Article - Issue 11, February 2002

Engineering London Transport's future

Robert R Kiley

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For many years the London Tube was regarded as one of the best underground systems in the world. In recent years this has not been the case. Robert Kiley looks at the most pressing challenge facing his organisation: how do we best restore the London Underground to its rightful place as the world standard for urban rapid transit?

As someone who has devoted much of his working life to delivering urban transport services, I can assure you that the Tube – until relatively recently – was perceived by transit professionals worldwide as the standard of excellence. That is certainly not so today. But the Tube does retain a solid human and physical infrastructure that can, with the right leadership, management and investment, again lead the world and, most importantly, serve the London community. I came here to help that happen. But I must also acknowledge that the first year of my term as Commissioner for Transport has hardly gone the way I had hoped. Nonetheless I still believe – particularly in light of recent events – that the job can be done.

The Royal Academy of Engineering, in evidence submitted to the House of Commons Transport Sub-Committee in March 2000, commented on the enormous investment required to restore the Underground, and on the efficacy of the Government’s PPP proposal as a means of doing this. The evidence concluded that there were ‘reservations’ about PPP, involving financing costs and the loss of management control over work on the Tube. Instead, the evidence proposed a programme ‘of issuing bonds coupled with a system of Government grants, as an attractive alternative which warrants serious consideration’. I could not agree more. I commend the authors of this report for common sense, foresight and wisdom.

To understand what it will take to restore the Underground to what The Academy’s report called a ‘decently modern metro’ requires in the first instance a discussion of the Government policies that led to the current situation.

During the Tube’s heyday in the 1920s and 1930s and continuing even into the post-war years, London Transport was unrivalled in the world as a finely tuned organisation that both invested in, and managed, transport. At the time that the national rail system was nationalised, shortly after the end of World War II, London Transport also became wholly dependent on Government financial support, which became over time ever more scarce. This led to a long term decline in asset health, the consequences of which are now all too clear.

Privatisation

As this trend accelerated through the 1970s and 1980s, Government policy in general began to shift away from state owned enterprises in favour of private sector ownership and control.

Government owned enterprises which were engaged in commercial activities, such as coal and steel production, and air transport, moved seamlessly into the private sector. The common trait amongst these companies was that, properly managed, they could compete in the private marketplace and price their products at a level which could serve the public, their customers and their investors, the private shareholders.

Successful privatisation in these sectors led Government policy makers to conclude that privatisation models could also be applied to activities which offered opportunity but which lacked true competition, such as the provision of electricity and water. Privatisation in these capital intensive industries, as in the traditional competitive industries, offered the potential benefits of both private sector management and shedding debt from the Government’s books.

Privatising essential services

These perceived successes in turn led Government policymakers to focus on a third class of privatisation candidates: enterprises providing an essential service to the public, but which cannot realistically charge fees high enough to function properly without public subsidy. These activities can best be identified as ones where the benefit to society as a whole is far greater than the benefits realised by each individual user. It is that incremental social benefit that justifies subsidies from public sources in addition to fees and fares. I am of course referring, in the main, to that word politicians dread most: taxes. The most obvious areas in which such enterprises function are higher education, health care and rail transport. I have neither the space nor the expertise to discuss usefully health care and education, but I can obviously give my views on rail transport and in particular the London Underground.

Perhaps the fact that both fares and subsidies are used to fund rail activities is what confuses politicians and their advisors. The fact that a fare is charged may lead the policymaker to look at a railway as just another transportation business. If a privately owned airline or shipping company can make a profit without a subsidy, these people reason, why shouldn’t a railway be able to do the same. So their first conclusion is that if railways are losing money it is not that the losses are inherent in the nature of the service – or in the range of resulting benefits being provided. Rather it is that public employees are badly managing that service. It is this conclusion that began to infect the thinking of the policymakers in Downing Street and the Treasury during the 1980s.

At some point in the 1980s, the Government concluded that the losses and declining service were somehow entirely the fault of the Underground’s management. It decided to address the ‘problem’ by starving the Underground of funds. I need not tell a readership such as this the obvious effect of such a tourniquet policy on physical plant as large and complex as the Underground. Inadequate funds for maintenance, unacceptable delays in financing essential renewals and replacements and no capital to invest in new cost saving technologies were the result of uniform Government policy under prime ministers from Margaret Thatcher to Tony Blair. Every year, the Government stonewalled the Underground’s pleas for a systematic, predictable level of support. No long term planning requisite to any soundly conceived investment programme of renewal and replacement was desired or delivered. The price the public has paid is the intolerable condition of the Underground today. While it is fashionable in Whitehall to blame the Underground performance on staff incompetence, the irony is that it is precisely the resourcefulness and the dedication of Underground staff in utilising the meagre crumbs dropped by the Government that keeps the Underground running at all.

But at least as ominous as the refusal to provide adequate funding to the Underground, was the Government’s conclusion that control of British Rail should be placed in private hands. No one was surprised when such a conclusion was initially reached in the mid-1990s by the Major Government. It was a decision superficially consistent with other privatisations; and no one paid much attention to the fact that in reality the railroad could not and should not make a profit. Indeed, the initial plan for Railtrack addressed the profit question by guaranteeing a substantial level of ongoing Government support.

Equally unsurprising was the Labour Party’s adamant opposition to rail privatisation and its election manifesto pledge never to privatise the Underground. What was surprising therefore, was the alacrity with which the new Labour Government, notwithstanding its pledge, moved toward private sector control of all the physical assets of the Underground. By 1998, the Government had rejected more than a dozen soundly conceived public sector alternatives and the PPP juggernaut had begun, premised on the Treasury’s hallowed ‘risk transfer’ and public sector borrowing.

For obvious political reasons, it was critical that the manifesto pledge appeared to be honoured; that whatever was done with the Underground it absolutely could not be called privatisation. And today, as the Government moves to restore public sector control over the national rail infrastructure, it continues to deny the relevance of that sorry experience to the Tube’s PPP.

The experience of Railtrack

Accordingly I propose to devote the remainder of this article to the case of Railtrack and its central relevance to the Tube’s PPP. Let’s begin with the principles that underpin the Government’s policies towards both the above ground and Underground rail systems. These principles roughly approximate the ‘guidelines’ handed to me by the Government during my brief tenure last summer as Chairman of London Transport when I headed the PPP negotiations. First, the Government mandated that ‘risk’ – meaning that invested funds might at least theoretically be lost – must be transferred from the public to the private sector.

Second, the capital projects must be financed in the ‘private markets’, so debt would not be in the Government’s books. What could be overlooked was that the Government, through payments to the infrastructure companies, would still be paying all the debt service. Finally, the private companies were to be responsible for ‘whole life’ management of the railway’s property. They were to have the sole and unfettered right to decide whether an asset – an engine, a coach, a section of track, a signal – should be repaired, replaced or just ignored.

On the national rail network, these same rights and responsibilities were handed to Railtrack, as owner of the infrastructure. The Government agreed only to subsidise Railtrack’s operating expenses in specified amounts for a fixed period of time. All other costs and risks were to be Railtrack’s responsibility. Let’s look at what happened.

A careful review of Railtrack’s annual and interim reports reveals Railtrack immediately began to make massive dividend payments to its shareholders, payments which continued until September 2001. The Rail Regulator identified these hasty dividend payments as a contributing factor in Railtrack’s failure to maintain the network in a manner that would allow the trains to run safely and efficiently. I am sure you will not be surprised to learn that the private companies taking over the Underground under the proposed PPP are contemplating an even greater level of dividend payout from inception.

Almost as soon as Railtrack began making premature and excessive dividend payments it began failing its mandate and losing access to the capital markets. Barely a year after opening its doors, Railtrack failed to secure bond funding for the Channel Tunnel Rail Link, its most important new initiative. To keep the project alive, the Government had to guarantee £3.75 billion of debt. With this step, the Government’s aggregate financial commitment to Railtrack already exceeded the initial purchase price. And far more was yet to come.

Third, throughout the rail network, Railtrack consistently deferred or ignored critical maintenance and renewals. When tragedy finally forced them to act, again the company came back to Whitehall, palms upturned. The initial subsidies had been spent and the capital markets would certainly not provide private financing for a fast deteriorating company.

Finally, the Government pulled the plug. All three guiding principles went by the wayside. Private financing was nonexistent. Competent management of the assets did not exist, resulting in consistently poor service and serious accidents. With the Government again holding the responsibility, virtually no risk was transferred to the private sector.

Indeed, look at the financial community’s reaction to Secretary of State Stephen Byers’ wise decision to cut the taxpayers’ losses. The City asked, ‘How could the Government treat the poor shareholders so shabbily? We bought shares on the assumption that Government would always give Railtrack what it needed.’ Does this sound like risk transfer? Or is it more that shareholders owned shares in a company with obvious problems because they knew – or thought they knew – that the Government would always have to pay to keep the trains running? The City’s error was in believing that the Government would be unwilling to admit its mistake, and instead would keep pouring money into Railtrack.

The ultimate resolution of Railtrack’s finances is already in litigation. What is important to us now and in the near future is whether the lessons of Railtrack will have any influence on the Government’s policy regarding the PPP.

Railtrack’s relevance to the Underground

We do know that the City has learned. Since the day of Stephen Byers’ announcement, the City has made it clear that the Government’s refusal to continue to bail out Railtrack’s shareholders would dearly cost the Government when it came to finalising the price of the Underground PPP. In other words, if the Government is really serious about transferring risk – and not just mouthing some quaint ideological mantra – then the City would have to get serious about the price of equity and debt. The 35% pre tax returns on equity now built into the PPP price will not be enough to justify real risk taking. How much will be? No one can say.

So we have the paradox of one partner – the ‘private’ one – in the Public Private Partnership saying that the Railtrack situation is highly relevant to the PPP contracts and the other partner – the Government – claiming there is no connection between the two cases.

Who’s right? The Government would seem to base its position entirely upon the fact that, under the PPP, the Underground will retain legal title to the Tube’s property: the private sector rights arise solely from a 30 year contract. But, as the lawyers are fond of saying, this is a distinction without a difference. No matter how many times the Government tries to spin the absurd notion that there is no connection between Railtrack and the Tube PPP – because Railtrack was a privatisation and PPP somehow isn’t – it just doesn’t wash. The issues are exactly the same in both cases: namely, whether profit maximising private companies – with complete authority over rail infrastructure – will make the right decisions about how to maintain and upgrade the system, and whether they will have the financial capacity to raise and invest the necessary funds to implement those decisions.

What the Government learned with Railtrack is that we must, in the words of Stephen Byers, ‘move away from the situation we have with Railtrack where they’ve got a conflict of interest between that of the shareholder and the need to invest in the railway network …’. There is simply nothing about the Tube PPP that makes the Secretary of State’s fear of conflict between profits and ensuring necessary investment any less relevant here.

In December 2000, I provided the Mayor Ken Livingstone and the Greater London Authority with two reports. One was a preliminary evaluation of the PPP, the other, a programme for the management and financing of the Underground. In the PPP report, I concluded that the PPP was ‘fatally flawed’. By splitting the system into four parts – London Underground and the three ‘Infracos’ – management accountability would be fragmented and transparency would be obscured in an environment that is dramatically less forgiving than the national rail system.

I also noted the inherent conflict between the interests of the shareholders and those of the travelling public, and the absence of any real risk transfer in the actual terms of the proposed PPP contracts.

It is precisely these problems that underpin the Government’s decision to take back the rail network.

In the second report, I proposed that the Underground be owned, maintained and operated by a public corporation, financing its capital requirements with bonds. While I would not be so bold to suggest that the Government ‘stole’ my plan (or the Academy’s original plan), I note that this is roughly equivalent to the structure they have proposed for a reorganised Railtrack.

In the US, such a company would be called a public benefit corporation. This model successfully provides a wide range of services from health care to housing to transport. These public benefit corporations rely very heavily on private sector contractors to perform engineering services and build projects, which is what they do best, but do not require that these same companies participate in legal and financial gymnastics to satisfy the equivalent of our public sector borrowing rules. Here in the UK, recent public discussions about converting Railtrack to a ‘public trust’ suggest that there is a growing consensus that fragmenting services in an effort to comply with risk transfer dogma does not stand the test of time or reason. So a decision now needs to be made about the future of the Underground. We can choose to be prisoners of public sector borrowing rules and risk transfer ideology, or we can honestly and candidly face up to the reality that the Tube is an essential public service, that it will always need to be underwritten by the public and that fragmenting its management for the sake of private finance requirements is a gross mistake.

The Secretary of State, the Chancellor and the Prime Minister have shown wisdom and courage in acting decisively to end the flawed and failed Railtrack experiment. Now it is time for them and us to face up to the requirements of the Tube in the context of the Railtrack experience and move forward in a new direction, not repeating the mistakes of past Governments.

I know that by working together we can produce and implement an aggressive plan that will make the tube the pre-eminent transport system it once was and deserves to be. Let’s put PPP to rest and start breathing life back into our Underground.

Bob Kiley was Chairman and CEO of New York's Metropolitan Transportation Authority from 1983 to 1990. He directed the rebuilding of New York's public transportation system, restructured its management, and raised over $16 billion from the State legislature for capital improvements to the subways, buses and roads in the region. He was appointed Commissioner of Transport for London in January 2001, having previously served as President and CEO of the New York City Partnership.

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