Back to the future redux: the Argentinian infrastructure cycle

One of the dispiriting consequences of being an economist with a memory is to see troubled governments embark on a policy cycle with well-established consequences. This thought is prompted by the announcement by the Secretary of State for Transport that regulated train fares will be frozen until March 2027. The Secretary of State has the power to do this because unlike other regulated utilities the Department for Transport (DfT) acts as regulator for train franchises rather than the Office of Rail and Road (ORR), which is responsible for regulating Network Rail. In addition, most passenger rail franchises are now controlled by either the Department for Transport or devolved administrations, while all but two of the remaining private franchises will revert to public control in 2026.

Even though the public sector controls most passenger fares, it does not control operating costs. In addition to wages, the train operating companies are tied into leasing contracts that are usually index-linked. Network Rail is publicly owned but its charges are subject to a 5-year price control set by ORR that extends to 2029. Its charges could only be frozen if the Department or Scottish Government were to increase their grants to Network Rail.

So, what is the Argentinian infrastructure cycle? It is a dynamic pattern that has been repeated over the last century in several Latin American countries, of which Argentina is the most notorious. A country starts with a railway network or other type of infrastructure system managed by the private sector. Because of external pressures, either inflation or declining incomes, its customers become increasingly unhappy about the prices charged by the railway operator. Regulations are introduced to cap or reduce prices, but operating costs continue to rise, so the operator cuts back on maintenance and quality of service declines leading to ever greater pressure for lower prices and government intervention.

After a period, the private operator gives up or the government acts to nationalise its assets. Once transferred to the public sector, political pressures ensure that prices are kept low, but the government lacks the funds required to cover higher operating costs and to invest in improving the network’s assets and performance. After a further period, the government in turn gives up and finds a way of transferring the asset back to the private sector linked to promises of better performance and new investment. For a while, performance improves and there is investment in shiny new kit, until new economic pressures arise and the whole cycle starts again.

The cycle is a slow-moving disaster driven by a combination of external economic constraints, political pressures, and a consistent choice to sacrifice long term efficiency and investment to protect current users at the expense of future users and taxpayers. The glib explanation is that most governments are short-sighted – they will always give priority to the immediate concerns of the public. However, that cannot easily be reconciled with climate policies which rest on the argument that we should take money from the current generation to benefit people who will live 100 or 200 years from now, even though they are likely to be much better off than those who bear the costs today.

Instead, we should ask: who benefit from lowering rail prices in real terms, as well as who bear the costs? In Argentina – and other Latin American countries – the answer is clear. Such policies amount to a transfer from the rural and mining sectors, who bear the costs of poor rail performance for freight and bear much of the tax burden, to urban rail users who are primarily middle-class commuters. Even more narrowly, the primary beneficiaries are people living in the conurbation of Buenos Aires including the city (with a population of about 3 million) and surrounding areas (with a population of about 14 million). The conurbation accounts for over 98% of all passenger rail journeys in Argentina, even though most of the rail network was built to transport agricultural goods, minerals and other bulk freight.

The freeze on train fares in England only applies to regulated fares which are dominated by (a) season tickets, and (b) flexible tickets for travel in and around major cities. About 47% of total fare revenue is generated from trips within London and the South-East, while another 15% is generated from “regional” trips, i.e. largely for travel in and around major cities excluding London. Hence, the fare freeze is essentially a subsidy aimed at rail travellers around London and a few cities such as Manchester, Birmingham and Leeds. It will be paid either by other rail travellers, whose fares have not been frozen, and by taxpayers in the rest of the country.

Research in different countries, including by the Institute of Fiscal Studies for the UK, has consistently shown that rail subsidies are quite regressive. This is because high-income households tend to rely on peak rail travel, which receives high subsidies per journey, while low-income households tend to rely on buses, which receive much lower subsidies per journey. On average, the top income quintile in the UK travels nearly 5 times as much on rail and light rail as the lowest quintile.

In practice, freezing regulated rail fares – and urging government-controlled operators to apply the same freeze to unregulated fares – amounts to a bung of about £500 million to rail travellers in the London area and a small number of other metropolitan areas. Given the size of the UK’s fiscal deficit, the immediate impact is small. However, experience suggests that it is all too likely that the freeze will be extended, at least in part, for several years and that will start the rail network down the path of the Argentinian infrastructure cycle yet again.

The future will be determined by the inescapable constraints on public enterprises during recurrent fiscal crises. By taking the operating companies into the public sector, any options to keep capital spending off the public sheet have disappeared. Leasing contracts become just another addition to public debt. Raising fares to generate greater operating revenues just becomes another way of raising taxes. Hence, everything depends on where spending on operating, maintaining and replacing rail infrastructure ranks in the hierarchy of priorities competing for attention and scarce fiscal resources.

Except for those who believe in fantasies – this time things will be different – the future is easily foretold. Operating performance will decline, maintenance will be neglected, and infrastructure assets will deteriorate. There will be no dramatic collapse, but everything will slowly run into the sand, until someone comes along with new sources of funding and new mechanisms of control. That means starting the cycle all over again by bringing in private capital and management.

However, it is not enough to note the persistence of some kind of public-private infrastructure cycle. The proximate causes are not the same in each case, though the nature of railway assets – long lived and inflexible – plays an important role. In Argentina and other Latin American countries, a combination of severe economic crises and systemic economic mismanagement is a crucial factor. Economic crises lead to sharp declines in railway revenues, so private and public operators try to reduce costs by cutting services, deferring maintenance and stopping all new investment. Passengers see a reduction in service quality and demand lower real fares in compensation, which produces a downward cycle in revenues and spending. Governments do not have the resources to offset the loss in operating revenues, so the cycle leads to a progressive deterioration in the state of railway assets and operating performance.

The story in the UK is slightly different. The number of passenger journeys grew rapidly in the period from the mid-1990s from a low of 0.74 billion in 1994-95 to a high of 1.75 billion in 2018-19. After a large decline caused by the pandemic, the number of passenger journeys had recovered to the level of the late 2010s by 2024-25. The financial crisis from 2007 to 2009 had almost no effect on the number of passenger journeys.

The real change was that the franchising model for operating companies began to break down from the mid-2000s onwards. Most of the initial round of franchises were awarded for periods of 7 to 10 years with substantial subsidies. The Labour Government thought that on rebidding it could reduce costs by getting operating companies to pay franchise fees, usually as a rising share of revenues. It believed that it could manage the overall system better via a Strategic Rail Authority effectively controlled by DfT. None of this worked very well and the difficulties were exacerbated by the dreadful performance of Railtrack and then Network Rail in upgrading network assets. The government response was to take more direct control of the network, which simply proved that the DfT was completely incapable of competent strategic and network management.

Any judgement on the roughly 30-year period of private operation of passenger rail services must be extremely mixed. There were clear successes from the huge growth in passenger journeys, the introduction of new rolling stock, and the general improvement in the quality of services relative to operating performance under British Rail.[1] There were also clear failures, especially in the operation of commuter rail systems with a recalcitrant workforce and outdated rolling stock. Also, some new entrants made catastrophic errors in bidding for franchises, but in this they were encouraged by a combination of poorly designed bidding and contract terms plus shambolic management of the process by the DfT. The whole system was made worse by constant rejigging of franchise coverage.

There is little doubt that the rail operating companies became very unpopular in the last decade. This was blamed on privatisation, though to an outsider it seems that the companies were the designated victim of a combination of unrealistic expectations and lack of money. The original success of the franchises, especially in terms of the growth in passenger numbers, rested on a heavy injection of public funds to underwrite a large-scale replacement of rolling stock and upgrade infrastructure assets. Once tighter constraints on public spending were imposed, passengers were being asked to pay higher prices to reduce operating subsidies, while the investment in new assets required to cope with much higher traffic volumes could only be funded very slowly.

The franchise contracts were a classic example of British legalism. Lawyers – or the DfT – acted as though all issues could be dealt with in contract terms, so the contracts were over-prescriptive but gave power to the DfT to interfere in too much detail. The problem of labour relations was never sorted out. Short and insecure contracts reinforced by political inconsistency gave the operating companies no reason to bear the costs of resisting demands for higher wages or to invest in either human capital (training and better systems) or physical capital (rolling stock). In the last decade, the management of the network by the DfT and wider political system was an unmitigated mess.

Most countries have their own version of suicidal stupidity. Parts of the UK’s elite are heavily committed to the ruinous mismanagement of infrastructure. This leads to an overriding focus on questions like: how can we finance more investment in infrastructure and do it more quickly? However, clearly a part of the answer should be that we should ensure that our existing infrastructure assets should be managed better to improve utilisation and higher performance. The consistent focus on new capital spending at the expense of good management of and gradual improvements in existing assets should convince anyone that the prospects for turning the British ship of state are low.

I should note that the UK is not alone in this delusion. When I was working in Eastern Europe and the Former Soviet Union from 1985 to 1995, the first question we would get was: how can we finance some new project – factory, machinery, or other assets? When it was pointed out that many businesses in the US and Europe could produce much higher levels of output from similar assets to those already in place, the invariable answer was to insist that large amounts of new investment were required to transform the performance of the business under review.

In a sense, our counterparts were correct, though unrealistic about the funds available. The problem was that in focusing so heavily on the magic properties of new investment, the effective management of existing assets was neglected and so they deteriorated more quickly than would have occurred under different incentives. The infrastructure cycle in the UK will persist for as long as we fail to reward effective management of existing assets rather than focus constantly on the mirage of new investment in the (probably) distant future.

The HS2 fiasco in England was very largely prompted by the complete mismanagement of the West Coast Mainline electrification and upgrade project, which in turn was preceded by similar issues with the East Coast Mainline electrification project. Wise heads may shake and point to the age of the UK’s rail network. However, if you think about this argument for more a minute, the English network is only a little older than rail networks in the US, France, Germany, and other parts of Western Europe. Of course, there have been disastrous upgrade projects in many countries but the belief that the UK is somehow special is intellectual self-deception.

Finally, a question. Why are all the AGR nuclear reactors in the UK being retired when they reach an age of 40-45 years? It is routine to operate nuclear reactors elsewhere in the world for up to 60 years. Poor design, gold-plating of safety standards or deficient maintenance?

[1] Some rosy-eyed romantics dispute this assessment, claiming that British Rail could have done better with more money and modern rolling stock. However, few who experienced British Rail’s performance in its last two decades are so foolish.