Rail regulatory reform in Europe-principles and practice

Tags: infrastructure, railways, operations, vertically integrated, Commission, European Union, passenger services, franchising, Britain, railway infrastructure, train operating companies, marginal cost, open access, social obligations, railway, European Commission, Mexican Transportation Institute, freight services, freight operations, state-owned, Germany, infrastructure company, freight operators, Network Rail, passenger companies, infrastructure charges, environmental costs, Western European Railways, railway company, rail transport, State owned organisation, vertically integrated company, Chris Nash, modes of transport, infrastructure managers, infrastructure manager, public service obligations, Rail Organisation
Content: Rail regulatory reform in Europe ­ principles and practice Chris Nash and Cesar Rivera-Trujillo Institute for Transport Studies University of Leeds Paper presented at the Conference on Competition in the rail industry, Madrid, Sep 2004. An earlier version of this paper was presented at the STELLA Focus group 5 synthesis meeting, Athens, June 2004. We are grateful to the discussant, Bill Waters, and other participants for comments. 1. Introduction European rail policy has concentrated on the introduction of competition into the rail transport market via separation of infrastructure from operations (at least in an accounting sense), by the progressive opening up of entry to the market for new operators and by rules regarding the allocation of slots and the pricing of infrastructure use, administered by an independent regulator. This is all in marked contrast to the US, where concentration has been on parallel competition between vertically integrated railroads. In the following section we explain the development of EU rail policy. We then consider alternative models of rail reform, both in principle and in practice, concentrating on developments in Europe. We present the results of studies examining the success of the European reforms, before concluding by outlining areas where more research is needed. 2. The development of EU Rail Policy For many decades, railways in most of Europe have been seen as a problem. They have steadily lost market share (figs 1 and 2), falling from 10% to 6% of passenger kilometres and 20% to 8% of freight tonne kilometres over 30 years. They also require high and increasing levels of subsidy; Table 1 shows that less than half of the total costs of rail transport in Europe are borne directly by passenger and freight customers. The initial response of the Commission to this situation was to encourage governments to reorganise railways as autonomous commercial bodies (in a number of countries the railways were still run directly by government departments), with separate and realistic accounts and with social obligations minimised but appropriate recompense paid where such obligations were maintained. Governments were not to interfere with market mechanisms by providing subsidies to railways except under specific conditions. Three regulations were critical in this process. These were: 1191/69 on Public Service Obligations 1192/69 on Normalisation of Accounts 1107/70 on Aids to Transport
Figure 1: Passenger Modal Share in the European Union (passenger-km %)
0% 1970
Cars Railway Buses and coaches Air
2000 Tram and Metro
Source: European Commission. Energy and Transport in figures. Statistical pocket book 2003
Figure 2: Freight Modal Share in the European Union (tonne-km %)
33.5 75%
50% 25% 0%
20.1 34.6 1970
14.7 36.2 1980
11.0 41.8 1990
8.1 43.8 2000
Road Rail Oil Pipeline Inland Navigation Sea*
Source: European Commission. Energy and Transport in figures. Statistical pocket book 2003 *Intra-EU traffic including domestic traffic.
Table 1: Total rail transport costs and revenues - million 1998-
Revenue over total cost
1) Operating, signalling and depreciation costs only 2) Rail owned buses included Source: Nash et al (2002)
Despite these measures, the Commission perceived continued major problems in the rail transport field. The most obvious of these is the continued loss of market share, particularly for international traffic. But behind this was thought to lie a number of problems in terms of organisation and control: (i) The fact that rail operators were still largely nationally based, with complicated arrangements requiring inter company negotiations regarding through traffic between countries. This was believed to affect the flexibility and quality of service offered to the customer, compared with situations in which the entire operation is under the control of a single operator. (ii) Growth in the level of financial support for rail services, together with the continuation of a system whereby compensation for social obligations was still largely provided ex post, with such compensation often being inadequate and not clearly identified with particular obligations. At the same time railways still frequently had totally unrealistic balance sheets containing inherited debts which bore no relation to the earning power of their assets. (iii) Inadequacy in the capacity and quality of infrastructure, particularly regarding the ability to operate high speed passenger and combined transport freight services on international routes. In some cases, the problem was a sheer lack of capacity, but more often it was difficulties such as inadequacies of speed and loading gauge. Where bottlenecks on one system led to loss of traffic by its neighbours, the Community as a whole clearly had a special interest. (iv) Following on from this, there remained the general problem of technical harmonisation, for instance in terms of systems of signalling and electric traction, which lead to difficulties in terms of through running and mass production of rolling stock. In the case of the Iberian peninsula and Finland there is of course the particular problem of different track gauge from the rest of the community. In the face of these problems, the Commission produced a new policy statement late in 1989 (CEC(1989) ), which advocated a radical change of policy. As well as further measures to ensure that railways had increased commercial and financial independence and realistic balance sheets, there was a new requirement for rail operators to establish separate divisions for infrastructure and operations, to require the infrastructure to be accessible to other operations, on fair and equal terms and to implement a system of charging for the use of infrastructure (based on train kilometres, speed, time, axle weight, etc) which would facilitate this in the context of fair competition between modes. In other words, for the first time a policy based on separating infrastructure from operations and seeking to attract new entrants to compete in the rail industry was being put forward. The second provision of the proposal was to require replacement of generalised public service obligations by contracts, spelling out clearly the services to be provided and the prices and subsidies to apply. The key issue is the extent to which a more formal contractual arrangement leads to a more transparent and effective relationship between government and railway. Whilst such a change would certainly make it easier to franchise out rail operations to private operators, who would compete for the franchise, at this stage there was no indication that this was what was intended. 4
The third and fourth measures related to harmonisation, and to financial measures to promote high speed rail and combined transport. After much negotiation, a limited version of these proposals was implemented in Directive 91/440. Separation of infrastructure from operations was only required in the form of separate accounts with transparent infrastructure charges. legal rights of access to railway infrastructure in EC countries were established for two types of undertaking: international groupings of railway undertakings - defined as two or more operations from different countries wishing to run international services between the Member States where the undertakings are based - and any railway undertaking wishing to run international combined transport goods services between any Member States. Two Directives followed this up. Directive 95/18 required states to designate licensing authorities, so that it could be clear that any operator wishing to run international trains had appropriate financial capacity, professional qualifications, insurance and safety certification. Directive 95/19 required governments to define an infrastructure manager and a path allocation body, and to lay down non-discriminatory rules for the allocation of paths and for access charges. However, by the time the Commission issued its next White Paper on Railways (CEC, 1996) relatively little progress had been made in introducing more competition to the railways and virtually no open access operations had emerged. Many argued that this was because the existing legislation only provided for minimal rights of access for international rail freight operators, and left the administration of those rights, and the charges to be levied, in the hands of the existing rail operators, who had a vested interest in preventing them from being exercised. Accordingly the Commission argued for stronger actions to open up the railways to market forces, including: - separation of infrastructure management and transport operations into distinct business units, rather than merely accounting separation; - open access for all freight and international passenger services; - introduction of market forces into domestic passenger services, possibly by competitive franchising; - establishment of `freight freeways' with `one stop shops' for access to the infrastructure. In 1998 a first 'railway package' of proposals was produced, calling for clearer separation of infrastructure from operations, at least into separate divisions, for a gradual extension of access rights and for transparent and non-discriminatory infrastructure charges. However, what was eventually agreed again was much more limited. Separation of infrastructure from operations was still only required in terms of accounting by Directive 2001/12, although separate balance sheets as well as profit and loss accounts, and separate accounts for passenger and freight, would now be required. Access for international freight services was to be extended throughout an extensive defined European rail freight network by 2005 and to all routes by 2008. There is an important separation of powers provided in the form of an independent regulator, and the separation of path allocation and infrastructure charging from any organisation responsible for running rail services. We return to the Directive on infrastructure charges (2001/14) below. There were also provisions to extend licensing to all train operating companies (2001/13) and to extend interoperability requirements to conventional lines (2001/16); previous interoperability legislation concerned high speed lines only. 5
More recently, in January 2002 the Commission adopted a communication (known as the second railway package) on the further development of the European railways: 'towards an integrated European railway area'. In this, they put forward five specific proposals: - a new directive on the regulation of safety and investigation of accidents and incidents on the community's railways; - amendments to two previous directives on interoperability; - a regulation to establish a new European safety and interoperability agency; - a recommendation for a council decision authorising the Commission to negotiate the conditions for community accession to the COTIF arrangements for international transport; - most fundamentally an amendment to 91/440 so as to open up access to the infrastructure for national services in order to completely open up the rail freight market. This has now been agreed and open access in the domestic freight market will be introduced in 2007. A proposal to open up international rail passenger markets to competition as part of a third rail package is already under discussion. A separate proposal to amend regulation 1191/69 would introduce compulsory competitive tendering for all subsidised services, but this met with opposition in both the European Parliament and the Council of Ministers, and a revised version is now being considered which would permit continued operation by the government owned operator without competitive tendering but allow this decision to be challenged by a company which believed it could do better. The issue of open access cannot be separated from pricing policy. To have the right of access, but at whatever price the infrastructure manager chooses, is valueless. It has long been the declared aim of the Commission that pricing policies should be developed which promote economic efficiency. This requires prices which relate to marginal social cost. Originally, this was seen mainly in terms of charging for the use of infrastructure according to marginal operation and maintenance costs, but more recently the concern with environmental problems has led to an emphasis on the external costs of transport as well - congestion, accidents and environmental costs. In 1995 the Commission published a Green Paper entitled `Towards Fair and Efficient Pricing' (CEC, 1995). The basic argument of this paper was that many elements of transport cost - congestion, accidents, environmental costs and infrastructure maintenance costs - were either not reflected at all in current prices or were reflected only in part. In total these uncovered costs might be as much as 250b ecu per year for the Union as a whole. The emphasis on external cost in this paper was a radical departure in EC discussion of infrastructure policy, but - whilst the paper proposed many sensible measures, including urban road pricing, a kilometre based tax for heavy goods vehicles and more differentiated rail infrastructure charges - it did not contain clear proposals for implementation. In 1998 the Commission published its proposals for the introduction of a common transport infrastructure charging framework, which placed a further emphasis on the marginal social cost pricing approach, whilst allowing non discriminatory mark-ups to be levied where this is not adequate for full cost recovery (CEC, 1998). The proposals on railway infrastructure charging emerging from the 1998 railways package were enshrined in Directive 2001/14, on 6
allocation of railway infrastructure capacity and levying of charges. In summary, the directive determines that charges must be based on `costs directly incurred as a result of operating the train service". They may include: - scarcity, although where a section of track is defined as having a scarcity problem, the infrastructure manager must examine proposals to relieve that scarcity, and undertake them unless they are shown, on the basis of cost benefit analysis, not to be worthwhile. - environmental costs, but only where these are levied on other modes. - recovery of the costs of specific investments where these are worthwhile and could not otherwise be funded - discounts but only where justified by costs; large operators may not use their market power to get discounts - reservation charges for scarce capacity, which must be paid whether the capacity is used or not. - compensation for unpaid costs on other modes - non discriminatory mark ups but these must not exclude segments of traffic which could cover direct cost In other words, this Directive reflects some quite sophisticated argument. It seems clear from the List of Elements that may be included in the charges that `the direct cost of operating the service' is to be interpreted as short run marginal social cost. However, the arguments that this form of pricing may lead infrastructure managers to artificially restrict capacity or to be unable to fund its activities in total or particular investments are all addressed by special provisions. Moreover, there is allowance for second best pricing in the face of distorted prices on other modes. However, the effect of these provisions, all sensible in themselves, is to considerably water down the likely effect of the Directive by giving infrastructure managers various loopholes under which they can argue for the maintenance of previous forms of infrastructure charging. In particular, the degree to which competitive charges for paths involving several countries, based on comparable pricing regimes, has been achieved is inevitably limited. Although the subsequent White Paper (CEC, 2001) proposed a framework directive and methodology paper extending marginal social cost pricing to all modes of transport, there has been little progress on this. A proposal to review the Eurovignette Directive on heavy goods vehicle charges would still tie the average level of charges to average infrastructure and uncovered accident costs, excluding other externalities, although these could be used to differentiate charges by vehicle type, time and location. Proposals for air and water transport have yet to be brought forward. 3. Alternative Models of Rail Restructuring It will be clear from the above that the European Union is pursuing a particular model of rail restructuring based on separation of infrastructure from operations and the introduction of competition between a variety of operators in the market in freight and international passenger transport and for the market for subsidised passenger services. Arguably this model reflects the particular problem of the importance of improving international services in the context of separate national vertically integrated companies. But it is important to recognise that this is only one model of many, and indeed it is one that is almost unique to Europe (Nash and Toner, 1999). 7
For the last fifty years or so in much of the world railways have been vertically integrated monopolies in the hands of the state. Only in North America has there been a serious attempt to maintain competition between private vertically integrated railway companies over parallel track, with limited use of access to each others' infrastructure. More recently a number of countries, including Japan and much of Latin America, has moved towards splitting the vertically integrated companies into a number of separate regional companies, either as part of outright privatisation or with very long franchises (30 year or more). The argument for vertically integrated monopoly is the belief that rail transport is characterised by having a large sunk cost and that therefore the rail industry is a natural monopoly. Under these circumstances, and in order to avoid the use of monopoly power, this kind of structure has been operated by a public firm, or heavily regulated. The main advantages of this type of structure come from the integration of the main stages of the production process which allow integrated planning and coordination of the whole network. That is, with the integration of the infrastructure and operation it can be easier to plan the future investment and to programme the operations. Moreover, it is possible to have a simple compatible tariff policy over the whole network and eliminate or reduce to a minimum any contract with other firms. On the other hand, the disadvantages of this monolithic structure are based in the lack of competition; as a result, it is difficult to provide incentives to improve efficiency and productivity in the industry. Moreover, as the industry belongs to the government, it is likely that the objectives are not in a commercial focus but a social basis. Thus, there may be limited pressure to improve the productive efficiency and there is practically no possibility of bankruptcy. The policy of moving to a situation where there is in each region a vertically integrated firm (as in South America) has several advantages in comparison with the traditional vertically integrated railway since, in this case, there is the possibility to introduce competition. The introduction of competition in this structure is possible by introducing the participation of the private sector by giving a concession which includes the infrastructure and the operations of a well-defined region for a certain period of time (as in Latin America). After the conclusion of a concession, this is revised and there is the possibility of changing or giving the concession to a different company. Thus, it can be said that there is competition for the market. However, this kind of competition is very limited due to the sunk costs involved in each region continuing to be significant, making necessary a significant investment. In fact, in some cases, the concessions are given for 30 or even 50 years making the competition for the market almost inexistent. On the other hand, the competition in the market can be quite significant since there is the possibility for every firm to use the infrastructure of the whole network by paying access charges to the other firms who have a concession. In other words, there is the possibility to have open access in the whole network by negotiating the access to the infrastructure between the different regional companies in the industry. In practice, the cross-concession traffic has not been easy to manage. For instance, in the rail privatisation in Brazil and Mexico, it was expected that the regional companies would reach an agreement on the railroad access and negotiate prices of these rights, however, some difficulties have emerged such as the agreement on the value of variable cost for track access and some issues of business risk have reduced incentives to share infrastructure between different concessions (Campos 2002). 8
This model has not yet been used on any significant scale in Europe. As explained above the basis of EU policy is the separation of rail companies into infrastructure and the operation of the services. The first case of vertical separation was given by the Swedish railways, when in 1988 the infrastructure management was separated from the traffic operations (Nilsson E. 2000). The basis for this type of structure is the introduction of competition in the operation of services while accepting the necessity for a monopoly in the infrastructure. The competition in the industry is carried out by allowing several firms to compete using the same infrastructure. Moreover, in this case, competition for the market can be quite significant. This is due to the elimination of the main sunk costs (infrastructure) to the operating companies, which eliminates the main barrier to entry. Thus, the train operating companies can compete for the right to operate certain routes by a certain period (e.g. franchise system), a period that will be significantly smaller than the concession of a vertical integrated firm. Competition for franchises is particularly important in Europe where subsidised passenger services are the dominant user of the infrastructure. Once again, the necessity of having different companies competing requires the participation of the private sector. The monopoly of the infrastructure can be maintained by the government or given to a private company. In the case of having a private company responsible for the infrastructure, it will be necessary to have strict regulation and to monitor the performance in order to avoid abuse of monopoly power. Apart from the introduction of competition there may be advantages from specialisation. For instance bus companies and airlines have become heavily involved in the operation of services, but may not have the expertise to take responsibility for the infrastructure. On the other hand, there are some disadvantages. This is due to the number of different firms running services on the same infrastructure, thus it is quite difficult to generate a timetable and to have a slot allocation in such a way that all the firms are satisfied. Moreover, as every firm dominates certain routes, which are independent from other routes that are dominated by other firms, there is the possibility to create monopolies in particular flows. In addition, a lack of compatibility in the tariff policy and in the characteristics of the services can be expected that may affect the final users. For instance, the incompatibility in the tariff policy of the firms in the industry can be a problem for users who need to travel along different routes that are dominated by different firms. In practice, even within Europe, progress in the liberalisation of railways varies enormously. This has been revealed in an independent study by IBM Business Consulting for Deutsche Bahn, in which a Rail Liberalisation Index is estimated taking into account the level of the national legal framework, the level of actually available access, opportunities and barriers and the level of market opening achieved (IBM and Humboldt University of Berlin, 2002). The results showed that Great Britain, Sweden and Germany are leading the liberalisation in the EU, following by the Netherlands, Denmark and Switzerland and much behind, Austria, Finland, Belgium, Norway, Portugal and France and at the bottom Ireland, Luxembourg, Greece and Spain. Thus, the degree of separation (vertical and horizontal), the level of competition, ownership of the infrastructure, etc. vary across countries. To give an idea how the rail industry is organised 9
in these countries, Table 2 shows key characteristics of the current rail organisation of selected Western European railways. The situation in North and South America is very different. As commented above in the US and Canada, most of the railways have been managed and organized as regional verticallyintegrated private companies, which not only own rail infrastructure but also operate transport services. The exception is the intercity passenger traffic which is provided by the Government using a significant part of the infrastructure belonging to private railways by paying an access fee. On the other hand, in Latin America, it was not until the 1990's that several countries started to change the state monolithic structure of the railways by the mean of concessioning and privatisation (Argentina, Bolivia, Brazil, Chile, Colombia, Guatemala, Mexico, Panama and Peru). In contrast to the Western European countries, railways in the American continent have their market focus oriented to the freight market rather than to the passenger market and different reasons can be given for this particular difference. For instance, in the cases of Canada and the United States the relatively long distances between cities make the use of airplanes more attractive than trains. Moreover, within an environment characterised by deregulation, high technological progress and significant competition, the air industry has been able to offer lower fares and also lower travel time in comparison to rail transport. Therefore, railway passenger operations in the American continent have not been competitive. As a result, the air industry in the US and Canada has been clearly dominant against the railways, taking the second place in the interurban transport passenger market. This is shown in Table 3 where the average modal split is compared between the European Union and North America. In the case of Latin American countries the situation is different, the financial restrictions and the geographical conditions have restricted the growth of interurban passenger rail transport in favour of interurban coach services. In these countries, air transport has been growing more slowly due to the economic conditions of the travellers. 10
Table 2: Rail Organisation in Western European Railways (selected cases)
No. Country 1 Austria
Degree of Separation of
from Degree of Competition
Main operator
Accounting separation
Limited to Regional passenger and freight services
OBB Integrated railway state owned
Mainly owned by the state (цBB Netz), 10% are privately owned
2 Belgium
Accounting separation
One freight operating company entrant
SNCB Integrated railway state-owned
Owned by the State
3 Denmark
Institutional separation
Freight and regional passenger services
DSB state owned
Public corporation (Banestyrelsen)
4 Finland
Institutional separation
VR state-owned
State owned company
5 France
Institutional separation
6 Germany
Organisational separation
7 Great Britain Institutional separation
8 Greece
Accounting separation
None All markets All markets None
SNCF state-owned
State owned company
DB AG Vertically DB Netz AG integrated railway divided state-owned company; some into groups and divisions private railways
Private companies
Owned by Network Rail: `not for profit' company
OSE Integrated state-owned
Owned by the state (OSE)
9 Ireland
Accounting separation
10 Italy
institutional separation
11 The Netherlands institutional separation
12 Portugal 13 Spain
institutional separation Organisational separation
IE Integrated railway: Owned by the state
Freight and regional passenger services
FS state-owned
State owned company (RFI)
Freight and regional passenger services
NS state-owned
State owned organisation (PRORAIL)
Only one private passenger operator
CP State owned
State owned organisation (REFER)
RENFE State-owned
State owned organisation
14 Sweden
institutional separation
regional passenger and State-owned passenger State owned organisation
freight services
and freight companies
Note: The term institutional separation is used to denote totally separate institutions; Organisational separation is used where infrastructure and operations are separate subsidiaries of the same holding company Source: NERA (2003)
Table 3 Average Modal Split in the Interurban Passenger Sector in 1999 (billion passenger-km)
MODE Passenger cars
European Union USA + Canada Pas-Km % Pas-Km % 3,788 79.0 4,146.6 79.1
Pas-Km %
Buses and coaches 406
8.4 265.1 5.1 385.3
Tram and Metro
5.4 791.9 15.1 15.7
4,801 100.0 5,239.3 100.0 401.3 100.0
Source: European Commission. Energy and Transport in figures: Passenger transport. Eurostat Statistics 1970-2000. Domestic travel by mode of transport source: Statistics Canada 1999. Mexican Transportation Institute, Statistical Report 2002. a Includes only intercity services NA Not Available
Thus, while in the European Union railways are the second most popular mode of transport in the interurban passenger sector with around 6% of the market and 10% of all trips, in the American countries its role in the passenger sector is very limited and in some cases railways have been only maintained mainly for tourist purposes (e.g. Mexico). On the contrary, railways in North and South America have a very important role in the freight sector. This is illustrated in Table 4 where figures for the modal share are compared between members of the European Union, USA and Canada and from Latin America Mexico.
Table 4 Modal Split in the Domestic Freight Sector in 1999 (billion Tonnes-km)
European Union Ton-Km % 1,322 78.7
USA + Canada Ton-Km % 1,600 35.8
Mexico Ton-Km % 19.0 74.3
14.1 2,288 51.3 47.3 17.7
Inland Navigation
12.9 21.2
1,679 100.0 4,464 100.0
Source: European Union - Energy and Transport in Figures. European Commission 2002. Statistics Canada. Statistics and Forecast 2003. Mexican Transportation Institute, Statistical Report 2002.
Figure 3 illustrates the range of options to be found. Figure 3 Rail restructuring options
Degree of competition
degree of separation
single vertically integrated company accounting separation organisational separation institutional separation
open access
As will be clear from the earlier table, almost all these options are to be found in Europe. Greece and Ireland are close to the top left hand corner, with a single vertically integrated company, although accounting separation is now an EU requirement. France is in the bottom left hand corner, with separation but so far no competition. Germany is in the top right hand corner, with a vertically integrated company owning most of the infrastructure but open access and some franchising. Going down the right hand side we find Sweden and Britain, with vertical integration, varying negrees of franchising, and (at least some) open access. 4. Studies of the Impact of Rail Restructuring Studies of the impact of rail restructuring fall into two broad groups ­ formal econometric studies and more pragmatic policy reviews. In terms of recent European literature the latter tend to dominate, because of problems with obtaining comparable data and the short period of experience of most of the reforms. The earliest study (Oum and Yu, 1994) predates the current round of reforms in Europe, in that it deals with data from the period 1978-89. In this study, the objective is the estimation of the productive efficiency and to make a performance comparison between 19 OECD countries. Basically, the idea of this study is to identify the implications of public subsidy and the degree of managerial autonomy in the technical performance. The study focuses on the passenger sector, and uses the non-parametric DEA model to estimate technical efficiency, assuming constant return to scale. After the estimation of the efficiency scores, which reflect a gross efficiency indicator, it is estimated the effects of policy and other variables beyond the managerial control in the efficiency of the rail companies. To do that, a Tobit regression model is estimated because the efficiency index is a truncated variable. Moreover, the variables used in the regression analysis are classified into two groups: the variables that are controllable by the Government and/or regulatory agencies and the ones that are not. The main finding of this study was the significant relationship found between public subsidies and inefficiency. Thus, railways with high public subsidies were found less efficient than those railways with less dependency on public funds. Moreover, it was found that railways with more freedom or less regulatory control from the government have a higher degree of efficiency. The importance of management and financial autonomy were confirmed by a subsequent study (Cantos, Pastor and Serrano, 1999) covering the years 1970-1995. Gathon and Pestieau (1995) aimed to decompose technical inefficiency into two main parts: management inefficiency and the regulatory environment. Managerial inefficiency is assumed to be in control of the rail companies, while regulatory inefficiency is assumed to be attributable to the regulatory environment (e.g. institutional, legal and administrative characteristics) in which the rail companies are operating; and is beyond their control. To do that a parametric approach based on Displaced Ordinary Least Squares (DOLS) is used. The rate of technical progress is estimated from the coefficients associated with the trend variable into the model. The effects of institutional factors on the efficiency of the railway companies is obtained by including an institutional autonomy index. This index is based on an empirical survey conducted by one of the authors in October-November 1989, that consisted in evaluating the relations between public authorities and the railway company's management. This index is divided into three different issues of autonomy: hiring autonomy, pricing autonomy and commercial autonomy. 16
The main results of this study are the empirical estimation of the level of autonomy of the railway companies and the relationship between managerial and regulatory efficiency in the gross efficiency. For instance, it is concluded that a railway company with a low autonomy index may increase the level of efficiency by increasing the level of managerial autonomy and reducing the level of regulation. Similarly Cantos and Maudos (2000) used a stochastic frontier approach to assess the efficiency, technical change, economies of scale and the rate of growth of Total Factor Productivity in the railways of 15 European countries during the period (1970-1990). The main findings in this study showed that the greater financial and managerial autonomy, the greater levels of efficiency would achieve the rail companies. For instance, according to the results obtained in this study, there is a negative relationship between the level of inefficiency and the level of subsidies. That is, a higher level of subsidies would imply a greater level of technical inefficiency. Thus it is well established that in the period up to the current round of reforms, those railways with greater autonomy and lower subsidies were the most efficient in terms of cost and productivity. However, a word of caution is in order. It may be that the direction of causation is different from that usually assumed ­ that inefficient railways require high subsidies to survive, whilst high costs and low productivity might be the result of public service obligations to provide services such as peak commuter services which are costly but socially desirable. As is commented earlier very few studies are available which extend to the impact of rail restructuring in the 1990s. Preston (1996) found that the optimal size for a vertically integrated railway was that of one of the medium sized European companies such as Norway or Belgium. It appeared that splitting the larger companies into several separate companies might be worthwhile; however, this result was based entirely on vertically integrated companies, so the implications for separate infrastructure and operating companies of such splits are unclear. Similarly there is no evidence on economies of scope from having passenger and freight operations within the same organisation that does not assume an integrated railway. A later study by Cowie (2002) examines the British train operating companies, and concludes that they all have unrealised economies of scale, so purely in terms of costs a smaller number of larger companies might be preferable. Cantos (2001) examines the interrelationships between freight and passenger output and the level of infrastructure costs, again using data for vertically integrated European railways for the period 1973-90. He finds, rather curiously, that increasing the value of infrastructure reduces the marginal cost of freight traffic but increases it for passenger. All he can conclude from this is that proposals for vertical separation must take into account the risk of inefficiencies from the failure of the separated companies to take these inter-dependencies into account. Two recent studies have attempted econometric estimation of the impacts of separation of infrastructure from operations and of open access. Both seem to imply that whilst open access is desirable, separation of infrastructure from operations is more questionable. The first study by Friebel et al. (2003) investigates to what extend third-party access, independent regulation and the separation of infrastructure from operations affect railway performance. The results showed that the introduction of reforms simultaneously does not improve efficiency but only when these are implemented one after another. Moreover, the 17
results did not show any evidence that full separation of infrastructure from operations is a necessary condition for increasing railroad efficiency. Moreover, it was found that smaller railways improved efficiency more than larger railways. A second study found that separation of infrastructure from operations contributed negatively to technical efficiency while open access was found to contribute positively (Rivera 2004). However, the results depend on the level of separation and open access in each case. For instance, the level and characteristics of vertical separation vary in each country. Moreover, many rail operations were still protected from competition in the analysed period, particularly in the passenger sector. In fact, in most of the cases, new entry has been implemented only for local or regional services and freight markets. As in the previous study, the results are not conclusive and better data is needed to corroborate the results. Thus, the effects of these reforms will need to be tested in further research to come to a final conclusion. As a result, it is not surprising to find opposite opinions about the separation of infrastructure from operations. For instance, while some believe that the separation of infrastructure brings advantages in efficiency, transparency, neutrality and competition (Evans 2003) others believe that the separation of railway infrastructure and operations have been a fundamental mistake (Pfund, 2003). It was noted above that the three countries to have carried out the most radical reforms are Britain, Sweden and Germany, and we will comment here on less formal assessments of the results. In Britain the infrastructure is owned and managed by a private sector monopoly, whilst passenger operations are divided into 25 privately owned operating franchises and freight operations are privately owned with open access. An independent regulator issues licenses, and approves track access agreements including charges (Foster, 1994). Open access for passenger train operators is very limited, both by explicit decisions of the Regulator and by lack of track capacity. Initially it appeared that the British experience was very positive, with rapid growth in both passenger and freight traffic. Costs and subsidies declined (Pollitt and Smith, 2002), following an initial substantial increase in subsidies as a result of privatisation of infrastructure and rolling stock and the introduction of commercially based charges for their use. However, following a serious accident attributed to poor infrastructure maintenance and resulting severe speed restrictions and disruptions to service, the private infrastructure company, Railtrack, was placed in the hands of receivers and a new not for profit company, Network Rail, took its place (Nash, 2002). The Regulator concluded that spending on infrastructure maintenance and renewals need to increase by more than 50%, whilst increases in the costs of major projects, such as West Coast Modernisation, were even more alarming. At the same time there were concerns that the fragmented nature of the industry was leading to poor punctuality and timetables that were lacking in robustness and made poor use of capacity, and that some of the passenger franchisees had got into financial difficulties as a result of unrealistic bids. The result was the launching in January 2004 of a review of the structure of the railways, in which most of the participants are arguing for a degree of reintegration. Exactly what form this will take is more uncertain. Network Rail argues that `virtual integration' with a smaller number of franchisees corresponding largely to the territory covered by its 8 route directors would be sufficient. The SRA is reported as believing that its franchising responsibilities should be merged with the infrastructure manager to unite 18
responsibility for operating and maintaining the network with planning and investment in the network and with franchising. The train operating companies wish to take control of day to day operations, signalling and timetabling for the part of the network for which they are responsible. The latter two measures are not necessarily mutually inconsistent. (see the collection of papers in Modern Railways, May 2004). Sweden also has complete separation of infrastructure and operations, but with a publicly owned infrastructure company, Banverket. There remain publicly owned passenger and freight train operating companies, but all services requiring subsidy are subject to competitive tender and there is open access for freight. The result is an increasing number of private companies sharing the track with the publicly owned companies. Nilsson (2002) concludes that the combination of marginal cost based infrastructure charges and open access bringing in competitors has probably worked well; although infrastructure charges are probably too low, and on the other hand government spending on services and investment too high. He believes open access should be extended to inter regional passenger services. In Germany, infrastructure and the majority of operations are in the public sector. DBAG, a public limited company with share capital, owned wholly by the federal government, formed a holding company for five other companies: two responsible for the infrastructure and three incumbent operators - one for long-distance passenger services, another for regional passenger services and a third for freight services (the two passenger companies have since been merged). In addition, some regional services are contracted out by the regional governments and there is open access in both passenger and freight operations. Germany has always had a number of small private railways and these are increasingly operating over DBAG tracks, whilst there has been new entry in both freight and passenger services. Nevertheless there has been criticism that the level of competition remains limited, and that the organisational arrangements favour the incumbent, for instance in the tendering process (Link, 2003). Link advocates complete separation of infrastructure from operations and compulsory competitive tendering for all subsidised services. The three countries have taken very different approaches to rail infrastructure charges (Crozet, 2004). For the main franchised operators, Britain has adopted a system of two part tariffs, with the variable element of the tariff based on an estimate of short run marginal cost. The fixed element was originally set to meet the full financial needs of Railtrack, but Network Rail now receives funding direct from the Strategic Rail Authority (a government body) as well. Open access passenger (where permitted) and freight operators now only pay the variable element, although previously they paid a negotiated charge on the basis of willingness to pay. By contrast Sweden has a simple charge per train kilometre, which is intended to reflect short run marginal social cost (although, as commented above, it has been argued that it is too low). The situation in Germany is the most complicated. Originally Germany had a system of charges per train kilometre differentiated by type of train and location and designed to recover total cost, except for those capital costs borne by government. In other words it is essentially an average cost pricing system. Modifications led to the introduction of a two part tariff, in order to meet complaints from regions about the high marginal costs of high frequency services. However, following complaints that the two part tariff favoured large operators, and especially DBAG itself, it has reverted to a single part tariff with a differentiated charge per kilometre. 19
Thus it may be seen that there are large differences in charging systems between countries. Partly these are philosophical; Sweden for instance subscribes to marginal cost pricing principles, whilst Germany appears to believe that average cost pricing is the basis of efficient allocation. Britain lies between the two, in that ­ at least at privatisation ­ it was believed important for efficiency that Railtrack covered its total costs from charges, whilst offering a variable charge related to marginal cost. But there are other reasons for the differences; for instance, the emphasis on open access in Germany makes non discrimination a key issue, whilst the constraints on open access in Britain mean that two part tariffs are more acceptable. Overall then it seems that there have been benefits from the introduction of competition into rail markets but that separation of infrastructure from operations has been more problematic. On the one hand it appears to have raised costs, and there is a general perception that, it least in the way it was done, it has not worked well in Britain. On the other hand there are obvious problems in increasing competition in a situation in which the major operator still controls the infrastructure. Perhaps the Swedish model with a publicly owned infrastructure company charging short run marginal social cost is the one that has worked best to date, but there is a need for much more research, and it is to the Research Questions that we turn in the next section. 5. Research Issues It has been seen above that railway reform in Europe has five key principles: a) separation of infrastructure from operations b) open access c) passenger franchising d) contracting out e) independent regulation All of these raise research issues but it is the first two which raise the greatest unknowns; they are a peculiarly European phenomenon on which there is very little experience, and they will be discussed first. 20
a) Separation of infrastructure from operations Separation of infrastructure from operations has been argued to be an essential prerequisite for non discriminatory access. Yet it raises important issues of transactions costs. Contracts between infrastructure managers and train operating companies need to: - give incentives for efficient use of capacity, with due regard to sections where capacity is scarce - embody access rights that give the train operating company confidence to invest, whilst leaving sufficient flexibility to adapt the timetables to changing needs - embody performance regimes that incentivise both parties to good performance without involving excessive costs of monitoring and delay attributions. - encourage development of appropriate projects for future development of the infrastructure. How best this may be done, and whether the result is an improvement or a worsening of performance over the vertically integrated railway, remains an important research question. Of course, it may be argued that, even if this approach raises costs, it is worthwhile in terms of the improvement in performance resulting from the introduction of competition in train operations. But for this argument to be sustained the impact on costs still needs to be measured. On the other hand, it may be that non-discriminatory access can be achieved without complete separation, and North American experience of operators running over each other's infrastructure would be of interest here. Even if separation is seen as desirable there remain major questions as to where to draw the line. Which organisation should be responsible for timetabling, signalling and operational control and station management is the source of much debate in Britain at the present time, as noted above. b) Open Access We have seen above that open access so far has had limited effects in Europe; where it has occurred, its effects may still be controversial. In freight, there is complete open access in a number of countries, and a number of small new operators have entered the markets. It appears that these have put pressure on rates, and therefore costs, and quality of service provided by the incumbent operators. Two important research questions arising are: - What are the barriers preventing greater market entry and how may they be overcome? - How much entry is necessary to achieve the objective of improving the performance of the incumbent? Given the much higher rail market share in North America, comparative research could be of particular value here. The Commission is fond of comparing European and North American rail freight market shares as a basis for justifying its policy of introducing more competition into the rail freight business. But how far is the difference the result of a more competitive industry in North America and how far of exogenous economic and geographical factors? 21
For passenger services, it is less clear that open access entry is desirable, since it may worsen the overall pattern of fares and services and increase the need for subsidy. (Preston, Whelan and Wardman, 1999). Important questions are therefore: - In what circumstances is open access desirable in the passenger sector? - Is open access compatible with franchising, and if not which approach to passenger services is best? c) Franchising Given that there is generally a need for subsidy and an argument for government involvement in the level of services and fares in the passenger sector, franchising rather than open access appears the obvious way of introducing competition into this sector. However, experience of franchising so far has been mixed, with some reductions in cost and improvement in services, but also problems in some aspects of performance, suggestions of predatory pricing (Alexandersson and Hulten, 2003) and opportunistic attempts at renegotiations. There appears to be a choice between short franchises, in which public authorities control service planning, fares and in investment, and long franchises in which much more responsibility for these is given to the franchisee (Preston et al, 2000). Key questions are: - Is franchising superior to provision of passenger services by monopoly public or private sector railways? - What pattern of franchise length, control of services and fares and responsibility for investment is best? - How large a network should each franchise cover? d) Contracting out The current trend throughout industry is to concentrate on core competencies and to contract out other services. This may lead to increased competition and opportunities for exploiting scale and scope economies by the contractor that are not available to the integrated railway. There has been a tendency to contract out services such as provision of rolling stock and of refreshment services; in Britain this process extended to track maintenance and renewals. However, the former is now being taken back in house after problems with costs and quality control. Contracting out track maintenance is uniquely problematic, in that the work often needs to be done whilst trains are running; it is therefore intimately bound up with safe and efficient operations of rail services. Questions arise as to: - Does contracting out track maintenance and renewal lead to an improved mix of quality and cost? - What sort of contractual arrangements (for instance in terms of contract length, allocation of responsibility for inspection and determination of work to be done, performance penalties and bonuses, information flows) give the best results? e) Independent Regulation 22
The key role of the regulator within the new regime in Europe is in regulating access conditions and charges in order to ensure fair and non discriminatory access to the infrastructure to all operators. Determination of appropriate infrastructure charges is however far from easy. In particular, pure marginal cost pricing requires substantial subsidies which governments may be unwilling or unable to provide and gives inadequate incentive to invest. If high cost recovery is needed, two part tariffs offer the least distorting option but risk placing barriers on entry. Requiring entrants to compensate incumbents for loss of contribution to fixed costs imposes severe information problems on the regulator. A second issue relates to maintenance of competition between train operating companies where this is seen as desirable. A particular issue concerns merger of train operating companies with each other and with infrastructure managers. Are there benefits in terms of cost and quality of services in allowing train operating companies in adjacent countries to merge or form strategic alliances (such as Railion, which brings together the freight operations of German, Dutch and Danish Railways together with the Bern Lotschberg Simplon railway in Switzerland), or should they be forced to compete for the entire length of the flow? Promotion of investment may require a degree of protection for incumbents ­ is this desirable? The key research questions here are: - What is the best structure of rail infrastructure charges, and does this vary with circumstances and priorities? - In what circumstances are mergers within the rail industry desirable? - Is there a need for regulatory control over mergers? 6. Conclusions We have seen that a wide variety of structures of the rail industry exist in Europe and are consistent with European Directives. However, a lot more research is needed on the relative success of each of these models. Whether there is a unique solution seems doubtful; the best structure in any one country is likely to depend on factors such as the importance of international traffic, the scope for open access entry and the willingness of government to subsidise infrastructure charges. As it stands, the trade off between integration and competition appears yet to be resolved. References Alexandersson G; Hultйn S. (2003) European regulation and the problem of predatory bidding in competitive tenders ­ a Swedish case study Competition and Ownership in Land Passenger Transport: The 8th International Conference, Rio de Janeiro. Campos J. (2002) Competition issues in network industries: the Latin American railways experience, Brazilian Electronic Journal of Economics, Vol. 5 (1). Department of Economics, Universidade Federal de Pernambuco. Cantos, P., Pastor J. and Serrano L. (1999) Productivity, Efficiency and Technical Change In The European Railways: A Non-parametric Approach, Transportation, 26, 337-357. 23
Cantos P. (2001) Vertical Relationships for the European Railway Industry. Transport Policy, Vol 8, No. 2. Cantos P. and Maudos J. (2000) Efficiency, Technical Change and Productivity In The European Rail Sector: A Stochastic Frontier Approach, International Journal of Transport Economics, 27, . Cantos, P. and Maudos, J. (2001) Regulation and Efficiency: The Case of European Railways, Transportation Research Part A, 35, . Christopoulos, Loizides and Tsionas (2000) Measuring Input-Specific Technical Inefficiency in European Railways: A panel data Approach. International Journal of Transport Economics, vol XXVII no 2 Commission of the European Communities (1989) Communication on a Community Railway Policy (COM (89) FINAL) Commission of the European Communities (1995): Towards Fair and Efficient Pricing in Transport. Brussels. Commission of the European Communities (1996) White Paper. A Strategy for Revitalising the Community's Railways. COM (96)421 FINAL. Brussels. Commission of the European Communities (1998) Fair Payment for Infrastructure Use: A Phased Approach to a common transport infrastructure charging framework in the EU, Brussels. Commission of the European Communities (2001) White Paper. European Transport Policy for 2010. Time to Decide. Cowie, J (2002) The Production Economics of a Vertically Separated Railway ­ the Case of the British Train Operating Companies. Transporti Europei, August. Crozet, Y (2003) European Railway Infrastructure: towards a convergence of infrastructure charging. European Transport Conference, Strasbourg. Evans, J. 2003. "The Case for Separation of Infrastructure". European Transport Forum ETF, Jun 2003. Foster C D (1994) The Economics of Rail Privatisation. Centre for Regulated Industries Discussion Paper 7. Friebel G, M Ivaldi and C Vibes (2003) Railway (de) regulation: a European efficiency comparison. IDEI report no 3 on passenger rail transport, University of Toulouse. Gathon, H. J. and Pestieau P. (1995) Decomposing Efficiency Into Its Managerial and Its Regulatory Components: The Case of European Railways, European Journal of Operational Research, 80, 500-507. 24
IBM and Humbold University of Berlin (2003) Rail Liberalisation Index 2002. Comparison of the Status of Market Opening in the Rail Markets of the 15 Member States of the European Union, Switzerland and Norway. IBM Business Consulting Services and Dr. Christian Kirchner, Humboldt University of Berlin January 2003. Link, H (2003) Rail infrastructure charging and on-track competition in Germany ­ nine years later. European Transport Conference, Strasbourg. Nash C A and Toner J.P. (1999) Competition in the railway industry, Journal of Competition Law and Policy, vol. 1, no. 1, pp 197-227. Nash, C A (2002) Regulatory Reform in Rail Transport - the UK experience. Swedish Economic Policy Review, vol 9 no 2. Nash, C A, Bickel, P, Friedrich, R, Link, H and Stewart, L (2002) The Environmental Impact of Transport Subsidies. Paper prepared for the OECD workshop on environmentally harmful subsidies. Paris, November. Nilsson JE (2002) Restructuring Sweden's railways: the unintentional deregulation. Swedish Economic Policy Review, vol 9 no 2. Oum T. H. and Yu C. 1994, Economic Efficiency of Railways and Implications For Public Policy: A Comparative Study of The OECD Countries' Railways, Journal of Transport Economics and Policy, 28-2, 121-138. Perelman, S. and Pestieau P. (1988) Technical Performance In Public Enterprises: A Comparative Study of Railways and Postal Services, European Economic Review, 32, 432441. Pfund, C. 2003. "The Seaparation of Infrastructure and Operations Constitutes a fundamental Mistake". Public Transport International 3/2003. Pollitt, M G and Smith, A S J (2002) The Restructuring and Privatisation of British Rail: Was it Really that Bad? Fiscal Studies, Vol. 23, No. 4. Preston J (1996) The economics of British Rail privatisation: an assessment. Transport Reviews, vol 16 no 1. Preston, J, Whelan G and Wardman M (1999) An analysis of the potential for on-track competition in the British passenger rail industry. Journal of Transport Economics and Policy, vol 33 part 1. Preston, J, Whelan G, Nash C A and Wardman M (2000) The Franchising of Passenger Rail Services in Britain. International Review of Applied Economics vol 14 no1 Rivera C. (2004) Measuring the Productivity and Efficiency of Railways (An International Comparison). University of Leeds. Forthcoming. 25
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