FEASIBILITY OF PRIVATIZATION OF EXPRESSWAY IN JAPAN by Yasuyuki Matsui B.E., Civil Engineering University of Tokyo, Tokyo, Japan (1987) Submitted to the Department of Civil and Environmental Engineering in Partial Fulfillment of the Requirements for the Degree of Master of Science in Civil Engineering at the Massachusetts Institute of Technology February 1993 © Yasuyuki Matsui 1993 All rights reserved The author hereby grants to MIT permission to reproduce and to distribute publicly copies of this thesis document in whole or in part. Signature of Author Department of Civil and Environmental Engineering January 15, 1993 Certified by Professor Fred Moavenzadeh Director, Center for Construction Research and Education Thesis Supervisor Accepted by Ole S. Madsen Chairman, Departmental Committee on Graduate studies FEASIBILITY OF PRIVATIZATION OF EXPRESSWAY IN JAPAN by Yasuyuki Matsui Submitted to the Department of Civil and Environmental Engineering in January 1993, in Partial Fulfillment of the Requirements for the Degree of Master of Science in Civil Engineering Abstract Recently, privatization has become very popular worldwide as an efficient means of constructing and operating infrastructure facilities. Like many other countries, Japan also has adopted a policy in favor of privatization, and has privatized several industries. Now, the privatization of expressway projects has become a controversial issue as the Japanese government has begun considering it as one of the next candidates for privatization. The purpose of this thesis is to examine the feasibility of privatizing expressway projects in Japan. With 5,000 km in operation and 6,500 km in various stage of planning, design or construction, the provision of an efficient expressway network is a national priority. Currently, because a public corporation, which is fully sponsored by the Japanese government, is the sole provider of the expressway network as toll roads, privatization may improve economic efficiency by bringing private parties into the projects. However, not all privatization schemes have been successful. In particular, when competition is very limited as in expressway projects, the critical issues for successful privatization are to increase the competitive environment by dropping artificial barriers to entry into the market, and to adopt a regulatory framework which does not distort the private firm's incentive to reduce operation costs and increase usage of expressways. In addition, appropriate risk sharing by the public sector may be necessary to reduce the high risk of a new construction project, and to secure new entrants into the expressway projects. Thesis Supervisor: Fred Moavenzadeh Title: Professor of Civil and Environmental Engineering Director, Center for Construction Research and Education Acknowledgments There are many people and friends who have encouraged me to complete this thesis, and I would like to express my deepest appreciation to all of them. Above all, Professor Fred Moavenzadeh gave me valuable suggestions and comments toward this thesis despite his busy schedule. Mr. Tomoji Hirukawa, Mr. Hiromichi Miyake, and Mr. Kuniaki Mitani gave me the information about the Japan Highway Public Corporation, the Trans-Tokyo Highway Corporation, and the Japan Railway Groups. Finally, I have to add that the completion of my thesis is greatly indebted to my dedicated wife, Junko, who has always encouraged and supported my study throughout my stay at Massachusetts Institute of Technology. Had it not been for her kind support and dedication, I could not have completed this thesis. Yasuyuki Matsui Table of Contents Title..................................................... 1 Abstract................................................... 2 Acknowledgments .......................... ................ 3 Table of Contents......................................... 4 List of Figures........................................... 8 List of Tables ............................................ 10 Chapter I Introduction ............................... 11 1.1 Background.............................................. 11 1.2 Objectives........................................... 12 1.3 Thesis Organization........................... ....... 12 Chapter II Road and Expressway System in Japan.. 15 2.1 Roads in Japan........................................ 15 2.1.1 Roads and Road Transportation.................... 15 2.1.2 Classification of Roads and their Administration. 18 2.1.3 Financial System for Road Works.................. 24 2.2 Expressway Projects........ .......................... 25 2.2.1 History of Expressway Development and Planning... 25 2.2.2 Procedures of Expressway Construction............ 27 2.2.3 Financial System for Expressway Projects......... 28 2.3 Problems of Expressway Projects...................... 30 2.3.1 Profitability of Expressway Network.............. 30 2.3.2 Management Responsibility of JHPC................. 32 2.3.3 Additional Financial Sources.................... 33 2.4 Privatization of Expressway Projects.................. 34 Chapter III Privatization ............................ 35 3.1 Introduction.......................................... 35 3.2 Privatization Trend .................................. 35 3.2.1 Western European Countries... .................... 35 3.2.2 The United States......................... ....... 36 3.2.3 Japan............................................ 37 3.3 Objectives of Privatization........................... 38 3.3.1 Improvement of Economic Efficiency............... 38 3.3.2 Reduction of Public Funds Requirement............ 44 3.3.3 Reduction of Intervention from Politics.......... 45 3.3.4 Capturing Development Gain....................... 45 3.4 Types of Privatization................................ 49 3.4.1 Divestiture ....................................... 49 3.4.2 Contracting Out.................................. 50 3.4.3 Franchise Arrangement............................. 51 3.4.4 Lease Arrangement. ............. .......... 52 3.5 Potential Problems of Privatization..................... 52 3.5.1 Service Quality.................................. 52 3.5.2 Control..................... ...................... 53 3.5.3 Rate of Return Regulation ....................... 53 Chapter IV Privatization, Competition and Regulation................................ 55 4.1 Introduction.......................................... 55 4.2 Real Merit of Privatization .......................... 55 4.2.1 Competition in the Production Market ............. 58 4.2.2 Competition in the Capital Market................ 60 4.2.3 Threat of Takeover and Bankruptcy................ 61 4.2.4 Profit-Seeking Aspect.............................. 62 4.2.5 Transferability of the ownership................. 63 4.3 Privatization of Natural Monopolies and Promotion of Competition........................................ 64 4.3.1 Transition from Natural Monopoly to Competitive Market............................... ................. 65 4.3.2 Breaking up of Monopoly ............................. 72 4.3.3 Auctioning a Monopoly Franchise.................. 76 4.4 Regulation of a Natural Monopoly ..................... o78 4.4.1 Rate of Return Regulation........................ 79 4.4.2 Price Regulation ................................. 81 4.4.3 Return on Output Regulation...................... 82 4.4.4 Return on Sales Regulation........................ 82 4.4.5 Return on Cost Regulation......................... 84 4.4.6 Summary of Natural Monopoly Regulation............ 86 Chapter V Cases of Highway Privatization......... 88 5.1 Introduction........................................... 88 5.2 Cases of Selected Private Toll Highway Projects...... 88 5.2.1 California AB 680 Projects....................... 88 5.2.2 Dulles Toll Road Extension Project................ 93 5.2.3 Trans-Tokyo Bay Highway Project................... 96 5.2.4 Channel Tunnel Project............................100 5.2.5 Sydney Harbor Tunnel Project.....................104 5.3 Regulatory Framework for Private Highway Projects....106 5.3.1 Concession Procedure.............................107 5.3.2 Ownership ......................................... 107 5.3.3 No-Development Clause.............................108 5.3.4 Safety and Maintenance...........................109 5.3.5 Toll Rate and Rate of Return Regulation..........110 5.3.6 Pre-determined Revenue Arrangement and Incentives for a Private Company.................113 5.4 Financial Arrangements for Private Highway Projects..114 5.4.1 Common Financial Structure ...................... 114 5.4.2 Debt and Equity..................................115 5.4.3 Financial Assistance from the Government ......... 117 5.5 Risk Sharing in Private Highway Projects.............117 5.5.1 Planning Stage...................................118 5.5.2 Construction Stage................................118 5.5.3 Operation Stage..................................121 Chapter VI A Plan for Expressway Privatization.. 125 6.1 Introduction...........................................125 6.2 Special Considerations for Expressway Privatization.........................................125 6.2.1 Rationale for Privatization............. ........ 125 6.2.2 Need for a Public Corporation............ ........ 126 6.2.3 Increase in the Number of Entrants ....... ........ 127 6.2.4 Preventing an Increase in Toll Barriers ......... 128 6.2.5 Continuity of Toll Rate Policy.......... ........ 129 6.2.6 Scope of Activities...................... ........ 130 6.3 A Plan for Expressway Privatization