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.

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.

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?

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.

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)

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.

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

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

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

The Mexican Example

Thus a 3 rd 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

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?

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

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 19 th century

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

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