LOOKING REALISTICALLY AT RAILWAY ECONOMICS

SYLVESTER DAMUS

In a series of articles in THE REVIEW these past several months we have suggested that the best contribution anybody can make towards devising a solution for the Argentine railway problem would be to establish what the demand price for passenger and goods services really is ( THE REVIEW, April 22, 1966, p. 80 ). Other aspects of the same approach were considered in two later articles (September 12 and October 31, 1966). It is probably time now to show that the demand price for rail services can be determined exactly and to indicate the statistical procedure by which this can be done.

Arising out of other related work at the University of Chicago, some preliminary estimates of the demand for goods transport (excluding livestock) by rail in Argentina were obtained. The results are -- as studies of this kind go -- quite satisfactory: It should be mentioned however that the demand equation obtained gives estimates of quantities demanded which fall within 10 per cent of the true values in only 84 per cent of all cases. This equation was computed as a function of the railway rate, national income, stock of road transport trucks available as an alternative to rail transport, and the costs which the rationing of services imposes on shippers. With these elements it is possible to ascertain and explain 74 per cent of all the changes recorded in the quantities demanded. Now, if we assume that there is no rationing, i.e., if we set the cost of waiting for wagons as equal to zero, we can estimate the prices that the railways could charge, consistent with a zero backlog and no reduction in the quantity of services supplied. The procedure is as simple as solving the equation for price and considering the quantity as equal to that actually supplied.

We have thus obtained the following quarterly estimates of the prices which the railways could have asked without losing traffic. In Table 1, P is the actual average revenue per ton-kilometre of goods (excluding livestock) obtained by the railways, and deflated by tfhe Central Bank's wholesale price index (1953=100) This P is the supply price. In the next column P* represents the demand price. It is the price which the railways could have asked without losing; traffic; it is the price at which rationing by decree is replaced by rationing operating through supply and demand.

TABLE I:

Using our estimates of demand prices, we can compute the total revenue from all goods traffic (excluding livestock) which the railways could have obtained in each year. These figures are as follows:

TABLE II:

The expenditure shown in Table II is that incurred by the railways in order to supply all goods transport including livestock and service traffic. It thus overestimates the expenditure necessary to obtain the revenues given in the third column, which exclude potential revenue from livestock traffic. We include these expenditure statistics only for their heuristic value.

In 1959/60, livestock produced, at the official prices, 725 million pesos. Adding these to the potential revenue at demand prices for all other traffic, we find that the railways' goods traffic could have yielded a small surplus of 100 million pesos, without even charging the livestock more than the supply price. Aso, note that from 1958/59 to 1959/60 the operating expenditure increased by 4,200 million pesos, while the potential revenue rose by at least (since we are not including livestock) 5,400 million pesos. This is a marginal surplus of 1,200 million pesos. The economy saved that amount since for 4,200 million pesos worth of resources it obtained additional services worth 5,400 million or more. Between 1958 and 1960 the railways did not waste resources but created 1,200 million pesos worth of them.

Two other conclusions follow from our demand equation. First, a one per cent increase in the stock of trucks will reduce the demand for railway transport by only 0.39 per cent, i.e., that for each additional truck added to those already on the road, the railways will lose only 24 tons por annum. To completely substitute thhe railways by roads we should need one million more trucks. In the last ten years, the number of trucks increased by only a quarter of a million. If national income should not increase, it would then take us forty years to completely substitute roads for railways. Second, the price elasticity of the demand for railway transport is only 0.596, i.e., if the railway rate is increased by one per cent, the quantity demanded falls by only 0.59 per cent. It is then possible to increase revenues by increasing tariffs, even in the absence of rationing. This is quite different from the current view that any tariff increase will bring about sharp reductions in output.

According to Ing. Guido Belzoni, "the decision to increase tariffs to balance higher expenditure must be made carefully. The only positive policy is to reduce costs." (R.R.P., June 22, 1966, p. 446). Of course the reduction in costs is the most desirable thing. Progress can only be ensured by reducing costs. But in a market economy, prices are not determined by costs alone, but by supply and demand. Our thesis is precisely that one should not be too careful in raising tariffs. Too much carefulness means rationing and deficits, and leads to a distorted view which induces the belief that there is, in fact, no room for raising tariffs. If a private firm has a deficit, it will decide that if it cannot raise its prices, it has to reduce costs or shut down. But this reasoning does not apply to the railways; the difference between the private firm and the railways being that the former does not ration its output, while the latter do.

The moral of all this is that one cannot serve two masters. One cannot subsidise shippers and at the same time expect an operating surplus. By trying both to have the cake and eat it we are getting into the position where we will achieve neither of these goals. It has become fashionable to demand the closure of so-called "uneconomical branch lines." Not only do branch line closures fail to reduce costs -- they only reduce total expenditures -- but if we continue with this policy of seting artificially low prices and closing every branch line which shows a deficit, we will soon have no more rilways through which to subsidise the shippers: We will get rid of the deficit, but we will also lose the medium through which we extended the subsidies. Who will then hand out the subsidies?

1. Source: Ministry of Transport, A Long Range Transportation Plan for Argentina, App. V, Table 13.