how to restructure natural monopolies. especially railways

How to Restructure Natural Monopolies.

Especially Railways.

Russell PittmanVisiting Professor, New Economic SchoolNES Guest Lectures Supported by E&Y

Polytechnic Museum, 6 April 2011

The views expressed are not represented to be those of the U.S. Department of Justice or the U.S. Government,

Traditional treatment of natural monopolies in market economies

• What are “natural monopolies”?– Industries subject to such economies of scale

that it would be inefficient to have competition– Typically some kind of “network industry”– Examples: electricity, telecommunications,

natural gas, railways, water supply


(continued)

• Who should own and control natural monopolies?– In most countries, traditionally owned and

controlled by the state– In the US and UK, often owned by private

shareholders but regulated by the state– Privatization and restructuring now the

dominant global trend


(continued)

• Regulator or government sets prices: wL + gM + rK = pQ

• Appears logical, straightforward• But problems:

– No penalty for inefficiency– No reward for efficiency– Wasteful disputes among lawyers and

experts, especially regarding r and K– Political pressures to increase L, use local M

Addressing the problems of regulation

• One alternative: improve regulation– “Incentive regulation”, price caps

• Second alternative: substitute competition for regulation– Growing appreciation of the benefits of competition:

lower prices and more innovation– Growing appreciation of the limitations of bureaucratic

knowledge– Technological changes have made “monopoly” less

“natural”

Competition in “natural monopolies”?

SECTOR Electricity Natural gas Telecoms Railways

NETWORK: MONOPOLY?

Long distance transmission lines, local distribution lines

Long distance pipelines

Local “loop” – fixed wire service to households and businesses

Track and signalling

COMPETITIVE? Generation: natural gas, coal, hydro, nuclear

Exploration and production

Long distance, mobile, internet

Trains

But competitive elements cohabit uneasily with monopoly networks…• How restructure the overall sector?• US telecommunications sector• First, 3rd party access

– MCI competed with AT&T for long distance, while AT&T maintained local service monopoly

– AT&T discriminated against MCI in order to favor its own long distance service

• Then U.S. v. AT&T: Vertical separation– AT&T forced to give up local service in order to insure

fair competition in long distance

The typical policy debate

• Economists and reformers prefer vertical separation– Removes incentives for network operator to discriminate – as in

U.S. v. AT&T

• Incumbents prefer 3rd party access– Maintains economies of vertical integration– May be implemented gradually– Interesting puzzle: why did economists and reformers

underemphasize economies of vertical integration?

• Other options? Horizontal separation – competition among smaller, vertically integrated companies?

• Status quo? Was it really so bad?

Is there a “best” policy?

• Probably not. “One size does not fit all.”– World Bank has retreated from previous strong

emphasis on vertical separation.

• Depends on the sector being restructured– Economies of vertical integration– Economies of scale in “competitive” part

• What’s worse than one monopoly? Two monopolies.

• Depends on the country and its institutions– Level of development– Rule of law, especially independence of courts– Abilities of regulators

Is there a “best” policy? (continued)

• Depends on the specific goals of restructuring– Increased efficiency?– Increasing innovation?– Attracting private investment?– Reducing economic power of giants?

• “Too big to fail”

– Reducing political power of giants?• “Too big to regulate”

Russian Railways

How to Restructure a Vertically Integrated Monopoly Railway?

• Economists’ favorite: Vertical Separation– UK, Sweden, Netherlands, Poland, Romania, parts of

Australia– Removes incentives to discriminate in providing

access to infrastructure

• Railways’ (grudging) favorite: 3rd Party Access– Germany, Austria, Italy, Chile, parts of Australia– Maintains economies of vertical integration: “where

steel meets steel”

How to Restructure a Vertically Integrated Monopoly Railway?

(continued)• North and South America’s favorite:

Horizontal Separation– USA, Canada, Mexico, Brazil– Parallel competition where possible

• Chicago to Los Angeles? BNSF or UP• Montreal to Vancouver? CN or CP

– “Geographic competition” otherwise• Imported steel to Mexico City? KCSM from

Monterrey (or Laredo), Ferromex from Manzanillo (or El Paso), Ferrosur from Veracruz

Russian Federation?

• Adopt a Western model?– "Our institutions and all of that are like birch trees that we’ve

thrust in the ground on the St. Trinity Day to make it look like a forest that grew naturally in Europe.” Levin, in Anna Karenina

– "There you have it -- reforms on unprepared ground, and copied from foreign institutions as well – nothing but harm!" The Devil, in Ivan’s dream, in The Brothers Karamazov

• Adopt its own model?– “God created Russia in order to show the world what not to do.”

attributed to Chaadaev, but it appears that what he really said was:

– “We are one of those nations, which do not appear to be an integral part of the human race, but exist only in order to teach some great lesson to the world.” First Philosophical Letter

RZhD’s 3-Stage Structural Reform Program of 2001

• First stage: 2001-2003– Creation of joint-stock company RZhD– Separation of commercial from regulatory

functions– Divestiture of non-core activities


• Second Stage: 2003-2005– Creation of “daughter companies”

• general freight, specialized freight, passenger, commuter, repair

– Implementation of non-discriminatory conditions for access to independent train operators

– Replacement of freight-to-passenger cross-subsidies with transparent government subsidies


• Third Stage: 2006-2010– Partial or complete privatization of subsidiary

companies– “Develop competition in the freight traffic

sphere”• “Estimate the opportunities of setting up several

railway companies, competing and vertically integrated”

“Competition in the freight traffic sphere”?

• Some progress– Daughter companies created, some perhaps

to be divested– Limited access to independent train operating

companies (TOCs, or in Russia “carriers”)– Large-scale private ownership of rolling stock

“Competition in the freight traffic sphere”?

• But significant hurdles remain– Continuing cross-subsidies required in both

freight and passenger operations– Continuing absence of laws, decrees

regulating infrastructure access by TOCs• One critical distinction: operators vs. carriers

– “Common carrier” requirements– Current tariff regulations: very high

infrastructure component (= access charge)

“Competition in the freight traffic sphere”? Current status

• Reformers argue for vertical separation• RZhD and government have allowed a

special Russian version of 3rd party access– Both independent operators and RZhD

daughters (Freight One, Freight Two, others) own rolling stock, deal with shippers

– But trains run with RZhD locomotives: Vertical separation, but with locomotives remaining part of monopoly infrastructure

• Horizontal separation off the table?

RZhD’s Strategy for Railway Development to 2030

• First stage, 2008-2015: “Modernization”– Replacement of depreciated rolling stock– Technological upgrades to entire system,

including electrification and expanding BAM

• Second stage, 2015-2030: “System Expansion”– International transportation corridors– Trans-Siberian and BAM

The Future

• Will there ever be 3rd party access in the European sense?

• If so, will 3rd party access evolve into vertical separation?

• Does system expansion – especially of BAM – make horizontal separation more feasible?