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Friday, July 29, 2005

Opening up the Railways to Private Investment?

Desipundit (one of the best sites to blogsurf) has a link to Michael Higgins' post on the concept of privatising Railways (and other such systems like Washington Metro)

Michael opines that the natural monopolies like the Railways do not have the incentive to invest in modernisation. The lacking incentive being "profit". The natural monopolies (which are invariably run by Govt or quasi govt institutions) are always touted to have a "socialist" goal where profit is a taboo.

However there is a bigger issue that both the Washington Metro and the Indian Railways share: these monopolies exhibit underinvestment. Instead of seeing new technology, we see the old technology persisting, and wearing out. Why is that? Well, if you price your commodity below cost, why would you want to invest more money in the production of it? Profits are the enticement that leads to new investment over time. But you need to be free to raise prices if you want to profit from improved service.
He rightly points to the way these services are priced:

In almost all cases, there is an attempt to set the price equal to average cost. Average cost pricing means no profits and therefore the consumer is getting the lowest possible price that can keep the natural monopoly going. Sometimes, the price is set below average cost and the government subsidizes the monopoly directly from tax revenue.

The complete Post is worth a read

The idea to price these services just equal to or below the average cost is purely for the socialist reason and the advocates of this theory will obviously believe that if the private arm is allowed to venture in such initiatives, they will have "profit" on their minds and the social good of the people at large will be lost. I am surprised that the capitalist economies like the USA also support this theory to some extent.

Even if we agree that we should price these services at cost or below cost, the following points beg an answer:

  1. Do these organizations (especially Indian Railways or Mumbai Locals) have the right tools and expertise to determine the actual cost of running these services?
  2. Do they have the visibility to all the indirect and directs costs of these services?
  3. Does the Government also consider the opportunity costs?
  4. A comment by Kaps in Michael's post points to the ticket less travellers. What about the cost to carry them?
  5. Do the railway authorities have the "authority" to discount the vacant occupancy on some of our trains and price them differently? Like this
There is one point which Michael has not mentioned in his post: Differential Pricing.

The Indian Railways also believe in "Differential Pricing" of a different sort. The one where the monopoly decides to cost the lower end services at par or below cost and price the higher end services (read First Class etc) at a much higher price and make up the losses. That is one of the reasons why the prices of First Class are much higher than that of the others. The cost of extra benefits awarded to these classes are supposed to be far less than the difference in prices. The age old adage "Haves to pay for Have Nots"

The Differential Pricing Theory will price the service / commodity equal to or more than the marginal willingness (utility) rather than the marginal cost. Thus if some sections of the society are willing to pay more for a slightly improved service, they are catered to at that price. This works both ways and does not necessarily mean higher prices. Even the concept of "Last minute discounts" is based on this concept.

However Michael scores a bulls eye in his post about how the private sector can run the show and the Govt can have quasi control of their activities. The Surplus generated in this set up will be pumped back to the society and thus creates a win win situation. This will also help improve the quality of the service.

On a side note though, I am highly impressed by the slight modernisation of the reservation counters in India. Step (albeit small) in the right (no pun intended here) direction.

13 comments:

Michael Higgins said...

Hi @mit
Thanks for linking to my piece.
I thought about differential pricing but I wasn't sure how effective it would be. It becomes controversial if you charge two different people different prices for the same ride (it's possible to do though). First class vs coach seating is an effective way of getting a bit more revenue from people who have money.

Govardhan said...

Good Point @mit - The idea of differential pricing is enticing. However that is unjust in some sense as well...something like our taxation ... it gets abbrasive after a while

Anonymous said...

-- Haves to pay for Have nots is a very "leftist" ides isn't it?

A bit Commie - don't you think?

@mit said...

Hi Michael - Thanks for the comments. The idea of Differential pricing actually is used more often even today by the Private and Public Sector, though in different ways.

e.g. Mumbai Locals charge Rs.80 for First class ticket and Rs. 8 for second class.

Same time the last minute discounts are a different way of the same idea.

Thanks for going through the post.

@mit said...

Govardhan - Thanks for the comments. As for the abbrasive part, actually it is not. It can be implemented in that way and thus makes it difficult. As I said the price is based on the Marginal Utility for the consumer and not on the Average Cost.

It is a bit tricky and is implemented a bit differently making it a bit skewed.

@mit said...

Annon - Read my previous comments and my post again :-)

Anonymous said...

I read ur post and comment and would just suggest that commies like you should go to hell

@mit said...

Annon - A few points worth noting:

I seldom respond to such comments, but today I have nothing to do and anyways I am thankful that you came looking for this post at least. Good to have a fan :-)

Secondly, you prefer to be annonymous.... I wonder why.... anybody's guess I think

Thirdly you require a very good lesson in economics.. I can help and Michael will be the best I believe... At least learn the basics about the Capitalism, Socialism and Capitalism.

At least understand the basis of capitalsim is free trade and that profit or reward for entreuprnership is the basis of this model and the differential pricing is an offspring with that motive...

Last but not the least.. thanks for visiting often...but i would prefer a thoughtful debate and not a hopeless one...

Gaya3 said...

Good Post and a nice theory. Looks like you like economics :-)

Anonymous said...

The idea of differential pricing is interesting and unique in the sense that it benefits most of the sections....

Kapil said...

nice post-- will blogroll you

Rakesh said...

Amit sir - great Post. Looks like your writing and teaching skills are still intact !

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