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UBC Theses and Dissertations

Economic efficiency losses arising from subsidized intercity rail passenger movements in Canada Andriulaitis, Robert J. 1987

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ECONOMIC EFFICIENCY LOSSES ARISING FROM SUBSIDIZED INTERCITY RAIL PASSENGER MOVEMENTS IN CANADA By ROBERT J. ANDRIUIAITIS B. Comm., (Honours) Queen's University, 1982 A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE (BUSINESS ADMINISTRATION) in THE FACULTY OF GRADUATE STUDIES COMMERCE AND BUSINESS ADMINISTRATION WE ACCEPT THIS THESIS AS CONFORMING TO THE REQUIRED STANDARD UNIVERSITY OF BRITISH COLUMBIA September, 1987 eRobert J . A n d r i u l a i t i s In presenting this thesis in partial fulfilment of the requirements for an advanced degree at the University of British Columbia, I agree that the Library shall make it freely available for reference and study. I further agree that permission for extensive copying of this thesis for scholarly purposes may be granted by the head of my department or by his or her representatives. It is understood that copying or publication of this thesis for financial gain shall not be allowed without my written permission. Department of COKM£/2Z.@. fl^o UtOiaue-^. AQr*i\JLt>7{Lft-TiOA-> The University of British Columbia 1956 Main Mall Vancouver, Canada V6T 1Y3 Date ocrohfrd ~f , i^^f ABSTRACT While a l l four of the main modes of intercity passenger transportation in Canada (air, automobile, bus, and r a i l ) are currently subsidized, r a i l recovers from i t s users a considerably lesser portion of the total cost of service than any of the other three modes. This thesis estimates the effect this imbalance has on the passenger network in two ways: i) in physical terms -- the change in modal volumes given f u l l -economic-cost pricing and the implications this has on network configuration; and i i ) in financial terms -- the dollar cost of the economic efficiency losses suffered due to non-full-economic-cost pricing. The f i r s t element is estimated by calculating modal fares based on f u l l cost recovery for 52 intercity routes between Winnipeg and Quebec City. The changes represent from the actual fares charged is translated into volume changes based on a set of demand el a s t i c i t i e s developed for this thesis. The second element is estimated for these same 52 routes using the standard deadweight loss triangle methodology which measures the loss in aggregate social welfare that exists when non-optimal prices are being charged. This result is then extrapolated to a national level. The calculations show that given full-economic-cost pricing, air volumes would increase by 4.76%, automobile volumes by 0.32%, and bus volumes by 3.47%. Rail volumes would decline by 56.67%. While the changes are marginal i i Abstract for the non-rail modes and would not li k e l y result in any changes to the network, r a i l would cease to be a viable mode on many routes. The economic efficiency distortion caused by the failure to charge fares based on f u l l economic costs amounted to about $130 million in 1986. This cost, along with the subsidy i t s e l f , is^what the social and p o l i t i c a l benefits of continued VIA Rail subsidization must be compared to, not simply the amount of the subsidy, as is currently done. This estimate of deadweight loss ignores positive tourism, energy, safety, and environmental externalities of r a i l , and thus overestimates somewhat the detrimental effect of VIA r a i l subsidies. i i i Abstract TABLE OF CONTENTS Abstract i i Table of Contents i v L i s t of Tables i x L i s t of Figures x i Acknowledgements x i i Chapter 1: Introduction A. Introduction 1 B. Motivations For This Thesis 3 C. Research Objective and Methodology 6 D. Value of This Research 9 E. A Word About Subsidies and Economic E f f i c i e n c y 10 F. Outline of the Thesis 13 Chapter 2: The Components of the I n t e r c i t y Passenger Network A. Introduction 15 B. The R a i l Mode 15 i ) the early years: 1820 to 1880 15 i i ) the emergence of the giants: 1881 to 1923 17 i i i ) the years of the Phoenix: 1923 to 1945 20 iv) down for the count?: 1946 to 1961 23 v) one down, one to go: 1962 to 1977 26 v i ) the establishment of VIA R a i l : 1977 to 1979 32 v i i ) VIA R a i l i n operation: 1980 to ???? 39 i v Table of Contents C. The Competing Modes 47 i ) the private automobile 49 i i ) the i n t e r c i t y bus 52 i i i ) the a i r mode 57 D. The Government 61 i ) as an owner/operator of transport firms 62 i i ) as an owner/provider of i n f r a s t r u c t u r e 63 i i i ) as the setter of rules of conduct 64 iv) as the overseer/enforcer of the rules 84 E. The Canadian Transport Commission 85 F. Summary 88 Chapter 3: L i t e r a t u r e Review A. Introduction 90 B. The L i t e r a t u r e Concerning Modal Economies of Scale 90 i ) economies of scale for the a i r l i n e industry 91 i i ) economies of scale f o r the road modes 95 i i i ) economies of scale for the r a i l mode 98 iv) conclusion 104 C. The L i t e r a t u r e Concerning Canadian I n t e r c i t y Passenger Network Modal Subsidization 105 D. The L i t e r a t u r e Concerning Demand Modelling 110 i ) s t a t i s t i c a l demand models I l l i i ) derived demand systems based on n e o c l a s s i c a l demand theory 124 E. The L i t e r a t u r e Concerning Economic E f f i c i e n c y Losses 130 F. Summary 146 v Table of Contents Chapter 4: Economic E f f i c i e n c y and the Measurement of Deadweight Loss A. Introduction 148 B. A l l o c a t i v e E f f i c i e n c y i n Production 148 C. "Overall" A l l o c a t i v e E f f i c i e n c y 150 D. The Impact of Subsidization on Economic E f f i c i e n c y 153 i ) departures from marginal conditions 153 i i ) the concept of deadweight loss 155 E. Economic J u s t i f i c a t i o n s f o r Subsidization 161 i ) economies of scale 162 i i ) economies of density 168 i i i ) e x t e r n a l i t i e s of production 169 iv) second best considerations 171 F. S o c i a l J u s t i f i c a t i o n s f o r Subsidization 172 G. Summary 173 Chapter 5: Price E l a s t i c i t i e s of Demand for I n t e r c i t y Passenger Travel A. Introduction 182 B. Published Price E l a s t i c i t i e s 176 C. Conclusions 181 Chapter 6: Modal Fares Based on Economic Costs A. Introduction 182 B. Presence of Economies of Scale and/or Density 185 C. R a i l Fares Based on Economic Costs 186 D. A i r , Automobile, and Bus Fares Based on Economic Costs . . . . 189 i ) the automobile mode 191 v i Table of Contents i i ) the bus mode 192 i i i ) the a i r mode 194 E . Modal Fares Used i n Deadweight Loss C a l c u l a t i o n s 195 F . Summary 202 Chapter 7: The E f f e c t of Unbalanced Modal S u b s i d i z a t i o n on Modal Volumes and Economic E f f i c i e n c y A. In troduct ion 203 B. Impl icat ions of Ful l -Economic-Cost P r i c i n g : Scenario 1 (Base Case) 204 i ) p h y s i c a l e f f ec t on the i n t e r c i t y passenger system . . . . 204 i i ) magnitude of deadweight loss 211 C. Impl icat ions of Ful l -Economic-Cost P r i c i n g : Scenario 2 ( A l t e r n a t i v e "Ideal" Case) 220 i ) p h y s i c a l e f f ec t on the i n t e r c i t y passenger system . . . . 220 i i ) magnitude of deadweight loss 224 D. Conclusions 228 Chapter 8: Summary and P o l i c y Impl icat ions of the Findings A. In troduct ion 232 B. Summary 232 C. P o l i c y Impl icat ions of the Findings 237 D. Caveats and Suggestions for Further Research 240 B ib l iography 242 Appendix A: A p p r o p r i a t i o n Act No. 1, 1977 257 v i i Table of Contents Appendix B: Estimating Price E l a s t i c i t i e s of Demand for I n t e r c i t y Passenger Travel A. Introduction 261 B. Data Requirements for Model Estimation • 262 C. Model Formulation 275 D. Model S p e c i f i c a t i o n 277 E. Data Construction 280 F. Variable S e l e c t i o n 282 G. Estimation Procedure 284 H. Results 285 Appendix C: C i t y - P a i r s Used i n Modelling 292 v i i i Table of Contents LIST OF TABLES Table 2.1: Route-Specific Modal Shares . 48 Table 2.2: Air Mode Fare Versus Travel Time Savings 60 Table 2.3: Federal Legislation Pertaining to Passenger Transportation in Canada 70 Table 3.1: Losses on Selected Corridor Routes 109 Table 3.2: Social Cost of Traffic Missallocation: A Summary of U.S. Studies 143 Table 3.3: Restatement of Efficiency Losses of Friedlaender, Boyer, and Levin Studies 145 Table 5.1: Elast i c i t y Results 178 Table 5.2: El a s t i c i t i e s Used in Calculation of Economic Efficiency Losses 180 Table 6.1: Percentage Cost Recovery by Mode 196 Table 7.1: Actual Versus Optimal Modal Volumes: Full-Economic-Cost Pricing 207 Table 7.2: Actual Price compared to Price on Adjusted Demand Curve Corresponding to Actual Quantity 215 Table 7.3: Deadweight Loss: Base Case Definition of Full-Economic-Cost Pricing 216 Table 7.4: Rail Fares Under Alternative Full-Economic-Cost Definition. . 221 Table 7.5: Actual Versus Optimal Modal Volumes: Alternative "Full-Cost" Scenario 222 Table 7.6: Actual Price compared to Price on Adjusted Demand Curve Corresponding to Actual Quantity. . . 225 ix List of Tables Table 7.7: Deadweight Loss: Alternative Definition of Full-Economic-Cost Pricing 227 Table 7.8: Comparison of Modal Volumes and Deadweight Loss Under Alternative Definitions of Full-Economic-Costs 229 Table B.l: ICTD Data Sources 266 Table B.2: Population Densities of Selected City-Pairs . . . 271 Table B.3: Linguistic Comparability of Selected City-Pairs 274 Table B.4: Log-Linear Results: Air Mode 286 Table B.5: Log-Linear Results: Automobile Mode 287 Table B.6: Log-Linear Results: Bus Mode 288 Table B.7: Log-Linear Results: Rail Mode 289 Table B.8: Correlation Matrix for Price Variables 290 x List of Tables LIST OF FIGURES Figure 1.1: Modal Breakdown of Intercity Passenger Travel 3 Figure 1.2: Government Operating Subsidies for the Canadian Intercity Passenger Rail System. . 5 Figure 2.1: Canadian Passenger Rail Volumes: 1923 to 1945 . . 22 Figure 2.2: Canadian Passenger Rail Volumes: 1946 to 1961 27 Figure 2.3: Canadian Passenger Rail Volumes: 1962 to 1977 29 Figure 2.4: Government Contribution to VIA Rail Operating Budget . . . . 36 Figure 2.5: VIA Rail Passenger Volumes: 1980 to 1986. 40 Figure 2.6: Canadian Bus Volumes: 1954 to 1984 53 Figure 2.7: Air Passenger Volumes: 1954 to 1984 58 Figure 4.1: Allocative Efficiency in Production. . . 149 Figure 4.2: Deadweight Loss Due to Subsidization 157 Figure 4.3: Illustrative Deadweight Losses in Canada's Passenger Transportation System 160 Figure 4.4: Scale Economies as a Rationale for Subsidization 163 Figure 4.5: Trade-off Between Efficiency Loss and Level of Required Subsidization 166 Figure 6.1: Effect of Shape of Marginal Cost Curve on Deadweight Loss. . 200 Figure 7.1: Deadweight Loss Measurement for Rail and Non-Rail Modes. . . 212 xi List of Figures ACKNOWLEDGEMENTS I would like to thank Professors Boardman and Heaver for their insightful comments and criticisms. Special thanks must go to' Professor Tae Oum for the data he provided, the considerable amount of guidance he gave, and the extreme patience he showed. Despite his incredible workload, he s t i l l managed to be generous with his time. I would like to thank Professor Mike Tretheway for the use of the Data General Computer, and his lack of patience with my pace during the slower moments of a three-year long gestation period. Pat Darragh made l i f e easier by transferring my f i l e s from the UBC computer to the Commerce DG MV10000 when nobody else knew what was going on. (Relative to Pat, they s t i l l don't.) I am indebted to Jenny Low for assistance in making f i n a l revisions, and for handling the myriad of administrative duties after I moved from Lotusland. If you can stand Edmonton's weather Jenny, I have some cider waiting for you. Special thanks to Corinna Kwok, who did a masterful job in producing the Tables and Figures (which I suspect impressed some (most?) more than the text) and who put in long hours making the f i n a l , the post f i n a l , and the fi n a l f i n a l revisions. I hope you had as much fun as I did. Finally, special thanks to Dave Frank for his constructive comments, and for travelling to Edmonton to provide the incentive for the last spurt by drinking my port and refusing to let me have any u n t i l I finished. I w i l l return the favour soon. x i i Acknowledgements CHAPTER 1 INTRODUCTION A. Introduction Throughout much of Canadian history, r a i l transport has played an integral role in the movement of people between population centres within our national boundaries. 1 Despite r a i l transportation's rather humble and hesitant beginnings in the 1840's, the passenger r a i l component of total Canadian intercity passenger transportation soon experienced steady growth which continued through the turn of the century. Passenger r a i l movements grew steadily during the Fir s t World War era, reaching a peak volume of over 51 million passengers in 1920. Subsequently, passenger r a i l volumes suffered a considerable decline: during the years of the Great Depression, r a i l passenger volumes dropped to levels less than 40% of the 1920 figure. The Canadian railways rebounded after the Depression, however, and achieved record annual passenger volumes by the close of the Second World War. This heyday of passenger r a i l travel was destined not to last. The post-war period witnessed extensive improvements both i n the equipment and in the infrastructure of the competing modes. This helped to undermine -^The focus of this thesis is on non-commuter travel between urban centres. It thus excludes from analysis urban r a i l services such as the subway/metro systems of Montreal and Toronto,, the LRT systems of Edmonton and Calgary, and the ALRT system of Vancouver, as well as interurban commuter r a i l services such as Ontario's GO TRANSIT system and British Columbia's proposed Vancouver-Port Coquitlam service. Chapter 1 1 Introduction significantly r a i l ' s relative importance in the passenger transport hierarchy. Figure 1.1 reveals the change in fortune of the r a i l mode and i t s principal competitors in the intercity passenger travel sector. Considering just the small share of total intercity passenger travel currently held by the r a i l mode and the long-run trend i t exhibits, one could easily be seduced into discounting the study of the current passenger r a i l system as an increasingly t r i v i a l pursuit. This would be an unfortunate and erroneous conclusion for reasons discussed below. B. Motivations For This Thesis Despite the substantial decline in passenger r a i l volumes, there exist a number of rationales which j u s t i f y continued academic interest in this service. The f i r s t concerns the travel volume i t s e l f . The 5,735,000 revenue - passengers c a r r i e d (or a l t e r n a t i v e l y , the 2,060,158,000 passenger-kilometres of service provided)^ by Canadian railways in 1986 s t i l l represents a significant amount of intercity passenger travel. The second concerns the monetary outlays resulting from the provision of passenger r a i l service. VIA Rail Canada incurred total expenses of $682,080,000 in 1986.3 This expenditure represent a non-trivial 2.93% of the total Canadian S t a t i s t i c s Canada Catalogue 52-003, 1986. These figures refer to the aggregate non-commuter t r a f f i c carried by the seven principal roads in Canada: the Canadian National Railways, Canadian Pacific Railway, Ontario Northland, British Columbia Railway, Quebec North Shore and Labrador Railway, Chesapeake and Ohio, and VIA Rail Canada. VIA Rail accounted for about 94% of the total passengers carried, and for about 96% of the total r a i l passenger-kilometres of service provided in 1986. •^Statistics Canada Catalogue 52-003, 1986. This figure includes the $243,327,000 paid to Canadian National and to Canadian Pacific by VIA Rail Canada as per the operating agreement between VIA and the two major railways. Chapter 1 2 Introduction FIGURE 1.1 Modal Breakdown of Intercity Passenger Travel (share of passengers) RAIL AIR 1964 1984 Source: Statistics Canada, Catalogues 51-002, 52-003, and 53-002. Chapter 1 3 Introduction Transportation Industry Gross Domestic Product (at factor cos t ) . ^ The third concerns the importance of the r a i l mode in serving many of Canada's remote regions. The fourth concerns the role intercity passenger r a i l travel, especially the transcontinental services, plays in attracting foreign tourists to Canada. Additional rationales, intangible perhaps, but nonetheless important, include the historical a f f i n i t y for railways embedded in the Canadian psyche and the role that the r a i l mode played in forging and maintaining a sense of national unity. A f i n a l rationale is the persistent suspicion among some Canadians that the faith placed in the r a i l mode by much of the rest of the developed world just might prove warranted, and thus we might be foolish to abandon passenger r a i l service just yet.-* Though a l l of these factors serve as motivators for this study, the element which provides the ultimate raison d'etre concerns the practice of governmental subsidization of Canadian i n t e r c i t y passenger r a i l transportation. Figure 1.2 illustrates the importance of this aspect of passenger r a i l service. Some have voiced their apprehension regarding the magnitude of these government payments. However, their common interpretation of the dollar amount of the subsidy as being reflective of the cost of subsidizing passenger r a i l travel is invalid. This interpretation understates the economic cost of ^Statistics Canada Annual Catalogue 13-201 gives the 1984 Transportation Industry Gross Domestic Product at Factor Cost as $21,396,000,000. This amounts to about $23,271,600 in 1986 dollars. ^The high passenger volumes on such glamorous services as France's TGV and Japan's Shinkansen high-speed trains are often taken as proof of the potential of passenger r a i l services. Chapter 1 4 Introduction FIGURE 1.2 Government Operating Subsidies for the Canadian Intercity Passenger Rail System LEGEND REVENUE SUBSIDIES .1979 1980 1981 1982 1983 1984 1985 1986 YEAR Source: VIA R a i l Canada, Annual Reports (1979-1985); Globe & Mail, 20 May 1987, p. B6 (1986). Chapter 1 5 Introduction subsidization in that i t ignores an important constituent of the true cost of subsidization: the economic efficiency losses caused by t r a f f i c misallocations arising out of price distortions. Although the concept of efficiency losses w i l l be dealt with later, a brief explanation is appropriate now. Subsidization of the r a i l mode, which eliminates the normal consequences of persistent operating deficits (bankruptcy), enables the railways to maintain a fare lower than the real cost of the service provided. This in turn results in a shift in modal shares, giving a higher rate of railway patronage than the economically efficient rate that would have occurred under purely competitive conditions. This requires, of course, that the competing modes are subsidized to a lesser extent than is the r a i l mode. An imbalance in modal subsidization is necessary for any efficiency loss to occur. By subsidizing the r a i l mode over and above the extent of subsidization of other modes, modal shares would stray from the efficient shares of the perfectly competitive model and a welfare loss would be incurred. The magnitude of this economic cost remains unknown. Thus we in Canada have a situation where subsidization policy has been formulated without any measure of the economic implications of this subsidization. It is this absence of an empirical measure of the economic cost of misallocated modal shares in the Canadian intercity passenger network which serves as the primary motivation for this study. Chapter 1 6 Introduction C. Research Objective and Methodology The objective of this study is to measure the overall economic efficiency effect of passenger r a i l subsidization on the four principal modes of the Canadian intercity passenger sector: air; automobile; bus; and r a i l . This effect w i l l be quantified in two ways: i) in physical terms - the change in modal volumes given alternative subsidization policies, and the implications this has on network configuration; and i i ) in financial terms - the dollar cost of the economic efficiency losses suffered due to any misallocation of modal shares. In order to gain a f u l l appreciation of the implications of subsidization policy, i t is necessary to understand not only the costs of the current policy, but also the changes that would arise in modal shares and through this, the changes that would occur in economic efficiency in the absence of subsidies. The following approach is used to quantify these effects. First, the economic characteristics of intercity passenger travel by each mode must be examined for economic justifications»for subsidization. Under certain circumstances, subsidization of a mode (or perhaps more than one mode) would not have a distorting effect on economic efficiency, but rather, would be a necessary component of the achievement of economic efficiency. Existence of these special circumstance could mean that the estimate of the economic efficiency loss is close to zero. Chapter 1 7 Introduction Second, given that no economic j u s t i f i c a t i o n of subsidization is found, the actual level of subsidization of each mode must be determined in a meaningful way. What might appear to be a very high absolute level of subsidization may appear much more reasonable when examined on a per-passenger or per-passenger-kilometre basis, or when compared to the total cost of providing that service. Since we are interested in the aggregate price distortion caused by subsidization, i t is the latter measure, subsidy as a percentage of total cost of service, which is most relevant to the purpose at hand. The determination of this percentage of total cost covered by subsidy must be a comprehensive measure. In other words, the estimate of the total subsidy paid to each mode must include both the direct and indirect subsidies enj oyed by that mode. Third, the relationship between changes in modal fares and changes in passenger volumes on a l l modes must be determined. If subsidy policy were to change, fares would ultimately change as well. In order to determine the impact such a change would have on passenger volumes, an estimate of the own and cross price e l a s t i c i t i e s of demand for intercity travel by mode must be obtained. Since the four principal modes operate in a complex interactive manner, the analysis of the relationship must accommodate such an interaction. This requires the estimation of a passenger demand model with sufficient f l e x i b i l i t y to incorporate parameters reflecting the interaction of the attributes of the four modes on their volumes. Such a model w i l l provide the modal share distribution given any set of fares. Chapter 1 8 Introduction Fourth, the estimate of e f f i c i e n c y losses a r i s i n g out of the current s u b s i d i z a t i o n p o l i c y must be made. This involves comparing the current scenario of modal costs, fares and volumes with the scenario depicting modal costs, fares and volumes that would a r i s e given the elimination of u n j u s t i f i a b l e e x i s t i n g subsidies. The concept of the deadweight loss t r i a n g l e i s used to measure these e f f i c i e n c y losses a r i s i n g from a number of a l t e r n a t i v e r a i l subsidy p o l i c i e s . The above four steps w i l l provide an i n d i c a t i o n of what the true cost of the current s u b s i d i z a t i o n p o l i c y i s . D. Value of This Research Canadian r a i l s u b s i d i z a t i o n p o l i c y has been formulated without the be n e f i t of a measure of the cost of economic i n e f f i c i e n c y a r i s i n g from t h i s p o l i c y . Since the l e v e l of su b s i d i z a t i o n i s not i n s i g n i f i c a n t , and since the r a i l mode s t i l l c onstitutes a r e l a t i v e l y important component of the Canadian i n t e r c i t y passenger network, there i s the p o s s i b i l i t y that t h i s measure of t o t a l economic consequence i s very s i g n i f i c a n t . Given a continuation of the trend established by the r a i l subsidy, the lack of a measure of these economic impacts could prove even more c o s t l y i n the future. As the magnitude of passenger r a i l subsidy grows, there w i l l be increased pressure brought to bear on the Federal Government by taxpayers and by Chapter 1 9 Introduction representatives of the competing modes to cut back on r a i l subsidies." The government w i l l find i t s e l f in the position of having to choose between maintaining the status quo and reducing the level of subsidization. Since the economic cost of the former is not yet known and since the economic consequences (economic cost, changes in modal shares, possible changes in network structure) of the latter are also unknown, the government's position would be unenviable, to say the least. This thesis then, by helping to eliminate the two crucial unknowns of the economic cost of the status quo and the economic consequences of changing the subsidization policy, w i l l enable the policy makers to make an intelligent and informed decision regarding possible revisions to government passenger r a i l subsidization policy. E. A Word About Subsidies and Economic Efficiency ^ At this point, i t is beneficial to delineate clearly the meanings accorded two key terms, lest the question of p o l i t i c a l philosophy cloud the issues under study here. That such an exercise seems necessary reflects the substantively varying semantics associated with these key terms. bThe bus operators appear to provide the most vehement opposition to what they consider "uncontrolled" and "excessive" passenger r a i l subsidization. Notable individuals who have gone on record as being very "concerned" about VIA Rail's a b i l i t y to draw upon Federal monies to support "discount" pricing are Paul E. Martin, the President of Canada Steamship Lines, the holding company controlling Voyageur Enterprises (the second largest intercity bus operator in Canada), and James Kearns, the President of Gray Coach Lines Ltd. (the third largest intercity bus operator in Canada). Chapter 1 10 Introduction The f i r s t term requiring c l a r i f i c a t i o n is the noun "subsidy". Although the term is a common one, i t seems that there is a differing interpretation to correspond with each possible position along the p o l i t i c a l spectrum. Unfortunately, since many of these definitions reek of prejudice, they can easily obscure much of the value of research such as t h i s . 7 To avoid this problem, the term subsidy, as applied in this paper, must not be interpreted in a pejorative manner. In fact, in order to retain objectivity, the working definition for "subsidy" must be one completely stripped of emotionalism. "Subsidy" w i l l thus be defined simply as a transfer of funds from the general revenue account of the government to a private or public firm or individual (direct subsidy), or to a government department or agency which provides a service to or f a c i l i t i e s for use by a private or public firm or individual at less than cost (indirect subsidy). In a similar fashion, the connotations of the expression "economic efficiency" must be clarified.** Defining the perfectly competitive scenario as the economically efficient form for the economy and establishing i t as the base case against which deviations are measured is not intended to bestow sanctity upon this economic model.^ Perfect competition merely provides a 7 A cynical, but common interpretation of subsidy is "an invitation for irresponsible and inefficient operations". A^ more rigorous treatment of economic efficiency is provided in Chapter 4. At this point, i t w i l l suffice to ensure the elimination of inappropriate connotations of this term as applied in this paper. ^Indeed, there are those who do not consider perfect competition as automatically leading to economic efficiency. For example, Schwartzman argues that "the case for maximum technical efficiency under competition [is] deficient" and that "even the more modest claim for the superiority of technical efficiency under competition than under alternative market structures remains questionable." (Schwartzman (1973), p. 756). In general, Chapter 1 11 Introduction useful and convenient standard which can be used to cost out programmes which move society from the situation dictated by the "invisible hand" of the market to any other situation dictated by the desires of society as instituted via the mechanism of governmental intervention. l u Moving away from the economically efficient case may not be a "bad thing". Though there is indeed an economic cost associated with deviating from this base case scenario to any other socio-economic environment by means of establishing a subsidy of some kind, there can be a corresponding economic, social or p o l i t i c a l benefit arising from the achievement of the desired end. Naturally, the net result of these offsetting costs and benefits, assuming i t can be determined, w i l l vary from case to case. As exemplified by the definitions above, the approach followed in this paper is a positive, rather than a normative one. That is to say, this paper attempts to discover what the cost of any subsidization of passenger r a i l however, economists support the contention that an economy characterized by perfect competition would be economically efficient. Chapter 4 discusses this issue in greater detail. luTwo points need to be made here. First, in the event of market imperfections (externalities, factor immobility, barriers to entry, imperfect information and the like) the unchecked workings of the free market would not lead to economic efficiency. Thus a free market with the surface appearance of a perfectly competitive market need not necessarily be an economically efficiency one. Second, in the event of certain conditions (no entry or barriers, no sunk costsi mobile resources, etc.) a market which f a i l s to have the surface appearance of a perfectly competitive market could in fact be an economically efficient one. (See Baumol, Panzar and Willig (1982) for a discussion of the theory of contestibility). The key is not the physical form of the market, but that the goods/services are priced at their marginal cost. Given that the key result of a perfectly competitive market is that price w i l l equal marginal cost, economists have adopted the perfectly competitive market scenario as the standard against which the cost of any programmes or events which cause diversions from this abstract ideal is measured. Chapter 1 12 Introduction service i s and not what i t should be. The judgement as to whether the actual cost of subsidizing passenger r a i l service is an acceptable one given the level of benefits derived from subsidizing passenger r a i l service is l e f t to policy makers. The aim of this paper is to assess accurately what the actual cost of any policy would be, so that the evaluation of the merits of any particular r a i l subsidization policy the government chooses to adopt is f a c i l i t a t e d . F. Outline of the Thesis This thesis contains eight chapters. Chapter 2 provides a description of the role played by the various components of the Canadian transport intercity passenger network. Chapter 3 contains a review of the empirical and theoretical works pertinent to this thesis. Economies of scale in transportation, modal subsides and costs, demand modelling, and estimations of efficiency losses are a l l examined. Chapter 4 describes the concepts of economic efficiency and dead-weight loss and the methodology of efficiency loss measurement. Chapter 5 details the sources used for obtaining e l a s t i c i t i e s describing the responsiveness of travellers to changes in fares. Chapter 6 estimates the actual level of subsidization of intercity passenger travel in Canada by mode. Chapter 7 combines the results of Chapters 5 and 6, and using the methodology described in Chapter 4, provides the actual calculation of efficiency losses for alternative Canadian passenger r a i l subsidy policies. Chapter 8 presents the policy implications of the findings and summarizes the options open to the Federal Government. This chapter also discusses, where applicable, caveats concerning this study. Chapter 1 13 Introduction The three appendices provide a copy of the section of Appropriation Act No. 1, 1977, which brought VIA Rail into existence, a description of the database and demand models used to obtain demand e l a s t i c i t i e s , and a l i s t of the city-pairs whose travel data were u t i l i z e d in the study, respectively. Chapter 1 14 Introduction CHAPTER 2 THE COMPONENTS OF THE INTERCITY PASSENGER NETWORK A. Introduction This Chapter provides background information and a description of the main components of the Canadian intercity passenger system: the four major modes ( r a i l , private automobile, bus, and a i r ) ; the government sector (as owner/operators, as providers of infrastructure, and as rule-makers); and the Canadian Transport Commission. B. The Rail Mode i) the early years: 1820 to 1880 The r a i l mode experienced very tentative beginnings in Canada. Although steam railways had made an appearance in both Canada and the United States in the 1820's and had prospered quite rapidly south of the border, they made no headway in Canada for the next thirty years. 1 There were several reasons for this: an important one being the d i f f i c u l t y in raising the substantial amounts of capital required for railway investment in such a sparsely settled 1 Contrasting with the approximately 10,000 miles of railway line in the United States by 1850 (Pratt; p. 20), the grand total for Canada was 66 miles (Railway Statistics of the Dominion of Canada, Sessional Paper no. 20b, 1918, p. v i i i ) . Chapter 2 15 Intercity Passenger Network country. An additional reason was that the major communities at Montreal and at Quebec City, as well as those then in existence in Ontario, bordered some navigable body of water and hence were relatively well served by marine transport. The Great Lakes, in conjunction with the connecting river system and augmented by canals where necessary, provided relatively good access to commercial markets. By the midpoint of the century, however, two important events occurred which altered both the need for and the f e a s i b i l i t y of railways. First, the need for railways increased as inland settlements expanded. Once these communities began to grow, they soon required a dependable mode of land transport.^ Second, the f e a s i b i l i t y of railways changed for the better when the Government came to the conclusion that: ...the means of rapid and easy communication by Rail-way, [sic] between the chief centres of population and trade in any country and the more remote parts thereof, are become not [sic] merely advantageous, but essential to i t s advancement and prosperity; And whereas experience has shown, that whatever be the case in long settled, populous and wealthy countries, in those which are new and thinly peopled and in which capital is scarce, the assistance of Government is necessary and maybe safely afforded to the construction of lines of Rail-way of considerable extent; and that such assistance is best given by extending to Companies engaged in constructing Rail-ways of a certain length...the benefit of the ^ The roads of this period were passable only in the summer (when they were dry) and in the winter (when they were frozen over). This might not have been too unbearable for a few small scale farmers who would only be taking f a i r l y small loads to market and who would not need the roads in the busy spring (planting) or autumn (harvesting) seasons. However, when the nature of the settlement changes from farm to town, this service level of transport becomes unacceptable. Persons engaged in occupations other than farming would require reliable transport services a l l year round. Chapter 2 16 Intercity Passenger Network guarantee of the Government... for loans raised by such Companies to enable them to complete their work...^ The passage of the historic Guarantee Act on May 30, 1849 set the precedent for Canadian governmental financial intervention in the "private" r a i l transport system. It also signaled the start of a railway construction boom in Canada. Within a decade after the passage of the Guarantee Act, Canada had 2,065 miles of main track in operation.^ By 1880, central Canada found i t s e l f with quite an extensive r a i l network. There were numerous railway companies providing r a i l services, although two lines, the Grand Trunk and the Great Western, dominated. Overall, there was very l i t t l e s t r i f e between the various lines, the relationships having coalesced into something best described as cozy. This comfortable f i r s t phase was ended by the February 16, 1881 incorporation of the Canadian Pacific Railway. i i ) the emergence of the giants: 1881 to 1923 In order for the newly founded C.P.R. to prosper, George Stephen (the co-founder and f i r s t president of the C.P.R.) realized that the railway needed •^Statutes of the Province of Canada 1849, Chapter 29: An Act to provide for affording the Guarantee of the Province to the Bonds of Rail-way Companies on certain conditions, and for rendering assistance in the construction in the Halifax and Quebec Rail-way. (Emphasis added). ^Railway Statistics of the Dominion of Canada, Sessional Paper no. 20b, 1918, p. v i i i . Chapter 2 17 Intercity Passenger Network access to the populated areas of central Canada. Within six weeks of the C.P.R.'s incorporation, Stephen had arranged to purchase the Canada Central Railway. This line linked Brockville with Ottawa and the Ottawa Valley. Stephen extended this line westward to Callander to link up with the main C.P.R. line. The C.P.R. then began negotiations with the long-time competitor of the Grand Trunk - the Great Western, in order to extend the C.P.R. network down through London and Hamilton to Windsor and Niagara Falls. These actions were vehemently opposed by Joseph Hickson, then the president of the Grand Trunk. An intense conflict arose between these two men and their respective companies. In order to counter the C.P.R. moves, Hickson proceeded to purchase the eight lines of the Midland group in February 1881. He then engineered a significant coup when he persuaded the Great Western to merge with the Grand Trunk. The net result of this intense interrailway competition was a significant consolidation of the railway lines in Canada. The structure of the r a i l system changed from one characterized by two large and numerous small railways, to one characterized by two giant and a few smaller railways. An important result of this was that as the number of independent operating companies decreased, the number of duplicate lines was reduced. The competition between the C.P.R. and the Grand Trunk (and hence the process of 5Lamb (1977; Chapter 7) provides the detailed description of the evolution of the C.P.R. and it s rivalry with the Grand Trunk from which the following summary was derived. Intercity Passenger Network 18 Chapter 2 consolidation) continued through the turn of the century. This inter-railway competition had forever changed the face of the r a i l transportation system.** The era of the Fi r s t World War brought about the next major event in r a i l transport in Canada: the formation of what became the Canadian National Railways. The Federal Government had become intimately involved in the railway industry when i t undertook in 1867 to finance the Intercolonial Railway. This arrangement also resulted in the Federal Government subsequently rescuing lines in the Maritimes as they floundered. In addition, the Federal Government had taken responsibility for building the National Transcontinental. These two railways became known as the Canadian Government Railways. The Federal Government, through the granting of loans, guarantees and subsidies also found i t s e l f deeply involved in the affairs of the Canadian Northern and the Grand Trunk Pacific. When the Canadian Northern experienced financial d i f f i c u l t i e s , i t was absorbed by the Canadian Government Railways in 1917. The Grand Trunk Pacific had also run into financial d i f f i c u l t i e s by this time. Due to the guarantees i t made concerning i t s subsidiary's debts, "An important aside to a l l of this steam railway competition is the rise and f a l l of the intercity electric railway (or "interurban") industry. John F. Due (1966) describes the history of the interurban in Canada in detail. Briefly, the industry made it s debut October 5, 1887 with a 7-mile run between St. Catharines and Thorold, Ontario. The interurban mode made f a i r l y significant progress in Ontario, where at one point there were eighteen companies operating over 553 miles of track. In 1921, the intercity group of lines in Canada reached i t s peak, carrying 9,261,000 passengers. The demise of the interurban was due in part to the Great Depression which forced the closure of lines in Toronto, Chatham, Hamilton, Niagara-on-the-Lake and Windsor. Competition from the bus mode also hurt this industry. The primary cause of the decline of the interurban, however, was the automobile. After the Second World War, the boom in automobile registrations sounded the death knell of the intercity electric railway industry. It was to be, however, a lingering death. The last run of an interurban in Canada (from Port Colborne to Thorold) did not occur u n t i l March 29, 1959. Chapter 2 19 Intercity Passenger Network the Grand Trunk, though sound it s e l f ) wound up in a very d i f f i c u l t position vis a vis the Canadian Government. After bitter negotiations which dragged on for years, the Government of Canada essentially simply took over both the Grand Trunk and the Grand Trunk Pacific in 1920.7 Eventually, 221 railway lines were absorbed by the Government and combined to form the nucleus of what was renamed in December 1918, the Canadian National Railways. Thus by 1923, the two c r i t i c a l conditions which were to exist in Canada's passenger r a i l industry for over half a century were set: active Federal intervention in r a i l transport and domination by two major national systems. i i i ) the years of the Phoenix: 1923 to 1945 Prior to the early 1920's, the philosophy concerning passenger t r a f f i c differed drastically between the C.N.R. and the C.P.R. The C.N.R., under David Blythe Hanna (1917 to 1921) had been content to focus on quietly consolidating the jumble of lines that the C.N.R. had inherited and to concentrate on developing freight t r a f f i c . The C.P.R., on the other hand, had been continuously s o l i c i t i n g passenger t r a f f i c since i t s inception. In fact, passenger t r a f f i c had remained an important component of the C.P.R.'s r a i l 'A bitter legal battle ensued and the case was f i n a l l y "resolved" in the Government's favour in 1923. 8Stevens (1973; Chapter 16) provides a more detailed history of the events leading up to the establishment of the C.N.R. Chapter 2 20 Intercity Passenger Network operations and had not done too badly in keeping pace with the rate of growth of freight t r a f f i c throughout the period 1886 to 1919.9 After Sir Henry Worth Thornton took over the helm of the C.N.R. in 1922, the attitude of management changed s i g n i f i c a n t l y . ^ Thornton was able to weld the fractious management groups of the various formerly independent lines into a team that set i t s e l f the goal of surpassing the standards of passenger service set by the C.P.R. Since the C.P.R. had no intention of giving up it s lead, Canada found i t s e l f with two railway lines that were serious about passenger r a i l service. Both companies set about attracting additional passenger t r a f f i c by acquiring and/or refurbishing passenger service r o l l i n g stock and by adding new passenger services. Unfortunately for the railways, the start of the heyday of the passenger automobile was just around the corner. In addition, this renewed effort to attract passengers to r a i l service coincided with the onslaught of the Great Depression. Both these factors h i t the railways hard. Figure 2.1 illustrates the extent to which national passenger r a i l volumes tumbled during the Depression. The Depression also served to change the relationship between the C.N.R. and the C.P.R. from one of antagonism to one of cooperation in an effort to cope with dwindling volumes and high fixed costs. One such example ^Freight t r a f f i c grew at an average (compounded) rate of just under 7.9% per annum in this period, from 2,046,000 revenue tons to 25,103,000 revenue tons. Passenger t r a f f i c grew at an average (compounded) rate of slightly more than 6.8% during this same period, from 1,791,000 revenue passengers to 15,816,000 revenue passengers. luLamb (1977; Chapter 23) provides an entertaining description of the impact Thornton had on the C.N.R. Chapter 2 21 Intercity Passenger Network FIGURE 2.1 Canadian Passenger R a i l Volumes: 1923 to 1945 (m i l l i o n s o f passengers and passenger-miles) 65 60-" 55--50 in cc Lul o Z 45--U l OO </) < Q_ 4-0 U-o OO Z O 35 30--25 20 7000 - - 6500 --6000 5500 LEGEND 00 5000 or UJ 4500 o Z Ld 00 00 4000 < D_ --3500 00 z o 15-1—^ *y 1923 1925 1927 1929 1931 1933 1935 1937 1939 1941 1943 1945 YEAR 3000 2500 2000 1500 1000 PASSENGER-MILES Source: Dominion Bureau of S t a t i s t i c s , Transportation Branch, Statistics of Steam Railways of Canada, Table 11, various years. Chapter 2 22 I n t e r c i t y Passenger Network was the pooling agreement for the Montreal-Ottawa-Toronto service. In spite of such efforts, i t f e l l to the advent of the Second World War, with i t s attendant gearing up of the economy, the change in focus from producing automobiles to producing tanks and the rationing of gasoline to revive the passenger r a i l industry. But revive i t , i t did. Out of the depths of the Depression, passenger r a i l volumes grew unt i l an all-time peak volume of 60,335,950 passengers was carried a total of 6,873,188,000 passenger-miles in 1944. Despite the impressive recovery, i t proved to be the swan song of the passenger r a i l industry. The post-war era saw a surge in the popularity of automobiles, buses and aircraft from which the railways never recovered. The year 1946 marked the beginning of the long and steady decline of passenger r a i l transportation in Canada. iv) down for the count?: 1946 to 1961 The immediate post-war period found the railways with r o l l i n g stock and infrastructure that had been allowed to deteriorate, since the Depression and the Second World War had inhibited refurbishing and replacement. On the heels of the^ three record years the railways had experienced, both the major railways put in a determined effort to revamp their passenger services. This took the form of their time-honoured approach of investing in new and improved r o l l i n g stock and in establishing new services. Chapter 2 23 Intercity Passenger Network The C.P.R. reacted to the expected continuing boom by adding more than 500 new passenger cars (some of them the new and expensive "dome" cars) to it s fleet between 1947 and 1954. Despite this considerable effort, i t soon became evident that the peak volumes of the mid-1940's were a temporary phenomenon. C.P.R. passenger volumes began declining right after the war and continued to decline unabated. By 1961 the C.P.R. was moving fewer passengers than they had moved during the deepest depths of the Depression. In fact, in 1961, the C.P.R. moved fewer people than they had moved in any year since 1904. Gradually, the C.P.R. switched from operating passenger trains to operating the less expensive diesel dayliners. The last major investment made by the C.P.R. to bolster sagging passenger r a i l t r a f f i c occurred in 1955, when the railway started operation of a new and faster transcontinental: the "Canadian". This service proved popular and even prompted an increase in transcontinental passenger r a i l volumes. Despite the success of the "Canadian", the system-wide passenger volumes kept dropping rapidly. In 1955, the same year the improved transcontinental service started, 39 other trains were discontinued.^ The C.N.R. faced the same post-war conditions that the C.P.R. did and for a brief period appeared to be set to phase down their efforts in passenger r a i l service. A cut in the transcontinental service, however, proved to have detrimental repercussions and the decision to cut back passenger services was reversed.^ The C.N.R. appeared convinced that passenger service remained an nLamb (1977; p. 375). 1 2Stevens (1973; pp. 436-438). Chapter 2 24 Intercity Passenger Network integral factor in maintaining the railway's overall reputation. Thus the C.N.R. started the 1950's with a determined endeavour to promote passenger r a i l travel. The C.N.R., however, did not attack the problem of declining passenger volumes in quite the same manner as the C.P.R. New investment played a role, but only 263 new passenger cars were ordered in 1953 (half the amount that the C.P.R. had ordered). Furthermore, unlike the C.P.R.'s fancy new domed cars, these cars were of the ordinary variety. The conversion to diesel locomotives did, however, seem to compensate for the lack of fancy equipment, attracting passengers by cutting down travel times considerably. The main difference between the two major roads seemed to be the difference in the tenacity of upper management. At the C.N.R. , management simply decided not to give up on passenger service. The C.N.R. kept trying new approaches such as forming a special department whose responsibility was to promote group holiday travel. The railway also set up and ran a Museum Train dedicated to the early years of railroading.^ 3 As a result of a l l this activity, the company experienced some success in reversing the trend in passenger volumes. From 1951 to 1952 the C.N.R. managed to buck the trend and enjoyed a significant increase in patronage. Thereafter, the downward spiral began again, but i t was not un t i l 1955 that the passenger volumes dipped back below the 1950 level. By the late 1950 - early 1960 period, the C.N.R. had managed to stabilize passenger 1 3Stevens (1973; pp. 436-440) details the C.N.R.'s efforts at reviving passenger travel. Chapter 2 25 Intercity Passenger Network volumes, in marked contrast to the situation at the C.P.R. (see Figure 2.2). An important factor which helped account for this was the signal from upper management that the C.N.R. wanted passenger t r a f f i c . Though passenger r a i l travel may have been "on the ropes" in the early 1960's, the fight was not yet over. v) one down, one to go: 1962 to 1977 The early 1960's saw the attitudes and the performances of the two major railways diverge sharply. The C.P.R. seemed ready and willing to abandon passenger r a i l services, whereas the C.N.R. seemed ready and willing to continue supporting passenger r a i l services. As mentioned above, the C.P.R. found i t s e l f with the lowest level of passenger volumes i t had experienced for over half a century, while the C.N.R. had actually succeeded in holding i t s own with respect to patronage levels. In the 1960's there was an important change in the circumstances surrounding passenger movements from that of the earlier years. With the exception of some of the innovative efforts of the C.N.R. in the 1950's, the standard approach to stimulating (or, at least, trying to stimulate) passenger t r a f f i c was to introduce new and improved equipment and/or to introduce new services. Regardless of the degree of success such an approach might achieve, the escalating capital costs of rol l i n g stock combined with the low returns on passenger r a i l service simply made such an approach no longer economically viable. Some completely different approach had to be found. Chapter 2 26 Intercity Passenger Network FIGURE 2.2 Canadian Passenger Rail Volumes: 1946 to 1961 (millions of passengers and passenger-miles) 45 Ul U l o to to < 0_ 4 0 + 3 5 " 30 o to z o 25--20 15 i 1 1 n I 5000 4500 4000 tO I or UJ 3500 < D_ 3000 O to z o _J _ J 2500 --2000 1946 1948 1950 1952 1954 YEAR 1500 1956 1958 1960 LEGEND P A S S E N G E R S PASSENGER-MILES Source: Dominion Bureau of Statistics, Transportation Branch, Statistics of Steam Railways of Canada, Table 11, various years; Statistics Canada, Catalogue 52-003. ter 2 27 Intercity Passenger Network The C.N.R. pioneered this new approach when i t introduced the Red, White and Blue Plan to eastern Canada on May 1, 1962. This plan, a straightforward peak/off-peak pricing scheme, was designed to appeal to the discount traveller. It also endeavoured to shift travel away from the busy Friday to Sunday period and to shift the corridor t r a f f i c to the off-peak hours during each day.^ In addition to this fare plan, the C.N.R. introduced a charge plan for payments, and added to the normal passenger trains special r a i l cars which could carry automobiles. This was designed to appeal to passengers who wanted to have their own car with them at their destination. The results of these efforts were quite remarkable. The C.N.R.'s passenger volumes underwent a steady and spectacular rise starting in 1962 and culminating in the "modern" era peak level in 1967 (see Figure 2.3).1-' The Red, White and Blue Plan seemed so effective that i t was adopted (in one form or another) by other railways. The increase in patronage was such that i t seemed to j u s t i f y the introduction of new equipment in the form of the "Rapido" and the infamous "Turbo" for Quebec-Windsor corridor service. Unfortunately for the railway, mechanical problems with the new equipment (especially the Turbo) had negative impacts on passenger volumes. More importantly, however, was r a i l ' s disappointing service standards compared to the private automobile, as perceived by the now automobile-spoiled Canadian ^Accomplishing such a shift would mean that the railway would require fewer trains to meet the peak-period passenger demand. ^Some of the credit for the peak in the passenger r a i l volume must go to the fact that Montreal hosted a World Exposition that year. Passenger demand for travel by a l l modes was thus abnormally high in 1967. Chapter 2 28 Intercity Passenger Network FIGURE 2.3 Canadian Passenger Rail Volumes: 1962 to 1977 (millions of passengers and passenger-miles) Chapter 2 Source: Statistics Canada, Catalogue 52-003. 29 Intercity Passenger Network public. Both these factors combined to keep people out of the trains and in their cars. Thus, despite the considerable efforts of the C.N.R., passenger volumes resumed their steady decline after the 1967 peak. While the C.N.R. was "fighting the good fight", management at the C.P.R. accepted the demise of the passenger r a i l industry. Although the C.P.R. had abdicated i t s position of leadership to the C.N.R. a while back, i t had played the follower for a good many years. By the mid-1960's, however, even this limited effort was in doubt. After the C.N.R. requested and received the C.P.R.'s agreement to end the pooling arrangement for the Montreal-Ottawa-Toronto services in 1966, i t did not take long for the C.P.R. to cancel service between Montreal and Toronto. Although the C.P.R. route between these two c i t i e s was inferior to the C.N.R. alignment, this decision shocked many since, after a l l , this was the nation's most densely populated link that the railway was abandoning. In a similar fashion, i t was not long after the C.P.R. f i r s t followed the C.N.R.'s discount pricing scheme (the Red, White and Blue Plan) with their own "Faresaver" plan that the C.P.R. was ready to abandon this as well. In 1964, the company conceded defeat in the passenger r a i l industry, stating in i t s annual report: The "Faresaver" plan, introduced in late 1963, though attracting additional patronage, did not produce sufficient revenue to j u s t i f y the drastically reduced fares. In view of the increased use of the private automobile over improved highways in short distance travel and the inherent advantages of the jet ai r l i n e r over long distances, no prospect is envisaged by your Company of attracting r a i l passengers in sufficient numbers, on many segments of our lines, at prices they are willing to pay, to offset the expenses of providing this service. 1** i bCP Annual Report. 1964, p. 9. Chapter 2 30 Intercity Passenger Network It was during this period of decline that the Federal Government acknowledged i t shouldered some of the financial responsibility for imposed passenger services with the passage of the 1967 National Transportation Act.17 Where a passenger service was shown to be unremunerative, but was ordered continued "for the public good", the Federal Government would cover 80% of the verified loss. During this period, the governmental share of passenger r a i l service costs grew as passenger volumes continued to decline. As time went on i t became clear that something had to be done with the entire passenger r a i l industry. Passenger volumes were but a shadow of their former levels. Losses on passenger services were mounting. The high cost of providing passenger r a i l service even resulted in the ironic situation where the exceedingly popular and (at least in the summer) well-travelled transcontinental service, the Super Continental, incurred exceedingly high losses. The C.P.R. clearly had no interest in passenger service and even the enthusiasm of the C.N.R. had waned considerably. Over time, the passenger r a i l industry became characterized by applications for abandonment of services by both railways.1** The "solution" to the problems inherent to the passenger •••'The implications of the NTA are discussed in more detail later in this chapter. ^An application for abandonment of service does not necessarily mean that the railway making the application wants to drop the service. Such an application is requisite in order to obtain the operating subsidies the Government made available under section 261 of the Railway Act. In other words, even i f a railway just wanted to receive the available subsidy for an unremunerative service, i t had to apply for discontinuation of service. This is dealt with more fu l l y later in this chapter. Chapter 2 31 Intercity Passenger Network r a i l industry was the formation of a single organization to oversee a l l the intercity passenger services of the C.N.R. and the C.P.R.: VIA Rail. vi) the establishment of VIA Rail: 1977 to 1979 In order to breathe new l i f e into an industry gone stale, the Federal Government inserted a $1 item into the supplementary estimates of Appropriation Act No. 1, 1977. This seemingly inauspicious move launched VIA Rail Canada Incorporated as "a railway company incorporated pursuant to Section 11 of the Railway Act" in order to provide "a unified management and control of r a i l passenger services in Canada. VIA Rail Canada was to be the body responsible for Canada's intercity passenger r a i l services. This is not to say that VIA is the only organization providing intercity passenger services in Canada. Other railways, for example the Algoma Central Railway (formerly the Algoma Central and Hudson Bay Railway Company) and the Ontario Northland Railway (part of the Ontario Northland Transport Commission), also provide passenger service. Nevertheless, VIA Rail is the dominant force in Canadian intercity passenger r a i l service. The i n i t i a l plan for VIA Rail was for i t to be a wholly-owned subsidiary of the C.N.R. This arrangement, however, lead to conflicts of interest which i yStatutes of Canada, 25-26 Elizabeth II, Chapter 7: Appropriation Act No. 1, 1977, Vote 52d. See Appendix A for the contents of Vote 52d in it s entirety. It is very interesting to note that VIA Rail has s t i l l not actually been provided with a mandate in legislation, although the Mulroney Government's B i l l C-97 "An Act respecting r a i l passenger transportation" received f i r s t reading on February 24, 1986, before dying on the order paper. Chapter 2 32 Intercity Passenger Network VIA's management found intolerable and detrimental to the operations of VIA Rail. This lead to the purchase of a l l the C.N.R. 's shares in VIA by the Federal Government for $30,000,000 on March 31, 1978. 2 0 Thus VIA Rail Canada became a separate, independent Crown Corporation on April 1, 1978. VIA Rail operates under contract with the Federal Government (through the Minister of Transport) to provide passenger r a i l services. VIA provides a l l the incidental passenger services such as ticketing and reservations. VIA also provides the locomotives and the r o l l i n g stock as well as the personnel which provide on-board services and the railways provide the engineers to run the trains. Since VIA does not own any track, VIA negotiates with the railways for operation of VIA passenger trains over the railways' track. The payment for the use of the track includes such items as switching, signalling and communications as well as VIA's share of the maintenance costs of the track. In addition, since VIA originally had no equipment maintenance f a c i l i t i e s whatsoever and did not own the passenger terminals they used, VIA also paid the two railways for equipment and station maintenance. The payment for the operation of the passenger trains includes a l l the labour, materials, fuel and administration costs incurred by the C.N.R. and the C.P.R. and attributable to passenger service, as defined by Costing Order R-6313. This costing order was established by the Canadian Transport Commission (prior to VIA Rail's formation) as the basis for determining the allowable costs the railways can claim in the applications for abandonment of service. ^Standing Committee on Transportation and Communications, 1979, Issue no. 9. p. 9:4 (Vote L115). Chapter 2 33 Intercity Passenger Network The basis for the C.N.R.'s and the C.P.R.'s charges to VIA Rail has been a perennial source of contention. The railways are provided with VIA's requirements for service for the year and return estimates of the costs the railways expect to incur in providing the requested level of service. At the end of the year, the railways submit the actual costs they incurred according to Costing Order R-6313 (subject to the adjudication of the Canadian Transportation Commission). The railways are not held to their original estimates which can vary substantially from the f i n a l costs the railways claim. Furthermore, the presentation of the so-called fourteenth b i l l to VIA Rail by the railways causes a great deal of uncertainties for VIA. ^  For example, VIA received well into 1981 a fi n a l b i l l for $3,136,900 from the C.P.R. and one for $13,522,615 from the C.N.R. for services rendered in 1980. 2 2 This represents about 3.6% of VIA's total expenses for 1980. VIA, in negotiating these charges with the railways, has l i t t l e enough leverage to start with, but since the railways provide the fi n a l b i l l after the services have been provided, VIA essentially has no control over the costs for which they are held responsible. Since the railways are guaranteed payment for their services, they have l i t t l e to no incentive to provide efficient services. This clearly leaves a great deal of leeway for abuse. Z iVIA receives 12 monthly b i l l s , an additional b i l l for the year-end adjustment and fi n a l l y , a post year-end adjustment b i l l . 2 2The Vancouver Province, May 22, 1981. p. C6. 2 3Cubukgil and Soberman (1984) provide an excellent analysis of the problems inherent to the institutional arrangement between VIA, the two major railways and the Federal Government. Chapter 2 34 Intercity Passenger Network The portion of the costs VIA incurs (be i t costs VIA incurs directly or the costs incurred by the railways on behalf of VIA) that is not met through passenger fare receipts is covered by the Federal Government.2^ Figure 2.4 illustrates the amount the Government has been required to provide since the inception of VIA Rail. The 1977 to 1979 period was basically one of establishing VIA as an organization capable of providing passenger r a i l service. The process of gearing up for the transfer of responsibility for passenger r a i l service began on June 1, 1977. As of this date, VIA assumed responsibility for marketing. The original timetable scheduled VIA to assume effective responsibility for both rationalized and non-rationalized passenger services by April 1, 1978 and definitive responsibility by April 1979.2-* Due to problems encountered in the transfer of services, however, VIA did not assume effective responsibility for the management of Canada's intercity passenger trains u n t i l September 28, 1978.- VIA took over i t s f i r s t rationalized service (the western transcontinental service) on October 29, 1978. z^The Railway Act. R.S., c. 234 provides for Federal r e l i e f to the tune of 80% of actual losses (as determined by the Canadian Transport Commission) arising out of the operation of uneconomic passenger services required by the Commission. This is circumvented in the case of VIA Rail by having the Minister of Transport contract out passenger r a i l services to VIA. In this manner, 100% of the operating deficit VTA incurs is covered by the Federal Government. 2-*A "rationalized" service replaced competing C.N.R. and C.P.R. services with a single VIA Rail service on one or the other r a i l line. "Non-rationalized" services were those where VIA continued to run "competing" services on both the C.N.R. and C.P.R. alignments. The difference between "effective" and "definitive" responsibility is that under the former, the railways are s t i l l responsible for submitting statements of passenger service losses incurred to the Canadian Transport Commission. Under the latter, VIA i t s e l f would be responsible for negotiating the service contracts with the Government. Chapter 2 35 Intercity Passenger Network F I G U R E 2 . 4 Government: Contribution to VIA Rail Operating Budget 5501 500- • 450--400-00 350-_ J o Q 300-oo 250--o _ l 2 200-150-100-50-LEGEND • PASSENGER REVENUE GOVERNMENT SUPPORT 1978 1979 1980 1981 1982 1983 1984 1985 YEAR Source: VIA Rail Canada Inc., Annual Report; Statistics Canada; Globe & Mail, 20 May 1986, p. B6. ter 2 36 Intercity Passenger Network 0 The year 1978 saw VIA acquire the passenger equipment of the C.N.R. (in March) and the C.P.R. (in October) as well as both railways' unionized passenger r a i l work-force (some 3600 people). VIA replaced the pricing plans of the two railways with a unified scheme called the "Fare For A l l " plan, which eliminated seasonal rates but provided for round-trip excursion fares, group rates, senior citizen discounts and established the VIAPASS.,£D In addition, VIA Rail began replacing the schedules of the two railways with one unified, integrated schedule. By October 1979, VIA had integrated a l l i t s passenger services, which ostensibly provided easy transfer between 27 services. • During this period, VIA was involved with Air Canada in the joint development of a computerized reservation and ticketing system called RESERVIA. It also oversaw the production of the 50 passenger cars and 22 locomotives of the new "Light, Rapid, and Comfortable" (LRC) type being built for VIA by Bombardier at a cost of $90,000,000. Also during this period, VIA started the lengthy but necessary on-going process of refurbishing the bThe average VIA fare was established at a level about 13% lower than the average C.P.R. fare, but somewhat higher than the average C.N.R. fare. Fares were increased by 5% in April 1979 and between 4% and 6% in November 1979. 2 7With the limited number of services offered i t was impossible to always meet demand and i t was inevitable that some transfers were exceedingly awkward, especially for travel to the United States. As an ill u s t r a t i o n of this, the Ontario Task Force on Provincial Rail Policy reports of a Task Force member who attempted to take the train from Toronto to Lansing, Michigan. To start with, VIA could not provide him with a ticket on the AMTRAK train he would take on the last half of the trip, nor even an AMTRAK schedule. After disembarking in the dark in Sarnia, he had to take a taxi over the border to Port Huron, stay there overnight and catch the AMTRAK train the next morning. (Ontario Task Force on Provincial Rail Policy (1980; p. 29)). Chapter 2 37 Intercity Passenger Network antiquated equipment i t had inherited from the railways. During 1978, 128 passenger cars and 39 locomotives were overhauled. An additional 108 passenger cars and 36 locomotives were overhauled in 1979. Thus by the end of 1979, about 30% of the fleet of passenger vehicles had been refurbished. Work on refurbishing the fleet of 90 Rail Diesel Cars (RDCs) was also begun in 1979. In addition to the work on equipment, scheduling and pricing, VIA was also heavily occupied with establishing harmonious relations with the labour unions, the other transportation modes and the travelling public. The labour negotiations centred around the fate of the former C.N.R. and C.P.R. employees whose positions became redundant when VIA Rail took over intercity passenger services. In addition to this, there were the usual wage and working condition issues to settle. VIA was also concerned with converting employee loyalty to VIA Rail from the previous loyalty to either the C.N.R. or the C.P.R. The discussions with the other modes stressed VIA's belief in the intermodality of intercity travel. VIA attempted to assuage the fears of the intercity bus industry by stating that VIA's goal was to supplement the other modes and not to replace any of them. To this end, VIA established plans for intermodal transportation centres in several c i t i e s across the country. For further assurance, VIA claimed that i t s target passenger was the automobile user, not the bus user, and therefore the bus industry had nothing to fear. ° The dialogue with the travelling public was designed mainly to explain to a 2®The fear of the bus industry is that a railway with unlimited access to federal funds (i.e. VIA) could cut it s price drastically to attract the low income traveller the primary user of bus transport. VIA's protestations that these travellers were not the primary target did not really do much to pacify the bus lobby. Chapter 2 38 Intercity Passenger Network somewhat confused public exactly what VIA Rail was and what i t s goals were. VIA also undertook to study how i t could improve i t s service to the handicapped. New Years Eve, 1979, found VIA Rail poised to enter i t s f i r s t f u l l year of f u l l responsibility for the entire intercity passenger r a i l network. The relationship with the railways and with the Federal Government was established, however flawed i t might have been. VIA owned the (antiquated) passenger car fleet and was taking steps to gain control over the terminals. The f i r s t set of labour negotiations was complete, the bus industry had not yet succeeded in convincing Parliament to eliminate the VIA Rail subsidies and the travelling public was gradually becoming aware of VIA. Despite the d i f f i c u l t i e s in the transition of responsibility and the fact that VIA had yet to be in charge of a l l passenger r a i l services for an entire year, the period 1977 to 1979 was generally regarded a success* in reversing the downward trend of passenger volumes. The 1978 passenger volume was 12% higher than in 1977 and the 1979 passenger volume was 8% higher than in 1978 (see Figure 2.5). With the new improved (faster) LRCs that were due on stream in the early 1980's, i t seemed that the passenger r a i l industry just might survive after a l l . v i i ) VIA Rail i n operation: 1980 to ???? The f i r s t f u l l year of total VIA operations and most of the second f u l l year saw a continuation of the honeymoon period for VIA Rail. Passenger Chapter 2 39 Intercity Passenger Network FIGURE 2.5 VIA Rail Passenger Volumes: 1980 - 1986 8000 1980 1981 1982 1983 1984 1985 1986 YEAR t e r 2 40 S o u r c e : S t a t i s t i c s C a n a d a . I n t e r c i t y P a s s e n g e r N e t w o r k volumes continued to increase. First class service (VIA 1), which was introduced to the Montreal-Toronto service in October 1980, was extended to a l l Rapido trains in the Quebec-Windsor corridor. This service experienced a 20% increase in patronage. The f i r s t LRC trains came into limited service in 1981 and plans for up to 10 more complete train sets were announced, giving proof of both VIA's and the Government's commitment to passenger r a i l service. As further proof of the Government's commitment, the Minister of Transport announced in July 1981 that VIA would get $1,100,000,000 in operating support for the three year period ending March 31, 1984. A substantial increase in VIA's capital budget (from $90,000,000 in 1981-82 to $174,000,000 in 1982-83 and $182,000,000 in 1983-84) was also announced at this time. VIA announced in April, 1981 that joint service from Toronto to New York with AMTRAK would be started - the f i r s t through service between these points since 1971. VIA added additional services on the Montreal-Quebec, the Montreal-Toronto, the Montreal-Ottawa and the Toronto-Ottawa routes in June. Two new services were added in October: Toronto-Windsor and Toronto-London. There were improvements in service in both the Prairies and the Maritimes as well. VIA achieved a great measure of success in i t s efforts to promote intermodality when i t reached an agreement in principle with the Government of Saskatchewan to convert Regina Station to a multimodal transportation centre. Finally, the RESERVIA system was introduced on March 1, 1980 and though there were problems i n i t i a l l y , they were gradually being ironed out. The boom f e l l on November 15, 1981 when the Minister of Transport, without benefit of public input, C.T.C. hearings or Parliamentary debate, decreed revisions to VIA services. These "adjustments", as J.F. Roberts so Chapter 2 41 Intercity Passenger Network euphemistically called them in his Chairman's Message in the 1981 VIA Rail Annual Report, called for substantial cuts in service. In 1982, VIA's route miles of service declined by 20% from the previous year. The 1982 VIA Rail Annual Report states that the 1981 service cuts resulted in a savings to the Federal Government of about $55,200,000. There were a few bright spots for r a i l passengers in 1982. The LRC entered f u l l revenue service in the Quebec-Windsor corridor. Tour packages were up by 25%. A direct Toronto-Chicago service (again with AMTRAK) was started, due to the success of the Toronto-New York service begun in the previous year. Less than 20% of the original fleet remained unrefurbished. In addition, the order for the 10 new LRC train sets (10 locomotives, 50 passenger cars) was placed. The interim maintenance f a c i l i t y in Montreal was to be completed for start-up in early 1983. This f a c i l i t y would maintain the new LRC trains u n t i l permanent f a c i l i t i e s were completed. Finally, another potentially important event occurred late in 1982 when VIA and the two railways reached an agreement concerning f a c i l i t a t i n g the exchange of restricted costing information. This would help VIA monitor the costs for which i t is responsible. The year 1983 saw a decided focus by VIA Rail on reducing the level of Government funding i t required. VIA, as a Crown Corporation, is expected to keep down the level of i t s d e f i c i t and yet s t i l l serve the "public interest". Since these two objectives are generally incompatible, one usually dominates over the other. In 1983, i t was the concern with the bottom line which received relatively more prominence. VIA Rail, however, did not cut back Chapter 2 42 Intercity Passenger Network entirely on service. VIA directed a great deal of i t s attention to marketing, station upgrading and improving the employee-passenger interface. As the 1983 99 Annual Report professes: "good customer service is VIA's number one goal". 7 Although these elements were a l l important, they did not get to the heart of the problem - that most of VIA's fleet was old and highly undependable. The Government gave VIA a much needed shot in the arm when i t announced that VIA Rail would get $306,000,000 for the construction of new maintenance f a c i l i t i e s in Halifax, Montreal, Toronto and Winnipeg. Unfortunately, given the continued reliance on antiquated equipment, this "medicine" was more placebo than panacea. Some new equipment, in the form of the Canadian-designed LRCs, began service in the Quebec-Windsor corridor. However, this was just a "drop in the bucket", and for most of the country, VIA continued to be represented by an antiquated fleet. The year 1984 saw the continued focus of VIA Rail on the bottom line. The company had, for two years running, managed to keep the d e f i c i t below the level that the Federal Government had budgeted for. In 1983, the anticipated Government funding requirement was $709,000,000. The actual amount used by VIA was "only" 597,000,000 - a f u l l $112,000,000 below that expected. In 1984, the anticipated Government funding requirement was $668,000,000. The actual amount used by VIA was $474,000,000 - a significant $194,000,000 below that budgeted for. The aggregate two-year "savings" amounted to $306,000,000. z yThe net result of this activity was somewhat disappointing. Passenger volumes in 1983 were about 7% below those of 1982 and about 16% below those of 1981, in part due to a f a i r l y severe recession in the Canadian economy. Chapter 2 43 Intercity Passenger Network Although the financial side looked somewhat brighter from Ottawa's point of view, the passenger volumes remained quite low. There was a small increase in the 1984 volumes over the 1983 levels (by about 3%). S t i l l , far fewer passengers used VIA in 1984 than did prior to the November 1981 cuts. In addition to a l l the other problems VIA had to worry about, i t had to deal with proposals to merge VIA with the C.N.R. This was strongly, and thus far successfully, opposed by VIA management who claim that the freight and passenger sides do not mix well. On the bright side for travellers, two of the discontinued services of the 1981 service revision were reinstated (one in the Prairies and one in the Maritimes). VIA upgraded a section of the Ottawa-Toronto line in order to improve travel times. Overall, however, aside from the reduction in the subsidy required, i t was not a particularly outstanding year for the intercity passenger r a i l sector. Given the high expectations surrounding VIA at i t s inception and the subsequent failure of VIA to deliver as expected J U i t was not surprising that VIA came under very heavy criticism. The bus industry became increasingly bitter over the large Government subsidies to VIA. The passengers became increasingly discontent with the service provided. i 3 0Even Harold A. Renouf, O.C., the Chairman of the Board of VIA Rail, was forced to admit in his letter of transmittal to then Minister of Transport Lloyd Axworthy, that: "Progress on some fronts was less than the public and management would have desired..." (VIA Rail Annual Report, 1983. p. 2) •^This discontent boiled over during the 1983-84 Christmas peak season. Numerous horror stories of trains freezing up and breaking down, of enormous delays and of surly service abounded in the press. In fact, VIA Rail managed only a 50% on-time performance level during this period. Furthermore, when there were delays, they averaged 100 minutes in duration. Much of the problem was out of VIA's control--namely the antiquated equipment combined with the Chapter 2 44 Intercity Passenger Network Finally, resentment in the west and in the Maritimes over VIA's "excessive" concern with the Quebec-Windsor corridor became even more pronounced. £-The year 1985 was also marked by progress and set-backs. On the equipment side, the Toronto maintenance centre was opened, and close to 1500 CN and CP maintenance workers were transferred to VIA. This would help VIA control maintenance costs more closely. A tendered contract for 20 new 3000 horsepower locomotives was awarded, and a tender for another 10 locomotives soon followed. VIA continued the testing of AMTRAK bi-level equipment started in late 1984, and_ negotiations for bi-level equipment were begun with a consortium of Bombardier and the Urban Transportation Development Corporation. However, not a l l was rosy: the new LRC equipment was plagued by teething problems and the negotiations with the consortium for the bi-level equipment bogged down over a failure to reach a mutually agreeable price. On the service side, improvements to the Ottawa-Brockville line were completed, lowering Montreal-Toronto travel times along this route. Several lines discontinued in 1981 were restored, notably: the "Atlantic" (Montreal-Halifax); the "Canadian" (Montreal-Ottawa-Sudbury leg); and the "Super Continental" (Vancouver-Jasper-Edmonton). Three services were dropped in 1985. Overall, passenger levels were the highest since the November 1981 cuts. excessively harsh winter conditions that year--yet something had to bear the brunt of passenger anger and VIA was that something. •^The LRC trains, after originally being promised for nationwide service a l l found themselves in corridor service. Furthermore, a considerable portion of VIA's research seemed to be focused on high-speed r a i l service - something economically feasible only in the central corridor, i f at a l l . Chapter 2 45 Intercity Passenger Network VIA also underwent an organizational restructuring in the attempt to improve i t s a b i l i t y to deal with the myriad of problems i t faced. However, this reorganization did not meet with unqualified approval. The Task Force on Passenger Rail Services (the Horner Task Force) suggested a restructuring quite different from that undertaken by VIA. Overall, VIA appeared to be making some small strides towards providing an effective service. Unfortunately, given the poor state of i t s equipment, the continued lack of a mandate, and unresolved problems with the institutional arrangements, "small strides" were far from what was required to address the fundamental problems. To summarize the current situation, the mid-1980's finds VIA Rail Canada s t i l l without a mandate in legislation clearly defining i t s objectives (although one is pending). VIA's relationship with the railways is s t i l l inadequately established and can best be described as being rather strained. VIA suffers from a poor reputation among the travelling public, and hence from a low level of patronage on most of it s services. Due to the combination of a l l these factors, VIA s t i l l requires substantial subsidies from the Federal Government. VIA now faces an environment in which the concept of competition is regaining favour at the expense of regulation. 3 3 Given this increasingly competitive environment, the stated user-pay philosophy of the National 3 3Despite the philosophy of the NTA., Canada never really enjoyed a high level of competition in many aspects of intercity passenger travel. This was recognized and passenger services remained very heavily regulated. The U.S. experience and relative success with deregulation, however, has stirred up Canadian interest in competitive policy once again. Chapter 2 46 Intercity Passenger Network Transportation Act and a national Conservative government which has pledged to find ways to reduce federal spending, i t certainly appears that VIA's current practices cannot remain as they are. Considerable changes in the operating environment are very li k e l y in store for the troubled Crown Corporation. VIA Rail must surely prepare i t s e l f for changes in the level of government support i t can expect in the future. C. The Competing Modes In addition to the r a i l mode, there are three other modes which are currently important factors in intercity passenger travel in Canada. These are the private automobile, the intercity bus and the airplane. Each of the four modes has i t s strengths and each of the four modes has i t s weaknesses. The private automobile, though offering the best service in f l e x i b i l i t y , convenience and privacy, is not particularly attractive for long distance travel. It has the additional drawback of the high financial outlay required for ownership and maintenance. Among the common carriers, the bus mode usually offers the most frequent departures and the lowest fare. Offsetting this are the relatively high travel times (especially on non-express routes) the lower levels of travelling comfort and the often unattractive nature of the terminals. The r a i l mode, though lower in f l e x i b i l i t y and convenience than the bus, is generally considered more comfortable, (sometimes) faster and is usually competitively priced. The r a i l mode, at least in Canada, tends to be the most unreliable of the modes. The air mode offers tremendous time savings over a l l but the shortest of routes, but i t tends to charge a substantially higher fare than the other modes. Chapter 2 47 Intercity Passenger Network The great variation in the nature of Canadian city-pairs, combined with the variation in the strengths and weaknesses of the modes, results in the great variation in route-specific modal shares. Table 2.1 illustrates this v a r i a t i o n . ^ The next three sections b r i e f l y review the private automobile, intercity bus and air modes in somewhat more detail. TABLE 2.1 Route-Specific Modal Shares Total Air Bus Car Rail City - Pairs Volume Share Share Share Share Toronto - Quebec 122,802 60. 1% 1. 4% 31. 6% 6, .8% Hamilton - Ottawa 160,107 13. 9% 2. 6% 82. 5% 1. .0% St. Catharines - Quebec 12,284 8. 7% 1. 3% 78. 2% 11. .8% London - Toronto 1,287,108 1. 2% 3. .5% 85. 0% 10. .2% Sarnia - Toronto 213,941 2. 3% 0. 2% 82. 8% 14. .6% Windsor - Toronto 562,773 16. 5% 2. 7% 60. 9% 19. .8% Windsor - Hamilton 169,266 1. 3% 1. 7% 94. 1% 3. .0% North Bay - Montreal 64,501 2. 55 3. 1% 91. 9% 2. .5% North Bay - Toronto 149,397 7. 3% 11. 1% 79. 6% 2. .0% Thunder Bay - Sudbury 15,079 30. 9% 29. 0% 36. 4% 3, .7% Winnipeg - Montreal 37,486 82. 4% 0. 8% 11. 3% 5, .5% Winnipeg - Toronto 101,035 88. 9% 2. ,0% 5. 1% 4, .0% •^This variation is based on the ICTD database used in the modelling segment of this thesis. Chapter 2 48 Intercity Passenger Network i ) the private automobile The private automobile, for reasons familiar to a l l , is by far the most dominant of the major modes currently in use for intercity passenger travel. Despite this fact, the amount and quality of the data available concerning automobile usage is far lower than for the common carriers. Data do exist concerning automobile ownership as well as the provision and maintenance of way. In addition, some data exist concerning the level of use of the automobile. From this, i t is possible to get a feel for the growth in the popularity of automobile travel. In the early days of motoring, automobiles were relatively expensive compared to disposable income, had relatively poor performance standards compared to the train, and were provided with only a limited network of roads. As such, the automobile was more of a novelty and a toy for the rich u n t i l after the Second World War. After the Second World War, incomes were rising thus lowering the relative cost of automobile ownership. Furthermore, the dependability and performance of automobiles improved dramatically. These two factors made automobiles more accessible and attractive to travellers. In addition, the wartime and postwar concern with the fast and efficient mobilization of materials within Canada contributed towards the provision of an improved roadway system. The dam was now broken. The more automobiles and roads the Canadian public had, the more they wanted. Growth in automobile registration and usage, as well as roadway construction, was rapid. Eventually the growth rate Chapter 2 49 Intercity Passenger Network of automobile registration tapered, although i t reflects more a reaching of a saturation point with respect to ownership than a decline in the popularity of automobiles as a mode. With 10,530,355 automobiles registered in Canada in 1982 there were approximately 0.43 automobiles for every man, woman and child in the country. 3^ Approximately four-fifths of Canadian households have an 36 automobile; approximately one-quarter of them have two or more automobiles. Similarly, the growth rate in the aggregate supply of roads has slowed down in recent years. In part, this reflects a decrease in the construction rate of new urban roads due to the already high concentration of roads in the c i t i e s . It also reflects the increase in road construction and maintenance costs, and the deteriorating state of the existing road network. In other words, the requirement for maintenance is increasing as the road network ages, while at the same time, the costs of maintaining a given section of roadway is increasing. Thus i t takes an increasing share of the roadway budget just to maintain what we already have. Obviously, this decreases the funds available for new construction. Nevertheless, Canada enjoys a relatively extensive network of roads compared to many other nations. Given the combination of a relatively extensive road system, the large number of automobiles available for private use and the relatively high level •^Statistics Canada, Road motor vehicles: Registrations. Catalogue 52-219 (Annual). 3 6Transport Canada (1979; p. 1). Chapter 2 50 Intercity Passenger Network of income in Canada-5' i t is not surprising that the Canadian Travel Survey found that the automobile was used for f u l l y 86.7% of a l l intercity person trips in 1979. Air was used for only 8%, while the bus and r a i l modes held a marginal share: 4% and 1.3%, respectively. 3 8 In the wake of the O i l Crisis of the mid 1970's, there were numerous discourses on the imminent demise of the passenger automobile. Use of the mode, however, has shown remarkable persistence, even during the period of soaring fuel prices. It would appear l i k e l y that, barring a major c r i s i s such as another o i l embargo, the automobile w i l l continue to be the favoured mode for the short to medium range segment of intercity passenger travel. Due to the continuing favour accorded the private automobile, the r a i l mode may not be as competitive with respect to automobile travel as the various presidents of VIA Rail seemed to believe (or, at least, as they publicly profess to believe). A s t a t i s t i c a l l y insignificant relationship between automobile volumes and r a i l fares would thus not be surprising. On the other hand, the implications of a s t a t i s t i c a l l y significant cross-price -''Canada ranked fourteenth in the world in per capita income after Denmark, Finland, West Germany, Kuwait, Luxembourg, Nauru, Norway, Qatar, Saudi Arabia, Sweden, Switzerland, United Arab Emirates, and the United States. (World Almanac, 1986). 38When the basis of comparison is passenger-kilometres rather than passenger volumes, the domination of the automobile is lessened somewhat. These figures represent overall travel. The picture changes slightly in the Quebec-Windsor corridor. In this high-density region, the three common carrier modes are able to provide a higher level of service than in the low density regions and hence enjoy higher patronage shares. The private automobile, however, is s t i l l the mode chosen for almost 60% of a l l intercity trips. (C.T.C. 1975; p. 3). 3^The price of imported crude o i l rose from $2.86 per barrel in 1972 to $42.99 per barrel in 1981. (Statistics Canada, Catalogue 62-001). Chapter 2 51 Intercity Passenger Network e l a s t i c i t y , even i f very small in magnitude, are substantial. This occurs because even a small percentage change in automobile usage could translate to a large absolute change in train patronage due to the sheer number of automobile travellers. The rail-automobile interaction must, therefore, be closely examined. i i ) the intercity bus The basic history of the intercity bus mode is much like that of the private automobile. Early buses suffered from poor performance and, of course, were limited by the same lack of roads that the automobile was plagued with. As in the case of the automobile, the technology involved in vehicle production progressed and as a result, bus performance improved over time. Unlike the automobile mode, when the road network expanded the bus mode did not enjoy the phenomenal growth rate private automobile use did. Nevertheless, the bus mode is a major player, as shown by Figure 2.6. It enjoys higher patronage than the r a i l mode on many routes and the air mode on the shorter routes, offering more frequent departures than the r a i l mode and lower fares than the air mode. From the point of view of the operators, the bus mode is exceedingly flexible. With no investment in fixed way to tie operators down and minimal requirements for passenger terminals, services can be altered very easily. Historically, bus users have been those "who do . not own automobiles, those who cannot drive, the very old, the very young, the unemployed and those Chapter 2 52 Intercity Passenger Network FIGURE 2.6 Canadian Bus Volumes: 1954 to 1984 65 1954 1959 1964 1969 1974 1979 1984 YEAR Chapter 2 Source: Statistics Canada, Catalogue 53-002. 53 Intercity Passenger Network who are in lower socioeconomic groups."^" The bus mode came to be characterized as a "lower class" of mode; one for those unable to afford one of the "better" modes. The bus industry has had a long, hard struggle to' r i d i t s e l f of this label. Buses have been improved to the point where they provide extremely smooth rides. With the reduction in the number of seats on some of the services (such as the VIP service run by Voyageur), buses offer far more room than they once did. In addition, the provision of hostesses, hot meals and telephone service has made the high-class express bus service an alternative to both r a i l and automobile for business travel. Indeed, the introduction of services such as Voyageur's VIP service on some of i t s shorter routes, and the Red Arrow luxury service between Calgary and Edmonton, has resulted in a dramatic change in the nature of the bus clientele. The bus mode seems to be shaking off the historical stereotype image of being a "second class" mode. To further this trend along, Voyageur recently joined forces with 47 smaller operators in both Ontario and Quebec in order to adopt an industry marketing approach. This a f f i l i a t i o n of independent companies has been having some success in reviving bus travel. Additional techniques used have included general unlimited bus passes (the "Tourpass") and special student passes. Preliminary results look promising, at least for the short to medium distance routes.^1 4 0Reschenthaler (1981; p. 9). 4 1The Globe and Mail, Wednesday July 25, 1984. p. BIO. Chapter 2 54 Intercity Passenger Network On the longer distance routes, the bus mode appears to be fighting a losing battle. The travel time savings of air travel seems to outweigh the higher fare for most long distance passengers. This is especially true given the recent practice of discount airfares. As a result, the intercity bus industry has a l l but given up hope for the future of long distance bus t r a v e l . 4 2 The bus is simply not a time-ef f icient way to travel long distances. 4 3 The biggest competitor that the bus industry faces for the short to medium distance, low income traveller seems to be with VIA Rail. The bus lobby feels that the annual operating subsidy given to VIA by the Federal Government allow VIA to engage in "predatory" pricing aimed directly at the class of passenger which previously had been vi r t u a l l y the exclusive domain of the bus industry. 4 4 In addition, the bus lobby resents the fact that VIA is concentrating i t s efforts on serving the lucrative Quebec-Windsor corridor -the lifeblood of the bus industry - while leaving the smaller volume routes unserved.4-' 4 2The Globe and Mail, March 30, 1984. p. R9. 4 3There is another type of long-distance traveller, one for whom "efficiency" of travel is not a consideration. This is the traveller/tourist out to "see the country". Such a traveller would clearly prefer a surface mode; however, in such cases, whether i t be for nostalgic or romantic reasons, the r a i l mode usually gets the nod. In addition, at a practical level, train travel tends to be more comfortable than bus travel over long distances. The bus mode tends to lose out on long-distance travel for most categories of traveller. 4 4The Globe and Mail, Monday July 12, 1982. p. B8. 4 5The bus mode has generally operated two types of scheduled service. The f i r s t is the local service between small centres. This service tends to have low load factors and high costs and is usually unprofitable, or only marginally profitable. The second is the express service between major Chapter 2 55 Intercity Passenger Network In many cases, the criticism of the bus industry executives is not leveled at VIA Rail i t s e l f . As businessmen they can understand VIA's efforts to attain financial respectability by concentrating on the most profitable areas. In fact, the bus companies have actually managed to co-operate and co-exist with VIA to a considerable extent. For example, VIA and Voyageur made plans to open a multimodal transportation centre at Gare du Palais, Quebec. In addition, Voyageur ran a connecting bus service between Ottawa and Kingston for VIA. It is Ottawa's failure to set appropriate guidelines or long-run objectives for VIA's operations which seems to infuriate the bus industry. 4*' Ottawa, in leaving a vacuum in which VIA is to operate, forces the bus industry to exist In this same vacuum because of the high degree of interaction between the bus and r a i l modes. This makes long-range planning exceedingly d i f f i c u l t for the bus operators. A l l the same, even though the bus mode has a l l but given upon long distance travel because of airline competition (and r a i l competition for the centres. This service tends to have high load factors and relatively lower costs and is usually profitable. The bus operators have historically used the profits from the latter type of service to cross-subsidize the former type of service. VIA, in competing with the bus industry for the profitable corridor routes and leaving the other routes uncontested, forces the bus industry to lower i t s fares on the corridor routes. This results in a much diminished a b i l i t y to internally cross-subsidize the non-corridor services. This puts the entire structure of the intercity bus industry in a precarious position, according to the Canadian Motor Coach Association. (The Globe and Mail, April 2, 1984. p. IBS.) 4 6The Globe and Mail, September 17, 1984. p. IB5. Chapter 2 56 Intercity Passenger Network tourist segment) , and has yet to come to a satisfactory arrangement with the Federal Government concerning passenger r a i l service and subsidy for the short to medium distance traveller, the bus mode s t i l l survives. It appears that the characteristics of the bus mode should ensure a continued role for this industry in the intercity passenger travel network for many years to come. Due to the current situation vis a vis VIA and the Federal Government, this may not necessarily hold true. The key element for the bus mode's continued existence w i l l be the degree of success VIA Rail achieves in the Quebec-Windsor corridor. Since this success seems primarily contingent upon the continued financial support given by the Federal Government, efficiency losses in the system due to VIA Rail subsidies w i l l l i k e l y arise predominantly out of the distortion of bus passenger volumes. i i i ) the a i r mode The history of the air mode in Canada follows that of the automobile and the bus modes. Prior to the Second World War, equipment was limited in performance. Also, both this equipment and the f a c i l i t i e s to serve i t had limited availability. The Second World War, however, stimulated rapid improvement in military aircraft which eventually resulted in improved passenger aircraft. Furthermore, the Canadian Government constructed numerous air f i e l d s in Canada during the war, so after the war Canadians found that the country possessed many of the prerequisites for passenger a i r service. Travellers were not long in learning how to u t i l i z e this new mode of travel, as Figure 2.7 clearly shows. Chapter 2 57 Intercity Passenger Network FIGURE 2.7 Air Passenger Volumes: 1954 to 1984 35 30 2 5 -00 Ol UJ o 00 20 GO < 0_ o £ 15 o 10----32000 40000 24000 00 UJ _J I or UJ o oo oo < 16000 o 00 8000 1000 1954 1959 1964 1969 1974 YEAR 1979 1984 LEGEND PASSENGERS PASSENGER-MILES Source: S t a t i s t i c s Canada, Catalogue 51-002. Chapter 2 58 In t e r c i t y Passenger Network The air mode's high speed gives i t an overwhelming travel time advantage over other modes, at least for the medium to long distance trips. For the time-conscious traveller, this makes the air mode the primary choice for the longer trips, since the fare premium "buys" a significant amount of saved time. For shorter trips, the travel time savings is insignificant or even non-existent. The premium fare buys a proportionately smaller time savings as distance drops, as Table 2.2 indicates. Not surprisingly, the share of air travel drops drastically as distance travelled declines. Canada is well served by national, regional and local air carriers. The two national carriers provide domestic intercity passenger service between the major centres. The regional air carriers, previously restricted by federal policy to rather limited geographic regions in order to constrain their a b i l i t y to compete with Air Canada, were freed from this regulation by the May 10, 1984 "New Canadian Air Policy" announced by then Minister of Transport, Lloyd Axworthy. These carriers, operating smaller aircraft, link even quite small centres with the major c i t i e s . Finally, the local carriers operate intercity services between the smallest of centres. This component of the air sector has been experiencing rapid growth: the C.T.C. reported an increase of 30 Level III, 23 Level IV, and 181 Level V carriers in Canada between 1972 and 1978. 4 7 It appears clear that the air mode has become and li k e l y w i l l remain, at least for the near future, the dominant mode for long-distance travel. In addition to this, the tremendous growth in the Level III, IV and V carrier 4 7Paget (1980; p. 5) Chapter 2 59 Intercity Passenger Network TABLE 2.2 Air Mode Fare Versus Travel Time Savings Time Fare Cost per Distance Savings Premium Minute Air City-Pair (miles) (minutes) (cents) Saved Share Winnipeg-Quebec 1,557 2650.6 4159. .9 1.569 61.2% Winnipeg-Montreal 1,403 2316.3 4076. ,7 1.760 82.4% Winnipeg-Ottawa 1,360 2192.4 4195. .3 1.914 87.1% Winnipeg-Toronto 1,290 2124.4 3127. .8 1.472 88.9% Toronto-Quebec 486 435.9 3745. .1 8.592 60.1% Toronto-Montreal 302 237.5 3360. .3 14.149 44.6% Ottawa-Quebec 266 220.5 2842, .2 12.890 30.9% Toronto-Ottawa 231 229.5 2924, .9 12.745 43.2% Montreal-Quebec 154 111.6 2553, .3 22.879 19.9% Ottawa-Montreal 110 74.9 2365 .4 31.581 2.8% Time Savings: geometric mean of travel time by automobile, bus and r a i l less air travel time Fare Premium: airfare less geometric mean of travel cost by automobile, bus and r a i l Cost per Minute Saved: Fare Premium divided by Time Savings Chapter 2 60 Intercity Passenger Network operations indicates that the air mode has a role to play, certainly in the medium-distance travel market, and lik e l y even in the short-distance travel market. Nevertheless, the air mode is quite vulnerable with respect to short-distance travel. There is some opportunity for a i r - r a i l competition over these distances. Thus VIA subsidies could have some distorting effect on air travel which would result in economic efficiency losses. The other side of this coin is that the air mode i t s e l f is not subsidy-free. This too w i l l have an impact on the f i n a l measure of economic inefficiency. D. The Government Government plays a role in Canadian intercity passenger transport in several ways: i) as an owner/operator of transportation companies; i i ) as an owner/provider of transportation infrastructure; i i i ) as the setter of rules of operation; and iv) as the overseer/enforcer of the rules of operation. The following four sections touch on the nature of government intervention in the intercity passenger transport sector through each of the above four roles. Chapter 2 61 Intercity Passenger Network i ) as an owner/operator of transport firms A l l three levels of government in Canada are directly involved in intercity passenger transport through one or more operating companies. The municipal presence i s , for the most part, non-existent 4 8 but the provincial presence is quite significant, with B.C. Rail, the Ontario Northland Transportation Commission, and Quebecair a l l being important provincial government operations, 4^ Furthermore, the Federal presence is very strong. The Federal Government owns Air Canada, the C.N.R., and VIA Rail. The fact that a given transportation company is owned and operated by a government does not materially affect the analysis of this thesis. A subsidy to a privately-owned company causes a market distortion similar to that which would have been caused had the company been a publicly-owned one. The difference in the "equity" of the distribution of income caused by the granting of a subsidy to a private versus a public organization is not germane to the measurement of efficiency loss. It does, however, raise an interesting philosophical question for governmental policy makers. ^°There are a couple of exceptions to this. For example, the Toronto Transit Commission (which is controlled by Metropolitan Toronto Council) owns Gray Coach Lines Ltd., one of the more important intercity bus operators in the area. In addition, the city of Hamilton owns Canada Coach Lines, another intercity bus operator in that area. 4 ^ I n addition, the Province of Quebec made a determined pitch to obtain control of Nordair but failed. The Province of Alberta once controlled Pacific Western Airlines, but now retains only 4% of the stock. Chapter 2 62 Intercity Passenger Network i i ) as an owner/provider of infrastructure Governments at a l l three levels are involved in the provision of infrastructure affecting intercity passenger travel. The municipal level of government does not provide infrastructure u t i l i z e d directly in intercity travel. The conditions of the urban road system, for which the municipal governments are responsible, w i l l have an impact on the choice of mode used for the intercity t r i p . The provincial level of government provides most of the road system used in intercity bus and automobile travel. The Federal Government provides a l l the infrastructure for the air mode as well as the remainder of the intercity road system for the bus and automobile modes.^u Infrastructure for the r a i l mode is provided, not by any government, but by the railways themselves. Thus, to the extent that the various governments do not recover the cost of the infrastructure they provide from the users of this infrastructure (i.e. the air, bus and automobile users), modal shares w i l l be distorted in the opposite direction to which the VIA Rail subsidies distort modal volumes. This would serve to mitigate the extent of the efficiency losses arising out of VIA Rail subsidies. This issue w i l l be handled in Chapter 6. •^Though the portion of the entire road network that the Federal Government maintains is small, (those roads on Federal lands), Ottawa on occasion lends i t s support to certain road projects. The most notable example is the joint Federal-Provincial effort made to construct the Trans Canada Highway and i t s annual contributions to roads such as the Alaska Highway. Chapter 2 63 Intercity Passenger Network i i i ) as the setter of rules of conduct Regardless of whether or not any government is directly involved in intercity passenger travel in the guise of either of the two roles described above, i t remains their prerogative to set rules governing the conduct of companies operating within their jurisdiction. This affects almost a l l aspects of the provision of transport services. This section describes the impacts that transport regulation has on the economic efficiency of the system. The municipal level of government is restricted in i t s abil i t y to regulate intercity passenger travel to regulations concerning land use and operations within municipal boundaries. The former could possibly have an impact on aspects such as terminal location or expansion for the common carriers. This may be a more important potential obstacle for the bus mode than for the air mode or VIA, since the smaller bus operators tend to have less financial and p o l i t i c a l clout than federally sponsored VIA or the air mode.-^ The latter (rules governing operating speed, noise levels, night-time operation and the like) w i l l also affect primarily the common carriers. The extent to which these factors contribute to the total economic efficiency loss of the intercity passenger network is unknown, but is probably very small. 3 i I n fact, the bus mode may not be as p o l i t i c a l l y helpless as one might expect. There have been instances where the bus lobby seems to have had considerable success in having "VIA Rail fares revised upwards" in order to "protect [bus] profits". (The Province Business Report, Sunday September 9, 1979. p. C3). Chapter 2 64 Intercity Passenger Network The provincial level of government, with a couple of important exceptions, is responsible for intercity passenger transportation systems that are entirely intraprovincial in nature. The air mode is the f i r s t exception to the rule: a l l aspects of air carrier operations f a l l under the jurisdiction of the Federal Government. The r a i l mode could be the second exception to the rule - but only in a piecemeal, selective way. Intraprovincial r a i l systems generally f a l l under provincial jurisdiction. Once any railway, even an entirely intraprovincial one, is deemed "to be a work for the general advantage of Canada" i t f a l l s under Federal jurisdiction.-* 2 At any rate, since intercity passenger r a i l service is provided by the federally regulated VIA Rail, provincial r a i l legislation becomes unimportant to this thesis. The auto and bus modes are also exceptions to the rule concerning provincial jurisdiction - but in the opposite direction. Not only does intraprovincial motor vehicle transport f a l l under provincial jurisdiction, interprovincial motor vehicle transport f a l l s under provincial jurisdiction.-^ The provinces regulate the use of automobiles through the licensing of •>zRailway Act. R.S., c.234, s. 7. ^ T h i s statement is only effectively true; technically, i t is inaccurate. Section 92, subsections 10 (a) and 10 (b) of the British North America Act, 1867., places responsibility for a l l interprovincial and international transportation with the Federal Government. On the other hand, the Federal Motor Vehicle Transport Act of 1954, which deals with interprovincial operations, basically defaults the authority back to the provinces. Furthermore, Part III of the National Transportation Act which provides for federal regulation of "extra-provincial motor vehicle transportation", has never been implemented. Thus through i t s virtual inaction with respect to this sector, the Federal Government has t a c i t l y and effectively delegated responsibility to the provinces. Nevertheless, Ottawa could legally "regain" jurisdiction any time i t wished. Chapter 2 65 Intercity Passenger Network v e h i c l e s and d r i v e r s . This p r a c t i c e i t s e l f does not serve to f o s t e r economic i n e f f i c i e n c y . - * 4 The actual p r o v i n c i a l l e g i s l a t i o n concerning the private automobile i s thus not germane to the determination of e f f i c i e n c y losses. P r o v i n c i a l regulation of the i n t e r c i t y bus industry does, however, have a d i r e c t impact on economic e f f i c i e n c y . The provinces, through t h e i r Transport Boards (or Commissions), regulate the granting of operating l i c e n s e s , the tra n s f e r of c o n t r o l , e x i t from the industry, abandonment of services and rate s e t t i n g . To the extent that these Boards i n t e r f e r e with the normal operations of the market, the issue of economic e f f i c i e n c y w i l l a r i s e . A most noteworthy aspect of i n t e r c i t y bus regulation that r e i n f o r c e s suspicions of the existence of economic e f f i c i e n c y losses i s that overlapping operating a u t h o r i t i e s are seldom issued, and when they are, i d e n t i c a l fares are usually required by the Boards. In other words, open entry and p r i c e competition are simply not elements of the i n t e r c i t y bus industry.-* 7 3 I f the charge imposed at l i c e n s i n g time does not cover adequately the costs to society that the l i c e n s i n g of that p a r t i c u l a r v e h i c l e w i l l generate ( i . e . cover that d r i v e r ' s share of the costs of i n f r a s t r u c t u r e , p o l i c i n g , administration and the l i k e ) then too many veh i c l e s and dr i v e r s w i l l be using the road system. This d i s t o r t i o n i s not caused by the p r a c t i c e of l i c e n s i n g , but from the in c o r r e c t charges imposed at l i c e n s i n g . 5 5 P a r t r i d g e and Fosbrooke (1980; p. 23). -^Reschenthaler (1980; pp. 14, 83) finds no evidence to suggest that the i n t e r c i t y bus industry i n Canada needs to be regulated. Partridge and Fosbrooke (1980; p. 1) come to the same conclusion. Thus any act i o n taken by these Boards with respect to a market that does not appear to require outside intervention, i s u n l i k e l y to improve the economic e f f i c i e n c y of the industry. 5 7Reschenthaler (1980; p. 7). Chapter 2 66 I n t e r c i t y Passenger Network If the Boards are not s t r i c t l y basing their judgements on sound economics, as seems to be the case, then the bus companies are unlikely to be operating in an economically optimal manner. Since open entry and price competition are not allowed in the intercity bus industry, i t seems unlikely that efficient bus fares are being charged and hence i t is li k e l y that bus volumes are being distorted by the provincial regulation. There is evidence to suggest that the Boards regulate in a very passive manner. In other words, they tend to accept whatever proposal the bus companies make with respect to fare setting, as long i t seems reasonable in comparison to what the other jurisdictions are accepting. Reschenthaler (1980) finds that: ...provincial boards rarely hold public hearings on proposed fare increases; they principally consider fare trends in other jurisdictions and demonstrated system-wide increases in operating costs. There is no evidence that any board is an active regulator; they simply do not examine cost control, efficiency, load factors, cost of capital,, propriety of equipment mix, efficiency of route systems and costs of cross-subsidization. They seldom review profit rates. While the boards do consider cost trends in reviewing fare applications, they rarely study the reasonableness of any company's costs. Given this assessment, i t seems reasonable to assume that the regulation by the provincial boards does not significantly constrain the fares charged by the bus operators. In other words, i f the operators have a great deal to say In determining their fares, they are highly unlikely to choose too low a fare. If anything, the protection of the regulatory boards is apt to result in fares Intercity Passenger Network 5 8Reschenthaler (1980; p. 15). Chapter 2 67 charged a passenger being greater than the marginal costs of providing bus service for that passenger. Partridge and Fosbrooke (1980) conclude that: Comparison with the United States intercity bus industry and other Canadian industries suggests that profits of the privately owned Canadian bus carriers assure their financial v i a b i l i t y and that their profits are, perhaps, more than they would be in a competitive environment. These factors suggest that one of the effects of regulation could be the realization of some degree of monopoly profits by the industry.^ Thus, in the absence of any subsidy provided to the bus mode, the optimal bus fare may be lower than the one currently charged. This would serve to further contribute to the total misallocation of intercity passenger t r a f f i c . In addition to contributing to the distortion of bus fares from their efficient level, some of the other activities of the Boards w i l l undoubtedly affect the economic efficiency of the intercity passenger network. For example, rulings regarding frequency of service and type of equipment used in service w i l l affect efficiency. Unfortunately, the determination of optimal departure frequency and type of equipment to use is beyond the scope of this thesis, given the lack of available data. Ideally, both of these factors, as well as any other service factors the Boards regulate, should be included in the determination of optimal bus passenger share. Since the distortion to optimal bus shares caused by the regulation of service quality is apt to be in the direction of a higher bus share*^ this should tend to offset the negative 5 9Partridge and Fosbrooke (1980; p. 3). ^The Boards are unlikely to order fewer or smaller buses than the operator desires to u t i l i z e on any given service. Assuming the bus companies to be prof it-maximizers (in the case of private companies) or at least Chapter 2 68 Intercity Passenger Network distortion due to the charging of fares higher than the efficient rate. Unfortunately, since only the distorted price and not the distorted quality factors are adjusted in this thesis, due to the lack of data, the "optimal" bus share determined is li k e l y to be somewhat higher than the "true" optimal bus share. The extent of this over-estimation is unknown, but i t is anticipated that i t is not too significant a factor with respect to the price-conscious bus patrons. Moreover, since the net result is a calculated efficiency loss based on an intercity travel network in which bus service levels are a r t i f i c i a l l y high in both scenarios, they should approximately cancel out. At any rate, i t is safe to conclude that provincial regulation of the intercity bus mode does contribute towards the total economic efficiency losses inherent to the current Canadian intercity passenger network. Thus, the determination of bus fares based on economic costs must incorporate the impact of provincial regulation. The Federal Government regulates absolutely passenger air and most of passenger r a i l transport in Canada. Federal regulation of passenger transportation is accomplished through a number of acts: general acts affecting a l l modes; mode-specific acts; and carrier-specific acts. Table 2.3 l i s t s the various pieces of Federal legislation applicable to passenger transport. Each of these Acts and their importance with respect to the issue of economic efficiency is discussed below. loss-minimizers (in the case of public companies), the Boards' concern with service levels is l i k e l y to result in a higher level of service than the unregulated company would elect to provide. Chapter 2 69 Intercity Passenger Network TABLE 2.3 Federal Legislation Pertaining to Passenger Transportation i n Canada at the level of the mode at the level of the individual carrier General: National Transportation Act Transport Act Department of Transport Act Passenger Tickets Act Financial Administration Act Canada Corporations Act various Appropriation Acts Rail: Railway Act Railway Relocation and Crossing Assistance Act Government Railways Act Canadian Pacific Railway Act Canadian National Railway Act Canadian National Railways Capital Revision Act (VIA Rail Canada Act) Air: Aeronautics Act Air Canada Act Motor Vehicles: Motor Vehicle Transport Act Motor Vehicle Safety Act Motor Vehicle Tire Safety Act Motor Vehicle Fuels Consumption Standards Trans Canada Highway Act Chapter 2 70 Intercity Passenger Network The 1967 National Transportation Act.^ was the legislative outcome of the 1960 Royal Commission on Transportation headed by M.A. MacPherson. The NTA specifies the role the Canadian Government defined for i t s e l f with respect to transportation in Canada. The basic assumption driving the MacPherson Commission was that Canada now enjoyed (or soon would, given the rate of growth of the country) a mature, well-developed national transportation system. This assumption became the implicit cornerstone of the philosophical foundation of the NTA: competition i t s e l f would be the chief regulator of the provision of transport services in Canada.^2 The NTA opens with a declaration of the national transportation policy of Canada: It is hereby declared that an economic, efficient and adequate transportation system making the best use of a l l available modes of transportation at the lowest total cost is essential to protect the interests of the users of transportation and to maintain the economic well-being and growth of Canada, and that these objectives are most l i k e l y to be achieved when all modes of transport are able to compete under conditions ensuring that having due regard to national policy and to legal and constitutional requirements (a) regulation of a l l modes of transport w i l l not be of such a nature as to restrict the a b i l i t y of any mode of transport to compete freely with any other modes of transport; (b) each mode of transport, so far as practicable, bears a f a i r proportion of the real costs of the resources, f a c i l i t i e s and services provided that mode at the public expense; 6 1Statutes of Canada, 14-15-16 Elizabeth II, Chapter 69. In the 1970 Revised Statutes of Canada, this act appears as Chapter N-17. ^2The NTA recognized that, in some instances, unfettered competition might prove to be contrary to the public interest. In order to insure against such an occurrence, the NTA provided for the establishment of a single regulatory body to supervise the multimodal Canadian transport network. This body, the Canadian Transport Commission, is described in the next section. Chapter 2 7 1 Intercity Passenger Network (c) each mode of transport, so far as practicable, receives compensation for the resources, f a c i l i t i e s and services that i t is required to provide as an imposed public duty; and (d) each mode of transport, so far as practicable, carries t r a f f i c to or from any point in Canada under t o l l s and conditions that do not constitute (i) an unfair disadvantage in respect of any such t r a f f i c beyond that disadvantage inherent in the location or volume of the t r a f f i c , the scale of operation connected therewith or the type of t r a f f i c or service involved, ( i i ) an undue obstacle to the interchange of commodities between points in Canada or unreasonable discouragement to the development of primary or secondary industries or to export trade in or from any region of Canada or to the movement of commodities through Canadian ports;... 6 3 The importance of the NTA lies with i t s emphasis on ensuring an efficient transportation system. Strict adherence to the philosophy of the Act would minimize the total efficiency losses. The NTA, however, did not entirely abandon the public interest in favour of economic efficiency. The Act provided for the retention of services known to be uneconomic, but yet considered to have some socially redeeming feature. Thus efficiency losses could occur under the NTA, since not a l l uneconomic services would necessarily be dropped. Another important aspect of the NTA is that i t stipulated that each mode receive, "so far as practicable", compensation for services imposed as a public duty. Prior to the passage of the NTA such compensation was not provided for in legislation. This reflected a change in philosophy: i f i t 6 3The National Transportation Act., R.S., c. 69, s. 3. (Emphasis added). Chapter 2 72 Intercity Passenger Network was in the public interest to impose the operation of an uneconomic service on any operator, then the public should pay directly for such a service. No longer would the costs of uneconomic services be hidden in the internal cross-subsidization of other services. The open payment of the subsidy would f a c i l i t a t e discussion regarding the relative merit of continuing any such service. Given this, unremunerative passenger services, and the efficiency losses that would arise from them, should exist only to the extent that such passenger services have some redeeming feature justifying their continued public support. The success of the NTA depended heavily on Canada's transportation system being sufficiently competitive. Unfortunately, i t became evident that the "mature and well-developed" passenger transportation system was very regional in scope and not national at a l l . In actual fact, i t appears that i t is only within the Quebec-Windsor corridor and a few other links that the basic philosophy of the NTA seems justif i a b l e . In regions without a mature transportation system, the concept of economic efficiency in transportation becomes somewhat strained. In severe cases (for example, the Arctic regions), few, i f any regular scheduled transportation services can be economically provided. In such cases, the social rationales come to the fore, and efficiency considerations become essentially moot. Hence the NTA came into some disrepute among various groups. In fact, the guiding philosophy behind the NTA was not followed with particular diligence beyond the mid-1970's, when regulation once again came into vogue among many of the policy shapers. Nevertheless, the attempts to officially revoke the stated policy of an Chapter 2 73 Intercity Passenger Network "economic, efficient and adequate transportation system" (culminating in B i l l C-20) failed. The Transport Act. R.S., c.271, deals with the issuance of licenses for the transport of goods or passengers (or both) by water, and establishes guidelines for t a r i f f s , t o l l s and agreed charges for water and r a i l transport. The provisions of this Act would not contribute substantively to economic inefficiency in passenger transport. The Department of Transport Act. R.S., c.171, set up the Department of Transport, established the powers of the Minister of Transport and dealt with issues such as the execution of contracts. There is nothing particularly noteworthy in this Act for the purposes of this thesis. The Passenger Tickets Act. R.S., c.202, details the conditions for appointing ticket agents. It also sets certain ticket conditions for travel by r a i l , steamship or ferry, including refunds and stopover rights. Again, nothing in this Act directly effects economic efficiency of the passenger network. • ' The category of general Acts directed at the level of the individual carriers includes the Financial Administration Act. This Act deals with the financial management and control aspects of Crown Corporations. VIA Rail, Air Canada and the C.N.R. are a l l subject to this Act. The one aspect of the Act which is of interest to this thesis, though only indirectly, deals with making confidential information public. Section 154 stipulates that information Chapter 2 74 Intercity Passenger Network whose public disclosure is deemed by the Minister of Transport to be detrimental to the operations of a Crown Corporation, need not be tabled before Parliament. The Canada Corporations Act, 1964-65, c.52, was the Act under which VIA Rail was originally incorporated. Shortly thereafter, VIA was established as a railway as per the Railway Act and thus f e l l under the provisions of the Railway Act. The Canada Corporations Act s t i l l applies to those companies incorporated under i t who provide intercity bus services. Briefly, this Act sets the rules for incorporation and defines the general powers and duties of corporations. The various Appropriation Acts are Acts passed in order to grant the Government of Canada money for any of a number of various projects. A number of such Acts can be and are passed during any given s i t t i n g of the legislature. VIA Rail is one Government "project" which continually receives funds via these Acts. Acts at the level of the mode pertaining solely to the r a i l mode are the Railway Relocation and Crossing Assistance Act, 1974, c.12 and the Railway Act, R.S., c.234. The former provides financial assistance to railways that need to relocate crossings or build overpasses or underpasses because of dangerous conditions in an urban setting. The latter is the main piece of legislation dealing with r a i l operations. Chapter 2 75 Intercity Passenger Network The Railway Act deals with virtu a l l y a l l aspects of the provision of r a i l (passenger or freight) services. Various sections deal with the "preliminary" aspects, such as the incorporation of the railway, the organizational structure and financial aspects of the railway, the acquisition of land and the opening of services. Safety is another prime concern of the Act, as is the maintenance of infrastructure and equipment used. Actual operating rules are specified as well. This has a direct impact on economic efficiency. For example, section 227 gives the C.T.C. authority to regulate train operations, including (but not restricted to) operating speeds, employee working hours, safety and even the means of propulsion used. This has the potential for a great deal of interference in r a i l operations. The actual amount of distortion i t causes depends, of course, on the attitude of the personnel of the Commission. The protection of the passengers' interests comprises a major portion of the Railway Act. Section 242 decrees that trains must start and run (as closely as possible) according to the schedules made public by the railway. Section 262 specifies that adequate accommodations for the t r a f f i c carried be provided at railway junction points. Section 280 states that passenger t a r i f f s be of two types, standard and special, and that both must be "just and reasonable". Sections 282 and 283 specify that these t a r i f f s must be f i l e d with the C.T.C. and published for public reference. Furthermore, section 281 ensures that i f anyone believes that the t o l l s or t a r i f f s charged or that some conditions of the carriage of t r a f f i c by a railway is prejudicial to the public interest, then that person is free to apply to the Commission for leave to appeal the t o l l , t a r i f f or condition which gave rise to the complaint. Chapter 2 76 Intercity Passenger Network These few examples are just some of the sections which endeavour to protect the public interest. The two most c r i t i c a l sections from the point of view of efficiency considerations are the sections added to the Railway Act by the Rational Transportation Act: sections 260 and 261. Section 260 outlines the procedure necessary for the discontinuation of any passenger service. A railway wishing to discontinue a service must f i l e an application accompanied by a statement of the costs and revenues attributable to that service. The Commission then reviews the figures in order to determine whether or not the service is truly uneconomic. Naturally, applications for abandonment of passenger services subsequently determined to be economic by the C.T.C. are rejected. On the other hand, i f the service is found to be uneconomic, the Commission may order the service discontinued, or order i t to be continued.**4 If an uneconomic service is ordered continued, the Commission w i l l review the service at some later date (within 5 years) and determine whether or not this service has remained uneconomic. If i t has, the same choices (discontinuation or continuation subject to future review) are open to the Commission; i f i t has not, the application is rejected. In deciding the fate of an uneconomic service, the Commission is expected to consider: °^The Commission has also taken i t upon i t s e l f to stipulate changes in operations designed to stimulate passenger volumes in an endeavour to make the uneconomic service an economic one. Thus contrary to normal expectations, in several recent cases i t has been the regulator and not the operating company who has been the innovative force behind the attempt to make a service remunerative. Chapter 2 77 Intercity Passenger Network . . . a l l matters that in i t s opinion are relevant to the public interest including, without limiting the generality of the foregoing, &' (a) the actual losses that are incurred in the operation of the passenger-train service; (b) the alternative transportation services, including any highway or highway system serving the principal points served by the passenger-train service, that are available or are lik e l y to be available in the area served by the service; (c) the probable effect on other passenger-train service or other passenger carriers of the discontinuance of the service, or of parts of thereof; and (d) the probable future passenger transportation needs of the area served by the service.*'-3 As the above excerpt indicates, the C.T.C. was given a broad set of cr i t e r i a to consider in deciding the fate of passenger service. Efficiency was only one of the many factors that the C.T.C. was expected to examine. The potential for the C.T.C to be inconsistent over time (as directors with varying views come and go) i s , therefore, quite high. This is touched upon in the next section. The relative weights that the C.T.C should give to both the "public interest" and "efficiency" sides of the issue is not specified by the Railway Act. In addition, the emphasis on efficiency inherent to both the MacPherson Commission and the NTA is not particularly evident within the Railway Act i t s e l f . The preamble of the NTA becomes an important component of the "The Railway Act. R.S., c. 234, s. 260(6). (Emphasis added) Chapter 2 78 Intercity Passenger Network execution of the responsibilities placed on the C.T.C under section 260 of the Railway Act. Section 261 of the Railway Act specified the process for obtaining financial assistance for uneconomic passenger services ordered continued as per the provisions of section 260. Section 261, subsection 8 allowed the Commission to include in or exclude from their calculations of "actual loss" any items they saw f i t . Up to 80% of the "actual loss" as determined by the C.T.C could be reimbursed. The logic behind the 80% ceiling was that the 20% the railways were l e f t to absorb would act as incentive to improve the efficiency of their performance. Actually, i t seems to have served as incentive for the railways to attempt to absolve themselves of passenger services altogether. 6 6 There is an interesting "discrepancy" between the Railway Act and the NTA that should be cleared up at this point. The NTA specified that the reimbursement of losses resulting from the imposition of a public duty should be paid "so far as practicable". The amendment to the Railway Act, however, limits such reimbursements to a maximum of 80%. The apparent difference in philosophy here reflects the government's hopes that efficiency would be improved through the imposition of this 20% penalty. This is something that is clearly consistent with the stated philosophy of the NTA. 6 6 T h i s certainly seems to be true with respect to the Canadian Pacific Railway. It is a b i t harsh on the Canadian National Railways, which did exert considerable effort to revive passenger services in the late 1960's, as described previously. Chapter 2 79 Intercity Passenger Network The Railway Act has a very important impact on the efficiency of the entire intercity passenger network. In specifying the factors to be considered in evaluating uneconomic passenger services, the actual loss incurred is only one of many. Due to the importance given other social (i.e. non-economic) considerations, the propagation of economic inefficiency is firmly entrenched in legislation, despite the prime tenet of the NTA. There are several pieces of legislation concerning the r a i l mode which are directed at specific carriers. The Government Railways Act, R.S., c.136, applies to only those railways that "are vested in Her Majesty, and that are under the control and management of the Minister" (section 4). This Act details the powers of the Minister of Transport with respect to the construction and maintenance - of government railways, sets the standards for some of the equipment used on passenger trains and details some of the operating procedures with respect to the payment of t o l l s . This Act bears no direct influence on the estimation of economic efficiency losses. The Canadian Pacific Act, 1872, c.73, deals with the incorporation of the C.P.R. as fulfillment of the Dominion obligations to British Columbia. The Canadian National Railway Act, 1919, c.13, deals with the formation and incorporation of the C.N.R. Both of these Acts basically deal with organizational matters. There have also been a number of Canadian National Railways Capital Revision Acts. Other Acts of a similar nature include Canadian National Railways Financing and Guarantee, Canadian National Railways Loan, and Canadian National Railways Refunding. These Acts "juggle the books" Chapter 2 80 Intercity Passenger Network with respect to the C.N.R.'s outstanding debt and/or provide the C.N.R. with low-cost capital. Since these Acts have the effect of unequally lowering the cost of carrier operations, (i.e. lowering costs for only one of several carriers), they introduce inefficiencies into the system. Since both C.N. and CP. are no longer responsible for intercity passenger transport, these Acts can be ignored. 6 7 A VIA Rail Canada Act, as mentioned before, has not yet been passed. There had been a considerable amount of talk about passing such an act prior to the transfer of power from the Liberals to the Progressive Conservatives. The Progressive Conservatives then introduced B i l l C-97, "An Act respecting r a i l passenger transportation", but the b i l l has yet to become law. Only time w i l l t e l l i f the new government w i l l be any more successful in defining a viable mandate for VIA Rail. The only Act at the level of the mode pertaining solely to the air mode is the Aeronautics Act, R.S., c.2. In this Act, section 3, part (a), places " a l l matters connected with aeronautics" under the authority of the Minister of Transport. This includes matters concerning both the licensing of pilots (s.6, ss.l(a)) and the registration of aircraft (s.6, ss.l(b)). In addition, the authority for regulation concerning a l l aspects of security is placed under the Governor in Council (s.5.1). The responsibility for the provision of government infrastructure is given to the Minister of Transport (s.3(c)). 6 7The C.N.R. s t i l l provides some passenger services and some combined passenger and freight services in remote regions. Chapter 2 81 Intercity Passenger Network One aspect of the Aeronautics Act which is of primary interest to this thesis concerns the provision that: "The Governor in Council may make regulations, or, subject to and in accordance with such terms and conditions as may be specified by him, authorize the Minister to make regulations prescribing charges for the use of (a) any f a c i l i t y or service provided by the Minister or on his behalf for or in respect of any aircraft; and (b) any f a c i l i t y or service not coming within paragraph (a) provided by the Minister or on his behalf at any a i r p o r t . " 6 8 This is in line with the National Transportation Act, R.S., c.69, s.3b, which reflects the "user-pay" philosophy of the MacPherson Commission. There i s , however, a great deal of f l e x i b i l i t y in this section of the Aeronautics Act. The Act does not specify what portion of the costs should be borne by the users. The fact that not a l l costs are necessarily required to be covered by the users denotes a (possible) subsidy which has a definite impact on the economic efficiency of the entire intercity passenger system. Another aspect of the Aeronautics Act of interest to this study is the declaration giving the C.T.C authority to make regulations: ...respecting t r a f f i c , t o l l s and t a r i f f s and providing for (i) the disallowance or suspension of any t a r i f f or t o l l by the Commission, ( i i ) the substitution of a t a r i f f or t o l l satisfactory to the Commission, or baAeronautics Act, R.S., C. 2, s. 5. Chapter 2 82 Intercity Passenger Network ( i i i ) the prescription by the Commission of other t a r i f f s or t o l l s in li e u of the t a r i f f s or t o l l s so disallowed;*'9 This of course gives rise to the possibility of ai r l i n e fares not in accordance with the objective of economic efficiency being set by the Commission to attain some alternative objective. The only piece of legislature concerning the air mode which is directed at a specific carrier is the Air Canada Act, 1978, c.5. This Act removed the contract basis of operation with the Minister of Transport. 7^ This allowed CP Air to compete head-to-head with Air Canada on a l l domestic routes. The Federal legislation concerning motor vehicle transport is not particularly important. Briefly, the Motor Vehicle Transport Act states that extraprovincial carriers wishing to operate in or through a province that requires a license for local undertakings, must also be licensed under the Motor Vehicle Transport Act. The provinces themselves, however, could issue an extraprovincial operating license to a carrier as though i t were a local undertaking. The Motor Vehicle Safety Act, the Motor Vehicle Tire Safety Act and the Motor Vehicle Fuel Consumption Standards a l l specify certain standards requisite for vehicles (and equipment) sold and operated in Canada. The Trans Canada Highway Act, R.S., c.269, details the cooperative undertaking between the Federal Government and the provinces to build the ^Aeronautics Act, R.S., c. 2, s. 14(l)(m). 7 0 T h i s arrangement, like the one currently employed by the Minister with respect to VIA Rail, effectively allows monopoly conditions along certain routes. Chapter 2 83 Intercity Passenger Network Trans Canada Highway. The only important provision, from the point of view of this thesis, is that the Minister of Finance may authorize payments to a province out of unappropriated moneys in the Consolidated Revenue Fund. No provision of this Act deals with charging the users of the Trans Canada Highway for i t s use. Given the fact that the construction of this highway preceded the passage of the NTA, the discrepancy in attitudes is understandable. It does, however, raise the question of economic distortions. These subsidies to the automobile and bus modes are dealt with in Chapter 6. Thus Federal legislation (and for that matter, provincial and municipal l e g i s l a t i o n ) contributes towards economic inefficiency despite the protestations of the national goal of "an economic, efficient and adequate transportation system". Given the nature of Canadian geography, demography and social and p o l i t i c a l beliefs, no truly economic transportation system could be erected without a serious departure from long-standing societal goals of adequate mobility and regional equity. General economic inefficiency is thus inevitable due to Canadian p o l i t i c a l r e a l i t i e s . Specific, individual causes of economic inefficiency, on the other hand, need not be inevitable. iv) as the overseer/enforcer of the rules Aside from matters pertaining to the Criminal Code of Canada, the supervision and enforcement of automobile and bus regulations is performed by the Provincial Transport Boards or Commissions.7^ The approach of these ^There is one intraprovincial bus company that is regulated federally. This is Terra Transport (formerly Canadian National Road Cruiser Service) which is owned by Canadian National and operates in Newfoundland. Chapter 2 84 Intercity Passenger Network boards has been dealt with above. The enforcement of air and r a i l regulations is performed on behalf of the Federal Government by the Canadian Transport Commission. Since the C.T.C. plays such a major role, i t w i l l be dealt with in a separate section. E. The Canadian Transport Commission72 The Canadian Transport Commission is a court of record established by Part I of the NTA and charged with "coordinating and harmonizing the operations of a l l carriers engaged in transportation by railways, water, 73 aircraft, extraprovincial motor vehicle transport and commodity pipelines.'" In addition to this blanket directive, the C.T.C. is charged with enforcing the provisions of the Railway Act, the Aeronautics Act and the Transport Act. Thus, the C.T.C. is responsible for dealing with applications for abandonment of services for federally regulated railways, for regulating railway and airl i n e fares and for specifying conditions for the operation of railways and airlines in Canada. Further duties, relevant to this study, as charged by the NTA are to: (a) inquire into and report to the Minister upon measures to assist in a sound economic development of the various modes of transport over which Parliament has jurisdiction; (b) undertake studies and research into the economic aspects of a l l modes of transport within, into or from Canada; (c) inquire and report to the Minister on the relationship between the various modes of transport within, into or from Canada and upon 7 2The predecessor of the C.T.C. was the Board of Transport Commissioners. 73NTA., s. 21. Chapter 2 85 Intercity Passenger Network the measures that should be adopted in order to achieve coordination in development, regulation and control of the various modes of transport; (d) perform, in addition to i t s duties under this Act, such other duties as may, from time to time, be imposed by law on the Commission in respect of any mode of transport in Canada, including the regulation and licensing of any such mode of transport, control over rates and tariffs and the administration of subsidies voted by Parliament for any such mode of transport; (e) inquire and report to the Minister upon possible financial measures required for direct assistance to any mode of transport and the method of administration of any measures that may be approved;... (g) establish general economic standards and criteria to be used in the determination of federal investment in equipment and f a c i l i t i e s as between various modes of transport and within individual modes of transport and in the determination of desirable financial returns therefrom; [and] (h) inquire into and advise the government on the overall balance between expenditure programs of government departments or agencies for the provision of transport f a c i l i t i e s and equipment in various modes of transport, and on measures to develop revenue from the use of transport facilities provided or operated by any government department or agency;...7 4 The C.T.C. was not established as a reactive body - i t was expected to v act of i t s own accord i f i t saw f i t to do so. Federal transportation regulation is an active process in Canada, with the C.T.C. undertaking numerous studies; both in-house, and contracted out to leading academics and consultants. The C.T.C. thus tends to be exposed to recent academic thought in addition to being up-to-date with respect to the operating environment. The C.T.C., however, is subject to the views of the Minister of Transport both directly and indirectly. The Minister (actually, the Governor in 7 V r A . , s. 22. Chapter 2 86 Intercity Passenger Network Council) can overturn C.T.C. decisions 7 5 and, as the 1981 VIA Rail service cutbacks il l u s t r a t e , even by-pass the Commission entirely. Furthermore, the Commission members are appointed by the Governor in Council. Thus, the C.T.C. tends to reflect, at least to a certain extent, the views of the current Minister of Transport.7** In general, despite the comings and goings of Ministers of Transport and of C.T.C. Commissioners, both the Railway Transport Committee and the Air Transport Committee have been relatively consistent in their approach. 7 7 In conclusion, the C.T.C. is a body intimately involved not only with the day-to-day operations of intercity passenger transport, but with the long-run aspects of Canada's passenger network. 7 8 The C.T.C. has a great deal of influence in determining the extent of efficiency losses arising from the intercity passenger r a i l services through i t s findings and rulings with respect to abandonment of unremunerative services. Since the C.T.C. is constrained by the attitude of the governing p o l i t i c a l party, the a b i l i t y to pursue a course independent of any given Minister is limited. The extent of efficiency losses, therefore, rests primarily on the Government and not the Canadian Transport Commission. 75NTA., s. 64(1). 7**This is a two-way street: a Minister of Transport cannot p o l i t i c a l l y afford to be continually overturning the decisions of the legally established regulatory body. 77Two recent studies have reviewed the decisions of the R.T.C. (Gibberd and Wesley (1981)) and the A.T.C. (Gibberd, Hariton and Wesley (1979)), and have found that these committees have been reasonably consistent. 7 8Indeed, there seems to have been a blurring of responsibility between Transport Canada and the C.T.C, with the C.T.C. now undertaking analysis of policy issues. Chapter 2 87 Intercity Passenger Network F. Summary This chapter reviewed the major components of the Canadian intercity passenger system. The intercity passenger transportation network in Canada is well served by the automobile, bus and air modes, in addition to r a i l services. Automobile travel currently dominates the passenger travel market and w i l l continue to do so for a number of years. The air mode has enjoyed rapid growth and now finds i t s e l f dominant in the long distance travel segment. It has also become a force to be reckoned with in the medium distance and even the shorter distance travel segments. The bus mode offers a great deal of competition to the r a i l mode since both tend to compete for the same clients over the same travel distance segment. The interactions of the four modes are complex and important, but could be generalized as being one of competition rather than as complementary components in a co-ordinated intermodal system. Governments in Canada play a complex and important role in the intercity passenger network. Governments own and operate several companies offering intercity passenger service. Governments provide the infrastructure for the air, auto, and bus modes and charge the users of this infrastructure for it s use. Since, as a rule, these charges do not f u l l y recover the f u l l share of a l l the infrastructure costs from the users, there is a government subsidy involved. This fee policy has a great impact on the extent of economic efficiency losses arising from the intercity passenger network. Governments Chapter 2 88 Intercity Passenger Network have established legislation which seeks to protect the "public interest" and other components of national and regional policy such as unity and equity, at the expense of economic efficiency. Governments have established bodies to oversee and enforce the legislation governing transportation. The provincial bodies, as described above, seem not to be overly concerned with encouraging economically efficient operations. Economic efficiency is only one of a number of objectives that the Federal Government considers. The existence of economic inefficiency in the Canadian intercity passenger transportation network i s , therefore, condoned and even propagated by governmental involvement in the network. The Canadian Transport Commission has played a particularly significant role in the transportation system, although this role is being diminished somewhat due to the current pro-competition environment favoured by policy makers. While the decisions of the C.T.C. do affect economic efficiency of the transportation system, the mandate and direction of the Commission is set by their p o l i c t i c a l masters. Chapter 2 89 Intercity Passenger Network CHAPTER 3 LITERATURE REVIEW A. Introduction This chapter reviews the available literature that is pertinent to this thesis. This includes literature dealing with the following: modal economies of scale; Canadian subsidization policies; demand modelling; and estimation of economic efficiency losses. B. The Literature Concerning Modal Economies of Scale The presence of increasing returns to scale for any of the modes under study is fundamental to the determination of efficiency losses arising out of non-marginal-cost pricing. The reason is simple: i f an industry is subject to increasing economies of scale at the relevant range of output, the maximization of economic welfare (i.e. efficiency) requires the subsidization of the monopoly firm in that industry.^ Thus the determination of economically efficient prices hinges on the assessment of the extent of economies of scale. The following sections summarize the results of studies investigating this issue. ^Tf returns to scale exist at an output level sufficient to satisfy, say, the a i r l i n e market, market forces w i l l tend towards the creation of a monopoly. This is the case of the "natural monopoly". 2Since the central focus of this thesis is not on the measurement of returns to scale, only the actual results and not the methodologies themselves are reviewed here. Chapter 3 90 Literature Review i ) economies of scale for the air l i n e industry The cost behaviour of the domestic air industry with respect to airline size has undergone a great deal of scrutiny, with the U.S. air l i n e industry receiving considerably more attention than i t s Canadian counterpart. There are, of course, potential dangers in extrapolating U.S. experience to the Canadian scene due to differences in industry structure. Having noted this, a review of the major U.S. studies shows that the general consensus is that the airl i n e industry is characterized by constant returns to scale. The available Canadian evidence seems to support this conclusion. Richard E. Caves, in an important early work on the airline industry and regulation, found that there was "no significant relation between size and average costs among the trunk-lines, although the local-service carriers suffer very substantial diseconomies of small scale. Eads, Nerlove, and Raduchel (1969) examined these local-service carriers in more detail. The conclusion was in direct contradiction to Caves (1962): "No evidence has been discovered that the local service airline industry is subject to substantial increasing returns to scale" and that there is in fact reason to believe that the industry is "subject only to slightly increasing returns to scale." 4 3Caves (1962; p. 58). 4Eads, Nerlove and Raduchel (1969; p. 268). Chapter 3 91 Literature Review Jordan (1970) seemed to support the findings of Eads, Nerlove and Raduchel (1969) through his findings in his study of intrastate carriers in California. Jordan concludes that there appear to be "no significant economies of scale in domestic air transportation that cannot be achieved by a carrier operating four or five aircraft of a suitable type over a small route structure. 5 The C i v i l Aeronautics Board (1972) also undertook a study of economies in airline services. The Board decided that although a scale effect was found, i t was a small effect at best. The conclusion was that there was no evidence to support a hypothesis of increasing returns to scale. Keeler (1972), in determining whether or not the regulation of airlines has affected fares and efficiency, developed a long-run airline cost model. The result of this model is much the same as the C i v i l Aeronautics Board (1972): a scale term that is s t a t i s t i c a l l y significant, but minimal in absolute terms.^ The study by Reid and Mohrfeld (1973) not only found that "increasing the size of an air l i n e firm beyond the point of minimum unit operating expense does not result in increased p r o f i t a b i l i t y " , but that their analysis 5Jordan (1970; p. 195). 6Keeler (1972; p. 411). Chapter 3 92 Literature Review "indicates that the large airlines do not operate as ef f i c i e n t l y as the smaller a i r l i n e s . " 7 Douglas and Miller (1974) undertook a major study of domestic air transport regulation and found only "slightly increasing, then decreasing, acknowledge the "possibility of no size effect whatsoever" given the marginal t-ratios they obtained for the crucial regression estimates. 9 Roy (1980) examined the issue of economies of scale in the Canadian air l i n e industry for the Canadian Transport Commission. Using a translog cost function, Roy concludes: The evidence on scale economies obtained from the estimates in this study is not sufficient to reject, for the Canadian airline industry, the evidence of constant returns to scale arrived at by air industry researchers analyses.^ Repeating the study using the more "traditional" approach of regression 'Reid and Mohrfeld (1973; pp. 170-171). Contrary to a previous stricture, one point concerning methodology should be noted here. Reid and Mohrfeld (1973) seem to have blurred the distinction between economies of scale and density. The scale measures they obtain include a reflection of differences in network structure between airlines. Thus conclusions concerning the implication of these measures on economies of scale are somewhat tenuous. unit costs with output". 8 Furthermore, Douglas and Miller were forced to 8 Douglas and Miller (1974; p. 17). Douglas and Miller (1974; p. 17, footnote 15). 10, 'Roy (1980; p. 80). Chapter 3 93 Literature Review analysis, Roy s t i l l finds that "[a]11 in a l l , this methodology sustains the hypothesis of constant returns to scale for the Canadian airline industry. Jordan (1982), in his analysis of Canadian airlines, finds that "very small airlines can achieve whatever scale economies exist in the airline industry."I 2 This serves to confirm his earlier findings [Jordan (1970)] with respect to the U.S. carriers. Finally, Gillen and Oum (1984b) undertook an extensive study of the Canadian Class I and Class II airlines. They determined that Air Canada showed slight diseconomies, Nordair showed slight economies, and the remaining airlines experienced constant economies of scale as of 1980. •LJ They did, however, find evidence of significant economies of density for the four smallest regionals and marginal economies of density for PWA (the largest regional carrier) and for CP Air (the smaller of the two national carriers). Air Canada does not appear to be characterized by economies of density.^ 4 Overall, i t seems safe to conclude that the airline industry in Canada is not l i k e l y to be subject to any significant degree of economies of scale. U R o y (1980; p. 111). 1 2Jordan (1982; p. 181). 1 3 G i l l e n and Oum (1984b; p. 50). This study shows that while Nordair was characterized by considerable returns to scale in the early 1970's, i t had experienced a significant and steady decline in scale economies afterwards. Nordair appeared to have almost exhausted the available returns to scale by 1980. 1 4 G i l l e n and Oum (1984b; Table 10, p. 51). Chapter 3 94 Literature Review i i ) economies of scale for the road modes Obviously, i t is not particularly constructive to discuss the possibility -of economies of scale for the private automobile. The possibility of economies of scale in the intercity bus industry, however, is an important question. Unfortunately, the body of existing literature concerning returns to scale is not nearly as extensive for the bus industry as i t is for the airline industry. Nevertheless, i t seems quite prudent, on the basis of the available literature, to conclude that the intercity bus industry does not enjoy increasing returns to scale. A recent study by the C.T.C. examined the regulation of the Canadian intercity bus industry.-'-5 This study noted the scarcity of rigorous studies dealing with the issue of bus industry economies of scale. Neither U.S. Department of Transportation (1977) nor I.C.C. (1978) studies, both of which determined that economies of scale are at best insignificant, was found to be particularly rigorous.^ Furthermore, an econometric study by Fravel (1978) which determined the U.S. Class I intercity bus industry to be characterized by positive returns to scale was found to have shortcomings that limited the usefulness of i t s conclusions.^-7 Nevertheless, Partridge and Fosbrooke, based Partridge and Fosbrooke (1980). Partridge and Fosbrooke (1980; p. 90). Partridge and Fosbrooke (1980; pp. 90-91). Chapter 3 95 Literature Review on their review, appear to believe that the Canadian intercity bus industry is not characterized by increasing returns to scale.^ 8 Williams and Hall (1981) also c r i t i c i z e d Fravel's (1978) use of a Cobb-Douglas cost function. This functional form imposes a value of unity on a l l e l a s t i c i t i e s of substitution between factor inputs. Williams and Hall tested the hypothesis of a Cobb-Douglas functional form and rejected i t . Using a generalized translog model as an exact representation of the minimum cost of producing output with given input prices,^ 9 Williams and Hall found evidence of positive returns to scale for the U.S. Class I bus operators. The data available for this study, however, were at a regional level - not the level of the individual firm. Although the assumption is made that the results are applicable to a l l the firms in the region, these results hold s t r i c t l y true only for the average firm in the industry. A later study of the U.S. intercity bus industry also found evidence of returns to scale, at least for the smaller operators. Tauchen, Fravel, and Gilbert (1983) found that: •L°The authors found that their review "of the relatively limited reference material on the intercity bus industry was unable to provide a clear explanation as to why i t is in fact regulated in Canada." (Partridge and Fosbrooke (1980; p. 1)). Clearly this precludes the existence of economies of scale in the Canadian intercity bus industry, since the potential for the existence of scale economies to lead to a natural monopoly situation would suggest a real need to regulate. l^The alternative approach is to u t i l i z e the translog model as a second-order approximation to a point on an arbitrary cost function. See, for example, Gillen and Oum (1984a, 1984b). Chapter 3 96 Literature Review "... the production of intercity bus-mile exhibits significant economies of scale for proportional increases in a l l services at output levels below the mean of the Class II and III carriers (0.06 per cent of total industry bus-miles) and constant or near constant returns to scale at higher output levels. In other words, the economies of scale in the production of intercity bus-miles are exhausted at an output level that is a very small fraction of total industry output." 2^ This conclusion was also based on a study employing a translog cost model of the U.S. bus industry. Perhaps the two studies which offer the greatest relevance for this thesis are Reschenthaler (1981) and Gillen and Oum (1984a). Both these studies deal with the Canadian intercity bus industry. Reschenthaler concludes that "there are no clear advantages to large size in this industry in the operation of terminals, use of drivers, use of supervisory personnel, marketing or maintenance.2^ Reschenthaler also concludes that there is "no evidence of economies of scale in the charter business and there are no economies in handling express which cannot be achieved by a relatively small regional carrier with the right to i n t e r l i n e . 1 , 2 2 Gillen and Oum (1984a) studied seventeen Class I and Class II Canadian intercity bus companies over the period 1974 to 1978. Using a translog cost 2 0Tauchen, Fravel and Gilbert (1983; p. 26). 2 1Reschenthaler (1981; p. 79). 2 2Reschenthaler (1981; p. 79). Chapter 3 97 Literature Review function, the authors find that the four largest firms (those with aggregate output of more than 15 million bus-miles per year) "experience strong decreasing ray returns to sc a l e . " 2 3 The smaller firms (those with aggregate output of less than 2 million bus-miles per year) experience "slightly increasing ray returns to scale", while the majority of firms (those with aggregate output of between 2 million and 15 million bus-miles per year) experience "more or less constant returns to s c a l e " . 2 4 Overall, i t seems that the Canadian intercity bus industry would be best characterized by the assumption of approximately constant returns to scale. i i i ) economies of scale for the r a i l mode The study of the cost behaviour of the r a i l industry with respect to railway size has a long history in the United States. Recently, this topic has received a considerable amount of attention in Canada as well. 2^ A brief review of some of the more recent U.S. and Canadian studies is offered below. Unlike the case of airline economies of scale, i t is not possible to proffer any easy general consensus as to the magnitude of r a i l scale economies. Very early studies of economies of scale in the r a i l industry tended to find substantial returns to scale. Griliches (1972) took the concept of 2 3 G i l l e n and Oum (1984; p. 378). 2 4 G i l l e n and Oum (1984; p. 378). 2^In fact, much of this recent Canadian attention is really a subproblem of more general efforts to assess the overall productivity of Canadian railways. Chapter 3 98 Literature Review "percent variable" used in many of the earlier studies (especially those of the I.C.C. Cost Section group) to task. He pointed out that such a measure of returns to scale can be seriously biased by the choice of the output level to measure i t at. Finding the "average" the I.C.C. used to base i t s measurement of economies on to be questionable, Griliches recalculated the measure using his own concept of "average" and the same basic methodology. The result was that there were approximately zero returns to scale in the U.S. r a i l 9 f% industry." Griliches then recalculated economies of scale using linear and log-linear regressions and determined that the larger railroads had essentially insignificant returns to s c a l e . 2 7 Griliches seems, however, to make light of the fact that his results indicated substantial economies of scale for the smaller U.S. railroads. Keeler (1974) u t i l i z e d a Cobb-DOuglas production function to develop short-run cost functions for U.S. railways (freight service) based on tr a f f i c and plant investment (trackage). From a cross-section of 51 U.S. railways, Keeler derived a long-run cost envelope from the estimated short-run relationships. This allowed Keeler to distinguish between returns to density and returns to scale. Keeler concludes that there exist "substantial unexploited economies of t r a f f i c density for most railroads, but constant long-run returns to s c a l e . 2 8 ^ G r i l i c h e s (1972; p. 28). 2 7 G r i l i c h e s (1972; Table 1, p. 35). 9fi '"'Keeler (1974; p. 207). The methodology employed by Keeler was also u t i l i z e d by Eads, Nerlove, and Raduchel (1969) for their estimation of airline cost functions. Chapter 3 99 Literature Review Hasenkamp (1976), using a more r e f i n e d model 2 9 found that there were s i g n i f i c a n t economies of scale i n the r a i l industry. This study attempted to c o r r e c t a t h e o r e t i c a l d e f i c i e n c y i n an e a r l i e r study, K l e i n (1947), but came up with much the same empirical r e s u l t . 3 ^ Harris (1977) pointed out several problems with many of the e a r l i e r studies. The p r i n c i p a l point was that the previous studies, by ignoring factors such as route system s i z e , b l u r r e d the d i s t i n c t i o n between returns to scale and returns to density. Furthermore, ignoring v a r i a b l e s such as average length of haul r e s u l t e d i n the i m p l i c i t assumption that "one ton c a r r i e d 1000 miles i s equivalent to 1000 tons c a r r i e d one m i l e . " 3 ! Harris used a simple l i n e a r cost model corrected for the aforementioned shortcomings and determines that "very s i g n i f i c a n t " economies of density e x i s t i n the p r o v i s i o n of r a i l 32 services. ^ A s e r i e s of studies lead by researchers from the U n i v e r s i t y of Wisconsin-Madison abandoned the methodology of the predecessor studies due to the severe a p r i o r i r e s t r i c t i o n s these studies imposed on the structure of costs and production. Brown, Caves, and Christensen (1979) i l l u s t r a t e d the s i g n i f i c a n t bias that r e s t r i c t i v e models, such as those assuming homogeneity 2 9 A Constant E l a s t i c i t y of Transformation model f o r outputs and both a Cobb-Douglas and a Constant E l a s t i c i t y of S u b s t i t u t i o n (CES) model for inputs. 3^The actual empirical estimates for the c r u c i a l parameter, which would r e c t i f y the flaw i n the e a r l i e r study, i n f a c t v i o l a t e d the very t h e o r e t i c a l requirement the study had intended to correct. (Hasenkamp (1976; p. 258, footnote 8). 3 1 H a r r i s (1977; p. 558). 3 2 H a r r i s (1977; p. 561). Chapter 3 100 L i t e r a t u r e Review (with or without separability) and those with the Cobb-Douglas functional form, impart to estimates of marginal costs. Using a translog joint cost function and firm-specific data for 67 U.S. railroads, Brown, Caves, and Christensen find evidence of "substantial scale economies".33 Caves, Christensen, and Swanson (1980) determined the returns to scale for the aggregate U.S. r a i l industry as part of a more general study of U.S. r a i l productivity. For the three years used for the estimations they determined, on the basis of a generalized translog cost function, positive returns to scale of .096 (1955), .114 (1963) and .088 (1974). 3 4 Expanding on this study, Caves, Christensen, and Swanson (1981), again using a generalized translog cost function, found that the aggregate measure for the U.S. r a i l industry returns to scale was between 1.042 and 1.209 for 1955, between 1.054 and 1.230 for 1963 and between 1.046 and 1.199 for 1974, based on total c o s t s . 3 5 Turning to the literature specifically dealing with Canadian railways, Caves and Christensen (1978) analyzed the productivity of CN and CP. In assessing productivity, measures of cost e l a s t i c i t i e s were required. The 33Brown, Caves, and Christensen (1979; p. 266). 3 4The scale for these measures is such that values greater than zero indicate positive economies, a value of zero indicates constant returns to scale, and values less than zero indicate diseconomies of scale. 3 5The scale for these measures is different than the previous one. Here values greater than one indicate positive economies, a value equal to one indicates constant returns to scale, and values less than one indicate diseconomies of scale. Chapter 3 101 Literature Review authors f e l t that the observations from merely two railways provided insufficient variation to ensure robust estimates of cost e l a s t i c i t i e s . Caves and Christensen thus used the coefficients estimated by Brown, Caves, and Christensen (1979), based on U.S. roads. The cost functions estimated from the U.S. data were applied to the actual CN and CP data to determine Canadian economies of scale. The authors found that for "the region of freight and passenger output levels produced by the CN and the CP, the hypothesis of constant returns to scale cannot be rejected." 3 6 Caves, Christensen, Swanson, and Tretheway (1982) incorporated observations for CN and CP in their comparison of U.S. and Canadian r a i l productivity. For the same reason as Caves and Christensen (1978), the authors did not estimate Canadian cost e l a s t i c i t i e s from Canadian data. Using the more recent coefficients from the generalized translog cost function of Caves, Christensen, and Swanson (1980, 1981), the authors determined that a one percent increase in each output index resulted in an increase in total costs of only approximately 0.88 percent. 3 7 This indicates the existence of significant returns to scale for the two Canadian railways. Freeman, Oum, Tretheway, and Waters (1985), in the fashion of the Wisconsin group, also conducted a general study of railway productivity - but solely for Canadian Class I railways. Although the study has the same starting point as Caves, Christensen, Swanson, and Tretheway (1982), a revision in methodology eliminated the problem of requiring estimates of cost 3 6Caves and Christensen (1978; p. 40). 3 7Caves, Christensen, Swanson, and Tretheway (1982; p. 134). Chapter 3 102 Literature Review e l a s t i c i t i e s for the two Canadian Class I railways. The estimation of these e l a s t i c i t i e s is planned by Freeman, Oum, Tretheway, and Waters, but has not yet been carried out. Nevertheless, the authors offer their assessment concerning returns to scale in the Canadian r a i l industry which they infer regressions, which include a time variable to account for a constant rate of technical change and a network size variable to account for the possibility of economies of density, the authors conclude that the Canadian r a i l industry seems to be characterized by approximately constant returns to scale with significant economies of density. 3 8 Roy and Cofsky (1985) appear to reject the assumption made by Caves and Christensen (1978) and by Caves, Christensen, Swanson, and Tretheway (1982) that U.S. cost functions could be used to represent Canadian conditions. Roy and Cofsky estimate a cost function for the two Canadian railways using the generalized translog functional form. The authors acknowledge that there are problems with their estimates of cost e l a s t i c i t i e s , noting that "the cost e l a s t i c i t i e s obtained are not only reflecting scale effects but also an evolving production process of r a i l services." 3 9 Roy and Cofsky conclude, however, that "basically, the assumption of constant returns to scale... cannot be rejected by the evidence gathered from the estimated cost function. from their results. Based on several simple total factor productivity 38 Freeman, Oum, Tretheway, and Waters (1985; p. 759). 39 Roy and Cofsky (1985; p. 780). 40 'Roy and Cofsky (1985; p. 781). Chapter 3 103 Literature Review Thus while the existing Canadian estimates are either based on U.S. experience [Caves and Christensen (1978), Caves, Christensen, Swanson, and Tretheway (1982)], or are tentative and preliminary [Freeman, Oum, Tretheway, and Waters (1985)] or are not as robust as would be ideal [Roy and Cofsky (1985)], the available evidence does seem to point to approximately constant returns to scale for aggregate Canadian r a i l services. On the other hand, the estimates for the U.S. r a i l industry tends to show positive economies of scale. The hypothesis assumed (somewhat hesitantly) here is that the Canadian r a i l industry is characterized by insignificant, or at most, marginal economies of scale. Although this is contrary to the majority of the U.S. evidence, i t is accepted primarily on the basis of a belief that sufficient differences in the institutional arrangements and industry structure exist between the U.S. and Canada to warrant weighting the Canadian evidence more heavily. 4^ iv) conclusion On the basis of the available literature concerning modal economies of scale, i t would seem best to conclude that none of the primary modes of intercity passenger transportation enjoys a significant degree of scale economies. This potential economic ju s t i f i c a t i o n for modal subsidization thus plays no role in the assessment of economic efficiency losses in the Canadian intercity passenger transportation network. 4 iHeaver and Waters (1982; pp. 154-156) offer several reasons which might account for the observation of superior Canadian r a i l productivity. A couple of these reasons would seem to apply directly to the issue of economies of scale. Chapter 3 104 Literature Review C. The L i t e r a t u r e Concerning Canadian I n t e r c i t y Passenger Network Modal Subs i d i z a t i o n Also fundamental to the determination of efficiency losses arising out of non-marginal-cost pricing is the extent to which current pricing deviates from economic costs. This section reviews the literature concerning the extent to which current modal revenues f a l l short of covering total modal costs: in other words, the degree of modal subsidization. As stated in the NTA, i t is the avowed philosophy of the Canadian Government that "each mode of transport, so far as practicable, bears a fa i r proportion of the real costs of the resources, f a c i l i t i e s and services provided that mode at the public expense." 4 2 Considerable effort has gone into the examination of the extent to which each mode actually covers i t s public costs. A major study was undertaken by the Ministry of Transport User Charges Committee in the early 1970's. Partly in support of this effort, the C.T.C. produced a series of studies on the "profitability" of public investment in transport infrastructure. The series of studies by the C.T.C. examined the annual costs and revenues associated with public investment in roads [Haritos (1972)], in the national r a i l system [Haritos (1973a)], in c i v i l aviation infrastructure [Haritos and Gibberd (1972)] and in c i v i l marine infrastructure [Haritos and Hildebrand (1973)]. A summary of these studies was published separately as Haritos (1973b). ^National Transportation Act. , R.S., c.69, s. 3(b). Chapter 3 105 Literature Review The basic objective was to obtain a measure of the extent to which user charges covered the public outlay for each of the modes. The basic methodology used in these four studies was to examine a l l the annual costs attributable to the users of each mode on an industry basis, and to match these against a l l the revenues corresponding to the costs included in the analysis. Public expenditures were classified as capital (including a charge for depreciation and for the cost of capital) or current (including administration, operation and maintenance) by year and region. These figures were then adjusted by means of a price index in order to convert to constant 1968 dollars. Revenues from taxes, fees, licenses, fines and any other sources attributable to the use of publically provided infrastructure (assuming the corresponding costs were included in the analysis) were then cla s s i f i e d by year and region and also converted to constant 1968 dollars. One significant problem arose. Due to an ina b i l i t y to allocate revenues meaningfully between infrastructure and rol l i n g stock for r a i l services, the r a i l mode is not s t r i c t l y comparable with the other modes. The preliminary investigation concerning infrastructure costs and revenues was extended to include vehicles, in order to obtain a common base which could support intermodal comparisons between the r a i l mode and the other modes. The f i n a l result was that the total d e f i c i t (public investment in infrastructure and equipment less the revenues from the users of this investment) of the modes, as a percentage of their own total costs, was found Chapter 3 106 Literature Review to be 3.7% for road, 19.3% for air, 25.5% for marine and 27.1% for r a i l . 4 0 These figures are based on the aggregate annual costs and revenues in the mid-1950's to late-1960's period. Acres Consulting Services (1974) found much the same result as the C.T.C. studies. The 1970 net public expenditure as a percentage of the mode's total costs were determined to be 5.7% for road, 18.5% for air and 25.6% for r a i l . 4 4 The C.T.C. later used a slightly different approach based on net government expenditures on a cash flow basis and determined that the 1972 level of subsidization by mode was between 0.58 and 0.87 cents per passenger-mile for road, between 2.17 and 2.44 cents per passenger-mile for a i r , and approximately 5.75 cents per passenger-mile for r a i l . 4 5 Unfortunately these latter C.T.C. figures are not s t r i c t l y comparable across modes within the same study (due to limitations in the data) nor are they s t r i c t l y comparable to the earlier study (due to differences in methodology). Nevertheless, both sets of figures give the same ranking and approximately the same relative magnitudes of subsidy. Johnson et a l . (1976) analyzed air and r a i l passenger transport pricing and subsidization. From their figures, i t can be seen that the average level of subsidy in the early 1970's was about 5.45 cents per passenger-mile for the 4 3Haritos (1973b; Table 6, p. 27). 4 4Derived from Tables 32 and 34, Acres Consulting Services (1974; pp. 57, 59). 4 5C.T.C. (1976; pp. 73-78). Chapter 3 107 Literature Review CN and about 7.275 cents per passenger-mile for CP, in constant 1971 dollars. The air mode, on the other hand, averaged a subsidy level of about 2.2575 cents per passenger-mile, also in constant 1971 dollars, for the same period. 4 6 The Strategic Planning Group of Transport Canada updated the 1972-1973 series of C.T.C. studies in the early 1980's, basing their analysis on the period 1969 to 1979. 4 7 This study examined modal costs and revenues using the methodology of the C.T.C. study (i.e. an inflation-adjusted analysis). In addition, the Transport Canada (1982) study repeated the exercise on a cash flow basis and on a book value basis. Transport Canada found the modal de f i c i t as a percentage of total costs on an inflation-adjusted basis to be 9.6% for road, 13.6% for air, 14.2% for r a i l and 22.2% for marine. 4 8 This study also determined the modal deficits on a per passenger-kilometre basis. On this basis, the 1979 level of subsidization was found to be 0.4 cents for intercity bus, 0.9 cents for private automobile, 1.1 cents for air and 14.1 cents for r a i l . 4 9 This exceedingly high level of subsidization for r a i l on the per passenger-kilometre basis had come about, in part, because of the significant increase in r a i l costs, and in part, because of the decline in the level of patronage. The 14.1 cents per passenger-kilometre average subsidy can be compared to the figures shown in Table 3.1, which shows some actual losses incurred during this period on selected corridor routes. 4 6Johnson et a l . (1976; p. 78, Table VI-4 and p. 102, Table VI:14). 4 7Transport Canada (1982). 4 8Transport Canada (1982; p. 57). 4 9Transport Canada (1982; p. 60). Chapter 3 108 Literature Review TABLE 3.1 Losses on Selected Corridor Routes (cents per passenger-kilometer) 1972 1973 1974 1975 1976 1977 Montreal-Quebec 3. .9 5. .8 6, .4 9, .4 13. .0 15. .2 Montreal-Ottawa 4. 6 7. .4 9, .4 14. .4 17. ,1 17. .5 Montreal-Toronto 1. .6 2, .7 2, .7 3, .7 4. .5 5. .1 Ottawa-Toronto 7. ,5 7, .5 6, .0 7. .8 7. .6 6, .2 Toronto-Kingston 2. ,1 3. .0 2. .8 3. .9 6. .8 6. .6 Toronto-Windsor 2. .1 3. .0 3. .9 4. .7 6. ,3 6. .2 Toronto-London-Sarnia 4. .7 6 .8 7, .4 7, .5 10. .2 10, .2 Chapter 3 Source: Derived from Partridge 109 (1979; Tables 2.5 and 2.6). Literature Review Thus while the air and especially the road modes receive a substantial amount of public funding in absolute terms, these subsidies represent a smaller percentage of total modal costs than does the r a i l subsidy. The bus mode comes closest to covering i t s share of public resources consumed. Furthermore, on the basis of a per unit output subsidy, the bus, automobile and air modes require considerably less assistance than does the r a i l mode. D. The Literature Concerning Demand Modelling Also important to the determination of efficiency losses arising out of non-marginal-cost pricing is the price responsiveness of travellers. In order to estimate this price responsiveness, modelling of the demand for travel is usually undertaken. This section reviews the literature concerning demand modelling. However, even a brief survey of the theoretical and empirical literature concerning demand modelling reveals a plethora of alternative methodologies or approaches. A comprehensive categorization and review of demand modelling methodologies is beyond the scope, and indeed the need, of this exercise. Since the objective of this thesis is not to produce the definitive travel demand model, but to develop a serviceable travel demand model as a means to an end (i.e. efficiency loss estimation), some "screening" of methodologies is required to reduce the selection process to a manageable scope. To this end, only those models that f a l l into two broad categories of demand models w i l l be considered. These two categories are s t a t i s t i c a l demand models and derived demand systems based on neoclassical demand theory. Despite a substantial narrowing of focus, these two categories s t i l l Chapter 3 110 Literature Review incorporate a very large number of different model types. Given the needs of this thesis and the nature of the available data (i.e. aggregate), this w i l l s t i l l provide a considerable variety from which to extract an appropriate model type. i ) s t a t i s t i c a l demand models The category of s t a t i s t i c a l demand models comprises a large number of diverse approaches. Included in this family are the common linear, semi-log and log-linear specifications. Each of these models, in turn, can be generalized by various transformations (for example, the Box-Cox or the Box-Tukey transformations) applied to the dependent variable or to a l l the variables. The popular "gravity model" and i t s variants are also numbered among the family of s t a t i s t i c a l demand models, as are the "abstract mode" type models. Despite the apparent superficial differences that exist in the form of these various specifications, these models share a common philosophy that, underlies their development. This philosophy is simply that since the true functional form of the demand for travel is not known with certainty, i t is best to allow the data to decide the specification. In other words, this approach amounts to an exercise in curve-fitting. whatever functional form appears best suited on the basis of s t a t i s t i c a l measures of goodness-of-fit w i l l be selected. Chapter 3 111 Literature Review The fact that this procedure is basically an ad hoc one, is not to say that i t is necessarily a haphazard one. For the experienced practitioner, the process of model development is far from random. It draws not only on intuition, but also on prior knowledge or experience as well as on a substantial body of implicit economic theory. Nor should the label."ad hoc" be construed as implying a lack of legitimacy in this approach. The objective of demand modelling is to achieve a manageable replication of some r e a l - l i f e phenomenon. For many purposes, including that of this thesis, i t is the bottom line of model performance that is paramount. If an ad hoc model can actually achieve a reasonable representation of the phenomenon in question, the model may be deemed useful despite the lack of rigorous economic just i f i c a t i o n . It is perhaps worth noting here that certain of the s t a t i s t i c a l demand models are not entirely without some theoretical economic underpinnings. Periodically, there are attempts to buttress the economic foundations of the gravity model. For example, Niedercorn and Bechdolt (1969) show that given an additive consumer u t i l i t y function and either a "logarithmic u t i l i t y of tripmaking function" or a "power u t i l i t y of tripmaking function" subject to a budget constraint, 50 the gravity model can be derived by assuming that the 9. . aggregate travel budget of the individuals at the origin is proportional to [the standard gravity model component of] the population of the origin raised to the power of the estimated parameter. Alternatively, the gravity specification can be derived by assuming that the aggregate travel budget of -)0The budget constraint can be expressed as either the amount of money or time which is allocated to travel. Chapter 3 112 Literature Review the individuals at the origin is proportional to the population of the origin multiplied by the [constant] per capita income of the origin. Cochrane (1975) derived the gravity model equation from another equation maximizing personal surplus, where "surplus" is measured by the difference between the probabilistic u t i l i t y and the deterministic cost of the t r i p . 5 1 Anderson (1979) provided a theoretical explanation for the gravity specification for international (or interregional) trade by u t i l i z i n g "the properties of expenditure systems with a maintained hypothesis of identical homothetic preferences across regions". 5 2 Despite these contributions, the gravity model specification s t i l l remains unreconciled with consumer theory. The restrictions imposed on the key parameters of consumer behaviour are quite severe, and as such, are questionable. The abstract mode methodology has also received considerable theoretical attention. 5 3 Quandt and Baumol (1966, 1969), Quandt and Young (1969), Young (1969) and a whole series of studies out of the Mathematica group a l l provided 5 1Cochrane (1975) also deals with the case of a probabilistic trip cost. 5 2Anderson (1979; p. 106). 5 3Although Quandt and Baumol (1966) pioneered the abstract mode models for transportation, their efforts paralleled the more general works of Lancaster (1966, 1971). In these works, Lancaster offers a "new approach" to consumer theory. This "characteristics" approach to consumer theory portrayed consumers as purchasing not a good but the bundle of attributes contained within that good. Hendler (1975; p. 199), however, maintained that the assumptions required by Lancaster's model are very restrictive and that this approach merely becomes "an interesting and special case of consumer choice rather than a general model of consumer demand." Nevertheless, the characteristics approach has found considerable acceptance among economists. Chapter 3 113 Literature Review theoretical as well as empirical support for this methodology. Bergsman (1967) offered three generalizations that would improve the abstract mode approach. These were: treating the "demand-type" variables as endogenous; realizing that cost variables may in certain circumstances not be exogenous (for example, i n corridors approaching capacity limitations); and acknowledging that travel along any given link is not independent of the attributes of the other links in the network. Groneau and Alcaly (1969), however, pointed out a d i f f i c u l t y with one of the fundamental benefits of using the abstract mode model: forecasting travel on as-of-yet non-existent modes. There is an inherent problem in evaluating a mode that li e s outside the attribute space defined by the existing modes. This observation casts considerable dispersion on the efficacy of u t i l i z i n g this methodology to forecast future u t i l i z a t i o n of non-existent products. Howrey (1969), in comparing various gravity and abstract mode models for parameter s t a b i l i t y and forecasting accuracy, found l i t t l e empirical evidence to suggest that the extra modelling effort involved in the abstract mode specification (as opposed to a simple gravity model) is worthwhile. Despite the considerable attention devoted to the theoretical aspects of the abstract mode methodology, this approach has not yet been satisfactorily reconciled with consumer u t i l i t y theory. One major unresolved problem is centred around the comparative process u t i l i z e d by consumers in evaluating modes. Standard abstract mode models compare any given mode with a composite "best" mode which does not actually exist. Chapter 3 114 Literature Review Thus, neither the abstract mode model or the gravity model benefit from a cohesive economic reconciliation with standard consumer theory. Furthermore, the simpler s t a t i s t i c a l demand models have virtu a l l y no economic rational justifying these specifications. In fact, Johnson (1979; p. 249) pointed out that an ad hoc model (one not derived from a u t i l i t y function) "will rarely, i f ever satisfy the budget constraint and w i l l not satisfy these two conditions [Engel aggregation and Cournot aggregation] implied by consumer demand theory." Despite this, the use of ad hoc demand models has a long and varied history in transportation analysis. A completely comprehensive review of a l l empirical transport analyses would be a horrendous task, thus the following review serves merely to illustrate some of the methodologies used in the past decade, and to establish the use of the ad hoc approach in transportation analysis. Jung and F u j i i (1976) analyzed U.S. domestic air travel by directly computing the arc ela s t i c i t y of demand. This was accomplished by examining individual routes which had experienced a fare change and comparing passenger volumes prior to and after the change. The authors found a median elas t i c i t y of -2.7365; however, the range of individual route e l a s t i c i t i e s was extremely high. Nine of the forty-two e l a s t i c i t i e s calculated were positive, while three were less than -8.0. Mutti and Murai (1977) took a more conventional approach in their time-series analysis of the demand for air travel across the North Atlantic. They explained the demand for both charter and scheduled travel separately, as a function of real average realized fare (own fare only) and real income, using Chapter 3 115 Literature Review a log-linear demand equation. The authors found charter demand to be price elastic (e — -1.43) but scheduled service demand to be price inelastic (e = -0.74). In addition, a variable expressing relative fares (charter versus scheduled service) was used in conjunction with total spending on the North Atlantic market in a separate set of demand equations to explain travel volumes. This approach vi r t u a l l y reversed the results of the previous set of equations. The demand for charter service was found to be price inelastic (e •= -0.51) while the demand for scheduled service was found to be unity (e = -1.01) with respect to price. The cross-price e l a s t i c i t i e s were found to be +0.12 for the demand for scheduled service with respect to price of charter service, and +0.92 for the demand for charter service with respect to price of scheduled service. The difference between the two sets of models clearly indicates the effect that a change in assumptions concerning cross-price e l a s t i c i t i e s can have on the model's r e s u l t s . 5 4 Straszheim (1978) also examined the North Atlantic market using a log-linear model based on time-series data. Straszheim modelled the demand for f i r s t class and for economy travel separately. Each was expressed as a function of real fares ( f i r s t class, economy and peak economy) and lagged GNP, although the inclusion of this income variable was not successful. Other fares, including excursion and high discount, as well as various fare indices were tried but were not found to be especially useful. Straszheim found the demand for f i r s t class travel to be price inelastic (e = -0.76, or e - -0.65 -•^Including own-price as the only price variable in the f i r s t set of equations is equivalent to assuming zero cross-price e l a s t i c i t i e s between the two services. Chapter 3 116 Literature Review depending on which sample size was used).- 5 The demand for economy travel was found to be price elastic (e = -1.48 in the off-peak season and e = -1.92 in the peak season). The cross-price e l a s t i c i t i e s between fareclasses were found to be insignificant. Hutton (1979) examined interstate and intrastate air travel in Australia using time-series data. Demand was modelled as a linear function of real income, real fare and c i v i l i a n employment, plus a couple of dummy variables to account for specific system shocks. The demand for air travel was found to be -1.45. There was no s t a t i s t i c a l difference found between the calculated price e l a s t i c i t i e s for interstate and intrastate air travel for a l l but one state (New South Wales) where an inelastic demand was determined. Hutton found that the demand for air travel was elastic with respect to real disposable income (e = 1.22). Intrastate travel was found to be even more responsive to changes in real disposable income, with calculated e l a s t i c i t i e s in the range of 1.38 to 1.91. Cigliano (1980) returned to the North Atlantic market, analyzing separately the aggregate demand for U.S.-Europe and Canada-Europe travel. Both demands were modelled simply as a function of average weighted fare and GNP. The fares Cigliano used were the average weighted fare between New York and London and the average weighted fare between Toronto and London, respectively, for the two models. The GNP variable was simply the U.S. GNP 5 5Straszheim modelled demand using data from 1948 to 1973 and from 1952 to 1973. The rationale was that there had been a structural change in 1952 when tourist-class service was introduced. The f i r s t sample util i z e s a dummy variable to capture the one-time shift from f i r s t class to tourist. The second sample merely looks at the post tourist-class-service era. Chapter 3 117 Literature Review for the f i r s t model and the Canadian GNP for the second model. The U.S. model was then broken down into four classes ( f i r s t , regular economy, short excursion and long excursion) and re-estimated, again using simply the average weighted fare between New York and London and the U.S. GNP. The demand for ai r travel between Canada and Europe was found to be inelastic with respect to price (e - -0.824), but elastic with respect to income (e - 1.765). The demand for air travel between the U.S. and Europe, however, was found to be elastic with respect to price (e - -1.247), and even more elastic with respect to income (e = 1.905). The breakdown of U.S.-Europe travel into the four fareclasses showed f i r s t class travel to be price inelastic (e = -0.447) and the other three classes to be price elastic (e = -1.3, -2.181, and -1.826 respectively, for regular economy, short and long excursion). Andrikopoulos and Baxevanidis (1981) examined air travel in and out of Toronto and Montreal using cross-sectional data for two separate years (1961 and 1971) and a log-linear demand equation. Travel was modelled as a function of fare, population, average family income, the number of families with incomes over $10,000, the number of white-collar workers and distance. The authors found evidence of structural change, especially for travel in and out of Toronto, since the e l a s t i c i t i e s differed by a s t a t i s t i c a l l y significant amount between the two years. The demand for air travel with respect to price changed from -3.743 in 1961 to -1.538 in 1971 for Toronto-related t r a f f i c . The change for Montreal-related t r a f f i c changed by a lesser amount: from -3.58 to -2.91. The authors conclude that there is evidence to support the hypothesis that the Montreal and Toronto observations were not drawn from the same population. Chapter 3 118 Literature Review Anderson and Kraus (1981) noted that while service delay is an extremely important variable in the demand for air travel, demand models do not usually include this component. Anderson and Kraus developed a log-linear demand equation which u t i l i z e d a delay function incorporating both frequency delay and stochastic delay. The model also included variables representing real fare, real income and the (assumed) real value of time.5*' The variables of price and service delay were combined, unfortunately, to create a " f u l l trip price" variable. The authors did not ex p l i c i t l y derive fare e l a s t i c i t i e s , rather, they dealt exclusively with "f u l l - t r i p - p r i c e e l a s t i c i t i e s " . The calculated results were s t a t i s t i c a l l y significant in 23 of 48 equations dealing with eight city-pairs, and ranged from -1.20 to -4.182. Abrahams (1983) also included service quality aspects in his time-series analysis of U.S. domestic air travel, but kept this component distinct from the fare variable. Abrahams modelled the demand for air travel as a function of air fare (lowest unrestricted coach), expected schedule delay, automobile costs, population, per capita income and the quarterly change in GNP, with and without a series of city-pair dummy variables. This demand equation was estimated as part of a set of simultaneous equations (demand and supply) using a two-stage least-squares procedure. 5 7 The demand for air travel was found to be inelastic in the short-run, but elastic in the long-run. Furthermore, the 5*'The original intent was to estimate the value of time. The authors found that the insufficient amount of variation within the data i t s e l f precluded such an estimation. Therefore, three values covering the feasible range for the value of time were selected and each, in turn, was used. 5 7 Anderson and Kraus (1981) also incorporated their demand equation in a simultaneous equations model. Chapter 3 119 Literature Review e l a s t i c i t i e s on the long-haul routes were " f a i r l y consistently" more elastic than the shorter routes. Jones and Nichols (1983) modelled the demand for intercity r a i l travel in the U.K. using a log-linear demand equation. Jones and Nichols, like Anderson and Kraus (1981) and Abrahams (1983), u t i l i z e service quality variables. Unlike the other two studies, however, Jones and Nichols employ service variables not only for the mode under study, but for alternative competing modes as well. The variables these authors determined to be appropriate to u t i l i z e as exogenous variables were: fare (average revenue per journey); r a i l frequency of departure; r a i l travel time; service level of non-rail modes; the price of gasoline; gross domestic product; economic activity and seasonal dummy variables. The authors determined the unweighted mean of the own-price el a s t i c i t y to be -0.64. Eight of the seventeen e l a s t i c i t i e s calculated f e l l between -0.6 and -0.8, with only two of them being very inelastic (-0.14 and -0.11) and two being elastic (-1.18 and -1.03). The latter two were both relatively long-hauls links. Babcock and German (1984) analyzed the demand for intercity bus travel in the U.S. using time-series data for Class I bus operators. They modelled the modal share of bus as a function of bus fare relative to r a i l fare, bus fare relative to air fare and income (or alternatively, automobile registration). The demand equation was expressed in log-linear form. Since the chosen dependent variable was share rather than volume, the calculated el a s t i c i t i e s are a l i t t l e different than what is usually cited. Moreover, in calculating the own-price e l a s t i c i t i e s , Babcock and German failed to sum a l l the relevant Chapter 3 120 Literature Review coefficients. This summation is necessary because the price of bus enters each equation in two places and both must be taken into account in determining the overall impact a change in bus fare w i l l have on bus volumes. Correcting this latter problem, the resultant own-price e l a s t i c i t i e s for the share of bus travel are -1.04 and -1.23, depending on whether income or automobile registrations is used as an independent variable. Cross-price e l a s t i c i t y with respect to air was either 0.48 or 0.58, again depending on which income variable was used. The corresponding values for the cross-price elasticity with respect to r a i l were 0.56 and 0.65. Douglas (1984) took a less conventional approach in his analysis of U.K. intercity bus travel, employing a "ratio" model. This approach utilizes a cross-sectional model based on data for two separate years, the objective being to explain the differences observed in travel volumes between these points in time. The year prior to and the year following the 1980 deregulation of the U.K. express coach industry were the years selected for this study. The variables used to model the change in demand for bus travel were the log of mean real fare and of scheduled mileage. This basic model was then refined by categorizing the sample by the degree of independent coach competition, the degree of bus-rail competition, season, and type of route. The latter element refers to classifying routes as to whether they are London-based links, trunk routes, non-trunk routes, or coastal routes. Four functional forms were tested by Douglas: linear, semi-log, log-linear and Box-Cox. The generalized form (i.e. the Box-Cox model) was found to be best according to goodness-of-fit c r i t e r i a . Chapter 3 121 Literature Review One most noteworthy point that arose from this study was the fact that the implications suggested by each of the four models differed substantially. This naturally leads to the conclusion that model results are a function of the model specification chosen. Results, therefore, w i l l be biased by choosing the "wrong" functional form. The suggestion that functional form plays a direct role in model results is certainly not a new one. Gaudry and Wills (1978) showed that "incorrect functional form specification may lead not only to incorrect e l a s t i c i t i e s but even to erroneous signs of important parameters." 5 8 Gaudry and Wills go on to conclude after extensive modelling that: ...models which used fewer restrictions...were preferable...because the sign, significance and e l a s t i c i t i e s associated with parameters of explanatory variables determined jointly with functional form parameters might be more convincing than results obtained otherwise. 5 9 It appears that there are some dangers inherent in the standard ad hoc modelling approach u t i l i z e d in many of the studies cited above, and certainly in most of the earlier ad hoc modelling efforts. In other words, blindly assuming the "appropriate" functional form could lead to misleading results. This does not invalidate this approach - i t merely suggests that extreme care is required' in attempting to model economic phenomenon using ad hoc methodologies. ^Gaudry and Wills (1978; p. 257). 5 9Gaudry and Wills (1978; pp. 286-287). Chapter 3 122 Literature Review Despite this danger, the ad hoc approach has been, and continues to be, a very common practice. Obviously, such popularity in approach is not without reason. Perhaps the most attractive feature of most of the ad hoc models is their easily understood nature. Especially in the case of demand models designed for use by administrators to f a c i l i t a t e decision making, the ease of interpretation, and even the basic acceptance of the model, is greatly f a c i l i t a t e d by the use of simple models. Additional advantages of ad hoc demand models are the relative ease and inexpensiveness of the actual estimation procedure. In certain circumstances, the lack of computing f a c i l i t i e s or funds might necessitate the use of rather simplistic models. Time is another constraint which might necessitate the use of quick and simple ad hoc models. Yet another potentially important advantage is the "frugalness" of simple ad hoc models in data requirements. In other words, databases that might be insufficient in size or quality to support "advanced" modelling methodologies could prove adequate for the estimation of simple ad hoc demand models. In addition, when the functional form is unknown, i t seems eminently rational to accept the most simple form that provides reasonable results and that conforms with intuition, prior knowledge and implicit theory. Finally, the most simple functional form might even appear to be a reasonable functional form on an a p r i o r i basis, rather than just simply on an a posteriori basis. These advantages do not come without cost. Already mentioned is the fact that the arbitrary choice of functional form could bias the results of the model. Another powerful criticism concerns the rather severe restrictions ad hoc specifications impose on the various e l a s t i c i t i e s of interest. Chapter 3 123 Literature Review E l a s t i c i t i e s are constrained to be constant across a l l observations (or, i f an interactive dummy variable is utilized, equal across a l l observations within a given class of observation). Furthermore, the conventional ad hoc specifications usually do not incorporate a f u l l complement of price and quality variables. This constrains important cross-price e l a s t i c i t i e s , e l a s t i c i t i e s with respect to quality, and el a s t i c i t i e s of substitution to be zero. Finally, ad hoc specifications are incapable of providing a true approximation to the consumer preferences that demand models seek, since they are not derived from consumers' u t i l i t y functions. These inadequacies led to the development of a new family of models designed to correct these faults: derived demand models based on neoclassical demand theory. 0 i i ) derived demand systems based on neoclassical demand theory The category "derived demand systems based on neoclassical demand theory" refers to those models which start with a consumer u t i l i t y function and derive a demand system consistent with the economic theory of u t i l i t y maximization. Several functional forms have been developed by economists, among them the Generalized Leontief (Diewert (1971)), S-Branch U t i l i t y Theory (Brown and Heien (1972)), the Generalized Cobb-Douglas (Diewert (1973)), the Transcendental Logarithmic, or "Translog" U t i l i t y Function (Christensen, Jorgenson, and Lau (1975)), the Generalized Box-Cox (Berndt and Khaled (1979)) and the "Almost Ideal Demand System" (Deaton and Muellbauer (1980)). A l l these methodologies have in common the development of a functional form with a Chapter 3 124 Literature Review high degree of " f l e x i b i l i t y " . That i s , the functional form contains a sufficient number of parameters to ensure that no, or at least few, assumptions (restrictions) need be imposed on the underlying theory of how consumers behave. Variations of these models have been used extensively for empirical estimation of a number of industries. Kraft and Kraft (1975) u t i l i z e d the S-branch u t i l i t y system to assess the preference orderings of transportation mode choice in the Northeast corridor of the United States. They found that the modes analyzed are not perfect substitutes, and that when a generalized cost is used (i.e. when the value of time of travellers is taken into account), the r a i l mode is the preferred mode. In other words, travellers in the Northeast corridor of the United States appear to derive more u t i l i t y from r a i l than from any other mode, a l l else held equal. Christensen and Manser (1977) used both a direct and an indirect translog model to study U.S. consumer preferences for meat. The indirect form of the model suggests that consumers face fixed prices and thus maximize their u t i l i t y by selecting the appropriate quantities. The direct form of the model, on the other hand, suggests that quantities consumed are constant across consumers and that they maximize their u t i l i t y by selecting the appropriate prices (i.e. select the appropriate type or cut of meat). Since both of these assumptions have some merit, Christensen and Manser tested both formulations. Chapter 3 125 Literature Review The empirical results of the two forms of the model varied quite substantially. Since both sets of results were plausible, and since the explanatory power of the two models was "virtually identical", Christensen and Manser demurred from choosing between the two. In the case of intercity passenger transportation, however, the direct form of the model appears less plausible. It does not seem reasonable to assume that quantities of travel are constant across persons. Rather, i t would seem more plausible to assume that travellers face constant prices and chose travel quantities accordingly. Thus, the indirect form of the model should be used for any transportation study using aggregate data. Caves and Christensen (1980) tested three functional forms: the Constant Ela s t i c i t y of Substitution (CES), the Generalized Leontief (GL) and the Translog models, using data from the Wisconsin Residual Time-of-Use El e c t r i c i t y Pricing Experiment. Since the partial e l a s t i c i t y of substitution between peak and off-peak e l e c t r i c i t y consumption is quite small, the translog form was less well-equipped than the CES and the GL forms to handle this demand. The CES model would be preferred over the GL due to i t s simplicity, however, this only holds true for a two-period case. Beyond two periods, the CES structure is not sufficiently flexible to provide an appropriate functional form and the GL would be superior. Oum (1979a, 1979b) u t i l i z e d the translog functional form to study the demand for freight transportation in Canada. Oum (1979a) found that earlier modelling approaches suffered from important deficiencies, and that a model should meet three conditions: Chapter 3 126 Literature Review 1. the model includes both price and quality variables of a l l competing modes so that the price and quality responsiveness of demand can be measured; 2. the functional form of the demand model allows for free variation of el a s t i c i t i e s of substitution; and 3. the demand model is a derived one so that the structure of the shipper's distribution technology can be inferred directly from the knowledge of demand functions. 6^ Oum (1979b) used a translog model to specify shippers' cost functions and constructed revenue shares as a function of both price and quality. Elasticities of demand varied substantially by commodity and link. Thus models which enforce restrictions on el a s t i c i t i e s would conceal a great deal of valuable information. There is no reason why this conclusion would not also hold true in the case of passenger transport. 0 Oum and Gillen (1983) used a translog model to estimate aggregate passenger travel demands in Canada. Oum and Gillen point out that "under certain regularity conditions, there is a symmetric duality between the direct u t i l i t y function U and the reciprocal of the indirect u t i l i t y function". This suggests that the reciprocal indirect version of the translog u t i l i t y function is the proper form to use, and indeed, the authors use this form to estimate the derived demand system. The model includes three modes of transportation (air, bus and r a i l ) as well as aggregate (non-transportation) services and aggregate (non-transportation) goods. It also allows for changes in consumer bUOum (1979a; p. 30). In the case of passenger transport, the third condition would read "...so that the structure of consumer preferences can be inferred directly...". Chapter 3 127 Literature Review preferences over time and by season. In addition, average weekly hours worked is included as a proxy for leisure time, since the "leisure-time-constraint" is quite important in modelling travel demand. Oum and Gillen found that the preference structure of travel varies with time and season, but is not affected by average weekly work hours. A l l three passenger modes were found to be price-elastic. Rail had an own-price el a s t i c i t y of approximately -1.1 in the early 1960's which gradually changed to about -1.3 by the mid 1970's. Bus had an own-price el a s t i c i t y of approximately -1.4, which became slightly more elastic over the time frame examined. Finally, air had an own-price el a s t i c i t y of approximately -1.2, which remained f a i r l y constant over time. The very aggregate nature of the data u t i l i z e d resulted in the findings of moderate complementarity between r a i l and bus and very weak complementarity between air and bus. The authors found a weak, but increasing degree of competition between r a i l and air. Oum and Gillen cite as the "most important result derived from [their] tests of separability was that the demand system for the three passenger modes is inextricably tied to the rest of the economy, and therefore, may not be studied i n isolation from the goods and other services sectors. Although the above finding does not bode well for transportation studied in isolation from the remainder of the economy, Oum, Gillen, and Noble (1986) u t i l i z e d a homothetically separable indirect u t i l i t y function to effect a two-stage consumer budget allocation. In other words, given budgetable and 610um and Gillen (1983; p. 175). Chapter 3 128 Literature Review decentralizable consumer preferences" , consumers f i r s t allocate the optimal mix between air travel and a l l other goods and services. Consumers then allocate their air travel budget among alternative fareclasses. 6 3 Thus the problem of studying transportation in isolation pointed out by Oum and Gillen (1983) is circumvented given these assumptions. Although disaggregate discrete choice data would be ideal for the modelling of fareclass demand conducted by Oum, Gillen, and Noble (1986), such data are simply not available. Using discrete choice models based on aggregate data has been shown to be i n v a l i d . 6 4 Thus the assumption is required that the indirect u t i l i t y function estimated using aggregate data is that of a representative consumer. The actual functional form used by Oum, Gillen, and Noble is the translog. To summarize: the preferred modelling approach for intercity travel in Canada would be to u t i l i z e a flexible functional form to approximate the homothetically separable reciprocal indirect u t i l i t y function of the representative consumer. The use of a flexible functional form, rather than an ad hoc form, avoids imposing a p r i o r i restrictions on the el a s t i c i t i e s of interest. The assumption of homothetically separable consumer preferences 6 2See Oum, Gillen, and Noble (1986) for a brief discussion of the implications of, and for further reference material concerning, these conditions. D J T h i s approach could easily be generalized to have consumers f i r s t allocate the optimal mix of total intercity travel and a l l other goods and services, and then allocate the total travel budget among the alternative modes. 6 4See Oum (1979c) for a discussion of the dangers involved in estimating discrete choice models using aggregate data. Chapter 3 129 Literature Review allows the modelling to proceed without having to incorporate the entire economy into the analysis. The reciprocal indirect form, as opposed to the direct form of the u t i l i t y function, is chosen on the grounds of the implications of duality theory. Finally, the assumption of the estimated function being that of the representative consumer allows the use of the available aggregate data. E. The Literature Concerning Economic Efficiency Losses There is one f i n a l , and exceedingly important area of concern that must be reviewed prior to determining the efficiency losses arising from non-marginal-cost pricing in the Canadian intercity passenger network. This is the issue of how economic efficiency losses should be measured. There exists a large body of literature concerned with the issue of the economic efficiency losses which arise out of differential legislative and regulatory treatment of carriers. Unfortunately, the majority of these studies deal solely with transportation in the United States. Very few deal specifically with Canada. Furthermore, vi r t u a l l y a l l of these studies concentrate on the economic efficiency of the freight transportation system. The passenger network is treated only superficially, i f at all.*'- 5 "Reasons for the concentration on the efficiency of freight movements include the fact that freight movements represent the major share of total commercial movements. The economic cost of inefficiency in freight transport is thus potentially much higher than the cost of inefficient passenger movements. Furthermore, distortions in freight movements, by virtue of freight transport's being an intermediate good, cause additional distortions in the markets of the goods being transported. The passenger sector has l i t t l e corresponding secondary effect. (There may be some with respect to the production of the vehicles and infrastructure used in travel.) Finally, the Chapter 3 130 Literature Review Nevertheless, a review of this literature provides a useful background to the problem of measuring efficiency losses. It also provides an illuminating portrayal of the changes, over time, in the techniques used, and hence in the results obtained, in estimating the extent of current economic efficiency losses. The issue of economic efficiency losses arising out of the institutional arrangements of the transport industry came into wide-spread prominence with the publication of Meyer, Peck, Stenason, and Zwick (1959). Included in this work was the f i r s t in a series of comparative cost analyses of the transport sector. This work lambasted the industry-wide practice of value-of-service pricing, which the authors determined to have resulted in an extremely inefficient allocation of t r a f f i c between modes.66 Since this study has become somewhat of a "classic", i t is reviewed here in some detail. The format of the Meyer et a l . (1959) study, as mentioned above, was as a comparative cost analysis. In other words, the basic objective was to av a i l a b i l i t y and quality of data tends to be greater for the freight sector than for the passenger sector. 6 6Value-of-service pricing establishes t o l l s on the basis of the maximum the market is willing and able to bear. Such t o l l s bear l i t t l e resemblance to the costs actually incurred in the provision of the service. An efficient allocation of resources, being fundamentally dependent on prices bearing a direct relationship with costs, is incompatible with value-of-service p r i c i n g . Nevertheless, the authors did not hold the practice of value-of-service pricing solely responsible for the sorry state of the American transportation sector. Meyer et a l . were harshly c r i t i c a l of governmental legislation and regulation concerning transportation and equally scathing of the attitudes and behaviour of both management and organized labour. Chapter 3 131 Literature Review determine which mode or modes could carry selected t r a f f i c " ' a given distance with the lowest possible total dollar outlay to society. The resultant "rational allocation of transportation" would then be compared to the actual t r a f f i c pattern at each of a number of mileage blocks. The procedure followed was relatively straightforward. An extensive analysis of the cost structure of the main modes was conducted in order to determine the marginal, average variable and total average costs of moving a ton-mile of goods.*'8 These costs were calculated for each of a number of mileage blocks defined by the authors. In order to account for the differences between r a i l and motor carriers with respect to the quality of service, a "service differential" was calculated and added to the actual carrier-incurred costs of r a i l freight transport.^ This service differential reflected the higher average inventory cost that shippers using the r a i l mode would incur due to r a i l ' s slower service and larger "economic" shipment size. The authors f e l t that such an adjustment to r a i l rates would ensure the reflection of a l l the costs incurred in transporting goods by rail.^O A ^The authors analyzed the situation for three categories of t r a f f i c : bulk commodities, high-value commodities and passengers. 6 8Meyer et a l . (1959; Chapters III, IV and V). 6 9Meyer et a l . (1959; pp. 189-193). 7°Even i f i t were conceded that only service factors which impact inventory costs are important, the Meyer et a l . (1959) service differential formula is lacking due to the absence of two components affecting inventory costs: the frequency of delivery and the r e l i a b i l i t y of delivery time. Adopting the more reasonable approach that any factor which shippers value should enter into the determination of service differential, then the Meyer et a l . (1959) formula becomes even more sorely lacking. Woods and Domincich (1975; pp. 267-268) cite the results of two surveys of shipper opinion. These surveys indicated that in addition to the aforementioned factors, several other attributes were also valued by shippers, some of them quite highly. It Chapter 3 132 Literature Review corresponding service differential was not exp l i c i t l y formulated for passenger service. The authors in comparing r a i l coach costs with air costs, appeared to use an implicit service differential. Meyer et a l . decided that while the actual costs of air service were higher, once the extra travel time of r a i l was taken into account, air travel would "appear to be competitive with r a i l coach t r a v e l " . 7 1 Given the cost characteristics determined, Meyer et a l . then sought instances where the f u l l costs (average total costs) of one mode were lower than the marginal or average variable costs of a competing mode in any mileage block. If such instances ocurred, all the t r a f f i c in that mileage block was assumed to "belong" to the low f u l l cost mode. After a l l such comparisons and allocations were completed, the next stage in the analysis was to see i f any of the remaining modes, which were the low marginal cost or average cost carrier for a given commodity in any mileage block, had sufficiently high total costs such that their elimination and the reallocation of t r a f f i c to the next most efficient competitor would lower the total transportation b i l l of society. The definition of economic loss thus implied by this procedure is the cost of total resources used to move society's goods using the current t r a f f i c pattern less the cost of total resources used to move the same output using the "least cost" mode in each mileage block. In other words, the demand for would appear then, that the service differential used by Meyer et a l . (1959) severely understates the true service differential. 7 1Meyer et a l . (1959; p. 158). Chapter 3 133 Literature Review transportation is not exp l i c i t l y dealt with. The implicit underlying assumption is that the shippers a l l have identical preferences, so that when the deregulated t o l l s of the r a i l mode become lower than the truck to l l s (less the service differential) for the average shipper, i t w i l l become so for all shippers and the entire t r a f f i c volume w i l l shift to the low-cost mode. This became the standard means by which to deal with this issue. On the basis of their cost analysis, Meyer et a l . (1959) found that the passenger automobile, the intercity bus and the air mode were a l l economically ju s t i f i a b l e modes of passenger transport. The authors also found that "the data clearly indicated that f i r s t class r a i l passenger operations are not very economical and i t also appeared that much coach passenger t r a f f i c by r a i l was not j u s t i f i a b l e , although short-haul, high density coach movements may constitute a substantial exception to this conclusion." 7 2 This conclusion was reached after determining that the long-run marginal costs of r a i l services were higher than the average total cost of both intercity bus and passenger automobiles and were comparable to average total costs (factored up by an allowance for corporate taxes and a 10% return on capital investment) of the air mode. Meyer et a l . (1959) did not extend the analysis to the determination of the dollar savings of reallocating passenger r a i l t r a f f i c to the various other "economic" modes. Similarly, with respect to the freight sector, Meyer et a l . did not determine the dollar savings of reallocating truck shipments to the "lower cost" r a i l mode. The authors did determine, however, that for the same 7 2Meyer et a l . (1959; p. 166). Chapter 3 134 Literature Review given transportation expenditure of some $5.5 b i l l i o n , the r a i l mode could 73 move an additional 153 b i l l i o n revenue-ton-miles of freight. Although Meyer et a l . did not provide a dollar estimate of the costs of t r a f f i c misallocation, one of the co-authors, in a later work, concluded that "with more complete data, my guess would be that the 'price' of the present misallocation would turn out to be several b i l l i o n dollars per year." 7 4 Furthermore, another author determined, on the basis of the cost differential between truck and r a i l estimated by Meyer et a l . , that approximately $2 b i l l i o n could be saved in the absence of regulation. 7 5 Meyer et a l . as well as Peck (1965) were hampered by a scarcity of available data. In 1966, however, the 1963 Census of Transportation was published. This document contained sufficient information concerning the breakdown of t r a f f i c by mileage block and mode to enable a more refined approximation of efficiency losses to be made. Harbeson (1969) made use of the Census data and undertook a comparative cost analysis in order to quantify the losses Meyer et a l . could only expose as existing. Harbeson based his motor carrier costs on an I.C.C. formula7** adjusted to reflect "the weighted average cost of single-line and inter-line 7 3Meyer et a l . (1959; pp. 161-162, Table 34.). 7 4Peck (1965; pp. 246-247). 7 5Moore (1975; p. 69). ^Bureau of Accounts, Interstate Commerce Commission, Statement No. 7-65, Cost of Transporting Freight by Class 1 and Class 2 Motor Common Carriers of General Commodities, 1964 (1965). Chapter 3 135 Literature Review traffic...[and] the deficiency in user-charge payments for heavy vehicles, of the kind commonly used in intercity trucking .,.". 7 7 Railroad costs were also based on an I.C.C. formula 7 8 and were factored up to reflect the service differential between r a i l and truck using the Meyer et a l . (1959) methodology. One point might be profitably cleared up here. While i t was true that the I.C.C. cost formulas had been c r i t i c i z e d on a number of points, Harbeson decided that the majority of these criticisms did not apply to the use he would put the formulas to. These formulas were based on the costs of general movements of broad categories of commodities through various regions, and thus would cause no problems in measuring general efficiency l o s s e s . 7 9 Based on these estimates of costs and the Census of Transportation breakdown of t r a f f i c by mileage block, Harbeson (1969) defined the economic loss as the excess of motor carrier costs over r a i l costs (in dollars per ton) multiplied by the amount of t r a f f i c carried by motor carriers (in tons) summed over each mileage block for which t r a f f i c was "uneconomically" carried by truck. o u The total economic loss was calculated to be "somewhere between a minimum of $1,128,623,300 and a maximum of $2,921,001,800."81 Comparative cost analyses generally, and Harbeson's calculations specifically, assume that 7 7Harbeson (1969; p. 326). 7 8Bureau of Accounts, Interstate Commerce Commission, Statement No. 6-66, Rail Carload Unit Costs by Territories for the year 1964 (1966). 7 9Harbeson (1969; p. 324). 8^By Harbeson's calculations, this would include a l l but the very shortest of mileage blocks. 8 1Harbeson (1969; p. 332). Harbeson notes that both these values would be reduced by only some $87 million i f the magnitude of the rail-truck service differential he determined was increased by 50%. Chapter 3 136 Literature Review i f , for any given mileage block, average r a i l costs were exceeded by average truck costs, all truck t r a f f i c should rightfully be allocated to the r a i l mode. Harbeson acknowledges that "an obvious and important limitation of the foregoing findings...[is that the] figures for economic loss are aggregates based on weighted average value and national average loads by r a i l and truck of commodities... and therefore conceal a wide range of rail-motor cost relationships on the movement of particular commodities for various lengths of haul." o z Harbe son then, acknowledges that i t is inappropriate to invariably reallocate a l l t r a f f i c from the high-cost mode to th^ low-cost mode even after the average service differential is accounted for. Unfortunately Harbeson did not revise his estimate of the social costs of misallocated t r a f f i c to reflect this. Friedlaender (1969) also took advantage of the data made available by the 1963 Census of Transportation. Friedlaender, like Meyer et a l . (1959), Peck (1965), and Harbeson (1969), concludes that "regulatory policies that prevent the railroads from practicing effective rate competition have enabled the trucks to maintain an uneconomic share of the t r a f f i c in high-value manufactured goods." 8 3 Even though Friedlaender finds that "substantial misallocation of t r a f f i c e x i s t s " 8 4 on the basis of a comparative cost analysis, she does not follow through and determine the dollar cost of this "misallocation" on the basis of the comparative cost methodology. Rather, Friedlaender estimated the social costs on the basis of the generally used 8 2Harbeson (1969; p. 334). 8 3Friedlaender (1969; p. 68). 8 4Friedlaender (1969; p. 66). Chapter 3 137 Literature Review measure of "deadweight loss" arising out of non-competitive p r i c i n g . 0 3 Friedlaender's measure of the social cost of inefficient allocation of t r a f f i c came to between $300 million and $400 million annually. Friedlaender (1971), using the same percentage deadweight loss calculated for 1964 in Friedlaender (1969), estimated the equivalent loss in 1969 to be between $198 million and $229 m i l l i o n . 8 6 She further determined the secondary distortion, that i s , the deadweight loss that arises out of the distortion of commodity prices due to inefficient r a i l charges, to be an additional $12 million to $41 m i l l i o n . 8 7 This gave a grand total of $220 million to $270 million as the economic loss from pricing above marginal costs. Woods and Domincich (1971) estimated that about two-thirds of truck shipments could be moved more economically by r a i l , without taking into account the service differential. Adding the cost of the service differential, based on Meyer et a l . (1959) for the modal differences with respect to the size of shipments and transit time, plus a further adjustment for " a l l other service differences", 8 8 the authors s t i l l found that almost one-quarter of a l l truck t r a f f i c should go by r a i l . This amounted to a 85Numerous authors have contributed to the theory and measurement of deadweight loss. The most notable contributions include Dupuit (1844), Hotelling (1938) and Harberger (1964). 8 6Friedlaender (1971; p. 227). 8 7Friedlaender (1971; p. 227). In order to accomplish this Friedlaender was forced to assume that of demand for a l l the goods carried by r a i l is equal to -1. This was due to a scarcity of data concerning the appropriate e l a s t i c i t i e s . 88Woods and Domincich (1971; ,pp. 262-271). Chapter 3 138 Literature Review savings of approximately $8 b i l l i o n per year (in 1969 dollars) based on their comparison cost analysis of trucking costs versus r a i l costs plus the service dif f e r e n t i a l . This sum also included the savings in highway expenditures that would be realized due to the lower demand for trucking services. Moore (1975) combined the works of other authors with his own and came up with a composite estimate of the total cost of regulation as being between $3.8 b i l l i o n (his "low" estimate) and $8.9 b i l l i o n (his "high" estimate). 8 9 After this time, the comparative cost approach, being subjected to considerable c r i t i c i s m 9 u faded from popular use in subsequent studies, though i t retained a great deal of popular support among proponents of deregulation. In it's place arose a series of studies which took the demand side into f u l l account. In other words, the demand for transport was modelled econometrically and u t i l i z e d in calculating social costs. These newer studies no longer relied on the simple assumption that a l l of the "misallocated" H yMoore (1969; p. 71, Table 3-2.). Moore's estimate is in fact the sum of three "costs" of regulation: the inefficiency within a mode engendered by regulation (for example, restrictive back-haul regulations), plus the standard comparative cost calculation of the cost of shifting t r a f f i c from the low-cost to the high-cost modes, plus the deadweight loss arising from pricing above marginal costs. 9 0 F o r example, Altonji (1976; pp. 380-384) showed that the comparative cost approach biased the estimates of the costs of misallocation in three main ways: i) i t overstates the r a i l cost advantage by inadequately specifying the service differential and by basing modal costs on the average cost of moving the existing t r a f f i c , which for r a i l tends to be "dense, easily handled and/or not highly susceptible to loss and damage"; i i ) i t overstates the t r a f f i c s h i f t to r a i l by treating the demand for r a i l as i n f i n i t e l y elastic at a rate level equivalent to the truck rate less the service differential, which exaggerates the price sensitivity of r a i l t r a f f i c ; and i i i ) i t overstates the estimates of social costs since the actual cost differential between r a i l and truck for shipments actually going by truck w i l l be smaller than the average cost differential which is used to value the social costs. Chapter 3 139 Literature Review t r a f f i c would shift [Meyer et a l . (1959), Harbeson (1969), Woods and Domincich (1971), and Moore (1975)] or on educated guesses as to the percentage of the t r a f f i c that would shift [Peck (1965)] or on the introduction of some ad hoc e l a s t i c i t i e s to measure distortion [Friedlaender (1971)]. Boyer (1977) uses two forms of the logit model: one based on the difference in rates ( r a i l - truck) and the other based on the ratio of rates (rail/truck). Variables representing the weighted average length of haul, the annual tonnage per link and the value-per-ton of the commodity, as well as a series of dummy variables to represent various commodities, were u t i l i z e d in order to "minimize specification bias". On the basis of his model results and a definition of social costs based on the welfare triangle rather than on the comparative cost approach, Boyer determined the social costs of minimum rate regulation to be on the order of $125.7 million per year. Boyer considered the $126 million figure to be an upper limit to the economic cost of t r a f f i c misallocation subject to a number of caveats concerning the accuracy of the estimate. 9 1 Basically, these points are: 1. the cost estimates are based on out-of-pocket costs which are not equivalent to marginal costs; 2. the rate estimates are the ratio of average rates which may not approximate well the average ratio of rates; 3. the social cost estimate is based only on a shift of manufactured goods t r a f f i c between motor carriers and the r a i l mode, thus ignoring the interactions with other modes and with other types of t r a f f i c ; y xBoyer Chapter 3 (1977; p. 507). 140 Literature Review 4. the data used is quite dated (mid-1960's) and may not be indicative of the current conditions; and the calculations assume a fixed quantity of freight t r a f f i c , thus assuming a perfectly inelastic aggregate demand for freight transportation. Levin (1978) followed an approach similar to Boyer (1977). Levin notes that there are several reasons to believe that rate deregulation w i l l not have the impact implied by the comparative cost analyses: 1. rising r a i l costs have probably narrowed the gap between railway rates and marginal costs and reduced the railways range of cost advantage over the competing modes; 2. the I.C.C. recently appeared less devoted to value-of-service pricing; and 3. the methodology employed by the comparative cost analyses to estimate social cost are "seriously flawed", since they f a i l to capture a l l the service advantage trucks have over r a i l and since they assume that a l l shippers have identical transportation service preferences. 9 2 Levin (1978) models transport demand using a multinomial logit model for truck, boxcar and piggyback. 9 3 Levin models the market shares as functions of rates, the economic cost of differences in speed (commodity value multiplied by the difference in transit time) and r e l i a b i l i t y (commodity value multiplied by the difference in the standard deviation of transit time). 9 4 U t i l i z i n g the 9 2 L e v i n (1978; p. 19). 9 3Boyer (1977), on the other hand, only models truck and r a i l . 9 4 L e v i n c r i t i c i z e s Boyer's use of independent variables, claiming that while the three independent variables he employs (rates, speed and r e l i a b i l i t y ) are consistent with economic theory and with empirical surveys of shipper preferences, Boyer (with the exception of the independent variable 'rates') "uses a string of ad hoc variables, some of which are poorly Chapter 3 141 Literature Review parameters of his freight demand model, Levin determines the social welfare loss on the basis of the welfare triangle and derives a total economic loss of between $53 million and $135 million in 1972. Table 3.2 compares the social costs based on the comparative cost approach and the welfare triangle method. Oum (1982), in his analysis of t r a f f i c misallocation in the Canadian intercity freight transport market, c r i t i c i z e d the methodology of the U.S. studies on the economic efficiency cost of I.C.C. minimum rate regulation. He points out that these studies [including Friedlaender (1971), Boyer (1977), and Levin (1978)] suffer from one or more of the following problems: 1. the efficiency loss in the trucking industry induced by the r a i l price distortions has not been treated as a part of the social cost of regulating r a i l freight rates; 2. the size of a given freight market Is assumed to be fixed; 3. those studies are subject to a linear approximation bias; and 4. the logit and log-linear demand models used in those studies impose r i g i d a p r i o r i restrictions on the e l a s t i c i t i e s . 9 5 Oum (1982) also points out a problem with the implicit assumptions of these studies. To assume, on the one hand, that cross-price e l a s t i c i t i e s are j u s t i f i e d " . (Levin (1978; p. 25)). 950um (1982; pp. 6-7). Chapter 3 142 Literature Review TABLE 3.2 So c i a l Cost of T r a f f i c M i s a l l o c a t i o n : A Summary of U.S. Studies Study Year Based On Type of Analysis Magnitude of So c i a l Cost Peck (1965) b i l l i o n Harbeson (1969) Moore (1975) 1963 CC. 1960's C C " s e v e r a l " $1.1 to $2.9 b i l l i o n C C * $2 b i l l i o n C.C.** $1 b i l l i o n Woods and Domincich (1971) 1966 C.C.*** $8 b i l l i o n Friedlaender (1969) million Friedlaender (1971) million 1964 1969 DWL DWL* $300 to $400 $220 to $270 Boyer (1977) Levin (1978) million 1963 1972 DWL DWL $125 million $53 to $125 Key: C.C: comparative cost C.C.*: C.C. based on Meyer et a l . (1959) cost differential C.C**: C.C. based on Friedlaender (1969) cost differential C.C.***: C.C. + savings due to reduced highway expenditure DWL: social deadweight loss in transport sector DWL*: DWL + induced deadweight loss in commodity markets Chapter 3 143 Literature Review equal to zero while simultaneously treating the aggregate freight demand as perfectly price inelastic, is actually contradictory. 9** Oum (1982) uses a freight demand model for the r a i l , truck and marine modes based on a translog cost function for the freight transport sector developed in Oum (1977). This model allows for nonlinearity of the demand curves and for free variation of the e l a s t i c i t i e s . In addition, the interaction between the demand for any mode and a change in rates of any other mode is ex p l i c i t l y treated. Furthermore, the demand curves are constrained to sum to a fixed demand curve for the aggregate freight sector and not to a fixed level of demand. In other words, the level of demand for freight is allowed to vary i n response to changes in the level of aggregate freight rates. This approach avoids the four inherent problems of the previous studies. Oum calculates the loss due to the unbalanced recovery of infrastructure costs for freight transport in Canada. For comparative purposes, he recalculates the same efficiency losses using the methodology of Friedlaender (1971), Boyer (1977), and Levin (1978). Table 3.3 indicates the extent of the inaccuracies of the earlier studies. The critique of Altonji (1976) and others, as well as the studies of Boyer (1977) and Levin (1978) served to discredit the comparative cost methodology as an appropriate estimator of the social costs of tr a f f i c misallocation. Oum (1982) refined the approach of Friedlaender, Boyer, and 960um (1982; p. 21, footnote 9). Chapter 3 144 Literature Review TABLE 3.3 Restatement of Efficiency Losses of Friedlaender, Boyer, and Levin Studies (in thousands of dollars) using Oum using earlier bias in earlier methodology methodology methodology Case A: r a i l truck marine total 2,089 8,873 14,369 25,331 0 4,414 16,267 20,681 -2,089 -4,459 1,898 -4,650 Case B: r a i l 430 0 -430 truck 14,690 5,665 -9,025 marine 17,087 17,686 599 total 32,207 23,351 -8,856 Case C: r a i l truck marine total 19 22,012 20,057 42,088 0 6,916 19,105 26,021 -19 •15,096 -952 •16,067 Key: Case A: aggregate Case B: aggregate Case C: aggregate freight e l a s t i c i t y freight e l a s t i c i t y freight e l a s t i c i t y of demand = -0.7 of demand = -1.0 of demand = -1.3 Chapter 3 Source: Oum (1982; Table 6, p. 20). 145 Literature Review Levin by using a model and methodology which eliminated four problems inherent to these studies. Although the extent of the underestimation of social costs is f a i r l y significant in the case of the Friedlaender, Boyer, and Levin methodologies, the adjusted results are s t i l l far less than the results that the comparative cost approach would give. F. Summary This chapter reviewed the available literature pertinent to this thesis. Returns to scale was discounted as an economic j u s t i f i c a t i o n for modal subsidization in Canada. However, there seems to be a case for returns to density for a l l modes. Canadian subsidization policy has resulted in an imbalance in the level of cost recovery achieved by the four principal modes. The latest Transport Canada data (1982) suggests a per-passenger-kilometre revenue shortfall of 0.4 cents for bus, 0.9 cents for automobile, 1.1 cents for air, and 14.1 cents for r a i l (1979 $). Modelling of demand can proceed using ad hoc functional forms or flexible functional forms derived from consumer theory. The advantage of the former is i t s simplicity; the advantage of the latter is the a b i l i t y to obtain route-specific e l a s t i c i t i e s . Given the objectives of this thesis, a flexible functional form would be preferred in order to obtain these route-specific e l a s t i c i t i e s . Chapter 3 146 Literature Review Measurement of economic efficiency loss has traditionally been done using the "comparative cost" methodology. Recent studies, however, have cast doubt on the va l i d i t y of this approach. The preferred methodology is the "welfare loss triangle" approach. Given a flexible demand model, the exact measurement methodology developed by Oum (1982) can be used to avoid the linear approximation bias inherent to the simplified welfare loss triangle measurement. Chapter 3 147 Literature Review CHAPTER 4 ECONOMIC EFFICIENCY AND THE MEASUREMENT OF DEADWEIGHT LOSS A. Introduction The term "economic efficiency" has already made several appearances throughout this thesis with only a brief informal and non-technical explanation of what i t i s , why i t occurs and how i t is measured. This chapter deals in greater detail with the economics underlying the nature, the sources and the measurement of economic efficiency. B. Allocative Efficiency i n Production Allocative efficiency in production deals with the optimal allocation of inputs to produce any given set of goods. Figure 4.1 shows an example of allocative efficiency in production for a simple industry which uses only two inputs: labour and capital. The production technology for this industry is described by the isoquant curves (e.g. Y-=100) which illustrate the technologically efficient alternative combinations of labour and capital which can be employed to produce any given amount of output.^- The relative input •'•A change in technology, for example, the introduction of diesel locomotives to replace steam locomotives, would result in an inward shift in these isoquant lines. For example, the curve showing input combinations which can currently be used to produce 300 units (of passenger service), might now represent the production of 400 units. Chapter 4 148 Economic Efficiency FIGURE 4.1 Allocative Efficiency i n Production Quantity of Labour per Period Quantity of Captial per Period I± : isocost lines showing alternative combinations of labour and capital costing " i " dollars. Y=x: isoquant curves showing alternative efficient combinations of labour and capital which can produce x units of output per period, given the existing technology. Chapter 4 149 Economic Efficiency p r i c e s give r i s e to the slope of the isocost l i n e , which show a l t e r n a t i v e combinations of labour and c a p i t a l which cost the same amount. A l l o c a t i v e e f f i c i e n c y i n production r e f e r s to those points of tangency between the isoco s t and the isoquant curves. The curve j o i n i n g these points i s r e f e r r e d to as the output-expansion path. This curve shows the least-cost, t e c h n o l o g i c a l l y e f f i c i e n t combination of inputs which can be used to produce any required output l e v e l . 2 Every point on the isoquant l i n e s other than those on the output-expansion path represent an i n e f f i c i e n t a l l o c a t i o n of resources i n production. C. " O v e r a l l " A l l o c a t i v e E f f i c i e n c y A l l o c a t i v e e f f i c i e n c y i n production i s an important component of " o v e r a l l " a l l o c a t i v e e f f i c i e n c y (or simply " a l l o c a t i v e e f f i c i e n c y " ) , but does not give the complete story. Even i f a given set of goods were produced i n an e f f i c i e n t manner as described above, an i n e f f i c i e n t distribution of the goods might occur. I t i s thus e s s e n t i a l that the method by which goods are a l l o c a t e d to consumers ( i . e . the system of p r i c e s i n " c a p i t a l i s t i c " economies) i s also e f f i c i e n t . However, before " a l l o c a t i v e e f f i c i e n c y " can be given a s p e c i f i c d e f i n i t i o n , some basis f or comparing society's welfare under two (or more) a l t e r n a t i v e a l l o c a t i o n s of resources must be developed. z I n the example shown i n Figure 4.1, the r e l a t i v e input cost and production technology i s such that as output increases, a s u b s t i t u t i o n of c a p i t a l f o r labour i s required i n order to remain e f f i c i e n t . With isoquant curves of a d i f f e r e n t shape, the output-expansion path could curve i n the other d i r e c t i o n , or could be a s t r a i g h t l i n e , i n d i c a t i n g no factor s u b s t i t u t i o n occurs at a l t e r n a t i v e output l e v e l s i n an e f f i c i e n t industry. Chapter 4 150 Economic E f f i c i e n c y \ Fundamental to the determination of this aggregate social welfare is the establishment of some basis for interpersonal comparisons of u t i l i t y . Unless the u t i l i t y different individuals derive from any given bundle of goods or services can be determined explicitly, i t would be impossible to maximize the total u t i l i t y of a l l individuals (i.e. society). Unfortunately, there is no legitimate means to compare u t i l i t i e s across individuals. Since u t i l i t y cannot be quantitatively measured, some alternative means of assessing social welfare must be found i f society is to be able to improve the aggregate level of satisfaction. The standard approach taken by economists is to base interpersonal comparisons on the Pareto criterion. The Pareto criterion simply states that any change that harms no one but improves the u t i l i t y of at least one person is an improvement for society. Thus the Pareto criterion essentially evades the issue of comparing u t i l i t i e s of individuals by avoiding tradeoffs. If no one loses, any gain to anyone is clearly a net gain. 3 Proceeding with the Pareto criterion, i t follows that i f a l l such improvements based on this criterion are. carried out, the resultant situation is Pareto-optimal: any further changes would result in a decrease in u t i l i t y of at least one person. Given the lack of a legitimate means to value the gain in u t i l i t y to one person versus the loss in u t i l i t y to another, 3This criterion also evades the normative issue of equity by adopting the existing distribution of income as the starting point. For most purposes, including that of this thesis, this i s x an acceptable approach since the question of efficiency can be treated separately from the issue of equity. In other words, i t appears reasonable to assume that regardless of the distribution of income - from the current one, to one exhibiting less variation than the current one, to one exhibiting no variation - we should s t i l l try to produce and allocate goods and services in an efficient manner within the income framework established by society. Chapter 4 151 Economic Efficiency Pareto-optimality is the best (i.e. least-controversial) basis we have available to improve the lot of society. The Pareto criterion is important to the basic purpose of this thesis in the following manner. Economists have shown that there are three marginal conditions requisite for optimal resource allocation under the Pareto c r i t e r i o n . 4 They are: i) the marginal rate of substitution between any two goods must be identical for any two consumers; i i ) the marginal rate of technical substitution between any two inputs must identical for any pair of producers; and i i i ) the marginal rate of substitution between any two goods must be identical to the marginal rate of product transformation between these two goods for any producer. The f i r s t condition means that u n t i l the situation arises where the relative value consumers place on two goods is the same across consumers, total u t i l i t y can be increased by exchanging goods among consumers. The second condition means that u n t i l the situation arises where the relative "productivity" 5 of a l l inputs is the same across producers, total output can be increased by reallocating inputs among producers. The third condition means that u n t i l the situation arises where the relative value consumers place on any commodity with respect to any other good is the same as what society 4For example, see Mansfield (1979; pp. 444-446). ^Productivity is not precisely the concept desired here. Productivity refers to amount of output produced per unit input. The marginal rate of technical substitution refers to the amount of input i that is required to replace a unit of input j in the production process. The two terms are thus not identical, but are closely related. Chapter 4 152 Economic Efficiency would be forced to give up in these other goods to produce an additional unit of that commodity, total u t i l i t y could be increased by reallocating production from the relatively less valued goods to the more valued items. Given the preceding discussion, a more precise definition of allocative efficiency than hitherto provided is now possible. Society's scarce resources are allocated e f f i c i e n t l y among i t s competing uses i f no reallocation among consumers and/or producers can increase the u t i l i t y of one or more persons without resulting in a decrease in u t i l i t y for anyone. In other words, economic efficiency in resource allocation is equivalent to Pareto-optimal resource allocation. The implication of this with respect to the Canadian intercity passenger transportation network is clear: i f any of the three marginal conditions for Pareto-optimality of resource allocation are not met, an efficient allocation of resources does not exist. 6 D. The Impact of Subsidization on Economic Efficiency i ) departures from marginal conditions As mentioned in the previous section, departures from any of the three marginal conditions of Pareto optimality are incompatible with economic efficiency. (Exceptions to this rule are discussed in the next section.) ^Section E of this chapter deals with the special situations in which this statement does not hold. Chapter 4 153 Economic Efficiency Subsidizing only one mode, or alternatively, subsidizing one mode to a greater degree than the other modes, w i l l violate the third condition of Pareto optimality, which for convenience is repeated here: i i i ) the marginal rate of substitution between any two goods must be identical to the marginal rate of product transformation between these two goods for any producer. The marginal rate of substitution between goods is the number of units of one good (X) that must be given up to obtain one more unit of another good (Y) . The number of units of good X that must be given up is expressed by the ratio of the prices of good Y to good X.7 The marginal rate of product transformation is the number of units of one good (X) that must be given up to increase production of another good (Y) by one unit. The number of units of good X that must be given up is expressed by Q the ratio of the marginal costs of good Y to good X. Thus, in order to satisfy the third condition for Pareto optimality, the ratio of product prices must be equal the ratio of their marginal costs. Clearly, this condition is satisfied in a perfectly competitive situation since marginal revenue (i.e. price) equals marginal cost. If only one product was to be subsidized (or i f unequal degrees of subsidization were to be adopted) then price would no longer equal marginal cost for that one product 7 For example, i f the price of good X is $2 and the price of good Y is $4, the marginal rate of substitution of X for Y is 2. 8For example, i f the marginal cost of good X is $1 and the marginal cost of good Y is $3, the marginal rate of product transformation of X for Y is 3. Chapter 4 154 Economic Efficiency (or for more than one product in the case of unequal subsidization) and the ratio of prices would deviate from the ratio of marginal costs. Thus the unbalanced subsidization of passenger r a i l transportation in Canada detracts from the allocative efficiency of the Canadian economy. i i ) the concept of deadweight loss It i s quite simple to state that unbalanced modal subsidization violates the third condition for Pareto optimality and hence results in an inefficient allocation of resources in the Canadian economy. But how is this inefficiency manifested? To understand this, i t is necessary to introduce the concept of deadweight loss. Simply put, deadweight loss is the difference between the actual aggregate level of u t i l i t y derived from a given set of resources and the highest potential aggregate level of u t i l i t y that same (rearranged) set of resources could provide without decreasing any individual's u t i l i t y level. Under conditions of Pareto optimality, the deadweight loss is zero. No reallocation of resources could improve anyone's lot in l i f e without diminishing someone else's. On the other hand, under non-Pareto-optimal conditions, a reallocation of resources which benefits at least one person without detracting from anyone else's u t i l i t y can be done, and hence a failure to do so implies a deadweight loss. While the concept of deadweight loss is reasonably straight-forward, empirical measurement of deadweight would seem not to be since i t involves the Chapter 4 155 Economic Efficiency measurement of aggregate u t i l i t i e s . As mentioned previously, u t i l i t i e s cannot be measured directly. Fortunately, i t is unnecessary to measure the aggregate u t i l i t y since the quantity of interest is the difference between the optimal and the sub-optimal u t i l i t y levels, and this can be measured quite simply, using the standard measurement procedure of the "welfare loss triangle". 9 Figure 4.2 depicts the deadweight loss in a simplified scenario in which marginal costs are constant , a l l other markets are perfectly competitive, and the subsidized good has no substitutes and no complements. ^  If price (P*) equals marginal cost, the quantity demanded is equal to Q* . The value the consumers place on this quantity of output is given by the area under the demand curve OACH. Society is required to give up resources which could have been turned into other goods valued at only OBCH for Q* units of output. This leaves society with a "consumers' surplus" of ABC. If the subsidized price is charged, P s u b, the quantity demanded rises to Qsub • Again, the value the consumers place on this quantity of output is given by the area under the demand curve--this time, OAGI. Society is required to give up resources valued at OBDI to produce Q s u b units of output. This leaves society with a consumer's surplus of ABC-CDG. Society is l e f t worse off than before by an amount CDG since this area represents resources 9Harberger (1954) is usually credited with the popularization of this measurement of welfare loss, although the concept had been treated by a number of authors concerned with the theory of taxation and public u t i l i t y regulation. ^Substitutes and complements, added later, complicate the analysis since they not only result in shifts along a demand curve, they also add in an additional demand curve. Chapter 4 156 Economic Efficiency FIGURE 4.2 Deadweight Loss Due to Subsidization P* , Q* : optimal price and quantity demanded, respectively (i.e. condition where price — marginal cost) P s u b, Q s u b: price and quantity demanded given subsidization MC: marginal cost curve Chapter 4 157 Economic Efficiency that were taken from alternative uses where they would have produced goods valued at, at least, CDG (recall that other markets were assumed to be cost.of production of which exceeded the value consumers placed on i t by the amount CDG. The formula for the calculation of deadweight loss i s , in this simple example of linear demand and constant marginal costs, the formula for a triangle: 1/2 of the difference between the optimal and the subsidized prices multiplied by the difference in the quantities demanded under these two prices. Oum (1982), in his assessment of efficiency of the Canadian freight transportation system, provides a formula general enough to handle non-linear demand curves: competitive) and used to produce an additional amount of Qsub"Q* o r a good the b DWLi - |[Q?(|Pj D^PiJdp ]| i a where the deadweight loss in mode i induced by unbalanced subsidization; the quantity demanded of mode i given the actual demand curve and observed prices; the economically optimal price of mode i ; the economically optimal demand function for mode i (as a function of only i t s own price) that would have existed had a l l modes been charging the economically optimal prices; the price corresponding to quantity QJ on the economically optimal demand function Dj; Chapter 4 158 Economic Efficiency a - p;, b a = P; , b This i s the formula that should be used to estimate deadweight losses in this thesis. Figure 4.3 illustrates possible deadweight losses (the shaded areas) arising in Canada's passenger transportation system, assuming linear demand curves. Note that these are only for i l l u s t r a t i v e purposes: the optimal demand curve D* could be to either side of the observed demand curve D due to the complex interactions between the various modes. In addition, the relationship between P' and the other prices is a function of the degree of ela s t i c i t y and the location of the optimal demand curve. Examination of the formula adapted from Oum (1982) provides the data requirements for calculation of deadweight loss: i) actual prices and quantities demanded for each mode; i i ) marginal costs of each mode to base the economically optimal prices on; i i i ) own-price e l a s t i c i t i e s to determine movement along the demand curve; and iv) cross-price e l a s t i c i t i e s to determine shifts in demand curves given changes in prices charged by other modes The f i r s t item is taken from observed data. The second can be calculated from h i s t o r i c a l published data. The last two items can be obtained from published demand models of intercity passenger travel. Chapter 5 deals with - Pi i f ?[ > ?l; and - ?l i f P^  < P* . n n M o d i f i e d from Oum (1982; p. 14). Chapter 4 159 Economic Efficiency FIGURE 4.3 Illustrative Deadweight Losses i n Canada's Passenger Transportation System P D: D* : P°, Q°: P* , Q* : P' : Chapter AUTO Q' Cf Q observed demand curve for each mode economically optimal demand curve for each mode observed prices and quantity demanded, respectively economically optimal prices and quantity demanded, respectively price on D* corresponding to Q° 160 Economic Efficiency obtaining these e l a s t i c i t i e s , while Chapter 6 deals with the calculation of optimal prices. Economic Justifications for Subsidization The previous section showed how subsidization results in a breakdown of the marginal conditions necessary for Pareto optimality. This creates inefficiencies in the allocation of resources and thus introduces a deadweight loss into the economy. However, circumstances do exist where the subsidization of passenger r a i l transportation (or any industry, for that matter) may not involve a departure from Pareto-optimality, or may even be requisite to the achievement of Pareto-optimality. These circumstances involve breakdowns in the assumptions implicit in the analysis of allocative efficiency and market structure. There are four potential economically sound justifications for subsidization: i i i i i i i v economies of scale in the provision of passenger r a i l service; economies of density in the provision of passenger r a i l service; externalities arising out of the provision of passenger r a i l service; and second-best considerations. These rationales are addressed below. Chapter 4 161 Economic Efficiency i ) economies of scale If the situation arises where the provision of passenger r a i l transportation enjoys increasing returns to scale, i t follows that the long-run average cost exceeds the long-run marginal cost of production for a l l levels of output. 1 2 Figure 4.4 illustrates such a situation, using hypothetical cost and demand curves. In these circumstances, i f Pareto-optimal marginal-cost pricing were to be employed, a price of P m c would be charged per unit and Q,,,c units of output would be demanded. At this level of output, however, the average cost of producing a unit of transportation is AC m c, which exceeds the price received for each unit produced and sold. The operator would thus lose AC m c -P m c per unit for a l l Q,,,c units produced. The total loss is equivalent to the area GCDH in Figure 4.4. In the absence of a subsidy equal to GCDH, the operator could not survive and would be forced to price according to average and not marginal costs. The equilibrium point would thus become where a price of P a c is charged per unit and Q a c units of output are produced. At this point, total revenues equal total costs OABI, the operator would be earning zero economic profits, and the situation would be stable in the long-run. The long-run equilibrium established by average cost pricing, while not detrimental from the producer's point of view, is clearly non-optimal from i ZActually, increasing returns to scale need only occur over the range of output level which would satisfy the entire demand of consumers. The behaviour of costs at output levels beyond any conceivable requirement or desire of consumers i s , of course, irrelevant. Chapter 4 162 Economic Efficiency FIGURE 4.4 Scale Economies as a Rationale for Subsidization m^c ' Qmc > AC m c P.o Q.C M C a c LRAC r a i l LRMC r a i l Chapter 4 price, quantity demanded, and average cost of passenger r a i l service, respectively, given marginal cost pricing price, quantity demanded, and marginal cost of passenger r a i l service, respectively, given average cost pricing long-run average cost curve for passenger r a i l service long-run marginal cost curve for passenger r a i l service 163 Economic Efficiency society's point of view. If one more unit of output were to be produced, i t would cost society slightly less than MCac in resources, but i t would be valued by a consumer at just under P a c , the price the consumer would be willing to pay for this unit. Since the value is greater than the cost, society's total welfare would be increased i f this unit of output were to be provided. This argument can be applied to subsequent increases in output, at least u n t i l the point is reached where an additional unit of output costs society as much to produce as the amount of benefit the purchasers of the unit derive. This occurs at the output level CL^ . Beyond this level of output, the marginal costs of production exceed the value consumers place on additional units of output. The total increase in societal welfare due to the production of the additional Qmc-Qac units beyond the Q a c units already being produced, is equivalent to the area FBH. Therefore, by adopting average cost pricing, an inefficient (because i t is insufficient) allocation of resources towards the production of passenger r a i l transportation occurs. This results in the foregoing of a benefit (i.e. a deadweight loss) to society equal to FBH. In order to avoid this deadweight loss and achieve an efficient (sufficient) allocation of resources towards the production of passenger r a i l transportation, marginal cost pricing should be u t i l i z e d . This w i l l result, as has already been pointed out, in a d e f i c i t operation of passenger r a i l services. In order to enable the operator to provide the efficient quantity of output and yet survive, a subsidy equal in amount to the d e f i c i t must be provided. Thus, in the case of increasing returns to scale, subsidization is Chapter 4 164 Economic Efficiency necessary in order to ensure the efficient allocation of resources to that industry. There is one important caveat which must be pointed out. The above discussion implicitly assumed that the subsidy to support the industry enjoying returns to scale could be raised in such a manner so as not to distort any other market. Unfortunately, such a non-distorting tax mechanism has yet to be discovered! Thus, the analysis of the scale economies rationale requires a slight modification for purposes of practical application. Figure 4.5, a "magnified view" of the deadweight loss region from Figure 4.4, shows the benefit of moving from average cost pricing to marginal cost pricing ( E ^ ) , as i t would accrue i f the movement were done step by step. Clearly the incremental benefit of each successive increase in output -represented by the vertical "slices" - decreases as price approaches marginal cost. In addition, the size of the subsidy required to achieve this benefit -represented by the horizontal "slices" - increases as price approaches marginal cost. If the funds which are required to provide the subsidy are raised by taxing a market in which marginal cost pricing is the rule, then the reverse of the above situation would occur. The incremental cost of each successive increase in price above marginal cost (to raise the tax revenue) increases as price moves away from marginal cost. At some point, the marginal benefit of an additional dollar of subsidy alloted to the passenger r a i l industry would Chapter 4 165 Economic Efficiency FIGURE 4.5 Trade-off Between Efficiency Loss and Level of Required Subsidization Price, Cost ($) / / / / / / \ : marginal increase in subsidy ' / / / / / \ requred to affect a one unit output increase : marginal benefit of one unit output increase . Qa Quantity (units of passenger rail service per period) p r i c e and quantity demanded of passenger r a i l service, r e s p e c t i v e l y , given average cost p r i c i n g p r i c e and quantity demanded of passenger r a i l service, r e s p e c t i v e l y , given marginal cost p r i c i n g LRMC r a i l long-run marginal cost curve f or passenger r a i l service Chapter 4 166 Economic E f f i c i e n c y exactly equal the marginal cost of taking that dollar from another market. Increasing the subsidy beyond this point would involve net disbenefits. •LJ The existence of scale economies, therefore, does not provide sufficient j u s t i f i c a t i o n for f u l l subsidization. Mohring (1972, pp. 273-277) analyzed this situation and found that for a given hypothetical market condition, low el a s t i c i t i e s and low scale economies would suggest that the social costs of raising the taxes (distortion of the other markets and collection costs) would outweigh the social benefits of establishing marginal cost pricing in the decreasing cost industry. Mohring's work suggests the following requisite conditions for the subsidization of passenger r a i l services: i) increasing returns to scale of at least moderate proportions in the passenger r a i l industry; i i ) a f a i r l y high (0.5 or greater) e l a s t i c i t y of demand for r a i l transport; and I i i ) reasonably low social costs in generating tax revenues (i.e. low costs of collection and of market distortion). Since some distortion is inevitable, the decreasing cost industry must be compromised to the extent that inefficiencies in the allocation of resources to that industry be decreased only to the point where the inefficiencies introduced elsewhere in the economy balance the benefits derived. In addition, since a review of the literature indicates that there is 1 3 0 f course, the "market" the subsidy is being raised from could be all other markets and hence the effect would be small. Chapter 4 167 Economic Efficiency considerable doubt as to whether there actually are "increasing returns to scale of at least moderate proportions" in the Canadian passenger r a i l system, this rationale for subsidization of VIA Rail i s , at best, tenuous. 1 4 i i ) economies of density Economies of density, like economies of scale, result in a situation where subsidization of the industry would be necessary in order to ensure that the optimum quantity of service is provided. 1 5 Thus i f the different modes were subject to varying degrees of density economies, unbalanced modal subsidization could be j u s t i f i e d . Density economies have been established for both the r a i l and air modes, as the literature review illustrates. While the existence of density economies is not as well established for the bus and automobile modes, i t would appear reasonable to assume that i t does exits, especially when f u l l economic costs (carrier costs plus a l l government costs) are taken into account. Since i t seems lik e l y that all modes are subject to density economies, and since accurate estimates do not exist for a l l modes, this rationale cannot be used to support differential levels for modal •L^As the literature review pointed out, this rationale is also unlikely to pertain to any of the other modes, given the available evidence. 1 5Economies of density in passenger r a i l service means that any given increase in output, holding the network constant, can be achieved with a less than proportionate increase in costs. Economies of scale, on the other hand, means that any given increase in all inputs w i l l result in a more than proportionate increase in output. Chapter 4 168 Economic Efficiency subsidization. It suggests, however, that some degree of subsidization for a l l modes may be in order. i i i ) externalities of production Externalities of production refer to cases in which the production of a good or service results in a divergence between private and social costs or between private and social benefits.16 Positive externalities reflect situations in which the production of a good or service by any producer results in extraneous benefits to others for which the producer receives no compensation.I7 Negative externalities reflect situations in which the •••"Private costs [benefits] are those incurred [enjoyed] by the producer [purchaser] of the good or service. Social costs [benefits] are those incurred [enjoyed] by those other than the producers [purchasers] of the good or service. The previous discussions referred only to marginal/average/total costs (or benefits) rather than marginal/average/total private costs (or benefits) or marginal/average/total social costs (or benefits) since i t was implicitly assumed that the two are equivalent. Only in the case of externalities is i t important to draw a distinction between them. ^Extraneous benefits refer to those benefits which might arise in addition to those benefits the purchaser/user of the good or service derives. For example, i f the production of passenger r a i l service results in a net reduction i n transportation-caused air pollution or a reduction in the number of automobile f a t a l i t i e s (see for example, Andriulaitis, Frank, Oum and Tretheway (1986) or Jordan (1986)), then this represents a positive externality. Undoubtedly the greatest opportunity for positive economic externalities arising from passenger r a i l services l i e s in the promotion of tourism. The western transcontinental r a i l services (the "Supercontinental" and the "Canadian"), have (or could have) significant drawing power, attracting U.S. and Pacific Rim vi s i t o r s . At this point in time, the opportunity has been identified (see for example, Bunting and Johnston (1984)), although some question remains as to the exact magnitude of the benefit. Chapter 4 169 Economic Efficiency I production of a good or service by any producer results in extraneous costs to others for which the producer bears no share. 1 8 While theory suggests that aggregate social welfare could be increase by subsidizing the passenger r a i l mode i f i t produces greater positive externalities and/or fewer negative externalities than i t s substitutes, practical application of this concept is fraught with problems. It requires a full-fledged social cost-benefit analysis, a procedure which involves a number of nebulous concepts (e.g. setting a value on a l i f e , valuing time, establishing the true cost of pollution, etc.). If a social cost-benefit analysis were to be done and indicate that passenger r a i l service does provide social benefits in excess of social costs, that would be a vali d reason for subsidizing passenger r a i l service. Such an examination has not been done in i t s entirety. Rather than try to assemble a piecemeal overview of possible net external benefits, this thesis adopts the conservative approach of divorcing i t s e l f from the issue of externalities. The purpose of this thesis is to provide a value for the efficiency distortion caused in other modes which in turn could then be included in the calculation of total net benefit (cost) of subsidizing passenger r a i l service. The efficiency loss would be used to offset such positive externalities as 1 8 P a r a l l e l to the footnote above, external costs refer to those costs which arise in addition to those costs the producer incurs. For example, i f the production of passenger r a i l services involves a net increase in the level of transportation-caused discharge of effluent into the air, society in general suffers from a deterioration in environmental quality for which the producer pays nothing. This is a negative externality of production. Chapter 4 170 Economic Efficiency fewer f a t a l i t i e s from automobile transport and enhanced tourism expenditures in western Canada. iv) second best considerations The theory of second best, developed by Lipsey and Lancaster (1956) deals with the consequences of relaxing the assumption that a l l other markets other than the one under examination are in fact based on marginal cost pricing. In other words, we are not dealing with an economy with only one "imperfection" that needs to be corrected, but with an economy with imperfect markets. In such a case, the relatively simple conditions for Pareto optimality are complicated tremendously. In fact, the consequence of relaxing the assumption of a perfect "rest-of-the-world" is that ceasing to subsidize one market such as transportation in general, may not bring us any closer to Pareto optimality. Second best considerations thus provide a substantially different type of rationale for continued subsidization of passenger r a i l services than the previous three potential justifications. While economies of scale, economies of density and externalities offer an active, positive reason for subsidizing r a i l transportation, the theory of second best offers a passive, negative reason for continuing to subsidize passenger r a i l transportation since we cannot be sure that ceasing to do so w i l l actually improve aggregate societal welfare. Chapter 4 171 Economic Efficiency This somewhat disturbing result arises from the complex interactions of the demand and supplies of complements and substitutes. Such a result does not mean we have to abandon efforts to improve allocative efficiency. Winch (1971) sums up the situation: While the first-best (necessary) conditions for a Paretian optimum are straightforward and rigourous, the corresponding conditions of a second-best optimum are complex in even the simplest model. The real world is an imperfect, second-best world of far greater complexity than our simple models. In such a world there are no simple a p r i o r i rules for establishing a second-best optimum, nor even rigorous c r i t e r i a of whether a particular change would constitute an improvement even i f not an optimum. In the presence of imperfections, the best policy in any situation cannot be calculated with precision from available data. The rules of f i r s t -best optimality, coupled with the caveat of second-best, do however, constitute part of the fund of guidelines from which good, i f not perfect, policy might be formulated.^ y This investigation the, adopts the "good, i f not perfect" approach of using the guidelines of Pareto optimality while keeping in mind that there are no guarantees that we can achieve our goal of maximum social welfare. F. Social Justifications for Subsidization There exists a myriad of "social" reason, in addition to the various economically sound justification, for subsidization. These include such rationales as income redistribution, maintaining reasonable levels of mobility, regional development, historical obligations and achieving "equity". 1 9Winch (1971; p. 116) Chapter 4 172 Economic Efficiency While i t is not the intention to denigrate the val i d i t y of such justifications, this thesis does not deal with social rationales for subsidization. This is simply because these justifications are not compatible with Pareto-optimality. In other words, such arguments introduce distortions into the economy, rather than eliminate them, since they involve departures from one or more of the marginal conditions outlined in the previous section. This should not be taken to suggest that social reasons cannot or should not be the primary or major ju s t i f i c a t i o n for subsidization. It merely means that subsidizing the production of any good or service involves an economic cost which must be taken into consideration when determining the net social benefit the subsidization creates. As stated previously, i t is in fact the purpose of this thesis to measure this economic cost to better enable policy-makers to judge the net benefit of social decisions taken in regards to subsidization. G. Summary This chapter has defined efficiency in allocation of resources, examined the distorting effect of subsidization on allocative efficiency and discussed circumstances under which subsidization is compatible with allocative efficiency. In general, the possible economically sound j u s t i f i c a t i o n for the subsidization of passenger r a i l services are not yet well enough established to offer concrete support for VIA Rail subsidies: Chapter 4 173 Economic Efficiency i) scale economies are lik e l y non-existent i i ) density economies are lik e l y relevant for a l l modes, possibly equally; and i i i ) externalities require a f u l l social cost-benefit analysis to quantify net benefits. To be conservative, the determination of efficiency losses w i l l proceed on the assumption that passenger r a i l subsidies do in fact move the Canadian economy away from Pareto optimality. The cost of this distortion can then be used as a yardstick against which the benefits of safety and tourism externalities, income redistribution, minimum mobility standards, regional development, "equity" and his t o r i c a l obligation can be measured. Chapter 4 174 Economic Efficiency CHAPTER 5 PRICE ELASTICITIES OF DEMAND FOR INTERCITY PASSENGER TRAVEL A. Introduction i As described in Chapter 4, measures of the price responsiveness of demand for intercity passenger travel are requisite to the determination of the economic efficiency losses arising out of unbalanced modal subsidization. There are two possible sources of the necessary e l a s t i c i t i e s : published econometric studies of travel demand; and estimates developed specifically for this study. Naturally, there are advantages and disadvantages to using either source. The advantage of using published estimates obviously is that i t makes unnecessary the considerable effort involved in developing first-hand estimates of e l a s t i c i t i e s . The disadvantage is that since the available studies either are based on different geographic regions, or do not use a l l four of the major modes, or are conducted at different levels of aggregation, none precisely duplicates the conditions necessary for this thesis. However, this shortcoming can be minimized by using some care in selecting the studies upon which to base the elas t i c i t y results. Hence, i t is quite possible to obtain reasonable estimates of the el a s t i c i t i e s l i k e l y to exist in Canadian intercity passenger travel. Chapter 5 175 Price Elasticities The advantage of developing e l a s t i c i t i e s specifically for the purposes of this thesis is that i t is possible to avoid the problems inherent in the use of the previously published estimates. This assumes, of course, that there are data available for the relevant geographic region, for a l l four modes, and at the proper level of disaggregation. This clearly points to the main disadvantage of this source of e l a s t i c i t i e s -- success in obtaining these measures is directly and highly dependent upon the nature and form of the available data. If there are weaknesses in the data,, there w i l l be problems with the estimated e l a s t i c i t i e s . Both of the aforementioned sources of ela s t i c i t y estimates are u t i l i z e d in this thesis. However, since some problems were encountered in developing el a s t i c i t y estimates, reliance was placed on the use of published e l a s t i c i t i e s . The remainder of this chapter deals with previously published results. (The description of the methodology and results of the attempt to specifically develop e l a s t i c i t y estimates is provided in Appendix B.) B. Published Price E l a s t i c i t i e s As mentioned above, this study relies on published results of other investigations into travel demand for the required e l a s t i c i t y estimates. Only the literature concerning travel demand in Canada, the United States, Great Britain, and Australia is included. The common heritage and other similarities between these (predominantly) English-speaking nations are believed to be sufficient to warrant applying the empirical results of a l l Chapter 5 176 Price Ela s t i c i t i e s these nations to the Canadian intercity passenger network. In order to be conservative, the results for travel in any non-English-speaking countries are eliminated from consideration. Table 5.1 provides a summary of the results of this review.1 As can be seen from Table 5.1, none of the studies reviewed contained a complete set of own and cross-price e l a s t i c i t i e s . But since these results represent among the best available, the calculation of economic efficiency losses must make do with these estimates. Some means must be found to f i l l in the gaps and reconcile the difference between results where more than one estimate exists. Table 5.2 provides the actual el a s t i c i t y results used in this thesis. It is based on a synthesis of the e l a s t i c i t y results presented in Table 5.1, supplemented with intuition and experience. The larger e l a s t i c i t i e s (in absolute terms) were discounted in favour of lower values in the belief that the models based on only a couple of modes w i l l overstate the el a s t i c i t i e s that would be found i f the whole system were to be modelled. An approximate mean of the remaining results was generally used, except in a few cases where this differed significantly from the general level of the other estimates. In these cases e l a s t i c i t i e s that provided an approximate symmetry to the results was selected. ^The results of the modelling process undertaken for this thesis (described in Appendix B) are included for the purpose of comparison. Chapter 5 177 Price Elasticities TABLE 5.1 Ela s t i c i t y Results El a s t i c i t y of demand for: Air with respect to price of: Automobile Bus Rail Air (1) (2) (3) (4) (5) (6) (7) •1.10 •2.75 •2.10 -0.77 -3.44 +0.30 +0.10 -0.01 +0.40 +0.02 +1.61 +3.99 Auto (1) (2) (3) (4) (5) (6) (7) +0.30 -1.40 -0.63 -2.35 •1.51 Bus (1) (2) (3) (4) (5) (6) (7) -0.10 +1.27 +0.48 •1.40 -2.35 50 87 23 10 -5.03 -0.38 +1.61 +0.56 + .045 +6.95 Rail (1) +0.35 - -0.80 -1.37 (2) +1.27 - +0.40 -2.59 (3) (4) - - - -(5) - - -(6) - - - -(7) - - - -0.83 Chapter 5 178 Price Ela s t i c i t i e s TABLE 5.1 (continued) E l a s t i c i t y Results Notes: (1) Oum and Gillen (1983) average of quarterly results for 1976 intercity travel in Canada. (2) Transport Canada (1975) study of Toronto-Montreal travel. (3) Babcock and Germain (1984) U.S. intercity bus travel study.• (4) Douglas (1984) U.K. intercity bus travel. (5) Taplin (1980) synthesis of Australian travel results. (6) Lave, Mehring, and Kuzmyak (1977) average of personal and business travel results. (7) Results of ad hoc models estimated by the author for this thesis (see Appendix B for details). Chapter 5 179 Price Elasticities The specific values chosen for these e l a s t i c i t i e s are certainly subject to criticism; however, they should be accurate enough to provide an order of magnitude estimate of economic efficiency loss. In other words, the result of this exercise w i l l not be the true measure of economic efficiency loss, but rather, a ballpark estimate of the lik e l y magnitude of this loss. While not ideal, such an estimate is far superior to the current [i.e. non-existent] estimate available to policy-makers. TABLE 5.2 El a s t i c i t i e s Used i n Calculation of Economic Efficiency Losses Ela s t i c i t y of demand for: with respect to price of: Air Automobile Bus Rail Air -1.10 +0.20 +0.20 +0.40 Automobile +0.30 -0.80 +0.20 +0.25 Bus +0.20 +0.20 -1.25 +0.45 Rail +0.35 +0.25 +0.40 -0.90 It should be noted that these e l a s t i c i t i e s must obviously be held constant for a l l routes. Given that most of the cost data is subject to similar assumptions (i.e. direct government subsidy is allocated in an identical fashion for each route and profit margins are assumed constant across routes) this simplification should not be too onerous. At any rate, Chapter 5 180 Price Elasticities applying route-specific e l a s t i c i t i e s , i f they exited, would not necessarily improve the accuracy of the f i n a l result, given the simplifications on the cost side of the equation. C. Conclusions Two possible sources of the necessary price e l a s t i c i t i e s exist: previously published results; and a demand model specifically calibrated for this thesis. Although both alternatives were utilized, problems in the latter method required a reliance on existing results. Several studies were review and the results obtained. The results were synthesized to obtain a plausible set of e l a s t i c i t i e s to use in the calculation of deadweight loss. Although there is some question as to the accuracy of the synthesized results, they are believed to be reasonable representations of how intercity travellers in Canada react to price changes among the various modes. However, this means that the resultant efficiency loss estimate obtained w i l l be only just that--an estimate. While i t is not lik e l y to be precise, i t w i l l nonetheless provide a ballpark figure for the use of policy-makers. Chapter 5 181 Price Elasticities CHAPTER 6 MODAL FARES BASED ON ECONOMIC COSTS A. Introduction This chapter calculates the modal fares for the r a i l mode and it s three competitors, based on f u l l economic costs. As mentioned previously, such a step is requisite to the determination of the economically efficient allocation of passengers among the four alternative modes. This is accomplished by u t i l i z i n g the difference between optimal prices and actual prices and the price e l a s t i c i t i e s developed in Chapter 5. This w i l l provide the passenger volumes and modal shares that would have occurred had the components of the intercity network been eff i c i e n t l y priced. This "optimal" passenger distribution is then compared to the actual passenger distribution in order to note changes and to determine the extent of the distortion engendered by the various subsidies. The insertion of quotation marks around the word optimal in the previous sentence should be explained. The fares based on economic costs calculated in this chapter are optimal only in a limited sense. In the f i r s t place, these fares w i l l not be true optimal fares, in other words, fares based on total social costs. As described in Chapter 4, social costs diverge from private costs in the presence of externalities. In the case of intercity passenger transportation, two major negative externalities arise: congestion and pollution. Thus in order to obtain a genuinely optimal fare, the economic i Chapter 6 182 Modal Fares costs of the provision of service (the private costs 1) , the costs to other travellers resulting from congestion of the network, and the costs to society in general from the despoilment of the environment arising from the provision of transportation services (the social costs), must a l l be summed together. This thesis addresses only the private costs of the provision of service, and not the social costs such as congestion and pollution. It is hoped that others might be stimulated to examine the issue of externalities and to determine a dollar value for the costs of these externalities in the intercity passenger travel sector. 2 At any rate, the absence of estimates of the social costs of these two externalities is not anticipated to be too serious. Congestion is not a major or even a minor problem for travel between many of Canada's city-pairs (as opposed to travel within a given city) by most of the intercity modes3. Furthermore, the impacts of pollution caused by intercity travel are spread over a larger area and hence are less severe than those of •'-As before, "private costs" does not refer to costs in what is commonly called the private sector. It refers to a l l the costs incurred for which someone actually pays real dollars to cover. It thus includes a l l the costs the operators' bear, as well as a l l the costs of infrastructure that the government bears. ^Congestion costs and pollution costs have been estimated for urban automobile travel, but, to the best of this author's knowledge, not for intercity passenger travel by a l l four modes. For the reader interested in the issue of automobile congestion externalities i n an urban setting, see Kraus, Mohring and Pinfold (1976), Keeler and Small (1977), Holland and Watson (1978) and Dewees (1978). For discussions concerning automobile pollution externalities in an urban setting, see Dewees (1974) and Small (1977). 3There are exceptions of course. Travel by the automobile and bus modes between the c i t i e s of Hamilton and Toronto, and travel by air to Toronto (Pearson International Airport) are two such examples. Chapter 6 183 Modal Fares urban t r a f f i c in a close, compact urban setting such as a downtown core. Thus the fares based solely on the economic costs of the provision of service are assumed to be insignificantly different from the fares based on a l l social costs arising from the provision of the same service. The second reason why the fares based on economic costs calculated in this chapter are optimal only in a limited sense is the problem arising from the modelling d i f f i c u l t i e s . The e l a s t i c i t i e s developed in Chapter 5 impose identical price e l a s t i c i t i e s of demand for a given mode on a l l routes in the network served by that particular mode. Thus the cost of the subsidies w i l l be allocated to each route equally (on a passenger-kilometre basis). This is an optimal approach only i f in fact the true e l a s t i c i t i e s do not vary by route. Since this is undoubtedly too restrictive an assumption, the allocation of subsidies to each route w i l l not be accomplished in the least economically distorting fashion possible. 5 Given the circumstances, this is the best that can be done. This is not to say that such externalities do not exist or are not important. It does seem reasonable, however, to assume that such charges would l i k e l y not substantially change the relationship between the modes of the fares based on private economic costs. 5 I f a model had been successfully estimated that had a functional form which allows for the variation of e l a s t i c i t i e s by individual route (i.e. the translog functional form), then the total amount of the subsidy could be allocated to each route u t i l i z i n g Ramsey-Boixteau pricing principles. This procedure is a means by which a lump sum tax can be raised from an industry or sector in the least distorting manner possible. Chapter 6 184 Modal Fares B. Presence of Economies of Scale and/or Density As described in Chapter 4, the existence of returns to scale or density in an industry is sufficient economic rationale for subsidization of that industry. Thus the possibility of scale economies in each of the passenger modes must be evaluated in order to find economic ju s t i f i c a t i o n for governmental subsidization.^ As the literature review reveals for the case of Canadian intercity passenger transportation, there does not appear to be sufficient grounds to support the contention that subsidization of any passenger mode is warranted on the grounds of the existence of positive scale economies. Any net subsidy provided to a mode by the government thus has a distorting effect, rather than the economically enhancing effect the same net subsidy would have i f the mode enjoyed positive returns to scale. The determination of modal fares based on economic costs thus can be conducted safely without taking into account scale considerations. 7 "As described in Chapter 4, externalities were ignored as potential valid economic rationales for unbalanced modal subsidization. This is not because the do not exit or are not important--on the contrary, externalities could be key. However, not enough is known about the magnitude of such externalities, making their use as jus t i f i c a t i o n for subsidization d i f f i c u l t to support. The preferred approach is thus to ignore externalities in the calculation of optimal fares and hence deadweight loss, and to compare the fi n a l estimate of deadweight loss to what one believes the externalities might conceivably be worth. 7Furthermore, the studies reviewed concerning returns to scale were based only on carrier costs -- not the f u l l economic costs which are important to this thesis. There is a notable absence of accurate measures of scale economies for a l l modes based on f u l l economic costs. This reinforces the decision to ignore scale economies in determining efficiency losses. Chapter 6 185 Modal Fares On the other hand, there is considerable evidence to suggest that a l l modes of transportation are subject to returns to density, especially when both the costs of the carrier and the costs of the infrastructure are taken into consideration. Thus there appears to be a va l i d economic reason to subsidize intercity passenger travel. Unfortunately, as is the case with estimates of scale economies, there is an absence of accurate measures of density economies based on f u l l economic costs. Thus i t is impossible to state to what degree intercity passenger transportation should be subsidized on the grounds of density economies, nor even whether equivalent or differential subsidy levels would be required for the four modes. This thesis adopts the approach that i t seems more appropriate to ignore the rationale of density economies than i t does to adopt an arbitrary subsidy policy based on this rationale. This w i l l have the effect of overstating somewhat the extent of the economic efficiency losses, since some of the subsidy is j u s t i f i a b l e and not distorting. C. Rail Fares Based on Economic Costs There are considerable theoretical problems inherent to the determination of economic costs incurred by the various transportation modes. Any transportation economics text w i l l detail a l l the problems; what is of special interest here is a problem which concerns the passenger r a i l mode. Real passenger r a i l costs in Canada are a compendium of costs incurred by the C.N.R., the C.P.R., and VIA Rail. While the costs VIA incurs i t s e l f are clearly attributable to passenger service, the costs the C.N.R. and the Chapter 6 186 Modal Fares C.P.R. incur are not as easily assigned to the various outputs of these railways. There is thus some doubt as to the valid i t y of the r a i l cost figures. 8 This is not to be taken as implying that these figures are without a reasonably sound basis. Like costing in general in the transportation sector, i t has i t s share of somewhat arbitrary and ad hoc assumptions. Nevertheless, given the experience of the people producing the cost estimates, the figures, where available, must be accepted as being reasonable. 9 The estimate of actual economic costs by route for the r a i l mode was developed as follows: i) multiply fare by passenger volume in order to obtain the portion of costs covered by the operator; i i ) multiply governmental subsidy per passenger-mile by the route's total passenger-miles of service provided in order to obtain the portion of costs covered by the government; and i i i ) sum the operator's and government's cost of the provision of service in order to obtain the total costs to be recovered through passenger fares. The f i r s t step is simple -- the ICTD database provides both elements. For the second step, Transport Canada estimated the average r a i l subsidy per °This issue was brie f l y addressed in Chapter 2. Cubukgil and Soberman (1984) provide a detailed discussion of the problems VIA has with the two major roads and the C.T.C. costing order which serves as the basis for the railways charges to VIA. 90nly dated (1976) cost data by route were made available to the author by Transport Canada. These data once were generally available - they no longer are. Chapter 6 187 Modal Fares passenger-kilometre to be $0,141 (1979 $ ) . i U Converting to a cost per passenger-mile and expressing i t in 1976 dollars gives a subsidy of $0.1769 per passenger-mile. The r a i l fares, where no better data were available, were adjusted upwards by the amount per route suggested by the Transport Canada figure. This was used for non-corridor routes included in the analysis (23 of 52 routes). For the remaining 29 corridor routes, a cost of 70.7% of the figure derived by Transport Canada was u t i l i z e d . This is based on data presented in Cubukgil and Soberman (1986; pp. 13-14) which suggest that the subsidy in the corridor is only 70.7% of the system average subsidy. Apportioning the r a i l subsidy on the basis of route volume (measured by passenger-miles of service) can be j u s t i f i e d since VIA's costs (and hence subsidy requirements) are basically a function of output. The most important costs that VIA incurs directly (labour, fuel, equipment maintenance) are a function of the number and length of trains run. The charges levied by the C.N.R. and C.P.R. are also determined on the basis of the number and length of trains run. Clearly the level of subsidy is predominantly a function of output. On a very micro level, the r a i l mode suffers from a much higher degree of "lumpiness" than do either of the bus or air modes. Passenger cars had h i s t o r i c a l l y been very large (and VIA continues to use some historical vehicles), so adding or deleting one car makes a significant difference to available seat miles. Since r a i l passenger levels are typically low, the ^ T h i s figure is over an order of magnitude larger than the next most heavily subsidized mode. Chapter 6 188 Modal Fares a b i l i t y of r a i l to adjust capacity to demand i s more l i m i t e d than f o r any of the other modes. However, the use of r a i l d i e s e l cars (RDCs) and the "new", smaller LRC t r a i n s ensures that the a b i l i t y of VIA to adjust capacity to match demand i s not e n t i r e l y out of l i n e . On the whole, i t seems reasonable to assume r a i l subsidy i s d i r e c t l y proportional to r a i l volume. D. Air, Automobile, and Bus Fares Based on Economic Costs In a d d i t i o n to the t h e o r e t i c a l problems inherent to costing transportation services, there i s one further problem i n costing Canadian t r a v e l modes. Detailed actual cost data f o r most of the bus operators and c e r t a i n of the a i r l i n e s , are not ava i l a b l e since they are p r i v a t e l y owned. Data r e f l e c t i n g p o t e n t i a l l y c o n t r o v e r s i a l or t o p i c a l issues concerning p u b l i c l y owned A i r Canada (and VIA R a i l ) are nigh on impossible to obtain due to the f a c t that such data i s i n e v i t a b l y considered p r o p r i e t a r y . ^ While data a c q u i s i t i o n i s d i f f i c u l t enough now, the recent d e c i s i o n to d r a s t i c a l l y "downsize" the Canadian Transport Commission, w i l l make the a c q u i s i t i o n of data concerning the Canadian transportation sector an even more formidable task. i i A n i l l u s t r a t i v e example depicting the ludicrous extremes the Canadian p r e d i l e c t i o n f o r c o n f i d e n t i a l i t y reaches concerns A i r Canada's domestic market share. Both the Av i a t i o n S t a t i s t i c s Centre of S t a t i s t i c s Canada and the Research Branch of the Canadian Transport Commission have t h i s information on f i l e , but are unable to provide i t since they are constrained by the alleged c o n f i d e n t i a l i t y of the data. (Presumably, no one at Canadian A i r l i n e s I n t e rnational would be able to cal c u l a t e i t as long as i t i s kept secret!). This same "proprietary" information i s ava i l a b l e , however, i n the publications of an international organization: the International C i v i l Aviation Organization (ICAO). Chapter 6 1 8 9 Modal Fares At any rate, despite the lack of route or carrier specific data, a reasonable proxy for actual economic cost by mode, by route, can be constructed by the following methodology: i) calculate historical profit margin of the mode based on the latest three years; i i ) divide fare by the historical profit margin in order to obtain the cost per passenger-trip covered by the operator; i i i ) multiply this cost per passenger trip by the passenger volume in order to obtain the portion of costs covered by the operator; iv) multiply governmental subsidy per passenger-mile by each route's total passenger-miles of service in order to obtain the portion of costs covered by the government; and iv) sum the operator's and government's costs of the provision of service in order to obtain the total costs to be recovered through passenger fares. The obvious drawback to this approach is that i t assumes that a l l modes have a uniform cost per kilometre of service and an identical rate of return on a l l routes. Although the former may be a reasonable enough assumption, the latter is undoubtedly not a very r e a l i s t i c assumption. Given the lack of route-specific data, this is the best that can be done. One other point should be raised. There is a slight difference in the nature of the subsidy given to VIA Rail from that of the subsidies given to the other three modes. VIA's subsidy is predominantly an operating subsidy, although i t also receives capital assistance. The reverse is true of the other three modes. The fewer the number of trains that VIA runs, the lower the required subsidy. Subsidy level is clearly related to output. As far as Chapter 6 190 Modal Fares the other three modes are concerned, since the subsidy provided primarily relates to fixed infrastructure, the natural inclination is to view the subsidization of these other modes as being independent of output. This is not quite true. A significant proportion of the costs borne by the government on behalf of air, automobile and bus users is directly related to the level of usage. Items such as maintenance (road, bridge, runway, airport etc.), and policing (road, airport) are examples of government-borne costs that vary with the level of usage of the resources provided. Even the decision as to the capacity of the infrastructure provided (i.e. the capital costs) is a function of output. Thus, i t does not seem unreasonable to treat total costs, and hence subsidy level, as a function of output. i) the automobile mode The "fare" for the automobile mode in the ICTD database is based on a standard cost per kilometre which reflects the actual operating costs associated with running and maintaining an automobile. This represents the costs borne by the operator. The cost of automobile travel borne by the government, according to the most recent estimate available, is approximately $0,009 per passenger-kilometre (1978 $ ) . 1 2 A l l automobile fares were thus simply increased by $0.0056 per passenger-mile^-3 to obtain the automobile fare based on economic costs. 1 2Transport Canada (1982), Table 6.6, p. 60. ^ 3An average passenger load of two persons per trip was assumed for a l l intercity travel by automobile; the cost was converted to a per-passenger-mile basis and restated in 1976 dollars. Chapter 6 191 Modal Fares i i ) the bus mode The fare for the bus mode in the ICTD database is the actual fare charged by route by the bus operator serving that route. Since, as pointed out in the literature review, some analysts have noted that bus operators generally enjoy some monopoly power granted them by the provincial regulation of the industry, the bus fares are somewhat higher than they would be in a perfectly competitive environment. The latest years for which data are available (1983-1984) show that the Class 1, 2 and 3 intercity bus operators in Canada had, on average, a profit margin of 4.12%14 Each bus fare in the ICTD database was thus factored down by 4.12% to obtain a measure of the economic costs borne by the operators. The governments' contributions towards intercity passenger bus service was calculated by Transport Canada to be in the neighbourhood of $0.004 per passenger-kilometre(1979 $ ) . 1 5 Converting to a cost per passenger-mile and expressing i t in 1976 dollars gives a subsidy of $0,005 per passenger-mile. This per unit output subsidy level is converted to a route-by-route basis and divided by the number of passengers u t i l i z i n g the service in order to get the ^ S t a t i s t i c s Canada Catalogue 53-215, "Passenger Bus and Urban Transit Statistics". 1 5Transport Canada (1982), Table 6.6, p.60. Other researchers endeavouring to estimate the net subsidy levels of the various modes generally come to the conclusion that the level of subsidization for the intercity bus mode is negligible. Rather than accepting the hypothesis of zero net subsidy, the conservative approach is taken here, and the Transport Canada figure used. This is conservative since i t would tend to diminish the f i n a l estimate of economic efficiency by reducing the relative difference between post-adjustment VIA Rail and bus fares. Chapter 6 192 Modal Fares governmental share of the cost of each passenger tr i p . Each bus fare in the ICTD database was factored up by the amount of this subsidy. There is an important point that needs to be raised here. This procedure assumes that the subsidy thus determined for each trip w i l l be relatively constant as passenger volumes change. For marginal changes to reasonably heavily travelled routes, the assumption of constant subsidy levels per passenger is quite acceptable. As passenger levels drop, even i f total subsidy levels remain the same, the share of the subsidy no longer borne by the recently departed passengers w i l l not amount to much when spread out among the large number of remaining passengers. For sparsely travelled routes, or for significant volume changes, the assumption of constant subsidy levels to be borne per passenger becomes somewhat strained. However, i t is unreasonable to assume that the total amount of subsidy required by a mode would remain constant even as passenger levels declined. In the case of the bus mode, a f a i r l y insubstantial proportion of the total operating costs are what could be considered fixed, even in the short run. (Moreover, due to the relatively small size of the vehicles the bus mode can make adjustments to output that are reasonably fine.) A portion of the government's costs are also related to output (e.g. administering provincial transport boards, policing, highway maintenance). Even those portions that are fixed in the short-run (i.e. capital costs of roads) are variable in the long-run. Overall, i t seems reasonable to conclude that total costs do vary with output, and hence to assume relatively constant subsidy levels per Chapter 6 193 Modal Fares passenger as the passenger volumes of the bus mode change, despite the fact that passenger volumes might not be too high on certain routes.^ i i i ) the a i r mode As for the bus mode, the air fare l i s t e d i n the ICTD database i s the actual fare charged by the operator serving the route. The nature of the industry structure and, as in the case of the bus mode, regulation (federal rather than provincial) has enabled the airlines to reap some degree of monopoly profits. Thus the actual fares charged exceeded the level that competitive markets would produce. Over the latest three years for which data are available (1983-1985), the Canadian level I carriers earned, on average, operating revenues in excess of operating expenses to the tune of 1.45%.^7 Thus each air fare in the ICTD database was factored down by this amount in order to obtain a measure of the economic costs borne by the operators. ear The federal government's contribution towards intercity passenger air service is substantially higher than that of the bus mode, but only marginally higher than the automobile mode on a per passenger-kilometre basis. Transport Canada estimated the subsidy to be $0,011 (1979 $) per passenger-kilometre.^ Converting to a cost per passenger-mile and expressing i t in 1976 dollars l**0f course, on very marginal routes, the level of subsidy each passenger is expected to cover w i l l vary substantially with volumes. The fineness of adjustment, even for the bus mode, is limited. One cannot, after a l l , run half a bus. 1 7 S t a t i s t i c s Canada, Catalogue 51-002, "Air Carrier Operations in Canada". 1 8Transport Canada (1982), Table 6.6, p. 60. Chapter 6 194 Modal Fares gives a subsidy of $0.0138 per passenger-mile. Again, this per unit output subsidy is converted to a per passenger trip basis by route and added to the operators' cost per passenger trip by route to provide the cost to be recovered from passenger fares. Although, at f i r s t glance, the airline industry might seem to be characterized by exceedingly "lumpy" investment (jet aircraft are, after a l l , big and expensive), but for several reasons, the industry is quite flexible in the adjustments i t can make to changing passenger volumes. One reason is that airlines using large aircraft tend to concentrate on high-volume corridors. Changes in volumes thus tend to be rather insignificant with respect to total output. Furthermore, since trips take very l i t t l e time relative to the other modes, additional trips can usually be performed by the same vehicle to a far greater extent than the other modes. If volumes should decline, aircraft can easily and quickly be moved to alternative service. Small operators serving very thin routes w i l l have the same problems the marginal bus operator has, although the minimum size of an aircraft that can be used in intercity service is smaller than that of an intercity bus. The assumption of reasonably constant subsidy levels per passenger is thus acceptable. E. Modal Fares Used i n Deadweight Loss Calculations Table 6.1 shows the cost recovery by mode, for 52 routes in central Canada. This clearly shows that none of the major modes of intercity passenger travel in the region under study currently recovers a l l the costs of Chapter 6 195 Modal Fares TABLE 6.1 PERCENTAGE COST RECOVERY BY MODE COST COST TOTAL COST CARRIER COST RECOVERY TOTAL COST CARRIER COST RECOVERY CITY-PAIR AIR ($) AIR ($) AIR (X) BUS ($) BUS ($) BUS (X) OTTAWA-QUEBEC 2,128,362 1,981,394 93.09 240,986 221,184 91.78 OTTAWA-MONTREAL 1,966,007 1,887,292 96.00 2,750,482 2,558,147 93.01 OSHAWA-MONTREAL 480,200 444,643 92.60 6,079 5,489 90.30 OSHAWA-OTTAWA 234,458 219,494 93.62 12,323 11,407 92.57 TORONTO-QUEBEC 5,185,258 4,715,630 90.94 51,725 46,854 90.58 TORONTO-MONTREAL 54,048,435 49,906,826 92.34 1,225,926 1,121,796 91.51 TORONTO-OTTAWA 22,520,625 21,022,229 93.35 1,547,782 1,421,211 91.82 GUELPH-MONTREAL 190,050 175,828 92.52 3,613 3,288 91.00 GUELPH-OTTAWA 92,582 86,597 93.54 25,685 23,396 91.09 KITCHNER-MONTREAL • 534,763 495,407 92.64 13,789 12,554 91.04 KITCHNER-OTTAWA 263,386 246,605 93.63 45,025 41,035 91.14 HAMILTON-QUEBEC 158,253 144,135 91.08 6,332 5,756 90.90 HAMILTON-MONTREAL 2,268,645 2,098,174 92.49 40,852 37,221 91.11 HAMILTON-OTTAWA 1,080,200 1,010,164 93.52 72,635 66,291 91.27 ST. CATHARINES-QUEBEC 79,758 72,470 90.86 5,161 4,709 91.23 ST. CATHARINES-MONTREAL 651,344 596,697 91.61 62,357 57,053 91.49 ST. CATHARINES-OTTAWA 349,335 325,420 93.15 79,444 72,904 91.77 LONDON-QUEBEC 253,614 228,402 90.06 1,778 1,615 90.80 LONDON-MONTREAL 2,181,398 1,995,396 91.47 25,787 23,446 90.92 LONDON-OTTAWA 1,707,999 1,574,883 92.21 46,333 42,194 91.07 LONDON-TORONTO 484,978 466,373 96.16 369,695 342,758 92.71 SARNIA-MONTREAL 313,641 284,913 90.84 1,502 1,361 90.57 SARNIA-OTTAWA 92,375 84,674 91.66 2,500 2,263 90.51 SARNIA-TORONTO 188,441 178,357 94.65 5,095 4,653 91.32 WINDSOR-MONTREAL 3,042,478 2,749,687 90.38 16,302 14,763 90.56 WINDSOR-OTTAWA 1,298,519 1,185,381 91.29 12,385 11,222 90.61 WINDSOR-TORONTO 3,980,698 3,732,254 93.76 206,134 187,910 91.16 WINDSOR-HAMILTON 92,254 86,667 93.94 29,433 26,681 90.65 WINDSOR-LONDON 4,131 3,820 92.46 43,515 39,490 90.75 NORTH BAY-MONTREAL 101,994 92,969 91.15 42,926 39,370 91.71 NORTH BAY-OTTAWA 25,027 23,268 92.97 114,718 105,125 91.64 NORTH BAY-TORONTO 457,035 429,121 93.89 232,087 213,949 92.18 NORTH BAY-LONDON 35,082 32,469 92.55 15,884 14,487 91.20 NORTH BAY-WINDSOR 32,121 29,404 91.54 7,595 6,886 90.67 SUDBURY-QUEBEC 46,773 42,477 90.82 1,783 1,629 91.37 SUDBURY-MONTREAL 344,127 312,050 90.68 39,500 36,205 91.66 SUDBURY-OTTAWA 274,863 255,140 92.82 81,864 74,968 91.58 SUDBURY-TORONTO 1,731,568 1,620,887 93.61 507,262 468,977 92.45 SUDBURY-HAMILTON 103,718 97,306 93.82 20,531 18,855 91.84 SUDBURY-LONDON 119,651 110,557 92.40 16,931 15,496 91.52 SUDBURY-SARNIA 19,595 17,994 91.83 1,274 1,160 91.04 SUDBURY-WINDSOR 94,786 86,682 91.45 11,212 10,203 91.00 THUNDER BAY-TORONTO 4,554.801 4,097.806 89.97 13,332 12.175 91.32 THUNDER BAY-SUDBURY 308,185 281,562 91.36 154,403 140,425 90.95 WINNIPEG-MONTREAL 3,818,530 3,320,552 86.96 18.872 16,504 87.45 WINNIPEG-OTTAWA 3,808,955 3,305,166 86.77 22,709 19,811 87.24 WINNIPEG-TORONTO 9,659,754 8,462,808 87.61 112,955 99,458 88.05 WINNIPEG-KITCHNER 385,359 338,661 87.88 9,016 7,918 87.83 WINNIPEG-HAMILTON 1,236,566 1,085,515 87.78 5,937 5,222 87.96 WINNIPEG-ST. CATHARINES 392,999 342,727 87.21 6,216 5,488 88.29 WINN I PEG-LONDON 809,835 703,495 86.87 12,654 11,148 88.10 WINNIPEG-WINDSOR 467,795 397,964 85.07 3,436 3,029 88.16 TOTAL/AVERAGE $134,701,304 $123,486,393 91.67 $8,403,750 $7,737,139 92.07 Chapter 6 196 Modal Fares TABLE 6.1 (Continued) PERCENTAGE COST RECOVERY BY MODE TOTAL COST CARRIER COST COST TOTAL COST CARRIER COST COST AUTOMOBILE AUTOMOBILE RECOVERY RAIL RAIL RECOVERY CITY-PAIR ($> ($) AUTO (%) ($> <$) RAIL (%) OTTAWA-QUEBEC 1,331,785 1,208,716 90.76 159,286 56,345 35.37 OTTAWA-MONTREAL 11,398,540 10,345,210 90.76 2,020,343 787,145 38.96 OSHAUA-MONTREAL 2.360,149 2,141,920 90.75 187,333 67,204 35.87 OSHAUA-OTTAUA 1.015,130 921,398 90.77 97,989 31,987 32.64 TORONTO-QUEBEC 1,142,840 1,037,231 90.76 762,445 233,378 30.61 TORONTO-MONTREAL 16,473,268 14,951,817 90.76 14,391,659 5,193,985 36.09 TORONTO-OTTAWA 6,970,842 6,325,519 90.74 1,888,341 641,160 33.95 GUELPH-MONTREAL 1,344.293 1,220,185 90.77 326,133 110,111 33.76 GUELPH-OTTAWA 552,114 501,017 90.75 56,892 18,647 32.78 KITCHNER-KONTREAl 3,228,513 2,929,958 90.75 275,916 92,736 33.61 KITCHNER-OTTAWA 1,330,837 1,207,892 90.76 158,278 52,905 33.43 HAMILTON-QUEBEC 764,488 710,910 92.99 57,318 17,141 29.90 HAMILTON-MONTREAL 5,131,227 4,656,706 90.75 308,706 106,447 34.48 HAMILTON-OTTAWA 2,122,472 1,926,397 90.76 91,715 30,568 33.33 ST. CATHARINES-QUEBEC 420.885 390,868 92.87 145,509 42,834 29.44 ST. CATHARINES-MONTREAL 3,641,295 3,304,980 90.76 498,208 169,660 34.05 ST. CATHARINES-OTTAWA 1,536,693 1,394,877 90.77 118,477 40,377 34.08 LONDON-QUEBEC 492,066 456,463 92.76 123,558 35,766 28.95 LONDON-MONTREAL 2,968,003 2,693,789 90.76 591,522 189,757 32.08 LONDON-OTTAWA 1,190,287 1,080,377 90.77 257,300 82,121 31.92 LONDON-TORONTO 6,283,700 5,701,511 90.73 3.192,396 1,263,885 39.59 SARNIA-MONTREAL 1,184,394 1,074,964 90.76 207,650 63,045 30.36 SARNIA-OTTAWA 472,001 428,410 90.76 84,601 25,732 30.42 SARNIA-TORONTO 1,918,895 1,741,326 90.75 1,103,449 417,862 37.87 WINDSOR-MONTREAL 2,413,565,497 2.190,529,741 90.76 735,382 219,551 29.86 WINDSOR-OTTAWA 974,231 884,274 90.77 174,717 51,529 29.49 WINDSOR-TORONTO 3,900,211 3,539,161 90.74 4,972,908 1,846,765 37.14 WINDSOR-HAMILTON 1,478,551 1,342,140 90.77 189,204 68,417 36.16 WINDSOR-LONDON 1,300,411 1,180.134 90.75 480,278 177,474 36.95 NORTH BAY-MONTREAL 1,138,122 1,032,867 90.75 136,868 36,235 26.47 NORTH BAY-OTTAWA 554,868 503,532 90.75 46.625 12,099 25.95 NORTH BAY-TORONTO 1,407,416 1,277,523 90.77 164.055 45,798 27.92 NORTH BAY-LONDON 231,555 210,157 90.76 22.657 5,935 26.19 NORTH BAY-WINDSOR 186,926 169,656 90.76 18,868 4,523 23.97 SUDBURY-QUEBEC 430,464 399,552 92.82 4.130 956 23.15 SUDBURY-MONTREAL 1.960,427 1,779.111 90.75 234,619 59,817 25.50 SUDBURY-OTTAWA 942,267 855,089 90.75 100,618 28,054 27.88 SUDBURY-TORONTO 2,654,898 2,409.561 90.76 449,051 124,867 27.81 SUDBURY-HAMILTON 809,548 734.621 90.74 4,790 1,299 27.12 SUDBURY-LONDON 450,987 409.280 90.75 26,949 6.917 25.67 SUDBURY-SARNIA 180,432 163,748 90.75 2,648 642 24.26 SUDBURY-WINDSOR 376,343 341,566 90.76 18,474 4,316 23.36 THUNDER BAY-TORONTO 1,171,204 1,081,585 92.35 321,898 86,895 26.99 THUNDER BAY-SUDBURY 243,510 226,078 92.84 76,340 21,559 28.24 WINNIPEG-MONTREAL 444,851 411.570 92.52 624.112 121,395 19.45 WINNIPEG-OTTAWA 279,698 258,899 92.56 433,481 86,451 19.94 WINNIPEG-TORONTO 503,731 466,664 92.64 1,119,440 234,283 20.93 WINNIPEG-KITCHNER 201,203 186,281 92.58 20,999 4,151 19.77 WINNIPEG-HAMILTON 263,198 243,735 92.61 42,441 8,561 20.17 WINNIPEG-ST. CATHARINES 152,780 141,416 92.56 46,465 9,273 19.96 WINNIPEG-LONDON 188,489 174,395 92.52 67,334 13,247 19.67 WINNIPEG-WINDSOR 201,356 186,493 92.62 8,282 1,617 19.53 TOTAL/AVERAGE $2,511,467,892 $2,279,491,273 90.76 $37,648,656 $13,053,424 34.67 Chapter 6 197 Modal Fares the provision of service from the users of the services. Air recovers about 91.7% of i t s costs; automobile, about 90.8%; bus, about 92.1%; and r a i l , only about 34.7%. 2 0 The previous two sections described the procedure for determining modal fares that would recover the f u l l cost of the 5provision of service. This procedure assumes that a l l costs should be recovered in order to maximize economic efficiency. However, the available evidence seems to indicate that this would not maximize efficiency because of the existence of returns to density. The determination of deadweight loss using the "optimal" fares as determined above w i l l thus overstate the economic efficiency loss. However, an eminently practical problem with u t i l i t z i n g these "optimal" prices is that the government could expect a great deal of opposition from all transport modes i f i t tried to end the historical practice of subsidization by increasing user charges to cover 100% of costs. Interestingly enough, the cost-recovery levels, and hence the required user charge increases, for the non-rail modes are very similar. This suggests a simple modification to the definition of f u l l economic costs: a l l modes should be subsidized by 10%. This treats a l l modes on an equitable basis, and i t requires changes to the ^yKeep in mind that this, and a l l subsequent results are based on averages. Certain modes on certain routes may actually pay a l l the costs; however, the route-specific data required to confirm this are not available. 2 uThe r a i l data are based on system averages where necessary, and corridor averages where applicable. If system average alone was used, r a i l would seem to recover only 28% of i t s total cost of operation. The difference between using system averages and using the somewhat better corridor averages (34.7%). points out the dangers in applying system averages to specific regions. The air, automobile, and bus results are based on system averages, for lack of better data. Chapter 6 198 Modal Fares pricing structure of only one operator. Thus this is a policy which could be rather easily implemented. The result of u t i l i z i n g an across-the-board 10% subsidy for passenger transportation is to offset, to some unknown degree, the failure to account for density economies.2^- Given the extreme attractiveness of this policy from a practical point of view, i t was adopted despite a lack of strong theoretical support. This thesis then, adopts a 10% subsidy level for all modes as being equivalent to charging prices that cover f u l l economic costs. This suggests that only the prices of r a i l need be adjusted. This, however, w i l l result in a shift in the demand curves of the non-rail modes, and depending on the shape of their marginal cost curves, may or may not result in a new equilibrium modal fare. Figure 6.1 illustrates a few of the po s s i b i l i t i e s . If the marginal cost curve of each of the three non-rail modes is constant over the range of outputs we are dealing with, there would be no change in the prices of the non-rail modes, and a new equilibrium would be reached in the passenger transportation sector after the one-time r a i l fare adjustment. If the marginal cost curves of the non-rail modes positively or negatively sloped, then the shift in non-rail demand due to r a i l fare changes would cause price changes among the non-rail modes and engender further shifts expected to stabilize. 2 ^ I t may thus improve the accuracy of the results although given the lack of measures of density economies, i t could actually decrease the accuracy. Unfortunately, i t is not known which case is true. Chapter 6 199 Modal Fares FIGURE 6.1 Effect of Shape of Marginal Cost Curve On Deadweight Loss N o n - R a i l M o d e M C , M C . D given adjustment to rail prices Quantity (units of passenger service per period) Chapter 6 200 Modal Fares Unfortunately, the data to determine the production function of the non-r a i l modes do not exist. However, the arguments presented in sections C and D concerning the relationship between total cost and volume offers a possible resolution. There appears to be reason to believe that total cost is a direct function of output. A considerable portion of the carriers' costs are directly attributable to output. In the short-run, some of the government's costs (policing, administration) are also directly attributable to output level, while many other (maintenance) while perhaps not so precisely related to output, nevertheless are clearly a function of output. The assumption made is that the total cost of the provision w i l l change by equal amounts as volume increases/decreases incrementally over the range of outputs being considered (i.e. a constant marginal cost curve). While an econometric analysis may well prove this conclusion wrong, i t is accepted here as being a reasonable assumption. Given this assumption, only the r a i l fares w i l l change, and each of the non-rail modes w i l l experience a one-time shift in their demand curve. Non-r a i l modal fares w i l l not change. ^  ^Actually, since the non-rail modes do not recover precisely 90% of total costs on each route, there should be some adjustments made. However, rather than making rather small adjustments to the route-specific prices charged by the non-rail modes, the actual prices were assumed to be equal to the "optimal" prices. Given the lack of actual route-specific cost data, and the very small variation between the actual and the desired cost recovery levels, i t does not seem reasonable to attempt "fine-tuning" of prices. Chapter 6 201 Modal Fares 0 F. Summary This chapter calculated the modal fares based on f u l l economic costs. For f u l l cost recovery, automobile fares need to be increased by $0.0056 per passenger-mile to reflect the portion of infrastructure costs not paid for. Bus fares need to be decreased by 4.12% to reflect bus company profits, and then increased by $0,005 per passenger-mile to reflect under-recovery of infrastructure costs. Air fares need to be decreased by 1.45% to reflect airline profits, and then increased by $0.0138 per passenger-mile to reflect under-recovery of infrastructure costs. Rail costs need to be increased by $0.1769 per passenger-mile on non-corridor routes, and $0.1251 on corridor routes. Given that the non-rail modes are a l l subsidized by approximately 10%, and that i t would be p o l i t i c a l l y and administratively d i f f i c u l t to change user charges for a l l four modes, i t was decided to use as "optimal" fares, fares based on 90% of the f u l l economic costs as determined in this chapter, in order to determine the economic deadweight loss. Thus only r a i l fares need be altered as described above to achieve an efficient allocation of travel. Chapter 6 202 Modal Fares CHAPTER 7 THE EFFECT OF UNBALANCED MODAL SUBSIDIZATION ON MODAL VOLUMES AND ECONOMIC EFFICIENCY A. Introduction The calculations done in Chapter 6 showed that the air, automobile, and bus modes are a l l subsidized to roughly the same degree. Only r a i l enjoyed subsidy levels markedly different from the 10% level. For reasons discussed in Chapter 6, i t was decided to accept the 10% level of modal subsidization for all modes as being equivalent to f u l l -economic-cost pricing. This chapter examines the implications of straying from this optimal pricing scenario to the situation we actually have in Canada.^ These implications are quantified in two ways: i) in physical terms - the change in modal volumes that would occur given a change in policy; and i i ) in financial terms - the dollar cost of the economic efficiency loss incurred by the deviation from the ideal allocation of modal shares. In addition to the optimal costing scenario adopted above (10% subsidy for a l l modes), one other "optimal" costing policy i s examined. This is the '^This optimal pricing scenario is referred to as Scenario 1 (Base Case), and is dealt with in Section B. Chapter 7 203 Unbalanced Modal Subsidization provision of a subsidy of 10% to the air, automobile, and bus modes, and a subsidy of 30% to the r a i l mode. The consequences of deviation from this alternative "ideal" scenario to the actual Canadian situation is examined for the reader's benefit in case he or she believes that greater economic justifications for subsidization exists for r a i l than for any other mode. This pricing scenario is referred to as Scenario 2 (Alternative "Ideal" Case), and is dealt with in Section C. Finally, this chapter discusses some of the simplifications that were necessary in calculating the economic efficiency losses and ideal prices and volumes, and points out areas for additional research. B. Implications of Full-Economic-Cost Pricing: Scenario 1 (Base Case) i) physical effect on the intercity passenger system As mentioned above, there are two elements of interest here: change in modal volumes; and economic deadweight loss. The f i r s t step is to calculate the quantity of travel by each mode under full-economic-cost pricing.^ Since the imposition of full-economic-cost pricing on a l l modes would result in increases in fares for only the r a i l mode, the amount of travel would be expected to decrease for only the r a i l mode. Offsetting the decline 2 I n this section, "full-economic costs" is defined as a 10% subsidy level for a l l four modes. Since the air, automobile and bus modes a l l enjoy a subsidy level of very close to 10%, the actual prices were used as the optimal prices, rather than attempting to "fine-tune" marginal changes, as discussed in Chapter 6. Chapter 7 204 Unbalanced Modal Subsidization in r a i l patronage would be an increase in volumes on the other three modes, given their positive cross-price e l a s t i c i t y with respect to r a i l fare, and no change in their own fares. The optimal modal volumes are calculated u t i l i z i n g the el a s t i c i t i e s developed in Chapter 5 and the change in r a i l fares when f u l l economic cost pricing is used. The formula for these optimal travel volumes for the four modes i s : (7.1)-Ql - Qi p* - p r p* + p Equation 7.1 stems from the equation for the arc cross-price e l a s t i c i t y . 4 The arc' form is used, rather than the point form, since we are dealing with large price changes and not with changes at the margin. In equation 7.1, the variables "actual volume" (QA) and "price of r a i l " (P r) are given in the database used. The optimal r a i l fare (P*) is calculated as 1 - 0.10 =» 0.90 times the full-economic-cost price as determined in Chapter 3Note that the definition of price e l a s t i c i t y is simply "percentage change in quantity demanded given a one percent change in the price of the good." Percentage change, however, can be measured from two points: the s t a r t i n g point; and the ending point. Both are legitimate, and, unfortunately, give different results. In order to avoid this problem, the approach suggested by Lipsey, Sparks and Steiner (1976; p. 91) of using the percentage change with respect to the average of the two price and the two quantity results, i s adopted. 4Arc own-price el a s t i c i t y in the case of r a i l . Chapter 7 205 Unbalanced Modal Subsidization 6. The only unknown is ,' which is solved for using an iterative number search. 5 The results of this process are shown in Table 7.1. Under the f u l l -economic-cost pricing system aggregate air volume increases from 2,286,067 to 2,394,922 passengers per annum on the 52 routes, an increase of 108,855 (4.76%). Automobile volume increases from 88,788,673 to 89,075,409, an increase of 286,736 (0.32%), while bus volume increases from 647,192 to 669,651, an increase of 22,459 (3.47%). These increases, while not insignificant, are not l i k e l y to result in any major shake-up of these industries. The same cannot be said for the passenger r a i l industry. Under the f u l l -economic-cost pricing system, aggregate r a i l volume drops from 737,677 to 319,627, a decline of 418,050 (56.67%). As foreboding as this aggregate forecast may appear to the r a i l mode, the picture is even less attractive at the route level of analysis. Annual volumes would drop below 10 passengers on three of the non-corridor routes. 6 A further seven routes (also non-corridor) would have between 10 and 100 passengers per year, for a total of ten very marginal routes under full-economic-cost pricing. Of the nine non-corridor routes for which actual volumes were greater than 1,000, only three are 5Such a procedure is necessary since the unknown (Q*) appears in two places in equation 7.1. This is resolved by inserting an i n i t i a l "guesstimate" for Q* , comparing the result of the l e f t hand side of the equation to the known value of the right hand side, and i f i t is not close enough (+/- 0.01), incrementing (or decrementing) the value of by some number and repeating the procedure. 6Links incorporating North Bay, Sudbury, Thunder Bay or Winnipeg. Chapter 7 206 Unbalanced Modal Subsidization TABLE 7.1 ACTUAL VERSUS OPTIMAL MODAL VOLUMES: FULL-ECONOMIC-COST PRICING INCREASE INCREASE AIR VOLUME AIR VOLUME IN AIR BUS VOLUME BUS VOLUME IN BUS CITY-PAIR (ACTUAL) (OPTIMAL) VOLUME (%) (ACTUAL) (OPTIMAL) VOLUME (%) OTTAWA-QUEBEC 44,560 45,126 1.27 14,144 14,333 1.33 OTTAWA-MONTREAL 60,680 62,151 2.42 307,736 315,452 2.51 OSHAWA-MONTREAL 8,128 8,240 1.38 312 317 1.46 OSHAWA-OTTAWA 4,798 4,880 1.71 832 847 1.82 TORONTO-QUEBEC 73,820 77,365 4.80 1,768 1.857 5.02 TORONTO-MONTREAL 946,740 1,012,509 6.95 58,500 62,789 7.33 TORONTO-OTTAWA 480,440 490,471 2.09 96,252 98,358 2.19 GUELPH-MONTREAL 3.251 3,401 4.61 156 164 4.84 GUELPH-OTTAWA 1,919 1,953 1.77 1,404 1,430 1.86 KITCHNER-MONTREAL 8,940 9,079 1.56 572 581 1.66 KITCHNER-OTTAWA 5,287 5,391 1.96 2,340 2,388 2.07 HAMILTON-QUEBEC 2,200 2,245. 2.05 208 213 2.19 HAMILTON-MONTREAL 38,724 39,108 0.99 1,820 1,839 1.04 HAMILTON-OTTAWA 22,259 22,408 0.67 4,160 4,189 0.70 ST. CATHARINES-QUEBEC 1,069 1,174 9.83 156 172 10.38 ST. CATHARINES-MONTREAL 11,379 11,631 2.21 2,496 2,554 2.33 ST. CATHARINES-OTTAWA 6,717 6,792 1.11 3,952 3,998 1.17 LONDON-QUEBEC 3,340 3,536 5.86 52 55 6.23 LONDON-MONTREAL 33,280 34,300 3.06 988 1,020 3.23 LONDON-OTTAWA 30,720 31,503 2.55 2,184 2,243 2.69 LONDON-TORONTO 15,320 16,377 6.90 45,656 48,937 7.19 SARNIA-MONTREAL 4,506 4,667 3.58 52 54 3.77 SARNIA-OTTAWA 1,500 1,555 3.66 104 108 3.88 SARNIA-TORONTO 5,005 5,538 10.65 468 521 11.25 WINDSOR-MONTREAL 41,520 41,523 0.01 520 520 0.00 WINDSOR-OTTAWA 19,520 19,984 2.38 468 480 2.49 WINDSOR-TORONTO 92,800 106,713 14.99 15,444 17,906 15.94 WINDSOR-HAMILTON 2,165 2,208 2.01 2,808 2,867 2.12 WINDSOR-LONDON 80 85 5.85 6,708 7,124 6.20 NORTH BAY-MONTREAL 1,603 1,635 2.03 1,976 2,019 2.15 NORTH BAY-OTTAWA 500 506 1.21 8,164 8,268 1.27 NORTH BAY-TORONTO 10,875 11,039 1.51 16,640 16,900 1.56 NORTH BAY-LONDON 691 701 1.45 832 845 1.54 NORTH BAY-WINDSOR 518 526 1.64 312 318 1.76 SUDBURY-QUEBEC 620 622 0.24 52 52 0.00 SUDBURY-MONTREAL 4,773 4,869 2.01 1,508 1,540 2.15 SUDBURY-OTTAWA 5,455 5,534 1.45 4,420 4,488 1.53 SUDBURY-TORONTO 38,011 38.751 1.95 30,628 31,264 2.08 SUDBURY-HAMILTON 2,202 2,204 0.09 1,144 1,145 0.10 SUDBURY-LONDON 2,204 2,224 0.90 780 788 0.97 SUDBURY-SARNIA 325 326 0.28 52 52 0.00 SUDBURY-WINDSOR 1,450 1,461 0.78 416 420 0.85 THUNDER BAY-TORONTO 58,302 59,134 1.43 260 264 1.54 THUNDER BAY-SUDBURY 4,660 4,783 2.65 4.368 4,489 2.77 WINNIPEG-MONTREAL 30,895 32,233 4.33 312 326 4.60 WINNIPEG-OTTAWA 31,580 32,617 3.29 416 431 3.49 WINNIPEG-TORONTO 89,788 92,535 3.06 2,028 2,094 3.25 WINNIPEG-KITCHNER 3,503 3,539 1.02 156 158 1.11 WINNIPEG-HAMILTON 11,331 11,424 0.82 104 105 0.88 UINNIPEG-ST. CATHARINES 2,919 3,001 2.82 104 107 3.09 WINN I PEG-LONDON 7,311 7,447 1.85 208 212 1.99 WINNIPEG-WINDSOR 5,884 5,899 0.25 52 52 0.00 TOTAL/AVERAGE 2,286,067 2,394,922 4.76 647,192 669.651 3.47 Chapter 7 207 Unbalanced Modal Subsidization TABLE 7.1 (Continued) ACTUAL VERSUS OPTIMAL MODAL VOLUMES: FULL-ECONOMIC-COST PRICING AUTOMOBILE AUTOMOBILE INCREASE RAIL RAIL INCREASE VOLUME VOLUME IN AUTO VOLUME VOLUME IN RAIL CITY-PAIR (ACTUAL) (OPTIMAL) VOLUME (X) (ACTUAL) (OPTIMAL) VOLUME (X) OTTAWA-QUEBEC 82,619 83,537 1.11 2,888 1,215 •^57.92 OTTAWA-MONTREAL 1,709,952 1,746,326 2.13 83,561 38,000 -54.52 OSHAWA-MONTREAL 140,178 141,883 1.22 3,170 1,348 -57.48 OSHAWA-OTTAWA 81,252 82,447 1.47 2,154 862 -60.00 TORONTO-QUEBEC 38,804 40,387 4.08 8,410 3,194 -62.02 TORONTO-MONTREAL 899,628 954,596 6.11 219,526 94,500 -56.95 TORONTO-OTTAWA 498,858 507,872 1.81 36,000 14,850 -58.75 GUELPH-MONTREAL 63,684 66,215 3.97 4,498 1,809 -59.78 GUELPH-OTTAWA 32,940 33.443 1.53 938 375 -60.00 KITCHNER-MONTREAL 151,890 153,939 1.35 3,680 1,482 -59.73 KITCHNER-OTTAWA 78,690 80,025 1.70 2,478 991 -60.00 HAMILTON-QUEBEC 18,470 18,798 1.78 596 218 -63.36 HAMILTON-MONTREAL 251,442 253,608 0.86 4,359 1,790 -58.94 HAMILTON-OTTAWA 132,126 132,885 0.57 1,562 625 -60.00 ST. CATHARINES-QUEBEC 9,606 10,407 8.33 1,453 531 -63.44 ST. CATHARINES-MONTREAL 188,856 192,476 1.92 6,617 2,687 -59.40 ST. CATHARINES-OTTAWA 102,114 103,095 0.96 1,853 751 -59.46 LONDON-QUEBEC 10,685 11,216 4.97 1,134 404 -64.41 LONDON-MONTREAL 123,342 126,595 2.64 7,107 2,803 -60.56 LONDON-OTTAWA 60,390 61,712 2.19 3,555 1,392 -60.84 LONDON-TORONTO 1,094,340 1,160,894 6.08 131,792 60,900 -53.79 SARNIA-MONTREAL 40,626 41,888 3.11 2,276 850 -62.64 SARNIA-OTTAWA 19,032 19,631 3.15 1,046 388 -62.87 SARNIA-TORONTO 177,144 193,882 9.45 31,324 14,000 -55.31 WINDSOR-MONTREAL 81,281,252 81,285,914 0.01 7,365 2,700 -63.34 WINDSOR-OTTAWA 38,430 39,204 2.01 1,966 716 -63.56 WINDSOR-TORONTO 342,942 388,654 13.33 111,587 49,500 -55.64 WINDSOR-HAMILTON 159,210 162,017 1.76 5,083 2,173 -57.25 WINDSOR-LONDON 230,946 242,912 5.18 22,212 9,825 -55.77 NORTH BAY-MONTREAL 59,292 60,308 1.71 1,630 539 -66.93 NORTH BAY-OTTAWA 44,286 44,735 1.01 827 268 -67.58 NORTH BAY-TORONTO 118,950 120,443 1.26 2,932 1,015 -65.40 NORTH BAY-LONDON 13,176 13,336 1.22 274 91 -66.79 NORTH BAY-WINDSOR 8,052 8,162 1.37 179 55 -69.27 SUDBURY-QUEBEC 9,600 9,619 0.20 30 9 -70.00 SUDBURY-MONTREAL 83,448 84,878 1.71 2,298 739 -67.82 SUDBURY-OTTAWA 55,998 56,692 1.24 1,294 453 -64.98 SUDBURY-TORONTO 192,150 195,356 1.67 6,968 2,385 -65.77 SUDBURY-HAMILTON 50,874 50,915 0.08 66 22 -66.67 SUDBURY-LONDON 23,058 23,233 0.76 298 96 -67.79 SUDBURY-SARNIA 7,320 7.337 0.23 26 8 -69.23 SUDBURY-WINDSOR 15,372 15,472 0.65 164 49 -70.00 THUNDER BAY-TORONTO 20,130 20,375 1.21 1,630 549 -66.32 THUNDER BAY-SUDBURY 5,490 5,612 2.22 561 195 -65.24 WINNIPEG-MONTREAL 4,236 4,384 3.49 2,043 543 -73.43 WINNIPEG-OTTAWA 2,731 2,804 2.65 1,535 411 -73.26 WINNIPEG-TORONTO 5,131 5.260 2.51 4,088 1,146 -71.96 WINNIPEG-KITCHNER 1,987 2,004 0.84 74 20 -72.97 WINNIPEG-HAMILTON 2,629 2,646 0.66 152 41 -73.03 WINNIPEG-ST. CATHARINES 1,490 1,524 2.31 164 44 -73.17 WINNIPEG-LONDON 1,799 1,826 1.52 228 61 -73.25 WINNIPEG-WINDSOR 2,026 2,030 0.20 26 7 -73.08 TOTAL/AVERAGE 88,788,673 89,075,409 0.32 737,677 319,627 -56.67 Chapter 7 208 Unbalanced Modal Subsidization forecasted to retain at least 1,000 passengers. The patronage on the most heavily travelled non-corridor route (Sudbury-Toronto) drops from 6,968 to 2,385. The corridor routes do not fare too well under full-economic-cost pricing either. The number of routes with fewer than 1,000 passengers per year is expected to rise from two to eleven. The heavily travelled Toronto-Montreal link is expected to decline from almost 220,000 passengers per year to below 95,000. The conclusion must be that based on average corridor costs and the assumed e l a s t i c i t i e s , the passenger rail mode would cease to exist as a means of intercity travel on many routes in Canada if passengers were required to cover all costs as currently calculated under Costing Order R-6313J Two points need to be mentioned concerning the r a i l results. The f i r s t is that e l a s t i c i t i e s measure responsiveness at a point (point el a s t i c i t i e s ) or over a range (arc e l a s t i c i t i e s ) . Most of the el a s t i c i t i e s taken from econometric studies and ut i l i z e d to synthesize the price e l a s t i c i t i e s used in this thesis were point e l a s t i c i t i e s . Even for those that were based on arc 'Various authors (e.g. Cubukgil and Soberman (1984), CTC (1984)) suggest that VIA Rail's payments to CN and CP would drop i f R-6313 were abandoned in favour of a costing system similar to the arrangement Amtrak has with the U.S. railroads. Under such a scenario, full-economic-cost pricing would result in a lesser increase in r a i l fares and a greater degree of v i a b i l i t y . It could be argued that this lower cost would represent f u l l economic costs because VIA Rail currently pays for items the railways would s t i l l be forced to cover even i f VIA Rail ceased operations tomorrow. In other words, VIA Rail currently pays for more than the incremental cost the railways incur in providing passenger-related services and could be seen, in effect, as subsidizing freight movements. This issue, however, is far from resolved. Chapter 7 209 Unbalanced Modal Subsidization e l a s t i c i t y measurements, there arises a possible problem. The change in r a i l fares brought about by the elimination of subsidization is huge. We are no longer dealing with responsiveness over a range established by the existing observations from which the e l a s t i c i t i e s were measured, let alone at the margin. However, given the available data, there is no way to avoid this problem when dealing with unprecedented changes of this magnitude. The only recourse is to assume that the e l a s t i c i t y results hold (at least approximately) outside of the range they were estimated for. The second is that the huge increase in r a i l fare under the optimal pricing scheme introduces a problem in forecasting volumes of the other modes. The cross-price e l a s t i c i t i e s of air, automobile, and bus with respect to the price of air are based on relatively small changes in the r a i l fare. In other words, i t is reasonable to expect that a 1% increase in rail fares w i l l , for example, increase a i r volumes by 0.3%; i t is not reasonable to assume that a 300% increase in r a i l fare w i l l increase air volume by 90%. This results in a problem since the calculation represented by equation 7.1 does not take into account the magnitude of the "pool" of r a i l travellers these other modes are drawing from. 8 The actual calculations indicate that the increase in r a i l fare w i l l increase air, automobile, and bus volumes by more than r a i l decreases. In fact, in some cases the increase in the other modes is found to be a number greater than the actual r a i l volumes were to start with. 8 I n other words, the aforementioned 0.3% increase in a i r volume w i l l represent a portion of the actual r a i l volume; the 90% increase w i l l represent a number larger than the entire r a i l volume, in many cases. Chapter 7 210 Unbalanced Modal Subsidization This problem is resolved by limiting the total increase in air, automobile and bus patronage to the decrease in r a i l passenger volumes. In other words, aggregate demand is held to a constant l e v e l . 9 The results presented in Table 7.1 show the "adjusted" optimal modal volumes, rather than the volumes that s t r i c t application of equation 7.1 would indicate. i i ) magnitude of deadweight loss The previous sub-section presented the effects on the intercity passenger network that would be anticipated by moving from the current situation to one based on full-economic-cost pricing. This sub-section deals with the economic deadweight loss that is incurred by not moving from the current situation to one based on full-economic-cost pricing. This is done in two stages. The f i r s t step is the calculation of deadweight loss arising in the corridor region under examination. The next step is to extrapolate the result to the national level. Figure 7.1 illustrates the area defined as economic deadweight loss, and indicates the information required to measure i t . For the r a i l mode, the calculation is quite simple, since we have only one demand curve to deal with. The deadweight loss is given by equation 7.2. yThis follows the procedure of Friedlaender, (1971), Boyer (1977), and Levin (1978). Oum (1982) pointed out that i t would be more appropriate to hold aggregate demand to a fixed demand curve, rather than a fixed point. However, this refinement was not attempted in this thesis. Chapter 7 211 Unbalanced Modal Subsidization FIGURE 7.1 Deadweight Loss Measurement for Rail and Non-Rail Modes Price ($) Rail Mode Marginal Cost Quantity (units of passenger service per period) Non-Rail Modes Marginal Cost D, given adjustment to rail prices Quantity (units of passenger service per period) Chapter 7 212 Unbalanced Modal Subsidization (7.2) DWL. ' r a i l = X/2 * K Q ? - Qr>l ' \(K - ? r ) l This represents the difference between the two pricing cases of the total consumer value of the service less the cost incurred in producing this service. Two of the variables in the equation are historical data (actual price and quantity); "optimal" price is 1 - 0.10 - 0.90 times the f u l l -economic-cost prices as determined in Chapter 6; "optimal" quantity is as determined in the previous sub-section. The calculation is somewhat more complicated for the other three modes since two demand curves enter the picture -- the original demand curve and the shifted demand curve after r a i l fares are adjusted. The deadweight loss is determined by the formula below: Again, two of these variables are given since they are actual historical data. One of the other variables, "optimal" quantity is determined in the previous subsection. This leaves the variable -- the price on the adjusted demand curve corresponding to the actual quantity of travel -- as the only unknown. This is calculated in an analogous manner to the variable Q*L in the previous subsection. (7.3) DWLi Chapter 7 213 Unbalanced Modal Subsidization The percentage change of quantity demanded (Qj - Q i)/((Qi + Qi)/2) can easily be determined. We also know the own-price el a s t i c i t y and the starting point of the price variable. It is thus easy to solve for the desired point on the adjusted demand curve by solving for the value which equates the percentage change in price with the percentage change in quantity divided by the own-price elasticity, as shown in equation 7.4. (7.4) Q 1 - Qi f Q; + Qi 1 . 2 . 2 Again, this is accomplished using an iterative number search. Table 7.2 shows the results of this computation, and compares these prices to the actual prices. The economic deadweight loss can now be determined, as per equations 7.2 and 7.3. Table 7.3 shows the deadweight loss by route. Under full-economic-cost pricing, the deadweight loss for the 52 routes analyzed is about $6,781,000 in 1976 d o l l a r s . 1 0 This represents less than 0.25% of total modal expenditures on intercity passenger services. By far the greatest distortion occurs for the r a i l mode. In fact, just under 96% of the total economic inefficiency costs occurs in the r a i l sector. The r a i l economic efficiency loss represents about 18% of total r a i l costs. 1 0 T h i s is about $13,460,300 in 1986 dollars. Chapter 7 214 Unbalanced Modal Subsidization TABLE 7.2 ACTUAL PRICE COMPARED TO PRICE ON ADJUSTED DEMAND CURVE CORRESPONDING TO ACTUAL QUANTITY AIR BUS AUTOMOBILE PRICE ON PRICE ON AUTOMOBILE PRICE ON AIR FARE ADJUSTED AIR BUS FARE ADJUSTED BUS COST ADJUSTED AUTC (CENTS) DEMAND CURVE (CENTS) DEMAND CURVE (CENTS) DEMAND CURVE CITY-PAIR (ACTUAL) (CENTSKPa') (ACTUAL) (CENTS)(Pb') (ACTUAL) (CENTSKPc') OTTAWA-QUEBEC 4,512 4,564 1,631 1,648 1,463 1,482 OTTAWA-MONTREAL 3,156 3,226 867 884 605 619 OSHAWA-MONTREAL 5,551 5,621 1,835 1,856 1,528 1,548 OSHAWA-OTTAWA 4.642 4,714 1,430 1,451 1,134 1,152 TORONTO-QUEBEC 6,482 6,766 2.764 2,875 2,673 2,795 TORONTO-MONTREAL 5,349 5,684 2,000 2,116 1,662 1,773 TORONTO-OTTAWA 4,440 4.524 1,540 1,567 1,268 1,294 GUELPH-MONTREAL 5,488 5,717 2,198 2,282 1,916 1,999 GUELPH-OTTAWA 4,579 4,653 1,738 1,764 1,521 1,547 KITCHNER-MONTREAL 5,623 5,703 2,289 2,319 1,929 1,958 KITCHNER-OTTAWA 4,733 4,818 1,829 1,859 1,535 1,564 HAMILTON-QUEBEC 6,648 6,771 2,886 2,936 3,849 3,923 HAMILTON-MONTREAL 5,498 5,548 2,133 2,151 1,852 1,870 HAMILTON-OTTAWA 4,605 4,633 1,662 1,671 1,458 1,468 ST. CATHARINES-QUEBEC 6,879 7,492 3,148 3,409 4,069 4,441 ST. CATHARINES-MONTREAL 5,321 5,428 2,384 2,428 1,750 1,788 ST. CATHARINES-OTTAWA 4,916 4,965 1,924 1,942 1,366 1,381 LONDON-QUEBEC 6,939 7,306 3,239 3,400 4,272 4,504 LONDON-MONTREAL 6,084 6,253 2,475 2,539 2,184 2,247 LONDON-OTTAWA 5,202 5,322 2,015 2,058 1,789 1,832 LONDON-TORONTO 3,089 3,282 783 828 521 556 SARNIA-MONTREAL 6,416 6,624 2,729 2,810 2,646 2,736 SARNIA-OTTAWA 5,728 5,917 2,269 2,337 2,251 2,329 SARNIA-TORONTO 3,616 3,962 1,037 1,129 983 1,087 WINDSOR-MONTREAL 6,720 6,721 2,961 2,962 2,695 2,696 WINDSOR-OTTAWA 6,162 6,296 2,501 2,550 2,301 2,352 WINDSOR-TORONTO 4,081 4,633 1,269 1,418 1,032 1,185 WINDSOR-HAMILTON 4,062 4,136 991 1,008 843 859 WINDSOR-LONDON 4,845 5,103 614 644 511 540 NORTH BAY-MONTREAL 5,885 5,994 2,078 2,114 1,742 1,775 NORTH BAY-OTTAWA 4,722 4,774 1,343 1,356 1,137 1,150 NORTH BAY-TORONTO 4,004 4,059 1,341 1,358 1,074 1,089 NORTH BAY-LONDON 4,768 4,831 1,816 1,838 1,595 1,617 NORTH BAY-WINDSOR 5,760 5,846 2,302 2,334 2,107 2,139 SUDBURY-QUEBEC 6,952 6,968 3,268 3.275 4,162 4,172 SUDBURY-MONTREAL 6,634 6,754 2,504 2.547 2,132 2,172 SUDBURY-OTTAWA 4,746 4,808 1,769 1,791 1,527 1,548 SUDBURY-TORONTO 4,327 4,403 1,597 1,623 1,254 1,278 SUDBURY-HAMILTON 4,484 4,488 1,719 1,720 1,444 1.446 SUDBURY-LONDON 5,090 5,132 2,072 2,089 1,775 1,790 SUDBURY-SARNIA 5,618 5,632 2,326 2,331 2,237 2,243 SUDBURY-WINDSOR 6,066 6,109 2,558 2,576 2,222 2,238 THUNDER BAY-TORONTO 7,132 7,224 4,884 4.944 5,373 5,446 THUNDER BAY-SUDBURY 6,131 6,278 3,353 3,426 4,118 4,222 WINNIPEG-MONTREAL 10,906 11,335 5,517 5,718 9,716 10,086 WINNIPEG-OTTAWA 10,620 10,938 4,967 5,104 9,480 9,765 WINNIPEG-TORONTO 9,564 9,828 5,115 5,248 9,095 9,355 WINNIPEG-KITCHNER 9,810 9,900 5,294 5,341 9,375 9,463 WINNIPEG-HAMILTON 9,721 9,793 5,237 5,273 9,271 9,340 WINNIPEG-ST. CATHARINES 11,914 12,220 5,504 5,638 9,491 9,733 WINN I PEG-LONDON 9,764 9,928 5,590 5,678 9,694 9,855 WINNIPEG-WINDSOR 6,863 6,879 6,076 6,089 9,205 9,226 Chapter 7 215 Unbalanced Modal Subsidization TABLE 7.3 DEADWEIGHT LOSS: BASE CASE DEFINITION OF FULL-ECONOMIC-COST PRICING DEADWEIGHT LOSS: DEADWEIGHT LOSS: DEADWEIGHT LOSS: DEADWEIGHT LOSS: CITY-PAIR AIR MODE ($) BUS MODE ($) AUTO MODE ($) RAIL MODE ($) OTTAWA-QUEBEC 147 16 86 26,832 OTTAWA-MONTREAL 511 656 2,555 302,576 OSHAWA-MONTREAL 39 0 173 31,071 OSHAWA-OTTAWA 30 2 110 17,821 TORONTO-QUEBEC 5,034 49 965 147,661 TORONTO-MONTREAL 110,163 2,488 30,507 2,357,246 TORONTO-OTTAWA 4,233 284 1,157 329,724 GUELPH-MONTREAL 172 3 1,051 58,110 GUELPH-OTTAWA 13 3 66 10,326 KITCHNER-MONTREAL 56 1 300 49,235 KITCHNER-OTTAWA 44 7 196 28,451 HAMILTON-QUEBEC 28 1 122 11,455 HAMILTON-MONTREAL 96 2 190 53,641 HAMILTON-OTTAWA 21 1 38 16,510 ST. CATHARINES-QUEBEC 322 21 1,489 29,312 ST. CATHARINES-MONTREAL 135 13 679 87,814 ST. CATHARINES-OTTAWA 18 4 72 20,897 LONDON-QUEBEC 359 3 616 25,446 LONDON-MONTREAL 862 10 1,025 109,494 LONDON-OTTAWA 470 13 283 47,964 LONDON-TORONTO 1,020 738 11,647 466,813 SARNIA-MONTREAL 168 1 568 40,759 SARNIA-OTTAWA 52 1 233 16,655 SARNIA-TORONTO 922 24 8,704 170,626 WINDSOR-MONTREAL 0 0 23 147,028 WINDSOR-OTTAWA 311 3 197 35,235 WINDSOR-TORONTO 38,399 1,834 34,970 782,724 WINDSOR-HAMILTON 16 5 231 31,115 WINDSOR-LONDON 6 63 1,742 75,989 NORTH BAY-MONTREAL 18 8 170 30,310 NORTH BAY-OTTAWA 2 7 29 10,500 NORTH BAY-TORONTO 45 23 110 34,801 NORTH BAY-LONDON 3 1 18 5,026 NORTH BAY-WINDSOR 4 1 18 4,472 SUDBURY-QUEBEC 0 0 1 1,000 SUDBURY-MONTREAL 58 7 288 53,351 SUDBURY-OTTAWA 25 7 74 21,217 SUDBURY-TORONTO 282 83 377 95,950 SUDBURY-HAMILTON 0 0 0 1,047 SUDBURY-LONDON 4 1 13 6,110 SUDBURY-SARNIA 0 0 1 625 SUDBURY-WINDSOR 2 0 8 4,460 THUNDER BAY-TORONTO 384 1 89 70,133 THUNDER BAY-SUDBURY 91 44 63 16,083 WINNIPEG-MONTREAL 2,870 14 273 166,107 WINNIPEG-OTTAWA 1,650 10 103 114,401 WINNIPEG-TORONTO 3,626 44 167 286,619 WINNIPEG-KITCHNER 16 0 7 5,532 WINNIPEG-HAMILTON 33 0 6 11,134 WINNIPEG-ST. CATHARINES 126 2 42 12,246 WINN IPEG-LONDON 111 2 22 17,827 WINNIPEG-WINDSOR 1 0 0 2,192 TOTAL $172,997 $6,504 $101,875 $6,499,670 Chapter 7 216 Unbalanced Modal Subsidization The distortion to the bus mode is minimal, and to air and automobile, f a i r l y insignificant in absolute terms. The percentage that the economic efficiency loss for each mode represents of each mode's total costs is 0.13% for air, 0.08% for bus, and essentially zero for automobile. These calculations, however, deal with only 52 routes in the Canadian passenger network. The next step is to extrapolate this to the level of the entire intercity system. Unfortunately, this is not a straight-forward calculation. The approximation used is to express the deadweight loss in dollars of economic distortion per dollar of r a i l subsidy (above the 10% "optimal" level), and apply this to the 1986 excess VIA Rail subsidy of $394,205,000.11 Since the total economic distortion of $6,781 million arises from the unbalanced (excessive) r a i l subsidy of $20,830 m i l l i o n , 1 2 each dollar of r a i l subsidy causes an additional $0.33 in economic deadweight loss. This suggests a national deadweight loss of $130,088,000 in 1986. ^ S t a t i s t i c s Canada, Catalogue 52-003, gives 1986 passenger r a i l expenditures of $676,757,000. Of this amount, $461,881,000 was covered by government subsidy. Applying the 10% subsidy rate suggests the appropriate subsidy level for 1986 was $67,676,000, indicating excessive r a i l subsidization of about $394,205,000. 1 2The actual r a i l sector expenditures for the 52 routes was $37,648,656, of which $24,595,232 was expanded by the government. Allowing 10% of total costs as the allowable subsidy level, the government should only expend $3,764,866 on passenger services. Actual expenditures exceeded this amount by $20,830,366. Chapter 7 217 Unbalanced Modal Subsidization There are several problems with this approach. First, i t assumes that the e l a s t i c i t i e s selected for the corridor apply equally to a l l regions of the country. As discussed in Appendix B, this is l i k e l y true only i f regional differences in population (or population density), income and linguistic comparability of points has been expl i c i t l y taken care of in the modelling approach that produced the e l a s t i c i t i e s . Since the e l a s t i c i t i e s u t i l i z e d are based on U.S., U.K., and Australian results (as well as Canadian), there is some question as to the applicability of the e l a s t i c i t i e s . Second, some routes in western and Atlantic Canada play a very different role than their central-Canada counterparts. While most passenger r a i l services in central Canada are primarily oriented towards short-haul travel by local residents, a significant portion of r a i l travel in western and Atlantic Canada is relatively long-haul tourist travel. To the extent that this portion of the market sees r a i l travel as an attraction in i t s e l f , as opposed to a means to achieve a movement from point A to point B, the degree of distortion w i l l be less outside central Canada. In other words, i f the situation is such that i f these tourists could not take the train, they would not travel in Canada at a l l , their subsidized fares would not distort the volumes of other modes.xJ i J T h i s is not to say no economic efficiency loss is incurred by subsidizing tourist r a i l fares. Domestic (and perhaps foreign) tourists might have otherwise spent their money on Canadian goods and/or services whose production costs more closely resemble the u t i l i t y obtained. Even i f they would not have done so, these tourists would be consuming resources that cost more than they earn in passenger r a i l revenue. Unless this is more than offset by externality effects of the influx of foreign tourist dollars (or the prevention of an exodus of domestic dollars for tourism elsewhere), this imposes a net cost on the Canadian economy. Chapter 7 218 Unbalanced Modal Subsidization In a similar fashion, remote services l i k e l y cause a lesser economic efficiency loss simply because few, i f any alternatives exist for many travellers. In this case, no other modal volumes are d i s t o r t e d . 1 4 Third, while the per dollar distortion caused by r a i l subsidies might be less for services such as the "Canadian", the "Super Continental" and the "Atlantic", this is offset somewhat since there are more dollars of distortion-causing subsidy to deal with. These services cover a far lesser proportion of their total costs than do the corridor routes. 1 5 Fourth, there is a significant portion of the market which views r a i l and air travel as complements and not as substitutes. For travellers who desire to travel one way by r a i l and return by air, increases in r a i l fares may result in a decision to not travel at a l l , and hence decrease air volumes. This would tend to offset the aggregate amount of deadweight loss since i t acts in the opposite direction to the "usual" situation. Unfortunately, given the lack of available data, i t is impossible to state the net impact of these conflicting factors. The most easily defensible position is to use the national estimate as calculated above and state the 1 4Again, this is not to say that no economic efficiency loss w i l l occur. If subsidized passenger r a i l service is inhibiting the entry of an alternative mode, an efficiency loss exists. In addition, subsidized travel may cause consumers to consume relatively too much travel, and diminish expenditures on alternative goods and services whose cost of production consumes far fewer resources than transportation but which provide about the same level of u t i l i t y . 1 5 C u b u k g i l and Soberman (1986) provide data which shows the transcontinental service recovered only about 25% of their total costs, while corridor service recovered about 35% of total costs in 1984. Chapter 7 219 Unbalanced Modal Subsidization caveats. Given that degree of competition between r a i l and other modes is less outside the central Canada region, at least for a substantial portion of the market, this national estimate is l i k e l y an upper bound for the deadweight loss. C. Implications of Full-Economic-Cost Pricing: Scenario 2 (Alternative "Ideal" Case) i) physical effect on the intercity passenger system This scenario assumes that the full-economic-cost pricing system would result in a 10% subsidy to the air, automobile and bus modes, and a 30% subsidy to the r a i l mode. The procedure follows exactly that of section B. Table 7.4 compares the r a i l fares under this costing scenario to those of the base case definition of f u l l economic costs and to the actual r a i l fares charged. Table 7.5 illustrates the changes in modal volumes that would be expected in moving from the current pricing system to this scenario's definition of f u l l economic costs. Aggregate air volumes would be expected to rise by 98,077 passengers per year to 2,384,144, an increase of about 4.3% over the actual level. Automobile travel would be expected to rise by a greater absolute amount, 258,777 passengers per year, although this represents a very marginal percentage increase of 0.29% over the actual level. The bus mode would be expected to benefit from a f a i r l y low absolute increase of 19,839, but this represents a slightly greater than 3% increase over the existing level. These increases are less than those experienced under the base case scenario (as Chapter 7 220 Unbalanced Modal Subsidization TABLE 7.4 RAIL FARES UNDER ALTERNATIVE FULL-COST DEFINITION BASE CASE ALTERNATIVE CASE ACTUAL FULL ECONOMIC FULL ECONOMIC RAIL FARE COST RAIL FARE COST RAIL FARE CITY-PAIR (CENTS) (CENTS) (CENTS) OTTAWA-QUEBEC 1.951 5,159 4,446 OTTAWA-MONTREAL 942 2,270 1,975 OSHAWA-MONTREAL 2,120 5,531 4,773 OSHAWA-OTTAWA 1,485 4,243 3,630 TORONTO-QUEBEC 2,775 8,437 7,179 TORONTO-MONTREAL 2,366 6,137 5,299 TORONTO-OTTAWA 1,781 4,899 4,206 GUELPH-MONTREAL 2,448 6,770 5,810 GUELPH-OTTAWA 1.988 5,658 4,842 KITCHNER-MONTREAL 2,520 7,000 6,004 KITCHNER-OTTAWA 2,135 5,962 5,112 HAMILTON-QUEBEC 2,876 8,943 7,595 HAMILTON-MONTREAL 2,442 6,618 5,690 HAMILTON-OTTAWA 1,957 5,480 4,697 ST. CATHARINES-QUEBEC 2,948 9,308 7,894 ST. CATHARINES-MONTREAL 2,564 7,033 6,040 ST. CATHARINES-OTTAWA 2,179 5,972 5,129 LONDON-QUEBEC 3,154 10,122 8,573 LONDON-MONTREAL 2,670 7,758 6,627 LONDON-OTTAWA 2,310 6,745 5,759 LONDON-TORONTO 959 2,276 1,983 SARNIA-MONTREAL 2,770 8,488 7,217 SARNIA-OTTAWA 2,460 7,525 6,400 SARNIA-TORONTO 1,334 3,304 2,866 WINDSOR-MONTREAL 2,981 9,284 7,884 WINDSOR-OTTAWA 2,621 8,260 7,007 WINDSOR-TORONTO 1,655 4,176 3,616 WINDSOR-HAMILTON 1,346 3,485 3,009 WINDSOR-LONDON 799 2,026 1,753 NORTH BAY-MONTREAL 2,223 7,779 6,545 NORTH BAY-OTTAWA 1,463 5,220 4,385 NORTH BAY-TORONTO 1,562 5,192 4,385 NORTH BAY-LONDON 2,166 7,659 6,438 NORTH BAY-WINDSOR 2,527 9,739 8,136 SUDBURY-QUEBEC 3,187 12,708 10,592 SUDBURY-MONTREAL 2,603 9,449 7.928 SUDBURY-OTTAWA 2,168 7,215 6,093 SUDBURY-TORONTO 1,792 5,979 5,049 SUDBURY-HAMILTON 1,968 6,728 5,671 SUDBURY-LONDON 2,321 8,371 7,027 SUDBURY-SARNIA 2,471 9,413 7,870 SUDBURY-WINDSOR 2,632 10,401 8,675 THUNDER BAY-TORONTO 5,331 18,307 15,423 THUNDER BAY-SUDBURY 3,843 12,631 10,678 WINNIPEG-MONTREAL 5,942 28,088 23,167 WINNIPEG-OTTAWA 5,632 25,979 21,457 WINNIPEG-TORONTO 5,731 25,218 20,888 WINN I PEG-KITCHNER 5,610 26,100 21,547 WINNIPEG-HAMILTON 5,632 25,692 21,235 WINNIPEG-ST. CATHARINES 5,654 26,065 21.529 WINNIPEG-LONDON 5,810 27,160 22,416 WINNIPEG-WINDSOR 6,221 29,291 24,164 Chapter 7 221 Unbalanced Modal S u b s i d i z a t i o n TABLE 7.5 ACTUAL VERSUS OPTIMAL MODAL VOLUMES: ALTERNATIVE "FULL-COST" SCENARIO INCREASE INCREASE AIR VOLUME AIR VOLUME IN AIR BUS VOLUME BUS VOLUME IN BUS CITY-PAIR (ACTUAL) (OPTIMAL) VOLUME (%) (ACTUAL) (OPTIMAL) VOLUME (%) OTTAWA-QUEBEC 44,560 45,067 1.14 14,144 14,310 1.18 OTTAWA-MONTREAL 60,680 61,962 2.11 307,736 314,465 2.19 OSHAWA-MONTREAL 8,128 8,227 1.22 312 316 1.26 OSHAWA-OTTAWA 4,798 4,871 1.52 832 845 1.59 TORONTO-QUEBEC 73,820 77,055 4.38 1,768 1,849 4.58 TORONTO-MONTREAL 946,740 1,005,961 6.26 58,500 62,357 6.59 TORONTO-OTTAWA 480,440 489,450 1.88 96,252 98,134 1.96 GUELPH-MONTREAL 3,251 3,380 3.97 156 162 4.13 GUELPH-OTTAWA 1,919 1,949 1.56 1,404 1,427 1.63 KITCHNER-MONTREAL 8,940 9,061 1.36 572 580 1.42 KITCHNER-OTTAWA 5,287 5,378 1.72 2,340 2,382 1.79 HAMILTON-QUEBEC 2,200 2,240 1.84 208 212 1.95 HAMILTON-MONTREAL 38,724 39,062 0.87 1,820 1,836 0.90 HAMILTON-OTTAWA 22,259 22,389 0.58 4,160 4,185 0.61 ST. CATHARINES-QUEBEC 1,069 1.163 8.78 156 171 9.33 ST. CATHARINES-MONTREAL 11,379 11,600 1.95 2,496 2,546 2.02 ST. CATHARINES-OTTAWA 6,717 6,782 0.97 3,952 3,992 1.01 LONDON-QUEBEC 3,340 3,515 5.23 52 55 5.51 LONDON-MONTREAL 33,280 34,187 2.73 988 1,016 2.83 LONDON-OTTAWA 30,720 31,427 2.30 2,184 2,236 2.40 LONDON-TORONTO 15,320 16,241 6.01 45,656 48,531 6.30 SARNIA-MONTREAL 4,506 4,652 3.23 52 54 3.41 SARNIA-OTTAWA 1,500 1,549 3.26 104 108 3.42 SARNIA-TORONTO 5,005 5,476 9.42 468 513 9.64 WINDSOR-MONTREAL 41,520 41,522 0.01 520 520 0.00 WINDSOR-OTTAWA 19,520 19,939 2.14 468 478 2.24 WINDSOR-TORONTO 92,800 105.231 13.40 15,444 17,619 14.08 WINDSOR-HAMILTON 2,165 2,203 1.78 2,808 2,860 1.85 WINDSOR-LONDON 80 84 5.27 6,708 7,075 5.47 NORTH BAY-MONTREAL 1,603 1,632 1.81 1,976 2,014 1.92 NORTH BAY-OTTAWA 500 505 1.08 8,164 8,258 1.15 NORTH BAY-TORONTO 10,875 11,020 1.33 16,640 16,875 1.41 NORTH BAY-LONDON 691 700 1.30 832 843 1.38 NORTH BAY-WINDSOR 518 526 1.49 312 317 1.57 SUDBURY-OUEBEC 620 621 0.23 52 52 0.00 SUDBURY-MONTREAL 4,773 4,861 1.84 1,508 1,537 1.95 SUDBURY-OTTAWA 5,455 5,527 1.32 4,420 4,482 1.40 SUDBURY-TORONTO 38,011 38,677 1.75 30,628 31,192 1.84 SUDBURY-HAMILTON 2,202 2,204 0.08 1,144 1,145 0.09 SUDBURY-LONDON 2,204 2,222 0.81 780 787 0.86 SUDBURY-SARNIA 325 326 0.26 52 52 0.00 SUDBURY-WINDSOR 1,450 1,460 0.70 416 419 0.74 THUNDER BAY-TORONTO 58,302 59,064 1.31 260 264 1.40 THUNDER BAY-SUDBURY 4,660 4,772 2.40 4,368 4,478 2.52 WINNIPEG-MONTREAL 30,895 32,169 4.12 312 325 4.32 WINNIPEG-OTTAWA 31,580 32,559 3.10 416 430 3.34 WINNIPEG-TORONTO 89,788 92,387 2.89 2,028 2.092 3.14 WINNIPEG-KITCHNER 3,503 3,536 0.95 156 158 1.03 WINNIPEG-HAMILTON 11,331 11,417 0.76 104 105 0.82 WINNIPEG-ST. CATHARINES 2,919 2,996 2.65 104 107 2.79 WINNIPEG-LONDON 7,311 7,438 1.74 208 212 1.83 WINNIPEG-WINDSOR 5,884 5,898 0.23 52 52 0.00 TOTAL/AVERAGE 2,286,067 2,384,144 4.29 647,192 667,031 3.07 Chapter 7 222 Unbalanced Modal Subsidization TABLE 7.5 (Continued) ACTUAL VERSUS OPTIMAL MODAL VOLUMES: ALTERNATIVE "FULL-COST" SCENARIO AUTOMOBILE AUTOMOBILE INCREASE RAIL RAIL INCREASE VOLUME VOLUME IN AUTO VOLUME VOLUME IN RAIL CITY-PAIR (ACTUAL) (OPTIMAL) VOLUME (X) (ACTUAL) (OPTIMAL) VOLUME (X) OTTAWA-QUEBEC 82,619 83,453 1.01 2,888 1,380 -52.22 OTTAWA-MONTREAL 1,709,952 1,742,251 1.89 83,561 43,250 -48.24 OSHAWA-MONTREAL 140,178 141,695 1.08 3,170 1,550 -51.10 OSHAWA-OTTAWA 81,252 82,355 1.36 2,154 965 -55.20 TORONTO-QUEBEC 38,804 40,308 3.88 8,410 3,590 -57.31 TORONTO-MONTREAL 899,628 949,827 5.58 219,526 106,250 -51.60 TORONTO-OTTAWA 498,858 507,216 1.68 36,000 16,750 -53.47 GUELPH-MONTREAL 63,684 65,947 3.55 4,498 2, ioo -53.31 GUELPH-OTTAWA 32,940 33,400 1.40 938 425 -54.67 KITCHNER-MONTREAL 151,890 153,740 1.22 3,680 1,700 -53.80 KITCHNER-OTTAWA 78,690 79,900 1.54 2,478 1,135 -54.20 HAMILTON-QUEBEC 18,470 18,768 1.61 596 253 -57.48 HAMILTON-MONTREAL 251,442 253,397 0.78 4,359 2,050 -52.97 HAMILTON-OTTAWA 132,126 132,818 0.52 1,562 715 -54.24 ST. CATHARINES-QUEBEC 9,606 10,349 7.74 1,453 601 -58.62 ST. CATHARINES-MONTREAL 188,856 192,141 1.74 6,617 3,060 -53.76 ST. CATHARINES-OTTAWA 102,114 103,004 0.87 1,853 858 -53.70 LONDON-QUEBEC 10,685 11,178 4.61 1,134 464 -59.12 LONDON-MONTREAL 123,342 126,314 2.41 7,107 3,200 -54.97 LONDON-OTTAWA 60,390 61,620 2.04 3,555 1,565 -55.98 LONDON-TORONTO 1,094,340 1,153,585 5.41 131,792. 68,750 -47.83 SARNIA-MONTREAL 40,626 41,789 2.86 2,276 965 -57.60 SARNIA-OTTAWA 19,032 19,581 2.88 1,046 445 -57.46 SARNIA-TORONTO 177,144 192,002 8.39 31,324 15,950 -49.08 WINDSOR-MONTREAL 81,281,252 81,285,514 0.01 7,365 3,100 -57.91 WINDSOR-OTTAWA 38,430 39,151 1.88 1,966 816 -58.47 WINDSOR-TORONTO 342,942 384,423 12.10 111,587 55,500 -50.26 WINDSOR-HAMILTON 159,210 161.703 1.57 5,083 2,500 -50.82 WINDSOR-LONDON 230,946 241.787 4.69 22,212 11,000 -50.48 NORTH BAY-MONTREAL 59,292 60,231 1.58 1,630 624 -61.72 NORTH BAY-OTTAWA 44,286 44,701 0.94 827 313 -62.14 NORTH BAY-TORONTO 118,950 120,332 1.16 2.932 1,170 -60.10 NORTH BAY-LONDON 13,176 13,325 1.13 274 105 -61.68 NORTH BAY-WINDSOR 8,052 8,154 1.27 179 64 -64.25 SUDBURY-QUEBEC 9,600 9,618 0.19 30 10 -66.67 SUDBURY-MONTREAL 83,448 84,779 1.59 2,298 850 -63.01 SUDBURY-OTTAWA 55,998 56,645 1.16 1,294 513 -60.34 SUDBURY-TORONTO 192,150 195,088 1.53 6,968 2,800 -59.82 SUDBURY-HAMILTON 50,874 50,911 0.07 66 26 -60.61 SUDBURY-LONDON 23,058 23,220 0.70 298 111 -62.75 SUDBURY-SARNIA 7,320 7,336 0.22 26 9 -65.38 SUDBURY-WINDSOR 15,372 15,465 0.60 164 58 -64.63 THUNDER BAY-TORONTO 20,130 20,361 1.15 1,630 634 -61.10 THUNDER BAY-SUDBURY 5,490 5,604 2.07 561 225 -59.89 WINNIPEG-MONTREAL 4,236 4,379 3.37 2,043 613 -70.00 WINNIPEG-OTTAWA 2.731 2,803 2.64 1,535 471 -69.35 WINNIPEG-TORONTO 5,131 5,256 2.44 4,088 1,300 -68.20 WINNIPEG-KITCHNER 1,987 2.003 0.81 74 23 -68.92 WINNIPEG-HAMILTON 2,629 2,646 0.65 152 48 -68.42 WINNIPEG-ST. CATHARINES 1,490 1.523 2.20 164 51 -68.90 WINN IPEG-LONDON 1,799 1,825 1.45 228 71 -68.86 WINNIPEG-WINDSOR 2,026 2.030 0.20 26 8 -69.23 TOTAL/AVERAGE 88,788,673 89,047,450 0.29 737,677 360,984 -51.06 Chapter 7 223 Unbalanced Modal Subsidization expected) because of the smaller increase in r a i l fares necessary given the relatively more generous r a i l subsidy provisions of this scenario. Similarly, although the r a i l patronage level drops, i t is by a lesser amount than i t would i f r a i l was put on the same subsidy basis as the other three modes. S t i l l , the decrease of 376,693 represents just over half the actual level. Only 360,984 passengers would be expected to remain users of the r a i l service on the 52 routes assessed. A route-by-route level of analysis shows that a number of routes s t i l l appear very suspect. Three of the 23 non-corridor routes have expected annual passenger levels of 10 or less, while another seven would serve between 11 and 100. Only three of these routes would have over 1,000 riders annually. Of the corridor routes, 10 would have fewer than 1,000 riders annually. The most heavily travelled r a i l service (between Montreal and Toronto) would drop from about 220,000 to around 106,000 passengers per annum. Thus even with a 30% subsidy level for passenger r a i l services, a number of services would undoubtedly have to cease operation. i i ) magnitude of deadweight loss As described previously, the price on the demand curve adjusted for r a i l price changes that corresponds to actual quantity demanded is required for the determination of deadweight loss. Table 7.6 shows the results of the iterative number search to determine these prices. Chapter 7 224 Unbalanced Modal Subsidization TABLE 7.6 ACTUAL PRICE COMPARED TO PRICE ON ADJUSTED DEMAND CURVE CORRESPONDING TO ACTUAL QUANTITY AIR BUS AUTOMOBILE PRICE ON PRICE ON AUTOMOBILE PRICE ON AIR FARE ADJUSTED AIR BUS FARE ADJUSTED BUS COST ADJUSTED AUTO (ACTUAL) DEMAND CURVE (ACTUAL) DEMAND CURVE (CENTS) DEMAND CURVE CITY-PAIR (CENTS) (CENTSHPa') (CENTS) (CENTSKPb') (ACTUAL) (CENTS)(PC) OTTAWA-QUEBEC 4,512 4,559 1,631 1,646 1,463 1,480 OTTAWA-MONTREAL 3,156 3,217 867 882 605 617 OSHAWA-MONTREAL 5,551 5,613 1,835 1,854 1,528 1,546 OSNAWA-OTTAWA 4,642 4,706 1,430 1,448 1,134 1,151 TORONTO-QUEBEC 6,482 6,742 2,764 2,865 2,673 2,791 TORONTO-MONTREAL 5,349 5,654 2,000 2,106 1,662 1,767 TORONTO-OTTAWA 4,440 4,515 1,540 1,564 1,268 1,292 GUELPH-MONTREAL 5,488 5,687 2,198 2,270 1,916 1,993 GUELPH-OTTAWA 4,579 4,644 1,738 1,761 1,521 1,544 KITCHNER-MONTREAL 5,623 5,692 2,289 2,315 1,929 1,955 KITCHNER-OTTAWA 4,733 4,807 1,829 1,855 1,535 1,561 HAMILTON-QUEBEC 6,648 6,759 2,886 2,931 3,849 3,919 HAMILTON-MONTREAL 5,498 5,542 2,133 2,149 1,852 1,868 HAMILTON-OTTAWA 4,605 4,630 1,662 1.670 1,458 1,466 ST. CATHARINES-QUEBEC 6,879 7.430 3,148 3,383 4,069 4,431 ST. CATHARINES-MONTREAL 5,321 5,415 2,384 2,422 1i750 1,785 ST. CATHARINES-OTTAWA 4,916 4,959 1,924 1.940 1.366 1,379 LONDON-QUEBEC 6,939 7,270 3,239 3,382 4,272 4,496 LONDON-MONTREAL 6,084 6.235 2,475 2,531 2,184 2,243 LONDON-OTTAWA 5,202 5.310 2,015 2.054 1,789 1,830 LONDON-TORONTO 3,089 3,258 783 622 521 553 SARNIA-MONTREAL 6,416 6,606 2,729 2,804 2.646 2,732 SARNIA-OTTAWA 5,728 5,899 2,269 2,331 2,251 2,324 SARNIA-TORONTO 3,616 3,926 1,037 1,117 983 1,077 WINDSOR-MONTREAL 6,720 6,721 2,961 2,962 2,695 2,696 WINDSOR-OTTAWA 6,162 6,282 2.501 2,546 2,301 2,350 WINDSOR-TORONTO 4,081 4,580 1,269 1,412 1,032 1,175 WINDSOR-HAMILTON 4,062 4.128 991 1,006 843 857 WINDSOR-LONDON 4,845 5.077 614 640 511 538 NORTH BAY-MONTREAL 5.885 5,982 2,078 2.110 1,742 1,772 NORTH BAY-OTTAWA 4,722 4.768 1,343 1,355 1,137 1,149 NORTH BAY-TORONTO 4,004 4,053 1,341 1.356 1,074 1,088 NORTH BAY-LONDON 4,768 4,825 1,816 1,836 1,595 1,615 NORTH BAY-WINDSOR 5,760 5,838 2,302 2.330 2,107 2,137 SUDBURY-OUEBEC 6,952 6,966 3,268 3,274 4,162 4,172 SUDBURY-MONTREAL 6,634 6,744 2,504 2,543 2,132 2,170 SUDBURY-OTTAWA 4,746 4,803 1,769 1,789 1,527 1,546 SUDBURY-TORONTO 4,327 4,396 1,597 1,620 1,254 1,276 SUDBURY-HAMILTON 4,484 4,488 1,719 1,720 1,444 1,446 SUDBURY-LONDON 5,090 5,126 2,072 2,086 1,775 1,789 SUDBURY-SARN IA '5,618 5,631 2,326 2,331 2,237 2,243 SUDBURY-WINDSOR 6,066 6,105 2,558 2,573 2,222 2,237 THUNDER BAY-TORONTO 7,132 7,216 4,884 4,939 5,373- 5,443 THUNDER BAY-SUDBURY 6,131 6,264 3,353 3,420 4,118 4,215 WINNIPEG-MONTREAL 10,906 11,317 5,517 5,710 9,716 10,086 WINNIPEG-OTTAWA 10,620 10,920 4,967 5,100 9,480 9,764 WINNIPEG-TORONTO 9,564 9,816 5,115 5,244 9,095 9,347 WINNIPEG-KITCHNER 9,810 9,894 5,294 5,337 9,375 9,461 WINNIPEG-HAMILTON 9,721 9,788 5,237 5,271 9,271 9,339 WINNIPEG-ST. CATHARINES 11,914 12.202 5,504 5,628 9,491 9,728 WINNIPEG-LONDON 9,764 9.918 5,590 5,672 9,694 9,854 WINNIPEG-WINDSOR 6,863 6,878 6,076 6,088 9,205 9,226 Chapter 7 225 Unbalanced Modal Subsidizat Combining the results of Tables 7.5 and 7.6 allows the computation of economic deadweight loss. This is presented in Table 7.7. Note that this computation followed exactly the process described for the Base Case scenario. The economic deadweight loss that is incurred by not moving from the current situation to one based on full-economic-cost pricing (alternative definition) is $4,826,611 in 1976 dollars, or about $9,581,000 in 1986 dollars for the 52 routes under analysis. Again, the vast majority of the deadweight loss accrues to the r a i l sector. Over 95% of the total inefficiency loss in fact occurs in the r a i l sector. -Extrapolating this deadweight loss is done using the same method followed previously. Total r a i l sector expenditures for the 52 routes under analysis was $37,648,656 in 1976. The economically efficient r a i l subsidy rate of 30% suggests the appropriate government expenditures to be $11,294,597, which is $13,300,635 less than what was actually expended. The $4,826,611 deadweight loss which arose from the excessive r a i l subsidy amounts to $0.36 per dollar of unwarranted r a i l subsidy. Applying this to the $258,854,000 of unwarranted VIA Rail subsidy in 1986, 1 6 gives a national deadweight loss of $93,187,000 in 1986. Keep in mind that this estimate is subject to the same caveats discussed in section B. 1 6 S t a t i s t i c s Canada, Catalogue 52-003 gives 1986 passenger r a i l expenditures of $676,757,000. Of this amount, $467,881,000 was covered by government subsidy. Applying the 30% subsidy rate suggests the appropriate subsidy level for 1986 was $203,027,000, indicating excessive r a i l subsidization of about $258 ,,854,000. Chapter 7 226 Unbalanced Modal Subsidization TABLE 7.7 DEADWEIGHT LOSS: ALTERNATIVE DEFINITION OF FULL-ECONOMIC-COST PRICING DEADWEIGHT LOSS: DEADWEIGHT LOSS: DEADWEIGHT LOSS: DEADWEIGHT LOSS: CITY-PAIR AIR MODE (S) BUS MODE ($) AUTO MODE ($) RAIL MODE ($) OTTAWA-QUEBEC 119 13 69 18,813 OTTAWA-MONTREAL 388 505 1,946 208,219 OSHAWA-MONTREAL 30 0 139 21.487 OSHAWA-OTTAWA 23 1 96 12,752 TORONTO-QUEBEC 4,206 41 887 106,128 TORONTO-MONTREAL 90,311 2,044 26,354 1,661,109 TORONTO-OTTAWA 3,379 226 990 233,413 GUELPH-MONTREAL 128 2 871 40,308 GUELPH-OTTAWA 10 3 53 7.318 KITCHNER-MONTREAL 42 1 243 34,496 KITCHNER-OTTAWA 34 6 159 19,988 HAMILTON-QUEBEC 23 1 105 8,083 HAMILTON-MONTREAL 74 1 152 37,498 HAMILTON-OTTAWA 16 1 28 11,608 ST. CATHARINES-QUEBEC 259 17 1,346 21,067 ST. CATHARINES-MONTREAL 104 10 567 61,814 ST. CATHARINES-OTTAWA 14 3 56 14,678 LONDON-QUEBEC 289 2 552 18.165 LONDON-MONTREAL 685 8 877 77,303 LONDON-OTTAWA 382 10 252 34.321 LONDON-TORONTO 779 561 9,479 322,873 SARNIA-MONTREAL 138 1 500 29,153 SARNIA-OTTAWA 42 1 200 11,839 SARNIA-TORONTO 731 . 18 6,983 117,772 WINDSOR-MONTREAL 0 0 21 104,550 WINDSOR-OTTAWA 251 2 177 25,212 WINDSOR-TORONTO 31,015 1,555 29,659 549,953 WINDSOR-HAMILTON 13 4 180 21.483 WINDSOR-LONDON 5 48 1,470 53,496 NORTH BAY-MONTREAL 14 6 143 21,738 NORTH BAY-OTTAWA 1 6 25 7,509 NORTH BAY-TORONTO 36 18 95 24,873 NORTH BAY-LONDON 3 1 15 3,610 NORTH BAY-WINDSOR 3 1 15 3,225 SUDBURY-QUEBEC 0 0 1 741 SUDBURY-MONTREAL 49 6 255 38,551 SUDBURY-OTTAWA 21 6 62 15,325 SUDBURY-TORONTO 230 65 316 67,870 SUDBURY-HAMILTON 0 0 0 741 SUDBURY-LONDON 3 0 11 4,400 SUDBURY-SARNIA 0 0 0 459 SUDBURY-WINDSOR 2 0 7 3,203 THUNDER BAY-TORONTO 321 1 80 50,259 THUNDER BAY-SUDBURY 75 37 55 11,483 WINNIPEG-MONTREAL 2,618 13 264 123,166 WINNIPEG-OTTAWA 1,468 9 102 84,231 WINNIPEG-TORONTO 3,275 41 158 211,286 WINNIPEG-KITCHNER 14 0 7 4,064 WINNIPEG-HAMILTON 29 0 6 8,113 WINNIPEG-ST. CATHARINES 111 2 39 8,969 WINNIPEG-LONDON 98 2 21 13,035 WINNIPEG-WINDSOR 1 0 0 1,615 TOTAL $141,860 $5,298 $86,089 $4,593,364 Chapter 7 227 Unbalanced Modal Subsidization P. Conclusions Table 7.8 summarizes the results of the deadweight loss calculation under two alternative definitions of f u l l economic costs. If ' a l l modes were required to recover the f u l l economic cost of the i provision of service, allowing for a subsidy level of 10% in order to avoid p o l i t i c a l l y and administratively d i f f i c u l t user-charge policy changes, slightly more than 43% of the existing r a i l ridership would continue to use VIA Rail. Most (about two-thirds) of the former ridership would u t i l i z e automobiles, while a significant percentage (about one-quarter) would switch to a ir. The remainder (less than one-twelfth) would patronize the bus mode.17 The number of non-corridor r a i l routes in central Canada with more than 1,000 passengers per annum would be expected to f a l l from nine to three. The number of corridor r a i l routes that would carry fewer than 1,000 passengers per annum would be expected to rise from two to eleven. Clearly, the passenger r a i l mode would need some major structural changes in order to survive. The 1986 deadweight loss created by the current economically inefficient r a i l pricing scheme is somewhere in the order of $130,088,000. When added to the $394,205,000 in subsidy above the economically efficient level that was 1 7 R e c a l l that total ridership was held constant. It is thus l i k e l y that these shares are a l l somewhat overstated, since some former r a i l passengers might choose not to travel at a l l . Chapter 7 228 Unbalanced Modal Subsidization T A B L E 7.8 Comparison of Modal Volumes and Deadweight Loss Under Alternative Definitions of Full-Economic-Costs A l l Modes Subsidized by 10% Rail Subsidized by 30%; A l l Other Modes by 10% Change in Air Volume1' +4.76 +4.29 Change in Bus Volume1' +3.47 +3.07 Change in Automobile Volume* +0.32 +0.29 Change in Rail Volume1' -56.67 •51.06 Excessive Rail Subsidization $394,205,000 $258,854,000 National Deadweight Loss** $130,088,000 $93,187,000 ** Expressed as percentage change from current situation on the 52 routes under analysis Regional deadweight loss extrapolated to national level (in 1986 $) Chapter 7 229 Unbalanced Modal Subsidization provided to VIA in 1986 by the federal government, i t would appear to cost the Canadian economy somewhere around $524,293,000 a year to keep VIA Rail operating. 1 8 Accepting a 30% r a i l subsidy level as being economically j u s t i f i e d (with the 10% level remaining for the other three modes) changes the volume results only marginally. Slightly less than one-half of the existing r a i l ridership would be retained. S t i l l only three non-corridor, central-Canada routes would retain annual riderships in excess of 1,000. Ten corridor routes would likely have annual ridership levels below 1,000, up from the existing two routes, but less than i f r a i l only received a 10% subsidy. The alternative definition of f u l l economic costs implies a national deadweight loss of $93,187,000 currently arising out of excessive VIA Rail subsidization. This suggests that keeping VIA Rail alive is burdening the Canadian economy to the tune of $352,041,000.19 Due to several simplifications made, the estimate of deadweight loss can only be considered a ballpark figure. As has been described previously, the determination of economic efficiency losses would proceed as follows under ideal circumstances: • L 0This is the amount of money being spent with no supporting economic j u s t i f i c a t i o n . 1 9 T h i s includes the $93,187,000 deadweight loss and the $258,854,000 "excess" in subsidization. It does not include $203,027,000 in subsidy which is assumed to be necessary to foster economic efficiency, through the realization of density economies. Chapter 7 230 Unbalanced Modal Subsidization 1. individual route cost data (for carriers and government) would be available to determine the f u l l economic cost (and hence optimal price) for each mode by route; 2. a system of flexible demand models providing individual e l a s t i c i t i e s by route would then u t i l i z e the full-economic-cost-based prices to determine the travel volumes (for each mode, by route) that would have occurred under this pricing system; and 3. the precise area under the demand curved representing the welfare loss could be determined by integration using the general formula presented in Oum (1982). The nature of the available data has made certain simplifications necessary, namely: 1. the f u l l economic cost for each mode by route was established using system averages; 2. a linear demand model was assumed using synthesized constant e l a s t i c i t i e s ; and 3. a linear approximation using the deadweight loss triangle methodology was adopted. Although these simplifications make i t unlikely that the estimate obtained is precise, i t should nonetheless provide order of magnitude accuracy. Given the current lack of any information concerning economic efficiency losses, an order of magnitude estimate should prove valuable to policy-makers. Chapter 7 231 Unbalanced Modal Subsidization CHAPTER .8 SUMMARY AND POLICY IMPLICATIONS OF THE FINDINGS A. Introduction This chapter bri e f l y summarizes the findings of this study, and discusses the policy implications of a continuation of the current imbalance in passenger transportation subsidization. B. Summary Intercity passenger transportation in Canada has undergone considerable change in the twentieth century. Rail, once the dominant mode, now finds i t s e l f in a relatively minor role, with the upstart private automobile being the mode of choice for the majority of intercity travel. Another relative newcomer, the air mode, also f i l l s an important niche, serving primarily (but not exclusively) the longer haul markets and the time-sensitive travellers. The bus mode, like r a i l , a struggling mode, is in a state of transition s t i l l trying to determine i t s role and hiding i t s own shortcomings by vehemently blaming VIA Rail subsidies for i t s problems. VIA Rail subsidies have not only drawn the ire of the bus industry, they have been the source of general criticism in an age of proclaimed "fis c a l restraint". However, not a l l of this criticism is rhetoric; subsidies can Chapter 8 232 Summary cause economic losses in the form of distorted passenger transportation markets. This loss is what is referred to by economists as economic efficiency, or social welfare, or "deadweight" loss. This loss represents the value that certain economic resources in alternative use could have produced over and above what they actually produced, without detracting from the value of any other production, simply by allocating these resources to that alternative use. A review of economic theory shows that is not subsidy per se which causes this deadweight loss, but. i t is an unbalanced, economically unjustified subsidy which is the cause. 1 The available information indicates that a l l four of the main modes of intercity passenger travel in fact receive a certain degree of subsidy. VIA Rail's subsidy is primarily an operating subsidy; the other three modes have their infrastructure provided by government. Transport Canada (1979) found that the road mode results in by far the largest unrecovered d e f i c i t (in aggregate dollars) , followed by the air mode and fin a l l y , the r a i l mode. Measured on a per-passenger-kilometre basis, the positions are reverse. Also, on a percentage-cost-recovery basis, the r a i l mode fares the worst. Air recovers about 91.7% of i t s costs; automobile recovers about 90.8%; bus, about 92.1%; and r a i l only about 34.7% of i t s total costs of providing service on the 52 routes examined. •"•Economic j u s t i f i c a t i o n refers to a certain select group of conditions which suggest that subsidy is in fact necessary to avoid deadweight loss. Social or p o l i t i c a l reasons are not numbered among the economically sound justifications. Chapter 8 233 Summary The actual determination of the deadweight loss caused by unbalanced modal subsidization requires a considerable amount of data: 1. an extensive database providing complete data on a l l aspects affecting consumer mode choice (socio-economic and demographic data, transportation network and service characteristics, and trip data for each trip taken); 2. a complete set of e l a s t i c i t i e s describing the responsiveness of travellers to changes in the prices of a l l modes on each route (obtained by a demand model that u t i l i z e s the database described above); and 3. complete cost data for each of the modes by route; Unfortunately, such data do not exist in Canada (or anywhere else for that matter). Hence a number of simplifications were necessary to allow the calculation to proceed using the data that are available, namely: 1. the f u l l economic cost for each mode by route was established using system averages; . 2. a linear demand model was assumed using synthesized constant e l a s t i c i t i e s ; and 3. a linear approximation using the deadweight loss triangle methodology was adopted. This naturally means that the deadweight loss calculated is not the deadweight loss caused by unbalanced modal subsidization in Canada, but is merely an estimate of the li k e l y magnitude of this loss. The base case definition of f u l l economic costs used in this study provided for a 10% level of government subsidy to a l l modes to minimize the p o l i c t i c a l and administrative problems arising from user-charge policy changes Chapter 8 234 Summary for transportation. It was found that i f full-economic-cost pricing was to be adopted for a l l modes, air would enjoy a 4.76% increase in volume, bus, a 3.47% increase, and automobile, a marginal 0.32% increase. On the other hand, the r a i l mode would lose almost 57% of i t s passengers. The economic efficiency loss associated with the current pricing policy is about $13,460,000 (1986 $) for 52 routes located in the Winnipeg - Quebec City region. Since the r a i l mode received about $41,348,000 (1986 $) in subsidy above the assumed allowable 10% subsidy for these 52 routes, this amounts to about $0.33 in deadweight loss for every dollar of unjustified r a i l subsidy. Since the r a i l mode received a total of $394,205,000 in unjustified subsidies in 1986, this would suggest an additional cost to the economy in the form of economic efficiency losses of about $130,088,000. An alternative definition of f u l l economic costs (30% subsidy to r a i l , 10% subsidy to other passenger modes) was also examined. If this definition of full-economic-cost pricing was to be adopted for a l l modes, air would enjoy an increase of about 4.3%, bus, a slightly greater than 3% increase, and automobile, a slight 0.29% increase. On the other hand, r a i l would lose about half of i t passengers. The economic efficiency loss associated with the current pricing policy relative to the alternative definition of full-economic-cost pricing is about $9,581,000. Extrapolating this to the national level suggests a total deadweight loss of $93,187,000 (1986 $) arising from r a i l subsidization in excess of the 30% economically efficient level. Chapter 8 235 Summary There are several possible problems with the accuracy of this estimate. First, i t assumes that the e l a s t i c i t i e s selected for the corridor apply equally to a l l regions of the country. Since the e l a s t i c i t i e s u t i l i z e d are based on U.S., U.K., and Australian results (as well as Canadian), there is some question as to the applicability of the e l a s t i c i t i e s . Second, some routes in western and Atlantic Canada play a very different role than their central-Canada counterparts. While most passenger r a i l services in central Canada are primarily oriented towards short-haul travel by local residents, a significant portion of r a i l travel in western and Atlantic Canada is relatively long-haul tourist travel. To the extent that this portion of the market sees r a i l travel as an attraction in i t s e l f , as opposed to a means to achieve a movement from point A to point B, the degree of distortion w i l l be less outside central Canada. In other words, i f the situation is such that i f these tourists could not take the train, they would not travel in Canada at a l l , their subsidized fares would not distort the volumes of other modes. In a similar fashion, remote services l i k e l y cause a lesser economic efficiency loss simply because few, i f any alternatives exist for many travellers. In this case, no other modal volumes are distorted. Third, while the per dollar distortion caused by r a i l subsidies might be less for services such as the "Canadian", the "Super Continental" and the "Atlantic", this is offset somewhat since there are more dollars of Chapter 8 236 Summary distortion-causing subsidy to deal with. These services cover a far lesser p proportion of their total costs than do the corridor routes. Fourth, there is a significant portion of the market which views r a i l and air travel as complements and not as substitutes. For travellers who desire to travel one way by r a i l and return by air, increases in r a i l fares may result in a decision to not travel at a l l , and hence decrease air volumes. This would tend to offset the aggregate amount of deadweight loss since i t acts in the opposite direction to the "usual" situation. Thus while there is some question as to the precision of this 1986 deadweight loss estimate of about $130 million, the extent to which i t is over or understated is impossible to determine given the available data. The most easily defensible position is to use the national estimate as calculated above and state the caveats. Given that degree of competition between r a i l and other modes is less outside the central Canada region, at least for a substantial portion of the market, this national estimate is lik e l y an upper bound for the deadweight loss. C. Policy Implications of the Findings The f i r s t point that is drawn out by the foregoing analysis is that the current imbalance in modal subsidization in favour of r a i l results in economically inefficient modal shares. The air mode is underutilized by 2Cubukgil and Soberman (1986) provide data which shows the transcontinental service recovered only about 25% of their total costs, while corridor service recovered about 35% of total costs in 1984. Chapter 8 237 Summary somewhat less than 5%; bus, by somewhat more than 3%; and automobile, by less than one-third of one percent. Rail volume should be only about 43% of what i t actually i s . The second point that is drawn out by the foregoing analysis is that evaluation of the "costs" of VIA Rail operating subsidies should not proceed on the basis of a simple examination of the magnitude of the subsidy actually paid out. Subsidizing one mode (rail) over and above the level the competing modes receive causes an economic efficiency loss in the order of about one third of the amount of the subsidy. The total cost of the unbalanced subsidization is thus about one and one-third times the amount of the excessive level of "government contract revenue" provided to VIA Rail. Any social or p o l i t i c a l benefits derived from maintaining substantial r a i l subsidies must be measured against this total economic cost rather than the simple amount of the subsidy. The third point that is drawn out by the foregoing analysis is that even with r a i l subsidy levels of 30% of total costs, the r a i l mode w i l l have a struggle on i t s hands to have any continued presence on a large number of routes. Changing the cost-recovery requirements to full-cost recovery without instituting any other structural changes to the r a i l system would likely result in the demise of many of the passenger r a i l services in Canada. This leads directly to the next point. The fourth point that is drawn out by the foregoing analysis is that any and a l l failure to take steps to increase operating efficiency of passenger Chapter 8 238 Summary r a i l services actually has an economic cost 1.33 times the impact these failures have on VIA Rail's bottom line. Thus any factor that increases VIA Rail's costs (or keeps them higher than the cost of an effi c i e n t l y run operation would be) and hence serves to keep a considerable gap between user payments and total costs, has a considerably greater impact on the economy than the effect on VIA's operations would indicate. This applies to the inefficient antiquated equipment VIA is forced to operate with, to the failure to provide VIA with enough negotiating clout through establishment of meaningful incentives to ensure that the railways provide efficient service, and to the continuation of antiquated work rules VIA inherited from the railways. The f i f t h point that is drawn out by the foregoing analysis is that the data available for conducting an analysis such as this are simply inadequate. This examination was forced to rely on system-wide cost averages for the air, automobile and bus modes, and system-wide and corridor-wide cost averages for the r a i l mode. This reduces the accuracy of the results somewhat, but more importantly, forces f a i r l y wide generalizations. In other words, despite the general finding that a l l r a i l services would suffer considerable declines in passenger volumes (a minimum decline of 53.8%) i f the r a i l mode was forced to cover i t s total cost of operation from the users, an analysis of route-specific costs might very well show that on a handful of select routes, r a i l actually i s an economically viable mode. Such detailed observations are impossible given the lack of available data, but yet would be valuable. Government policy decisions should not have to rely on such a limited database. Chapter 8 239 Summary D. Caveats and Suggestions for Further Research The determination of the deadweight loss arising out of current subsidization policy and the implications of requiring full-cost recovery by the operators of a l l modes was based on the following simplifications and/or assumptions: 1. the f u l l economic cost for each mode by route was established using system averages; 2. the actual costs incurred were assumed to reflect the efficient operation of a l l modes; 3. a linear demand model was assumed using synthesized constant e l a s t i c i t i e s ; and 4. a linear approximation using the simplified deadweight loss triangle methodology was adopted. The accuracy of the results could be improved by research addressing the f i r s t and third points. Route-specific data pertaining to costs and demand attributes would allow more precision in determining the interaction of the four modes. Given the f l e x i b i l i t y of route-specific data, the fourth point could easily be resolved by following the methodology developed by Oum (1982). The f i r s t , third, and fourth points pertain to what the deadweight loss i s , and what modal volumes would be under changes to subsidization policy, based on the way the system operates currently. Addressing the second point goes beyond this assumption to determine what reductions in deadweight loss could be obtained even without changing pricing policy (or alternatively what Chapter 8 240 Summary deadweight loss would s t i l l exit even after full-economic-cost pricing was imposed3). This too warrants investigation in order to refine the estimates developed in this thesis. i 3This is the concept of "X-inefficiency" introduced by Leibenstein (1966). Chapter 8 241 Summary B I B L I O G R A P H Y 242 BIBLIOGRAPHY Abrahams, Michael (1983). 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"An Abstract Mode Approach to the Demand for Travel," Transportation Research vol. 3. pp. 44 3 - 4 6 1 . 256 Bibliography APPENDIX A Appropriation Act No. 1,1977 257 APPENDIX A 25-26 ELIZABETH II CHAPTER 7 An Act for granting to Her Majesty certain sums of money for the public service for the financial year ending the 31st March, 1977 Appropriation Act No. 1, 1977. SURFACE TRANSPORTATION PROGRAM Amount ($) 52d Surface Transportation--With respect to surface transportation: (a) to deem VIA Rail Canada Inc., a railway company incorporated pursuant to Section 11 of the Railway Act, (b) to authorize, subject to the approval of the Minister, VIA Rail Canada Inc. and any railway company to enter into contracts for the purpose of providing a unified management and control of r a i l passenger services in Canada; and (c) to authorize the Minister subject to such terms and conditions as the Governor in Council may prescribe by regulations (i) to enter into a contract with VIA Rail Canada Inc. with respect to (a) the provision, management, or the operation of selected r a i l passenger services in such a manner as to improve efficiency, effectiveness and economy in r a i l passenger services in Canada; (b) the reimbursement of the net cost to the corporation of operating a r a i l passenger service in accordance with the provisions of the contract; (c) incentive payments for the efficient operation of the r a i l passenger services in accordance with the provisions of the contract; Appendix A 258 Appropriation Act No. 1, 1977 ( i i ) to reimburse, out of monies to be appropriated by Parliament, a railway company for the prescribed portion of the cost incurred by the company for the provision of income maintenance benefits, layoff benefits, relocation expenses, early retirement benefits, severance benefits and other benefits to it s employees where such costs are incurred as a result of the implementation of the provisions of the contract or discontinuance of a r a i l passenger service provided that the aggregate of the amounts payable annually pursuant to this authority for the purposes set out in Clauses (b) and (c) does not exceed $240,000,000 Appendix A 259 Appropriation Act No. 1, 1977 APPENDIX B Estimating Price Elasticities of Demand For Intercity Passenger Travel 260 APPENDIX B ESTIMATING PRICE ELASTICITIES OF DEMAND FOR INTERCITY PASSENGER TRAVEL A. Introduction As described i n Chapter 4 , measures of the price responsiveness of demand for i n t e r c i t y passenger travel are requisite to the determination of the economic e f f i c i e n c y losses a r i s i n g out of unbalanced modal subsidization. Chapter 5 dealt with one method of obtaining such e l a s t i c i t i e s - - d e r i v i n g them from published econometric studies. Chapter 5 also pointed out that an alternative method exists by which to obtain the required e l a s t i c i t i e s - -estimate them s p e c i f i c a l l y for the purpose at hand. In order to obtain such measures, two primary components are necessary: data providing d e t a i l s of the transportation system and the passenger movements within the system; and a model to describe the underlying behavioural patterns of tr a v e l l e r s using t h i s system. This appendix deals with the data and the model used i n the attempt to derive an estimate of passenger response to price changes. Appendix B 261 Estimating Price E l a s t i c i t i e s B. Data Requirements for Model Estimation Since demand modelling i s designed to provide quantitative measures of the way people respond to c e r t a i n conditions or changes i n conditions, the more v a r i e d and the more complete the a v a i l a b l e data, the more l i k e l y the modeller w i l l be able to develop a model which s u c c e s s f u l l y r e p l i c a t e s human behaviour. With respect to the t r a v e l l i n g p u b l i c , the i d e a l database f o r t h i s thesis would be an extensive body of disaggregate data r e l a t i n g to the consumption of the good " i n t e r c i t y t r a v e l " . These data would be required f o r a l l regions served or af f e c t e d by VIA R a i l . In other words, the database would include the following: i ) t r i p data (e.g. o r i g i n , destination, number of persons t r a v e l l i n g together, t r i p purpose, time of t r i p , e t c . ) ; i i ) network data (number of competing modes, number of competing c a r r i e r s , e t c . ) ; i i i ) s e r vice c h a r a c t e r i s t i c s (fares, t r a v e l times, departure frequency, comfort, r e l i a b i l i t y , safety, e t c . ) ; iv) socio-economic c h a r a c t e r i s t i c s (income, occupation, culture, gender, r e l i g i o n , age, etc. of t r a v e l l e r s ) ; v) demographic data (population, income, c u l t u r a l make-up, etc. of o r i g i n s and destinations); and v i ) a l t e r n a t i v e s to t r a v e l (prices, c h a r a c t e r i s t i c s etc. of goods and services which could be purchased instead of an i n t e r c i t y t r i p ) . 1 This l i s t i s by no means exhaustive. Any other v a r i a b l e that helps to further describe the consumers, t h e i r objectives and the a l t e r n a t i v e s open to them should be included i n t h i s l i s t . Estimating Price E l a s t i c i t i e s 262 Appendix B Such an ideal database does not exist in Canada, nor for that matter, anywhere in North America.2 Thus any database, including the one used in this thesis, w i l l have shortcomings which impose on the comprehensiveness of the models. The database used for the demand modelling segment of this thesis is the Intercity Travel Demand (ICTD) database compiled by Professor Tae Hoon Oum, currently of the University of British Columbia.3 This database is cross-sectional in nature, containing modal service characteristics and regional demographics based on 1976 intercity travel to and from 20 c i t i e s in central Canada.4 The region from which the ICTD data was drawn is essentially the Quebec City (Quebec)-Windsor (Ontario) corridor. There are additional points from outside this corridor, including Winnipeg, Manitoba and the important centres in northern and western Ontario. 5 The ICTD database contains both modal service characteristics and demographic information. The modal service characteristics include travel ^Miller (1985;p. 2). Miller provides an assessment of several major transportation databases currently available in Canada. Miller concludes that these databases are inadequate for detailed policy analysis and modelling. 3The database was compiled by Professor Oum while teaching at Queen's University, Kingston, Ontario. 4A complete set of data is not available for a l l the 190 city-pairs that are possible given 20 c i t i e s . Although the region has a f a i r l y extensive transportation network, the common carriers of the various modes do not provide direct or even one-transfer service between every possible city-pair. In addition, accurate t r a f f i c counts were not available for automobile travel between a l l points. Thus, the actual number of usable observations varies by mode and i s , in each case, less than 190. 5Appendix C l i s t s the linkages which were extracted from the ICTD database and u t i l i z e d in the demand models formulated for this study. Appendix B 263 Estimating Price E l a s t i c i t i e s volumes, fares (or operating cost in the case of automobile travel), travel times, and departure frequency by route for the automobile, air, bus and r a i l modes. The demographic data includes population and income figures for each of the 20 centres, as well as a measure of the linguistic comparability between the two centres of the various city-pairs.^ Modal volumes are annual one-way volumes. There are 98 observations for the air mode, 171 for the automobile mode, 138 for the bus mode and 97 for the r a i l mode. The overlap in the routes of these observations is considerable, but by no means perfect. As is the case of most transportation databases, the volumes depict travel along a route link. This is not necessarily equivalent to the ultimate origin and/or destination of those travelling along that link. Modal fares are a l l one-way fares for the common carriers. For the automobile mode, a "standard" automobile operating cost is used and is multiplied by the highway distance to obtain the "price" of automobile travel. Travel time is given in minutes for a l l modes. Automobile travel times were determined on the basis of an average speed multiplied by the highway distance between the centres. Common carrier travel times were obtained from the actual carriers' timetables. "Network data such as number of competing modes can be derived easily from the database, while knowledge of the area under study provides the number of competing carriers on each route. 264 Estimating Price Ela s t i c i t i e s Appendix B The departure frequency for the common carriers is given as the number of departures per week. Of course, this variable is nonsensical for the private automobile and does not exist in the database. Distance between points is also provided in the database, and is obtained from a standard road map for the automobile mode, and from the carriers' timetables for the common carriers. Population is determined on the basis of the 1976 census of metropolitan areas, as is personal income. The linguistic measure (L) is calculated on the basis of the following equation: (B.l) L - 1.0 - |Li - Lj| where L^ = the proportion of the population speaking English in city i , and Lj = The proportion of the population speaking English in city j 7 Table B.l provides the details concerning the sources of the data in the ICTD database. A quick comparison of the ICTD database and the "ideal" database discussed earlier shows that the ICTD database f a l l s short of perfection. Trip data, such as the true origin and destination, is not available. Trip purpose is another important aspect not included. The variable l i s t describing service characteristics is incomplete; for example, variables 7This measure was u t i l i z e d by Gaudry and Wills (1978) . Appendix B 265 Estimating Price Elasticities T A B L E B . l I C T D D a t a Sources Variable Source Volumes - Ontario Ministry of Transportation and Communications (see note 1) a) C.T.C. Ground Access Survey (air) b) M.T.C. Highway Traffic Survey (bus and automobile) c) C.N. , CP. ticket surveys (rail) Fares - Ontario Ministry of Transportation and Communications (see note 2) - carrier-supplied data Frequency - schedules or system timetables of the various carriers Travel times - schedules or system timetables of the various carriers Demographics - Census of Canada (1976) - Financial Post Survey of Markets - Statistics Canada Catalogue 91-207 Note 1: The Ontario M.T.C. bad access to the three sources of data l i s t e d here, and supplied Professor Oum with these data. Where possible, travel volumes were then v e r i f i e d using other published data, primarily Statistics Canada. Note 2: The Ontario M.T.C. data was the principal source of this data. The carrier-supplied data was primarily used to verify the M.T.C. data. Appendix B 266 Estimating Price Elasticities providing data on r e l i a b i l i t y , comfort or safety are absent. Socio-economic indicators such as occupation and cultural heritage are also missing. Finally, there are no data concerning other goods and services which might be consumed in l i e u of intercity travel. Despite these shortcomings, the ICTD database provides considerable information about the nature of the intercity transportation network. In fact, there is no cross-sectional database currently in existence that provides such a comprehensive amount of data concerning intercity passenger travel in Canada by a l l four major modes. The ICTD database is not only simply the best available, i t has considerable merit as a transportation database. Two points raised by Miller (1985) in his critique of Canadian transportation databases could be directed at the v a l i d i t y of using the ICTD database to help estimate current, Canada-wide economic inefficiencies arising from unbalanced modal subsidization. These objections are the age and the limited geographic scope of the database. The f i r s t criticism, that the data are too dated to provide meaningful results for today's circumstances, should not come as a surprise. In fact, the time-consuming process of collecting and verifying data makes such a criticism rather common. The response to this criticism is that the demand model is conditioned solely by the u t i l i t y function of the consumer. In other words, while the attributes of the transportation network can and do change over time, as long as there is no shift in consumer tastes, the demand model Appendix B 267 Estimating Price Ela s t i c i t i e s remains valid. In fact, i t does seem reasonable to assume that the tastes of Canadian intercity travellers have not undergone any significant shifts within the time period 1976-1986.8 In effect, the behavioural patterns, or the response of travellers to changes in service attributes, would be expected to be much the same today as they were in 1976.9 It thus seems appropriate to assume that the parameters estimated based on 1976 data w i l l s t i l l be valid today. The second criticism the limited geographic scope of the database (i.e. the absence of western Canada and Atlantic Canada from the database) implies that the parameter estimates obtained would not be applicable to the nation as a whole. This issue can be dealt with in an analogous manner to the f i r s t criticism. In this case, however, the assumed s t a b i l i t y is not temporal in nature, but spatial. The assumption of spatial s t a b i l i t y means that an individual in British Columbia, Ontario or Nova Scotia would be expected to react in a similar fashion to the same change in the intercity transportation environment, everything else held equal. In other words, the underlying behavioural pattern of Canadians is consistent across the country. In order to get at this underlying behavioural pattern, i t is necessary to account for 8No significant new modes have arrived on the scene to alter consumer tastes, nor have any previously important modes made their demise in this period. There do not appear to have been any other major structural changes to Canadian society that would be manifested in changed attitudes towards transportation. One possible exception is the recent interest in Canada and the United States over airline safety. Rail safety has also come under the spotlight with the recent derailment at Hinton and the resultant Foisey Commission into r a i l safety. 9This assumption of the s t a b i l i t y of consumer tastes over time i s , in fact, a common one in economic literature. Often this assumption is implicit, or unobtrusively incorporated within the term "ceteris paribus". Appendix B 268 Estimating Price Ela s t i c i t i e s the potential sources of difference between these various regions that might be reflected in the response of residents of these areas to changes in the intercity passenger transportation network. That is to say, a l l important factors which affect consumer behaviour would be e x p l i c i t l y parameterized within the model. The most important factors to be accounted for would be population, population density, income levels and culture. The combined 1976 population of the 20 c i t i e s incorporated in the ICTD database at the time the database was compiled was approximately 10,138,600. This represents a significant 44.1% of the national population and an equally impressive 65.3% of the combined population of the three provinces involved: Quebec, Ontario and Manitoba. These same ci t i e s boasted a combined population of 10,505,932 by 1981, the latest census year. This represents 43.2% of the national population and 65.3% of the combined Quebec, Ontario and Manitoba populations. 1^ It is quite clear that this region is the dominant one in Canada, at least in number of people. It is plausible to assume then that this region would generate a higher total number of intercity passenger trips than would any other region of the nation. However, before any conclusions are drawn concerning the network implications of this high regional population vis a vis the rest of the country, one other aspect of demography should be considered--the spatial distribution of this population. 1 U1981 Census of Canada, publications 93-905, 93-906 and 93-907 (Volume 2 - Provincial Series) entitled Population: Geographic Distributions. These three documents (for Quebec, Ontario and Manitoba respectively) give both the 1976 and the 1981 population figures. Appendix B 269 Estimating Price Ela s t i c i t i e s The population density of the ICTD region is not, by any means, constant for a l l the links in the area, as Table B.2 indicates. 1 1 On the one hand, the Montreal-(Ottawa-Kingston-Oshawa)-Toronto segment of the Quebec City-Windsor corridor is more densely populated than any other corridor in the country. In 1981, these five c i t i e s encompassed 6,699,491 people over the 340 mile (547 kilometre) corridor, for an average density of about 19,704 people per linear mile (12,248 per linear kilometre). The Calgary-Edmonton corridor is the only other Canadian intercity pair outside the Quebec City-Windsor corridor which can r i v a l the Montreal-Toronto link. It boasts a population of 1,249,805 over a 182 mile (293 km.) corridor, for an average density of 6,867 people per mile (4,266 per km.). On the other hand, many of the intercity links which include non-corridor c i t i e s such as Winnipeg, Sault Ste. Marie, Thunder Bay or North Bay have rather low densities, like much of the rest of the country. In effect then, the ICTD region can be considered a microcosm representative of the Canadian intercity network. Many of the routes in the ICTD region have a population density directly comparable to much of the rest of the country. Moreover, even though the Montreal-Toronto corridor density e c l i p s e s the country's next most densely populated corridor (Calgary-Edmonton), i t seems to merely represent a point higher on the same continuous scale, rather than some discontinuous jump to the levels of the 1 1Density, as a measure of objects per given area, does not really apply to the linear links considered below. Nevertheless, an appreciation of the impact that "density" can have is important. In order to get a feel for the differences i n the "density" among the different routes, the concept of "people per linear kilometre" is commonly uti l i z e d . This is merely the sum of the populations of the two cit i e s of any link, divided by the distance between the c i t i e s . Appendix B 270 Estimating Price Ela s t i c i t i e s T A B L E B.2 Population Densities for Selected City-Pairs City-Pair Persons per linear mile Persons per linear kilometre Quebec-Windsor: Quebec City - Montreal Montreal - Ottawa Ottawa - Toronto Toronto - Windsor 22,107 32,239 16,091 17,261 13,737 20,033 9,999 10,726 Corridor Branches: Toronto Toronto Toronto North Bay Sudbury Thunder Bay 15,672 13,811 3,925 9,738 8,582 2,439 Non-Corridor: Winnipeg - Thunder Bay 1,635 1,016 Winnipeg - Sault Ste.Marie 772 480 Winnipeg - Sudbury 695 432 Thunder Bay - Sault Ste.Marie 536 333 North Bay - Thunder Bay 280 174 Appendix B 271 Source: ICTD Database Estimating Price Elasticities major U.S., European or Japanese corridors. The inclusion of a population, or population density variable in the demand model thus should be sufficient to ensure that any significant regional differences in population or population density which could affect consumer behaviour are captured ex p l i c i t l y and are not embedded within other parameters of interest. Along with the population magnitudes and densities, there is another important potential source of regional differences: income levels. Significant differences in income levels w i l l result in different responses to changes in modal prices and travel times. Obviously, a higher income level enhances the user's a b i l i t y to pay for more costly modes and magnifies the travellers' value of time. In addition, a higher income level tends to increase the desire to travel. In other words, the e l a s t i c i t y of demand for intercity transportation with respect to income is positive. The 1980 average family income level (weighted by population) of the census metropolitan areas in the Quebec-Windsor corridor is $13,596. This compares closely with the national average of $12,993.12 It seems evident that the ICTD region has an income level higher than, but reasonably similar to the other regions of Canada. Thus, as in the case of population, the inclusion of an income variable in the demand model should be sufficient to ensure that the existing regional differences in income which could affect 1 21981 Census of Canada, publications 93-953, 93-954 and 93-955 (Volume 2 - Provincial Series) entitled Population: private households, census families in private households, Income. These documents give, respectively, data on the 1980 income levels of the provinces of Quebec, Ontario and Manitoba. Appendix B 272 Estimating Price Elasticities consumer behaviour are captured e x p l i c i t l y and are not embedded within other parameters of interest. The f i n a l characteristic of the ICTD region's population which plays a role in determining the nature of the intercity network is the bilingual/bicultural make-up of central Canada. Although, s t r i c t l y speaking, the region is more accurately described as being multilingual/multicultural rather than bilingual/bicultural, two major groups - the French Canadian and the English Canadian - dominate. 1 3 Table B.3 illustrates the degree of cultural a f f i n i t y between points in the study area based on the linguistic comparability measure defined above. While linguistic background may or may not affect the propensity to travel, i t is quite l i k e l y that i t plays at least some role in the choice of destination. This linguistic element thus poses and additional factor not inherent to intercity travel within western Canada or Atlantic Canada (with minor exceptions) . This suggests that this element should definitely be e x p l i c i t l y handled in any demand model of intercity travel in Canada. If the differences in cultural make-up between the ICTD region and the remainder of Canada can be removed from the variables of interest by the use of some "linguistic" variable, then the model should be equally applicable to a l l regions of the country. ••-^ The label "English Canadian" is a b i t of a misnomer, since in general usage, i t incorporates a l l Canadians (outside of the native population) who use English as the main language at home - not just those of Anglo-Saxon descent. This group includes many people of diverse ethnic backgrounds who, though they use English at home, consider some language other than French or English their mother tongue. As an i l l u s t r a t i o n of this point, Statistics Canada publications 92-725 and 92-726 indicate that while in 1971, only 70.8% of the residents of Winnipeg had English as their mother tongue, f u l l y 86.5% of these residents spoke English as their main language at home. Appendix B 273 Estimating Price Elasticities TABLE B.3 Linguistic Comparability of Selected City-Pairs Value of L City-Pair (as per Equation B.l) High Comparability: Winnipeg - Toronto 0.9922 London - Hamilton 0.9394 St.Catharines - Kingston 0.8947 Montreal - Quebec City 0.8122 Medium Comparability: Oshawa - Ottawa Sudbury - Sarnia Peterborough - Ottawa Montreal - North Bay 0.7011 0.6982 0.6136 0.4806 Low Comparability: Montreal - Kingston Quebec City - Kitchener Quebec City - Guelph Quebec City - Brantford 0.3346 0.2200 0.1675 0.1485 Appendix B 274 Source: ICTD Database Estimating Price Elasticities In conclusion, given the assumption of temporal s t a b i l i t y and the explici t parameterization of as many regional differences affecting consumer behaviour as possible, i t seems reasonable to assume that the response of travellers to marginal changes in modal fares or any other service characteristic would be much the same today in Vancouver or Halifax, as i t was in 1976 in Montreal or Hamilton. In other words, in the absence of any fundamental change in consumer tastes (i.e. changes in the shape of indifference curves), the e l a s t i c i t i e s based on consumer behaviour in central Canada in 1976 are l i k e l y to be representative of consumer behaviour wherever VIA Rail provides intercity service. Consumer choice changes due to changes in prices and/or service attributes are accounted for in the model. It thus appears reasonable to base the e l a s t i c i t i e s required for the computation of efficiency losses on a demand model(s) calculated using the ICTD database. C. Model Formulation There are a large number of factors which influence the travel patterns observed in the Canadian intercity passenger network. There are two aspects of these travel patterns which are important to the determination of economic efficiency losses. These are the total number of trips taken between points, and the mode chosen for travel between points. Factors which influence the total number of trips taken between points are sometimes referred to as "pull" variables. These variables attempt to capture the degree of "attraction" inherent to each city. Travel volume to any ci t y would be proportional to the attraction the city exudes. Pull Appendix B 275 Estimating Price Elasticities variables are generally demographic or socio-economic in nature and include population, aggregate income and linguistic comparability. 1 4 Factors which influence the choice of mode for intercity travel are the service attributes of the alternative modes, as well as demographic and socio-economic variables. Service attributes include the cost, travel time, and departure frequency of competing modes. Socio-economic variables affecting mode choice are personal income and culture. Combining these factors, the basic relationship hypothesized i s : p l i j . T K I J , T H J , F K I J , F L I J ; P O P I J ( INC-ij, LINGij) the volume of travel between points i and j on mode k; the price of travel between points i and j on mode k; the price of travel between points i and j on mode 1; where 1 = any (or a l l ) alternative mode(s) to mode k the travel time between points i and j on mode k; the travel time between points i and j on mode 1; the departure frequency between points i and j of mode k; the departure frequency between points i and j of mode l ; the population of points i and j ; the aggregate personal income of points i and j ; and a measure of the linguistic comparability between points i and j . (B.2) V k i j = f ( P k i j where v k i j p k i j p l i j T k i i F k i j F l i j POPij INCij LINGij . T h i s should not be taken to mean that people are more li k e l y to decide to travel to any given point i f that city has a lot of people and/or money. These variables are surrogates for measures for how much activity goes on in that ci t y which would serve to attract travellers. The true "pull" variables are items such as theatre, symphonies, concerts, medical f a c i l i t i e s , sporting a c t i v i t i e s , shopping areas and the like. These activities and f a c i l i t i e s are highly and positively correlated with readily available variables such as population and aggregate income, which are used in their stead. Appendix B 276 Estimating Price Ela s t i c i t i e s D. Model Specification In order to estimate a demand model based on the general relationship presented in equation B.2 above, a specific functional form must be chosen. As described in the literature review, there is a large number of plausible functional forms to choose from. In order to simplify matters, only four functional forms were tested. Three were of the "ad hoc" variety: the linear, semi-log, and log-linear (or log-log) functional forms. One was of the "neoclassical" variety: transcendental logarithmic (or translog) functional form. The f i r s t three forms were u t i l i z e d for the standard reasons: they are simple and inexpensive to estimate (and easy to understand), and despite their shortcomings (as described in Chapter 3, Section III) often prove remarkably serviceable. The translog form was u t i l i z e d since i t is a member of the family of "neoclassical" demand models. This permits the modelling to proceed without the imposition of arbitrary restrictions on the values of the parameters reflecting the responsiveness of modal volumes to changes in economic conditions. Given the number of flexible functional forms available for modelling, and the limited resources for model estimation, only one of the "flexible" functional forms was ut i l i z e d . The transcendental logarithmic, or "translog" functional form was chosen to represent the consumer's u t i l i t y function for several reasons. The translog specification allows for the free variation of a l l the e l a s t i c i t i e s important for the purposes of this thesis. Furthermore, Appendix B 277 Estimating Price Elasticities Berndt, Darrough and Diewert (1977) found the translog form preferable to both the generalized Leontief and the generalized Cobb-Douglas functional forms on an a posteriori empirical b a s i s . 1 5 Finally, the translog specification appears to have gained a considerable degree of acceptance among economists. Alternative methodologies such as the "Almost Ideal Demand System" have not been as widely used. 1^ A brief description of the neoclassical modelling approach is called for. Neoclassical modelling refers to models which are derived in a manner consistent with the neoclassical theory of the consumer (or f i r m ) . 1 7 In other words, the modelling proceeds with the assumption that the demand for travel is part of the overall u t i l i t y maximizing behaviour of consumers. When normalized at mean values these models, unlike their ad hoc counterparts which impose severe restrictions on the functional form of the u t i l i t y function, give an exact second-order approximation to the true (unknown) u t i l i t y function at that p o i n t . 1 8 1 5Berndt, Darrough and Diewert (1977; pp. 661-662) point out that an a p r i o r i evaluation of model superiority among these three functional forms is not possible on either theoretical or econometric grounds. The authors thus develop a method of a posteriori comparison based on Bayesian techniques and u t i l i z e this to select the "preferred" functional form. ^ I n a l l fairness, the "Almost Ideal Demand System" (Deaton and Muellbauer (1980)) i s f a i r l y recent and it s lack of wide-spread use may merely reflect either inertia among empiricists, and/or publishing lags. 1 7Such models include the generalized Leontief (Diewert, 1971), the generalized Cobb-Douglas (Diewert, 1971), S-branch u t i l i t y theory (Brown and Heien, 1972), the transcendental logarithmic (translog) u t i l i t y function (Christensen, Jorgenson and Lau, 1975) and the Almost Ideal Demand System (Deaton and Muellbauer, 1980). 1 8Aside from providing an exact second-order approximation to the unknown true u t i l i t y function, an additional advantage arises out of the " f l e x i b i l i t y " of these forms. This refers to the fact that these models allow the Appendix B 278 Estimating Price Elasticities The indirect form of the translog u t i l i t y function is used. Separability between the demand for travel and the demand for other goods and services is assumed. The system of u t i l i t y maximizing demand equations is obtained: (B.3) M S i M where SA «= The share of the travel budget expended on mode i P* •= the hedonic (i.e. quality adjusted) price of mode i „ P . n a i l • n a i 2 • • n a i n r i ' l i 1 ^ i 2 • • • 4 i n XL " quantity of travel by mode i M -= total travel budget q A J — j t h attribute of mode i tt , Pii , a i n = parameters to be estimated In addition, the symmetry condition /3Li = are imposed as well as the normalization of the parameters £ a k = - l . ^ e l a s t i c i t i e s to vary by route, rather than restricting them to be constant for a l l routes as is the case with the three ad hoc functional forms used. Thus they can provide useful, valid estimates of the responsiveness of travel demand to various elements of interest by route. l^For the actual derivation of the translog function see Christensen, Jorgenson and Lau (1975). Christensen and Manser (1977), Caves and Christensen (1980), Gillen and Oum (1983) and Oum, Gillen, and Noble (1984) also provide a more formal description of the derivation of the translog function. Appendix B 279 Estimating Price Elasticities E. Data Construction The ICTD data must be manipulated to satisfy the requirements of the actual demand models specified in Section D. There are a number of ways in which each of the potential independent variables outlined above could be measured. Each different definition has some intuitive appeal. The alternatives tested are as follows: p k i j • 1) absolute dollar cost of travel between i and j by each of the modes; 2) price of travel by mode k relative to the price of travel by the other modes; 3) cost of travel deflated by distance; 4) cost of travel deflated by travel time; 5) absolute price of mode k, in conjunction with the geometric mean of the price of the other modes; or 6) absolute price of mode k deflated by distance, in conjunction with the geometric mean of the similarly deflated prices of the other modes. ^ k i j : 1) absolute travel time between i and j by mode k; 2) travel time by mode k relative to the other modes; 3) absolute travel time of mode k, in conjunction with the geometric mean of the travel times of the other modes; 4) travel time relative to the geometric mean of the travel times of the other modes; or 5) difference in travel time between mode k and the other modes. F k i j : 1) number of departures per week for each of the modes; or 2) number of departures per week of mode k relative to the other modes. POP^j : 1) aggregate sum of the populations of i and j (for linear models); 2) aggregate product of the populations of i and j (for log-linear models); or 3) separate variables for aggregate English-speaking and French-speaking populations (again, additive for linear models, multiplicative for log-linear models). INC^j: 1) aggregate sum of the incomes of i and j (for linear models); 2) aggregate product of the incomes of i and j (for log-linear models); or 3) per capita income of the combined ci t i e s i and j . Appendix B 280 Estimating Price E l a s t i c i t i e s LING^j: 1) as a distinct and separate variable; or 2) in conjunction with the population variable (i.e. in splitting up the p o p u l a t i o n between E n g l i s h - s p e a k i n g and French-speaking). In addition, several dummy variables were defined for use in the models: M: dummy variable for major ci t i e s M — 1 i f the travel link joins two centres, each with a population of over 500,000 M - 0 otherwise. L: dummy variable for linguistic compatibility L - 1 i f the travel link joins an "English" centre with a "French" centre L = 0 otherwise. DLL: dummy variable for "long" distance travel ("long" version) DLL = 1 i f the distance between the two centres is over 750 miles DLL = 0 otherwise. DLS: dummy variable for "long" distance travel ("short" version) DLS - 1 i f the distance between the two centres is over 250 miles DLS — 0 otherwise. The dummy variables were considered both as separate independent variables in their own right (to account for different y-intercepts) and as interactive independent variables in multiplicative form 2^ with other important variables (to account for different slopes). In a l l , some 200 variables were created from the ICTD database to serve as potential independent variables for the four models tested. However, a limited number of variables were used in the translog model since the variables incorporating a ratio (e.g. relative fare) cannot be used in such 2 ^ I f two variables "price" and "price * dummy variable" are included in the model, the coefficient of the former w i l l show the degree of price responsiveness for one class of traveller (or city, or whatever the dummy variable serves to distinguish between) and the coefficient of the latter w i l l show the degree of price responsiveness of the other class of traveller. Appendix B 281 Estimating Price Elasticities models. This is because the equations for a l l modes are estimated jointly, as a system, and the use of relative variables in each of the equations would result in severe multicollinearity problems. Thus only the basic form of the variables was used in the translog model. F. Variable Selection Although an intuitive approach to selecting the variables to be included from those defined above might seem commensurate with the style of ad hoc models, the sheer number of possible determinants would make such an approach somewhat formidable. The indiscriminant use of a large number of independent variables would also l i k e l y cause two problems: i) the model would become unwieldy and more d i f f i c u l t to interpret due to the overlapping impacts of related variables; and i i ) multicollinearity could result in very large variances and covariances and hence in very wide confidence intervals, making the true impact of individual regressors much harder to assess. Thus a considerable degree of care is required in selecting the variables to be included in the demand equations. The actual approach adopted to systematically discard the less desirable and/or unnecessary variables is as follows. First , correlation analysis was undertaken to observe the degree to which the independent variables are linearly related to the dependent variables. The more promising variables were used in a stepwise procedure with an entry/exit level of significance set i n i t i a l l y to 0.20. These results were examined for potential sources of multicollinearity. If any pair of independent variables retained by the stepwise procedure were found to have a Appendix B 282 Estimating Price Ela s t i c i t i e s partial correlation of 0.75 or greater, one of the two was dropped. Four c r i t e r i a are u t i l i z e d to make this selection: i) s t a t i s t i c a l significance; i i ) intuition; i i i ) theoretical justification; and iv) necessity. St a t i s t i c a l significance i s , of course, an important consideration in deciding whether to keep or delete an independent variable from any given equation. Given the choice between two variables, the one with the highest t-st a t i s t i c was retained, a l l else being equal. However, s t a t i s t i c a l significance by i t s e l f does not guarantee an economically sound model. Variables which might be excluded on the basis of a low t - s t a t i s t i c may be deemed essential to the model. Conversely, variables with a high t - s t a t i s t i c may be considered economically "spurious" and dropped from an equation. Intuition, the results of previous studies, and the existing body of theoretical knowledge a l l can and do provide rationales for including or deleting a given independent variable from a model despite s t a t i s t i c a l evidence in support of the opposite action. The f i n a l criterion, necessity, is somewhat superfluous in this specific case, but is mentioned here for the sake of completeness. For the purposes of this thesis, i t is necessary to include both the own-price variable and the rail- p r i c e variable, irrelevant of the level of s t a t i s t i c a l significance. Appendix B 283 Estimating Price Elasticities Fortunately, the inclusion of both these variables is in f u l l accord with intuition and theoretical expectations. As a result of this process, i t was inevitable that certain of the independent variables included in the f i n a l models were highly correlated with each other. The primary example of this is the aforementioned inclusion of both the own-price and the rail-price variables. The price of r a i l travel is highly correlated with the price of automobile travel (0.97121), with air travel (0.91302) and especially with bus travel (0.99385). Thus the e l a s t i c i t i e s determined from the coefficients corresponding to the variables are, unfortunately, somewhat suspect. Given the nature of the Canadian intercity network and the needs of this thesis, however, this result is inescapable. G. Estimation Procedure The estimation of the demand models for this study was accomplished using two different computer software packages. The econometrics package SHAZAM^  , developed at the University of British Columbia, was u t i l i z e d for the ad hoc models, primarily due to the ease in conducting stepwise regressions. The parameters of the ad hoc models were estimated using the ordinary least squares procedure. The s t a t i s t i c a l package TSP (Time Series Processor) 2 2 was Z iWhite (1978). 2 2 H a l l , Brode and Ripley. TSP and Time Series Processor are trademarks of TSP International. Appendix B 284 Estimating Price Elasticities u t i l i z e d in the development of the translog model. The translog models were estimated using the iterative Zellner approach. H. Results The results of the ad hoc log linear models estimated for each of the four modes are presented in Tables B.4 through B.7 2 3. These three models were selected as "best" within their respective categories on the basis of r 2 , t-stat i s t i c s of the individual regressors, correct (i.e. expected) signs of the estimated coefficients, and simplicity. The importance of "simplicity" in this case is due to the high degree of multicollinearity that exists among independent variables. Table B.8 provides a partial correlation matrix for the major independent variables. As can be seen from this table, multicollinearity is a severe problem. This means that many of the potentially useful independent variables had to be excluded from the models to reduce the extent of multicollinearity. Unfortunately, among the "required" variables are own-price and r a i l price. Thus the air, automobile and bus equations necessarily suffer from multicollinearity. This finding is not unexpected. It simply reflects a fact of the Canadian intercity passenger system: fares are highly correlated across Z 3The linear and semi-log models did not provide as promising a set of results as the log-linear forms, and were abandoned in favour of log-linear models. Appendix B 285 Estimating Price Elasticities TABLE B.4 Log-Linear Model Results: Air Mode Dependent Variable: natural logarithm of the volume of a i r t r a v e l Number of Observations: 52 R 2: 0.8749 Estimated Independent Variable C o e f f i c i e n t * T - S t a t i s t i c l n a i r fare -3. .443 -4. .209 l n r a i l fare 3. .988 8. .065 l n population "density" 1. .068 10. .705 l n per ca p i t a income 5. .797 1, .872 dummy v a r i a b l e f o r major c i t i e s 0 .427 1, .467 dummy v a r i a b l e f o r English-French c i t y p a i r -0 .196 -0, .493 * For the log-;linear f u n c t i o n a l form, the estimated c o e f f i c i e n t i s the e l a s t i c i t y showing the percentage change i n the value of the dependent v a r i a b l e given a one percent change i n the value of the independent v a r i a b l e . Appendix B 286 Estimating Price E l a s t i c i t i e s TABLE B.5 Log-Linear Model Results: Automobile Mode Dependent Variable: natural logarithm of the volume of automobile travel Number of Observations: 52 R2: 0.9842 Estimated Independent Variable Coefficient* T-Statistic ln cost of automobile travel -2. .350 -10. ,230 ln r a i l fare 1. .510 4. ,340 ln population "density" 0, .594 16. .832 ln per capita income 1, .157 -1. ,104 dummy variable for major citi e s -0, .179 -1. .701 dummy variable for English-French city pair 0, .064 0. .474 * For the log-linear functional form, the estimated coefficient is the ela s t i c i t y showing the percentage change in the value of the dependent variable given a one percent change in the value of the independent variable. Appendix B 287 Estimating Price Elasticities TABLE B.6 Log-Linear Model Results: Bus Mode Dependent Variable: natural logarithm of the volume of bus travel Number of Observations : 52 R2: 0.8414 Estimated Independent Variable Coefficient* T-Statistic ln bus fare -5. .040 -1. .860 ln r a i l fare 6. .952 2. .527 ln bus travel time -8. .085 -6. .666 ln r a i l travel time 4. .562 3. .576 ln population 0. .963 7. .264 ln per capita income -5. .952 -1. .466 dummy variable for English-French city pair -2. .094 -3. .183 For the log-linear functional form, the estimated coefficient is the el a s t i c i t y showing the percentage change in the value of the dependent variable given a one percent change in the value of the independent variable. Appendix B 288 Estimating Price Elasticities TABLE B.7 Log-Linear Model Results: Rail Mode Dependent Variable: natural logarithm of the volume of r a i l travel Number of Observations: 52 R2: 0.8001 Independent Variable Estimated Coef f icient 1' T-Statistic ln r a i l fare ln population "density" ln per capita income ln linguistic comparability -1.831 • -2.564 1.044 10.277 4.865 1.505 -0.207 -0.490 For the log-linear functional form, the estimated coefficient is the el a s t i c i t y showing the percentage change in the value of the dependent variable given a one percent change in the value of the independent variable. Appendix B * 289 Estimating Price Elasticities carriers. 4 It appears as i f bus fares on any route serviced by VIA r a i l are set on the basis of what VIA charges on that route. 2 5 TABLE B.8 Correlation Matrix for Price Variables Cost of Automobile Travel Air Fare Rail Fare Bus Fare Cost of Automobile Travel 1.0000 0.9299 0.9712 0.9684 Air Fare 1.0000 0.9130 0.9187 Rail Fare 1.0000 0.9939 Bus Fare 1.0000 These factors raise a serious question as to the va l i d i t y of the el a s t i c i t y estimates obtained from this modelling exercise. In the presence of multicollinearity, the relationship between the dependent variable and each of the affected independent variables cannot be determined individually with a 2 4 F o r example, bus and r a i l fares have a correlation of 0.9939 on the 52 ICTD routes modelled. The mean ratio of bus fare to r a i l fare is 0.8899 with a standard deviation of only 0.0937. 2 5 T h i s i s the reason the attempts to estimate a demand system were unsuccessful. The results of the translog model were reasonable for the air, automobile and r a i l modes, but not for the bus mode. The bus results invariably showed a positive own-price e l a s t i c i t y and a high degree of complementarity with the r a i l mode. Appendix B 290 Estimating Price Elasticities great deal of confidence. b Furthermore, a complete set of cross-price e l a s t i c i t i e s could not be obtained. To attempt to do so would only exacerbate an already significant multicollinearity problem. Since the opportunity to obtain a f u l l slate of e l a s t i c i t i e s was one of the key rationales for using this approach, the actual results f a l l well short of the ideal. It is for these reasons that the alternative approach of using published e l a s t i c i t i e s from other studies w i l l l i k e l y prove superior to simply relying on the estimates of e l a s t i c i t i e s obtained from any of these models. ^ bJoint tests of s t a t i s t i c a l significance can be conducted, but this is of l i t t l e benefit for the purpose of this thesis. Estimating Price Elasticities 291 Appendix B APPENDIX C City-Pairs Used in Modelling 292 APPENDIX C City-Pairs Used In Modelling OTTAWA - QUEBEC OTTAWA - MONTREAL OSHAWA OSHAWA MONTREAL OTTAWA TORONTO - QUEBEC TORONTO - MONTREAL TORONTO - OTTAWA HAMILTON - QUEBEC HAMILTON - MONTREAL HAMILTON - OTTAWA GUELPH GUELPH MONTREAL OTTAWA KITCHNER - MONTREAL KITCHNER - OTTAWA ST. CATHARINES ST. CATHARINES ST. CATHARINES QUEBEC MONTREAL OTTAWA SARNIA - MONTREAL SARNIA - OTTAWA SARNIA - TORONTO WINDSOR - MONTREAL WINDSOR - OTTAWA WINDSOR - TORONTO WINDSOR - HAMILTON WINDSOR - LONDON NORTH BAY - MONTREAL NORTH BAY - OTTAWA NORTH BAY - TORONTO NORTH BAY - LONDON NORTH BAY - WINDSOR SUDBURY - QUEBEC SUDBURY - MONTREAL SUDBURY - OTTAWA SUDBURY - TORONTO SUDBURY - HAMILTON SUDBURY - LONDON SUDBURY - SARNIA SUDBURY - WINDSOR WINNIPEG - MONTREAL WINNIPEG - OTTAWA WINNIPEG - TORONTO WINNIPEG - KITCHNER WINNIPEG - HAMILTON WINNIPEG - ST. CATHARINES WINNIPEG - LONDON WINNIPEG - WINDSOR LONDON - QUEBEC THUNDER BAY - TORONTO LONDON - MONTREAL THUNDER BAY - SUDBURY LONDON - OTTAWA LONDON - TORONTO A p p e n d i x C 293 C i t y - P a i r s 

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