This is the third in a series of Policy Updates on the topic of public-private partnerships (PPPs) and transportation. The first Policy Update introduced the topic of using PPPs for transportation projects, presenting the advantages and disadvantages of this approach, as well as CMAP's position on the topic. The second reviewed the status of PPPs in the ongoing federal reauthorization process. This one focuses on the application of PPPs for transit projects. Although the broad conclusions from the previous Policy Updates -- that PPPs can bring greater efficiency and cost savings, appropriate risk sharing, and accelerated project delivery, but cannot provide "free" money and may result in a loss of public control over important policy areas -- apply equally to transit projects, there are unique economic and policy issues that apply to transit projects alone.

History of the Private Sector and Transit
It may be surprising to learn that public transportation in this country was initially developed by the private sector, often in conjunction with real estate development or electric utilities. In the 19th Century, the City of Chicago granted companies limited-term franchises for the exclusive use of various corridors and the use of public right-of-way. Despite monopolies over individual lines, the financial situation of privately-operated transit was perilous as early as the late 1890s, in part due to public regulation. The City and State capped fares at a nickel beginning in 1859 and taxed profits at 55 percent beginning in 1907. Under these conditions, transit companies found it difficult to raise capital to modernize or expand the system. Additionally, and perhaps most importantly, the growing use of the automobile and the lower density development patterns it enabled reduced public transportation's market share.

Public dissatisfaction with the quality of transit service -- including crowding, poor ride quality, accidents, and uncoordinated service among the private operators -- and over private management's perceived corruption led to calls for public ownership of the transit system as early as the 1890s. Transit's eroding market share and rising costs eventually forced private operators out of business, and the Chicago Transit Authority was established in 1945 to take over the bankrupt private transit systems. Transit's financial situation remained tenuous under public ownership, and in 1975 the Regional Transportation Authority was established to continually subsidize mass transit in northeastern Illinois.

Modern Public-Private Partnerships for Transit
Interest in greater private participation in transit has grown in recent years, as evidenced by recent articles in The Atlantic Cities and New Geography. This interest is motivated in part by a desire to increase cost efficiency and expand new services. To illustrate, the outline for the U.S. House of Representatives transportation reauthorization bill supports "private sector partnering" for the nation's public transportation in order to "do more with less." Like highway projects, transit PPPs can achieve cost and time savings by combining the various components of the project delivery process. And like highway PPPs, the private role can range from relatively little participation (e.g., limited to design and construction) to substantial participation (e.g., expanded to include finance or operations).

As an example, the Denver Eagle Project includes 39 miles of commuter rail and a maintenance facility to be designed, built, financed, operated, and maintained by a private consortium for 34 years. Throughout the contract period (approved in FY11), the Denver Regional Transportation District (RTD), a public agency, will retain ownership of all assets, set fare policy, and collect project revenues. The RTD will make availability payments to the private consortium based on pre-established performance criteria. Through an availability payment, the public sector pays the private sector an agreed-upon sum, often annually, over the period of a contract as compensation for design, construction, operations, and/or maintenance work. The private entity is not exposed to toll or fare revenue risks, and the public sector can budget for predetermined expenditures spread over many years, similar to a homeowner paying a mortgage. The Denver Eagle project is supported by a variety of federal loans and grants, local loans and grants, and private equity, with total costs estimated at approximately $2 billion.

The Federal Transit Administration supports transit PPPs through its Public-Private Partnership Pilot Program ("Penta-P") for new fixed-guideway capital projects, in part to address regulatory challenges. There are three main regulatory issues that are addressed by Penta-P:

• Transit PPP projects are not eligible for Private Activity Bonds, one tool which helps to reduce the private sector's higher costs of capital.
• Transit projects are eligible for a smaller share of federal funding compared to highway projects -- 50 percent and 80 percent, respectively.
• Transit projects are subject to a more extensive environmental review process than highway projects, which includes cost-benefit analysis and a formal alternatives analysis.

These additional requirements increase the length, costs, and uncertainty of the project development process, making transit PPP projects less attractive to private investors.

Finally, highway public-private partnerships, such as those discussed in the first Policy Update, may offer indirect opportunities for transit. For example, a public sponsor of a highway PPP could require its private concessionaire to incorporate bus rapid transit into its plans, provide additional right of way for transit, exempt transit vehicles from tolls, or allow transit vehicles access to newly-constructed high-occupancy/toll or express lanes.

Contracting for Service
In addition to innovative project delivery mechanisms discussed above, the private sector plays a significant role in transit as a more limited contract operator. In fact, contracting is the most common form of private activity in public transportation in the U.S. According to CMAP analysis of the National Transit Database, 371 of 710 transit agencies (52 percent) outsourced some service in 2009, with those contracts totaling $3.45 billion in value. Additionally, these transit agencies incurred $1.26 billion in other costs related to their contracts, such as maintaining or fueling the contractor's vehicles.

Although transit agencies outsource many types of service, only two categories account for the vast majority of contracts: demand-responsive transit and bus service. Demand-responsive transit, also known as dial-a-ride or paratransit, represents 823 of 1,324 contracts (62 percent). In 2009, public agencies spent $1.75 billion on demand-responsive contracts. Traditional bus service accounts for an additional 407 contracts (31 percent). The eight other forms of transit service, ranging from rail to ferryboat, represent the remaining 7 percent of contracts.

The empirical evidence on private contracting in transit is somewhat mixed. Some studies find relatively high cost savings, in the range of 15 to 20 percent, while others find more modest 8- to 15-percent savings. Broadly, contracting can reduce costs from 10 to 40 percent, in part due to the private sector's more efficient service practices and lower labor costs. However, the empirical evidence also finds that contracting is associated with generally lower-quality transit service (e.g., higher accident rates) due to factors such as poor maintenance, high labor turnover, and the use of less-experienced drivers.

Transit Economics and Challenges to PPP
The economic and social nature of transit may complicate attempts to invite greater private participation. These issues include natural monopoly, social policy, and, perhaps most fundamentally, transit's near-constant fiscal distress. Each is discussed in turn.

Transit as Natural Monopoly
A natural monopoly is an economic situation in which it is most efficient for a single operator to supply the entire market for a specific good or service. Transit, along with other urban infrastructure such as power utilities and waterworks, is often considered a natural monopoly because of its physical infrastructure, economies of scale and density, and networked service. Each is discussed below; for further details, consult this paper.

• Mass transit requires high upfront capital costs that cannot easily be converted to other uses; the difficulty of securing these fixed and sunk costs acts as a barrier to entry to potential competitor firms.
• Economies of scale and density refer to transit's declining unit costs as the volume of production increases and as more traffic is carried on the network. A service provider may find it cheaper to move 100,000 passengers than 10,000 passengers, and to run a full bus rather than a sparsely patronized one.
• Finally, transit is a networked service. A unified transit agency can provide convenient scheduling, ticketing, and transfers to allow travel across an entire metropolitan area. Also, a single provider can cross-subsidize money-losing routes with profitable ones, allowing broader geographic service coverage.

Due to their lack of competition, monopolies can lead to higher prices and lower qualities of service for users. Public regulation can curb the negative effects of natural monopolies while preserving their operational efficiencies. For example, the public sector can regulate transit fares and service levels while allowing a single entity to benefit from economies of scale. However, some argue that this very regulation can be overly restrictive, stifling potential competition, and thus the incentive to control costs, from non-traditional transit operators such as jitneys and taxis.

Transit and Social Policy
Concern over social equity is a major motivator for public involvement in mass transportation. Governments choose to subsidize transit in part to provide access and mobility to those who cannot or choose not to drive an automobile. These groups include the poor, the disabled, the elderly, and the young. These so-called "transit dependents" or "captive riders" often have no other alternative mode of travel, and represent the steadiest customers of urban mass transit. It is possible that private ownership and operation of transit in the context of a natural monopoly can lead to higher fares and/or poorer service for transit riders, with corresponding implications for social justice.

Additionally, public officials turn to transit to achieve a number of other social and environmental goals. By offering low fares, public officials hope to encourage transit use and discourage driving. Less driving, in turn, reduces traffic congestion, reduces traffic accidents, and improves air quality. One study finds that large operating subsidies for transit can be justified in part based on these positive externalities, and are efficient for society as a whole. That analysis does not consider the effects of the tax burden required to finance these subsidies, and assumes that efficiency gains due to subsidy are not captured by interest groups.

Transit's Fiscal Distress
Transit has been in a state of near-constant fiscal distress for most of the past century, and private operators may not be able to fully address the reasons for this crisis. Transit has lost much of its customer base to the automobile and today primarily serves two markets: downtown commuters and transit dependents. The downtown market is subject to high spatial, directional, and temporal peaking -- demand is greatest during relatively short periods, in concentrated areas, and for passengers traveling in the same direction. These factors increase costs because much of the capital and labor required to meet peak demand lies unused -- and thus not generating fare revenue -- throughout most of the day. Moreover, work rules often forbid more flexible practices to better meet peaking, such as the expanded use of part-time labor. Additionally, public regulation generally limits fare increases, requires flat fares that prevent sophisticated time- and distance-based pricing, and pressures transit systems to extend service into low-density areas along the metropolitan fringe.

GO TO 2040 acknowledges that, after decades of underinvestment, the region's transit infrastructure is aging and in need of improvement. To pay for these improvements, GO TO 2040 recommends that the transit agencies address the rapidly-rising cost of their services, and that the region identify new revenues to support transit. Such revenues could include a portion of future congestion pricing or parking revenues, value capture revenues, or a dedicated portion of a state gas tax increase.

Evaluating PPPs for Transit
Transit is unlikely to be profitable due to a combination of several reasons, including lack of market share, peaking, and public regulations. Fully privatized transit is thus unviable, and, given transit's tendency toward natural monopoly, perhaps undesirable. More limited PPPs may be used to improve the procurement of new transit service with better cost control, risk management, and project delivery than possible for the public sector. Additionally, private operations of existing transit service may improve transit's efficiency -- for example in labor utilization, fare policy, and service policy -- and thus reduce operating deficits. However, a contracted operator can only act within the scope allowed by public regulations, which often forbid such reforms, and the empirical evidence on contracting out transit service to private operators is mixed.

Transit's status as a natural monopoly requires public intervention to avoid abuse of pricing power and service quality, and any such public regulation would need to be incorporated into a PPP agreement. Additionally, transit merits public subsidy for its support of other valued social goals: providing mobility and access to transit dependents, congestion mitigation, and environmental benefits.

In sum, PPPs for transit have potential to improve services and reduce costs, but must be carefully evaluated to determine if the public sector could implement similar practices at comparable costs and risk. One cannot say that private operators are always more efficient than public operators, but rather we must consider the broader regulatory and competitive context.