On a couple of posts in the last two days I’ve mentioned Hernando de Soto’s important book The Other Path. I have two copies of this book, one with the original subtitle of “The Invisible Revolution in the Third World,” and the other with the later subtitle, “The Economic Answer to Terrorism.” I suspect the latter was the publisher’s attempt to profit off 9/11, but in fact de Soto is from Peru, home to the Shining Path, a violent communist insurgency, so there is a real homegrown element to that subtitle change. The book is now a quarter-century old, and deserves to be read by anyone interested in the interplay of politics and markets (as is his later book, The Mystery of Capital).
My specific reference was to de Soto’s chapter on public transportation in Lima, Peru. All I want to do in this post is quote extensively from that chapter, to give a sense of the point I’ve been making. Remember, this was written in 1989, so things may not be the same, but this is not so much about what Lima is, as about one example of how private, albeit illegal, transportation services can thrive and out-compete a state-provided service. It doesn’t mean I’m arguing for full privatization of bus, subway and commuter rail service in the U.S. Importantly, it seems to be the particularly poor quality of the state-provided service that makes it vulnerable to competition from the illegal transportation sector. I’m only saying that the argument that the private sector cannot do public transit may not be so solid as some instinctively think.
…91% of the 16,228 vehicles used for mass transit were being operated informally…Formal transport accounts for the remaining 9 percent of mass transit. Of this the state-owned National Urban Transport Corporation of Peru (ENATRU) provides 4 percent, and former cooperatives, worker-owned corporations, and the Lima Metropolitan Transport Corporation (TLMEPS) account for the remaining 5 percent.
Two brief notes: First, When de Soto uses the term “informal,” he means operating in black or gray markets; activities that are technically illegal, but to which government sometimes (but not always, and not consistently or reliably) turns a blind eye. Second, the “former cooperatives” and “worker-owned corporations” are previously informal transit services that managed over time to gain official authorization. There is a cost to balance against the gains of official authorization, as the transit operators have to accept controlled fares, and limits on routes serviced.
Informals provide a very important social function by meeting the transport needs of dwellers in informal settlements…Informal transport operators concentrate their services in popular areas, while the state corporation and other formal companies mostly serve traditional neighborhoods.
These informal settlements are also illegal. Like the transit services, they are sometimes ignored, occasionally treated with harsh reprisals, and sometimes–through years of diligent effort–made legal and brought into the formal sector. But being illegal, the state-run transport services tend not to serve them, lest it lend them an aura of legitimacy.
[I]nformal transport operators invade routes. Routes are not physical assets like land or the street, however, but intangible assets defined by the population’s movements and travel needs. A route is a unit consisting of different journeys between a first and last point…
The process is an economic calculation in which, primarily, informal transport operators try to evaluate different possible routes in order to decide which one to take over. To do this they must identify, at minimum, where there is potential demand, for which journeys there is inadequate service, and which new neighborhoods or settlements lack transportation…
Invasion is used not only to discover and appropriate original routes. It is also used by established informal transit operators to extend or modify the routes they already use. Such invasions are carried out not by individuals, but by groups, since an informal organization or committee must approve the invasion at a general meeting.
The actual routes, it seems, are “owned” by individuals who are part of that committee. De Soto emphasizes that these individuals can sell their rights to a route. In some organizations they can sell it to anyone, but if they sell it to someone outside the organization the purchaser must join, usually paying a sort of admission fee. Other organizations require the seller to offer it first to others already within the organization.
As the invaded route and the rights to it gradually increase in value, the informal operators begin to have incentive to organize, negotiate and deal with legal institutions. This requires them to set up organizations at basically two levels: first, committees of informal transport operators operating the same route; and second, different committees grouped together into unions, and, later, federations.
…There is an initial stage [to an invasion] in which, after invading a route independently, each informal transport operator runs a separate service, manages its hours and timetables and decides what fares to charge. The operator cannot remain independent indefinitely, however, and will have to organize with other transport operators covering the same route, for a route well chosen for its length and number of passengers increases in value and tempts an increasing number of invaders.
Organizing has a number of advantages. Operating a route in an orderly manner helps to reduce operating costs and ensures a regular service, which keeps passengers happy. Organizing also brings together a sufficient number of transport operators to negotiate with the authorities and preserve the route they have established. Third, it keeps out new invaders once there are sufficient vehicles to meet demand.
It’s worth noting that the negotiation with authorities takes the form of not only of legitimate negotiation, asking for official recognition, but of bribery and payoffs, not necessarily out of the operators’ fondness for corruption but because it’s the most efficient way to secure at least an unofficial toleration.
By the 1950s, traditional transport [a combination of state-owned and private firms that were officially authorized and mostly predated the development of the state-owned transit firms–JH] had ceases to be profitable. In 1959, when the El Sol Transport Company closed its doors, an unexpected succession of bankruptcies left Lima almost without formal transport services. Byu 1960, 32 of the 42 private bus companies then in existence had ceased to be operated by their owners.
At least three factors underlay this situation. Declining profits, a result of strict fare controls, forced formal companies to postpone dealing with the depreciation of their vehicles, with the result that their fleets became ramshackle and obsolete. Second, informal transport, since it was not subject to state control, was better able to adapt to the growing demand created by Lima’s urban growth. Last, the increasing reserves which the formal companies were required to maintain to pay their workers’ social benefits ultimately condemned them to insolvency.
Informal operators stepped into the gap. Importantly, their profit-motivation did not induce them to provide poor service in ill-maintained machinery at prices people could not afford. Instead they constantly sought out routes that were not being sufficiently served, charged fares that people dependent on public transit could afford (even though it was more than the state-approved privates were allowed to offer), and continually upgraded their equipment, primarily meaning adding larger and larger buses to increase capacity. The general trend was from sedans to minibuses to Dodge D-300s, then, when the government ended its policy of keeping gasoline cheap, the D-500, a longer variant of the D-300, then the yet-again-larger D-800 and the Volvo Bb-57. Even then they could not keep up with demand, so eventually a Swedish firm that manufactured buses in Brazil offered them Marco Polo buses, which in contrast to the old Dodges, which were primarily repurposed or just a very old-style frame with a domestically built body, were “state of the art vehicles designed specifically for the service, with diesel turbo engines [and] an average capacity of 80 passengers…” (de Soto, p. 121).
In contrast, the legal operators were in a regulatory-induced race to the bottom.
The fact is that, over the years, the legal system has not allowed the tremendous business energies and entrepreneurial talents of formal and informals alike to be tapped. On the contrary, it seems to be designed to deal politically with only a very small number of interest groups, not with a widespread entrepreneurial class. Legal recognition of transport operators is not considered a right, but an agreement to be negotiated in exchange for the acceptance of political interference and the imposition of numerous burdens, including the control of fares.
This situation has completely altered the behavior of the transport operators and has shifted the competition in transit services from prices and quality to safety. Instead of competing by lowering fares or improving quality, the transport operators have been forced, over the years, to compete by reducing safety and paying the bribes requested by the authorities. One of the many privileges which transport operators have received in exchange for accepting government controls is, in fact, the relaxation of safety requirements by the authorities.
Again, this is not a an argument for privatizing urban transit services. It’s only a demonstration that a private transit service can be profitable and provide good customer service even in a competitive market.
[Note: In a comment to KatherineMW, I said this was going up tomorrow. Tod has asked me to go ahead and put it up today.]