Privatisation of Three European Railways: failure or success?
Kees Walters*
Abstract
A vast number of empirical studies hypothesize a relationship between privatisation and performance of a firm. According to the literature, post- privatized firms are expected to perform better than before the privatisation. This paper examines the privatisation processes of, formerly national, railway companies in three European countries (Great Britain, Germany and the Netherlands) and tests the three biggest benefits claimed by their governments: greater efficiency, improved quality for customers and a reduction in public subsidies. The results indicate that the claimed benefits were not achieved.
Keywords: Privatisation public sector, European railways
* International Economics & Business student, Department of Economics, Groningen University Email: c.p.walters@student.rug.nl
2
INTRODUCTION ... 4
PRIVATISATION AND THE RAILWAY SECTOR ... 7
Benefits and their Limitations ... 8
Incentives ... 8
Capital market... 8
Competition... 9
Models for Industry Organization... 10
Natural monopoly and regulation... 10
Horizontal separation and franchising... 12
Vertical separation ... 12
PRIVATISATION AND THE EUROPEAN RAILWAYS... 14
European rail policy ... 14
Great Britain... 16
Privatisation process ... 16
Regulatory environment... 18
Germany... 21
Privatization process ... 21
Regulatory environment... 23
The Netherlands ... 25
Privatization process ... 25
Regulatory environment... 27
Summary ... 29
PRIVATISATION AND PERFORMANCE ... 31
Hypotheses ... 31
Sample, data and method ... 32
Empirical Results ... 35
Profitability ... 35
Quality ... 37
Subsidy... 40
PRIVATISATION AND OUTCOMES ... 41
General reasons for failure... 41
Competition and sunk costs... 41
Conflicting objectives ... 42
Vertical separation ... 43
Historical inheritance ... 44
3
Great Britain... 44
Indistinct structure... 44
Infrastructure problems ... 45
Franchise period... 46
Germany... 46
Problems with introducing competition ... 46
The Netherlands ... 47
Market relationships... 47
Competition... 47
CONCLUDING REMARKS ... 49
REFERENCES ... 51
4
Introduction
Traditionally, the railway industry belongs to the most heavily regulated sector. In Europe the railways have been nationalized, in other countries like the USA the railway industry has been regulated. But in the last twenty years, the picture has dramatically changed. Privatisation and deregulation are now common features of the railway industry, it can be observed all over the world. It can be seen as an important aspect of the increasing use of markets to allocate resources worldwide. Privatisation essentially involves the transfer of assets from the public sector to the private sector. In a more broad sense however it is accompanied by wider regulatory reforms. The aims for these reforms are quite clear: the railway companies in industrialized countries have experienced massive losses of market shares; the European public enterprises have produced big financial deficits, which created an additional burden for the government budgets (Brenck, 1999).
Since 1989, the EU gave the start of liberalization (European Directive 91/440) of rail transport. The policy of the EU to introduce competition has four elements: One via a separation of infrastructure from operations. Second, the progressive opening up of entry to the market for new operators. Thirdly, by rules regarding the allocation of slots and fourth, the pricing of infrastructure use, administered by an independent regulator (Rietveld and van Gent, undated).
These policies have been implemented by different European Governments in the mid
90’s. The Dutch government decided to liberalize the railways as from 1995, the German
Government as from 1994 and the British Government as from 1993. The degree in
which these four elements have been implemented differs across these countries. The
5 British Government, with its history of public privatisation schemes
1, took the European directive to its extreme by separating infrastructure and operation and applying franchising and contracting-out schemes wherever possible (Knill, 2001). The Dutch and German Government were less extreme in applying the European Directive. In the Dutch case, the mixture of areas assigned to either the public sector, such as the responsibility for infrastructure ownership and management, or to the private sector, such as freight transport, expresses the reconciliation of the contradicting values of legitimate state intervention and liberal business practices rooted in Dutch political culture (Lehmkuhl, 2001). The German reform is somewhat ambiguous. On the one hand, the reform was remarkable as an opening of market access which was a sign of a market-oriented regulatory policy. On the other hand, the federal government can still intervene in major railway decisions. These privatisations (or liberalizations) have been justified through (micro) economic arguments about the greater efficiency of the private sector and the importance of market mechanisms. Privatisation was seen as the solution to reform the rigid, state owned companies to flexible organizations who would be better able to survive the increasingly changing markets, as well as to increase the consumer welfare.
The well known benefits of privatisation (i.e. greater efficiency, improved quality for customers) were mentioned as if privatisation would guarantee them. The purpose of this paper is to examine whether these benefits actually occurred, and if not, why the expected benefits did not came about.
1 British Telecom in 1984, British Gas in 1986, Electricity in 1989 and the water industry in 1990/1991
6 The first section discusses privatisation in the context of the railways. It outlines the unique economic characteristics of the railway sector as well as different models and rationales for privatizing the railways. The second section describes the railway reforms in three European countries (Great Britain, Germany and The Netherlands) and their different regulatory environments. The proceeding section assesses the financial performance and the service quality of these railways before and after the privatisation.
The final two sections provide reasons for the failure of the railway privatisation and
some concluding remarks.
7
Privatisation and the Railway Sector
Although governments often enjoy large financial benefits from selling their transport assets, it is not the only reason that governments undertake privatisation. Essentially, the railways (and also other publicly owned firms) are privatised because it was felt that the service could be more effectively provided by the private sector. The European legislation in the early 1990’s also partly instigated the reform process in the railway sector by publishing EU Directive 91/440. This directive opted for the privatisation of the railway sector (or, introduce competition) so that the EU could profit from the liberalized rail sector. Moreover, the ever increasing public expenditure on the railways was also an important aspect in favour of privatising the railways. The politicians expected that the privatisation would, in time, lead to a railway sector which would not require government support. Thus, next to benefiting the customers through price reductions and better service, the government would also benefit because they could spend the reductions in public subsidy elsewhere.
For the railways, privatising meant selling off all passenger trains, because it was felt that consumers have little or nothing to gain from the government owing the assets. This process needs to produce a benefit to consumers and the public must be better off after privatisation, than they were before it. These benefits for consumers can be achieved through financial savings (i.e. public subsidy and/or lower fares), improved service, or preferably, both.
However, because of the unique characteristics and complexities of the railway sector,
privatisation is less straightforward than in other industries. The general arguments in
favour of privatisation may therefore not be valid in this specific context. Considering the
unique characteristics of the railway sector, the following section describes the general
advantages of privatisation and assesses whether the expected advantages can be
achieved in the railway sector. The different models for organising the privatised industry
are discussed after that.
8 Benefits and their Limitations
Incentives
The first argument for privatisation is the creation of incentives for publicly owned firms.
The logic underlying this argument is known as the Principal-Agent problem. In the ideal situation, the principle (or owner) of a firm would like the agent (or manager) of the firm to maximize their interests. This, however, may not be possible because of information asymmetry. The principle may have problems monitoring the performance of the agent, and the agent may not receive clear objectives form the principle (Vickers & Yarrow, 1991). It is argued that privatisation brings the interests of the principle (the state and ultimately the tax-payer) and the agent (management of the railway company) closer together through the creation of a single objective, maximizing profit. This seems a logical and straightforward argument. However, when applying this benefit to the railway sector, a problem arises. The firm’s objective to maximize profit is in the case of the railways not compatible with the interests of the government, who want a reliable and affordable means of transportation for the public. Furthermore, if the managers of the industry know that any losses they make will be covered by a subsidy, then the incentives to be efficient are low. (This also partly explains the drive towards privatisation of previously nationalised industries, on the argument that accountability to shareholders will improve incentives.)
Capital market
The second argument is that the former publicly owned firm becomes exposed to the
capital market. Capital markets exert certain powers on a firm to operate in a cost
effective manner because of the risk of a takeover and possible bankruptcy. Therefore,
when managers act not in the interest of the company, share prices will fall making it
more vulnerable to a takeover. This provides management an incentive to act in a way
which is consistent with the shareholders expectations. The reason that this benefit is not
valid in the context of the railways is because the governments often set restrictions on
ownership in privatising the railways, limiting the percentage of shares that can be
9 owned, or retaining majority ownership to inhibit the possibility of takeover in the period immediately after the asset sale (Hensher and Brewer, 2001). Because of this, the actual exposure to the capital market does not take place. This fact undermines the central premise of the privatisation process itself, because it is argued that threat of takeover is one of the key drivers of productive efficiency (Wiltshire, 1987).
Competition
The last argument evolves around competition. Just like exposure to the capital market, exposure to competition may force the privatised firm to meet the objectives of the customers in a more cost efficient manner. In other words, if the firm is not efficient enough, it cannot sustain its position in the market and will exit the market.
However, to create a competitive environment, the market must be ‘contestable’. A contestable market is a market where there are potential entrants and entry and exit costs are (close to) zero, and where the market responds by keeping pricing constant (Hensher and Brewer, 2001). In a contestable market, potential entrants can therefore exert pressure to keep prices in check. When a firm is earning above normal profits, other firms will enter the market to take advantage. But since the railway sector is characterised by the presence of very high sunk costs, it is quite difficult for new players to enter the marketplace to take advantage of above normal profits that may be enjoyed by an incumbent. The level of market contestability is therefore quite low. Because of this, it is hard to introduce competition. In contrast, the taxi market shows a high level of market contestability, since the start-up costs (i.e. taxi and license) are very low.
Summarising, we see that the potential benefits of competition are hard to accomplish in
the context of the rail sector. Competition is hard to accomplish because of the high entry
barriers. Exposure to the capital market has not provided incentives (or private capital for
that matter) for managers since the majority of shares are kept in government hands
(Dutch and German situation). And finally, the creation of a single objective is hard to
realize when interests are conflicting and one has to rely on contracts to assure
compliance with social goals.
10 Models for Industry Organization
In light of the distinctive economic characteristics of railways, what are some of the approaches that can be taken for privatisation? Overall, there are two kinds of approaches that can be taken to introduce market based competition in a privatised rail environment:
horizontal and vertical separation. But before discussing these two, some attention will be given to another important characteristic of the railway industry which is important in organising the railway sector, the presence of a natural monopoly in infrastructure.
Natural monopoly and regulation
As already discussed in the previous section, competition requires some conditions to work. In the rail sector, some of these the conditions can not be met (no free entry because of high entry costs, dominant incumbent firm). In this case, intervention is necessary to ensure that the pursuit of profit does not conflict with the social welfare (or, the interests of the public). Natural monopoly is the classic case. A natural monopoly occurs when it is more economical for one firm to provide a certain good or service than for multiple firms. In the context of the railway sector, Hensher and Brewer (2001) assert that natural monopolies exist when there are economies of scope, economies of scale, economies of network integrity, or any combination of these factors. In the rail sector, economies of scope can be gained by supplying a diverse set of services (i.e. a combination of freight and passenger services). Economies of scale occur when there are cost efficiencies in providing a large amount of a service or good (i.e. run a large number of routes to cover minimum administrative and labour costs). Economies of network integrity are the concept that it is better for a single operator to operate the network, rather than multiple operators, because interests of the consumer will be more satisfied.
However, a condition for competition (that is, numerous firms) conflicts with the
realization of the benefits of competition (production at the lowest possible costs, which
requires one firm in the case of a natural monopoly). In such cases, regulation becomes
important. The purpose of regulation is to ensure socially desirable outcomes (minimal
11 level of quality, reasonable fares) when competition cannot be relied on. Regulation replaces the invisible hand (competition) by a visible hand (direct regulation). Because the regulator does not have full information about the firm (it’s cost functions and so on), it has to create incentive schemes that induce the firm, next to making a profit, to achieve the social goals as well.
The central issue in dealing with natural monopolies is designing the ‘mechanism’ that regulators can apply to steer the behaviour of the firms towards achieving the social goals. In the context of the rail sector, this is done by drawing up a performance contract with the (various) train operators. This contract sets out certain obligations, such as punctuality, conditions related to fare increase and minimum service levels. The consequence of breaking the contract often results in a (financial) penalty. In an effective regulatory regime, the operator obtains a greater profit (or is financially better off) when it complies with the contract. That is, the regulator should create a situation in which the outcome that is socially optimal also generates the most profit for the operator, such that the operator chooses it voluntarily. The creation of such an environment is hard. An example taken from the British situation illustrates this. In order to make more profits, Railtrack was known to delay on-time local trains, in the interests of reducing late- running for higher capacity Intercity routes, even though total delays on the network would have been lower by not doing so. Running the higher capacity intercity routes was more beneficial for them, despite the social more desirable outcome of lower total delays.
At a more extreme level, the train operators were known to deliberately not recover a
service after an infrastructure failure, because they would make more money on penalties
from Railtrack compared with the cost of the disruption.
12 Horizontal separation and franchising
The most popular model for rail privatisation is that which involves horizontal separation.
Horizontal separation can be in the form of product separation (i.e. freight and passenger), or differentiating services by geographic area (interstate, regional, and urban railways). Horizontal separation of rail operations helps delineate those services which the government needs to subsidise and those which it does not. The promotion of competition is a further benefit of horizontal separation. By separating operations according to specific geographic markets, comparisons can be made between the productive efficiency of different companies. However, some trade offs need to be made under this approach. Contracts need to be established and service levels monitored.
Vertical separation
Vertical separation occurs when specific functions are separated, in the railway case, track infrastructure and operations. Vertical separation can be organizational or institutional, depending on the ‘depth’ of privatisation chosen by the government.
Organizational separation means that both functions, track infrastructure and operations, are still organized under ‘one roof’. Whereas institutional separation indicates that two different companies are founded to carry out the two functions.
Vertical separation was considered to be an appropriate strategy for the railway reforms in Europe. The argument behind this strategy centres on the idea that a natural monopoly exist in the supply of infrastructure. Intuitively, this argument makes a lot of sense. There would obviously be few benefits of having 10 different train operators each having their own infrastructure maintenance groups. The shared nature of networks means many sections of track are shared by multiple operators, which obviously can raise conflicts about which companies should be responsible for maintaining certain sections of track.
The principle underlying the competitive environment is that any rail operator can
compete for the right to run trains on a line at a specific time (slots), and so the
consumers can enjoy the benefits of competition in provision of services, despite the
limitations of a natural monopoly in the network. The separation of infrastructure from
13 operations can give rise to some problems. How does one decide how much to charge individual operators, so that costs are allocated in an equitable manner and in such a way that ensures track can be maintained in the long term? It is very hard to formulate access charges in a situation where there as so many shared costs as there are in rail. As the number of operators increases, so too do the shared costs which makes access charging more complicated.
14
Privatisation and t he European Railways
After discussing some characteristics of the railway sector and different models for organising the privatisation, we will take a closer look at the countries under study: Great Britain, Germany and The Netherlands.
Each government chose its own path in privatising the national railway sector. Whereas the British Government took the European directive to its extreme by separating infrastructure and operations and applying franchising schemes, the Dutch and German Government were less extreme and still reserved a considerable role for the Government.
Next to the nature of the privatisation, the regulatory environment of the railway industry is also very important. When privatising a national company, a regulatory framework should be in place to substitute for the (direct) control the government had in the old situation. The design of the regulatory regimes should relate to steering the behaviour of firms in the market (i.e. pricing, subsidisation and service performance. Because of the existence of a natural monopoly, competitive forces are not present to force efficiency.
Therefore, strong regulation is necessary to secure the social goals (quality of services and prices) as well as the economic goals (making a profit and thus being independent of subsidies).
This section starts with a short description of the European policies regarding the
liberalization of rail transport in Europe. The second part describes how these policies
took shape (nature and structure of privatisation and the different rationales for
privatising the railway sector) as well as the regulatory environment in the three countries
under study.
15 European rail policy
The rail liberalization in Europe is based on the realization that rail market share has been decreasing steadily since the 1950s and, more importantly, that the financial deficits of the different national railway companies were –and still are- imposing a growing burden on government budgets. The problems of rail were mostly attributed to structural problems, such as lack of dynamism, where every European railway was run by a large public monopoly. There were two general ideas behind the reforms launched by the European. On the one hand, concerning the idea of introducing competition of different suppliers on the same infrastructure, the railways were just but one further case in the line of the Commission's efforts to realise the Single Market Program in the area of public utilities such as telecommunication and electricity. On the other hand, the Commission's goal to revitalise the European railways by strengthening its competitive position in relation to other modes of transport was closely linked to the objective to increase the environmental sustainability of transport (Lehmkuhl, 2001).
Because the rail infrastructure displays large economies of scale, it was decided to split up operations and infrastructure to introduce competition in operations. Since the competition between railway operators must be fair, the policy required equal track access and fair pricing, not favouring the incumbent operator. These considerations led to the publication of several directives. The first is EU Directive 91/440. It outlines: 1.
Separations of infrastructure from operations, with separate accounting (organisational
separation) as a minimum requirement. Institutional separation is recommended, but not
compulsory. 2. Setting of non-discriminatory rules and prices for track access, opening
up entry for potential entrants to the market. 3. Allowing competition in international
freight transport by rail. Next to the first Directive, several other directives followed for
the purpose of specifying the rules for the separation of accounts, rules for track access
and so on. The next section describes how these European policies took shape in the
different countries.
16 Great Britain
Privatisation process
Throughout the 1980s British Rail (BR) was not a priority in the privatisation scheme of the British government. Although other public industries such as telecommunications (1984), gas (1986), water (1989) and electricity (1990/1991) were privatized, the British national railway company at first was not really considered. An important reason for this was the unprofitability of the existing network and the presumed unpopularity of any major contraction of services (Crompton and Jupe, 2002). Early justifications of privatisation were economic in nature and emphasis was placed on reducing the scope of the government (Letza and Smallman, 2004); in particular reducing the public sector borrowing.
Because of Britain’s rich history with privatization programmes, there was never likely to
be a shortage of reform concepts. However, in comparison with other privatizations
carried out, the privatization of the rail industry seemed to be the most complex. In
contrast with the other public utility privatisations, British Rail was a loss-making firm
which was highly dependent on public funding. In order to cope with the troublesome
financial position of British Rail, the Government relied on experience with franchising,
contracting-out and performance regimes introduced in bus deregulation in 1985. Since
this deregulation was a success (the average bus operating cost, per mile, was reduced by
44% over the period 1986 to 1996), the British government was enthusiastic about
applying the concept to the railway sector. The (political) uncertainties about the
outcomes of the radical reform that remained were washed away when the European
Railways Legislative Directive 91/440 was published. It provided the domestic political
leaders with extra legitimisation to carry out the reform programme. At that time, the
board of British Rail preferred a vertically separated firm, preferably a public limited
company (PLC). The key argument against this was presented in the form of transaction
cost economics. According to the Government, “…the time had come to replace the
current command structure by contractual relationships between autonomous bodies”. BR
as a PLC would have prevented the replacement of the complicated and inefficient
command structure.
17 This reform was the most fundamental change in the British railway history. The reform not only implied the transformation of a public-sector monopoly into private ownership (as the other mentioned industries), but also the introduction of different forms of competition, and the establishment of formal contractual regimes between the different actors involved (Gibb, Lowndes and Charlton, 1996).
The former structure of the government owned railways was based on a single organization. The different functions of the railway system (provision and maintenance of infrastructure and rolling stock, passenger operations, freight operations) were integrated in one hierarchical structured organization. The post-privatisation structure is characterized by a far-reaching vertical and horizontal fragmentation with respect to the former structure.
In the vertical separation, the institutional separation of train and infrastructure operations was established. This meant that the entire infrastructure of British Rail was transferred to Railtrack, the new private body which was responsible for the infrastructure provision and maintenance, the supply and access to tracks and stations and the management of time-tabling, train planning and signalling. When Railtrack went bankrupt, all operations were transferred to the newly formed Network Rail.
Several aspects of horizontal fragmentation were carried out. First, BR passenger
operating businesses were split into thirty train operating companies (the TOCs). Second,
the passenger rolling stock was separated from the TOCs and divided up into three rolling
stock leasing companies (ROSCOs). These ROSCOs took over all domestic passenger
trains of BR and started to lease the trains to the TOCs. Third, a broad range of service
companies was set up, including infrastructure and maintenance companies
(INFRACOs). This organizational break-up was followed by the transformation of these
new companies into private ownership. The different TOCs were franchised to private
companies. The new structure is outlined in figure 1.
18
Figure 1 Source: Crompton and Jupe, 2003
Because of the vertically integrated structure, the different business units of BR were coordinated through internal agreements. However, the new structure implies a more formal approach. The different horizontal and vertical separated companies now have to communicate through formal contractual relationships. This form of coordination required a new regulatory environment.
Regulatory environment
The privatisation of the British railways did not imply that they were operated without any further involvement on the part of the public authorities. The privatisation is Britain was accompanied by the establishment of a regulatory framework that controls the operations of the different parties involved. The role of the state has been decreased, but is still responsible for the regulation of the private market activities and the provision of subsidies for unprofitable passenger services. This contrasts with the previous situation when British Rail was nationalized. Although the board of British Rail formally was autonomous in day-to-day management, government interventions were regular.
Because of the mentioned horizontal and vertical separation, a new regulatory framework
was necessary. This led to the creation of two new agencies to regulate and control the
British railway sector: the rail regulator (ORR) and the strategic rail authority (SRA,
formerly OPRAF).
19 Office of Rail Regulation
The three main functions of the Rail Regulator are:
• Regulation of the licensing process. This includes granting the rights to access to the track, stations and depots.
• Promote competition. This involves preventing anti-competitive practices in the provision of railway services including investigating possible monopolies.
• Guarding the interests of the users. This includes deciding in case of a proposed closure of a line by an operator.
The legislation (section four of the Railways Act of 1993) specifies that the Regulator should exercise his functions in a manner best calculated to: protect users interests, promote the use and development of the railway network, promote efficiency and competition and promote measures designed to facilitate through journeys (Yarrow, 1999). Another important aspect of the ORR is its degree of independence; it is since 1997 completely independent of government control.
Strategic Rail Authority
The main function of this regulatory body is to designate services which are suited for
franchising, to award the franchise and to assure continuity at the end of the franchise
period. Moreover, the SRA is also concerned with the franchising provisions. That is, the
government expects that not all TOCs are economically profitable and therefore need to
be subsidized. The SRA is responsible for allocating these subsidies. The primary
objective is to get a good quality of services at the lowest cost. Because the SRA is
concerned with the provision of ‘public’ money in the form of subsidies, the organization
has strong ties with the government (Department of Transport Local Government and the
Regions, DTLR) who provides guidance.
20 Licenses and safety
The main characteristic of the British railway system is the use of licenses. These are required for the operation of railway assets. There exist four main types: network, train operator (passenger/non-passenger), station and depot. Before a certain operator can acquire a franchise, the necessary licenses must be in place. The licenses contain conditions relating to different issues, such as insurance, claims allocation and handling, compliance with railway standards and the provision of information to the ORR. Station and passenger licenses have conditions of consumer protection. Passenger licenses include requirements that network benefits are protected (ticketing and timetable requirements).
The responsibility for safety lies with the body controlling the activity. The TOCs are therefore responsible for train safety. To ensure the overall safety of the system, Network Rail imposes safety requirements before access is granted.
Regulatory instruments
The transformation of the railways in Britain introduced, as was one of the goals, different degrees of competition for different business units. Infrastructure was transferred to be a private monopoly (Network Rail) and competitive frameworks were established for train operations (franchising scheme).
Market access is restricted by a competitive bidding process for franchises, which grants the successful bidder a regional monopoly for a limited period. Detailed service obligations as well as possible subsidy payments are specified in formal contracts (franchise agreements). Since the SRA gradually got more understanding about the level of services that are achievable on a certain track, it could compare the different franchisees and thus significantly reduce the amount of agreed subsidy payments (get
‘value for money’). The regulatory control of the railways is not limited to market access.
Market operations, such as performance with respect to the agreed contract with the franchisee, are closely monitored by the SRA. However; the most important instrument for the ORR is the approval of an agreement between Network Rail and a future train operator. The ORR has a final ‘vote’ in approving a certain agreement.
21 Germany
Privatization process
At a first glance, the privatisation of the German railways seems to be the most conservative one of the three countries under investigation. Nevertheless, the German reform went beyond the minimum requirements laid out by the European commission; by transforming the railways in a joint-stock firm (Deutsche Bahn Aktien Gesellshaft, DB AG); by separating infrastructure and operations organizationally; and, finally by opening up national infrastructure to third party rail operators.
As in the other two countries, the negative consequences were becoming increasingly apparent during the mid 1980s. The decline in railway usage was forcing the German Government to increase subsidies; the railway unions were not able to prevent the decline in jobs in the railway sector; and, finally, the leading business associations (such as the German Transport Forum) were questioning the current transport policies and argued for a more liberal and deregulated transport policy.
In 1989, a commission was launched to develop proposals for establishing a new structure for the German railways. In its work, the commission was affected, like the other two countries, by the European legislation. However, the most important factor affecting the commission was the German unification. As a result of this factor, the commission had not only to take into account the worrying financial position of the Deutsche Bundesbahn, but also the disastrous financial position of the Deutsche Reichsbahn.
To provide a reliable (financial) basis, the commission established a broad consensus that
commercial autonomy was the most preferred option. They agreed on transforming both
railway companies into one German operator, a joint stock company under public
ownership. Their ideas were incorporated into a Law in 1993. In short, three major
changes were carried out. First, the DB and the DR (Deutsche Reichsbahn merged. Along
with this process two new administrative bodies were formed: the Federal Railways
Office (Eisenbahn Bundesamt) which was granted authority over planning, licensing and
supervision and the Federal Railways Asset Fund (Bundeseisenbahnvermögen, BEV)
22 which controlled the debt and management of assets. The BEV took over the accumulated debts from both the DB and the DR. Second, arrangements were made to provide for a shift to a purely commercial operation. Since neither the accounting system nor the legal structure would allow it to judge the success of the Deutsche Bahn on commercial grounds, the Commission decided that the railways should not have social responsibilities anymore. The responsibility of the new company would be determined by Law to be exclusively commercial and the DB was transformed into the DBAG, the Deutsche Bahn Aktiengesellshaft. All sovereign activities were transferred to the Federal Railways Office. Third, the introduction of competition from third parties on the rails.
Competition from foreign operators will be permitted as long as the use of the infrastructure is reciprocal. That is, the DBAG must be in turn allowed to also use the foreign infrastructure. The methods of charging (foreign) operators for access to their infrastructure are based on access to slots for which a price per kilometre has to be paid.
The infrastructure division of DBAG who controls the infrastructure remains in public ownership and keeps a monopoly position.
The issue of vertical separation attracted the most debate. The Deutsche Bundesbahn was strongly opposing any separation beyond internal reorganisation; just as the NS was opposed to vertical separation of the railway sector in the Netherlands. However, the pressure from the Deutsche Bundesbahn was more convincing, as the commission advocated an immediate organisational and accounting separation of operational and infrastructure activities, instead of an institutional separation of operations and infrastructure. Nevertheless, the option was kept open the institutionally separate operations and infrastructure in the future. In consensus with the railway unions and the railway operator, this internal separation took shape in the form of a holding structure.
This consensus-based approach established a gradual transition process towards four
joint-stock companies (regional passenger, long distance passenger, freight and
infrastructure) under the umbrella of the holding company, Deutsche Bahn AG. The
current structure of the DBAG is shown in figure 2.
23
Figure 2
Regulatory environment
As mentioned before, next to the creation of the Deutsche Bahn AG in 1994, two government agencies were founded: the Federal Railway Office (Eisenbahn Bundesamt) and the Federal railway Authority (Bundeseisenbahnvermögen).
Federal Railway Office
The regulation of the Deutsche Bahn AG (and its business divisions) is the territory of the Federal Railway Office (FRO). Their responsibilities include:
• Issuing operating licenses to infrastructure and transport units of the DB and other railway operators
• Regulating access to the infrastructure when conflicts arise
• Deciding on closure of certain tracks
• Developing and approving plans with respect to the infrastructure
• Reviewing applications made by the DB AG for state financing of different
investments in the rail network
24 With respect to the last point, the FRO can decide to provide a grant or interest-free loan to the DB AG. In any case, the money provided comes from the annual budget of the Ministry of Transport. It is also the responsibility of the FRO to make a distinction between commercial and non-commercial investments. For commercial investments, an interest-free loan is provided. The interest-free aspect is to promote investment in the railway sector. For non-commercial investments, or investments initiated by the government (acting through the FRO), subsidies may be granted.
Federal Railway Authority
The other regulator in the German train sector is the sister agency of the FRO, the Federal Railway Authority (FRA). The FRA is basically a ‘warehouse’ for the old debts and other obligations assumed by the government in order to provide the DB AG a ‘fresh start’ in 1994. Its responsibilities include:
• Administration and management of real estate not essential to railway operations
• Managing and servicing the old debts (valued at DM 66 billion on December 31, 1993) of the Deutsche Bundesbahn and Deutsche Reichsbahn
• Responsibility for the pension fund for railway personnel
• Maintenance of welfare schemes for railway personnel
Especially the aspect of a repository for civil servants solved a difficult problem. These
civil servants benefited from employment guarantees inconsistent with the privatisation
of the railways. The creation of the FRA made it possible for these servants to continue to
work for the government (and thus retain their civil servant status), with the DB AG
contracting for their services at market rates. The difference in amount paid by the DB
AG for these services and the cost to the FRA of the civil servant salaries and other
benefits are subsidized by the Ministry of Transport. The total cost of funding the FRA
with public money can be seen as the cost of the privatisation.
25 The Netherlands
Privatization process
Since 1938 the Nederlandse Spoorwegen (NS) has been the owner of the Dutch rail infrastructure and the operator of the rail services which are carried out on the infrastructure. In the early 90s, however, triggered by the European Directive, the Dutch railway reform initiated. Although it did not follow the path of liberalisation and commercialisation taken in Great Britain, it went beyond the requirements set in the European Directive. Next to the implementation of the directive, the Dutch policy was also more in line with the new regulatory approach towards transport markets, i.e. to establish the market principle while maintaining the government’s privilege to intervene when necessary.
An important feature of the policy-making approach of the Dutch Government towards the railway privatisation was the desire to take the interaction between different modes of transports i.e. road, rail and waterways more into account. This approach rested on the pillar to make the Dutch economy more competitive using deregulation and by introducing the market-principle wherever possible. Thus, transport was not only viewed as a mode of transportation but also as an input for other economic actors. This underlines the broad consensus among political, social and economic actors in favour of a strengthening of the railways.
But, the development of a consensus-based solution for the failing domestic regulation
was hampered by the integration of freight and passenger services into one organisation
and their dependence on the same infrastructure. However, with the additional legitimacy
of the European legislation, the Dutch government was able to draw strength from the
European policy. Most importantly, the European policy proposed a splitting up of the
complex and troublesome structure of the railways, thereby allowing policy makers to
deal with the specific problems one at a time. Like in the British case, the European
policies fitted well with the Dutch approach to reform the railways. Instead of following
the recommendations of the board of the NS (who opted for a radical reorganisation
which would have left the NS still as an integrative unit), the Dutch Government adopted
26 a reform model that was proposed by a committee (Wijffels committee, 1992) which laid the foundation for the restructuring of the Dutch railways. The advice was in line with the European Directive (91/440) and recommended a horizontal and vertical splitting up of different railway units. The implementation of this vertical and horizontal separation created a ‘market sector’ (operating under market principles) and three so-called ‘task organizations’ whose costs are covered by the Ministry of Transport (van de Velde, 2000). The market sector is basically composed of NS Reizigers (passenger services), NS Stations (operates stations) and NS Vastgoed (manages property and develops real estate). The NS also has interests in Railion (formerly NS Cargo, the freight division of NS). The three ‘task organizations’ are: Railned (responsible for licensing train operators and allocating existing capacity), NS Verkeersleiding (NS traffic control) and NS Railinfrabeheer (NS Rail Infrastructure Management). In 2002, these three task organizations are no longer part of the NS Holding and become under the responsibility of the Ministry of Transport. In 2003, an independent organization “ProRail” is founded and the task organizations are now under the umbrella of ProRail. Accordingly, their names are changed into: ProRail Railinfrabeheer, ProRail Railned and ProRail Railverkeersleiding. The structure is outlined in figure 3.
Figure 3
27 The reform made competition possible and several new operators made their appearance in 1996-2000. During this period, the NS continued to provide all intercity, express and local train services on the main-line network. However, the important changes occurred in the regional train services. In the eastern part of the Netherlands, ConneXXion (a state- owned bus operator) won the right to operate a short local railway line from NS Reizigers by competitive tendering. In the same region, NS Reizigers started a joint venture called Syntus with ConneXXion to operate a bus-train network in the province of Gelderland. In the north of the Netherlands, Arriva (a British operator) and a bank were granted a non- competitive contract by the local Frisian (Friesland) government to operate the NoordNed bus-train network. Since then, they also won a tender for the right to operate train services in the neighbouring province of Groningen.
Regulatory environment
At the heart of the Dutch railway privatisation lays the disentanglement (horizontal and vertical separation) of public and private functions and responsibilities (Knill et al., 1998). The three parties who constitute the new institutional environment are:
• Rail Transport Authority (Dutch Ministry of Transport)
• Infrastructure manager (ProRail)
• Service provider or operator (NS, Syntus, NoordNed)
The Dutch Ministry of Transport has the major tasks to oversee that conditions are created to form an efficient and healthy environment for railway transport. This means the setting and guarding of guidelines and standards as well as the provision of investments in infrastructure to ensure sufficient capacity in the long run.
The infrastructure manager has been set up as an independent company by the Dutch Government to oversee the provision, planning and management of the rail infrastructure.
Although it operates since 2003 independently, it is still 100% owned by the State. The
State influences ProRail by agreements made in the concession and by providing
financial funding for the repair and maintenance of the infrastructure.
28 The NS runs on commercial principles and is encouraged to work as an entrepreneur. Its primary task is to provide reliable services at an acceptable quality level.
For the use of the infrastructure, the NS has to pay fees to the infrastructure provider (ProRail). For additional infrastructure, the NS has to put forward proposals which are considered by the Ministry of Transport to determine the social and economic gains of the project.
Performance contract
In line with the European Directive, the infrastructure was institutionally separated from
operations. The infrastructure related questions were kept under public authority, as this
was seen as an important precondition for the presence of public intervention alongside
competition. The government granted the NS a 10-year concession to operate the main
network. However, this concession will be subject to certain obligations, such as
punctuality, conditions related to fare increase and minimum service levels. However, for
the Dutch Ministry of Transport, it is hard to formulate a performance contract that
provides good incentives due to the lack of information. This problem was solved in
Britain through the use of competitive tendering (franchising), but this has been rejected
in the Netherlands for the main network.
29 Summary
We can conclude from the previous section that the privatisation of the railways took a somewhat different shape in each country. Whereas the British Government took the European directive to its extreme by separating infrastructure and operations and applying franchising schemes, the Dutch and German Government were less extreme and still reserved a considerable role for the Government.
We see that the reform in Great Britain was mainly inspired by the experience gained in previous utility reforms. In particular, the organisational structure was influenced by the
‘regulation by competition’, which not only led to the fragmentation of the industry, but also to the market-driven franchisee structure. Because of the absence of previous reforms in utilities, the German reform drew much more on gradual implementation and the involvement of different (political) parties. It was furthermore facilitated by the railway operator itself (DB), which managed to control the extent of the vertical separation (organisational instead of institutional). In the Dutch case, we see a consensus- based approach with gradual implementation of the European policies. The reform went beyond the minimum requirement, institutional separation was introduced.
A summary of the regulatory environments in each country is given in figure 4 on the
next page.
Figure 4 Summary regulatory environment
Privatisation and performance
Hypotheses
Now that we have outlined the different privatisation processes and regulatory environments, this part of the research paper examines the outcomes of the privatization in order to test the three biggest benefits claimed by the Governments of the three European countries: greater efficiency, improved quality for customers and the decline in subsidy paid by the Government (and eventually the taxpayer) to the railway company.
Therefore, my general research question is:
• Does the outcome of the privatization of the Dutch, German and British railways actually endorse the acclaimed benefits?
To answer this question, I’ve developed three specific research questions. These are:
• Did the privatization of the Dutch, German and British railways lead to greater efficiency?
• Did the privatization of the Dutch, German and British railways lead to improved quality for customers?
• Did the privatization of the Dutch, German and British railways lead to a decline in subsidy paid to the railway company?
To provide answers to these three specific research questions, I will test the following hypotheses. The privatization of the Dutch, German and British railways, compared to the pre-privatization period, led to:
• Hypothesis 1: greater efficiency, proxied by the return on equity (ROE),
return on sales (ROS) and lower relative costs (proxied by total operating expenses relative to total operating income)
• Hypothesis 2: improved quality for customers, proxied by train punctuality (% of trains arriving on time), number of derailments and collisions per billion train kilometres
• Hypothesis 3: a decline in subsidy paid to the railway company
32 Sample, data and method
Since my analysis evolves around European railway companies, the sample in my paper consists of three in-depth case studies of the, formerly national, railway companies in the Netherlands (Nederlandse Spoorwegen), Germany (Deutsche Bundesbahn) and Great Britain (British Railways). These countries are chosen because they have different views with regard to how firms are governed. At one end of the continuum, Britain employs a neoliberal ideology according to which rail transport must be governed by market principles and serves as an instrument of the economy. Nearly at the other end is Germany, which has a traditional public-service-oriented view. The Netherlands occupy a mid-range position. Although market-liberal principles are important, the Dutch have always maintained that the state should be able to intervene in the market to safeguard public interests. Because these different beliefs play an important role in privatization issues, these three countries should provide an interesting comparison.
The data I use to test my pre- and post-privatization performance hypotheses consists of
two sources: the annual reports of the railway companies and financial data from
AMADEUS. By cross-referencing the financial variables from both sources, a reliable
financial picture should emerge. The specific economic variables I will examine from the
annual reports and AMADEUS are return on assets and return on sales. These are often
used to estimate the financial performance of firms (Megginson et al., 1994; Boubakri
and Cosset, 1998; Boycko et al., 1996; Kikeri et al., 1992). The third profitability
indicator (cost recovery ratio) is to estimate the total expenses relative to the total
income. This should provide a clear measure as to whether the relative expenses have
increased or decreased after privatization. A ratio below 1 indicates that the firm is not
able to fully cover its costs. The quality variables as well as the subsidy variable are
33 obtained from the annual reports. The data on the number of derailments and collisions are obtained from the national agencies responsible for rail safety
2.
Table 1 gives an overview of the variables, how they are calculated and the predicted relationship with respect to the pre- and post-privatization period.
The years I compare are the averages of years -5 to -2 to estimate the pre-privatization situation and the averages of years +2 to +5 to estimate the post-privatization situation (where 0 is the year of privatization). The years of comparison are chosen such that the privatization phase (one year prior (-1) to privatization, privatization year itself (0) and one year after privatization (+1)) is excluded to avoid any influence on the target variables through privatization externalities (i.e. reorganisation costs). The Dutch, German and British railway company privatized in the early 90’s, so for each company all desired comparison years are available. The only variable that wasn’t available was the amount of subsidy for the Deutsche Bahn.
2 HSE for Great Britain, FRO for Germany and ProRail for the Netherlands
34
Characteristics Proxies Predicted Relationship
Profitability Return on Sales (ROS) = Net Income / Sales ROS
A> ROS
BReturn on Assets (ROA) = Net Income / Assets ROA
A> ROA
BCost recovery ratio (CR) = Total Operating Income / Total Operating Expenses
CR
A> CR
BQuality Train Punctuality (TP) = % trains arriving within five minutes of their scheduled time
TP
A> TP
BCollisions (CL) = number of collisions per billion train kilometres
CL
A< CL
BDerailments (DR) = number of derailments per billion train kilometres
DR
A< DR
BSubsidy Subsidy (SUB) = amount of subsidy received from Government in million Euro
SUB
A< SUB
BTable 1 Variables to compare pre- and post-privatization. Subscript A and B refer to After and Before the privatization
To test the hypotheses I use the two-tailed, two related samples test (t-test), with α = 0.05.
This test concerns those situations in which persons (or companies) are closely matched or the phenomena are measured twice. It is designed to test whether a specific variable has significantly changed after a specific event (such as privatization). With the t-test, the null hypothesis states that the means are not statistically different whereas the alternative hypothesis states that the means are statistically different. Therefore;
• H
0= The average mean before and after the privatisation is not statistically different
• H
1= The average mean before and after the privatisation is statistically different
35 Empirical Results
In the following section, I present the empirical results using the sample and variables described in the previous section. To provide a clearer picture, each subsection will have a graphical reproduction of the key variable along the ‘privatisation’ timeline.
Variable
Mean Before
Mean
After N Mean Change
T-statistic For Difference in Means
Sig. (two- tailed) Profitability
Return on Assets Return on Sales Cost Recovery Ratio
-1,99 2,0367 0,9333
-0,8233 1,7633 0,9600
3 3 3
1,1667 -0,2734 0,0267
-2,173 1,034 -0,339
0,162 0,410 0,767 Quality
Train Punctuality Collisions Derailments
92,8700 0,3300 0,4500
92,3000 0,4733 0,3667
3 3 3
-0,57 0,1433 -0,0833
0,292 -1,315 0,819
0,798 0,319 0,499 Subsidy
Subsidy 551,6950 599,7700 2* 480.750 -0,264 0,836
Table 2 Summary of Results
* Subsidy figures not available for Deutsche Bahn
Profitability
Because the government has the long term aim of reducing subsidy and with private
investors in rail business demanding a return on their capital, the profitability of the
railways will be increasingly important. The results show a mixed outcome in
profitability. The Return on Assets increased from -1,99 to -0,8233, but the Return on
Sales decreased from 2,0367 to 1,7633. The Cost Recovery Ratio remains roughly the
same with an increase of 0,0267. However, for all three profitability indicators the change
is not significant, therefore we can accept the null hypothesis that the means did not
significantly change.
36 When we look at the graphical reproduction of the key variable cost recovery ratio in figure 5, we observe a confirmation of the results of the t-test; the ratios change a little but stay roughly the same. An exception is formed by the DB. Here we observe a significant improve in the cost recovery ratio during the transition period. This can be explained by the transfer of its giant debt to the Federal Railway Asset Fund. But despite this transfer, the DB still cannot fully cover its costs, the ratio remains below 1.
These results lead to a rejection of my first hypothesis; the privatisation of the British, German and Dutch railways did not lead to greater efficiency, proxied by the return on equity (ROE), return on sales (ROS) and lower relative costs (proxied by total operating expenses relative to total operating income).
Figure 5 Cost Recovery ratios BR/TOCs, NS and DB
37 Quality
The quality variable also shows little change between the pre- and post-privatisation period. The little changes that occurred contradict my second hypothesis. The quality did not improve for customers, as the average punctuality decreased by a half percent and the number of collisions per billion train kilometres increased. When we look at the p-value, we can conclude that the little changes are not significant. We can accept the null hypothesis that there exists no significant difference in the means of the quality variables.
This leads to a rejection of my second hypothesis; the privatisation of the British, German and Dutch railways did not lead to improved quality for customers, proxied by train punctuality (% of trains arriving on time) and the number of derailments and collisions per billion train kilometres.
The graphical reproduction of the key variable punctuality, support the t-test results. In figure 6 we observe only little changes over time. We see that the punctuality percentages for the newly formed franchisees and the Nederlandse Spoorwegen deteriorated but show an upward trend as of 2001/2002. Punctuality for the Deutsche Bahn improved slightly but already showed an upward trend before the privatisation, and this is therefore hard to attribute to the railway privatisation.
Figure 6 The % of trains arriving within 5 minutes of their scheduled time
38 The lack of improvement in quality for the railway companies is also reflected in other sources, the DB customer satisfaction index (Figure 7) and the complaints-rate graphs (Figure 8) for Great Britain for example.
Figure 7 DB Customer Global Satisfaction
In 1994, the DB Global Satisfaction Index stood at 2.87 (on a 5-point scale where 1 = Completely satisfied and 5 = Dissatisfied). By 2001 it had fallen to 3.19, the worst value since 1994.
For Great Britain, the complaints rate published by the SRA also provides a signal with
regard to the quality of services. Figure 8 on the next page displays the number of
complaints per 100,000 passenger journeys. We observe that the rate is slightly
increasing, instead of decreasing, indicating that the service quality did not improve. This
is also in line with the results of the t-test.
39
Figure 8 Complaints rate TOCs per 100,000 passenger journeys
40 Subsidy
Since one of the primary goals of the privatisation was to reduce public subsidy, this section concludes with an evaluation of the subsidy reductions. When we look at the means before and after the privatisation, we notice an increase (instead of decrease) in the average amount of subsidy paid to the railway companies by almost 50 million Euro. The p-value, however, indicates that the change is not significant at the .05 level. We can accept the null hypothesis that there exists no significant difference in the means of the variable subsidy before and after the privatisation.
The graphical reproduction of the subsidy variable in figure 9 shows a reduction in subsidy paid to the NS. From the year 2000 onwards, the NS is even able to pay dividend to the Dutch government. However, a different picture emerges when we look at the British situation. Despite the substantial subsidy reductions (roughly from 2,5 billion euro to 1,5 billion euro) after the privatisation, the amount of subsidy the TOCs receive is still considerable. On top of this, we also observe an increasing trend (from 2001 to 2004) in the amount of subsidy received by the TOCs. These findings clearly contradict the premise that the amount of public subsidy would decrease after the privatisation.
Therefore we can reject the third hypothesis; the privatisation of the British, German and Dutch railways did not lead to a decline in subsidy paid to the railway companies.
Figure 9 Amount of public subsidy paid to BR/TOCs and the NS
