The Invisible Hand Works Backwards, Too

One of the reasons the study of history and foreign countries is so vital, and our schools' total failure to teach them is so worrying, is because it's hard to understand and appreciate our way of life unless you have some different perspective to compare it to.  Human nature being what it is, most people naturally assume that whatever their own way of life happens to be came about by some natural law and there's really no other way to do things.

Nowhere is this more true in economics.  In American thought, life, and experience, there really is no such thing as a "shortage."  Whatever good or service you might happen to want, you simply go out and buy it.  Now, you might not have enough money to be able to pay for it right away, but there's no problem with the good simply not being available at any price.

Contrast this with the old Soviet Union.  Under Communism, the "price" of goods was set by a bureaucrat, and so was the amount of the goods to be produced this year.

If the bureaucrat set the price too low, the stock would run out early, and there would be a literal shortage: there simply would be no pens, or shoes, or light bulbs, or whatever available at any price because they were all gone.  If the price was set too high, then the opposite happened: there'd be warehouses full of extra widgets rotting away that nobody wanted to buy.

Adam Smith's famous invisible hand of market capitalism lets its will be known through pricing: high prices create an incentive for producers to make more of something because people want more of it, whereas low prices tend to drive inefficient producers out of the market entirely.  Suppliers adjust their prices as well as their production to make sure they aren't left with an overstock, and to take advantage of high demand.

Eventually you reach a state of equilibrium where the price, the demand, and the supply are more or less in balance.  Except in very rare and special situations like natural disasters, a free-market economy like America's will always provide as much of whatever anybody wants in fairly short order - because it is in the natural fiscal interest of businessmen to do so.

What happens, though, when thanks to government interference, the invisible hand is wired backwards?  Public mass transit in an age of high gas prices and government deficits provides a cautionary example.

Transportation For Profit

For most of American history, most transportation was provided by private, for-profit businesses.  The government contributed directly to building state-owned infrastructure (the Erie Canal), and gave subsidies in other cases (the Transcontinental Railroad), but by and large public transportation was provided by private firms.

Each town had its local trolley company; the great railroads built lines and ran trains where they believed people would pay to use them; eventually, private trucks, bus companies, and airlines followed in this model.  From New York's privately owned and operated subways to the Pacific Electric system in Los Angeles, "public" transit was very much private and very much profit-driven.

It should be common sense, but it bears repeating: for a private transport business, more ticket sales is a good thing.  You want more customers, because more customers means making more money.  If necessary, you'll move heaven and earth to get this done.

What is now Amtrak's Northeast Corridor was originally built by the Pennsylvania Railroad as a private venture - sadly, much of today's corridor infrastructure is the exact same as what the old PRR left, only much much older now.  Because it was in the best financial interests of the Pennsy to move passengers efficiently and well, that is what they did.

In 1953, the Pennsy expected tremendous crowds coming to Washington for Dwight Eisenhower's inauguration.  They scheduled extra trains for this purpose and sold enough tickets to paper the station.  A few days before the Big Day, though, a mechanical malfunction caused a dreadful accident - a train's brakes failed, the train ran through the buffers and off the tracks directly into Washington Union Station, then fell through the floor into the basement.  The main train station where thousands of passengers were expected to arrive was all but destroyed.

It's easy to imagine what would happen after an accident like that nowadays - all trains would be canceled and the station shut down for months, if not years.  But for the Pennsy, millions of dollars were on the line, as they'd have to refund all the tickets if they couldn't move the passengers.

By the very next morning after the wreck, most of the mess was cleaned up, and the hole in the floor was covered with plywood. Union Station was reopened within days, in time for the inauguration, and received the special passengers on schedule exactly as planned.

Government Edict vs the Invisible Hand

That was a half century ago.  This year, we had a similar situation - an inauguration expecting millions of attendees.  This time, thankfully, there was no train wreck; the DC Metro and local commuter rail authorities did their jobs passably well.

Are they enjoying the fruits of their labors?  No - exactly the opposite.  The Washington Post reports:

Metro spent more than $5 million to operate extra service for Inauguration Day and the three days before, General Manager John B. Catoe Jr. told board members yesterday. Although Metro also collected about $3 million in fares for the four days from Saturday to Tuesday, that still leaves the agency more than $2 million short in covering immediate expenses for additional manpower, equipment and other costs. [emphasis added]

Something is very badly wrong here.  Who ever heard of a business that did not want more customers because they lose money on each one?

That's exactly what our government transit agencies have created.  Forget building new rail lines, buying more trains, or expanding services.  The ticket sales to passengers don't even cover the wages and the electric bill.

In order for public transit agencies to operate, they have to receive billions in government subsidies, otherwise they'd shut down.  Their incentives are exactly backwards.  The highest profit point for the agency would be for them to keep the doors locked all day and not move one single person - because each person they move loses them money!

Is it any wonder that most transit agencies don't act like they want your business?  They don't - you are a cost to them, not a source of profit.  Their every incentive is to drive you away.

Filthy stations?  Unreliable service?  Rats in the tunnels?  As long as you are sufficiently ticked off to travel some other way, but not so much so as to demand that their government subsidy end, their goal has been achieved.

The Washington Metro is merely the most prominent example, but other transit systems illustrate the same problem.  Thanks to the recent spike in gas prices, commuter rail system started scoring the highest ridership levels since its creation.

What's the response?  According to the L.A. Times,

The situation is particularly dire in California, where Gov. Arnold Schwarzenegger, facing a $41-billion state budget shortfall, has proposed eliminating grants to local transit agencies for the current fiscal year and the next -- a move that would save $559 million, according to H.D. Palmer, spokesman for the state Department of Finance.  In San Francisco, that possibility has transit officials considering cuts to the popular Bay Area Rapid Transit trains -- even though they were ripping out seats last year to cram in record numbers of riders. [emphasis added]

From Florida to San Francisco, commuters have decided that it's a good idea to ride the train instead of wasting expensive gas fighting rush-hour traffic, but because the transit agency loses money on each passenger, the increased ridership is crashing into the budget crisis.  The agencies can't get more money from the state; their only recourse is to forcibly lower their ridership by canceling trains.

Even the supposedly privatized United States Postal Service has the same instincts.  The USPS is posting record financial losses for 2008, and what do you suppose their plan is?

Layoffs?  Increased efficiency with computers?  Closing two-bit post offices in teeny towns?  Of course not!

Postmaster General John Potter noted that the agency is cutting costs, reducing work hours, and asking Congress to ease requirements for advance funding of retiree benefits and to allow mail to be delivered five days a week instead of six. [emphasis added]

Now there's a way to grow the business, shut down for an additional day every week!

The problem with government subsidized operations isn't necessarily that they don't know their business.  It's that their business isn't what you think it is.

The goal of a government operation is to find a suitable gun to hold to the head of taxpayers.  Give us more money, or we'll stop running trains entirely, or stop delivering the mail on Saturdays!

Stop the Perverse Incentives

The right solution, of course, is to set up the incentives properly.  No company should simply receive a block grant from the government.

The money, and its amount, should be directly tied to what you want them to accomplish.  For rail systems, it could be a set amount per passenger-mile traveled - so the more people they can convince to use them, the more money they get.  Maybe for the post office, it could be a subsidy per letter delivered, or some such.

Left as it is, the only possible result is exactly the result we're seeing in cities across the country: a shortage of a desired good, in this case public transportation.  Because we've not learned from the example of the Soviet Union that planned economies don't work, we're being forced to relearn the lesson much closer to home.

The invisible hand of pricing is tremendously powerful; fight against it at your peril.  It's time to stop providing perverse incentives which leave us wondering why government agencies act so perversely.