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Time For Change And The Economics Of Rail In New Zealand

Much has been written about the financial performance of Rail in New Zealand over the past few years but few seem to understand, at least from the writer’s perspective, the true economics, or dare I say it the bigger picture of Rail in the broader economy and in the socio / political environment. This post is about the former, the broader economic  justification for Rail in the macro sense.
 
In reading the Productivity Commissions draft report on New Zealand “International Freight Transport Services”, released this week, it struck me that once again there was a challenge as to the wisdom of further major Rail investment in New Zealand. This is quite a widely held view of academic economists and ex Treasury officials in New Zealand and is a matter of the public record. It is also not surprising as one David Heatley has written much on Rail economics in New Zealand (see below) and he is also a key advisor to the Commission. David does seem to be trying to make a point somewhere here about Rail viability.
 
It may not be widely known by the Public but in 1988/89 the New Zealand Governments Treasury went as far as recommending the complete closure of the nations entire railway system. It was only the valiant efforts of the NZRC Board and Railways management at the time that saved the day for Rail in New Zealand. Together with a somewhat sympathetic  Minister of Railways, by the name of Richard Prebble.  Treasury maintained this view well into the 1990’s and off -loading this “liability” business played a big part in the decision to privatise Rail that was to follow a few short years later. Basically if we can’t close it lets sell it! I will write more about this history in due course and what lead to that view and conclusion but back to the present.
 
More recently a strong view is still held by certain interests that a wholesale closure of parts, or even all, of the current network is desirable. What is interesting is that this is a view held by otherwise broadly well informed, intelligent observers rather than the users of the Railway system, the public or the politicians.
 
Big companies like Fonterra, Solid Energy, the nations major export ports such as Port of Tauranga, freight forwarders such Mainfreight and Toll, the forestry industries are keen supporters of Rail and lobby the Government for investment in Rail assets and upgrades. What is it they see that the academic, research fellows and ex Treasury officials don’t seem to see? Is it just big business promoting its own self interest as some might say? That they see a way of getting cheap freight rates below economic costs at the cost of taxpayer investment? Thank you Mr Taxpayer! Or is it more about broader economic comparative advantage and lowering supply chain costs in order to make our supply chain to the worlds markets for our produce cheaper than our international competitors?  So that in turn we export more produce overseas and therefore have a higher GDP for the good of the nation’s economic prosperity overall? The truth most likely is that it is a combination of these factors. It is good for their business’s growth but also a way of subsidising their transport costs through government intervention by public investment of taxpayers money in Rail. This in turn leads to a stronger export lead economy and a higher profit for those businesses and a better performing New Zealand overall from which we all benefit. In a pure efficient market this may sound like a nonsense, but other countries we compete against do it so we seem to be forced into a corner.
 
It seems Rail in its history has so often been wedged into this somewhat uncomfortable position itself as it is in many other parts of the world. New Zealand at large, it would seem, should generally benefit from these investments in Rail infrastructure much like it does in Roads.  But many struggle to see the public good in Rail that they can easily see in Roads because Rail is more of a closed system not open to causal users like the Roads. Only the Rail operating company has access to the tracks. When it comes to Roads everyone seems to be a socialist as it enables us all to put our “snout in the trough”.
 
Surely we have got past the Road vs. Rail arguments in 2012. Where the more neo classical academic economists seem to struggle is the allocative efficiency of this “intervention” in the freight market by the Government and the investment of scare public funds in Rail. It is after all a more Keynesian approach and the Government trying to help pick winners. Pity for Coastal Shipping as they currently seem to, unfairly, miss out on any of these economic welfare transfer payments - except maybe the local body owned Ports. Welfare economics has always been a difficult area for these types of investments – it sees these “welfare transfer payments” to Rail as having lots of economic leakage and waste. But what is your choice?  Is there a welfare gain or loss from the investment in Rail? Someone needs to do the “Gods work” on this. Certainly if we are just talking about the market for Railfreight you could say that over the last 30 years the private and public provision of this market for Railfreight services has failed for the Rail business, and its markets for that matter.
 
An interesting view on this failure is a report by Ross Clark, Rail Performance Manager for Transport, Scotland. Ross used to work in the Rail sector in New Zealand and is more qualified than most to form a view. His report makes a very interesting read. It can be found at the following links.
 
 
 
Another very interesting, insightful and well researched paper was released by David Heatley from ICSR. David's, now advising the Productivity Commission, paper was released in 2009 is titled “The History and future Of Rail in New Zealand” . It is hard to fault much of David’s analysis and it is generally a good piece of well researched work. It covers the history well, at least from an economic view. However it does get a few things wrong. For example the lines south of Christchurch are perhaps some of the best Rail in New Zealand outside the Golden Triangle of Auckland - Hamilton - Tauranga. Fonterra traffic has been exploding down there. It is very debatable if Fonterra would be as viable in the South Island in the way it is without the important rail transport links from the Edendale factory or even the Clandeboye (not directly rail served but served from the nearby Temuka Railhead). Then there are the freezing works for export meat at Mataura,  Finegand etc, the forestry fibre plants, the coal from Nightcaps, the Gold Slurry to Palmerston to name a few major traffics.  Also missing from his work is much commentary on the larger strategic reasons why Rail exists in New Zealand. But from a simple micro economic point of view on Rail in isolation his work is hard to fault. The facts are there. Read it and form your own views. The report can be found at the link below:
 
 
Another piece of work is by Luke Malpass from the Centre for Independent Studies.  In his report titled  ”KiwiRail: Doomed to Fail?” Luke made some interesting points also and his work has much in common with David’s. But I don't believe he fully appreciates the nature of the broader NZ Railways business well enough to draw the rather dire conclusions he does. He seems to start from the proposition that Rail is and always will be failure in New Zealand. He needs to talk to the customers of Rail and have another look at his work to form a more balanced view. To suggest as he does that much or even most of the network should be closed down and the land sold off would seem indeed to be act of national, if not broader economic, vandalism. However as stated some of what he says is accurate and again it is a welcome addition to the debate. As stated he does have some questions that need to be addressed and answered by the industry. His report can be found at the link below.
 
 
It is not the intention of this blog to criticise out of hand such reports but to critically examine them. As I have stated they have many valid points and in my view are a welcome addition to the debate to tease out once and for all these issues of Rail viability. I will have more to say on this in due course.
 
Some will say this debate shouldn’t happen – having a national Railways in New Zealand is a given. I don’t agree. Rail like everything in society should continually justify its existence particularly as the world is changing so fast. Debate is to be encouraged. There is still much confusion as to what the purpose of the general Rail network in New Zealand is and in my view this doubt places Rails future in peril.
 
The Regional Councils by taking effective "ownership" and responsibility of the nations urban Rail assets, if not literally the rail itself and below infrastructure yet, have at least for now resolved that issue for urban Rail assets and investment.  Kiwi Rail needs to get on with doing that with the rest of the national network. It is not just about commercial sustainability for it was the Network should have probably been closed in 1989 as Treasury suggested. There are much bigger issues at play and it will take some bravery on the part of Rail Stakeholders to finally admit this in due course.
 
If you suggest otherwise you just need to look at the proposed write down of Kiwi Rail operating assets (non land) values from around $6 Billion to around $1 Billion. From a commercial view point that may make sense in a valuation sense as that is the value of the commercial asset base that the Rail “commercial business” can support via a simple commercial ROI calculation. But clearly the assets can’t be perpetuated at that written down value unless you go to a Pay as you go (PAY GO) approach for capital where all such expense is expensed to the P&L at time of purchase. This would instantly kill the commercial businesses profitability of the business in one hit. Goodness they are spending close to $400 million outside of Metro Rail capex a year and long range average capital is not that much lower than that for a viable network for above and below Rail assets if it to remain up to date in perpetual state. Are they going to have a several $Billion asset write off every few years in order to keep asset values at a level that can sustain a reasonable cost of capital economic return?  This sure would be ammunition to close the business. We have been here before as David and Luke point out.
 
Much to date has been achieved by KiwiRail but make no mistake they need to do a lot more in selling their case for the current National network sustainability. To date they have largely been silent on what they contribute to New Zealand in the broader sense, outside the narrow commercial model purpose, to justify their existence and in particular the large investments of new public money in the business Turnaround.  A new fairer way will need to be found to look at the Rail investment in New Zealand if it is to be sustained. A simple narrow commercial sustainability criteria for the national network is unlikely to be sufficient to sustain all of it. It would be simple if it were but life is hardly simple when it comes to Rail.  
 
Our network traffic density in a country of under 5 Million people, with barely 15 Million tonnes of current railfreight with average haul length of around 300 km on offer, over 4000 km of network (track density average barely a 1 Milllion tonnes a kilometre!) through tough difficult terrain split by a rough Cook Strait is too low for commercial sustainability of any quality railway anywhere. Even doubling the tonnage would likely be too low by any sort of international comparison. Anway, how would they do that without drastically reducing freight rates to gain market share and be competitive? Freight rates need to rise on the back of better service propositions not lower in a race to the bottom. 
 
However this doesn’t mean it should close for if it did, then surely most of our Road networks and towns across the nation should close also and the nation would ultimately be the poorer for it. The externalities need to be examined and are likely much broader than generally supposed when one looks at the broader GDP effects outlined above resulting from a more internationally competitive supply chain that goes with having a high capacity transport system such as Rail can and does provide. It goes without saying of course that Rail should be as effiicient as it can be. A lot of work remains to be done there and KiwI Rail are, commendably, getting on with that good work but much remains to be done.
 
The world is changing. Markets are changing. Supply chains are changing. Global warming is now.  Peak Oil is close. New technology such as ultra-fast broadband is becoming widespread changing transport patterns. Trade and economic allegiances are changing. Transport technology is changing. It is not just about a narrow view of Commercial sustainability anymore. If it is, as stated the future is indeed rather bleak for our national Rail system. Moving towards that nirvana is right and good but in itself is unlikely to be enough to sustain it.  It is as Trevor Hayward, former General Manager of NZ Railways, said back in 1979 a “Time for Change” in the way we look at our national Rail network.
 

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