Why rail fares should be deregulated
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.