The Future ofRail transport in Europe

Marc IvaldiToulouse School of Economics

Directive 91/440/CEE Basics

Integration versus separation On track competition

Freight: January 1st 2007 Reforms

National versus international markets Passengers: 2008 or 2010

Financing the USO

Outside the scope: Competition for the track

Integration versus Separation

Unround wheels

The longer a wagon is operating, the more irregular the shape of wheels becomes

It increases the wear-and-tear on tracks, and hence the risk of accidents

Use of novel technologies sensors, transponders

Requirement Investment below and above the wheel Standardized data

Integrated

utility

Infrastructure

Rail services

Verticalintegrati

on

Infrastructure

manager

FirmA

FirmB

Verticalseparatio

n

Integrated“competito

r”

Challenger

Partialdisintegration

Commission’s view

Through separation all firms on an equal footing

same rules of access to tracks transparency about performance

incumbents and entrants prerequisite for a competitive and

sustainable solution

Dilemna

Contra: Infrastructure under the control of the incumbent depress competition (risk of entry discrimination) be costly for consumers

Pros:Transferring infrastructure to state property expensive to implement reduce the efficiency of incumbent (coordination) reduce the competitiveness of rail vis-à-vis other

transportation modes

Dilemna

Strong need for coordination Integration

Strong need for competition Separation

Experiences

In most countries, integration Separation

UK Japan The Netherlands France Germany

The US case

Integrated firms Infrastructure &

freight operations

No passenger services

Competition law

year#

firmsHHI

1985 23 837

1990 14 1290

1995 11 1363

2000 8 2246

Projected Costs Integrated Firm

Separated Firms Diversified Firms

Fixed Cost 169,067 338,134 169,067 338,134

Infrastructure 217,410 217,410

Operations

Bulk 823,799

General Freight

984,802

Subtotal 1,065,292 1,808,601

Total 1,150,860 1,451,769 1,620,836 2,195,080 2,364,147

Empirical findings

Empirical findings

Economies of scope between infrastructure-related activities and train operations

Economies of scope among various type of freight services

Conclusion: we should expect big firms

The investment problem

Rail versus Air New routes in air transport is a good

signal for congestion Decentralization and competition

In railways, network investment leads rather than lags new route Coordination

Transaction costs The hold-up problem

Williamson, 1985 Reason for the failure to invest

Investment creates a specific asset Example

- A track specific to HST with only one operator- The operator has an incentive to ask for a lower

price by threatening not to make its own share of the investment

Solution Long term contracts Coordination

Complementary view A regulatory agency

Independent from Government Rail industry

Monitoring the industry to ensure efficient entry and fair competition

Yardstick competition Sharing of information among national

regulating agencies

What to do next?

”one solution clearly better” is wrong Use subsidiarity???

Main test: Effectiveness of competition

On track competition

Features

Low short-run cross elasticities Competition cannot provide rapid profits

Large economies of density Competition can be tough

Implications

Stable but fierce on track competition is rare

Firms are looking to strategies to soften competition Non-interchangeability of tickets, non-

cooperation on schedules, etc Intermodal competition can be efficient The role of internet

Likely outcomes of competition Questions

Many firm? Symmetric market shares?

Replies Degree of differentiation between

services Switching costs

Higher for business than leisure travelers Difference in terms of cost efficiency

Incumbents vs Entrants

Possible outcomes

Case Incumbent operates a network

Additional cost: opportunity cost on connecting routes

Entrant competes on point-to-point routes Network 1 / 2: connecting traffic is a

large / small fraction of network No too much entry / cherry picking Germany / France

Possible outcomes (Contd)

Mohring effect The opportunity cost for incumbent

increases as frequencies decreases since value of frequency of service diminishes

Costs/Pricereaction

Entrant’s marketshare

Incumbent’s accounting cost

Incumbent’s accounting costplus opportunity cost= price reaction

Entrant’s accounting cost

withnetwork effects

withoutnetwork effects

Conclusion Intermodal competition can be

important Delineation of the relevant market

Competition can be tough with asymmetric market shares

More polycentric networks favor asymmetric market shares

The level of market shares is not the right measure for competition

The freight market

Questions

Is rail freight sustainable? Is intermodal competition in freight

market welfare enhancing?

What is the impact of Eurovignette? What is the correct level of road charge?

Replies

Is rail freight sustainable?YES, BUT

INTERMODAL FREIGHT COST STRUCTURE CREATES A MARKET FAILURE THAT

NEEDS A REMEDY

What is the impact of Eurovignette?SIGNIFICANT,

EUROVIGNETTE IS A POTENTIAL REMEDY

Intermodal Freight Cost Structure

COST (€)

VOLUME (T-Km)

ROAD

RAIL

Intermodal Freight Cost Structure

COST (€)

VOLUME (T-Km)

ROAD

RAIL

Intermodal Freight Cost Structure

COST (€)

VOLUME (T-Km)

ROAD

RAIL

OPTIMAL SOLUTION FOR THE SOCIETY

Sustainable freight market

How to implement the optimal solution? Economic textbook says:

A TAX SYSTEM IS NEEDEDTO SOLVE THE MARKET FAILURE

Question?IS A ROAD CHARGE

A POTENTIAL SOLUTION?

A simple model of the freight industry Competition analysis

As for analyzing competitive concerns Three hypothetical firms

“Rail” “Road” “Others”

Sea, Waterways, Pipelines, …. ReLocalisation of shippers and customers

Strategic behaviors of firms Competition in price

Impact on modal split

0

5

10

15

20

25

0,00 0,25 0,50 0,75 1,00

Road Charge (c / TKm)

Ch

an

ge i

n R

ail

Vo

lum

e (

%)

French level

Swiss level

Impact on consumer surplus (example)

DIRECT EFFECT

INDIRECT EFFECT

(reducing congestion &

external effects)

NET EFFECT

Road Charge & Efficiency Gains on Rail

+4.5% +9.0% +13.5%

Road Charge & Efficiency Gains on Rail & Road

+1.5% +6.0% +7.5%

Implications and questions

Road charges have an effective impact on modal split Substitution to alternative modes and choices? Technological progress?

Railway efficiency programs and road charges are complements in enhancing rail's competitive position Link between road charges and efficiency gains?

Further open questions Road charges could affect consumer

surplus positively by reducing congestion and external costs Precise evaluation?

More on the design of road charges To check the cost structure of transport

systems Transparency

To know more about marginal costs To do European research on road usage

Financing the USO

Universal Service Obligation

A definition The obligation of an operator to provide all

users with a range of basic services of good quality at affordable rates

A call for an integrated framework Content Cost Financing

Universal Service Obligation

Economic justifications Remedy for network externalities Redistribution policy instrument Means to supply a public good Instrument to conduct regional policy Outcome of a political economy process

Universal Service Obligation

Costs Profitability cost of the USO

Loss in profits incurred by the operator dues to the USO

Measure: compare profits with & without USO Critics: not easy to implement

Welfare cost of the USO Loss in welfare (consumer & producer) surplus Redistribution: Equity versus efficiency cost

Financing of the USO The monopoly case

Assumptions Regulated firm (balanced budget) different costs for providing the service to different

customers linear prices

Cross-subsidies: High-cost customers pays a lower price (implicit tax on low-cost customers)

Efficiency loss Versus the benefits in terms of the objectives of

USO (redistribution, public good, etc…)

Financing of the USO

The liberalized sector case Two issues of inappropriate USO financing

mechanism Efficiency losses (as before) Market distortion:

- Obstacle to entry to more efficient operators- Inefficient entry

Requirement: The USO financing mechanism must be

competitively neutral

Financing of the USO

Two settings The operator(s) is/are designated outside

the USO The designation of the USO operator is part

of the mechanism used to implement the USO

Financing of the USO USO imposed to single operator

The USO operator is solely responsible for its financing Cross-subsidies / transfers (as before) Risk for the viability of the operator

- cream skimming Solution?

- Reserve sector Main problem

- As the tax base is restricted there are welfare losses

Financing of the USO USO imposed to single operator

All operators contribute to the financing of the USO Creating a universal service fund Implicit or explicit taxes on operators to finance

a transfer to compensate the USO operator Well designed taxes allow for efficient entry Different systems

- Taxes (ex: specific feed on competitors’ sales)- Access surcharges- Lump sum entry fees

Financing of the USO Franchising of the USO

Attractive system Most efficient USO operator Avoiding cream skimming, bypass, inefficient

entry Reducing transaction costs

Drawbacks Outcome depend on the number of bidders

- Collusion Investment, expropriation, etc

Universal Service Obligation

Financing The monopoly case A liberalized sector

Conclusion

The need of a political agenda Investment in transport infrastructure Environmental issues