Competition Issues in the Restructuring of Freight Railways

1. Competition Issues in the Restructuring of Freight Railways Russell Pittman Antitrust Division, U.S. Department of Justice and New Economic School 2 April 2009 Laboratory for Institutional Analysis of Economic Reforms Higher School of Economics Moscow The views expressed are not those of the U.S. Department of Justice.

2. Background: U.S. v. AT&T • AT&T (Bell Telephone) was a vertically integrated monopolist, regulated at both federal and state levels • Changes in technology possibility of competition in long distance • Changes in economic thinking search for ways to substitute competition for regulation • Continued discrimination by vertically integrated incumbent against non-integrated entrant • Finally: U.S. v. AT&T. Vertical separation.

3. Gradually, a new paradigm • Network industries everywhere: grid networks carrying products and services • Grids natural monopolies, services potentially competitive? • Telecoms: monopoly fixed wire network, but competitive long distance (later: mobile, internet)? • Electricity: monopoly transmission/distribution network, but competitive generation? • Natural gas: monopoly pipeline network, but competitive exploration and production? • Railways: monopoly track/signaling network, but competitive trains?

4. How to encourage competition? • Clearly: Open up services component to competition, entry • But not so clear: Separate ownership of network from ownership of service provider? • Economists: Of course. Otherwise impossible to prevent discrimination. See U.S. v. AT&T. • Incumbents: Of course not. Loss of vertical economies.

5. Eventually… • “Vertical separation” became conventional wisdom of economists. • “Third-party access” (TPA) – i.e. entry upstream, but maintaining vertical integration of network provider – became fallback of industry • Lost in the shuffle: Transactions Cost Economics • Benefits of vertical integration, or at least close coordination, in complex environments (bounded rationality, imperfect foresight, incomplete contracts)

6. Results • Telecoms: Lots of TPA, lots of success. Regrets at slow speed of introducing competition. But still discrimination concerns. Next on the horizon: internet neutrality? • Electricity: Lots of vertical separation; mixed results. Some success stories in UK (eventually), US. The “but” in every conversation: California. • Railways: Even more mixed. Some TPA, some vertical separation. The “but” here: the UK. But here a new factor: the “American” model.

7. Consider “railway economics” more closely. • Some countries mostly freight (US, Russia, Eastern Europe, Australia), others mostly passenger (Western Europe, Japan). • Freight pays its way; passenger usually requires subsidies. • Broadly consistent econometric results: • Economies of system size exhausted at fairly small levels (5-15K km) • Economies of density exhausted at much higher levels • Vertical economies at least moderate, perhaps larger

8. Consider “FREIGHT railway economics” more closely • History of privately owned, vertically integrated railways (especially US and UK) • Often competition over “parallel” routes (J.S. Mill vs. Alfred Marshall) • Motor carriers competitive for high-valued commodities and short-distance hauls • Rail has big advantage for bulk commodities, especially over long hauls

9. A crucial concept: “source” (or “geographic”) competition • Independent, vertically integrated railways compete to carry goods from a common origin • Independent, vertically integrated railways compete to carry goods to a common destination • Econometric support strong, especially for grain traffic • US and Canada rely on • One basis for reform strategies of Mexico, Brazil, Argentina

10. The Mexican Example

11. Thus a 3rd option for railways restructuring • Vertical separation: Sweden, UK, European Union (according to the Directives) • Third party access: Germany, much of Europe so far • HORIZONTAL separation: the Americas • The mystery: Russia

12. Eastern Europe • Some mix/hybrid of vertical separation and TPA • Mixed success of entrants in capturing freight traffic • Romania 20-25%, Poland 15%, Others near 0 • The surprise: who entered • Large shippers integrating into transport • Freight forwarders integrating into transport • Not much by neighboring incumbents • Mutual forebearance? • Prefer purchase?

13. Russia • 3-stage reform plan included • Increased reliance on independent train operating companies • Consideration of “horizontal separation” model • So far: • Lots of privately owned rolling stock • Lots of private “operators” using RZhD trains • Lots of “daughter companies” • Very few private “carriers” – and no legal and regulatory support structure for them

14. An alternative plan • Horizontal separation: an “American model” restructuring in Russia • Vertically integrated railways, operated by private companies under long-term franchise agreements, competing • To carry freight to and from Moscow in different directions • Parallel routes between Omsk and Moscow • Large enough to achieve economies of system size • “Back to the future”: Russia had something like this in late 19th century

15. An example of dividing the grid in the Western part of Russia into twocompeting vertically integrated rail networks. Source: Guriev et al. (2003).

16. What’s next? • Complete vertical separation? • At least, an independent “2nd Cargo Company”? • At least, legal and regulatory framework for independent carriers? • If not: • Vinit’ strelochnik? • Vinit’ ekonomist?