More reversals in British rail privatization

The FT reports that the British government has decided to change the subsidy transfer mechanism to the country's railway operators. The proposal would mean that £3.9 bn annual subsidies would be transferred directly to the 22 private train operating companies (TOCs), instead of the earlier practice of granting to Network Rail, the state-owned rail infrastructure operator. The TOCs will in turn pay higher access charges to Network Rail. The entity, which controls 2500 stations, tracks, tunnels, and level-crossings, has recently been at the receiving end of widespread criticism about poor management that causes half the commuter trains to arrive late, despite the most expensive ticket prices in Europe.

This constitutes yet another reversal in Britain's tortuous rail privatization process which started in 1994. The re-nationalization of Network Rail came after a failed privatization through unbundling and formation of private infrastructure (Railtrack) and rolling stock operators. Further, before the current arrangement, Railtrack received all its income from rail access charges, and the subsidies were transferred to rail operators. The latest announcement restores status quo ante with respect to subsidy transfer channel.

So why should this be any more efficient than the earlier practice? To answer this, it is necessary to bear in mind that while access charges (a mix of fixed cost, variable usage, and capacity charges) are regulated by the Office of Rail Regulator (ORR), only half the passenger fares are regulated, with off-peak and advance-purchase prices being unregulated. This, especially with higher (and presumably closer to commercial cost recovery) access charges, makes Network Rail a more regulated entity than the TOCs and with lower commercial risks. In contrast, the TOCs face a critical restriction arising from capped passenger tariffs and face the full brunt of traffic risks. It is therefore only more efficient that the subsidy be transferred to the TOCs to make up for loss of profitability from revenue shortfalls, contingent on some service level standards. Further, this would also be more incentive compatible in so far as it would encourage the TOCs to improve passenger service delivery standards.

But on the flip side, with their upside capped, the new subsidy transfer arrangement may not do enough to incentivize Network Rail to improve operational efficiency and safety. Also, the TOCs flexibility with unregulated tariffs leaves open the possibility of abusing the subsidy system.