Economics of privatization
Why government’s rationale for KORAIL’s privatization makes little sense?
By Chung Hee-hyung
Since late 2011, the Lee Myung-bak administration has pushed for the privatization of KORAIL, the state-owned railway operator. Privatization, so runs the government’s argument, would bring much needed efficiency to KORAIL’s lax management, lower ticket prices and improve the overall service of the railways.
Critics in turn contend that the administration’s scheme is nothing short of handing over the lucrative railway line ― built with billions of taxpayer’s won ― to the private sector at a fraction of its construction costs. They argue that the ostensibly all-efficient privatization would only mirror Britain’s infamous experience of railway decentralization from the 1990s.
Which rationale holds more truth? Would privatization under the “business-friendly” Lee administration be the panacea for all the problems of KORAIL, or would it herald more serious hitches at cost to its passengers?
An ambitious plan
The privatization scheme, first reported to President Lee last December, is comprised of two parts. Through competitive bidding, the first part of the plan would be to end exclusive operating rights on a rail service that runs approximately 60 kilometers from Suseo, southern Seoul, down to Pyongtaek of the southwestern Gyeonggi Province. These rights will be sold to a private operator. This line is scheduled for completion by 2015, with the commercial franchise set to span 15 years.
Secondly, KORAIL and a private company that obtains the right to share the operation of it will run a train service from Pyongtaek to both Mokpo and Busan, located respectively at the southwestern and southeastern ends of the country. Unlike the Suseo-Pyongtaek line, these two routes already exist and are currently operated by KORAIL.
The administration argues that letting both the private and the public sector share the two lines would “introduce competition” to the troublesome railway system that is in serious need of an overhaul.
However, critics point out that this seemingly innocuous phrase could be misleading. “The government is reluctant to use the term ‘privatization’ because public opinion is so unfavorable about this, and thus it has substituted ‘introducing competition’ to make it more palatable,” said Yun Sun-chul of Citizens’ Coalition of Economic Justice (CCEJ), a non-profit watchdog.
“The government’s scheme, however, still amounts to a de facto privatization, whatever label it attaches.”
The rationale of the government is best summed up in a report commissioned last September by the Ministry of Land, Transport and Maritime Affairs (MLTM) to examine the feasibility of privatizing the country’s rail network.
The report, completed by the state-sponsored Korea Transport Institute (KOTI), calculated that the privatization would bring a 20 percent reduction in fares while cutting down on state subsidies necessary to sustain the rail network.
It also confidently declared that the infusion of fresh investment and dynamic management from the private sector would resuscitate the dying public railway. Unfortunately, KOTI has less than a stellar record when it comes to projecting the extent of benefits that privatization would supposedly bring about.
Back in 1999, KOTI then predicted that the number of passengers per day using the commuter train running from Incheon International Airport to Seoul would be 210,000 in its first year of operation.
The actual figure turned out to be less than 17,000 for two years. The route was bleeding with deficit, and the government was eventually forced to buy back the railway line from Hyundai Engineering & Construction. So great was the gap between the institute’s estimate and the real number that the Prosecutors’ Office suspected bribery and put the author of the report under criminal investigation.
KOTI made another spectacular miscalculation when it forecast back in 2003 that the Busan-Gimhae Light Rail Transit would transport 170,000 commuters per day. In fact, less than one-fiftieth of that number used the train.
But the government is apparently unperturbed by KOTI’s disastrous past predictions. The MLTM, the government agency in overall charge of pushing through KORAIL’s privatization, still cites almost verbatim the institute’s report last year.
“Introducing private sector to the rail network would increase competitiveness, lessen the abuse of monopoly and improve management efficiency, all of which would benefit customers in the end,” noted Bae Seok-joo of the MLTM.
Why privatization is less than meets the eye?
However, critics are quick to point out numerous flaws in the ministry’s argument. The first pertains to the Suseo-Pyongtaek line itself. Why is the private sector, critics charge, only interested in the most lucrative part of the entire rail network while neglecting other unprofitable routes which are in dire need of investment?
“The Suseo-Pyongtaek line is a goose that will always lay golden eggs,” said Lee Young-ik, chairman of Korean Railway Workers’ Union (KRWU) at a press briefing in April. “Why sell a goose to the private sector which never took part in feeding it?”
Critics point out that it is not difficult to see why corporations are tempted by the government’s offer. The route is expected to bring a 20 percent profit margin to its operator with virtually no risk of outside competition or loss of market.
Moreover, the winner does not even have to purchase the train that will run on the rail line. The state-owned Korea Rail Network Authority (KRNA), which is responsible for the maintenance of the country’s entire rail network, will buy the trains instead and lease it to private enterprise.
In a rebuttal, the MLTM says that whichever private company wins operating rights will be subject to terms more stringent than that of KORAIL. “The winner is obliged to reduce the current fare by 10 percent, and make additional annual payments for using the route, more than its public counterpart,” states the ministry’s press release.
Lee Eui-young, professor of Economics at Gunsan National University, disagrees. “If the government is really concerned about the fare, it could simply force KORAIL to reduce it. After all, it is a state-owned company.”
Lee also said that privatization is unlikely to bring the fare down. “Whoever wins the operating franchise will make numerous excuses, such as a large-scale deficit, in order to raise the fare after running the line for only a couple of years.”
Crucially, the professor pointed out that all of the talking about reducing the price misses the point. “The Suseo-Pyongtaek line is an express train, and its passengers are willing to pay extra money in exchange for saving time. Even if privatization brings about a reduction in price, as the government claims, it is not very likely to attract more passengers.”
In turn, the ministry refutes the argument that it should pay more attention to privatizing less profitable lines if it is truly concerned with improving the efficiency of the rail network. The government is selling the Suseo-Pyongtaek line first, according to the MLTM, since introducing competition to unprofitable routes could potentially lead to massive lay-offs once private enterprises take charge of them.
“It is much easier to sell a franchise of a newly-built line, because the private operator does not have to wrestle with personnel who were formerly employed by the state,” said Bae of the MLTM. Moreover, the government would eventually sell operating rights for unprofitable routes as well, Bae added.
“Bidders who ask for the least amount of state subsidies would get the franchise to run those lines,” he explained.
Most of all, KORAIL is accused of various forms of mismanagement. It is burdened with more than $80 billion of debts. Its trains often don’t arrive on time and it even made front line news when several high-profile accidents last year caught the public’s attention. Only by introducing competition into the unwieldy rail network, the government contends, will the public company be prodded into embarking upon self-reform.
“For every kilometer of rail, KORAIL has more maintenance personnel than any other country in the world,” stated MLTM’s comprehensive review of the rail operator released on June 11.
The public company has 10 maintenance staff for each kilometer, the review pointed out, while Germany and Japan employ seven and France a mere six. In other words, KORAIL needs 60 percent more workers than France to maintain the same length of railway.
However, there are other facts that the government does not point out. KORAIL does have a large amount of debt, but mostly because it has to pay interest on government bonds issued to furnish the building costs of the country’s rail network. The KTX, the high-speed rail system operated by KORAIL, actually recorded operating profits in 2009 and 2010 excluding the payment for construction cost.
Yun of CCEJ attacks the very assumption of the government’s argument: “If KORAIL is indeed riddled with inefficient management, as the administration claims, it should also bear at least partial responsibility because the company is 100 percent backed by the state.”
“But the real problem is that one cannot judge KORAIL on efficiency alone. Its main goal is to provide a convenient means of transportation to passengers at a reasonable rate, not maximizing profit.”
Britain’s wrecked privatization
The example of rail privatization in Britain is a sobering lesson for anyone who is contemplating the same idea. Although many countries let the private sector run their rail networks, Britain’s privatization is the best model of what can happen after the process is completed. It is the most salient example of complete decentralization of a government-owned rail network, watchers say.
The privatization of Britain’s rail network was originally considered during Margaret Thatcher’s term of office, but the idea built up a full head of steam when John Major became prime minister in 1990 of a successive Conservative government. The Railway Act of 1993 called for a dismantling of the state-owned British Rail into 100 separate private companies, including 25 passenger train operators called TOCs (Train Operating Companies).
Just as the Korean MLTM is putting the operating rights of the Suseo-Pyeongtaek rail route out to tender by private enterprise, an umbrella group of companies called Railtrack doled out similar franchises to regional TOCs. The company was also charged with the overall maintenance of the country’s rail network, leaving the task of ferrying passengers to train operators.
The result was an unmitigated failure, and the Economist called it “a catalogue of political cynicism, managerial incompetence and financial opportunism.” Labor Transport Minister John Prescott scorned the privatized railway system as a “national disaster,” and John Major did not even mention it in his autobiography.
There was no shortage on the list of problems. The state assumed that the rail network would require fewer state subsidies as privately run railways would improve its balance sheet. The result was precisely the opposite, and the network cost four times the amount it did under British Rail.
Moreover, the McKinsey consultancy recommended a “patch and mend” approach to Railtrack in lieu of bold investment plans originally envisaged by the company, putting the safety of passengers secondary to profit. As a result, the rail network suffered from poor maintenance, and the Hatfield rail crash in 2000 that claimed the lives of four people put an end to Railtrack’s short life. The company was eventually liquidated and replaced by Network Rail.
The successor to Railtrack is still technically a private enterprise, but the government is essentially a de facto underwriter of its debt. Such was the degree of control wielded by the government over Network Rail that The Guardian newspaper called it “nationalization in all but name.”