This report concerns bus and rail markets in Great Britain. Our analysis examines the pros and cons of existing policy for both of these transport markets and makes policy recommendations for railway in Great Britain (GB rail) and bus markets outside London.

We find that although both of these markets could benefit from reform, the national policy debate has focused too heavily on GB rail and not enough on buses, which are used by three times as many passengers each year. In fact, a closer examination of the two sectors reveals that the regulated markets for GB rail and London buses, which have generated significant increases in patronage and quality in recent years, provide a number of lessons for the liberalised bus markets outside London.

Historical policy and outcomes

The relative success of London buses and GB rail

The markets for London buses and GB rail have a number of similarities. They are both heavily regulated, operate under government contracts, and the government has strong legal duties to ensure that these markets succeed. For GB rail, the government is legally obliged to provide train services should a train operating company (TOC) unexpectedly stop doing so, as was the case with East Coast. London buses are indispensable to the mayor’s statutory duty to promote and encourage safe, integrated, efficient and economic transport facilities and services in London. Government has strong powers over fare levels for both, takes much of the fare revenue risk in relation to GB rail and all of the risk in relation to London buses.

Both GB rail and London buses have seen significant growth in patronage in recent years. GB rail patronage has increased by 88 per cent since 1996/97 when the industry was restructured. London bus patronage has increased by 72 per cent since 2000/01, when Transport for London (TfL) was established. In both cases, taxpayer subsidy levels increased for a period before falling back.

The London bus subsidy increased because the policy of growing bus patronage was a victim of its own success. Public expenditure rose sharply in the early 2000s to increase the number of buses and improve the quality of the network, while fares fell in real terms. The result was that costs rose faster than fare revenues. The taxpayer subsidy is now falling again and fare rises are at the rate of inflation. The taxpayer has clearly enjoyed value for money. London buses are available to people from all backgrounds and the subsidy per passenger is lower than for bus passengers outside London.

By contrast, GB rail’s subsidy increase was driven by the need to improve infrastructure, which was essential after a series of horrific accidents in the years following the break-up of the industry. This has successfully improved the safety of our railways to the credit of both industry and the last government. Grants to Network Rail have now fallen by 26 per cent since 2007/08. Although Network Rail remains an inefficient infrastructure manager in comparison to the top 25 per cent of international rail infrastructure managers, it is on course to deliver 44 per cent efficiency savings since 2004. Given this track record, we are hopeful Network Rail, working with the Office of Rail Regulation, will deliver further efficiency savings.

In addition to the infrastructure subsidy, TOCs were provided with a net taxpayer subsidy for most of the period since the industry was restructured. The economics of many franchises meant that services could only operate at a loss because there were too few passengers. In the last three years, the audited accounts of the Department for Transport (DfT), Transport Scotland and the Welsh assembly show that the TOCs have transformed themselves from subsidy addicts to net contributors to the exchequer. Last year the TOCs paid back over £400 million net to the Treasury.

With more rail passengers than at any time since the 1920s, TOCs paying a net premium to government and the infrastructure subsidy decreasing (excluding expenditure on Crossrail), GB Rail has, on balance, become a policy success. There is, however, an inherent conflict of interest within GB rail policy. The government wants both to protect the taxpayer (by increasing patronage) and to protect the passenger (by decreasing patronage at peak hours to prevent an increase in overcrowding).

As a result, above-inflation rail fare rises over the past decade have hit rail commuters hard. Meanwhile, policy has done little to make GB rail available to those on lower incomes. Households with gross incomes in the top quintile spend almost three times as much on fares as households in the bottom quintile.

There is also a regional imbalance. Rail passengers in Scotland, Wales and the English regions continue to travel in older rolling stock while newer rolling stock is operated on intercity routes, and in London and the south east. The former group have seen the average fare paid per journey increase by over 8 per cent in real terms since 2004. Over the same period, the average fare paid per journey by intercity passengers has dropped just over 8 per cent and passengers in London and the south east have seen a drop of 2.5 per cent, both in real terms. Within these groups, advance fare passengers have benefited the most. It seems the TOCs have kept these unregulated fares low to increase patronage overall. Unregulated fares now make up two thirds of passenger revenue, helping to reduce taxpayer subsidy.

Since blame for these disparities lies as much with central government as with the TOCs, GB rail policy and budgets need a new round of devolution so that decisions are made in and by the communities that they effect. We make a series of recommendations relating to this below. Notwithstanding these issues, GB rail and London buses clearly show that taxpayer subsidies can be used to deliver positive outcomes where combined with clear regulatory powers.

The failure of buses outside London

Bus markets outside London are dramatically different. These markets are completely liberalised and there is a much weaker legal duty on government to guarantee bus services than is the case for either London buses or GB rail.

Liberalisation has not resulted in a competitive market – 37 per cent of weekly services outside London do not face any effective head-to head-completion and just 1 per cent of weekly services face effective head-to-head competition over all or most of their route. Many operators are now making excessive profits. The Competition Commission found that average profits for operators were 3.5 percentage points above the mid point of its calculated range of appropriate returns.

Instead of a liberalised market driving better outcomes, fares have risen and patronage has fallen. Fares in England (outside London) rose by 35 per cent above inflation between 1995 and 2013. Fares rose in real terms in Wales by 34 per cent and in Scotland by 20 per cent over the same period. Overall bus patronage across Great Britain (excluding London) dropped by 32.5 per cent since 1986 compared to a 99 per cent increase in London. The bus is therefore not fulfilling its potential in terms of relieving congestion, increasing access to jobs and public services, and reducing the carbon emissions of transport. This is a public policy failure since buses are used by households from all income groups.

Public spending on buses has tended not to be strategic. For example, the Department for Education and the Department of Health spend approximately £1.4 billion per year on transport. Much is spent on buses at specific times of the day, such as the school run and some hospital shuttle services. The same bus companies often operate commercial services during the rest of the day, often with state support, or alternatively receive further state funding from the local authority to provide tendered services. This approach to local transport procurement may suit Whitehall budget headings but does not support a community’s local transport needs.

Meanwhile, austerity has hammered support for buses. The bus service operator grant, which subsidises fuel duty costs, has been cut by 20 per cent, and the local government grants, from which local authorities support tendered services, have also been cut. As a result, many unprofitable services have ceased to operate and local authorities have been unable to cover the slack in many cases.

That said, the decline in bus patronage has not been uniform across the country. Where concessionary fare spending has been particularly high, for example in the south west, south east, east and east midlands, bus patronage has increased. At the same time, strong local political leadership in cities such as Nottingham, Brighton and Oxford where car use has been restricted has resulted in increased bus patronage. In essence, some intelligent public sector interventions have bucked what is otherwise a depressing national trend.

Policy recommendations

While policy for London buses seems to be performing reasonably well, there are challenges facing GB rail which need addressing. But these pale in comparison to those facing bus markets outside London. We make the following recommendations to improve these sectors.

In relation to GB rail, the north tends to do worse than the south, fares remain unaffordable to many, and – although falling – the public subsidy for infrastructure improvement is still too high.

To ensure that taxpayers and consumers are getting the best value for money, public sector rail operators should be allowed to compete for franchises as and when they come up, including as part of a joint venture with the private sector. Continuing to prohibit the British government from bidding for franchises does not stop operators owned, for example, by the French government from doing likewise. To ensure that the operation of a franchise by the public sector delivers a strong risk/reward ratio to the taxpayer, the DfT and HM Treasury should work together to examine the potential increase in the national debt that might result following an award.

In order to create a level playing field for the private sector, the Office of Rail Regulation should take over the franchising process from the DfT. Over time, we believe that regional franchising (that is, not for intercity) should be carried out by regional transport bodies (discussed in more detail below). There is a case for some regional transport bodies electing to move from franchising to management or concession contracts similar to those for Merseyrail and the London Overground.

Meanwhile, we believe that new franchising arrangements should encourage TOCs to make a greater contribution to infrastructure costs. To facilitate this, Network Rail will need to remove an existing regulatory conflict of interest in co-managing infrastructure with TOCs. Its capacity management activities (scheduling, signalling, planning new investment) and its operation, maintenance and renewal activities should be regulated separately. Much as the public sector pays for the maintenance of Britain’s road network, we do not believe that all infrastructure costs should be born by the private sector. But taxpayer support for Network Rail can and should be reduced further.

As outlined above, the deregulation of buses has largely failed with patronage down and fares rising higher than inflation. That said, there have been some good examples of local authorities working effectively with bus companies to deliver a better deal for citizens. As with GB rail, we do not believe that a uniform change to the system of bus regulation is the right approach. Instead, we believe that it should become easier for local government to take on regulatory powers known as quality contract schemes (QCSs). This would allow them to re-regulate their bus markets and have greater control over routes, service frequency and prices. Although available to local authorities, QCSs have never been used because of the costs and legal difficulties involved in their implementation. We recommend that the test to implement a QCS should be removed and replaced with a simple requirement that the relevant local transport authority satisfies itself that the QCS is ‘justified’.

Our research recognises that in many instances local authorities do not have sufficient scale to negotiate better deals for local residents from national bus companies. To address this we recommend the creation of regional transport bodies modelled on Transport for London at the level of city-regions and combined authorities. These new bodies should reflect travel-to-work areas. They should have a remit to take on the delivery of transport policy, including the regulation and contracting of bus markets, regulation of regional rail services, and the encouragement of modal shift. This would allow for better services, quality and fare levels; help address the regional imbalance that currently exists in GB rail; and allow for greater integration of GB rail with buses and other modes of transport. The ‘Transport for the North’ rail body, previously recommended by IPPR North, would be consistent with this approach with bus regulation and contracting remaining at the city-region level.

These new regional transport bodies should be allowed to take statutory responsibility for the delivery of transport services relating to education and health. Community transport funds at the local level should be established by carving out the relevant transport budgets from other government departments. The regional transport bodies should be able to keep any savings made from achieving efficiencies and reinvest the funds into other sustainable transport projects at the local level.

To satisfy the UK’s longer-term public transport needs, the DfT should put together a national transport strategy. This should examine how changing demographics and employment patterns, technological changes and the need to decarbonise the economy by 2050 are likely to affect the demand for transport at the national, regional and local level. The strategy should model a number of scenarios and provide a basis around which to make decisions about modal shift, demand management and future infrastructure investments.

The outcome of different transport markets in recent years clearly shows that the liberalised approach of the 1980s towards local bus markets has failed. Where regulatory powers and taxpayer subsidies are used strategically by strong political leaders alongside private sector providers, outcomes for consumers in terms of fares, frequency, quality and safety can improve. If the government wants to ensure that the UK’s transport markets deliver their social and economic functions of connecting people to employment, public services and the marketplace while delivering the UK’s legally binding decarbonisation targets, major reform is clearly needed.