1. Should governments subsidise rail fares? To see more of our products visit our website at www.anforme.co.uk Steve Earley

2. Economists maintain that government involvement in specific aspects of economic provision is justified whenever market failure occurs. Where the price mechanism fails to produce a desirable outcome from society’s point of view, state intervention is a way to enhance economic welfare. Overcrowding on UK roads causes congestion – a classic example of market failure. Fare subsidies paid by government to rail operators is a potential solution to decreasing road congestion and economic waste. The background

3. Road capacity can cope with traffic flows up to quantity OX. With levels of demand up to D1, there is no variation between marginal private cost and marginal social cost - meaning there is no external cost and the free market delivers allocative efficiency. Up to this point, an extra road user does not adversely affect the speed of other road users. There are no third party problems of time wasting. The problem of road congestion 1

4. Once the volume of traffic exceeds OX there will be a ‘spill-over’ cost on other road users as time will be lost due to increased congestion. If demand was shown by D2, the free market would deliver a traffic flow of OQ journeys, where D = S (MPC). As this exceeds society’s optimal level of OQ*, where D = MSC, inefficient use of road space results. Overconsumption of road space occurs with a deadweight loss to society shown by the shaded triangle. The CBI estimates that this time wasting costs the UK economy over £20 billion per year. The problem of road congestion 2

5. The provision of subsidies to providers of rail services is one way of reducing demand for road use. Government provision of subsidies will shift the supply curve from S to Ssubsidies. A new market equilibrium will result at OPs rather than at OP, leading to an increased use of rail services from OQ to OQs. With some of these extra rail passengers having switched from using cars, the demand curve for road use will shift to the left and help to diminish the market failure of overconsumption of road space. The subsidy solution

6. Keynesians refute the classical assertion that the economy is self- regulating, believing that it will stay in recession unless the government or central bank take action to boost aggregate demand. Is price of prime importance when choosing to travel by train? If the price elasticity of demand for rail travel is inelastic, only a limited amount of extra passengers may be attracted by lower prices. If the railway network is not in exactly the right places to meet the needs of consumers, then it may be better to use the money to improve the provision of rail services. Some issues 1

7. Non-price factors may be more important in determining the extent of car travel, such as time saving and convenience. Where the cross elasticity of demand for road journeys with respect to a change in price of rail fares is inelastic, there would be limited impact in reducing the demand for road use. Even if price and cross elasticities were conducive to encouraging greater rail travel, the rail network might not be able to cope with the extra demand. In this situation of inelastic supply, attracting more customers but being unable to accommodate them would be counter- productive. Some issues 2

8. Over time subsidised rail fares may lose their attraction as incomes grow. Where rail travel is seen as an inferior good, with a negative income elasticity of demand, subsidised fares may not work in periods of rising prosperity. Travellers attracted by lower subsidised prices may be offset by others switching to road travel as a result of rising incomes. The money spent on subsidies would then be better used in another way. Some issues 3

9. The use of public money to fund fare reductions for rail travel could well have little real impact on rail customer numbers in either the short or long run. Elasticity concepts of both demand and supply indicate that subsidies which lower the price of rail travel may fail to achieve any meaningful effect on our congested road network. Money could be better spent to improve the breadth of provision of rail services and the overall quality of service offered. Conclusions