Working Paper: CEPR ID: DP7088
Authors: Gianni De Fraja; Emanuela Michetti; Piercarlo Zanchettin
Abstract: The paper studies the regulatory design in a industry where the regulated downstream provider of services to final consumers purchases the necessary inputs from an upstream supplier. The model is closely inspired by the UK regulatory mechanism for the railway network. Its philosophy is one of vertical separation between ownership and operation of the rolling stock: the Train Operating Company (TOC) leases from a ROlling Stock COmpany (ROSCO) the trains it uses in its franchise. This, we show, increases the flexibility and competitiveness of the network. On the other hand, it also reduces the specificity of the rolling stock, thus increasing the cost of running the service, and the TOC's incentive to exert quality enhancing effort, thus reducing the utility of the final users. Our simple model shows that the UK regime of separation may indeed be preferable from the point of view of welfare.
Keywords: Incomplete Contracts; Network Regulation; Railways; Relation Specific Investment
JEL Codes: D2; L1; L5; L92
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Vertical separation of TOCs and ROSCOs (L92) | Increased flexibility and competitiveness (L19) |
| Vertical separation of TOCs and ROSCOs (L92) | Reduced specificity of rolling stock (L92) |
| Reduced specificity of rolling stock (L92) | Increased operational costs (D24) |
| Reduced specificity of rolling stock (L92) | Diminished incentives for TOCs to exert quality-enhancing efforts (L15) |
| Reduced specificity of rolling stock (L92) | Compromised service quality (L15) |
| Compromised service quality (L15) | Negative impact on consumer utility (D11) |
| Choice of specificity by ROSCO (Z00) | Operational quality of services provided by TOCs (L15) |
| Regulatory mechanism (G18) | Quality of service and investment decisions (G31) |
| Vertical separation of TOCs and ROSCOs (L92) | Lower quality efforts and higher costs of running services (L15) |