Governance in India's Public Transport Systems: Comparing Indian Railways and Airlines

SPECIAL ARTICLEEconomic & Political Weekly EPW july 12, 2008119This paper first appeared as the Indira Gandhi Institute of Development Research’s working paper no 2007-019. It was presented at the International Conference on Transportation System Studies (ICOTSS-2008), Bombay University, January 10-12, 2008. I thank S Sriraman for the invitation to write this paper, Kishore Kanjilal for discussions on Air India, Sudesh for comments on Indian Railways and T S Ananthi for help with the word processing.Ashima Goyal (ashima@igidr.ac.in) is with the Indira Gandhi Institute of Development Research, Mumbai.Governance in India’s Public Transport Systems: Comparing Indian Railways and AirlinesAshima GoyalThe paper examines the basic reasons and feasible remedies for organisational weakness in India’s public transport systems and the possible contribution of ownership, industry and management structure, leadership, social norms, and institutional incentives to alleviating the weaknesses. The arguments are illustrated with reference to the public rail and air services and help to understand why some public sector transport undertakings have performed better than others. The most effective changes are those that create incentives, broadly defined, for individuals to improve productivity.Systemic changes are required to improve the delivery of public services and the quality of public goods for the com-mon man. This is the single most pressing reform essential to fertilise all others. The experience with reform has clearly shown market failure exists along with government failure, espe-cially in the provision of public services. We will compare public rail and air services in India to explore the range of issues impacting pub-lic service provision and draw out some implications for policy.Williamson (1999) suggests the “remediableness criterion” – what is a feasible replacement for or modification of an inefficient organisation? He further defines “governance as the means by which order is accomplished in a relation in which potential conflict threatens to undo or upset opportunities to realise mutual gains” (ibid:312) thus lowering transaction costs. We search for this order in the context of the Indian transport sector, examining design elements that improve incentives for the deliv-ery of public services. Incentives are not just monetary but include mechanisms that motivate players to cooperate and com-pete at those margins that raise productivity.1 Rise in quality and decrease in the cost of public services have great potential for lowering inequality as the quality of life improves for the average citizen. 1 IntroductionBoth the public air and rail networks were created by nationalisa-tion of private lines. The state-owned Indian Airlines (IA) (largely domestic) and Air India (AI) (the international carrier) are under the ministry of civil aviation (these two companies have now been merged to form the National Aviation Company of India with the brand name Air India). With the repeal of the Air Corpo-rations Act in 1993 government monopoly was abolished. A number of private players entered. The number of aircraft in-creased three times in 10 years, although the number is still small by international standards. Some restrictions continue – foreign airlines cannot invest more than 49 per cent in any private India-based airline, the Airports Authority of India still largely controls most airports, and taxation and other charges are high by inter-national standards. There is now severe congestion at airports. Some private participation has occurred and expansion is ongoing. The government receives 50 per cent of the revenue collected in air travel. The market share of the new Air India has shrunk and it has gone deep into the red, despite advantages such as better airport space. Competition has reduced fares, innovation has raised the facilities and conveniences offered and no-frills air-lines are making it possible for a much larger population than

SPECIAL ARTICLEjuly 12, 2008 EPW Economic & Political Weekly120before to fly, a task the government airlines could not achieve [Wikipedia 2007].The Indian railway (IR) is a department of the government of India, managed by a railway board, under the railways’ ministry. After nationalisation of private and princely lines in 1951 the Indian railways has had a monopoly on rail transport. The network already largely covered the country at the time of independence, but carrying capacity has increased substantially in the period since. Both passenger and freight traffic increased about eight times, and train density doubled. But while the growth in freight traffic has been less than that of the gross domestic product (GDP), the increase in passenger traffic has far exceeded population growth, as mobility increased. For many years the railways have barely been covering operating expenses, and are dependent on government transfers for expenditures on maintenance, capacity expansion and upgradation for safety. Shortfall in capital ex-penditure is met by borrowings through the Railway Finance Corporation and budgetary transfers from the central govern-ment. The Indian railways also pay dividend to the central gov-ernment on capital-at-charge.2 Inefficiency, wage costs, populist cross-subsidisation (without attention to elasticity of demand) and inability to raise fares, contributed to this state of affairs. Remunerative freight traffic was over-priced compared to pas-senger fares and lost to competitors. Even so, it contributed 70 per cent of rail revenues and made profits compared to losses on passenger traffic. The highest-to-lowest passenger fare ratio was 14.4 in the late 1990s. Second class ordinary passengers were 71 per cent of the total passenger traffic but contributed to only 16 per cent of the revenue in 2003-04. Employment in the railways peaked at 1.6 million3 in the late 1990s, and provisions for pen-sions were about 20 per cent of the operating costs in 2005-06 [Gokarn 2007; Wikipedia 2007]. There has been some rationali-sation of freight and premium passenger fares. The IR has 16 zones further divided into divisions (67 in all) reporting to the board. Functional specialists report to their division heads. Re-structuring of departments and reorganisation along corporate lines would be helpful.The Present Set-UpUnder the current railway minister Lalu Prasad Yadav, appointed in 2004, rail finances have seen a turnaround with passenger and freight traffic and revenue rising with an operating ratio of 80 per cent and fund balance of Rs 20,000 crore in 2007. The pri-mary contribution has been from management innovations and better use of resources and new technology. Load limits for freight wagons were raised by 11 per cent, and turnaround times speeded up. There are attempts to structure like a corporation, even while fulfilling social responsibilities. Liberalisers generally push for privatisation and raising user charges. But partial priva-tisation, better utilisation of assets, and corporatisation or re-structuring of management are delivering results. The ideas were there, but someone to push and implement, seems to have made a difference. Among partial privatisation initiatives are outsourc-ing stations management, railway hospitals, allowing companies to run their own container trains, letting suburban trains run as separate companies, raise funds through and accept the discipline of markets. The management structure has been largely unchanged since independence. BothIR andAI are planning massive modernisation expendi-tures with a thrust on infrastructure – a modern freight corridor for IR, aircraft acquisition byAI, the largesse coming from the higher growth of the economy, improved demand and govern-ment finances.The formerIA also made a profit in 2003, after a loss the previ-ous year. But profits as a percentage of revenues were only 2.7 compared to 20.7 forIR in 2005-06 and its revenues were only 8.5 per cent of the IR revenues.4 The costs of the merger will be about Rs 1,000 crore. Productivity has plummeted with hectic lobbying at the ministry for reduced posts. IA was operating in a more competitive environment compared toIR yet IR has done better. IA had the opportunity to learn and adopt the best practices of its rivals, but did not. It has gone in the space of a few years from be-ing the monopoly player to not even being the dominant player.5 Neither ownership nor industry structure is able to explain these outcomes. Ownership was the same and IA was operating in a better market structure. It is true that the airline did not have full commercial freedom, there was no acquisition over 1999-2003 when private airlines were expanding, passenger service was poor, there was a shortage of pilots, fuel prices shot up but, other airlines and the railways did well in similar circumstances. We explore the other factors that matter. The structure of the paper is as follows. Section 2 examines the fundamental organisational weaknesses and feasible responses. The subsequent sections take up these responses one by one and analyse their performance as actual or suitability as potential re-form of Indian railways and airlines. Section 3 examines the con-tribution of varying degrees of ownership, the extent to which an activity should be in the public or in the private sector. Section 4 turns to the industry structure, Section 5 analyses the role of leaders and organisation norms, Section 6 looks at management reforms and individual incentives, Section 7 studies various pos-sibilities in the provision of institutional incentives and Section 8 makes a concluding assessment.2 Organisational Weaknesses and ResponsesContracts, which are bilateral coordination arrangements for market transactions, tend in general, to be incomplete because of bounded rationality. Opportunism makes them difficult to en-force. Although economic actors may not have perfect foresight, they have the capacity to look ahead and plan strategically. These features are the core of transaction cost economics [Williamson 1999], which says that alternative modes of governance differ with respect to incentive intensity, administrative controls and the contract law regime. Markets emphasise autonomy by the combination of high-powered incentives, few controls and legal-istic dispute settlement; hierarchy seeks to achieve cooperation through low-powered incentives, extensive controls and internal dispute resolution. Since contracts are incomplete, a variety of institutional fea-tures have evolved to enforce commitments.6 Renegotiations, laws, regulations, sanctions, private conflict resolution mechanisms, organisational forms and norms, all have a role in providing

SPECIAL ARTICLEEconomic & Political Weekly EPW july 12, 2008121therequired mix of commitment and flexibility. It is not possible to costlessly include unforeseen or unspecified contingencies in contracts, so the ex-post bargaining position is important. Residual rights of control, in uncontracted for circumstances, determine agents’ incentives. For example, either residual con-trol rights must be given to the party who makes a relationship specific investment or that party will underinvest. When such allocation of control is not possible, internalising the transac-tion can improve welfare. This is one of the justifications for theexistence of a firm. Under complete contracts, agents are induced to take appropri-ate discretionary actions and reveal their information. Control rights, however, cannot fully substitute for this mechanism. If con-trol rights are conferred on a single group, it may result in self-serving actions. Therefore control rights have to be carefully di-vided and civic society and other democratic pressures used. Su-pervisory or coercive mechanisms may be required to ensure that parties respect their commitments, but these should not restrict the flexibility required to ensure ex post optimal coordination. Dif-ferent transaction structures solve the coordination problem to different degrees. If complete contracts could be written public or private provision of public services would be equivalent. 3 Ownership: The DynamicsA number of factors affect the decision on whether an activity should be in the public or the private sector. Since modern tech-nology facilitates unbundling this is no longer an either or deci-sion – various degrees of privatisation are possible. A division between public and private based on first principles can improve outcomes.The prime motive for public ownership and control comes from externalities that the private sector would neglect in its decisions. In public transport in a poor country these include universal service obligations (USO). This is more relevant for rail as air was earlier regarded rather as a luxury good that should pay high taxes and contribute to cross subsidisation. Public ownership or at least regulation is essential to prevent potential exploitation of consumers, since network economies of scale give rail transport some features of a natural monopoly.Wherever multiple objectives have to be satisfied the public sec-tor is more likely to provide them. Incentives have to be low for bureaucrats to satisfy these multiple objectives, some of which are not measurable. High-powered incentives or residual control rights, for measurable performance targets, lead to a neglect of non-measurable aspects. Among non-incentivised tasks a public good provider has to satisfy is the inclusion of the poor, or the geo-graphically dispersed difficult to serve categories, and other USOs. The more specific the assets are to the particular service, own-ership and control should stay more with the public sector. The private sector would have an incentive to underinvest, since it is liable to “holdup” once it has invested in assets, which have no use elsewhere.Public sector provision should dominate, the greater the uncer-tainty affecting the quality and the more difficult it is to enforce quality standards or contract for quality. Public goods and services are often experience rather than search goods – only consuming reveals their quality. Contracts are incomplete for such goods because all dimensions of quality of service cannot be fully specified. The literature generally expects quality to be higher in the public sector because incentives to reduce costs and quality are too high for the private sector. Pricing and QualityTwo extremes in pricing rules have opposite effects on the incen-tives of a firm. With a price cap, incentives are high-powered since the residual profit share lies with the producer. The latter is motivated to decrease costs. Since rate of return regulation reim-burses the cost of the service, incentives are low-powered. Profits from improvements do not stay with the producer. Thus there is a trade-off between rent extraction and providing incentives for additional effort. With a low enough price cap the regulator extracts all rent, but incentives to invest and improve quality may fall. Since costs rise with quality low-powered incentives are required for the provision of quality.With residual control rights or under a price cap from a regulator the service provider would retain any profits made from a reduction in cost. Better accounting and more transparency makes price caps possible. Laffont (2005) argues that poor monitoring in developing countries limits the power of incen-tives that regulators can give public service providers. But technology is changing this. He advocates cost plus pricing initially in developing countries and a shift to price caps later as accountingimproves.In the public sector, although the bureaucrat-manager has poor incentives or control rights since he is transferable, the mission, reputation or career concerns, or political pressure may enforce quality service. Hart et al (1997) point out that while private pro-vision will always have lower costs than public, quality in private provision may be lower if quality requires higher costs but higher if quality increases with innovation. The latter is normally higher under private provision and is likely to be more important in some kinds of services. Private provision would be superior in cases where quality can be contracted for, or is insensitive to cost reduction, or opportunities for cost reduction are small. Private provision will also dominate if incentives for quality improve-ment are poor for public managers, or low quality is used as a means of rationing. What then explains the poor quality associated with provision of public sector services in India? Competitive populism in an era of political fragmentation did not allow user charges to rise after the 1970s oil price shocks. This effectively meant price caps were low. Even costs were not covered. This over-extraction of rent created a disincentive to invest and expand capacity. Even the sunk costs made for investment were expropriated. Low quality, delays and overcrowding, served as a rationing device helping target the poor, but made things worse as revenue sources found alternatives leaving only the subsidy burden. In railways, the revenue to cost ratio fell steadily from the early 1970s. The ratio of the public sector deflator to GDP deflator was below 100 since 1961, there was a sharp fall in 1973, some recovery, but in 2001 it was still 83 per cent of its level in 1961 [Nagaraj 2006]. The Indian railways were eating reserves: “All along the provision for

private competitors who are doing much better in these respects.9

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