I had a series of exchanges recently at the Transport Committee on the subject of rail regulation which illustrated how far economic regulation has drifted from economic reality. The transcript is here.
The Chief Executive of Network Rail appears not to appreciate the role of price and freedom to contract, or at least he is prepared to submit to the Office of Rail Regulation’s subversion of those mechanisms:
Q39 Steve Baker: Sir David, you talked about trade-offs, the fight for access and, in particular long distance versus commuter passenger versus freight and so on. I was just looking at some of the cash flows in the industry. To what extent do you have sufficient freedom to contract and, in particular, to vary and enable competition over track access charges?
Sir David Higgins: They are set by the regulator.
Q40 Steve Baker: That sounds like you do not have sufficient freedom to use those mechanisms.
Sir David Higgins: The regulator has clear accountability in terms of ensuring equal access. They hold us to account. We have freedom, provided we comply with the obligations that the regulator sets us.
Q41 Steve Baker: If you had a greater degree of freedom from the regulator in this regard, could you achieve more in terms of resolving these tensions over the fight for access?
Sir David Higgins: No, I do not honestly think that is the issue. I do not think there is anything that the regulator does in terms of freedom of track access that causes that.
And the Regulator appears to be content to hamper price formation, restrict freedom to contract and create political problems to be solved by what is supposed to be a business:
Q121 Steve Baker: We have been reminded this morning that Network Rail is a profit-making company with scarce resources over which its customers compete for access, but also they lack freedom to contract and the ability to set prices for access to those scarce resources. Could you explain how it is that Network Rail is supposed to resolve this fight for access among its customers without that freedom to contract and set prices?
Richard Price: I heard what David had to say about that. The key thing is that Network Rail is able to deliver its existing targets on punctuality, performance and capacity as it has been financed to do in its regulatory deal. The structure of access charges reflects the decisions that were taken in the last periodic review, which made allowance for delivering the level of capacity and the level of punctuality that were set out in that deal.
Chair: Mr Baker is asking you a different point. He is asking you about the way in which the current system works and whether that can produce direct results.
Q122 Steve Baker: Thank you, Chair. We have listened to a conversation about the tension between commuter trains and long-distance trains, and between freight and passengers. There is a requirement for freight trains to have flexible access to track, but that might well come at the expense of not just passenger train operating companies but also no doubt all their passengers. But we have not had a conversation about how price is used to resolve these conflicts over scarce resources. It sounds like you are not recognising a role for price in that conflict, yet earlier Ms Walker mentioned the role of fares in incentivising people’s travel times. Where do you draw the line? Are fares and prices relevant to resolving access to scarce resources or not? If they are relevant, what are you going to do to enable Network Rail to use the price mechanism to resolve access questions?
Richard Price: There are two answers to this question. First, we have to make sure that users get access to the rail network on an equal basis with no undue discrimination. Secondly, there is some scope for varying access prices in relation to different kinds of service and also different kinds of rolling stock. We recently published a consultation document, looking forward to the next control period, which is looking at the extent to which more flexibility can be brought into that structure of access charges. There is a trade-off. On the one hand, you want to make sure that, as far as possible, the price mechanism is available to have the effect that you are describing. On the other hand, doing that adds a great deal of complexity to the charging mechanisms across the railway. There is a trade-off between having a set of incentives that is clear, simple and understandable enough for people to respond to it and, on the other hand, having such a degree of flexibility that it is so hard to understand that people cannot respond to it.
Q125 Steve Baker: If I were to play back very briefly what I have heard, it seems that you are saying that this enormously complex resource management issue has to be managed without recourse to unhampered access to market mechanisms-that is prices and freedom to contract.
Anna Walker: No; I think we are saying it is restricted.
Richard Price: We are consulting now on more flexibility and a more complex charging structure. As I said before, there is a trade-off between having a simpler system, which sends in some senses weaker signals, and a more complex graduated system, which is just harder to understand and maintain.
Q126 Steve Baker: Can you foresee ever reaching a circumstance where, for example, a freight company can bid to buy a train path, including all the costs on other people of, say, for example, inconveniencing all the passengers who otherwise would have been on that train path and would wish to be compensated?
Chair: Is it possible to do that under the current system?
Richard Price: Under the current system it is not possible to do that. If you are asking in principle if it is possible to do that-
Q127 Steve Baker: Can you foresee Network Rail being able to auction train paths so that a freight company that wants flexible access can just say, “We will pay that much for that path”, and it is then up to Network Rail?
Richard Price: In principle, it is possible to do that. As I say, the question is whether the complexity of that approach is better than a simpler approach, which sends some clearer signals.
Q128 Chair: But the question is: can it be done?
Richard Price: In principle it can be done.
Two fundamental problems emerge from this conversation. First, that the regulator and the regulated are attempting to solve an economic problem — the use of scarce train paths — by decree. Second, that they do not recognise the extent to which they are doing so and the problems they are creating for themselves. The idea that auctioning train paths would be complex seems to me a red herring: the main disadvantage from the ORR’s point of view is presumably that they would be increasingly redundant.
Resource allocation problems cannot be solved efficiently and in line with the relative preferences of those who wish to use those resources unless prices are formed without interference. The regulator does not allow that price formation, so the proper relationship between supply and demand cannot be established.
The supply of train paths is tightly constrained and the taxpayer pays almost as much as the farepayer, a massive subsidy bound to induce demand. The mechanisms necessary to resolve the problem are not merely being encumbered, they are scarcely recognised as being relevant. It should begin to be obvious why rail is in something of a mess and why so many of us are dependent on rail subsidy, for which we pay through taxation.
What a dreadful environment within which to embark on building a national high speed rail network.
For more on why all this is a problem, I recommend Israel Kirzner’s brief book, How Markets Work: Disequilibrium, Entrepreneurship and Discovery. In the meantime I wonder, did we win the Cold War before suffering a Communist takeover? I jest, but only just.