Saturday, December 17, 2005

On transportation

Kway Teow man has posted his opinions on Singapore's transportation system. I would like to take a closer look at his policy suggestions. While his recommendations are socialistic in nature and really does care for the underprivileged in our society, there are economic drawbacks.

(1) Monopolies are allocatively and productively inefficient.

He clearly understood that concept, and thought that nationalisation is the answer. He rightly point out that the burden will fall on taxpayers, but not just initially. It will continue to be a burden on tax payers. His goal of nationalisation is to force the monopoly to produce where price = Marginal Cost, and quantity is at minimum average total cost. That is not possible. At P=MC, demand at that price is way higher. And at min. ATC (the productively efficient point), the price is higher than P=MC price (the allocatively efficient point).

Let's say we don't care about productive efficiency, since it focuses more on the firm than consumers (forcing a monopoly to operate at that point also creates a loss). Let's say we look allocative efficiency where consumers. This is where opportunity cost to produce the marginal unit equals to the cost consumers are willing to pay for that unit. If the monopoly is forced to produce at P=MC. This means that the monopoly is going to operate at a loss. Total revenue < Total cost. This is where the tax payers come in again. Tax payers have to pay for the bus service whether they take it or not. That's hardly as fair as the current system. Now everyone, not just public transport users, have to pay for the system.

Ok. So we produce at higher quantities and lower prices at either of the two points, but let's say people cannot stomach paying for public transport through taxes. So we try to produce where the firm breaks even, or where marginal revenue = marginal cost, then the price will be far lowers than its allocatively efficient point, but the quantity will continue to be at the level before the nationalisation. That's your break even point. Doesn't solve anything because at that Price, demand is more than the quantity supplied. So there's a shortage. And a black market may open up to meet the demand.

There is almost no good way to regulate a monopoly. At least not from the economic stand point. The only thing I can think of is a profits tax. Which adds to nothing, but it does take away incentive to invest in the future, but for transport monopolies in Singapore, it's ok, since the government invests in improvements. The firm can also be forced to update equipment by law or regulation, as it does with taxis.

(2) Not raising or reducing consumption tax

That sounds like a good idea. Consumption taxes usually affect the poor more than the rich since the cost of fixed spending increases proportionally higher in poor household, than in rich households.

Let's say that society accepts government run, subsidised transportation, through taxation. If consumption tax is not moved, we have to pay for it somehow. A rise in income tax is another way to do it. Corporate taxes should not be raised simply because this would discourage businesses in an already weak economy. So income tax it is. This means raising the income tax. A rise in income tax means that consumption goes down. This is because there is less money to spend now that it is being taxed. Along with the multiplier effect, consumption and investment could go down. This affects the overall GDP. Y= C + I + G + NX. Y = economy, C = consumption, I = investment, G = government spending, NX = net exports.

Let's say the government decides not to raise taxes, but sell bonds to raise money. Unlike US t-bills and t-notes, Singapore's government bonds are not as enticing as US government bonds. Which means we can only sell so much. There are a few problems with that. Assume that all our bonds are snapped up. This could lead to a "crowding out" effect. Where private firms cannot raise capital to invest, since a large sum of the private money is going to the government. It also means a rise in capital inflow, currently Singapore has a capital account deficit, of $22 million. I suspect maintaining a bus system would require another 5 to 6 million at least. So this means that our capital account deficit will be reduced.

Before you go cheering at a reduction in deficit, it also means that our current account balance surplus will be reduced by that much. It means we export less or import more. If that doesn't happen then it means that our foreign exchange assests is set to fall even more. Which means drawing from our reserves.

(3) Individual licences for taxis

I agree with you. I would argue going a step further. Abolish cab companies. This would create a near perfect competition market. It would have a large number of buyers and sellers, homogenuous product (travel in a taxi is more or less homogenous), perfect information (no advertising), and negligible barriers to entry (a driving license and a license to operate a taxi and cost of taxi). This produces both allocative and productive efficiencies. Too wonderful. The only problem is no economic profits in the long run (there might still be accounting profits) for the taxi drivers. As long as the requirement to obtain a taxi is kept to the minimum and we hand out as many licenses as demanded, the market would regulate itself. This could mean alot more taxis or a lot less taxis on the road, but it is a good model.

The problem with a dual structure with a few large firms and many small ones (individual owners) is that the big firms will lower prices to the point that the small firms are priced out (economies of scale let them do that), which benefits the consumer in the short run. The long run is that once all these small firms are no longer a threat to the large firms, prices return to their high levels. Worst if the taxi companies are in collusion. Nothing like some small fish to make the big ones work together to protect their interests.

Another senario could be one of price leadership. The biggest firm basically becomes a price leader, and everyone follows. This is usually because of uncertainty, which is what many small firms could cause to the market. In then end, they all agree that one firm set prices and the rest follow. It'll help the taxi drivers but not us the consumers.

In the oligopoly model, regulation could get somewhat complicated. The regulator could make it so that barriers to entry are too high for potential entrants. I mean the regulator might not be colluding with the oligopolies, but it could ask for better safety standards, safe driving records, low prices to help consumers, annual barrage of inspections, license renewal every year, new car every 10 years, only certain types of cars to be used and so on. It's not to help the established firms, but to have some safety and to help the consumer.

Yes KT man, this is my analysis of your proposals. I would commend you for making them, but there are some areas you failed to analyze when you made those proposals. I know my analysis is economically based and it reveals sort of my biases. For those not in the know, I am a Liberal in the traditional sense. Free market, limited government intervention in the market, and all that good stuff.

There is no good way to counter monopoly power in my opinion, regulation can only go so far. A Profit tax is my answer. That works best in my opinion. That may bug the shareholders, but if they're not happy, they can sell the shares.

Keeping consumption tax low is good, in my opinion. That does mean the the government has to raise revenue elsewhere. If your proposal to nationalise all transportation is to take place, we'll have to pay somehow. There are pitfalls to other forms of revenue collection.

Individual licences all around. Totally abolish cab companies. In fact regulate so that none may form. A perfect competition market? That would be my dream come true.

That's it. I hope you don't take this as me knocking you, just looking at your proposals and dissecting them. Helps us both understand the situation better.

Related links: Molly Meek


At 2:24 PM, Blogger kwayteowman said...

Thanks for commenting on my proposals.

I believe that you have some misconceptions about my proposals and some holes in your logic.

First, let's talk about the transportation system as a natural monopoly. If you read your Econs texts, you will realise that natural monopolies are a little different from the regular market monopolies.

Your claim that if I cap prices, demand will go up is true only if the demand is elastic. You think that the demand for public transportation is elastic?

Just because it's cheaper to take buses or the MRT, people will take joyrides for fun? I have my doubts.

You referred to a black market. I have no idea what that means in terms of public transport.

Let's look at the problem from a macro perspective. Like it or not, transportation costs will rise and the people will have to pay for it.

Whether they pay for it directly by paying fares or whether they pay taxes and then Government subsidizes is immaterial.

My key point is that I believe that there are merits in keeping public transport costs low (perhaps even artificially below the operational costs) because (i) the lower income people are apparently struggling to cope with rising costs and (ii) I believe that keeping the cost of living low will boost our long term competitiveness.

You rightly pointed out that there are long term costs and you also rightly pointed out that it's a socialist proposal, i.e. the rich who don't take public transport will probably end up subsidizing the poor.

The tradeoff here is that perhaps it will benefit the rich indirectly by improving competitivness.

To be honest, I haven't spent very much time analysing if what I'm saying completely makes sense. It's really just a random attempt to try to be radical. I'm quite happy to be proven wrong, but I do not think you have succeeded in doing so with your above argument.

Your claim that there is no good way to regulate natural monopolies somewhat audacious. :-) There are textbooks on this topic and I studied one for a whole semester many many years ago and we only covered perhaps 30% of the book.

Yes, it's hard to do it right, but I don't think it's impossible.

You completely missed my point about consumption tax. I said that I agreed with a consumption tax.

I was only suggesting that necessities like food, milk and perhaps diapers be exempt. You will continue to pay GST for everything else, perhaps at an even higher rate in the future.

Two points: (i) necessities are rather cheap and thus do not contribute much to the Government coffers at present anyway; and (ii) the lower income people are struggling. I am suggesting that we help them cope and, like I said before, contain costs and rein in the cost of living, with a hope that it may help us become more competitive in the long term.

Let me digress for a moment and highlight that one of my key proposals is also to help the poor in an indirect way by containing costs, rather than giving handouts.

I suspect that we can achieve the same net effect either way, but I think (at least for now) that the former is a better approach economically.

Politically, the latter might score more points, but I am not altogether certain and my preference is to withhold judgment for now.

Clearly if we lose some tax revenue by eliminating GST on necessities, there may be a shortfall (which I believe will be small) in tax revenues.

There's really no need for the Government to sell bonds. There are many creative ways to do progressive taxation. Cutting some fat from Mindef is also a possibility.

I believe Government bonds are in fact very attractive to institutional investors. Our main problem is that we have no need to borrow and pay interest.

From my understanding, the Government issued some bonds in recent times not because of a need to borrow, but mainly to give the local bond market a shot in the arm.

I have no love for taxi companies and I do not find your proposal to ban taxi companies particularly disagreeable. I cannot however agree with your economic arguments.

I am of the opinion that it's unnecessary 'cos as long as we remove barriers to entry for individual drivers, i.e. by issuing them licences, we can let the market deal with any efficiencies.

Your point about taxi companies lowering prices to price out the individual drivers is a naive in my opinion.

The reasoning is very simple: the taxi companies still need taxi drivers. They also need to give a fat cheque to the CEO and provide reasonable returns to their shareholders.

The individual drivers do not have these overheads. If you ask me, the odds very much favour of the individual drivers and probably allows them to do predatory pricing to price out the companies, and not the other way around.

Learning economic concepts from a textbook is one thing. Applying it to real life situations is a little different.

I like robust discussions. I hope that my above points are not too robust for your taste.

Thanks for your feedback. I'm happy to continue to engage you on this topic. :-)

At 2:50 PM, Blogger The Legal Janitor said...

just some comments.

I don't believe that public transport is a natural monopoly. I would argue that it is an artificial monopoly.

Government licensing is probably the highest barrier of all. It should not be surprising that all present public transport companies have some sort of link to the government.

The definition of the 'market' also warrants attention. I would argue that buses, taxis and the MRT are all substitutes, or can be, if they were not owned by the same companies. And in Singapore's context, the only reason why the same companies own the same infrastructure is again, due to government intervention. I would argue that public transport can be alot more competitive than the state allows, which is why the price is rising all the time.

If the chief barrier to entry, licensing, is removed, I believe that entrants to the market would easily push prices down again.

And to KT Man's question regarding black market in public transport, have you ever been to a foreign country where some person driving an unmarked car suddenly stops and asks if you want to take a ride to some destination for a fixed price? That's the black market in public transport for you.

The existence of such a black market indicates that production is below market demand, and that the production is artificially suppressed. Again I point the finger at government licensing. I would also argue that such withholding of licenses usually indicate lobbying on the part of incumbents, so that they may continue extracting monopoly rents.

The best solution is for the government to stay out of business.

At 2:57 PM, Blogger kwayteowman said...

Shianux, excellent points. I agree with you. :-)

At 3:06 PM, Blogger kwayteowman said...

One quick comment. It's really not in the taxpayer's interest for the bus companies and taxis to compete with the MRT actually.

Why? 'cos it cost us a lot of money to build the darn thing and it's the taxpayers who paid for it. In order to make the capital outlay worth it, we need it to be used.

In fact, I was suggesting that it may even be in our interest to have the Government use subsidies to keep MRT fares artificially low.

Public transportation is quite a complicated inter-connected system in more ways that one -- but that's also what makes it interesting.

At 3:45 PM, Blogger The Legal Janitor said...

KT Man:

Yes, I agree. In fact I think there is an entire branch of economics devoted to public transport and its network effects. Very specialised. heh.

I would like to make an additional point about taxis though.

I pondered over the taxi industry and I realised why firms are inevitable and perfect competition amongst individual operators is an unlikely market outcome.

Information search costs.

Imagine if you were a passenger about to take a taxi. you have 2 choices. One is a 'firm' taxi, which has a standardised formula for calculated fares; the other is an individual operator, and you have no idea how much that person will charge unless you ask.

Which will people be more likely to choose? Simply put, hundreds of individual operators all with their own fare structure is too confusing and too complex for the average consumers. It is too troublesome for each passenger to calculate and decide which fare structure is the most value for money.

Even if each individual operator finds some way to display their rates prominently, it still doesn't change the fact that it would be too difficult to calculate which fare is best for themselves.

I would argue that in the end most passengers would end up taking only 'firm' taxis as the fare structure would be standard across all taxis from the same firm. Thus, passengers can easily compare the fare structures between different firms.

If we take the 'free license' model, which allows for any firm to enter the market, we can still say that a proliferation of firms would not overly complicate the matters. 5, 10 or even 20 firms would still be easier to calculate than hundreds of individual operators.

One possible way for individual operators to get around this informationc complexity would be to adopt a fixed rate fare structure. Meaning to say, junk the meter, and instead use a fixed fee that's based on region, say, from this area to another area will be set at $10, $15 or $20. That way complexity would be reduced, and the fares can be easily displayed by the taxis, and easily compared by passengers between firms and individual operators.

Sorry for the long ramble, just some points. =)

At 3:52 PM, Blogger The Legal Janitor said...

oh and last point, if we have a 'free license' model for taxis, say even if we end up having 30 firms or more, we can still set up a website that incorporates their fare structures and calculates their costs for passengers so that they may decide which choice is best for them.

This particular solution would be quite impossible if there are hundreds of different fare structures.


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