NEW ZEALAND BUSINESS ROUNDTABLE
SUBMISSION
TO THE MINISTRY OF TRANSPORT ON
OPTIONS FOR THE FUTURE: LAND TRANSPORT PRICING STUDY
AUGUST 1997
1. Introduction
This submission is made by the New Zealand Business Roundtable (NZBR),
an organisation of chief executives of major New Zealand business firms. The purpose of
the NZBR is to contribute to the development of sound public policies that reflect overall
national interests.
The NZBR believes that substantial efficiency gains could be achieved by
reforming the management of the roading system. It has therefore strongly supported the
work on these issues that has been undertaken by the Ministry of Transport and has had
valuable contacts with Transit New Zealand on the subject.
The latest report Options for the Future: Land Transport Pricing
Study (the Report) prepared by the Ministry of Transport reviews the Ministry's
position on issues covered in the 1996 discussion documents in the light of public
responses and sets out five possible options for institutional reform. The first two are
variants of the status quo, while the third (the business option) proposes analysis of a
number of commercial issues. The fourth and fifth involve corporatisation.
In section 2 below we review the Report's discussion of the topics that
were the subject of the previous Land Transport Pricing Study's discussion documents.
Section 3 discusses the options for institutional change outlined in the Report.
Concluding comments are presented in section 4.
2. The Land Transport Pricing Study Issues
2.1 Introduction
The Report provides an update of the Ministry of Transport's position on
key issues that were the subject of earlier discussion documents. We provide below some
brief comments on the Ministry's views.
A number of issues are identified where further work is required. We agree they are important and note that some of them should be researched prior to decisions being made on reform options.
2.2 Pricing and Economic Efficiency
In the discussion of pricing and economic efficiency the Report:
ï recognises the importance of efficient pricing, including the concept
of marginal cost-based prices;
ï focuses less than in previous documents on the recovery of past sunk
costs; and
ï presents some preliminary information on the incremental and
stand-alone costs for various classes of road users which could provide guidance on the
recovery of common costs.
The recognition of the importance of efficient pricing is a major step
forward and addresses one of the major reservations we had with the previous documents.
The Report presents some new analysis on the stand-alone and incremental
costs for different road users to guide the allocation of common costs. The analysis is a
useful step in establishing an efficient pricing framework.
However, in applying the stand-alone/incremental cost methodology,
Appendix II of the Report includes a capital charge based on past sunk costs. This is
inconsistent with economic efficiency. The methodology should apply to the recovery of
current and future costs, not past sunk costs. The Report also appears to assume that if
some roads are being run down, road users should be charged to compensate the road owner
for the loss in value. This would also appear to conflict with efficient pricing.
The Report notes that in determining the allocation of common costs,
benefits should be taken into account. Although the Report does not elaborate, it appears
to advocate the use of a benefit principle. The benefit principle is an equity principle
(i.e. concerned with income distribution), and may in some circumstances be inconsistent
with prices based on an efficiency criterion. In our view, efficiency should be the
primary criterion for deciding road charges.
The Report notes that the role of lightly-used rural roads in the
roading network should be examined. It does not provide a strong case for non-rural road
users contributing towards the funding of rural roads. In our view, substantial efficiency
gains might be achieved by ensuring that maintenance expenditure on these roads was much
more closely related to the willingness of users to pay. User charges levied on
non-resident road users could supplement funding by local residents if this could be
achieved efficiently.
The Report provides only a brief analysis of other pricing issues, such
as the extent of economies of scope and scale, the implications of joint production costs,
the feasibility of shadow tolling, and the likely timing of introduction of direct billing
systems. Studies of these issues by officials need to be advanced as soon as is
practicable.
2.3 National Roading Accounts
The Report recognises that efficient prices are based on future rather
than past costs. As noted above, we believe this is a major advance over previous
analysis.
We concur with the suggestion that establishing a balance sheet is
useful as a management tool, but note that administratively determined values for sunk
cost assets may be seriously defective as a guide to efficient pricing.
The Report notes that an important issue is the future use of the petrol
tax and rates to fund road services. It suggests that the justification for using rate
revenue to fund roads is weak. However, as long as direct user charging is not viable,
roads must be funded in part from non-use related charges. Even if direct charging is
feasible, marginal-cost based pricing might not cover average costs. None of the possible
options for raising this shortfall in revenue is 'perfect' - the choice is between flawed
alternatives. Possible options include general tax funds, Ramsey pricing, an increase in
road access charges or the current options. The preferred option is the one that minimises
distortions to road use (since marginal cost pricing provides the appropriate short-run
signals) and induces the road operator to provide the quality and quantity of roading
services that consumers desire.
A direct access charge levied on all households is one option. It has
the advantage of establishing a relationship between the roading operator and road users.
It would ensure that all of the funding went directly to the road operator. It would
remove local authorities, with their conflicting objectives and relatively poor incentives
for performance, from involvement in roading. There would be costs associated with setting
up and running a direct billing system but these costs would have to be incurred in the
future once direct charging for road use becomes feasible.
The advantage of using the rating system is that it is already in place.
However, as noted in the paper, there are a number of problems with rate-based funding.
The lack of transparency is one problem - it is not obvious to property owners what
portion of their rates is being used for roading. There is also a risk that councils would
not pass on the appropriate amount of funding to the road operator. Political pressures
result in competing priorities for rate revenue. Further, the anti-motorist attitudes of
some councils and their favouring of public over private transport is of concern. Thus,
while we accept that levying a fixed charge on households to cover fixed roading costs may
be consistent with efficient pricing, we share some of the Report's reservations about
using rate revenue.
The Report notes that further work is required to resolve the issue of
who owns the roading network and whether a capital charge could improve economic
efficiency. It suggests that a capital charge that reflects the opportunity cost of
capital would be consistent with efficient pricing. We agree that this might be so but
reiterate our view that a capital charge on sunk cost investment is unlikely to be
economically efficient.
2.4 Externalities
Environmental
The Report notes that there is insufficient evidence to justify levying
road users for any environmental 'externality' impacts of road use. It also recognises
that problems are likely to be site specific in many cases, so that levying externality
charges on everyone is unlikely to be efficient. We concur with these points.
There is still an idea running through the Report that road users are
imposing costs on others and that the optimal level of external impact is zero. However, a
zero level of impact is unlikely to be optimal and there should be no presumption that it
is efficient for road users to bear all of the costs of reducing road use effects. The
important issue is to provide incentives for road users to face the full marginal costs of
an increase or decrease in impact. This could be achieved by a tax or a subsidy. In
addition, those affected by road use should face the appropriate incentives to mitigate
the environmental impacts (e.g. by not locating close to a motorway, or double glazing
windows where noise is a problem) at the margin. The transaction costs of identifying and
implementing changes that improve on current arrangements should not be underestimated.
Safety
We concur with the Report's view that there is no current justification
for introducing a safety externality charge. A charge is likely to be poorly targeted on
those who create safety problems. The NZBR's submission on Road Management: Options for
Reform discusses in more detail our views on how assigning accountability for safety
to a single organisation, the roading operator, in a commercial environment could provide
strong incentives for the delivery of the optimal level of road safety.
Congestion
The Report notes that road users should face the marginal costs of their
decisions to travel, including congestion costs. The Report offers little comment on the
feasibility of different charging options, noting that the preferred approach in any
particular area is likely to be site specific and that regional and local solutions to
traffic congestion may offer more appropriate solutions.
Congestion is an important issue in Auckland and Wellington. While it
might be true that solutions need to be developed on a local basis, the quality of
analysis currently being undertaken at a local level does not provide confidence that the
issues will be properly analysed if central government does not take a lead role. For
example, the Wellington Regional Council commented in its long-term strategy document Facing
the Future: The Next 10 Years 1997-2007 that "it is more important for the
Region's road system to meet the needs of commercial, recreational, rural and off-peak
users rather than those of rush-hour car commuters". This statement is clearly
inconsistent with an efficiency criterion.
Given the mixed ownership of the roads in Auckland and Wellington (i.e.
between Transit New Zealand and the territorial local authorities) and the overlapping
responsibilities of the regional councils (public transport) there is a case for a
coordinated approach to the congestion issue. The involvement of these various agencies
may increase the difficulty of reaching a solution, given their different interests. For
example, there are a number of possible options for congestion pricing. These include
electronic tolling, requiring a licence for peak hour travel, or a tax on commuter car
parks. The different options assign control, costs and revenues to different parties and
do not necessarily ensure that the signals provided by consumers' willingness to pay will
be passed back to the road operators.
We note that the Working Group on Demand Restraint and Regional Funding
of Community Passenger Transport Services has been established to develop proposals for
managing urban traffic congestion and funding public transport. We are concerned that
different agencies with their various political interests may not identify an efficient
solution, but we reserve our judgment until the outcome of the study is made public.
We note that the Ministry of Transport and Transfund are currently
reviewing the justification for public transport subsidies separately from the Land
Transport Pricing Study (and that the above working group is also studying this issue). We
consider that the grounds (in efficiency terms) for subsidising public transport are weak
at best (being based largely on a second-best argument that road users would be willing to
pay people to use public transport if that relieved road congestion). This justification
disappears once direct charging for road use is possible. If a congestion charge is
applied, road users would face the marginal costs of travelling at peak time. People could
then choose what form of transport to use based on the relative costs to users. In our
view, the elimination of subsidies could yield substantial efficiency gains.
2.5 Summary
The Report has recognised a number of important issues which were
ignored in the 1996 Land Transport Pricing Study's discussion documents and therefore
represents solid progress towards ensuring that reforms will enhance efficiency.
However, we believe officials should be moving with greater speed to
review some of the major unresolved issues, irrespective of the reform option chosen. The
greater the information base, the easier it will be to select the appropriate option for
the future. Government officials could usefully contribute to research in the following
areas:
ï principles of efficient pricing including:
- the implications (if any) of network externalities;
- the extent of economies of scale or scope;
- the likely timing for cost-effective introduction of direct user
charging;
- the long-term role of funding from rates, petrol tax, registration
fees, stickers and other sources;
ï the case for subsidisation of public transport;
ï the optimal maintenance of rural roads; and
ï monopoly constraints, interconnection and competitive neutrality
issues.
3. Options for the Future
3.1 Introduction
The discussion of options for the future recognises the importance of
institutional arrangements in giving incentives for efficient road management. The
examination of the different options is welcome and fills an obvious gap in previous
discussions.
We are confident that, in the long run, a commercial model will yield
the greatest efficiency gains. We are less certain about the timing of a move to a
commercial model given that in the short term direct charging for road use is not yet cost
effective.
In this section we examine the five options presented in the Report. We
begin by reviewing the case for adopting a commercial approach.
3.2 Commercial Options
The commercial options envisage corporatisation of the roading
operations owned by the Crown and local authorities, either as a single entity or multiple
entities. In either case, the corporatised entities would be required to move towards
direct charging mechanisms in a competitively neutral environment. Although not discussed
explicitly, shadow tolling could possibly be used as a transitional measure.
The corporatisation model has been applied beneficially in a variety of
situations at both the central and local government levels. It works most successfully in
a competitive environment where users can be billed directly for services supplied. With
suitable regulatory constraints (the Commerce Act and disclosure regulations),
corporatisation can provide significant efficiency benefits where an organisation has a
monopoly position.
We are confident that once direct billing is economically feasible,
corporatisation of roading operators would yield significant efficiency gains.
Corporatisation of the roading operators would improve management
performance by clarifying management's objectives and increasing accountability. With a
profit objective, a roading operator would have strong incentives to provide the services
most valued by consumers (assuming revenues were sensitive to users' willingness to pay).
It would have incentives to produce those services at minimum cost since by doing so the
commercial operator would maximise its profits (unless profits were controlled by
regulation).
If direct charging for road use were possible, users could express their
preferences for such diverse roading attributes as congestion, safety and surface quality
through their willingness to pay. Direct charging would allow time of day charging or
route-specific pricing. A fully commercial operator would have strong incentives to
maximise the information it received from customers on their willingness to pay for
roading attributes and to use that information to deliver the services desired at lowest
cost.
A fully commercial operator has strong incentives to optimise investment
and maintenance decisions since by doing so it would maximise profits. With access to
direct electronic billing it could achieve efficiency gains by:
ï better managing existing capacity and improving the timing of
enhancements to capacity. Congestion pricing could reduce demand for road use and may
allow the road operator to defer capital expenditure. Consumers' willingness to pay to
travel at peak periods would provide strong signals as to when additional capacity should
be built. New capacity should not be built unless users are prepared to cover the full
costs - all costs are marginal when an investment has not yet been made; and
ï improving road maintenance decisions, including decisions on the
timing and extent of maintenance. For example, a reduction in maintenance of lightly used
rural roads which allowed the quality of these roads to deteriorate might better reflect
the preferences of users if they faced the true marginal costs of upkeep. The same factors
would determine when to upgrade road quality in response to increased road use.
While we are clear that corporatisation would offer substantial benefits
if direct user charging were feasible, the gains achievable without direct billing would
be smaller.
In the absence of direct billing, corporatisation could still provide
benefits by clarifying the objectives of road operators, increasing their accountability
for performance, improving price signals, decreasing the scope for political interference
in operations and improving monitoring of performance.
Commercialisation would also improve the incentives of the roading
operator to introduce a use-related direct billing system when that became economically
feasible since by doing so the operator would maximise profits. A commercial operator is
less likely to be concerned by adverse consumer and political reactions to the
introduction of user charging.
However, until electronic billing is economic the roading operator could
not rely on direct user charges to fund road use. Without this source of revenue, the
roading operator would be forced to rely on the existing user charges, on access charges
and possibly on existing petrol tax and rates funding. These funding approaches provide
limited information on what roading attributes road users are prepared to fund. The
funding is largely unaffected by the roading operator's performance, reducing the
incentives of the operator to meet consumer preferences. Thus a significant proportion of
the benefits normally provided by a commercial imperative would be absent.
Commercialisation might be possible using shadow tolling. Again,
however, there are problems with this option.
Under the shadow tolling option, the road operator would be paid a toll
for each car using a particular part of the road network. The payment would be made by the
Crown (or a Crown agency) with the funds possibly raised by the government from the
current combination of licensing, fuel taxes, rates and direct user charges. A commercial
organisation's objective would be to maximise its profits subject to the constraint that
payments received were based on the shadow toll.
The approach does not provide signals to road users to balance the costs
and benefits of road use. For example it does not encourage users to take account of the
costs they impose on others when they travel during peak hour traffic flows. Conversely,
it does not allow road users the ability to express their preferences through their
willingness to pay for different road services - the only way such preferences can be
expressed is by use of the network.
Shadow pricing has the potential to distort roading signals. For
example, operators would have incentives to channel traffic on to roads where vehicle
counts were made.
Because the quality of information generated through shadow tolling is
likely to be much poorer than that generated through direct charging and because in some
cases the approach may distort the behaviour of road managers, we are not certain that
this approach would offer adequate benefits as a long-term option.
On the other hand, it might be a reasonable option as a transition to a
commercial model if direct charging were likely to be feasible in the relatively short
term. The shadow pricing regime would have to be carefully designed to maintain the
incentive for the operator to introduce direct charging as it became economic. There might
be a transition period during which the commercial operator derived funds both from direct
charging and from shadow tolls.
In our view, because the strength of the case for corporatisation
depends on the likely timing of direct billing, it would be prudent for officials to
review when electronic billing was likely to be feasible before deciding on the preferred
reform option.
Commercial Model: Multiple Versus Single Owners
The paper canvasses two commercial options. In the first, the Crown's
assets would be transferred to a state-owned enterprise and the assets of each territorial
local authority would be transferred to a local authority trading enterprise. The second
option would involve establishing a single corporate entity, owned jointly by the Crown
and territorial local authorities.
Normally, decisions on the optimal structure, organisational
arrangements and deployment of resources in an industry are made through the pressures
that operate in markets. The structure of industries evolves through experimentation with
firm size, product bundling, organisational arrangements, contract design and so on.
Because the survivorship of successful approaches rather than the reasons for their
success is important in a market, it is often difficult to understand why an industry is
organised in a particular way and even more difficult for a central agency to plan an
efficient industry structure.
The roading industry is no exception. It would be very difficult for a
government agency to obtain the information needed to choose between single or multiple
ownership of roading operations. This suggests that the best option for determining the
structure of the roading industry might be to give the owners and managers of current
entities the flexibility and incentives to restructure their businesses in response to
market pressures. The restructuring of the electricity supply industry with
corporatisation and some privatisation experiences indicate the scope for significant
efficiencies to be realised when the managers of individual companies have the incentives
to undertake restructuring.
However, even with corporatisation, managers of roading operations are
unlikely to have the ability or incentives to contemplate major restructuring. Parochial
local government interests would be a major impediment to rationalisation. The reluctance
of central government and local authorities to contemplate privatisation is another. If
rationalisation is unlikely then a case can be made for central government deciding on the
preferred shape of the industry. However, the difficulty of choosing the optimal structure
should not be underestimated.
We have not undertaken sufficient analysis to be able to express a firm
view on whether multiple or single ownership of roading entities would be preferable.
However, it is possible to identify some of the trade-offs with the different options.
Multiple ownership could increase the costs of introducing direct
billing. For example, cars might need to be fitted with multiple transponders to cope with
different electronic systems. On the other hand, operators might voluntarily agree on
standardisation.
If roads were funded in part through access charges under a multiple
ownership model, individual motorists might have to pay a number of operators depending on
the roads they were likely to use. Each roading operator would need to be able to bill
each road user for any direct charges incurred. Alternatively the roading operators would
need revenue sharing agreements.
A major concern with multiple ownership is the motivation and ability of
local authorities to adopt a commercial approach to road management. Unless a commercial
approach is adopted for all roads, the ability to adopt efficient pricing on other roads
might be compromised. For example, the economics of constructing the Transmission Gully
road and funding it through user charges would depend on whether or not user charges were
also levied for the use of the coast road. The likelihood that some operators would adopt
inconsistent approaches would increase with the number of entities.
Multiple smaller operations would generally be less able to attract high
quality managers and board members than a single large organisation.
On the other hand, retaining multiple ownership provides greater
opportunities for competition between providers. The scope for competition is, however,
limited, particularly on local access roads. If there were a number of organisations it
would be possible to compare the costs and prices charged by the different organisations
(although there may be significant differences in the nature of the assets).
Multiple ownership allows greater scope for experimentation with
different billing and other arrangements. It avoids the initial costs of agreeing the
relative valuation of assets contributed by different authorities to a single
organisation.
We commend the idea of exploring a North Island/South Island split of road operators, among other options.
3.3 Other Options Discussed in Report
Status Quo and Modified Status Quo
The status quo option represents the 'do-nothing' scenario. The modified
status quo increases funding to ensure projects with a benefit-cost ratio of 4.5 or more
proceed.
The efficiency case for maintaining the status quo rests on three
possible arguments. First, the current method of funding, relying on an access charge
(registration fee), indirect charges correlated with road use and road wear (petrol taxes
and road user charges), and rates may be more efficient than direct charging when the
costs of introducing a direct billing system are taken into account. The second possible
reason for retaining the status quo is that public ownership might be an efficient way of
addressing monopoly issues. Third, it might be best to retain the status quo while further
work is undertaken to clarify the preferred option.
The first issue is an empirical one. While the current charging regime
might be more efficient than alternatives at present, there will be a point in the future
when direct billing becomes economic. Once direct charging becomes feasible, the case for
moving to a commercial model is very strong. In the interim before full charging is
possible, partial direct charging for congestion and for trucks might be feasible and
should be introduced when economic. Officials should obtain expert opinions on the
feasibility of introducing such technology.
On the second issue, the Commerce Act and disclosure regulation have
proved to be a viable regulatory option for other network industries. Local access roads
do raise potential monopoly problems but these do not necessarily warrant maintenance of
the status quo.
The third justification for doing nothing does not withstand scrutiny,
since some reforms are likely to be justified whatever the long-term arrangement chosen.
Possible reforms include clarifying the objectives of the roading manager, eliminating the
sharing of responsibility for road safety between many agencies, introducing direct
billing when appropriate, franchise options, and introducing a road management regime that
puts all road providers on the same legal basis.
Assuming that the benefit-cost analysis presented in the Report is
soundly based, then additional funding as proposed in the modified status quo option
should be applied to roading. In principle, all projects with a benefit-cost ratio greater
than one should be undertaken. If a higher benchmark than this is applied, then either
decision makers do not believe the results of the benefit-cost analysis or projects that
would generate net benefits are being rejected.
The separation of the funding and provision of road services would
continue under the status quo. The paper does not discuss the implications of the
funder-provider split. A funder-provider split provides the greatest advantages when there
are competing providers but where direct billing of users is not feasible or is precluded
by government policies. The funder-provider split could be retained in the transition if
shadow tolling proves to a useful intermediate step. However, once direct user charging is
possible, it would not usually be relevant.
Business Model
The business model proposes that the roading providers adopt consistent
accounts and that a number of issues such as efficient pricing, the role of rates and tax
funding, the feasibility of shadow tolling, and congestion pricing be investigated.
All of the issues discussed under this option should be investigated
whatever option the Crown chooses. Given their importance, the government should embark on
detailed analysis as a matter of priority. The outcome of a review of these issues could
influence the reform model chosen or the timing of reform.
Other Options: Privatisation
Corporatisation is likely to provide substantial benefits once direct
billing is feasible. This option should be advanced at the appropriate time, whether or
not the further possible option of privatisation is considered. In our view, privatisation
would lock in initial gains in efficiency achieved through corporatisation and realise
significant additional gains.
Private owners are likely to be more effective at monitoring management
and better able to provide incentives for performance. Private investors put their own
wealth at risk when they invest in an organisation and therefore have better incentives to
monitor and take an active interest in the performance of a firm and its management. The
threat of takeover of a poorly performing private firm provides another constraint on
management performance. The opportunity of investing in a firm and improving performance
provides incentives for monitoring by potential investors. For listed companies, share
price performance provides strong feedback on the performance of management. Private
ownership also reduces the risk of political interference in the management of the firm.
Private ownership could also be encouraged by ensuring neutral treatment
of all operators and moving existing state-owned and local government road operators on to
a commercial footing. Private operators would be better able to fund new developments
through user charges in a competitively neutral commercial environment. Governments
frequently face capital constraints because of taxpayer and ratepayer resistance.
Franchising of roads (with the government retaining ownership) is another option for introducing private sector involvement. An examination of the implications of such an approach could be of value.
4. Summary
In summary, the Report recognises a number of important issues which we
believed were not adequately addressed in the previous discussion documents:
The Report acknowledges the importance of institutional arrangements in
providing road managers with incentives to operate efficiently and makes useful progress
in outlining options for institutional reform.
In our view, corporatisation would offer significant efficiency gains in
the longer term, with eventual privatisation likely to achieve the greatest benefits.
However, the benefits of corporatisation are likely to be smaller as long as direct
charging is not cost effective.
A commercial model based on shadow tolling might offer some benefits in
a transition to a commercial option.
Whatever option is chosen, the issues outlined under the business model
- that is, a review of efficient pricing, the role of rate and tax-based funding, shadow
tolling and so on - should be examined as soon as is practicable. The results of such a
study may influence the choice of reform option or the transition path.
Variants of the status quo are unattractive since they fail to address
problems with existing institutional arrangements.