Why rail fares should be deregulated

Britain’s railways were privatised in the mid-1990s. This did not however mean an end to state control. The government tightly regulated the sector, imposing price controls on a high proportion of fares.

Regulated fares now make up approximately 50 per cent of passenger revenue on the heavy-rail network, with both London commuter routes and off-peak inter-city services affected. Price increases are limited by inflation-linked price formulae determined by central government or the relevant regional transport agency.

Economic theory suggests price ceilings lead to shortages since they encourage more demand than would occur at the market price, while also reducing supply. Accordingly, regulated off-peak saver fares are responsible for severe overcrowding on some services at the end of the evening peak. Instead of a gradual drop in prices as demand subsides, as would occur under market conditions, the regulation creates a cliff edge with a big fall in fare levels immediately after the departure times when saver fares become valid (typically around 7pm). There is a particularly severe problem with ‘artificial demand peaks’ on Friday evenings on some long distance services to the North. Fare regulation creates the perverse situation where there is often substantial spare capacity on the peak services that leave at the most convenient times, but overcrowding on less convenient services that depart later in the evening. The role of the price mechanism in allocating capacity efficiently is undermined.

A similar problem afflicts regulated commuter routes. In this case, fare regulation means that passengers travelling at the very busiest peak-times typically pay the same as those commuting during the shoulders of the peak. The result once again is severe overcrowding on certain services. Train operators are prevented from using the price mechanism to make better use of capacity by incentivising passengers to shift to quieter services. The marginal cost of each additional passenger may be very high on overcrowded trains, but regulation means fares cannot reflect this. The government recently considered introducing higher-rate ‘super-peak’ fares to address the problem, but this was rejected for political reasons.

The marginal cost of a journey is particularly high when not just the train is full, but the infrastructure itself has reached capacity. The provision of new heavy-rail capacity is extremely expensive. Crossrail 2, for example, is forecast to cost an astounding £27 billion. Moreover, the new infrastructure is typically not commercially viable, forcing taxpayers to fund a high proportion of the budgets. And price controls also make it more difficult to reclaim the costs of new infrastructure from the major beneficiaries – i.e. commuters on the busiest peak-time services – as would happen in a commercial investment, thus making subsidies much more likely. This combination of price controls and state subsidy turns the allocation of resources on the railways into a political rather than a commercial process. Fare regulations generate problems of overcrowding which in turn put pressure on policymakers to provide additional infrastructure.

An important point is that ‘market-power’/monopoly issues do not necessarily justify price controls. Regulation is far from costless and is prone to economic calculation problems and capture by special interests. Thus the costs of intervention may exceed the alleged costs of the original ‘market failure’. In any case, the market power of rail firms would seem to be greatly exaggerated by the government. Although sunk costs and planning restrictions make it very difficult for new entrants to build competing infrastructure, rail is just one element in a diverse market for mobility that now includes low-cost virtual options such as video-conferencing and home-working. Transport markets are typically highly contestable and competition would act as a check on any rail firm seeking to take advantage of its ‘market power’ (see this paper for further discussion).

There is therefore a strong economic case for phasing out fare regulation completely, or at least giving train operating companies far more flexibility in pricing. In particular, the introduction of ‘super-peak’ fares, that charged passengers more for travelling during the very busiest periods, would flatten peak demand, thereby addressing overcrowding problems at low cost. Greater fare flexibility would also create new possibilities for market segmentation, for example by allowing train operators to introduce cut-price, high-capacity carriages. And deregulation would enable rail firms to make infrastructure enhancements on a commercial basis, since they would be free to charge passengers higher fares for an improved service. The level of taxpayer subsidy could be lowered substantially with beneficial effects for the wider economy.

Richard Wellings is the author of Fair Deal for the Taxpayer: Why rail fares should be liberalised.

Deputy Research Director & Head of Transport

Richard Wellings was formerly Deputy Research Director at the Institute of Economic Affairs. He was educated at Oxford and the London School of Economics, completing a PhD on transport and environmental policy at the latter in 2004. He joined the Institute in 2006 as Deputy Editorial Director. Richard is the author, co-author or editor of several papers, books and reports, including Towards Better Transport (Policy Exchange, 2008), A Beginner’s Guide to Liberty (Adam Smith Institute, 2009), High Speed 2: The Next Government Project Disaster? (IEA , 2011) and Which Road Ahead - Government or Market? (IEA, 2012). He is a Senior Fellow of the Cobden Centre and the Economic Policy Centre.

4 thoughts on “Why rail fares should be deregulated”

  1. Posted 11/02/2015 at 17:24 | Permalink

    There are many things that lead to the cost to the taxpayer being the scale it is. Fares regulation, whilst it may have some effect, is by no means a genuinely dominant factor in the costs of operating the railway. The matter of Health & Safety for example increased industry costs considerably (in some cases by a factor of three or more for aspects of infrastructure delivery and maintenance) following the Hatfield crash. And there are many inter-company interface inefficiencies that have been highlighted by many commentators from both inside and outside the industry.

    That the author has chosen the subject of regulated fares suggests more a digruntled rail customer than an informed researcher. If he thinks that dergulation of season ticket prices would result in prices falling (thus benefitting customers), he is wholly mistaken. Customer demand at peak times is pretty inelastic and operating costs of providing extra peak time capacity on commuter railways is high (and often not recouped). Season ticket prices would almost certainly rise considerably more than inflation if pricing were left to the market.

    Government interference in other aspects of train operation has a much more detrimental effect on operators – for example by not allowing enough flexibility in operating agreements to let operators respond to potential new markets. Why not have a good look at that and see how the so-called “franchises” are really just operating agreements for fixed service patterns. That’s one area where consumer benefit could really be exploited. Look at the number of train operators that didn’t run on Boxing Day (again) because it’s not covered in their operating agreements, for example.

    It’s a shame that such a learned and respected research body should be let down by inadequate understanding of what’s really going on in the industry and how it could really be improved.

  2. Posted 12/02/2015 at 01:08 | Permalink

    Stupid idea.

    The trains used to be able to help people get to work. Now they are all a profiteering business. You think charging more on overcrowded trains is a good idea? Well people don’t get on trains for fun! Overcrowding happens during “rush hour” times – people are using the trains because they need to! Making them pay more just gives the train operators more money for doing a c$%p job, running insufficient services for the passengers.

    We pay so much money for our rail travel in this country. Our rail service is broken and people are forced to use it, despite the ridiculous fares. Instead of building HS2, Why not improve our current rail network and unprivatise the network so that money from tax payers goes to the rail network and not to profiteering rail operating companies?

  3. Posted 14/02/2015 at 14:54 | Permalink

    I think most people will accept that the peak / off peak binary is very limiting, I don’t think that making it trinary by adding super peak or whatever is a solution though. What about setting the average cost per passenger km on an annual basis and allow train companies to flex their pricing accordingly?

    I accept the point from other commenters that demand around peak times is very inelastic, however, because a large percentage of people commute during peak times, an average limit would force off peak to become much cheaper, incentivising flexible working by exaggerating price differences.

  4. Posted 18/08/2015 at 13:14 | Permalink

    The problem of regulation of fares might affect things at the margin a little bit but it does not address the problem of foreign state runned railway companies (eg. in Germany/France) buying up parts of British rail and using it as a cash cow by overcharging British commuters to subsidise fares to their commuters back home. German politicians have even boasted about screwing over English commuters to their electorates.

    The truth is privatisation has not led to the efficiencies that were predicted and in some cases has just been a smash and grab raid by foreign owned private entities.The East Coast Railway demonstates this well where the line did so well whilst being run by the state and had to be bailed out by the state when private franchises failed spectacularly. Its very strange that the Governments response to this is to re-privatise it!

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