The UK rail industry was privatised by the Conservative government in the mid-1990s. As Case Study 14.8 on the Economics 10th edition website states:
The management of rail infrastructure, such as track, signalling and stations, was to be separated from the responsibility for running trains. There would be 25 passenger train operating companies (TOCs), each having a franchise lasting between seven and fifteen years. These companies would have few assets, being forced to rent track and lease stations from the infrastructure owner (Railtrack), and to lease trains and rolling stock from three new rolling-stock companies. …In practice, the 25 franchises were operated by just 11 companies (with one, National Express, having nine of the franchises).
In 1996, at the start of the franchise era, the train operating companies were largely private-sector companies such as National Express, Stagecoach, Virgin Rail and Prism Rail. By 2020, most of the franchises were operated by a foreign state-owned business or a joint venture with a foreign state-owned firm.
As a result of poor performance (see above case study), Railtrack was effectively renationalised in 2002 as Network Rail – a not-for-profit company, wholly dependent upon the UK Treasury for any shortfall in its funds.
TOCs had mixed success. Some performed so poorly that their franchise contracts had to be temporarily taken over by a state-owned operator. For example, in June 2003 the Strategic Rail Authority withdrew the operating licence of the French company Connex South Eastern. The franchise was temporarily taken over by the publicly-owned South Eastern Trains from November 2003 until March 2006 before being returned to a private operator.
Perhaps the most troubled franchise has been the East Coast Main Line between London and Scotland. It was renationalised in 2009, reprivatised in 2015 and renationalised in 2018.
The effect of the coronavirus pandemic
The spread of the coronavirus and the accompanying lockdowns and social distancing saw a plummeting of rail travel. Passenger numbers fell to just 10% of pre-pandemic levels. In March 2020, the UK Government introduced Emergency Measures Agreements (EMAs), which temporarily replaced rail franchise agreements. TOCs were paid a 2% fee (based on pre-Covid costs) to run trains and losses were borne by the government.
When the EMAs ran out on the 20 September, they were replaced by Emergency Recovery Measures Agreements (ERMAs), set to last until no later than April 2022. Under these measures, the fees paid to TOCs were reduced to a maximum of 1.5%. These consist partly of a fixed fee (again based on pre-Covid costs) and partly on a performance payment, depending on punctuality, passenger satisfaction and financial performance. As with the EMAs, the new arrangements involve virtually no risk for the TOCs (except for the size of the performance-related fee). Costs and revenue will be passed to the Department for Transport, which will bear any losses.
TOCs were required to run a virtually full service to allow reduced passenger numbers to observe social distancing. Despite journeys still being only 30% of pre-pandemic levels, social distancing on trains meant that many trains were sold out.
The ERMAs also contain provisions for the replacement of franchises when they come to an end. The precise nature of these will be spelt out in a White Paper, which will respond to the recommendations of the Williams Review of the railways. This review was set up in 2018 in the aftermath of difficulties with various franchises and a chaotic nationwide timetable change. The review’s findings were originally scheduled to be published in Autumn 2019, but were then put back because of the general election and the disruptions caused by the pandemic. The government hopes that it will be published before the end of 2020.
It is expected that the review will recommend replacing the franchise system with something similar to the currents ERMAs. TOCs awarded a contract will be paid a performance-related fee and revenues will go to the government, which will bear the costs. While this is not quite renationalisation, it is not the previous franchise system where TOCs bore the risks. It is in effect a contract system where private companies are paid to deliver a public service.
The CrossCountry franchise
The first test of this new approach to contracting with TOCs came this month. Arriva’s franchise for running CrossCountry trains ran out and was replaced by a three-year contract to run the services, which span much of the length of Great Britain from Aberdeen to Penzance via Edinburgh, Glasgow, Newcastle, Sheffield, Birmingham, Bristol and Plymouth; from Bournemouth to Manchester via Reading, Oxford, Wolverhampton and Stoke; from Cardiff to Nottingham via Gloucester, Birmingham and Derby; and from Birmingham to Stanstead Airport via Leicester and Cambridge.
The contract will last three years. The Department for Transport will gain the revenues and cover the costs and pay Arriva (owned by Deutsche Bahn) a management fee that is ‘performance related’ – as yet unspecified. This, like the EMAs and then the ERMAs, will remove the risks from Arriva.
Nationalisation in Wales
The Welsh government has announced that Transport for Wales will be taken over by a publicly owned company in February 2021. TfW operates many of the routes in Wales and the borders and most of the branch lines in Wales, including the valley commuter lines into Cardiff. It is currently owned by KeolisAmey (a joint company owned 70% by the French company, Keolis (part of SNCF), and 30% by the UK company, Amey), which took over the franchise in 2018 from Arriva. The Welsh government considered that KeolisAmey would collapse if it did not provide support. Ministers decided that nationalisation would give it greater control than simply subsidising KeolisAmey.
James Price, chief executive of the Welsh Government, stated that this allows it:
to reduce the profit we pay to the private sector massively over time, and make sure that when the revenue comes back, it comes back in to the taxpayer.
Under emergency measures, KeolisAmey has already been supported by the Welsh government to the tune of £105 million (£40 million in March and £65 million in June) to continue operating the franchise. Passenger numbers fell by 95% as the pandemic hit.
Is nationalisation a better way forward, or should private train operating companies continue with the government taking on the risks, or should the franchise system be amended with greater support from the government but with the TOCs still bearing risk? The articles below consider these issues.
- Rail nationalisations may be coming down the track
BBC News, Tom Burridge (17/9/20)
- ONS recognises full nationalisation of the UK railways
Financial Times, Tanya Powley (31/7/20)
- Train services are very efficient for shareholders – less so for customers
The Conversation, Daniel Fisher (22/8/19)
- UK government on standby to nationalise more rail lines
Financial Times, Jim Pickard and Philip Georgiadis (17/9/20)
- British Government Ends Rail Franchising
Railway-News, Josephine Cordero Sapién (21/9/20)
- British government announces end for rail franchise system
Trains, Keith Fender (12/10/20)
- Monday essay: A new era?
Railnews, Sim Harris (19/10/20)
- Arriva secures three-year CrossCountry contract
International railway Journal Kevin Smith (16/10/20)
- New contract signed for Arriva CrossCountry
RTM, Ailsa Cowen (16/10/20)
- Franchising is Dead
Railway-News, Josephine Cordero Sapién and Gareth Davies (16/9/20)
- Transport for Wales rail services to be nationalised
BBC News (23/10/20)
- Transport for Wales to be nationalised
- Why has the Welsh Government nationalised rail’s Wales and Borders franchise?
BusinessLive, Sion Barry (22/10/20)
- Explain how the franchising system worked (prior to March 2020).
- To what extent could each franchise be described as a ‘contestable monopoly’?
- What incentives were built into the franchising system to deliver improvements in service for passengers?
- What were the weaknesses of the franchising system?
- In the context of post-pandemic rail services, compare the relative merits of nationalisation with those of awarding contracts where the government receives the revenues and bears the costs and pays train operating companies a fee for operating the services where the size of the fee is performance related.
- What are the arguments for subsidising rail transport? What should determine the size of the subsidy?
Virgin’s franchise to run the West Coast Main Line from London to Birmingham, Manchester, Liverpool, Glasgow and Edinburgh was due to expire in December. The Department of Transport thus invited tenders to run a new 13-year franchise, worth around £5 billion, and on 15 August announced that the franchise had been awarded to FirstGroup. It had bid substantially more than Virgin.
Virgin immediately challenged the decision, arguing that FirstGroup’s figures were flawed. According to the second BBC article below:
It argued that FirstGroup’s revenue projections were wildly optimistic – that passenger growth of 6% a year was unlikely given that Virgin had seen growth of 5% a year from a much lower base. This level of passenger growth would have seen FirstGroup’s revenue from the franchise grow by more than 10% a year, which was simply unrealistic, Virgin argued.
And it is not alone. “Everybody in the industry thought that this bid was not sustainable and that the risks had not been taken into account by the Department for Transport,” says rail industry expert Christian Wolmar.
If revenue targets are not met, the franchisee doesn’t have the money to pay the government the promised fee for the contract, which in FirstGroup’s case was back-loaded towards the end of the 13-year term.
After making its decision, the Transport Secretary at the time, Justine Greening, said that the process of assessing the bid was robust and fair and conducted with due diligence. Sir Richard Branson of Virgin strongly and publicly disagreed and Virgin decided to take the Department of Transport to court. The court case was scheduled to begin on 4 October.
However, in preparing its case to put to the court, the Department of Transport uncovered significant errors in the evaluation of the bids. These errors involved the overestimation of passenger numbers, the undervaluation of risk and a failure to take inflation into account. The errors stemmed from inputting the data incorrectly.
The errors were so serious that the new Transport Secretary, Patrick McLoughlin, on the day before the court case was due to begin, announced that he was scrapping the contract to FirstGroup and would invite new bids. All four of the original bidders would have their costs refunded, amounting to some £40 million.
The minister also announced that he was setting up two reviews. One would seek to establish just what went wrong in the assessment of the West Coat Main Line bids and what lessons could be learned. This is due to report at the end of October. The other review would examine the wider rail franchise programme and how bids are appraised. In the meantime, three other franchise competitions had been ‘paused’ pending the results of this second review, due to report in December.
The articles look at the problems of assessing bids and properly taking into account risks associated with both revenue and cost projections. Not surprisingly, they also look at the politics of this amazing and unprecedented U-turn
Webcasts and podcasts
West Coast Main Line rail franchise deal scrapped BBC News, Richard Westcott (3/10/12)
West coast rail franchise deal scrapped Channel 4 News, Krishnan Guru-Murthy (3/10/12)
‘Major problem’ for West Coast Main Line BBC Today Programme, Louise Ellman (3/10/12)
Philip Hammond on West Coast Main Line contract BBC News, Andrew Neil (7/10/12)
Virgin to run West Coast route ‘for at least nine months’ BBC News, Richard Westcott (15/10/12)
British transport secretary cancels West Coast franchise International Railway Journal, David Briginshaw (3/10/12)
Wrong track: Another humiliation for the government The Economist (5/10/12)
West Coast Main Line: total chaos as government scraps franchise deal The Telegraph, Alistair Osborne (3/10/12)
West Coast Main Line deal scrapped after contract flaws discovered BBC News (3/10/12)
Q&A: West Coast Main Line franchise BBC News (4/10/12)
What derailed the Transport Department BBC News, Robert Peston (3/10/12)
Transport official suspended over rail fiasco is ex-Goldman banker Independent, Oliver Wright and Cahal Milmo (5/10/12)
West Coast Main Line: Civil servant Kate Mingay speaks out BBC News (6/10/12)
Civil servant: I wasn’t to blame over West Coast bid The Telegraph, Louise Armitstead (5/10/12)
West coast rail fiasco: three government officials suspended Guardian, Gwyn Topham (3/10/12)
What does west coast shambles mean for big rail franchises? Guardian, Dan Milmo (3/10/12)
West coast mainline fiasco may claim further victims Guardian, Gwyn Topham and Dan Milmo (4/10/12)
The West Coast mainline, wasted taxes, and a secretive shambles at the heart of the Civil Service Independent, Steve Richards (4/10/12)
Why all the West Coast bids were wrong BBC News, Robert Peston (9/10/12)
- What were reasons for awarding the contract to FirstGroup back in August?
- How is discounting used to assess the value of projected future revenue and costs? How does the choice of the rate of discount impact on these calculations?
- In what way should risk be taken into account?
- Why was the FirstGroup bid particularly sensitive to the calculation of risk?
- If both costs and revenues go up with inflation, how is inflation relevant to the calculation of the profitability of a bid?
- What are the arguments for and against making franchises longer?
- Is it only at the bidding stage that there is any competition for train operators? Explain.
- Should full social costs and benefits be taken into account when assessing bids for a rail franchise? Explain.
Rail companies will be permitted to raise average regulated rail fares next year by 6.2%. Not surprisingly, this has been met with dismay and anger by rail travellers, especially long-distance commuters, who could see their annual season tickets going up by several hundred pounds.
Some fares, such as advance tickets, are unregulated. Others, such as anytime, off-peak and season tickets, are regulated by the government. The formula for working out permitted price rises for regulated fares is RPI plus 3%, where RPI is the July annual inflation rate based on the retail price index.
The RPI figure was announced by the ONS on 14 August and was a surprisingly high 3.2% – up from 2.8% in June: see Table 21 in the ONS’s CPI And RPI Reference Tables, July 2012. (Click here for a PowerPoint of the chart on the left.) Hence average fares can rise by 3.2% + 3% = 6.2%.
Rail travellers are angry on three counts:
First, the RPI measure of inflation is generally around 0.5% higher than the CPI measure (which is used for working out public-sector pay increases and the uprating of pensions and benefits). The July figure for CPI inflation was 2.6%.
Second, the extra 3% added on top of RPI means that that rail fares are going up more rapidly than other prices, and incomes too. The reason given for this is to shift the burden of funding the railways from the taxpayer to the traveller.
Third, the formula applies to average fares. Rail companies can raise particular regulated fares by up to 5 percentage points more than the formula provided they raise other fares by less than the formula. Thus some fares are set to rise by 11.2% – including some of the most expensive season tickets.
The government justified the increases by arguing that the higher fares will allow more investment by the rail companies, which could result in lower costs in the future. Nevertheless, two thirds of the revenue from the above-inflation increases will go to the government and only one third to the rail companies.
Inflation shock as rail fares set to soar Channel 4 News, Ciaran Jenkins (14/8/12)
Protests as rail fare price rises announced The Telegraph (14/8/12)
How do our rail fares compare with the rest of Europe? BBC News (14/8/12)
Rail fare increase will make life better, says minister BBC News (14/8/12)
Passenger Focus: Train companies ‘using dark arts’ BBC News, David Sidebottom (14/8/12)
Rail fares set to increase by 6.2% Financial Times, Mark Odell (14/8/12)
Rail fares set to rise by 6.2% in January Guardian, Gwyn Topham (14/8/12)
Rail fare hike of 6.2% sparks angry reaction BBC News (14/8/12)
Soaring rail fares will do nothing for the recovery The Telegraph (14/8/12)
Commuters plead with Osborne to prevent 10 per cent rise in rail fares Independent, Oliver Wright (15/8/12)
Rail fare rises: how to keep your ticket prices as low as possible Guardian, Mark King (14/8/12)
Documents and information
Fares Review Conclusions 2003 Strategic Rail Authority (June 2003)
Fares Office of Rail Regulation
Fares on National Rail Association of Train Operating Companies
- What are the arguments for and against the general principle of using an RPI+X formula for regulating rail fares?
- What are the arguments for and against allowing train operating companies to raise regulated rail fares by an average of RPI plus 3%, with 2 of the 3 percent above RPI inflation going to the government?
- In what ways are travellers likely to respond to the higher prices?
- Why are some travellers likely to have a much lower price elasticity of demand for rail travel than others? What determines this price elasticity of demand?
- What externalities exist in rail transport? How should this impact on the government’s rail pricing strategy?
- How is infrastructure development funded for (a) rail, (b) roads and (c) airports? Does this lead to an efficient allocation of transport investment?
- How does rail pricing in the UK compare with that in other European countries? Should other European countries follow the UK’s policy of above inflation fare increases to fund rail investment?
On June 20, the Review of the Government’s case for a High Speed Rail programme was published. This was commissioned by the Transport Select Committee from the independent consultancy, Oxera.
The programme is initially for a high-speed rail link form London to Birmingham and then subsequently for two additonal routes from Birmingham to Manchester and from Birmingham to Leeds. The whole thing is known as the ‘HS2 Y programme’
Oxera’s brief was to ‘provide an independent review of the economic case for the programme and to provide a set of questions that the Committee could use to probe the evidence base put forward by witnesses during its inquiry.’ In considering the economic case, Oxera focused on the economic, social and environment impacts, both monetary and non-monetary.
The summary to the report states that:
Overall, the case for the High Speed Rail programme seems to depend on whether and when the capacity is needed, the selection of the best VfM [value-for-money] approach to delivering that capacity, the degree of uncertainty around the monetised benefits and costs of the preferred options, and judgements on the balance of evidence relating to non-monetised items, such as environment and regeneration impacts (which are likely to be substantive in their own right but not fully set out in the Government’s assessment).
On July 19, the Institute for Economic Affairs, the pro-free-market think-tank, published a highly critical disussion paper, challenging the case for HS2. The paper, High Speed 2: the next government project disaster? arges that:
There is a significant risk that High Speed 2 (HS2) will become the latest in a long series of government big-project disasters with higher-than-forecast costs and lower-than-forecast benefits. HS2 is not commercially viable and will require substantial and increasing levels of subsidy. Taxpayers will therefore bear a very high proportion of the financial risks, which are wholly under-represented in the Economic Case presented by the Department for Transport.
The publication of the report and the IEA discussion paper has fueled the debate between supporters and opponents of HS2, as the articles below demonstrate.
In November 2011, the House of Commons Transport Select Committee came out in favour of the government’s HS2 plans. According to the committee’s chair, Louise Ellman:
A high speed rail network, beginning with a line between London and the West Midlands, would provide a step change in the capacity, quality, reliability and frequency of rail services between our major cities.
A high speed line offers potential economic and strategic benefits which a conventional line does not, including a dramatic improvement in connectivity between our major cities, Heathrow and other airports, and the rest of Europe.
However, she did raise some issues that would need addressing concerning the overall level of investment in the rail network and the encironmental impact of HS2.
Investment in HS2 must not lead to reduced investment in the ‘classic’ rail network. We are concerned that the Government is developing separate strategies for rail and aviation, with HS2 separate from both. We call again for the publication of a comprehensive transport strategy.
Investment in high speed rail has potential to boost growth but may have a substantial negative impact on the countryside, communities and people along the route. This must be better reflected in the business case for HS2 and future phases of the project. We would encourage the Government to follow existing transport corridors wherever possible.
In January 2012, the government approved HS2. The Transport Secretary, Justine Greening, said:
I have decided Britain should embark upon the most significant transport infrastructure project since the building of the motorways by supporting the development and delivery of a new national high speed rail network.
The ‘articles for further update’ below give reactions to the announcement.
Is the UK’s high speed rail project a waste of money? BBC News, Rory Cellan-Jones (21/7/11)
On a collision path The Economist blogs, Blighty (21/7/11)
High speed rail dismissed as ‘vanity project’ by right-wing think tank The Telegraph, David Millward (19/7/11)
HS2 high-speed rail plans ‘a recipe for disaster’ Guardian, Dan Milmo (19/7/11)
High speed rail report shows ‘uncertainty’ over benefits Rail.co, A. Samuel (21/7/11)
Our high speed rail future BBC News, Rory Cellan-Jones (21/7/11)
Anger as high-speed rail link to London branded ‘vanity project’ Yorkshire Post (20/7/11)
Articles for update
MPs support plans for a high speed rail network BBC News, Richard Lister (8/11/11)
High-speed rail project will boost economy, say MPs Guardian, Dan Milmo (8/11/11)
High speed rail report ‘raises questions’ say opponents BBC News (8/11/11)
MPs back controversial high-speed rail link Yahoo News, Sebastien Bozon (8/11/11)
HS2 project: ‘Wrong to castigate locals’ BBC Today Programme (8/11/11)
Articles for further update
HS2 go-ahead sees mixed reaction BBC News (10/1/12)
HS2 – What’s in it for you? Channel 4 News (10/1/12)
Ready to depart: But will the HS2 express be derailed before it arrives? Independent, Nigel Morris (11/1/12)
HS2 go-ahead sees mixed reaction BBC News (10/1/12)
HS2 go-ahead sees mixed reaction BBC News (10/1/12)
Reports and discussion paper
Review of the Government’s case for a High Speed Rail programme Oxera Publishing (20/6/11)
High Speed 2: the next government project disaster? IEA Discussion Paper No. 36 (19/7/11)
Good case for high speed rail to run to Birmingham and beyond, say MPs House of Commons Transport Select Committee News (8/11/11)
Transport Committee – Tenth Report: High Speed Rail House of Commons Transport Select Committee (8/11/11)
- Itemise (a) the monetary costs and benefits and (b) the non-monetary costs and benefits of HS2 that were identified by Oxera. Try to identify other costs and benefits that were not included by Oxera.
- Why are the costs and benefits subject to great uncertainty?
- How should this uncertainty be taken into account by decision-makers?
- Explain the process of discounting in cost–benefit analysis. How should the rate of discount be chosen?
- What are the main criticisms of the report made by the IEA discussion paper?
- Assess these criticisms.
The east coast mainline from London to Edinburgh is a ‘premium route’. This means that it is one of the lines in the UK that is profitable. When the franchises come up for renewal on such lines, potential operators bid to pay the government for the franchise. National Express won the eight-year franchise in 2007 for a total of £1.4 billion, paid in annual rising instalments.
Although the east coast mainline is still profitable, the recession has meant that passenger numbers have been insufficient for National Express to make its annual payments to the Department for Transport and still be left with a profit. As a result, the government will take the franchise into public ownership later this year. This specially created nationalised company will then operate trains on the route until a new franchise is awarded to a private company at the end of 2010.
So why has this proved necessary? Is it all down do the depth of the recession? Or was the £1.4 billion cost of the franchise unrealistically expensive? Would the answer be for National Express to merge with another operator, such as the First Group? Or should the government be prepared to waive, or at least reduce, the franchise payments until passenger numbers are growing fast enough? Or is it time to rethink the whole UK model of rail privatisation and perhaps return to a nationalised rail system? The articles below consider the issues.
National Express loses East Coast line Independent (2/7/09)
National Express goes off the rails on east coast line Times Online (4/7/09)
Q&A: the future of National Express and the east coast mainline rail service Guardian (1/7/09)
East Coast main line: Q&A Telegraph (2/7/09)
Runaway train: The crisis in the rail sector Scotsman (5/7/09)
First Group sets sights on East Coast Business7 (3/7/09)
National Express’s decision to quit East Coast franchise is a lose-lose for nearly everyone Telegraph (4/7/09)
Focus turns to rail franchise system Financial Times (2/7/09)
Rail network: red signals ahead Guardian (2/7/09)
Have we reached the end of the line for privatisation? Observer (5/7/09)
Privatisation has been a train wreck: Ken Livingstone Guardian (2/7/09)
New Capitalism: Old Capitalism except taxpayer money is at risk: Iain Macwhirter Sunday Herald (5/7/09)
- Consider the relative merits of temporary nationalisation of the east coast mainline services with providing temporary support for National Express.
- Should profitable rail franchises be awarded to the highest bidder? Similarly, should loss-making franchises be awarded to companies bidding for the lowest subsidy?
- Discuss the arguments for and against a complete re-nationalisation of the railways.
- With reference to the final article above, explain what is meant by a Special Purpose Vehicle and whether it was an appropriate means for National Express to fund its £1.4 billion franchise. What dangers are associated with this and other new forms of ‘no-risk capitalism’? Is there a ‘moral hazard’ in this form of capitalism?