Designing Incentive Schemes for Public Transport Operators in Hordaland County, Norway

In 1999 the Hordaland County Council decided that the county should introduce so-called ”quality contracts” for public transport in the county. The main idea of this type of contract is that decisions on the level of service (routes and frequencies) are left to the operators while the fares are subject to regulation by the county. A basic ingredient of such contracts should be a remuneration scheme linked to the level of service. The purpose of the remuneration is to internalise the impacts on consumers’ surplus caused by changes in the level of service. This impact is inadequately captured by the changes in fare revenue. Theory gives some guidance with respect to the principle of proper remuneration. A model was calibrated for each of the three main bus operators in Hordaland and used to estimate the rates of remuneration that would induce the operator to provide an optimum level of service based on maximisation of profit. Modelling indicated that the remuneration schemes should consist for fixed rates per revenue kilometre and vehicle hour of revenue service for basic services and additional peak services respectively. Due to substantial deviation between fare and marginal cost for peak passengers, two operators should also have a remuneration per peak passengers. Modelling also showed that the sum of fare revenue and remuneration per km, hour and peak passenger would imply excessive profits and that the contracts therefor should include the deduction of a fixed amount. This is a novel and promising approach to contracting for public transport services. The heavy reliance on modelling means that the stakeholders must have confidence in the model and the results produced. In year 2000, contracts were implemented in the County of Hordaland based on these principles and results from modelling. Introduction Two aspects of public transport makes the industry subject to increasing returns to scale irrespective of the economics of scale with respect to firm size. One aspect is due to the economics of vehicle size. Within certain limits the cost of the driver is a fixed element when the size or capacity of a unit increases. The other aspect comes from the demand side. When demand increases and capacity per route departure remains constant, frequencies or route density will increase if the load factor shall remain at an optimum level. Thus the average user cost will decrease due to shorter waiting times and/or walking distances. Decreasing average cost makes a classic case for public subsidies and also for a situation where a competitive market may fail to produce the “usual” efficiency characteristics. In the absence of efficient road pricing, the case for public subsidies is strengthened in urban areas subject to congestion in the road network. This is due to the general “second best” argument in welfare theory. A counteracting force is the fact that public funds have a cost due to the distorting effect of high tax rates. On the other hand, public subsidies and lack of a competitive market raises other issues of efficiency, notably X-efficiency in the firms that provide public transport