Transport economics Why is transport important?

The tax imposed raises the market price of transport to 0P* from 0P1 the price charged without intervention. As MSC = MSB at this new level of output (0Q*) the allocation of resources is allocatively efficient. This is known as internalizing the externality - the full social cost is now reflected in the price paid by the consumer.

 Estimating the social costs and benefits involved.

 Differentiating between the road users that cause externalities.
In 1999 road users paid £26bn more in tax than was spent on roads. This represents a cost, as stated earlier, of 5.4p per vehicle km. According to Mumford’s figures an HGV driving through an urban centre at peak times imposes 87p of external costs on society for each km traveled, but a private car traveling in rural areas imposes just 0.8p of external costs. Thus a single tax policy will fail to reduce the demand sufficiently in urban areas and will penalise those who live in rural areas.
Who pays for the infrastructure?
This is known as the track costs argument. Confusingly it is applied to roads not rail, but is concerned with who pays for and who benefits from the provision of roads. In the case of railways it is fairly easy to see who should pay for the provision of track, but who should pay for the roads and their maintenance.
The track costs are;

Construction costs

Maintenance costs
The payments made are in the form of;

Fuel tax

Vehicle excise duty (the Road fund licence)

Value added tax
Originally the road fund licence was seen as a fund from which road network improvements could be financed. In the technical jargon it was hypothecated for road building and ongoing maintenance. The link is no longer made.
Cars and light vehicles paid 3.7 times more in tax than the track costs associated with them in 1994/95. Heavy goods vehicles paid only 1.4 times more than the costs due to them.
Due to externalities it is argued than private cars should pay more (even more) to use the roads, but that as heavy goods vehicles are production related they should pay less, i.e. just their track costs.

Public transport reduces the level of negative externality and so should be encouraged with lower taxes or even subsidies.

As we have seen there are a considerable number of sources of external costs in transport. This makes the pricing of all transport services difficult.

A couple are going from London to Birmingham for the weekend, a journey of 115 miles. In 1992 the train fare (cheapest possible) is £23 each (£46 in total) while the cost of taking the car is £11 of petrol (remember 1992 prices).

A monopolist could charge 0P1 for output 0Q1 and make a profit.

The solution to the problem is to discriminate between customers to allow the overall service to make a profit when charging one price would not.

Table 10 in Bamford illustrates a typical BR pricing policy on one route.

Subsidies can bring social benefits by;

reducing traffic congestion,

limiting harmful emissions,

reducing journey times and

improving the mobility of low income groups.

The total subsidy necessary to move the market to the socially optimal output of 0Q* is equal to ABCD. This allows the market price to fall from Pm to 0D at which consumers are prepared to purchase 0Q* units. Effectively the supply curve has been moved to the right, passing through point C.

Subsidies are little used in the UK, but transport is an exception. Transport subsidies are either targeted at certain groups. e.g. pensioners or the rural bus subsidy, or are swallowed up within national costs and not reflected greatly in lower fares, e.g. the subsidy paid to the rail franchise operators.

Local subsidies can have an effect, e.g. West Yorkshire where the Passenger Transport Authority subsidized the local rail network. In 1995 the average fare per passenger mile for journeys wholly within the West Yorkshire metropolitan area was 12.2p, for journeys not wholly within the area it was 16.7p.
Arguments for subsidies in passenger transport are:
Social equity - groups who could not otherwise afford to travel are able to do so.

Promote positive externalities - greater use of public transport in urban areas reduces traffic congestion.

Urban regeneration - Establishing a cheap, efficient public transport service to a run down area promotes growth, e.g. Manchester Metrolink, London Docklands.

Environmental protection - reduce pollution or damage in an area such as the world heritage city of Bath, where pollution from cars attacks the limestone buildings.

This could be achieved by subsidizing ‘Park and Ride’ schemes.
Arguments against subsidies in passenger transport are:

Blanket subsidies are indiscriminate - a general subsidy benefits all passengers regardless of income.

 Subsidies breed inefficiency - if subsidies are offered managers come to rely on them and operating costs are higher than they need be.
The inefficiency argument has had significant impact on UK policy towards bus and railway subsidy.
How much subsidy?
A private firm will assess a transport service according to the financial viability of the service, what might be called a ‘cost revenue analysis’. As we have established the external costs and benefits of transport services means that this is not always going to lead to an optimal allocation of resources. However knowing this does not tell us which services to subsidise or by how much.
A cost-benefit analysis would allow us to judge if it was worth subsidising a service.

The reason for using CBA is because;

 Identification of all costs and benefits

Valuation of all costs and benefits

Assessment of risk and uncertainty in forecasting costs and benefits

Discounting future costs and benefits to find net present value

Compare alternative projects

Capital replacement cost savings; Loss of train service revenue.

(Stations, track, bridges, signaling, Cost of alternative bus service.

rolling stock.)

Operating cost savings;

(Labour, fuel, maintenance.)

Resources transferred to other services.

Revenue from alternative bus service.

 The existing users of other modes of transport, e.g. private car users and pedestrians.

 The transport operators and the authorities providing roads.

 The rest of the economy.

 The effect on feeder services - the loss of one service may reduce traffic on the rest of the network making it less viable.

 Accident savings on roads - the closure of the railway implies higher road traffic volumes and so more accidents.

 Overcrowding - on roads (congestion) and buses. More congestion means that existing road users have longer journey times and this implies a loss of welfare for them.

 Time savings on road - the alternative trip may be shorter.

 Journeys not made - some people will simply not undertake the journey anymore. This will mean a deadweight loss of welfare for those who used to use the service.

 Employment impact - the loss of the service will lower railway employment, but may raise employment elsewhere. A local multiplier effect may be involved.

 Environmental effects - e.g. more road use implies higher pollution.

Benefits in journey times. Replacement costs on non-passenger (For former rail customers that spend services.

less time traveling and existing bus (Freight and parcels taken by road users who get an improved service.) transport.)

Connecting services. Journey time increases.

(Cost savings due to fewer connecting (Former rail users journeys taking longer.)

passengers.)

Journeys not made.

Environmental effects. (Loss of mobility by individuals)

(Lower noise, pollution for those living Increased car operating costs.

near railway.) (From journeys transferred to cars.)

Increased congestion costs.

(From increased passenger and freight traffic.)

Increased accident costs.

(From increased traffic flows.)

Additional road maintenance costs.

(Avoided by the retention of the rail service.)

Additional public transport resource costs.

(This cost relates to additional vehicles.) Loss of employment in local area.

(Multiplier effects.)

Environmental effects.

(Higher noise, pollution etc. from roads.)
The amount of subsidy a scheme receives should not exceed the net benefit of retaining the scheme. This ensures that society as a whole gains.
The main problem is that the funding of subsidies will often be limited by available cash and may be subject to political decision making also. There are probably more public transport services in need of subsidy than there are funds on the basis of performing a CBA.
Valuing time
One of the factors that has a great deal of impact on CBA’s of transport projects is the value of time. In the example of the bus and train routes above the value of time lost or gained by users was included. Often it is the value of time that is decisive.
There is an accepted formula for valuing time. Where time is gained the passengers gain consumer surplus. This is evaluated by the use of Department of Transport Manual which gives values for ‘in-vehicle time in non-working hours’. The DoT data is based on survey and behavioural study data that considered mainly journey-to-work trips and choices made by people between, for example, lengthy trips at a lower cost rather than shorter more expensive journeys. This is a form of shadow-pricing, putting a value on something where there is not an actual market, but it is priced as if there was.

In the case of journeys undertaken during working hours the value of travel time is based on the price paid for a persons labour.

Car driver 17.44

Car passenger 13.69

Bus passenger 11.09

Rail passenger 25.17

Underground passenger 21.15

Bus driver 6.68

All workers 11.57

(Source:Transport economic Note, DETR.)

Car – commuting 4.75

Car – other (i.e. leisure, shopping) 6.81

Goods vehicle 8.42

Bus/coach 59.16

Average all vehicles 9.30

1. Infrastructure investment - new motorways, bypasses, light railways.

2. Purchase of vehicles.
Most infrastructure decisions are taken by government agencies (although many more are now taken by the private sector).
The private sector uses methods of investment appraisal that look at the rate of return on the investment. Because much of public sector infrastructure investment is in public goods where market prices do not exist special methods of appraisal must be used. (Private road investment is only 2% of total expenditure on road infrastructure.)
Recall that public goods have two special features;

Non-excludability - providing the good for one person means it is available for everyone else too.

Non-rivalry - the consumption of the good by one person does not prevent others from enjoying it also.

Some goods exhibit qualities of non-rivalry up to a point, e.g. a road, but when they reach capacity usage there is rivalry. Also some goods are restricted to certain groups, e.g. roads - only over 17’s with current licences may drive cars on them.

2. It involves a high capital outlay.

3. It generates both positive and negative externalities.

4. It represents an important part of local or central government capital spending.

Thus the government must decide how much it spends on infrastructure and which projects it funds and which it does not. All projects are cash limited and there has not been a period when the budget of the department of transport has been sufficient to undertake more than a few of the possible capital projects. There is, therefore, a need to prioritize infrastructure projects.

Journey time savings - based on the ‘time is money’ principle these usually turn out as the most important benefit. A monetary value is put on the aggregate time saved by users of the new network. The value depends upon the purpose of the trip e.g. work or leisure as shown on page 40. The method assumes that any time saved would be put to good use and that the value of output must at least be equal to earnings.

 Capital costs - land purchase, construction costs, admin and design.

 Maintenance costs - street lighting, repairs and resurfacing.
All costs used are resource costs. This is because opportunity cost is the relevant economic cost for CBA. Although market prices largely reflect resource cost taxes and subsidies must be eliminated.
The standard period considered is 30 years into the future. The discount rate currently used by the DoT is 6%.
The NPV of the road tells us if it is of net benefit to society (a positive NPV). The ratio of benefits to costs is worked out. Thus if the Present Value of Benefits (PVB) is £40m and the Present Value of Costs (PVC) is £20m the NPV is £20 and the Benefit-Cost rato (BCR) is 2 (or 2:1). This ratio helps in prioritising schemes.
It is claimed that COBA has three practical purposes.

 It establishes the need for a particular scheme.

It allows priorities to be established.

It provides the basis for wider discussion.

• The traffic split on existing roads (A41, A429 and A34 in this case).

• The modal split of cars, LGV’s, HGV’s, buses and coaches.

• The peak demand periods, how long they last and where they occur.

• Type of journeys made (work, education, weather) and the number of trips made of each type.

• The modal split of passenger and freight journeys.

• Trips expected to be made along each route.

• Effect of new road on existing roads, transfers to new route and new traffic generated.
Forecasts in traffic planning and COBA
The problem of forecasts is that they are only well informed guesses and can’t anticipate policy changes. The classic example is the M25 where the forecasts suggested that the road would have sufficient capacity for 30 years, it was full the day after it opened because they failed to predict the diversion of local traffic on to the new road and because of increased leisure traffic from south-west London to north London. The forecast flows were 80,000 pcu’s (passenger car units) per day, the current figure is 190,000.
Transport is a derived demand and so traffic forecasts must also take in to account macroeconomic factors. Household income, GDP growth, changing trade patterns, manufacturing output, and changes in land use (such as out of town shopping and entertainment) are all examples of variables determined outside of the transport industry that affect it. The forecasting of transport demands and costs and a realistic appraisal of transport projects therefore requires a wide understanding of trends and developments in the whole economy.
Criticisms of COBA

It is not a comprehensive CBA - COBA only considers the benefits to users of the new road. It therefore ignores the effects on other groups - externalities.

Environmental issues are ignored - there is a loss of land when new roads are built. The environmental effects are;

+ Traffic noise

+ Visual intrusion

+ Pollution

+ Loss of amenities

The Department of Transport now incorporates an assessment of environmental damage (the Environmental Statement) into the appraisal process, but no monetary value is placed on this. This is required by EU law.

 safety;

 economy;

 accessibility; and

 integration.
The AST tries to:
 understand the problem and ask what priority it deserves;

 identify a range of options;

 appraise options to determine the extent to which they meet the Government's objectives as cost effectively as possible, given the need for benefits to outweigh costs and to achieve value for money.
The criteria have been divided into a number of sub-criteria, reflecting the wide variety of impacts arising from schemes.