FINANCING TRANSPORT INFRASTRUCTURE - CURRENT ISSUES IN BRITAIN

Chris NASH` Professor Institute for Transport Studies University of UK

INTRODUCTION

The problems of the transport sector have risen high on the political agenda in Britain in recent years. There are a number of reasons for this. Firstly, the continued growth of road traffic has led to acute problems of traffic congestion spreading from the urban peak to the off-peak and to inter-urban roads. Secondly, growth in the demand for public transport in has led to acute overcrowding on the underground and suburban rail systems. Thirdly, a spate of accidents on all modes has led to major concern about transport safety, with a resulting large increase in spending, particularly on rail transport. Fourthly, the transport sector is a major cause of environmental externalities, both from the construction of infrastructure and from the movement of traffic. In the former case the principal direct effects are landtake and the destruction of property and visual intrusion; in the latter, noise and air pollution. Air pollution includes both local effects of emissions of lead, carbon monoxide etc, the contribution of nitrogen oxide and in the case of electric traction sulphur dioxide to acid rain, and the contribution to global warming particularly of carbon dioxide. In addition to these direct effects there are significant indirect effects, for instance from the production and transport of oil, and from the extraction of construction materials. One reason for taking the problems of the transport sector very seriously is the rapid growth in demand for the most congested and polluting transport modes - namely road and air. For instance, in Britain road traffic has doubled since 1968 and the DTp forecasts that road traffic will grow by between 83 and 142% by the year 2025 compared with 1988 (Table 1). This will more than offset any environmental gains from planned measures such as the fitting of catalytic convertors to cars, whilst even major spending on transport infrastructure is unlikely to be able to keep pace with such a growth in demand. The initial reaction of the British Government to the emerging situation was to announce a major increase in transport spending, financed in the traditional way through government spending, and concentrated on trunk roads (Table 2). However, it was soon realised that this would do nothing to solve the problems in urban areas, and might well make them worse. In London, studies of new public transport schemes suggested at

• I am grateful to Dr John Preston for comments on an earlier draft of this paper, and for permission to reuse material prepared as part of a joint paper with him (Nash and Preston, 1992).

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least one north-south and one east-west tunnel should be built to supplement the capacity of the existing rail system, whilst extensive investment would be needed in upgrading and renewing the existing aged and somewhat decrepit rail system. In other cities, public transport had been dominated by the bus since the closure of tramways in the 1950's, and the rapid transit and light rail revolution which had already swept through continental Europe and North America had largely passed Britain by. However, local authority after local authority now began studies of light rail systems, each one costing hundreds of millions of pounds. At the same time the main line rail system was seen to be in need of major investment, particularly to link it to the and to upgrade the busiest route in the country, the West Coast Main Line, where speeds had improved little since electrification in the 1960's. Partly as a consequence of this major perceived need for investment, and partly as an element of the general pro-privatisation of the government, the last few years have seen a spate of schemes designed to bring private capital into transport infrastructure investment. The most important of these are the idea of private toll roads, private investment in light rail systems and the complete privatisation of . We now consider methods of funding infrastructure in each of these three sectors in turn, before reaching our own conclusions on an appropriate way forward.

1. THE ROAD SYSTEM

In Britain, as in most countries, responsibility for investment in roads is divided between central and local government. Central government takes responsibility for motorways and trunk roads; other roads are the responsibility of local authorities, although théy receive earmarked funding towards these roads in the form of Transport Supplementary Grant. This is paid towards the cost of justified improvements in local roads which are of more than local significance. There is no direct link between receipts from fuel tax and vehicle excise duty,- which are paid to central government - and spending on roads. Only a limited number of very expensive estuarial crossings bear a toll. It has been argued that private funding of road infrastructure would both increase the volume of resources devoted to it and lead to greater innovation and efficiency. Apart from a limited amount contributed by developers to the cost of road improvements to serve their schemes, the first schemes announced involved estuary crossings (the Dartford bridge over the River Thames and the second crossing of the River Severn between England and ), where tolls were already the norm. However, since then private consortia have been encouraged to prepare proposals for toll roads to parallel a number of existing congested trunk roads - the first to be built will be the Northern Relief Road. Whether private trunk roads will actually be of benefit remains the subject of much debate. The costs of requiring private consortia to develop competitive proposals in detail with no certainty that they will be built appears to be prohibitive, so it is likely

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that the scope for completely original developments, as opposed to handing to the private sector developments planned by government, appears to be limited. Roads are already designed and built by private companies as a result of competitive tendering, so the scope for increased efficiency in their construction is small. Most seriously, the imposition of tolls on new roads designed to relieve existing untolled roads could lead to an inefficient allocation of traffic which would reduce the degree of relief of congestion and environmental degradation produced by the new road. Whilst there is a growing opinion that the use of tolls or more sophisticated road pricing systems should be introduced, it is generally thought that these should be set so as to restrict traffic on existing congested roads and particularly in urban areas, rather than being designed to earn a commercial rate of return on specific new pieces of infrastructure.

2. URBAN RAIL SYSTEMS

Urban rail systems in Britain at the present time are provided by two main operators - London Underground Limited, in London, and British Rail for longer distance services in London and all suburban services in other cities. In the major cities outside London British Rail operates services as specified by the Passenger Transport Executive, a joint board of local authorities in the area, which also plays a major role in funding investment. Two PTE's also own their own rail systems; Tyne and Wear a modern metro and a very small underground system. London Underground and British Rail are both owned by central government, and fund investment either from their own resources or by borrowing from central government. In recent years, a large part of rail investment has been funded by the sale of property (Table 3), but the current recession in the property market has led to the collapse of this source of funds, and consequently - given the simultaneous decline in railway revenue from customers - to a virtual halt in the authorisation of new rail schemes. Local authority rail investment used to be funded on the same basis as local road schemes, through the transport supplementary grant, but this was stopped some years ago, and an earlier measure, Section 56 of the 1968 Transport Act, was revived. Under this, local authorities may apply for funding of investment of more than purely local significance if the benefits to nonusers (in the form of decongestion of roads, economic development and environmental improvement) exceed the total public sector contribution towards the cost. Benefits to users are excluded from the case for grant aid, as they are expected to be recouped by the operator in the form of revenue. This both leads to a requirement for premium fares, which reduces the volume of traffic attracted to the system, and greatly reduces the measured net present value of the project (see, for example, the figures quoted for the light rail scheme in Table 5. In fact in Manchester the justification of the scheme was based largely on reductions in subsidy required compared with the existing rail service). The sponsoring authority also has to show that it has exploited to the full any possibilities of private sector funding either from developers, who stand to gain from the investment, or

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operators, who might be able to service the capital from fares revenue (Nash and Preston, 1991). So far the contribution to infrastructure costs from the private sector under these measures has been small. The Docklands Light Railway received a considerable contribution to the costs of upgrading and extending it from the developers of the Canary Wharf office complex, this being a case where a single developer was undertaking a massive development for which improved public transport would be absolutely essential. A number of other developments have received contributions to the costs of particular stations or alignments. But in general it appears that the effects on property values are too marginal and the ownership of the property too diverse for this sort of voluntary contribution to be achieved. The free-rider problem applies, whereby there is no incentive for any particular property developer to contribute to the system if they think that their contribution will be too marginal to influence whether it gets built. For instance, a light rail project for Bristol which was intended to be funded entirely from property developers has yet to go ahead and the promoters now accept that it will need some degree of public funding. Regarding Section 56 grants themselves, two major light rail schemes (Manchester and ) have so far been funded, together with a handful of more modest rail schemes. At this rate only a few of the largest cities can expect to get light rail schemes funded by the end of the century. This is in marked contrast to the pace of development of such schemes in other countries, particularly Germany and France.

3. MAIN LINE RAIL

We have already mentioned that British Rail receives its investment funding either from its own resources or from borrowing from Central Government. Until recently, it financed investment heavily from property sales and development, but the decline both in its own revenue and in property values has led to a virtual halt in all new rail investment projects. Consequently it is not surprising that the government should have turned to the private sector to contribute towards the investment in main line rail infrastructure. Its first major attempt was in the proposal that a new high speed line between the Channel Tunnel and London should be privately funded. However this proposal collapsed because the private sector required a much higher rate of return than the 8% (in real terms) required by Central Government from British Rail, and - especially after allowing for the costs of measures to relieve the environmental impact of the route , including lengthy tunnelling - the original project could not provide this. The government seems to be seeking a combination of private and public sector funding for its current proposals, with the public sector grant being in respect of the benefits to commuter services from the extra capacity and higher speeds of the new line. A more ambitious plan would be to privatise the rail infrastructure as a whole. Following nationalisation in 1947, British Rail (BR) adopted the traditional hierarchial

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organisational form on a mainly geographical basis consisting of central Headquarters, Regions, Divisions and Areas that, to some extent, had its roots in the military organisation model. This organisational form evolved over the years but was thoroughly revised in the early 1980s when a new layer of management, the business sectors, was created, resulting in a matrix management approach in which organisation was split by function, region and sector (Allen and Williams, 1985). This organisational form has been recently revised by a programme called Organising for Quality (OFQ), whereby the organisation has adopted a multi divisional approach based on separate businesses. There are eight businesses overall. Four of these businesses deal with passenger services. • InterCity which consists of the five main inter city passenger routes, plus services from London to Gatwick and Norwich. • Network South East which comprises the main commuter routes into London. • Regional which consists of all other commuter, rural and cross country passenger routes. • European Passenger Services. Freight is split into two businesses. • which consists of four subsectors (Coal, Metals, Construction and Petroleum). • Rail Freight Distribution which concentrates on containers and inter-modal transport. The former parcels sector is now operated jointly by the three main passenger whilst businesses, ancillary services are split into two businesses (BR Telecommunications and Central Services Division). However, further organisational reform seems inevitable given the Government's commitment to privatization and the low level of esteem with which BR is viewed by the public. As will be seen from table 4, only two of the sectors (Inter City and Trainload Freight) are currently profitable, and it is generally accepted that there will be a continuing need for subsidies for Network Southeast and even if they are privatised. Privatization of BR was first seriously proposed by Beesley and Littlechild (1983) who suggested that BR's large property endowment should be used to attract private investment. In the meantime, BR has divested itself of its ancillary activities; , Ferries, British Rail Engineering Limited and the Vale of Rheidol railway, whilst it has encouraged private investment, particularly in the freight sector where a joint venture company, Charterail, has been set up with the private sector and a large number of wagons are now privately owned. Furthermore,the Channel Tunnel has been constructed entirely with private funds and a private firm, Eurotunnel, will operate the shuttle service. Nonetheless, the calls for privatisation have continued with at least four organisational forms having been considered. 1. Privatization as a single unit. This option was at one time favoured by the but, given the difficulties of developing effective competition for

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utilities privatised in this form (British Gas, British Telecom), is not believed to be in serious contention. 2. Splitting BR into a number of regional independent companies. This option was put forward by Gritten (1988) and would effectively be a denationalization programme. Critics argue that it would merely convert a national monopoly into a series of local monopolies, with competition limited to boundary areas. However, it would introduce the possibility of yardstick competition (Vickers and Yarrow, 1988) and has been used as the basis for commercialising Japanese National Railways with apparent success (Hirooka, 1991). 3. An alternative for splitting BR might be on the basis of the main business sectors (Inter City, Network South East, Regional and Freight) but this would again little effective competition. 4. The separation of infrastructure and operations. This was initially put forward by Starkie (1984) who argued that the natural monopoly characteristics of the rail industry lay in the sunk costs of the infrastructure. If this remained in state ownership or control, then operations would represent a contestable activity. This proposal was taken up by Irvine (1987) who proposed that the track should be leased to competing companies. With any of the above methods of privatising BR, it is likely that attempts would be made to stimulate competition in two ways: (a) By giving access rights to the infrastructure to other operators. (b) By moving towards competitive tendering for the provision of subsidised services. What is still far from clear is how a system of privately owned rail infrastructure would work in practice. If there is to be on-the-tracks competition, where tracks are owned by a competing firm, it would clearly be necessary to regulate access and price, so that the incumbent operator is prevented from using its ownership of the tracks to make entry unattractive. This poses big problems for the regulator, in determining whether the existing timetable has been deliberately designed to inhibit entry, and in determining a fair price for use of the track. For instance, to price at marginal cost in a decreasing cost industry , is not sustainable; the owner of the track would be placed at a competitive disadvantage by having to pay for the fixed costs of infrastructure. On the other hand, if the price is above marginal cost, then the owner of the track is at an advantage in that it can operate any services which at least cover their marginal cost and cover the fixed costs as and where market conditions allow. At the same time, successful entry which did not totally displace the incumbent operator would lead to loss of economies of density, and may also disbenefit passengers (eg. if a ticket for one company's 5.10 train is not also valid on another's 5.40). The problem of ensuring free and fair access to the infrastructure may be lessened if the option of a totally separate non vertically integrated track company is followed, as there is then less scope for deliberate strategic entry forestalling. However, there are other reasons to doubt whether this is likely to be an efficient solution. One of the strengths of the sector management approach as adopted by British Rail (and copied by

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other railways, including French and Spanish Railways) has been the strong links between commercial planning and infrastructure planning and the commercial decisions of the sectors. Broadly, the approach has been that on each stretch of track the prime user has first been asked what level and quality of infrastructure it requires and is able to pay for. Then the other sectors in turn have been given the choice of making use of any spare capacity within the infrastructure as specified by the prime user, or paying for it to be enhanced. The result has been a major improvement in the efficiency with which the infrastructure is provided and used. The result of these complexities is that at the time of writing the government still has not announced its intentions regarding the method of rail privatisation, although this should be known by the time of the conference. Whatever method is chosen, however, it may be doubted whether privatisation will lead to a big increase in rail investment. Although theoretically it would release British Rail from the constraints imposed by public sector borrowing and give it access to the private capital market, it may be doubted whether the volume of rail investment able to offer purely commercial returns at the sort of rate required to attract private capital to what will be seen as a risky business will be large.

4. ALTERNATIVE SOLUTIONS

So far we have seen that there is a perceived need for a big increase in infrastructure spending in the transport sector in , but that none of the government's attempts to attract private capital into the sector appear to be bearing much fruit. Naturally, then, a number of other approaches to funding this infrastructure have been suggested in recent years. The first is simply to argue for more government spending. For instance it is pointed out that total spending on roads is exceeded by the level of taxes several times over, although this comparison makes no allowance for the external costs of road transport. However, the government has always regarded this excess as a contribution to general revenue, and appears unlikely to change its view. A second approach would be to continue existing levels of spending but to change the way in which it is allocated. For instance, the existing approach seems to favour roads over public transport in a number of respects (Nash, Hopkinson, Tweddle and Preston, 1991): roads are appraised on a full cost-benefit analysis including user benefits; most rail schemes are appraised on a purely commercial basis, and where social cost- benefit analysis is used, benefits to users are disallowed as a case for grant-aid. road investment, being funded out of general taxation, is very much less susceptible to the state of the economy than is rail; as explained above, rail investment can be virtually halted by a recession because of its dependence on rail revenue and on property prices. funding of local road schemes under Transport Supplementary Grant is much

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easier to obtain than is funding of rail investment under Section 56 grants. This approach would see a unification of the funding systems, with national road and rail schemes funded out of general taxation on comparable criteria, and with local schemes both eligible for Transport Supplementary grant on the same terms. Thirdly it is argued that there may be a need for a new earmarked tax to fund transport infrastructure. At least four suggestions have come forward as to what this should be. Revenue from road pricing. A number of cities have now undertaken recent comprehensive transport studies that have come up with an integrated strategy involving both investment in rail schemes and road pricing. The two complement each other both in terms of transport facilities, with the rail investment proving an attractive alternative to the use of the car, and in funding terms, with the revenues from road pricing paying for the rail system. Although until recently the government was adamant that it would not consider road pricing as an acceptable option, it has now launched a programme of major studies on the subject in London. A surcharge on petrol, as is used in Germany as an earmarked tax for transport infrastructure and goes a long way to explain the much greater investment in rail systems in Germany than in Britain in the last two decades. It is argued that higher fuel taxes will in any case be needed to help reduce energy consumption in the face of the feared consequences of global warming. An employment tax earmarked for transport improvements as in France. Here it is argued that if employers wish to site premises in congested city areas then it is they who should pay for the transport facilities to serve the major flows of commuters they generate. Some other form of tax on business, such as an explicit tax on property values or some kind of surcharge on the business rates (the existing property tax on businesses) in areas where a high level of spending on transport infrastructure takes place.

5. CONCLUSIONS

We have seen that there is a perceived need for an increase in transport investment as part of a strategy to overcome the growing problems of congestion and environmental damage, but that increased involvement of the private sector in the funding of transport infrastructure has limited potential and many problems. We have also seen that existing funding and appraisal mechanisms in Britain favour road investment over investment in public transport infrastructure, somewhat perversely in view of their relative environmental merits. In our view then two measures are needed. One is to put the methods of funding and appraisal for the two modes on to a comparable basis, with a national rail infrastructure programme funded out of general taxation in the same way as that for

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roads, and with local rail and road schemes being eligible for funding from Transport Supplementary Grant on the same terms. The second is to find a new source of funding for local transport spending. This might be from road pricing, in those cases where it is implemented. But there seems to be an urgency about the requirement which will not wait for the large scale implementation of road pricing. There seems much in favour of a tax on employment linked to the level of transport spending on the site in question, although administrative simplicity may make a supplementary business rate a preferable option.

BIBLIOGRAPHY

Allen, D., and Williams, G.. The development of management information to meet the needs of a new management structure for British Rail. In Button, K.J. and Pitfield, D.E. (Eds) International Railway Economics. Aldershot: Gower, 1985.

Beesley, M., and Littlechild, S.. Privatization: principles, problems and priorities. Lloyds Bank Review, 1983. 149, 1-20.

Gritten, A.. Reviewing the railways - a Victorian future. London: Centre for Policy Studies, 1988.

Hirooka, H.. Privatization of Japanese railways. Presented to the Second International Conference of Privatization and Deregulation in Passenger Transportation. Tampere, Finland. 1991.

Irvine, K.. The right lines. London: Adam Smith Institute, 1987.

Nash, C.A., and Preston, J.. Appraisal of rail investment projects: recent British experience. Transport Reviews 11. 1991. 295-309.

Nash, C.A., and Preston, J.. Barriers to entry in the railway industry. Paper presented at the seminar on Entry Barriers at University, 28 February 1992.

Nash, C.A., Hopkinson, P.G., Tweddle, G., Preston, J.. Evaluation of road and rail projects: issues and new developments. In The Future of Railways and Roads. London: Institute for Public Policy Research, 1991.

Starkie, D.N.M.. BR - privatisation without tears. Economic Affairs, 1984.

Vickers, J., and Yarrow, G.. Privatization: an economic analysis. Cambridge: MIT Press, 1988.

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Table 1 Road traffic growth

Index 1988 = 100 1958 25 1968 50 1978 68 1988 100 2025 Forecast Low 183 High 242

Source: DTp (1989)

Table 2 Planned expenditure on roads 1990-91 to 1992-93 (by Central Government on national roads system)

£ million 1988-89 1989-90 1990-91 1991-92 1992-93 Current 102 93 120 130 140 Capital 897 1301 1694 1770 1850 Administration 93 105 121 130 140

Source: The Governments Expenditure Plans 1990-91 to 1992-93, Chapter 7 - Department of Transport, HM Treasury, London, 1990.

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Table 3 Receipts from BR property

Gross income Property sales from letting 1984/85 131 82 1985/86 81 70 1986/87 101 75 1987/88 181 82 1988/89 264 101 1989/90 319 121 1990/91 121 131

Source: BR Annual Report and Accounts

Table 4 British Rail - Financial Results (£m)

Revenue Surplus Inter City 851.2 49.7 Network South East 998.3 (154.9) Regional 303.7 (503.4) Trainload Freight 509.5 98.7 Distribution 172.8 (152.3) Parcels 115.8 (25.8)

TOTAL 2951.3 (688.0)

Grant 671.5 (16.5)

Source: BRB Annual Report and Accounts 1990/91 (figures in brackets indicate a loss, before receipt of grant aid).

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Table 5 Comparison of cost-benefit and Section 56 appraisals of the Manchester light rail project (discounted 30-year totals)

£m £m 1. Cost-benefit analysis Capital cost Metrolink 87.00 BR capital cost avoided 41.44 Bus capital cost avoided 1.80 43.76 Net capital cost Benefits Operating cost savings 8.06 User benefits (time savings) 68.46 Revenue from ex-car users 12.19 Congestion reduction 6.00 Accident cost savings 3.00 Total benefits 97.71 Net present value 53.95 Benefit to cost ratio 2.23 2. Section 56 criteria Capital cost 87.00 87.00 Public sector costs avoided and non-user benefits BR capital expenditure 41.44 Tendered bus services 1.31 BR Rail Subsidy savings 36.98 Congestion savings 6.00 Accident cost savings 2.00 Total 87.73 Ratio 87.73 1.01

Source: Tyson (unpublished)

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