INTRO: Concessioning and privatisation started to transform the management of state-run railways about 10 years ago. Experience to date suggests that private sector managers handle investment projects better than their public sector counterparts and do not sign up to vote-catching white elephants

BYLINE: Louis S Thompson

Railways AdviserThe World Bank

RAILWAYS are changing. Long-missing concepts like the need to retain market share, or the impact of increasing customer sovereignty, or the weakness of not having financial stability, are looming ever nearer on the managerial radar screen of state-owned railways. In many cases governments and railway management have concluded that the best way to foster the transition to market-driven enterprise is by bringing the private sector into the management role, and sometimes into the ownership role as well.

Until the beginning of the 1990s, proponents of private railway management were restricted to a theoretical argument about the difference between private and public managerial behaviour. Outside the USA and Canada, railways were generally the preserve of the public sector, and there was little concrete experience to show how privately managed railways would behave. Private versus public comparisons were a ’more heat than light’ situation.

That has now changed, and with a vengeance. During the 1990s, all of the major railways in Latin America have been shifted to private management. This has happened through concessioning in which the ownership of the infrastructure remains in public hands but the management is transferred to the private sector, or through privatisation in which the assets of the railway are actually sold to private owners.

Private operators start to spread

There are now several concessions in Africa, and more are on the way. The Aqaba Railway in Jordan was leased in a way equivalent to concessioning. New Zealand Railways is now privately operated, and three of the major passenger railways in Japan are partly in the private sector.

Canadian National Railway was sold on the Toronto Stock Exchange, and the new CN is a major player in a proposed merger with the Burlington Northern Santa Fe, the largest of the US railways. Plans are afoot to privatise parts of the Polish State Railways and the Romanian State Railways, and many other concessions or privatisations are ongoing. Nor can we leave out the railways of Britain, now run by a flourishing collection of nearly 30 private rail-related operating companies, plus others that supply rolling stock and provide maintenance services for track, signalling and trains.

Overall, there are roughly 34 freight concessions and 11 passenger concessions already in operation in 14 developing countries. Over the past decade, about 29 companies have arisen to operate on newly privatised railways.

None of these new operators are older than eight to 10 years, so we do not have the kind of long-term experience that would definitely convince all doubters. Nor, given the degree of passion in the debate, are we ever likely to end the argument, no matter how strong the results. Proponents of state control can still say that we ought to wait 20 years to be sure.

Perhaps more importantly, the experience with public to private transitions shows that there are always exceptions. There are broad things that can be said about how the public sector behaves as compared to the private sector, and our experience in railways supports many of these assertions - but the country context is also important. There are some countries in which private commercial management is roughly the same as, or only marginally better than, public management (usually in developed countries) but there are also developing countries in which neither private nor public control seems to work. Good government and long traditions of effective civil managers can accomplish a lot: nothing works well in places where there is no working legal system or where the government is dysfunctional.

Keeping these caveats in mind, is there anything useful we can say now about how concessioning and privatisation affect investment in railways? Do private managers and their investors behave differently and better (or worse) than their public predecessors?

Whether the difference is ’better’ or ’worse’ depends on the objectives that the reader believes the managers should have. Also, the only available answers are generalisations: there are some well-managed public sector enterprises and some poorly managed private companies. Overall, though, the answer to the question appears to be: ’Yes, private managers do behave differently, and the experience in railways seems to be proving the case. Specifically, private managers do tend to operate more efficiently and use capital more productively than public managers.’

The fundamental difference which rail management sees is in the contrasting goals of government as shareholder versus the goals of private shareholders. Government objectives are usually complex and, as in all things political, conflicting. Overall, government managers tend to follow those objectives that earn them the most approval from their political superiors of the moment - ultimately those actions which will tend to re-elect their elected bosses, and eventually maximise the budget of the managers.

The net result is pressure toward the shorter term, prestige building, voter-pleasing projects. There is rarely a fully consistent direction over the longer term in which most investment decisions are made, implemented and eventually paid back. In the actual budgeting decision, there is rarely serious consideration of return on investment, although there is often the appearance of analysis. Even rarer is a systematic public programme of post-hoc analysis in which the actual results of an investment are compared with the benefits promised when the investment was sold to the government.

Focus on risk

Private shareholders, and their managers, in sharp contrast, tend to focus on investment risk and payback, either from increased revenues and market position or from reduced costs, or both. Boards of directors normally want to know whether an investment will produce enough benefits to increase the bottom line of the enterprise (increased revenues and/or decreased costs greater than the financing costs of the project). If not, the project does not get approved.

Boards use a cost of capital for the investment that is often far higher than in the public sector, and managers whose projects do not pay off are often positively unwelcome in the boardroom the next time they have a proposal to sell. High costs of capital reinforce the idea that ’time is money’, and they also underline the importance of getting the investment costs right.

Despite short-term gyrations in the stock market resulting from external forces, longer term stock prices are eventually related to enterprise performance (measured by clear and auditable results - another departure from government accounting) and boards know it.

Successful private managers thus approach investments in a much more demanding way than public managers because they have to deliver on their promises in an environment in which their objectives tend to be simpler (bottom line), clearer (results-oriented accounts), more demanding (much higher costs of capital), and a lot less forgiving. The result is that we can say with confidence that private railway investment decisions tend to be made only if the benefits are quantified, the investment is designed to yield maximum ’bang for the buck’, nothing is spent before it must be spent, and projects are finished on time. Anything less will not help the bottom line, and that eventually leads to lower rewards and eventually unemployment. At the same time, private investment decisions tend to be a little less sensitive to year-to-year vagaries; management, once committed, tends to stay the course - unlike the political budgeting process in which last year’s starts can easily become this year’s inconveniences.

Criteria for investment

It is, of course, harder to say whether the public/private difference yields a ’better’ railway. Private railways will only invest where there are net benefits, but they will almost always invest where benefits are clear and convincing. Public railways will always spend whatever funds are available through the political process for investment and, when labour forces and local suppliers are politically strong, the funds available can be considerable.

Experience shows that investment in the absence of the right criteria can be a recipe for white elephants that often actually weaken the railway because they cost money to maintain and because they divert money from areas of critical importance. Such investment also yields engineering ’Taj Mahals’, because no-one asks whether the same result could be achieved without making things perfect. In other words, the private sector tends to err on the side of under-investment, while public enterprises tend to over-invest whenever they can get away with it. It seems a paradox to point out also that poor investment analysis tends both to produce the wrong investments and to weaken the ability of public railway managers to justify (or even identify) the right decisions.

In fairness, it is important to acknowledge that there are ’externalities’ which public authorities legitimately seek that private managers cannot include in their bottom line evaluation. Such things as reduced pollution, urban congestion and noise, less wear and tear on highways, and so on, are issues which do not yield profits to private railways but are clearly of public value. Public railways sometimes invest to earn these benefits when private railways do not.

A good example is in Public Service Obligation investments in railways that are providing social benefits. The traditional model held that only public agencies could pursue social objectives because the profit motive was seen to be inconsistent with non-monetarised benefits - a recipe for exclusively public operation by definition. The answer has been to define public objectives more clearly and then ask private operators to compete for the business of providing social services. The public gets what it is willing to pay for far more effectively than before, and private operators are strengthened.

Productivity rises

Nice words, even a plausible argument, but where is the evidence? Has productivity or efficiency really improved when operations shift from public to private operation?

Fig 1 gives an interesting suggestion, comparing labour productivity for the US private freight railways and the publicly owned Amtrak. Even though Amtrak has more management freedom, on paper, at least, than most public enterprises elsewhere, productivity of the freight railways has far outstripped Amtrak.

Second, Fig 2 shows that the 1981 transition in the freight railways from heavy regulation and intrusive public interference to much more businesslike management after deregulation - in effect a kind of privatisation - had a clear impact in accelerating labour and asset productivity growth on the freight railways.

Fig 3 reveals that many of the benefits of the higher productivity were returned to shippers and consumers, a positive development which appears to have happened in Argentina and Brazil as well after concessioning.

Fig 4 puts the labour productivity levels for a number of public and private railways on the same chart. Acknowledging immediately that no two railways are quite the same, it is not a coincidence that the labour productivity of the privately managed railways ranges well above that of the public railways. And, in all the concessions, the transition from public to private was accompanied by a dramatic increase in the first years of the change. Studies done on the results in Mexico and New Zealand have reached the same conclusion. Interestingly, the ’socially’ driven suburban passenger railways of Argentina have a far higher productivity than any of the public railways listed, evidence that the private sector can serve social objectives at least as well as public management.

Productivity, either assets or labour, is not, of course, the only measure of performance, though it is a critical determinant of financial success and of market performance. There are many reasons why governments might choose to have railways operated in the public sector, especially where public ownership serves a security interest or an ideological objective - but governments should be careful to define and cost such non-market objectives.

With increasing frequency, governments are concluding that careful use of the private sector, especially for operations, permits them to have a stronger rail sector, better rail service to support social needs, and reduce public outlays at the same time.

CAPTION: Remarkably, all the major railways in Latin America are now in the private sector. Brazil’s Ferronorte is linked to the rest of the national network by a 3 km bridge across the Paran