Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs.
Ian King of Sky News recently highlighted the lunacy of a Transport for London statement about profits from London Underground: “We don’t make a profit, because we reinvest all our income to run and improve your services.”
To begin with, this is a nonsensical statement that would probably be challenged by the authorities if it were made by a private company. If a company reinvests its income, it still makes a profit. A company that has net income after interest and taxes of £300 million and invests it in (say) new trains has none the less made a profit of £300 million, and those new trains go on the balance sheet as assets. Indeed, privatised energy companies were heavily criticised about three years ago for reinvesting all their profits in new plant, thus avoiding corporation tax because of the investment allowances they received.
But, let us assume that it is really true that London Underground does not make a profit, and is proud of the fact. Should it be? Certainly not. King made some very good points; I will elaborate and make some further ones.
A profit is an indicator that the factors of production are being used efficiently to provide something of value to customers. Of course, London Underground is a monopoly, and profits could be a sign of the exploitation of its monopoly position, but making no profits is nothing to be proud of – it is an indication that the organisation is wasting the precious resources vested in it by London’s taxpayers. Catholic social teaching has put this point rather well. Whilst criticising unjust exploitation, one of John Paul II’s most important encyclical letters states: “The Church acknowledges the legitimate role of profit [italics in original] as an indication that a business is functioning well. When a firm makes a profit, this means that productive factors have been properly employed and corresponding human needs have been duly satisfied.”
Indeed, you could argue that even if the owners of a business wanted to give all its profits away, a business might still wish to make a profit, because the profit sends information about whether the business is doing something socially useful.
But let’s put aside the semantic issue of whether London Underground does or does not make profits as properly defined. There are two other peculiarities of a business reinvesting all its revenues.
Firstly, it suggests that amount of money the business invests will depend on past profits. Why should that be? Whether London Underground replaces all the carriages on the Bakerloo line or adds some more escalators or platform space should depend on the future returns from those investments, and not on the cash that happens to be flowing into the business from the profits it is making now.
Secondly, who exactly is taking the risks? That part of future investment not financed by recycling profits will, no doubt, be financed by some form of borrowing or taxes levied on Londoners. There are all sorts of ways in which this might happen and the borrowing might be kept off the balance sheet, but the capital must be raised from somewhere. If those investments don’t pay off, it is the taxpayers of London who suffer. They will pay higher taxes to service the debt or subsidise the investments. In a sense, London Underground is thumbing its nose at the taxpayers. If investments pay off, the money gets reinvested in the business and Londoners never see a return. If investments do not pay off, the Underground will need subsidies. In other words, there is no equity cushion – just a one-way bet against London’s taxpayers.
This is all symptomatic of entirely the wrong approach to policy in relation to the tube. The last Labour Government tried to privatise the infrastructure whilst keeping the trains government-run. As an article by Robert Jupe published in the Institute of Economic Affairs’ journal suggested a few years ago, this is the wrong way round. Either the network could be privatised as separate lines with some competition between them, or the tracks could remain in Government hands and the services be contracted-out (to at least three contractors).
The contractors should be free to innovate. They could decide whether their workers were contractually prevented from striking (this should not be a matter for Government regulation); they could move to driverless trains if they wished; and so on. Because there would be competition, the strike threat would be nullified. Yes, one line might shut down as a result of strikes, but others would be more likely to stay open (if they kept drivers at all).
Not all contracting-out works. Sometimes what economists call the “transactions costs” are too big. However, it seems to me that the upside from privatising the train services in the current situation could be huge. The move could break the trade union domination and drive the innovation in service provision that is desperately needed.