Chunnel Project

Economic Policy April 1989 Printed in Great Britain

The Channel Tunnel

John Kay, Alan Manning and Stefan Szymanski

Summary

Channel Tunnel connecting the UK to France is due to open in May 1993. Tliis paper analyses both the social and private profitability of the Tunnel project. We do this by modelling the competitive process in the cross-Channel market and assessing the impact of the Tunnel on prices and demand. We find that the characteristics of the Tunnel (enormous capacity and very low marginal costs) will have the effect of driving down prices and hence providing a huge social benefit. We find that the private profitability is less clear cut and although positive, is quite sensitive to changes in the strength of competition and demand. This analysis can be used to explain the fact that although the Channel Tunnel is widely perceived as a beneficial infrastructure project, it proved extremely difficult to raise finance for the venture.

The economic benefits of the Channel Tunnel

John Kay, Alan Manning and Stefan Szymanski

London Business School and Birkbeck College

1. Introduction Since the early 19th century both public and private sectors in the UK and France have contemplated the construction of a fixed link between the UK and the continent. Whilst the technology of the project has never been particularly challenging, all earlier projects had failed to convince investors that the revenue stream would meet the substantial sunk cost. In 1987, however, Eurotunnel, a private company possessing a monopoly franchise awarded by the UK and French governments, raised over £lbn of equity and £5bn of loan finance to build and operate a rail only tunnel between Dover and Calais. The Channel Tunnel presents a radically different technology from existing ferry services. The major part of its costs are literally sunk and its marginal costs are negligible. This compares to existing ferry services which have relatively low fixed and sunk costs and...