ABSTRACT
Policymakers have adopted two broad approaches to restructuring newly privatized rail systems: horizontal separation and vertical separation. Existing literature has identified potential advantages and disadvantages of these approaches, but it leaves unresolved conclusions about the broader impact of these approaches on consumer and social welfare. This chapter develops a conceptual framework for thinking through these impacts that starts from the recognition that these two structure structures create different incentives for pricing rail transport services and for investing in network quality. We conclude that horizontal separation is likely to outperform vertical separation in inducing investments in network quality and may also tend to result in higher levels of consumer surplus and social welfare, although there are also reasons why vertical separation might outperform horizontal separation on these metrics. The best-case scenario for vertical separation to create high levels of consumer and social welfare is for price competition between rail transport operators to be intense (though the combination of economies of density in freight operations and sunk costs of entry may limit entry into the market, making this scenario the exception rather than the rule). The best-case scenario for horizontal separation to create high levels of consumer and social welfare occurs when there is modest, but not cutthroat, competition between the vertically integrated systems. Ensuring these best-case levels of competition is a partly function of public policy, and on balance, horizontal separation may be a better option than vertical separation in countries with less well-developed regulatory institutions and public governance. The chapter concludes by applying the insights of framework to freight railway restructuring in China.
