Prabhu May Have Got His Surge Pricing Formula Wrong, But Real Issue Is Our Distrust Of Market-Based Solutions

Railway Minister Suresh Prabhu has been widely criticised for “experimenting” with “surge pricing” in a limited way on Rajdhani, Shatabdi and Duronto fares. The criticism is largely based on two ideas: that the Railways are a monopoly, and so attempts to squeeze higher fares are an abuse of its monopoly; and that the formula for implementing dynamic pricing based on demand is wrong. It seems, fares can be jacked up by up to 50 percent even if 40 percent of seats are empty (read two editorial comments here and here).

Both criticisms are valid – but only up to a point. To criticise a formula for dynamic fares even before it is fully implemented and the results verifiable is wrong. If surge pricing starts coming into effect when too many seats are vacant, the net result will be a regular loss of passengers to other modes of transport. So, presumably, the surge formula will be corrected at some point based on experience. One presumes Prabhu is not trying to de-optimise rail revenues.

The other argument – that this is an abuse of monopoly – is theoretically valid, but in a situation where the political consensus to open up the railways for private competition does not exist, it is essentially an argument for status quo, barring probably the appointment of a regulator to decide fares.

The problem with monopoly is that we tend to see it too narrowly. Railway travel may be a monopoly of the Indian Railways, but travel in general is not. If we take passenger travel as the market being addressed, competitive alternatives to railway travel exist. Air fares are fairly competitive on busy routes compared to railway upper class travel, especially First Class in Rajdhani; bus fares too are competitive on shorter point-to-point routes. And then there are luxury taxi services between short-distance cities.

The point is we should not define monopoly is such a limited way in a world where options are expanding. Monopolists ultimately lose by making costs so expensive that other substitutes emerge.

The abuse of railway monopoly in freight has ensured a large shift in cargoes to road transport. The abuse of government monopoly in power and coal has made solar power now nearly as competitive.

So the real issue is the wisdom of experimenting with surge pricing in the one area where passengers have many options between rail, air and road transport. But then it is politically impossible to introduce surge pricing where it is really needed – in lower class travel in the railways.

Moreover, monopolies are contextual. Outside a cinema hall, the limited number of autorickshaws available compared to the surge in passenger demand makes autos a temporary monopoly. This is why surge pricing helps, since it either improves supply or reduces demand. The railways are no exception to this rule. If surge pricing works, it would enable even a monopoly to offer more trains on busy routes.

At the core of all our objections to surge pricing – whether in the railways or in air fares or in taxi hailing services – is our innate distrust of the markets as an efficient allocator of resources. Politicians and the public believe that someone should have the power to determine what travel or food or education or land should cost, and not the markets.

But it is this distrust of the markets that ultimately creates inefficiency and higher costs.

And this is why even appointing regulators to determine rail fares will not solve the problem. What do regulators do? They will look at the cost of running a service and recommend a price that is presumably fair to producer and consumer. In perennially loss-making services like second class travel, any future regulator’s recommended increase may be less than needed, but they will essentially try to narrow the cost-breakeven gap.

What they cannot do is regulate the cost of providing a service. How valid is our belief in regulators’ ability to solve a problem when that problem is a structural one - overmanning, poor use of technology and lack of accountability in the public sector. The issue is to change the cost base, and a railway regulator cannot do that without the government first allowing competition and corporatisation of the railways.

And we aren’t even talking of the real monopoly that distorts costs: the railway unions, who will not allow a reduction in the workforce or link wages to productivity.

We have regulators in the power sector, but has that resulted in lower power tariffs anywhere? On the contrary, state governments artificially keep power costs for the rural sector low, and allow state discoms to accumulate huge amounts of overdues, which ultimately have to be paid for from higher tariffs and taxes.

So, having a regulator in a system where prices are not set by the markets is, by definition, a non-solution. In any case, assuming a railways regulator asks the ministry to up second class fares, will any politician dare to take that medicine in full?

The only solution is for politicians to accept the reality that markets are more efficient allocators of resources, and regulators are useful to ensure that competition is fair to all players. But we are nowhere near that stage, and are, in fact, moving further away from markets in many areas.

To criticise Prabhu using theoretical arguments about monopoly and unfair pricing makes no sense till we can agree to allow him to throw open the railways to competition. He is, like all ministers before him, trying to cross-subsidise populist underpricing of second class travel by fleecing the rich.