Chapter 10
Transport regulation
and ownership
Learning Outcomes:
On reading this chapter, you will learn about:
᭿ The forms of regulation of transport services and the rationale for and drawbacks of
regulatory measures
᭿ The practical aspects involved when attempting to regulate the market behaviour of a
private sector concern
᭿ The reasons behind public ownership and control of transport operations and the management
of transport assets
᭿ The main motivations behind a general movement towards reform of public ownership in
transport services
᭿ The models under which the public and private sectors combine to produce transport
services and facilities.
INTRODUCTION
In many respects this chapter is concerned with ‘control’ and speciﬁcally the control by relevant
transport authorities on the levels and behaviour of transport users and operators under their
authority. Whilst at ﬁrst sight this may appear to be only related to public transport, it concerns all
areas of transport, whether that be public, private or freight. Government control of transport
markets can be achieved through one of two measures – in the ﬁrst instance the transport authority
can own the assets and the means of production. In this case the market is brought into the public
sector and thus it does not have to operate along market principles. This it would mainly do in the
pursuit of the public interest. This however is not the only reason for public ownership, and others
are examined later in the chapter. Alternatively, rather than control through ownership the
authority could exhibit its control through direct command, i.e. by telling operators what to do.
This would be through regulation of the market, which again would be undertaken on the premise
of the public interest, although once more other reasons exist for regulation.
The chapter begins by examining the diﬀerent forms of regulation before going on to look at
the issues surrounding ownership and operation of transport assets by public bodies. It then
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considers diﬀerent ownership forms in transport activities and outlines the various models under
which transport services are delivered to the market. In some ways, regulation is a lesser form of
ownership, and thus examining regulation ﬁrst gives a better understanding and leads into the
issues surrounding public ownership.
FORMS OF TRANSPORT REGULATION
The main forms of transport regulation can be generally categorised under the broad headings of
qualitative and quantitative regulation.
Qualitative regulation
Currently most forms of movement, irrespective if a mode of transport is involved or not,
constitutes regulated behaviour. This is for the simple reason that all forms of movement, if
completely unchecked, can result in potentially hazardous outcomes, particularly where others are
involved. Even the simple act of walking can result in broken limbs and scraped knees. Individuals
therefore need to be able to move around with a reasonable level of conﬁdence that this will not
result in serious injury to either themselves or to others. If this was not the case, many individuals
would simply not travel at all. This is the basic rationale for qualitative regulation.
Qualitative regulation therefore is where the regulatory authority intervenes in the market in
order to stipulate minimum criteria that regulate behaviour within the market. This tends to come
in the form of direct legislative measures that lay down the laws to be followed by users of the
transport system. Such actions need to be enforced and breach of any of rules penalised, either
through ﬁnancial penalties or by the withdrawal of the right to use the system. Thus speed
restrictions for example are a form of qualitative regulation, as these regulate the speed of vehicles
on the roads, with diﬀerent speed limits applying to diﬀerent types of roads. Breach of those rules
will normally result in the imposition of a ﬁnancial penalty, whilst a continuous breach of speed
limits leads to the withdrawal of the driver’s licence. The same type of conditions apply to
operators of public transport services or road haulage operators, where there are clear minimum
criteria relating to driver behaviour and vehicle condition and a major breach of these rules can
lead to the suspension or removal of the operators’ licence.
Quantitative (Economic) regulation
Quantitative regulation, more commonly known as economic regulation, is where the regulatory
bodies intervene in the market in order to place economic controls on the operation of the market.
This is either in terms of restrictions with regard to the price or restrictions or minimum
speciﬁcations with regard to the supply. Dealing ﬁrstly with price regulation, this comes in a
number of diﬀerent forms:
Specify the price to be charged
In theory, this is the simplest form of price regulation and is illustrated in Figure 10.1.
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In the ﬁgure, the free market price is given where supply equals demand, hence PFM. The
transport authority however sets a maximum price below the equilibrium price at PRM. Note it
only makes sense to set a regulated maximum price below the equilibrium price, otherwise it
would have absolutely no impact on the market. As can also be seen from Figure 10.1, however,
a price at the regulated fare will create excess demand, i.e. there will be more wanting to use the
service than is being supplied to the market. This is shown by the diﬀerence between QRM and QS.
The authority would therefore have to address this problem. What it would have to ensure is that
the supply curve moved to the right. This can be done in several ways, with the ‘simple’ solution
being to pay the operator a subsidy. Alternatively the whole rationale for imposing a maximum fare
may be to motivate the operator to lower its cost. Hence the supply curve would shift to the right
thereby eradicating the excess demand. In practice this has normally been done over time by
regulating price increases, as outlined below.
Specify the maximum increase in price allowed
Rather than state a speciﬁc price, the authority limits the extent to which the operator can
increase its prices over time. In the UK this has normally been done through an ‘RPI-X%’ formula,
where RPI relates to the prevailing rate of inﬂation and X the value to which price increases are
restricted to. Hence in theory prices should rise at lower than the rate of inﬂation, thereby falling
in real terms. Hence if the rate of inﬂation is 3 per cent, and X is set at 2 per cent, then the
maximum fares can rise by is 1 per cent. In real terms, therefore, this would be a 2 per cent cut in
the fare. As stated above, this would primarily be used to motivate eﬃciency improvements, as it is
only through reducing costs, and not increasing prices, that operators can maintain or increase
proﬁtability.
Nevertheless, where price increases are expected to rise by well in excess of the rate of
inﬂation, these can be limited through an ‘RPI+X%’ formula. Thus fares on most of the rail
Figure 10.1 Simple price regulation
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franchises in Britain are currently regulated on the basis of RPI+1% with some of the franchises
allowed to raise fares by RPI+3%.
Regulate the (ﬁnal) price through the tax charged on the good or service
Varying tax levels can be used to regulate the price in the market, and these can be speciﬁed either
as a percentage or set at a speciﬁc value. In most case such taxes are used as general tax-raising
measures in which the government acquires public ﬁnance to spend on the provision of public
services. In the UK, for example, all goods except exempt items are charged Value Added Tax
(VAT) at a rate of 17.5 per cent. Hence this adds 17.5 per cent to the price of the good with this
additional tax revenue passed on to the government. Additional or speciﬁc taxes however may be
imposed to regulate the price in the market, thus fuel duty has the eﬀect of signiﬁcantly increasing
the price of fuel to the consumer. If the government wished to limit car usage, it could do so by
increasing fuel duty, thus increasing the price. As seen in Chapter 9, this would be a form of a
‘Pigouvian’ tax, which is one that is imposed in order to correct for a negative externality.
Specify the rate of return (proﬁt) to be gained
Prices charged by transport operators can be regulated based upon the level of proﬁt to be gained.
Hence a ‘reasonable’ rate of return may be set and then prices regulated accordingly to achieve that
rate of return. This will normally take place where the level of demand can be estimated to a very
high level of accuracy, and hence the only real variation in total revenue will be as a result of the price
charged. Network Rail for example is regulated by the Oﬃce of Rail Regulation with regard to the
level of track access charges it imposes on the train and freight operating companies on this basis. The
charge is based upon a rate of return on the assets employed. Given that the level of train movements
on the network are known a year in advance, then the level of revenue gained can be accurately
predicted by the price. This however is a considerable oversimpliﬁcation of the problem, as obviously
operating costs as well as eﬃciency gains also need to be estimated in advance. If eﬃciency gains
are not taken into account, then the level of the access charge, or fare in more general terms, would
be set at a rate that would provide a higher level of proﬁts than had been deemed to be a ‘fair’ return.
In order to fully illustrate these principles, the whole issue of regulating the former British
infrastructure provider, Railtrack, is covered in more depth in Case study 10.1.
Through introducing yardstick competition
Yardstick competition exists where direct competition in the market is not feasible but is introduced
indirectly through regulation, and is normally used to control price levels. This is achieved
by linking the performance of diﬀerent ﬁrms in diﬀerent markets to each other. If it was conceived
today, therefore, ‘yardstick’ competition would probably be termed ‘benchmark’ competition, as
eﬀectively the performance of each ﬁrm in the industry is benchmarked against one another. As an
example, if two ﬁrms A and B faced similar cost and market conditions, then under yardstick
competition the price that A could charge would be dependent upon the level of costs in ﬁrm B.
Thus if B was to lower its costs, the result would be that under the regulatory system A would be
forced into charging a lower price in its market and vice-versa. Such regulatory measures are said
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to be appropriate where the potential for cost savings is unknown and diﬃcult to estimate in
either market, and where cost and demand conditions in each market are very similar. Exercise
10.2 explores further some of the ideas behind yardstick competition.
These are the ﬁve main mechanisms through which the price charged in the market can be
controlled; however, price regulation is only one form of economic regulation. The other main
form is where the level of available capacity is controlled through regulatory measures, normally in
the form of speciﬁcation of minimum frequencies and/or through the control of market entry.
Specify a minimum frequency
In the simple case the authority speciﬁes the minimum level of frequency to be provided. This will
normally be in the form of actual frequencies and operating hours; however, it can take other
forms such as total vehicle kilometres supplied. This is shown below in Figure 10.2.
In the ﬁgure the free market position is shown by supply curve S and demand curve D. In this
case no market would exist for this transport service as the highest price that consumers are
willing to pay, as shown by the demand curve, is below the lowest price that suppliers would be
willing to provide a service, as shown by the supply curve. There is no market equilibrium and thus
no transport service is provided. In this case, the transport authority speciﬁes a minimum service
frequency in order to create a regulated market where none existed before. This is set at level QR.
Note however that such action taken on its own would be entirely pointless; even if an operator
did, for whatever unwise reason, enter the market it would quickly go out of business as the level
of demand would be insuﬃcient to support the level of supply. As with simple price regulation,
therefore, such regulatory action cannot be taken on its own. The regulatory authority would need
to have some belief that supply will increase and result in a shift of the supply curve from S to S1.
Figure 10.2 Simple quantity regulation
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Thus it may again pay a subsidy or alternatively ‘package’ the non-existent service with other more
proﬁtable routes and put these out to tender to the highest bidder.
Limit market entry
We have already seen in Chapter 7 the legal control of market entry as a barrier to entry, but it is one
that would usually be imposed in transport markets as a form of capacity regulation. This is where the
regulatory authority will set clear limits on those operating in the market and thereby directly restrict
supply. Taxi services in most locations are a good example of this form of regulation, where the
regulating authority sets a limit on the number of licences issued. Such measures were originally
imposed to avoid street congestion and to limit the competition to public transport services.
The rationale for the regulation of transport services
In most cases regulations, both qualitative and quantitative, are imposed due to some form of
market failure, with the main reasons outlined below.
To overcome the market failure of imperfect/dissymmetry of information
The ﬁrst rationale for the regulation of transport services covers most forms of qualitative regulation,
where these are imposed in order to regulate user behaviour and to impose minimum standards on
the operation of the transport system. This is directly to overcome the market failure of imperfect
information, or more generally because a dissymmetry of information exists where some know more
than others. In many ways this is akin to the view that every other driver on the road is an idiot apart
from me, and in many ways, there is actually some truth in that statement. In general, users of a
transport system need to have a level of conﬁdence in others’ movements in order to feel more
secure when undertaking their own. Hence when walking on the pavement, pedestrians need to feel
reasonably assured they will not be run over by a high-speed vehicle. Similarly, drivers need to feel
reasonably assured that pedestrians will not aimlessly walk out in front of the vehicle, hence causing
them to swerve dangerously or, worse, run them over! They also need to have conﬁdence in the fact
that other drivers will not attempt to use the same piece of road space they are using at that point in
time, hence causing a collision. Through regulating behaviour, e.g. you can only walk on pavements,
you must obey road signs, you must adhere to maximum speed limits etc, a minimum overall level of
behaviour is assured when moving around and total chaos avoided.
Not only individual behaviour however needs to be regulated, but also the condition of vehicles
used in the transportation of people and freight. This relates to all forms of transport, private,
public and freight haulage, and through this a minimum standard of the equipment used is ensured.
None of us when boarding a bus, or an airline, or a train, have suﬃcient knowledge to be able to
assess the skills of the driver/pilot or the condition of the vehicle. Even if we did, the practicalities
of doing so would make the whole system completely unworkable. Such knowledge however is not
necessary, as that is one of the main functions of the regulatory authorities. They have the skills and
the knowledge to assess these issues on behalf of all users of the transport service. In simple terms,
qualitative regulation overcomes the market failure of imperfect information and makes the whole
system work.
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The market can no longer regulate itself
If the market can no longer regulate itself, then external regulation is required to ensure that
economic eﬃciency is achieved. Why this occurs is because most transport industries tend towards
anti-competitive market structures, namely monopoly and oligopoly, hence regulation is required
to attempt to minimise the disadvantages associated with such market structures.
To correct for externalities
Even where the market can regulate itself through strong competitive pressures, it may still not
produce the ‘right’ answer in terms of modal splits that maximise economic welfare. This is due to
the high level of externalities present in transport markets, hence all decisions are based on private
costs and beneﬁts and do not take into consideration the wider implications of these decisions. As
a result the ‘wrong’ society maximising decision is reached. External intervention in the form of
regulation, which although a further breach of the conditions of perfect competition, is required to
rectify this situation on the basis that two ‘wrongs’ will make one ‘right’. The extent to which this
has been successful or not in actual transport markets is considered later in the chapter.
To ensure the quality of the service provided
Ensuring the quality of service provided in the market relates directly to qualitative controls on the
standards of service to be provided. Whilst relating to ‘qualitative’ controls, however, most of these
are imposed through economic and not qualitative regulatory measures. Thus for example in
Britain, Statutory Bus Quality Partnerships are agreements between the local authority and the bus
operators, where the local authority can limit entry to the market to only those bus companies that
meet the vehicle standards speciﬁed in the agreement. Other examples exist where the quality of
service is regulated even more directly. British passenger rail franchises agreements for example
specify the minimum level of service to be provided and the investments in new rolling stock to be
made by the operator over the course of the franchise.
Regulation may also be used to ensure the quality of service in the longer term. For example
market entry may be restricted in order to provide market protection and hence maintain the
proﬁtability of those already in the market. It is out of proﬁts that investments are funded; hence
restricting entry gives current operators the business conﬁdence to make future investments in
new vehicle stock and thus maintain or improve quality levels. A similar reason may be to protect
the livelihood of those in the industry. The most well-known example is the EU’s Common
Agricultural Policy, which was originally conceived to lend support to farmers within the industry
through regulating the prices of agricultural produce. Regulated prices were set above the market
price in order to ensure future livelihoods and thus the future of the industry.
To provide a transport service where none existed before
Rather than leave entirely to the free market, transport authorities may decide to intervene and
package routes in order to ensure that all necessary services are provided. It may therefore restrict
entry on certain (proﬁtable) routes in exchange for the protected operator providing services on
unproﬁtable routes. This is known as cross subsidisation, where the revenue earned from proﬁtable
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services is used to fund the losses incurred on unproﬁtable routes. Whilst such measures prevent the
cherry picking of ‘good’ routes and can provide a far more overall balance in the provision of
transport services, there are generally far better measures that can be used to ensure that all necessary
services are provided. This is a topic that is developed further in the next chapter.
To improve efﬁciency within the industry
As outlined above, the regulatory framework can be used in an attempt to bring about eﬃciency
improvements within the industry, normally through restraining price increases. This was a
measure that was extensively applied in the British privatisation programme of the 1980s, where
charges relating to telecommunications, electricity, gas, water and so on were carefully monitored
by an industry speciﬁc regulator. After privatisation, rail fares in Britain were also regulated on an
RPI – X% basis, where X ﬁrst equalled zero and then subsequently one. These measures are used
to not only instigate eﬃciency improvements, but also to ensure that productivity improvements
result in lower consumer prices rather than higher shareholder dividends. As noted above, however,
the British rail franchises are now regulated on an RPI+X% formula, which hardly provides an
incentive to improve eﬃciency but has been introduced for other reasons mainly surrounding
investments in rolling stock.
The drawbacks of economic regulation
We have looked above at the rationale behind the regulation of transport activities; however, it does
not always result in the desired outcomes and has a number of drawbacks.
Limits free enterprise
Often cited as the biggest drawback of economic regulation, the issue of the limitation of free
enterprise was often put forward as a reason for the removal of economic regulatory measures during
the enterprise culture of the 1980s. Acting out of self interest, whether that be at a company or at an
individual level, is said to be a far stronger motivator to ‘do the right thing’ than a regulator acting in
the public interest. This is related to the free market ideology of consumer sovereignty, where those
that proﬁt most are those that are able to give the consumer what they want. In a transport context,
the argument would be that not only would an entrepreneur be far better positioned to identify
users’ needs and provide services users want, but also would be far more motivated to do so by the
proﬁt motive, i.e. direct beneﬁt to themselves. This contrasts with a regulatory authority that would
plan such networks at a distance and be motivated by the public interest, i.e. simply doing the job
they are employed to do. Closely related to limiting free enterprise, regulated markets are said to also
limit innovation, as it dampens the free enterprise spirit. This is because there are clear limitations
imposed upon the market and consequently less room for the operator to use entrepreneurial ﬂair
and innovative solutions in the provision of transport services.
Inefﬁcient, second best solution
As will be developed further in the next chapter on subsidy, issues of subsidy and regulation are
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what are termed ‘second best solutions’. The best solution is that the market itself regulates the
performance of operators. This would be an internal/automatic type of regulation. As we saw in
Chapter 6 with perfect competition, any operator that cannot oﬀer services at the lowest price and
produce these at the lowest possible cost will be driven out of business, hence the market regulates
itself. The problem with an external regulatory body is that this leads to added costs in the
operation of the market, as the administrative burden of the regulatory mechanism adds to the
overall cost of providing the service. The annual costs of running the Oﬃce of Rail Regulation
(ORR) in the UK for example came to a total of £30.5m in ﬁnancial year 2007/8 (ORR, 2008).
Whilst these are not all additional costs, as for example if the ORR did not exist then a number
of its duties would need to be amalgamated into other government bodies, a large part of it is,
particularly those concerning economic regulation. Thus transport services are provided at a
higher cost due to increased administration costs.
Also under this heading is the time issue, and in particular the time gap between changes in
market conditions and changes in the provision of services. It has often been argued that due to the
added layer of regulatory bureaucracy, a regulated market does not act as quickly as the free
market in responding to changing conditions in demand and supply. A classic case of this would be
the bus industry in Britain, where during the period of the bus wars (see Case studies 6.1 and 8.2)
a large number of mergers and acquisitions were referred to the relevant regulatory body, in this
case the Monopolies and Mergers Commission. By that time, however, the act of merger/acquisitions
had already occurred, hence many of these referrals ended in purely nominal measures and
the upholding of the merger. Cowie (2002) for example highlights that of 33 cases referred to the
Monopolies and Mergers Commission1
between 1986 and 1998, only 3 resulted in dissolution of
the merged company.
Asymmetry of information
In order to regulate eﬃciently, the regulator needs a high level of information in order to plan and
control operations. Whilst sounding obvious, the major drawback with this is that the regulator
will undoubtedly be the authority and not the operator, and hence the operator, unsurprisingly,
knows more about their own business than the regulator does. There is therefore a need for a ﬂow
of high quality information between the two. It may however be in the interests of the operator to
withhold important information from the regulator if they believe this may be used against them.
There is thus an imbalance of information, with the operator often holding the key information
that the regulator needs to regulate eﬀectively.
The issue of regulatory capture
The theory of regulatory capture was originally put forward by George Stigler (1971) and after the
negative eﬀect on entrepreneurial ﬂair is often cited as the second biggest drawback of economic
regulation. The issue of regulatory capture is where the regulator, who is supposed to oversee and
control the industry on the grounds of the public interest, is in eﬀect not as ‘tough’ on the industry
as they perhaps should be in the public interest. The consequences are that the regulator better
serves the interests of the industry than the interests of the consumer. Whilst the term ‘capture’
suggests that the regulator is enticed in some manner, ‘capture’ also refers to capture with regard
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to the prestige that goes with being an industry regulator. In simple terms, the status and overall
prestige of the regulator rises with the importance of the industry. What happens therefore is that
instead of regulating the industry, the regulator becomes the protector of the industry. A more
direct form of regulatory capture is where the regulator becomes dominated by the vested
interests in the industry, where political pressure may be applied from above forcing the regulator
to take a ‘soft’ stance in regulation of the industry.
Cumbersome regulatory procedures make avoidance of regulatory measures
possible
This is the most basic drawback of regulation where it simply fails to regulate the actions or behaviour
it is designed to regulate through avoidance. This is because regulatory measures are by their very
nature cumbersome processes that can be avoided or ignored by those they are designed to aﬀect. As
a result, the expected outcomes are not achieved. Case study 10.1 shows how diﬃcult and costly it
can be to regulate an industry, and such cumbersome processes can make it very diﬃcult to get it
‘right’. An obvious example is the issue of the regulation of rail fares highlighted above. These were
initially regulated on the basis of RPI-0%, thus in theory rail fares should not have risen above the rate
of inﬂation, and fallen in real terms when the base moved to RPI-1%. Nevertheless, the process used
to regulate fares was, and still is, to have a collection of ‘regulated’ fares and ‘unregulated’ fares.
Hence train companies are at liberty to increase the price fares of unregulated fares. More obviously,
given the diverse range of train tickets available for a given journey, companies were at liberty to
withdraw lower fare tickets, hence eﬀectively bypassing the regulatory mechanism and increasing the
price of the rail ticket above the rate of inﬂation.
Note that whilst these major drawbacks of regulation have been listed separately, they all in
some form relate to the issue of it being a second best solution – in simple terms, the only problem
with regulation is that it is needed at all. If there are thus problems with regulating the market for
transport services, the alternative is to take it into public ownership. The issues surrounding the
public ownership of transport assets are considered after Case study 10.1, which attempts to put
some of the issues outlined into practice through examining the process of regulating the British
rail infrastructure provider.
Case study 10.1 The practicalities of industry regulation –
regulating the British railway infrastructure provider
Whilst in theory the process of regulation can appear reasonably straightforward, the practice
is almost always far more complicated. This case study attempts to illustrate this through the
examination of regulatory mechanisms surrounding the former British railway infrastructure
provider, the private sector company Railtrack.
Under British rail privatisation, the single nationalised operator, British Rail, was divided
into 104 separate companies with the main purpose to introduce competition at all levels of
railway operation. Competition would exist not only between train operators in the passenger
and freight sectors, but also between industry suppliers. Thus there were three rolling stock
leasing companies and 14 infrastructure maintenance and renewal companies. The one
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exception was the infrastructure provider,where it was considered that the advantages of having
a single national network operator signiﬁcantly outweighed the drawbacks of splitting the
network up into separate geographical areas. This therefore left a monopoly provider of the
infrastructure throughout the country. This was organised into a company called Railtrack
which was ﬂoated on the stock exchange. The company was expected to operate primarily on a
commercial basis;hence all infrastructure access charges were to be at full cost.As a result,the
ﬁrm would return a proﬁt and receive no direct subsidy except to assist the funding of railway
investment.
Being in a monopoly position, therefore, the access charges levied on the train-operating and
freight-operating companies required to be regulated in order to avoid abuse of this market
position. The Ofﬁce of the Rail Regulator (ORR) was thus established as an independent
regulator to oversee the market actions of the infrastructure provider, Railtrack. This however
was not only in terms of the access charge levied on train companies but also to ensure that
the conditions under which Railtrack had gained its network licence, which gave the company
the right to be the infrastructure provider, were upheld. The ORR was thus empowered to
set the contractual and ﬁnancial framework under which Railtrack operated the network,
ensure that the company carried out its activities efﬁciently and ﬁnally had an obligation to see
that the company was adequately funded to enable it to discharge its responsibilities effectively.
This in many respects underlines the balancing act that a regulator has to achieve between the
needs of the company and the needs of the customer. The company needs to have sufﬁcient
proﬁts to be in a position to undertake investments whilst at the same time leaving a reasonable
level of proﬁts to satisfy shareholders in the form of dividends. This would tend to suggest
higher prices, whilst the interests of the consumer are obviously best served by lower prices.
The regulator therefore needs to set a price that strikes a ‘fair’ balance between these two
parties. In this particular case, however, the situation is further complicated by the indirect
payment of subsidy. Although Railtrack was not directly subsidised, its principal customers, the
train-operating companies, were, and in most cases to fairly substantial amounts. Failure to
regulate correctly therefore could have serious knock-on effects in terms of the whole industry
supply, i.e. increase subsidy, and the imposition of ﬁnancial penalties difﬁcult to impose given
the contrasting nature of the responsibilities of the regulator, i.e. to regulate Railtrack and
ensure it had sufﬁcient funds for investment.
Figure 10.3 illustrates the independent nature of the rail regulator in the privatised rail
industry structure created by the Railways Act 1993.Whilst OPRAF was delegated responsibility
for the awarding and the overseeing of the passenger rail franchises (and hence was directly
accountable to the DfT),the Ofﬁce of the Rail Regulator was an independent body outside of the
direct control of government. It could therefore, in theory at least, act in the public interest
without fear of political interference or pressure.
How therefore was regulation to be achieved?
The key to the whole regulatory structure was centred upon the setting of the access charge to
be paid by the train- and freight-operating companies. This would then ensure that sufﬁcient
revenue was raised through the charge to cover operating and maintenance costs, depreciation
charges and provide a return on capital (i.e. proﬁt) of 8 per cent, which was the agreed form of
regulation. The 8 per cent rate of return and depreciation charges were set on Railtrack’s
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Regulatory Asset Base (the RAB),which in simple terms was a list and valuation of all assets to
be included for regulatory purposes in order to determine the level of proﬁt. Valuation of the
RAB was initially based upon a Modern Equivalent Asset Value (MEAV), in other words how
much would it cost to replace all the assets in the RAB? This by and large was a highly
questionable basis from which to value the asset base (Stittle, 2002), and most agreed one
that would produce an artiﬁcially high valuation and consequently an over-inﬂated proﬁt. For
the purposes of regulation, the RAB was to be revalued every ﬁve years, which divided the
regulatory periods into the ﬁrst control period, running from 1995 to 2001, the second control
period from 2001 to 2006 and the third control period from 2006 to 2010.
To recap, therefore, in order to set the access charge the regulator needed to calculate the 8
per cent return on capital (the RAB), estimate Railtrack’s operating and maintenance costs
over 5 years and its depreciation charges over these periods.Around that basic ﬁgure then arose
questions of Railtrack’s investment needs, its borrowing requirements (and more importantly
associated interest payments) and its possible efﬁciency gains (see next paragraph). This would
then produce a ﬁgure that amounted to Railtrack’s ﬁnancial requirements over the 5-year
period. In (very) simple terms, this would then be divided by total track usage to derive the
access charge. Through such a pricing regime, therefore, the infrastructure provider would
recover the full cost of the use of the network and its investment requirements to which it would
add an 8 per cent mark up for its proﬁt – sound simple?
During the process of regulating Railtrack several highly contentious points arose. The ﬁrst
concerned Railtrack’s investment needs.If Railtrack was to be regulated on the basis of an 8 per
cent rate of return on capital, then higher investment needs would push up depreciation charges
and interest payments, and thus if not properly accounted for would literally eat into the 8 per
cent rate of return. This debate also included questions over the cost of capital to Railtrack, as
higher costs of capital would again reduce proﬁt if not appropriately accounted for. The second
and perhaps greatest disagreement between the ORR and Railtrack was over the issue of
Figure 10.3 Rail industry regulatory structure 1997–2001
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TRANSPORT REGULATION AND OWNERSHIP
efﬁciency gains. Again if Railtrack was to be regulated on the basis of proﬁt, then the question
of the extent to which Railtrack could lower its unit operating costs over time became crucial.
As mentioned above, this is because the level of access charges required to produce the 8 per
cent return needed to be set in advance, and if efﬁciency gains were not taken into account then
even modest improvements would increase the level of proﬁt and push it above the 8 per cent
regulated limit. The regulator therefore commissioned an independent report from NERA to
examine the potential for efﬁciency gains in the infrastructure provider. One of the problems
facing any such assessment however was a lack of empirical evidence of other systems, as very
few rail systems at the time had such a vertical separation of infrastructure from services.
Nevertheless NERA (2000) estimated potential efﬁciency gains of between 3.3 to 3.9 per cent
per annum. Railtrack on the other hand, in their own evaluation (Railtrack, 1999), forecast
signiﬁcantly lower efﬁciency gains of around 1.5 per cent per annum (Railtrack, 1999). A
second group of consultants, Booz, Allen and Hamilton (BAH), were then commissioned by the
ORR to examine Railtrack’s own estimates. BAH (1999) derived a target ﬁgure of between 4
and 5 per cent for efﬁciency gains for Railtrack in the period 2001–2006. Other stakeholders,
notably the freight companies,also commissioned a separate report into potential cost savings in
the provision of the infrastructure company, and one that estimated potential efﬁciency gains of
a higher order, at around 6 to 7 per cent (LEK, 2000). In very broad terms therefore, there were
three estimates of Railtrack’s potential efﬁciency gains, ranging from 1.5 per cent (Railtrack),
around 4 to 5 per cent (ORR commissioned studies) and ﬁnally 6 to 7 per cent (a Railtrack
‘customer’). Eventually, the efﬁciency target was set at 3.6 per cent per annum (Pollitt and
Smith, 2002).
One of the problems however was that Railtrack had effectively very little control over its
own costs. Under the structure created at privatisation, sub-contractors carried out all of
Railtrack’s maintenance and renewals. This was further compounded by a loss of railway
engineering expertise in the company that could either evaluate the need for the work or the
standard of the work completed. Thus most efﬁciency gains were not under the direct control of
Railtrack but rather were dependent upon the structure created on privatisation delivering a
competitive market in rail infrastructure maintenance and renewal.
To worsen problems, a train derailed at Hatﬁeld resulting in four fatalities and seventy
injuries. This was as a result of a broken rail that had been known for some time to be ‘at risk’.
The fear that more rails on other parts of the network might be similarly affected led to the
imposition of temporary speed restrictions in many parts of the network whilst these were
checked, resulting in widespread disruption. Under the terms of the track access agreements,
Railtrack then had to pay more than £500m to the train-operating companies as a result of the
disruption caused. This combined with major cost overruns on the company’s major infrastructure
project at the time, the upgrade of the west coast mainline between London and
Glasgow, led to the company being placed in administration by the then Minister for Transport
in October 2001.
This case study not only shows some of the difﬁculties with industry regulation, but also the
failure of Railtrack raises the question if this was a case of regulatory failure? In other words,
did Railtrack fail due to failure of the regulator to sufﬁciently protect it and enable it to
continue in proﬁtable operation? Whilst regulatory failure can come in a variety of guises, such
as regulatory capture highlighted in the text, Lodge (2002) only ﬁnds some evidence of what is
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known as regulatory ‘drift’. This occurs when there has been an insufﬁcient upholding of the
policy by the regulator. In this case, this was as a result of agenda selection where certain areas
of the regulator’s remit were overly focused upon at the expense of other aspects which were
also under the regulator’s control. Lodge, however, suggests that the failure of Railtrack was
more as a result of a far more complicated and widespread set of circumstances,many of which
are connected to the general reform of public transport services. In simple terms, implementing
reforms into transport markets is not easy.
THE ISSUE OF OWNERSHIP IN TRANSPORT MARKETS
If you have read the book up to this point, then you should realise by now that transport markets
except with one or two exceptions cannot be left entirely to market forces to resolve economic
transport issues. In most cases, therefore, they need some form of external intervention in order to
correct for market failures. One way that this can be achieved, as seen above, is through regulation
of the market. The alternative is far more direct and is where the state eﬀectively takes control of
the market by bringing it into state ownership. The market therefore does not have to follow
market principles, i.e. be subject to the forces of supply and demand, nevertheless the economics
of the whole operation still need to add up.
Reasons for the public ownership of transport assets
The issue therefore of ownership within transport markets in most cases comes down to the simple
choice of whether services should be provided by the public sector or a regulated private sector.
The ‘old’ view was that transport services, both passenger and freight, were vital services to the
national and local economies that they served. Rather than questions surrounding issues such as
the standard of service to be provided or the fare to be charged being left to the private sector
to decide, these should be resolved by the state on the basis of the public interest. The ‘best’ way to
achieve this was through direct ownership and control of the assets required to produce such
services. This view is best exempliﬁed with what eventually developed into the ‘Morrisonian
model’ of public ownership, named after one of the leading Labour politicians of the time, Herbert
Morrison. In the early 1930s, London’s public transport services comprised of buses, trams and
the underground, and all operated as individual transport modes by 89 mainly private sector
operators. Morrison’s view was that these individual services could only be fully exploited (in
terms of public beneﬁt, not proﬁtable reward) as part of a single uniﬁed system that was controlled
and operated by a single transport authority. The authority should operate ‘at arm’s length’ to the
local authority with the remit to provide economic and eﬃcient transport services. This was the
origins of London Transport, which was enacted by the London Passenger Transport Act (1933)
that established the London Passenger Transport Board to bring all passenger modes in London
into public ownership and under the Board’s direct control.
However, the public interest argument is not the only reason why assets should be taken into
the public sector, or nationalised, the main other ones being:
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Eradicate wasteful competition
Wasteful competition has already been outlined in Chapter 7, and is where two or more services
exist where one would be suﬃcient. One way that this can be eradicated is to bring competing
services under the control of a single operator. The problem however with such a re-organisation is
that the eradication of competition would leave a monopoly provider with all the associated
problems of such a market structure. One way these drawbacks can be overcome is through direct
control of the operator via public ownership. The operator could then be managed on the basis of
the public rather than the proﬁt interest. If managed correctly, this should result in economic
eﬃciency. Alternatively, wasteful competition could be removed through regulation, thereby
replacing the free market with a planned or regulated market and ensuring that capacity matched
demand.
Military signiﬁcance
The industry is seen to have important military applications that mean it cannot be simply left in
private hands. In some ways the rail industry is an example of this, where during WW2 the ‘big
four’ rail companies were jointly managed in order to better assist the British ‘war eﬀort’ and to
co-ordinate troop and equipment movements.
Public goods
If left to the market certain types of beneﬁcial goods, known as public goods (see Chapter 1 for a
description), would not be provided as no single ﬁrm could make a proﬁt out of doing so. One way
to ensure that such goods are provided is through state ownership.
Essential to the economy
This is an extension of the public interest argument. Certain industries were viewed as underpinning
the whole economy and hence could not be left to market forces because if the particular
industry suﬀered the whole economy would suﬀer. Hence for example the coal industry was
nationalised in 1947 and steel in 1965 as at that time these were important raw materials to
the whole British economy. Many transport industries came under this same argument, hence the
railways nationalised in 1947, road haulage and the major ports in 1948 and most of the bus
industry taken into public ownership in 1968.
A large employer
Very much a rationale of the times of mass production, where ﬁrms were major employers and
thus their potential collapse could not be contemplated in unemployment terms. As an alternative,
they were nationalised. Hence British Leyland, a major British car manufacturer and mass
employer at the time, was nationalised in 1975 following its bankruptcy. This was and remains a
particularly acute threat in certain areas or localities, where certain ﬁrms may be the only major
employer in the area, and hence its collapse would have implications far beyond the direct loss of
employment. The aerospace industry in South West England for example is a major employer, and
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TRANSPORT REGULATION AND OWNERSHIP
hence the collapse of the industry would result in considerable economic hardship throughout the
whole region.
Key industry
A key industry is diﬀerent from an essential industry to the economy as it is one that is seen to be
of vital importance to the country. Hence for example Rolls-Royce was nationalised in 1971, the
only ﬁrm to be taken into the public sector by a Conservative government, for reasons that
primarily related to it being a key industry. This is because ﬁrstly retention of the skills and
knowledge employed in the company were seen to be important to the country and secondly, it
was and remains one of a small number of ‘prestigious’ companies that stand for excellence in
British engineering. Note also that the Rolls-Royce example falls under the military rationale, as
most Royal Air Force and Royal Navy aircraft are powered by Rolls-Royce engines. Retention of
such engineering skills and knowledge was therefore also of military signiﬁcance.
High project development costs
Any major project requires considerable ﬁnancial outgoings before any revenue is forthcoming. In
many instances these can be of such a size that the whole company is put at risk. In the case of
Rolls-Royce, for example, the company ran into major cash ﬂow problems over the development of
the civil RB211 aero engine that ultimately forced it into liquidation. Because of such high business
risks, projects of this nature would not be undertaken by the private sector regardless of any wider
beneﬁts that may follow completion. Consequently under ‘normal’ circumstances, only a publicly
owned company could take on such a project.
In the 21st century many of these arguments are outdated and reﬂect diﬀerent times. In several
cases, other alternatives to public ownership can now be used to overcome many of the issues. In
other instances, however, reasons for public ownership still apply. For example, the net outcome of
the reform of ferry services to the islands oﬀ the west coast of Scotland, which was required under
EU competition laws, resulted in the services being provided by a combination of two heavily
subsidised public sector companies rather than previously where they were only provided by one
heavily subsidised public sector company. All private sector bidders withdrew in the course of the
bidding process as they were unwilling to bid under the terms of the tender. As the ferries are
essential to the economy and social foundation of these islands, if no private sector company was
willing to take the risk in providing services they could only be operated by a public sector
concern. Whilst this is not a typical example, it does nevertheless lead into the more general issue
of public ownership reform.
Reasons for reform
If transport services should or can only be provided on the basis of the public interest, which can
be ‘best’ guaranteed under the direct control of public ownership, then why reform? Some of the
reasons for reform are outlined below:
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Increasing discontent with the model of public ownership
Over the years there has been increasing discontentment with the model of public ownership for a
number of reasons. The ﬁrst is the basic eﬃciency argument, where such organisations are
perceived to suﬀer from general management slackness and thus are not as eﬃcient as private
enterprise. This is the classic x-ineﬃciency argument. The second relates to the constraints that
operating in the public sector imposes on such concerns, which may limit options and overall
performance. This particularly surrounds ﬁnancial constraints, where because all borrowings count
as part of the National Debt, these are closely scrutinised and controlled. For companies and
organisations working in the public sector this limits planning horizons and investment plans, and
consequently leads to much shorter planning frameworks.
Changing macroeconomic environment combined with social change
A changing macroeconomic is mainly as a result of changing global economic conditions (see
Chapter 12). As a consequence, the economic power of governments and their ability to inﬂuence
markets has been considerably reduced due to the rise of multinational and transnational companies.
Governments therefore have found it increasingly diﬃcult to intervene directly in markets,
and hence the government’s role in certain markets has changed more towards that of one of a
facilitator. Reduced economic power has also meant that governments can no longer aﬀord to
simply give public transport operators an open budget with which to provide services. Over this
time there has also been major social change, with changing mobility patterns and overall increases
in levels of personal travel. In particular, less people are now reliant on public transport services,
thus the gap between costs and revenues have grown substantially causing an increased subsidy
requirement. One ‘solution’ to this was to cut transport services, a view best encompassed by the
‘Beeching’ approach, where unproﬁtable railway lines were closed in the 1960s in the UK in search
of the proﬁtable railway. An alternative approach is to attempt to run the existing network but at a
reduced cost, hence the motivation for reform.
The desire to introduce competition into the provision of transport services
This is partly connected to increasing discontentment with public service provision. The
Morrisonian view of transport provision is that of a public corporation being the sole provider of
transport services. Apart from the x-ineﬃciency argument cited above, reform may be motivated
because of social change and the increased desire for choice and options. Whilst ﬁfty years ago
people would generally put up with the bus service provided by the local city corporation
regardless of the quality of the service, now they won’t. Choice is more a part of today’s society
than it has been in the past, hence introducing competition into the market gives the consumer
more viable choices.
Ownership forms in the provision of transport services
Even where considerable market reforms have been enacted in the provision of transport services,
there still remains a wide range of ownership forms within the sector: public ownership is far from
being completely removed from the provision of transport services. Ownership structures range
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TRANSPORT REGULATION AND OWNERSHIP
from a tightly controlled government department to a free market proﬁt maximising company. In
many ways the issue of the ownership of transport assets is very closely associated with the issue of
transport governance, as those empowered by the state to provide transport services are generally
those that own or control transport assets. This close relationship is very similar to the old adage
that possession is ninth tenths of the law. Nevertheless, Figure 10.4 attempts to summarise the
main ownership forms with focus on the economic rather than the legal issues. Some cross over
between the two however is inevitable.
Central government department
Beginning at the top of Figure 10.4, a central government department is where the provision of
transport services or the management of transport assets, such as national roads, remains directly a
responsibility of central government administration. The department receives an annual budget
from central government funds to enable it to fulﬁl this obligation. Rather than perform all of these
duties internally however, it may delegate a speciﬁc task or aspect of these responsibilities to an
external body in the form of an Executive Agency. As an example, the Highways Agency is an
executive agency of the Department for Transport (DfT) and is responsible for the management,
maintenance and development of the national road network in England. The running of the British
passenger rail franchises was also formerly under the control of an executive agency, the Strategic
Rail Authority. This however was abolished in 2006 and the function brought directly back under
central government administration in the shape of the DfT Rail Group.
Figure 10.4 Ownership forms in the provision of transport services
Source: Adapted from Jain et al. (2008) and Cowie (1995)
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TRANSPORT REGULATION AND OWNERSHIP
In many other instances, responsibility may be delegated to other bodies further removed from
central government, which leads into the traditional forms of public ownership.
Traditional public ownership forms
These are subdivided into centralised and decentralised provision.
Centralised provision
This is where transport services are provided on a national basis, usually by a nationalised operator in
the form of a statutory corporation. These are legally constituted bodies given the authority by the
state to perform a public service. Within the transport sector, this has normally related to rail
services. Thus in Britain, for example, until 1996 all rail services were provided by the nationalised
British Rail. Statutory corporations still exist in other countries in Europe and other parts of the
world. Interstate passenger rail services in both Canada and America for example are provided by
statutory corporations, VIA Rail in the case of the former and Amtrak in the latter. These bodies will
generally plan and operate all transport services for which they have been given the legal authority.
Decentralised provision
Rather than run on a national basis, under this form of public ownership transport services are
owned and controlled at the local level. This is usually done either directly by the local council or
responsibilities are delegated to a third party.
The municipal department
This is where the local council plans and directly provides transport services. In Britain prior to the
Transport Act 1985, this form of public ownership was widespread in bus operations, where buses
were part of a transport department that was no diﬀerent to any other local authority department
such as housing, education, refuse collection, libraries, social services etc. Under this model of
ownership, the transport department is given a budget and for that budget expected to provide
local transport services. Many transport assets in Britain are still managed in this way, such as
urban and county roads, bus stations and many ports and harbours.
Delegate to a third party
As with central government, the local council may also transfer speciﬁc responsibilities to a third
party. This can come under a multitude of legally constituted forms, from the wholly owned
subsidiary through to an executive agency or statutory corporation. Thus for example Transport
for London is a statutory corporation responsible to the Greater London Authority for most
aspects of the city’s transport system, whilst Highlands and Islands Airports Ltd is a wholly owned
company of the Scottish Government. As a very general rule, at the local level planning and coordinating
bodies are normally constituted as statutory corporations, whilst operating arms as
wholly owned subsidiaries. Thus London Underground Ltd is a wholly owned subsidiary of
Transport for London. In all cases, however, the level of public control is very high as the third
party is wholly responsible to the local council.
One of the major reasons for this type of public ownership structure rather than it being part
of the local administration is that it allows the organisation with the responsibility to focus entirely
on the speciﬁc activity. A further reason is that a degree of competition can be more easily
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TRANSPORT REGULATION AND OWNERSHIP
introduced into operational activities rather than simply giving a budget to an internal department.
Thus subsidised transport services can be put out to competitive tender, and even (if desired)
competition introduced on proﬁt-making routes. The performance of the publicly owned company
can thus be ‘benchmarked’ or even more directly set against private operators in the market. For
example Lothian Buses in Edinburgh, by far the largest publicly owned bus company remaining in
Britain, not only openly competes in the market against private sector companies for patronage,
but also has to tender for local authority contracts. It receives no direct funds from the council, and
proﬁts made on operations are paid to the council in the form of dividends. Nevertheless, in
Britain this form of public ownership is a peculiarity left over from bus privatisation in the 1980s.
Most of these companies were organised separately from the council as a prelude to privatisation,
hence the ownership type transitory, as it was never intended that they should remain in public
ownership. Nevertheless, there are many examples in Europe and other parts of the world where
either publicly owned transport ﬁrms compete with private sector companies or perform speciﬁc
transport functions for the local authority.
Revisionist privatisation models
Under revisionist privatisation models, aspects of the private sector are directly involved in the
provision of transport services and/or the management and operation of transport assets. This
would be consistent with what Swann (1988) termed as a ‘wide’ form of privatisation, in which
any measure designed to refocus the public enterprise towards market-based principles can be
described as privatisation. The main forms of revisionist privatisation models to be found in the
delivery of transport services are also shown in Figure 10.4 and outlined below.
Public–private partnership
As the name clearly indicates, this is where there is some form of partnership between the public
and private sectors. The most straightforward is where a joint company is set up to operate the
service or transport facility. In France for example some bus companies are jointly owned by
the public and private sectors. Other examples exist of joint public–private operation of airports.
Under this model of ownership, this is a straightforward partnership, where a hypothetical case
would be where Lothian buses, rather than being entirely owned by City of Edinburgh Council, was
partially owned by a private sector operator. Interestingly, however, research has consistently
shown that in terms of operational eﬃciency, this tends to be the worst form of ownership. Roy
and Yvrande-Billon (2007) for example in a study of French bus operators found that privately
owned ﬁrms were technically more eﬃcient than publicly owned companies, but that the worst
form of ownership was the mixed public–private model. This they attributed to three possible
reasons. Firstly, that it led to opportunistic behaviour due to responsibilities being diﬃcult to
attribute between the two partners. Secondly, public administrations were ‘captured’ by their
private partners so that their performance was even worse than if acting alone. Thirdly, that those
public administrations that had retained the direct management of their public transport systems
were particularly proactive in this respect, i.e. were keen to see, and highly active in providing, a
high-quality public transport service. This last argument is particularly valid, especially when it is
considered that technical eﬃciency assessments completely ignore the quality of service as they are
solely based on quantitative measures of service output. This research as a whole, and this aspect
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TRANSPORT REGULATION AND OWNERSHIP
in particular, illustrates very clearly some of the major issues in the reform of public transport
services.
The other form of public–private partnership is far more complex and is where there is a clear
division of responsibilities between the public and private partners. The ﬁrst of these forms
highlighted is where the private sector constructs and owns the transport assets, which it then
leases to the public authority to use. Examples of such ownership structures in transport however
tends to be limited, but does include some bus stations where the station may be part of a larger
development that is owned by a private sector company and leased to and operated by a public
authority. It has however been extensively applied in other areas of public service provision, such
as schools and hospitals. The advantage of this model of delivery is that the authority may be able to
bring forward investments in transport facilities, because the private sector will carry the debt,
hence by-passing the ﬁnancial constraints of the public sector.
The second form of vertical separation is where the private sector operates the service; however,
the assets are eﬀectively owned by the public authority. Such structures are fairly common in lightrail
schemes, where the infrastructure and vehicles are constructed and built by the private sector, but
ultimately owned by the public sector. One of the ﬁrst examples of this model of delivery was the
Manchester light-rail scheme, Metrolink, which was constructed in the late 1980s and opened in
1991. Construction was undertaken by a private sector consortium, which then had a ﬁfteen-year
concession on the operation and maintenance of the system. After that period, ownership of the
assets reverted back to GMPTE, the local transport authority, who then re-let the franchise.
Private enterprise
The last main heading given in Figure 10.4 is private enterprise. This is where the service is
provided entirely by the private sector. The constitutional forms of private sector companies are
far more straightforward than public sector concerns, and are outlined below:
Stock market listed
This is the public limited company (plc), where shares are quoted on the stock exchange. Any
investor therefore can purchase shares in the company. Most of the major private operators in
transport markets are of this form, as the ability of plcs to raise ﬁnance and the options to spread
ﬁnancial risks are considerably enhanced. Liability is limited to the amount invested in the shares in
the company. Plcs can and normally do have wholly owned subsidiaries, which are in the form of
private limited companies.
Private limited companies (Ltd)
Private limited companies are similar to plcs in that shares are purchased and liability limited to the
level of investment in shares; however, the diﬀerence is that shares cannot be sold openly on the
stock market, any share transfers will be in the form of private sales. These therefore tend to be
smaller transport operators as ﬁnancing levels tend to be limited to the ﬁnancial reserves of the
(private) shareholders in the company. As stated above, however, many bus companies are wholly
owned subsidiaries of plcs. Hence for example First South Yorkshire Ltd was previously Mainline
Partnership Ltd, which was a private limited company owned by the management and employees
of the ﬁrm. However, after a majority of the shareholding agreed to sell their shares to First Group
plc, the company then became a wholly owned subsidiary of First.
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In terms of how private sector companies provide services to the market, two possibilities are
outlined. The ﬁrst is under a regulated market, where normally a private operator will run services
to the speciﬁcation of a public transport authority. This is the model found in many urban areas,
notably London Buses, and other examples are given in Case study 10.2. The second is the deregulated
market, where any operator that meets the requirements of business start up can operate
services. This is the most extreme form of revisionist privatisation model where the whole transport
market is privatised and operates like any other normal good. Better known examples of such
markets are buses and road haulage in Britain and air, trucking and rail freight services in America.
What this discussion shows is that even with major reforms, such as bus deregulation in Britain,
there is still a signiﬁcant element of public provision in deregulated transport markets. The only
possible exceptions are freight speciﬁc railways such as in America; however, even these are subject
to minor forms of economic regulation from the US Surface Transportation Board, particularly in
the area of proposed railroad mergers. What should not be taken from this discussion however
is that Figure 10.4 presents a deﬁnitive set of discrete forms of ownership and operation in the
provision of transport services. There are not only many other variants that exist, but also a high
degree of cross over between a number of the structures outlined. Hence for example public
ownership/private operation is normally tendered on a regulated market basis. Ownership forms
are thus very diﬃcult to speciﬁcally pigeonhole into a number of well-deﬁned and discrete
categories.
Some of the issues surrounding reform through introducing private sector practices into the
running of publicly owned transport services are explored further in Case study 10.2, which
examines three diﬀerent models of reform, two in urban-based systems and one in a national railway.
Case study 10.2 The move away from control through ownership
to control through regulation in public transit markets
‘Regulatory reform is often seen as a road paved by good intentions, but leading to “policy
hell” ’ (Lodge, 2002, p. 271).
We have already examined in Chapter 7 the impacts of reforms on the British bus market
outside of London. Whilst that is an example of reform, it is only one example of reform. In this
case study we underpin a number of the ideas outlined in this chapter by considering other
examples where there has been a reform away from a traditional public ownership model
towards some form of revisionist approach. Three examples are given, two from major European
cities and one state railway. The case begins with the London example, as this picks up
from the Morrisonian model of public transport provision outlined earlier in the chapter and the
reforms enacted in London have been broadly followed in other major cities.
Prior to reform,as we have seen public transport in London was provided by a single at arm’s
length authority, London Transport, which planned and operated all services. Under the provisions
of the London Regional Transport Act 1984, these functions were divided and separated
out of a single unitary authority. The planning function was transferred to a new body, London
Regional Transport, which was formed to take responsibility of the public transport network
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under the direct control of central government. In 2000 this was replaced by Transport for
London (TfL), who now report to the Greater London Authority and have wider responsibilities
that also include implementing transport strategy. The bus operating arm of London Transport,
London Buses Ltd, was divided into ten subsidiaries and these were then eventually sold to the
private sector in the mid 1990s. TfL put individual bus routes out to tender and private sector
bus companies operate the service to fare levels and service patterns speciﬁed by TfL. These
contracts are purely on an operational basis (to be examined further in the following chapter),
hence the tender is for the cost of operation and all revenue returned to the authority. TfL
also lay down other service speciﬁcations, such as the standard of vehicles to be used and
importantly in the case of London, that all buses are red. The London Underground remains in
public ownership and is operated by London Underground Ltd, which since 2003 has been a
wholly owned subsidiary of TfL. Like the private sector bus companies, London Underground
runs services to a pattern speciﬁed by TfL. In 2003 responsibility for maintenance of the trains,
stations and infrastructure was transferred to two private sector companies, Tube Lines and
Metronet, who supplied these under contract to London Underground Ltd. Following ﬁnancial
difﬁculties,however,in May 2008 the Metronet companies,which were responsible for maintenance
on 9 of the 12 tube lines, were transferred to new companies within Transport for London.
Hence maintenance responsibilities on these lines are now back in the public sector.As all urban
public transport services within London are under the direct control of a single transport
authority,TfL,an integrating ticketing scheme is operated where tickets are valid on all services
as well as some rail services.This is the well-known Oyster card seen in Chapter 8,where debit is
built onto the card and the ‘fare’ deducted from the value on the card.
This model of urban public transport provision whilst not the ﬁrst of its kind is probably
the most well known. In essence, the buses have been privatised and are run under contract
to the local transport authority, whilst urban rail remains in public ownership. Very similar
characteristics to these are to be found in other major cities; however, under slightly different
delivery models. Using Helsinki as an example, the city has a wide range of different public
transport services that include the bus,the tram,two ferry services,mainline rail services and an
underground. The overseeing transport authority, Helsinki City Transport (HKL), was formerly
the operator of all of these modes outside of mainline rail, which was the preserve of Finnish
State Railways. Bus services however were merged with another city-owned bus company in
2005 and privatised to form a new private sector operator. HKL now specify the bus services to
be run,and as in London these are contracted out to private sector companies on an operational
basis with a similar model of the passenger revenue being returned to the authority. HKL
however remains as the direct owner and operator of the trams, metro and ferries in Helsinki.
Public transport services to the outlying areas of Helsinki are overseen by the regional transport
authority, the Helsinki Metropolitan Area Council, YTV, who plan and specify bus services in
the same manner as the HKL. Again an integrated electronic ticketing system is used and is
valid on all modes operated within the city. Whilst very similar to the situation in London, this
model of delivery is more consistent with the traditional form of public ownership, particularly
in character, where operation and management of all transport assets except buses remain
directly within the local transport authority.
The ﬁnal example given is of reform in state railways. British privatisation has been well
covered elsewhere in this text, but this is only one example of the approach taken in the reform
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of European railways. Britain however was not the ﬁrst country in Europe to radically
restructure its railway. In the late 1980s, Sweden divided its rail operations between infrastructure
and services. Infrastructure was separated out into the National Rail Administration,
Banverket, which is a government agency directly responsible to central government for the
maintenance and development of the national rail network. To carry out this responsibility,
it receives a budget every year directly from state funds. Operator track access charges are
paid directly to the Swedish government and are levied on the basis of the marginal cost, hence
do not meet the full cost of the network. At the time of the split, services remained the responsibility
of the Swedish State Railway (SJ). The rail network however was notionally divided
between a commercial sector, mainly intercity routes, and a contract sector, made up of local
and interregional services. On the commercial sector SJ had a monopoly over the provision of
these services and was expected to cover the cost of operations out of passenger revenue. Note
that it only pays the marginal and not the full cost on infrastructure. SJ now however faces
some direct competition on parts of these routes in the south west of the country following
the loss of the Oresund train contract to DSB First, a joint venture between the Danish state
railway and First Group. For information, the Oresund is the sea strait between Malmo in
Sweden and Copenhagen in Denmark and was bridged in 2000 by a combined bridge/tunnel
ﬁxed link.SJ may also face further competition in the commercial sector as a result of EU-wide
rail reforms, speciﬁcally the opening up of the market for international passenger rail services
that includes cabotage rights, i.e. the right to pick up and put down passengers along the whole
route.
On the contract sector of the network, train services are run under contract to regional
government transport authorities on regional and local lines on the basis of operational contracts
where the authority pays for the cost of providing the service and takes all the revenue,
and the Swedish National Public Transport Agency (a government agency) on interregional
services under net cost contracts, which is the net difference between cost and passenger
revenue. Contracts are normally awarded for ﬁve years. Here SJ faces competition in the
bidding for these contracts from other rail operators, such as Arriva and the French operator
Veolia Transport and other state railways,speciﬁcally Norwegian,Danish and German.In 2005,
SJ had around 74 per cent of the total Swedish passenger rail market.
After the reforms of the late 1980s, freight operated as a separate division within SJ.
In 2001, however, SJ was further divided into six separate operating companies, all wholly
government owned. The two main ones are passengers, which remains as SJ, and freight, named
Green Cargo. In 2002 Green Cargo returned heavy losses and the government contemplated
privatising the company in the form of a private sale to another rail freight operator. The
company now however appears to have returned to reasonable proﬁt levels and remains state
owned.
As with Britain, however, Swedish rail reform has not been without its problems. Alexandersson
and Hultén (2006) report many similarities between the two, with over-optimistic bids,
disruptions in services, several cases of bankruptcies of the train operators, problems with
co-ordinating and integrating tickets between services supplied by different operators,
monopolistic behaviour by SJ and ticket prices up 43 per cent in real terms since the beginning
of the reforms in 1988. On the positive side, passenger numbers have risen by 32 per cent since
1995 and subsidy levels have usually decreased by 10 to 20 per cent. Over time however with
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subsequent re-tendering, the general trend has been for the level of reduction to fall and even in
one case, to increase.
What this case study shows is that whilst it is relatively easy to talk about models of reform
of public transport services, in practice implementation is far from straightforward. It also
shows some of the general dangers of involving the private sector in the provision of public
services, in this case speciﬁcally public transport. The biggest danger is that failure of the
company will result in withdrawal of the public service, a situation that the relevant authorities
simply cannot allow to happen. Many other facets are related to the original reasons for taking
public transport services out of the private sector and thus no longer subjected to market forces
in the ﬁrst place. This is particularly relevant to the eradication of wasteful competition, that
services should be run on the basis of the public interest and ﬁnally that these are vital industries
to the economy. Whilst these and other objectives can be achieved successfully with private
sector involvement,such as shown in the case of London and Helsinki buses,further involvement
appears to become more problematic and hit or miss. Why for example should Tube Lines
deliver London Underground maintenance and network enhancements on time and to budget
and Metronet not? This raises the question of when does private sector involvement ‘work’ and
when does it not? This case study, in common with many learned transport professors, cannot
provide an answer to this question as this is a multifaceted topic and one of the major issues in
transport economics today. One reason however why bus services have been the most reformed
and rail services the least is that any private bus company is fairly easily, i.e. cheaply, ‘replaceable’
by another bus company. In the case of mainline and urban-rail-based operations however
it becomes far more problematic, i.e. expensive and disruptive.
CHAPTER SUMMARY AND REFLECTION
This chapter has examined the issues of regulation and ownership in transport organisation and
operation. As should have been seen in the course of the text, there is a balance somewhere
between the regulation of transport markets through the mechanisms of ownership and regulation.
The old style model is encompassed in the ideas of what became known more generally as
the Morrisonian model, where a national public corporation is a publicly owned company that
operates at arm’s length to the state with a remit to act in the public interest and break even. Such
a model originated from a transport problem, i.e. London’s public transport. Various drawbacks
however were identiﬁed and encountered with this approach in public ownership, and much
transport provision across the globe has been privatised or reformed. Much however still remains
in public ownership, with buses normally privatised but metros, trams and rail services in most
cases still remaining in public ownership. The problem now has switched from trying to overcome
the problems with public ownership to trying to steer the private sector towards doing what the
public authorities want it to do through the regulatory mechanism.
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CHAPTER EXERCISES
Exercise 10.1 Regulating the price
In the following exercise, you are given some basic information for a local bus operator for the ﬁrst
year of operation and then asked to ﬁnd the regulated average price over the following two years.In the
following calculations, you should round all ﬁgures to the nearest whole unit (i.e. nearest £000s, 1000
journeys or the nearest pence in terms of the actual price).Information on the ﬁrst year of operation is
thus given below:
As seen above,the level of proﬁt margin in the ﬁrst year is 16 per cent at an average fare of £0.97.You
are given the following information below in order to set the regulatory price:
Increases in passenger numbers are expected to arise from other external factors that impact on the
local bus market, therefore you should assume that this growth is not dependent upon the ﬁnal price
that will be set. It is also anticipated that this increase will be incorporated on existing available
capacity,thus any changes in passenger numbers will have no effect on costs,therefore any increases in
costs are purely as a result of inﬂation.
a) You should calculate the regulated average price (to the nearest pence) for the following two
years on the following two bases:
On a straight RPI-X% basis where X is set at 1 per centi
On a return on capital employed basis, where the regulatory asset base is set at £1.2mii
and the rate of return at 8 per cent.
b) Now re-calculate both a(i) and a(ii) on the basis of an anticipated rise in passenger trafﬁc of
2 per cent over the next two years.
c) Using your answers to parts a and b, outline the advantages and disadvantages of regulating
based upon RPI-X% as opposed to a return on capital basis in an expanding and a declining
market.
d) The company proposes to undertake an increased investment programme in order to enhance
existing bus services.It estimates that it will invest £500k up front and write these investments
Year One
Operating Costs (£000s): 500
Journeys in thousands: 600
Proﬁt Margin: 16%
Average Fare Charged: 0.97
Revenue (£000s): 580
Proﬁt (£000s): 80
Expected inﬂation in prices and operating costs in each of the next two years: 3%
Rise in passenger trafﬁc in each of the next two years: 1%
Expected annual efﬁciency improvements: 2%
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off over a ten year period. It will fund this investment initially from increased borrowings,
which on average will be borrowed at a 5 per cent rate of interest over the ﬁrst two years. It
forecasts however that these enhancements will have a major impact on demand, increasing
it by 12 per cent in each of the ﬁrst two years. The authority agrees that £300k of this new
investment can be added to the regulatory asset base. Using your original calculations for part
a(ii),what would be the revised regulated price over the ﬁrst two years that would maintain an
8 per cent return if the proposed investments were made? Should the regulator agree to this
investment plan – note that whilst a ‘good’ thing as it will increase passenger numbers, are
there any other reasons why the regulator should agree to this investment plan?
Exercise 10.2 Yardstick competition
Yardstick competition as a principle is not extensively applied in transport markets, nevertheless as a
subject it does raise a number of issues concerning the economic regulation of transport operators.
This exercise will therefore take the ideas of yardstick competition and illustrate some of the principles
involved in using such a system to regulate the price of transport operators and then examine some of
the issues raised.
Consider the following two transport operators:
The level of the price for these two companies in Period 2 is to be based on a straight percentage of the
reduction in the other’s costs. Thus, for example, a 10 per cent reduction in B’s average costs will cut
the price in Period 2 for ﬁrm A by 10 per cent. Using that as the basis of regulation, you should now
calculate the respective prices and associated unit proﬁt levels for each of the following three
scenarios:
Questions:
a) What is the basic equity problem created by scenario 1 and how may the regulatory formula be
adjusted to partially overcome this issue?
b) If we assume equal numbers in both markets:
which scenario is the best possible outcome from the passengers’ perspective?i
would that answer still apply if B was a deprived area and A a relatively prosperousii
one?
c) Although unrealistic as a scenario, what are the problems that are likely to arise from
scenario 3?
Unit costs and prices:
1st Period Company A Company B
Average Revenue 2.00 2.00
Average Costs 1.75 1.75
Proﬁt per unit 0.25 0.25
Scenario 1: B cuts its average cost to £1.60; A fails to make any cost savings
Scenario 2: Both A and B cut their average cost to £1.60
Scenario 3: B undertakes a massive cost-reduction exercise and cuts its unit cost to £1.40; A fails to
make any cuts in costs
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d) From undertaking this exercise, what is the basic assumption underlying operator behaviour
that is required for yardstick competition to work? As probably a very big hint, in this market
there will only ever be a small number of ﬁrms ‘competing’.
e) Why can yardstick competition only be practised in markets in which there is inelastic
demand?
f) What do you see as the main problems in introducing yardstick competition:
in general?i
speciﬁcally in certain transport markets?ii
g) Compare and contrast yardstick competition with competitive tendering and outline the main
strengths and weaknesses of the two approaches.
h) Whilst yardstick competition may not be extensively practised in transport markets, what role
might such a model of competition play in the contracting of transport services through a
negotiated contract?
Other questions
1 Outline the main roles and responsibilities of a regulator in the transport industries.
2 What do you see as the main advantages and disadvantages of public ownership in transport
markets?
3 What do you see as the main advantages and disadvantages of involving the private sector in the
provision of public transport services?
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