Aug 6, 2019 in Case Study

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Central Issue:

It is necessary to determine whether the interventions in the operations of trains are justified. In particular, it is reasonable to specify whether the Rail Safety Improvement Act should become obligatory for all companies operating in the industry.

Recommended Course of Action:

It seems that the recommendations for increasing safety standards should be formulated and made available for all companies and passengers. However, they should not be obligatory, and the large-scale government intervention in this sphere is unjustified.

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Basis for Recommendation:

It is necessary to take into consideration the following key issues. On the one hand, the proposed innovations and the new system of control may considerably improve safety standards. On the other hand, it is associated with considerable costs that outweigh the potential benefits. Costs cannot be neglected as many customers may become unable to use these services. As a result, they may have to use other transportation alternatives that are even more risky. Although the mortality rates in the sphere of railroads may decline, the overall mortality in the transportation system may increase. Moreover, the government intervention will impose additional costs on companies and, thus, decrease their profitability. Some companies may even have to leave the industry. It will reduce competition and the quality of the offered services. However, the safety recommendations might be published. It may be expected that they will be introduced by some companies in certain (the most risky) regions of the country.

Reasonable Alternatives:

1. The government should not develop the Rail Safety Improvement Act. It should exist neither as an obligatory document nor as mere recommendations. This is rejected because this problem cannot be neglected. Various government agencies should control safety standards and inform the public about their suggestions and recommendations.

2. The Rail Safety Improvement Act should become obligatory for all companies in the industry. The implementation of the requirements should be closely controlled. Any companies that violate these regulations should be correspondingly fined. This is rejected because the government should not violate cost considerations. The actual choice is not between the higher safeties versus the lower safety. The actual problem is searching for the optimal conditions that will allow balancing the interests of companies and customers. Moreover, the neglecting of cost issues will create problems for both companies and clients. Companies will suffer additional costs, and their profitability may decline. Some clients will not afford these services for higher prices and will have to shift to other transportation options even if they are associated with higher risks. Therefore, the general social system will be negatively affected.

3. The Rail Safety Improvement Act should become obligatory only for the largest companies in the industry while other market participants could be free to adopt them or not. This is rejected because the attempts to discriminate against some companies cannot lead to effective solutions. In this case, small companies will receive artificial privileges that may reduce the quality of the services. It seems that market conditions and regulatory requirements should be identical for all companies from the industry. Only in this environment, they will have the necessary incentives for introducing innovations and adopting the most safe and responsible policies. Facing the conditions of a free competition, companies will also be more oriented to the needs and preferences of their clients.

Significant Factors:

1. Consumer safet.

2. The overall quality standards.

3. The level of average costs.

4. The average profitability in the industry.

5. The rate of adopting innovations in the industry.

6. Competition.

7. The industry’s flexibility.

8. The overall social and economic development in the country.

 

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Discussion: Significant Factor # 1:

Consumer safety One of the major factors that outlined the seriousness of the problem is consumer safety. It is a direct responsibility of producers of any products and services to ensure an adequate level of safety. At the same time, safety standards do not exist in isolation from other relevant factors. They are closely related to the costs of production, competition, the incentives of all parties, etc. Therefore, the government attempts to maximize safety, presenting a very narrow view on this problem. Consumer safety should be maximized as far as it is possible under the current economic conditions. In other words, the rights of all parties should be respected. The Federal Railroad Administration should not violate the rights of companies and adopt decisions that will lead to their bankruptcy. Moreover, consumer safety should be understood from the dynamic rather than static perspective. For example, the desire to maximize consumer safety at any cost will have a negative impact on the long-term safety standards. Higher costs will decrease the companies’ profitability, and some of them will have to leave the industry. As a result, the overall level of competition will decline, and the companies from this industry will not be open to introduce innovations establishing higher safety standards.

Significant Factor # 2:

The overall quality standards Safety is not the only important factor for consumers. They are also interested in the highest possible quality standards. Moreover, the quality of transportation services is always subjective. Therefore, any recommendations and regulations introduced by the Federal Railroad Administration or other government agencies cannot be complete to satisfy the whole variety of the consumer needs. Although these regulations may be precise and correct from a technical perspective, they neglect consumer preferences and constantly changing consumer needs. For this reason, the system governing decisions in the sphere of railroads should be decentralized, and companies should be subjected to the forces of the free competition.

If the regulations of the Federal Railroad Administration are developed but not legally enforced (in other words, if they are not obligatory), it will contribute to higher diversity and companies’ abilities to adjust their services to consumer needs. It may be expected that in some regions, the higher safety standards will be adopted while in other regions, the previous system will remain due to the corresponding cost-and-benefit calculations. In any case, from a consumer perspective, the competitive system will generate the highest possible level of quality and services diversity.

Significant Factor # 3: The level of average costs

The level of average costs is also significant in this context, as it directly influences the level of profitability of the companies in the industry. Other things being equal, higher average costs will lead to lower profitability. As a result, consumers will face higher prices, thus some of them will be unable to afford more highly priced services and will have to shift to other transportation services. Consequently, companies will face a lower consumer demand, and their relative revenues will decline. Some companies may be unable to cover their total costs and will have to leave the industry.

All these considerations demonstrate that the neglect of the dynamics and level of the average costs constitute a serious problem and disadvantage of the current government regulations. Safety standards cannot be improved based on mere positive intentions of the government or companies. These improvements require additional scarce economic resources. Thus, companies have to be profitable (at least in the previous periods) to be able to introduce corresponding innovations. If companies neglect cost considerations, they will not be able to maintain the highest quality of their services in the end.

Significant Factor # 4: The average profitability in the industry

In order to understand all secondary consequences of various decisions in this sphere, it is reasonable to focus not only on individual companies but also on the industry in general. The reason is that industries also compete with one another. In the long run, some companies may change their industries. Moreover, the scarce economic and financial resources flow constantly between various industries. In this way, entrepreneurs and business people try to determine the optimal allocation of their resources as well as maximize their profits and companies’ capitalization.

Therefore, new government regulations do not only affect the profitability of the specific companies but also change the corresponding competitive positions between industries. Additional regulatory requirements that lead to higher costs will negatively affect competitive positions of a given industry. As a result, numerous investors will shift to other industries where they can receive higher returns on their investments.

Thus, it seems that the government should also take into consideration the secondary and long-term effects of its initiatives. For this reason, it is irrational to make new regulatory requirements obligatory and impose higher costs on all companies. However, it is reasonable to inform all market participants about the safety risks and allow the market system to make corresponding adjustments.

 

Significant Factor #5: The rate of adopting innovations in the industry

The questions of safety standards are closely related to the rate of adopting innovations. The reason is that higher safety requires new technological development and the companies’ desire to implement them. All things being equal, companies will adopt innovations if they will generate higher revenues from them and that will allow strengthening their competitive positions. Otherwise, their incentives for implementing innovations are minimal. Therefore, it is important to stimulate technological development and companies’ freedom in various ways.

The attempts of artificially increasing the rates of technological development and innovations in the country or in a given industry cannot be successful because they neglect the essence of the entrepreneurial decision-making as well as lead to the incorrect allocation of resources. Thus, the highest rates of technological development and innovations’ introduction may be achieved only if the market conditions are free, and all companies are subject to the forces of the free competition. The government should not make its safety requirements obligatory as it can only make the situation even more problematic.

Significant Factor #6: Competition

The significance of competition should be recognized. Not all companies exist in isolation. Moreover, the majority of them pursue their narrow interests related to profit-maximization and increasing the market share. However, the competition impacts companies to change, when the only way for obtaining higher profits and additional revenues is satisfying consumer needs in the most effective and precise way. Thus, competitive forces are the major factor that allows maintaining the desirable level of safety. Those companies that do not meet consumer expectations will suffer losses and may even leave the industry.

It means that the optimal way for maximizing consumer safety is encouraging a free-market competition rather than imposing any artificial government regulations and restrictions on the market participants. It seems that the current level of competition in the industry will determine the dynamics of quality and safety standards in the future. Competition is also effective in determining the optimal size of companies in the industry. If companies can achieve the economy of scale, comparatively large companies will dominate. Otherwise, small companies will enjoy positions that are more preferable. In any case, competition will optimize the use of all available resources and contribute to the sustainable development of the most effective companies.

Significant Factor #7: The industry’s flexibility

In order to introduce timely and adequate safety standards, the industry should be not only effective at the present period but also be able to adjust effectively its operations to the constantly changing consumer needs. The industry’s flexibility demonstrates the ability to reorganize the use of resources and technologies, when consumer needs change. The government should inform the public about its safety considerations. On the one hand, it is possible to introduce additional safety and control standards. On the other hand, it will lead to substantial additional expenses to consumers. The government should inform them about its considerations but do not impose the conclusions and decisions. Consumers should be free to decide whether additional costs are worth the decline of risks or not. It may be expected that some of them will be ready to pay higher prices for additional safety while others will not. Correspondingly, some companies will begin to satisfy these additional requirements under higher prices while others will serve traditional needs.

In the long run, companies will adjust to consumer needs, and the entire industry’s structure will be optimized. Both consumers and companies will determine the optimal combination between the risks and prices that is optimal for them.

Significant Factor #8: The overall social and economic development in the country

The above factors do not operate in isolation from the general social and economic situation in the country. Consumers can pay higher prices for new safety requirements only if their real income increases. Therefore, it may be expected that the demand for safer transportation will increase during the stages of economic growth. During this period, both wages and profits increase. Thus, many consumers may pose additional requirements to safety. As a result, companies will adjust their operations and services. They will provide safer services, and the prices for them will increase.

During economic recessions, the situation is very different. The entrepreneurs’ profits tend to decline while wages are comparatively stable. As a result, the consumer demand either remains stable or even declines. Consumers cannot pay higher prices. Some of them will decide to reorient to less expensive services even if they are associated with higher risks. The market will also adjust to these changes.

Therefore, the government should not impose universal requirements to all companies in any time. As the macroeconomic situation in unstable, consumer preferences and needs are also subject to change. Thus, different combinations of risk and prices are optimal at different points of time.

 

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