## **Box 4: Subsidizing freight rail**

Although many rail services have close substitutes in other transport modes, these other transport modes are, in most cases, not yet efficiently priced (i.e. reflecting all infrastructure, accident, environmental and congestion costs). For example, although there are individual exceptions, it is not yet common for road prices (where they exist) to vary with congestion levels. If the road mode is underpriced, it is economically efficient (if only second best) to also underprice the rail mode, with associated subsidies if necessary. In the absence of government intervention, the price of rail services would be too high and the consumption of rail services would be too low relative to other transport modes. Due, in part, to this mispricing of substitute modes virtually all OECD countries subsidize the rail sector in some way.

## _Source: Structural reform in the rail industry_ _<u>(OECD, 2005)</u>_

One could argue that Transnet’s general freight rail business operates in a distorted market since it competes with a road freight sector which is not efficiently priced. However, this cannot justify opaque cross‐subsidies. Without adequate controls and efficiency incentives, cross‐subsidies could be costlier to the economy as a whole than transparent transfers and open tenders for infrastructure upgrading and services provision (Stoerer and Teljeur, 2003). The current opaque method of cross‐subsidization, determined by a commercial entity is highly undesirable.

_4.3 Highly competitive road freight sector that benefits from an unlevel playing field_ The regulatory environment of South Africa’s freight transport sector not only impacts relative modal efficiencies through its impact on pricing and investment decisions in rail and ports directly, but also through the competition it creates in the road freight sector.

# <u>Deregulation and increasing dominance of the road freight sector</u>

The deregulation of road freight transport allowed firms to compete with the rail sector, and it started to gain in market share from the 1990s. Growing market share led to large investment by road transporters and logistics companies, particularly in the 2000s based on strong economic growth. The relatively low barriers to entry also meant that several new companies entered the market while firms divested from in‐house logistics to focus on core operations. The privately owned and operated road transport carriers quickly responded to the new market conditions (e.g. developing the new 56 tonne GVM Superlink truck), whereas the railway did not.

As a result, the road freight sector is highly competitive, even in the transportation of bulk goods over long distances, which is typically the where rail freight should be most competitive. Dry bulk, used in domestic steel, energy and construction industries, represents the majority of domestic freight in South Africa in volume terms. And more than 80 percent is moved by road (CSIR, 2014). For agricultural goods the road bias is even higher, only 4.4 percent of agricultural dry bulk flows are moved on rail. In terms of containers, road transport also dominates. Of the 964,000 containers that were exported through South African ports, only 15 percent arrived at the ports by rail (Transnet, 2014a).

# <u>High levels of competition and a privileged regulatory environment</u>

The competitiveness of road compared to rail is in part due to the high levels of competition within road transport. The deregulation of freight transportation led to increased supply from new trucking companies, causing road freight tariffs to fall. There is a degree of consensus among transport officials that the growth in road freight transportation has been too fast and that some freight should be encouraged to return to rail. There is concern that the level of competition in the trucking industry is excessive and destructive. The weak economic climate, combined with increased trucking capacity has intensified competition, reducing tariffs further for road freight. The intense competition, combined with a lack of enforcement, has contributed to trucking operators overloading their vehicles, _18_