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Coase-ting Roughly on British Rails

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I’m in Manchester, England, for a Liberty Fund [2] colloquium on the great free-trader Richard Cobden. More on this man and his work in later posts.

My friend Steve Davies (organizer of the colloquium) told me this morning about the privitization of railways in the U.K. It was done during the prime-ministership of John Major. It was done unwisely. Franchises for the tracks and the stations were sold separately from franchises for the rolling stock which were sold separately from the franchise to run the maintenance which was sold separately from the franchise to operate the track signalling. Importantly, this separation in the ownership and management of these various aspects of running railroads cannot be altered by, say, Virgin (owner of a franchise to operate rail service) buying the tracks over which its trains run or by buying the maintenance operations that service its trains.

Steve — a native Brit — reports that privitization has improved rail service (as evidenced in part by the much-increase ridership), but that the service improvements are not what they could have been if the different franchisees were permitted to buy and sell parts of their different operations.

As Steve points out, “this is a great Coasean experiment, showing that Coase was right”. Coase [3], of course, wrote what is still the definitive article on why firms exist and what determines how much of their inputs they produce themselves and how much they purchase from outside suppliers. If a firm can raise its profits by supplying its own maintenance service than by contracting out for such service, it will do so. Consumers in the end will be better served, either through lower prices or improved service or both.

But the political prohibition against greater or lesser vertical integration — that is, the prohibtion on U.K. railway franchisees changing how much of their operations they perform in-house and how much they purchase from outside suppliers — means that a critical tool is kept from managers who wish to improve rail service in the U.K.

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