1. Economic Analysis in Network Industries Russell Pittman Antitrust Division, U.S. Department of Justice and Visiting Professor, Kyiv School of Economics The views expressed are not necessarily those of the U.S. Department of Justice.

2. The issue: Incumbent monopolist in network industry Industry structure Network, perhaps a “natural monopoly” – for example, railway infrastructure, electricity transmission and distribution lines “Upstream” sector, perhaps potentially competitive – for example, train operators, electricity generators Incumbent monopolist vertically integrated, controls both network and upstream Likely industry condition Network depreciated, in poor condition User prices often not related to costs Regulator uninterested in competition What are the best policy options going forward?

3. Option 1: Don’t restructure; regulate better Maintain structure of vertically integrated monopolist, but … Find money to improve network Public-private partnerships? Find money to improve upstream sector Make sure most tariffs at least cover costs Where tariffs subsidized, use government funds rather than cross-subsidies within sector Improve quality of operations Technocrats rather than politicians as managers Buy-outs for excess labor Improve quality of regulation, prepare for future competition Possible example: Ukrainian electricity?

4. Option 2: Restructure to allow competition upstream Maintain network monopoly (railway infrastructure, electricity transmission distribution) Allow entry upstream and enforce competition law there (train operating companies, electricity generators) Big issue: Allow network monopolist to operate upstream? That is: “Vertical separation” or “third party access”? World Bank and others: Vertical separation, of course. Otherwise always discrimination issues. U.S. v. AT&T. Skeptics: Third party access, of course. Why throw away economies of scope between network and upstream? Possible example: Ukrainian railways (government’s legislation before Rada)

5. Option 3: Restructure to allow horizontal competition Divide network into competing vertically integrated monopolists, creating competition where possible Sell long-term franchises to private firms For example: Mexican, Brazilian, and Argentine railways Advantages Bring in private investments (Mexican railways: US$100K per track-km in franchise bidding alone – investments in system followed) Create some competition – e.g. railways serving common points Disadvantages Some users will be served by private monopolist Protect with residual regulation and/or antimonopoly enforcement “Privatization”? No, but it looks like it. Possible example: Ukrainian railways About the same size as Mexican system, which was divided into three companies Vertically integrated railway companies competing to serve Kyiv, Odessa, eastern and western export points

6. Might the same principles apply in industries with platforms, like smart phones? Network/platform with high fixed costs, perhaps “natural monopoly” characteristics Multiple applications developed that require platform Policy issue: Mandatory, regulated access to platform? Competition law instinct: Of course. Otherwise how can independent suppliers of apps reach customers? But might “closed systems” be efficient? Better able to protect and incentivize quality? Might competition either between closed and open systems, or even between closed systems, be as beneficial as competition among apps using a monopoly platform?