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Chapter 2

Context for the Panel's Review

Transportation plays a key role in the Canadian economy. With a small population, spread over a vast geographic expanse, and a trade-oriented economy, Canada is especially dependent on a well developed and efficient transportation system. This is the reality today, much as it was a century ago. Views about how government can contribute to achieving an efficient transportation system have changed dramatically over the years, especially in the last two decades.

Fundamental changes in the federal government's role regarding transportation provide part of the context for the Panel's review. The review also took place against a backdrop of change in the Canadian and global economies. These shifts present new opportunities and challenges for suppliers and users of transportation services. At the same time, they raise new questions about the policy framework that has been created to promote the development of an efficient transportation system.

Policy Context

In 1961, the MacPherson commission produced a seminal report that continues to have a major influence on transportation policy. In line with the commission's recommendations, the principle of competition between modes became a cornerstone of the National Transportation Act of 1967. The act also adopted the commission's principle of user pay (although implementation was limited).

In the next major revision of transportation legislation, the National Transportation Act, 1987 extended the principle of competition to require competition within as well as between modes; competition was now to serve as the principal mediating force across the entire system. The 1987 legislation also brought further deregulation of air and trucking, legislated pro-competitive rail measures, and introduced provisions for adjudicating disputes.

Five years after it became law, the National Transportation Act, 1987 was subject to statutory review by the National Transportation Act Review Commission. That review, which took place at the end of the most severe recession since the Second World War, focused particularly on legislative restrictions that were limiting carriers' ability to rationalize operations. Its recommendations led to the Canada Transportation Act of 1996.

TheCanada Transportation Act

The Canada Transportation Act, which came into force on July 1, 1996, was the culmination of efforts to update and modernize the National Transportation Act, 1987 (NTA 1987) and the Railway Act, a venerable fixture of the railway regulatory environment since before the turn of the last century. The Canada Transportation Act (the Act) continued the trend of deregulation and commercialization:

• A substantial commercial harm test was introduced, requiring that before the Canadian Transportation Agency granted a remedy, it be satisfied that the shipper would face substantial commercial harm without the remedy.
• On airline regulation, new consumer protections were instituted and the more rigorous licensing requirements of NTA 1987 for operation in the far North were eliminated.
• For the rail sector, the Act introduced sale and discontinuance provisions allowing railway companies to rationalize their networks more easily. It also lowered barriers to market entry. Its final offer arbitration provisions were modified and made applicable to northern marine re-supply and grain rates; availability of the recourse was also extended to commuter and passenger rail operators.

Other significant changes resulted from passage of the Act (see Appendix 2 for more detail on the Act and these changes). For the Agency, the Act brought new restrictions and powers, including the expanded authority to hear complaints from persons with disabilities in all transportation undertakings under federal jurisdiction.

The Act was amended further in 2000. A first set of amendments focused on the air industry and was introduced to respond to concerns arising from Air Canada's acquisition of Canadian Airlines. A second set addressed concerns in western Canada based on reports by the Honourable Willard Estey and Mr. Arthur Kroeger on the grain handling and transportation system.

Commercialization and Decentralization

Along with reduced regulation, the last two decades of the twentieth century saw substantial cutbacks in government subsidies and a major contraction of the federal government's direct role in providing transportation services. Under the twin themes of commercialization and decentralization, dramatic changes occurred. The government completed privatization of Air Canada in 1989 and of Canadian National Railway in 1995. Some east coast ferries were also privatized, while others were turned over to provincial governments or replaced by other means of transportation, such as the bridge to Prince Edward Island. The major components of air and marine infrastructure are now managed by independent not-for-profit organizations — airport authorities, port authorities, NAV Canada, and the St. Lawrence Seaway Management Corporation.

The shift toward a more commercial approach also resulted in the reduction or elimination of federal subsidies and a greater emphasis on user pay. The February 1995 budget announced the end of subsidy programs under the Atlantic Region Freight Assistance Act and the Maritime Freight Rates Act and repeal of the Western Grain Transportation Act. VIA Rail reduced its dependency on subsidies, increasing the percentage of its operating budget funded by users. Similarly, for Marine Atlantic and other private ferry operators receiving subsidies, the percentage relationship between revenue generated by users and operating/overhead costs improved.

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Pressures and Challenges

The policy framework developed to foster efficient transportation is now being severely tested. At the root of many of the challenges to the framework are some broad economic and social trends.

Globalization and North American Economic Integration

International trade and the internationalization of business have been increasing for decades, but the pace of change accelerated in the past 20 years. Canada has long been an open economy but has become significantly more outward-oriented in the last decade. Since the signing of the Canada-U.S. Free Trade Agreement and NAFTA, Canada's economic ties with the United States in particular have become much stronger. An efficient transportation system is needed to ensure that Canadian firms can compete effectively in more integrated North American and global markets. At the same time, transportation carriers have come under pressure to improve their capacity to compete for North American traffic. In transportation, as in other sectors, one result has been a trend toward fewer, larger companies. Firms have merged to achieve economies, to expand the scope (including the geographic range) of their services, and to increase their market power.

These trends are expected to continue. Moreover, producers may not always be able to rely on a weak Canadian dollar to make their exports competitive. Substantial depreciation of the dollar has helped improve the international competitiveness of Canadian products over the past decade, but this crutch may not be available in the future. In coming years, pressures on transportation firms to compete effectively and support the efforts of other Canadian companies to meet the tests of international competition may well intensify.

Weak Commodity Prices

Resource industries did not share in the extraordinary economic boom of the second half of the 1990s. Prices have been low for coal, grain, lumber and most forest products and fisheries. Some of this might be transitory — the result of restructuring in eastern Europe and the financial crisis in eastern Asia — but over the longer term, real commodity prices (with the exception of the energy sector) have been drifting downward. Because transportation is a major component of the delivered price of resource products, producers are under pressure to reduce transportation costs. It is not surprising, therefore, that Canadian commodity producers have been among the most vocal critics of Canadian transportation policy.

Tighter Controls on Public Spending

During the slowdown of the early 1990s, governments came under pressure to reduce deficits and bring debt under control. This was an important factor underlying the devolution of air and marine infrastructure facilities, and other initiatives to reduce government involvement in and support to transportation. Spending cutbacks, combined with the strong economy of the second half of the '90s, brought most deficits under control, but governments continue to be resistant to major new spending commitments. This stance is based partly on the lessons of the past and recognition that strong economic growth cannot be sustained indefinitely. In addition, governments face demands in health and other core areas of public spending, along with pressure to make tax rates more competitive with U.S. rates. In future, then, public policy will have to be more inventive, forging partnerships and joint ventures and using public funds strategically to leverage other investment.

The Internet and E-Business

Information and communication technologies are transforming the way firms organize their activities. The consequences for transportation are twofold. First, information technology is greatly improving co-ordination and efficiency in transportation operations. Second, transportation requirements are changing as firms adapt their practices to pursue full supply chain management and the opportunities created by new technologies. Efficient, reliable and fast transportation is the underpinning of the tighter production and distribution systems that now characterize modern business operations. For transport policy, the challenge is to ensure that legislation supports the adoption of technologies with the capacity to improve industry productivity significantly.

Environmental Concerns

As a major petroleum user, the transportation sector is necessarily part of the focus of increasing environmental concerns. Local air pollution problems have received significant attention from policy makers over the years. Now there is intense debate about the possible broader consequences — global warming and climate change — of collective reliance on carbon-based energy.

Although Canada has emission standards and related pollution control measures, environmental concerns and sustainable development objectives do not feature significantly in the current policy framework governing transportation. Environmental considerations are a notable omission from the policy statement in section 5 of the Canada Transportation Act. Mechanisms are needed to address sustainable development concerns and to ensure co-ordination of relevant environmental and transport policies.

Urbanization

Canada is highly urbanized, with densely clustered settlement around a number of urban centres. In recent decades the proportion of the population living in large metropolitan areas has increased significantly. More than a fifth of the country's inhabitants are concentrated in the largest metropolitan region, the Golden Horseshoe of southern Ontario. Supplying and managing transportation, both passenger and freight, in increasingly congested cities has become a major challenge.

Urban transportation problems are complicated by an imperfect arrangement of jurisdiction and powers. Urban areas are arguably the location of the most significant transportation problems facing Canadians: congestion, accidents, air pollution, and so on. Yet city governance is fragmented, with municipalities pursuing their own objectives, often in conflict with neighbouring communities, and with very limited taxation powers. Although the federal government's constitutional responsibility is limited, it has a legitimate role, because urban transportation issues loom large among the challenges of developing a sound regime for transportation.

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Factors Influencing Transportation Decision Making

Economic and social forces are creating the demand for a more efficient, more environmentally sensitive transportation system that can satisfy new logistical requirements arising from adoption of information technologies. At the same time, these forces raise new questions about the existing policy framework and its ability to foster the type of transportation system that serves the needs of Canadians.

In evaluating the current system, of central importance is the nature of the incentives governing the actions of users and providers of transportation services: passengers, shippers, carriers, governments and not-for-profit infrastructure organizations. These incentives determine whether appropriate resources are devoted to transportation, whether these resources are allocated correctly within the sector, and whether they are used efficiently to produce services that satisfy the needs of shippers and passengers. The economic and social forces just discussed focus attention on several potentially significant weaknesses in the incentives now in place.

• First, they draw attention to incentive problems created by the failure to give transport users correct price signals.

In an efficient transportation system, all costs are reflected in the prices charged for services. This includes the costs incurred by firms transporting goods and passengers and the costs borne by governments or others in operating and maintaining the fixed facilities on which transportation operations take place. It also includes the costs transportation activities impose on society, such as congestion and pollution.

The Canada Transportation Act recognizes the principle of establishing correct prices that ensure "the best use of all available modes of transportation at the lowest total cost." However, many of the charges for government-provided transportation services and infrastructure do not reflect the cost of meeting various users' requirements.

Moreover, little progress has been made in introducing fees and charges that would ensure transportation users recognize the costs their activities impose on society. This has more serious implications at a time of heightened concern about environmental effects and about the delay and inconvenience users impose on each other when they use congested urban roads. The development of policies to sensitize transportation users to the costs associated with their choices raises complex issues — issues that touch on the responsibilities and concerns of all three levels of government.

• Second, they raise issues about the incentives that influence the activities of public and not-for-profit providers of transportation infrastructure.

In a climate of spending restraint, it is especially important to allocate the limited resources available for transportation infrastructure carefully. This implies a greater role for institutional arrangements and reporting systems to guide policy makers and help discipline public spending on transportation infrastructure.

The not-for-profit organizations established to manage airports, ports, the air navigation system and the St. Lawrence Seaway represent one attempt to inject greater commercial discipline into infrastructure operations. It is still early in the life of the air and marine infrastructure corporations, but the government's general approach to commercializing air and marine infrastructure may be a useful model that can be extended.

• Third, they are causing some shippers and travellers to question the current reliance on markets and market incentives to achieve transportation objectives.

Of the three concerns about transport incentives, this poses the most serious challenge. Reliance on market forces as the principal mechanism for organizing transportation is a major element of current policy. Market forces have appeal because they are an impartial mechanism that is generally effective in promoting efficiency. But if, as a result of industry consolidation, markets are not competitive and cannot be relied on to achieve efficiency, policy intervention may be necessary — either to find ways to increase competition or to devise regulatory substitutes for it.

Both the United States and Canada have witnessed consolidation in the transportation sector, but concerns about the high degree of concentration in transportation markets are much greater in Canada. Canada has long been limited to two Class I freight railways, compared to half a dozen in the U.S., even after recent consolidations. Canada's domestic air market now has one dominant carrier. A single firm dominates intercity bus transportation. The intercity courier industry is highly concentrated in both countries. One of the major tasks facing the Panel was to determine whether and to what extent changes in market structure call into question the principle — accepted since the National Transportation Act, 1987 — that market pressures should be the primary force shaping developments in transportation.

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A Modal Perspective

In developing a policy approach, the Panel recognized that concerns about incentives apply differently to the various modes. Issues differ in sectors where infrastructure is provided by industry, government, or not-for profit organizations. Concerns about social costs are greater in some sectors than others. Market concentration is an issue in some modes but not in modes where it is relatively easy for new carriers to enter the market. Modal distinctions are also important because the major participants in some modes fall under federal jurisdiction, while other modes are the responsibility of provinces and municipalities.

Rail

Railways were mainly under federal jurisdiction in the past, but with the growth of the short line industry, there are now several railways under provincial jurisdiction. All share the characteristic of vertical integration of infrastructure and operations. Further, they operate on commercial principles, so that if portions of infrastructure and operations are not commercially viable, companies have been allowed to divest themselves of infrastructure and terminate operations on it. Policy must take account of the need for incentives that promote both efficient carriage and efficient infrastructure provision by commercial railways.

Road

Roads are provided mainly by provincial governments, supplemented by municipalities. Federal involvement is limited. Both federal and provincial governments levy taxes on fuels used by road vehicles, but these are not user charges and do not reflect the different costs various types of users impose on the road network. Moreover, provision of road infrastructure is not guided by commercial principles — although there is some correlation of road investments with traffic volumes.

In part because road users — unlike railways — do not bear the financial risk of making major investments in infrastructure, the trucking industry is a relatively easy one to enter. In trucking, therefore, competition should logically promote efficient market outcomes, subject to correct charging for road use.

Air

Airlines are a federal responsibility. With much of Canada's air infrastructure now being supplied by not-for-profit organizations, however, a main focus is the incentives governing the decisions of these independent operators of airports and the air navigation system. There is a need to examine whether these organizations are being encouraged to make decisions that support the development of an efficient air sector.

In the case of air carriers, the degree of concentration in the domestic industry is of concern. Options for strengthening competition — so that market incentives are more likely to lead to results consistent with the public interest — must be examined.

Water

Water transportation makes use of 'natural' infrastructure — oceans, lakes, rivers and harbours — but some infrastructure investments are still required, including dredging, navigational aids and ice-breaking. Providing marine infrastructure has traditionally been a federal responsibility, but major ports and the Canadian portion of the St. Lawrence Seaway are now operated by not-for-profit organizations. As with air infrastructure, the question is whether private operators are subject to governance arrangements that promote efficient management.

Marine freight transportation is provided by commercial carriers that operate in a largely competitive environment. Passenger transport has not been guided to the same degree by commercial principles; federal subsidies for ferry operations have declined in recent years, however, and several east coast services have been privatized or eliminated. Some subsidized services remain on both coasts, fulfilling constitutional obligations or maintaining long-standing services to remote communities.

Urban Transportation

Urban transportation is a provincial and municipal responsibility. Federal involvement has been minimal — restricted to vehicle safety and emissions regulations and ad hoc expenditures. Local road infrastructure is supplied from general government revenues, mainly by municipalities, although provincial grants and road building projects can also play a role.

Urban transit, including buses and rail transit, is still supplied mainly by government rather than the private sector. Rail transit is generally government-owned and heavily subsidized. The latter reflects both a social policy of providing transportation for those not able to drive and recognition that reducing traffic congestion benefits motorists and reduces the need for new road investment.

Commercial motivation has almost no role in the provision of urban transportation. There is a wide gap between the cost of providing urban transportation — whether by car or by transit — and the price paid by users. In addition, the signals conveyed to road users are distorted because of their failure to convey the high social costs of increasing automobile use in urban regions.

With this backdrop as the context for the Panel's review, the next chapter looks at the principles and themes that provided both the starting point and a compass to orient the Panel's work.

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