Liberalization of the European Railway industry:

Does vertical separation work?

Erasmus University Rotterdam

Erasmus School of Economics

MSc in Economics & Business

Specialization: Urban, Port & Transport Economics

Supervisor: Peran van Reeven

Author: Ioannis Kougioumtzidis

e-mail:

Student No.: 358557

Rotterdam, August 2014

“A developed country is not a place where the poor have cars.

It’s where the rich use public transportation”

Gustavo Petro, Columbian Politician & Economist

Acknowledgements

I would like to thank my supervisor, professor Peran van Reeven for his patience and the inspiring conversations we had. Without his guidance and valuable advice this paper would never be complete. I would also like to thank professorMartijn van der Horst for helping me structure the content of this paper, and transform my idea into measurable output. All errors are mine.

Contents

1.Introduction

1.1 Background

1.2 Problem Statement

1.3 Research Questions

1.4 Thesis Outline

2. Literature Review

2.1 European Union directives on railway reforms

2.2 Existing railway structures

2.2.1. Sweden

2.2.2. Great Britain

2.2.3. Netherlands

2.2.4. Germany

2.2.5. Switzerland

2.2.6. France

2.3 Lessons from the world, the ideal case of Japan

2.4 Pros & Cons of vertical separation

2.5 Results of vertical and horizontal separation in literature

3. Data & Methodology

3.1 Sample

3.2. Similar Research and Variable selection

3.3 Data description

3.3.1 Dependent variables

3.3.2 Independent variable

3.3.3. Controlling variables

3.3.4 Dummy variables

3.3.5 Regressions

4. Results

4.1 Passenger Market

4.2 Freight Transport

4.3 Limitations & Discussion

5. Conclusion

References

Appendix

Abstract

Purpose of this assignment is to map the trends occurring in the railways in the European territory and particularly to identify the impact of the vertical separation of national railway companies on their performance and competitiveness. Railways’ competitiveness has kept on being worsened during the last three decades, a fact that dictated the adoption of reforming measures by the side of the EU in order for the industry to compete with other modes more successfully. The most drastic and widely met reform has been the vertical separation of the integrated national railway companies. By analysing the structure of 28 European railways over the period 2003-2011 we will try to conclude whether the decision of vertically separating a national railway system did manage to increase the modal share and ridership of railways. We find that in the case of passengers vertical separation has been quite an obstacle in their attempt to increase their modal share and ridership, once it has brought the opposite results from the ones expected. Regarding the freight market our sample has not been able to prove any causal relationship.

1.Introduction

1.1 Background

During the second half of the 20th century Europe has been dominated by publicly owned railway regimes (Cantos et al., 2012).This can be related to the ‘natural monopoly’ characteristics that the railway industry was believedto present (Jupe, Crompton, 2006, Laabsch, Sanner, 2012), a fact that discouraged the enhancement of competition in it. However, the development as well as the competitiveness of the national railway networks was found to be moderate during that period, compared to the other modes. Eventually, the public governance regimes was accused of assisting the establishment of publicly owned monopolies, that in most of the cases have been providing quite moderate services, followed by poor profitability. One of the most prevailing explanations on that has been that an insufficient growth in revenues led to sub optimum outputs (Cantos, Maudos, 2001).During the rising of European Union on the 50's, the member states partly agreed on 'developing a common transport policy in the Treaty of Rome'. Traditionally,the railway industry in Europe has been nationally oriented, though, mainly because of the special features and differences occurring between the states-markets (Marti-Henneberg, 2013). However no significant initiatives, towards that direction, were taken before 1985.

The already disadvantageous position of the railways in comparison with other transportation modes was to be worsened after the deregulation that followed in road and air transportation (Barea, Dizy, Ruiz, 2007). The previously existing legislation regarding those two modes of transportwas reformed in order to facilitate the cross-border commuting of goods and passengers. On the contrary the cross-border transportation by rail was lagging behind, due to the different national railway regulations. This led to a further reduction of the already small share of the railways regarding the intermodal competition(Stehmann, Zellhover, 2004). Eventually, during the past two decades the European Union has tried to give incentives that will lead to the liberalization of the national railway networks of its member states, through a number of reforms,the essential legislative steps being taken after 1985 (Stehmann, Zellhofer,2004).From then on, the national railway networks in Europe started considering new governance regimes, in order to render the industry more financially efficient, as well as in an attempt to face the shrinkage of the market share of railways in the international traffic (Nash, 2008).

Core of those incentives have been the four railway packages introduced by the Union since the eve of the new century, referring mainly to the freight market, and later also to the one for passengers (3rd and 4th package). The simple previous national integrated structures, of the one company responsible for the provision of the infrastructure as well as for the railway operations, have been replaced by more complicated ones (Thompson, 2003).Policies such as the vertical separation of the infrastructure provision and maintenance with the railway operations have been widely adopted, as well as particular reforms in order to facilitate competition and profitability for railway operators.

The rapidly changing environment in the European railways has attracted a lot of attention during these two decades. A lot of scholars have tried to map the trends and investigate whether there is a relation between the reforms and the relative efficiency and productivity of the networks that they are applied into. However, we focus on the performance and attractiveness of the railway industry rather than productivity and efficiency. Additionally, the continuous evolution of the sector as well as the inclusion of even more countries to those with reformed organisational structures, give a reason of existence to our research.

In this paper we will examine the impact of vertical separation on the performance of the railways in 28 European countries over the period 2003-2011. The sample contains all the European member states (except Malta and Cyprus once they have no railway network established) plus Switzerland, Norway and Croatia.

1.2 Problem Statement

Despite the numerous reforms even in big European countries (Germany, Spain, Italy, France),the ownership of the railway operating companies, as well as the responsibility of planning and regulating the network is still on the state. Beria et al. (2010), argues that the conflicting interests that are being generated out of this regime, 'tend to slow down the liberalization process', and harm the productivity of the businesses involved. This opinion is found to be widely supported on the broad literature existing on the topic (Friebel, Gonzalez, 2005). Most of the scholars vote for the liberalization of the market including the privatization of the main railway operators. Nevertheless, in countries that have already done so, like Great Britain, the academic community has been, in some cases, metto raise doubts. Jupe and Crompton in their paper (2006) argue that when it comes to a highly capital-intensive industry, which is dependent on governmental subsidy, privatization is inappropriate. However, this is a subject that will notbe covered in our analysis due to the lack of available data.

What we will do examine here is the effect of dividing the responsibilities of the incumbent railway companies in Europe, into at least one responsible for the provision and maintenance of the network and another, independent, company responsible for the railway undertakings, on the railways’ performance. This method for many countries constitutes the essential reform adopted in an effort to comply with the European directives, and it aims in an independent network provider, who will be willing to facilitate that use of the network by new railway operators. The independent nature of the network provider would, thus, ensure the minimising of discrimination against the candidate Railway Operating Companies (ROCs) that want to use the network, and in favour of the incumbent company. On the contrary, it would facilitate competition, increased quality of services, as well as international commuting of cargo and passengers by rail.

1.3 Research Questions

As referred previously the vertical separation of the integrated national railway companies has been a core concern of the EU[1], and one of the first steps that the member states have adopted on their way of rethinking the structure of railways. Additionally the data available regarding all the other widely met reforms like the introduction of competition, through a range ofmeasures, has not been enough for them to be included in a consistent econometric model. Thus, we will try to measure the impact of the European directives on the development of the railway industry in Europe, by measuring the impact of the most widely met reform proposed, that being the vertical separation. And as two of the main goals of the union in this procedure has been increasing the throughputs of the railways in terms of cargo and passengers in one hand, and improving the railways’ competitive position regarding the intermodal competition, on the other, we will try to give an answer to the following questions:

  • What was the impact of vertical separation proposed by the EU, on the ridership of railways over the period 2003 – 2011?
  • What was its impact on the modal share of railways compared to other modes, over the same period?

In order to answer these questions we will apply a panel data analysis regarding all the European Member States that have a railway network established, plus candidate members (Croatia), as well as countries that have agreed to comply with the unions directives regarding the railway sector (Switzerland, Norway). We then use vertical separation as our main independent variable, and examine its impact on the two segments of railway industry, that is passenger and freight transport. For the first research question we regard ridership in terms of passengers-km and tonnes-km respectively, which we set as dependent variables. Accordingly, in our attempt to answer the second research question we replace the dependent variables with the modal share of railways for passenger and freight market.

1.4 Thesis Outline

The next chapter is dedicated to the existing literature on the structure of the European railways at the moment, the legislation proposed by the EU and the results that it has brought by now according to the academic community. A detailed presentation of some of the most important national organisational structures is also presented there. In the third chapter we present and analyse the data to be used, and in the forth themethodological approach that will be followed in the paper. The fifth chapter presents our results, the limitations of our researchand a discussion on our findings and tips for future research. Last, our conclusions are presented in chapter six.

2. Literature Review

2.1 European Union directives on railway reforms

The intention of the European Commission to revitalize the Union's railway network was put in track with three directives[2] in the first half of the 90's, aiming specifically on the development of the community's railways, on the licensing of the Railway undertakings, on the allocation of railway infrastructure capacity and the charging of infrastructure fees (Holvad, 2006).

Key elements in this respect have been:

The establishment of independent management for railway undertakings

The separation of accounts for infrastructure management and transport operations

The dept restructuring for incumbent companies

Access provision to railway infrastructure for new companies

Amendments on those three directives, would later (2001) form the base where the first 1st railway package[3] was built on. The package was presented in 1998 and adopted in December 2000, and was mainly focused on the freight railway transportation. Its initial purpose was to revitalize the international goods transportation by rail in the Community, and to lead in a more integrated European railway network where the cross-border services would be facilitated. It was meant to be transposed in the Member States until 15 March 2003 and its particular goals were:

the vertical separation of the basic functions of the railway industry, namely the infrastructure provision and the actual railway operations

the establishment of an independent railway regulator in each Member State and the reduction of the governmental influence in the sector

a reconsideration of the technical barriers between the different railway networks so that the international freight movements would be eased

a gradual opening of the European rail freight network to all operators that have been licensed according to the Community's regulations. Within seven years (as of March 2008) from the adoption of the Council Directive, the aforementioned operators should have access to the whole international European railway freight network

However, despite the efforts put by the Union, it appeared that this gradual opening that would allow operators from all member states to use the ‘integrated European’ network was not as easy as was initially believed. At the moment there are countries that still lag behind and fail to follow the Union's directives regarding the international freight. (Holvad, 2006) Finally, an additional measure[4] came to complete the 1st package in March 2001.

The 2nd railway package[5] was proposed by the union on the 30st of April 2004,and contained legislative proposals that,among others, pointed on:

Proposing a common strategy to guarantee a greater degree of rail safety[6] and establishing a European Railway Agency in charge of these issues

Enhancing the interoperability principles proposed with previous directives[7]

 (safety and interoperability)

Accelerating the opening of the rail freight market[8]

Joining the Intergovernmental Organization for International Carriage by Rail (OTIF)

After the 2nd package, the new date agreed for the opening of the rail freight markets would be the 1st of January 2007.

Two more railway packages were adopted by the parliament during the years to follow, this time mainly focused on the passenger market. The 3rd railway package (2007) aimed in the opening of the passenger market to international services. In more detail, it proposed that starting in 2010 all the passenger service operators that have a licence and meet the safety preconditions should be able to provide international services in the Community[9]. Two more particular legislative measures are included in this 3rd package, one on the protection of the passengers’ rights when using international services, and the other on the certification methods of the railway drivers.

Finally, the 4th railway package was adopted by the European parliament on 26th of February 2014, and aimed to ensure the competitiveness of the railway sector and improve the quality of rail services by:

  • enhancing competition
  • eliminating remaining market distortions and suboptimal structures
  • alleviating long and costly procedures
  • removing access barriers for new entrants, and
  • harmonising market access rules in the Member States[10].

This last package is still to be confirmed by the European Council.

2.2 Existing railway structures

Summing up the directives sited above we can identify three basic axes of restructuring where the interest of European Union was focused on. That is the vertical, examining the relationship between the infrastructure provision and maintenance in one hand, and the railway undertakings on the other, the horizontal, examining the relationships between railway operating companies (ROCs) functioning on the same network; and a third one, regarding the existence or not of an independent regulatory authority, which would ensure the minimising of the ‘free rider’ behaviour from the side of the national holding integrated railway companies. Thus,it is obvious that vertical separation has played a very important role in the restructuring Europe’s railways, and is considered as a necessary condition for the industry to achieve a more competitive performance and minimize the negative effects in terms of governance and ownership. However, despite the fact that those directives are meant to be applied in the same way, significant differences can be identified in the way that MS’s have implemented them (European Commission, 2006).

Hence, the implementation of the revised legislation on the railways in Europe has evolved to give birth to a number of different, and sometimes unique, structures, with varying levelsof separation as well as induced competition, and a number of different policies adopted regarding the governance and independence of the particular national railway regulatory authorities. Table 1 (Appendix) summarizes the current situation in the countries of our sample, regarding the three aspects of reforms mentioned above.As we see there, 13 countries in the sample have either retained the traditional integrated model, or have adopted partially separated structures where two companies function under the same holding, but with partial division of key powers (Nash, 2008). 13 countries have adopted the fully separated model, while two countries have applied a hybrid model (France and Czech Republic), which will be further analyzed later in this chapter. There are cases where there is no vertical separation, but there is established within-railcompetition[11] (e.g. Germany, Austria, Italy), by licensing new operators to function in the same network with the incumbent company (Campos, Cantos, 2000). However, the enhancement of competition hasn’t experienced the progress that EU might have expected, once only seven countries (Netherlands, Germany, Austria, Italy, United Kingdom, Denmark and Sweden) have managed to establish ‘high’ levels of competition according to IBM (2011).. In Italy 49 have been licensed, though only 16 of them are operating (2009). For France and Spain the situation is pretty monopolistic, regarding the passenger market, once almost the absolute number of passengers is still being served by the incumbent company. The freight market is more promising, once in Spain the new entrants managed to serve 5% of the market by 2008, and in Italy 13% (Beria et al., 2010)