Railways on the market

If we compare the performance of railways throughout the world, we can observe striking differences. On the one hand we have advanced economies, where this type of transportation has acquired a relatively high market share, and on the other we observe that in most developing countries railways are strongly underperforming. Sometimes rail transport even is no longer in use, as in the case of Jamaica. Generalizing, underperformance is rather the rule, and only in some selected first world countries do we have well performing railways. What lies behind all these striking differences? Where to search for remedies to this situation?

1. Comercial successes of railways

Railways are experiencing successes in densely populated urban areas, where their market share can be even higher than the share of motor vehicles, as in the case of Tokyo (Terada 2001, p.49). Rail mode carries over 78% of all journeys into central London in the morning rush hours1. Railways serve 40% of traffic between the city centres of Manchester and Leeds and 55% between Manchester and Newcastle. They have high modal share in journeys to major airports, for instance 27% to Stansted (SRA 2003, p.7).

If sections of high-speed railway line infrastructure exists, train operators can effectivly compete with airlines on distances up to 1 thousand kilometers2. In Japan, it is the bullet train Shinkasen, that has the largest market share for distances between 100 and 600 km, and wins the battle with private cars and airlines (Terada 2001, p.54). The train operator Eurostar UK Ltd controls 60 % of the market for the Paris- London route (Briginshaw 2003, p.14). Its share for the Brussels-London route is 40 %. Thalys, another high speed operator of the Paris- Brussels route, carries on average 13,700 passengers daily, compared to Air France airlines carrying only 450 passengers daily (Hofmann 2003, p.34). The newly opened high speed line Madrid- Barcelona, operated with a commercial speed of 350 km/h, caused Iberia airlines to lose over 60 % of its passengers (Hofmann 2003, p.34). High Speed trains proved to be commercially successful, generating a return on capital of approx. 15 % on the Paris- Lyon route and have created substantial new demands beyond the simple shift from other modes (Roosters 1998, p. 73).

Not only high speed lines, however, contribute to the commercial success of railways. Innovations on existing infrastructure are also reversing negative trends. The experiences of the German railway company DBAG show, that the improved quality of services offered on some routes has caused an increase of up to 90 % in passenger traffic. Freight railways can also experience revival in competition with lorries and pipelines. United States of America provide an example of competitive freight railways, serving 40 % of the domestic freight transportation market3 (Batisse, 2003 p. 45), aprox. 5 times more that the market share of freight railways in Europe.

2. The influence of rail transport on urbanisation

Of special importance is the performance of railways in urbanised areas. Here, the opportunity costs of not using the railway infrastructure (costs of pollution from private vehicles, congestion costs on roads) are the highest. Many observers share the opinion that the cities are the market of the future for rail passenger transport. According to UNO prognosis, in the year 2025 50 % of the world’s population will live in urban areas (Takatsu 2003, p.4). Here the demand structure for transport services allows for frequent train services with attractive commercial speeds. Urban rail services, in particular, provide an example of a market, where public ownership offers a very passive market strategy and this results in the loss of market share in the long term. The case of Japan clearly shows that private passenger railways offer far more than the transportation service itself. In Japan more than 100 private railways are concentrated on very profitable operations in the urban market, where they can carry huge amounts of passengers (Terada 2001, p.48). They offer commuter and intra-metropolitan local trains and operate on over 6,000 km of intra-metropolitan tracks (Kopicki, Thompson, 1995, p.75). Many of these private railway lines were constructed in the 1950s and 1960s.

Right from the start, these private railways were engaged both in railway operations and in real estate development along their lines. The companies have built along their railway lines warehouses, offices, cultural centers and and in many cases, profits from the sale of railway-built housing compensated for losses in railway services (Terada 2001, p.50). The commercial strategy of private railways heavily influenced the “radial geography of suburban development in Japan” (Kopicki, Thompson, 1995, p.75).

The highest concentration of private railways in the world exists in the Tokyo area: 29 private networks offer their passenger services to over 13 billion passengers yearly (Batisse, 2003 p. 45). In Tokyo, the largest metropolitan area in Japan, the railway market share of all travel modes is 54 % (Terada 2001, p.49). Railways carry 49 % of all passegers in Japan’s three largest metropolitan areas (Tokyo, Osaka, Nagoya), which means that railways and motor vehicles carry almost the same amounts of passengers. According to Batisse, there is no other comparable country in the world where the railways are more oriented to mass movements of passegers. The Japanese railway system carried 21 billion passengers in 2001, which shows their enormous commercial success if we compare this to the whole of the rest of the world which carries only 19 billion.

3. Unfair economic conditions

All forms of transport- for instance private motor vehicles on highways or suburban rail systems- have had an impact on land use patterns (Hensher, Waters, 1994, p.150). Looking at the case of USA, where the passenger market is dominated by the private car, and rail passenger transport accounts for less than 0.3 % (Beaujeu-Garnier, Lefort, 2001), we can observe that this type of transportation has influenced the density of land use. American cities tend to sprawl, and are far more sparsely populated then their European counterparts (Stewart 2000, p.14).

In case of United States the reason for the dominance of the private car, besides the low value of the land, is the inequality in financing of rail and road infrastructures (Beaujeu-Garnier, Lefort, 2001). Rail infrastructure is predominantly private, and its development has not been supported from taxpayers money, as in the case of publicly owned roads, which have received approx. 800 billion dollars in subsidies for transport infrastructure. Europe followed a different approach- the infrastructure was in most cases publicly owned, and in many cases is sufficiently financed. The best illustration is the case of Germany, where the financial responsibility of the state for the rail infrastructure is even laid down in the constitution, and in recent years public investments in the rail network have been higher than in the road network.

Competition between railways and roads is in fact unfair, because road users do not pay directly for their costs (Transport 2000, cited in Gibb et al., p.38) Investment in road building is justified through the implementation of cost-benefit analysis. Roads are not expected to earn a profit on the capital invested. (Gibb et al, p.38). In contrast to this, railways when upgrading their infrastructure, have to implement capital yielding a minimum 8 per cent financial rate of return (Transport 2000, 1989 cited in Gibb et al.p.38)

It remains unclear whether the unfair conditions for railways are not the effect of a transport policy trying to overcome the market failure of railways. It is possible to limit the exercise of market power of railways by creating economic conditions enabling competing transport modes to offer similar products to those of railways by improving their infrastructure which would improve their competiveness. Although it might be considered to be a wasteful use of resources to double the infrastucture networks, it could be the only solution as long as the railway monopolies are unable to be efficiently regulated.

Another reason for the discrimination on the market might be the historical background. Railways were historically private, monopolistic and profit oriented ventures. For this reasons any support to rail infrastructure could be viewed as contradictory to the principles of a free market. The fact that roads receive multiple support from the government, and road infrastructure is subjected to far deeper regulations than the railways is often ignored.

The most important feature of state intervention in roads is the unitary pricing scheme for the whole network (through fuel duty), although it is evident that the branch sections of the road network are not economically viable (as well as the railway lines in rural areas). The refusal to finance unprofitable rural rail lines caused the shift of customers to subsidized road network in these areas. In effect, railway infrastructure in most countries has lost its universal network effect, and does not cover as many areas as road network does. In effect, the consumers’ freedom of choice is disturbed, because their decison on how to travel is influenced by governemental intervention in the market forces (subsidizing road infrastructure in rural areas).

A strong argument in favour of railways is its safety and relatively low external costs. Rail mode is extremely safe in comparison with the car. The British data4 indicate that the chances of dying in a car accident for each kilometer of journey were more than six times higher than the probability of dying in a rail accident (SRA 2003, p.36). Safety can also have negative consequences: railways can be made (and mostly are) very safe, which would result in nearly no fatal accidents, but the increased cost due to the higher safety standards would reduce railway usage and move part of the demand to roads and therefore could result in an increase in total fatality. It is probable that this negative trade-off can only be reduced by governmental intervention in the market forces aimed at reducing total fatalities.

4 Recent trends in railway reform

Railways have some specific particularities. They are characterized by large, unavoidable fixed costs such as tracks and stations, and the costs of those facilities are considered as sunk (Estache, Goldstein, Pittman 2000, p.3). Estache, Goldstein and Pittman observe that in nearly all countries railways has been one of the most heavily regulated sectors of the economy. Government control supervises nearly all the areas of commercial activities of the sector. Entry, exit, prices, technology, operating procedures, and ownership are subjected to strict regulations aimed at restraining the competition that has been seen as unnecessary (Estache, Goldstein, Pittman 2000, p.3).

4.1. Changed demand patterns

Not long ago, textbooks convinced readers, that railways were a natural monopoly. The idea behind the intervention in the market structure has been to control the economic power resulting from the domination of a single enterprise serving the whole market. Government ownership was thought to be a solution to the potential or actual abuse of market power that could result in the case of an unregulated monopoly (Kopicki, Thompson, 1995, p.2). Another reason was the general perception that there existed large economies of scale. According to this traditional thinking, the costs of providing services declines as the scope and scale of rail operations increase. So in effect the role of the state was to ensure that the economies of scale were realized, and that they were fairly distributed within the market participants (Kopicki, Thompson, 1995, p.11). The state “intervened” in order to fully realize the potential of the economies of scale.

Today the economies of scale that at one time existed within the industry, exist only at the level of distinct functions or process elements (Kopicki, Thompson, 1995, p.2). The economies of scale have in recent years been strongly reduced because of more segmented transport markets, where a strong need exists from both passengers and shippers for more tailored and customized services (Kopicki, Thompson, 1995, p.11). Besides, intensified competition from other transport modes has reduced drastically the extent of economies of scale in reducing transport lots, pressing down delivery times and generally demanding a type of service that is rather unique for each customer. Diseconomies of scale, that emerge where the effects of scale are nonexistent, cause public rail operations to slow their reactions to the signals from the market, to “become bloated”, as Kopicki and Thompson observe.

4.2. Growing dissatisfaction

Since the late 1970s many countries have experienced difficulties with the financial and market performance of their railways- there has especially been growing dissatisfaction with the performance of publicly owned railways (Estache, Goldstein, Pittman 2000, p.2). Particularly in the developing countries, a broad movement towards a privatization-and-regulation strategy has replaced the “monolithic railway”, an integrated and most often state-owned firm owning and operating its own facilities and vehicles and protected from competition (Estache, Goldstein, Pittman 2000, p.3).

4.3. Reasons for poor performance

Kopicki and Thompson (1995, p.1) have suggested that publicly owned railways often lack the perpetual adjustment to the needs of their customers, this “continuous reinvention”, needed to survive in a constantly evolving economy. In contrast, privately owned railways respond to competition with a perpetual stage of market adaptation, reinvention, strategic realignment. Such constant adaptation is not always visible in the case of publicly owned railways.

Kopicki and Thompson demonstrate through case studies analysis, that the railways must “reinvent themselves” in order to reclaim their inherent competitive advantage (Kopicki, Thompson, 1995, p.1). They remark that both private and state-owned railways require a “periodic strategic overhaul” (Kopicki, Thompson, 1995, p.9). According to these authors, railways need to evolve in order to become customer “problem solvers”, instead of “order takers”. Evidence suggests that the constant evolution with the changes of market they serve and the adaptation to the needs of shippers is the primary reason for the comparative advantage of railways in a free market system (Kopicki, Thompson, 1995, p.2).

Railways are characterisied by high capital intensity5, are also labour intensive, and their complexity of business requires intensive management and coordination (which is often rare in governmental organisations, and therefore railways in such cases underperform). Railways are information intensive, and often base their activities on outdated techology and operating methods. They require from their employees highly specialised skills, and are unionized organisations. Wages paid here are high, and workers receive high benefits. Reformers observe that railways are also a part of government labour policy. In many countries, railway employment is used as a “social safety net and economic stabilizer” (Kopicki, Thompson, 1995, p.11).

4.4. Trigger for reforms

Ron Kopicki and Louis Thompson observe, in their study on railway restructuring and privatisation, that financial crisis is the usual trigger that starts the restructuring of state-owned railway company. They indicate that in many developing countries it is financial crisis that shows the futility of the “business as usual”-approach and allows the radical alternatives to be considered (Kopicki, Thompson, 1995, p.1). By the time the pressure for reorganisation is so high that the politicians decide to restructure, the state-owned railways have often completely lost touch with the needs of the customers that they were expected to serve (Kopicki, Thompson, 1995, p.9).

4.5. Trends for vertical separation

Recently the direction of the debate seems to have moved towards complete vertical separation. Some economists argue that the natural monopoly component of the railways is not its operations but its infrastructure. In this case competition can be efficiently produced by allowing competing train operators to provide services on infrastructure. The opinion of EU Competition Commissioner Monti is a good example of such tendencies: “the only way I can see of removing those risks [of market foreclosure and abuse of dominance] entirely when it comes to the allocation of capacity is the complete and irreversible structural separation of infrastructure from operations” (Monti 2002, cited in Pittman 2004, p.168).

This model has been the component of rail reforms in the United Kingdom and Sweden, where attempts were made to introduce market principles into their railways in order to reduce costs to the Treasury (Estache, Goldstein, Pittman 2000, p.7). The German case of vertically integrated railways with open access show that although the conditions for entering the market exist, discrimination-free infrastructure use is still far from granted. Japan, the last case, is an example of following a different path, with little competition on the tracks and a relatively high degree of monopoly regulation.

Adam Fularz

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