The dwindling cost of transportation

Compared to the arrangements it replaced, [shipping] containerisation has damn near abolished the cost of transporting stuff by sea, which means that the economic significance of mere geographical proximity has now been, if not abolished, at least radically diminished. Regional trading blocks like EUrope now look like relics from that bygone age when it would take a week to unload a ship

Brian Micklethwait

From personal interest I can tell you that distance does still matter. If you, for example, manufacture something relatively perishable (e.g. 3 months shelf life) in China and ship it then you could save thousands in labour costs. The problem is the month spent waiting for the ship can seriously disrupt your sales process. And sure, you can unload a ship quickly, but those containers need to be sorted through and items re-united with their owners or their agents to be taken to the point of utilisation, which all takes time and money.

Delays like this mean it may be more affordable to pay for someone in the UK to produce your items, especially if your batch is small or product perishable. Of course, anything less perishable or higher margin and you’re onto a winner.

trans-asian-raliway-networkThey are not known for small batches, but HP have started shipping computers overland by train from eastern China to Germany. Getting the containers through the various borders and changes of gauge is a project in itself however they can shave off ten days compared to shipping, according to an episode of CNNs The Gateway . What the program didn’t cover is the fact that the destination in Germany was also well connected by sea. It would be nice to see that route fully commercialised, new tracks with standardised gauges, and a steady flow of traffic down the old silk road. Those ten days and potentially (even) easier loading and unloading times will help smaller manufacturers. There is a painfully slow UN process trying to do that politically as part of a big graniose scheme.

nepal-water-mill-mountain-stream-crppedAlso via The Gateway I found a much more modest scheme, though not short of vision, which is exporing the use of autonomous helicopters (drones) for the delivery of goods via a network of base stations. An “airborne internet of things”. The slideshow seemed to depict Africa as a deployment environement and mentioned that the scheme woukld allow them to leapfrog the building of roads in the way mobiles allowed them to leapfrog laying telephone cables. My immediate thought was that a mountainous environement would be a better use case. There are equally few roads, but more rich mountaineers would use the service for medicine and luxuries. Also you have ample water power available, which mountain some cultures already use. This might be cheaper to install and potentially better than expensive photovoltaics.

I’m happy to notice they are talking about using it for grocery deliveries in New Zealand. Happy days.

HS2: Should the Taxpayer Be Going Loco?

A recent study by the Institute of Economic Affairs (IEA), a free market think tank, has suggested that the cost of the proposed rail investment High Speed 2 (HS2) will be close to the £80 billion mark, nearly £40 billion more than the last government estimate. Does HS2 still have any economic rationale or is this ambitious investment rapidly running out of steam?

© Dotting

© Dotting

HS2 is a planned high-speed rail network that will create a route from London to Birmingham, with extensions to Leeds and Sheffield. The cost of building the rail link was originally projected at £32 billion but recent reports suggest this figure is wildly optimistic. Even if one accepts a conservative estimate, it is questionable whether HS2 will offer any value for money to the taxpayer.

Large-scale infrastructure projects are rarely financed by private capital simply because they aren’t commercially viable. The reason why HS2, and similar projects such as Crossrail, have been allowed to materialise is because of the external benefits they bring to society. The Government argues they will bring widespread returns to the country by increasing productivity in the economy and relieving pressure on the existing rail network.

The claim that HS2 will increase productivity seems a fairly reasonable one at first. People travelling on the new high-speed network will experience a much quicker service, with time savings from London to Birmingham, Manchester and Leeds in the region of 40%. However, the actual value of these time savings to the economy is less significant. As part of their cost-benefit analysis (CBA), the Government estimated that the value of time savings was £37 an hour, on the assumption that very little work gets done on train journeys. Needless to say this is completely ludicrous. Since the use of laptops, tablets and high-speed internet has become commonplace in trains across the country the opportunity cost of travelling by rail has gradually decreased. With this in mind the benefit of lower journey times is unlikely to create a major advancement in productivity.

The other primary justification for this huge investment is that it will relieve pressure on the existing rail network. HS2 will undoubtedly deliver a large increase in capacity with platforms at over 400 metres in length and trains able to accommodate 1100 passengers. However, such statistics divert attention from the core issue: whether or not these benefits outweigh the costs of building the network as well as the opportunity cost of the billions of pounds of taxpayer’s money. The short answer is no.

The Government has said that HS2 will generate £2 worth of benefit for every £1 invested. This calculation doesn’t take into account information from new studies, such as the IEA’s, which demonstrate that the cost of building the network has been massively underestimated. As the general election draws closer it is inevitable that the costs of building HS2 will continue to rise, due in part to environmental concessions being made on the route in order to satisfy local authorities and conservationists.

That aside, the opportunity cost is the most pressing concern. If we take the Government’s estimate of the cost of building HS2, it is still equivalent to 2% of the UK’s gross domestic product (GDP). This money could be used in more efficient ways, for example, lowering income and corporation taxes. Rather than targeting one particular area, reducing taxation will bring benefits to the whole of the economy through the creation of wealth and jobs, whilst encouraging investment and consumption. Furthermore, these impacts will be immediate and will not cost the taxpayer a penny.

It is true that the rail industry does need investment to increase its capacity, mainly due to overcrowding on the South East network and inter-city lines. However, HS2 is not the solution. The current rail market is organised so that if passenger revenues for train companies are more than 6% above their target, the government takes 80% of the extra revenue – equally the government makes up 80% of the extra revenue if takings are 6% below target. This system destroys the incentive for train companies to invest in extra capacity. The Government should let companies take more of the risk and reward of operating their services, which would then encourage investment into the rail industry without emptying the public coffers.

Whitehall must ignore the pressure from special interest groups and pull the plug on this enormously expensive project. Since the plan was first announced, the cost benefit analysis has deteriorated, leaving the economic foundations for HS2 crumbling. The Government will argue that the rail link will bring wider benefits to society but, as aforementioned, these benefits are either overvalued or heavily outweighed by the costs. There are other public road and rail schemes that will create jobs and relieve pressure on the railways without breaking the bank. Alternatively, the Government could let the free market decide where investment should go by lowering taxes and giving more autonomy to private train companies. It may be a bumpy ride but the sooner this project derails, the better.

What to do with the railways

The government needs to loosen its regulatory stance on the railway industry and let the private sector take command of both infrastructure and services, which in turn will create investment, encourage innovation and ease pressure on the public purse.

Clapham Junction over crowdingIn the last few years there has been a growing debate over the state of the UK railway industry, politicians and passengers alike argue that it is in dire need of reform. Overcrowding on South East commuter lines and inter-city routes has become a major concern due to the lack of spare capacity, whilst the huge costs of running the network is shifted on to the taxpayer in the form of a £5.2 billion annual subsidy.

Advocates of the nanny state are quick to suggest that renationalising the industry is the silver bullet. However, in reality this is highly unlikely. Since 1993, when the then state-owned British Rail was privatised, the rail industry has benefited from a doubling of passenger numbers along with improvements in punctuality and safety. Doubtless the industry needs structural reform but of the kind that reduces state intervention rather than increases it.

To understand what needs to be done, we need to take a closer look at the structure of the industry itself. Currently it is split into two main parts: tracks, signalling and stations are handled by the government-backed Network Rail, whilst passenger and freight services are run by nineteen train operating companies (TOCs) as part of a franchise agreement.

This market structure creates unnecessary costs as Network Rail is the only company in charge of maintaining and operating infrastructure. In defending this framework, politicians argue that the rail industry is a classic example of a ‘natural monopoly’, thus having more than one firm managing the infrastructure would involve a wasteful duplication of resources. However, this isn’t strictly true as before WWII rail infrastructure was successfully managed by a number of separate companies on a purely commercial basis. As with any monopoly, the absence of competition with Network Rail means they have no incentive to maximise efficiency and keep costs to a minimum – a recent report recommended that £1 billion a year in cost savings could be achieved by 2020.

Market structure isn’t the only cause of dysfunction. The rail industry is subject to layers of red-tape by the Office of Rail Regulation (ORR), a quango, the most damaging of which is a cap on ticket price rises. The government’s rationale for price caps is that rail travel is a merit good; its consumption is beneficial to society due to the reduction in carbon emissions and lower congestion on the roads. Therefore many ministers believe setting limits on ticket price rises and subsidising the costs of running the network is an effective way of encouraging people to use trains.

This however has led to overcrowding on commuter and inter-city lines as demand for tickets has outstripped supply. Conversely, on regional routes the government has been forced to subsidise 60% of the running costs in order to keep ticket prices low. Bearing in mind that just 3% of passengers use these routes, this is a blatant misuse of taxpayer’s money.
To resolve some of these issues several actions should be undertaken. TOCs should be given responsibility for infrastructure maintenance and operation in addition to passenger and freight services. This would achieve two things: firstly, companies would be able to gain from vertical integration; having control of train stations and platforms as well as the actual service would increase efficiency and reduce transaction costs. Secondly, the maintenance of infrastructure, previously operated by the monopoly, Network Rail, would be subject to competitive tender. This would drive down the running costs of the network which will, in turn, trickle down to passengers in the form of lower fares.

Likewise, removing regulation on ticket prices would let the market mechanism function properly. Allowing fares to rise on commuter and inter-city lines would enable train companies to invest in greater capacity where demand is high, alleviating the problems of overcrowding. Letting the private sector choose where and when to invest is far more favourable to the current alternative of government officials wasting public funds on ‘white elephants’ such as HS2.

Moreover there should be a reduction in financial support for regional train lines. These lines, which currently consume 50% of the rail subsidy, are under-utilised and offer very little value for money to passengers and the taxpayer. Reducing the public subsidy for them could save a substantial £1.8 billion a year – at a time of austerity this is hardly a figure to scoff at.

Without a doubt these changes would eventually lead to a smaller and leaner rail industry operating much closer to its optimum size. More importantly however, it would allow the free market a greater degree of autonomy over the network which would start up the engines of efficiency and put it back on track to profitability.