The latest debate surrounding the government’s decision to hike passenger fares and freight charges for the railways has dragged a skeleton out of the closet making the country turn white with fear.

As any undergraduate student of economics should be able to explain, the price of a commodity is the sum total of payments needed to induce service providers to transform the raw materials they have paid for into final products meant for different uses. The services in question tend to flow towards the production of commodities that yield the best return for them and markets function in the nature of sluice gates that ensure free economic activity. Preventing the free functioning of markets amounts to closing the sluice gates during a flood or not opening them during a drought.

Of course, when the government itself assumes charge of production, the market law may not apply. The returns that attract the government are hard to measure in financial terms. The government’s much lauded objective is the generation of social welfare. And once social welfare takes the driver’s seat, dry economic logic begins to sink into long lasting coma. The disastrous impact of the economic coma is invariably perceived in the long run and this is exactly where violated economic principles have the last laugh as they watch the economy crumble.

The railways in fact are a case in point. It appears that the branch of the Indian Railways that is concerned with freight transport earns substantial profits. On the other hand, the passenger service division has been merrily generating losses, thereby making it next to impossible for the authorities to keep things in healthy shape since time began. It is not hard to observe here a conflict between the two goals, monetary returns and social welfare. As far as freight traffic goes, the railways are mostly serving the private business sector that is engaged in profit oriented ventures. Consequently, even though run by the government, profit seeking through freight transport need not be inconsistent with welfare motives.

Passenger travel on the other hand is a totally different story, if railways are run by a government instead of the private sector. The government’s objective in this case should be the generation of passenger comfort and safety. And for this to happen, the burden of the fare imposed on the public must not outweigh the latter’s perception of the value of the comfort. This is all the more true since a section of the passengers are daily commuters to workplaces in cities from suburban towns. Such passengers usually include a large number persons belonging to the lower echelons of society, viz. the informal sector labour force. These individuals are deprived of social welfare benefits, such as dearness allowance, provident fund and so on, that the so called formal sector takes for granted. A major reason why the passenger division of our railways runs at a loss relates to accommodating these passengers, whom the Indian Government, even after enjoying more than half a century of economic independence, has not been able to endow with economic liberty.

Hence the question of subsidizing the passenger section of the railways, that is charging a price for the service that falls short of the expenditure involved in producing it. The costs, being financial in nature, have to be incurred from some source or the other. In the case of the railways, the source is readily available in its freight division coffers. Freight transport generates profits and these are siphoned off to cover the losses incurred in passenger transport. According to the Finance Minister, the figure stands now at Rs. 26,000 crore.

Using the profit of one organization to meet the losses of another is referred to as cross-subsidization and cross-subsidization runs counter to the logic of economics. Profits earned by a producing organization is a major source for the enlargement as well as improvement of its capital base. In the case of the railways, the capital base consists largely of infrastructure. Maintenance and improvement of infrastructure, both its quality as well as quantity (the freight corridor being an obvious example), helps to reduce per unit cost of transportation. Even if other costs, such as the cost of fuel and labour were to rise, investment in infrastructure has the beneficial effect of keeping transport costs on hold and along with it the prices of the commodities transported. Needless to say though, infrastructure building is a time consuming process, and to that extent its favourable impact on prices cannot be realized overnight. A period of waiting is involved, after which prices might be tamed, but the immediate impact of a rise in freight rates can be inflationary.

Cross-subsidization, however, rules out even the delayed gains. It prevents adequate investment in the freight sector and this in turn clogs up avenues leading to cost reduction and inflation control. The government’s decision to remove cross-subsidization can therefore be easily defended, especially from the point of view of eventual price control. Indeed, not only has the government decided to do away with cross-subsidization, it has announced an increase in freight rates too by 6.5 per cent. Given that the freight division is making profits, it is not clear why the increase in freight rates was called for. It is possible that the government is planning for a massive improvement in freight infrastructure and this requires profits in excess of what the railway freight service is earning now. Hopefully, the upcoming Rail Budget will throw some light on the issue.

As far as the passenger section goes, the fare rise has to be justified, partly at least, by the decision to do away with cross subsidization. But the government has announced its intention to come up with world class passenger services as well. The extra fare to be raised from passengers is therefore expected not only to eliminate subsidies but also generate adequate surplus to create infrastructure. And it is here again that time plays a crucial role. The increased fare has to be shelled out immediately, but infrastructure investment will bear fruit with a lag.

The government wishes to initiate tough measures and make the railways follow market principles. This makes eminent sense provided the market logic is carried to its logical limit, which involves minimizing the time gap between payment by a customer and the delivery of the commodity. Quite clearly, the government needs the money right away and this is what lies at the root of its decision to increase fares. However, given that the fare increase (somewhat reduced now from the initial 14.2 per cent) is motivated by the need to improve infrastructure, it is essential to specify a time frame for its delivery. In the private sector, when a promoter accepts advance payment for constructing a new residential complex, there is a pressure on him to deliver the flats within a stipulated period of time. A government that believes in market principles and abhors subisidies cannot behave any differently from the promoter.

It is imperative therefore not only to announce a rise in fare, but also the time horizon chosen to deliver world class passenger comfort. The government itself admits that passenger services are in miserable shape and holds past governments responsible for their failure to meet international standards. The point is well taken and the government’s decision to raise fares to help Indian Railways reach the coveted destination makes eminent sense. However, till that destination is reached, passengers (and the less privileged in particular) will be paying more for a state of services that the government itself deplores.

If past governments have to be criticized for indolence, the present one needs to act with alacrity. The immediate escalation of fares ought not to yield results in the distant long run, when, as Keynes had observed, we are all likely to be stone dead.

(Published in Telegraph, Kolkata, July 7, 2014)