Supply Chain Transportation Infrastructure and Policies

Roads, seaports, airports, rail, and canals are some of the major infrastructural elements that exist along nodes and links of a transportation network. In almost all countries, the government has either taken full responsibility or played a significant role in building and managing these infra­structure elements. Improved infrastructure has played a significant role in the development of transportation and the resulting growth of trade. The role of the railroads and canals in the eco­nomic development of the United States is well documented. More recently, the impact of improved road, air, and port infrastructure on the development in China is very visible.

Before considering policy questions related to transportation infrastructures, it is worth looking at the history of rail and road infrastructure in the United States to see some of the issues involved. We summarize some of the discussion by Ellison (2002) of the history of railroads and regulation in the industry. The construction of railroads in the United States occurred rapidly dur­ing the 1850s. The railroads were privately owned but were built with significant government subsidy, often in the form of land grants. By the 1870s, the railroad network connected most of the United States. Each railroad was the exclusive provider of carriage over its track. This monopoly allowed railroads to determine the price they charged, as well as the level of service they provided to their customers. Initial construction of new railroads led to some competition over rates. The railroad companies responded by entering into agreements with each other that effectively ended competition and raised rates. Protests by farmers and other users of the rail­roads led eventually to the establishment of the Interstate Commerce Commission (ICC), which prohibited discriminatory pricing. The ICC required railroads to file their rates with the ICC and made them public. The railroads responded by forming cartels to restrict supply. This led to the passage of the Sherman Antitrust Act in 1890. Responding to the financial difficulties of railways in the 1940s, the government allowed them some degree of coordination and exempted them from the antitrust regulations. With the growth of other modes of transport and the need to revi­talize their assets, the railroads were in bad financial shape in the early 1970s. The Staggers Rail Act of 1980 deregulated the railroads, allowed them some rate-making powers, and eased entry and exit. The act also removed the antitrust immunity of the railroads. Deregulation in the United States was followed by a wave of reorganization and mergers within the railroad industry. Over­all, deregulation has resulted in improved financial performance of the railroad industry and increased use of rail by shippers.

Levinson (1998) provides an excellent discussion of the history of road construction and pricing. In the late 1700s, turnpikes were built using public funds in Virginia, Maryland, and Pennsylvania but were then turned over to private companies that collected tolls. Over time, other turnpikes were built as a result of competition between towns to gain trade. Other than federal land grants, these roads were typically built with local effort and money. The tolls on these turnpikes were generally structured to keep local travel free and make people traveling across an area pay for this right. With the growth in railroads and canals, however, turnpikes suf­fered financially in the mid-1800s and were eventually converted into public roads. In the twen­tieth century, as the modes of transport changed, there was a need for higher quality roads. A network of national toll-free highways was built, largely using gasoline taxes as the source of funding. At the same time, other facilities, such as tunnels and bridges, were often constructed as toll facilities. In many other countries, such as France and Spain, concessions were granted to private companies that received toll revenue. More recently, private toll roads have also been built in Malaysia, Indonesia, and Thailand.

From these examples, it seems reasonable that the government must either own or regulate a monopolistic transportation infrastructure asset. When the transportation infrastructure asset has competition either within a mode or across modes, private ownership, deregulation, and competition seem to work well. The deregulation of the transportation industry within the United States is a case in point. Keep in mind, however, that roads, ports, and airports are largely public and not private because of the inherently monopolistic nature of these transportation infrastruc­ture assets. In such a setting, the public ownership of these assets is justified. This raises the policy question of financing the construction and maintenance of these publicly owned transpor­tation assets. Should roads be financed through a gasoline tax, or is some other form of financing such as tolls more appropriate?

Some economists have argued for public ownership of these assets with the setting of quasi­market prices to improve overall efficiency. Quasi-market prices need to take into account the discrepancy between the incentives of an individual using the transportation infrastructure and the public as a whole that owns the infrastructure. This discrepancy is illustrated in Figure 14-1 in the context of road traffic.

A vehicle driver bases his or her decision to use a highway on the cost and benefit of doing so. Figure 14-1 assumes that different people have different values for making the trip and these values are uniformly distributed over an interval. The number of users whose value from a trip exceeds a particular cost is thus defined by the demand curve. We assume a simple demand curve given by traffic f = 1,000 – cost. The costs incurred by a motorist include any tolls and the cost of time spent on the highway and the cost of operating and maintaining the vehicle. It is well known that the time spent increases with congestion on a highway. Thus, the average cost to each motorist increases with traffic flow, as shown in Figure 14-1. We start with the case when there are no tolls and motorists incur only costs related to congestion, operation, and maintenance. We assume that the total cost grows with traffic f and is given by total cost = 3f². The average cost per motorist is thus given by cost = 3f²/f = 3f. Because there are no tolls for accessing the highway, demand will materialize based on the average congestion, operation, and maintenance cost incurred by people on the road. Given people’s valuation of the trip, the number of motorists using the road is determined by the intersection of the demand curve with the average cost curve at point A as shown in Figure 14-1. For our demand curve f = 1,000 – cost and average cost function cost = 3f, we obtain f = 1,000 – cost = 1,000 – 3f. Solving this equation forf, we obtain f = 1,000/4 = 250 motorists at equilibrium. This results in an average cost to motorists of P₀ = 3f = 3 X 250 = 750 and a traffic flow of Q₀ = f = 250.

From the perspective of the public, however, it is more appropriate to consider how each additional motorist impacts the total cost, not just the average cost. Observe that an additional motorist increases the average cost 3f by a small amount but increases the total cost 3f ² across all motorists by a much larger amount. This is represented in Figure 14-1 by the marginal cost curve, which measures the marginal increase in total cost as a result of additional traffic flow. For a total cost curve total cost = 3f², the marginal cost is given by taking the derivative d(total cost) /df = 6f. Observe that the marginal cost curve 6f is higher than the average cost curve 3f. In other words, the marginal impact of a motorist on total cost is much higher than his or her average share of the impact. Ideally, we should charge motorists a toll for highway use based on this marginal cost that they add to the system. If we were to do so for our example (i.e., somehow charge 3f as additional toll to raise the total marginal cost to 6f), from our demand curve, we obtain f = 1,000 – marginal cost = 1,000 – 6f. Solving this equation for f we obtain an equilibrium traffic of f = 1,000/7 = 143 motorists. Motorists should be charged a toll 3f that depends on the amount of traffic on the highway. If the traffic is at a level below 143, motorists pay a lower toll. As traffic increases, the toll rises in proportion and this increase in costs now discourages motorists from joining the highway. At equilibrium, there are f = 143 motorists on the highway, each is charged a congestion-related toll of 3f = 3 X 143 = 429, and each incurs average congestion-related costs of 3f = 429 for a total cost of 838 per motorist. With a toll in place, fewer motorists join the highway because they bear the true cost they are imposing on the highway system. This toll lowers the vehicle flow rate from Q₀ = 250 to Q₁ = 143 and reduces the average congestion cost per motorist from 750 to 429. In other words, the absence of a congestion toll results in an overuse of the transportation infrastructure and a higher resulting congestion cost on all users.

The problem is well illustrated by a simple illustration given by Vickrey (see Button and Verhoef, 1998). Each member of a group going out to dinner is likely to order an expensive item if the plan is to share the bill equally at the end instead of having each person pay his or her true charge. Thus, it is fair to say that the overall bill is higher if it is shared equally compared with each person paying based on actual consumption. The same is true with transportation infrastruc­ture if pricing is not linked to congestion.

Quasi-market prices for transportation infrastructure thus result in higher prices at peak locations and times and lower prices otherwise. Such pricing is not commonly observed for transportation infrastructure except for roads in Singapore and city centers in a few European cities. Congestion is a major factor at several ports and airports. The Los Angeles-Long Beach port, for example, experienced significant congestion in 2004. Several factors affected the con­gestion, including capacity problems on railroads taking containers away, labor shortages, and technology issues. However, congestion was also affected by the desire of many shippers to bring weekly shipments from Asia over the weekend to ensure supply for the entire week. This created a peak time with significant congestion. The peak workload also becomes exaggerated as container ships get larger. In such a situation, the use of peak tolls to level out the arrivals can be an effective policy. Overall, it is important to keep in mind that transportation infrastructure faces congestion-related problems unless users are forced to internalize the marginal impact of their actions on society. It may be most effective to charge a congestion toll and use the money gener­ated to improve the effectiveness of the transportation infrastructure.

Key Point

Transportation infrastructures often require government ownership or regulation because of their inher­ently monopolistic nature. In the absence of a monopoly, deregulation and market forces help create an effective industry structure. When the infrastructure is publicly owned, it is important to price usage to reflect the marginal impact on the cost to society. If this is not done, overuse and congestion result because the cost borne by a user is less than the user’s marginal impact on total cost.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.