Now that a new Fare Review Mechanism Committee (FRMC) has been created to fundamentally review the public transport fare adjustment formula, it’s a good time to write about how the formula could be fixed. I think that the Public Transport Council’s formula is well-intentioned, but that doesn’t mean it can’t be better.
What is the current formula?
The formula was last amended in 2005. If we simplify the language, it looks like this:
Maximum Fare Adjustment = 0.5 CPI + 0.5 WI – 1.5%
CPI = Change in Inflation compared to last year
WI = Change in Singapore’s average wage compared to last year
1.5% = Sharing of productivity gains achieved by Public Transport Operators (PTOs)
Since the formula is a price cap, the previous fare increases weren’t always at the cap:
There’s also the matter of a Fuel Equalisation Fund (FEF), which requires the PTOs to contribute some revenue into a pool that is used to mitigate volatile energy costs. The PTC approves any drawing from this pool on a case by case basis.
What are the good things in the formula?
Since the formula reflects inflation and national average wage, it is clearly meant to protect commuters by ensuring that the fares do not rise faster than inflation and wage growth. As a general principle, that’s a good thing. The formula also somewhat reflects changes in the PTO’s operations cost, which are themselves affected by inflation and wages.
The “-1.5%” component makes the PTOs pass on some productivity savings to commuters. It forces PTOs to become more efficient, and commuters benefit through their fares. Again this is well-meaning.
But as the saying goes “The road to hell is paved with good intentions.” Well-meaning intentions do not necessarily cause good results. Can we do better?
What needs fixing?
If you thought that the above formula looked over-simplified, you may be right. Running a public transport company is no small feat. There must be a number of constantly moving components which have been glossed over in this simplified formula. In my opinion, this over-simplification is the overall theme of the imperfections in the formula.
1. Not reflective of actual fuel costs
The current formula tries to capture the effect of rising fuel costs in its CPI component. I doubt this accurately reflects the PTO’s true fuel costs because it really depends on the impact of fuel on CPI (which is a general measurement of inflation), versus the impact of fuel on a PTO (which is a company-specific cost). For example, fuel & utilities make up only 3.5% of the CPI index, but for a PTO that could be much higher since its a business that involves moving lots of large vehicles.
The fuel cost inaccuracy is worsened by how different PTOs are affected very differently by changes in fuel cost. It is clearly shown in the FEF chart that buses incur a lot more in fuel costs than trains. Bus companies obviously have different cost structures compared to rail companies.
Back in 2005, nobody expected oil prices to rise to over $100/bbl. But today, oil prices are not expected to fall below $90/bbl. Hence it won’t be surprising if fuel costs take up a much higher portion of a PTO’s cost today. The new formula should reflect the actual cost of fuel borne by a PTO. Otherwise, it is possible that commuters are over-paying (or underpaying) for what is assumed to be the PTO’s fuel cost.
While we’re talking about fuel costs, we should also talk about the FEF.
2. Scrap the Fuel Equalisation Fund
There are many things that global oil analysts disagree on, but one thing that they do agree on is that oil prices will always rise over the long term. The FEF aims to mitigate the impact of volatile oil prices, but this only really works if oil prices stay roughly the same over a long period of time.
Against a rising tide of oil prices, the FEF is unsustainable. It will eventually be drained out as the PTOs withdraw from the FEF to mitigate constantly rising fuel costs. To prevent such draining, the PTC will be forced to make the PTOs contribute more revenue to the FEF. This causes the FEF to become an expensive form of “insurance” as oil prices trend upwards.
Furthermore, the FEF will act as an undue burden on commuters during a recession. During a recession, the common citizens’ earning power are worst hit. Hence, recessions are the most appropriate time to reduce fares and protect commuters, but the existence of the FEF means that fares are artificially inflated, so as to allow the PTOs to maintain their FEF contributions.
Finally, fares are only revised once a year. One year is more than sufficient time for the volatility of oil prices to be averaged out, even if the FEF did not exist. Since there is no real benefit in retaining the FEF, it should be scrapped. (If fares were revised every month or quarter, there might still be an argument to retain the FEF.)
3. Use a “fit-for-purpose” Wage Benchmark
Oil prices aren’t the only thing that has drastically changed since 2005. The effect of globalisation means that the rich are getting rich faster, while the poor’s wages are likely to stagnate due to oversupply of cheap labor.
We must recognise that the average wage benchmark (I think it’s this one) includes data from all Singaporeans, rich and poor. Globalisation means it is quite possible that the increase in earnings is driven by the rich, which masks the data of slower (or stagnant) wage growth in the average or lower income worker.
The average wage benchmark could therefore be rising faster than the wage growth of the non-rich worker. The non-rich worker is also more likely to be taking public transport compared to the rich. This means that fares benchmarked to “average wage” could be rising faster than the wages of the actual commuter, thus making fares less affordable.
Furthermore, although about 50% of the PTOs wages are manpower costs, most of these is paid to operational staff. SBS stated that their latest pay revision allows Singaporean bus drivers to earn $2500/mth on average, which is still lower than the 2011 average wage/mth of $4334. This means that fares benchmarked to “average wage” could be rising faster than the actual wage cost of the PTOs, thus giving the PTOs a windfall gain.
In short, the existing Average Wage benchmark is probably outdated. We should in fact be using a new wage benchmark – one that reflects the average wage of the typical public transport commuter and PTO operations staff.
4. Allow productivity gains to be more sustainable
The PTC explained that the “-1.5%” productivity component is derived by taking half of the average productivity gain of 3% from the earlier years. The PTO gets to keep the other half of the gain. But this explanation doesn’t tell us the full story.
There are a number of ways to increase productivity, and not all of these are good. For example, slashing wages or compromising on maintenance costs is a “slash-and-burn” way to reduce operational costs in the short-term, and thus increase productivity (on paper). A more sustainable way to increase productivity would be to harness technology gains or train workers to perform better. Unfortunately the existing formula isn’t able to differentiate between unsustainable and sustainable ways of increasing productivity.
5. Be more transparent about how the revenue from PTOs’ other businesses is treated
Whereever new MRT stations appear, surrounding property prices rise. It is obvious to see that public transport is a valuable thing due to its convenience and high human traffic. The PTOs know and harness this by earning lots of rental and advertising revenue from its infrastructure.
Indeed in 2011, SMRT’s profit after tax is $161.1m, of which about $74m came from rental and advertising profits. These businesses contribute to nearly half of companies’ entire profits.
This aspect of the PTOs’ business cannot be ignored. Unfortunately the current fare adjustment formula does not explictly recognise this. My guess is that this revenue is probably “implicitly” recognised when the PTC chooses not to allow the PTOs to raise their fare increases to the formula cap.
More transparency in how the revenue from these businesses is treated will be useful in ensuring that the fares are calibrated to help the PTOs remain reasonably profitable (as opposed to overly profitable).
In this post, I have listed down what I think are some of the more serious flaws with the fare formula. Addressing these flaws may require major changes to the formula itself.
But it is not easy to determine what these specific changes should be. After all, it is always easier for armchair warriors like me to critique without offering solutions. Nevertheless, I think a solution is possible. Not easy, but possible.
I may try to offer some suggested solution in my next post on this topic, hence the (Part 1?) in the title of this post. Otherwise, I’ll probably talk about WP’s idea of nationalising our public transport system.