Lessons on Railway Reorganization
By JOHN ROSS
CHINA has announced reorganization of its railways. For most people from the U.K. this news might evoke apprehensive shudders. Reorganization of Britain’s railways led to successive disasters. First the system was privatized, and a catastrophic series of fatal rail crashes followed. The railway track and other infrastructure were then renationalized. Infrastructure construction on the London Underground system was also privatized, leading to losses of US $2 billion, and renationalization again followed. Now 70 percent of the British population wants renationalization of the entire rail system. What lessons can China learn from the U.K. on how to avoid such disasters?
This is especially important bearing in mind that China’s railway development still has far to go. China has 98,000 kilometers of railway, while the U.S. has 228,500 kilometers. As China’s population is more than four times that of the U.S., the density of railway coverage per person in the U.S. is 10 times that of China. Anyone wanting to understand why the Chinese government rightly places so much emphasis on improving the country’s logistics need only consider that figure.
My involvement with railways was on the economic, not engineering, side. But experience taught me that the two are inseparably linked. In the Mayor of London’s office I was in charge of negotiations for the construction of the US $15 billion cross-London rail link Crossrail. So my views on these issues are based on practice and not simply theory.
The fundamental economic fact about a railway is that it is necessarily an integrated monopoly, because building any significant number of competing rail lines is too expensive. The reason for this inherent monopoly structure is the enormous investment costs of railway construction. These in turn mean that the finances of railway construction are central. The key question on railways is: how best to control a monopoly?
This immediately makes clear that a “market solution” is the last thing railways require, as the economics of a monopoly are simple: left to themselves, monopolies always either over-charge, or deliver low quality, and often both!
The disasters on the U.K. railways were due to ignoring this reality. They overturned the fundamental rule that the legal form of an economic unit must correspond to its real productive nature or serious error will follow.
The first legal fiction of the U.K. railways was separating the running of trains from ownership of the track, which was supposed to create competition in infrastructure and train operation. Safety would be allegedly maintained by supervision of the private companies carrying out the operations.
In practice such supervision cannot be detailed enough, because railway infrastructure companies have thousands of employees carrying out millions of operations. These private rail infrastructure companies inevitably evaded supervision and attempted to increase profits by cost savings on work. The resulting low quality led to successive fatal rail crashes – at Paddington in 1999, Hatfield in 2000, and Potters Bar in 2002. The only solution was to renationalize railway infrastructure, which was done. Since then there have been no similar fatal disasters.
The same mistake was made on London’s underground railways. The London authorities ran the trains but infrastructure construction and maintenance were privatized, so artificially legally splitting an integrated system. The result was that private companies lost the taxpayer US $2 billion before the system was renationalized.
All this was part of Public Private Partnership (PPP) promoted in the UK at that time in an attempt to bring private capital into the state sector. The PPP is now generally discredited and has been abandoned due to large financial losses. Borrowing by private companies is necessarily more expensive than state borrowing, as the risk is higher for lenders, which made borrowing for large-scale capital expenditure on railways, hospitals etc, more expensive when carried out by private companies.
Genuine competition is powerful and useful. But for it to operate there must exist economic units that are genuinely competing – whether they be the millions of farmers, tens of thousands of city taxi drivers or 12 large companies dominating the global motor industry. But attempting to create a legal fiction that something is competitive when it is really a monopoly necessarily leads to serious errors, as the U.K. experience demonstrates. That is why polls show that 70 percent of the U.K. population wants the whole rail system back under state ownership.
Giving an opinion on the precise details of China’s railway reorganization would require more detailed interaction with the precise situation. But certain universal principles apply to dealing with monopolies, and successes occur where these are followed.
The starting point is to firmly reject any artificial illusion that competition can be created. The starting point must be clear recognition that what is being dealt with is a monopoly and that monopolies, if left to themselves, necessarily charge excessive prices and produce low quality. Therefore management structures that continuously fight the consequences of the monopoly structure must be in place.
First, people doing the supervision must be separated from those running operations – otherwise there will be both a monopoly and a supervisory system that are hiding management mistakes.
Second, monopolies thrive on bureaucracy. Therefore the management command structure must be as “flat” as possible, with the minimum number of layers.
Third, state managers of such a hugely capital intensive monopolistic operation must be the best available, and beyond reproach as regards the possibility of being tempted into corruption, given that they have huge responsibilities wherein single decisions can lose hundreds of millions or even billions of dollars. The head of London’s integrated transport system, who had held a similar job in New York, successfully set about overcoming the problems created by the earlier erroneous policies, and received a salary of US $2 million a year. Similarly the company in charge of infrastructure construction for the 2012 Olympic Games – also a monopoly but delivered on time and to budget – was led by experienced, well-paid managers. Such workers secure the best leadership, and earning such salaries moreover precludes any significant temptation to undertake corrupt practices. Singapore uses a similar system in its famously non-corrupt administrative structures.
Fourth, these managers must have no security of tenure, so if they make mistakes they can be removed immediately – a quid pro-quo for high salaries and essential for fighting bureaucracy. The London Mayor removed a previous transport system head by walking into his office at 8 am, sacking him, and instructing him to leave the building immediately.
Naturally more issues could be discussed. But these points illustrate the fundamental issue: that success has been achieved where the consequences of the necessarily monopolistic character of railways has been faced up to, and that failure was the result of illusory attempts made to deny them.
John Ross is a visiting professor at Antai College of Shanghai Jiao Tong University. From 2000 to 2008 he was director of economic and business policy in the administration of Mayor of London Ken Livingstone. He previously served as adviser to several major international mining, finance and equipment manufacturing companies.
