What Next for Russian Railways
New Economic School and Antitrust Division, U.S.
Department of Justice
Российская экономическая школа
30 September 2013
The views expressed are not purported to reflect the views of the U.S. Department of Justice.
How to handle “natural monopolies” (II):
The restructuring debate
Natural gas Telecoms
– fixed wire
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
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
Favorite of the World Bank, EU
3rd party access
(Grudging) favorite of incumbents
“Horizontal separation”: competition among vertically
Competition where networks intersect
The old status quo: Regulation of vertically integrated
Was it really so bad, compared to the costs of restructuring?
How to restructure a vertically
integrated monopoly railway?
Economists’ (and EU) favorite: Vertical Separation
One track owner, many “train operating companies” (TOC’s)
UK, Sweden, Netherlands, Poland, Romania, parts of Australia
Removes incentives to discriminate in providing access to
Railways’ (grudging) favorite: 3rd Party Access
Track owner is one of the many TOC’s
Germany, Austria, Italy, Chile, parts of Australia
Maintains economies of vertical integration: “where steel meets
Can be imposed gradually (to a fault)
Other options? “Horizontal separation” preserves
vertical economies, requires less regulatory
This is the model
of North and South
Chicago to Los
Angeles? BNSF or
Montreal to Vancouver?
CN or CP
Export grain from
with the Gulf
Mexico, where “horizontal separation” relies
on “geographic competition” only
• Imported steel to
from Manzanillo (or
El Paso), Ferrosur
• Exported auto
parts from Mexico
City? Same, in
How to decide?
Vertical separation removes incentives to discriminate but
loses economies of scope (operations/infrastructure) and
risks double marginalization
3rd party access maintains economies of scope but creates
incentives to discriminate
Horizontal separation removes incentives to discriminate but
loses economies of scale (in this case, system size) and risks
preserving local monopoly power
How to decide (II)? Facts and
Small system or large? Passenger-based or freight-based?
Lessons from a small, passenger-based system (UK) may
translate poorly for a large, freight-based system (RF)
What are you trying to accomplish?
Improve efficiency? Usually for rich countries
Attract private investment? Usually for poor and middle-
In years past: Satisfy World Bank conditionality
Improve political and economic integration?
Reduce political power of giant firms?
What can economics contribute?
Economies of scope (i.e. vertical economies)
Presence not much in dispute, though estimates vary
Early econometric estimates of 20-40% likely too high
Most recent results: more important in a) densely operated and b) freight-
Economies of scale: density
Probably exhausted for most densely operated systems
Economies of scale: system size
Certainly exhausted for largest systems
One takeaway from this combination: For largest systems, horizontal
separation may dominate vertical separation (Savignat and Nash, 1999)
Access pricing issues
Especially, potential welfare advantages of discrimination
RZhD reform program 2001-2010, later
extended to 2015
Improve sustainability, accessibility, safety and quality of the rail transport service to help create the
country’s common economic space and ensure the national economy’s development
Establish a single harmonised national transport system
Lower rail transport costs
Meet the increasing demand for rail transport services
Phased-in reforms and minimisation of irreversible action
Separation of government regulation and operations
Separation of the core and non-core operations
Migration from monopoly to competition
Function-based organisational structure
Government’s regulation of and control over the monopoly (infrastructure)
Partial infrastructure integration with freight transport during the first stages of the reform to be
phased out to ensure rolling stock privatisation
(from a 2011 RZhD slide presentation)
How to achieve “migration from
monopoly to competition”?
From the original reform plan:
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”
This last point has faded from the discussion
What competition has been created so far?
Rolling stock, repair facilities
“Daughter” operating companies
But INDEPENDENT train operating companies?
Current state of reforms
In RF there are plenty of independent “operators” (companies that
arrange transportation for shippers and may own rolling stock)
but not yet any “carriers” (companies that operate their own trains
with their own locomotives on the RZhD infrastructure)
Barriers/complications to “carriers”
Continued cross-subsidy requirements for RZhD trains
“Common carrier” requirements – other countries do not impose
Very high track access charges
Thus RF pioneered its own form of vertical separation:
“infrastructure” includes locomotives
Kazakhstan, Ukraine have followed
“Target Model of the Cargo Railway Transportation Market till 2015”
“Continuing integration of rail transport infrastructure and transport activities
until at least 2015”
“Pilot projects aimed at creating private carriers based on the principle ‘for
route’ and ‘en route’ competition” – though RZhD resisting “en route” pilot
After 2015: Vertical separation?
Sale of majority shares of Freight One to ITC
Encouraging “further consolitation of rolling stock operators and, in the future,
the formation of three or four companies operating across the whole rail
network in Russia.”
Note the careful language!
“Operators”, not “carriers”
It appears that RZhD has not committed to exiting the locomotive business.
RZhD’s secret weapon: The Institute of
Natural Monopolies Study
1. Detailed engineering/accounting cost analysis of a) vertical separation and
b) creation of 3 competing vertically integrated firms
A. Vertical separation would increase railways transports costs by RUB 223
billion – about 1/3 – with small and uncertain benefits
“Occurrence of the positive consequences has probabilistic nature. Occurrence of the
negative consequences is inevitable.”
B. In fact, given these costs as well as additional complexities of operation,
vertical separation is “not feasible”.
C. Regarding vertically integrated firms, parallel competition is “impossible ...
as there is only one shortest distance between two stations.”
D. For vertically integrated firms, geographic competition is feasible, but would
increase costs by RUB 105 billion – over 15 percent – with small benefits
RZhD’s secret weapon: The Institute of
Natural Monopolies Study (II)
2. Extensive review of the international economics literature on vertical separation in
railways – 25 “foreign studies”
(Full disclosure: I was the author of 2 of the foreign studies and the co-author of a 3 rd.)
A. “There is no practical evidence that vertical separation increases the internal
competition and the rail’s modal share in freight or passenger transport or enhances the
productivity and efficiency of the rail transport.”
B. “The authors of the majority of studies assert that the efficiency of each structural
model depends on conditions ... in each country.”
C. A large number of the studies focus on Western Europe. Russian railways are very
different from Western European railways.
D. “For rail networks with high traffic density and a large share of freight trains [like the
RF] the preferable solution is not to perform vertical separation.”
Footnote: The authors do not seem to have noticed that the study they rely on for this point uses an
unusual measure of traffic density, under which density in the RF is below average: 48 train-km per
route-km per day, in contrast to the sample average of 61.
Large railway networks
Freight Passengerton-KM(M) KM(M)
KM Track/ Population
Land Km2 (2010)/ Land
Sources: US Census, CIA World Factbook, World Bank
Responses to the Study
1. Literature review is accurate.
Vertical separation has not been shown to be important for competition or efficiency.
In any case, it is difficult to apply the experience of UK or Sweden to Russia.
2. But RZhD’s conclusion – “competition does not have a direct impact on improving the
efficiency of railways and should not be an end in itself” – does not follow.
3. The report underestimates the benefits of competition.
Companies with different costs can compete quite fiercely.
Parallel railways in the US and Canada
TSR with the all-water route from East Asia to Europe
The benefits of competition are not limited to shaving a few rubles off costs – competitors improve
quality and come up with new products and services to capture business.
US airline deregulation
US rail deregulation
Also, competition may reduce, not increase, the requirements for regulation.
The report is correct: Vertical separation creates increased complexity and requirements of regulation.
But competition among vertically integrated railways greatly reduces the need for regulation.
This is certainly the US experience.
So: Competition among vertically integrated
railways in the RF? Why not?
3 is a good number (as in Mexico).
One possibility is plan: “Geographic competition among 3 vertically integrated
railways”, all moving in different directions from the Kuzbass
An alternative possibility: parallel competition based on the TSR and the BAM through
the Kuzbass to Moscow, with geographic competition from a 3 rd railway between
Moscow and the Baltic Sea
Facts and figures:
RF Railway Strategy 2030 calls for doubling capacity and tripling traffic on the BAM,
including plan for “strategically important” extension to Magadan. Why not direct,
parallel competition between TSR and BAM?
Traffic density on the Russian railways much greater than US (in fact 2 nd in the world to
China). So economies of density likely exhausted.
86,000/3 = 29,000 km average track length. Not as big as BNSF or UP in US, but in the
same range as NS, CSX, and CN, and larger than CP. (Average length of 7 US Class I
railways is 33,000 km.) So economies of system size likely exhausted, or nearly so.
Analysis of the Feasibility to Divide the Single Business Entity (Russian Railways JSC) into Several Vertically
Integrated Companies (VICs) Competing among Themselves
Work distribution among VICs:
Focused on the Kuzbass — Northwest flow, participates in forming and
advancing the North — South flow in its service range. Competes with the
Southern VIC when relocating the Centre — Volga Region — Ural Mountains
flow, and probably competes for part of the Kuzbass — Centre flow.
Focused on the Kuzbass — Azov-Black Sea Traffic Centre and North — South
flows, maintains the Centre — West flow, competes with the Northern VIC
when relocating the Centre — Volga Region flows, and also probably for part
of the Kuzbass — Centre flow.
Focused on the work with the Kuzbass — Far East Traffic Centre cargo
flow, forms and sends the Kuzbass — Northwest and Kuzbass — AzovBlack Sea Traffic Centre flows to the Northern and Southern VICs.
Each VIC services customers located in its region of activity and performs the domestic and international freight
transportation with the use of its infrastructure.
An alternative plan, combining parallel
competition with geographic competition