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.