full information about the need for investment.

Franchising is crap. It works for McDonalds because franchised restaurants are open to the laws of competition, and if they don’t provide a well priced good service, other operators will take their business, such as Burger King, KFC, etc. Franchised rail firms are not open to this competition and the associated problems outlined above become apparent.

Argument Two – If a Market requires heavy regulation, it’s a sign it’s not working

Economists call this market failure – left to it’s own devices, the market for rail on its own does not produce an outcome in the interests of society. So the government intervenes with regulation, but this can make the problem worse rather than better – called government failure. But the size of the regulation and intervention needed by governments including franchising agreements, contracts, price regulation, etc, shows the market isn’t working effectively. The regulatory framework has become “incredibly complex” and “fragmented” in a desperate bid to try and get the rail network to work better.

In many of the franchises, there is evidence that they have been managed in the interest of shareholders and franchisees than of the passengers that use them. Consider performance metrics of a CEO of a franchise. They are likely to be given a weighted performance bonus based upon short term profit, which can produce outcomes that are not in the interests of passengers, such as lower investment and higher prices. But what would these weighted performance bonuses be if the franchise was in public hands? Overcrowding could be one – bonuses paid if overcrowding is reduced. Or bonuses for punctuality of the network, reduction in rail prices to passengers, or all three; thereby incentivising the network to work better in the interests of customers. A monopoly rail firm would have no incentive to do this.

Another sign of the market failure is shown by the level of subsidies rail firms receive from the UK taxpayer – thereby transferring wealth from the public hands to private ones. Economists may be concerned with this because it is not equitable. Originally, a key argument for privatisation was reducing the burden on the taxpayer. It was assumed rail firms would be able to operate independently without taxpayer help. The opposite happened. The Blair government had to substantially increase subsidy payments because of huge under performance and guarantee investment of at least £1 billion per year. It is not a political argument to say the UK taxpayer is subsiding franchise profits, but an economic one. During 1996/97 to 2003/04, the actual subsidy to rail firms always exceeded the expected level, in one year, it was 4 times as much. Hence, the Major government did not realise the problems that would be produced when privatised.

Argument Three – Look at the data, and the above is proven

Lets just analyse four metrics, on time performance, government subsidies, overcrowding, and prices, as this post has already gotten way too long. If you have gotten this far, congratulations.

The above shows the percentage of trains arriving on time. Just after full privatisation in 1997, it was 89.7%. Following this, there is a significant decline, hovering at around 80% up till 2004. At this point, the planned fall in subsidies are abandoned and kept at least £1 billion per year. On time performance is now at 89.4% – i.e., no different to before privatisation. There are two points of note from this. First, the idea that British Rail was some inefficient beast that never ran on time is clearly not true for its later years. And second, the whole point of privatisation was to produce a more effective on time network – yet it is no different on this metric alone, and even became substantially worse for a good few years. Meanwhile, the increase in subsides from taxpayer funds is evident – over £5 billion in the latest time period. (Note this is mostly due to payments made to Network Rail, which is in public hands as they look after the track. But a major aim of privatisation was for the rail firms to take most of this burden, and even if you exclude this, subsidies still hover at at least £1.5 billion).

Second, overcrowding. This is measured by calculating the maximum capacity of a route and then measuring how many journeys have passengers above this level. Thus, a level of 2% means 2% of train journeys are overcrowded, but does not measure how much this train is overcrowded by. In short, this metric significantly under estimates the true level of overcrowding (not my argument, but the Select Committee’s no less). Infact, their own evidence in 2002 when overcrowding was relatively lower stated that “it was clear from our evidence that it is commonplace for vehicles to be so full that passengers cannot enter them, or even alight from them,” and that on some routes capacity was 213% higher than a vehicle was deemed to be able to take. This is shown below.

When was overcrowding at a record low? Just prior to privatisation in 1996 at 1.9%. Since then overcrowding has only become worse, and currently resides at a seemingly natural level of around 3%. Note, that this measure can distort what is really going on. For example a 0.5% percentage point increase in the measure actually suggests a very significant increase in overcrowding.

Finally, and the biggie, prices and profits. This shows just how good it is to run a monopoly firm. Total net income for all franchisees in 2000 was £4.92bn. It’s steadily climbed ever since, and for the latest available data, net income was £7.46bn in 2011. It’s probably even more since then. Meanwhile, between 2004 and 2015, average fares have increased 71.2% for Long Distance routes, and 61% for regional fares. Frankly such figures speak for themselves. That is an increase significantly above the rate of inflation, and taking into account the recent trends of declining real wages, then the burden to travellers is actually even more significant. TLDR; we may pay a lot more money for a service that is worse rather than better, in order to subsidise the transfer of wealth from your pocket to those of shareholders.

So there we are. That was rather lengthy and I could go on for a lot longer. What a mess. Just gobble it all up and nationalise it. It won’t be perfect, but it’ll be a lot better. Now watch everyone ignore me and leave it as it is.